Case Law Details
Honda R & D (India) P. Ltd. Vs Additional/Joint/Deputy/ACIT (ITAT Delhi)
Income Tax Appellate Tribunal (ITAT) Delhi recently addressed the case of Honda R&D (India) P. Ltd. versus the Additional/Joint/Deputy/ACIT, focusing on the inclusion of Magma Advisory Services Ltd. in the list of comparable companies for transfer pricing purposes. The dispute centered on the Transfer Pricing Officer’s (TPO) decision to exclude Magma, based on its reported “peculiar economic circumstances,” specifically persistent negative cash flow as stated in its annual report. However, the ITAT’s examination of Magma’s financial records revealed that the company did not exhibit persistent losses. The tribunal highlighted that a company should only be excluded from the comparable list if it demonstrates losses over three consecutive financial years, which Magma did not.
During the proceedings, the Departmental Representative (DR) raised an objection regarding functional disparity, arguing that Magma, being a manpower services provider, was not comparable to Honda R&D, which engages in research and development activities. The ITAT noted that the TPO had not cited functional disparity as a reason for excluding Magma. Furthermore, the tribunal addressed Honda R&D’s operational nature by referencing a prior case, ITA No. 5853/Del/2011, wherein the tribunal had previously determined that Honda R&D was involved in R&D activities. This earlier ruling, however, was subsequently challenged and overturned by the Delhi High Court in ITA No. 616/2015.
The Delhi High Court, in its review, examined the observations of the Dispute Resolution Panel (DRP) from an earlier assessment year. The DRP had characterized Honda R&D’s activities as primarily market research and testing services, rather than core R&D. The High Court, after considering the DRP’s findings, concluded that Honda R&D’s activities were more aligned with market support services. This reversal of the tribunal’s earlier stance led the ITAT to reject the DR’s objection regarding functional disparity in the current case. The tribunal reasoned that the High Court’s decision clarified the nature of Honda R&D’s operations, thereby negating the functional disparity argument presented by the DR.
Based on the evidence and judicial precedent, the ITAT directed the Assessing Officer (AO)/TPO to include Magma Advisory Services Ltd. in the list of comparable companies. The tribunal found the TPO’s initial reasoning for excluding Magma to be unsubstantiated by the company’s financial data. The ITAT’s decision underscores the importance of accurate financial analysis and adherence to judicial precedents in transfer pricing disputes.
FULL TEXT OF THE ORDER OF ITAT DELHI
This appeal by the assessee is directed against the assessment order dated 30.04.2021, passed u/s. 143(3) r.w.s.144C(13) r.w.s 144B of the Income Tax Act, 1961 (hereinafter referred to as ‘the Act’), for assessment year 2016-17.
2. Shri Nageswar Rao, appearing on behalf of the assessee submits at the outset that the assessee in appeal is only pressing ground no. 3, ground no. 4 restricting submissions on inclusion of Magma Advisory Service Ltd. only, (in short ‘Magma’) and ground no. 17 to 20 of appeal. The other grounds of appeal viz. ground no. 1, 2, 5 to 16 are not pressed.
2.1. The ld. Counsel for the assessee submits that the Transfer Pricing Officer ( in short ‘the TPO’) while passing order dated 07.04.2021 has failed to give effect to directions of the DRP in so far as computing the margins of comparable companies. He pointed that the Dispute Resolution Panel (DRP) in para 2.5.7 of directions dated 24.03.2021 had directed the TPO to allow working capital adjustment using OECD methodology given in Annexure to Chapter III and apply SBI Prime Lending rate (as on 30th June of the relevant Financial Year) as the interest rate. However, while giving effect the TPO has failed to comply with the directions of DRP in full.
2.2. With regard to ground no. 4, the ld. Counsel submits that the TPO has erred in rejecting comparables selected by the assessee. He contended that at this stage he is restricting his arguments only for inclusion of Magma in the list of comparables. He submitted that the TPO has rejected Magma for the reason that the company has peculiar economic circumstances which are not in line with industry trend and is incurring persistent negative cash flow. Referring to para 8.1 of the TPO order he contended that the TPO has not raised any objection in so far as functional disparity of the said company. The ld. Counsel referring to annual report of Magma for Financial Year 2015-16 at page 1059 of the paper book Vol II submitted that the company was having profits in the Financial Year 2014-15 and 2015-16. The TPO has erred in rejecting Magma on the ground that said company is having persistent negative cash flow. The company can be rejected as comparable only if, the company is a persistent loss making company. He further submitted that Magma is not facing any peculiar circumstances as alleged by the TPO nor it has negative cash flow. The said company is functionally comparable.
2.3. Qua issues relating to Corporate Tax Adjustment, the ld. Counsel for the assessee submits, that in ground no. 17 to 19 of appeal the single issue is with regard to rejection of assessee’s claim of higher rate of depreciation on computer software. He contended that the assessee had purchased computer software to the tune of Rs.17,70,64,983/- and treated the same as intangible assets. The assessee claimed depreciation on computer software at the rate of 60%. The Assessing Officer (AO) disregarded assessee’s claim of higher rate of depreciation on computer software and restricted depreciation rate to 25%. The assessee filed objections before the DRP inter alia assailing rejecting assessee’s claim of higher rate of depreciation on intangible assets/software. The DRP directed the AO to verify details of computer software provided by the assessee and treat the same as intangible asset if it involves any kind of patent etc. and determine the rate of depreciation as per the Act. He submitted that as per schedule of depreciation, the assessee is eligible to claim higher rate of depreciation that is @ 60% on computer software and same should be allowed to the assessee.
2.4. The ld. Counsel further submitted that in para 20 of grounds of appeal the assessee has assailed disallowance made u/s. 40(a)(ia) of the Act on account of non deduction of taxes at source on International Travel Expenses amounting to Rs.2,99,61,732/-. He submitted that the DRP after considering this issue had directed the AO to verify contentions of the assessee and take necessary action as per law. The assessee had categorically submitted before the DPR that out of disallowance of Rs.89,88,520/-, taxes on International Travel Expenses Rs.3,03,55,292/- was duly deducted and deposited. The ld. Counsel submits that the AO may be directed to comply with directions of the DRP.
3. Per contra, Shri S.K Jhadav representing the Department submits that Magma is not functionally comparables to the assessee. He pointed that Magma is engaged in providing man power services, advisory services, annual maintenance contracts, marketing, market research & analysis, whereas, the assessee is engaged in providing market research and testing services to its Associated Enterprises Honda R & D Japan. The assessee is engaged in R & D activities that cannot be compared to a company providing man power services and advisory services.
4. The ld. Counsel controverting submissions of the ld. DR asserted that the Tribunal in AY 2005-06 in ITA No. 5853/Del/2011 had held that the assessee is engaged in providing R & D Services. The matter travelled to the Hon’ble Delhi High Court in ITA No. 616/2015. The High Court vide order dated 02.08.2016 held that the Tribunal has erred in holding that the assessee is involved in R &D Activities. He explained that the assessee is engaged in providing market research and testing services which lead to better product development by the AE. The assessee does not itself undertake research and development for the products, the assessee only gives market research feedback. The ld. Counsel further asserted that the TPO at no point of time has raised objection with regard to functional difference, now the DR cannot argue on fresh ground for not including Magma in the list of comparables.
5. We have heard the submissions made by rival sides and have examined the orders of authorities below. The assessee is a wholly owned subsidiary of Honda R & D Japan and is engaged in conducting market research and testing activity for Honda R & D Japan. The assessee is remunerated on cost-plus markup basis. During the period relevant to assessment year under appeal, the TPO made adjustment in respect of International transactions carried out by the assessee with its AE in Japan. The TPO rejected assessee’s list of comparables, introduced some new comparables, excluded the comparables selected by the assessee and thus, made adjustment of Rs.8,43,99,995/-. Apart from above, the AO made certain additions/disallowances with regard to corporate tax issues. The assessee filed objections before the DRP. The DRP vide directions dated 19.03.2021 granted part relief to the assessee. The TPO vide order dated 07.04.2021 while giving effect to directions of the DRP u/s. 144C(5) of the Act, complied with the directions in part. The AO passed final assessment order dated 23.04.2021, in accordance with the order giving effect dated 07.04.2021 and directions of the DRP. While passing final assessment order, the AO also gave part effect to directions of the DRP.
6. The assessee in appeal has raised as many as 20 grounds. The ld. Counsel for the assessee stated at Bar that except ground no.3, ground no. 4 limited to the assailing of inclusion of Magma Advisory Services Ltd. and ground no. 17 to 20 is not pressing other grounds of appeal. The ld. Counsel further urged that the assessee reserves the right to argue the grounds not pressed in the present appeal in other assessment years.
7. In ground no. 3 of appeal, the assessee has assailed the order of TPO/AO in not computing margins of the comparables companies in accordance with the directions of the DRP. We find that the DRP while adjudicating this issue in para 2.5.7 of the directions held as under:-
“2.5.7 In this view of the matter, and following the judicial decisions in Mentor Graphics (109 ITD 101), Sony India (288 ITR 52 (Delhi- ITAT), Philips Software (26 SOT 226) (Bangalore- ITAT), Mercer Consulting (India) Pot. Ltd (Delhi ITAT), Sunlife India Service Centre Put. Ltd. Vs DCIT (2015-TII-420-ITAT-DEL-TP), the TPO is directed to give working capital adjustment using the OECD methodology given at it in Annex to Chapter III and apply SBI Prime Lending rate (as on 30th June of the relevant financial year) as the interest rate.”
The TPO is directed to give effect to the above directions of the DRP in letter and spirit. The ground no. 3 of appeal is thus allowed for statistical purpose.
8. The assessee in ground no. 4 of appeal has limited his arguments to inclusion of Magma in the list of comparables. A perusal of order passed by the TPO reveals that the TPO has excluded Magma from list of comparables solely on the ground that as per annual report of company, the company has peculiar economic circumstances that is persistent negative cash flow. No other reason has been given by the TPO for rejection of said company. Before us, the ld. DR has raised a question of functional disparity of the said company. We have examined the financials of Magma, Annual Report of the company is placed on record at page 1059 of the paper book Vol. II. The total revenue of the company is Rs.258.14 lacs for the Financial Year ending on 31.03.2016 and Rs. 290.70 lacs for the Financial Year ending on 31.03.2015. The profit after tax in Financial Year 2015-16 is Rs.2.71 lacs and Rs5.35 lacs in Financial Year 2014-15. Hence, the company is not a persistent loss making company. A company can be rejected from the list of comparables only, if, the said company is persistent loss making company, that is, having loss in relevant three consecutive Financial Years. We find that reason given by the TPO for exclusion of Magma from the list of comparables are contrary to financial results reported in Annual Report for FY 2015-16.
8.1. The ld. DR has argued that the company is functionally different. Magma is engaged in providing man power services and the assessee is engaged in R&D Activities. We find that no such observations have been given by the TPO to exclude Magma from the list of comparable companies. Secondly, as regards the objection of the ld. DR that assessee is engaged in R &D Activities, we find that in AY 2005-06, the Tribunal in ITA No. 5853/Del/2011 vide order dated 29.01.2015 inter alia held that the assessee is engaged in R & D Activities. The assessee carried the order of Tribunal in appeal before the Hon’ble High Court in ITA No. 616/2015. One of the question for consideration before High Court was:
“(i) Whether the TIAT was justified in concluding that the Assessee is involved in the research and development activity and not provision of market support services?”
The Hon’ble High Court referred to the DRP directions dated 12.07.2011 for AY 2007-08 wherein the DRP had observed as under:
“4.5 Facts on record show that assessee has Research, Service Agreement with its AE i.e. Honda R&D Japan. Under the agreement – HRID undertakes market research of product, styling modification and testing activities related to research and development of products to be manufactured by Honda Motors. The show cause notice dated 10.09.2010 states the functions performed by assessee are strategic management, corporate services, research services, testing services. An analysis of work done shows no hard core R&D. In. our view assessee gathers information from market and analyses it for further action by its AE. So we find that the assessee is engaged in providing “market” research services and testing services which lead to the development of better products by their associated enterprises and that the assessee does not itself develop or undertake research for these products. In our view, the type of R&D by the assessee, cannot be compared to pure science R&D where product is developed, clinically tried, refined and soft marketing intangibles are also created. Even if there is no vertical segregation as claimed by TPO, we find there is a major functional difference. While assessee does analysis and passes it on to its AE for product development, TCG develops the products itself. This fundamental functional difference cannot be ignored To quote from TCG’s annual report for FY 2006-07”.
The Hon’ble High Court after considering the observations of the DRP answered the question in negative and reversed the findings of the Tribunal. The Hon’ble Court concluded that the Tribunal was not justified in concluding that the assessee was involved in R & D activity and not provision of market support services. Thus, objection raised by the DR is rejected. For the reasons recorded above, we direct the AO/TPO to include Magma Advisory Services Ltd. in the list of comparables. Ground no. 4 of appeal is partly allowed.
9. The next issue in appeal is with regard to assessee’s claim of depreciation at the rate of 60% on intangible assets i.e. computer software. We find that the DRP while dealing with this issue had observed as under:-
“16.1.2. In Ground number 2 the assessee has contended disallowance of Rs.61,972,744/- as excess tax depreciation on computer software treated as intangible assets by the AO. The Panel directs the AO to verify the details of computer software provided by the assessee and treat the same as intangible asset if it involves kind of patent etc. and determined the rate of depreciation as per the Act. Ground number 2 is disposed off.”
The AO is directed to comply with the directions of the DRP and decide the issue, accordingly. Thus, ground no. 17 to 19 of appeal are allowed for statistical purpose.
10. In ground no. 20 of appeal, the assessee has assailed disallowance made u/s. 40(a)(ia) of the Act for non deduction of taxes on payment for International Travel Expenses. The short contention of ld. Counsel for the assessee is that the AO while passing final assessment order has not complied with the directions of the DRP. The DRP in para 16.1.3 of the order had given following directions in this regard:-
“16.1.3. Ground number 3 is with reference to disallowance under 40a(i)(a) of the Act. Vide submissions dated 27.07.2020 the assessee has submitted that out of Rs.8,988,520/- of disallowance so made, taxes on international travel expense of Rs.30,355,292/- was duly deducted and deposited. The AO is directed to verify this contention of the assessee and take necessary action as per law. Ground number 3 is disposed off.”
The AO is directed to decide this issue in accordance with the aforesaid directions. Ergo, ground no. 20 of appeal is allowed for statistical purpose.
11. In so far as, other grounds of appeal are concerned no submissions were made by the assessee, hence, they are dismissed as such.
12. In the result, appeal of the assessee is partly allowed.
Order pronounced in the open court on Wednesday the 15th day of January, 2025.
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