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Case Law Details

Case Name : M/s Greaves Cotton Limited Vs. The Income Tax Officer (ITAT Mumbai)
Appeal Number : IT Appeal No. 3103 (MUM.) Of 2011
Date of Judgement/Order : 08/02/2013
Related Assessment Year : 2003- 04

ITAT MUMBAI BENCH ‘K’

Greaves Cotton Ltd.

versus

Income-tax Officer

IT Appeal NO. 3103 (MUM.) OF 2011
[ASSESSMENT YEAR 2003-04]

Date of Pronouncement – 08.02.2013

ORDER

P.M. Jagtap, Accountant Member

These two appeals, one filed by the assessee being ITA No.3103/Mum/2011 and the other filed by the Revenue being ITA No. 4450/Mum/2011 are cross appeals which are directed against the order of learned CIT(Appeals)-15, Mumbai dated 10-03-2011.

2. In ground No. 1 of its appeal, the assessee has challenged the action of the learned CIT(Appeals) in setting aside the issue relating to dis allowance of Rs. 48,94,509/- on account of MK 20 Development Expenses to the AO despite the fact that all the relevant details were available on record.

3. The assessee in the present case is a Company which is engaged in the business of manufacturing and trading of engines. The return of income for the year under consideration was filed by it on 27-11-2003 declaring a loss of Rs. 71,98,89,222/-. In the profit & loss account filed along with the said return, the assessee had debited Rs. 47,76,850/- and Rs. 1,21,659/- on account of MK 20 Engine Development Expenditure. In the assessment completed u/s 143(3), the said expenditure was disallowed by the AO treating the same as of capital nature on the ground that the same was incurred for acquiring enduring benefit in terms of better sales and higher profitability owing to the development of engines. Before the learned CIT(Appeals), it was submitted on behalf of the assessee that its core business being that of manufacture and sale of various types of engines, the expenditure incurred on research to make modifications, corrections and development in the existing products as ongoing process was revenue in nature. It was also submitted that the expenditure in question being in the nature of research and development, the same was fully allowable u/s 35(2)(ia) of the Act even if the same is capital in nature. After considering these submissions made on behalf of the assessee, the learned CIT(Appeals) found that a similar issue involved in assessee’s case for assessment year 2001-02 was restored by the Tribunal to the file of the AO with the directions to verify and allow the same as per law. Respectfully following the said decision of the Tribunal rendered on similar issue in the earlier year, the learned CIT(Appeals) also restored this issue to the file of the AO with a direction to reconsider the same as per the same direction as given in assessment year 2001-02.

4. We have considered the rival submissions and also perused the relevant material on record. The learned counsel for the assessee has submitted that a similar issue was restored by the Tribunal to the file of the AO in assessment year 2001-02 with a direction to verify and allow the same as the relevant details were not available on record. She has submitted that in the year under consideration, such details however, were furnished by the assessee before the AO as well as before the learned CIT(Appeals) and the learned CIT(Appeals), therefore, ought to have decided this issue on merit instead of sending back to the AO following the order of the Tribunal for assessment year 2001-02. In our opinion, even though the relevant details in support of its claim on the issue under consideration were furnished by the assessee before the learned CIT(Appeals), he has not decided the issue on merit after verifying the said details. It is, therefore, not appropriate for us to consider and decide this issue on merit without there being any decision of the learned CIT(Appeals) available on this issue on merit. Moreover, a similar issue was restored by the Tribunal to the file of the AO in assessment year 2001-02 with a direction to verify the relevant details and allow the claim of the assessee as per law and the rule of consistency, in our opinion, was rightly applied by the learned CIT(Appeals) while sending back the similar issue to the file of the AO for deciding the same as per the same directions as given by the Tribunal in assessment year 2001-02. We, therefore, find no justifiable reason to interfere with the impugned order of the learned CIT(Appeals) on this issue and upholding the same, we dismiss ground No.1 of the assessee’s appeal.

5. The issue raised in ground No.2 of the assessee’s appeal relates to the disallowance of Rs. 7,40,215/- made by the AO and confirmed by the learned CIT(Appeals) on account of legal expenses treating the same as capital in nature. During the year under consideration, payment of Rs. 7,10,215/- made to Advocates M/s Doijode Phatraphekar Associates for preparing draft agreement for sale of loss companies’ shares were claimed under the head “Legal Expenses”. The AO as well as the learned CIT(Appeals) held the said expenditure as capital in nature and disallowed the same. Similarly, fees of Rs. 30,000/- paid by the assessee to Advocate C.M. Khorde for defending acquisition proceedings of company’s plot of factory land at village Akurdi claimed by the assessee as revenue expenditure, was disallowed by the AO as well as by the learned CIT(Appeals) treating the same as capital in nature.

6. At the time of hearing before us, the learned counsel for the assessee has not pressed the dis allowance of Rs. 7,10,215/- made on account of legal fees paid to M/s Doijode Phatraphekar Associates. She, however, submitted that the sum of Rs. 30,000/- paid to Advocate Shri C.M. Khorde should be allowed as deduction being expenditure incurred for protection of its business assets by the assessee. In reply to the query raised by the Bench, she however, has submitted that there is no evidence available with the assessee in the form of bill or receipt issued by the concerned Advocate to support and substantiate this claim and in the absence of the same, we find no justification in allowing the claim of the assessee for deduction on account of Rs. 30,000/- paid to Advocate Shri C.M. Khorde. We, therefore, uphold the impugned order of the learned CIT(Appeals) confirming the dis allowance made by the AO on account of legal expenses and dismiss ground No. 2 of the assessee’s appeal.

7. The issue raised in ground No. 3 relates to the dis allowance of Rs. 26,29,053/- made by the AO and confirmed by the learned CIT(Appeals) on account of irrecoverable debit balance written off.

8. In its profit & loss account, the assessee company had debited a sum of Rs. 40,43,690/- on account of bad debts written off. On verification, it was found that out of the said amount, a sum of Rs. 26,29,062/- represented advances given by the assessee to its suppliers. Since the said amount was never shown by the assessee as its income earlier, it was held by the AO as well as by the learned CIT(Appeals) that the same could not be allowed as bad debts u/s 36(1)(vii) read with section 37(2).

9. We have heard the arguments of both the sides on this issue and also perused the relevant material on record. The learned counsel for the assessee has agreed that the amount in question representing advances given to the suppliers cannot be allowed as bad debts written off u/s 36(1)(vii) read with section 37(2). She, however, contended that the allow ability of the said amount as business loss as claimed by the assessee alternatively having not been considered either by the AO or by the learned CIT(Appeals), this issue may be sent back to the AO for this purpose. Since the learned DR has not raised any material objection in this regard, we restore this issue to the file of the AO for the limited purpose of examining whether the amount in question can be allowed as business loss in the year under consideration as alternative claim by the assessee. Ground No. 3 of the assessee’s appeal is accordingly treated as allowed for statistical purposes.

10. The issue raised in ground No.4 of the assessee’s appeal relates to the disallowance of Rs. 1,70,218/- made by the AO and confirmed by the learned CIT(Appeals) on account of contributions made by the assessee to various funds by invoking the provisions of section 40A(9).

11. During the year under consideration, the assessee had contributed the amounts aggregating to Rs. 1,70,218/- to the following funds:

Sl. No.

Description

Amount

1.

Contribution to welfare fund at:
Petrol Engine Unit, Thoraipakkam

84,206

Heavy Engineering Unit, Chennai

3,900

88,106

2.

Contribution to family welfare fund at Light Engines Unit – II, Ranipet

40,580

3.

Contribution to disability fund at Petrol Engine Unit, Thoraipakkam.

3,113

4.

Contribution to benevolent fund at Petrol Engine Unit, Thoraipakkam.

15,326

5.

Contribution to death relief fund at Light Engine Unit – II, Ranipet

10,145

Petrol Engine Unit, Thoraipakkam

6,716

16,861

6.

Contribution to Superannuation fund (not recognized) Petrol Engine Unit, Thoraipakkam

6,232

Total

1,70,218/-

According to the AO, none of the above funds was covered u/s 36(1)(iv) or section 36(1)(v) and there being nothing to show that the contributions made by the assessee to the said funds was as per the requirement of any law, he therefore, disallowed the entire amount paid by the assessee as contributions to the various funds by invoking the provisions of section 40A(9). Before the learned CIT(Appeals), it was submitted by the assessee that all the contributions made to the various funds other than the contributions to unrecognized superannuation funds were as per the agreement with workers’ union and since the same was done as per the Industrial Dispute Act, 1947, the provisions of section 40A(9) were not applicable. The learned CIT(Appeals), however, did not find merit in these contentions of the assessee. According to him, all the contributions having been made by the assessee to non statutory funds, the same were not eligible for deduction in view of the express provisions contained in section 40A(9).

12. We have heard the arguments of both the sides on this issue and also perused the relevant material on record. The learned counsel for the assessee has reiterated before us the submissions made before he learned CIT(Appeals) to the effect that most of the contributions having been made by the assessee as per the settlement arrived at with the workers’ union, the same are covered by the Industrial Dispute Act, 1947 and provisions of section 40A(9) of the Act cannot be invoked. However, she has not been able to produce any evidence in the form of the copy of agreement with the workers’ union to support and substantiate her stand taken on this issue and in the absence of the same, we find no justifiable reason to interfere with the impugned order of the learned CIT(Appeals) confirming the disallowance made by the AO on this issue by invoking the provisions of section 40A(9). Ground No. 4 of the assessee’s appeal is accordingly dismissed.

13. Now we shall take up the appeal of the Revenue, ground No. 1 of which involves the issue relating to addition of Rs.39,75,000/- made by the AO by way of TP adjustment in respect of the transactions of the assessee company with its AE involving import of components.

14. As already noted, the assessee is in the business of manufacturing and trading of engines such as Vibratory Compactors, Road Rollers, Concrete Mixers etc. It imports spares and components required for these machines from Germany and Italy and the items so imported are assembled in the factory of the assessee in Tamilnadu. During the year under consideration,, such imports were made by the assessee from two of its associate enterprises, namely BOMAG -, Germany and CIFA, Italy at the value of Rs. 7,27,24,225/- and Rs. 2,64,84,158/- respectively. A reference in this regard was made by the AO u/s 92A(1) of the Act to determine the arm’s length price of the said transactions involving import of components, kits and spares from AEs. In its transfer pricing report, the assessee had adopted resale price method to benchmark these transactions and since its gross margin of 7.26% was more than the average gross margin of two comparable cases, namely, Larson & Tubro Ltd. with 2.34% and Ingersoll Rand India Ltd. with 9.18%, it was claimed that the relevant transactions with its AEs were at arm’s length. The TPO, however, took the margin of 9.18% shown by Ingersoll Rand Ltd. as arm’s length margin and applying the same to the sale of Tandem Rollers and Vibratory Compactors shown by the assessee for the year under consideration at Rs. 2350.32 lakhs, he worked out the arm’s length gross profit of the assessee at Rs. 215.76 lakhs as against the gross profit of Rs. 176.01 lakhs shown by the assessee. Accordingly, the difference of Rs. 39.75 lakhs was added to the total income of the assessee by way of TP adjustment in respect of its transactions with AEs involving import of components/kits/spares.

15. The addition of Rs.39,75,000/- made by the AO/TPO by way of TP adjustment was challenged by the assessee in an appeal filed before the learned CIT(Appeals). During the course of appellate proceedings before the learned CIT(Appeals), detailed submissions were made on behalf of the assessee in support of its case that there was no justification on the part of the AO/TPO to reject L&T Ltd. taken as other comparable. These submissions were forwarded by the learned CIT(Appeals) to the TPO who commented in his report submitted to the learned CIT(Appeals) that L&T Ltd. should not be taken as comparable since its product range includes metal glass packing, welding and industrial product, construction equipment and earth moving equipment. When this remand report was confronted by the learned CIT(Appeals) to the assessee, the latter filed before the learned CIT(Appeals) a copy of segmental accounts of L&T to show that the items manufactured by the said company included construction equipment. The assessee also filed the copies of orders passed by the TPO u/s 92CA(3) for assessment years 2005-06 and 2006-07 in which the TPO himself had considered L&T as a comparable company. Keeping in view these submissions made by the assessee, the learned CIT(Appeals) held that L&T also being engaged in the business of manufacturing of construction equipment, was functionally comparable with the assessee company in broad sense. He also noted that the TPO himself has included L&T as comparable in the subsequent years i.e. assessment years 2005-06 and 2006-07. He, therefore, held that the action of the TPO in excluding L&T as comparable was arbitrary and taking the said company as comparable, he held that the gross margin of the assessee company at 7.26% being more than the average gross margins of the two comparables, namely, Ingersoll Rand India Ltd. and L&T at 5.76%, no addition by way of TP adjustment on this count was justified. Accordingly, he deleted the addition made by the AO on this issue.

16. We have heard the arguments of both the sides on this issue and also perused the relevant material on record. The only contention raised by the learned DR on this issue is that the learned CIT(Appeals) has taken net margin of the assessee as well as that of the two comparables assuming that the method adopted by the assessee is TNMM whereas he should have taken only the gross margin as the method actually adopted by the assessee for the relevant transactions is resale price method. The learned counsel for the assessee has not disputed that gross margin should be considered if the method adopted is resale price method. She, however, has submitted that the assessee has followed TNMM in its transfer pricing study for benchmark transactions involving import of components. It is, however, observed from the copy of TP report placed on record before us that the method adopted by the assessee in this respect was resale price method. Keeping in view the same, although we agree with the learned CIT(Appeals) that L&T should be taken as comparable keeping in view the functional similarity as well as the fact that the TPO himself has accepted the L&T as comparable in assessment years 2005-06 and 2006-07, the working to arrive at arm’s length price on the basis of comparability analysis has to be done by taking into consideration the gross margin of the assessee company as well as the two comparables. We, therefore, restore this issue to the file of the AO/TPO for the limited purpose of doing this exercise. Ground No. 1 of the Revenue’s appeal is accordingly treated as partly allowed for statistical purposes.

17. In ground No.2 of its appeal, the Revenue has challenged the action of the learned CIT(Appeals) in deleting the addition of Rs. 37,05,254/- made by the AO by way of TP adjustment in respect of transactions involving payment of royalty by the assessee company to its associated enterprises.

18. During the year under consideration, the assessee had paid royalty at the rate of 5% of sales in India (net ex-works value) to BOMAG, Germany and CIFA, Italy amounting to Rs. 16,85,962/- and Rs. 20,19,222/- respectively for use of technical know-how provided by the said associated enterprises. In the TP report submitted by the assessee, working was given showing that the effective rate of royalty paid to its AEs was only 1.87% on the exfactory invoice value. It was submitted that the said rate was much lower than the rate of royalty approved by RBI as well as other Government authorities. It was pointed out that even the semi Government companies, like Maruti Udyog was paying royalty at the rate of 5% of sales. It was further pointed out that the operating margin of the assessee company after payment of royalty was well compared to the profit margin of other comparable companies. It was claimed that the royalty paid to its AEs by the assessee thus was at arm’s length. According to the TPO, the assessee however was not able to furnish the details regarding rate at which other AEs or group companies were paying royalty to BOMAG – Germany and CIFA, Italy and in the absence of the same as well as other relevant details, the TPO determined the arm’s length price of the royalty at nil. Accordingly, the entire amount of royalty was added to the total income of the assessee by way of TP adjustment.

19. The matter was carried before the learned CIT(Appeals) and the following submissions were made on behalf of the assessee before him in support of its claim that the payment of royalty to its AE at the rate of 1.87% being at arm’s length, no addition by way of TP adjustment was required to be made :

(1) There are no rules for establishing arm’s length price for royalty; Effective rate at which assessee paid royalty was 1.87% as per the working given even though RBI has permitted royalty of 5%.

(2) AEs being foreign enterprises, do not disclose the cost of development of technology. Similarly they refused to inform us as regards its recovery from other parties.

(3) None of our group entities have been charged royalty. Our group entities include leasing and investment companies.

(4) Information asked for by TPO was given vide letter dated 14/3/2006.

(5) Profit Margin justifies royalty paid.

(6) Hon’ble Dispute Resolution Panel in assessment year 2006-07 deleted adjustment of royalty considering effective rate at which royalty was paid.

20. The learned CIT(Appeals) found merit in the submissions made on behalf of the assessee on this issue and deleted the addition made by the AO/TPO by way of TP adjustment on account of royalty paid by the assessee to its AEs for the following reasons given in paragraph No. 14.8 and 14.9 of his impugned order :

“14.8 I have perused the facts of the case. The TPO has treated the Arms Length Price of Royalty at Nil basically on the ground that the appellant failed to file the details of rate of royalty payment made other AE’s to BOMAG of Germany and CIFA, Italy. In doing this, it assumed that there are other AE’s of BOMAG Germany and CIFA, Italy and also they are availing technology so as to be liable for levy of royalty. The basis of these assumptions are not disclosed. Even otherwise if it is assumed that other AEs are also paying royalty it would not be of any help in determining the ALP as it would be a controlled transactions. The appellant has sought to benchmark its royalty payment on the basis of better margins (7.26%) as compared to other independent companies (5.26%). Even after adding the royalty of 1.87% to the average mean of comparables 5.26%, the figure would have come to 6.63% only which would be still below its overall margin of 7.26% achieved by the appellant after paying Royalty.

14.9 The appellant is engaged in manufacturing of vibrating compactors, road rollers and concrete mixers for which it imports its spares and components from Germany and Italy. These items required technical know how which is developed in Germany and Italy and no third/independent party would have parted with it without charging royalty on its intellectual property. The payment at the rate of 1.87% is reasonable if one look’s at the margin earned. It can be inferred that the intellectual property has contributed to 7.26% margin of the appellant. It is often said that Transfer Pricing is not a science but an art and this proposition allows a certain degree of judgment as to the level of evidence required to determine the Arms Length Price. For the reasons recorded as aforesaid it is felt that the royalty paid at 1.87% is at Arms Length and the TPO was not right in arbitrarily restricting it to Nil. The consequent addition is deleted.”

21. The learned DR strongly relied on the TPO’s order in support of the Revenue’s case on this issue. He submitted that the learned CIT(Appeals) has not followed any method of transfer pricing to arrive at the conclusion that the royalty paid by the assessee company to its AE is at arm’s length. As regards the higher profit margin of the assessee relied upon by the learned CIT(Appeals) to come to the conclusion that the royalty paid is at arm’s length, he submitted that there are various factors which affect the profit margin and not royalty alone.

22. The learned counsel for the assessee, on the other hand, strongly relied on the impugned order of the learned CIT(Appeals) in support of the assessee’s case on this issue and submitted that the same is well reasoned and well discussed on this issue. She also submitted that similar payment of royalty made by the assessee company to its AE has been accepted by the DRP in the subsequent years.

23. We have considered the rival submissions and also perused the relevant material on record. The issue involved in the present case is relating to the determination of arm’s length price in relation to the international transactions involving payment of royalty by the assessee company to its associated enterprises. As provided in section 92C of the Act, such arms’s length price is to be determined by one of the methods prescribed, which is found to be the most appropriate method having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as may be prescribed. The manner in which such most appropriate method is to be applied for determination of arm’s length price is prescribed in Rule 10B of Income-tax Rules, 1962. In the present case, it appears from the TP report submitted by the assessee as well as the orders of the authorities below that neither the assessee nor the TPO or even the learned CIT(Appeals) has followed this procedure prescribed in section 92C of the Act and Rule 10B of the Income-tax Rules, 1962 to determine the arm’s length price in relation to the royalty payment made by the assessee to its associated enterprises and this being so, we find merit in the contention of the learned DR that this matter should go back to the AO/TPO to do such exercise. The learned counsel for the assessee has submitted that payment of similar royalty made by the assessee to its associated enterprises in the subsequent year has been accepted by the DRP. She, however, has not placed on record the copies of the relevant orders passed in the said years to ascertain whether the arm’s length price of the royalty was determined in the said years by following the proper procedure. We, therefore, restore this issue to the file of the AO with a direction to verify whether the similar payment of royalty has been accepted in the subsequent years as at arm’s length after undertaking the exercise as prescribed in section 92C read with Rule 10B. If it is found that such exercise has been done in the subsequent years, the AO is directed to accept the similar payment of royalty made by the assessee for the year under consideration as at arm’s length. However, if it is found that such an exercise has not been done even in the subsequent year, the AO/TPO is directed to do the same in the year under consideration to determine the arm’s length price in relation to the royalty paid by the assessee to its associated enterprises. Ground No. 2 of the Revenue’s appeal is accordingly treated as allowed for statistical purposes.

24. In ground No. 3, the Revenue has challenged the action of the learned CIT(Appeals) in allowing the dis allowance of Rs. 66,69,785/- made by the AO on account of payments made by the assessee to various professionals for taking a4

25. During the year under consideration, the assessee had made payments to various professionals aggregating to Rs. 66,69,785/- for taking their advise for restructuring its business. According to the AO, the expenditure incurred by the assessee on this count resulted in advantage of enduring nature to the assessee and accordingly he disallowed the same treating it as capital in nature. On appeal, the learned CIT(Appeals) deleted the said dis allowance made by the AO following the order of the Tribunal in assessee’s own case for assessment year 2001-02 wherein similar expenditure incurred by the assessee was allowed by the Tribunal treating the same as revenue in nature on the ground that the same meant to revive the ailing business of the assessee was related to its existing business.

26. At the time of hearing before us, the learned representatives of both the sides have agreed that this issue is squarely covered by the order of the Tribunal passed in assessee’s own case for assessment year 2001-02 relying on which the learned CIT(Appeals) has given relief to the assessee in the year under consideration. Respectfully following the said decision of the Tribunal for assessment year 2001-02, we uphold the impugned order of the learned CIT(Appeals) giving relief to the assessee on this issue and dismiss ground No.3 of the Revenue’s appeal.

27. The grievance projected by the Revenue in ground No. 4 is that the learned CIT(Appeals) erred in allowing the MK 20 Development Expenses of Rs. 48,98,509/- holding the same to be revenue in nature.

28. At the time of hearing before us, the learned DR has submitted that the issue as raised in ground No. 4 of the Revenue’s appeal is not arising from the impugned order of the learned CIT(Appeals) as the learned CIT(Appeals) has actually not allowed the impugned expenditure and has simply restored the issue to the file of the AO with a direction to verify the claim of the assessee and allow the same as per law. Accordingly, ground No.4 of the Revenue’s appeal which is not arising from the impugned order of the learned CIT(Appeals) is treated as infructuous and dismissed.

29. In the result, the appeal of the assessee and the appeal of the Revenue are partly allowed for statistical purposes.

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