Expense on feasibility study report for establishing BPO business for assessee’s own function is revenue in nature

Brief of the case:

In the case of M/s NYK Line (India) Ltd Vs. Addl. CIT Mumbai Bench of ITAT have held that payment made to professional firm for conducting a Feasibility Study Report for establishing a BPO business for assessee’s own function, cannot be treated as capital expenditure, or for non business purpose or any kind of pre-operative expenses. It was held that nothing has been brought on record that some kind of new line of business was to be set up or was to be controlled by different management. In assessee’s case BPO business could not take off and whatever expenditure has been incurred has to be allowed either as business expenditure or as a business loss incurred during the course of business.

Facts of the case:

• Assessee is a shipping agent in respect of shipping activity of its principal, NYK Japan in India.
• The primary activity of the assessee company was to derive income from shipping agency services in India to its overseas principal, for which it receives commission income only.
• The assessee had made an investment in shares and mutual funds for sums aggregating to Rs. 10,33,85,369/- on which it has earned a dividend income of Rs. 30,29,856/- which was claimed as exempt.
• Assessee claimed depreciation @ 60% on purchase of printers and UPS which was restricted to 15% by treating it as plant & machinery.
• Assessee has claimed payment made for purchase of print server software as revenue expenditure, which has been disallowed by the AO on the ground that it has an enduring benefit to the assessee.
• The shipping agency services of the assessee are governed by the agency agreement. The activities of the assessee included booking of container cargo for ships owned or operated by NYK Japan.
• The activities of the assessee included booking of container cargo for ships owned or operated by NYK Japan.
• The assessee collects the freight and other receipts arising in the course of shipping business of its principal in India and remit back to its overseas principal i.e. NYK in accordance with the regulation prescribed under FEMA.
• Container detention Charges (CDC) represented on such receipts collected and remitted by the assessee on behalf of the principal in India. CDC is a charge levied for the detainment of the containers in excess of the permissible time period.
• Reserve Bank of India vide its circular has directed to retain container detention charges at US $ 1.5 per day per 20 ft. equivalent units as ‘administrative charges’ for an agent’s local use.
• AO noticed that contention detention charges (CDC) was shown as liability in balance sheet.
• During the year, the assessee has reported international transaction of Rs. 14,83,83,874/- on account of agency commission and other services.
• For benchmarking the transaction, the assessee has adopted TNMM as a most appropriate method (MAM) and selected 9 comparables after taking PLI as operating profit to total sales.
• TPO noted out of above comparable that there were 5 common comparables which were in the earlier three years also including one comparable, Wuhu Port Storage and Transportation Co., which the assessee had rejected this year on the ground of excess profit.
• The assessee had appointed McKinsey & Co. a professional firm for conducting the Feasibility Study for setting up of BPO Unit and had advanced an amount of Rs. 26,02,846/- towards the professional fees.
• Later on, the company took a decision that BPO activity will not be suitable for it and accordingly, certain amount was written off and claimed as an expenditure.

Contention of the assessee:

• No expenditures have been incurred directly or indirectly for earning of the dividend income for the reason that;

Firstly, the entire investment was made out of its own funds and

Secondly, dividend earned have been directly credited to the bank account and no cost at all can be said to be allocated.

• In the assessment year 2002-03, the Tribunal has deleted the said disallowance on the ground that there is no nexus between any expenditure incurred and earning of tax free dividend income.
• In this year also no such expenditure can said to be allocable especially when investments in shares and mutual fund were coming from earlier years and were sold in the subsequent years.
• Printers and UPS are computer peripherals only and they are to be treated as part and parcel of computer on which depreciation is to be allowed @ 60%.
• Since assessee did not have any agreement with the principal for such retention, therefore, the container detention charges was directly credited to the Balance sheet as a liability.
• Containers are owned by NYK Japan and CDC)are charges levied on 3rd parties importer by the principal on certain circumstances and conditions.
• Assessee merely collects CDC on behalf of principal as an agent which is deposited in separate bank account.
• CDC which is collected on behalf of principal, though retained by the assessee company as per the RBI guideline, is the receipt belonging to the principal and no part of the said receipts can be said to be accrued to the assessee at all either in terms of agency agreement or otherwise.
• Reliance was placed upon the decision of Hon’ble Supreme Court in the case of E D Sassoon and Co. Ltd. vs CIT [1954] 26 ITR 27 (SC) where it was held that the income can only be said to accrue to the assessee only when it has a right to receive the income or there is doubt owed by somebody in favour of the assessee.
• In AY 2008-09, the DRP has specifically excluded Wuhu Cold Storage and Transportation Company on the ground of very high margin and functional dissimilarity. If this comparable is excluded from the final list, then assessee’s margin will fall within the range of ± 5% of the arm’s length price.
• This proposed BPO business was for the same line of the business with same management and common control. It was definitely not for any new line of business as held by the Assessing Officer

Contention of the revenue:

• Printers and UPS cannot be equated with computer and admissible depreciation provided for computer will not be applicable.
• As per the RBI guidelines, the assessee could not have remitted the CDC amount to the principal. Once it cannot be remitted, then whether it can it be held that same is taxable or is to be assessed in the hands of foreign enterprise i.e. principal.
• If the said CDC is never received by the principal, then it cannot be taxed in the hands of the principal and therefore, the said amount will go untaxed as it is neither taxed in the hands of the principal nor in the hands of the agent.
• If the CDC is receipt / income of the principal then assessee company being agent of principal in India, has to treat this income taxable in India.
• If the comparable with abnormal profits are removed then on the same logic, comparables with lower profits should also be removed.
• Expenditure on feasibility report was incurred for new line of business and that too it did not commenced therefore, such an expenditure cannot be allowed as revenue expenditure.

Held by DRP:

• So far as interest component is concerned, the same cannot be disallowed, because the investment was out of business receipts surplus and no borrowed funds have been utilized.
• DRP directed the AO to restrict the disallowance on UPS and printers @ 15%.
• DRP rejected the assessee’s objection with regard to the exclusion of Wuhu Cold Storage and Transportation Co. on the ground that the TPO has merely adopted the comparables selected by the assessee in TP Study report and also which were included by the assessee in the earlier years.

Held by ITAT:

• DRP has taken note of the fact that; firstly, Rule 8D is not applicable in this year; and secondly, there is no interest expenditure attributable for the earning of exempt income; and lastly, for the purpose of indirect expenses, already direction have been given to the AO to identify the manpower cost of the persons.
• AO after analyzing the entire details has restricted the disallowance at Rs. 1 lakh on account of manpower / administrative cost, which can be said to be attributable for earning of exempt income.
• Such a finding of AO cannot be faulted with in absence of any proper rebuttal and also the disallowance as it is appears to be quite reasonable. Disallowance u/s 14A is confirmed.
• Claim of depreciation on UPS and printer is concerned the same is to be allowed @ 60% as they are part and parcel of computer itself and are peripheral component/equipment connected with the computer.
• Reliance was placed on the decision of ITAT Delhi Bench in the case of Omini Club Informational Technology P Ltd., 131 ITD 280 where it was held that printer and UPS are part of computer and hence depreciation has to be allowed @ of 60%.
• So far as claim of depreciation on air-conditioners installed in server’s room, the same cannot be treated as part of computer and therefore, restricting the claim of depreciation @ 15% by the AO is fully justified.
• If the expenditure incurred on the software is to facilitate the assessee’s business or enable the management to conduct the business more efficiently or profitably, then it has to be treated as revenue expenditure.
• It is abundantly clear that assessee is a shipping agent of NYK Japan, the principal who owns the ships and the containers. In accordance with the agency agreement, the assessee collects the freight income and other receipts (including CDC charges) arising in the course of the principal’s shipping business in India and remits the same to its principal.
• The CDC charges are recovered from the third party on and on behalf of the principal.
• As per the agency agreement, the CDC charges are collected by the assessee solely on behalf of the principal and are deposited in the separate bank account. These funds are then use to meet the expenses of the principal in India and then it is remitted back to the principal in accordance with the foreign exchange regulations.
• RBI had issued a Circular, whereby a small portion of CDC charges are to be retained in India towards discharging of administrative charges on and behalf of principal in India.
• The agent is bound to conduct the business of its principal according to the terms and conditions and directions given by the principal. Here CDC collected on behalf of the principal, though retained by the assessee in view of RBI Circular, however, belongs to the principals.
• The assessee-agent undertakes to collect the amount in its fiduciary capacity and hold the money as a trust. Thus, it cannot be held that assessee had any enforceable right to receive the CDC charges or any income can be said to have arisen or accrued to the assessee qua the CDC charges.
• ITAT held that no income regarding CDC has accrued or arisen to the assessee in this year.
• The assessee before the TPO as well as before the DRP has disputed the comparable based on high margins.
• In the subsequent year, the DRP has directed the AO/TPO to remove the said comparable from the final list of comparable company on the ground that, firstly, its margin is too high and secondly, the business and functions of Wuhu Cold Storage and Transportation Co. is quite different from the assessee.
• Following subsequent order of the DRP, we exclude the Wuhu Cold Storage and Transportation Co. from the list of final comparables.
• Accordingly, AO is directed to exclude the same and benchmark the average margin of other comparables with that of the assessee and if the margin of such comparables falls within the range of ± 5% of the Arm’s length price, then needless to say, no adjustment should be made.
• Nothing has been brought on record that some kind of new line of business was to be set up or was to be controlled by different management. Hence, Expenditure incurred for feasibility report cannot be treated as capital expenditure, or for non business purpose or any kind of pre-operative expenses.