2016 (5) TMI 1276 - AT - Income Tax

Tribunal Rules in Favor of Assessee, Disallowances Overturned

The Tribunal allowed the assessee's appeals, overturning disallowances and adjustments made by the AO/TPO based on legal precedents. Disallowance of sales ... Allowability of sales promotion expenses as business expenditure - prospective application of CBDT Circular dated 01.08.2012 - treatment of interest on current account for deduction under Section 80HHC - requirement of direct and proximate nexus - net interest exclusion under clause (baa) of Explanation to Section 80HHC - classification of various receipts for computation of deduction under Section 80HHC (insurance claims, sale of scrap, service charges, cenvat/modvat credit, extraordinary income) - characterisation of payments for e-connectivity / access to software - revenue expenditure vs capital expenditure - transfer pricing - selection of Most Appropriate Method (TNMM v. CUP) and acceptance of segmental/internal comparables subject to verificationAllowability of sales promotion expenses as business expenditure - prospective application of CBDT Circular dated 01.08.2012 - Deletion of adhoc percentage disallowance out of sales promotion expenses (gifts) sustained for the years under appeal. - HELD THAT: - The Tribunal followed its earlier decisions in the assessee's own case for earlier assessment years where adhoc disallowances (10%-20%) were held to be based on mere surmises and presumptions when the assessee had demonstrated internal controls, that gifts bore the company logo and were used in promotion. The Co-ordinate Bench in Syncom Formulations was applied to hold that the CBDT Circular dated 01.08.2012 is prospective w.e.f. 01.08.2012 and therefore not applicable to the assessment years under consideration. Respecting these precedents and factual matrix, the adhoc disallowance in respect of gift articles is deleted. [Paras 7]Adhoc disallowance in respect of gift articles deleted.Treatment of interest on current account for deduction under Section 80HHC - requirement of direct and proximate nexus - net interest exclusion under clause (baa) of Explanation to Section 80HHC - Interest on current account balances is not to be treated as income 'derived from' export business for Section 80HHC, but only net interest is to be excluded under clause (baa) to the Explanation. - HELD THAT: - Relying on the jurisdictional High Court's analysis that income by way of interest on surplus funds invested does not automatically qualify as business income unless there is a direct and proximate nexus with the export business, the Tribunal held that interest on current account did not satisfy the 'derived from' requirement for Section 80HHC. However, adopting the Special Bench / Supreme Court position on quantification, the Tribunal directed that only net interest be eliminated under clause (baa) of the Explanation to Section 80HHC and remitted computation to the Assessing Officer accordingly. [Paras 12]Interest on current account excluded from being 'derived from' export business; only net interest to be eliminated for Section 80HHC computation.Classification of various receipts for computation of deduction under Section 80HHC (insurance claims, sale of scrap, service charges, cenvat/modvat credit, extraordinary income) - Treatment of specific receipts for computing deduction under Section 80HHC: insurance claims and sale of scrap are profits of business; service charges are not derived from the industrial undertaking and are to be reduced; cenvat/modvat credit is derived from industrial undertaking; extraordinary income remanded for verification of character. - HELD THAT: - The Tribunal accepted that insurance recoveries related to operating losses and sale of scrap arise from business operations and therefore cannot be excluded by applying clause (baa). Service charges (reimbursements with markup) were held not to be derived from the industrial undertaking and thus 90% thereof may be excluded when computing deduction under Section 80HHC. Following authority and reasoning that modvat/cenvat benefit has an inextricable link to manufacturing activity, the Tribunal held that cenvat credit is to be treated as derived from the industrial undertaking and not to be reduced. The Tribunal observed that the extraordinary income (difference of assets over liabilities on acquisition) may not be income at all and restored that aspect to the Assessing Officer for fresh adjudication to determine its character. [Paras 16]Insurance claims and sale of scrap treated as business profits (not reducible); service charges excluded (90%) as not derived from industrial undertaking; cenvat credit held to be derived from industrial undertaking; extraordinary income remanded to AO for fresh adjudication.Characterisation of payments for e-connectivity / access to software - revenue expenditure vs capital expenditure - E-connectivity charges paid to parent company for access/usage of SAP and related services are revenue expenditure and not capital expenditure creating an enduring asset. - HELD THAT: - On examination of the agreement and nature of services (access/usage of SAP modules, data security, backup, helpdesk, email, intranet access, PeopleSoft services etc.), the Tribunal found no acquisition of software, ownership rights or enduring benefit for the assessee. The payments were for ongoing access and support services and were periodic in nature; cessation of payment would end access. Accordingly, the amounts were held to be revenue in nature and allowable as business expenditure rather than capitalized. [Paras 20]E-connectivity charges are revenue expenditure; addition for capitalisation set aside.Transfer pricing - selection of Most Appropriate Method (TNMM v. CUP) and acceptance of segmental/internal comparables subject to verification - CUP method rejected and segmental/transaction-wise TNMM accepted as the most appropriate method for benchmarking international purchase of APIs, subject to factual verification by Assessing Officer/TPO. - HELD THAT: - Following the Tribunal's earlier directions in the assessee's own case for prior years, the CIT(A) and DRP had accepted that CUP was not the most appropriate method and that transaction-wise/segmental TNMM, including internal comparables where external comparables are unavailable, should be applied. The Tribunal found no infirmity in the CIT(A)'s order; it upheld the change of method while permitting the Assessing Officer/TPO to factually verify the benchmarking analysis and segmental computations in accordance with the Tribunal's earlier directions. [Paras 26]Adjustment under CUP deleted; TNMM accepted as MAM subject to verification; Revenue's TP appeals dismissed.Final Conclusion: The Tribunal partly allowed the assessee's appeals and dismissed the Revenue's appeals: adhoc disallowances on sales promotion gifts deleted; interest on current account not 'derived from' export business though only net interest to be excluded for Section 80HHC; insurance recoveries and sale of scrap treated as business income while service charges excluded and cenvat recognised as deriving from the industrial undertaking (extraordinary income remanded); e connectivity charges held revenue in nature; and transfer pricing adjustments under CUP were set aside with TNMM accepted subject to factual verification. Issues Involved:1. Disallowance of sales promotion expenses.2. Disallowance of bank interest as business income for deduction under Section 80HHC.3. Deduction of 90% of various incomes (insurance claim, miscellaneous income, service charges, Cenvat credit, extraordinary income) under Section 80HHC.4. Classification of e-connectivity charges as capital expenditure.5. Transfer pricing adjustments and the appropriate method for benchmarking international transactions.Issue-Wise Detailed Analysis:1. Disallowance of Sales Promotion Expenses:The assessee contested the disallowance of Rs. 10,42,837/- for sales promotion expenses, which included gifts to doctors and sponsoring a trip. The Tribunal noted that similar disallowances in previous years were deleted as they were based on mere surmises and presumptions. The Tribunal held that the CBDT Circular No. 5 of 2012, which disallowed such expenses, was applicable prospectively from 1st August 2012 and not for the Assessment Year 2004-05. Therefore, the disallowance was deleted, allowing the assessee's appeal.2. Disallowance of Bank Interest as Business Income for Deduction under Section 80HHC:The assessee argued that interest on current accounts should be considered business income and only net interest should be excluded under clause (baa) of Explanation to Section 80HHC. The Tribunal referred to its prior decisions and the Supreme Court's ruling in ACG Associates Capsules Pvt. Ltd. vs. CIT, which supported the exclusion of only net interest. However, it upheld that interest on current accounts does not have a direct nexus with the business of exports and thus cannot be considered for deduction under Section 80HHC. The Tribunal directed the AO to exclude only the net interest.3. Deduction of 90% of Various Incomes under Section 80HHC:The Tribunal analyzed various incomes:- Insurance Claim and Sale of Scrap: These were considered business income and thus not to be reduced by 90% for Section 80HHC computation, supported by the decision in Pfizer Ltd.- Service Charges: Upheld as not derived from business operations, thus 90% to be excluded.- Cenvat Credit: Following the decision in ACIT vs. Total Packaging Services, it was held that Cenvat credit is derived from industrial undertakings and should not be reduced by 90%.- Extraordinary Income: The matter was remanded to the AO to verify if this amount should be treated as income or capital reserve.4. Classification of E-Connectivity Charges as Capital Expenditure:The assessee argued that e-connectivity charges were annual payments for services like SAP modules, data security, and email capacity, not for acquiring software. The Tribunal found that these charges did not result in acquiring any software or enduring benefit and were necessary for day-to-day business operations. Thus, it held these charges to be revenue in nature, allowing the assessee's appeal.5. Transfer Pricing Adjustments:The Tribunal reviewed the method for benchmarking international transactions. It rejected the CUP method adopted by the TPO and upheld the segmental TNMM method as the most appropriate, following its previous decisions and the DRP's directions for subsequent years. The Tribunal directed the AO/TPO to verify the benchmarking analysis under TNMM on a transaction-to-transaction basis.Conclusion:The appeals filed by the assessee for the respective years were allowed, and the disallowances and adjustments made by the AO/TPO were largely overturned based on prior Tribunal and Supreme Court rulings. The appeals filed by the Revenue were dismissed. The Tribunal emphasized adherence to established legal precedents and proper verification of facts in transfer pricing matters.