2012 (6) TMI 286 - AT - Income Tax

Assessee's Appeals Partly Allowed with Detailed Reasoning and Legal Precedents

The Tribunal partly allowed the assessee's appeals for both assessment years, dismissing the department's appeal for the 2005-06 assessment year. Detailed ... Arm's length price - operating margin - reimbursement of advertisement expenses as operating income - transfer pricing adjustments for differences in functions, risks and assets - application of section 35DDA - amortisation of voluntary retirement scheme payments - constructional approach to section 35DDA and Rule 2BA - revenue v. capital characterisation of expenditure on closure of business - depreciation on block of assets and ownership/user test - amortisation of restructuring/legal costs over five years - treatment of advertisement and sales-promotion expenses - revenue v. capital - deductibility of tax deposited under protest - special provision for computation of capital gain on cessation of a block of assetsArm's length price - operating margin - reimbursement of advertisement expenses as operating income - Reimbursement of advertisement expenses received from Associated Enterprises is to be included as operating income for determining operating margin for transfer-pricing purposes. - HELD THAT: - The Tribunal held that prior Tribunal orders for assessment years 2002-03 to 2004-05 are binding precedent and, on identical facts, reimbursement cannot be treated as ad-hoc or gratuitous. The agreement showing 50% reimbursement and material showing that, but for reimbursement, the assessee would not have incurred such high advertisement expenditure, support inclusion as part of normal operating profit. Accordingly the TPO/AO exclusions were reversed and the reimbursement is included in operating income for arm's length determination.Inclusion of advertisement reimbursements in operating income allowed; transfer-pricing adjustment on this ground disallowed.Operating margin - notice pay and penalty - Amounts received as notice-pay and penalties from staff cannot be included in income for determining operating margin. - HELD THAT: - The Tribunal applied its earlier precedent rejecting inclusion of such receipts in operating income and upheld the exclusion as decided in preceding years.Exclusion of notice-pay and penalty receipts upheld (decision adverse to the assessee).Transfer pricing adjustments for differences in functions, risks and assets - Reasonably accurate functional/risk/asset adjustments for comparables may be made and, on the facts, a 20% deduction was accepted as reasonably accurate. - HELD THAT: - Relying on the assessee's earlier favourable Tribunal decisions for preceding years, the Tribunal found no distinguishing features in the year under appeal and accepted the 20% adjustment for intangibles, R&D, risk factors and working capital as a reasonably accurate method rather than permitting only ad-hoc or minimal adjustments.Adjustment of 20% in respect of functional/risk/asset differences allowed for transfer-pricing computation.Application of section 35DDA - amortisation of voluntary retirement scheme payments - constructional approach to section 35DDA and Rule 2BA - Payments made under the assessee's scheme are payments under a Voluntary Retirement Scheme and are deductible by amortisation under section 35DDA; Rule 2BA conditions are not to be read into section 35DDA. - HELD THAT: - The Tribunal accepted the finding of the CIT(A) (that payments were under a VRS) as final on facts, and rejected the revenue's contention that Rule 2BA (framed under section 10(10C)) must be read into section 35DDA. The Court observed that the legislature intentionally omitted the Rule 2BA conditionalities from section 35DDA and declined to import them by construction. Consequently the assessee is entitled to claim one-fifth of the VRS expenditure in the year of payment and balance over the next four years. [Paras 17]Expenditure under the VRS held to be deductible under section 35DDA; one-fifth allowed in the year and the balance amortisable over four subsequent years.Revenue v. capital characterisation of expenditure on closure of business - amortisation of restructuring/legal costs over five years - Legal, professional and other restructuring expenses incurred in connection with closure of the Dharuhera manufacturing unit are capital in character for the assessee but should be amortised over five years under the same treatment as VRS payments. - HELD THAT: - The Tribunal found that the closed unit was a separate and distinct business unit and the expenses were connected with closure. Such one time restructuring expenses were held to inure an enduring benefit and thus capital in nature. However, following the approach adopted for VRS payments and relevant judicial observations, the Tribunal directed that these expenses be allowed in five equal annual instalments (one-fifth in the year and balance over four years).Restructuring/legal expenses treated as capital but amortisable over five years; one-fifth allowed in the relevant year.Depreciation on block of assets and ownership/user test - special provision for computation of capital gain on cessation of a block of assets - Depreciation on factory building and plant & machinery of the Dharuhera unit is not allowable as the relevant blocks ceased to exist on transfer and the assets were neither owned nor used by the assessee; loss on transfer to be considered under section 50. - HELD THAT: - On the facts the Tribunal concluded that the Dharuhera manufacturing unit's building and plant & machinery were transferred in the year and therefore ownership and user necessary under section 32 were absent. The consolidated block computations could not supplant the factual exhaustion of the specific blocks. The Tribunal directed the AO to consider computation under section 50(2) for capital gain/loss as applicable.Depreciation disallowed on the exhausted blocks; AO to compute capital gain/loss under section 50.Depreciation on block of assets and ownership/user test - Printers, UPS and switches used as parts of computer systems qualify for depreciation at the higher rate (60%) as applied to computers. - HELD THAT: - Following the coordinate Bench decision relied upon by the assessee, the Tribunal accepted that these items form part of the computer block and directed allowance of depreciation at 60%.Depreciation on printers, UPS and switches allowed at 60%.Treatment of advertisement and sales-promotion expenses - revenue v. capital - Advertisement and sales-promotion expenses incurred by the assessee are revenue in nature and no part is to be disallowed as capital or attributable to parent company benefit. - HELD THAT: - The Tribunal held there was no allegation that the expenditure related to products outside the assessee's normal business. Citing authority that such payments to third parties are incurred in the course of business, it concluded incidental benefits to the parent do not warrant part-disallowance and deleted the addition sustained by the CIT(A).Disallowance of 10% on advertisement and sales-promotion expenses deleted; full revenue allowance restored.Deductibility of tax deposited under protest - Sales-tax deposited under protest is deductible in computing income; the appellate authority may admit a fresh claim notwithstanding non filing of a revised return where facts are on record. - HELD THAT: - Although the assessee had not filed a revised return, the Tribunal followed precedent permitting the Tribunal/CIT(A) to entertain a fresh claim where all facts are on record and the amount was paid within the prescribed time. The deposit under protest qualifies for deduction under the relevant provision.Deduction of sales-tax deposited under protest allowed; departmental appeal dismissed on this ground.Final Conclusion: The Tribunal partly allowed the assessee's appeals for assessment years 2005-06 and 2006-07, including (inter alia) inclusion of advertisement reimbursements in operating income for transfer-pricing, allowance of a 20% functional adjustment, treatment of VRS payments under section 35DDA with one-fifth deduction in the year and balance amortisable, amortisation of restructuring/legal costs over five years, allowance of 60% depreciation on computer-related items, deletion of the advertising disallowance and allowance of sales-tax deposited under protest; depreciation on exhausted Dharuhera factory asset blocks was disallowed and the AO directed to compute capital gain/loss under section 50. Appeals of the department were dismissed where noted. Issues Involved:1. Validity of the orders passed by the AO, TPO, and CIT(A).2. Addition to total income on account of arm's length price determination for international transactions.3. Disallowance of expenses under the Voluntary Retirement Scheme (VRS).4. Disallowance of legal and professional charges related to business restructuring.5. Claim of higher depreciation on certain assets.6. Disallowance of depreciation on factory assets.7. Partial disallowance of advertisement and sales promotion expenses.8. Reduction of claims under sections 10A and 10B.9. Deduction of sales-tax deposited under protest.10. Depreciation on license fees for computer software.11. Initiation of penalty proceedings under section 271(1)(c).Detailed Analysis:1. Validity of the Orders Passed by AO, TPO, and CIT(A)- Issue: The assessee challenged the validity of the orders passed by the AO, TPO, and CIT(A), claiming they were bad in law.- Judgment: The Tribunal decided that these grounds would be resolved automatically upon addressing the other specific grounds raised by the assessee.2. Addition to Total Income on Account of Arm's Length Price Determination- Issue: The addition of Rs. 38,98,79,056/- for import of finished goods based on arm's length price.- Judgment: The Tribunal found that the reimbursement of advertisement expenses by AEs should be included in the operating profit (OP) for determining operating margin, following earlier Tribunal decisions. Notice-pay and penalty received from staff were excluded from OP. Adjustments for differences in functions, risks, and assets were allowed at 20%. The 5% adjustment from the mean value of comparables was deemed unnecessary due to the favorable decision on advertisement expenses.3. Disallowance of Expenses Under the Voluntary Retirement Scheme (VRS)- Issue: Disallowance of Rs. 6,70,49,994/- on account of VRS expenses.- Judgment: The Tribunal held that the VRS expenses were deductible under section 35DDA, rejecting the CIT(A)'s view that the scheme needed to comply with section 10(10C) and Rule 2BA. The Tribunal also allowed the deduction under section 37(1), considering the expenses were revenue in nature.4. Disallowance of Legal and Professional Charges Related to Business Restructuring- Issue: Disallowance of Rs. 1,72,07,000/- incurred for legal and professional charges.- Judgment: The Tribunal held that the expenses were capital in nature as they were incurred for closing the manufacturing business. However, it allowed the expenses to be amortized over five years, similar to VRS expenses.5. Claim of Higher Depreciation on Certain Assets- Issue: Higher depreciation on printers, UPS, and switches by considering them as parts of computers.- Judgment: The Tribunal allowed the claim, directing the AO to allow depreciation at 60% on these items, following the precedent set by the Kolkata Bench of the Tribunal.6. Disallowance of Depreciation on Factory Assets- Issue: Disallowance of Rs. 4,42,22,475/- on factory assets after the closure of the Dharuhera unit.- Judgment: The Tribunal upheld the disallowance, stating that the assets were neither owned by the assessee nor used for its business. It directed the AO to compute the loss under section 50(2).7. Partial Disallowance of Advertisement and Sales Promotion Expenses- Issue: Disallowance of 10% of advertisement and sales promotion expenses.- Judgment: The Tribunal deleted the disallowance, holding that the expenses were revenue in nature and incurred in the course of business. It rejected the notion that incidental benefits to the parent company justified the disallowance.8. Reduction of Claims Under Sections 10A and 10B- Issue: Reduction of claims by Rs. 1,68,970/- and Rs. 90,795/- respectively.- Judgment: The Tribunal dismissed this ground, following its earlier decision against the assessee in similar cases.9. Deduction of Sales-Tax Deposited Under Protest- Issue: Deduction of Rs. 15,51,403/- deposited as sales-tax under protest.- Judgment: The Tribunal upheld the CIT(A)'s decision to allow the deduction, noting that the payment was made within the prescribed time, and the technicality of not filing a revised return did not prevent the Tribunal from granting relief.10. Depreciation on License Fees for Computer Software- Issue: Restriction of depreciation on license fees to 25%.- Judgment: The Tribunal upheld the restriction, noting that licenses are classified as intangible assets with a prescribed depreciation rate of 25%.11. Initiation of Penalty Proceedings Under Section 271(1)(c)- Issue: Appeal against the initiation of penalty proceedings.- Judgment: The Tribunal dismissed this ground, stating that no appeal lies against the mere initiation of penalty proceedings.Conclusion:The appeals of the assessee for both assessment years were partly allowed, while the appeal of the department for assessment year 2005-06 was dismissed. The Tribunal provided detailed reasoning for each issue, adhering to legal precedents and statutory provisions.