2014 (6) TMI 562 - AT - Income Tax

Key Wins for Assessee in Appeal Decision: Service as Business Income, Royalty Expenditure Allowed

Yum! Restaurants (India) Private Ltd. Versus ITO, Ward 18 (4), New Delhi

The appeal was partly allowed in favor of the assessee, with the Tribunal deciding various issues such as characterizing service income as business ... Corporate Tax matter Service income - Income from other sources or not – Held that:- Following ITO, Ward 18 (4), New Delhi Versus Yum! Restaurants (India) Private Ltd. [2014 (4) TMI 532 - ITAT DELHI] - the word “business” is one of wide import and which means an activity carried out continuously and systematically by a person by the application of his labour and skill with a view to earn income - the assessee is receiving the income from parent company i.e. YRI and not making payment to it – the AO miserably failed to appreciate the facts and circumstance - The assessee has been offering income from consultancy etc. as a business income - It has duly been accepted by the department since 1998-99 - The AO without assigning any valid reason concluded that it is an income from other sources – the First Authority has considered this issue in right perspective –Decided in favour of Assessee. Disallowance of royalty expenses – Held that:- Following ITO, Ward 18 (4), New Delhi Versus Yum! Restaurants (India) Private Ltd. [2014 (4) TMI 532 - ITAT DELHI] - The AO has misread the approvals granted by the Govt. of India while arriving at a conclusion that assessee has not been remitting the payment as per the approvals - In the approval SIA has used expression “royalty as well as fee for technical services” loosely and interchangeably - Apart from all these things, the tax rate for remitting a royalty as well as fee for technical service is 15% plus the research and development cess - The assessee has paid both these amounts while remitting the payment - The expense is directly related to its business - It has been incurred wholly and exclusively for running the franchises within India – Decided in favour of Assessee. Hypothetical disallowance of the administrative expenses – Held that:- Following ITO, Ward 18 (4), New Delhi Versus Yum! Restaurants (India) Private Ltd. [2014 (4) TMI 532 - ITAT DELHI] - YRMPL was incorporated on 8th June, 1999 - It is a 100% owned subsidiary of the assessee - It has been incorporated to carry out advertisement, marketing and promotion activities of the assessee as well as various franchise - The assessee had entered into a tripartite agreement with its franchise and YRMPL - As per this agreement, the franchise shall pay AMP contribution to YRMPL and assessee may not pay a separate contribution - YRMPL was to carry out the activities on no profit no loss basis - The AO has disallowed the expenses which are attributable to YRMPL but in fact, he ought to have not disallowed any such amount because ultimately it is the assessee who has to contribute for all these sums - The assessee can bear the cost of administrative expenses to be incurred by YRMPL or it can separately remitted the amount to YRMPL towards such cost - it is the assessee or its franchise who has to contribute this amount - CIT(A) has rightly deleted the disallowance – Decided in favour of Assessee. Disallowance of depreciation u/s 32 of the Act – Held that:- Following ITO, Ward 18 (4), New Delhi Versus Yum! Restaurants (India) Private Ltd. [2014 (4) TMI 532 - ITAT DELHI] - The AO has highlighted certain discrepancies in the maintenance of WDV of the assets as well as identification of each asset - There may be some shortcomings but that does not mean that assessee was not having any assets and they were not used for the purpose of business - AO ought to have identified each item and find out how that item is treated in the block of assets, if it is established that those assets were not used for the purpose of the assessee’s business then he should make out a care for disallowance of depreciation - By making general observation, he cannot deny the total claim of the depreciation of the assessee - CIT(A) has already directed the AO to give effect outcome of 1999-2000 - The depreciation disallowed in asstt. year 1999- 2000 would be considered for disallowance in this year also – Decided in favour of Assessee. Disallowance of excessive advertising, marketing and promotion (' AMP') contribution – Held that:- Following ITO, Ward 18 (4), New Delhi Versus Yum! Restaurants (India) Private Ltd. [2014 (4) TMI 532 - ITAT DELHI] - The DRP has given a finding that the major beneficiary of the AMP expenditure was foreign associate concerns who are the owner of the brand and the franchisees are only marginal beneficiaries - no finding has been recorded with regard to the relevant provisions with regard to advertisements etc. in the franchisees agreement between the assessee and the franchisees – the matter is liable to be remitted back to the AO for fresh adjudication – Decided in favour of Assessee. Disallowance of the research and development expenses – Held that:- Following ITO, Ward 18 (4), New Delhi Versus Yum! Restaurants (India) Private Ltd. [2014 (4) TMI 532 - ITAT DELHI] - In its day to day operations, assessee is experimenting new dishes, where it incurred expenses on food items and spices etc. - On many of occasions, the flavor may not come to the expectation for commercialized use - Thus, these are the routine research work carried out by the assessee and no capital assets came into existence - DRP has erred in treating this amount as a capital expenditure – Decided in favour of Assessee. Disallowance of tax depreciation @60% on computer peripherals – Held that:- Following CIT vs. BSES Yamuna Powers Limited [2010 (8) TMI 58 - DELHI HIGH COURT] - computer accessories and peripherals such as, printers, scanners and server etc. form an integral part of the computer system - the computer accessories and peripherals cannot be used without the computer - they are the part of the computer system, they are entitled to depreciation at the higher rate of 60% - Decided in favour of Assessee. Selection of comparables – Support services outside India – Functionally different companies - Held that:- Saket Projects Ltd. cannot be held to be comparable on the basis of functional dissimilarities and the assets employed – Relying upon ITAT, Delhi Bench-I, New Delhi in the case of M/s. Premier Exploration Services Pvt. Ltd. vs. ITO [2013 (11) TMI 1413 - ITAT DELHI] - When direct comparables are available then segmental results of companies engaged in other business should not be taken as comparable - the specific characteristics of services provided, assets employed and risk assumed, i.e. the FAR of the comparable is decisive and inclusion or exclusion of comparables - Saket Projects Ltd is functionally different as it is organizing events with various kinds of sponsorships - The company in the division is earning revenue from selling event fees and offering space for rent which cannot be comparable with provision of marketing and sales support services - the segmental allocation of expenses was also not reliable. Also, M/s. Choksi Laboratories Ltd., was engaged in chemical testing services which are highly technical and not comparable to assessee – thus, Choksi, Rites and Wapcos are functionally different from the assessee company and cannot be held to be proper comparables – the TPO is directed to exclude them from the TPO adjustment while determining the ALP - As far as, M/s. Indus Technical & Financial Consultants Ltd. is concerned, it is engaged in rendering services pertaining to environment and energy conservation which cannot be held to be different from the assessee company - the assessee’s claim that as per the website of the company, M/s. Indus Technical & Financial Consultants Ltd. is a renowned manufacturer of TMT Bars, there was no substance in the claim – Decided partly in favour of assessee. Issues Involved:1. Characterization of service income as 'income from other sources' vs. 'business income.'2. Disallowance of royalty expenditure.3. Hypothetical disallowance of administrative expenses.4. Disallowance of tax depreciation.5. Disallowance of advertising, marketing, and promotion (AMP) contribution.6. Disallowance of research and development expenses.7. Depreciation on computer peripherals.8. Transfer pricing adjustments.Detailed Analysis:1. Characterization of Service Income:The issue was whether the service income of Rs.10,98,31,254/- from Yum! Restaurants Asia Pte Ltd., Singapore (YRAPL) should be characterized as 'income from other sources' or 'business income.' The ITAT had previously decided this issue in favor of the assessee in earlier years, recognizing the income as business income due to the continuous and systematic nature of the services provided. The Tribunal reiterated that the service income was part of a regular business activity, thus allowing the appeal in favor of the assessee.2. Disallowance of Royalty Expenditure:The assessee paid royalty to YRAPL for using technology and systems for operating KFC and Pizza Hut restaurants. The AO disallowed this expenditure, arguing it was not in line with the SIA approval. However, the ITAT had previously ruled in favor of the assessee, recognizing the payments as genuine business expenditures. The Tribunal followed the precedent and allowed the royalty expenditure, dismissing the AO's disallowance.3. Hypothetical Disallowance of Administrative Expenses:The AO disallowed Rs.23,87,46,837/- of administrative expenses, attributing them to the subsidiary YRMPL. The ITAT had previously ruled that such expenses were legitimate business expenditures, incurred for the mutual benefit of the assessee and its franchisees. The Tribunal found no merit in the AO's disallowance and allowed the administrative expenses.4. Disallowance of Tax Depreciation:The AO disallowed Rs.25,59,253/- of depreciation claimed by the assessee. The ITAT, referencing its earlier decisions, held that the depreciation should be allowed under the block of assets concept, where the actual physical possession of assets is not relevant. The Tribunal allowed the depreciation claim.5. Disallowance of AMP Contribution:The AO disallowed Rs.1,91,74,987/- contributed by the assessee to YRMPL for AMP activities, arguing that the primary beneficiaries were the foreign brand holders. The Tribunal found that the issue required a fresh examination to determine the relevancy of the expenditure under Section 37 and Section 40A(2) of the Act. The matter was restored to the AO for reconsideration.6. Disallowance of Research and Development Expenses:The AO disallowed Rs.9,48,831/- of R&D expenses, treating them as capital expenditures. The ITAT had previously ruled that such expenses were routine and revenue in nature, incurred for day-to-day operations without creating any capital assets. The Tribunal allowed the R&D expenses.7. Depreciation on Computer Peripherals:The AO allowed depreciation on computer peripherals at 15% instead of the claimed 60%. The ITAT, following the jurisdictional High Court's decision, held that computer peripherals form an integral part of the computer system and are entitled to depreciation at 60%. The Tribunal allowed the higher depreciation rate.8. Transfer Pricing Adjustments:The Tribunal addressed several transfer pricing issues, including the selection of comparable companies and the use of data. The Tribunal directed the exclusion of certain companies (Saket Projects Ltd., Choksi Laboratories Ltd., Wapcos (India) Ltd., and Rites Ltd.) from the comparables due to functional dissimilarities. The issue of double taxation due to disallowed expenses was restored to the DRP for fresh consideration. The Tribunal dismissed the grounds related to the use of single-year data and the +/- 5% adjustment, following established precedents and legislative amendments.Conclusion:The appeal was partly allowed for statistical purposes, with several issues decided in favor of the assessee and others remanded for further consideration. The Tribunal's decisions were largely based on precedents and consistent application of legal principles.