2014 (8) TMI 837 - AT - Income Tax

ITAT directs fresh review on offshore operations, stresses expense justification

Clough Engineering Ltd., C/o. Devesh K. Shah & Co. Versus ADIT, Range-1, International Taxation, Mumbai

The ITAT set aside the matter to the AO/TPO for fresh consideration, directing them to examine whether the appellant conducted distinct business ... Transfer pricing adjustment - Offshore activities – whether there are separate out of India activity or not – Held that:- There are so many disputed facts which need further verification by the AO to arrive at the just and proper conclusion to make a just assessment - The claim of the assessee is that contract is in two parts which has been disputed by the CIT(DR) - As per him, there is only one contract in case of the assessee and there is no such division “inside India” and outside India” activities - CIT(DR) has also disputed the contentions of the assessee that there are activities outside of India that can be considered as separate, identifiable and distinct activity - the activities of procurement of material from third party are for executing the contract in India - no separate project have been developed out of India - the issue is not that how the outside India activities and it revenue was attributable to the PE of the assessee in the form of offices and construction of PE but the issue is that there are no separate out of India activity - Against the claim of the assessee that there is absolutely no material to even remotely suggest that Indian offices had any role to play in the offshore activities of designing, fabricating, procurement of equipment and supply - The project has been managed and executed from Indian offices of the assessee - The procurement, fabrication, designing, services, if any, rendered from outside India have been compensated by Indian PEs - The body and sale of the ONGC project lies in India and it had role in all the activities, if any, carried outside India. Burden to prove – Fabrication and designing services were rendered from outside India or not - Held that:- The primary burden of proof is on the assessee to justify that fabrication and designing services were rendered from outside India - It should have submitted the details of all the expenses and location and incurring the expenses against the so called receipts on account of “imported components” - This receipt has gone in the hands of the assessee without justifying the expenses against the same and profits earned - in absence of providing the basic information of activities, the assessee could not claimed that revenue should prove what role the Indian offices had in regard to those unproved activities outside India. The fabrication and supplies are made by the third parties outside India to the assessee and the revenue is not taxing the profits of these third parties. Profits out of price “imported components “ is receipts minus expenses on purchases for which information is not filed to the authorities in India and AO has made a reasonable estimation on income chargeable to tax in India – thus, the matter is remitted back to the AO for examination of the related facts based on the material made available on record to arrive at a definite conclusion as to whether the assessee has carried out any distinct and identifiable business operation in respect of the project outside India, after affording adequate opportunity of being heard to the assessee and make the afresh assessment accordingly – Decided in favour of Assessee. Issues Involved:1. Violation of statutory provisions and principles of natural justice.2. Misrepresentation of facts by the appellant.3. Taxability of consideration received for obligations carried out outside India.4. Ad-hoc disallowance of 25% of overall expenses.5. Ad-hoc disallowance of various costs leading to a total profit calculation.6. Adjustment in international transactions not at arm's length.7. Incorrect application of proviso to section 92C(2).8. Transfer pricing adjustment and deemed profitability.9. Levy of interest under sections 234B and 234C.10. Initiation of penalty proceedings under section 271(1)(c).Detailed Analysis:1. Violation of Statutory Provisions and Principles of Natural Justice:The appellant argued that the DRP and AO erred in passing the impugned order without adhering to statutory provisions and principles of natural justice, rendering the order null and void.2. Misrepresentation of Facts:The appellant contended that the DRP/AO incorrectly observed that the appellant misrepresented facts and misled the Income-tax authorities, ignoring documents and facts on record.3. Taxability of Consideration Received for Obligations Outside India:The appellant received Rs. 2,245,597,453 for obligations outside India, which the AO deemed taxable in India. The appellant argued that since all operations were outside India, no part of this consideration should be taxable in India. The ITAT noted that the appellant's contract with ONGC involved both offshore and onshore activities. The appellant's claim that offshore activities were distinct and should not be taxed in India was disputed by the revenue, which argued that the entire project was managed and executed from India, and the bifurcation into offshore and onshore activities was not justified.4. Ad-hoc Disallowance of 25% of Overall Expenses:The AO made an ad-hoc disallowance of 25% of the overall expenses incurred by the appellant, which the DRP did not address. The appellant argued that this disallowance was arbitrary and without basis.5. Ad-hoc Disallowance of Various Costs:The AO made ad-hoc disallowances of 50% of material cost, 40% of plant cost, 50% of office cost, and 100% of legal cost, leading to a total profit calculation at 25%. The appellant argued that these disallowances were arbitrary and lacked justification.6. Adjustment in International Transactions Not at Arm's Length:The AO/TPO made an adjustment of Rs. 36.02 crores on account of TP adjustment, applying a net profit margin of 7.89% on the entire transaction, including both A.E. and non-A.E. transactions. The appellant argued that the TP adjustment should only apply to transactions with A.Es and not the entire turnover. The appellant cited various decisions supporting this view.7. Incorrect Application of Proviso to Section 92C(2):The appellant argued that the DRP/AO did not correctly apply the proviso to section 92C(2) of the IT Act.8. Transfer Pricing Adjustment and Deemed Profitability:The appellant contended that the DRP/AO erred in not considering offshore revenues taxable at a deemed profitability rate of 25% as part of operating income while making the transfer pricing adjustment. The appellant argued that the adjustment should be restricted to the proportionate value of the international transaction.9. Levy of Interest Under Sections 234B and 234C:The appellant questioned the levy of interest under sections 234B and 234C, arguing that it was consequential and did not need separate adjudication.10. Initiation of Penalty Proceedings Under Section 271(1)(c):The appellant argued that the initiation of penalty proceedings under section 271(1)(c) was premature and did not need adjudication.Conclusion:The ITAT set aside the matter to the AO/TPO for fresh consideration, directing them to examine the related facts and determine whether the appellant carried out any distinct and identifiable business operations outside India. The ITAT emphasized the need for the appellant to justify expenses and profits related to offshore activities. The appeal was allowed for statistical purposes, with the levy of interest being consequential and the initiation of penalty proceedings deemed premature.