2020 (5) TMI 82 - AT - Income Tax

Tribunal's decisions on revenue appeals and assessee's objections impact various tax issues

The Tribunal partly allowed the Revenue's appeals for statistical purposes and fully allowed the assessee's cross objections. The Assessing Officer was ... Allowability of leave encashment under payment basis and interplay with section 43B(f) - quantification of disallowance under section 14A read with Rule 8D - direct expenses, proportionate interest and administrative overheads - binding effect of Settlement Commission orders as precedent by way of voluntary settlement - allowance of additional depreciation under section 32(1)(iia) - carry forward of balance when asset first put to use for less than 180 days - whether corporate guarantee is an 'international transaction' under section 92B - benchmarking of interest on loans/advances to associated enterprises - internal CUP and relevant LIBOR/foreign currency benchmark - allowability of provision for foreseeable losses on construction contracts under accounting standard AS-7 and section 37 principles - deductibility of employees' PF/ESI contributions where paid before due date of filing return - treatment of mark-to-market loss on derivatives (AS-11) - real v. notional loss - onus and evidentiary standard for genuineness of payments to third-party service providers - real-income principle versus book entries for notional interest where debtor is non performing - condonation of delay in filing cross-objections and substantive treatment of educational cess under section 40(a)(ia)Allowability of leave encashment under payment basis and interplay with section 43B(f) - CIT(A)'s allowance of leave encashment on the basis of actual payments was upheld - HELD THAT: - The Tribunal reviewed the CIT(A)'s finding that leave encashment could be accepted on the basis of actual payments and noted the CIT(A)'s reliance on the jurisdictional High Court decision quashing the relevant statutory provision as ultra vires and its stay in the Supreme Court. The Revenue did not successfully demonstrate illegality or irregularity in the CIT(A)'s approach of accepting the claim on payment basis under section 43B(f). The Tribunal found no infirmity and dismissed Revenue's grievance on this issue.Allowance of leave encashment by CIT(A) on payment basis affirmedQuantification of disallowance under section 14A read with Rule 8D - direct expenses, proportionate interest and administrative overheads - binding effect of Settlement Commission orders as precedent by way of voluntary settlement - Partial interference: (a) suo moto direct expense disallowances offered by assessee were upheld; (b) proportionate interest disallowance under Rule 8D(2)(ii) deleted where interest free/own funds exceed interest bearing funds; (c) administrative overhead disallowance under Rule 8D(2)(iii) to be recomputed by AO limited to exempt income yielding investments (direction to restrict to 3% only rejected as precedent binding) - HELD THAT: - The Tribunal accepted that Rule 8D provides the formulaic quantification for section 14A disallowances from AY 2008 09 onwards. It upheld the assessee's suo moto direct expense figures (first limb). For the interest proportion limb, the Tribunal followed coordinate bench and High Court precedents holding that proportionate interest disallowance is not called for where an assessee's interest free/own funds exceed interest bearing funds; thus the AO's invocation of Rule 8D(2)(ii) was declined. On administrative overheads under Rule 8D(2)(iii), the Tribunal held only investments yielding exempt income are to be included and restored computation to the AO for reassessment on that basis; it disagreed that the Settlement Commission's voluntary order is a binding precedent to restrict disallowance to 3% and therefore reversed the CIT(A)'s reliance on that as a binding rule while directing the AO to compute administrative disallowance limited to exempt income investments.Suo moto direct expense amounts upheld; interest proportion disallowance deleted; administrative overhead disallowance restored to AO for recomputation limited to exempt income investments (not bound by Settlement Commission as precedent)Allowance of additional depreciation under section 32(1)(iia) - carry forward of balance when asset first put to use for less than 180 days - CIT(A)'s allowance of the remaining additional depreciation in the subsequent year was affirmed - HELD THAT: - The Tribunal agreed with the CIT(A) that additional depreciation under section 32(1)(iia) is a mandatory allowance and where assets were first put to use for less than 180 days leading to a reduced allowance in the earlier year, the balance additional depreciation is claimable in the immediately succeeding year. The tribunal relied on Explanation 5 to section 32 and consistent Tribunal precedent to hold the claim admissible even though raised first at appellate stage.Balance additional depreciation allowed in the relevant assessment year; CIT(A)'s direction to AO affirmedWhether corporate guarantee is an 'international transaction' under section 92B - CIT(A)'s conclusion that corporate guarantees constituted shareholder activity and not an international transaction under section 92B was affirmed - HELD THAT: - The Tribunal examined authorities and found substantial precedent holding that issuance of corporate guarantees as shareholder/quasi equity activity does not have a real bearing on profits, losses or assets of the guarantor and therefore falls outside the scope of an international transaction even after the 2012 Explanation; the onus lies on tax authorities to show real impact. Given the factual matrix that guarantees were shareholder oriented to protect investments and no fee was charged, the CIT(A)'s deletion of transfer pricing adjustments was held to be correct and affirmed.Corporate guarantee not an international transaction in the facts; TPO/AO adjustment deletedBenchmarking of interest on loans/advances to associated enterprises - internal CUP and relevant LIBOR/foreign currency benchmark - CIT(A)'s acceptance of internal CUP benchmarking at 3.6% (foreign LIBOR related rate) for loans/advances to AEs was upheld - HELD THAT: - The Tribunal found the TPO's methodology (cost of funds/ROCE plus ad hoc spread) to be unsound and not one of the prescribed Rule 10B methods, and noted absence of adequate disclosure and hearing. It followed coordinate precedents that foreign currency denominated inter company loans are appropriately benchmarked to the relevant currency LIBOR (or the actual arm's length borrowing rate), and the assessee had demonstrated 3.6% as the applicable rate. The AO/TPO's higher imputation was therefore set aside.Internal CUP at 3.6% accepted as ALP; TPO/AO adjustments deletedAllowability of provision for foreseeable losses on construction contracts under accounting standard AS-7 and section 37 principles - Provision for foreseeable contract losses made in conformity with AS 7 was held deductible; AO's disallowance as contingent liability was rejected - HELD THAT: - The Tribunal endorsed CIT(A)'s reliance on AS 7 and precedent (Mazagon Dock, ITD Cementation, etc.) holding that where, on reasonable and technical estimates, foreseeable losses on fixed price contracts exist, prudence requires immediate provisioning and such provisions are allowable deductions. The AO neither disproved the basis nor showed the provision was speculative; subsequent realization of losses further supported the allowance.Provision for foreseeable losses allowed; AO directed to recompute income accordinglyDeductibility of employees' PF/ESI contributions where paid before due date of filing return - Disallowance under section 36(1)(via) was deleted where contributions were deposited before due date of filing return - HELD THAT: - Following the jurisdictional High Court authority, the Tribunal held that statutory disallowance under section 36(1)(via) does not apply if PF/ESI contributions were deposited before the due date for filing the return. The facts showed timely deposit and the CIT(A)'s deletion was therefore affirmed.PF/ESI disallowance deleted; CIT(A) affirmedTreatment of mark-to-market loss on derivatives (AS-11) - real v. notional loss - MTM loss on interest rate hedging derivatives held to be real and deductible; AO's disallowance under CBDT Instruction rejected - HELD THAT: - The Tribunal agreed with CIT(A) that the MTM loss arose from a hedging arrangement tied to revenue bearing borrowings and falls within AS 11. Supreme Court and Tribunal precedents (e.g., Woodward Governor) treat revaluation losses on outstanding foreign currency/derivative contracts as real rather than notional. CBDT Instruction No.3/2010 was contrary to that ratio and could not override judicial authority; the MTM loss was allowed for normal and MAT computations.MTM derivative loss allowed for tax and MAT computations; AO's disallowance set asideOnus and evidentiary standard for genuineness of payments to third-party service providers - AO's disallowance of payment to alleged shell/payee was deleted where assessee produced contemporaneous documentary evidence and payments routed through banking channels - HELD THAT: - The Tribunal affirmed CIT(A) that where the assessee produced invoices, service tax registration, TDS certificates and banking evidence, and where the payee was later struck off after the transaction, adverse inference of bogusness cannot be drawn absent cogent contrary material. Precedent (Inbuilt Merchant, Nangalia Fabrics, etc.) supports that books and documentary evidence maintained in ordinary course discharge the onus.Disallowance in respect of payment to M/s Rajshila Nirman Pvt. Ltd. deletedReal-income principle versus book entries for notional interest where debtor is non performing - Addition of notional/penal interest on loans to a defaulting borrower was deleted where no real income accrued and entries were unilateral by debtor and subsequently reversed - HELD THAT: - Applying authoritative Supreme Court and High Court precedents, the Tribunal held that mere book entries in the debtor's accounts (and TDS reflected in Form 26AS) do not convert hypothetical or contingent amounts into real taxable income of the creditor. Facts showed the borrower was sick, penal interest was never demanded or realised, and was later reversed by agreement; therefore no accrual of real income to the assessee occurred and the AO's addition was unsustainable.Notional interest addition deleted; CIT(A) affirmedCondonation of delay in filing cross-objections and substantive treatment of educational cess under section 40(a)(ia) - Delay in filing cross objections condoned on merits; cross objections allowing deletion of disallowance for educational cess under section 40(a)(ia) were accepted - HELD THAT: - The Tribunal condoned the 166 day delay in filing cross objections in the interest of substantial justice and then followed recent coordinate and High Court decisions holding that statutory provisions and CBDT guidance on withholding tax under section 40(a)(ia) do not extend to educational cess; accordingly the CIT(A)'s deletions were to be given effect and the AO directed to finalise computations accordingly.Delay condoned; educational cess disallowance under section 40(a)(ia) deleted and cross objections allowedFinal Conclusion: The Tribunal disposed of the appeals by partly allowing certain Revenue grounds for statistical purposes but largely upholding the CIT(A)'s deletions and allowances: leave encashment accepted on payment basis; Rule 8D/section 14A disallowances partly deleted (interest limb) and administrative overhead recomputed by AO limited to exempt income investments; additional depreciation allowed; corporate guarantee TP adjustments deleted; internal CUP (3.6%) ALP for inter company loans accepted; provisions for foreseeable contract losses, PF/ESI paid before return due date, MTM derivative losses, payments to the service provider and deletion of notional interest were all held in assessee's favour; cross objections condoned and educational cess disallowances deleted. Issues Involved:1. Allowance of Leave Encashment Claims2. Section 14A/Rule 8D Disallowance3. Additional Depreciation Disallowance4. ALP Adjustment for Corporate Guarantee5. ALP Adjustment for Interest on Loans to AEs6. Provision for Foreseeable Loss in Contract Revenue7. Disallowance of Employees' Contribution to PF & ESI8. Provision for Market-to-Market Loss on Derivative Transactions9. Disallowance of Management Consultancy Services Payment10. Notional Interest Income Addition11. Educational Cess DisallowanceDetailed Analysis:1. Allowance of Leave Encashment ClaimsThe Revenue's appeals challenged the CIT(A)'s action allowing leave encashment claims on a payment basis. The CIT(A) relied on the jurisdictional High Court's decision in Exide Industries Ltd. vs. Union of India, which quashed the statutory provision as ultra vires. The Tribunal found no irregularity in the CIT(A)'s decision, rejecting the Revenue's grievance.2. Section 14A/Rule 8D DisallowanceThe Revenue contested the CIT(A)'s restriction of disallowance under Section 14A/Rule 8D to 3% of dividend income. The Tribunal noted that the CIT(A) followed the Income Tax Settlement Commission's order for earlier years. However, the Tribunal reversed the CIT(A)'s findings, emphasizing the statutory formula under Rule 8D(2)(ii) and (iii) and remanded the matter to the Assessing Officer for re-computation.3. Additional Depreciation DisallowanceThe CIT(A) allowed the assessee's claim for additional depreciation on machinery used for less than 180 days in the preceding year. The Tribunal upheld the CIT(A)'s decision, noting that the issue was settled by various judicial precedents, including the jurisdictional ITAT's decisions.4. ALP Adjustment for Corporate GuaranteeThe Revenue challenged the CIT(A)'s deletion of ALP adjustments for corporate guarantees. The CIT(A) held that corporate guarantees do not amount to international transactions. The Tribunal affirmed this view, citing various judicial precedents, including the ITAT's decision in Bharti Airtel Limited vs. Addl. CIT, which held that corporate guarantees provided without cost do not constitute international transactions.5. ALP Adjustment for Interest on Loans to AEsThe CIT(A) deleted the ALP adjustments for interest on loans to AEs, applying the LIBOR rate as the benchmark. The Tribunal upheld the CIT(A)'s decision, noting that the assessee's interest rates were higher than those for third-party comparables and that the TPO's methodology was inappropriate.6. Provision for Foreseeable Loss in Contract RevenueThe CIT(A) deleted the disallowance of provisions for foreseeable losses, which were made in compliance with AS-7. The Tribunal affirmed the CIT(A)'s decision, citing judicial precedents that support the recognition of such provisions under the principle of prudence.7. Disallowance of Employees' Contribution to PF & ESIThe Revenue's disallowance of employees' contributions to PF & ESI was deleted by the CIT(A), as the contributions were deposited before the due date of filing the return. The Tribunal upheld this decision, citing the jurisdictional High Court's ruling in Commissioner of Income Tax vs. M/s Vijay Shree Ltd.8. Provision for Market-to-Market Loss on Derivative TransactionsThe CIT(A) allowed the provision for market-to-market losses on derivative transactions, treating them as real losses. The Tribunal affirmed this view, referencing the Supreme Court's decisions in CIT vs. Woodward Governor India P. Ltd. and other judicial precedents.9. Disallowance of Management Consultancy Services PaymentThe CIT(A) deleted the disallowance of payments made for management consultancy services, holding that the transactions were substantiated with proper documentation. The Tribunal upheld this decision, citing the jurisdictional High Court's decision in CIT vs. Inbuilt Merchant Pvt. Ltd.10. Notional Interest Income AdditionThe CIT(A) deleted the addition of notional interest income, as the penal interest was not demanded or received by the assessee. The Tribunal affirmed this decision, emphasizing the principle of real income and citing relevant judicial precedents.11. Educational Cess DisallowanceThe Tribunal condoned the delay in filing the assessee's cross objections and allowed the claim for educational cess disallowance, following the Rajasthan High Court's judgment in Chambal Fertilizers & Chemicals Ltd. and other judicial precedents.Conclusion:The Tribunal partly allowed the Revenue's appeals for statistical purposes and fully allowed the assessee's cross objections, directing the Assessing Officer to recompute the disallowances accordingly.