2016 (9) TMI 1684 - AT - Income Tax

ITAT allows employee housing depreciation, restricts Section 14A disallowance to 2% of exempt income, remands transfer pricing matters

ITAT Chennai-AT rendered multiple decisions on various tax issues. The tribunal upheld disallowance of management fees under Section 35D(2)(c)(iv) and ... Deduction u/s 35D(2)(c)(iv) - disallowance of management fees paid to the lead managers - HELD THAT:- As in our opinion the lower authorities taken a correct view of the fact of the assessee’s case and disallowed management fees paid to the lead managers. It does not fall under the provisions of Sec. 35D(2)(c) (iv) of the Act. Accordingly, the ground of the assessee is dismissed. Deduction u/s. 80HHC - DR submitted that the only expenditure incurred to earn these income to be reduced from the gross rent or interest not the rent or interest have no nexus with this income - HELD THAT:- The Supreme Court in the case of ACG Associated Capsules (P) Ltd [2012 (2) TMI 101 - SUPREME COURT] wherein held that ninety per cent of not the gross rent or gross interest but only the interest or net rent, which had been included in the profits of business of the assessee as computed under the head ‘’Profits and gains of business or profession’’, was to be deducted under clause (1) of Explanation (baa) to Sec. 80HHC for determining the profits of the business.‘’ In view of the above judgment 90% of the net interest which have been included in the profits of the business of the assessee under the head income from business to be excluded for the purpose of applying clause (1) to Explanation (baa) to Sec. 80HHC of the Act. The same is applicable in the case of rent if the rent payment is included as business expenditure of the assessee. With these observations, we remit the issue to the file of the ld. Assessing Officer for re-computation after giving an opportunity to the assessee. TP Adjustment - transactions entered into with the associated enterprises based on the data annexed to the form 3CEB filed on 31.10.2005 - HELD THAT:- Similar issue came for consideration before this Tribunal in assessee’s own case for assessment year 2006-2007 [2016 (2) TMI 1278 - ITAT CHENNAI] as held Chartered Accountant report is based on the Audited books of accounts maintained by the assessee were the international transaction have been incorporated and are authenticated. The report of the Chartered Accountant cannot be ruled out and also factual position has to be considered to correct any mistake in calculating of Arms Length Price(ALP) for valuation, and it is evident that the revised form 3CEB includes the proper comparables in respect of vehicles, parts which are integral product of commercial vehicles. Though ld. Departmental Representative vehemently argued against filing of revised form 3CEB and limitation period, we consider the apparent facts, provisions of law, evidence and the action of TPO in rejecting the revised form 3CEB is not proper as factual comparables certified by the Chartered Accountant in Revised form 3CEB cannot be ignored and we in the interest of justice, remit the disputed issue to the file of the Assessing Officer and to consider Revised form 3CEB filed by the assessee for assessment and calculation of Arms Length Price. Further the AO should provide adequate opportunity of hearing to the assessee and pass the order. Disallowance by wrongly assuming that the claim is the balance of 50% of additional depreciation u/s. 32(iia) in the current year in respect of the assets acquired in the 2nd half of preceding year - HELD THAT:- Similar issue came for consideration before this Tribunal in assessee’s own case for assessment year 2006-2007 [2016 (2) TMI 1278 - ITAT CHENNAI] as held on perusal of provisions u/s. 32(1)(iia) of the Act and the decisions relied by the assessee which are in leasing business and cannot be brought into category of manufacture of commercial vehicles. The provisions are very clear on this issue. The claim of additional depreciation is in violation of provisions u/s. 32 of the Act were deprecation is allowed. We are of the opinion that the decisions relied by the assessee are not directly on the issue and distinguishable and additional deprecation on leased asset does not fit into the provisions of the Act and we uphold the findings and order of the Assessing Officer on this ground and allow the ground in favour of the Revenue. Disallowance of depreciation restricted to 5% on residential buildings - This issue was considered by the Tribunal for the assessment year 2000-01 as held on the perusal of the CSDT Instructions/letter, we find that no such distinction is made. In our opinion, the Circular/letter issued ambiguous language and no second interpretation is required. We, therefore/hold that the AO was not justified in restricting the depreciation to 5% in respect of the five residential flats which are used by the employees of the assessee company. We, therefore, allow ground no.2 in favour of the assessee and on this issue set aside the order of CIT (Appeals). Disallowance of foreign currency convertible notes issue expenses as it goes to increase the capital base of the company - HELD THAT:- Expenditure incurred on issue of debentures whether convertible or non convertible is allowable as Revenue expenditure. Nature of receipts - treating the exchange gain on FCNN as Revenue Receipts - HELD THAT:- The issue was covered by the judgment of Supreme Court in the case of CIT vs. Woodward Governor India P. Ltd [2009 (4) TMI 4 - SUPREME COURT] were it was held that increase or decrease in liability for repayment of foreign loan in respect of acquisition of an asset has to be taken into account to modify the figure of the actual cost in the year in which the increase or decrease in liability arises on account of fluctuation of foreign exchange rates, irrespective of the date of actual payment in foreign currency. This is as per pre-amended provisions of Sec 43A of the Act before 1st April, 2003. However, after amendment the aforesaid increase or decrease only to be considered only at the time of making the actual payments. However, even the amendment would not change the character of the receipt. In other words, the income arises out of the transaction relating to the capital assets then it is only a capital receipt not to be treated in Revenue field so, as to tax the same as income of the assessee. In view of this, we are inclined to hold that the income from exchange fluctuation on FCCN to be treated as capital receipts. This ground raised by the assessee is allowed. Interest u/s. 220(2) charged - HELD THAT:- In our opinion filing of stay petition cannot disentitle the Department from charging interest u/s. 220(2) of the Act. Accordingly, we do not finding any merit in the argument of the ld. Authorised Representative. This ground of the assessee is dismissed. Disallowance of additional deprecation on leased assets - HELD THAT:- Tribunal in assessee’s own case for assessment year 2006-2007 [2016 (2) TMI 1278 - ITAT CHENNAI] as held on perusal of provisions u/s. 32(1)(iia) of the Act and the decisions relied by the assessee which are in leasing business and cannot be brought into category of manufacture of commercial vehicles. The provisions are very clear on this issue. The claim of additional depreciation is in violation of provisions u/s. 32 of the Act were deprecation is allowed. We are of the opinion that the decisions relied by the assessee are not directly on the issue and distinguishable and additional deprecation on leased asset does not fit into the provisions of the Act and we uphold the findings and order of the Assessing Officer on this ground and allow the ground in favour of the Revenue. Disallowance of additional deprecation on assets eligible for 100% depreciation and put to use for less than 180 days - HELD THAT:- Tribunal in assessee’s own case for assessment year 2006-2007 [2016 (2) TMI 1278 - ITAT CHENNAI] as held since the asset was purchased during the second half of financial year 2004-05 and only 50% of depreciation was allowed and pleaded for carry forward of balance 50% to be claimed in the assessment year 2006-07. On perusal of the judicial decisions and objections of Finance Minister speech Additional depreciation has to be allowed only in the case of new plant and machinery and not WDV value on subsequent years. Disallowance of depreciation on Aircraft - HELD THAT:- In our opinion if the Aircraft is kept ready for use for the business purpose, the assessee is entitled for depreciation. Before us, the ld. Authorised Representative submitted that Aircraft was kept ready for usage and permission from Director General of Civil Aviation is not necessary for assessee’s own use but giving the Aircraft on hire to others it requires permission. In our opinion whether specific licence to use the Aircraft for assessee’s own business purpose is required or not to be required to be examined by Assessing Officer to so as to grant depreciation. Accordingly, AO is directed to examine the issue afresh and decide accordingly. This ground of the assessee is partly allowed for statistical purpose. Disallowance u/s. 14A - HELD THAT:- We direct the AO to disallow 2% of exempt income as disallowance u/s. 14A of the Act. This ground of the assessee is partly allowed. Addition on account of difference in Arm’s Length Price - HELD THAT:- As assessee is not able to show that the price variation was less than 5% when individual transaction were compared. Since, the price variation is more than 5% of tolerable limit, the addition made by the lower authorities is justified. This ground of the assessee is rejected. Disallowance of weighted deduction on R & D expenditure covered u/s. 43B - HELD THAT:- According to AR the provisions of Sec. 43B will not apply in computation of weighted deduction u/s. 35D of the Act. In our opinion, the provision of Sec. 43B(f) is applicable only on actual payment, it is to be allowed. However, we are of the opinion that on actual payment basis the claim to be allowed in the relevant assessment year. This ground of the assessee is partly allowed. Addition of capital creditors written back - HELD THAT:- Provisions of Sec. 43(1) of the Act cannot be applied in respect of capital receipts written back. The trading liability written back is only to be considered as income of the assessee in terms of Sec. 43(1) of the Act. Hence, this ground of the assessee is allowed. Disallowance of expenditure on software licence u/s. 40(a)(i) /40(a) (ia) - as observed that it is the responsibility of the payer to deduct tax on the acquisition of the software licences & during the payments on the receipt of computer related series as per the provisions of Chapter XVII-B and assessee has not complied with Chapter XVII B - HELD THAT:- In our opinion this is purchase of software which is in a nature of capital asset. Hence, the assessee is entitled for deprecation at prescribed rates, the issue is remitted to Assessing Officer for fresh consideration. Difference in Arm’s Length price - HELD THAT:- In our opinion the plea of the assessee is justified. Accordingly, we hold that the assessee is entitled for volume discount in respect of sale of spare parts. Regarding guarantee commission as it was held by the Co-ordinate Bench of the Tribunal in the case of Redington India Ltd (cited supra) that the corporate guarantee issued for benefit of AE does not involve any cost to the assessee and does not have any bearing profit, income and loss of assets of the assessee. Therefore, it was outside the ambit of international transaction to which ALP adjustment can be made. Accordingly, this ground of the assessee is allowed. Weighted deduction u/s. 35(2AB) for the entire period from 01.04.2004 to 31.03.2005 as against the allowance made by AO for the period from 21.09.2004 to 31.03.2005 on the basis of notification no.245/2004/ SO/1021(E) dated 21.09.2004 - CITA(A) allowed claim - HELD THAT:- As going through the above order of the Commissioner of Income Tax (Appeals), the Commissioner of Income Tax (Appeals) has rightly observed that though the notification has come into effect on 21.09.2004 but it is to be applicable for the full previous year relevant to assessment year 2005-2006. Accordingly, we confirm the findings of the ld. Commissioner of Income Tax (Appeals) on this issue. This ground of the Revenue is dismissed. Disallowance of warranty provision - HELD THAT:- The warranty provisions should be based on actuarial valuation or to be based on scientific method. The ld.CIT(A) relied on the judgment of Supreme Court in the case of Rotark Control India Ltd. [2007 (2) TMI 200 - MADRAS HIGH COURT] without examining the basic on which the royalty was provided for. Accordingly in the interest of justice, we remit the issue to the file of the ld. Assessing Office. Wealth Tax paid in respect of business assets allowable expenditure even as per the explanation to Sec. 40(a)(iia) of the Act - HELD THAT:- As decided in own case [2016 (2) TMI 1278 - ITAT CHENNAI] as held Authorised Representative are not convincing and the provisions are very clear u/s. 40(iia) as any sum paid on account of Wealth Tax is not deductable. Considering the apparent facts, we confirm the disallowance of the AO and dismiss the assessee ground’. Additional depreciation on the computer system installed in the factory premises - whether the computer system is entitle for higher depreciation @ 60% and cannot be considered as the part of the plant and machinery for claiming additional depreciation? - HELD THAT:- As decided in own case [2016 (2) TMI 1278 - ITAT CHENNAI] on perusal of provisions u/s. 32(1)(iia) of the Act and the decisions relied by the assessee which are in leasing business and cannot be brought into category of manufacture of commercial vehicles. The provisions are very clear on this issue. The claim of additional depreciation is in violation of provisions u/s. 32 of the Act were deprecation is allowed. We are of the opinion that the decisions relied by the assessee are not directly on the issue and distinguishable and additional deprecation on leased asset does not fit into the provisions of the Act and we uphold the findings and order of the Assessing Officer on this ground and allow the ground in favour of the Revenue. Section 40(a)(i) applicability in respect of income accrued to non-residents on conversion of foreign currency convertible notes(FCCN) - HELD THAT:- Plain reading of Sec. 47(x) r.w.s. 49(2A) of the Act does not specify transfer on conversion of FCCN to shares and it cannot be said that the assessee incurred any expenditure so as to deduct TDS u/s. 40(a)(i) of the Act and accordingly, deletion by the Commissioner of Income Tax (Appeals) is justified. This ground of the Revenue is rejected. 1. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered by the Tribunal across the various appeals include:Whether the expenditure incurred on management fees and selling commission paid to lead managers in connection with Euro issue qualifies for deduction under section 35D(2)(c)(iv) of the Income-tax Act.Interpretation and applicability of section 35D regarding amortisation of preliminary expenses, particularly in the context of expansion or extension of industrial undertakings.Whether the 90% exclusion under Explanation (baa) to section 80HHC should apply to gross interest and rent or only to net interest and rent.Determination and treatment of Arm's Length Price (ALP) adjustments in transfer pricing assessments, including the validity of revised Form 3CEB submissions and the application of the 5% tolerance limit.Allowability of additional depreciation under section 32(1)(iia) on leased assets and assets put to use for less than 180 days.Allowability of depreciation on residential buildings and treatment of depreciation rates applicable thereto.Whether foreign currency convertible notes (FCCN) issue expenses are capital or revenue expenditure.Tax treatment of exchange gains arising on FCCN, whether to be treated as revenue receipts or capital receipts.Allowability of depreciation on aircraft used by the assessee, including the necessity of DGCA licence and maintenance of log books to prove exclusive business use.Tax treatment of capital creditors written back and whether such amounts should be treated as income under section 41(1).Disallowance of expenditure on software licences under sections 40(a)(i) and 40(a)(ia) for failure to deduct tax at source.Applicability of disallowance under section 14A and Rule 8D regarding expenditure incurred to earn exempt income.Allowability of weighted deduction under section 35(2AB) in light of provisions of section 43B and related notifications.Tax treatment of warranty provisions and whether such provisions constitute allowable expenditure under section 37.Allowability of wealth tax paid on business assets as deductible expenditure.Whether conversion of FCCN to shares results in income attracting tax deduction at source under section 40(a)(i).2. ISSUE-WISE DETAILED ANALYSISIssue 1: Deductibility of Management Fees and Selling Commission under Section 35D(2)(c)(iv)The legal framework revolves around section 35D(2)(c)(iv) which allows amortisation of certain preliminary expenses including underwriting commission, brokerage, and charges for drafting, typing, printing, and advertisement of the prospectus. The assessee claimed deduction for fees paid to lead managers and selling commission related to Euro issue expenses.The Tribunal examined the agreement which provided for a combined management and underwriting commission of 1.25% of the issue proceeds. The Assessing Officer (AO) allowed only 50% of this amount as underwriting commission for amortisation, disallowing the management fees portion.The Tribunal relied heavily on the Madras High Court decision in the assessee's own case, which clarified that only those expenses explicitly mentioned in section 35D(2)(c)(iv) are allowable. The Court held that management commission is not covered under this section and hence disallowance of management fees was justified. The Tribunal rejected the assessee's contention equating selling commission and management commission with underwriting commission.Competing arguments included the assessee's reliance on judicial precedents equating expansion and extension of business for claiming amortisation and the Department's insistence on strict adherence to statutory language. The Tribunal concluded that the lower authorities correctly restricted the deduction to underwriting commission and related expenses only.Issue 2: Application of Explanation (baa) to Section 80HHC - Deduction on Interest and RentThe assessee contended that the 90% exclusion under Explanation (baa) to section 80HHC should be applied on net interest and rent rather than gross amounts. The Supreme Court decision in ACG Associated Capsules Ltd was cited in support.The Tribunal noted that the Supreme Court held that 90% exclusion applies to the net interest or rent included in business profits, not the gross. The Department argued that only expenditure incurred to earn such income should be reduced.The Tribunal remitted the issue to the AO for recomputation in accordance with the Supreme Court ruling, allowing the assessee's contention partly.Issue 3: Transfer Pricing - Determination of Arm's Length Price and Revised Form 3CEBThe AO, based on the TPO's order, made adjustments to the ALP on individual transactions exceeding the 5% tolerance limit. The assessee argued that the 5% tolerance should apply to aggregate transactions with the associated enterprise, not each transaction separately, and that revised Form 3CEB submitted before completion of assessment should be considered.The Tribunal referred to its earlier decision in the assessee's own case where it held that the TPO erred in rejecting the revised Form 3CEB on limitation grounds and that revised submissions with proper comparables should be considered. It remitted the matter to the AO for fresh consideration with opportunity to the assessee.Regarding the 5% tolerance, the Tribunal upheld the AO's approach that price variation exceeding 5% on individual transactions justifies adjustment.Issue 4: Additional Depreciation on Leased Assets and Assets Used Less Than 180 DaysThe Tribunal consistently held that additional depreciation under section 32(1)(iia) is not allowable on leased assets as the assessee is in manufacturing business and leased assets do not qualify as plant and machinery for this purpose. Similarly, for assets used less than 180 days, only 50% additional depreciation is allowable with the balance to be claimed in subsequent years.Issue 5: Depreciation on Residential BuildingsThe Tribunal rejected the AO's restriction of depreciation at 5% on residential flats used by employees, holding that the circular relied on by AO was ambiguous and no distinction was made between employees' quarters within factory premises and residential flats away from factory. Depreciation was allowed at normal rates.Issue 6: Foreign Currency Convertible Notes (FCCN) - Issue Expenses and Exchange GainsThe AO disallowed FCCN issue expenses as capital expenditure related to capital base expansion. The Tribunal referred to judicial precedents that issue expenses on debentures, whether convertible or non-convertible, are revenue in nature and allowable. Hence, the claim was allowed.Regarding exchange gains on FCCN, the AO treated gains as revenue receipts since funds were not yet used for capital asset acquisition. The Tribunal distinguished between capital and revenue receipts based on actual use and held that gains arising from exchange fluctuations on FCCN should be treated as capital receipts once the funds are applied to capital assets. Accordingly, the Tribunal allowed the assessee's claim treating such gains as capital receipts.Issue 7: Depreciation on AircraftThe AO disallowed depreciation on aircraft on grounds that the assessee did not maintain log books as required under Aircraft Rules and did not have DGCA licence for non-scheduled operator during the relevant year. The Commissioner of Income Tax (Appeals) upheld this.The Tribunal observed that permission from DGCA is required only for commercial operation, not for own business use. The Tribunal directed the AO to examine the issue afresh considering whether the aircraft was kept ready for business use and whether licence was necessary for such use. The ground was partly allowed for statistical purpose.Issue 8: Capital Creditors Written BackThe AO added amounts written back relating to capital creditors to income under section 41(1) on the ground that cessation of liabilities constitutes income. The assessee contended that since the creditors were capital in nature, the amount should be adjusted against block of assets.The Tribunal held that section 43(1) applies only to trading liabilities and that capital creditors written back should be treated as income under section 41(1). The addition was sustained.Issue 9: Disallowance of Software Licence Expenditure under Sections 40(a)(i) and 40(a)(ia)The AO disallowed software licence expenses for failure to deduct tax at source, treating payments as royalty under Explanation 4 to section 9(1)(vi). The assessee argued that payments were for operational software and only right to use was acquired, not copyright, thus not royalty.The Commissioner of Income Tax (Appeals) rejected this, relying on judicial precedents that software licence payments are royalty and subject to TDS. The Tribunal remitted the issue to AO for fresh consideration, observing that software is a capital asset eligible for depreciation and the nature of payments requires detailed examination.Issue 10: Disallowance under Section 14A and Rule 8DThe Tribunal held that disallowance under section 14A for expenditure incurred to earn exempt income should be limited to 2% of exempt income as Rule 8D applies only from assessment year 2008-09 onwards. The AO's higher disallowance was set aside.Issue 11: Allowability of Weighted Deduction under Section 35(2AB) vis-`a-vis Section 43BThe AO disallowed weighted deduction claimed on provisions for leave encashment and gratuity under section 35(2AB) due to non-payment as per section 43B. The Tribunal held that weighted deduction can be claimed only on actual payment basis and not on mere provisions, partly allowing the claim.Issue 12: Warranty ProvisionsThe AO disallowed warranty provisions as contingent liabilities. The Commissioner of Income Tax (Appeals) allowed the claim relying on Supreme Court decision affirming allowability under section 37. The Tribunal remitted the issue for fresh examination to ensure provisions are based on actuarial or scientific method.Issue 13: Wealth Tax on Business AssetsThe Tribunal upheld the AO's disallowance of wealth tax paid on business assets as deductible expenditure under section 40(a)(iia), consistent with earlier decisions.Issue 14: Conversion of FCCN to Shares and TDS under Section 40(a)(i)The AO disallowed expenditure for failure to deduct tax on income accrued to non-residents on conversion of FCCN to shares. The Commissioner of Income Tax (Appeals) and Tribunal held that conversion does not amount to transfer or income accruing to note holders and hence no TDS obligation arises under section 40(a)(i).3. SIGNIFICANT HOLDINGS'Only those expenses which are specified in the statute could be allowed and nothing else. The observations of the High Court are as under: 'The expenditure that qualified for consideration under Section 35D is restricted by reason of use of the phrase 'being'. Thus expenditure incurred in connection with the issue of shares and debentures of the company to public subscription, which qualify for consideration under Section 35D, are underwriting commission, brokerage and charges for drafting, typing, printing and advertisement of the prospectus and nothing more.'''The Supreme Court in the case of ACG Associated Capsules Ltd held that ninety per cent of not the gross rent or gross interest but only the interest or net rent, which had been included in the profits of business, was to be deducted under Explanation (baa) to Section 80HHC.''The Tribunal held that the TPO erred in rejecting the revised Form 3CEB on limitation grounds and that revised submissions with proper comparables should be considered. It remitted the matter to the AO for fresh consideration.''Additional depreciation under section 32(1)(iia) is not allowable on leased assets as the assessee is in manufacturing business and leased assets do not qualify as plant and machinery for this purpose.''Depreciation on residential flats used by employees is allowable at normal rates; restriction to 5% is not justified.''Issue expenses on foreign currency convertible notes are revenue expenditure and allowable.''Exchange gains on FCCN are to be treated as capital receipts once the funds are applied to capital assets; until then, gains are revenue in nature.''Depreciation on aircraft is allowable if the aircraft is kept ready for business use; requirement of DGCA licence for own use is to be examined afresh.''Capital creditors written back are income under section 41(1) and not to be adjusted against block of assets.''Software licence payments are in the nature of royalty and subject to TDS; however, the nature of expenditure and capitalisation requires detailed examination.''Disallowance under section 14A should be limited to 2% of exempt income where Rule 8D is not applicable.''Weighted deduction under section 35(2AB) is allowable only on actual payments as per section 43B.''Warranty provisions are allowable expenditure if based on actuarial or scientific method.''Wealth tax on business assets is not deductible.''Conversion of FCCN to shares does not attract TDS under section 40(a)(i) as no income accrues to note holders.''The Tribunal consistently remitted issues for fresh consideration where factual and legal complexities required detailed examination, ensuring fair opportunity to the assessee.'