2022 (9) TMI 1681 - AT - Income Tax

Order upholds assessee's transfer pricing analyses, rejects TPO adjustments; remands expenses, applies 1% Section 14A, notes Rule 8D

M/s. Mahindra Homes Pvt. Ltd. Versus Addl. /Joint/Deputy/Assistant Commissioner of Income Tax/Income Tax Officer, National e-Assessment Centre, Delhi.

ITAT upheld that the TPO's selection of comparables and rejection of the assessee's primary and secondary ALP analyses was not sustainable and, in view of ... Transfer pricing adjustment - Interest paid on Compulsorily Convertible Debentures (CCDs) to Associated Enterprises (AE) - Most Appropriate Method (MAM) - determination of ALP as well as secondary analysis done using RBI term loan lending rate - funds from its shareholders for the land acquisition through issuance of debentures - Joint Venture arrangement between Mahindra Lifespace Developers Limited (MLDL) and SCM Real Estate (Singapore) Private Limited (SCM Real Estate) - activity of developing residential projects in India - Assessee on without prejudice basis, also underwent secondary analysis by using RBI term loan lending rates on a quarterly basis in respect of advances other than export credits and concluded that even on secondary analysis, its interest payment to AE was at ALP, as the said rates were in the range of 16 to 19%. HELD THAT:- The ld. TPO rejected the primary economic analysis of the assessee on BSE, NSE, NSDL and Bloomberg databases for the determination of ALP as well as secondary analysis done using RBI term loan lending rates. TPO as per section 92C(3) of the Act did not exist in the instant case. The ld. TPO selected SVOGL Oil & Gas Energy Ltd and Soma Enterprises Ltd as comparables and determined the ALP of the international transaction of the assessee. We find that the ld. DRP also followed its earlier order passed for the A.Y. 2014-15 vide para 6.2.2. of its directions and upheld the action of the ld. TPO. We find that this Tribunal in assessee’s own case for the A.Y. 2014-15 in ITA [2022 (12) TMI 527 - ITAT MUMBAI] dated 03/08/2022 had rejected the two comparables chosen in A.Y. 2014-15 and deleted the entire transfer pricing adjustment made by the ld. TPO. Allowability of legal & professional charges, advertisement & sales promotion expenses and Commission & brokerage charges - ld. AR submitted that the indirect revenue expenses incurred towards legal and professional charges, advertising and sales promotion and commission & brokerage expenses should be allowed as deduction u/s 37(1) of the Act once it is proved that they are incurred for the purpose of business of the assessee - HELD THAT:- It is not in dispute that the expenditures incurred by the assessee were incurred wholly and exclusively for the purpose of business only. What is required to be analysed here is as to whether they are connected with the project or to be allowed as general administrative and selling costs. In any event, allowing revenue expenditure to the extent of 42.08% of relevant expenditure is grossly incorrect. There is absolutely no basis for the ld. AO for doing this. All said and done, the relevant expenditure has already been incurred by the assessee. Restricting the business expenditure to the extent of business income is certainly not provided in the entire scheme of the Act. Considering the totality of facts and circumstances of the case, we deem it fit and appropriate, in the interest of justice and fair play, to remand this entire issue to the file of ld. AO for adjudication. Disallowance u/s 14A - We find that the assessee had received dividends from certain mutual funds which were duly redeemed / closed during the year itself. The balance mutual funds outstanding at the balance sheet date were only growth oriented mutual funds, which would not fetch any exempt income in the form of dividend, as growth funds are aimed at achieving capital appreciation. Hence we are in agreement with the ld. AR that the computation mechanism provided in Rule 8D(2) of the Rules fails here. We hold that the computation mechanism provided in Rule 8D(2) of the Rules fails in the instant case and hence no disallowance u/s 14A of the Act need to be done in the instant case by applying Rule 8D(2) of the Rules. However, the purpose of section 14A of the Act is only to ensure that no expenses are claimed as deduction against the exempt income. Admittedly, the assessee had earned exempt income during the year. Hence some expenditure is definitely to be disallowed u/s 14A of the Act thereon. Accordingly, we feel that the disallowance of administrative expenses at the rate of 1% of dividend income u/s 14A of the Act would meet the ends of justice. Hence we direct the ld. AO to disallow u/s 14A of the Act under normal provisions of the Act. Accordingly, the Ground Nos. 26 to 31 are partly allowed. Disallowance u/s 14A of the Act while computing book profits u/s 115JB - HELD THAT:- This disallowance is done as per the computation mechanism provided in Rule 8D(2) of the Rules. We have already held that computation mechanism provided in Rule 8D(2) of the Rules fails in the instant case. In any case, no disallowance could be made in terms of clause ‘f’ of Explanation 1 to section 115JB(2) of the Act by applying the computation mechanism provided in Rule 8D(2) of the Rules. Hence the Ground No. 32 raised by the assessee is partly allowed. Non-granting of set-off of unabsorbed depreciation as per the computation sheet - HELD THAT:- In the computation sheet accompanying the final assessment order passed by the ld. AO pursuant to be directions issued by ld. DRP, the ld. AO had failed to grant credit for the said unabsorbed depreciation brought forward against the income earned from other sources. This aspect requires factual verification. Hence we direct the ld. AO to verify the same factually and decide the issue in accordance with law. Accordingly, the Ground raised by the assessee is allowed for statistical purposes. ISSUES PRESENTED AND CONSIDERED 1. Whether delay of two days in filing the appeal should be condoned in view of Covid-19-related relaxations. 2. Whether the transfer pricing adjustment in respect of interest paid on Compulsorily Convertible Debentures (CCDs) to an Associated Enterprise is sustainable - specifically: (a) whether the Comparable Uncontrolled Price (CUP) analysis conducted by the assessee using BSE/NSE/NSDL/Bloomberg and RBI term-lending rates is acceptable; (b) whether the TPO was justified in conducting a fresh Bloomberg search producing lower comparable rates; (c) whether selected comparables (including entities from Oil & Gas and Infrastructure) are appropriate; and (d) whether the CCDs can be re-characterised as loans for TP purposes. 3. Whether indirect expenditures (legal & professional fees; advertisement & sales promotion; commission & brokerage) debited to profit & loss are deductible as revenue expenses or require capitalization to inventory/work-in-progress, and if so, to what extent. 4. Whether disallowance under section 14A read with Rule 8D is properly computed where exempt dividend income arises mainly from growth-oriented mutual funds and where investments were funded by customer advances. 5. Whether a corresponding disallowance under section 14A should be made while computing book profits under section 115JB (Explanation 1(f)). 6. Whether interest under section 234A and consequential interest under section 234B were correctly levied. 7. Whether initiation of penalty proceedings under sections 271(1)(c) and 270A is premature. 8. Ancillary factual issues directed to the AO for verification: short credit of TDS, non-grant of set-off of unabsorbed depreciation. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Condonation of delay Legal framework: Procedure for condonation of delay in filing appeals is governed by relevant rules and judicial relaxation for Covid-19 interruptions. Precedent treatment: Bench applied Supreme Court/Court relaxations applicable to pandemic period. Interpretation and reasoning: The Tribunal accepted that the appeal filing deadline fell during the Covid-19 pandemic and applied the pandemic-related relaxation, finding the two-day delay excusable. Ratio vs. Obiter: Ratio (procedural decision). Conclusion: Delay condoned; appeal admitted for adjudication. Issue 2 - Transfer pricing adjustment on interest paid on CCDs (CUP vs. TPO's Bloomberg search; selection and rejection of comparables; re-characterisation) Legal framework: Transfer Pricing provisions (section 92C and relevant rules), MAM requirement, CUP method requiring high degree of comparability and consideration of Rule 10B(1)(e)(iii) adjustments (risk, functions, tenor, currency, country risk). Precedent treatment: Tribunal expressly followed an earlier coordinate Bench decision in assessee's own case for AY 2014-15 and the Bombay High Court decision in a related matter which criticized benchmarking using external databases lacking INR-denominated issuances and upheld use of domestic data and reasonable adjustments; the DRP/TPO approach (using Bloomberg comparables including non-real estate lenders) was distinguished and rejected. Interpretation and reasoning: The assessee's CUP analysis using NSE/BSE/NSDL comparables produced a mean around 18% (close to the coupon of 17.65% gross). Secondary RBI term-lending analysis supported similar rates. The TPO's fresh Bloomberg search (yielding ~8.6%) relied on comparables from dissimilar industries (Oil & Gas, Infrastructure) and external databases lacking INR-denominated instruments, resulting in significant unadjusted currency/credit/tenor distortions. Applying the jurisdictional High Court/Tribunal precedents, the Bench held that (a) reliance on Bloomberg/Thomson/DealScan without INR-denominated debt is improper where domestic comparables exist; (b) CUP requires high comparability on product characteristics, functions, contractual terms and market conditions; (c) comparables used by the TPO should be rejected if industry and functional filters (real estate filter) are not applied; and (d) TPO cannot re-characterise the nature of an instrument contrary to its accounting/contractual character without cogent reason. Ratio vs. Obiter: Ratio - deletion of TP adjustment following acceptance of assessee's CUP/RBI-based benchmarking and rejection of TPO's Bloomberg comparables; Obiter - observations on high comparability requirement and inappropriateness of external databases for INR instruments. Conclusion: TP adjustment deleted; interest on CCDs accepted at arm's length (no re-characterisation or downward adjustment upheld). Issue 3 - Allowability vs. capitalization of indirect expenses (legal & professional; advertisement & sales promotion; commission & brokerage) Legal framework: Section 37(1) - deduction if wholly & exclusively for business and not capital; Accounting Guidance Note on Real Estate Transactions (ICAI 2012) and AS-7/AS-9 principles govern accounting recognition and identification of project costs vs. general/selling overheads. Precedent treatment: Tribunal relied on applicable accounting guidance and earlier Tribunal decision in assessee's own AY 2014-15 (coordinate Bench) which allowed such expenditures as revenue in that year. Interpretation and reasoning: The AO allowed only 42.08% of the claimed expenses, capitalizing balance to project cost based on matching with recognized revenue percentage. The Tribunal found no statutory basis for restricting allowable business expenses to the percentage of revenue recognized and held that (a) direct and indirect expenses related to construction should be inventoried; (b) indirect expenses not related to construction should be allowed as revenue (general administration/selling); and (c) the AO must identify expenses directly attributable to pre-construction/construction and capitalize them, while other expenses should be allowed as revenue. Given factual complexity, the Tribunal remanded the issue to the AO for verification in light of these directions rather than deciding quantum itself. Ratio vs. Obiter: Ratio - remand with directions specifying criteria (identify directly attributable pre-construction/construction costs for capitalization; allow other expenses as revenue); Obiter - criticism of blanket application of 42.08% rule. Conclusion: Grounds allowed for statistical purposes; matter remitted to AO for factual verification and recategorisation per directions. Issue 4 - Disallowance under section 14A and applicability of Rule 8D Legal framework: Section 14A disallows expenditure in relation to exempt income; Rule 8D prescribes computation mechanism for disallowance; principle that Rule 8D may fail where its mechanics do not reflect reality. Precedent treatment: Tribunal invoked its analysis and analogue to earlier High Court decision (Calcutta) which accepted a notional 1% disallowance pre-Rule 8D; also referred to Special Bench decision (Vireet Investments) regarding inapplicability of Rule 8D for book profit computation. Interpretation and reasoning: Majority of the investments were in growth-oriented mutual funds (no dividend expected) and dividend income actually earned was limited (Rs 77,77,844). Investments were funded by customer advances/internal accruals, not borrowed funds. Tribunal held Rule 8D computation produces anomalous results in these circumstances and therefore 'fails'. Recognising that some disallowance is nonetheless warranted to accord with section 14A's object, Tribunal adopted a pragmatic approach disallowing 1% of dividend income (Rs 77,778) as administrative expenses attributable to exempt income. Ratio vs. Obiter: Ratio - Rule 8D calculation set aside as inapplicable on facts; limited disallowance of 1% of dividend income ordered; Obiter - general observations on funding source and Rule 8D limitations. Conclusion: Disallowance under section 14A substantially reduced to Rs 77,778; corresponding adjustment for book profits under section 115JB likewise reduced. Issue 5 - Section 115JB book profit consequences Legal framework: Explanation 1(f) to section 115JB refers to adjustments similar to section 14A; interplay with Rule 8D and relevant tribunal precedents. Precedent treatment: Tribunal followed Special Bench authority that Rule 8D cannot be mechanically applied to book profit computation where it yields distorted results. Interpretation and reasoning: Since Rule 8D-based disallowance was held inapplicable, the same conclusion and limited disallowance (Rs 77,778) was applied for book profit computation. Ratio vs. Obiter: Ratio - book profit adjustment reduced in line with section 14A conclusion. Conclusion: Ground partly allowed; corresponding addition to book profits remitted/adjusted to Rs 77,778. Issue 6 - Interest under sections 234A/234B Legal framework: Section 234A levies interest for delay in filing return; section 234B levies interest for default in payment of advance tax. Interpretation and reasoning: Return was filed within time under section 139(1); therefore interest under section 234A cannot be levied. Section 234B was consequential and depended on tax computation changes. Ratio vs. Obiter: Ratio - 234A interest disallowed; 234B treated as consequential. Conclusion: Interest under 234A to be deleted; 234B dealt with as consequential. Issue 7 - Initiation of penalty proceedings (sections 271(1)(c), 270A) Legal framework: Penalty proceedings require adjudication of culpability and are premature if substantive assessment adjustments are unresolved. Interpretation and reasoning: Tribunal found initiation premature at assessment stage and dismissed/specified as premature. Ratio vs. Obiter: Ratio - initiation dismissed as premature. Conclusion: Penalty proceedings under section 271(1)(c) and 270A dismissed as premature. Issue 8 - Ancillary factual verifications (TDS credit; unabsorbed depreciation) Legal framework: Grant of TDS credit and set-off of unabsorbed depreciation are fact-sensitive accounting/tax computations requiring verification of records and computation sheets. Interpretation and reasoning: Tribunal directed AO to verify TDS short credit and non-grant of set-off of unabsorbed depreciation factually and decide as per law; reserved these grounds for factual adjudication. Ratio vs. Obiter: Procedural/directional (ratio limited to remand). Conclusion: Grounds allowed for statistical purposes and remitted to AO for factual verification and decision in accordance with law.