2025 (5) TMI 276 - AT - Income Tax

AO's failure to follow DRP directions makes final assessment order void ab initio under Section 144C(13)

ITAT Mumbai held the final assessment order void ab initio for contravening Section 144C(13) as the AO failed to follow DRP directions, citing ESPN Star ... Disallowance of Franchisee fee and the intra-group services u/s 37(1) - As argued that the final assessment is void ab initio as the Ld. AO has not followed the specific direction issued by the Ld. DRP by contravening the provision of Section 144C(13) - HELD THAT:- contravening of section 144C(13) of the Act the impugned final assessment order is bad in law and void as same has not been passed in confirmatory with the direction of the Ld. DRP. The issue is covered by the order of the coordinate bench of ITAT-Mumbai, Bench-J in assessee’s own case [2025 (5) TMI 193 - ITAT MUMBAI] wherein as relied on the ruling of ESPN Star Sports Mauritius S.N.C. ET Compagnie [2016 (4) TMI 45 - DELHI HIGH COURT] and Olympus Medical Systems Pvt Ltd. [2022 (1) TMI 886 - ITAT DELHI], Global One India (P.) Ltd. [2019 (12) TMI 503 - ITAT DELHI] and Software Paradigms Infotech (P.) Ltd. [2018 (1) TMI 1550 - ITAT BANGALORE] find that the Ld. AO is required to pass the final assessment order in conformity with the DRP directions. In the present case, since the final assessment order passed by the Ld. AO is not in conformity with the DRP directions the same is bad in law and therefore should be quashed. Disallowance of payment of Intra-group services [IGS] - assessee is one of the largest players in the premium pet food market in India and heavily relies on its AEs for a range of services essential to its business operations. HELD THAT:- We find that the assessee has sufficiently demonstrated the availing and actual receipt of intra-group services through supporting documentation including invoices, agreements, and cost allocation statements. The payments made towards intra-group services were made without any markup and have been benchmarked alongside other international transactions, which collectively meet the arm’s length principle. It is settled law that the necessity or commercial benefit of an expense cannot be questioned by the tax authorities when the transactions are genuine and undertaken for business purposes. The requirement of establishing a tangible commercial benefit (Benefit Test) does not emanate from the statutory provisions under the Act or under Transfer Pricing Regulations. We respectfully relied on EKL Appliances Ltd. [2012 (4) TMI 346 - DELHI HIGH COURT] and Lumax Industries Ltd. [2008 (3) TMI 679 - DELHI HIGH COURT] that the expenditures are genuine and fully related on the business purpose. The adjustment made on account of disallowance of payment of intra-group charges by the AO is unsustainable in law and on facts. In view of the above discussion, the adjustment made on account of disallowance of payment of intra-group charges is hereby directed to be deleted. The core legal questions considered by the Tribunal in this appeal include:1. Whether the final assessment order passed under section 143(3) read with sections 144C(13) and 144B of the Income-tax Act, 1961, was valid and in conformity with the directions issued by the Dispute Resolution Panel (DRP) under section 144C(5) of the Act.2. Whether the Assessing Officer (AO), Transfer Pricing Officer (TPO), and DRP erred in enhancing the income of the assessee by disallowing the payment of franchise fees to its Associated Enterprise (AE) on the ground that such payments did not satisfy the arm's length principle under the Act.3. Whether the AO, TPO, and DRP erred in disallowing the payment for intra-group services (IGS) made by the assessee to its AEs, including the methodology applied and the treatment of benchmarking analysis.4. Whether the DRP erred in enhancing the disallowance of intra-group charges from 50% to 100%, particularly in its interpretation of the Need Benefit Test and acceptance of evidence submitted by the assessee.5. Whether the alternate disallowances proposed by the DRP under section 37(1) of the Act in respect of franchise fees and intra-group services were justified.6. Whether penalties under sections 271DA and 270A of the Act were rightly imposed on the assessee for alleged non-compliance and under-reporting of income.Issue-wise Detailed Analysis1. Validity of Final Assessment Order vis-`a-vis DRP Directions (Section 144C(13))The legal framework mandates under section 144C(13) of the Act that the AO must pass the final assessment order in strict conformity with the directions issued by the DRP under section 144C(5). The AO is not permitted to deviate from such directions or provide any further opportunity of hearing beyond the DRP proceedings.The assessee contended that the final assessment order dated 22/10/2024 was not in conformity with the DRP's directions, particularly regarding the alternate disallowance under section 37(1) for franchise fees, and thus was void ab initio.The Tribunal relied on coordinate bench precedents, including decisions where final orders passed without following DRP directions were held to be null and void. Notably, the Tribunal cited rulings that emphasized the binding nature of DRP directions and the mandatory compliance by the AO within the prescribed time frame.Applying these principles, the Tribunal found that the AO had failed to comply with the DRP's directions and thus the final assessment order was bad in law and liable to be quashed.2. Disallowance of Franchise Fees under Transfer Pricing ProvisionsThe franchise fees paid by the assessee to its AE, Royal Canin SAS, France, amounted to INR 288,806,121. The TPO applied the Comparable Uncontrolled Price (CUP) method and determined the arm's length price (ALP) as Nil, leading to a substantial addition.The assessee argued that the TPO and DRP failed to follow the mandatory statutory procedures under Rules 108(1)(a) and 100 of the Income Tax Rules, 1962, to identify and apply the Most Appropriate Method (MAM). The AO and DRP were criticized for disregarding the assessee's benchmarking analysis and prior judicial pronouncements where similar payments were accepted as arm's length.The assessee also contended that it was legally incapable of operating as a franchisee in India outside the franchise agreement, and that the bundle of rights received, including marketing rights and trademarks, justified the franchise fee.However, the Tribunal did not adjudicate the merits of the franchise fee disallowance in detail because the issue was subsumed under the invalidity of the final assessment order for non-compliance with DRP directions. The Tribunal's primary finding was procedural, leading to quashing of the order on this ground.3. Disallowance of Intra-Group Services (IGS) PaymentsThe assessee paid INR 160,306,842 towards intra-group services including professional services, information services, advertisement, sales promotion, employee training, and recruitment expenses to its AEs.The TPO disallowed 50% of these payments on an ad hoc basis, asserting that the services did not satisfy the arm's length principle. The DRP further enhanced this disallowance to 100%, concluding that the Need Benefit Test was entirely failed.The assessee submitted detailed documentary evidence including service agreements, invoices, cost allocation workings, and benchmarking analysis. It argued that the payments were at cost (without markup), necessary for business operations, and that the arm's length nature was corroborated by benchmarking of aggregated international transactions.Legally, the Tribunal noted that the law requires only that payments for services be at arm's length; there is no statutory mandate to prove the necessity or commercial benefit of such services for their allowability. The Tribunal relied on authoritative precedents including CIT v. Dhanrajgirji Raja Narasingirji and EKL Appliances Ltd, which held that legitimate business expenditures cannot be disallowed merely on the basis of business losses or lack of immediate profit, and that the manner of conducting business is not subject to Revenue's scrutiny if transactions are genuine and commercially tenable.The Tribunal also noted that the DRP's enhancement of disallowance from 50% to 100% was based on misinterpretation of the TPO's order and failure to appreciate the evidence accepted during transfer pricing proceedings.Applying these principles, the Tribunal held that the disallowance of intra-group service payments was unsustainable and directed deletion of the addition.4. Alternate Disallowance under Section 37(1) of the ActThe DRP proposed alternate disallowances of franchise fees and intra-group service payments under section 37(1), contending that these payments were not eligible deductions.The assessee challenged this alternate disallowance, arguing that such payments were incurred wholly and exclusively for business purposes and supported by benchmarking analyses.The Tribunal did not expressly uphold the alternate disallowances but noted that the AO was bound to follow DRP directions. Since the final assessment order was quashed for non-conformity with DRP directions, the alternate disallowance issue was not separately adjudicated in detail.5. Penalty Proceedings under Sections 271DA and 270AThe assessee challenged the imposition of penalty under section 271DA for alleged non-compliance of section 269ST (cash transaction restrictions), and penalty under section 270A for under-reporting of income.The Tribunal held that the penalty under section 271DA was premature as it pertained to a separate proceeding and dismissed the ground accordingly.Ground relating to penalty under section 270A was dismissed as consequential and no specific adjudication was warranted at this stage.Significant Holdings'The Assessing Officer, as per law, was required to pass the final order of assessment ... in conformity with the directions issued by the DRP ... which are binding on him as per section 144C(10) thereof and within the time prescribed u/s 144C(13) of the Act. ... since the final assessment order passed by the Ld. AO is not in conformity with the DRP directions, the same is bad in law and therefore should be quashed.''The law mandates only that the payment for services must be at arm's length. There is no statutory requirement to prove the necessity of such services ... The requirement of establishing a tangible commercial benefit (Benefit Test) does not emanate from the statutory provisions under the Act or under Transfer Pricing Regulations.''It is also not necessary for the assessee to prove that such expenditure resulted in immediate profits; the only requirement is that the expenses were incurred wholly and exclusively for business purposes.''The adjustment made on account of disallowance of payment of intra-group charges by the Ld. AO is unsustainable in law and on facts.'The Tribunal's final determinations were:The final assessment order passed by the AO was quashed for non-compliance with the binding directions of the DRP under section 144C(13).The disallowance of intra-group services payments was deleted as the payments were at arm's length, supported by benchmarking and documentary evidence, and incurred wholly and exclusively for business purposes.The grounds relating to penalty under sections 271DA and 270A were dismissed at this stage.The issues relating to franchise fees were not decided on merits due to procedural infirmity in the final order.