2025 (8) TMI 1319 - AT - Income Tax

Appeal partly allowed; royalty disallowance upheld, section 40(a) and loss quantum sent back for reconsideration

Neotiss Private Limited Versus ACIT Circle-8 (1) Hyderabad

ITAT HYDERABAD (AT) held the Assessing Officer did not exceed limited-scrutiny scope, rejecting the assessee's plea on excess traversal. The AO's ... Scope of limited scrutiny - Whether Assessing Officer erred in traversing beyond the three issues while completing the assessment? HELD THAT:- The case has been selected for limited scrutiny under CASS for verifying three issues, i.e., to examine (i) whether receipt of foreign remittance has been correctly offered for tax (ii) whether sales turnover/receipts has been correctly offered for tax and (iii) whether outward foreign remittance is from disclosed sources and appropriate withholding and reporting obligations have been complied with. If we consider the issues for limited scrutiny assessment and the additions made by the AO towards disallowance of royalty expenses, it was stemmed from sales turnover/receipts that has been correctly offered for tax, because the assessee had claimed deduction towards royalty expenses against the receipts/sales turnover from sale of scrap. The other issue considered by the AO, i.e. carry forward of losses of earlier years on the basis of assessed income/loss as per the order passed u/s 143(3) is also stemmed from the issues taken up for limited scrutiny, because, once the total income has been determined for any assessment year, on the basis of assessment order passed by the AO, then the consequent brought forward losses if any has to be allowed in accordance with the provisions of section 71 to 72 of the Act. Therefore, we are of the considered view that there is no merit in the arguments of the assessee that the AO has travelled beyond the scope of limited scrutiny and made additions towards other issues. Thus, we reject the ground taken up by the assessee. Additions made towards disallowance of royalty and restriction of carry forward losses of earlier assessment years as per the order passed u/s 143(3) - Scope of products defined in Section 1, Definitions of the agreement between the parties and more particularly another product, whether by virtue of being a component part or raw material or otherwise cannot be extended to a scrap generated during the course of manufacturing process, because the scrap is not a by-product or any other product arises in the course of manufacturing activity. Therefore, we are of the considered view that there is no merit in the arguments of the assessee. Thus, royalty payment on scrap is covered by the agreement between the parties and thus, we reject the ground taken up by the assessee on the issue of disallowance of royalty. Royalty expenses and SAP maintenance expenses - Addition u/s 40(a) for non-deduction of taxes - As argued by the learned counsel for the assessee, the issue of disallowance of royalty expenses and SAP maintenance expenses for the earlier assessment year 2009-10, 2011-12 and 2014-15 was set aside to the file of the CIT(A) by the ITAT on 23.11.2023 and the matter is pending for adjudication. Since the issue involved for the year under consideration is having nexus with the appeals filed by the assessee for the A.Y.2009-10, 2010-11 and 2014-15 and pending before the CIT(A), as per the order of the Tribunal in [2023 (11) TMI 1388 - ITAT HYDERABAD] in our considered view, this issue needs to be set aside to the file of the Ld.CIT(A) for reconsideration. Restriction of carry forward losses - AO has restricted the carry forward losses on the basis of assessed income/losses as per the orders passed u/s 143(3) of the Act for the earlier assessment years. In our considered view, there is no error in the reasons given by the AO for restricting the losses as per the assessment order. However, the fact remains that, since the assessee has challenged the additions made towards various expenditure for the earlier assessment years, which is the reason for restriction in brought forward losses, in our considered view, unless the issue reaches finality in the appellate proceedings, the correct loss to be carried forward to subsequent years cannot be determined. Therefore, we are of the considered view that this issue also needs to go back to the file of the Ld.CIT(A) for reconsideration. Appeal filed by the assessee is partly allowed for statistical purpose ISSUES PRESENTED AND CONSIDERED 1. Whether the Assessing Officer exceeded the scope of limited scrutiny (CASS) by making additions not covered by the three specified scrutiny issues. 2. Whether royalty paid on sale of scrap is an allowable deduction under the Act where the payment is made pursuant to a royalty/technical know-how agreement between the taxpayer and its parent. 3. Whether expenditures (royalty and SAP maintenance) previously disallowed in earlier years for non-deduction of tax at source can be allowed in the current year under section 40(a) when TDS has subsequently been deducted and remitted, where related appeals for earlier years are pending. 4. Whether carry forward of business losses must be restricted to assessed losses as per prior section 143(3) assessment orders, or whether recomputation is required pending final adjudication of related additions in earlier years. ISSUE-WISE DETAILED ANALYSIS - 1. Scope of limited scrutiny (CASS) Legal framework: Limited scrutiny under the Centralised Application Screening System (CASS) permits examination of specified issues only; conversion to full scrutiny requires competent authority approval per CBDT circulars governing limited scrutiny. Precedent treatment: No specific precedent was invoked in the text; the Tribunal applied the governing CASS limited-scrutiny principles. Interpretation and reasoning: The three CASS issues were (i) correct taxation of foreign remittances, (ii) correct offer of sales turnover/receipts, and (iii) whether outward foreign remittances are from disclosed sources and withholding/reporting compliance. The Tribunal found the AO's additions (disallowance of royalty on scrap and recomputation of carry forward losses) to be connected to the second and third CASS issues: royalty claimed against scrap affected the correctness of sales turnover/receipts; carry forward losses flowed from determination of total income. Consequently, the AO's actions were held to arise from the limited scrutiny remit rather than an impermissible expansion requiring conversion to full scrutiny. Ratio vs. Obiter: Ratio - where an assessment issue is logically connected to a declared limited-scrutiny issue (e.g., deduction claimed against sales turnover), the AO may examine and make adjustments without conversion to full scrutiny. Obiter - none additional. Conclusion: The Tribunal rejected the ground that the AO exceeded the scope of limited scrutiny; the AO's additions were within the ambit of the specified CASS issues. ISSUE-WISE DETAILED ANALYSIS - 2. Allowability of royalty on scrap under the agreement Legal framework: Deductibility of business expenses is tested by the agreement's scope and the nature of the payment; royalty for use of technical know-how/brand is allowable to the extent it is germane to the product or activity that generated the receipts. Precedent treatment: No binding precedent was cited; Tribunal applied contractual interpretation principles to the royalty agreement. Interpretation and reasoning: The taxpayer relied on the definition of 'products' (including 'other products') in the agreement to argue that scrap fell within the royalty charge. The Tribunal analysed the contractual language and the commercial nature of scrap, distinguishing scrap from by-products or component parts arising in manufacturing. The Tribunal concluded that scrap, being generated as waste in manufacturing, is not encompassed as a product entitled to royalty under the technical know-how agreement; royalty on scrap thus appeared to be an arrangement to shift funds rather than a genuine royalty expense linked to know-how use. Ratio vs. Obiter: Ratio - royalty payable under a technical know-how agreement does not extend to scrap sales where the agreement's definitions, commercial context, and nature of scrap do not support inclusion; such royalty may be disallowed. Obiter - analysis of potential commercial motivations (ploughing back funds) used to support the interpretive conclusion. Conclusion: The Tribunal upheld the disallowance of the royalty portion attributable to scrap sales; the AO and CIT(A) conclusions on disallowance were sustained. ISSUE-WISE DETAILED ANALYSIS - 3. Allowance under section 40(a) for royalty and SAP maintenance expenses tied to earlier years Legal framework: Under section 40(a), an expenditure disallowed in an earlier year for non-deduction of tax at source may be allowable in a later year if TDS has been deducted/paid in the later year; deductibility depends on factual and legal nexus with the year of allowance and compliance with TDS provisions. Where related issues for earlier years are pending adjudication, the outcome may affect the current year's entitlement. Precedent treatment: The Tribunal referenced prior remittal of the same issue for earlier assessment years by the Tribunal itself (orders dated 23.11.2023) and recognized that the earlier appeals are pending; accordingly, the Tribunal treated the issue as factually and legally interlinked across years. Interpretation and reasoning: The Tribunal accepted as correct the legal proposition that expenditure disallowed earlier for non-deduction of TDS can be claimed in the year when TDS is deducted. However, because appeals in respect of the disallowances for earlier assessment years remain pending (and those adjudications may alter the status of the contested expenditures), the Tribunal concluded that the current-year claim cannot be finally adjudicated independently. Given the direct nexus between the current-year claim and the earlier years' disputes, the Tribunal exercised case management and remitted the issue to the CIT(A) for reconsideration alongside the pending appeals to ensure consistent and final determination. Ratio vs. Obiter: Ratio - where current-year deduction depends on the resolution of identical issues pending in earlier-year appeals, the correct course is to remit the current year to the appellate authority for joint consideration to avoid inconsistent outcomes. Obiter - affirmation of the general principle that section 40(a) allows deductions when TDS is subsequently deducted. Conclusion: The Tribunal set aside the CIT(A)'s rejection of the grounds regarding royalty and SAP maintenance expenses and restored the issue to the CIT(A) for reconsideration together with the pending earlier-year appeals. ISSUE-WISE DETAILED ANALYSIS - 4. Restriction and recomputation of carry forward losses Legal framework: Carry forward and set-off of losses are governed by sections 71-72 and related provisions; the quantum of losses available depends on earlier years' final assessment outcomes. An assessing authority's recomputation in a later year must respect the finality of prior assessments, but if prior assessments are under challenge, the correct carry-forward amount may be unsettled. Precedent treatment: The Tribunal relied on the settled administrative/appeal process logic rather than cited case law: inability to determine correct carry-forward until earlier-year disputes are finally resolved. Interpretation and reasoning: The AO restricted carry forward losses based on assessed losses as per earlier section 143(3) orders. The Tribunal agreed that, prima facie, restriction per assessed figures is permissible. However, because the assessee has contested additions in earlier years (which affect the amount of assessed losses) and those contests remain pending on appeal, the Tribunal held that the precise loss to be carried forward cannot be finally determined until earlier appeals reach finality. For consistency and correct adjudication, the Tribunal remitted the carry-forward issue to the CIT(A) for reconsideration in light of the pending earlier appeals. Ratio vs. Obiter: Ratio - where carry-forward quantum depends on unsettled earlier-year assessments, the matter should be remitted for reconsideration after or in conjunction with resolution of those earlier appeals to achieve accurate computation. Obiter - concurrence that assessed orders can govern carry-forward computations in the absence of pending disputes. Conclusion: The Tribunal found no substantive error in the AO's reasoning for restricting carry forward losses to assessed figures, but set aside the CIT(A)'s dismissal and remitted the matter to the CIT(A) for reconsideration in accordance with law and pending appellate outcomes. OVERALL DISPOSITION The appeal was partly allowed: the Tribunal upheld the limited-scrutiny scope finding and the disallowance of royalty on scrap, but set aside the CIT(A)'s rejection of the section 40(a) issues (royalty and SAP maintenance) and the carry-forward recomputation issue and remitted those matters to the CIT(A) for reconsideration in conjunction with the pending earlier-year appeals to ensure consistent final adjudication.