2025 (11) TMI 916 - AT - Income Tax

Partly allowed appeal: ESOP expense allowed under Section 37; DDT claim dismissed; EURIBOR benchmarking for overdue interest; comparables reassessed

ITAT, Bangalore (AT) allowed the appeal partly: disallowance of employee stock option expense deleted, holding it allowable under section 37 following the ... Nature of expenditure - employee's stock compensation cost holding that same is capital in nature and not allowable u/s 37 - HELD THAT:- We find that that the honourable Karnataka High Court [2024 (10) TMI 755 - KARNATAKA HIGH COURT] has considered as per substantial question of law wherein on identical facts and circumstances as relying upon the decision of Biocon Ltd [2020 (11) TMI 779 - KARNATAKA HIGH COURT] held that same is an allowable expenditure and there is no merit in the contention sought to be put forth by the revenue. Accordingly, we also direct the learned assessing officer to delete the disallowance on account of the employee stock option expenditure being compensation cost paid to its parent company considering it allowable under section 37 of the act. Accordingly ground No. 4 of the appeal is allowed. Refund of excess dividend distribution tax - claim of the assessee is that dividend distribution tax was calculated originally at the rate of 20.56% paid to its foreign shareholders wherein according to the double taxation avoidance agreement the impugned tax rate should have been 10% - HELD THAT:- The arguments of the assessee are same as were raised before the special bench in case of Total Oil India private limited [2023 (4) TMI 988 - ITAT MUMBAI (SB)]. As the issue is squarely covered against the assessee, ground No. 5 of the appeal of the assessee, respectfully following the decision of the special bench in case of Total Oil India private limited, this ground is dismissed. Interest on overdue outstanding receivable - assessee submitted that the receivable should be netted off against the payable from its associated enterprises and the net amount should be subject to interest determination of the arm's-length price - second argument of the assessee is that the rate of SBI Term deposit rates adopted by the learned assessing officer/transfer pricing officer for computation of interest on overdue receivable is incorrect and EURIBOR should be adopted for benchmarking the transaction - HELD THAT:- If it is an independent transaction, it could not have been offset by the other transaction which does not have any impact on the income of the assessee. The basic rule according to the provisions of section 92 is that the international transaction should impact the income arising. Thus, clubbing together, the transactions which does not result into income arising [ outstanding payable] be off set with the transaction [interest on overdue receivable] which relate to the income. Even otherwise there is no reason that outstanding payable to the associated enterprises should be net of with the outstanding receivable from the associated enterprises. Had that been the case, the assessee would itself have adjusted the same in its annual accounts which has not been done. This clearly shows that it is not the intention of the assessee also to consider both the transaction as one transaction, otherwise the assessee would have disclosed the same in its annual accounts on net basis only. This is neither in accordance with the accounting standards, accounting policies of the assessee which are approved by the board of directors and the auditors and therefore the contention of the netting of the outstanding debt with the outstanding liability of the associated enterprises is rejected. We agree with the contention of the assessee that as invoices are prepared in Euro, then Euribor should have been accepted as the proper benchmarking index rates. Accordingly ground No. 6 of the appeal is allowed to that extent. Comparable selection - Microsoft Corporation (India) private limited - We find that the direction of the learned dispute resolution panel is half-hearted if PLI is operating profit/operating revenue, the operating profit will include the operating cost also. Therefore, if the cost segment of operating profit is also hit by RPT and it crosses the maximum percentage of RPT transactions as far as cost is involved, even then this comparable is to be excluded. Therefore, we modify the direction of the learned dispute resolution panel and direct the learned transfer pricing officer that if the comparable company fails the RPT filter with respect to sales or with respect to cost, it needs to be excluded. However, we are not impressed with the argument that the learned dispute resolution panel has excluded this comparable for assessment year 2020 – 21, therefore it should be excluded for this year also, the filters are required to be evaluated and applied for each year independently and separately. Tally solutions private limited - We find that the learned dispute resolution panel itself has agreed that that company is involved in the research and development which is not the function carried on by the assessee. Further that company also has incurred substantial expenditure on research and development. Such cost is 7.17% of its annual turnover. Further when we look at the corporate information of this company, it shows that this company is engaged in the business of development and sale of accounting and business management software and incidental services. Thus, it also develops that software and then sells it which is different from the mere distribution activities. Therefore, we direct the learned transfer pricing officer to exclude the above comparable. Innovana think labs Ltd. - Since the revenue from the sale of products are more than 95% there is no need of segmental data. However, the objection of the assessee is that that company is engaged into the business of software development and not distribution. The learned dispute resolution panel has also recorded sales segment but has included this company. On reading the explanation of the assessee we find that this company is not comparable as it is engaged in software development. Hence the learned transfer pricing officer is directed to exclude the same. Quick Heal technologies Ltd is engaged in various products developed by it being sold and is not merely a distributor of a product developed by somebody else. Therefore, this comparable company is not functionally like the functions performed by the assessee. The learned transfer pricing officer is directed to exclude the same. Compucom software Ltd, the learned dispute resolution panel has directed the learned transfer pricing officer to consider only the segment margin of the learning solution, but the learned TPO has not followed the same. TPO is directed to follow the direction of the learned dispute resolution panel mentioned at paragraph No. 6.1.1 of the direction. ISSUES PRESENTED AND CONSIDERED 1. Whether employee stock option plan (ESOP) costs cross-charged by the parent and borne by the taxpayer are deductible as revenue expenditure under section 37 of the Income-tax Act or constitute capital/notional expenditure disallowable as per authorities below. 2. Whether dividend distribution tax (as charged under section 115-O) paid at a higher domestic rate is refundable to the extent it exceeds the rate prescribed by the relevant Double Taxation Avoidance Agreement (treaty) for dividends to non-resident shareholders. 3. Whether interest on overdue receivables from associated enterprises constitutes an independent international transaction to be benchmarked under section 92 (and related provisions); whether outstanding receivables can be netted against outstanding payables for ALP determination; and what benchmark rate (domestic deposit rate v. EURIBOR/LIBOR) is appropriate where invoices are denominated in foreign currency. 4. Whether selected comparable companies used for the Transactional Net Margin Method (TNMM) in respect of software distribution services are functionally comparable, including treatment of segmental data, related party transaction (RPT) filters and the need for year-wise application of filters; and whether working capital adjustment and certain comparability filters were correctly applied. 5. Whether the assessing officer/transfer pricing officer correctly granted credit for tax deducted at source (TDS) claimed in the return, and whether any short credit requires direction for rectification. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Deductibility of ESOP costs under section 37 Legal framework: Expenditure allowable under section 37 unless capital or otherwise disallowed; accounting treatment and substance of ESOP cross-charges relevant to revenue/capital character. Precedent treatment: The Tribunal followed a coordinate High Court decision on identical facts and relied on the High Court's reasoning (and earlier Biocon Ltd decision) that ESOP cross-charges by the parent for employees' stock compensation were allowable as compensation expense. Interpretation and reasoning: The Tribunal accepted that the ESOP scheme was conceived as employee compensation to encourage ownership and motivation; the cross-charge represented actual outflow borne by the taxpayer (via debit notes) and was not merely a notional loss. The Tribunal gave weight to the High Court's ruling on substantially identical facts and held there was no merit in revenue's contention that the cost was capital or notional. The Tribunal implicitly treated substance over form - the parent's cross-charge represented genuine employee compensation expense. Ratio versus obiter: Ratio - where ESOP cost is a genuine cross-charge by the parent to a subsidiary for compensation to employees and there is actual outflow/charge in books, such cost is deductible under section 37; obiter - none significant beyond reliance on factual parity with High Court decision. Conclusion: Disallowance deleted; ESOP expenditure of Rs. 55.4 crores held allowable under section 37. Issue 2 - Claim for refund of excess dividend distribution tax under section 115-O vis-à-vis treaty rate Legal framework: Section 115-O imposes dividend distribution tax; treaty provisions (article on dividends) may prescribe a lower rate for dividends to non-residents, creating a ground for refund where domestic tax exceeded treaty entitlement. Precedent treatment: The Tribunal followed a special bench decision adverse to the taxpayer on the identical issue (Total Oil special bench) and thus declined the refund claim. Interpretation and reasoning: The Tribunal found the issue squarely covered by adverse precedent and therefore dismissed the ground without re-opening treaty interpretation or altering the precedent. No fresh factual or legal distinction was found sufficient to depart from the special bench ruling. Ratio versus obiter: Ratio - where binding bench precedent holds against the taxpayer on treaty-based reduction of section 115-O liability, identical claims are to be dismissed; obiter - none beyond reliance on precedent. Conclusion: Refund claim for excess dividend distribution tax dismissed following adverse precedent. Issue 3 - Interest on overdue receivables: independent transaction, netting, and benchmark rate Legal framework: Under transfer pricing provisions (section 92 and related), international transactions (including financing/interest consequences of delayed payments) must be benchmarked at arm's length; retrospective amendment treating deferred receivables as independent international transactions is noted by lower authorities. Precedent treatment: The Tribunal reviewed coordinate bench decisions; one coordinate bench had allowed netting of payables and receivables for computing interest, but the present Tribunal found that decision did not articulate sound legal or factual basis and relied on statutory conception of independent transactions post-amendment. Interpretation and reasoning: The Tribunal reasoned (i) outstanding receivable beyond agreed credit period is an independent international transaction (capital financing) and thus properly benchmarked independently; (ii) netting against outstanding payables is improper where accounting treatment and commercial reality show separate transactions - absence of netting in annual accounts indicated no intention to treat them as one; (iii) interest benchmarking should use an index consistent with currency of invoices - since invoices were in Euro, EURIBOR (or appropriate Euro benchmark) is the correct index rather than domestic SBI short-term deposit rates. The TRP's adoption of SBI rates was rejected to that extent; the rest of the TPO/DRP view on independent benchmarking was upheld. Ratio versus obiter: Ratio - (a) deferred receivables constitute an independent international transaction to be benchmarked independently; (b) receivable and payable cannot be mechanically netted where they arise from distinct transactions and are not recorded net in accounts; (c) benchmarking index should align with invoice/currency exposure (EURIBOR for Euro-denominated invoices). Obiter - criticism of the coordinate bench's unexplained netting decision. Conclusion: Netting rejected; interest treated as independent international transaction; benchmark index changed to EURIBOR - ground allowed in part to the extent of adopting EURIBOR but independent benchmarking and interest adjustment otherwise sustained. Issue 4 - Comparability of selected companies, segmental data and RPT filter application (TNMM comparables & working capital) Legal framework: TNMM requires functional comparability, appropriate filters (including RPT thresholds), use of segmental data where multi-segment entities exist, year-wise application of filters, and possible working capital adjustments where relevant. Precedent treatment: The Tribunal applied principles from the transfer pricing code and earlier directions by the DRP/TPO, but modified certain DRP directions where incomplete or inconsistent with functional comparability principles. Interpretation and reasoning: The Tribunal examined several challenged comparables: (i) where DRP/TPO used segmental margins and segmental data existed, the comparable could be retained; (ii) where a company undertook substantive R&D/development (e.g., Quick Heal, Tally, Innovana) and was functionally different from a pure distributor, such companies are not comparable and must be excluded; (iii) RPT filter application must be done year-wise and should test RPT as proportion of sales or of cost as relevant to the profit level indicator (OP/OR or OP/OC). The Tribunal found some DRP directions half-hearted and directed that if a comparable fails RPT filter either on sales or cost basis, it should be excluded; it also directed the TPO to follow DRP directions where appropriate (e.g., compute segment margin for Compucom as directed by DRP). Ratio versus obiter: Ratio - comparables that perform software development (significant R&D) are not functionally comparable to pure distributors and should be excluded; RPT filters must be applied consistently for the same year and may require exclusion where RPT exceeds applicable thresholds in relation to sales or cost depending on PLI; working capital adjustments and recomputations directed where DRP/TPO omissions are identified. Obiter - comments on half-hearted DRP directions and the need for year-specific filter application. Conclusion: Several challenged comparables excluded (Tally, Quick Heal, Innovana); some directions modified (RPT filter application clarified and segmental margin to be used for Compucom); ground partly allowed and remitted for recomputation consistent with directions. Issue 5 - Short grant of TDS credit Legal framework: Assessing officer to grant credit for taxes deducted at source as claimed in return subject to verification. Precedent treatment: Both parties agreed correction was necessary; Tribunal directed AO to verify and grant the short credit. Interpretation and reasoning: On verification, AO to grant the short TDS credit of Rs. 780,770. Ratio versus obiter: Ratio - clerical/verification corrections to TDS credit are to be rectified by AO on direction; obiter - none. Conclusion: Ground allowed; AO directed to grant TDS credit after verification. OVERALL RESULT The appeal was partly allowed: ESOP disallowance deleted; interest benchmarking modified to EURIBOR (netting rejected); certain comparables excluded and DN/ recomputation directed; TDS credit directed to be granted; dividend tax/treaty refund claim dismissed following binding precedent.