TaxTMI 
TaxTMI 
2008 (9) TMI 420
X X X X Extracts X X X X
X X X X Extracts X X X X
....nd also in directing the Assessing Officer to exclude the said provision while computing the book profit under section 115JB. 3. In its profit and loss account, warranty charges amounting to Rs. 4,04,12,572 were debited by the taxpayer company. The said amount was inclusive of the warranty expenses actually incurred by the taxpayer company to the extent of Rs. 1,78,73,650 and the remaining amount of Rs. 2,25,38,920 was on account of provision made for anticipated warranty expenses in respect of the remaining part of the warranty period. According to the Assessing Officer, the amount that may be payable by the taxpayer company on account of possible claims of warranty arising in the future constituted its contingent liability and the provision made for such contingent liability was not deductible while computing its total income. He, therefore, disallowed the same while computing the total income of the taxpayer under the normal provisions of the Act and also added the same while computing its book profit under section 115JB. The matter was carried before the ld. CIT(A) and it was submitted on behalf of the taxpayer company before him that the provision for anticipated liability ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....has not disputed this position. She, however, has made an attempt to point out from page 4 of the impugned order of the learned CIT(A) that the provision for warranty made by the taxpayer company at the rate of 2 per cent of the total turnover was highly excessive taking into consideration its own past history wherein such provision was required to be made at only 0.72 per cent. However, as clarified by the learned counsel for the taxpayer, the provision of 2 per cent as referred to by the learned CIT(A) in his impugned order was in the context of a case of Voltas Ltd. decided by Mumbai Bench of ITAT whereas the provision made for warranty by the taxpayer in the present case was only to the extent of 0.75 per cent. We, therefore, hold that the decision of Hon'ble Punjab and Haryana High Court in the case of Majestic Auto Ltd. on a similar issue is squarely applicable in the present case and respectfully following the same, we uphold the impugned order of the learned CIT(A) allowing the deduction claimed by the taxpayer on account for provision for warranty holding the same to be an ascertained liability. Similarly, we also uphold his impugned order deleting the addition made by....
X X X X Extracts X X X X
X X X X Extracts X X X X
....puting deduction under section 80HHC. Reliance in support of this contention was placed on behalf of the taxpayer company on the decision of Hon'ble Bombay High Court in the case of CIT v. Bangalore Clothing Co. [2003] 127 Taxman 637. In the said decision, it was held by the Hon'ble Bombay High Court in this context that if any receipt forms part of the operational income of the taxpayer having regard to its dominant business, the same would be entitled to be included in the profits of the business for the purpose of computing deduction under section 80HHC. According to the ld. CIT(A), all the receipts i.e., sale of scrap, amounts written back and sale proceeds of spare parts included in the miscellaneous income of the taxpayer company were directly related to its dominant business. He, therefore, held that the same forming part of its operational income was liable to be included in the "profits of the business" for the purpose of computing deduction under section 80HHC. 8. After considering the rival submissions and perusing the relevant material on record, we find no infirmity in the impugned order of the learned CIT(A) holding that the miscellaneous income of the taxp....
X X X X Extracts X X X X
X X X X Extracts X X X X
....t the same was includible in the total turnover (denominator). Before the ld. CIT(A), it was submitted on behalf of the taxpayer that the foreign exchange gain has a very close nexus with the export activity of the company. Relying inter alia on the decision of Delhi Bench of ITAT in the case of Smt. Sujata Grover v. Dy. CIT [2002] 74 TTJ 347, it was contended that the same thus was rightly claimed as part of the eligible profits. After considering the submissions made on behalf of the taxpayer, it was held by the ld. CIT(A) that forex gain relating to the export proceeds was the direct result of the export sales and taking into consideration this close nexus between the two, it was not possible to exclude such gain from the export turnover. He, therefore, directed the Assessing Officer to include the said gain even in the figure of export turnover (numerator) for the purpose of computing exemption under section 10A/10B. 11. We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that this issue has also been raised by the taxpayer in ground No. 4 of its appeal being ITA No. 1189/Delhi/2005. At the time of hearing before us,....
X X X X Extracts X X X X
X X X X Extracts X X X X
....me Court in the cases of Alembic Chemicals Works Co. Ltd. v. CIT [1989] 177 ITR 377 and Empire Jute Co. Ltd. v. CIT [1980] 124 ITR 1 as well as Tribunal's decision in the case of Media Video Ltd. v. Jt. CIT [2002] 122 Taxman 28 (Delhi) (Mag.), it was contended on behalf of the taxpayer that as a result of acquisition of the said software, only an operational or commercial advantage was obtained which being in the revenue field, the expenditure incurred on such acquisition was a revenue expenditure. 16. The details of software expenses claimed by the taxpayer were examined by the ld. CIT(A) and on such examination, he found that the same were incurred for acquiring the following softwares:- "(i) Software for TDS calculation, which needs to be revised each year based on changes in Budget Notifications; (ii) E-CRM networking/Internet gateway for B2B, which requires to be updated periodically based on changes in Marketing requirement, change in product line, new launches etc.; (iii) License fees etc., payable for usage of certain application software and which have no reuse or sale value; (iv) Design and Development/Consultancy charges for Sof....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nexure-4. As regards the recent decision of Delhi Special Bench of ITAT in the case of Amway India Enterprises, he submitted that the said decision supports the case of the taxpayer. He contended that as held by the Special Bench of the Tribunal in the said case, where the advantage consists merely in facilitating taxpayer's trading operations or enabling conduct of taxpayer's business more efficiently or more profitably, the expenditure would be on revenue account. He submitted that the details of the software expenditure incurred by the taxpayer in the present case as given in Annexure-4 would make it clear that the said expenditure was incurred for improving the day-to-day efficiency and for carrying out the business of the taxpayer company in a more efficient manner. He contended that the said expenditure thus was incurred on revenue account as held by the Special Bench of the Tribunal in the case of Amway India Enterprises and the softwares acquired by the taxpayer company being mere facilitators, the expenditure incurred thereon was rightly held by the learned CIT(A) as of revenue in nature. 20. We have heard the arguments of both the sides and also perused the rel....
X X X X Extracts X X X X
X X X X Extracts X X X X
....lp of relevant details furnished on record, we are of the view that this exercise can more appropriately be done by the Assessing Officer. Moreover, the benefit of the decision of Special Bench in the case of Amway India Enterprises was not available to the authorities below when this issue came to be decided by them and it would be in the interest of justice to give them an opportunity to re-examine the same in the light of criteria/guidelines laid down by the Special Bench. Accordingly, we set aside the impugned order of the learned CIT(A) on this issue and restore the matter to the file of the Assessing Officer for deciding the same afresh as per the guidelines laid down by the Special Bench of ITAT in the case of Amway India Enterprises. Ground No. 5 of the revenue's appeal is accordingly treated as allowed for statistical purposes. 22. The next issue raised in ground No. 6 of the revenue's appeal relates to the taxpayer's claim on account of loss due to fluctuation in foreign exchange rate. 23. While finalizing its books of account, the foreign currency transactions were reinstated by the taxpayer company at the exchange rate prevailing on the balance sheet d....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... company was going to strengthen the brand image of SONY worldwide and the benefit thereof was going to flow to the parent company also viz., Sony Corporation, Japan. He, therefore, disallowed the said expenditure to the extent of 10 per cent on estimated basis treating that the same was attributable to the benefit flown to the parent company. The learned CIT(A), however, deleted the disallowance made by the Assessing Officer on this issue holding that as the expenditure on advertisement and sales promotion was incurred by the taxpayer company wholly within India, no benefit had accrued to its parent company in Japan. In addition to the disallowance of 10 per cent made out of advertisement and sales promotion expense on the ground that the same was attributable to the brand promotion resulting in benefit to the parent company in Japan, a further disallowance of 10 per cent was made by the Assessing Officer out of advertisement and sales promotion expenses treating the same to be of capital nature on the ground that advantage of enduring nature had accrued to the taxpayer company. The learned CIT(A), however, deleted the said disallowance observing that as the memory of the customer....
X X X X Extracts X X X X
X X X X Extracts X X X X
....any had also received some indirect benefit from the advertisement expenditure, he submitted that the said subsidy amount received from the parent company was duly reduced from the total advertisement expenditure and only net amount was claimed as deduction. He placed reliance on the decision of Delhi Bench of ITAT in the case of Nestle India Ltd. v. Dy. CIT [2007] 111 TTJ 498 stating that a similar issue involved in the said case has been decided by the Tribunal in taxpayer's favour. He also placed reliance on the decision of Mumbai Bench of ITAT in the case of Star India (P.) Ltd. v. Addl. CIT [2006] 103 ITD 73 (TM). As regards the disallowance of 10 per cent made by the Assessing Officer out of advertisement and sales promotion expenses treating the same as of capital nature, the learned counsel for the taxpayer submitted that since the expenditure on advertisement and sales promotion is required to be incurred every year, there was no benefit of enduring nature derived by the taxpayer company by incurring the said expenditure. He also submitted that the said expenditure in any case was made by the taxpayer company on revenue account and the same, therefore, could not be tre....
X X X X Extracts X X X X
X X X X Extracts X X X X
....h might have accrued to its parent company. For this conclusion, we derive support from the decision of Mumbai Bench of ITAT in the case of Star India (P.) Ltd. wherein it was held that advertisement expenses incurred on promoting viewership on TV channel by the taxpayer engaged in procuring programs for those channel were expenditure incurred wholly and exclusively for the purpose of its business and it could not be disallowed on the ground that it might have also benefited the taxpayer's principal. To the similar effect is the decision of Delhi Bench of ITAT in the case of Nestle India Ltd. cited by the learned counsel for the taxpayer wherein it was held that advertisement and sales promotion expenses incurred by the taxpayer for promoting sales in India in respect of products manufactured by it under various brands of a foreign company were allowable in entirety even though it might have benefited the non-resident company who owned the said brands. Keeping in view both these decisions of the Tribunal and taking into consideration the facts of the case as discussed above, we hold that the disallowance of 10 per cent made by the Assessing Officer out of advertisement and sale....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e fluctuation can be considered only at the time of actual repayment and not at the intermediary stage. He held that the depreciation claimed by the taxpayer by capitalizing the loss as a result of foreign exchange fluctuation thus was not allowable. The learned CIT(A), however, allowed the said claim of the taxpayer for depreciation relying on the pre-amended provisions of section 43A as applicable to the year under consideration. 33. At the time of hearing before us, the learned representatives of both the sides have agreed that this issue is squarely covered in favour of the taxpayer by the judgment of Hon'ble Delhi High Court in the case of Woodward Governor India (P.) Ltd. wherein it was held that in a case where a taxpayer has acquired any capital asset from abroad for the purpose of his business or profession on credit or on deferred payment terms or against a loan in foreign currency and the whole or part of the cost of such asset or of the loan in foreign currency is outstanding as on the date on which there was a change in the rate of exchange of currency, the original actual cost to the taxpayer of such asset is required to be increased or as the case may be reduc....
X X X X Extracts X X X X
X X X X Extracts X X X X
....and dismiss ground No. 9 of the revenue's appeal. 37. The next issue raised in ground No. 10 of the revenue's appeal relates to the levy of interest under section 234D. 38. In the assessment order, interest under section 234D was levied by the Assessing Officer on the amount of excess refund granted to the taxpayer company while processing its return of income originally under section 143(1). The learned CIT(A), however, noted that the provisions of section 234D have been introduced in the statute by the Finance Act, 2003 with effect from 1-6-2003. According to him, the said provisions thus were applicable only in relation to assessment year 2003-04 onwards and interest under that provision could not be levied in the taxpayer's case involving assessment year 2001-02. 39. We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that this issue is squarely covered in favour of the taxpayer by the recent decision of Delhi Special Bench of ITAT in the case of ITO v. Ekta Promoters (P.) Ltd. [2008] 113 ITD 719 wherein it has been held that interest under section 234D is chargeable from assessment year 2004-05 and....
X X X X Extracts X X X X
X X X X Extracts X X X X
....s regard, he invited our attention to the details of 'Miscellaneous Income' placed on record and submitted that a perusal of the said details makes it amply clear that the entire miscellaneous income originates in the process of carrying on the core business activity of the undertaking. He submitted that similarly 'Service Income' was mainly comprising of income received by the taxpayer company from repairs of goods sold to the customers. He submitted that since the goods sold by the taxpayer were consumer electronic goods, it was pertinent for the appellant to provide appropriate 'after sales services and support' beyond the warranty period to ensure that consumers of goods receive good value for their money and quality service. He contended that servicing of these components thus constituted an essential ingredient of the business activity of the taxpayer company and was inextricably linked to the goods being sold by it. 45. As regards the advisory service income received from Sony Corporation of Hong Kong Ltd. in pursuance of an advisory service agreement, he submitted that for carrying out its manufacture and sales operations in the Indian market, the....
X X X X Extracts X X X X
X X X X Extracts X X X X
....d to be not eligible for deduction under section 80-IA by the Tribunal holding that the same could not be said to have been derived by the taxpayer company from its industrial undertaking. She submitted that for this conclusion, the Tribunal relied, inter alia, on the judgments of Hon'ble Supreme Court in the case of Cambay Electric Supply Industrial Co. Ltd. v. CIT [1978] 113 ITR 84, CIT v. Sterling Foods [1999] 237 ITR 579 and Pandian Chemicals Ltd. v. CIT [2003] 262 ITR 278 wherein the scope and ambit of the expression "derived from" as used in section 80-IA was explained by the Hon'ble Apex Court. 48. We have considered the rival submissions and also perused the relevant material on record. It is observed that a similar issue relating to eligibility of service income and miscellaneous income earned by the taxpayer for deduction under section 80-IA had arisen for consideration before the Tribunal in taxpayer's own case for assessment year 2000-01 and vide its order dated 31-8-2004, the Tribunal decided the same against the taxpayer for the following reasons given in paragraph No. 23 of the said order:- "23.The next question for our consideration is as to ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ory, none of the other incomes can be considered as profits derived from an industrial undertaking. The reason being that the impugned business of the eligible industrial undertaking is of manufacture and the sale of electronic goods and the other receipts cannot be construed to be directly connected with the impugned activity of the eligible industrial undertaking. We do not dispute the fact that such receipts would, on parameters of being incidental to business, can fall within the business of the taxpayer, yet cannot be said to be derived from the eligible industrial undertaking of the taxpayer. Therefore, on this count, we sustain the stand of the taxpayer only to the extent mentioned herein above. Before we part, we may discuss the alternative plea of the appellant that in order to exclude the aforesaid incomes from profits eligible for deduction under section 80-IA, what was required to be excluded was the net income of such activity and not the gross receipts from such activities. We do not find any infirmity in the aforesaid pleas of the taxpayer. For this limited purpose, we remit the issue to the file of the Assessing Officer to re-work the deduction allowable to the taxp....
X X X X Extracts X X X X
X X X X Extracts X X X X
....derived from an industrial undertaking" again was explained by the Hon'ble Supreme Court by stating that for application of the words "derived from", a direct nexus between the profits and gains and industrial undertaking must be there and if such nexus is not direct but only incidental, the same could not be said to be the "profits derived from an industrial undertaking". In the case of Pandian Chemicals Ltd., Hon'ble Supreme Court reiterated this position by holding that in order to fall within the expression "profits derived from an industrial undertaking", the immediate source of earning such income should be the industrial undertaking itself. In the present case, the business of the eligible industrial undertaking of the taxpayer company is to manufacture and sale of electronic goods and keeping in view the nature of this main business, we are of the view that the miscellaneous income and service income earned by the taxpayer could not be said to have been derived from such business by the said industrial undertaking for the purpose of allowing deduction under section 80-IA. As regards the reliance of the learned counsel for the taxpayer on the decision of Hon'ble ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....HHC, the taxpayer company had included service income of Rs. 21,78,729 in the profits of the business. According to the Assessing Officer, this income was not derived by the taxpayer company from its business and the same, therefore, was not eligible for deduction under section 80HHC. Accordingly, he excluded the said income from the profits of the business for the purpose of computing deduction under section 80HHC. The matter was carried before the learned CIT(A) who examined the nature of service income and found on such examination that the said income did not form part of the main business activity of the taxpayer company. He, therefore, upheld the action of the Assessing Officer in excluding the service income from the profits for the purpose of computing deduction under section 80HHC. 52. The learned counsel for the taxpayer, at the outset, submitted that service income constituted a part of business income of the taxpayer company which is evident from the fact that in its return of income, the said income was offered to tax under the head "Profits and gains of business or profession". He submitted that this treatment given by the taxpayer company was accepted by the Asses....
X X X X Extracts X X X X
X X X X Extracts X X X X
....yer company. He also contended that the service income earned by the taxpayer company is essentially linked with its prime business activity and the same, therefore, cannot be clubbed with residuary sources of income such as rent, brokerage etc. so as to exclude it from the profits of the business for the purpose of computing deduction under section 80HHC. According to him, the said income in fact clearly constitutes operational income of the taxpayer company having regard to its nexus with the main activity of business and the same, therefore, was liable to be included in the profits of the business as held by Hon'ble Bombay High Court in the case of Bangalore Clothing Co. 54. The learned DR, on the other hand, submitted that the service income in question was earned by the taxpayer company for the services rendered to its sister concern abroad and keeping in view the nature of such services rendered by it relating to marketing, it cannot be said that it has got any link either direct or even indirect with the main business operations of the taxpayer company. She contended that the said income, therefore, cannot constitute the operational income of the taxpayer as explained....
X X X X Extracts X X X X
X X X X Extracts X X X X
...., therefore, very difficult to say that the activity of earning service income was forming part of the manufacturing activity of the taxpayer company and having regard to the nature of the said activity vis-a-vis the main activity of the taxpayer company, it cannot be said that the service income accrued to it as a part of the main business activity. At the most, the said activity could be treated as incidental business activity of the taxpayer company and the income earned therefrom could be said to be accrued to it out of such incidental business. This view gets support from the decision of Hon'ble Bombay High Court in the case of CIT v. K.K. Doshi & Co. [2000] 245 ITR 849 wherein the taxpayer firm was in the business of export of polished diamonds out of India. During the relevant year, it undertook work of polishing diamonds on job work/contract basis for third parties in India and the income earned from the said activity in the form of service charges was claimed to be includible in the profits of the business for the purpose of computing deduction under section 80HHC. This claim of the taxpayer, however, was held to be not allowable by the Hon'ble Bombay High Court ob....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 58. As regards ground No. 2, it is observed that the issue raised therein relating to inclusion of income from sale of scrap in the profits eligible for deduction under section 80-IA is also squarely covered in favour of the taxpayer by the decision of the Tribunal in taxpayer's own case for assessment year 2000-01 rendered vide its order dated 31-8-2004 in ITA No. 4790/Delhi/2003. Respectfully following the said decision of the Tribunal in the aforesaid case, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No. 2 of the revenue's appeal. 59. As regards ground No. 3 relating to deduction under section 80HHC in respect of miscellaneous income i.e., sale of scrap, accounts written back etc., it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No. 2 of the revenue's appeal for assessment year 2001-02 being ITA No. 1181/Delhi/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No. 3 of the revenue's appeal. 60. As regards ground No. 4 of the revenue's appeal relati....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ating to the addition of Rs. 1,68,77,174 made by the Assessing Officer on account of brand promotion expenses, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No. 7 of the revenue's appeal for assessment year 2001-02 being ITA No. 1181/Delhi/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No. 7 of the revenue's appeal. 65. Ground No. 9 raised by the revenue in its appeal for assessment year 2002-03 relates to the transfer pricing issue which is being considered separately along with the relevant grounds raised by the taxpayer relating to the same issue while disposing of the appeal of the taxpayer. ITA No. 819/Delhi/2007-Taxpayers appeal for A.Y. 2002-03 66. Ground No. 1 raised by the taxpayer in this appeal is general seeking no specific adjudication from us. 67. Ground No. 2 relates to the disallowance of taxpayer's claim for deduction under section 10A/10B in respect of miscellaneous Income. 68. The taxpayer company is running two software development centres at Bangalore viz., S.I.S.C.....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... cancellation of contract awarded by the said company to the taxpayer company in relation to research and development of application software. He invited our attention to the copy of the said agreement placed in his paper book as Annexure-1 and pointed out that Article-6 of the said agreement explicitly provided for the terms of cancellation of contract and related compensation that shall be awarded upon such termination. He contended that since the said agreement was in relation to development of software which is the core business activity of the undertaking, compensation received on breach thereof forms an integral part of the undertaking making it eligible for deduction under section 10A/10B. He also contended that the entire miscellaneous income in any case originated from the prime business activity of the taxpayer company and the same, therefore, was the income derived from the said activity which is eligible for the said deduction. He submitted that the theory of income derived adopted by the Assessing Officer as well as by the learned CIT(A) relying on the various judicial pronouncements rendered in the context of various provisions of Chapter VI-A cannot be applied in the....
X X X X Extracts X X X X
X X X X Extracts X X X X
....alf of the taxpayer, the ambit and sweep of the words "any profits and gains" are restricted by the words "derived by any taxpayer from an industrial undertaking" following those words giving rise to the conclusion that only those profits which are having immediate source in the industrial undertaking can enjoy the exemption and not those profits whose immediate source is not the industrial undertaking but something removed therefrom. Keeping in view this ratio of the decision of the Tribunal in the case of Jubiliant Enpro Ltd., we find that the notice pay received by the taxpayer company from its employees cannot be said to have its immediate source in the industrial undertaking so as to make it eligible for deduction under section 10A as claimed by the taxpayer. Moreover, the notice pay received by the taxpayer company from its employees is not certainly reimbursement of the salary expenses incurred by the taxpayer company and the same, therefore, cannot be adjusted against such expenditure as sought to be contended by the learned counsel for the taxpayer. We, therefore, hold that the notice pay received by the taxpayer company from its employees was not eligible for deduction un....
X X X X Extracts X X X X
X X X X Extracts X X X X
....unt of Rs. 83,06,011 received by the taxpayer company on account of cancellation of contract entrusted to it in relation to development of software constituted its profit derived from the undertaking eligible for deduction under section 10B and the deduction under that section was rightly claimed by it in respect of the said income. In that view of the matter, we set aside the impugned order of the learned CIT(A) on this issue and direct the Assessing Officer to allow the deduction under section 10A/10B in respect of compensation amounting to Rs. 83,06,011 as claimed by the taxpayer company. Ground No. 2 of the taxpayer's appeal is thus partly allowed. 73. As regards ground No. 3 of the taxpayer's appeal relating to its claim for deduction under section 80-IA in respect of miscellaneous income and service income which stands disallowed by the Assessing Officer as well as by the learned CIT(A), it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.2 of the revenue's appeal for assessment year 2001-02 being ITA No. 1189/Delhi/2005. Following our decision rendered on the said issue, we reverse the ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....oncluded in assessment year 2002-03. According to him, the deduction on account of the said amount thus has been disallowed by the department in both the years i.e., assessment years 2002-03 and 2003-04 which has caused a genuine grievance to the taxpayer. The learned DR left this issue to the Tribunal to be decided in accordance with law. 78. After considering the rival submissions and perusing the relevant material on record, it is observed that the expenditure of Rs. 6,81,551 claimed by the taxpayer company in assessment year 2003-04 on account of retrospective price revision made by its supplier was categorized by the auditors as "prior period expenses" being pertained to assessment year 2002-03 and relying on the said comment of the auditors, the claim of the taxpayer for deduction on account of the said expenditure was disallowed by the Assessing Officer. Thus, a definite stand was taken by the Assessing Officer relying on the auditors' comment that the said expenditure was actually pertaining to assessment year 2002-03 and this being so, we are of the view that the deduction claimed by the taxpayer for the said expenditure in assessment year 2002-03 should have been a....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e also relied on the decision of Hon'ble Calcutta High Court in the case of Hindustan Aluminum Corpn. Ltd. v. CIT [1986] 159 ITR 673 and that of Hon'ble Supreme Court in the case of CIT v. Royal Calcutta Turf Club [1961] 41 ITR 414 and submitted that the expenses incurred on training of employees in these cases to achieve efficient running of business was held to be revenue in nature. He also submitted that the decision of Hon'ble Supreme Court in the case of Madras Industrial Investment Corpn. Ltd. relied upon by the revenue is clearly distinguishable on facts as the issue involved therein was relating to the allowability of discount on issue of debentures which was held to be liable for spreading over the life of debentures. 82. The learned DR submitted that the substantial expenditure incurred by the taxpayer company for imparting training to its employees had definitely given a benefit of enduring nature to it and since the disallowance made by the Assessing Officer out of the said expenditure to the extent of 50 per cent assuming that such benefit had accrued for a period of two years only was quite fair and reasonable, the learned CIT(A) was fully justified in ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....s. In the case of Associated Cement Co. Ltd., the advantage secured by the taxpayer by incurring the expenditure was absolution or immunity from liability to pay municipal rates or taxes for a period of fifteen years and as the said liability was on revenue account, it was held by the Hon'ble Supreme Court that the expenditure incurred was of revenue nature as the advantage secured was in the field of revenue and not capital. In the present case, the expenditure incurred by the taxpayer company on imparting training to its employees in order to increase their efficiency in day-to-day working was in the revenue field and this being so and keeping in view the legal position emanating from the judicial pronouncements discussed above, we hold that the same was entirely deductible in the year under consideration as rightly claimed by the taxpayer. The impugned order of the learned CIT(A) confirming the disallowance made by the Assessing Officer to the extent of 50 per cent on this issue is, therefore, reversed and the Assessing Officer is directed to allow the said expenditure in full. Transfer Pricing Issue involved in assessment year 2002-03 84. Ground Nos. 7 to 11 raised in....
X X X X Extracts X X X X
X X X X Extracts X X X X
....roducts 169.9 2. Import of finished products for resale 58.75 3. Export of 21 inches Wega TV 9.2 4. Software services provided to AEs 15.43 5. Marketing advisory services provided to AEs 4.04 6. Reimbursement of advertisement expenses 14.88 7. Import of moulds 0.62 8. Reimbursement for defective CRTs and rebate received 0.71 9. Services received for IT, communication and sharing of best practices 1.14 86.1 The taxpayer had imported electronic components and CRTs from its associated concerns and had claimed that above items were acquired at Arm's Length Price and for that purpose had relied upon Transactional Net Margin Method (TNMM). It had chosen the foreign AEs from whom the components were imported as tested parties and had computed the profit of AEs with comparable chosen from Indian and other data bases. The same method was chosen for the distribution activities relating to high-end electronic products, projector tapes etc. where the taxpayer was taken as a tested party. Operating profit margin on sales had been chosen as the Profit Level Indicator (PLI). Likewise, TNMM analysis were also employe....
X X X X Extracts X X X X
X X X X Extracts X X X X
....nsactions can be closely interlined only when they impact each other's profitability in a material manner. No such conclusion can be arrived at in these sets of facts. The TP report's approach is contrary to the claim forwarded during the proceedings. It is an implicit rejection of separate analysis of the trading activity under TNMM. The onus to explain this departure and to sort out the void created by this rejection rests on the taxpayer which has not been discharged." In the long arguments as also in oral submissions, Shri Bhutani, the ld. representative of the taxpayer, did not challenge above action of the TPO. Further, no reference was made before the Tribunal to any consolidated figures. Accordingly, we do not deem it necessary to carry further discussion on this point. Most Appropriate Method 87.2 The TPO agreed that TNMM was the Most Appropriate Method in the circumstances as it is more tolerant to functional differences and accounting differences at gross level gets eliminated due to a comparison at net level while selection of comparables. The TPO further observed that no internal TNMM was possible and, therefore, external independent enterprises engage....
X X X X Extracts X X X X
X X X X Extracts X X X X
....d. (b) Godrej Appliances Ltd. (c) Hitachi Home & Life Solutions (India) Ltd. (d) Carrier Aircon Ltd. (e) Whirlpool of India Ltd. 89. The TPO accepted B.S. Refrigerators Ltd. as a comparable entity but rejected other companies as they were engaged in different activities. Carrier Aircon Ltd., Whirlpool of India Ltd. and Hitachi Home & Life Solutions (India) Ltd., according to the TPO, had comparable controlled transactions with related parties for benchmarking and, therefore, not fit to be taken as comparable companies. Godrej Appliances Ltd. was showing persistently heavy losses and was, therefore, not accepted as comparable by the TPO. Accordingly, the operating margin was worked by the Assessing Officer at 9.01 per cent as under:- Name of the company Operating Profit Margin o Sales (OP/Sales) Weighted Average Mean for the years 99-2000 and 2000-2001 BS Refrigerators Ltd. 4.47% Videocon Appliances Limited 14.06% Videocon Communication Ltd. 4.06% Videocon International Ltd. 9.42% Arithmetic Mean 9.01% 90. The taxpayer for working out its operative margin claimed deduction and benefit for not ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... advertising campaigns of new product launches not through reimbursements but through equity contribution or through an unsecured loan, it would not have been possible for the taxpayer to claim that the said expenditure was not an operating expenditure. The mere fact that the expenditure was received as assistance does not make it a non-operating expenditure." As noted earlier, trading and manufacturing activities of the taxpayer were considered separately for benchmarking. According to the TPO, the taxpayer had shown profit margin of 3.93 per cent from trading. However, after adjustment, the profit margin from trading operation was computed by TPO at - 1.64 per cent which was obviously below the Arm's Length margin of 3.93 per cent. The TPO was, therefore, of the view that adjustment on account of purchases of items was to be made by applying margin of 5.57 per cent (3.93 + 1.64) which he applied to Rs. 116,75,77,000. Thus, total value of international transactions was taken at Rs. 52,24,36,416 against Rs. 58,74,70,454 shown in books and an adjustment of Rs. 65,034,038 was directed to be made as per calculation below:- "Amount of adjustment = 5.57% of Rs. 1,167,577....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... Difference in per cent terms between ALP and International Transactions = 25.65 per cent 12.2.1 Proviso to section 92C(2) permits a maximum variance of 5 per cent from the Arm's Length Price. In this case the difference of 25.65 per cent being more than 5 per cent is not acceptable. Hence it is concluded that the price adopted by the taxpayer have to be reduced by Rs. 347,080,908 which is 20.41 per cent of the value of the international transactions. Therefore, 79.59 per cent of the international transaction value becomes the arm's length price. The ALP for different groups of transactions summarized in the table below: Name of the Associated Enterprise (AE) Transaction Amount (in Rs.) Arm's Length Price (79.59% of Transaction Amount) Sony Electronics (Singapore) Pte. Ltd. ("SES") 512,172,310/- 407,637,942 Sony Electronics (Singapore) Pte. Ltd. - Sony Display Device Division ("SDD") 604,101,283/- 480,804,211 Sony Electronics (Malaysia) SDN BHD, ("SEM") 826,893/- 658,124 Sony Corporation, Tokyo ("SC") - Sony Trading International Corporation ("STIC") 190,604,872/- 151,702,418 Sony Technology Malaysia SDN BHD ("....
X X X X Extracts X X X X
X X X X Extracts X X X X
....r. On these objections, the learned CIT (Appeals) sought a remand report from the Assessing Officer/TPO. After considering facts and circumstances of the case and the report of the TPO as also arguments of the Assessing Officer, the learned CIT (Appeals) did not find any force in objections on violation of principle of natural justice, on not providing sufficient opportunity of being heard, on order of TPO being not binding on the Assessing Officer, on validity of reference to the TPO and on choice of the tested party. All these objections raised on above issues were rejected by the learned CIT (Appeals) after a detailed discussion. Above issues have not been carried in further appeal. No reference was made to above objections in oral or in the written submissions by the ld. Authorized Representative of the taxpayer. Therefore, we do not deem it necessary to refer to the finding recorded by the learned CIT (Appeals) on above issues. 93.1 The learned CIT (Appeals) held that for purposes of transfer pricing evaluation, each and every transaction should be taken as a distinct and separate transaction. Profit of each segment should be separately worked out through an accepted method....
X X X X Extracts X X X X
X X X X Extracts X X X X
....competitive and has to take the overhead costs of the export transaction into account. For instance, freight is disproportionately large in the export of consumer electronic products since the value/volume ratio in case of such products is usually very low. Further, the appellant received export benefits under the DEPB to engage in the export sales. Taking into account such factors, the export prices would be more beneficial than the price fetched by the same product in the domestic market. (v) The ld. AR further submitted that it operated in a "limited risk" environment. In the absence of comparable companies operating under similar circumstances, i.e., marginal costs, the appellant has chosen full fledged manufacturers of consumer electronics as comparables. Since a full fledged manufacturer operating under uncontrolled environment would normally undertake more functions (marketing, sales, after sales support) and risks (warranty risk, business risk, credit risk etc.) as compared to the appellant's export transaction, their operating margins are likely to be higher than those of a company exporting under contracts with its related party. Hence, an adjustment is warra....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... 2,071 2,071 Interest Received from customers for delayed payment 1,631 Nil Other Misc. Revenue 6,739 Nil Total 39,970 20,577 94.1 After considering arguments of learned representative of the taxpayer, learned CIT (Appeals) allowed relief on five items noted above. Other items were not treated as part of operational expenses. Relief allowed by the ld. CIT (Appeals) has not been challenged by the taxing authorities and, therefore, would not be part of discussion here. Adjustment on differences between comparables and Tested party: 94.2 Before the learned CIT(Appeals), the taxpayer sought reasonable adjustments on account of the following differences between the taxpayer and the comparable companies: (i) Local Area Development Tax ('LADT') - It was claimed that LADT was imposed only in State of Haryana and not outside the State. Therefore, appellant had to bear additional operational cost of Rs. 12 crores during financial year 2001-02 whereas other comparable did not incur such expenditure. (ii) Import Duties - The taxpayer claimed that adjustment be made for the import duty paid on parts imported by the taxpayer as lo....
X X X X Extracts X X X X
X X X X Extracts X X X X
....t year 2002-03. He found that TPO did not allow similar adjustment in assessment year 2003-04 and there was a contradiction in the approach of the TPO in the two years before him. With a view to maintain parity in the finding, a show-cause notice was given to the taxpayer - why the above reduction be not reduced. After considering objections of the taxpayer, the learned CIT (Appeals) held that there were differences in profile of appellant and the comparable companies as far as ownership of intangible and R&D expenses were concerned. Thus it led to certain distortions in the net margin earned by the company. All the same he was of the view that absence of intangibles or R&D section did not effect taxpayers earning. "Sony" brand is much bigger and powerful than most of competitive and comparables. Therefore, ownership of intangible was immaterial. In respect of research and development, the learned CIT(Appeals) held that deduction of 20 per cent was excessive and unreasonable. He, therefore, restricted it to 10 per cent against 20 per cent allowed by the Assessing Officer. The learned CIT (Appeals) further held that taxpayer was not entitled to any other adjustment on account of dis....
X X X X Extracts X X X X
X X X X Extracts X X X X
....k-I, filed by the taxpayer. 97.2 It is further claimed that Sony Pacific as a marketing support company is responsible for building of Sony branch in Pan Asia Region. In order to achieve above and to help the marketing and promotional activities and to promote the Sony brand in India and Asia, Sony Pacific entered into above agreement and reimbursed part of advertisement cost incurred by the taxpayer. T.P.O. was of the view that transaction between the taxpayer and Sony Pacific could have been in the form of loan or equity and had it been the case, the source of expenditure would not have made it an operating expenditure. In para 11.4-4 of his order, the TPO has made the following observations: "The source of an expenditure may be traced back to equity or windfall gain but the source does not characterize the purpose of such expenditure. In this case if the associated enterprise had chosen to fund the advertising campaign of new product launches not through reimbursements but through equity contributions or through an unsecured loan, it would not have been possible for the taxpayer to claim that the said expenditure was not an operating expenditure." He further obser....
X X X X Extracts X X X X
X X X X Extracts X X X X
....low made by learned representative of taxpayer in support of the claim. We are of the view that arguments taken by learned representative of the taxpayer are well founded. We record our reasons for accepting them. (i) Under Fiscal Laws, actual transaction, as entered into between the parties, is to be considered. Authorities have no right to rewrite the transaction unless it is held that it is sham or bogus or entered into by the parties in bad faith to avoid and evade taxes. That is not the case here and, there is no allegation that transaction had any other purpose then one reflected and shown by the parties in the transaction. The doctrine of substance over the form was not fully approved by the House of Lords in Duke of Westminster v. IRC [1936] 19 TC 490 (HL) and in IRC v. Wesleyan General Assurance [1940] 30 TC 11 (HL). In the first case, the following observations were made: "I must confess that I view with disfavour the doctrine that in taxation cases the subject is to be taxed if in accordance with a court's view of what it considers the substance of the transaction, the court thinks that the case falls within the contemplation of spirit of t....
X X X X Extracts X X X X
X X X X Extracts X X X X
....o cases in which the legal relation is recorded in a formal document and to cases where it has to be gathered from evidence - oral and documentary - and conduct of the parties to the transaction." 101. We are further of the view that above principles applicable to fiscal statutes are incorporated in special regulations on transfer pricing under rule 10B(2)(c) of Income-tax Rules wherein it is provided that the comparability of an international transaction with an uncontrolled transaction is to be judged with reference to the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions. 101.1 U.S. Transfer Pricing Regulations also support similar approach, as is evident from the following provision- "Agreements that are in writing and made in advance of the transaction will be respected if the terms are consistent with economic substance of the underlying transaction.": (US) Trans. Reg. §1.487-1(d)(3)(ii)(B)(1). "Greatest weight is given to "actual conduct" of the parties".....
X X X X Extracts X X X X
X X X X Extracts X X X X
....red wholly and exclusively for the purposes of the business. This fact is admitted by the TPO as is evident from para 11.4-1 of his order as under: "It is an admitted fact that the taxpayer company spent the money reimbursed by its associated enterprises on advertising, marketing and in providing after sales service to customers. All these expenditures were made wholly and exclusively for the purpose of the business of the taxpayer." 103. There is further no dispute that expenditure had nexus and resulted in increase in business of the taxpayer. The TPO at page 12 of his order noted as under: "The fact that the amount of Rs. 23 crores received as reimbursement was actually spent to further the business interest of the taxpayer has not been disputed at all. The company has admitted repeatedly that the amounts were spent wholly and exclusively for the purpose of the business i.e., to increase the sales of its products and to improve customer satisfaction ... leads to increased market awareness and has immediate nexus with increased sales (or at least possibility of increased sales) of such products." There is no finding that the AE of the taxpayer did not actu....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ome of the taxpayer. We allow this ground of appeal. 105. We next take ground No. 8.3(d) where exclusion of reimbursement received from Sony Gulf as part of the operating expenses has been challenged. During the financial year 2001-02, Sony Gulf FZEUAE (Sony Gulf) reimbursed the taxpayer for expenses incurred by it for master production of Sony Audio TV Commercials (TVC) for telecast in Africa and Middle East. Sony Gulf used the TVC for telecast in Africa and Middle East. For the functions performed and for facilities provided to Sony Gulf, the taxpayer received a sum of INR 4,831,840 in the period under consideration. 105.1 The TPO was of the view that reimbursement received was not part of operating profit and excluded the amount received while computing operating profit of the taxpayer. 105.2 The learned CIT (Appeals) agreed with the view taken by the TPO and the Assessing Officer. 105.3 In the appellate proceedings before us, the learned representative of the taxpayer submitted that amount in question was purely in the nature of reimbursement of cost incurred by the appellant on behalf of and for the purposes of its AE. It is unfair and inappropriate to treat entire....
X X X X Extracts X X X X
X X X X Extracts X X X X
....mputing operating profit. 106.1 The first of these items is, provision written back amounting to Rs. 57,02,000. For exclusion of above item and for balances written back, interest received from customers and other miscellaneous revenue receipts, the ld. CIT(A) gave the following consolidated reasons:- "(A) I find that interest received is a financial income and as such cannot be considered as operational receipts. (B) The items which have been written back as mentioned in sub-paras (i) & (ii) of this para, are nothing but merely accounting entries and are not connected to the operations of the appellant. (C) The exact constitution of the item Miscellaneous Income is not explained and so it is not possible to consider it operational revenue. Hence, the same is being treated as non-operational. Hence, the Assessing Officer's action for exclusion of these items for calculating the margin of the appellant are upheld." General remarks of the TPO on what are non-operating profit items have already been noted. No specific reason for not treating these items as part of business profit is available in the orders of the TPO/Assessing Officer. The ld. D.R.....
X X X X Extracts X X X X
X X X X Extracts X X X X
....iability has ceased to exist and is required to be accounted for and shown as income by the taxpayer and, in case it is not so shown the taxpayer can be subjected to a penal action under Indian regulations. In this connection, we can refer to decision of Supreme Court in the case of CIT v. S. Teja Singh [1959] 35 ITR 408. Having regard to statutory provisions, it cannot be said that provisions or writing back of liability is not part of operating profit or would not be taken into consideration for computing the same. The aspect of liabilities written off was ignored without considering nature and character of such liabilities. It would have been different if a finding was recorded that provision written back did not relate to business operations of the taxpayer. There is no suggestion on the above lines. Further it is not the case of the revenue that liabilities written back were wrongly provided for. It is a settled and well-accepted proposition that adjustment can be made only on account of differences. It is not possible to believe that other comparable entities taken into consideration are not making and writing back provision of liabilities no more required. There is no materi....
X X X X Extracts X X X X
X X X X Extracts X X X X
....y received have observed as under:- "If the amounts are not paid at the proper time and interest is awarded or paid for such delay, such interest is only an accretion to the taxpayer's receipts from the contracts. It is obviously attributable and incidental to the business carried on by him. It would not be correct, as the Tribunal has held, to say that this interest is totally de hors the contract business carried on by the taxpayer. It is well-settled that interest can be assessed under the head "Income from other sources" only if it cannot be brought within one or the other of the specific heads of charge. We find it difficult to comprehend how the interest receipts by the taxpayer can be treated as receipts which flow to him de hors the business which is carried on by him. In our view, the interest payable to him certainly partakes of the same character as the receipts for the payment of which he was otherwise entitled under the contract and which payment has been delayed as a result of certain disputes between the parties." The above decision has been followed by several High Courts. The Kerala High Court in the case of United Construction Contractors v. CIT [1....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rectly taken by the taxpayer. He further held that the profit margin shown by the taxpayer was gross margin in which direct expenses like wages, depreciation, power and fuel were excluded. The taxpayer was, therefore, asked to explain its position on above points. The explanation of the taxpayer and TPO's comments are available in paras 12.33 to 12.39'of TPO's order. The TPO thereafter proceeded to compute by TNMM the net profit margin of taxpayer on total cost barring advertisement, selling, warranty and cash discount expenses and found that it was a loss. Operating loss was worked out at (-7.73 %) against average operating profit margin of com parables at 5.25 per cent. The difference between the two was thus taken at 12.98 per cent. The TPO suggested adjustment of Rs. 12,025,988 in the above I.T (International Transaction) as per the following calculation/observation:- "Amount of adjustment + 12.9896 of Rs. 92,650,139 = Rs. 12,025,988 Total value of international transaction pertaining to export of finished goods = Rs. 92,650,139 Arm's Length Price = Rs. 92,650,139 + Rs. 12,025,988 = Rs. 104,676,127 Difference in % terms betwee....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ly claimed because the adjustments for differences between export and domestic sales are to be taken into consideration. Like has to be compared with like. Further, the revenue has not been able to show that export realization was lower than the domestic sale realization and this is sufficient to prove that the transactions were at Arm's Length. The ld. DR in reply submitted that marginal costing theory was being submitted for the first time during the appellate proceedings. The ld. DR further submitted that exports were pre-planned as a multinational company could never have worked on an idle capacity. It was further submitted by ld. DR that the details regarding domestic sale of models in question were never furnished to the TPO. While computing the operating margin, cost of power and fuel were not taken into consideration. In rebuttal the ld. Counsel pointed out that export transaction was not preplanned. Idle capacity is normal to any manufacturing/assembling unit and is a practical business problem faced by all similar concerns. It was wrong to contend that details of domestic sales and models in question were never furnished to the TPO. The TPO had made reference to these....
X X X X Extracts X X X X
X X X X Extracts X X X X
....r determining the question whether the units were exported at Arm's Length Price. We are of the opinion that under-utilization of capacity, if any, are burden of overheads and motive to reduce them, cannot justify export of CTV at a price less than the price to any unrelated party. It was to be shown that the similar price was charged for similar item in similar circumstances. Therefore, the ld. CIT(A) was quite justified in rejecting the main argument of the taxpayer. However, before the CIT(A), the taxpayer had raised an alternative argument that export price was quite comparable to local sales price of a similar model. It was pointed out that similar model was sold for Rs. 16,138. In the above sale price, there was an element of excise duty - Rs. 1,929, sales tax - Rs. 2,010 and other taxes Rs. 144. If adjustment for above duty and taxes which are not leviable on export sales is made, the sale price works out to Rs. 12,056 against Rs. 12,595 charged from Sony Japan after taking benefit permissible in export scheme at the rate of 18 per cent. The ld. CIT(A) has duly noted the contention but for reasons best known to him, did not comment on this alternative submission justifyi....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ve levy when it had decided to operate from the State of Haryana. It is not material that other states had not imposed such a levy. She pointed out that one comparable relied upon by the taxpayer was subjected to such a levy. The ld. Counsel for the taxpayer, on the other hand, supported the impugned order of CIT(A). It was argued that levy was unique to units operating from the State of Haryana. Other enterprises carrying on similar activities were not subjected to levy. The levy had nothing to do with assembly or sale activity carried on by the taxpayer. The levy was further accepted as arbitrary and unconstitutional by Punjab & Haryana High Court and struck down. On further appeal, the Hon'ble Supreme Court has maintained the order of the High Court. Copies of above decisions are placed on record. 114.3 After considering rival submissions of the parties, we do not see any justification for interfering with the impugned order of the CIT(A) on this issue. This statutory levy has nothing to do with operating profits of the taxpayer. Other enterprises taken into account by the TPO are not subjected to such levy. Even if one of several comparables is also paying LADT, then whi....
X X X X Extracts X X X X
X X X X Extracts X X X X
....onics are sought to be included in comparables." After obtaining the clarification as above about the exact stand of the taxpayer, we now proceed to consider and decide the issue relating to selection and rejection of comparables. 115.2 We will first deal with the objection of the taxpayer in respect of non-inclusion of Hitachi, Carrier and Whirlpool as comparables. We find that only objection raised for excluding above enterprises from the list of comparables was that these enterprises are "having controlled/related party transactions". The learned D.R. in arguments before us also reiterated the same submissions. The learned representative of the taxpayer, on the other hand, submitted that these allegations are totally unsubstantiated. With reference to information available on record as per Annexure 7, it is stated that Carrier, Hitachi and Whirlpool had related party transactions merely at 10.18 per cent, 13.90 per cent and 6.88 per cent respectively of the revenue receipt. It was accordingly contended that related party transactions of these companies are not very significant. It has been argued that above companies have been excluded from the list of com parables on extr....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rs. No dispute having been raised by TPO or the ld. CIT(A) that the other filters of functions, economic activities, product profiles etc. are satisfied, we are of view that these three entities should also be taken in the list of comparables for working average/mean operating profit. Even as per OECD Guidelines, it is emphasized that large number of similar entities should be taken to make comparison broad based. 116. We now consider objection of the taxpayer relating to exclusion of Godrej from the list of comparables. It was submitted by the learned representative of the taxpayer that Godrej satisfies all the filters chosen by the TPO himself. Filter No. 3 of the search process employed by the TPO refers to "exclusion of companies with negative net worth" i.e., companies with liabilities in excess of their assets. However, Godrej has been excluded by holding that it is a loss making company. Godrej did not have negative net worth as is dear from the balance sheet of company for financial years 1999-2000 and 2000-01 (Annexure 6 of written submissions on record). It is further argued that the ground that it is a loss making company, is contrary to the OECD Draft Notes on Compar....
X X X X Extracts X X X X
X X X X Extracts X X X X
....taxpayer industry. Every industry has to deal with over-crowded market with too many players and face competition on account of fierce price cutting, heavy advertisement spend, launches of new products, easy credits etc. Loss is normal incident of any industry. So is utilization of installed capacity, it might be in the case of Godrej at 50 per cent. It was thus little more than other similar industries. The learned counsel for the taxpayer further relied upon the following extract from page 3 of annual report of Godrej: "The company was affected by the general state of the refrigerator as well as the washing machine industry, both of which recorded negative growth during the year under review. The market is overcrowded with too many players, all with huge unutilized capacities. The only way out for all players was fierce price-cutting, heavy advertisement spend, new product launches and easy credit terms in an attempt to boost consumer sales." 119. We have given careful thought to the objections of the taxpayer on the exclusion of Godrej with reference to material on record. It is no doubt true that loss and competition are normal incident of business and merely on abo....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ery different. It can earn more profit than other multinational competitors who import their components. 121. It is further submitted that Videocon International is quite dissimilar vis-a-vis the taxpayer on account of product comparability. The company earns significant portion of its revenue from sale of non-comparable products like glass shells and CRTs and this fact has been completely ignored by CIT (Appeals) in the impugned order. Further the turnover of Video con International is six times that of the appellant. It is 3,000 crores against 500 crores of the appellant. It is urged that TPO was wrong to use filter to eliminate companies with lower turnover, without according similar treatment to companies with significantly higher turnover which has disturbed the balance of the results. Thus inclusion of Videocon International with such high turnover was incorrect. The learned counsel also challenged DR's submission that Videocon entities including Videocon International were included in taxpayer's own comparables. It was explained that the taxpayer had furnished bigger set of comparables subject to adjustments and in proceedings before the T.P.O and the CIT (Appeals....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ts employed or to be employed and the risks assumed, by the respective parties to the transactions; (c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. Further caution required to be adopted while looking to the differences between controlled and uncontrolled transaction is provided in sub-rule (3) of rule 10B which is as under:- "(3) An uncontrolled transaction shall be comparable to an international transaction if- (i) none of the differences, if any, between the transaction s being compared, or between the enterprises entering into such transactions are likely to materially affect the price o....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... location of comparable is possible. For example, a mere consideration that controlled transaction relates to "software supply" is not sufficient as there are hundreds of softwares with different characteristics which materially affect their open market value. The characteristics that are required to be considered include in case of transfer of tangible property, the physical feature of the property, its quality, reliability and availability (supply). In case of provisions of services, the nature and extent of services and where tangible property is involved for comparison, the form of transaction. To put it in other words, all the characteristics of the controlled transaction which are likely to affect its open market value must be taken into account. The study should include analysis of functions, risk and assets of the controlled transaction for correct location of similar or nearly similar characteristics in uncontrolled transactions. Specific characteristics are necessary to carry search of similar comparable with similar characteristics. 27. After the selection of the comparables, best method of determining Arm's Length Price is selected. Thereafter, functional a....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ost of the comparable analysis carried in India, the latter type of risk are not being taken into consideration although these can lead to major difference in Market Value of transactions. 27.2 The European tax authorities are reluctant to accept "adjustments" because adjustments necessarily involve consideration of question whether they are appropriate or not and therefore it is always better to find comparable requiring the least or no adjustment. The position in India as per Indian regulations on the subject has been noted earlier. If there are differences which can be adjusted, then adjustments are required to be made. If the difference between the companies are so material that adjustment is not possible, then com parables are required to be rejected. 27.3 Further in the analysis numerous ratio are applied, depending on the specific of the comparables. The search may include the following:- Inventory/sales; operating assets to total assets, fixed assets to total sales, fixed assets to number of employees, operating expenses to sale, cost of sales." 123.1 The Tribunal also referred to and commented upon Para 3.27 of OECD Report of July, 1995 but re....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ilar to the controlled transactions under examination should be excluded from the comparison. (DECD Guidelines para 3.42). This statement is sometimes interpreted as prohibiting the company-wide application of TNMM. However, a more reasonable interpretation is that it requires the same treatment of unlike business segments as set forth in the U.S. regulation statement that: The reliability of the allocation of costs, income, and assets between the relevant business activity and other activities of the tested party or an uncontrolled comparable will affect the reliability of the determination of operating profit and profit level indicators. (Treas. Reg. §1.482-5(d)(3)(iii)" 125. Famous author Karl Wundisch in his book on "International Transfer Pricing in the Ethical Pharmaceutical Industry' issued by International Bureau of Fiscal Documentation has pointed out in [H54] at page 250 to several areas on which disagreements can arise between the taxpayer and the tax authorities. Thereafter in [H55], the learned author has observed as under: "[H55] A particular area of disagreement might be that concerned with the question of what is a comparable o....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... the Annual Report, under the heading "Expansion of Glass Shell Unit", it has been mentioned that: "Your company is the only leading manufacturer of glass parts required for its manufacture of picture tubes." At para 1.2 on page 13 under Management Discussion and Analysis the Report states: "with the captive manufacturing of CTV shells the Company enjoys cost advantage vis-a-vis the competitors." In Para V on Page 13, the Report states:- "The Company manufactures consumer electronic products in India in modern vertically integrated facilities. The Company by having manufacturing facilities within India, is able to reduce dependence on import, tariffs protection and which restrict its foreign competitors in their ability to import finished goods and components." In Para 4.1 on Page 14, it is mentioned: "Further the Company earns a sizeable portion of its revenue from the manufacturing of Glass Shells which are used in the manufacturing of TVs. The Company has earned a revenue of Rs. 2,465 Million from Glass Shell (Panels) for CTV Picture Tubes and a revenue of Rs. 1,332 Million from Glass Shell (Funnels) for CTV Picture Tubes." 126.1 T....
X X X X Extracts X X X X
X X X X Extracts X X X X
....impressed by the arguments of learned Departmental Representative that Videocon International was included in the list of comparables furnished by the taxpayer. In our considered opinion, there is sufficient material on record to show that taxpayer in proceedings before the TPO as well as before the learned CIT (Appeals) had argued that there were huge differences between the taxpayer and the Videocon International and, therefore, Videocon International should be excluded from comparison. Be that as it may, we do not see any good reasons to debar the taxpayer from raising the claim that Videocon International should be excluded from the list of comparables. For all the aforesaid reasons, we direct that Videocon International be excluded from the list of comparables. 20 per cent deduction on account of intangibles, R&D etc. and enhancement of assessment by learned CIT (Appeals) 128. The TPO after determining mean margin of comparable companies allowed deduction of 20 per cent therefrom on account of difference in ownership of intangibles and R&D etc. in assessment year 2002-03. However, the TPO allowed no deduction for above factor in the subsequent assessment year 2003-04. ....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... procuring important components whereas comparables were required to deal with outsiders, maintain quality control and carry negotiations. For all the above factors, risk was involved for which comparables were getting returns. Therefore, adjustments were necessary for the risks stated above. 129.3 The learned CIT (Appeals) quoted para 25.3 from the order of his predecessor for assessment year 2002-03 and agreed with the view taken in assessment year 2002-03. He concluded as under: "Thus after considering the fact, I allowed the reduction on the account of R&D to the extent of 10 per cent. I had also given finding that there was no need to provide any reduction/rebate on the ground of ownership of intangibles and brand. For the sake of convenience, the relevant portion of my observation on this issue as contained in para 25.3 of the last year appellate order is quoted below." 130. The revenue has accepted above finding of the learned CIT (Appeals). Therefore, reduction to the extent of 10 per cent has attained finality and is no more in issue before us. The taxpayer through his representative argued that there was no justification on the part of the learned CIT (Appe....
X X X X Extracts X X X X
X X X X Extracts X X X X
....llant. These comparables are also responsible for storage and subsequent sale of finished goods and bear the risk of obsolescence/damage of its inventory. The learned representative of the taxpayer also challenged the finding of learned CIT (Appeals) that appellant had to pay no consideration towards intangibles. In fact above finding was irrelevant. The relevant thing is that appellant is not owner of any intangible whereas every tangible expects some return on account of handling intangible and, therefore, some adjustment in the case of the taxpayer not having intangibles. 131.1 As regards working capital, amount receivable and money tied up in holding inventory is an operating expenses and when the same is higher and different from those in the hands of the comparables, there is necessity to accurately evaluate the difference. This is an internationally accepted trade principle. The learned counsel for the taxpayer also challenged DR's observation that Chinese rule prohibit the use of adjustment of working capital. The learned counsel for taxpayer drew our attention to the detailed working available in the paper book of the differences in the working capitals of the taxpa....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... and even the Tribunal in the case of Mentor Graphics (Noida) (P.) Ltd. has accepted this proposition in principle. The question, however, is whether in the facts and circumstances of the present case, any such adjustment would be justified on account of working capital to the operating margins of the comparables. In this regard, it is observed on perusal of the working given by the taxpayer company itself that such adjustment by reducing the operating margin can be allowed only in the case of M/s. Videocon Appliances and M/s. B.S. Refrigerators. Even in the case of M/s. Videocon International, the adjustment which is called for on the basis of the figures for 2001 is to the extent of 1.81 per cent whereas the same comes to 0.51 per cent on the basis of figures for the year 2000. This substantial variation in the adjustment required to be done on the basis of figures for the immediately two preceding years makes it clear that the difference in working capital requirement between the taxpayer company and M/s. Videocon Appliances is not consistent on long-term basis and the same is fluctuating in a wide range. In these circumstances, even if we take the simple average of these two ye....
X X X X Extracts X X X X
X X X X Extracts X X X X
....by the com parables. Moreover, the local levies such as sales tax etc. are also required to be taken into account for such comparison. It is also pertinent to note here that if the taxpayer company has purchased the imported components after payment of custom duty at a higher price than the indigenous components purchased by the comparables, this decision must have been taken by it consciously taking into account all the commercial considerations including the obvious benefits of better quality which is bound to reflect or translate into a higher selling price of the product. This leaves hardly any scope for adjustment to the profit margins of the comparables on this count. 137. For the reasons given above, we allow deduction at 20 per cent for various differences on account of intangibles, research and development, risk factors, working capital, etc. etc. against 10 per cent allowed by the learned CIT (Appeals). This ground is disposed of accordingly. ITA No. 1656/Delhi/2007-Revenues appeal for AY 2003-04 138. As regards the issue raised by the revenue in ground No. 1 relating to the addition of Rs. 3,01,89,816 made by the Assessing Officer on account of brand promotion e....
X X X X Extracts X X X X
X X X X Extracts X X X X
....Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) disallowing the taxpayer's claim for deduction under section 80-IA in respect of miscellaneous income and service income and dismiss ground No. 2 of the taxpayer's appeal. 144. As regards the issue raised by the taxpayer in ground No. 3 relating to the disallowance made on account of expenditure incurred by the taxpayer company on training of its employees, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No. 6 of the taxpayer's appeal for assessment year 2002-03 being ITA No. 819/Delhi/2007. Following our decision rendered on the said issue, we reverse the impugned order of the learned CIT(A) disallowing the taxpayer's claim on this count and allow ground No. 3 of the taxpayer's appeal. 145. The next issue raised by the taxpayer in ground No. 4 of its appeal for assessment year 2003-04 being ITA No. 820/Delhi/2007 relates to its claim for inclusion of the following items of miscellaneous income in profits eligible for deduction under section 10A/10B:- (i) Notice pay received ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....facts and in law the CIT(A) failed to adjudicate on ground No. 16 taken in the Memorandum of Appeal before him regarding the argument that the Assessing Officer had only mechanically followed the order passed by the TPO without any application of mind on his part. The said ground reads as under:- 'That on the facts and circumstances of the case, the ld. Assessing Officer has erred by relying on the order passed by the ld. TPO without recording any cogent reasons for the same.' 6. That on facts and in law the CIT(A) erred in upholding addition to income of Rs. 400,660,016 under Chapter X of the Income-tax Act, 1961. 7. That on facts and in law, the assumption of jurisdiction by Assessing Officer/TPO to determine Arm's Length Price is bad in law and void ab-initio. 8. That on facts and in law the CIT(A) erred in upholding the modified Arm's Length Price. 9. That without prejudice on facts and in law the Assessing Officer/TPO erred and the CIT(A) inter alia erred in: 9.1 Not appreciating that the Assessing Officer/TPO has erred by not applying Transactional Net Margin Method ("TNMM") in the manner enunciated under r....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ellaneous income was not known and by not soliciting such information from the appellant before drawing the aforesaid conclusion. 9.11 Not adjudicating on the argument that final assessment should be "having regard" to ALP and not based thereon. 9.12 Allowing for a limited reduction i.e., 10 per cent in the margin of the comparable companies to account for differences in functions, risks and assets employed by the appellant vis-a-vis comparable companies in para 18.2 of the impugned order and not allowing working capital adjustment, import duty adjustment, foreign exchange adjustment and other adjustments on account of differences in risks undertaken, functions performed, ownership of intangibles and other business circumstances of the appellant vis-a-vis the comparable companies. 10. That on facts and in law the Authorities below erred in not allowing the option exercised by the appellant in determining the ALP by adjusting the arithmetical mean by 5 per cent as stipulated in the proviso to section 92C(2) of the Income-tax Act." 149. The revenue, in their cross appeal, has challenged the relief allowed by ld. CIT(A) by excluding Local Area Development....
X X X X Extracts X X X X
X X X X Extracts X X X X
....the Profit and loss account. The gist of the argument of the taxpayer is noted in para 9.12 of impugned order which shows that position in the year under consideration was the same as in the last year. The argument taken by Transfer Pricing Officer for rejecting the claim of the taxpayer are also same except for some isolated observations here and there, which, to our mind, do not make any material difference. 152.1 In the appellate proceedings, the ld. CIT(A) in para 17.3 of his order, posed the question whether the reimbursement received by the appellant on account of advertising expenditure should be considered as part of operating profit for purposes of comparison? Ld. CIT(A) has conceded, "I find that the marketing expenditure which has been reimbursed to the appellant was nothing but a part of the operating cost of the appellant and there is no dispute on the same." We agree. However, after having accepted that expenditure incurred by the taxpayer was part of operating cost, the ld. CIT(A) raised the question "whether reimbursement received should be treated as part of operational revenue". In fact, it is the case of the taxpayer that amount received from its AE was reimbu....
X X X X Extracts X X X X
X X X X Extracts X X X X
....T(A) which should not have been entertained. According to her, TPO had no occasion to examine above items. She further submitted that excluded item could not be treated as related to trading activity or trading operation. Therefore, exclusion of the said items of other income was fully justified. She further submitted that similar treatment was accorded to other comparables. The claim of the ld. DR was challenged by the ld. Counsel for the taxpayer and attention was drawn to submission dated November 29, 2005. It was submitted that exclusion was made by TPO and therefore such exclusion was rightly challenged before the CIT(A). 154. After hearing both the parties, we find no error in ld. CIT(A)'s approach in entertaining claim of the taxpayers in respect of these items and allowing some relief. In fact, revenue has not challenged the finding of the ld. CIT(A) allowing relief to the taxpayer. Out of the items excluded by the ld. CIT(A) this year, we find that in appeal relating to assessment year 2002-03, we have discussed in detail and allowed "provisions written back" as proper inclusion while computing operating profit. Likewise, interest on delayed payment has been held to....
X X X X Extracts X X X X
X X X X Extracts X X X X
....ll consider the same on merits. The issue relating to inclusion of other income in the operating profit is accordingly disposed of. Exclusion and Rejection of Comparables 155. In appeal for assessment year 2002-03, the taxpayer has vehemently challenged exclusion of Godrej Appliances Ltd., Hitachi Home & Life Solutions (India) Ltd. ("Hitachi"), FAL Industries Limited ("FAL") and Monica Electronics Ltd. ("Monica") from the list of comparables. The TPO and on appeal the ld. CIT(A) in assessment year 2002-03, had excluded Godrej and Hitachi from the list of comparables as they found that facts and circumstances in the year under consideration are similar. The above two companies have again been excluded from comparables taken into consideration. FAL and Monica Electronics Ltd. have been excluded in the year under consideration as their total turnover was much less than Rs. 100 crores. A lower filter was adopted by the TPO to take only companies having turnover of Rs. 100 crores or more. We are of the view that above Liter having been universally applied, there is no justification to take FAL (Rs. 47.85 crores) and Monica Electronics Ltd. (Rs. 62.8 crores) as comparable for deter....
X X X X Extracts X X X X
X X X X Extracts X X X X
....e allowed to the taxpayer for not possessing any intangible assets or/and R&D facilities. The taxpayer also claimed further deductions for various risks like price risk etc. It also sought deduction for "working capital" and for the higher "custom duty" the taxpayer has to pay on imports as against other comparable companies. After considering the rival submissions of the parties and the relevant material on record, it is observed that a similar deduction at 20 per cent has been allowed by us in assessment year 2002-03 involving identical circumstances. The same to that extent is allowed in this year too. Application of proviso to section 92C(2) 157. The taxpayer also claimed benefit of adjustment under proviso to section 92C(2) which is as under:- "Provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices, or, at the option of the taxpayer, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean." 158. The TPO did not allow any benefit in both the assessment years under appeal as in his view ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....o the taxpayers in the initial years of implementation of transfer pricing provisions introduced for the first time for assessment year 2002-03. The press note makes its intention clear for not making any adjustment if the price adopted by the taxpayer was up to 5 per cent less or up to 5 per cent more than the Arm's Length Price determined by the Assessing Officer. In effect, transfer pricing shown by the taxpayer was not disturbed if such price fell within the range of +/- 5 per cent of determined price. But if the variation in the disclosed price and the determined Arm's Length Price was more than the above limit, then the Circular provided that transfer price declared by the taxpayer was not to be accepted and adjustment for the variation was required to be made. 161. The ld. CIT(A) further held that provision under review was like a safe harbour i.e., if one was within the harbour i.e., within 5 per cent limit variation, such person was entitled to exercise the option. The ld. CIT(A) further observed that proviso under consideration was not a provision like any standard deduction to the taxpayer as to enable it to opt the 5 per cent deduction everywhere. It was not ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....al mean" makes it amply clear that the taxpayer may exercise the option allowed under law and choose the price varying from the arithmetic mean by 5 per cent as the arm's length price. (v) It appears that the DR has interpreted the Proviso solely in light of the Circular without any regard to the wordings or the intent of the Proviso." 162.1 Reliance was placed on the decision of the ITAT Kolkata Bench in the case of Development Consultants (P.) Ltd. v. Dy. CIT [2008] 23 SOT 455. 162.2 The ld. DR, on the other hand, relied upon the reasoning given by the ld. CIT(A). The ld. DR has further made the following submissions in writing:- "The adjusted mean ALP is taken as ALP by TPOs only in cases where the declared transfer price falls within +/- range. Consequently, the transfer price shown by the taxpayers in such cases is accepted and no transfer pricing adjustment is made. But, in cases where the declared transfer price falls outside + 5 per cent range, the main ALP is taken as ALP and consequently, transfer pricing adjustments are made by TPOs from the mean ALP and not from adjusted mean ALP. The dispute over + 5 per cent adjustment in ....
X X X X Extracts X X X X
X X X X Extracts X X X X
....Act, 2002, provided that where more than one price is determined by the most appropriate method, the arm's length price shall be taken to be arithmetical mean of such prices. This would have resulted into addition to the total income on account of transfer pricing adjustments in all cases wherever there was any variation between the arithmetical mean arm's length price (i.e., mean ALP) determined by the Assessing Officer/TPO and the transfer price as shown by the taxpayers. The transfer pricing provisions were brought on the Statute by the Finance Act, 2001 with effect from 1-4-2001. With a view to avoid hardship to the taxpayers in the initial years of implementation of these provisions, the Government of India, through a Press Note issued by the Ministry of Finance (Department of Revenue) on 22-8-2001, expressed its intention of not making any adjustment if the price adopted by the taxpayer was up to 5 per cent less or up to 5 per cent more than the arm's length price determined by the Assessing Officer. Immediately thereafter, the Board issued the Circular No. 12, dated 23-8-2001 specifying that the Assessing Officer shall not make any adjustment to the pric....
X X X X Extracts X X X X
X X X X Extracts X X X X
.... the TPO. This is sought to be achieved by taking the arithmetical mean price after adjustment of variation up to +/- 5 per cent (i.e., adjusted mean ALP), as the arm's length price so that in cases of marginal variation up to +/- 5 per cent, there would be no difference between the transfer price declared by the taxpayer and the ALP determined by the TPO. Consequently, there would be no addition on account of transfer pricing adjustment in cases of marginal variation up to +/- 5 per cent between the transfer price declared by the taxpayer and the mean ALP determined by the TPO. The benefit of adopting the adjusted mean ALP as the arm's length price is not intended to the available to a case where the variation between the transfer price shown by the taxpayer and the mean ALP determined by the TPO exceeds +/- 5 per cent of mean ALP. In case, the variation between the transfer price declared by the taxpayer and the mean ALP determined by the TPO exceeds +/- 5 per cent of mean ALP, then the arm's length price shall be taken to be mean ALP and not the adjusted mean ALP. Consequently, the transfer pricing adjustment would be made for the difference between the tran....
X X X X Extracts X X X X
X X X X Extracts X X X X
....rovision where "an option" is given to the taxpayer to take Arm's Length Price which may vary from the arithmetic mean by an amount not exceeding 5 per cent of such arithmetic mean. Here again, there is no controversy that taxpayer can take Arm's Length Price which is not exceeding 5 per cent of the arithmetic mean. The "option", as is clear from the language is to take Arm's Length Price which is not in excess of 5 per cent of the said mean. The word "option" as per The Law Lexicon is synonymous with "choice" or "preference". Therefore, it is the choice of the taxpayer to take Arm's Length Price with a marginal benefit and not the arithmetical mean determined as the Most Appropriate Method. The controversy is in cases where the International Price shown in related party transaction exceeds 5 per cent of the Arithmetic mean envisaged by the provision and such Arm's Length Price is contested by the taxpayer. According to the revenue, in such a situation, the second limb of the provision is not applicable. The reasons put forth in support of such a view by the revenue have already been noted. It is their contention that the second part/limb of the provision is mea....