AI OCR 
TaxTMI 
TaxTMI 
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2017 (5) TMI 1639
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....Rs. 96,13,655/- for the calculation of deduction u/s 80HHC ignoring that the assessee failed to file documentary evidence to justify its claim and as per provisions of explanation (baa) of section 80HHC, for computing "profits of business" 90% of sums referred to in clauses (iiia) to (iiie) of section 28 or any receipt by way of brokerage, commission, interest, rent, charges of any receipt of similar nature included in such profits have to be deducted from the profits and gains of business or profession. Reliance is also placed on the decision of Hon'ble ITAT in Beekay Engineering & Casting Ltd. v. JCIT A. No. 4961(Del) of 2002. 3. The Ld. CIT(A) has erred on facts and in law in directing the AO to allow the claim of the assessee on account of additional depreciation amounting to Rs. 20,61,050/- ignoring that documentary evidence in support of the asessee's claim for additional depreciation u/s 32(iia) of the I.T. Act is not available on record. Further, the assessee also failed to file the audit report even before the completion of the assessment. 4. The Ld. CIT(A) has erred on facts and in law in deleting addition of Rs. 1,57,35,495/- on account of Arm's Length Price u/s 90CA....
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....EPB license at a loss therefore amount subject to non add back under third proviso to Section 80HHC(3) is NIL, on failure on the part of appellant to produce the evidence required by said proviso; Kindly note that the similar ground of appeal has been decided in the favour of appellant by CIT- A VI in AY 2002-03. Copy of CIT-A order for AY 02-03 adjudicating similar ground of appeal in the favour of appellant is enclosed for your reference (Attachment-2)". 6. The ld. CIT(A) after considering the submissions of the assessee decided the issue in favour of the assessee by stating that the similar issue was decided in assessee's favour for the assessment year 2002-03. 7. Now the department is in appeal. The ld. DR strongly supported the order of the AO and also filed the written submission which read as under: "The AO has held that since the assessee failed to furnish any evidence that the rate of Duty Drawback was higher than the rate of DEPB as per the amended provision (3rd proviso of Section 80HHC read with 28(iiid)) hence the amount of DEPB of Rs. 1,27,73,524/- shall not be included in 90% of the amount to be added to "profits of business". The assessee submitted before the ....
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....ales. " 7.1 Undisputedly, ITAT Mumbai Bench (SB) in case of Topman Exports v. ITO (2009) 33 SOT 337 answered the aforesaid question in favour of the assessee by returning the following findings: "We, therefore, hold that in the scheme of section 80HHC, the face value of DEPB cannot be reduced from the purchase cost but is separate income under section 28(iiib), which accrues at the time of making application pursuant to exports. Only the profit element on the sale of DEPB, that is the amount in excess of sale proceeds over the face value, is covered under section 28(iiid). " 7.2 Then the matter went to Hon 'ble Apex Court in the case entitled Topman Exports v. CIT [2012] 18 taxmann.com 120 (SC) Hon'ble Apex Court upheld the order passed by Special Bench of the Tribunal (Mumbai) and the crux of the findings returned is as under for ready reference: "The aforesaid discussion would show that where an assessee has an export turnover exceeding Rs. 10 crores and has made profits on transfer of DEPB under. clause (iiid) of section 28, he would not get the benefit of addition to export profits under third or fourth proviso to sub-section (3) of section 80HHC but he would get the be....
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.... not be included in 90% of the amount to be added to the profits of business and thereby 90% of the DEPB amount i.e. Rs. 1,02,59,456/-0 was reduced from computation of profits of business for the purpose of calculating the deduction u/s 80HHC. Consequently, Assessing Officer reduced the deduction u/s 80HHC from Rs. 3,03,36,393/- to Rs. 2,31,60,167/-. 7.4 Undisputedly, in case, turnover of the assessee is up to Rs. 10 crores, the assessee will get deduction of 90% of the amount to be added to profits of business of export incentive and consequent deduction u/s 80HHC(3). It is also not disputed that the assessee has failed to furnish the requisite evidence to prove that he rate of duty drawback was higher than the rate of DEPB. 7.5 However, Ld. A.R. contended that the assessee has claimed the addition under 3rd proviso to Section 80HHC(3) at Rs. 6,61,653/- i.e. 90% of Rs. 7,35,170/-. Ld. A.R. further contended that 3rd and 4th proviso to section 80HHC(3)(c) operate only prospectively and relied upon the judgement cited as Pawan Kumar Jain v. Union of India [2014] 46 taxmann.com 341 (Delhi). 7.6 The Assessing Officer denied the benefits claimed by the assessee by invoking provis....
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....t charges. He asked the assessee to show cause as to why the same be not excluded from the computation of income. The AO held that such income are in principle acceptable to the existence of 90% out of profits of business in terms of explanation (baa) of Section 80HHC of the Act by observing in para 3.2.5 of the assessment order dated 28.03.2006 which read as under: "3.2.5. Sample Design & Development Charges Received - The assessee has shown receipts of Rs. 96,13,655/- on account of sample design and development charges. The assessee was asked to show cause as to why the same be not excluded from the computation of deduction. No reply has been filed in this regard, it may be pertinent to refer to the assessment and appellate proceedings in the case of the assessee for A.Y. 2001-02 in order to arrive at a conclusion regarding the treatment of these receipts. During the aforesaid proceedings it was stated by the assessee that the consideration on account of such sales did not have an element of profit, being in the nature of reimbursement of expenses. Also as per the provisions of explanation (baa) of section 80HHC, for computing profits of business", 90% of sums referred to in cl....
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....er are included in the profit and loss account. 32.11 It has, therefore, been clarified that "profits of the business" for the purpose of section 80HHC will not include receipts by way of brokerage, commission, interest, rent, charges or any other receipt of a similar nature. As some expenditure might be incurred in earning these incomes, which in the generality of cases is part of common expenses, ad hoc 10 per cent deduction from such income is provided to account for these expenses." (emphasis supplied) Therefore it is amply clear from para 32.10 of the circular that the purpose of excluding receipts like interest, Commission, other receipt etc. from the ambit of the profits of the business is to exclude such receipts which do not have an element of turnover. Whereas in the case of appellant the development of sample designs is core business activity regularly carried on by the appellant; the proceeds from the export of sample designs satisfy the test of 'Export Turnover' laid down in clause (b) to Explanation to Section 80HHC. Further the proceeds from export of sample designs have been upheld to be 'Export Turnover' by the Hon'ble ITAT in the case of assesses during AY 01-....
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....nd assigned a different meaning alleging a nexus with manufacturing or processing or core business activities. Therefore, the word "Other Receipt" appearing in clause (baa) of Explanation to section 80HHC should be read as receipts similar to receipts in the nature of brokerage, commission, interest, rent, etc." 14. The reliance was placed on the following case laws: * CIT v. Bangalore Clothing Co. [2003] 127 Taxman 637/260 ITR 371 (Bom.) * CIT v. Kiran Processors [2007] 158 Taxman 407/288 ITR 165 (Mad.) * ITO v. Su-raj Jewellery (India) Ltd. [2008] 21 SOT 79 (Mum.) * Asstt. CIT v. Herbal Isolates (P.) Ltd. [2002] 83 ITD 310 (Cochin) 15. The ld. CIT(A) after considering the submissions of the assessee held that the reimbursement of sample design and development charges constitute export turnover of the business and hence represent business income of the assessee, the same could not be included as other receipt under Explanation (baa) to Section 80HHC of the Act. 16. Now the department is in appeal. The ld. DR submitted that the AO had reduced 90% of Rs. 96,13,655/- which the assessee had shown receipt on account of "sample design and development charges", as per the prov....
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....the customers. The sale proceeds were received in foreign currency. The plea that the receipt was in the nature of reimbursement of expenses and did not include an element of profit has not been accepted by the CIT (Appeals) for lack of evidence and the position remains the same even before us. We are, therefore, of the view that no fault can be found with the income-tax authorities when they included the receipt of Rs. 10,66,725/- in the total turnover of the business. As regards the alternative claim for including the receipt as part of the export turnover, which is the numerator in the formula prescribed by the section, it cannot be said that the assessee exported samples, since sending samples is a means to procure export orders. The same goes for the design and sample charges. However, since the assessee has not been able to prove that there is no profit element imbedded in the receipt and we have on the ground held that the receipt is includible as part of the total turnover, it will be inconsistent to hold that the receipt cannot be included in the export turnover. For this reason - for the sake of consistency alone - it is held that the alternative claim of the assessee can....
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....ctured, licensed capacity and installed capacity are mentioned as N.A therefore the increase in installed capacity remained unsubstantiated. In this context kindly note that final products in appellant's industry are extremely diverse and dynamic and therefore it is not practicable to provide the details of licensed and installed capacity. Therefore AO has grossly erred in law in arbitrarily concluding that appellant is not eligible for additional depreciation without going into the facts of the case. It is therefore preyed to kindly admit Form 3AA as an additional evidence for claim of additional depreciation u/s 32(l)(iia) filed with your goodself vide letter dt. 26.10.2006." 23. Reliance was placed on the following case laws: * CIT v. Magnum Exports (P.) Ltd. [2003] 262 ITR 10/130 Taxman 702 (Cal.) * CIT v. Jayant Patel [2001] 117 Taxman 707/248 ITR 199 (Mad.) * CIT v. Shahzadanand Charity Trust [1998] 96 Taxman 494/[1997] 228 ITR 292 (Punj. & Har.) * CIT v. Hardeodas Agarwalla Trust [1992] 198 ITR 511 (Cal.) 24. The ld. CIT(A) after considering the submissions of the assessee asked the remand report from the AO and after considering the submissions of the assessee a....
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....on which is a body corporate under the laws of state of Vermont United States of America and is an associated enterprises(A.E.) of the assessee company and was engaged in the business of designer's garments which included study of latest fashion trends in the market, developing styling the market and conceptualizing designs. M/s Pike Rive Corporation (PRC) is the owner of brand in the name of Apprel Cornell which is patent with office of United States. Since, the assessee had undertaken international transaction, the AO referred the matter to the TPO for determination of Arm's Length Price. 30. The TPO noticed that the assessee had undertaken following international transactions with its groups companies: S. No. Description of transaction Method Value (in Rs.) 1 Garments made ups CPM 35,10,62,665 2 Receipts Charges for samples provided for various styles TNMM 95,80,428 3 Payment of royalty CUP 1,57,35,495 The assessee benchmarked its major international transaction of sale of garments using cost plus method and had earned gross profit of 19% as calculated in Annexure B of Transfer Pricing Report whereas the comparables had earned 12% to 16% as per Annexure C of ....
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....nufacturer, did not carry the risk of marketing and therefore was not worried about the latest trends in the market, this risk was borne by the entity providing work to the contract manufacturer who necessarily carries the manufacturing risks like decline in production, maintenance of quality, timely delivery etc. and in the present case, when the assessee company was performing functions of the contract manufacturer, it was very difficult to understand why there were payments for intangibles like royalty and technical know- how in the nature of designs provided by the associated enterprises. The TPO also observed that the designs and its production technology was being provided by the AE to ensure that the quality of goods which will be supplied by the assessee company after its production should match to the requirements of the AE so that it does not suffer any risk in selling them in the competitive market and that in an arrangement, where the reward of the marketing was enjoyed by the AE and similarly the fruits of intangibles such as logo are being plucked by the other party, the contract manufacturer cannot have been load with the expenses of those items. According to him, th....
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.... disallowed by the country of the buyer, would depend very much upon the circumstances of each deal and there would appear to be no general principle which can be applied except that there should be no double deduction for the provision of technology. The transfer price may be a package price, i.e., for the goods and for the intangible property, in which case, depending on the facts and circumstances, an additional payment for royalties may not need to be paid by the purchaser for being supplied with technical expertise. This type of package pricing may need to be disaggregated to calculate a separate arm's length royalty in countries that impose royalty withholding taxes." 34. The TPO pointed out that the assessee company was making its total sales to the related parties and the benefit of producing quality of garments was reaped by overseas entity, the payment of charges for royalty or technical know-how did not confirm to arm's length principle. The payment of royalty/technical know-how to the extent of Rs. 1,57,35,495/- in an international transaction was treated to be a payments against services having arm's length value at Nil. 35. The AO on the basis of recommendation of t....
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..... Whether a particular international transaction (i.e. payment of royalty in this case) between associated enterprises has been laid out wholly and exclusively for business purposes, is to be judged under section 37 of the IT Act and not under section 92. Hence the AO has erred in law in disallowing the above amount u/s 92. B. Royalty is wholly and exclusively for business purposes Without prejudice to the above, it is stated that irrespective of the section under which the AO has disallowed the royalty payment, the AO has erred on facts in concluding that the royalty payment is not wholly and exclusively for business purposes. In reaching the above conclusion, the AO has disregarded the findings of his predecessor who has not only concluded that the payment of Royalty has been made wholly and exclusively for business purposes but has also agreed to the quantum of royalty. For the year ended March 31, 2002, the payment of Royalty was considered a payment laid out wholly and exclusively for the business purposes and the amount paid was considered well within the ALP. These findings were recorded in the order passed by the AO under section 143(3) of the IT Act. Subsequently, ....
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....rnational transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or junctions performed by such persons or such other relevant factors as the Board may prescribe, namely:- (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; transactional net margin method; (f) such other method as may be prescribed by the Board. (2) The most appropriate method referred to in sub-section (1) shall be applied, for determination of arm's length price, in the manner as may be prescribed: [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 assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean.] (3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or doc....
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....he parameters prescribed in Rule 10B, it can be seen that merely because royalty payments were made to one of the associated enterprises on sales made to the associated enterprises cannot be a factor to determine the arm's length price of Royalty. It is humbly submitted that the TPO has exceeded his limitation by following the method which is not authorised under the Act or rules and hence the ALP determined by the TPO and adopted by the AO in respect of the Royalty payable is not as per the procedure prescribed and cannot be sustained. The above conclusion is supported by the decision of the Mumbai bench of the ITAT in the case of CA Computer Associates v. DCIT. A copy of the case is attached for your ready reference. D. The TPO has erred in holding that the appellant is a Contract Manufacturer The TPO in his order has held the appellant to be a contract manufacturer. In arriving at this conclusion, the TPO has grossly erred in appreciating the functional profile of the appellant. In this connection it is stated that the appellant is a full fledged, risk bearing manufacturer and is not a limited risk contract manufacturer. In support of this contention, the following points ....
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....of bad debts. In fact this is one of the most important characteristics of a contract manufacturer. The appellant has taken the bad debt risks for all its sales as is evident from the FAR analysis mentioned in the TP Report. Also in the future years, the appellant has had bad debts and the same have been accounted for in its books of accounts as such and have not been passed on to the associated enterprises. This again establishes the fact that the appellant is not a contract manufacturer but is a licensed manufacturer. 5. Para 9.27 of REPORT ON THE TRANSFER PRICING ASPECTS OF BUSINESS RESTRUCTURINGS CHAPTER IX OF THE TRANSFER PRICING GUIDELINES issued on 22 July 2010 outlines the relationship between the contract manufacturer and the principal by way of an example. Suppose now that a principal hires a contract manufacturer to manufacture products on its behalf, using technology that belongs to the principal. Assume that the arrangement between the parties is that the principal guarantees to the contract manufacturer that it will purchase 100% of the products that the latter will manufacture according to technical specifications and designs provided by the principal and following....
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....llant have been computed after considering the royalty as an expense and these gross margins are greater that the average industry margins. E. Royalty Computed on Sates, Including Sates to Associated Enterprise Itself, Satisfies Arm's Length Standard When Taxpayer Is Not a Contract Manufacturer Since the appellant is not a contract manufacturer, whatever royalty is paid (even if it is paid on the sales to associated enterprises) if recovered from the sales made has to be considered as being paid at ALP. The Delhi bench of the Income-tax Appellate Tribunal held that the taxpayer's payment to an associated enterprise of a royalty-the amount of which was computed based on sales made to the associated enterprise itself-complies with the arm's length standard when the taxpayer is not a contract manufacturer and the royalty payment is recovered from the associated enterprise as part of the selling price. ACIT v. Sona Okegawa Precision Forging Ltd. [2010-TII-41-ITAT-DEL-TP] The case is briefly explained in the paragraphs below: Background During Financial Year 2003-04, the taxpayer paid a royalty to its associated enterprise, and the royalty payment was benchmarked under the Com....
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....f Income Tax [201O-TII-54-ITAT-DEL-TP] (12 November 2010, Assessment Year 2004-05). The tribunal noted that commercial expediency is the domain of the taxpayer and that it had not been alleged by the tax authorities that the agreement was non-genuine or that it was a sham. The case is briefly explained in the paragraphs below: Background The taxpayer is an Indian company engaged in manufacturing of car seat belts for the Indian domestic market. For specific categories of seat belts, the taxpayer imports raw materials and avails technical know-how from its associated enterprise for assembling the seat belts, which are then supplied to India's domestic car manufacturers. In the transfer pricing documentation for financial year (FY) 2003-04, the taxpayer had stated that the raw material imported from the associated enterprise was not available from any other supplier and, hence, it was difficult to ascertain an arm's length price for this transaction. In relation to the transaction for payment of the royalty and technical know-how, it was asserted that because the payments were made in accordance with agreements approved by regulatory agencies, the question of arm's length c....
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....03.2006. The ld. CIT(A) further observed that since the international transaction of royalty of export of garments had been clubbed to arrive at the gross profits and if the gross profit margins are at arm's length, automatically it followed that both the international transactions are at arm's length. The reliance was placed on the decision of the ITAT Delhi Bench in the case of ACIT v. Sona Okegawa Precision Forging Ltd. [2010]-TII-41-ITAT-Del-TP wherein it has been held as under: "royalty paid by the taxpayer , computed on the basis of sales made to the associated enterprise, was at arm's length given that the taxpayer was not a contract manufacturer. Further, the amount paid as a royalty was recovered by the taxpayer from the associated enterprise as a part of the sale price; thus, the transaction was revenue neutral." In view of the above, the addition made by the AO was deleted. 38. Now the department is in appeal. The ld. DR strongly supported the order of the AO and reiterated the observation made in the assessment order dated 28.03.2006. He further submitted that the ld. CIT(A) effectively held that the international transactions can be benchmarked at entity level and ....
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....sessee's paper book. It was further stated that the ld. CIT(A) observed that the royalty was included in the sale price and was part of cost charged from AEs and that the royalty expenses had been reduced to arrive at Gross Profit for the purpose of benchmarking international transaction of export of garments, the gross profit mark-up earned by the assessee was at 19% after reducing royalty whereas industry had earned mark-up of 12-16%, therefore, royalty transaction was also at arm's length. It was pointed out that the assessee was recovering royalty from AEs by including it in the price quoted to the buyer and the royalty was also part of cost of production, therefore, arm's length nature of royalty expenses was established while benchmarking international transaction of export of sales. It was stated that the royalty agreement was effective from 02.04.2001 and the TPO had accepted in assessment year 2002-03 that the assessee was a full fledged risk bearing manufacturer and entitled to pay royalty to AEs. A reference was made to page nos. 146 & 147 of the assessee's paper book. It was further stated that the functional, and risk profile of the assessee remain the same in the asse....
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....TAT Delhi Bench in the case of Asstt. CIT v. Kehin Panalfa Ltd. 244/65 SOT 174 (URO). It was further submitted that the assessee had undertaken all business risks, inventory risk related to obsolescence, risks related to procurement of raw material and asscessories, spent on research & development and hence had taken R&D risk, marketing risk, production & planning risks and the quality risk. It was further stated that as per the TPO's own admission, the contract manufacturer did not take market risk whereas the assessee was undertaking market risk as it traded in open market conditions and bears risks of excessive supply, presence of competitors, risk of advent of new designs in the market etc. It was contended that the design and technical know-how was being provided under the technical know-how and trade name licensing agreement. Therefore, the TPO was factually incorrect in inferring that since the assessee was contract manufacturer, therefore, it was being provided with this guidance and was required to adhere to basic quality parameters under the licensing agreement so that trade name of licensor was not damaged which was present in every technical assistance and trade n....
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....a guard lest there is duplication of payment by tested party for technology; first by way of increased price of goods purchased and again by way of royalty. However, the assessee is procuring raw material from independent parties from open market and was availing technical assistance from one AE and the finished products were sold to some other AEs. Therefore, the OECD guidelines cited by the TPO were not applicable to the facts of the assessee's case. It was submitted that the contract manufacturer is a step away from licensed manufacturer because it owns plant and machinery and employs skilled labour force but instead of making goods, holding them as stock and selling them to distributors, the goods are made for principal and that the contract manufacturer has none of the risks associated with holding finished goods, or selling those goods and the principal will guarantee to buy all the goods manufactured, provided it meets a specified quality and quantity, but in the assessee's case none of the characteristics of contract manufacturer were present. It was further submitted that the TPO acknowledged in the assessment year 2002-03 that the benefit was derived under the "technical ....
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....eld (India) (P.) Ltd. (supra) * Hero Honda Motors v. Addl. CIT [IT Appeal No. 5130 (Delhi) of 2010, dated 23-11-2012] * Dresser-Rand India (P.) Ltd. v. Addl. CIT [2012] 53 SOT 173 (Mum.) * CA Computer Associates (P.) Ltd. v. Dy. CIT [2010] 37 SOT 306 (Mum.) * LGE & C-NCC (Joint Venture) v. ITO [2013] 37 taxmann.com 402 (Hyd. - Trib.) * SC Enviro Agro India Ltd. v. Dy. CIT 143 ITD 195 (Mum. - Trib.) 42. We have considered the submissions of both the parties and carefully gone through the material available on the record. In the present case, it is not in dispute that the assessee entered into an agreement with its AE i.e. Pike River Corporation (PRC), USA under "Technical Assistance, Trade-Mark and Royalty Garments" for use of technical know-how, designs, logos, trade names, and trade-marks. The royalty was paid @ 5% on net sale of products manufactured with the technical assistance of PRC, USA. The royalty agreement was effective from 02.04.2001 and for the assessment year 2002-03, the royalty payment was accepted by the TPO at arm's length. However, the AO considered that the royalty was a capital expenditure and not the revenue expenditure. Being aggrieved the assessee....
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....r unto LICENSEE no proprietary rights whatsoever in the name or "APRIL CORNELL", the Marks or the goodwill now attached or hereafter to become attached thereto. 4.6 (LICENSEE, its agents and its employees shall keep any and all elements of LICENSOR's know-how strictly confidential and w111 refrain from using such ( know-how for any purpose other than the purpose of this Agreement Upon termination thereof for any reason whatsoever, LICENSEE will return to LICENSOR any and all elements of LICENSORs know-how fixed in a tangible medium of expression. " 8.2 A perusal of the provisions of Agreement (supra) goes to prove that the assessee company has made the royalty payment to manufacture/sell products designed by licensor and also used its name, the label and the mark and has also availed technical assistance having limited right during subsistence of agreement for the aforesaid technical knowhow / use of name label and mark and technical assistance of the licensor. Assessee paid 5% of the net sales of the product during each year of the agreement. Now, the question arises for determination is, "as to whether payment of Rs. 1,26,58,195/- on account of royalty payment is to be capita....