2014 (10) TMI 943 - AT - Income Tax

Arm s length price adjustment - commission /service fees segment of assessee s activities - Held that - We deem it appropriate to uphold the grievances of the assessee in principle, as the terms above, delete the notional adjustments by TPO s adopting cost base of the AEs in assessee s ALP determination, and remit the matter to the file of the TPO for the necessary factual verifications on impact of this corrections. Accordingly, the matter stands restored to the file of the TPO in this respect also. Disallowance under section 40(a)(i) - payments made, without deduction of tax at source, to the foreign entities which did not have any permanent establishment in India - Held that - We find that once it is an undisputed position that the recipient entities did not have any permanent establishment in India and the transactions in question, as in these cases, are of purchases simplictor, the payments made to entities cannot give rise to any income taxable in India. It is so for the reason that it is only when the recipient has a PE in India under article 5 of India Japan tax treaty, it s income from trading can be brought to tax in India only when such an income is directly or indirectly attributable to such a PE.Once we come to the conclusion that the assessee did not have any obligation to deduct tax at source from these payments, the very foundation of impugned disallowances ceases to hold good in law. By no stretch of logic, therefore, payments made to these entities can be disallowed under section 40(a)(i) on the ground that taxes have not been deducted at source from these payments. Disallowance of payments under section 40(a)(i) made to the foreign entities, without deduction of tax at source, which may not have any permanent establishment in India but there is no material to establish that fact and there is also no material on record to show that revenue s claim of their having PE in India is negated by the judicial authorities - Held that - Normal purchases from non-resident companies based in Thailand, Singapore and USA, as these vendors are, cannot give rise to taxability of income from such purchases, in the hands of the non-resident vendor, unless such non-resident companies have a permanent establishment in India. The onus to show that a foreign company has a PE in India is on the revenue and when that onus is not discharged, there cannot be any occasion to hold taxability of business profits of those entities in India. It is also well settled legal position that when the income embedded in the payments in question is not held to be taxable in India, there is no requirement to deduct tax at source under section 195. There is no failure on the part of the assessee in deducting tax at source under section 195 and there is no cause of action for disallowance under section 40(a)(ia). In view of these discussions, we deem it fit and proper to direct the Assessing Officer to delete the impugned disallowance under section 40(a)(ia) in respect of payment to Mitsubishi Corporation Singapore, MC Tubular Inc USA, Thai MC Co Ltd, Thailand, and Peto Diamond Corporation, Japan. Disallowance under section 14A - Held that - It is not open to the Assessing Officer to make the aforesaid disallowance under section 14A as admittedly there was no tax exempt in this assessment year. For this short reason alone, the grievance of the assessee must be upheld. The impugned disallowance is thus deleted.

Summary

Issues Involved:
1. Correctness of Arm's Length Price (ALP) adjustment under Section 92C.
2. Justification of disallowance under Section 40(a)(i).
3. Justification of disallowance under Section 14A.

Detailed Analysis:

1. Correctness of ALP Adjustment under Section 92C:
Background:
- The ALP adjustment of Rs. 68,15,17,853 was contested. The case involved Mitsubishi Corporation India Pvt. Ltd. (MCI), a subsidiary of Mitsubishi Corporation Japan (MCJ).
- MCI's transactions with its Associated Enterprises (AEs) included provision for services, purchase of goods, and other expenses.
- The Transfer Pricing Officer (TPO) rejected the use of the Transactional Net Margin Method (TNMM) with Berry Ratio as the Profit Level Indicator (PLI), arguing it excluded the cost of sales and did not comply with legal provisions.

Tribunal's Observations:
- The Tribunal noted the uniqueness of the sogo shosha business model, emphasizing the low-risk, high-volume nature of MCI's operations.
- It was observed that the Berry Ratio is suitable for intermediary activities where the value of functions performed is proportional to operating expenses and not materially affected by the value of products distributed.
- The Tribunal referred to the OECD guidelines and other judicial precedents supporting the use of Berry Ratio in similar cases.

Conclusion:
- The Tribunal held that the use of Berry Ratio as PLI was appropriate and rejected the TPO's objections.
- The matter was remitted to the assessment stage for fresh adjudication, considering the Tribunal's observations.

2. Justification of Disallowance under Section 40(a)(i):
Background:
- The disallowance of Rs. 102,17,16,483 was made for payments to non-resident entities without tax deduction at source (TDS).
- The Assessing Officer argued that these entities had Permanent Establishments (PEs) in India, making the payments taxable under Indian law.

Tribunal's Observations:
- For entities like MC Metal Services Asia and Metal One Corporation, it was established that they did not have PEs in India, and thus, payments to them were not taxable in India.
- For entities where the existence of PE was not established, the Tribunal held that the onus was on the revenue authorities to prove the existence of a PE.
- For payments to MCJ, which had a PE in India, the Tribunal considered the non-discrimination clause in the India-Japan DTAA. It was noted that the recipient had taken the payments into account in their income computation and filed returns accordingly.

Conclusion:
- The Tribunal directed the deletion of disallowance for payments to entities without PEs in India.
- For payments to MCJ, the Tribunal held that the second proviso to Section 40(a)(ia), which provides relief if the recipient has paid taxes on the income, should be read into Section 40(a)(i) due to the non-discrimination clause in the DTAA.

3. Justification of Disallowance under Section 14A:
Background:
- The disallowance of Rs. 2,33,728 was made under Section 14A for expenses related to investments, despite the assessee not earning any exempt income during the year.

Tribunal's Observations:
- The Tribunal referred to the jurisdictional High Court's ruling that Section 14A cannot be invoked if no exempt income is earned.

Conclusion:
- The Tribunal upheld the assessee's grievance and deleted the disallowance under Section 14A.

Final Outcome:
- The appeal was allowed in part. The ALP adjustment issue was remitted for fresh adjudication, the disallowance under Section 40(a)(i) was deleted, and the disallowance under Section 14A was also deleted.