2016 (8) TMI 1433 - AT - Income Tax

Disallowance of Provision for Leave Encashment - HELD THAT - Deduction on account of provision for leave encashment was made on the basis of the judgment of Hon'ble jurisdictional High Court in the case of Exide Industries Ltd. Vs. Union of India EXIDE INDUSTRIES LIMITED AND ANOTHER VERSUS UNION OF INDIA AND OTHERS. 2007 (6) TMI 175 - CALCUTTA HIGH COURT and subsequently Hon'ble Supreme Court has stayed this judgment of Hon'ble jurisdictional High Court. As Hon'ble Supreme Court decide the issue and by that time the matter can be remitted back to the file of ld AO for fresh adjudication in terms of the decision of Hon'ble Supreme Court. On this, Ld. CIT DR has not objected to the same. Accordingly, we set aside this issue to the file of the AO to await the decision of Hon'ble Supreme Court and decide the issue accordingly. This issue of assessee s appeal is remitted back to the file of AO Disallowance of Depreciation on Intellectual Property Rights and Goodwill - main emphasis for disallowance is only on the point that the intellectual properties is not approved by any government or any competent authority - HELD THAT - Nowhere the income tax act mandates the registration of the intellectual properties for the purpose of granting depreciation u/s 32 of the Act. Getting the intellectual properties registered is within the domain of the assessee and it only offers protection to the assessee from preventing other parties to use the same. The revenue cannot thrust the mandate of registration of the same and mere non-registration of the same does not make the transaction ingenuine or sham. Hence the version of the revenue that IP should be certified by the government authority and it does not fall within the assets specified in IT Rules is without any basis and not tenable. AO is also directed to rework the opening WDV of this asset in the subsequent year and rework the allowability of depreciation on the same pursuant to this order. In view of this decision, we are not inclined to entertain the alternative claim of the assessee vide ground no. 1(a) that the consideration so paid in the sum of ₹ 4,92,00,000/- has to be construed as Goodwill and depreciation has to be granted accordingly. Allowability of depreciation on goodwill - HELD THAT - Hon ble Apex Court in the case of CIT vs Smifs Securities ltd 2012 (8) TMI 713 - SUPREME COURT had held that the assessee is entitled for depreciation on goodwill. It is not in dispute that the assessee had paid consideration towards acquisition of Goodwill. This issue is now well settled and not with any dispute. We find lot of force in the argument advanced by the ld AR that the benefit of decision of the apex court supra was not available during the pendency of proceedings before the ld AO and ld CITA. The facts relating to the same are already on record and does not require any investigation. Accordingly we admit the additional ground raised by the assessee with regard to the claim of depreciation on goodwill in the light of the decision of the Hon ble Apex Court in the case of NTPC Ltd vs CIT 1996 (12) TMI 7 - SUPREME COURT . Levy of Interest u/s 234 C - HELD THAT - We find that the provisions of section 234C of the Act are very clear without any ambiguity that the same is chargeable only on the returned income. Adjustment to Arm s Length Price - Comparable selection - HELD THAT - There is no dispute with regard to the Most Appropriate Method (in the instant case Resale Price Method) chosen by the assessee for its trading segment. There is no dispute with regard to the identification of Profit Level Indicator. The dispute is only on account of selection of related comparables and adoption of single year margins based on audited financials. In view of the detailed submissions made hereinabove , we deem it fit and appropriate, to set aside this issue to the file of the ld TPO / ld AO to accept the comparable companies who are engaged in the related field as that of assessee and adopt the single year margins based on audited financials of those comparable companies for the purpose of determination of Arm s Length Price. The adjustment towards the tolerance limit of 5% is also entitled for the assessee while determining the Arm s Length Price. Purchase of raw materials components - Manufacturing Domestic segment - whether the comparable companies have a PE or a branch in India as the assessee had benchmarked the profitability earned in the regions of the AEs ? - HELD THAT - DRP failed to understand the benchmarking approach as submitted by the assessee. The DRP did not recognize the fact that assessee was comparing AEs margin with comparable companies in AEs region rather than comparing the latter with assessee s margin earned in India. Thus the ld DRP summarily rejected the transaction by transaction approach adopted by the assessee. We find that the revenue had not brought anything concrete on records either factually or legally to negate the assessee s approach of determining the Arm s Length Transaction Price. Payment of Royalty Manufacturing Domestic Segment - HELD THAT - We find that adoption of TNMM by the ld TPO for purchase of raw materials components under manufacturing domestic segment, had resulted in an abnormal outcome in the transfer pricing adjustment which was even more than the value of international transactions. Hence it would be just and fair to ignore the same. The ld TPO had made the adjustment of ₹ 43,27,604/- to Arm s Length Price based on a fallacious approach which is neither intended by the Act nor in OECD guidelines. In view of the above discussions, in order to meet the ends of justice in the facts and circumstances of the case, we deem it fit and appropriate, to set aside this issue to the file of the ld TPO / ld AO for determination of Arm s Length Price based on transaction to transaction approach submitted by the assessee taking the AE as a tested party using CPM as the Most Appropriate Method. Adjustment to Arm s Length Price - Sale of finished goods Manufacturing (Export) Segment - HELD THAT - TPO had accepted the certified segmental profitability as he has considered Manufacturing Segment profitability from the same. However, he did not consider the sub-segment profitability of Manufacturing Segment into Manufacturing (Domestic) segment and Manufacturing (Export) segment based on difference in FAR analysis to determine the profitability from sale of finished goods. The ld AR further stated that the ld TPO in the earlier years has considered prices of international transaction pertaining to export of goods to AEs to be at Arm s Length wherein the assessee followed the same economic analysis to determine the Arm s Length Price. In view of the aforesaid findings and in the facts and circumstances of the case and respectfully following the judicial precedents relied upon hereinabove, we direct the ld TPO / ld AO to consider the certified segmental profitability to determine the Arm s Length Price of the relevant international transactions and hereby reject the combined segment approach adopted by the ld TPO. Purchase of raw materials components Manufacturing (Domestic) Segment - selection of MAM - HELD THAT - TPO by selection of wrong tested party produced an abnormal outcome wherein a loss of 5.81% (8.31% - 2.50%) was determined to have occurred for a transaction value of 2.47% of the entire segment. Hence it would be just and fair to ignore the same. TPO had made the downward adjustment to Arm s Length Price based on a fallacious approach which is neither intended by the Act nor in OECD guidelines. In order to meet the ends of justice in the facts and circumstances of the case, we deem it fit and appropriate, to set aside this issue to the file of the ld TPO / ld AO for determination of Arm s Length Price based on transaction to transaction approach submitted by the assessee taking the AE as a tested party using CPM as the Most Appropriate Method. Payment of royalty Manufacturing (Domestic) Segment - HELD THAT - TPO while passing the order u/s 92CA(3) of the Act ignored the CUP analysis undertaken by the assessee for justifying the Arm s Length nature of the international transaction and instead went ahead and clubbed the transaction under the TNMM analysis undertaken by TPO with respect to manufacturing segment. Moreover, when the ld DRP remanded back the case to the file of the ld TPO for analysis of the CUP benchmarking and providing ground wise observations for grounds filed in Form 35A, the ld TPO did not offer any adverse comments with regard to the payment of royalty. TPO while passing the order u/s 92CA(3) of the Act ignored the CUP analysis undertaken by the assessee for justifying the Arm s Length nature of the international transaction and instead went ahead and clubbed the transaction under the TNMM analysis undertaken by TPO with respect to manufacturing segment. Moreover, when the ld DRP remanded back the case to the file of the TPO for analysis of the CUP benchmarking and providing ground wise observations for grounds filed in Form 35A, the ld TPO did not offer any adverse comments with regard to the payment of royalty. Payment of Management Service fees Manufacturing (Domestic) Segment - HELD THAT - Based on functional analysis, AE was determined as the least complex party and accordingly determined to be the tested party for the purpose of the analysis. Further , TNMM was determined to be the MAM. We find that the assessee undertook to identify comparable companies rendering similar services and the international transaction was determined to be at Arm s Length. These are enclosed in Pages 295 -303 of the Paper Book. The TPO while passing the order u/s 92CA(3) of the Act ignored the separate transaction level analysis undertaken by the assessee for justifying the Arm s Length nature of the international transaction and instead went ahead and clubbed the transaction under the TNMM analysis undertaken by TPO with respect to manufacturing segment. Moreover, when the ld DRP remanded back the case to the file of the TPO for analysis of the separate transaction level analysis and providing ground wise observations for arguments raised by the assessee before the DRP, the ld TPO did not offer any adverse comments with respect to economic analysis carried out by the assessee for transaction pertaining to the payment of management service fees. We hold that the study made by the assessee with regard to payment of management service fees which has been accepted by the revenue in the subsequent years, should be applied for the Asst Year 2008-09 also to put an end to this controversy. Hence in order to meet the ends of justice, we direct the ld TPO/ ld AO accordingly

Summary

Issues Involved:

1. Disallowance of Provision for Leave Encashment
2. Disallowance of Depreciation on Intellectual Property Rights and Goodwill
3. Levy of Interest u/s 234C
4. Adjustment to Arm’s Length Price for various International Transactions

Detailed Analysis:

1. Disallowance of Provision for Leave Encashment:

The assessee claimed a deduction for the provision for leave encashment amounting to ?5,27,580/-, which was disallowed by the AO under section 43B(f) of the Income Tax Act, 1961. The assessee cited the jurisdictional High Court's decision in Exide Industries Ltd. Vs. Union of India. However, the Supreme Court stayed this judgment. Consequently, the matter was remitted back to the AO for fresh adjudication pending the Supreme Court's decision. This issue was allowed for statistical purposes.

2. Disallowance of Depreciation on Intellectual Property Rights and Goodwill:

The assessee, engaged in manufacturing electric meters, acquired a sole proprietorship unit, TECRES, which had developed metering-related software. The AO disallowed the depreciation claim of ?61,50,000/- on the grounds that the assets did not fall under recognized intangible assets. The DRP upheld this view. The assessee contended that the know-how acquired was an intangible asset eligible for depreciation under section 32 of the Act. The Tribunal found that know-how does not need government recognition to qualify as an intangible asset and allowed the depreciation claim. The Tribunal also directed the AO to rework the opening WDV of the asset for subsequent years. The alternative claim of considering the amount as Goodwill was not entertained. The Tribunal admitted additional grounds for depreciation on goodwill based on the Supreme Court's decision in CIT vs. Smifs Securities Ltd. and allowed the claim.

3. Levy of Interest u/s 234C:

The Tribunal found that interest under section 234C is chargeable only on the returned income. Therefore, the ground raised by the assessee was allowed.

4. Adjustment to Arm’s Length Price:

4.1 Trading Segment:

The assessee justified the arm’s length nature of its international transactions using the Resale Price Method (RPM) and identified 11 comparables. The TPO rejected some comparables and used single-year data for others, resulting in a downward adjustment of ?51,29,012/-. The Tribunal directed the TPO to re-evaluate the margins based on audited financials and give the benefit of the 5% tolerance limit.

4.2 Manufacturing Segment:

The TPO rejected the Cost Plus Method (CPM) used by the assessee and adopted the Transactional Net Margin Method (TNMM), resulting in a downward adjustment of ?43,27,604/-. The Tribunal found that the transaction-by-transaction approach should be used, and the AE should be the tested party. The Tribunal directed the TPO to re-assess the arm’s length price using CPM and the AE as the tested party.

4.3 Payment of Royalty:

The Tribunal admitted additional evidence for benchmarking the royalty payment using the CUP method. The Tribunal directed the TPO to use the CUP method and the RoyaltyStat database for benchmarking, as accepted in subsequent years.

4.4 Payment of Management Service Fees:

The assessee provided detailed documentation for management services received. The TPO clubbed this with the TNMM analysis for the manufacturing segment. The Tribunal directed the TPO to consider the separate transaction level analysis and accept the benchmarking study as done in subsequent years.

Conclusion:

The appeals for both assessment years 2007-08 and 2008-09 were allowed for statistical purposes, with directions for fresh adjudication on various issues. The order was pronounced on 03.08.2016.