2022 (2) TMI 1338 - AT - Income Tax

TP adjustment - international transactions entered with AE - plea of the assessee to restrict the transfer pricing adjustment to international transactions entered with A.E only - HELD THAT - We notice that the decisions relied on by Ld. A.R.of Hindustan Unilever Ltd. 2012 (12) TMI 458 - ITAT MUMBAI and Tara Jewellers Exports Pvt. Ltd 2015 (12) TMI 1130 - BOMBAY HIGH COURT support the plea of the assessee. Accordingly, we direct the AO/TPO to restrict the transfer pricing adjustment to the international transactions relating to import of raw materials and finished goods entered with its A.Es. Exclusion of two comparable companies - M/s. HPM Chemicals Fertilizers Ltd company is engaged into diversified business activities, viz., manufacture and sale of pesticides, dealing in fertilizers and running a pulverizing mill. However segmental results have not been given. In respect of fertilizers business, this company has received subsidy towards freight as well as for sale of imported fertilizers. All these facts in our view makes this company not comparable with the assessee company. Accordingly, we direct the A.O./TPO to exclude this company. M/s. Bharat Insecticides Ltd - principal product dealt by the company is stated as pesticides formulation . The total revenue from operations is shown at ₹ 261.88 crores in the profit loss account and the entire turnover pertains to pesticides formulation only as per information given at page Nos.2370 2371. We also notice that this company has not reported any other operating revenues in the profit loss account meaning thereby, the assessee has not carried out any toll manufacturing works during the year under consideration, as submitted by Ld. A.R. Accordingly, we are unable to appreciate the contentions of Ld. A.R. Accordingly, we do not find any other reason to exclude this company from the list of comparable companies. Accordingly, we confirm the order of the AO in including this company as comparable company. Disallowance of claim of capital expenditure u/s 35(1)(iv) - HELD THAT - As finding of Ld DRP would make it clear that the assessee s role is only to provide services for R D activity of its AE, i.e., it is carrying on the R D activity also on behalf of its AE. Further, it cannot own the intangible rights arising out of the research and development activities carried on by it. R D activities also are in the nature of support services provided by the assessee to its AE. Accordingly, DRP has given the finding that the work carried on by the assessee at the instruction, direction and supervision of the parent company happens to be related to R D. We also find merit in the observation of Ld DRP that the incentive provisions like deduction u/s 35(1)(iv) are given by the Government to encourage Indian Companies and not for doing work for some company located abroad. Accordingly, we are of the view that the tax authorities are justified in disallowing the claim for deduction of Capital expenditure u/s 35(1)(iv) of the Act. Since the disallowance of capital expenditure is upheld by us, the assessee would be eligible for depreciation on them at applicable rates. We notice that the AO has disallowed only the WDV amount of Rs.1,86,04,299/- claimed by the assessee after deducting the depreciation claimed in the books of account. The AO may examine the claim of the assessee for allowing correct amount of depreciation, if the above said claim is not in accordance with the rates prescribed under the Income tax Rules. TDS u/s 195 - disallowance of payroll expenses u/s 40(a)(i) - assessee submitted that the above said sum represented only reimbursement of salary and related cost of an employee who was deputed by its AE and the said employee was working with the assessee under its supervision and direction - HELD THAT - hat is required to be examined in the present context is the terms and conditions of agreed between the assessee and its AE, the nature of services rendered by the expatriate to the assessee etc. In the absence of the factual details, it would be difficult to apply the legal principles laid down by the Hon ble Karnataka High Court in the above said case. Under these set of facts, we are of the view that this issue requires fresh examination at the end of AO. The assessee should furnish the terms and conditions of agreement, nature of services rendered by the expatriate etc. Even, if there is no written agreement between the assessee and AE, there should be some other material to show the purpose for which the expatriate was deputed to the assessee. Accordingly, we restore this issue to the file of AO. The AO may take a decision on this issue afresh after considering the details, information and explanation that may be furnished by the assessee. After hearing the assessee, the AO may take appropriate decision in accordance with law. Disallowance of claim of foreign exchange fluctuation on External Commercial Borrowing (ECB) - assessee had availed ECB of USD 20,00,000/- from its foreign AE and said loan was used to acquire assets for its R D activity - HELD THAT - As noticed that the AO had disallowed the claim for deduction of capital expenditure u/s 35(1)(iv) - as already confirmed the said disallowance. We also directed the AO to allow applicable depreciation on the capital expenses so disallowed. Consequent thereto, the claim of deduction of loss arising on revaluation of outstanding balance of ECB cannot be allowed u/s 35(1)(iv) of the Act. We noticed that the AO has disallowed the claim holding it to be notional loss. Though the view taken by the AO may not be right, yet the disallowance has to be confirmed for the reasons discussed above. Accordingly, we confirm the disallowance made by the AO. It is not clear as to whether the provisions of sec.43A would apply to the ECB Loan. Hence the assessee may claim the benefit of provisions of sec.43A, if it is applicable to the ECB Loan repayments. Disallowance of Product development expenses - HELD THAT - As it is necessary to find out as to whether the assessee has incurred all these expenses on its own account or on behalf of its AE. If the assessee has incurred expenses on behalf of the AE and the benefits of these expenses go the AE, then the Ld DRP was justified in disallowing this claim. If it is not so, then the assessee is required to prove that these expenses are not capital in nature. The facts available on record are not clear as to whether these expenses are routine expenses incurred for expansion of existing business or not. If it is so, then the relevant expenses are allowable as revenue expenditure. In the absence of relevant details, we feel it proper to restore this issue to the file of AO for examining it afresh in the light of discussions made supra and also in accordance with law. Accordingly we restore this issue to the file of AO. Disallowance of claim of finance lease charges - HELD THAT - This issue is now settled by Hon ble Supreme Court in the case of ICDS 2013 (1) TMI 344 - SUPREME COURT wherein the Hon ble Apex Court held that the lessor is the owner of the leased property in case of finance lease and he is entitled to depreciation on it. The contra is that the lessee is eligible to claim the lease payments as deduction. Hence the view taken by the tax authorities are against the decision rendered by Hon ble Supreme Court. Accordingly we direct the AO to allow the claim of the assessee in accordance with the decision rendered by Hon ble Apex Court in the case of ICDS (supra). Disallowance of loss on foreign exchange fluctuation - AO followed the circular issued by CBDT in No.3 of 2010 dated 23.03.2010 and held that the mark to marked loss (revaluation of forward contracts as on Balance sheet date) is not allowable as deduction - HELD THAT - We dealt with the disallowance of Rs.1,03,58,338/- pertaining to loss arising on revaluation of ECB loan. Also confirmed the disallowance made by the AO. Hence, the disallowance of very same amount, which is included in the above said amount results in double disallowance. However, there is slight difference in the figures. The Loss arising on revaluation of ECB loan was Rs.1,03,58,338/- when we dealt with the issue in the earlier paragraph. However, the loss arising on revaluation of ECB loan was shown in the break-up details given above. Hence this difference needs to be reconciled and it has to be shown by the assessee that both the figures pertain to same claim. Accordingly, we direct the AO to examine the claim of double disallowance and delete the double disallowance, if any. There should not be any dispute that the realised losses pertaining to revenue account is allowable as deduction. The AO may verify the details and allow the deduction. We are unable to understand as to why the assessee did not offer the amount pertaining to Forward contract premium and MTM transaction as its income. Accordingly, we restore this issue to the file of AO for examining this issue. Disallowance of interest expenditure - HELD THAT - As submitted that the Ld DRP directed the AO to examine the above said claim of the assessee, but the AO retained the disallowance in the final assessment order without carrying out necessary examination. In view of the above, we restore this issue to the file of AO for examining the claim of the assessee in accordance with law. Setting off of brought forward business losses and unabsorbed depreciation - HELD THAT - This issue requires examination at the end of AO as per the records. Accordingly, we restore this issue to the file of AO.

Summary

Issues Involved:
1. Addition on account of Transfer pricing adjustment.
2. Disallowance of Research & Development expenses claimed u/s 35(1)(iv) of the Act.
3. Disallowance of Payroll expenses u/s 40(a)(i) of the Act.
4. Disallowance of foreign exchange fluctuation on ECB Loans.
5. Disallowance of Product development expenses.
6. Disallowance of finance lease.
7. Disallowance of mark to marked loss arising on account of foreign exchange fluctuations.
8. Disallowance of interest expenditure payable to Micro, Small and Medium Enterprises.
9. Non-granting of set off of brought forward business loss and unabsorbed depreciation.

Issue-wise Detailed Analysis:

1. Addition on account of Transfer Pricing Adjustment:
The assessee prepared segmental results for "Manufacture and sale of products" and "Sourcing & business support services". The TPO proposed transfer pricing adjustment for the "Manufacture and Sale of products" segment, reallocating expenses and rejecting the assessee's segmental results. The TPO selected comparable companies and computed an average margin of 6.25%, leading to a transfer pricing adjustment of Rs.24.63 crores. The Tribunal directed the AO/TPO to restrict the adjustment to international transactions with AEs and excluded HPM Chemicals & Fertilizers Ltd from the list of comparables due to its diversified business activities and lack of segmental results. However, Bharat Insecticides Ltd was retained as a comparable.

2. Disallowance of Research & Development Expenses u/s 35(1)(iv):
The AO disallowed the claim of capital expenditure for R&D activities, arguing that the R&D was conducted for the benefit of the parent company and not the assessee's own business. The Tribunal upheld the disallowance, stating that the incentive provisions are meant to encourage Indian companies, not for activities benefiting foreign entities. However, the Tribunal allowed the assessee to claim depreciation on the disallowed capital expenditure.

3. Disallowance of Payroll Expenses u/s 40(a)(i):
The AO disallowed payroll expenses paid to the AE for an expatriate employee, treating it as "fee for technical services" and noting the absence of a clear agreement and nature of services rendered. The Tribunal restored the issue to the AO for fresh examination, directing the assessee to provide detailed information about the terms and conditions of the deputation and the nature of services rendered.

4. Disallowance of Foreign Exchange Fluctuation on ECB Loans:
The AO disallowed the loss on revaluation of ECB loans, treating it as a notional loss. The Tribunal confirmed the disallowance, noting that the capital expenditure claim u/s 35(1)(iv) was already disallowed, and directed the AO to allow depreciation on the capital expenses.

5. Disallowance of Product Development Expenses:
The AO disallowed product development expenses, considering them capital in nature and noting that they provided enduring benefits. The Tribunal restored the issue to the AO for fresh examination to determine whether the expenses were incurred for the assessee's own business or on behalf of the AE and whether they were capital or revenue in nature.

6. Disallowance of Finance Lease:
The AO disallowed finance lease charges, arguing that the assets should be recognized as capital assets. The Tribunal directed the AO to allow the claim in accordance with the Supreme Court's decision in the case of ICDS vs CIT, which held that the lessee is eligible to claim lease payments as a deduction.

7. Disallowance of Mark to Marked Loss on Foreign Exchange Fluctuations:
The AO disallowed the loss on foreign exchange fluctuation, treating it as a notional loss. The Tribunal directed the AO to examine the claim of double disallowance and verify the details of realized losses, allowing the deduction for realized losses on revenue account.

8. Disallowance of Interest Expenditure Payable to Micro, Small and Medium Enterprises:
The AO disallowed interest expenditure payable to MSMEs. The Tribunal restored the issue to the AO for examination, directing the AO to verify the assessee's claim that the outstanding amount pertains only to the principal portion of supplies.

9. Non-granting of Set Off of Brought Forward Business Loss and Unabsorbed Depreciation:
The Tribunal restored the issue to the AO for examination, directing the AO to verify the records and allow the set-off as per the law.

Conclusion:
The appeal of the assessee was partly allowed for statistical purposes, with several issues restored to the AO for fresh examination and appropriate decision in accordance with the law. The Tribunal provided specific directions for each issue, ensuring a thorough and detailed review of the assessee's claims.