2022 (5) TMI 1502 - AT - Income Tax

TP Adjustment - Profit arising from goodwill - Rejecting the computation of Tested Party margin as undertaken by the Appellant and recomputing the margin considering amortisation of goodwill - goodwill was recorded by the Applicant pursuant to the acquisition of the 'Shared Services Business' of TE Connectivity Global Shared Services Pvt Ltd ( TECGSS ) on a slump sale basis - HELD THAT - Payback period of an acquisition ought to 5 years always, regardless of any business dynamics, which is patently an incorrect proposition under law. Appellant cannot be expected to recover the premium paid towards acquisition of the business along with a mark-up by the end of the 5-year period, by carrying on the same business that was undertaken by the transferor prior to such acquisition. Appellant cannot be expected to earn double or multiple times the margin earned by the transferor or any other company in the same business, merely on account of payment of a premium for acquiring the said business. This proposition is impractical and absurd since no customer will be willing to pay an additional price for the same product / service even in an arms' length transactions, merely because the business is acquired by another party who is continuing to offer the same product / service. He referred to the illustration of the Case Law Compilation. Inclusion of comparable companies - We remit this issue to AO/TPO to include the comparables, if the comparables are not incurring the losses continuously in 2 out of 3 assessment years. Ordered accordingly. Inclusion of companies accepted by the DRP - In our opinion, the AO is bound by the directions of DRP and he has to pass the final assessment order in conformity with the directions of the DRP. Ordered accordingly. Working capital adjustment for determining the ALP - The assessee in the present case has given all the details required for working capital adjustment. Therefore, the Revenue Authorities were not justified in denying the claim of the assessee for deduction. AO / TPO is directed to allow the working capital adjustment in the light of the material placed on record, after affording a reasonable opportunity of hearing to the assessee. Disallowance of depreciation claimed by the Assessee on Intangible assets on account of slump purchase - Valuation report/ methodology cannot be disregarded by the AO - DCF is an internationally recognized, which is also recognized and accepted by the RBI, ICAI as well as under the provision of the Act. Hence, the rejection of such an established method by the AO merely because it involves assumptions, is without any basis. A valuation exercise in itself, irrespective of the method adopted, is not an exact science and can never be done with arithmetic precision and involves several assumptions - it is a settled principle of law that a hindsight comparison of the projections with the actual revenues cannot be a basis for rejecting any valuation. Erroneous invocation of the sixth proviso to section 32(1) - Additionally, 6th proviso to section 32(1) of the Act was invoked. It was observed that the transferor KBDL had not claimed any depreciation on G/W prior to the transfer and hence, applying said proviso, it was concluded that no depreciation shall be allowed in the hands of UB, since the transferor did not claim any depreciation thereon. It was therefore concluded that the amalgamated company cannot claim such depreciation that was never claimed by the amalgamating company. The above basis formed the twin grounds on which the depreciation was denied to the UB. However, it is important to note that the Tribunal has clarified at para 15 of the decision that goodwill is a depreciable asset having regard to the Supreme Court judgment in Sniffs Securities 2012 (8) TMI 713 - SUPREME COURT Amendment by Finance Act 2021 clarifies the position on Goodwill depreciation - As held by the Bangalore Tribunal in the case of M/s. Innoviti Payment Solutions Pvt. Ltd. 2019 (1) TMI 688 - ITAT BANGALORE the primary onus to prove the correctness of the valuation Report lies on the assessee as it has special knowledge and it is privy to the facts of the company and that only it has opted for this method. Thus, the assessee has to satisfy about the correctness of the projections, Discounting factor and Terminal value etc. with the help of Empirical data or industry norm if any and/or Scientific Data, Scientific Method, scientific study and applicable Guidelines regarding DCF Method of Valuation. None of these are produced by the assessee either before the department. Therefore, the Valuation report in question cannot be relied upon and as such is liable for rejection. We have heard both the parties and perused the material on record. Similar issue came for consideration before the Delhi Tribunal in the case of Rockland Diagnostics Services P. Ltd 2021 (3) TMI 17 - ITAT DELHI As held by the Co-ordinate Bench of the Tribunal that in absence of any specific inaccuracies or short comings in the DCF valuation report other than stating that yearwise results as projected are not matching with the actual results declared in the final accounts, the Assessing Officer cannot substitute his own value in place of the value determined either on DCF method or NAV method. Therefore, we are of the considered opinion that the Lower Authorities were not justified in rejecting the valuation report as submitted by the assessee in this regard. We also note that the observation of the Ld. CIT (A) that the Chartered Accountant has relied on the data supplied by the assessee in this regard is irrelevant in as much as the Chartered Accountant has carried out the valuation in accordance with the prescribed method as per Rule-11UA of the Income Tax Rules, 1962 and, therefore, such valuation report, in absence of specific defects being pointed out, has a binding value. We note that neither the Ld. CIT (A) nor the Assessing officer have evaluated the valuation report in light of the relevant material but have only rejected the same on assumptions and presumptions and the same cannot be upheld. In our considered view the Assessing officer should examine the issue afresh after giving due opportunity to the assessee to present its case in this regard. Thus, this ground is allowed for statistical purposes.

Summary

Issues Involved:
1. Treatment of Goodwill Amortization in Transfer Pricing.
2. Application of Turnover Filter in Comparability Analysis.
3. Inclusion/Exclusion of Comparable Companies.
4. Working Capital Adjustment.
5. Disallowance of Depreciation on Intangible Assets from Slump Purchase.

Detailed Analysis:

1. Treatment of Goodwill Amortization in Transfer Pricing:
The primary issue revolved around whether the amortization of goodwill should be considered as an operating expense for the purpose of computing the appellant's margin on cost. The appellant argued that goodwill amortization is an extraordinary item and should be excluded from the operating costs, citing various judicial precedents and guidelines, including the OECD TP Guidelines 2010 and Safe Harbour Rules. The appellant further emphasized that goodwill represents a future economic benefit and its amortization is merely an accounting effect, not an operational expense. The Tribunal, referencing prior decisions, including the case of ST-Ericsson India Pvt. Ltd., directed the AO/TPO to treat the amortization of goodwill as a non-operating expenditure for computing the operating margin.

2. Application of Turnover Filter in Comparability Analysis:
The appellant contested the TPO’s application of a lower turnover filter without considering an upper turnover limit. The Tribunal acknowledged the principle that companies with a turnover significantly higher than the appellant’s should be excluded from the list of comparables due to differences in size and scale of operations. The Tribunal directed the AO/TPO to reconsider the comparability of companies in line with the precedent set by the case of Autodesk India Pvt. Ltd., which excluded companies with turnovers exceeding INR 200 crores.

3. Inclusion/Exclusion of Comparable Companies:
The appellant challenged the inclusion of certain companies (Tech Mahindra Business Services Ltd., Infosys BPM Ltd., SPI Technologies India Pvt Ltd.) and the exclusion of Ace BPO Services Pvt. Ltd. The Tribunal remitted the issue back to the AO/TPO to include companies that are not persistent loss-makers, as established in the case of Brigade Global Services P. Ltd. The Tribunal also directed the AO to include Microgenetics as a comparable, following the DRP’s directions.

4. Working Capital Adjustment:
The appellant argued for a working capital adjustment to account for differences in working capital levels between the appellant and comparable companies. The Tribunal, referencing the case of M/s. Inflow Technologies P. Ltd., directed the AO/TPO to allow the working capital adjustment, recognizing its impact on profit margins and the necessity for such adjustments as per Rule 10B(1)(e)(iii) of the IT Rules.

5. Disallowance of Depreciation on Intangible Assets from Slump Purchase:
The appellant claimed depreciation on goodwill arising from a slump purchase, which was disallowed by the AO on the grounds of valuation methodology and alleged that the transaction was a colorable device to reduce tax liability. The Tribunal referred the issue back to the AO, directing a fresh examination in light of the principles established in cases like Rockland Diagnostics Services P. Ltd. The Tribunal emphasized that the valuation report should not be disregarded unless specific inaccuracies are identified and that the DCF method is a recognized valuation approach.

Conclusion:
The Tribunal partly allowed the appeal for statistical purposes, directing the AO/TPO to reconsider several issues, including the treatment of goodwill amortization, application of turnover filters, inclusion/exclusion of comparable companies, and the working capital adjustment. The Tribunal also remitted the issue of depreciation on goodwill back to the AO for a fresh examination, emphasizing adherence to established judicial principles and guidelines.