2016 (6) TMI 100 - AT - Income Tax

MTA including the exclusion of interest income for the purpose of computing the ALP - Held that - It was not the case of the TPO that surplus funds of the company were parked with the bank, that the advance received against the exports were immediately placed in FDR with the bank for the purpose of taking letter of credit in favour of the overseas sellers. A perusal of the balance sheet of the assessee reveales that the reserve and surplus of the assessee for the year under consideration was at ₹ 63. 06 crores. Therefore, it could not be said that the surplus funds were parked in the FDRs to earn interest income. It is a fact that import/ export of the goods did not take place from or to India and the assessee came into picture to participate in the trading of international trade documents only. The participation by the assessee at a particular juncture resulted in earning of interest income which would not have been earned if the trade would have taken place completely and directly outside India. In our opinion, the interest income was an inherent an integral part of the assessee is business activity and same was rightly considered as an operating income for the purpose of calculation of operating margin, by the FAA. So, we endorse the views of the FAA that the interest income emanated from MTA and that same could not be excluded from calculating the operating margin of such activities for the purpose of section 92 of the Act. Thus held that the assessee s international transactions of MTA were at arm s length - Decided in favour of assessee Addition with regard to import of raw material and related issues including the treatment to be given to the segmental accounts - Held that - TPO had made an adjustment of ₹ 48. 65 crores to the entire segment of manufacturing activities instead of making the adjustment to only international transactions, that it had an effect of reducing the import price by 54. 27%, that the FAA had reworked the adjustment after considering the extra ordinary items that would affect the profit margin of the assessee for the year under consideration, that the factors like underutilisation of capacity and non-operating expenditure was given due importance by the FAA, that the assessee had he calculated revised margin of the 20 comparables selected by the TPO, that the arithmetic mean arrived at by the assessee was not considered by him, that FAA had held that TPO was incorrect in not considering the revised caL/Culation of margins, that the FAA had objected to the treatment given to the six comparable where the TPO had not taken the segments based on their economy profile, that the FAA had mentioned that revised margin (1. 07%) had to be adapted for determining adjustments and the resultant ALP. In our opinion, the TPO was not justified in making adjustment to the entire segment of manufacturing activity and not restricting the same to the international transactions. We find that while reworking the adjustment, the FAA had taken the margin at the rate of 2. 36%. We find that the assessee had not filed any application before the FAA pointing out the apparent mistake in adopting the revised margin i. e. adopting the rate of 2. 36% instead of rate of 1. 07%. Considering these facts, we are of the opinion that matter should be restored back to the file of the AO/TPO to verify the fact and decide the value of the adjustment by taking appropriate revised margin rate Treatment to interest income as business income - Held that - Placing of money in the banks in the forms of FDRs was directly linked with the carrying out of business of the assessee. We further find that interest income and by the assessee has been accepted to be taxable under the head income from dismiss a profession in the earlier as well as in the subsequent AY. s i. e. AY. s. 2003-04, 2004-05, 2008-09 and 2011-12. The AO has not brought anything on record to prove that the facts of the earlier and subsequent years were different from the facts for the year under consideration. The rule of consistency stipulates that in absence of distinguishing facts and circumstances, the AO should not deviate from the stand taken/followed in the earlier years. Allowability of expenditure on non-compete fee - Held that - Expenditure incurred under the head non-compete fee is to be treated as capital expenditure, that same is eligible for depreciation. Disallowance of market research expenses - Held that - We are of the opinion that the expenditure incurred by the assessee on market research was a revenue expenditure and that it could not be treated capital expenditure Disallowance of expenditure incurred on land and site development - Held that - As no further amounts were incurred during the previous year relevant to AY. 2006-07, that the onus was on the appellant to produce evidence if it claimed deduction on any item that same was not produced, that it had made general arguments without any reference to specific material data or evidence. Thus we confirm the disallowance. Disallowance of premium on payment of leasehold land - Held that - A lump sum was paid at the time of obtaining a lease. We are of the opinion, that it is a capital expenditure by its nature itself. The lease was for a period of twenty years. So, we are not inclined to disturb the findings of the FAA and hold it to be a capital expenditure. However, we want to allow the alternate claim made by the assessee i. e. allowing depreciation as per the provisions of section 32 of the Act Disallowance of provision towards obsolete stores - Held that - We find that though the assessee had claimed that it had followed a scientific method with regard to the obsolete stores, but it has not furnished any documentary evidence before the AO or the FAA or even before us. Making a claim is not sufficient it has to be backed by hard core evidences. In the case under consideration, the assessee has made only a provision. Historical data or analysis which could have tilted the scale in favour of the assessee, is not available. Therefore, we are of the opinion that the FAA had rightly upheld the order of the AO. The was not able to rebut the fact that the amount in question was only a provision. As far as the case relied upon by the assessee is concerned it is found that the assessee in that matter was a government owned company and had changed its method of valuation as per the directions of the C&AG. The facts of the present case are totally different. Disallowance confirmed Disallowance of expenses being provision made for Employee Stock Option Plan(ESOP) - Held that - We find that the issue of allowability of expenditure related with ESOPs has been deliberated upon and discussed extensively in the case of Biocon Ltd 2013 (8) TMI 629 - ITAT BANGALORE wherein held that once it is held as a consideration for employment, the natural corollary which follows is that such discount (i) is an expenditure (ii) such expenditure is on an ascertained (not contingent) liability and (iii) it cannot be treated as short capital receipt. In view of the foregoing discussion, we are of the considered opinion that discount on shares under the ESOP is an allowable deduction

Summary

Issues Involved:
1. Transfer Pricing Adjustments for Merchanting Trade Activity (MTA)
2. Application of Comparable Uncontrolled Price (CUP) Method vs. Transactional Net Margin Method (TNMM) for import of oil
3. Treatment of Interest Income as Business Income
4. Non-Compete Fee as Revenue or Capital Expenditure
5. Market Research Expenses as Revenue or Capital Expenditure
6. Disallowance of Expenditure on Land and Site Development
7. Disallowance of Provision for Obsolete Stores
8. Disallowance of Expenses for Employee Stock Option Plan (ESOP)
9. Disallowance of Loss on Hedging Transactions

Detailed Analysis:

1. Transfer Pricing Adjustments for Merchanting Trade Activity (MTA):
The Assessing Officer (AO) and Transfer Pricing Officer (TPO) found that the assessee entered into international transactions with associated enterprises (AEs). The TPO excluded interest income from Fixed Deposit Receipts (FDRs) while computing the operating profit margin for MTA, considering it as income from other sources under Section 56 of the Act. The First Appellate Authority (FAA) held that the interest income was inextricably linked to MTA and should be included in operating income. The Tribunal upheld the FAA’s decision, emphasizing that the TPO’s exclusion of interest income without prior notice violated principles of natural justice.

2. Application of CUP vs. TNMM for Import of Oil:
The TPO rejected the CUP method used by the assessee for determining the Arm's Length Price (ALP) of oil imports, opting instead for TNMM. The FAA, however, reworked the adjustments considering extraordinary items affecting profit margins and allowed partial relief to the assessee. The Tribunal restored the issue to the AO/TPO for fresh adjudication, emphasizing that adjustments should be limited to international transactions with AEs, not the entire segment.

3. Treatment of Interest Income as Business Income:
The AO taxed interest income from FDRs under "Income from Other Sources." The FAA and Tribunal, however, held that the interest income was directly connected with the business activity of MTA and should be taxed as business income. The Tribunal noted that the interest income had been consistently treated as business income in earlier and subsequent years.

4. Non-Compete Fee as Revenue or Capital Expenditure:
The AO treated non-compete fees paid to Hindustan Lever Ltd. (HLL) and Prestige Foods Ltd. (PFL) as capital expenditure. The FAA allowed it as revenue expenditure, but the Tribunal, following its earlier decision, held that non-compete fees constituted capital expenditure eligible for depreciation.

5. Market Research Expenses as Revenue or Capital Expenditure:
The AO disallowed market research expenses, treating them as capital expenditure. The FAA and Tribunal, however, held that such expenses were revenue in nature as they did not provide enduring benefits and were incurred annually.

6. Disallowance of Expenditure on Land and Site Development:
The AO disallowed the claim for land and site development expenses due to lack of evidence. The FAA upheld the disallowance. The Tribunal confirmed the FAA’s decision, noting the absence of supporting documentation.

7. Disallowance of Provision for Obsolete Stores:
The AO disallowed the provision for obsolete stores due to lack of evidence. The FAA upheld the disallowance. The Tribunal confirmed the decision, emphasizing the need for documentary evidence to support the claim.

8. Disallowance of Expenses for ESOP:
The AO disallowed the provision for ESOP expenses. The Tribunal, following the decision in Biocon Ltd., allowed the claim, recognizing ESOP expenses as allowable deductions.

9. Disallowance of Loss on Hedging Transactions:
The assessee withdrew the ground related to the disallowance of loss on hedging transactions, and the Tribunal dismissed it as withdrawn.

Conclusion:
The Tribunal’s judgment addressed various complex issues related to transfer pricing, tax treatment of interest income, non-compete fees, market research expenses, and provisions for obsolete stores. The Tribunal emphasized the importance of adhering to principles of natural justice and consistency in tax treatment across different assessment years.