2018 (5) TMI 581 - AT - Income Tax

Deduction u/s 10B - exchange fluctuation gain - forward contracts are devices to hedge foreign currency fluctuation risk - Held that - AO has not brought anything on record to prove that foreign exchange gain was due to any speculative transaction entered into by assessee. - Foreign exchange gain earned by assessee was arising out of business of eligible undertaking for purposes of deduction under section 10B Expenses towards royalty/technical know-how - revenue or capital in nature - Held that - assessee acquired merely right to draw upon technical knowledge of foreign companies for a limited purpose of carrying on its business, and that foreign companies did not part with any of their assets absolutely for ever or for a limited period of time, that they continued to have the right to use their knowledge and, even after agreements had run their course, their rights in this behalf was not lost, that assessee had not, therefore, acquired any asset or advantage of an enduring nature for benefit of its business and that payments were, therefore, revenue in nature and were deductible. Exemption u/s 10A/10B - Interest income - deposits made with banks for obtaining letters of credit - these letters of credit are utilised for purposes of export activity carried on by assessee - Held that - Since there is no bifurcations that has been provided by assessee either before us or before the authorities below it cannot be assumed that entire interest income claimed by assessee could be linked with the export activity. - Benefit of deduction u/s 10B on interest income related to export activity allowed - AO directed to bifurcate the interest related to export activities and other activities. Bad debts deleted by holding that these are unascertained liabilities - Held that - Hon ble Supreme Court in the case of CIT versus HCL Commet Systems & Services Ltd. 2008 (9) TMI 18 - SUPREME COURT has held that provisions for bad and doubtful debts being ascertained liability are not required to be added in the matter of computation. He submitted that subsequent to the decision of Hon ble Supreme Court, an amendment has been made in section 115 JB by Finance Act 2009 with retrospective effect from 2001, and the issue now has to be decided against assessee. Indexation granted on the sale of shares by assessee of State Bank of Bikaner and Jaipur - Held that - It is an admitted position that this is the sole transaction entered into by assessee of sales/purchase of shares in view of which loss has been incurred during the year under consideration. There is no evidence that has been brought on record by department to establish that assessee has been carrying on with activity of sales/purchase of shares. Under such circumstances applicability of Explanation to section 73 has to be construed in a narrow sense, which indicates where the income is derived from business activity of sales/purchase of shares

Issues Involved:

1. Transfer Pricing Adjustments
2. Deduction under Section 10B of the Income Tax Act
3. Disallowance under Section 14A read with Rule 8D
4. Treatment of Royalty and Technical Know-how Fees
5. Computation of Book Profits under Section 115JB
6. Treatment of Miscellaneous Income
7. Interest Income from Deposits

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustments:

The primary contention was the selection of the tested party for benchmarking international transactions. The assessee argued for using its foreign associated enterprise (AE) as the tested party, citing its simpler functions and nominal risks. The Transfer Pricing Officer (TPO) rejected this, citing incomplete financials and controlled transactions of the AE, and instead selected the assessee as the tested party. The Tribunal directed the TPO to reconsider the AE as the tested party if complete financials and comparables are provided. The Tribunal emphasized that the tested party should be the least complex entity with reliable data available.

2. Deduction under Section 10B of the Income Tax Act:

The assessee's claim for deduction under Section 10B was disputed on several grounds. For Assessment Year 2005-06, the deduction was disallowed for unrealized export proceeds. The Tribunal set aside this issue, directing the Assessing Officer (AO) to verify the realization of export proceeds within the extended period allowed by the RBI. For foreign exchange gains and forward contract sales, the Tribunal held that these were directly linked to the export business and allowed the deduction. The treatment of miscellaneous income, including write-back of credit balances and insurance claims, was also allowed for deduction under Section 10B, as they were found to have a direct nexus with the industrial undertaking.

3. Disallowance under Section 14A read with Rule 8D:

The Tribunal noted that Rule 8D is not applicable retrospectively and is only effective from Assessment Year 2008-09. For the years under consideration, the AO was directed to recompute the disallowance under Section 14A without applying Rule 8D, ensuring that any disallowance is based on actual satisfaction recorded regarding the expenditure incurred for earning exempt income.

4. Treatment of Royalty and Technical Know-how Fees:

The AO treated 25% of the royalty and technical know-how fees as capital expenditure, citing enduring benefits to the assessee. The Tribunal disagreed, noting that the assessee only had a license to use the know-how and did not acquire ownership of any intangible assets. The payments were thus considered revenue in nature and allowed as deductions.

5. Computation of Book Profits under Section 115JB:

The AO's computation of book profits under Section 115JB was contested, particularly the inclusion of interest income and the treatment of income and expenses of units eligible for deduction under Section 10A/10B. The Tribunal directed the AO to recompute the book profits, excluding the income and expenses of eligible units from the computation, in line with the Tribunal's earlier decisions and the Delhi High Court's ruling in the assessee's own case.

6. Treatment of Miscellaneous Income:

The AO's exclusion of miscellaneous income from the computation of deduction under Section 10B was disputed. The Tribunal allowed the inclusion of such income, including write-back of credit balances and insurance claims, for deduction under Section 10B, as they were found to have a direct nexus with the industrial undertaking.

7. Interest Income from Deposits:

The treatment of interest income earned on deposits kept as margin money for letters of credit (LC) was contested. The AO treated it as income from other sources, not eligible for deduction under Section 10A/10B. The Tribunal set aside this issue, directing the AO to verify if the interest income was directly linked to the export business. If so, it should be included in the computation of deduction under Section 10A/10B.

Conclusion:

The Tribunal provided detailed directions for each issue, emphasizing the need for proper verification and adherence to legal principles. The decisions highlight the importance of accurate financial data, proper documentation, and the application of relevant legal provisions in determining tax liabilities and entitlements.

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