2019 (6) TMI 1117 - AT - Income Tax

TP Adjustment - comparable selection - functional comparability - HELD THAT - Hindustan Housing Co. Ltd. assessee company is engaged in providing pre-sales support and post-sales support services primarily to the customers of Comverse Network Systems Ltd., Tel Aviv and also to the Indian customers of Verint Systems Inc (another subsidiary of the holding company) which are the Associated Enterprises (AE). On the other hand, Hindustan Housing Co. Ltd. undertakes a wider variety of activities like providing air conditioning, lift and intercom services which typically included operating and service maintenance services thereof. Thus, although providing post sales services is a part of the activities of Hindustan Housing Co. Ltd., its spectrum includes providing air conditioning, lifts and intercoms also. Thus, it cannot be considered as a company which is functionally comparable to the assessee company. Also, the company fails the Related Party Transaction filter. Rightly excluded by CIT(A). Choksi Laboratories Ltd. - A perusal of the Directors Report and the Annual Financial Statements shows that the contentions of the Ld. AR are correct on both the counts. We also note that the TPO himself has observed that the core activity of this company was providing analytical and testing services. We also note that this company had a significantly high proportion of testing instruments which was approximately 58% of its total net assets which implies that the functions performed by the company are capital intensive in nature and there is no similarity with the functions of a service provider. Rightly excluded by CIT(A). Vimta Labs Ltd. - A perusal of the Directors Report and the Annual Financial Statements shows that the contentions of the Ld. AR are correct on both the counts. We also note that this company had incurred huge expenditure on testing and analysis whereas the assessee company did not incur any expenditure on testing services. We also note that the assets employed by the assessee in terms of plant and machinery were approximately 70% of its total net assets which implies that the functions performed by this company were more capital intensive than the assessee company which was a mere service provider. Thus, it can be safely concluded that this company is not a good comparable to the assessee company. Rightly excluded by CIT(A). Scal Services Ltd. and Isgec Coverma Ltd. , whose exclusion by the Ld. CIT (A) was being challenged, the Ld. AR has submitted that the assessee had no objection if these two comparables were included in the final set of comparables. Accordingly, we direct the TPO/AO to include these two companies in the final set of comparables. Disallowance of club expenses - HELD THAT - Hon ble Bombay High Court in the case of C.I.T. vs. Lubrizol India Ltd. 2015 (8) TMI 134 - BOMBAY HIGH COURT has held that entrance fee for membership of a club is to be considered as revenue expenditure. Although entrance fee does have an enduring benefit, it was not considered to be capital in nature by the Hon ble Bombay High Court as no asset was created. Applying the same analogy, membership fee would also necessarily have to be regarded as revenue in nature. The nature of expenditure is not in doubt here. The Assessing Officer also has not brought out any fact which would justify the disallowance - dismiss ground no. 2 of the department s appeal. Admitting additional evidence - approval letter of gratuity fund - HELD THAT - CIT(A) has not admitted any evidence which could be taken as being in the nature of additional evidence. The approval letter pertaining to the gratuity fund is a matter of record and we find no infirmity in the action of the CIT (Appeals) in taking cognizance of this approval letter while deleting the related disallowance. Thus, ground no. 3 also stands dismissed. Allowability of Provision of gratuity and leave encashment u/s 115JB - ascertained liability - HELD THAT - As against accumulated provision of ₹ 8,55,136/-, a payment of ₹ 8,50,000/- has been made against the gratuity and, thus it is not an estimate as inferred by the Assessing Officer but is based on actual payment. As far as the provision for leave encashment is concerned, it is undisputed that it is based on actuarial valuation of the assessee s liability in this regard. The same has been duly disclosed by way of a note in the notes on accounts annexed to the annual financial statement of the assessee company. We also find support in the case of C.I.T. vs. Echjay Forgings (P) Ltd. 2001 (2) TMI 56 - BOMBAY HIGH COURT wherein held that provision for doubtful debts, gratuity etc. on the basis of actuarial valuation would have to be excluded from the net profit for computing the book profit u/s 115JB

Summary

Issues Involved:
1. Rejection of comparables by the CIT (A) for determining Arm's Length Price (ALP).
2. Deletion of disallowance of club expenses by the CIT (A).
3. Admission of additional evidence by the CIT (A) without calling for a remand report from the AO.
4. Treatment of provision for gratuity and provision for leave encashment as ascertained liabilities for book profit calculation under section 115JB.

Detailed Analysis:

1. Rejection of Comparables by the CIT (A) for Determining ALP:

The primary issue was whether the CIT (A) erred in rejecting five out of six comparables selected by the TPO for determining the ALP. The assessee had initially selected four comparables, but the TPO replaced them with seven new comparables based on the previous year's study. The CIT (A) excluded five of these comparables, leading to the department's appeal.

- Hindustan Housing Co. Ltd.: The CIT (A) rejected this company as a comparable because it was primarily engaged in providing air conditioning, lift, and intercom services, which were not functionally comparable to the assessee's business of providing pre-sales and post-sales support services. Additionally, the company's Related Party Transactions constituted 38.86% of its operating revenue, failing the Related Party Transaction filter.

- Choksi Laboratories Ltd.: This company was excluded as it was a commercial testing and analysis laboratory, which was not functionally comparable to the assessee's service-oriented business. It also had a high proportion of testing instruments, indicating capital-intensive operations.

- Vimta Labs Ltd.: This company was engaged in multi-disciplinary contract research and testing services, which were not comparable to the assessee's services. It had significant expenditure on testing and analysis and was more capital intensive.

- Scal Services Ltd. and Isgec Coverma Ltd.: The assessee had no objection to including these two companies in the final set of comparables.

2. Deletion of Disallowance of Club Expenses by the CIT (A):

The CIT (A) deleted the disallowance of club expenses made by the AO, who had disallowed 50% of the expenditure on the grounds of potential personal use. The CIT (A) observed that the AO had made the disallowance on an ad hoc basis without any factual basis. The ITAT upheld the CIT (A)'s decision, referencing the Bombay High Court's ruling in C.I.T. vs. Lubrizol India Ltd., which treated club membership fees as revenue expenditure.

3. Admission of Additional Evidence by the CIT (A) without Calling for a Remand Report from the AO:

The department contended that the CIT (A) erred by admitting additional evidence regarding the approval of the assessee's gratuity fund without calling for a remand report. The ITAT found that the CIT (A) had not admitted any new evidence but had considered the approval letter of the gratuity fund, which was a matter of record. Therefore, the ITAT found no infirmity in the CIT (A)'s action.

4. Treatment of Provision for Gratuity and Provision for Leave Encashment as Ascertained Liabilities for Book Profit Calculation under Section 115JB:

The department challenged the CIT (A)'s treatment of provisions for gratuity and leave encashment as ascertained liabilities. The ITAT noted that the provision for gratuity was based on actual payment, and the provision for leave encashment was based on actuarial valuation. The ITAT referenced the Bombay High Court's judgment in C.I.T. vs. Echjay Forgings (P) Ltd., which held that such provisions should be excluded from net profit for computing book profit under section 115JB. Therefore, the ITAT upheld the CIT (A)'s decision.

Conclusion:

The ITAT partly allowed the revenue's appeal by including Scal Services Ltd. and Isgec Coverma Ltd. in the final set of comparables and dismissed the other grounds of appeal. The assessee's Cross Objection was dismissed as it was not pressed. The final result was that the revenue's appeal was partly allowed, and the assessee's C.O. was dismissed.