2020 (5) TMI 356 - AT - Income Tax

Disallowance on account of Sham Agreement - AO found that the transaction is with a related party - revenue has been transferred to its holding company - assessee is not eligible for deduction of expenditure incurred towards services obtained from its holding company at the 25% of the revenue - HELD THAT - A compulsion at source imposed by a third party is necessary to create a superior title. Just because diverted income is collected by the assessee himself for and on behalf of the beneficiary; it cannot be inferred that it was only an application and not diversion. In the instant case, the assessee has been obligated by virtue of the agreement to divert the income at source and also for the contributions made by the holding company. Revenue sharing agreement entered with the holding company by the assessee is diversion of income by overriding title. The revenue's contention that the entire transaction is sham and aimed at only to divert the income to EMLL cannot be said to be correct based on the facts and the judicial pronouncements. In case of assessee 2020 (1) TMI 458 - ITAT DELHI itself based on the same agreement, we do not find any merit in the appeal of the assessee in deleting the addition made by the learned CIT A holding that the agreement between the holding company as well as the assessee was not sham agreements. Accordingly, we dismiss the appeal of the learned assessing officer. Payment of the disbursement income to the holding company - diversion of income by overriding title or merely on application of income - HELD THAT - As decided in case of assessee 2020 (1) TMI 458 - ITAT DELHI payment made to the holding company is obligated the in diversion of income by overriding title. The coordinate bench also after considering the contribution made by the holding company and keeping in view the amounts that have been already offered for taxation in the hands by the respective entities the above expenditure is allowable in the hands of the company. The relevant paragraphs as cited above that the revenue sharing agreement entered with the holding company by the assessee is a diversion of income by overriding title, we allow ground number one of the appeal following the reasoning given by the coordinate bench.

Issues Involved:
1. Legality of the revenue sharing agreement between the assessee and its holding company.
2. Whether the disbursement of income as per the revenue sharing agreement constitutes a diversion of income by overriding title or an application of income.
3. Appropriateness of the deduction of expenditure incurred towards services obtained from the holding company.
4. Method of computing reasonable expenditure related to services obtained from the holding company.

Detailed Analysis:

1. Legality of the Revenue Sharing Agreement:

The revenue contended that the CIT(A) erred in deleting the disallowance of ?12,99,96,970 on account of a sham agreement. The AO found the revenue sharing agreement dated 7/4/2008 between the assessee and its holding company to be dubious and a colorable device to reduce tax liability. The AO's main reasons for disallowance included:
- The agreement was an afterthought and surfaced for the first time during assessment proceedings.
- Contradictory contents in the agreement mentioned in the balance sheet.
- The holding company was already compensated adequately through interest costs.
- The holding company, as the shareholder, was inherently responsible for arranging funds and assuming project risks.
- Dubious accounting treatment and lack of actual fund movement.
- Non-deduction of tax at source, invoking Section 40(a)(i.a).
- The transaction being between related entities, invoking Section 40A(2)(a).

The CIT(A) followed the predecessor's order and allowed the claim of the assessee, confirming that the revenue sharing agreement was not a sham and that the disbursement of income was an application of income.

2. Diversion of Income by Overriding Title vs. Application of Income:

The assessee argued that the revenue sharing agreement resulted in a diversion of income by overriding title. The CIT(A) concurred with this view, which was upheld by the coordinate bench in earlier years. The bench noted that the assessee was obligated to part with the source of income to the holding company, creating a lien over 25% of the sales proceeds. This was seen as a division of the source of income, not an application of income.

The bench referred to several judgments, including CIT vs. Sitaldas Tirathdas and Dalmia Cement Ltd. v. CIT, to establish that an obligation to apply income before it accrues results in a diversion of income by overriding title. The bench concluded that the revenue sharing agreement constituted a diversion of income by overriding title, not merely an application of income.

3. Deduction of Expenditure for Services Obtained from Holding Company:

The assessee contended that the CIT(A) erred in not allowing the deduction of expenditure incurred towards services obtained from the holding company at 25% of the revenue. The CIT(A) allowed only the actual cost/expenses incurred by the holding company. The coordinate bench, considering the contributions made by the holding company and the amounts offered for taxation by respective entities, allowed the expenditure in the hands of the assessee.

4. Method of Computing Reasonable Expenditure:

The CIT(A) adopted its method of computing reasonable expenditure related to services obtained from the holding company, which the assessee argued was not permissible in law. The coordinate bench, following its earlier decisions, allowed the expenditure claimed by the assessee, thus rejecting the CIT(A)'s method.

Conclusion:

The appeal filed by the revenue was dismissed, and the appeal filed by the assessee was allowed. The coordinate bench's findings from earlier years were upheld, confirming that the revenue sharing agreement was not a sham, and the disbursement of income was a diversion by overriding title. The expenditure incurred towards services obtained from the holding company was allowed, and the CIT(A)'s method of computing reasonable expenditure was rejected. The order was pronounced on 13/05/2020.

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