2022 (2) TMI 1503 - AT - Income Tax

TP Adjustment - Comparable selection - HED THAT - Deselection of comparables as functionally dissimilar with that of assessee and related party transaction was more than 15%. Computation of deduction u/s 10A - exclusion of expenditure incurred in foreign currency in respect of telecommunication expenses / insurance / freight etc. - HELD THAT - We remand this issue to the Ld.AO to compute the deduction u/s. 10A in accordance with the principles laid down in case of HCL Technologies Ltd. 2018 (5) TMI 357 - SUPREME COURT Non-granting deduction u/s. 80JJAA - AO observed that assessee had strength of 2783 at the beginning of the year and at the end of the year the strength increased to 3582 - AR submitted that the additional wages are paid to the new regular workmen by the assessee which is in accordance with the provisions that were applicable to assessee during the relevant Assessment Year - HELD THAT - If some workmen were employed for a period of less than 300 days in the previous year then no deduction is allowable in respect of payment of wages to such work men in the present year even if such workmen was employed in the preceding year for more than 300 days but in the present year such workmen was not employed for 300 days or more. By the very same reasoning the fact that in the first year of employment the additional wages paid is not allowed deduction for the reason that the workmen did not work for 300 days or more but if the next two Assessment years if he works for more than 300 days each then the deduction u/s.80JJAA of the Act has to be allowed. It is not proper to say that if the deduction is refused in the first year of employment of the new employee then for the next two succeeding Assessment Years also the benefit of deduction will not be available. Such an approach defeats the very purpose for which deduction u/s.80JJAA of the Act is allowed for three consecutive Assessment years. This aspect has now been clarified in the Finance Act 2018 by adding a second proviso to the definition of additional employee in Explanation (ii) to Sec. 80JJAA of the Act. Even prior to such curative or clarificatory amendment we are of the view that the claim for deduction u/s.80JJAA of the Act ought not have been disallowed. The Ld.AO is therefore directed to verify the details and consider the claim of assessee in accordance with law. Disallowance u/s. 14A - Counsel submitted that the entire investments cannot be taken into consideration for disallowance under Rule 8D(2)(iii) at 0.5% - HELD THAT - In the above observations for Assessment Year 2008-09 2021 (9) TMI 350 - ITAT BANGALORE there no disallowance was made by assessee this Tribunal deem it appropriate to restrict the disallowance to Rs. 2 Lakhs considering the less number of schemes that fall under growth / investment schemes. Going by the above principle and also observing the fact that the Ld.AO has not expressly mentioned any dissatisfaction in the suomoto disallowance computed by assessee we hold that the disallowance computed by the assessee is appropriate. Foreign tax credit not granted to assessee against the tax paid by assessee in Germany - HELD THAT - As AR submitted that the foreign tax credit may be granted to assessee as per the provisions of section 90 on the taxes that are paid by assessee. Assessee is directed to file relevant document in support of the claim. AO shall verify the evidences / documents in respect of FTC and consider the claim of assessee in accordance with law. Deduction of Education cess and Higher secondary Education cess - DR submitted that education cess is a tax and therefore it cannot be granted as deduction to the assessee by the virtue of the provisions of Section 40(a)(ii) - HELD THAT - We find that assessee has raised the additional ground claiming deduction of education cess paid by the assessee on the total income as well as dividend distribution tax. On careful analysis we find that the issue of deduction of education cess as an allowable deduction is covered in favour of the assessee by the decision of Sesa Goa Ltd 2020 (3) TMI 347 - BOMBAY HIGH COURT and therefore we direct the Ld.AO to consider the claim afresh.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in the present appeals are:

(a) Whether the Dispute Resolution Panel (DRP) erred in excluding certain comparable companies based on turnover filters and functional dissimilarities in the transfer pricing analysis for software development (SWD) and IT enabled services (ITES) segments?

(b) Whether the turnover filter applied by the DRP and Transfer Pricing Officer (TPO) for excluding comparables is legally sustainable given the provisions of Rule 10B of the Income Tax Rules and the absence of prescribed turnover criteria?

(c) Whether the expenditure incurred in foreign currency should be excluded from export turnover while computing deduction under section 10A of the Income Tax Act, particularly with respect to export of computer software as opposed to technical services?

(d) Whether the assessee is entitled to full deduction under section 80JJAA for additional wages paid to new regular workmen, including those who resigned during the year?

(e) Whether the provisions of Rule 8D of the Income Tax Rules, 1962, can be invoked to make additional disallowances under section 14A without demonstrating the insufficiency of the assessee's claim regarding expenses relatable to exempt income?

(f) Whether the Transfer Pricing Officer and DRP erred in rejecting the economic/comparability analysis performed by the assessee and in determining the arm's length price for receipt of services from associated enterprises as NIL?

(g) Whether the assessee is entitled to additional Foreign Tax Credit (FTC) for taxes paid in Germany post original assessment, and whether such credit can be claimed after expiry of the time limit for filing revised returns?

(h) Whether the Dividend Distribution Tax (DDT) paid at an effective rate of 16.6088% can be restricted to 10% as per Article 10 of the India-Germany Double Taxation Avoidance Agreement (DTAA)?

(i) Whether Education Cess and Higher and Secondary Education Cess paid on total income tax are allowable as deductions?

(j) Whether the Assessing Officer erred in charging interest under sections 234B and 234D and initiating penalty proceedings under section 271(1)(c) when adjustments were due to difference of opinion?

(k) Whether the TDS credit claimed by the assessee was properly granted?

2. ISSUE-WISE DETAILED ANALYSIS

(a) Exclusion of Comparable Companies on Turnover and Functional Grounds in Transfer Pricing

Legal Framework and Precedents: The transfer pricing provisions under Chapter X of the Income Tax Act require determination of arm's length price (ALP) for international transactions using prescribed methods. Rule 10B of the Income Tax Rules provides guidelines for selection of comparable companies but does not prescribe turnover filters. The Tribunal's earlier decisions, including those in the assessee's own cases and other precedents, have recognized the application of turnover filters based on commercial studies (Dun & Bradstreet) and functional comparability.

Court's Interpretation and Reasoning: The Tribunal noted that the DRP and TPO excluded several comparables on turnover grounds (below Rs. 200 crores or above Rs. 2000 crores) and on functional dissimilarities such as presence of diversified activities, product development, or lack of segmental data. The Tribunal relied on coordinate bench decisions in the assessee's own cases for AY 2008-09 and other cases involving similar companies, which upheld such exclusions. It was observed that the turnover filter is a recognized commercial parameter to ensure comparability and that functional dissimilarities must be considered to maintain the integrity of the ALP determination.

Key Evidence and Findings: The Tribunal examined segmental details, business activities, risk profiles, and financial metrics of the comparables. For instance, companies like Acropetal Technologies Ltd., Infosys Ltd., and Persistent Systems were excluded due to product orientation, risk profile, or lack of segmental information. The Tribunal also noted that the revenue failed to place any distinguishing features to justify inclusion of these comparables.

Application of Law to Facts: Applying the principles established in prior judgments and the functional analysis, the Tribunal upheld the exclusion of the disputed comparables. It directed the TPO to verify functional similarity for companies like LGS Global Ltd. which the assessee sought to include, as there was no adverse observation by the TPO.

Treatment of Competing Arguments: Revenue challenged the exclusion of comparables, but failed to provide sufficient evidence or legal basis to overturn the DRP's and Tribunal's earlier findings. The assessee's submissions on functional dissimilarities and turnover filters were accepted as sound and consistent with established jurisprudence.

Conclusions: The Tribunal dismissed the revenue's appeal regarding inclusion of comparables excluded on turnover and functional grounds and allowed the assessee's appeal for exclusion of certain comparables and inclusion of others subject to verification.

(b) Expenditure Incurred in Foreign Currency and Deduction under Section 10A

Legal Framework and Precedents: Section 10A provides deduction for profits from export undertakings, with Explanation 2(iv) excluding certain expenditures incurred in foreign currency from export turnover for technical services exports. The question arises whether this exclusion applies to export of computer software.

Court's Interpretation and Reasoning: The Tribunal referred to its own decisions in the assessee's cases for AYs 2007-08 and 2009-10, which held that exclusion of foreign currency expenditure from export turnover is permissible only when the export relates to technical services outside India, not for export of computer software. The Tribunal noted that the factual matrix, including the Software Project Agreement, did not conclusively establish that the foreign currency expenditure related to technical services outside India.

Key Evidence and Findings: The Tribunal emphasized the absence of detailed breakup of foreign currency expenditure and the nature of exports being software development rather than technical services. It noted that the issue required factual verification.

Application of Law to Facts: The Tribunal set aside the order of the CIT(A) and remanded the issue for fresh adjudication with directions to examine the nature of foreign currency expenditure in light of the aforesaid principles. It also noted the Supreme Court's ruling in HCL Technologies Ltd. that any amount reduced from export turnover must also be reduced from total turnover for computing deduction under section 10A.

Treatment of Competing Arguments: The assessee's contention for exclusion of foreign currency expenditure was accepted for reconsideration, while the revenue's contrary stand was rejected due to lack of conclusive evidence.

Conclusions: The issue was remanded for fresh examination and computation of deduction under section 10A in accordance with law.

(c) Deduction under Section 80JJAA for Additional Wages Paid to New Regular Workmen

Legal Framework and Precedents: Section 80JJAA allows deduction of 30% of additional wages paid to new regular workmen employed for at least 300 days during the previous year, subject to conditions including a minimum increase of 100 workmen and 10% increase over the preceding year's strength.

Court's Interpretation and Reasoning: The Tribunal analyzed the facts that 544 workmen resigned during the year and the net increase was 799. It held that the legislative intent is to incentivize employment of new regular workmen and that wages paid to workmen who did not complete 300 days should not be excluded in a manner defeating the purpose of the provision. It referred to the Finance Act, 2018 amendment clarifying this aspect.

Key Evidence and Findings: The Tribunal noted the strength of employees at the start and end of the year and the nature of employment contracts.

Application of Law to Facts: The Tribunal directed the AO to verify details and allow deduction in accordance with law, emphasizing that denial of deduction in the first year should not preclude allowance in subsequent years.

Treatment of Competing Arguments: The assessee's submissions were accepted, and the AO's disallowance was set aside for reconsideration.

Conclusions: The ground was remanded for verification and appropriate allowance of deduction under section 80JJAA.

(d) Disallowance under Section 14A and Invocation of Rule 8D

Legal Framework and Precedents: Section 14A read with Rule 8D provides for disallowance of expenditure incurred in relation to exempt income. The AO must demonstrate that the assessee's claim regarding expenses relatable to exempt income is incorrect or insufficient before making additional disallowance.

Court's Interpretation and Reasoning: The Tribunal observed that the assessee had already disallowed actual expenditure incurred in earning exempt income and computed disallowance under Rule 8D. The AO made further disallowance without demonstrating any deficiency in the assessee's claim.

Key Evidence and Findings: The Tribunal examined the quantum and nature of investments and expenditures and noted the limited number of mutual fund schemes and the nature of investments.

Application of Law to Facts: The Tribunal held that mechanical application of Rule 8D without proper demonstration is impermissible and restricted the disallowance to Rs. 2 lakhs, consistent with earlier decisions in the assessee's own cases.

Treatment of Competing Arguments: The assessee's computation was accepted as appropriate, and the AO's additional disallowance was disallowed.

Conclusions: The ground was allowed in favor of the assessee with disallowance restricted to Rs. 2 lakhs.

(e) Rejection of Assessee's Economic/Comparability Analysis and Determination of Arm's Length Price for Receipt of Services

Legal Framework and Precedents: Transfer pricing provisions require that the ALP be determined based on reliable comparables and appropriate adjustments for differences in risk profiles and functions performed.

Court's Interpretation and Reasoning: The Tribunal found that the AO/TPO and DRP rejected the assessee's comparability analysis and accepted comparables functionally different from the assessee. No adjustment was made for differences in risk profiles. The ALP for receipt of services from associated enterprises was determined as NIL without adequate basis.

Key Evidence and Findings: The Tribunal noted the lack of segmental details and functional comparability in the comparables accepted by the AO/TPO and DRP.

Application of Law to Facts: The Tribunal directed the TPO to reconsider the comparability analysis and ALP determination after excluding functionally dissimilar comparables and considering risk adjustments.

Treatment of Competing Arguments: The assessee's submissions were accepted, and the AO/TPO's approach was set aside for reconsideration.

Conclusions: The matter was remanded for fresh determination of ALP in accordance with law and principles of transfer pricing.

(f) Additional Foreign Tax Credit Claim

Legal Framework and Precedents: Section 90 of the Income Tax Act and Article 23(2) of the India-Germany DTAA provide for relief from double taxation by allowing foreign tax credit for taxes paid in the foreign country.

Court's Interpretation and Reasoning: The Tribunal admitted the additional ground raised by the assessee for claiming FTC on additional taxes paid in Germany after completion of German tax assessments. The Tribunal noted that the time limit for filing revised returns in India had expired before the German assessments were finalized.

Key Evidence and Findings: Detailed tables of income, costs, profits, and taxes paid in Germany were examined, showing additional tax payments for calendar years 2010 and 2011.

Application of Law to Facts: The Tribunal directed the AO to verify the documents and consider the claim for additional FTC in accordance with law.

Treatment of Competing Arguments: The assessee's claim was admitted for consideration; no contrary submissions were recorded.

Conclusions: The issue was remanded to the AO for verification and appropriate grant of FTC.

(g) Dividend Distribution Tax (DDT) at Reduced Rate under DTAA

Legal Framework and Precedents: Article 10 of the India-Germany DTAA restricts tax on dividends to 10% if the recipient is the beneficial owner. Section 115-O of the Income Tax Act prescribes DDT at 15% plus surcharge and cess, resulting in an effective rate of 16.6088%.

Court's Interpretation and Reasoning: The Tribunal admitted the additional ground raised by the assessee seeking relief to restrict DDT to 10% as per DTAA provisions. It noted the assessee's status as a wholly owned subsidiary of a German resident company without a permanent establishment in India.

Key Evidence and Findings: The Tribunal considered the audited financial statements, Form 26AS, and the assessment order of the German parent company confirming no PE in India.

Application of Law to Facts: The Tribunal remitted the issue to the AO for decision in accordance with law and DTAA provisions.

Treatment of Competing Arguments: The assessee's claim was admitted for consideration; the revenue's opposition was noted but not upheld at this stage.

Conclusions: The issue was remanded for fresh adjudication.

(h) Deduction of Education Cess and Higher and Secondary Education Cess

Legal Framework and Precedents: Education cess and related cesses are levied on income tax payable but their deductibility as business expenses is contentious. The Bombay High Court in Sesa Goa Ltd. held in favor of deductibility.

Court's Interpretation and Reasoning: The Tribunal admitted the ground and relied on the Bombay High Court's decision and other precedents supporting deductibility of education cess as an allowable expense.

Application of Law to Facts: The Tribunal directed the AO to consider the claim afresh in light of the favorable legal position.

Treatment of Competing Arguments: The revenue's contention that cess is a tax and not deductible was noted but not accepted.

Conclusions: The ground was admitted and remanded for reconsideration.

(i) Interest and Penalty Proceedings under Sections 234B, 234D, and 271(1)(c)

Legal Framework and Precedents: Sections 234B and 234D deal with interest for default in payment of advance tax and TDS, while section 271(1)(c) penalizes concealment or furnishing inaccurate particulars of income.

Court's Interpretation and Reasoning: The Tribunal found that the adjustments made by the AO were due to differences of opinion in interpretation of law, not due to any wrong claim or inaccurate particulars by the assessee. The DRP did not adjudicate these grounds.

Application of Law to Facts: The Tribunal held that penalty proceedings were not justified on these facts and that the interest charges require adjudication after final determination of income.

Conclusions: The grounds were held premature and not adjudicated at this stage.

(j) Grant of TDS Credit

Legal Framework and Precedents: TDS credit must be granted to the assessee upon verification of the claim and compliance with statutory provisions.

Court's Interpretation and Reasoning: The Tribunal directed the AO to grant the TDS credit claimed by the assessee after verification.

Conclusions: The ground was allowed for statistical purposes.

3. SIGNIFICANT HOLDINGS

"The Tribunal upheld the application of turnover filters and functional comparability tests in transfer pricing analysis, holding that comparables with turnover below Rs. 200 crores or above Rs. 2000 crores and those functionally dissimilar must be excluded."

"The Tribunal held that expenditure incurred in foreign currency can be excluded from export turnover for computing deduction under section 10A only if related to export of technical services outside India, and not for export of computer software."

"The Tribunal recognized the legislative intent of section 80JJAA to incentivize employment and directed allowance of deduction for additional wages paid to new regular workmen, including those who resigned, subject to verification."

"The Tribunal restricted disallowance under section 14A to a reasonable amount when the assessee had already disallowed actual expenditure and the AO failed to demonstrate inadequacy of the claim."

"The Tribunal admitted the claim for additional foreign tax credit arising from higher tax assessments in Germany and directed verification and grant in accordance with law."

"The Tribunal admitted the claim for restricting dividend distribution tax to 10% as per DTAA provisions and remitted the issue for fresh adjudication."

"The Tribunal held that education cess and higher and secondary education cess paid on income tax are allowable deductions, following the Bombay High Court's decision."

"The Tribunal held that penalty under section 271(1)(c) is not justified where adjustments arise from difference of opinion and not from concealment or inaccurate particulars."

"The Tribunal directed grant of TDS credit claimed by the assessee upon verification."p>