2008 (9) TMI 420 - AT - Income Tax

Determination of Operational Income - deduction under section 80HHC in respect of service income - deduction under section 10A/10B in respect of miscellaneous Income - Exclusion and Rejection of Comparables - Transactional Net Margin Method (TNMM) - Transfer Pricing Regulations - Application of Proviso to Section 92C(2) - Most Appropriate Method - Determination Of Arm's Length Price - HELD THAT - The decision of Hon'ble Bombay High Court in the case of Bangalore Clothing Co. 2003 (1) TMI 89 - BOMBAY HIGH COURT or the guidelines laid down therein thus cannot be applied while deciding the issue relating to the eligibility of income for deduction under section 80-IA as the expression used in the said provision is derived from , the scope of which is quite narrow as explained by the Hon'ble Supreme Court in the case of Sterling Foods 1999 (4) TMI 1 - SUPREME COURT by observing that a direct nexus or a first degree connection with the industrial undertaking is must so as to treat any income as derived from the industrial undertaking. We, therefore, find no justifiable reason to take a view on this issue different from the one taken by the Tribunal in any taxpayer's own case for assessment year 2000-01 and respectfully following the order of the Tribunal for that year, we uphold the impugned order of the learned CIT(A) disallowing the taxpayer's claim for deduction under section 80-IA in respect of miscellaneous income and service income. Ground No. 2 of the taxpayer's appeal is accordingly dismissed. Deduction under section 80HHC in respect of service income - Admittedly, the dominant business of the taxpayer company is to manufacture and sale of electronic goods and having regard to this main activity of the taxpayer company, it has to be seen as to whether the service income accrued to it as a part of the main business activity or whether it accrued out of incidental business. In this regard, it is observed that the nature of service income earned by the taxpayer company is such that it cannot be said that the same was earned by the taxpayer company using its undertaking which manufactured the electronic goods and for the purpose of earning the said income, the expenditure normally incurred for its main activity of manufacture of electronic goods was also not required to be incurred. It is, therefore, very difficult to say that the activity of earning service income was forming part of the manufacturing activity of the taxpayer company and having regard to the nature of the said activity vis-a-vis the main activity of the taxpayer company, it cannot be said that the service income accrued to it as a part of the main business activity. At the most, the said activity could be treated as incidental business activity of the taxpayer company and the income earned therefrom could be said to be accrued to it out of such incidental business. Keeping in view the said decision of Hon'ble Bombay High Court in the case of K.K. Doshi Co. 2000 (8) TMI 74 - BOMBAY HIGH COURT and the broad guidelines laid down in the case of Bangalore Clothing Co. 2003 (1) TMI 89 - BOMBAY HIGH COURT as applied to the facts of the case, we are of the view that there was no infirmity in the impugned order of the learned CIT(A) excluding the service income earned by the taxpayer company from the profits of the business for the purpose of computing deduction u/s 80HHC observing that the same did not form part of its main business activity. The same is, therefore, upheld dismissing ground No. 3 of the taxpayer's appeal. Deduction under section 10A/10B in respect of miscellaneous Income - Keeping in view this ratio of the decision of the Tribunal in the case of Jubiliant Enpro Ltd. 2006 (12) TMI 265 - ITAT DELHI , we find that the notice pay received by the taxpayer company from its employees cannot be said to have its immediate source in the industrial undertaking so as to make it eligible for deduction under section 10A as claimed by the taxpayer. Moreover, the notice pay received by the taxpayer company from its employees is not certainly reimbursement of the salary expenses incurred by the taxpayer company and the same, therefore, cannot be adjusted against such expenditure as sought to be contended by the learned counsel for the taxpayer. We, therefore, hold that the notice pay received by the taxpayer company from its employees was not eligible for deduction under section 10A as rightly held by the Assessing Officer and the learned CIT(A) was fully justified in upholding the action of the Assessing Officer on this issue. The impugned order of the learned CIT(A) on this issue is accordingly upheld. For the application of words derived from , there should be a direct nexus between the income and the industrial undertaking and once such nexus is established, the said income certainly constitutes the income derived from such undertaking. Thus, we are of the view that the amount of Rs. 83,06,011 received by the taxpayer company on account of cancellation of contract entrusted to it in relation to development of software constituted its profit derived from the undertaking eligible for deduction under section 10B and the deduction under that section was rightly claimed by it in respect of the said income. In that view of the matter, we set aside the impugned order of the learned CIT(A) on this issue and direct the Assessing Officer to allow the deduction under section 10A/10B in respect of compensation amounting to Rs. 83,06,011 as claimed by the taxpayer company. Ground No. 2 of the taxpayer's appeal is thus partly allowed. Disallowance made on account of prior period expenditure - As rightly contended by the learned counsel for the taxpayer before us, there was no justification in disallowing the said deduction in both the years i.e., assessment years 2002-03 and 2003-04 as done by the Assessing Officer. We, therefore, direct the Assessing Officer to allow the claim of the taxpayer for deduction on account of the expenditure of Rs. 6,81,551 in question incurred by the taxpayer on account of retrospective price revision made by its supplier in assessment year 2002-03. Ground No. 5 is accordingly allowed. Disallowance made on account of expenditure incurred by the taxpayer company on training of its employees - In the present case, there is no dispute that the expenditure in question incurred by the taxpayer company on training of its employees was wholly and exclusively incurred for the purpose of its business. As regards the nature of the said expenditure, the submission of the taxpayer company before the authorities below as well as before us has been that the said expenditure was incurred for the purpose of imparting training to its employees in order to increase their efficiency in day-to-day working and there is nothing brought on record on behalf of the revenue to controvert/rebut this position. In the present case, the expenditure incurred by the taxpayer company on imparting training to its employees in order to increase their efficiency in day-to-day working was in the revenue field and this being so, we hold that the same was entirely deductible in the year under consideration as rightly claimed by the taxpayer. The impugned order of the learned CIT(A) confirming the disallowance made by the Assessing Officer to the extent of 50 per cent on this issue is, therefore, reversed and the Assessing Officer is directed to allow the said expenditure in full. Thus, we do not see any justification for not treating the amount received from Sony Gulf as part of operating profit of the taxpayer. There is no finding that taxpayer did not incur expenses or did not perform functions which benefited Sony Gulf. Therefore, AE was obliged to reimburse the taxpayer. We also find force in the contention of the learned representative of the taxpayer that revenue authorities are not justified in disregarding the matching principles. Having regard to purpose of the expenditure and to the extent expenses were for the benefit of Sony Gulf, the reimbursement received from the AE was to be treated as part of operating cost/profit of the taxpayer. Amount could not be excluded. Accordingly, we hold that exclusion of INR 48,31,840 on facts and circumstances of the case was not justified. Exclusion of other amounts credited in P L Account - It is a settled and well-accepted proposition that adjustment can be made only on account of differences. It is not possible to believe that other comparable entities taken into consideration are not making and writing back provision of liabilities no more required. There is no material nor there is any finding to support action of the revenue authorities. We can therefore make a general observation that all business enterprises are making and writing back liabilities as a normal incident of operating business. The expenses for which provisions were originally made were considered operating in nature and allowed in assessment. These provisions no longer required by the taxpayer during the year under review were reversed in the books of account as per mercantile system of accounting and shown as income. Therefore on facts we do not see any justification for excluding provisions written back in the profit and loss account as not forming part of the operating profit of the taxpayer. Accordingly claim of the taxpayer is accepted. In our considered opinion, finding given in respect of provisions written back is equally applicable to balances written back more particularly when ld. CIT(A) has not given any separate finding and the Transfer Pricing Officer has said nothing specifically on this item. The balances written back should also be treated as part of operating profit. We direct accordingly. Customers for delayed payment - It is not in dispute that details of misc. receipts were not furnished although while considering issues other than under the transfer pricing, some details were filed and considered. The learned representative stated that matter is different. It was explained during the course of hearing that details could not be furnished in view of immateriality of the amounts involved. Without detail of expenses, the TPO and CIT (Appeals) were justified in not accepting the case of taxpayer. No serious dispute is raised before us. In the above circumstances, we are unable to interfere on this issue. The ground is rejected. Selection and rejection of Comparables - It needs financial restructuring. It is carrying on disputes on account of demands raised by Punjab Small Scale Industries and Export Corpn. Ltd., apart from the disputes made by its employees for increased wages, reinstatement on termination and suspended employees. The joint venture of the company stands terminated. All this is admitted in the official report of Godrej. Besides, it is also carrying on related party transactions. Each of above factors which is considered and highlighted in the annual report, may not have a significant effect, if taken singly. However, when cumulative effect of all the factors is considered, one gets a totally different picture. It has therefore to be held that Godrej was rightly excluded from the list of the comparables. We concur with the view taken by the revenue authorities and reject all the arguments advanced by learned counsel for the taxpayer. This ground of appeal is rejected. Profit margins of the comparables​​​​​​​ - In our opinion, this basis adopted by the taxpayer for seeking the adjustment on account of excess custom duty borne by it is not correct inasmuch as consideration of duty payment alone would not justify such adjustment and it would be necessary to take into account the cost of components imported along with the custom duty paid thereon for the purpose of comparison with the corresponding indigenous components consumed by the com parables. Moreover, the local levies such as sales tax etc. are also required to be taken into account for such comparison. It is also pertinent to note here that if the taxpayer company has purchased the imported components after payment of custom duty at a higher price than the indigenous components purchased by the comparables, this decision must have been taken by it consciously taking into account all the commercial considerations including the obvious benefits of better quality which is bound to reflect or translate into a higher selling price of the product. This leaves hardly any scope for adjustment to the profit margins of the comparables on this count. Thus, we allow deduction at 20 per cent for various differences on account of intangibles, research and development, risk factors, working capital, etc. etc. against 10 per cent allowed by the learned CIT (Appeals). This ground is disposed of accordingly. In our considered opinion, the Arm's Length Price determined on application of Most Appropriate Method is only an approximation and is not a scientific evaluation. Therefore, the Legislature thought it proper to allow marginal benefit to cases who opt for such benefit. In the case of a taxpayer who exercises the option and accepts Arm's Length Price as per the second limb of the proviso or in other words, he accepts the Arm's Length Price even exceeding 5 per cent of Arithmetic mean determined by the tax authority as correct and is ready to pay tax on the difference between price disclosed by him and the above Arm's Length Price. Mere fact of acceptance or non-acceptance of arithmetic mean can be taken to be the determining factor relating to right to contest Arm's Length Price in appeal. Such inference has no support of language of the provision. In our view, both in the first as also in the second limb, implications of determined Arm's Length Price are the same except for the marginal benefit allowed to the taxpayer under the second limb. Hence, we are of the view that second limb is applicable even to cases where the taxpayer intends to challenge Arm's Length Price taken as arithmetic mean and determined through the Most Appropriate Method. As stated above, the second proviso is intended to give marginal relief to all taxpayers as determination of Arm's Length Price is not an exact science but is an approximation. Option is given to the taxpayer as in some cases, variation not exceeding 5 per cent of arithmetic mean might not suit the taxpayer, and, therefore, taxpayer in such cases should not be put to a prejudice. Otherwise, there is no difference between the first and the second limb of the provision as far as right of the taxpayer to challenge the determined price is concerned. The second limb only allows marginal relief to the taxpayer at his option to take ALP not exceeding 5 per cent of the arithmetic mean. Conclusion The appeals of the taxpayer for all three years under consideration and the appeals of the revenue for assessment years 2001-02 and 2002-03 are partly allowed, whereas the appeal of the revenue for assessment year 2003-04 is dismissed.

Summary

Issues Involved:
1. Deletion of addition on account of provision for warranty.
2. Inclusion of miscellaneous income in profits for computing deduction u/s 80HHC.
3. Exclusion of excise duty from total turnover for computing deduction u/s 80HHC.
4. Inclusion of forex gain in numerator and denominator for computing deduction u/s 10A.
5. Disallowance of belated payment of provident fund contributions.
6. Treatment of software expenses as capital or revenue.
7. Tax treatment of loss due to foreign exchange fluctuation.
8. Disallowance of advertisement and sales promotion expenses.
9. Depreciation on enhanced WDV of fixed assets due to foreign exchange fluctuation.
10. Addition to book profits u/s 115JB on account of provision for doubtful debts.
11. Levy of interest u/s 234D.
12. Deduction u/s 80-IA in respect of miscellaneous income and service income.
13. Deduction u/s 80HHC in respect of service income.
14. Transfer pricing adjustments and related issues.

Summary:

1. Deletion of Addition on Account of Provision for Warranty:
The Tribunal upheld the CIT(A)'s decision to delete the addition made by the Assessing Officer (AO) on account of provision for warranty, holding it as an ascertained liability. This provision was made on a scientific basis and consistently followed as per Accounting Standard 4. The Tribunal relied on the Supreme Court's decision in Bharat Earth Movers v. CIT and other relevant cases.

2. Inclusion of Miscellaneous Income in Profits for Computing Deduction u/s 80HHC:
The Tribunal upheld the CIT(A)'s decision to include miscellaneous income in profits for computing deduction u/s 80HHC. The income from sale of scrap, amounts written back, and sale of spare parts was directly related to the taxpayer's dominant business and thus considered operational income.

3. Exclusion of Excise Duty from Total Turnover for Computing Deduction u/s 80HHC:
The Tribunal upheld the CIT(A)'s decision to exclude excise duty from total turnover for computing deduction u/s 80HHC, following the Supreme Court's decision in CIT v. Laxmi Machine Works.

4. Inclusion of Forex Gain in Numerator and Denominator for Computing Deduction u/s 10A:
The Tribunal upheld the CIT(A)'s decision to include forex gain in both numerator and denominator for computing deduction u/s 10A, recognizing the close nexus between forex gain and export activity.

5. Disallowance of Belated Payment of Provident Fund Contributions:
The Tribunal upheld the CIT(A)'s decision to delete the disallowance made by the AO on account of belated payment of provident fund contributions, as the payments were made within the grace period allowed under the relevant statute.

6. Treatment of Software Expenses as Capital or Revenue:
The Tribunal set aside the CIT(A)'s order and restored the matter to the AO for fresh decision in light of guidelines laid down by the Special Bench of ITAT in Amway India Enterprises. The decision emphasized the importance of the functional test and the nature of the software's utility to the business.

7. Tax Treatment of Loss Due to Foreign Exchange Fluctuation:
The Tribunal upheld the CIT(A)'s decision to allow the loss due to foreign exchange fluctuation, following the Delhi High Court's judgment in CIT v. Woodward Governor India (P.) Ltd.

8. Disallowance of Advertisement and Sales Promotion Expenses:
The Tribunal upheld the CIT(A)'s decision to delete the disallowance made by the AO on advertisement and sales promotion expenses, recognizing that these expenses were incurred wholly and exclusively for the taxpayer's business.

9. Depreciation on Enhanced WDV of Fixed Assets Due to Foreign Exchange Fluctuation:
The Tribunal upheld the CIT(A)'s decision to allow depreciation on enhanced WDV of fixed assets due to foreign exchange fluctuation, following the Delhi High Court's judgment in Woodward Governor India (P.) Ltd.

10. Addition to Book Profits u/s 115JB on Account of Provision for Doubtful Debts:
The Tribunal upheld the CIT(A)'s decision to delete the addition made by the AO to book profits u/s 115JB on account of provision for doubtful debts, following the Special Bench of ITAT in Jt. CIT v. Usha Martine Industries and the Delhi High Court's decision in CIT v. Eicher Ltd.

11. Levy of Interest u/s 234D:
The Tribunal upheld the CIT(A)'s decision to cancel the interest levied by the AO u/s 234D, following the Special Bench of ITAT in ITO v. Ekta Promoters (P.) Ltd.

12. Deduction u/s 80-IA in Respect of Miscellaneous Income and Service Income:
The Tribunal upheld the CIT(A)'s decision to disallow the taxpayer's claim for deduction u/s 80-IA in respect of miscellaneous income and service income, following the Supreme Court's decisions in Cambay Electric Supply Industrial Co. Ltd., Sterling Foods, and Pandian Chemicals Ltd.

13. Deduction u/s 80HHC in Respect of Service Income:
The Tribunal upheld the CIT(A)'s decision to exclude service income from the profits of the business for computing deduction u/s 80HHC, recognizing that the service income did not form part of the main business activity of the taxpayer.

14. Transfer Pricing Adjustments and Related Issues:
The Tribunal dealt with multiple transfer pricing issues, including the exclusion of advertisement reimbursement, selection and rejection of comparables, and adjustments for differences in functions, risks, and assets. The Tribunal upheld certain adjustments and directed fresh consideration for others, emphasizing the need for accurate and reasonable adjustments to determine the arm's length price. The Tribunal also allowed the taxpayer's claim for the benefit of the 5% variation under the proviso to section 92C(2), following the decision of the Kolkata Bench in Development Consultants (P.) Ltd. v. Dy. CIT.