2013 (11) TMI 927 - AT - Income Tax

Disallowance of written off of bad stock - Shortage in stock-in-trade - No evidence produced to prove that the entire loss had crystallized during the year - Held that - The assessee is in share broking business and many a times, the clients or stock exchange return stocks to the assessee due to reasons such as difference in signature of transferor, forged/ fake share certificate etc. and therefore to take care of such unforeseen circumstances, the assessee has been making provision for such loss @ .01% of turnover. The provision so made is added in the computation of income and actual claim of loss is made after due verification. This year assessee claimed loss of Rs.4,84,796/- which was disallowed by the AO - assessee had been regularly making analysis of the bad stock and only after arriving at the conclusion that the stock had become worthless/ unsaleable, the business decision was taken to write-off the stock - there was no dispute that the assessee was consistently following this accounting practice of write-off of stock - Decided against Revenue. Transfer pricing adjustment - Determination of arm's length price - Expenditure on royalty and business development - Held that - CIT(A) has examined the business development system followed by other comparable companies in India and has given a finding that these companies on average were incurring business development expenditure which was 6.4% of brokerage turnover whereas similar expenditure incurred by the assessee was only 1.28% including royalty of 1% paid by the assessee . Therefore expenditure incurred by the assessee on royalty and business development could not be considered as excessive compared to the comparable parties. CIT(A) has also applied the TNMM method for benchmarking international transactions. There are 29 comparables selected details of which have already been given earlier which gave an average margin of -5.5% and, in case, loss making companies were excluded, the average margin came to 16.06% whereas in case of the assessee the margin declared was 57.58%. Therefore it is held that no TP adjustment is required to be made in case of the assessee - Decided against Revenue.

Summary

Issues Involved:

1. Addition on account of write-off of stock.
2. Addition on account of transfer pricing adjustment.

Issue-wise Detailed Analysis:

1. Addition on account of write-off of stock:

The first issue pertains to the addition made by the Assessing Officer (AO) on account of the write-off of bad stock. The AO noted that the assessee claimed a deduction of Rs. 11,98,000/- for provisions for stock shortage in the Profit and Loss Account but adjusted this to Rs. 4,84,796/- for the actual write-off. The assessee explained that it periodically reviewed and wrote off unsaleable stock, but the AO rejected this explanation due to a lack of evidence proving the loss crystallized during the year. The AO also referenced a similar disallowance in the previous assessment year 2001-02, leading to the disallowance of the claim.

The assessee contested this decision before the Commissioner of Income Tax (Appeals) [CIT(A)], arguing that it consistently made provisions for unexpected stock losses and only claimed actual losses after verification. The CIT(A) accepted this explanation, referencing decisions from assessment years 1999-2000 and 2000-01, and allowed the claim. The revenue appealed this decision to the Tribunal.

Before the Tribunal, the Senior Counsel for the assessee argued that the issue was settled in favor of the assessee by the Tribunal's decision in the 1999-2000 assessment year. The Tribunal, after reviewing the records, noted that the assessee consistently followed the practice of writing off worthless stock and confirmed the CIT(A)'s order, thereby allowing the assessee's claim.

2. Addition on account of transfer pricing adjustment:

The second issue concerns the transfer pricing adjustment related to royalty payments. Under Section 92 of the Income Tax Act, income from international transactions with associated enterprises must be computed at arm's length price. The assessee, a subsidiary of CLSA BV, paid a royalty of Rs. 711,466/- to CLSA BV at 1% of net receipts. The AO referred the matter to the Transfer Pricing Officer (TPO) for determining the arm's length price.

The TPO questioned the basis of the royalty rate and noted that no other CLSA group entity had a similar agreement. The TPO concluded that the internal comparable uncontrolled price (CUP) was nil, as no other CLSA entity paid royalty, and thus, adjusted the arm's length price of the transaction to nil. The AO followed the TPO's findings and made an adjustment of Rs. 711,466/-.

The assessee challenged this decision before the CIT(A), providing evidence of the trademark registration and the benefits derived from using the CLSA brand. The assessee argued that the internal CUP method was incorrectly applied, as it involved related parties and lacked comparable transactions. The CIT(A) agreed with the assessee, noting that the CLSA brand was registered and maintained in India, and the royalty payment was justified. The CIT(A) also found that the CUP method was inapplicable due to a lack of comparable transactions and upheld the use of the Transactional Net Margin Method (TNMM), which showed the assessee's margins were significantly higher than industry averages.

The revenue appealed to the Tribunal, arguing that the internal CUP method was correctly applied and that the TNMM method was inappropriate. The Tribunal, however, upheld the CIT(A)'s decision, noting that the TPO/AO's approach was flawed as it compared transactions with related parties and lacked proper information for applying the CUP method. The Tribunal confirmed that the TNMM method was appropriate, given the higher margins declared by the assessee compared to industry averages, and thus, no transfer pricing adjustment was required.

Conclusion:

The Tribunal dismissed the revenue's appeal, confirming the CIT(A)'s decisions on both the write-off of bad stock and the transfer pricing adjustment. The order was pronounced in the open court on 22/02/2013.