2014 (2) TMI 555 - AT - Income Tax

Purchase cost of films and other production materials Capital or Revenue - Held that - Relying upon the decision in ADDL COMMISSIONER OF INCOME TAX Versus M/s JOHNSON & JOHNSON LTD 2013 (6) TMI 286 - ITAT MUMBAI - The said expenditure is revenue expenditure - Decided in favour of assessee. MODVAT credit attributable to the closing stock Held that - Relying upon the decision in ADDL COMMISSIONER OF INCOME TAX Versus M/s JOHNSON & JOHNSON LTD 2013 (6) TMI 286 - ITAT MUMBAI The issue has been restored for fresh adjudication. Disallowance u/s 40A(2)(b) Held that - Relying upon the decision in M/s. Johnson & Johnson Limited Versus The Addl. Commissioner of Income-tax 2013 (4) TMI 228 - ITAT MUMBAI - For the payments for legal counseling, it is futile to think of comparables because counsels may not charge standard fee but may charge according to the issue involved Also the AO have failed to establish the excessiveness of the payment Decided in favour of assessee. Adhoc disallowance of travelling expenses and professional sponsorship Held that - The disallowance on the ground that the expenditure being personal in nature cannot be made in the case of a company Relying upon the decision in case of Sayaji Iron & Engg. Co Versus Commissioner of Income Tax 2001 (7) TMI 70 - GUJARAT High Court - DRP has not pointed out the expenses which are not in connection with business activity of the assessee inspite of facts that the details were filed by assessee before DRP Decided in favour of assessee. Professional sponsorship In earlier years the expenditure were Rs.2.23 crores and Rs.4.36 crores in assessment year 2001-02 and assessment year 2002-03 respectively under the head Professional Sponsorship - Whereas in the assessment year under consideration the total expenditure incurred is of Rs.23,11,26,595 - The assessee filed only scanty details of the foreign visits of doctors etc - The addresses of doctors and the organizers have not been given in the details filed by assessee even before us - The assessee was not able to justify with documentary evidence that entire expenditures had been incurred by the assessee for the purpose of its business - The earlier orders as referred to by ld. AR could not be considered as precedent in the assessment year under consideration - It will be fair and reasonable to make an adhoc disallowance of 2% of the expenditure claimed by assessee which comes to Rs.46,22,500/- as against Rs.11,55,63,298/- disallowed by AO - Payment of FBT does not establish that expenditure was for business purpose Partly allowed in favour of assessee. Depreciation on testing equipment Held that - Relying upon the decision in M/s. Johnson & Johnson Limited Versus The Addl. Commissioner of Income-tax 2013 (4) TMI 228 - ITAT MUMBAI - The Tribunal passed an order in another group concern of the assessee, whose facts have not been distinguished by the DR is followed - The depreciation should be allowed on the testing equipment provided to laboratories and hospitals free of charge as the said equipments have been provided to the laboratories and hospitals for making profit from the sale of slides Decided in favour of assessee. Adhoc disallowance of expenditure towards free samples Held that - The assessee is required to furnish requisite details to the satisfaction of AO to justify that the expenditure has been incurred for business purpose Relying upon the decision in the case of Goodyear India Ltd. V/s CIT 2000 (7) TMI 32 - DELHI High Court - The details of expenditures, which are not substantiated by vouchers and assessee was unable to furnish the detail to justify the claim, the disallowance made by AO is justified and availability of tax audit report does not preclude AO from calling for supporting materials . Even though it is a commercial practice in the line of business of the assessee, to give free samples to promote its product, the assessee is expected to maintain details to enable the AO to verify as to whether the said samples had been given by assessee wholly and exclusively in connection with its business - Payment of Fringe Benefit Tax (FBT) does not establish that expenditure has been incurred by the assessee for its business purpose - It will be fair and reasonable to restrict disallowance to 2% of the claim of assessee which comes to Rs.31,61,000/-as against Rs. Rs.11,85,03,996/- disallowed by AO Partly allowed in favour of assessee. TPA - Disallowance of royalty paid Held that - Payment of royalty at the rate of 4% is as per RBI formula and the average royalty rate for comparable technical know-how /marketing know-how approval worked out to 4.84% on sales and therefore royalty of 4% paid by assessee to J&J US is lesser than Arm s Length of 4.84% - No disallowance can be made by TPO on the basis that there was no necessity by the assessee to pay royalty at the enhanced rate of 4% as it was excessive and unnecessary. Rule 10B(1) of Income Tax Rules, 1962 does not authorize the TPO to make disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same - Such kind of observations and thereafter to make disallowance by TPO while considering the price at Arm s Length are outside his purview - The quantum of expenditure can be examined by TPO as per law but in judging the allowbility thereof as business expenditure, TPO has no authority to disallow the entire expenditure or part thereof on the ground that the said expenditure is excessive - The TPO has to examine whether price paid or the amount paid was at Arm s length under the provisions of Transfer Pricing and its Rules - It is relevant to state that the Ld.AR stated that the average royalty paid by assessee is comparable and it is lower than the Arm s Length rate of 4.84% as per information available on website of SIA which provides rate which is approved by SIA/RBI - The TPO cannot suggest the disallowance merely because as per his assumption it is excessive though the payment is at Arm s length Decided in favour of assessee. Publicity and sales promotion expenses Held that - The TPO has suggested disallowance on the ground that the AE of the assessee viz J&J US is reaping the benefit of higher royalty amount as a result of higher sales realized by assessee by incurring higher expenses by way of publicity and sales promotion undertaken by assessee and therefore the parent company of the assessee-company should share some of the expenses - The TPO is to determine the Arm s length by following one of the method and /or most appropriate method as prescribed in section 92C(1) of the Act - The TPO cannot suggest adjustment/disallowance on the basis of his assumptions that the payment is excessive though it is at arm s length Relying upon the decision in the case of Kodak India Pvt. Ltd. V/s Addl. Commissioner of Income Tax 2013 (11) TMI 667 - ITAT MUMBAI - Rule 10B specifically provides the procedure to be followed for determining Arm s Length Price. No specific submissions were made made by the TPO regarding excessiveness of the expenses incurred by following any of the method specified - Considering the fact that the assessee justified the payment of technical know-how royalty at the rate of 4% of net sales which is lower than Arm s length rate of 4.84%, the payment of royalty by assessee to its parent company is at Arm s Length - Decided in favour of assessee.

Summary

Issues Involved:
1. Disallowance of expenditure on production of advertisement films.
2. Addition of MODVAT credit attributable to closing stock.
3. Disallowance of reserve for cash discount.
4. Disallowance under section 40A(2)(b) for payments to Crawford Bailey & Co.
5. Ad-hoc disallowance of traveling expenditure.
6. Ad-hoc disallowance of professional sponsorship expenses.
7. Disallowance of bonus provision.
8. Disallowance of depreciation on testing equipment.
9. Addition of profits attributable to Sri Lanka and Bangladesh branches.
10. Ad-hoc disallowance of expenditure on free samples.
11. Transfer pricing adjustments related to royalty payments and related taxes.
12. Disallowance of part of publicity and sales promotion expenses.
13. Charging of interest under sections 234B and 234D.
14. Initiation of penalty proceedings under section 271.

Detailed Analysis:

1. Disallowance of Expenditure on Production of Advertisement Films:
The assessee disputed the disallowance of Rs. 45,520,504/- on the ground that it is capital in nature. The Tribunal referred to its earlier decisions in the assessee's own case, confirming that such expenditures are revenue in nature. Therefore, the disallowance was reversed, and the expenditure was allowed as revenue expenditure.

2. Addition of MODVAT Credit Attributable to Closing Stock:
The AO added Rs. 38,815,192/- to the total income for not including MODVAT credit in the closing stock. The Tribunal restored the issue to the AO for fresh adjudication, directing the AO to adjust the opening stock, purchase, and closing stock by including various duties and rework the disallowance.

3. Disallowance of Reserve for Cash Discount:
The AO disallowed Rs. 1,815,938/- for reserve for cash discount, treating it as an unascertained contingent liability. The Tribunal upheld the disallowance, noting the issue was covered against the assessee in earlier years.

4. Disallowance under Section 40A(2)(b) for Payments to Crawford Bailey & Co.:
The AO disallowed 10% of payments made to Crawford Bailey & Co. amounting to Rs. 107,373/-. The Tribunal deleted the disallowance, emphasizing that the AO must establish the excessiveness of the payment, which was not done.

5. Ad-hoc Disallowance of Traveling Expenditure:
The AO disallowed Rs. 32,750,973/- on an ad-hoc basis, citing potential personal use and non-business-related expenses. The Tribunal deleted the disallowance, referencing earlier decisions that such disallowances are not justified in the case of a company.

6. Ad-hoc Disallowance of Professional Sponsorship Expenses:
The AO disallowed 50% of professional sponsorship expenses amounting to Rs. 115,563,298/-. The Tribunal reduced the disallowance to 2%, noting the lack of detailed evidence from the assessee to justify the entire expenditure.

7. Disallowance of Bonus Provision:
The assessee did not press for this ground, and it was rejected as not pressed.

8. Disallowance of Depreciation on Testing Equipment:
The AO disallowed Rs. 63,69,962/- for depreciation on testing equipment installed at various locations. The Tribunal allowed the depreciation, following its earlier decisions in the assessee's own case.

9. Addition of Profits Attributable to Sri Lanka and Bangladesh Branches:
The assessee did not press for these grounds, and they were rejected.

10. Ad-hoc Disallowance of Expenditure on Free Samples:
The AO disallowed 75% of the expenditure on free samples amounting to Rs. 118,503,996/-. The Tribunal reduced the disallowance to 2%, recognizing the commercial practice of distributing free samples but noting the lack of detailed evidence.

11. Transfer Pricing Adjustments Related to Royalty Payments and Related Taxes:
The AO/TPO made several disallowances related to royalty payments, taxes borne by the assessee, service tax, and R&D cess. The Tribunal deleted these disallowances, noting that the payments were made as per agreements and RBI guidelines, and the TPO did not apply any specific method to determine arm's length price.

12. Disallowance of Part of Publicity and Sales Promotion Expenses:
The TPO disallowed Rs. 200.82 lakhs, suggesting that the parent company should share the cost of publicity and sales promotion expenses. The Tribunal deleted the disallowance, noting that the TPO did not follow any specific method for determining arm's length price.

13. Charging of Interest under Sections 234B and 234D:
This ground was dismissed as it is consequential.

14. Initiation of Penalty Proceedings under Section 271:
This ground was rejected as premature.

Conclusion:
The appeal of the assessee was allowed in part, with several disallowances being deleted or reduced by the Tribunal. The Tribunal emphasized the need for the TPO to follow specific methods for determining arm's length price and rejected adhoc disallowances not supported by detailed evidence.