2014 (4) TMI 568 - AT - Income Tax

Disallowance of advertisement and sales expenses - Disallowance of miscellaneous expenses - Adhoc disallowance of expenses Held that - The disallowance made by the AO is adhoc disallowance without pointing out any defect in the claim of the assessee - Such course of action cannot be adopted by the AO if assessee has maintained proper accounts which are audited, then the AO, without either rejection of books of accounts or without pointing out any defect in the expenses cannot make an adhoc disallowance - disallowance cannot also be deleted simply for the reason that the accounts of the assessee are audited and there is no adverse comment of the auditor in the audit report - The expenses claimed by the assessee for the purpose of business were subject to examination by the AO and expenses can be claimed only if they have been incurred wholly and exclusively for the purpose of business - CIT(A) has wrongly deleted the addition without recording a finding that the expenses are verified to be incurred for the purpose of business of the assessee thus, the matter is required to be remitted back to the AO for fresh adjudication Decided in favour of Revenue. Transfer pricing adjustment - Royalty payment made Held that - In subsequent years the assessee had submitted the calculations regarding calculation of net domestic / export sales for the purpose of calculating the payment of royalty and described that if the royalties calculated on the basis of agreement of the assessee with Dow Netherland then royalty paid by the assessee will be on lower side and such contention of the assessee has been accepted by the TPO - out of export as well as local sales the cost of imported goods have been reduced and net sales have been computed accordingly, on which royalty payable is calculated - For the year under consideration the computation is made in the similar manner and it has been shown that overall the assessee has paid less royalty as compared to royalty paid by UK AE to Dow Nether land thus, there is no reason to interfere in the order of the CIT(A) Decided against Revenue.

Summary

Issues Involved:
1. Disallowance of Rs. 1,82,00,000/- on account of advertisement and sales expenditure.
2. Disallowance of Rs. 4,65,00,000/- on account of miscellaneous expenses.
3. Transfer Pricing adjustment of Rs. 1,54,45,230/- towards royalty payment.

Comprehensive, Issue-wise Detailed Analysis:

1. Disallowance of Rs. 1,82,00,000/- on account of advertisement and sales expenditure:
The revenue appealed against the CIT(A)'s decision to delete the disallowance made by the AO. The AO had disallowed 50% of the advertisement and sales expenditure amounting to Rs. 1,82,00,000/- on an adhoc basis, arguing that the assessee failed to justify the expenses. The CIT(A) deleted the disallowance, noting that the accounts were audited and sample invoices were provided, indicating the genuineness of the expenses. The Tribunal held that the AO's adhoc disallowance without pointing out specific defects was inappropriate. However, it also noted that the CIT(A) erred in deleting the disallowance without verifying the expenses. The Tribunal restored the issue to the AO for re-adjudication, directing that only expenses not falling within the ambit of section 37 of the Act should be disallowed.

2. Disallowance of Rs. 4,65,00,000/- on account of miscellaneous expenses:
Similar to the first issue, the AO disallowed 50% of the miscellaneous expenses amounting to Rs. 4,65,00,000/- on an adhoc basis, citing the lack of detailed justification from the assessee. The CIT(A) deleted this disallowance as well, based on the same reasons given for the advertisement and sales expenditure. The Tribunal reiterated its stance that adhoc disallowances are not justified without specific defects. It restored the issue to the AO for re-examination, instructing that disallowances should be made only for expenses not incurred wholly and exclusively for business purposes as per section 37.

3. Transfer Pricing adjustment of Rs. 1,54,45,230/- towards royalty payment:
The AO and TPO made an adjustment of Rs. 1,54,45,230/- towards royalty payments, arguing that the royalty rate paid by the assessee (5% on domestic sales and 8% on exports) was higher than the rate paid by the UK AE (3% on sales). The CIT(A) deleted the adjustment, concluding that the assessee's transactions were at arm's length, given that the assessee's net profit margin was higher than the comparables. The Tribunal noted that in subsequent years, the TPO accepted the assessee's method of calculating net sales for royalty purposes, which included deductions for the cost of imported goods. Given this acceptance in later years, the Tribunal upheld the CIT(A)'s deletion of the adjustment, dismissing the revenue's grounds on this issue.

Conclusion:
The Tribunal directed the AO to re-adjudicate the disallowances of advertisement, sales, and miscellaneous expenses, ensuring that only non-business-related expenses are disallowed. The Tribunal upheld the CIT(A)'s deletion of the Transfer Pricing adjustment for royalty payments, noting the acceptance of the assessee's methodology in subsequent years. The appeal by the revenue was partly allowed, with specific directions for re-examination of certain issues.