2014 (11) TMI 97 - AT - Income Tax

Disallowance u/s 40A(2)(a) 50% of Professional fees paid to the subsidiary company - Held that - The assessee is a holding company, has made payment to its subsidiary company, such payment cannot be covered within the provisions of sub-clause (iv) of section 40A(2)(b) of the Act - section 40A(2)(a) refers to the disallowance of any expenditure incurred by the assessee in respect of which payment has been or is to be made to any person referred to in clause (b), if the AO is of the opinion that such expenditure is excessive or unreasonable - having regard to fair market value of the goods, services or facilities for which payment is made or the legitimate needs of the business or profession of the assessee, the benefit derived by or accruing to the assessee therefrom - The three situations, warranting disallowance u/s 40A(2), are joined by the word or and are independent of each other - if a payment falls into any of these three situations, it is liable to be disallowed - the AO has not determined the fair market value of the professional services received by the assessee, for which the payment was made. The fact that the assessee made the payment to MM Mumbai for the services which were sine qua non for the carrying on of its business, goes to amply prove that such payment was made on account of legitimate needs of the assessee s business - The sum and substance of the third situation is the disallowance u/s 40A(2) to the extent of the payment made to the person specified in section 40A(2)(b) in excess of the benefit derived by the assessee from the receipt of services - the rate at which the assessee paid to MM Mumbai cannot be considered as unreasonable or excessive for three reasons. The case of the assessee does not fall in any of the three situations contemplated by section 40A(2)(a) of the Act - once a payment is held to be not excessive or unreasonable having regard to the fair market value of the services or the legitimate needs of the business or the benefit derived by or accruing to the assessee, there can be no question of making or sustaining any disallowance u/s 40A(2) of the Act - there is no assignment of the intellectual property rights of such products to the assessee - The licenses have been granted on non-exclusive basis to the assessee and for a limited period - The assessee is not authorised to use or permit others to use such technology and the technical documentation, except as specifically permitted under the Agreement to the assessee - There is a confidentiality clause, which prohibits the assessee from making any disclosure to the others - the payment made by the assessee to its associated enterprises cannot be considered as a capital expenditure. It is further interesting to note that the assessee was consistently paying such royalty amount to its associated enterprises from the financial year 2003-04 onwards and no such disallowance has ever been made in the past Decided in favour of assessee. Deletion u/s 14A Held that - The assessee earned exempt dividend income and also incurred expenses in relation to income - the application of section 14A cannot be ruled out following the decision in Maxopp Investments Ltd. Vs. CIT 2011 (11) TMI 267 - Delhi High Court - rule 8D is prospective and is applicable from the assessment year 2008-09 - no interference can be made in the order to the extent of non-applicability of rule 8D - CIT(A) is correct in sustaining the addition u/s 14A Decided against revenue.

Issues Involved:
1. Disallowance under section 40A(2)(a) of the Income-tax Act, 1961.
2. Disallowance of royalty payment as capital expenditure.
3. Disallowance under section 14A of the Income-tax Act.

Issue-wise Detailed Analysis:

1. Disallowance under section 40A(2)(a) of the Income-tax Act, 1961:
The assessee's appeal revolved around the disallowance of Rs. 24.16 lakh, which is 50% of the total professional fees paid to its subsidiary company, MM Mumbai. The Assessing Officer (AO) disallowed this amount, citing a lack of justification for the Rs. 500 per hour rate paid to MM Mumbai and the absence of comparable market rates. The CIT(A) upheld this disallowance.

The Tribunal examined the applicability of section 40A(2)(a) and concluded that the payment made by the holding company to its subsidiary falls under sub-clause (vi)(B) of section 40A(2)(b). The Tribunal found that the AO did not determine the fair market value of the services and did not provide justifiable reasons to refute the assessee's claim that the services were necessary for its business. The Tribunal noted that the rate of Rs. 500 per hour was reasonable, considering the same rate was charged by the assessee to MM Mumbai and higher rates were charged to other group companies. The Tribunal also highlighted that similar payments in previous years were accepted without disallowance. Consequently, the Tribunal ordered the deletion of the addition sustained by the CIT(A).

2. Disallowance of royalty payment as capital expenditure:
The Revenue's appeal contested the deletion of Rs. 2,26,97,568 disallowed by the AO on royalty payments made to associated enterprises, treating it as capital expenditure. The AO allowed depreciation at 25% on this amount. The CIT(A) deleted the addition.

The Tribunal reviewed the agreements and found that the royalty payments were for non-exclusive, non-transferrable rights without any assignment of intellectual property. Citing precedents like CIT vs. Ciba of India Ltd. and CIT vs. Indian Oxygen Ltd., the Tribunal held that such payments are of revenue nature. The Tribunal also noted that similar royalty payments were consistently treated as revenue expenditure in previous years. Therefore, the Tribunal upheld the CIT(A)'s decision to delete the addition.

3. Disallowance under section 14A of the Income-tax Act:
The Revenue's appeal also challenged the reduction of disallowance under section 14A from Rs. 7,18,857 to Rs. 3,59,429 by the CIT(A). The AO had invoked Rule 8D for the disallowance, which the CIT(A) found inapplicable for the assessment year 2007-08, as per the jurisdictional High Court's decision in Maxopp Investments Ltd. Vs. CIT.

The Tribunal agreed with the CIT(A) that Rule 8D is prospective and applicable from AY 2008-09. However, it affirmed that some disallowance under section 14A on a reasonable basis is warranted. The Tribunal found the CIT(A)'s reduction to Rs. 3,59,429 reasonable and upheld the order.

Conclusion:
The Tribunal allowed the assessee's appeal, deleting the disallowance under section 40A(2)(a). It dismissed the Revenue's appeal, upholding the CIT(A)'s deletion of the royalty payment disallowance and the reduction of disallowance under section 14A. The Cross Objection filed by the assessee for further reduction under section 14A was not pressed and thus dismissed. The order was pronounced on 30.10.2014.

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