2015 (6) TMI 667 - AT - Income Tax

Disallowance u/s 14A - CIT(A) deleted the addition - Held that - This is admitted position of law as per the judgment of M/s Godrej & Boyce Mfg. Co. Ltd. Vs. DCIT reported in 2010 (8) TMI 77 - BOMBAY HIGH COURT that Rule 8D is prospective and therefore, applicable from assessment year 2008-09 and afterwards. Therefore, Rule 8D is not applicable in the present year. At the same time, even prior to assessment year 2008-09 from when Rule 8D is applicable, some reasonable disallowance has to be made u/s 14A of the Act. The learned CIT(A) has confirmed the disallowance of ₹ 12,000/- . In our considered opinion, the disallowance of ₹ 12,000/- for average investment of ₹ 491.08 lac is not reasonable and therefore, we hold that disallowance should be made of ₹ 50,000/- on account of administrative expenses. - Decided partly in favour of assessee. Addition on account of adjustment of arms length price - CIT(A) deleted the addition - Held that - From the provisions of clause (b) of sub Rule 1 of Rule 10B of Income-tax Rules, it is seen that resale price method is applicable where there is purchase of property or service from associate enterprise but in the present case, the assessee is not purchasing the goods from the associate enterprises but the assessee is selling the goods to associate enterprise. Based on this fact, this finding is given by CIT(A) that resale price method does not apply to the assessee s case. After examining the facts and after giving this finding that the T.P.O., while dealing with international transactions with the A.Es., has himself accepted the commission rates upto 10% given to the US (A.E.) on referred sales and upto the 8% to UK(A.E.) and therefore, the CIT(A) has held that the gross margin available to the A.E. should have been benchmarked at 8% and not at 5% as the T.P.O. has himself treated all these commission payment at arm s length and has made no adjustment in the commission transactions of the assessee. Thereafter, the CIT(A) has examined the agency agreement and held that that certain adjustments on account of functional differences between a person who acts as principal to principal i.e. a trader and a person who acts as a mere commission agent would be allowed because in case of principal to principal transaction, person, inter alia, incurs expenditure on imports, storage and distribution of the goods which in normal course are not incurred by a commission agent and therefore, suitable adjustments for such expenditure has to be given and then only the resultant gross margin can be compared with the benchmarked 8% gross margin. On this basis, the CIT(A) has reduced the import expenses of goods from sale price by the A.E. and worked out the gross margin of the A.E. @7.04%, which is less than 8% even when no other expenses have been allocated except import expenses on goods and under these facts, it was held by CIT(A) that the adjustment made by the T.P.O. is not justified and correctly deleted the same.- Decided against revenue.

Summary

Issues Involved:
1. Deletion of addition made under Section 14A.
2. Deletion of addition on account of adjustment of arm's length price.

Issue-wise Detailed Analysis:

1. Deletion of Addition Made Under Section 14A

Ground No. 1:
"The Ld. CIT (A) has erred in law and on facts in deleting the addition of Rs. 13,61,713/- made u/s 14A without appreciating the fact- (a) It was onus of the assessee to furnish the details of source of investment in shares however, the assessee had not discharged its onus. (b) The provisions of sub-section (2) & (3) to sec. 14A has been instituted by the Finance Act 2006 and was effective from 01.04.2007 i.e. from A.Y. 2007-08, assessment in question. Hence, the provisions of Rule 8D are applicable."

Analysis:
The Revenue argued that the assessee did not furnish details of the source of investment in shares and that Rule 8D should apply from the assessment year 2007-08. The assessee countered by citing the Hon'ble Bombay High Court's decision in Godrej And Boyce Mfg. Co. Ltd. vs. DCIT, which held that Rule 8D is prospective and applicable from the assessment year 2008-09 onwards.

The Tribunal agreed with the assessee, stating that Rule 8D is not applicable for the assessment year 2007-08. However, it also noted that some reasonable disallowance should be made under Section 14A even for years prior to 2008-09. The CIT(A) had confirmed a disallowance of Rs. 12,000, which the Tribunal found unreasonable given the average investment of Rs. 491.08 lakh. The Tribunal increased the disallowance to Rs. 50,000 on account of administrative expenses.

Regarding the deletion of disallowance of interest expenditure under Section 14A, the CIT(A) had relied on the judgment in CIT vs. Reliance Utilities and Power Ltd., which established a presumption that investments were made out of interest-free funds when mixed funds are used. The Tribunal found no reason to interfere with the CIT(A)'s order on this point. Thus, the disallowance of Rs. 50,000 under Section 14A was upheld, and this ground of appeal was partly allowed.

2. Deletion of Addition on Account of Adjustment of Arm's Length Price

Ground No. 2:
"The Ld. CIT(A) has erred in law and on facts in deleting the addition of Rs. 1,29,19,127/- on account of adjustment of arm's length price without appreciating the fact of the case as discussed by the T.P.O in order u/s 92CA(3)."

Analysis:
The Revenue supported the assessment order, while the assessee supported the CIT(A)'s order. The CIT(A) had decided this issue based on a thorough study of transfer pricing by the assessee, which the TPO had rejected without convincing reasons. The assessee had adopted the cost-plus method, accepted by the Department in earlier years. The CIT(A) emphasized the "Principle of Consistency," stating that the TPO's rejection of the method was unjustified without specific reasons.

The CIT(A) also noted that the Resale Price Method (RPM) does not apply to the assessee as it is applicable to imports into the country. Instead, the TPO had wrongly applied the internal CUP method, assuming a gross margin of 5%, which was incorrect. The average commission paid by the assessee was up to 20%, with an average of 7.2%. The TPO had accepted commission rates up to 10% for the US (A.E.) and up to 8% for the UK (A.E.). Thus, the CIT(A) benchmarked the gross margin at 8%.

The CIT(A) also allowed adjustments for functional differences between a trader and a commission agent, reducing the import expenses from the sale price and calculating a gross margin of 7.04%, less than the benchmarked 8%. Based on these findings, the CIT(A) deleted the adjustment made by the TPO. The Tribunal found no infirmity in the CIT(A)'s detailed examination and upheld the deletion of the adjustment. This ground of the Revenue was rejected.

Conclusion:
The appeal of the Revenue was partly allowed. The Tribunal upheld the disallowance of Rs. 50,000 under Section 14A but rejected the adjustment of Rs. 1,29,19,127 on account of arm's length price. The detailed and reasoned findings of the CIT(A) were affirmed.