2019 (8) TMI 799 - AT - Income Tax

Disallowance of credit notes for software consulting and support services to AE - the assessee stated that he has earned more margin than the margin prescribed under the safe harbour rules - assessee claimed that no TP adjustment required as it satisfied ALP - AO considering the credit notes as undisclosed income and also state that this is not a international transaction - CIT(A) not adjudicated all grounds and dismissed appeal just stating that she found force in the arguments of the AO - effect of not passing speaking order by CIT(A) - HELD THAT - The Ld. first appellate authority has simply dittoed the observations of the AO and has upheld the findings of the AO without even examining the observations of the AO vis-a-vis the objections/contentions of the assessee. It is our considered opinion that it was incumbent upon Ld. first appellate authority to pass a speaking order after proper appreciation of the facts before her. Hon'ble Apex Court in the case of Kapoorchand Shrimal 1981 (8) TMI 2 - SUPREME COURT had stated in connection with the appeal before the Ld. CIT (A) that it is the duty of appellate authority to remove the errors in the order of authorities below and remit the issue with or without direction for reconsideration unless prohibited by law. Accordingly, since the Ld. CIT (A) has not passed a speaking order on this issue, we are of the considered opinion that the interest of justice will be served if this issue is remitted to the file of the Ld. CIT (A) with a direction to pass a speaking order after duly examining and considering all the contentions raised by the assessee. Accordingly, the appeal is restored to the file of the Ld. First Appellate Authority with directions. - the appeal of the assessee stands allowed for statistical purposes

Issues Involved:
1. Adjustment of INR 390,000,000 to the total income due to credit notes issued to Associated Enterprises (AEs).
2. Compliance with the intercompany agreement and provisions of the Income Tax Act.
3. Interpretation and application of Chapter X provisions.
4. Alleged manipulation of accounts to reduce taxable profits.
5. Application of the concept of real income.
6. Requirement of reference to the Transfer Pricing Officer (TPO).
7. Classification of the credit notes as part of the international transaction.
8. Profit margin comparison with arm's length margin.
9. Permissibility of adjustment of tentative consideration for services.
10. Consideration of detailed objections and evidences by the appellate authority.
11. Interest under section 234A and 234B.
12. Initiation of penalty proceedings under section 271(1)(c).

Detailed Analysis:

1. Adjustment of INR 390,000,000 to Total Income:
The Assessing Officer (AO) made an upward adjustment of INR 390,000,000 to the assessee's income, considering the credit notes issued to AEs as undisclosed income under section 28 of the Income Tax Act. The AO concluded that the credit notes were issued to maintain a minimum level of operating profit acceptable to Indian tax authorities and to repatriate the balance to AEs, thereby evading taxes in India.

2. Compliance with Intercompany Agreement and Provisions of the Income Tax Act:
The assessee argued that the credit notes were issued in accordance with the intercompany agreements and the Global Trading Model (GTM) of the Fujitsu group. It was submitted that the credit notes were necessary to ensure that AEs were charged correctly as per the contracts and that the arms-length income was retained in India, aligning with section 92(1) of the Act.

3. Interpretation and Application of Chapter X Provisions:
The AO and CIT (A) were criticized for misinterpreting the provisions of Chapter X, leading to an unlawful adjustment to the returned income. The assessee contended that the adjustment was in line with the contractual agreements and the provisions of the law, and the AO's presumption that the adjustment was for other purposes was incorrect.

4. Alleged Manipulation of Accounts to Reduce Taxable Profits:
The AO and CIT (A) alleged that the issuance of credit notes was an attempt to manipulate accounts to adjust taxable profits downward. The CIT (A) supported the AO's view that the credit notes were issued to maintain only the minimum level of operating profit acceptable to tax authorities, which was seen as an attempt to evade taxes.

5. Application of the Concept of Real Income:
The assessee argued that the concept of real income applies to both normal provisions of the Act and Chapter X. It was submitted that the issuance of credit notes was a legitimate adjustment based on actual costs and foreign exchange gains, and not an attempt to evade taxes.

6. Requirement of Reference to the Transfer Pricing Officer (TPO):
The assessee contended that the AO erred in not referring the case to the TPO, as mandated by CBDT Instruction No. 3/2016, since the case involved transfer pricing implications. The AO's failure to make this reference was argued to render the assessment bad in law.

7. Classification of the Credit Notes as Part of the International Transaction:
The assessee maintained that the credit notes were part of the provision of software development services transaction and not a separate international transaction. The AO and CIT (A) were criticized for failing to appreciate this fact.

8. Profit Margin Comparison with Arm's Length Margin:
The assessee highlighted that even after issuing the credit notes, it earned a profit margin of 20.64%, which was higher than the arm's length margin of comparable companies (11.08%) and the safe harbour margin (20%). This was argued to demonstrate that there was no tax evasion.

9. Permissibility of Adjustment of Tentative Consideration for Services:
The assessee argued that the adjustment of tentative consideration for services based on actual costs was permissible by law. The AO's addition to the returned income based on incorrect presumptions was deemed impermissible and unlawful.

10. Consideration of Detailed Objections and Evidences by the Appellate Authority:
The assessee criticized the CIT (A) for passing the order without considering the detailed objections and evidences placed on record. It was argued that the CIT (A) summarily rejected the contentions without independent application of mind.

11. Interest under Section 234A and 234B:
The assessee contended that the AO erred in proposing to charge interest under sections 234A and 234B of the Act.

12. Initiation of Penalty Proceedings under Section 271(1)(c):
The assessee argued that the AO erred in initiating penalty proceedings under section 271(1)(c) without recording adequate reasons for such initiation.

Conclusion:
The ITAT observed that the CIT (A) failed to independently adjudicate the grounds before her and merely upheld the AO's findings without proper examination. The ITAT remitted the issue back to the CIT (A) with directions to pass a speaking order after duly considering all the contentions raised by the assessee and giving proper opportunity to the assessee. The appeal was allowed for statistical purposes.

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