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TMI Blog2018 (5) TMI 337X X X X Extracts X X X X X X X X Extracts X X X X ..... ng expenses and arriving at a positive total income by assuming that there was an expenditure of a capital nature incurred by the Assessee in arriving at a loss as declared in the return of income and further disallowing such expenditure and consequently arriving at a positive total income chargeable to tax is without any basis and not in accordance with law and the said manner of determination of total income is hereby deleted. - Decided in favour of assessee - ITA No. 202/Bang/2018 And ITA No.693/Bang/2018 - - - Dated:- 25-4-2018 - SHRI N.V VASUDEVAN, JUDICIAL MEMBER AND SHRI JASON P BOAZ, ACCOUNTANT MEMBER For The Revenue : Shri C.H. Sundar Rao, CIT For The Assesse : Shri Percy Pardiwala, Advocate ORDER PER BENCH : ITA No.202/Bang/2018 is an appeal by the Assessee and ITA No.693/Bang/2018 is an appeal by the Revenue. Both the appeals are directed against the order dated 22.12.2017 of CIT(A)-3, Bengaluru, relating to AY 2015- 16. 2. The Assessee is a company. During the relevant previous year it was engaged in the business of wholesale trader/distributor of books, mobiles, computers and related accessories. It filed a return of income f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Sri.Rajnish Baweja, by issuing summons to him by virtue of his power to summon witness u/s.131 of the Income Tax Act, 1961 (Act). The sum and substance of the statement of the Vice-President according to the AO was that the strategy of selling at a price lower (predatory pricing) than the cost price is to capture market share and to earn profits in the long run. According to the AO the benefit to the online buyer in the short run in the form of lower price is to create indirect benefit to the Assessee in the long run. 8. The AO thereafter concluded that the strategy of selling goods at lower than cost price was to establish customer goodwill and brand value in the long run and reap benefits in the later years. The AO in this regard referred to the fact that the Assessee during the previous year relevant to AY 2015-16 sold its shares at a huge premium (Equity shares of face value of Re.1/- was sold at a premium of ₹ 18,999/- per equity shares) based on the valuation of those shares under the Discounted Cash Flow method(DCF Method). The DCF Method estimates the cash flows in future and uses appropriate discounting factors to arrive at the current enterprise value. This was o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... evenue expenditure. Hence the value of marketing intangibles should be disallowed and 25 % only should be allowed as depreciation u / s . 32 of IT Act, 1961 . 10. The AO called upon the Assessee to explain why the difference between higher purchase price and lower selling price should not be inferred as a pricing strategy leading to enduring benefits; and hence leading to generation of capital asset. The Assessee replied that no part of purchases by an enterprise carrying on trading business can be considered as capital expenditure. The Assessee submitted that expenses on purchases in the business of wholesale cannot and does not create any asset of an enduring advantage. 11. The AO however concluded that the Assessee followed predatory pricing in order to create marketing intangibles and brand. According to him the enhanced valuations at which venture capitalists invest in the Assessee is based on intangibles generated by Assessee. Hence, selling at a price below prices is not an irrational economic behaviour. It is a clearly thought strategy to establish a monopoly in market by brand building by generating consumer goodwill. This strategy naturally leads to gener ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... database for wholesalers dealing in consumer and electronic goods. He took profit margins of companies whose turnover was above ₹ 20 crores and whose revenue from trading was more than 75% of the total revenue. The search process yielded an average gross profit margin of 16.95%. This was compared with Assessee s profit margin of (-2.52%). The AO thereafter arrived at the total income of the Assessee as follows: 3 . 20 . The market average of gross profit margin for wholesalers is 16 . 95 %. On perusal of the comparables, it is seen that none of comparable has an abnormally negative gross profit margin . It can be concluded that these comparable wholesalers follow a profit - based business model . In any case, averaging irons out the differences in these market comparables . Had assessee not followed a predatory pricing policy, its ( market average ) sale price would have been Rs . 9593,89,99,046 + ( 16 . 95 % of Rs . 9593,89,99,046 ) i . e . Rs . 11220,06,59,384 . Assessees real sales is Rs . 9351 ,75,05,3 19 . The reduction in sales due to following assessee's strategy of selling at a price lower than Cost ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... y is computed as under . Issue demand notice and penalty notice accordingly . 14. Aggrieved by the order of the AO, the Assessee preferred appeal before CIT(A). The CIT(A) confirmed the order of the AO. The CIT(A) in exercise of his powers of enhancement u/s.251(2) of the Act also withdrew depreciation of 25% on the intangible assets allowed by the AO while computing total income, for the reason that though the Assessee incurred expenses for creating intangible assets but was not owner of the intangible. In doing so, he did not give notice to the Assessee before exercising power of enhancement which he was bound to do u/s.251(2) of the Act. Further the CIT(A) in coming to the aforesaid conclusion relied on ground No.4( e) raised by the Assessee in the grounds of appeal, which reads thus: Ground No . 4 ( e ): The learned AO failed to appreciate the fact that during the year under consideration, the appellant was not owning any Brand / Intellectual Property ( transferred by way of slum sale in FY 2012 - 13, also disclosed in the financial statement for AY 2012 - 13 that are available in the learned AO s files for verification ) and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ourt in W.P.No.6533 of 2018 (T-IT) by its order dated 15.2.2018 has directed the Tribunal to hear the appeal filed by the Assessee on 9.4.2018 itself on which date the appeal was fixed for final hearing. The Hon ble High Court has directed the parties not to seek any adjournment of hearing and conclude the hearing on the given date. The Hon ble High Court has also directed that the Tribunal shall decide the appeal within 3 months from 15.2.2018. 18. First we shall take up for consideration the appeal by the Assessee. The learned counsel for the Assessee submitted that the manner in which the revenue authorities have proceeded to determine the total income of the Assessee is not in accordance with the provisions of the Act. In this regard he submitted that Income under the head Income from Business or Profession has to be computed in accordance with Sec.28 to Sec.44DB of the Act. The Starting point of computation of income from business has to be therefore the sales as recorded by the Assessee in its books of accounts. He drew our attention to the fact that the sales figure as per the books of accounts of the Assessee was ₹ 9351,75,05,319/-. It is not the case of the AO t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... her accrued nor was received by the assessee-firm. In accordance with the opinion of the President, the assessment was reduced by deleting the extra commission from the computation. The Hon ble High Court agreed with the majority view of the Tribunal and held that the larger sums cannot be regarded as income of the Assessee for the relevant previous year. On further appeal to the Hon ble Supreme Court on a certificate by the Hon ble High Court as a fit case for reference u/s.66A(2) of the Income Tax Act, 1922 (1922 Act), the Hon ble Supreme Court held Income-tax is a levy on income. No doubt, the IT Act takes into account two points of time at which the liability to tax is attracted, viz., the accrual of the income or its receipt; but the substance of the matter is the income. If income does not result at all, there cannot be a tax, even though in book- keeping, an entry is made about a hypothetical income , which does not materialise. Where income has, in fact, been received and is subsequently given up in such circumstances that it remains the income of the recipient, even though given up, the tax may be payable. Where, however, the income can be said not to have resulted at all ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rse is not impermissible under law. When one trader transfers his goods to another trader at a price less than the market price, the taxing authority cannot take into consideration the market price of those goods, ignoring the real price fetched. Now this position of law will stand modified after insertion of provisions of Sec.40A(2)(a) of the Act which lays down that if the parties are related to each other than the fair price paid for the goods can be scrutinized by the revenue. Also it needs to be noted that none of the transactions of the Assessee either purchase or sale is from or to a related party. 21. The learned counsel for the Assessee placed reliance on the decision of the Hon ble Supreme Court in the case of CIT Vs. A.Raman Co. 67 ITR 11 (SC). The facts in the aforesaid decision was that the assessees, M/s A. Raman Co., (a partnership firm) were dealers in mill stores . In the course of their business they sell mill stores to other dealers including two concerns trading in the names of M/s A.M. Shah Co. M/s R. Ambalal Co., which are owned by the HUFs, managers of which are the only partners of the assessees. The case of the revenue was that the assessees, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stries for a sum of ₹ 9,30,080/- and the average selling price comes to ₹ 2,277/- per MT. The Assessing Authority was of the view that the assessee purchased rice bran from M/s.Venkata Padmavathi Paddy Rice, Nellore at a higher rate and sold the rice bran to M/s. Nicko Agro Industries at a very low rate. By such sales, the assessee reduced the profit and passed on the benefit to this concern, which also operates from the adjacent premises. Therefore, the Assessing authority proceeded under Section 145(3) of the Income tax Act and rejected the accounts maintained by the assessee. Thereafter, he proceeded to value 408.495 MT of rice bran sold by him at the rate of ₹ 3,890/- per MT based on the average purchase price and thus the difference was arrived at in a sum of ₹ 6,58,965/- and that was treated as an additional income of the assessee and taxed. The Hon ble Karnataka High Court held on the correctness of the action of the Revenue authorities as follows: 4 . We have heard the learned counsel appearing for the parties . The Apex Court in the case of Commissioner of Income - Tax, West Bengal V / s . Calcutta Discount Co . Ltd . , re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ionale behind those provisions. Even domestic transfer pricing provisions u/s.92(2A) of the Act are not applicable as the Assessee has not undertaken any transaction with a related party as laid down in Sec.40A(2)(b) of the Act. Besides the above the domestic Transfer Pricing provisions are applicable to the following Domestic transactions only viz., (i) Any expenditure u/s 40A(2)(b); (ii) Any transactions referred to in S. 80A, (iii) Transactions referred to u/s 80IA(8) and 80IA(10); (iv) Transactions referred to under S.10AA or (v) Any others as maybe prescribed. It was submitted that none of the above conditions exist in the case of the Assessee and therefore the action of the revenue authorities cannot be sustained. 25. His next submission was that wherever the legislature wanted to tax income not earned, it had made specific provisions in the Act by way of deeming fiction. In this regard he drew attention to certain statutory provisions. ( i ) Sec . 43CA ( 1 ) Where the consideration received or accruing as a result of the transfer by an assessee of an asset ( other than a capital asset ) , being land or building or both, is less than the value ado ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on the following observations of the Hon ble Court: Now while s . 10 ( 1 ) of the Act of 1922 imposes a charge on the profits or gains of a business it does not provide how these profits are to be computed . Sec . 10 ( 2 ) enumerates various items which are admissible as deductions . They are, however, not exhaustive of all allowances which can be made in ascertaining the profits of a business taxable under s . 10 ( 1 ). It is undoubtedly true that profits and gains which are liable to to be taxed under s . 10 ( 1 ) are what are understood to be such under ordinary commercial principles . The loss for which the deduction is claimed must be one that springs directly from the carrying on of the business and is incidental to it . If this is established the deduction must be allowed provided that there is no provision against it, express or implied, in the Act ( See Badridas Daga vs . CIT ( 1958 ) 34 ITR 10 ). In that case loss sustained by the business by reason of embezzlement by an employee was held to be an admissible deduction under s . 10 ( 1 ) although it did not fall within s . 10 ( 2 )( xi ) of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... een capital and revenue expenditure but no test is paramount or conclusive . There is no all - embracing formula which can provide a ready solution to the problem; no touchstone has been devised . Every case has to be decided on its own facts, keeping in mind the broad picture of the whole operation in respect of which the expenditure has been incurred . But a few tests formulated by the Courts may be referred to as they might help to arrive at a correct decision of the controversy between the parties . One celebrated test is that laid down by Lord Cave L . C . in Atherton vs . British Insulated Helsby Cables Ltd . ( 1925 ) 10 Tax Cases 155 ( HL ) , where the learned Law Lord stated : .... when an expenditure is made, not only once and for all, but with a view to bringing into existence an asset or an advantage for the enduring benefit of a trade, I think that there is very good reason ( in the absence of special circumstances leading to an opposite conclusion ) for treating such an expenditure as properly attributable not to revenue but to capital . This test, as the parenthetical clause shows, must yield where there are spec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ring benefit in the capital field was acquired by the assessee in purchasing loom hours and the test of enduring benefit cannot help the Revenue . ( emphasis supplied ) 31. According to the learned counsel for the Assessee, the expenditure on intangibles/brand, even assuming that it was incurred by the Assessee merely facilitates the Assessee carrying on his business and cannot be said to be any enduring nature so as to say that the expenditure in question was capital expenditure. 32. The learned counsel for the Assessee also placed reliance on the decision of the Hon ble Supreme Court in the case of SA Builders Vs. CIT 288 ITR 1(SC) wherein the Hon ble Supreme Court was dealing with a case of disallowance of interest paid on loans borrowed which were given to the sister concern without charging interest. The Hon ble Supreme Court held that the High Court and other authorities should have enquired as to whether the interest-free loan was given to the sister company (which is a subsidiary of the assessee) as a measure of commercial expediency, and if it was, it should have been allowed. The expression commercial expediency is an expression of wide import and includes su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ty and business rectitude of the owners, the nature and character of the business, its name and reputation, its location, its impact on the contemporary market, the prevailing socio - economic ecology, introduction to old customers and agreed absence of competition . There can be no account in value of the factors producing it . It is also impossible to predicate the moment of its birth . It comes silently into the world, unheralded and unproclaimed and its impact may not be visibly felt for an undefined period . Imperceptible at birth it exists enwrapped in a concept, growing or fluctuating with the numerous imponderables pouring into, and affecting, the business . 35. Our attention was also drawn to a decision of the Hon ble Bombay High Court in the case of Evans Fraser Co. Vs. CIT 137 ITR 493(Bom) which again explains the nature of goodwill in the following terms: Does this, however, make any difference ? As we have seen earlier, goodwill is a fluctuating thing . It increases and it decreases, but such increase or decrease is not like the periodic waxing and waning of the moon nor is it like the tide which regularly ebbs and flows twice in twenty ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the market value of goodwill, with the goodwill remaining constant, or as the cost of improving or adding to the quality of the goodwill . Such increase is really due to the fact that by further selfgeneration the goodwill has increased . The argument of Mr . Joshi, that the ratio of the Supreme Court decision in the case of B . C . Srinivasa Setty ( supra ) applies only where there is no cost of acquisition is, therefore, not correct and cannot be accepted . In the judgment in that case the Supreme Court referred to the two views which had prevailed until it finally settled the law, the preponderance of judicial opinion being the same as the view taken by the Supreme Court in B . C . Srinivasa Setty's case, the only two High Courts to have taken a contrary view being the Gujarat High Court in CIT vs . Mohanbhai Pamabhai ( 1973 ) 91 ITR 393, and the Calcutta High Court in K . N . Daftary vs . CIT 1976 CTR ( Cal ) 23 : ( 1977 ) 106 ITR 998 ( Cal ). The Supreme Court has also mentioned in its judgment the decisions of High Courts which had earlier taken the same view as the Supreme Court did, and obviously approv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ious grounds of appeal comprised in Gr.No.5 can be directed to be reconsidered by the AO/CIT(A). 39. The learned DR submitted that the Assessee is a wholesaler. He submitted that a wholesaler buys goods at a price and adds to such price indirect costs and profits and the sale price is determined accordingly. The Assessee in the present case incurs loss at the gross level. According to him such loss at gross level in the case of a wholesaler is exceptional. It can happen only when the wholesaler is dealing in perishable goods and the Assessee admittedly is not dealing in goods of a perishable nature. The Assessee has itself admitted that it incurs loss at the gross profit level (gross level) only to capture market. The Assessee s personnel admitted in his statement that the Assessee indulges in predatory pricing only to capture market and help its retailers to survive in the recently developing ECommerce. It was further brought to our notice that over and above the sale price being below its cost of purchase, the Assessee has also offered cash discount at 3% of its sales. These circumstances according to him show that the Assessee s business model is not normal business model. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ome of the Assessee as done by the AO is justified. 5. On the argument of the learned counsel for the Assessee regarding methodology of determining income, the learned DR submitted that when predatory pricing methodology is employed to create intangibles for an Assessee there is nothing wrong in treating the profits foregone as an expenditure incurred for creating intangibles and regarding the same as capital expenditure. In this regard it was argued by the learned DR that the tests laid down in the decision of the Hon ble Supreme Court in the case of Empire Jute case (supra) would be satisfied in the present case. According to him indulging in predatory pricing expands the profit making apparatus and therefore the profits foregone can be regarded as capital expenditure. 41. The learned DR therefore submitted that the approach adopted by the AO was justified in the facts and circumstances of the case and was well within his powers while determining total income under the Act. 42. With regard to the manner of determination of valuation of intangibles and depreciation on intangibles allowed by the AO but withdrawn by the CIT(A), he relied on the orders of the AO and CIT(A) r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... en expended for the purpose of realising the interest, and are therefore, not allowable as deductible e xpenditure. 44. According to him what the revenue has sought to do in the present case by bifurcating the difference between an assumed sale price and the actual sale price and attributing the difference to an expenditure incurred by the Assessee on acquiring intangibles is contrary to the aforesaid ruling of the Hon ble Supreme Court. 45. On the argument of the learned DR on the cash discounts offered by the Assessee, it was submitted by him that cash discount are revenue expenses and cannot be disallowed. It was submitted by him that predatory pricing is a business strategy and time will tell whether it results in generation of goodwill or brand or any other intangible. If the business model of the Assessee fails where is goodwill or brand or other intangible that has come or will come into existence. Therefore it is premature to say that the Assessee has incurred expenditure to build goodwill or create intangibles or brand. 46. With regard to the contention of the learned DR on sale of shares of the Assessee at a premium, the learned counsel for the Assessee submitte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... counsel for the appellants that if it was intended that a national of a third State should be precluded from the benefits of the DTAC, then a suitable term of limitation to that effect should have been incorporated therein. Art. 24 of the Indo-US Treaty on Avoidance of Double Taxation specifically provides the limitations subject to which the benefits under the Treaty can be availed of. One of the limitations is that more than 50 per cent of the. beneficial interest, or in the case of a company more than 50 per cent of the number of shares of each class of the company, be owned directly or indirectly by one or more individual residents of one of the Contracting States. Art. 24 of the Indo-U.S. DTAC is in marked contrast with the Indo-Mauritius DTAC. The appellants rightly contend that in the absence of a limitation clause, such as the one contained in art. 24 of the Indo-U.S. Treaty, there are no disabling or disentitling conditions under the Indo-Mauritius Treaty prohibiting the resident of a third nation from deriving benefits thereunder. They also urge that motives with which the residents have been incorporated in Mauritius are wholly irrelevant and cannot in anyway affect the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nce of an international transaction in the matter of incurring of Advertising Marketing and Promotion Expenses (AMP expenses), it was not permissible to invoke chapter X of the Act. 49. As far as the appeal by the revenue is concerned, the issue involved is with regard to quantification of the profit margin of comparable companies chosen by the AO. On the revenue s appeal, the learned DR relied on the order of the AO and pleaded that the computation of expenses on creating intangibles as done by the AO should be restored. 50. We have given a very careful consideration to the rival submissions. As far as the Assessee s appeal is concerned, the issue that arises for consideration is as to whether the determination of total income as done by the AO was justified in the facts and circumstances of the case. The Assessee as we have seen is a wholesale trader. He purchases goods for the purpose of trading at say ₹ 100/- from unrelated parties. He sells it to retailers at ₹ 80/-. The retailers are also unrelated parties. The retailers sell the goods through the Assessee s web portal flipkar.com . The trading by the retailers to the end user is through ECommerce. The cust ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that year in accordance with, and subject to the provisions of the Act in respect of the total income of the previous year of every person. Section 5 of the Act lays down the scope of total income under the Act and it lays down that total income of any previous year of a person who is a resident includes all income from whatever source derived which(a) is received or is deemed to be received in India in such year by or on behalf of such person; or(b) accrues or arises or is deemed to accrue or arise to him in India during such year; or(c) accrues or arises to him outside India during such year. Sec.2(24) of the Act defines income by laying down that income includes and lists out several categories of receipts which can be characterised as income. The definition is inclusive definition and therefore what can be regarded by ordinary connotation of the said term as income can be regarded as income even though they do not fall within any of the categories of income set out in various sub-clauses of Sec.2(24) of the Act. The aspect to be noted is that there should be income and its receipt or accrual because it is only income which accrues or arises that can be subject matter of total ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the case of Calcutta Discount Company(supra), when one trader transfers his goods to another trader at a price less than the market price, the taxing authority cannot take into consideration the market price of those goods, ignoring the real price fetched. As laid down by the Hon ble Supreme Court in the case of A.Raman Co. (supra), income which has accrued or arisen can only be subject matter of total income and not income which could have been earned but not earned. The decision of the Hon ble Karnataka High Court in the case of A.Khader Basha (supra) is squarely applicable to the facts of the present case. The facts of the Assessee s case and the facts of the case decided by the Hon ble Karnataka High Court were identical. The Hon ble Karnataka High Court held following Hon ble Supreme Court decision in the case of Calcutta Discount Co. Ltd., reported in 1973(91) ITR 8 (SC) that where a trader transfers his goods to another trader at a price less than the market price and the transaction is a bonafide one, the taxing authority cannot take into account the market price of those goods, ignoring the real price fetched to ascertain the profit from the transaction. The Hon ble Co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Assessee was purchase at ₹ 100 and selling the goods to retailers at ₹ 80/- the rationale for incurring loss by a wholesale trader at the gross level was very peculiar. Since such a pricing was done keeping in mind the long run profits of the Assessee which will grow because of the intangible/brand or goodwill which will be generated in the long run. Therefore to the extent profits are foregone by the Assessee, the Assessee can be deemed to have incurred expenditure on creating intangibles/brand or goodwill and such expenditure has to be regarded as capital expenditure and added to the total income of the Assessee. 55. We find no basis for the above conclusions of the AO. The first presumption of the AO is that the Assessee had incurred expenditure. As rightly contended by the learned counsel for the Assessee there was no accrual of any liability on account of any expenditure or actual outflow of funds towards expenditure. One cannot proceed on the basis of presumption that the profit foregone is expenditure incurred and further that expenditure so incurred was for acquiring intangible assets like brand, goodwill etc. As pointed by the Hon ble Supreme Court and the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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