Sony India Transfer Pricing

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH H: NEW DELHI BEFORE SHRI VIMAL GANDHI, HONBLE PRESIDENT
AND SHRI P.M.JAGTAP, HONBLE ACCOUNTANT MEMBER I.T.A.Nos.1189/Del/2005, 819/Del/2007 & 820/Del/2007 Assessment Years : 2001-02, 2002-03 & 2003-04
M/s Sony India (P) Limited, A-31, Mohan Cooperative Industrial Area, Mathura Road, New Delhi. (Appellant)
Vs.
Deputy Commissioner of Income Tax, Circle-9(1), Room No.163, C.R.Building, New Delhi 110 002. (Respondent)
I.T.A.Nos.1181/Del/2005, 1257/Del/2007 & 1656/Del/2007 Assessment Years : 2001-02, 2002-03 & 2003-04
Deputy Commissioner of Income Tax, Circle-9(1), Room No.163, C.R.Building, New Delhi 110 002. (Appellant) Taxpayer by :
Vs.
M/s Sony India (P) Limited, A-31, Mohan Cooperative Industrial Area, Mathura Road, New Delhi. (Respondent)
Department by
Shri N.Venkataraman, Sr.Advocate with Shri Arijit Prasad, Advocate and Shri Mukesh Bhutani, Shri Sanjiv Malhotra, Ms.Ashima Gupta & Ms.Manvi Sharma, CAs. Smt.Himalini Kashyap, CIT-DR & Smt.Nidhi Singh, TPO. ORDER
PER BENCH:These six appeals, three filed by the taxpayer and three filed by the Revenue are cross-appeals which are directed against three separate orders passed by the learned CIT(A) dated 31.12.2004, 21.12.2006 and 31.1.2007 for AY 2001-02, 2002-03 & 2003-04 respectively. As some common issues are involved therein, the same have been heard together and are being disposed of by this single consolidated order. ITA No.1181/Del/2005 Revenues appeal for AY 2001-02 2. In ground No.1, the Revenue has challenged the action of the learned CIT(A) in deleting the addition of Rs.2,25,38,920/- made by the Assessing Officer on account
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of provision for warranty while computing the total income of the taxpayer under the normal provisions and also in directing the AO to exclude the said provision while computing the book profit u/s 115JB. 3. In its profit and loss account, warranty charges amounting to Rs.4,04,12,572/were debited by the taxpayer company. The said amount was inclusive of the warranty expenses actually incurred by the taxpayer company to the extent of Rs.1,78,73,650/- and the remaining amount of Rs.2,25,38,920/- was on account of provision made for anticipated warranty expenses in respect of the remaining part of the warranty period. According to the AO, the amount that may be payable by the taxpayer company on account of possible claims of warranty arising in the future constituted its contingent liability and the provision made for such contingent liability was not deductible while computing its total income. He, therefore, disallowed the same while computing the total income of the taxpayer under the normal provisions of the Act and also added the same while computing its book profit u/s 115JB. The matter was carried before the ld. CIT(A) and it was submitted on behalf of the taxpayer company before him that the provision for anticipated liability on account of warranty claim for unexpired period was made on scientific basis taking into consideration the past history and this method as prescribed in Accounting Standard 4 issued by the Institute of Chartered Accountants of India was being regularly followed consistently from the inception. Relying inter alia on the decision of Hon'ble Supreme Court in the case of Bharat Earth Movers Vs. CIT - 245 ITR 428, it was contended that the said provision thus was made for an ascertained liability and the same was deductible as claimed by the taxpayer company. This stand of the taxpayer was found acceptable by the ld. CIT(A) and relying inter alia on the decision of Hon'ble Supreme Court in the case of Bharat Earth Movers (supra) as well as that of Mumbai Bench of ITAT in the case of Voltas Ltd. Vs. CIT - 64 ITD 232, he held that the liability on account of warranty claim for the unexpired period was in praesenti and although it was liable to be discharged at a future date, the taxpayer was entitled for deduction on account of provision made for the said liability. He also held that the said provision for warranty being not for an ascertained liability, the addition thereof made by AO while computing the book profit u/s 115JB was not permissible. 4. We have heard the arguments of both the sides and also perused the relevant material on record. As pointed out by the learned counsel for the taxpayer, a similar issue has been decided by the Honble Punjab & Haryana High Court in the case of CIT Vs. Majestic Auto Ltd. - 150 Taxman 460 wherein it was held relying inter alia on the decision of Hon'ble Supreme Court in the case of Bharat Earth Movers (supra) that the provision for warranty claims made on scientific basis keeping in view the past history is an admissible business expenditure. To the similar effect is the decision of Honble Delhi High Court in the case of CIT Vs. Vinitec Corporation Pvt. Ltd. - 278 ITR 337 wherein it was held that warranty clause is a part of sale transaction and liability for warranty expenses is a committed liability in the relevant accounting year though its actual quantification and discharge is deferred to a future date. It was further held that the provision made for such warranty expenses on the basis of figures of past years thus is deductible in the relevant year itself. The learned DR has not disputed this position. She, however, has made an attempt to point out from page 4 of the impugned order of the learned CIT(A) that the provision for warranty made by the taxpayer company @ 2% of the total turnover was highly excessive taking into consideration its own past history wherein such provision was
required to be made at only 0.72%. However, as clarified by the learned counsel for the taxpayer, the provision of 2% as referred to by the learned CIT(A) in his impugned order was in the context of a case of M/s Voltas Limited (supra) decided by Mumbai Bench of ITAT whereas the provision made for warranty by the taxpayer in the present case was only to the extent of 0.75%. We, therefore, hold that the decision of Honble Punjab & Haryana High Court in the case of Majestic Auto Ltd. on a similar issue is squarely applicable in the present case and respectfully following the same, we uphold the impugned order of the learned CIT(A) allowing the deduction claimed by the taxpayer on account for provision for warranty holding the same to be an ascertained liability. Similarly, we also uphold his impugned order deleting the addition made by the AO of the said amount while computing the book profit of the taxpayer company u/s 115JB. Ground No.1 of the Revenues appeal is accordingly dismissed. 5. In ground No.2, the Revenue has challenged the action of the learned CIT(A) in directing the AO to include miscellaneous income of Rs.2,16,97,607/- in profits of the business for the purpose of computing deduction u/s 80HHC and also in directing the AO to exclude the excise duty from the total turnover for computing the said deduction. 6. After considering the rival submissions and perusing the relevant material on record, it is observed that one of the issues raised in this ground relating to the exclusion of excise duty from total turnover for the purpose of computing deduction u/s 80HHC is squarely covered in favour of the taxpayer by the decision of Hon'ble Supreme Court in the case of CIT Vs. Laxmi Machine Works - 290 ITR 667 wherein it was held that excise duty and sales tax being indirect taxes cannot form part of the turnover and the same therefore have to be excluded from total turnover for the purpose of computing deduction u/s 80HHC. Respectfully following the said decision of the Hon'ble Supreme Court, we uphold the impugned order of the learned CIT (A) on this issue. 7. As regards the other issue raised in ground No.2 of the Revenues appeal relating to the inclusion of miscellaneous income of Rs.2,16,97,607/- in profits of the business for the purpose of computing deduction u/s 80HHC, it is observed that while computing the deduction allowable to the taxpayer company u/s 80HHC, the miscellaneous income of Rs.2,16,97,607/- was excluded by the AO from the profits of the business relying on Explanation (baa) below Section 80HHC. Before the learned CIT(A), it was contended on behalf of the taxpayer company that the miscellaneous income received by it did not constitute any receipts of a nature similar to the items given in Explanation (baa). It was contended that the said income was comprised of receipts by way of sale of scrap, amounts written back, sale of spare parts etc. and the same being derived directly from the business activities of the taxpayer company, they could not be excluded from the profits of the business for the purpose of computing deduction u/s 80HHC. Reliance in support of this contention was placed on behalf of the taxpayer company on the decision of Honble Bombay High Court in the case of CIT Vs. Bangalore Clothing Ltd. - 180 CTR 127. In the said decision, it was held by the Honble Bombay High Court in this context that if any receipt forms part of the operational income of the taxpayer having regard to its dominant business, the same would be entitled to be included in the profits of the business for the purpose of computing deduction u/s 80HHC. According to the ld. CIT(A), all the receipts i.e.
sale of scrap, amounts written back and sale proceeds of spare parts included in the miscellaneous income of the taxpayer company were directly related to its dominant business. He, therefore, held that the same forming part of its operational income was liable to be included in the profits of the business for the purpose of computing deduction u/s 80HHC. 8. After considering the rival submissions and perusing the relevant material on record, we find no infirmity in the impugned order of the learned CIT(A) holding that the miscellaneous income of the taxpayer was eligible for inclusion in the profits of the business for the purpose of computing deduction u/s 80HHC. As rightly held by him, the said income comprising of sale of scrap, amounts written back and sale proceeds of spare parts was directly related to the dominant business of the taxpayer company and the same, therefore, represented its operational income which, as held by Honble Bombay High Court in the case of Bangalore Clothing Company (supra) was entitled for inclusion in the profits of the business for the purpose of computing deduction u/s 80HHC. The said decision of Hon. Bombay High Court thus clearly supports the taxpayers case on this issue and the learned CIT(A), in our opinion, was fully justified in deciding the same in favour of the taxpayer relying thereon. His impugned order on this issue is therefore upheld and ground No.2 of the Revenues appeal is accordingly dismissed. 9. Ground No.3 raised by the Revenue in this appeal also has two limbs i.e. inclusion of forex gain in both numerator and denominator for the purpose of computing deduction u/s 10A and exclusion of the amount of Rs.43.28 lakhs on account of tax withheld in Singapore from the total turnover for the purpose of said computation. 10. Insofar as the second limb of this ground is concerned relating to exclusion of Rs.43.28 lakhs on account of tax withheld in Singapore from the total turnover, the learned counsel for the taxpayer at the time of hearing before us has conceded this issue in favour of the Revenue. Accordingly, the impugned order of the ld. CIT(A) on this issue is set aside and that of the AO is restored. As regards the issue relating to inclusion of forex gain in both numerator and denominator, it is observed that the taxpayer has software development centers at Bangalore namely SSDI & ATLAV, the profits of which are claimed as exempt u/s 10A/10B. While computing the said exemption, the taxpayer company had included foreign exchange fluctuation gain in respect of export proceeds in the profits of the business. According to the AO, the said gain was arising as a result of depreciation in the value of Indian Rupee and the same having no direct nexus with the main export activity, he held that it was liable to be excluded from the profits of the business despite the fact that the same was includible in the total turnover (denominator). Before the ld. CIT(A), it was submitted on behalf of the taxpayer that the foreign exchange gain has a very close nexus with the export activity of the company. Relying inter alia on the decision of Delhi Bench of ITAT in the case of Smt. Sujata Grover Vs. DCIT - 74 TTJ 347, it was contended that the same thus was rightly claimed as part of the eligible profits. After considering the submissions made on behalf of the taxpayer, it was held by the ld. CIT(A) that forex gain relating to the export proceeds was the direct result of the export sales and taking into consideration this close nexus between the two, it was not possible to exclude such gain from the export turnover. He, therefore, directed the
AO to include the said gain even in the figure of export turnover (numerator) for the purpose of computing exemption u/s 10A/10B. 11. We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that this issue has also been raised by the taxpayer in ground No.4 of its appeal being ITA No.1189/Del/2005. At the time of hearing before us, the learned counsel for the taxpayer, however, has not pressed the same thereby conceding this issue in favour of the Revenue. Accordingly, the impugned order of the learned CIT(A) on this issue is set aside and that of the Assessing Officer is restored. Ground No.3 of the Revenues appeal is thus allowed. 12. In ground No.4, the Revenue has challenged the action of the ld. CIT(A) in deleting the disallowance of Rs.9,97,725/- made by the AO on account of belated payment of employers and employees contribution to provident fund. 13. At the time of hearing before us, the learned counsel for the taxpayer has submitted that all the payments in question on account of employers and employees contribution to provident fund were made by the taxpayer company after the due date but within the grace period. The due date for payment of PF contribution as defined in Explanation to Section 36(1)(va) gets extended by the grace period of 5 days allowed under the relevant statute and as held by Honble Madras High Court in the case of CIT Vs. Shri Ganapathy Mills Co. Ltd. - 243 ITR 879, the payment of PF contribution made within such grace period cannot be disallowed. We, therefore, find no infirmity in the impugned order of the ld. CIT(A) deleting the disallowance made by the AO on this issue and upholding the same, we dismiss ground No.4 of the Revenues appeal. 14. Ground No.5 of the Revenues appeal relates to the disallowance of Rs.14,14,701/- made by the AO on account of software expenses treating the same as of capital nature which stands deleted by the learned CIT(A). 15. In its return of income, the taxpayer company had claimed an expenditure of Rs.35,36,753/- on account of computer software. According to the AO the said expenditure was incurred by the taxpayer company on purchase of software and since the same has resulted in accrual of enduring benefit, it was of capital nature. He, therefore, allowed only the depreciation on the said software @ 60% which resulted in the disallowance of balance amount of Rs.14,14,701/-. Before the ld. CIT(A) it was submitted on behalf of the taxpayer company that the softwares acquired by it were enabling software which facilitated its business operations. Relying inter alia on the judgments of Hon'ble Supreme Court in the cases of Alembic Chemicals Works Co. Ltd. - 177 ITR 377 and Empire Jute Company - 124 ITR 1 as well as Tribunals decision in the case of Media Video Ltd. - 122 Taxman 28, it was contended on behalf of the taxpayer that as a result of acquisition of the said software, only an operational or commercial advantage was obtained which being in the revenue field, the expenditure incurred on such acquisition was a revenue expenditure. 16. The details of software expenses claimed by the taxpayer were examined by the ld. CIT(A) and on such examination, he found that the same were incurred for acquiring the following softwares :-
(i) Software for TDS calculation, which needs to be revised each year based on changes in Budget Notifications; (ii) E-CRM networking/Internet gateway for B2B, which requires to be updated periodically based on changes in Marketing requirement, change in product line, new launches etc; (iii) License fees etc., payable for usage of certain application software and which have no reuse or sale value; (iv) Design and Development/Consultancy charges for Software development which do not have reuse/sale value. (v) Payment of SAP Service module is related to the implementation of SAP by the appellant company during the assessment year 2000-01, the expenses related to which have now been allowed by the ITAT. During the relevant assessment year, the Service module was implemented at Sony Service centres at different locations. It mainly relates to historic data compilation, preparation and uploads in system. 17. The learned CIT(A) also found that the said expenses were also inclusive of an amount of Rs.9,20,958/- spent by the taxpayer on acquisition of software which was meant as inputs for developing the software products by the taxpayer for exports. According to him, the said expenditure thus was akin to raw material and the same therefore was revenue expenditure. As regards the expenditure incurred on purchase of other softwares indicated above, he held that no lasting benefit was accrued to the taxpayer from acquisition of the said softwares and there was only an improvement in efficiency as a result of the said software. He, therefore, held relying on the judicial pronouncements cited on behalf of the taxpayer that the entire expenditure incurred by the taxpayer on acquisition of the said softwares was of revenue nature. 18. Before us, the learned DR relied on the order of the Special Bench of ITAT at Delhi in the case of Amway India Enterprises 111 ITD 112. She contended that as per the guidelines laid down by the Special Bench, the nature of expenditure incurred on software, whether revenue or capital, has to be ascertained taking into consideration mainly the function it is going to perform in the business set up of the taxpayer. She urged that this issue may, therefore, be sent back to the AO for deciding the same afresh in the light of guidelines laid down by the Special Bench of ITAT in the case of Amway India Enterprises (supra). 19. The learned counsel for the taxpayer submitted before us that the expenditure in question was incurred by the taxpayer for upgradation/purchase/development of software which was being used for the purpose of MIS reporting, intercompany connectivity etc. He also placed on record the details of such expenditure incurred by the taxpayer company during the year under consideration alongwith a descriptive functional analysis as per Annexure-4. As regards the recent decision of Delhi Special Bench of ITAT in the case of Amway India Enterprises 111 ITD 112, he submitted that the said decision supports the case of the taxpayer. He contended that
as held by the Special Bench of the Tribunal in the said case, where the advantage consists merely in facilitating taxpayers trading operations or enabling conduct of taxpayers business more efficiently or more profitably, the expenditure would be on revenue account. He submitted that the details of the software expenditure incurred by the taxpayer in the present case as given in Annexure-4 would make it clear that the said expenditure was incurred for improving the day to day efficiency and for carrying out the business of the taxpayer company in a more efficient manner. He contended that the said expenditure thus was incurred on revenue account as held by the Special Bench of the Tribunal in the case of Amway India Enterprises (supra) and the softwares acquired by the taxpayer company being mere facilitators, the expenditure incurred thereon was rightly held by the learned CIT(A) as of revenue in nature. 20. We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that a similar issue has been considered and decided by Delhi Special Bench of ITAT in the case of Amway India Enterprises (supra). The conclusions drawn by the Special Bench of the Tribunal in the said case on this issue are as under:Our conclusions on the issue under consideration thus can be summarized as under:(i) When the taxpayer acquires a computer software or for that matter the license to use such software, he acquires a tangible asset and becomes owner thereof as held above relying on the decision of Hon'ble Supreme Court in the case of TCS (supra). (ii) Having regard to the fact that software becomes obsolete with technological innovation and advancement within a short span of time, it can be said that where the life of the computer software is shorter (say less than 2 years), it may be treated as revenue expenditure. Any software having its utility to the taxpayer for a period beyond two years can be considered as accrual of benefit of enduring nature. However, that by itself will not make the expenditure incurred on software as capital in nature and the functional test as discussed above also needs to be satisfied. (iii) Once the tests of ownership and enduring benefit are satisfied, the question whether expenditure incurred on computer software is capital or revenue has to be seen from the point of view of its utility to a businessman and how important an economic or functional role it plays in his business. In other words, the functional test becomes more important and relevant because of the peculiar nature of the computer software and its possible use in different areas of business touching either capital or revenue field or its utility to a businessman which may touch either capital or revenue field. 21. As further held by Delhi Special Bench of the Tribunal in the case of Amway India Enterprises (supra), the exact nature of expenditure incurred by the taxpayer for
acquiring the software has to be determined in the light of the aforesaid criteria/guidelines laid down and for the purpose of doing this exercise, the matter needs to be restored back to the file of the AO. Although the learned counsel for the taxpayer has made an attempt to explain the nature and use of each and every software acquired by the taxpayer during the year under consideration with the help of relevant details furnished on record, we are of the view that this exercise can more appropriately be done by the AO. Moreover, the benefit of the decision of Special Bench in the case of Amway India Enterprises (supra) was not available to the authorities below when this issue came to be decided by them and it would be in the interest of justice to give them an opportunity to re-examine the same in the light of criteria/guidelines laid down by the Special Bench. Accordingly, we set aside the impugned order of the learned CIT(A) on this issue and restore the matter to the file of the AO for deciding the same afresh as per the guidelines laid down by the Special Bench of ITAT in the case of Amway India Enterprises (supra). Ground No.5 of the Revenues appeal is accordingly treated as allowed for statistical purposes. 22. The next issue raised in ground No.6 of the Revenues appeal relates to the taxpayers claim on account of loss due to fluctuation in foreign exchange rate. 23. While finalizing its books of account, the foreign currency transactions were reinstated by the taxpayer company at the exchange rate prevailing on the balance sheet date and the resulting loss on account of foreign exchange fluctuation on such reinstatement of current assets or liabilities amounting to Rs.31,33,745/- was debited to the profit & loss account. Similarly, the gain due to fluctuation in foreign exchange amounting to Rs.14,00,761/- was credited in the profit & loss account. According to the AO, the corresponding liabilities having not become due in the year under consideration and the same were payable in the subsequent years, the loss claimed by the taxpayer on account of foreign exchange fluctuation was only notional. He, therefore, disallowed the said loss. The learned CIT(A), however, allowed the claim of the taxpayer company for the said loss holding that it was not a notional loss as alleged by the AO. 24. At the time of hearing before us, the learned representatives of both the sides have agreed that this issue is squarely covered by the judgment of Hon'ble Delhi High Court in the case of CIT Vs. Woodward Governor India Pvt.Ltd. 294 ITR 451 wherein it was held that the liability arising out of contracts had already accrued the minute the contract was entered into and the mere postponement of the payment of such liability to a future date would not extinguish the same so as to render it notional or contingent. It was also held that any increase in such liability as a result of fluctuation in the value of foreign currency in relation to Indian currency thus was a fate-accompli and such increase in liability as per the exchange rate prevailing on the last date of the financial year was allowable as deduction being not notional or contingent. Respectfully following the said judgment of Honble Jurisdictional High Court, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No.6 of the Revenues appeal. 25. The next issue raised in ground No.7 of the Revenues appeal relates to the disallowance of advertisement and sales promotion expenses made by the AO to the extent of 20% which stands deleted by the learned CIT(A).
26. During the year under consideration, the taxpayer company had incurred a total expenditure of Rs.19,63,54,856/- towards advertisement and sales promotion and the same was claimed as deduction. According to the AO, the said expenditure incurred by the taxpayer company was going to strengthen the brand image of SONY worldwide and the benefit thereof was going to flow to the parent company also viz., Sony Corporation, Japan. He, therefore, disallowed the said expenditure to the extent of 10% on estimated basis treating that the same was attributable to the benefit flown to the parent company. The learned CIT(A), however, deleted the disallowance made by the AO on this issue holding that as the expenditure on advertisement and sales promotion was incurred by the taxpayer company wholly within India, no benefit had accrued to its parent company in Japan. In addition to the disallowance of 10% made out of advertisement and sales promotion expense on the ground that the same was attributable to the brand promotion resulting in benefit to the parent company in Japan, a further disallowance of 10% was made by the AO out of advertisement and sales promotion expenses treating the same to be of capital nature on the ground that advantage of enduring nature had accrued to the taxpayer company. The learned CIT(A), however, deleted the said disallowance observing that as the memory of the customers is short and advertisement is required to be done on year to year basis, the expenditure incurred on advertisement and sales promotion could not be said to have resulted in accrual of any benefit of enduring nature to the taxpayer company. He, therefore, held that the said expenditure was of revenue nature and the disallowance made by the AO was not justified. 27. The learned DR submitted that the substantial expenditure incurred by the taxpayer on advertisement was definitely going to help in building of brand name SONY and the benefit thereof thus was obviously to flow to the entire Sony Group. She submitted that the very fact that the foreign entity had reimbursed substantial portion of the advertisement expenses in the subsequent years was sufficient to establish that the incurring of the said expenditure was going to benefit the said entity in building their brand image. She also submitted that the global advantage of spending on advertisement in India cannot be ignored and since a very fair and reasonable disallowance to the extent of 10% out of the total advertisement expenditure was made by the AO on this count, the learned CIT(A) was not justified in deleting the same. She further contended that the huge advertisement expenditure incurred by the taxpayer company was also going to result in accrual of an advantage of enduring benefit to it and the AO, therefore, had rightly treated 10% of the advertisement expenditure as of capital nature. In support of this contention, she relied on the decision of Hon'ble Calcutta High Court in the case of Berger Paints India Limited 254 ITR 503. 28. The learned counsel for the taxpayer submitted that the advertisement and sales promotion expenses in question were incurred by the taxpayer company to promote the sale of its products manufactured and traded in India and not for promoting the Sony global brand. He contended that what needs to be seen for allowability of an expense is whether the same has been incurred wholly and exclusively for the purpose of taxpayers business and it is immaterial whether such expense benefits a third party. As regards the reliance placed by the learned DR on the advertisement subsidy received by the taxpayer company from the parent company to point out that the parent company had also received some indirect benefit from the advertisement expenditure, he submitted that the said subsidy amount
received from the parent company was duly reduced from the total advertisement expenditure and only net amount was claimed as deduction. He placed reliance on the decision of Delhi Bench of ITAT in the case of Nestle India (ITA No.2755/Del/2003 dated 30.4.2007) stating that a similar issue involved in the said case has been decided by the Tribunal in taxpayers favour. He also placed reliance on the decision of Mumbai Bench of ITAT in the case of Star India Pvt.Ltd. 103 ITD 73. As regards the disallowance of 10% made by the AO out of advertisement and sales promotion expenses treating the same as of capital nature, the learned counsel for the taxpayer submitted that since the expenditure on advertisement and sales promotion is required to be incurred every year, there was no benefit of enduring nature derived by the taxpayer company by incurring the said expenditure. He also submitted that the said expenditure in any case was made by the taxpayer company on revenue account and the same, therefore, could not be treated as capital expenditure even if the test of enduring benefit is assumed to be satisfied. In support of this contention, he relied on the decision of Hon'ble Supreme Court in the case of Empire Jute Co. 124 ITR 1 wherein it was held that the enduring benefit test is not a conclusive test for determining the allowability of a particular expense. As regards the decision of Hon'ble Calcutta High Court in the case of Berger Paints India Limited 254 ITR 503 cited by the learned DR, he submitted that the said decision in fact supports the taxpayers case as it was held therein that advertisement expenditure is generally of revenue in nature since the memory of purchasing market is short and the advertisement is required to be done from year to year. 29. We have considered the rival submissions and also perused the relevant material on record. It is observed that the expenditure incurred by the taxpayer during the year under consideration on advertisement and sales promotion was disallowed by the AO to the extent of 10% on estimated basis on the ground that the same to that extent was going to strengthen the brand image of Sony worldwide and the benefit thereof thus was going to flow to the parent company viz. Sony Corporation, Japan. At the time of hearing before us, the learned DR has sought to support this action of the AO by pointing out that the substantial portion of advertisement and sales promotion expenses incurred by the taxpayer company was reimbursed by Sony Corporation in other years and this fact was sufficient to show that the benefit of the said expenditure had actually flown to the said company. In our opinion, this factual position, however, goes against the Revenue in the sense that if at all any benefit of the advertisement and sales promotion expenditure incurred by the taxpayer company had flown to the parent company as alleged by the AO, the same was suitably compensated by the parent company by actually reimbursing the substantial portion of the said expenditure. Moreover, the said expenditure was incurred by the taxpayer company to promote the sales of the products dealt with by it in India and the same thus having been incurred wholly and exclusively for the purpose of its business, it was fully deductible as an allowable business expenditure irrespective of any direct or indirect benefit which might have accrued to its parent company. For this conclusion, we derive support from the decision of Mumbai Bench of ITAT in the case of Star India Pvt.Ltd. Vs. Addl.CIT 104 TTJ 1 (Third Member) wherein it was held that advertisement expenses incurred on promoting viewership on TV channel by the taxpayer engaged in procuring programs for those channel were expenditure incurred wholly and exclusively for the purpose of its business and it could not be disallowed on the ground that it might have also benefited the taxpayers principal. To the similar effect is the decision of Delhi Bench of ITAT in the case of Nestle India
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Limited Vs. DCIT 111 TTJ 498 cited by the learned counsel for the taxpayer wherein it was held that advertisement and sales promotion expenses incurred by the taxpayer for promoting sales in India in respect of products manufactured by it under various brands of a foreign company were allowable in entirety even though it might have benefited the non-resident company who owned the said brands. Keeping in view both these decisions of the Tribunal and taking into consideration the facts of the case as discussed above, we hold that the disallowance of 10% made by the AO out of advertisement and sales promotion expenses on the ground that the same resulted in the benefit to the parent company was not sustainable and the learned CIT(A) was fully justified in deleting the same. 30. As regards the further disallowance of 10% made by the AO out of advertisement and sales promotion expenses treating the same to be of capital nature on the ground that the same had resulted in advantage of enduring nature to the taxpayer, it is observed that substantial amount of expenditure on advertisement and sales promotion was being incurred by the taxpayer company every year which by itself supports the case of the taxpayer that having regard to the nature of consumer products dealt with by it, such expenditure is required to be incurred regularly. In our opinion, it cannot therefore be said that the expenditure incurred by the taxpayer company on advertisement and sales promotion had resulted in accrual of any advantage of enduring nature in its favour as alleged by the AO. Moreover, even if it is assumed for the sake of argument that there was such advantage of enduring nature that had accrued to the taxpayer company as a result of incurring of the said expenditure, the same, having regard to the nature of such expenditure, was in the revenue field and not certainly in the capital field so as to treat the same as of capital nature. The said expenditure thus was rightly claimed by the taxpayer as of revenue nature and, in our opinion, there was no infirmity in the impugned order of the learned CIT(A) deleting the disallowance of 10% made by the AO by treating the same as of capital nature. The same is, therefore, upheld on this issue and ground No.7 of the Revenues appeal is dismissed. 31. The next issue raised in ground No.8 of the Revenues appeal relates to the taxpayers claim for depreciation on enhanced WDV of fixed assets as a result of foreign exchange fluctuation. 32. The liability on account of loans borrowed by the taxpayer company in foreign exchange for the purpose of acquisition of fixed assets was reinstated by it in the books of account at the exchange rate prevailing on the balance sheet date and the corresponding loss was added to the WDV of the respective assets for the purpose of claiming depreciation. According to the AO, the impact of foreign exchange fluctuation can be considered only at the time of actual repayment and not at the intermediary stage. He held that the depreciation claimed by the taxpayer by capitalizing the loss as a result of foreign exchange fluctuation thus was not allowable. The learned CIT(A), however, allowed the said claim of the taxpayer for depreciation relying on the pre-amended provisions of Section 43A as applicable to the year under consideration. 33. At the time of hearing before us, the learned representatives of both the sides have agreed that this issue is squarely covered in favour of the taxpayer by the judgment of Hon'ble Delhi High Court in the case of Woodward Governor India
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Pvt.Ltd. (supra) wherein it was held that in a case where an taxpayer has acquired any capital asset from abroad for the purpose of his business or profession on credit or on deferred payment terms or against a loan in foreign currency and the whole or part of the cost of such asset or of the loan in foreign currency is outstanding as on the date on which there was a change in the rate of exchange of currency, the original actual cost to the taxpayer of such asset is required to be increased or as the case may be reduced correspondingly, inter alia, for the purposes of depreciation. It was also held that the amendment made to Section 43A w.e.f. 1.4.2003 was prospective and would accordingly apply in relation to AY 2003-04 and subsequent years. As the assessment year involved in this appeal is 2001-02, we respectfully follow the judgment of Hon'ble Delhi High Court in the case of Woodward Governor India Pvt.Ltd. (supra) and uphold the impugned order of the learned CIT(A) on this issue. Ground No.8 of the Revenues appeal is accordingly dismissed. 34. The next issue raised in ground No.9 of the Revenues appeal relates to the addition made to the book profits u/s 115JB on account of provision for doubtful debts treating the same as unascertained liability. 35. While computing the book profit u/s 115JB, the taxpayer company had deducted provision for doubtful debts aggregating to Rs.28,81,134/-. According to the AO, the said provision was nothing but an unascertained liability of the taxpayer company and he, therefore, added the same while computing the book profit u/s 115JB. The learned CIT(A), however, deleted the said addition holding that provision for doubtful debts created by the taxpayer company was not a liability, much less an unascertained liability. He held that the same represented provision created towards an asset i.e. debtors and the AO was not justified in adding the said amount while computing the book profit u/s 115JB. 36. After considering the rival submissions and perusing the relevant material on record, it is observed that this issue is squarely covered in favour of the taxpayer by the decision of Kolkata Special Bench of ITAT in the case of Usha Martin Industries 104 ITD 349 wherein it is held that the provision for doubtful debts is not an unascertained liability but the same is the provision created for diminution in the value of assets and the same, therefore, cannot be added/disallowed while computing the book profit u/s 115JB. A similar view has been taken by the Hon'ble Delhi High Court in the case of Eicher Limited 287 ITR 170 cited by the learned counsel for the taxpayer. Respectfully following the said judicial pronouncements, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No.9 of the Revenues appeal. 37. The next issue raised in ground No.10 of the Revenues appeal relates to the levy of interest u/s 234D. 38. In the assessment order, interest u/s 234D was levied by the AO on the amount of excess refund granted to the taxpayer company while processing its return of income originally u/s 143(1). The learned CIT(A), however, noted that the provisions of Section 234D have been introduced in the statute by the Finance Act, 2003 w.e.f. 1.6.2003. According to him, the said provisions thus were applicable only in relation to AY 2003-04 onwards and interest under that provision could not be levied in the taxpayers case involving AY 2001-02.
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39. We have heard the arguments of both the sides and also perused the relevant material on record. It is observed that this issue is squarely covered in favour of the taxpayer by the recent decision of Delhi Special Bench of ITAT in the case of Ekta Promoters Pvt.Ltd. rendered vide its order dated 11.7.2008 in ITA Nos.2551 to 2553/Del/2006 wherein it has been held that interest u/s 234D is chargeable from AY 2004-05 and the same could not be charged for earlier years. Since the assessment year involved in the present appeal is 2001-02, we uphold the impugned order of the learned CIT(A) cancelling the interest levied by the AO u/s 234D respectfully following the decision of the Special Bench in the case of Ekta Promoters Pvt.Ltd. (supra). Ground No.10 of the Revenues appeal is accordingly dismissed. ITA 1189/Del/2005 Taxpayers appeal for AY 2001-02 40. Ground No.1 raised by the taxpayer is general seeking no specific decision from us. 41. The issue raised in ground No.2 relates to the taxpayers claim for deduction u/s 80IA in respect of miscellaneous income and service income which stands disallowed by the AO as well as by the learned CIT(A). 42. While computing the deduction under Section 80IA of the Act, the taxpayer company included Miscellaneous Income of Rs.2,16,97,607/- and Service Income of Rs.21,78,729/- in the profits eligible for deduction. The Assessing Officer, however, recomputed the profits eligible for deduction after excluding Miscellaneous Income and Service Income holding that the same cannot be said to be derived from the industrial undertaking and thus are not eligible for deduction under Section 80IA of the Act. The learned CIT(A) relied upon the decision of ITAT in taxpayers own case for AY 2000-01 rendered vide order dated August 31, 2004 in ITA No.4790/Del/2003 to uphold the action of the AO in excluding Miscellaneous Income of Rs.2,13,89,947/- (after reducing sale of scrap of Rs.3,07,660/-) and Service Income of Rs.21,78,729/- from profits eligible for deduction under Section 80IA. 43. The learned counsel for the taxpayer submitted that the decision of the Tribunal for AY 2000-01 on this issue was not contested by the taxpayer company since it was liable to Minimum Alternate Tax for that year under the special provisions of Section 115JB and reduction in claim of deduction under Section 80IA, therefore, did not have any adverse financial impact on its total tax liability. 44. On merits, he submitted that the Miscellaneous Income was mainly comprising of excess provisions written back, interest received, insurance claims etc. In this regard, he invited our attention to the details of Miscellaneous Income placed on record and submitted that a perusal of the said details makes it amply clear that the entire miscellaneous income originates in the process of carrying on the core business activity of the undertaking. He submitted that similarly Service Income was mainly comprising of income received by the taxpayer company from repairs of goods sold to the customers. He submitted that since the goods sold by the taxpayer were consumer electronic goods, it was pertinent for the appellant to provide appropriate after sales services & support beyond the warranty period to ensure that consumers of goods
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receive good value for their money and quality service. He contended that servicing of these components thus constituted an essential ingredient of the business activity of the taxpayer company and was inextricably linked to the goods being sold by it. 45. As regards the advisory service income received from Sony Corporation of Hong Kong Ltd. in pursuance of an advisory service agreement, he submitted that for carrying out its manufacture and sales operations in the Indian market, the taxpayer company needs to constantly update its knowledge of various technological advancements, customer perceptions and changes in the demand pattern in the Indian market. As a result, it gains substantial knowledge of the sales and marketing practices prevalent in the Indian market and with the aid of this experience and knowledge gained, it renders advisory services to Sony Corporation of Hong Kong Ltd. relating to Sony products. He contended that the advisory services rendered by the taxpayer company thus were technical in nature and the same having been directly based on the experience gained by it during the course of manufacturing activity, there was an inextricable link between the said services and the prime business activity. He also contended that these services having been provided to a foreign company and the taxpayer company having received consideration thereof in foreign exchange, the same, in any case, essentially constituted export of services. 46. The learned counsel for the taxpayer further submitted that even though the decision of Hon'ble Bombay High Court in the case of Bangalore Clothing (supra) was in the context of Section 80HHC, the principle laid down therein shall also apply to Section 80IA. He contended that this matter, therefore, may be remanded back to the AO to examine afresh the nature of each element of Miscellaneous Income and Service Income in the light of the said decision. He also urged that the ratio of the earlier years order of the ITAT in taxpayers own case may not be applied unilaterally to all the items of Miscellaneous Income and Service Income. 47. The learned DR submitted that this issue is squarely covered by the decision of the Tribunal rendered in taxpayers own case for AY 2000-01 vide its order dated 31.8.2004 passed in ITA No.4790/Del/2003. She contended that as the facts involved in the year under consideration are undisputedly similar to AY 2000-01, this issue is required to be decided against the taxpayer following the decision of the Tribunal in AY 2001-02. She invited our attention to the copy of the said order of the Tribunal placed at pages 124 to 146 of the taxpayers paper book and pointed out that the miscellaneous income and service income received by the taxpayer was held to be not eligible for deduction u/s 80IA by the Tribunal holding that the same could not be said to have been derived by the taxpayer company from its industrial undertaking. She submitted that for this conclusion, the Tribunal relied, inter alia, on the judgments of Honble Supreme Court in the case of Cambay Electric Supply Undertaking 113 ITR 84, Sterling Foods 237 ITR 579 and Pandian Chemicals 262 ITR 278 wherein the scope and ambit of the expression derived from as used in Section 80IA was explained by the Honble Apex Court. 48. We have considered the rival submissions and also perused the relevant material on record. It is observed that a similar issue relating to eligibility of service income and miscellaneous income earned by the taxpayer for deduction u/s 80IA had arisen for consideration before the Tribunal in taxpayers own case for AY 2000-01
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and vide its order dated 31.8.2004 (supra), the Tribunal decided the same against the taxpayer for the following reasons given in paragraph No.23 of the said order:23. The next question for our consideration is as to whether the receipts from activity of services and the miscellaneous incomes can be considered to be profits derived from industrial undertaking of the taxpayer. We find that the legal position in this regard is now well-settled by various judgments of the apex court. The decision of the apex court in the case of Cambay Electrical Supply Industrial Co.Ltd. 113 ITR 84 makes a distinction between the expression namely attributable to and derived from. According to the Honble Apex Court, the expression attributable to has a much wider import than the expression derived from, thereby intending to cover receipts from sources other than the actual conduct of the business of the industrial undertaking. In other words, it can be said that there can be receipts which are incidental to the actual conduct of the business yet may not fall within the expression derived from so as to be eligible for the benefits envisaged. The second judgment on the issue is in the case of Sterling Foods 237 ITR 579 (SC). Herein also, the Honble Apex Court opined that where the nexus between income and the industrial undertaking was not direct but was only incidental, it would not fall within the expression profits derived from industrial undertaking. The third decision of the Apex Court is in the case of Pandian Chemicals Ltd. 262 ITR 278. Their Lordships, in the impugned case, were dealing with the question as to whether the interest derived from the deposit with the Electricity Board could be construed as a profit derived from the industrial undertaking for the purposes of deduction u/s 80HH. The Honble Apex Court held that the same was not eligible for the purposes of the claim u/s 80HH. In the instant case before us, we do not find ample ground to hold that the income in relation to the services being rendered by the taxpayer can be said to have been derived from the industrial undertaking of the taxpayer and, therefore, the same has been rightly excluded for the purposes of computing deduction u/s 80IA. Similarly, in relation to items of income comprised in the miscellaneous income, detail of which is placed at page 189 of the paper book filed before us, we find that except for the items a) sale of parts manufactured by the taxpayer in its industrial undertaking and b) scrap sales relating to scrap generated in factory, none of the other incomes can be considered as profits derived from an industrial undertaking. The reason being that the impugned business of the eligible industrial undertaking is of manufacture and the sale of electronic goods and the other receipts cannot be construed to be directly connected with the impugned activity of the eligible industrial undertaking. We do not dispute the fact that such receipts would, on parameters of being incidental to business, can fall within the business of the taxpayer, yet cannot be said to be derived from the eligible industrial undertaking of the taxpayer. Therefore, on this count, we sustain the stand of the taxpayer only to the extent mentioned herein above. Before we part, we may discuss the alternative plea of the appellant that in order to exclude the aforesaid incomes from profits eligible for deduction u/s 80IA, what was required to be excluded was the net income of such activity and not the gross receipts from such activities. We do not find any infirmity in the aforesaid pleas of the taxpayer. For this limited purpose, we remit the issue to the file of the AO to re-work the deduction allowable to the taxpayer u/s 80IA on the
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basis of the aforesaid discussion. The second ground is accordingly disposed of. 49. Before us, the learned counsel for the taxpayer has submitted that the decision of the Tribunal on this issue rendered in AY 2000-01 was not contested by the taxpayer company as the same did not have any adverse financial impact on its total tax liability since it was liable to pay MAT for that year u/s 115JB. He has contended that the said decision, therefore, may not be taken as a binding precedent on merits and the issue may be considered and decided afresh in the present appeal involving AY 2001-02. We find it difficult to accept this contention of the learned counsel for the taxpayer. First of all, he has not been able to point out that there is any distinction between the issue involved in the year under consideration as well as all the material facts relevant thereto than that of AY 2000-01. Moreover, even though an attempt has been made by him to explain the nexus between the miscellaneous income and service income earned by the taxpayer company with its main business, we find that the same was not sufficient to establish that such income having regard to the nature of the main business of the taxpayer company could be said to be derived by its industrial undertaking from the said business. The nexus sought to be explained by him could be sufficient to establish that the said income was incidental to the main business of the industrial undertaking of the taxpayer company but that alone was not sufficient to say that it was the income derived from such business by the industrial undertaking of the taxpayer company within the expression used in Section 80IA as explained by the Honble Supreme Court, inter alia, in the cases of Cambay Electric Supply Undertaking (supra), Sterling Foods (supra) and Pandian Chemicals (supra). In the case of Cambay Electric Supply Undertaking (supra), a distinction between the two expressions viz. attributable to and derived from was clearly made out by the Honble Supreme Court which makes it clear that the receipts which are incidental to the actual conduct of the business may fall within the expression attributable to but the same cannot fall within the expression derived from. In the case of Sterling Foods (supra), the meaning of the expression profits derived from an industrial undertaking again was explained by the Honble Supreme Court by stating that for application of the words derived from, a direct nexus between the profits and gains and industrial undertaking must be there and if such nexus is not direct but only incidental, the same could not be said to be the profits derived from an industrial undertaking. In the case of Pandian Chemicals (supra), Honble Supreme Court reiterated this position by holding that in order to fall within the expression profits derived from an industrial undertaking, the immediate source of earning such income should be the industrial undertaking itself. In the present case, the business of the eligible industrial undertaking of the taxpayer company is to manufacture and sale of electronic goods and keeping in view the nature of this main business, we are of the view that the miscellaneous income and service income earned by the taxpayer could not be said to have been derived from such business by the said industrial undertaking for the purpose of allowing deduction u/s 80IA. As regards the reliance of the learned counsel for the taxpayer on the decision of Honble Bombay High Court in the case of Bangalore Clothing (supra), it is observed that the same was rendered in the context of computation of profits of the business for the purpose of computing deduction u/s 80HHC and as held by their Lordships having regard to the definition given in Explanation (baa) below Section 80HHC, the operational income was eligible to be included in the profits of the business for the purpose of computing deduction u/s 80HHC. The scope of operational income has also been explained by the Honble
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Bombay High Court by pointing out that if any income is generated from the operation of the taxpayers pre-dominant business, the same can be taken into account for the purpose of computing deduction u/s 80HHC. The concept of operational income as explained by the Honble Bombay High Court is thus close to the expression attributable to and as already held by the Honble Supreme Court in the case of Cambay Electric Supply Undertaking (supra), there is a distinction between the expression attributable to and derived from. The decision of Honble Bombay High Court in the case of Bangalore Clothing (supra) or the guidelines laid down therein thus cannot be applied while deciding the issue relating to the eligibility of income for deduction u/s 80IA as the expression used in the said provision is derived from, the scope of which is quite narrow as explained by the Honble Supreme Court in the case of Sterling Foods (supra) by observing that a direct nexus or a first degree connection with the industrial undertaking is must so as to treat any income as derived from the industrial undertaking. We, therefore, find no justifiable reason to take a view on this issue different from the one taken by the Tribunal in any taxpayers own case for AY 2000-01 and respectfully following the order of the Tribunal for that year, we uphold the impugned order of the learned CIT(A) disallowing the taxpayers claim for deduction u/s 80IA in respect of miscellaneous income and service income. Ground No.2 of the taxpayers appeal is accordingly dismissed. 50. The next issue raised in ground No.3 of the taxpayers appeal relates to the taxpayers claim for deduction u/s 80HHC in respect of service income. 51. While computing the deduction u/s 80HHC, the taxpayer company had included service income of Rs.21,78,729/- in the profits of the business. According to the AO, this income was not derived by the taxpayer company from its business and the same, therefore, was not eligible for deduction u/s 80HHC. Accordingly, he excluded the said income from the profits of the business for the purpose of computing deduction u/s 80HHC. The matter was carried before the learned CIT(A) who examined the nature of service income and found on such examination that the said income did not form part of the main business activity of the taxpayer company. He, therefore, upheld the action of the AO in excluding the service income from the profits for the purpose of computing deduction u/s 80HHC. 52. The learned counsel for the taxpayer, at the outset, submitted that service income constituted a part of business income of the taxpayer company which is evident from the fact that in its return of income, the said income was offered to tax under the head profits and gains of business or profession. He submitted that this treatment given by the taxpayer company was accepted by the AO himself while completing the assessment and he, therefore, was not justified in excluding the said income from profits of the business for the purpose of computing deduction u/s 80HHC. Referring to explanation (baa) to Section 80HHC, he submitted that the said explanation provides for certain specific deductions such as rent, interest, brokerage, commission or other receipts of similar nature for the purpose of computing the profits of the business. He contended that as the service income is essentially linked with the prime business activity of the taxpayer company, the same cannot be clubbed with residuary sources of income as specified in explanation (baa) to Section 80HHC which are generally assessable as income from other sources.
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53. The learned counsel for the taxpayer then explained the exact nature of service income received by the taxpayer during the year under consideration in pursuance of an advisory service agreement with Sony Corporation, Hong Kong. In this regard, he submitted that for carrying on the manufacturing and sales operation in the Indian market, the taxpayer company needs to constantly update its various technological advancements, customers perceptions and changes in the demand pattern in the Indian market. According to him, it gains substantial knowledge of the sales pattern and market practices prevalent in the Indian market in process and with the aid of this, advisory services are rendered to Sony Corporation, Hong Kong pertaining to the Sony products. He submitted that the advice so rendered includes, inter alia, advice on marketing plan and strategy for products, making necessary arrangements for release of products and providing marketing support. He contended that these advisory services rendered by the taxpayer company are thus of technical nature and the same being inextricably linked to the experience gained by the taxpayer company during the course of its manufacturing activity, it certainly constitutes operational income eligible for inclusion in the profits of the business as held by Honble Bombay High Court in the case of Bangalore Clothing Co. (supra). He contended that the nature of the service income is required to be seen in the context of the main business activity of the taxpayer company and if it is so done, the said income would certainly constitute operational income of the taxpayer company. He also contended that the service income earned by the taxpayer company is essentially linked with its prime business activity and the same, therefore, cannot be clubbed with residuary sources of income such as rent, brokerage etc. so as to exclude it from the profits of the business for the purpose of computing deduction u/s 80HHC. According to him, the said income in fact clearly constitutes operational income of the taxpayer company having regard to its nexus with the main activity of business and the same, therefore, was liable to be included in the profits of the business as held by Honble Bombay High Court in the case of Bangalore Clothing Co. (supra). 54. The learned DR, on the other hand, submitted that the service income in question was earned by the taxpayer company for the services rendered to its sister concern abroad and keeping in view the nature of such services rendered by it relating to marketing, it cannot be said that it has got any link either direct or even indirect with the main business operations of the taxpayer company. She contended that the said income, therefore, cannot constitute the operational income of the taxpayer as explained by the Honble Bombay High Court in the case of Bangalore Clothing Co. (supra) and the same was liable to be excluded from the profits of the business for the purpose of computing deduction u/s 80HHC as rightly held by the AO as well as by the learned CIT(A). 55. We have considered the rival submissions and also perused the relevant material on record. It is no doubt true that the service income earned by the taxpayer company was shown by it as business income and this treatment was even accepted by the AO. However, this alone was not sufficient to establish that the said income was eligible for inclusion in the profits of business for the purpose of computing deduction u/s 80HHC within the meaning of Explanation (baa). As held by Honble Bombay High Court in the case of Bangalore Clothing Co. (supra)., it is necessary to establish that the said income constituted operational income of the taxpayer company having regard to its main business activity so as to include the same in the profits of the business for the purpose of computing deduction u/s 80HHC. As observed by the
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Honble Bombay High Court in the case of Bangalore Clothing Co. (supra)., it is difficult to lay down any standard test for deciding what would constitute operational income. However, this issue can be decided keeping in view the broad guidelines laid down by the Honble Bombay High Court in the said case. In this regard, it is necessary to ascertain as to what exactly is the dominant business of the taxpayer company and whether the service income had accrued to it as a part of its main business activity. Admittedly, the dominant business of the taxpayer company is to manufacture and sale of electronic goods and having regard to this main activity of the taxpayer company, it has to be seen as to whether the service income accrued to it as a part of the main business activity or whether it accrued out of incidental business. In this regard, it is observed that the nature of service income earned by the taxpayer company is such that it cannot be said that the same was earned by the taxpayer company using its undertaking which manufactured the electronic goods and for the purpose of earning the said income, the expenditure normally incurred for its main activity of manufacture of electronic goods was also not required to be incurred. It is, therefore, very difficult to say that the activity of earning service income was forming part of the manufacturing activity of the taxpayer company and having regard to the nature of the said activity vis--vis the main activity of the taxpayer company, it cannot be said that the service income accrued to it as a part of the main business activity. At the most, the said activity could be treated as incidental business activity of the taxpayer company and the income earned therefrom could be said to be accrued to it out of such incidental business. This view gets support from the decision of Honble Bombay High Court in the case of CIT Vs. K.K.Doshi & Co. 245 ITR 849 wherein the taxpayer firm was in the business of export of polished diamonds out of India. During the relevant year, it undertook work of polishing diamonds on job work/contract basis for third parties in India and the income earned from the said activity in the form of service charges was claimed to be includible in the profits of the business for the purpose of computing deduction u/s 80HHC. This claim of the taxpayer, however, was held to be not allowable by the Honble Bombay High Court observing that the activity of polishing undertaken by the taxpayer firm on job work/contract basis having no nexus with its main export activities, the service charges could not be considered as part of the business profits while working out deduction u/s 80HHC. Keeping in view the said decision of Hon'ble Bombay High Court in the case of K.K.Doshi & Co. (supra) and the broad guidelines laid down in the case of Bangalore Clothing Co. as applied to the facts of the case, we are of the view that there was no infirmity in the impugned order of the learned CIT(A) excluding the service income earned by the taxpayer company from the profits of the business for the purpose of computing deduction u/s 80HHC observing that the same did not form part of its main business activity. The same is, therefore, upheld dismissing ground No.3 of the taxpayers appeal. 56. Ground No.4 raised by the taxpayer in its appeal challenging the inclusion of foreign exchange gain in export turnover as well as total turnover for the purpose of computing deduction u/s 10A/10B has not been pressed by the learned counsel for the taxpayer at the time of hearing before us. The same is accordingly dismissed as not pressed. ITA No.1257/Del/2007 Revenues appeal for AY 2002-03
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57. As regards ground No.1 raised by the Revenue in its appeal for AY 2002-03 being ITA No.1257/Del/2007, it is observed that the issue involved therein relating to inclusion of foreign exchange gain in the profits eligible for deduction u/s 10A/10B is squarely covered in favour of the taxpayer by the decision of Coordinate Bench of this Tribunal rendered in the case of Sujata Grover 74 TTJ 347 wherein it was held that the basic character of receipt on account of foreign exchange remains the same inasmuch as any profit or loss as a result of foreign exchange fluctuation ultimately goes to increase or reduce the figure of export turnover recorded initially by the taxpayer in its books of account. It was held that the income from the foreign currency fluctuation thus is nothing but part of export turnover and is a sort of additional sales price. Respectfully following the said decision of the Tribunal in the case of Sujata Grover (supra), we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No.1 of the Revenues appeal. 58. As regards ground No.2, it is observed that the issue raised therein relating to inclusion of income from sale of scrap in the profits eligible for deduction u/s 80IA is also squarely covered in favour of the taxpayer by the decision of the Tribunal in taxpayers own case for AY 2000-01 rendered vide its order dated 31.8.2004 in ITA No.4790/Del/2003. Respectfully following the said decision of the Tribunal in the aforesaid case, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No.2 of the Revenues appeal. 59. As regards ground No.3 relating to deduction u/s 80HHC in respect of miscellaneous income i.e. sale of scrap, accounts written back etc., it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.2 of the Revenues appeal for AY 2001-02 being ITA No.1181/Del/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No.3 of the Revenues appeal. 60. As regards ground No.4 of the Revenues appeal relating to exclusion of excise duty from turnover for deduction u/s 80HHC, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.2 of the Revenues appeal for AY 2001-02 being ITA No.1181/Del/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No.4 of the Revenues appeal. 61. The issue raised by the Revenue in ground No.5 relating to the taxpayers claim on account of loss due to fluctuation in foreign exchange rate has already been decided by us in the foregoing portion of this order while disposing of ground No.6 of the Revenues appeal for AY 2001-02 being ITA No.1181/Del/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No.5 of the Revenues appeal.
62. As regards ground No.6 relating to the taxpayers claim for depreciation on enhanced WDV of fixed assets as a result of foreign exchange fluctuation, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.8 of the Revenues appeal for AY 2001-02 being ITA No.1181/Del/2005. Following our decision rendered on the said issue, we
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uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No.6 of the Revenues appeal. 63. Ground No.7 raised by the Revenue in this appeal relates to the disallowance of Rs.19,39,976/- made by the AO on account of software upgradation expenses which stands deleted by the learned CIT(A). It is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.5 of the Revenues appeal for AY 2001-02 being ITA No.1181/Del/2005. Following our decision rendered on the said issue, we set aside the impugned order of the learned CIT(A) on this issue and restore the matter to the file of the Assessing Officer for deciding the same afresh in the light of the directions given by us on the said issue. Ground No.7 raised by the Revenue is accordingly treated as allowed for statistical purposes. 64. As regards the issue raised by the Revenue in ground No.8 relating to the addition of Rs.1,68,77,174/- made by the AO on account of brand promotion expenses, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.7 of the Revenues appeal for AY 2001-02 being ITA No.1181/Del/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No.7 of the Revenues appeal. 65. Ground No.9 raised by the Revenue in its appeal for AY 2002-03 relates to the transfer pricing issue which is being considered separately alongwith the relevant grounds raised by the taxpayer relating to the same issue while disposing of the appeal of the taxpayer. ITA No.819/Del/2007 Taxpayers appeal for AY 2002-03 66. Ground No.1 raised by the taxpayer in this appeal is general seeking no specific adjudication from us. 67. Ground No.2 relates to the disallowance of taxpayers claim for deduction u/s 10A/10B in respect of miscellaneous income. 68. The taxpayer company is running two software development centres at Bangalore viz. S.I.S.C. and S.A.R.D. for development of product related and application software. SISC and SARD were eligible for deduction u/s 10A & 10B respectively during the year under consideration. While computing the said deductions, the taxpayer company had included miscellaneous income comprising of notice pay received from employees amounting to Rs.54,017/- and compensation of Rs.83,06,011/- received from Sony International (Europe) GmbH on cancellation of contract for research and development in relation to application software. The Assessing Officer, however, excluded the said miscellaneous income aggregating to Rs.83,60,028/- from the profits eligible for the said deductions stating that the same has not been derived from the business of the undertaking. The action of the AO on this count was confirmed by the learned CIT(A) for the same reasons as given by the AO.
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69. The learned counsel for the taxpayer submitted before us that the notice pay of Rs.54,017/- included in the miscellaneous income was received by the taxpayer company from the employees on their resignation from the employment of its undertaking. He submitted that as the salary of the said employees was claimed as an expense of the undertaking of the taxpayer company, it was only logical that subsequent recovery on account of termination of employment of these employees should also be credited to the respective undertaking. He submitted that the notice pay received from the said employees actually should have been reduced by the taxpayer company from the corresponding salary expenses and only the net amount should have been claimed as expenditure. He contended that the taxpayer company instead shown the notice pay amount separately as miscellaneous income which cannot change the real nature of the transaction. In support of this contention, he relied on the decision of Delhi Bench of ITAT in the case of Jubiliant Enpro Limited 12 SOT 194. He contended that as held in the said decision by the Tribunal, notice pay received from employees represents income derived from the undertaking and it is thus eligible for deduction u/s 10A/10B. As regards the other amount of Rs.83,06,011/- forming part of the miscellaneous income, he submitted that the said amount was received by the taxpayer from Sony International (Europe), GmbH, Germany on account of cancellation of contract awarded by the said company to the taxpayer company in relation to research and development of application software. He invited our attention to the copy of the said agreement placed in his paper book as Annexure-1 and pointed out that Article-6 of the said agreement explicitly provided for the terms of cancellation of contract and related compensation that shall be awarded upon such termination. He contended that since the said agreement was in relation to development of software which is the core business activity of the undertaking, compensation received on breach thereof forms an integral part of the undertaking making it eligible for deduction u/s 10A/10B. He also contended that the entire miscellaneous income in any case originated from the prime business activity of the taxpayer company and the same, therefore, was the income derived from the said activity which is eligible for the said deduction. He submitted that the theory of income derived adopted by the AO as well as by the learned CIT(A) relying on the various judicial pronouncements rendered in the context of various provisions of Chapter VI-A cannot be applied in the present case as the issue involved is relating to the exemption provisions of Section 10A/10B falling under Chapter III which is separate and distinct from Chapter VI-A. 70. The learned DR, on the other hand, submitted that only the income derived from the export of software is eligible for deduction u/s 10A & 10B and unless there is a direct nexus between the miscellaneous income and the main business of the undertaking, such income cannot be said to be derived from the said business in order to be eligible for deduction u/s 10A & 10B. She contended that the income in question received by the taxpayer on account of notice pay from employees and compensation for cancellation of contract had no such direct nexus with the business of export of software and the same, therefore, could not be said to be derived by the taxpayer company from the business of its undertaking. She contended that the same at the most could be treated as income incidental to the business of the taxpayers undertaking which is not eligible for deduction u/s 10A & 10B going by the expression derived from used in the said provisions.
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71. We have considered the rival submissions and also perused the relevant material on record. As regards the claim of the taxpayer company for deduction u/s 10A/10B in respect of notice pay of Rs.54,017/- received from its employees, the learned counsel for the taxpayer has relied on the decision of the Tribunal in the case of Jubiliant Enpro Limited (supra) in support of the taxpayers case. A perusal of the order of the Tribunal passed in the said case, however, shows that the issue involved therein was relating to the eligibility of income earned by the taxpayer in the form of interest on fixed deposits for exemption u/s 10A and in this context, it was held by the Tribunal that even if it is assumed for the sake of arguments that the word any qualifying the words profits and gains gives a wider scope to the exemption u/s 10A, it was still required to be established by the taxpayer that the said income was derived from the industrial undertaking by showing that industrial undertaking was the direct and immediate source of the income. Explaining further, it was observed by the Tribunal that even if one has to construe the word any as meaning all as sought to be contended on behalf of the taxpayer, the ambit and sweep of the words any profits and gains are restricted by the words derived by an taxpayer from an industrial undertaking following those words giving rise to the conclusion that only those profits which are having immediate source in the industrial undertaking can enjoy the exemption and not those profits whose immediate source is not the industrial undertaking but something removed therefrom. Keeping in view this ratio of the decision of the Tribunal in the case of Jubiliant Enpro Limited (supra), we find that the notice pay received by the taxpayer company from its employees cannot be said to have its immediate source in the industrial undertaking so as to make it eligible for deduction u/s 10A as claimed by the taxpayer. Moreover, the notice pay received by the taxpayer company from its employees is not certainly reimbursement of the salary expenses incurred by the taxpayer company and the same, therefore, cannot be adjusted against such expenditure as sought to be contended by the learned counsel for the taxpayer. We, therefore, hold that the notice pay received by the taxpayer company from its employees was not eligible for deduction u/s 10A as rightly held by the AO and the learned CIT(A) was fully justified in upholding the action of the AO on this issue. The impugned order of the learned CIT(A) on this issue is accordingly upheld. 72. As regards the other amount of Rs.83,06,011/- forming part of miscellaneous income, it is observed that the said amount was received by the taxpayer company from Sony International (Euro), Germany on account of cancellation of a contract. The said contract was awarded by Sony International (Euro) to the taxpayer company in relation to research and development of application software in its centre located at Bangalore. As already noted, the said centre at Bangalore was set up for development of product related and application softwares and the contract undertaken by it in relation to research and development of application software for Sony International (Euro) thus was a part of its main activity carried on at Bangalore centre. The said contract was to be executed as per the terms and conditions of the agreement entered into between the taxpayer company and Sony International (Euro) and Article-6 of the said agreement had explicitly provided for the terms of cancellation of the contract and related compensation that shall be awarded upon such termination. As the work undertaken under the said agreement was in relation to the development of software which is the main business activity of its undertaking eligible for deduction u/s 10B, the compensation received by the taxpayer company on cancellation/termination of the said contract/agreement, in our opinion, was integral part of its main business.
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There was thus a clear and direct nexus between the amount of Rs.83,06,011/received by the taxpayer company as compensation for cancellation of the contract and the main business of software development of its undertaking at Bangalore and the said income forming part of the said main business of the undertaking was eligible for deduction u/s 10B being derived from the said undertaking. For the application of words derived from, there should be a direct nexus between the income and the industrial undertaking and once such nexus is established, the said income certainly constitutes the income derived from such undertaking. As such, considering all the facts of the case, we are of the view that the amount of Rs.83,06,011/- received by the taxpayer company on account of cancellation of contract entrusted to it in relation to development of software constituted its profit derived from the undertaking eligible for deduction u/s 10B and the deduction under that Section was rightly claimed by it in respect of the said income. In that view of the matter, we set aside the impugned order of the learned CIT(A) on this issue and direct the AO to allow the deduction under Section 10A/10B in respect of compensation amounting to Rs.83,06,011/- as claimed by the taxpayer company. Ground No.2 of the taxpayers appeal is thus partly allowed. 73. As regards ground No.3 of the taxpayers appeal relating to its claim for deduction u/s 80IA in respect of miscellaneous income and service income which stands disallowed by the AO as well as by the learned CIT(A), it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.2 of the Revenues appeal for AY 2001-02 being ITA No.1189/Del/2005. Following our decision rendered on the said issue, we reverse the impugned order of the learned CIT(A) and direct the Assessing Officer to allow the claim of the taxpayer on this issue and allow ground No.3 of the taxpayers appeal. 74. As regards the issue raised by the taxpayer in ground No.4 relating to its claim for deduction u/s 80HHC in respect of service income, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.3 of the Revenues appeal for AY 2001-02 being ITA No.1189/Del/2005. Following our decision rendered on the said issue, we reverse the impugned order of the learned CIT(A) on this issue and direct the Assessing Officer to allow the claim of the taxpayer and allow ground No.4 of the taxpayers appeal. 75. The next issue raised in ground No.5 relates to the disallowance made on account of prior period expenditure. 76. The taxpayer company had incurred a sum of Rs.6,81,551/- on account of retrospective price revision made by its vendor M/s Dakshin Speakers. The deduction for the said amount was claimed by the taxpayer originally in AY 2003-04 which was, however, not allowed by the AO on the ground that the relevant expenses pertained to the earlier year. The taxpayer company, therefore, revised its return filed for AY 2002-03 and claimed the said deduction in that year which again was disallowed by the AO stating that the taxpayer company could not justify its claim for the said deduction in AY 2002-03. 77. The learned counsel for the taxpayer submitted before us that the expenses on account of price revision claimed by the taxpayer company in its books of account for AY 2003-04 were categorized by the auditors as prior period expenses since the price
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revision pertained to the transactions concluded in AY 2002-03. He submitted that relying on the said comment of the auditors, the deduction claimed by the taxpayer company on account of price revision was appropriately disallowed by the AO in AY 2003-04. He contended that the AO, however, disallowed the claim of the taxpayer for deduction of the said amount in AY 2002-03 again which was not justified as the transactions in respect of which there was a price revision had been admittedly concluded in AY 2002-03. According to him, the deduction on account of the said amount thus has been disallowed by the department in both the years i.e. AY 2002-03 & 2003-04 which has caused a genuine grievance to the taxpayer. The learned DR left this issue to the Tribunal to be decided in accordance with law. 78. After considering the rival submissions and perusing the relevant material on record, it is observed that the expenditure of Rs.6,81,551/- claimed by the taxpayer company in AY 2003-04 on account of retrospective price revision made by its supplier was categorized by the auditors as prior period expenses being pertained to AY 2002-03 and relying on the said comment of the auditors, the claim of the taxpayer for deduction on account of the said expenditure was disallowed by the AO. Thus, a definite stand was taken by the AO relying on the auditors comment that the said expenditure was actually pertaining to AY 2002-03 and this being so, we are of the view that the deduction claimed by the taxpayer for the said expenditure in AY 2002-03 should have been allowed by the AO. As rightly contended by the learned counsel for the taxpayer before us, there was no justification in disallowing the said deduction in both the years i.e. AY 2002-03 & 2003-04 as done by the AO. We, therefore, direct the AO to allow the claim of the taxpayer for deduction on account of the expenditure of Rs.6,81,551/- in question incurred by the taxpayer on account of retrospective price revision made by its supplier in AY 2002-03. Ground No.5 is accordingly allowed. 79. The next issue raised in ground No.6 of the taxpayers appeal for AY 2002-03 relates to the disallowance made on account of expenditure incurred by the taxpayer company on training of its employees. 80. During the year under consideration, a sum of Rs.66,13,440/- was spent by the taxpayer company on training of its employees and the same was claimed as revenue expenditure deductible u/s 37(1) on the ground that it was incurred in order to increase the efficiency of the employees in their day to day working. According to the AO as well as learned CIT(A), the benefit of the said expenditure incurred on employees training, however, was accrued to the taxpayer company at least over a period of two years and therefore relying on the decision of Hon'ble Supreme Court in the case of Madras Industrial Development Corporation 225 ITR 802, the expenses incurred by the taxpayer company on training of its employees were disallowed by them to the extent of 50%. 81. The learned counsel for the taxpayer submitted that the training imparted to its employees by the taxpayer company was only intended to improve their day to day working efficiency and as such, the expenses incurred on such training did not result in any benefit of enduring nature to the taxpayer company. He contended that it is settled position that whenever an expenditure has been incurred for facilitating taxpayers business operations or enabling its efficient conduct, the same is of revenue nature even though it may give rise to some benefit of enduring nature. In
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support of this contention, he has relied on the decision of Hon'ble Supreme Court in the case of Alembic Chemical Works Co.Ltd. 177 ITR 377 and in the case of Associated Cement Companies Ltd. 172 ITR 257. He also relied on the decision of Honble Calcutta High Court in the case of Hindustan Aluminum Corporation Ltd. 159 ITR 673 and that of Hon'ble Supreme Court in the case of Royal Calcutta Turf Lug - 41 ITR 414 and submitted that the expenses incurred on training of employees in these cases to achieve efficient running of business was held to be revenue in nature. He also submitted that the decision of Hon'ble Supreme Court in the case of Madras Industrial Development Corporation (supra) relied upon by the Revenue is clearly distinguishable on facts as the issue involved therein was relating to the allowability of discount on issue of debentures which was held to be liable for spreading over the life of debentures. 82. The learned DR submitted that the substantial expenditure incurred by the taxpayer company for imparting training to its employees had definitely given a benefit of enduring nature to it and since the disallowance made by the AO out of the said expenditure to the extent of 50% assuming that such benefit had accrued for a period of two years only was quite fair and reasonable, the learned CIT(A) was fully justified in confirming the same. 83. We have considered the rival submissions and also perused the relevant material on record. It is by now well-settled that if the expenditure incurred by the taxpayer is of revenue nature, the same is entirely deductible even if there accrues an advantage of enduring nature in favour of the taxpayer as a result of the said expenditure. This is because going by the very nature of the expenditure being revenue, it operates in the revenue field leaving the capital field untouched. The enduring benefit resulting from the said expenditure may justify the action of the taxpayer to write off the said expenditure in his books of account over a period of more than one year. However, such accounting treatment by itself is not conclusive to decide the nature of the relevant expenditure, whether capital or revenue. In the case of Amar Raja Batteries Limited Vs. DCIT 91 ITD 280, Hyderabad Bench of ITAT has held after taking into consideration the decision of Hon'ble Supreme Court in the case of Madras Industrial Investment Corporation Limited (supra) that even though the taxpayer had written off the expenditure in its books of account over a period of five years, it must be allowed in its entirety in the year in which it was incurred if it was the revenue expenditure and if it was wholly and exclusively incurred for the purposes of its business. In the present case, there is no dispute that the expenditure in question incurred by the taxpayer company on training of its employees was wholly and exclusively incurred for the purpose of its business. As regards the nature of the said expenditure, the submission of the taxpayer company before the authorities below as well as before us has been that the said expenditure was incurred for the purpose of imparting training to its employees in order to increase their efficiency in day to day working and there is nothing brought on record on behalf of the Revenue to controvert/rebut this position. In the case of Hindustan Aluminum Corporation Limited (supra) cited by the learned counsel for the taxpayer, the expenditure incurred on practical training and experience of its employees by the taxpayer company in order to achieve efficient running of factory for getting optimum production was held to be a revenue expenditure by the Hon'ble Calcutta High Court observing that the same was directly linked to profit earning process. In the case of CIT Vs. Associated Cement Companies Ltd. (supra), the advantage secured by the taxpayer by incurring
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the expenditure was absolution or immunity from liability to pay municipal rates or taxes for a period of fifteen years and as the said liability was on revenue account, it was held by the Hon'ble Supreme Court that the expenditure incurred was of revenue nature as the advantage secured was in the field of revenue and not capital. In the present case, the expenditure incurred by the taxpayer company on imparting training to its employees in order to increase their efficiency in day to day working was in the revenue field and this being so and keeping in view the legal position emanating from the judicial pronouncements discussed above, we hold that the same was entirely deductible in the year under consideration as rightly claimed by the taxpayer. The impugned order of the learned CIT(A) confirming the disallowance made by the AO to the extent of 50% on this issue is, therefore, reversed and the AO is directed to allow the said expenditure in full. Transfer Pricing Issue involved in AY 2002-03 84. Ground Nos.7 to 11 raised in the taxpayers appeal and ground No.9 raised in the Revenues appeal involve issues relating to transfer pricing and pertain to the addition made by way of adjustments under Section 92CA of the Act by determining higher arms length price than disclosed by the taxpayer in the international transactions carried with its associated enterprises AEs". 85. The taxpayer Sony India (P) Ltd. (Sony India) is a wholly owned subsidiary of Sony Corporation, Japan (Sony Japan). Sony Japan is a global leader in consumer electronics business. Its product profile includes audio and video products, televisions, projectors, play stations, media tapes, motion pictures, insurance, leasing and credit card, satellite distribution and other allied businesses. However, consumer electronics business alone contributes about 68% of total revenue of Sony Corporation. 85.1 Sony India is engaged in assembly and distribution of colour televisions and audio products. It also distributes high-end electronic goods (DVDs and HandyCams), recordable media tapes, play stations, projectors and spare parts of these goods imported from its associated enterprises (AEs). Most of the revenues are generated from assembly and sale of colour televisions and trading of other electronic goods. The company also renders advisory services and software development services to its AEs. 85.2 Sony India does not have any intangibles and does not invest in research and development (R&D) although it is bearing all risks of an assembler and distributor as are inherent in these lines of business. The taxpayer also assumes normal risk of business like foreign exchange risk, price/market risk, product liability risk and inventory risk. 86. The taxpayer submitted its return of income for AY 2002-03 in October 2002 showing a total income of Rs.87,108,860. Subsequently, a revised tax return was submitted on March 31, 2003 in which total income was shown at Rs.86,746,730. The Assessing Officer (AO) on scrutiny of accounts found that the taxpayer had carried out the following transactions with its associated concerns: Annexure 1
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Details of international transactions entered into by the appellant Sl.No. Value (Rs. Crores) & rounded off for the sake of clarity Import of components used in manufacturing of 169.9 colour TVs and audio products Import of finished products for resale 58.75 Export of 21 inches Wega TV 9.2 Software services provided to AEs 15.43 Marketing advisory services provided to AEs 4.04 Reimbursement of advertisement expenses 14.88 Import of moulds 0.62 Reimbursement for defective CRTs and rebate 0.71 received Services received for IT, communication and 1.14 sharing of best practices International transaction
1. 2. 3. 4. 5. 6. 7. 8. 9.
86.1 The taxpayer had imported electronic components and CRTs from its associated concerns and had claimed that above items were acquired at Arms Length Price and for that purpose had relied upon Transactional Net Margin Method (TNMM). It had chosen the foreign AEs from whom the components were imported as tested parties and had computed the profit of AEs with comparable chosen from Indian and other data bases. The same method was chosen for the distribution activities relating to high-end electronic products, projector tapes etc. where the taxpayer was taken as a tested party. Operating profit margin on sales had been chosen as the profit level indicator (PLI). Likewise, TNMM analysis were also employed to justify fees received for advisory services to Sony Singapore and profit earned by the taxpayer. All international transactions (IT) were claimed at arms length. The AO referred question of determination of arms length price to the Transfer Pricing Officer (TPO). 87. On consideration of facts and circumstances of the case, the TPO accepted fees received by taxpayer for software development services rendered to its AEs was at arms length. The TPO also agreed that TNMM method was rightly applied. The TPO, however, did not agree that foreign AEs could be taken as tested parties while determining Arms Length Price of imported electronic components and finished goods. The TPO asked the taxpayer to give fresh transfer pricing report taking the taxpayer as a tested party and Indian entities as comparable. The taxpayer accordingly furnished information on above lines. In the course of proceedings before us, the taxpayer did not rely upon transfer pricing report furnished by it in Form 3CEB but raised objection on Arms length Price computed by the TPO and on appeal by the CIT(A). It is therefore not necessary for us to refer to in detail the basis of Arms Length Price furnished by the taxpayer in Form 3CEB or on the tested parties taken by the taxpayer in this case. 87.1 The TPO was also of the view that trading and manufacturing activities of the taxpayer should not be considered together for comparison and for determination of ALP, although taxpayer had claimed that trading activity was inter-linked and 28 http://www.itatonline.org
integrated with its manufacturing activities. It was further submitted that because of this intertwining of transactions and activities, it was not possible to reliably compute profit margin from the manufacturing and trading activities separately. The TPO, however, found that in its TP documentation the taxpayer had shown profit margin from its trading operations separately at 3.20% (Annexure 15 of the TP report). The TPO further found that in functional and economic analysis furnished by the taxpayer, the existence of close integration of manufacturing and trading activities was conspicuously absent. He therefore rejected above contention of the taxpayer. For taking profits from manufacturing and trading activities separately, the TPO in his report further observed as under:Two sets of transactions can be closely interlined only when they impact each others profitability in a material manner. No such conclusion can be arrived at in these sets of facts. The TP reports approach is contrary to the claim forwarded during the proceedings. It is an implicit rejection of separate analysis of the trading activity under TNMM. The onus to explain this departure and to sort out the void created by this rejection rests on the taxpayer which has not been discharged. In the long arguments as also in oral submissions, Shri Bhutani, the ld. representative of the taxpayer, did not challenge above action of the TPO. Further, no reference was made before the Tribunal to any consolidated figures. Accordingly, we do not deem it necessary to carry further discussion on this point. MOST APPROPRIATE METHOD 87.2 The TPO agreed that TNMM was the Most Appropriate Method in the circumstances as it is more tolerant to functional differences and accounting differences at gross level gets eliminated due to a comparison at net level while selection of comparables. The TPO further observed that no internal TNMM was possible and, therefore, external independent enterprises engaged in similar functions were identified. Such process was carried out through screening of PROWESS Database. For selection of comparable companies engaged in similar functions, following filters were applied:Steps Nature of the filter applied Reasons Filter 1 To filter those companies that are in the To identify the larger set of manufacturing industry comparables in manufacturing industry which is the business function under analysis Filter 2 To identify companies having economic To identify companies activity and product profile as manufacture of having similar economic Domestic Appliances, Color TV receivers & activity and product profile Home Theatre, Refrigerators, Video Tape as that of the taxpayer recorder systems, Programmable Washing company Machines, Air conditioners, Audio assemblies etc. Filter 3 Exclude those companies with negative net To exclude those worth companies with huge liabilities and dwindling
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Filter 4
Exclude those companies with sales less than 100 crores
Filter 5
To exclude those companies whose manufacturing sales, as a percentage of total sales is less than 90%
Filter 6
To exclude companies having controlled party transactions
profitability To exclude those companies with relatively lower turnover as compared to the taxpayer company, to bring about parity for economies of scale To identify those companies which are substantively into manufacturing activity which is the focus of our analysis To identify companies with uncontrolled transaction
As a result of the above search process, four companies were identified (i) BPL Limited (ii) Videocon Appliances Limited (iii) Videocon Communication Limited (iv) Videocon International Limited 88. The taxpayer objected to the selection of above enterprises for comparison. The BPL Limited was stated to have carried on transactions with related parties. The TPO accepted this objection and excluded BPL as a comparable company. The TPO took operating margin on sale as Profit Level Indicator (PIL) of comparable and the taxpayer. 88.1 The taxpayer also submitted that five more companies engaged in the business of manufacturing consumable electronics be included in the list of comparables. These were as under:(a) (b) (c) (d) (e) B S Refrigerators Ltd. Godrej Appliances Ltd. Hitachi Home & Life Solutions (India) Ltd. Carrier Aircon Ltd. Whirlpool of India Ltd.
89. The TPO accepted B.S. Refrigerators Ltd. as a comparable entity but rejected other companies as they were engaged in different activities. Carrier Aircon Ltd., Whirlpool of India Ltd. and Hitachi Home & Life Solutions (India) Ltd., according to the TPO, had comparable controlled transactions with related parties for benchmarking and, therefore, not fit to be taken as comparable companies. Godrej Appliances Ltd. was showing persistently heavy losses and was, therefore, not accepted as comparable by the TPO. Accordingly, the operating margin was worked by the AO at 9.01% as under:Name of the company Operating Profit Margin on Sales
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BS Refrigerators Ltd. Videocon Appliances Limited Videocon Communication Ltd. Videocon International Ltd. Arithmetic Mean
(OP/Sales) Weighted Average Mean for the f.yrs. 99-2000 and 2000-2001 4.47% 14.06% 4.06% 9.42% 9.01%
90. The taxpayer for working out its operative margin claimed deduction and benefit for not having any tangible property or R&D unit before TPO. It was urged that taxpayer was not bearing risks and was getting no return on account of nonavailability of intangibles and research and development activities like the comparables taken into consideration. The TPO accepted above argument and thought it reasonable to allow deduction of 20% out of mean margin of profit of comparables. Therefore, instead of 9.01% calculated as above, he took 80% thereof i.e. 7.2% as operating average profit for purposes of comparison and for determination of Arms Length Price. In order to determine the operating profit of the taxpayer, the TPO made some adjustments of expenses claimed in the accounts by the taxpayer. He found that in its TP report, the taxpayer had not compared profit margin on its manufacturing activities as it had chosen overseas AEs as tested parties. The taxpayer was asked to furnish segmental accounts of manufacturing and trading activities. This was done. 90.1 On examination of taxpayers accounts, the TPO found that taxpayer had received Rs.14.88 crores as assistance from its AEs Sony Marketing Asia Pacific, Singapore and Sony, UAE to meet its advertisement and selling expenses. He found that out of total advertisement and selling expenses of Rs.40.85 crores, only Rs.25.97 crores were shown in profit and loss account by netting off the reimbursement of Rs.14.88 crores. The TPO did not find any force in detailed arguments submitted by the taxpayer that expenses were shared between the taxpayer and its associated concerns for marketing of Sony products in Asia Pacific region and that taxpayer would not have incurred the expenses but for commitment of reimbursement by its AEs under written agreements and that all the expenditures were incurred wholly and exclusively for purposes of business and to promote sales. The TPO held that amount of reimbursement received from AEs could not be taken as part of operating profit. The TPO for excluding reimbursement has observed as under:11.4.4 Whether an expenditure is operating or non-operating does not depend on the source of its funding. The source of an expenditure may be traced back to equity, debt or a windfall gain but the source does not characterize the purpose of such expenditure. In this case, if the associated enterprise had chosen to fund the advertising campaigns of new product launches not through reimbursements but through equity contribution or through an unsecured loan, it would not have been possible for the taxpayer to claim that the said expenditure was not an operating expenditure. The mere fact that the expenditure was received as assistance does not make it a non operating expenditure. As noted earlier, trading and manufacturing activities of the taxpayer were considered separately for benchmarking. According to the TPO, the taxpayer had shown profit 31 http://www.itatonline.org
margin of 3.93% from trading. However, after adjustment, the profit margin from trading operation was computed by TPO at 1.64% which was obviously below the Arms Length margin of 3.93%. The TPO was, therefore, of the view that adjustment on account of purchases of items was to be made by applying margin of 5.57% (3.93 + 1.64) which he applied to Rs.116,75,77,000. Thus, total value of international transactions was taken at Rs.52,24,36,416 against Rs.58,74,70,454 shown in books and an adjustment of Rs.65,034,038 was directed to be made as per calculation below:Amount of adjustment = 5.57% of Rs.1,167,577,000= Rs.65,034,038 Total value of international transactions pertaining = Rs.587,470,454 to import of finished goods Arms Length price = Rs.587,470,454 Rs.65,034,038 = Rs.522,436,416 Difference in % terms between ALP and International Transactions = 12.44% 12.11 Proviso to Sec. 92C(2) permits a maximum variance of 5% from the Arms length Price. In this case the difference of 12.44% being more than 5% is not acceptable. Hence it is concluded that the price adopted by the taxpayer have to be reduced by Rs.65,034,038 which is 11.07% of the value of the international transactions. Therefore, 88.93% of the international transaction value becomes the arms length price. The ALP for different groups of transactions is summarized in the table below:-
Amount paid as per Arms Length Price books (88.93% of Amount paid) 497,313,650 Purchases from Sony Rs. 559,219,217 Marketing Asia Pacific, Singapore Purchases from Sony Rs. 5,166,951 4,594,970 Computer Entertainment Europe Ltd. Purchases from Sony Rs. 23,084,286 20,528,855 Corp, Hong Kong Total Rs. 587,470,454 522,436,416 12.1.2 The Assessing Officer, therefore, shall make an addition of Rs. 65,034,038 to the total income of the taxpayer on this account.
Transaction Description
The TPO also directed to make the following adjustment in manufacturing profit of the taxpayer:12.2 Manufacturing (customers) Activity for Sales Made to Unrelated parties
As discussed supra the operating profit margin of the manufacturing activity was computed after making allocation of advertising and selling http://www.itatonline.org
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expenses at 1.47%. For a TNMM analysis a set of comparables had been chosen; their mean margin on sales had been worked out to be 9.01%. The difference between the two, i.e. 7.2(-)1.47 = 8.67% of the trading sales is the adjustment to be made in the transfer prices in respect of import of finished goods to bring them at arms length. Amount of adjustment = 8.67% of Rs. 4,003,240,000 = Rs.347,080,908 Total value of international transactions pertaining to = Rs. 1,699,736,071 Import of finished goods Arms Length Price = Rs.1,699,736,071 Rs.347,080,908 = Rs.1,352,655,163 Difference in % terms between ALP and International Transactions = 25.65% 12.2.1 Proviso to Sec. 92C(2) permits a maximum variance of 5% from the Arms Length Price. In this case the difference of 25.65% being more than 5% is not acceptable. Hence it is concluded that the price adopted by the taxpayer have to be reduced by Rs.347,080,908 which is 20.41% of the value of the international transactions. Therefore, 79.59% of the international transaction value becomes the arms length price. The ALP for different groups of transactions summarized in the table below.
Name of the Associated Transaction Enterprise (AE) Amount (in Rs.)
Sony Electronics (Singapore) Pte.Ltd. (SES) Sony Electronics (Singapore) Pte. Ltd. Sony Display Device Division (SDD) Sony Electronics (Malaysia) SDN BHD, (SEM) Sony Corporation, Tokyo (SC) Sony Trading International Corporation (STIC) Sony Technology Malaysia SDN BHD (STM) Shanghai Suoguang Visual Products Co. Ltd. (SSV) Total
512,172,310/604,101,283/-
Arms Length Price (79.59% of Transaction Amount) 407,637,942 480,804,211
826,893/190,604,872/-
658,124 151,702,418
353,511,552/38,519,161/1,699,736.071/-
281,359,844 30,657,400 1,352,655,163
12.2.2 The Assessing Officer shall, therefore, make an addition of Rs.347,080,908 to the total income of the Taxpayer. 91. The TPO also found that the taxpayer had exported 8680 units of 21 inches Television for Rs.9964.65 each to Sony Japan. The TPO found that sale price of TV 33 http://www.itatonline.org
sold to independent distributors in India was ranging between Rs.20,000 to Rs.17,000 as detailed in para 12.3 of its order. The TPO rejected taxpayers submissions that these TVs were manufactured in unutilized idle capacity of the taxpayer and were sold at Arms length Price. After applying TNMM method and taking operating profit on total cost, the Arms Length Price of these TVs were taken at Rs.104,676,127. This way, an adjustment (addition of Rs.12,025,988) was made on this account. The TPO also excluded certain expenses claimed under some heads by the taxpayer while working margin of profit by holding them non-operating. These adjustments are also challenged by the taxpayer in appeal and we shall refer to them in detail a little later. On the basis of above discussion, the TPO in its order directed the following adjustments:14.1 The net addition to be made by the Assessing Officer to the total income of the taxpayer is the sum of following figures: Adjustment on account of manufacturing activity for non AE sales Rs.347,080,908 Adjustment on account of trading activity Rs. 65,034,038 Adjustment on account of manufacturing activity for AE sales Rs. 12,025,988 ---------------------Total Rs. 424,140,934 --------------------14.2 The Assessing Officer, therefore, shall enhance the total income of the Taxpayer company by an amount of Rs.424,140,934. 92. The Assessing Officer adopted above adjustments suggested by the TPO and passed assessment order in conformity with the order of the TPO as far as international transactions with associated enterprises were concerned. He also made addition under the other heads and computed total income of the taxpayer at Rs. 59,92,40,000. 93. The taxpayer impugned above addition and adjustment in appeal before the CIT (Appeals). Number of legal and technical objections were raised against the approach adopted by the TPO and the Assessing Officer. On these objections, the learned CIT (Appeals) sought a remand report from the Assessing Officer/TPO. After considering facts and circumstances of the case and the report of the TPO as also arguments of the A.O., the learned CIT (Appeals) did not find any force in objections on violation of principle of natural justice, on not providing sufficient opportunity of being heard, on order of TPO being not binding on the A.O., on validity of reference to the TPO and on choice of the tested party. All these objections raised on above issues were rejected by the learned CIT (Appeals) after a detailed discussion. Above issues have not been carried in further appeal. No reference was made to above objections in oral or in the written submissions by the ld. Authorized Representative of the taxpayer. Therefore, we do not deem it necessary to refer to the finding recorded by the learned CIT (Appeals) on above issues. 93.1 The learned CIT (Appeals) held that for purposes of transfer pricing evaluation, each and every transaction should be taken as a distinct and separate
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transaction. Profit of each segment should be separately worked out through an accepted method of evaluation. In support of above finding the learned CIT (Appeals) relied upon para 1.42 of OECD Guidelines. It was accordingly held that stand taken by TPO in treating assembly and distribution as separate business segment was correct. The learned CIT (Appeals) also quoted from taxpayers reply dated 18.3.2005 to show that segmented figures of margin of profit were furnished by the taxpayer. It was held that taxpayer was now changing its stand. 93.2 On the objection of the taxpayer that the selection of the comparables and screening process adopted by the TPO was flawed, the learned CIT (Appeals) noted various criteria adopted by the TPO for the purposes of screening and carrying search on prowess to identify and select comparables. The learned CIT (Appeals) considered the comparable enterprises and held that selection of comparables by the TPO was correct. The learned CIT (Appeals) held that exclusion of Godrej Appliances and selection of Videocon International and other entities for purposes of comparison was correct and was fully justified. The learned CIT (Appeals) accordingly upheld the action of the TPO on selection of comparables. 93.3 The claim of taxpayer that 8,680 colour T.Vs were manufactured and exported to Sony Japan to utilize idle facilities and to enable the company to improve recovery of its fixed assembly cost was also carefully considered. It was submitted before the ld. CIT(Appeals) that under-utilization of capacity of the plant was evident from the financial statement of the taxpayer that was in possession of the TPO. The taxpayer further claimed that colour T.Vs were exported at ALP and this submission was supported with reference to the following chart noted by the ld. CIT(A) in the impugned order :Particulars Model Sales Value Less: Excise duty @ 16% Less: Sales tax @ 14% Less: Other taxes @ 1% Add: Export benefit @ 18% Comparative prices Local Sales KV-XA21P80 Per Unit 16,138 1,929 2,010 144 12,056 Export KV-XA21P80 Per Unit 10,674
1,921 12,595
93.4 The learned CIT (Appeals) did not record any finding on above claim but noted further submissions of the appellant and rejected them, with the following observations: In this regard, the AR submitted that the pricing of the products has to be competitive and has to take the overhead costs of the export transaction into account. For instance, freight is disproportionately large in the export of consumer electronic products since the value / volume ratio in case of such products is usually very law. Further, the appellant received export benefits under the DEPB to engage in the export sales. Taking into account such factors, the export prices would be more beneficial than the price fetched by the same product in the domestic market. 35 http://www.itatonline.org
(v) The ld. AR further submitted that it operated in a limited risk environment. In the absence of comparable companies operating under similar circumstances, i.e., marginal costs, the appellant has chosen full fledged manufacturers of consumer electronics as comparables. Since a full fledged manufacturer operating under uncontrolled environment would normally undertake more functions (marketing, sales, after sales support) and risks (warranty risk, business risk, credit risk etc.) as compared to the appellants export transaction, their operating margins are likely to be higher than those of a company exporting under contracts with its related party. Hence, an adjustment is warranted for such differences in functions and risks. However, no adjustment has been made by the learned TPO on account of the difference in risks undertaken by the appellant vis-avis uncontrolled entities. 20.3 On considering of ld. ARs argument, I find that the AR has put forward the theory of marginal cost to substantiate the fact that exports made to its AEs are at arms length. On going through the TP order dated 11.03.05, para 12.3, I find that the TPO has rejected the contention of the appellant assigning detailed reasons. As regards ld. AR contentions, I find that the same are general in nature and nothing specific could be established. However, specific items, which are affecting the calculation of mean margin/marginal profits, have been discussed in detail and necessary findings have been given in this order to that extent. Thus, this ground of appeal is rejected. 93.5 The learned CIT (Appeals) then referred to and considered taxpayers objection about exclusion of advertisement reimbursement receipt to the extent of Rs 14,40,29,400/- from Sony Marketing Asia Pacific Pvt. Ltd. and Sony Gulf as these were rightly shown in accounts as operating expenses. The taxpayer had contended that as per OECD Guidelines on transfer pricing, transactions actually undertaken by parties were to be considered. Even under Matching Principle of taking expenses with receipts was ignored by the TPO. Similar exclusion from the operating profit were not made in other comparables. The taxpayer also relied on Indian Accounting Standard12 (AS-12). The submissions made before the TPO were also reiterated. The learned CIT (Appeals), however, held that reimbursement by A.E on account of advertisement was not part of operational receipt and, therefore, rightly excluded by the TPO. 94. The taxpayer also challenged before the ld. CIT(A) the exclusion of certain items of other income while working out the operating margin. Details of such items and the relief allowed by the learned CIT(A) on this issue are as under:Amount (000) Service Revenue 9,192 Scrap Sale 4,130 Rebate Received 5,184 Provision W/Back 5,702 Balances written back 3,548 Insurance claim received 1,772 Reimbursement against defective CRTs 2,071 Interest Received from customers for 1,631 36 Particulars in Rs Relief allowed by CIT(A) 9,192 4,130 5,184 Nil Nil Nil 2,071 Nil http://www.itatonline.org
delayed payment Other Misc. Revenue Total
6,739 39,970
Nil 20,577
94.1 After considering arguments of learned representative of the taxpayer, learned CIT (Appeals) allowed relief on five items noted above. Other items were not treated as part of operational expenses. Relief allowed by the ld. CIT (Appeals) has not been challenged by the taxing authorities and, therefore, would not be part of discussion here. Adjustment on differences between comparables and Tested party: 94.2 Before the learned CIT (Appeals), the taxpayer sought reasonable adjustments on account of the following differences between the taxpayer and the comparable companies: (i) Local Area Development Tax (LADT) It was claimed that LADT was imposed only in State of Haryana and not outside the State. Therefore, appellant had to bear additional operational cost of Rs. 12 crores during financial year 2001-02 whereas other comparable did not incur such expenditure. (ii) Import Duties The taxpayer claimed that adjustment be made for the import duty paid on parts imported by the taxpayer as local comparable manufacturers were at considerable cost advantages. The taxpayer was using 80% of imported parts / material as compared to 6% to 39% by other local comparable enterprises. For working capital employed by the taxpayer and the comparable companies The taxpayer sought adjustment on account of funds locked up in working capital. Inventory investment The taxpayer also sought adjustment for inventory which led to higher operating expenses in an economic sense. Therefore, while comparing enterprises financial reserves to account for difference in relative level of inventory was necessary. Risk adjustment The taxpayer contended that it exported items against confirmed orders of AEs and there was very little collection risk. The risk was even lower in comparison to sale of domestic assembly goods.
(iii)
(iv)
(v)
94.3 The learned CIT (Appeals) after considering facts of the case allowed adjustment and deduction of Rs.11.61 crores towards LADT, which according to the learned CIT (A) is a specific tax imposed by the government of Haryana. 94.4 As regards adjustment for import duty and working capital, the learned CIT (Appeals) held that no specific working showing distinction between the appellant and other comparables was filed before him. Hence no other adjustment was required. The claim was rejected.
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94.5 Some other claims were considered in para 25.3 of the impugned order discussed hereinafter. As regards adjustments under proviso to section 92C(2) of Income-tax Act, the ld. CIT (A) observed as under:- . Adjustment in arithmetical mean under proviso to Section 92C(2): 95. As regards claim under proviso to section 92C(2), the learned CIT (Appeals) held that the benefit of variation of 5% was available only in those cases where the transfer pricing shown by the taxpayer was within range of 5%. If the transfer pricing shown by the appellant was beyond the above range then no benefit under the proviso was to be allowed. For above view, he relied upon order of his predecessor CIT(A) in the case of M/s Mentor Graphics (Noida) Pvt.Ltd. dated 30.03.2006. Enhancement of income: In para 25 of the impugned order, the learned CIT (Appeals) discussed the question of reduction of 20% allowed by TPO on account of difference in ownership of brand and R&D in assessment year 2002-03. He found that TPO did not allow similar adjustment in assessment year 2003-04 and there was a contradiction in the approach of the TPO in the two years before him. With a view to maintain parity in the finding, a show cause notice was given to the taxpayer- why the above reduction be not reduced. After considering objections of the taxpayer, the learned CIT (Appeals) held that there were differences in profile of appellant and the comparable companies as far as ownership of intangible and R&D expenses were concerned. Thus it led to certain distortions in the net margin earned by the company. All the same he was of the view that absence of intangibles or R&D section did not effect taxpayers earning. Sony brand is much bigger and powerful than most of competitive and comparables. Therefore, ownership of intangible was immaterial. In respect of research and development, the learned CIT (Appeals) held that deduction of 20% was excessive and unreasonable. He, therefore, restricted it to 10% against 20% allowed by the Assessing Officer. The learned CIT (Appeals) further held that taxpayer was not entitled to any other adjustment on account of distribution or on account of sale of finished goods to AEs. According to the ld. CIT (Appeals), these activities did not call for any adjustments. In the light of above discussion, the learned CIT (Appeals) allowed total relief of Rs. 101,683,508/- to the taxpayer as per calculations and computation available on pages 69 & 70 of the impugned order. 96. Both the parties are aggrieved and have brought the issue in appeal challenging some specific issues decided against them. 97. We have given careful thought to the rival submissions advanced before us and examined them in the light of material available on record including the impugned orders of revenue authorities. The Tribunal in its earlier decisions of M/s Aztec Software & Technology Services Ltd. vs. ACIT, Cir.11(1), Bangalore 107 ITD 141 (Bangalore) (SB) and in the case of Mentor Graphics (Nodia) Pvt.Ltd. vs. Dy. CIT (2007) 109 ITD 101 (Del), considered the principles which are applicable under the Indian transfer pricing regulations. In the present case, we need not repeat them. In the beginning the taxpayer adopted foreign enterprises as tested parties in respect of parts of T.V. imported by the taxpayer and by applying TNMM tried to justify acquisition at arms length price. However in course of proceedings before the TPO the Taxpayer agreed to take itself as a tested party and application of TNMM for TP analysis. Filter applied by TPO were also more or less accepted. Certain specific
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issues relating to inclusion and exclusion of certain items of income and expenditure or entities have been raised here by the parties. We would deal with the issues raised before us. The first relates to exclusion of advertisement reimbursement from taxpayers AE Sony Marketing Asia Pacific PTE LTD (Sony Pacific) as not forming part of operating profit. 97.1 The taxpayer as part of market penetration strategy incurred advertisement expenditure in India. With a view to sustain aggressive marketing activities on yearto-year basis, taxpayer entered into an Advertisement Contribution Agreement (Agreement) dated April 1, 2001 with Sony Pacific whereby the latter undertook to reimburse 50% of expenditure incurred by the appellant subject to maximum of US $ 29,50,000 by way of advertisement and sales promotion of Sony products in India. Copy of the Agreement is available at pages 299A 299C of Paper Book-I, filed by the taxpayer. 97.2 It is further claimed that Sony Pacific as a marketing support company is responsible for building of Sony branch in Pan Asia Region. In order to achieve above and to help the marketing and promotional activities and to promote the Sony brand in India and Asia, Sony Pacific entered in to above agreement and reimbursed part of advertisement cost incurred by the taxpayer. T.P.O. was of the view that transaction between the taxpayer and Sony Pacific could have been in the form of loan or equity and had it been the case, the source of expenditure would not have made it a operating expenditure. In para 11.4.4 of his order, the TPO has made the following observations: The source of an expenditure may be traced back to equity or windfall gain but the source does not characterize the purpose of such expenditure. In this case if the associated enterprise had chosen to fund the advertising campaign of new product launches not through reimbursements but through equity contributions or through an unsecured loan, it would not have been possible for the taxpayer to claim that the said expenditure was not an operating expenditure. He further observed that all valid business deductions permissible for tax purposes may not be considered as expenditure for computing operating profit margin. Accounting Standard-12 (AS-12) was of no help in resolving this controversy. The TPO further observed that investment of spare funds of the business are commonly taken as non operating income. He further held that the other entities taken as comparable have not received similar assistance although they have spent on advertising and marketing. 98. On appeal, learned CIT (Appeals) observed that amount received in the form of reimbursement was in the nature of an ad hoc receipt. He further observed that the taxpayer would have incurred such expenditure even if there was no receipt from its Associated Enterprise. He further held, there is no evidence to suggest that even in the comparable cases, there was such type of receipt. Hence, by including such an abnormal receipt by way of reimbursement expenses from its foreign AEs and without having similar receipt in the case of comparables will result in untrue comparison. [Para 21.2(iv) page 54 of order of CIT (Appeals)]. According to the ld. CIT
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(Appeals), advertisement expenses were routine operational expenses and were in no way dependent on the reimbursement. 99. In appellate proceedings before us, the ld. Representative reiterated the submissions advanced before the revenue authorities. These are discussed herein after in detail. 99.1 The learned Departmental Representative before the Appellate Tribunal submitted that the reimbursement was not part of operating expenses. She denied that TPO had conceded in favour of the taxpayer as contended on behalf of the taxpayer. The reimbursement was like subsidy received from AEs. The learned D.R. in her arguments further emphasized that transfer-pricing analysis has nothing to do with accounting treatment of the item for taxation or matching principles e.g. interest receipt is included in business income but is not operating expenditure. She placed strong reliance on the orders of the revenue authorities and contended that reimbursement was a sort of subsidy or grant from the associated concern and cannot form part of operating income. Source of funding was immaterial. 100. We have taken into account above objection of the revenue authorities and the learned D.R. We have also considered forceful arguments noted below made by learned representative of taxpayer in support of the claim. We are of the view that arguments taken by learned representative of the taxpayer are well founded. We record our reasons for accepting them. (i) Under Fiscal Laws, actual transaction, as entered into between the parties, is to be considered. Authorities have no right to re-write the transaction unless it is held that it is sham or bogus or entered into by the parties in bad faith to avoid and evade taxes. That is not the case here and, there is no allegation that transaction had any other purpose then one reflected and shown by the parties in the transaction. The doctrine of substance over the form was not fully approved by the House of Lords in Duke of Westminster vs. IRC (1936) 19 TC 490 (HL) and in IRC vs. Wesleyan General Assurance (1940) 30 TC 11 (HL). In the first case, the following observations were made: I must confess that I view with disfavour the doctrine that in taxation cases the subject is to be taxed if in accordance with a courts view of what it considers the substance of the transaction, the court thinks that the case falls within the contemplation of spirit of the statute If all that is meant by the doctrine is that having once ascertained the legal rights of the parties you may disregard mere nomenclature and decide the question of taxability or non-taxability in accordance with the legal rights, well and good. This is what this House did in the case of Secretary of State in Council of India vs. Scoble (1903) 4 TC 618 (HL), that and no more. If, on the other hand, the doctrine means that you may brush aside deeds, disregard the legal rights and liabilities arising under a contract between parties, and decide the question of taxability or non-taxability upon the footing of the rights and liabilities of the parties being different from what in law they are, then I entirely dissent from such a doctrine. Lord Wright observed that the true
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nature of the legal obligations arising out of a genuine transaction and nothing else is the substance. The aforesaid proposition has been accepted by Courts in India more particularly the Supreme Court of India. 100.1 In the case of CIT vs. Motors & General Stores (P) Ltd. 66 ITR 692(S.C), their Lordship observed as under: In the absence of any suggestion of bad faith or fraud the true principle is that a taxing statute has to be applied in accordance with the legal rights of the parties to the transaction. When the transaction is embodied in a document the liability to tax depends upon the meaning and content of the language used in accordance with the ordinary rules of construction. 100.2 In the case of CIT vs. Gillanders Arbuthnot & Co. 87 ITR 407 (S.C) their Lordship observed at page 418 of the report, as under: that it is now well settled that the taxing authorities are not entitled, in determining whether a receipt is liable to be taxed, to ignore the legal character of the transaction which is the source of the receipt and to proceed on what they regard as the substance of the matter. The taxing authority is entitled and is indeed bound to determine the true legal relation resulting from a transaction. If the parties have chosen to conceal by a device the legal relation, it is open to the taxing authority to unravel the device and to determine the true character of the relationship. But, the legal effect of a transaction cannot be displaced by probing into the substance of the transaction. This principle applies alike to cases in which the legal relation is recorded in a formal document and to cases where it has to be gathered from evidence oral and documentary and conduct of the parties to the transaction. 101. We are further of the view that above principles applicable to fiscal statutes are incorporated in special regulations on transfer pricing under Rule 10B(2)(c) of Income-tax Rules wherein it is provided that the comparability of an international transaction with an uncontrolled transaction is to be judged with reference to the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions. 101.1 U.S. Transfer Pricing Regulations also support similar approach, as is evident from the following provision Agreements that are in writing and made in advance of the transaction will be respected if the terms are consistent with economic substance of the underlying transaction.: (US) Trans. Reg. 1.487-1(d)(3)(ii)(B)(1). Greatest weight is given to actual conduct of the parties. : (US) Trans. Reg. 1.487 1(d)(3)(ii)(B)(1).
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OECD Regulations also impress upon consideration of actual contracts between the parties. 102. We are, therefore, of the view that TPO and other revenue authorities were not justified in equating this reimbursement with equity or windfall gain or subsidy or some ad hoc payment. The AE had chosen to fund the advertising campaign for products launched under the brand name Sony. The genuineness or bona-fide of the agreement has not been doubted or disputed at any stage of the proceeding. In fact it has been accepted that the agreement has been given effect to and reimbursement received by the taxpayer from Sony Pacific as per agreement. In para 11.4.5, the TPO has observed as under: During the course of the proceedings, the counsels of the taxpayer had repeatedly emphasized the fact that the taxpayer, in the absence of commitment to receive reimbursements, would not have incurred these advertisement expenses. There is no dispute to this contention. 102.1 Moreover, the following facts relevant to this issue are also clearly borne out of the records:(i) The Agreement between the taxpayer and Sony Pacific clearly provides that Sony Pacific agreed to pay 50% of cost and expenses actually incurred which shall not exceed US $ 2,950,000. The Agreement further lays down certain conditions which the taxpayer has to meet in order to receive reimbursement amount. The claim for reimbursement is to be made by the taxpayer in writing within 30 days following the last day of the relevant period. The taxpayer has to submit the claim to the payer with documentary evidence as provided in Article 4 of the agreement which includes full description of sale promotion activities carried, details of cost and expenses, copies of publication and other details of advertisement carried, copies of invoices etc. Sony Pacific is to make payment within 60 days of receipt of the claim. As noted earlier, there is no allegation or dispute that the Agreement was intended to serve some purpose other than the one stated in the agreement or said purpose of business was not achieved. There is further no dispute that advertisement expenses in the line of business, with which we are concerned, are operating expenses and which in the case in hand were incurred wholly and exclusively for the purposes of the business. This fact is admitted by the TPO as is evident from para 11.4.1 of his order as under: It is an admitted that that the taxpayer company spent the money reimbursed by its associated enterprises on advertising, marketing and in providing after sales service to customers. All these expenditures were made wholly and exclusively for the purpose of the business of the taxpayer.
(ii)
(iii)
(iv)
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103. There is further no dispute that expenditure had nexus and resulted in increase in business of the taxpayer. The TPO at page 12 of his order noted as under: The fact that the amount of Rs 23 crores received as reimbursement was actually spent to further the business interest of the taxpayer has not been disputed at all. The company has admitted repeatedly that the amounts were spent wholly and exclusively for the purpose of the business i.e., to increase the sales of its products and to improve customer satisfaction ..leads to increased market awareness and has immediate nexus with increased sales (or at least possibility of increased sales) of such products.
There is no finding that the AE of the taxpayer did not actually benefit from the advertisement carried by the taxpayer. In fact in A.Y 2003-04 in the case of taxpayer, a part of advertisement expenses have been disallowed as benefit was derived by other AEs of the taxpayer. The reimbursement it made is / was for increasing awareness of the product and its sales in Asia Pacific. The reimbursement of expenditure is admitted even by the learned CIT (Appeals) who at page 53 of the order states as under: I find that the marketing expenditure which had been reimbursed to the appellant was nothing but a part of the operating cost of the appellant and there is no dispute on this fact. 104. The learned CIT (Appeals) however, erroneously called reimbursement an ad hoc receipt. This finding, with respect, is without any basis and is found to be contrary to material available on record including agreement between the taxpayer and its AE. The learned CIT (A) is also not correct in observing that taxpayer would have incurred these expenses even if there was no such reimbursement. This is contrary to what has already been accepted by the TPO. In our view, the learned CIT (Appeals) should have seen that because of reimbursement, expenditure of the taxpayer on advertisement were as high as 9.06% against 3% to 4% spent by other similarly situated companies. It is specifically provided that Sony Pacific would pay 50% of cost and expenses incurred by the taxpayer. It is a matter of common knowledge that advertisement carried on T.V and other media have worldwide effect and multi national companies enter into such cross border arrangements. Such special circumstances, as would entitle the revenue to disregard and treat the reimbursement as inconsistent with economic realities of transaction, have not been brought on record. It is not material that other comparables have not entered into similar arrangements. Business necessity of entering in to the agreement by the taxpayer has been fully explained. On facts we are unable to disregard the assertion of the taxpayer that it would not have incurred such huge expenses on advertisement but for agreement of reimbursement. We do not see any good ground for not accepting this reimbursement as part of normal operating profit of the taxpayer. Accordingly, the revenue authorities are directed to include reimbursement as part of operating income of the taxpayer. We allow this ground of appeal. 105. We next take ground No. 8.3(d) where exclusion of reimbursement received from Sony Gulf as part of the operating expenses has been challenged. During the 43 http://www.itatonline.org
financial year 2001-02, Sony Gulf FZEUAE (Sony Gulf) reimbursed the taxpayer for expenses incurred by it for master production of Sony Audio TV Commercials (TVC) for telecast in Africa and Middle East. Sony Gulf used the TVC for telecast in Africa and Middle East. For the functions performed and for facilities provided to Sony Gulf, the taxpayer received a sum of INR 4,831,840 in the period under consideration. 105.1 The TPO was of the view that reimbursement received was not part of operating profit and excluded the amount received while computing operating profit of the taxpayer. 105.2 A.O. The learned CIT (Appeals) agreed with the view taken by the TPO and the
105.3 In the appellate proceedings before us, the learned representative of the taxpayer submitted that amount in question was purely in the nature of reimbursement of cost incurred by the appellant on behalf of and for the purposes of its AE. It is unfair and inappropriate to treat entire cost of master production as taxpayers operating cost without taking into consideration reimbursement received from AE for the facilities provided to the AE. The approach of the revenue authorities was stated to be contrary to the matching principle of accounting; and their decision unsustainable. Learned D.R. during the course of hearing opposed above submissions and contended that reimbursement and subsidy were used by the taxpayer itself as interchangeable terms in their submission before TPO. Therefore subsidy allowed by the A.E cannot be taken part of operating expenses of taxpayer. In reply, the learned representative of the taxpayer stated that it was only TPO who had used phrase subsidy in his order. The taxpayer had all along called it reimbursement and in this connection the taxpayer invited our attention to the following documents: (a) Financial statements filed by the taxpayer, (b) Form 3CEB, (c) Details of reimbursement and rebate transactions with AE. 105.4 On careful consideration of rival submissions of parties, we do not see any justification for not treating the amount received from Sony Gulf as part of operating profit of the taxpayer. There is no finding that taxpayer did not incur expenses or did not perform functions which benefited Sony Gulf. Therefore, AE was obliged to reimburse the taxpayer. We also find force in the contention of the learned representative of the taxpayer that revenue authorities are not justified in disregarding the matching principles. Having regard to purpose of the expenditure and to the extent expenses were for the benefit of Sony Gulf, the reimbursement received from the AE was to be treated as part of operating cost/profit of the taxpayer. Amount could not be excluded. Accordingly, we hold that exclusion of INR 48,31,840 on facts and circumstances of the case was not justified.
EXCLUSION OF OTHER AMOUNTS CREDITED IN P&L ACCOUNT 106. The TPO while computing operating profits of the taxpayer, has excluded some more items as discussed in para 4 above but on appeal, the CIT(A) accepted the contention of the taxpayer and allowed relief on five items (shown in chart in para 11 above) and took them as part of operating profit. The Revenue has not challenged
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above action of the ld. CIT(A). We therefore, proceed to consider the items which still remain excluded for computing operating profit. 106.1 The first of these items is, provision written back amounting to Rs.57,02,000. For exclusion of above item and for balances written back, interest received from customers and other miscellaneous revenue receipts, the ld. CIT(A) gave the following consolidated reasons:(A) I find that interest received is a financial income and as such cannot be considered as operational receipts. (B) The items which have been written back as mentioned in sub para (i) & (ii) of this para, are nothing but merely accounting entries and are not connected to the operations of the appellant. (C) The exact constitution of the item Miscellaneous Income is not explained and so it is not possible to consider it operational revenue. Hence, the same is being treated as non-operational. Hence, the AOs action for exclusion of these items for calculating the margin of the appellant are upheld. General remarks of the TPO on what are non- operating profit items have already been noted. No specific reason for not treating these items as part of business profit is available in the orders of the TPO/AO. The ld. D.R. submitted that claim was not raised before the TPO and he had no occasion to examine these items. The ld. CIT(A) was wrong in examining these items and in allowing relief to the taxpayer. Accordingly she insisted upon a fresh examination and an external auditor certification be carried out and revenue be allowed to rebut the claim of the taxpayer. 106.2 After considering facts and circumstances of the case, we do not see any good ground for not permitting the taxpayer to raise the ground before the Income-tax Appellate Tribunal which is clearly arising out of the impugned order. As noted earlier, the revenue has not challenged relevant part of the order of the CIT(A). Therefore, the objection now being taken by the ld. D.R. is not justified. On merit, we see no good reason to exclude provisions written back as not forming part of computing operating profit of the taxpayer. In our considered opinion, exclusion of above provision is based upon misconception of real nature of the entry generating income. It is not practically possible for a businessman to actually disburse all expenses incurred by it in the financial year and, therefore, a large number of business liabilities (manufacturing included) are provided in the accounts of a given year. It is elementary that there is no difference between actual disbursement of an expenditure or provision thereof. However, recovery of liability provided may become barred by limitation or for some other reasons, liability gets unenforceable or is reduced or ceases to exist with the passage of time. Therefore it may be necessary to write back such a liability. But it cannot follow that the liability was not expenditure of business or operating expense. Cessation of a liability is a taxable income u/s 41 of the Income Tax Act. The underlying principle behind above provision is that revenue takes back a benefit which it granted earlier, but which, due to subsequent events or changed
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circumstances should be charged to tax as income. Statutory provision overrides general understanding that mere creation of a benefit to a taxpayer by admission or cessation of a debt or a liability should not result in an income. Thus, creation of unpaid liability and its write back is a normal incident of a business operation which is carried everywhere in accounts to have true picture of profits of the relevant period. If a liability has ceased to exist and is required to be accounted for and shown as income by the taxpayer and, in case it is not so shown the taxpayer can be subjected to a penal action under Indian regulations. In this connection, we can refer to decision of Supreme Court in the case of CIT Vs Teja Singh 35 ITR 408. Having regard to statutory provisions, it cannot be said that provisions or writing back of liability is not part of operating profit or would not be taken into consideration for computing the same. The aspect of liabilities written off was ignored without considering nature and character of such liabilities. It would have been different if a finding was recorded that provision written back did not relate to business operations of the taxpayer. There is no suggestion on the above lines. Further it is not the case of the revenue that liabilities written back were wrongly provided for. It is a settled and well-accepted proposition that adjustment can be made only on account of differences. It is not possible to believe that other comparable entities taken into consideration are not making and writing back provision of liabilities no more required. There is no material nor there is any finding to support action of the revenue authorities. We can therefore make a general observation that all business enterprises are making and writing back liabilities as a normal incident of operating business. The expenses for which provisions were originally made were considered operating in nature and allowed in assessment. These provisions no longer required by the taxpayer during the year under review were reversed in the books of account as per mercantile system of accounting and shown as income. Therefore on facts we do not see any justification for excluding provisions written back in the profit and loss account as not forming part of the operating profit of the taxpayer. Accordingly claim of the taxpayer is accepted. 107. The next item relates to balances written back. In our considered opinion, finding given in respect of provisions written back is equally applicable to balances written back more particularly when ld. CIT(A) has not given any separate finding and the Transfer Pricing Officer has said nothing specifically on this item. The balances written back should also be treated as part of operating profit. We direct accordingly. 108. The TPO and on appeal, ld. CIT(A) also excluded insurance claim received by the taxpayer while computing its operating profit. It is not in dispute that these insurance claims pertained to recovery of loss/damage suffered by the taxpayer company during its day-to-day operations such as during transit of goods and due to pilferage etc. Such losses and compensation in our view are directly connected to the operations and are accounted for in routine. It is not shown that damages were received for any capital or non-business asset. Damages received from insurance, in our considered opinion do not have and cannot be treated differently from the price of the goods realized from the customers. Therefore, there is no question of excluding insurance claims while computing operating profit of the taxpayer. 109. The next item relates to interest received from customers for delayed payment. On facts and circumstances of the case, we see no good ground for excluding interest
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received from customers for delayed payment as not forming part of the operating profit of the taxpayer. In the case of CIT Vs Govinda Choudhury & Sons 203 ITR 881, their lordships of Supreme Court on interest similarly received have observed as under:If the amounts are not paid at the proper time and interest is awarded or paid for such delay, such interest is only an accretion to the taxpayers receipts from the contracts. It is obviously attributable and incidental to the business carried on by him. It would not be correct, as the tribunal has held, to say that this interest is totally de hors the contract business carried on by the taxpayer. It is well-settled that interest can be assessed under the head Income from other sources only if it cannot be brought within one or the other of the specific heads of charge. We find it difficult to comprehend how the interest receipts by the taxpayer can be treated as receipts which flow to him de hors the business which is carried on by him. In our view, the interest payable to him certainly partakes of the same character as the receipts for the payment of which he was otherwise entitled under the contract and which payment has been delayed as a result of certain disputes between the parties. The above decision has been followed by several High Courts. The Kerala High Court in the case of United Construction Contractors Vs CIT 208 ITR 914 observed as under:Held, (i) that the interest paid to the taxpayer partook of the same character as the receipts the payment of which he was otherwise entitled to under the contract and which payment was delayed as a result of certain disputes. 109.1 Having regard to the nature of receipt, we are unable to hold that interest on delayed payment could be excluded while computing operating profit of the taxpayer. In our considered opinion, the revenue authorities are not justified in excluding above receipt. We order accordingly. 110. The last item excluded in the computation of operating profit is miscellaneous income. The revenue authorities have excluded miscellaneous income on the ground that exact constitution of items of miscellaneous income was not furnished and therefore, it was not possible to consider it as operational revenue. It is not in dispute that details of misc. receipts were not furnished although while considering issues other than under the transfer pricing, some details were filed and considered. The learned representative stated that matter is different. It was explained during the course of hearing that details could not be furnished in view of immateriality of the amounts involved. Without detail of expenses, the TPO and CIT(Appeals) were justified in not accepting the case of taxpayer. No serious dispute is raised before us. In the above circumstances, we are unable to interfere on this issue. The ground is rejected. SALE OF CTV TO SONY JAPAN
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111. The next ground relates to addition on account of sale of colour TVs to Sony Japan. 111.1 During the year under consideration, the taxpayer sold 8680 units colour TV (Type 21 Flat screen WEGA CTV Model KV-XA 21 P80) @ Rs. 9964.65 each unit. The TPO found that the TVs with minor variant of Model 21 WEGA were also sold to domestic dealers. The sale price of above models was furnished by the taxpayer and is noted by the TPO in para 12.3 page 17 of his order. It ranges between Rs. 17000 to Rs. 20,000. The TPO further found that in its T.P report and by relying on TNMM, the taxpayer had worked operating profit margin over total cost at 5.25% (Arithmetic Mean of 2000-01) for the comparables as against operating margin of 5.38% claimed by the taxpayer. The TPO held that profit margin @ 5.38% was incorrectly taken by the taxpayer. He further held that the profit margin shown by the taxpayer was gross margin in which direct expenses like wages, depreciation, power and fuel were excluded. The taxpayer was, therefore, asked to explain its position on above points. The explanation of the taxpayer and TPOs comments are available in paras 12.33 to 12.39 of TPOs order. The TPO thereafter proceeded to compute by TNMM the net profit margin of taxpayer on total cost barring advertisement, selling, warranty and cash discount expenses and found that it was a loss. Operating loss was worked out at (-7.73%) against average operating profit margin of comparables at 5.25%. The difference between the two was thus taken at 12.98%. The TPO suggested adjustment of Rs.12,025,988 in the above I.T (international transaction) as per the following calculation/observation:Amount of adjustment + 12.98% of Rs.92,650,139 = Rs,12,025,988 Total value of international transaction pertaining = Rs. 92,650,139 To export of finished goods Arms Length Price = Rs. 92,650,139+Rs.12,025,988 = Rs.104,676,127 Difference in % terms between ALP and International = 12.44% Transactions 12.3.10 Proviso to Sec. 92C(2) permits a maximum variance of 5% from the Arms Length Price. In this case, the difference of 11.48% being more than 5% is not acceptable. Hence, it is concluded that the price adopted by the taxpayer have to be increased by Rs.12,025,988 which is 12.98% of the value of the international transactions. The Arms Length Price (ALP) of the sale price for exports made to Sony Japan is therefore determined at Rs.104,676,127.
12.3.11 The Assessing Officer shall, therefore, make an addition of Rs.12,025,988 to the total income of the taxpayer. 111.2 The taxpayer challenged above adjustment in appeal before the CIT(A).
111.3 The taxpayer claimed that 8,680 colour T.Vs were assembled and exported to Sony Japan to utilize idle capacity of assembling facilities to enable the company to improve recovery of its fixed assembly cost. Accordingly goods were priced taking into consideration marginal cost. The taxpayer further claimed that colour T.Vs were
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exported at ALP and this submission was supported with reference to the following chart: Particulars Model Sales Value Less: Excise duty @ 16% Less: Sales tax @ 14% Less: Other taxes @ 1% Add: Export benefit @ 18% Comparative prices Local Sales KV-XA21P80 Per Unit 16,138 1,929 2,010 144 12,056 Export KV-XA21P80 Per Unit 10,674
1,921 12,595
111.4 The learned CIT (Appeals) recorded no finding on above alternative claim. He noted further submissions of the appellant but found no force in them with the observations already noted in para 10.4 of this order. 112. The taxpayer is aggrieved and has brought the issue in appeal before the Appellate Tribunal. It was reiterated that TVs exported to Sony Japan were assembled to utilize idle assembling facilities of the taxpayer. It was submitted that the TPO went wrong in not considering arguments which could not be taken in the transfer pricing documents. Alternatively, the taxpayer contended that export sale was quite comparable with local sales and, therefore, colour TVs were sold at Arms Length Price. It was contended that adjustment for excise duty, sales tax and other taxes and benefit for export was rightly claimed because the adjustments for differences between export and domestic sales are to be taken into consideration. Like has to be compared with like. Further, the revenue has not been able to show that export realization was lower than the domestic sale realization and this is sufficient to prove that the transactions were at Arms Length. The ld. DR in reply submitted that marginal costing theory was being submitted for the first time during the appellate proceedings. The ld. DR further submitted that exports were pre-planned as a multinational company could never have worked on an idle capacity. It was further submitted by ld. DR that the details regarding domestic sale of models in question were never furnished to the TPO. While computing the operating margin, cost of power and fuel were not taken into consideration. In rebuttal the ld. Counsel pointed out that export transaction was not pre-planned. Idle capacity is normal to any manufacturing/assembling unit and is a practical business problem faced by all similar concerns. It was wrong to contend that details of domestic sales and models in question were never furnished to the TPO. The TPO had made reference to these detail in his report. Further, TPO wrongly took variant models and not exact model which were exported. This is quite evident from model numbers mentioned in the TPOs report. 112.1 The ld. Departmental Representative also placed the following submissions in writing on record:(a) The taxpayer had claimed that the export sales of CTVs to its AE were based on marginal costing as it was suffering from underutilization of capacity. As the TPO pointed out in his order that this position was not taken in the TP report prepared under Rule 10D, the 49 http://www.itatonline.org
taxpayer has contended that the fact of under-utilization of capacity was evident from the financials which was in possession of the TPO. This is a position which is completely untenable in law. The law mandates the taxpayer to prepare contemporaneous documentation to justify transfer prices based on guidelines. The taxpayer had hired an expert to do the same. The expert in his report did not consider the fact of under-utilization of capacity as a factor relevant to the determination of arms length price in relation to the export of TVs to AE. No documents at any stage have been produced to substantiate this claim, yet it is expected that this contention would be treated with seriousness. (b) The functions, assets and risks analysis contained in the TP report in pages 17-19, Vol.1 of the paper-book clearly states that the manufacture of CTVs for the purposes of export to AEs is a clear well thought part of the overall supply chain strategy. In fact, the manufacture is based on strict scheduling and budgeting by the AEs in this regard. Moreover, the report manifestly admits that the price is based on negotiations and the taxpayer is exposed to price/market risk. (c) The numbers of TVs exported is 8680/-. This figure is not a rounded off figure. It shows a conscious purchase by the AE, not a random usage if idle lying capacity. (d) The costing proposed by exported TV is wrong. Fuel, raw material and power expenses cannot be excluded from costing, as is being proposed by taxpayer. These expenses were not occurring in idol capacity. 113. We have given careful thought to the rival submission of the parties. The taxpayer had exported KV XA 21 P80 and, therefore, this was the unit which should have been taken into account for comparison with an uncontrolled transaction for determining the question whether the units were exported at Arms Length Price. We are of the opinion that under-utilization of capacity, if any, are burden of overheads and motive to reduce them, cannot justify export of CTV at a price less than the price to any unrelated party. It was to be shown that the similar price was charged for similar item in similar circumstances. Therefore, the ld. CIT(A) was quite justified in rejecting the main argument of the taxpayer. However, before the CIT(A), the taxpayer had raised an alternative argument that export price was quite comparable to local sales price of a similar model. It was pointed out that similar model was sold for Rs.16,138. In the above sale price, there was an element of excise duty Rs. 1929, sales tax Rs. 2010 and other taxes Rs.144. If adjustment for above duty and taxes which are not leviable on export sales is made, the sale price works out to Rs.12,056 against Rs.12,595 charged from Sony Japan after taking benefit permissible in export scheme @18%. The ld. CIT(A) has duly noted the contention but for reasons best known to him, did not comment on this alternative submission justifying sale transaction to AE at Arms Length by application of CUP method. In the circumstances when similar unrelated transaction was available, the same was to be utilized for taking Arms length price. No error in the computation furnished by the taxpayer has been pointed out. Besides this, we are of the view that on bulk sale of
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8680 colour TVs, the purchaser was entitled to some rebate of 1 to 2% which is normally allowed by the producer/manufacturer on such sales. It is not correct to contend that details of domestic sales of various models were not furnished to the TPO. A copy of such detail has been placed by the taxpayer as Annexure 8A in the paper book. Only the model exported was to be taken in to account. In the light of above evidence, we are of the view that transaction of sale of CTV to Sony Japan was carried by taxpayer at Arms Length and, therefore, adjustment made by the TPO and upheld in appeal by the CIT(A) is not called for. It is directed to be deleted. 114. In the revenues appeal for the AY 2002-03, there is challenge to the deletion of Local Area Development Tax (LADT). 114.1 The TPO, while working out operating margin of profit, excluded expenses of INR 11.61 crore debited in the account for payment to Haryana Government as Local Area Development Tax (LADT). The TPO did not agree to the taxpayers contention that similar tax was not being paid by other comparables. The same contention was reiterated before the CIT(A) in appeal who held that taxpayer was required to be placed on equal footing with comparables while calculating the margin of profit. Since such type of payment was not involved in cases of other comparables, the ld. CIT (Appeals) saw justification to direct to exclude Rs. 11.61 crore paid as LADT and then calculate the profit margin. 114.2 The revenue is aggrieved on account of above directions of the ld. CIT(A) and has brought the issue in appeal before the Appellate Tribunal. She submitted that this issue was not raised before TPO and therefore, the ld. CIT (A) should not have permitted to raise it. The ld. DR submitted that local development tax was an operational levy and not a difference needing adjustment. Even otherwise line to line comparison of expenses is not permissible under Rule 10B(2)(a) to (d) of I.T. Rules. The taxpayer was fully aware of the above levy when it had decided to operate from the State of Haryana. It is not material that other states had not imposed such a levy. She pointed out that one comparable relied upon by the taxpayer was subjected to such a levy. The ld. Counsel for the taxpayer, on the other hand, supported the impugned order of CIT(A). It was argued that levy was unique to units operating from the State of Haryana. Other enterprises carrying on similar activities were not subjected to envy. The levy had nothing to do with assembly or sale activity carried on by the taxpayer. The levy was further accepted as arbitrary and unconstitutional by Punjab & Haryana High Court and struck down. On further appeal, the Honble Supreme Court has maintained the order of the High Court. Copies of above decisions are placed on record. 114.3 After considering rival submissions of the parties, we do not see any justification for interfering with the impugned order of the CIT(A) on this issue. This statutory levy has nothing to do with operating profits of the taxpayer. Other enterprises taken into account by the TPO are not subjected to such levy. Even if one of several comparables is also paying LADT, then while working average operating profits, this levy is to be excluded in that case also. Besides, the levy has been struck down as unconstitutional by the Supreme Court. On this additional argument, the finding of ld. CIT(A) can further be supported. For the reasons given above, we uphold the order of CIT(A) on this issue and rejected the ground raised by the revenue.
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Selection & rejection of Comparables 115. While there is no controversy on application of most appropriate method (TNMM) and in selection of filters applied by the Transfer Pricing Officer, there is big controversy on the comparables selected. The learned counsel for the taxpayer vehemently argued that Videocon Appliance Ltd. has wrongly been taken as comparable and Godrej Appliances Ltd. (Godrej), Carrier Aircon Ltd. (Carrier), Whirlpool of India Ltd. (Whirlpool) and Hitachi Home & Life Solutions (India) Ltd. (Hitachi) have wrongly been rejected and excluded from the list of the comparables. 115.1 As regards the other comparables selected by the TPO for AY 2002-03 viz. B.S.Refrigerators Ltd., Videocon Appliances Ltd. And Videocon Communication Ltd., no arguments were advanced on behalf of the taxpayer raising any objections about selection/inclusion of the said comparables. It was, however, noticed during the course of dictation/deliberation that a statement has been placed in the paper book filed by the taxpayer giving comparative FAR analysis of these companies selected as comparables. In order to seek clarification about the exact stand of the taxpayer on this issue, the case was fixed for hearing on 11.9.2008. The exact position which transpired during the course of hearing so fixed was recorded in the order sheet entry as under:Present for the taxpayer - Shri Mukesh Bhutani, CA. Present for the Department - Smt.Himalini Kashyap, CIT-DR. First clarification sought from Shri Bhutani is about the companies to be included as comparables. He replies that Hitachi, Godrej, Carrier & Whirlpool are sought to included for AY 2002-03. As regards exclusion, he submits that Videocon International alone is sought to be excluded as comparable in AY 2002-03. Regarding AY 2003-04, he submits that Videocon International again is sought to be excluded and Godrej, Whirlpool, FAL Industries and Monica Electronics are sought to be included in comparables. After obtaining the clarification as above about the exact stand of the taxpayer, we now proceed to consider and decide the issue relating to selection and rejection of comparables. 115.2 We will first deal with the objection of the taxpayer in respect of non inclusion of Hitachi, Carrier and Whirlpool as comparables. We find that only objection raised for excluding above enterprises from the list of comparables was that these enterprises are having controlled / related party transactions. The learned D.R. in arguments before us also reiterated the same submissions. The learned representative of the taxpayer, on the other hand, submitted that these allegations are totally unsubstantiated. With reference to information available on record as per Annexure 7, it is stated that Carrier, Hitachi and Whirlpool had related party transactions merely at 10.18 percent, 13.90 percent and 6.88 percent respectively of the revenue receipt. It was accordingly contended that related party transactions of these companies are not very significant. It has been argued that above companies
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have been excluded from the list of comparables on extraneous and baseless grounds. The shareholders of these companies are outside India and what was important was to consider the quantum of related party transactions and not the share holding. It was also submitted that same norms were not adopted by revenue authorities while taking Videocon as comparable and related party transactions of above concerns were not placed on record. The appellant was blamed for its failure to place such record of related party transactions and its possible impact on the margin of profit of these companies. (The ld. Departmental representative has now stated in case of Videocon Appliance and Videocon International, such figures are 0.81% and 3.2% respectively of total sales). Above finding has been challenged by the taxpayer as against record and it is contended that figures were placed before learned CIT (Appeals) and are noted by him vide para 19.1(iv) at page 44 of the impugned order. The related party transactions of Videocon Appliances and Videocon International were shown at Rs.4.8 crores and Rs. 40.3 crores respectively. 115.3 On careful consideration of rival submissions, we see no justification for excluding above named three entities from the list of comparable for working out mean operating profit. It is an admitted position that these companies satisfy screening criteria (filters) adopted by the Transfer Pricing Officer at page 10 of the order except his observation that companies were having controlled transactions with related parties. The TPO and on appeal, the learned CIT (Appeals) did not substantiate the allegation by furnishing figures of controlled transactions to show that such transaction had significant impact on the profits of these companies. The taxpayer, on the other hand, has given percentage of transaction with related parties and we are of view that they are not so high as to exclude them from the list of comparables. We are further of view that an entity can be taken as uncontrolled if its related party transaction do not exceed 10 to 15% of total revenue. Within the above limit, transactions cannot be held to be significant to influence the profitability of comparable. For the purposes of comparison, what is to be judged is the impact of the related party transaction vis--vis sales and not profit since profit of an enterprise is influenced by large number of other factors. No dispute having been raised by TPO or the ld. CIT(A) that the other filters of functions, economic activities, product profiles etc are satisfied, we are of view that these three entities should also be taken in the list of comparables for working average / mean operating profit. Even as per OECD Guidelines, it is emphasized that large number of similar entities should be taken to make comparison broad based. 116. We now consider objection of the taxpayer relating to exclusion of Godrej from the list of comparables. It was submitted by the learned representative of the taxpayer that Godrej satisfies all the filters chosen by the TPO himself. Filter No.3 of the search process employed by the TPO refers to exclusion of companies with negative net worth i.e. companies with liabilities in excess of their assets. However, Godrej has been excluded by holding that it is a loss making company. Godrej did not have negative net worth as is clear from the balance sheet of company for financial year 1999-2000 and 2000-2001 (Annexure 6 of written submissions on record). It is further argued that the ground that it is a loss making company, is contrary to the OECD Draft Notes on Comparability released for public comments on May 10, 2006 wherein it is stated as under:
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In general, business commentators consider that the principle that the taxpayer should use all relevant information suggests that there should not be an overriding rule on the inclusion or exclusion of loss-making comparables. Indeed, it is the facts and circumstances surrounding the company in question that should determine its status as a comparable, not its financial result. As pointed out by some commentators, most, if not all, companies experience losses at some point in their history. Losses are normal part of business; therefore, companies should not be automatically excluded from consideration because of losses. 117. It has been further argued that objection of learned CIT (Appeals) that Godrej should be excluded as it had gone for re-structuring exercise to take care of an abnormal situation is misplaced since abnormal or unique losses are one which arise out of flood, fire, strike, or any other such abnormal happening, which is not the case with the Godrej. The revenue authorities were wrong in taking only high profit companies and excluding loss making companies for purposes of comparison. In the like manner DRs argument that if loss making companies are accepted as comparable then entire purpose of Transfer Pricing Regulation would be defeated is untenable. Further emphasis of D.R on the Annual Report of the company for financial year 2001-02 relating to future outlook and framework of initiatives, company intended to reduce cost and improve its efficiency, was stated by Shri Bhutani to be irrelevant. The Annual Report of Godrej referred to above states like this: The Companys performance during the year under review reflected the general state of the refrigerator industry and washing machine industry, which recorded negative growth. The market situation, already over-crowded with too many players, resulted in fierce pricecutting, heavy advertisement spend, new product launches and easy credit terms in an attempt to boost consumer sales. 118. The learned counsel for the taxpayer tried to meet above objection by stating that harsh industry conditions such as competition, price cuttings, heavy ad spending etc. were normal conditions and not specific to Godrej as made out by the revenue authorities. They are also applicable to the taxpayer industry. Every industry has to deal with over-crowded market with too many players and face competition on account of fierce price cutting, heavy advertisement spend, launches of new products, easy credits etc. Loss is normal incident of any industry. So is utilization of installed capacity, it might be in the case of Godrej at 50%. It was thus little more than other similar industries. The learned counsel for the taxpayer further relied upon the following extract from page 3 of annual report of Godrej: The companys was affected by the general state of the refrigerator as well as the washing machine industry, both of which recorded negative growth during the year under review. The market is over-crowded with too many players, all with huge unutilized capacities. The only way out for all players was fierce price-cutting, heavy advertisement spend, new product launches and easy credit terms in an attempt to boost consumer sales.
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119. We have given careful thought to the objections of the taxpayer on the exclusion of Godrej with reference to material on record. It is no doubt true that loss and competition are normal incident of business and merely on above factors, exclusion may not be justified. But above factors are not to be considered singly but cumulative effect of the same alongwith large number of other factors is to be considered to see whether Godrej can be taken as comparable. When a conclusion is to be reached on application of a number of factors whether such conclusion is sound or not must be determined not by considering the weight to be attached to a single factor in isolation but by assessing the cumulative effect of all the factors in their setting as a whole. Godrej in the first place is making refrigerator and not T.Vs. Secondly, it has suffered huge losses over a period of several years. It has recorded negative growth as admitted at page 6 &7 of its annual report for financial year 20002001. It had huge unutilized capacity. It needs financial restructuring. It is carrying on disputes on account of demands raised by Punjab Small Scale Industries and Export Corpn. Ltd., apart from the disputes made by its employees for increased wages, reinstatement on termination and suspended employees. The joint venture of the company stands terminated. All this is admitted in the official report of Godrej. Besides, it is also carrying on related party transactions. Each of above factors which is considered and highlighted in the annual report, may not have a significant effect, if taken singly. However, when cumulative effect of all the factors is considered, one gets a totally different picture. It has therefore to be held that Godrej was rightly excluded from the list of the comparables. We concur with the view taken by the revenue authorities and reject all the arguments advanced by learned counsel for the taxpayer. This ground of appeal is rejected. Objection on inclusion of Videocon International 120. To support exclusion of above company, the learned counsel for the taxpayer Shri Bhutani argued that material available on record clearly shows that Videocon International is carrying full-fledged manufacturing activities as against mere assembly of T.Vs with imported components carried by the taxpayer. Revenue authorities further ignored that Videocon International enjoys cost benefits due to backward integration and indigenous manufacturing of components as reflected in the companys relevant annual report. It is stated that with this backward integration the companys profile is very different. It can earn more profit than other multi national competitors who import their components. 121. It is further submitted that Videocon International is quite dissimilar vis--vis the taxpayer on account of product comparability. The company earns significant portion of its revenue from sale of non comparable products like glass shells and CRTs and this fact has been completely ignored by CIT (Appeals) in the impugned order. Further the turnover of Videocon International is six times that of the appellant. It is 3,000 crores against 500 crores of the appellant. It is urged that TPO was wrong to use filter to eliminate companies with lower turnover, without according similar treatment to companies with significantly higher turnover which has disturbed the balance of the results. Thus inclusion of Videocon International with such high turnover was incorrect. The learned counsel also challenged D.Rs submission that Videocon entities including Videocon International were included in taxpayers own comparables. It was explained that the taxpayer had furnished bigger set of comparables subject to adjustments and in proceedings before the T.P.O and the
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CIT(Appeals), the taxpayer had constantly urged for exclusion of Videocon International. It is not a new plea. 122. We have given careful thought to the rival submissions of the parties and examined them in the light of material available on record. To appreciate above objection of the taxpayer, we refer to sub-rule (3) of Rule 10B of Income-tax Rules providing for criteria for comparing an uncontrolled transaction with an international transaction as under: 10B. Determination of arms length price under section 92C. .. (3) An uncontrolled transaction shall be comparable to an international transaction if (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or reasonably accurate adjustments can be made to eliminate the material effects of such differences.
(ii)
123. The aforesaid rule was examined by the Tribunal in the case of Mentor Graphics (Noida) (P) Ltd. vs. Dy. CIT 109 ITD 101 (Del) and it was held as under: 24. It is true that transfer pricing is not an exact science, evaluation of transactions through which the process of determination is carried in an art where mathematical certainty is indeed not possible and some approximation cannot be ruled out, yet it has to be shown that analysis carried was judicial and was done after taking into account all the relevant facts and circumstances of the case. Minimum requirement is to prima facie show that controlled international transaction was properly examined, comparable and arms length price fixed objectively, honestly and in a bona fide manner as required by the statutory regulations. The requirement of the statutory regulation has been thoroughly discussed by the Appellate Tribunal in the case of Aztech Software (supra), but in order to dispose of this appeal, these are reiterated here:25. The comparability of an international transaction i.e. uncontrolled transaction and a controlled transaction is to be judged under Rule 10B(2) with reference to the following, namely: (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions;
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(c)
the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. Further caution required to be adopted while looking to the differences between controlled and uncontrolled transaction is provided in sub-rule (3) of Rule 10B which is as under:(3) An uncontrolled transaction shall be comparable to an international transaction if (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii )reasonably accurate adjustments can be made to eliminate the material effects of such differences. Further Rule 10B(1)(e) of Income Tax Act providing for determination of Arms Length Price u/s 92C required that following steps are to be taken while applying TNMM after selection and evaluation of controlled transactions. It is as under:(e) transactional net margin method, by which, (i) the net profit margin realized by the enterprise from an international transactions entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realized by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;
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(iv) the net profit margin realized by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arms length price in relation to the international transaction. As noted in the case of Aztech Software (supra) rarely one is able to locate an identical uncontrolled transaction. The Arms Length Price is determined by taking result of a comparable transaction in comparable circumstances and by making suitable adjustments for the differences. 26. The first step in the determination of Arms Length Price is to analyse the specific characteristics of the controlled transaction whether it relates to transfer of goods, services or intangible. Without proper study of specific characteristics of controlled transaction, no meaningful comparison or location of comparable is possible. For example, a mere consideration that controlled transaction relates to software supply is not sufficient as there are hundreds of softwares with different characteristics which materially affect their open market value. The characteristics that are required to be considered include in case of transfer of tangible property, the physical feature of the property, its quality, reliability and availability (supply). In case of provisions of services, the nature and extent of services and where tangible property is involved for comparison, the form of transaction. To put it in other words, all the characteristics of the controlled transaction which are likely to affect its open market value must be taken into account. The study should include analysis of functions, risk and assets of the controlled transaction for correct location of similar or nearly similar characteristics in uncontrolled transactions. Specific characteristics are necessary to carry search of similar comparable with similar characteristics. 27. After the selection of the comparables, best method of determining Arms Length Price is selected. Thereafter, functional analysis is carried to identify functions, risk and assets of uncontrolled transactions and comparison is carried with characteristics of the controlled transaction. This is necessary to find whether comparable selected are really comparable and reliable. Comparison based on functional analysis include economically significant activities and responsibilities undertaken or to be undertaken by the independent and associated enterprises. The structure and organization of the group and more particularly the judicial relationship between different entities of same group are to be seen. The function that need to be identified while carrying comparison as per OECD guidelines include design, manufacturing, assembling, research and development, servicing, purchasing, distribution, marketing, advertising, transportation, financial and management activities. It is also necessary to examine as
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to what is the principal function of the entities. The analysis of comparison should consider total assets employed and assets used to earn profit. The risk assumed by respective parties is a very important consideration. It is a simple principle of economics that the greater the risk, the greater the expected return (compensation). If there are material and significant differences in the risk involved, then the comparable identified are not correct as appropriated adjustments for differences in such cases are not possible. Therefore, while performing searches for potential comparable companies, not only turnover and operating profit but functions performed and risk profile are also to be considered. However, it can always be shown on the given facts of the case that comparable found are similar or almost similar to the controlled transaction and no adjustments are needed. It is useful to see the level of intangible assets in comparable to an appropriate base. Depending on facts of the case, final set of comparables may need to eliminate differences by making adjustments for the following: a) b) c) working capital adjustment for risk and growth adjustment of R&D expenses 27.1 The risk not only due to human resources, infrastructure and quality which are normally taken into account yet more significant risks like market risk, contract risk, credit and collection risk and risk of infringement of intellectual property are being ignored here. In most of the comparable analysis carried in India, the latter type of risk are not being taken into consideration although these can lead to major difference in Market Value of transactions. 27.2 The European tax authorities are reluctant to accept adjustments because adjustments necessarily involve consideration of question whether they are appropriate or not and therefore it is always better to find comparable requiring the least or no adjustment. The position in India as per Indian regulations on the subject has been noted earlier. If there are differences which can be adjusted, then adjustments are required to be made. If the difference between the companies are so material that adjustment is not possible, then comparables are required to be rejected. 27.3 Further in the analysis numerous ratio are applied, depending on the specific of the comparables. The search may include the following:Inventory/sales; operating assets to total assets, fixed assets to total sales, fixed assets to number of employees, operating expenses to sale, cost of sales. 123.1 The Tribunal also referred to and commented upon Para 3.27 of OECD Report of July, 1995 but read the above para alongwith Paras 3.29, 3.34, 3.35, 3.37 and 3.39 of the Guidelines to emphasize that even where Transaction Net Margin Method is
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applied, the functional profile, assets, risk assumed of controlled and uncontrolled transaction are to be screened. 123.2 It is clear from above quoted provision that while comparing controlled and uncontrolled transactions or enterprises, one has to look for the differences and whether such differences are likely to affect the price, cost charged or paid or profit arising from the transaction in the open market. It has further to be examined whether a reasonable accurate adjustment can be made to eliminate the material effect of the differences between the transactions or entities. If a reasonable accurate adjustment for the difference to eliminate material effect of the differences cannot possibly be made, then such comparables (uncontrolled) are to be rejected. 124. Valerie Amerkhail in her Commentary Practical Guide to U.S. Transfer Pricing, Third Edition has noted the apprehension of member countries of OECD and had quoted thus from OECD Guidelines: Many countries are concerned that the safeguards established for the traditional transactions methods may be overlooked in applying the transactional net margin method. (OECD GUIDELINES 3.53.) As emphasized by the learned author, the adjustment should be made to account for the differences that affect the net margin. The U.S.Regulations also call for similar adjustments to account for any differences that would materially affect profits under the chosen profit level indicator. The learned Author concedes that judgments about what effects are material and what adjustment should be made on account of those effects, tend to be highly subjective. The learned author has further stated as under with reference to para 3.42 of OECD Guidelines and U.S.Treas. Regulation 1.482-5(d)(3)(iii): The OECD Guidelines also state that it would be inappropriate to apply TNMM on a company-wide basis: if the company engages in a variety of different controlled transactions that cannot be appropriately compared on a aggregate basis with those of an independent enterprise. Similarly, when analyzing the transactions between independent enterprises to the extent they are needed, profits attributable to transactions that are not similar to the controlled transactions under examination should be excluded from the comparison. (OECD Guidelines 3.42). This statement is sometimes interpreted as prohibiting the companywide application of TNMM. However, a more reasonable interpretation is that it requires the same treatment of unlike business segments as set forth in the U.S. regulation statement that: The reliability of the allocation of costs, income, and assets between the relevant business activity and other activities of the tested party or an uncontrolled comparable will affect the reliability of the determination of operating profit and profit level indicators. (Treas. Reg. 1.482-5(d)(3)(iii)
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125. Famous author Karl Wundisch in his book on International Transfer Pricing in the Ethical Pharmaceutical Industry issued by International Bureau of Fiscal Documentation has pointed out in [H54] at page 250 to several areas on which disagreements can arise between the taxpayer and the tax authorities. Thereafter in [H55], the learned author has observed as under: [H55] A particular area of disagreement might be that concerned with the question of what is a comparable operation or function. For example, sales of ethical pharmaceuticals by a research-based multinational group would not be comparable with sales of generic pharmaceutical substances by a multinational group not engaged in research for, and the development of, innovatory products. Also, contract or toll manufacture, being comparatively risk-free, would not be closely comparable with the manufacture by a multinational group bearing all the manufacturing and marketing risks associated with the product. (underlined by us to emphasise) Thereafter the learned author refers to the choice of party with respect to CPM, which is American equivalent of TNMM and the following illustration is given by the learned author to express the difficulty in the selection of the comparable: [H56] .If one computes the profit level, for example, for a company which purchases a commodity and re-sells it, perhaps after having modified it in some way, one will derive one theoretical arms length price for the purchase. If one computes, by the same rules, the profit level for the company, which sold the commodity to the re-seller in the first place (which would normally have been carrying on a different type of operation in another country), one will derive another price for that transaction. It is by no means obvious that the results of these two calculations will necessarily be the same or even closely similar. (underlined by us to emphasise) Para 1.20 of OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrators, 1995 states as under: in dealings between two independent enterprises, compensation usually will reflect the functions that each enterprise performs (taking into account assets used and risks assumed). Therefore, in determining whether controlled and uncontrolled transactions or entities are comparable, comparison of the functions taken on by the parties is necessary. 126. In the case of Videocon International, apart from the fact that its turnover is five times more than that of the taxpayer in the relevant period it has valuable intangibles and R&D unit which was not held and possessed by the taxpayer in the relevant period. The notes of annual report of Videocon International for the year 2000-2001, mentions that the company manufactures glass shell Panels for colour T.V. Picture tubes, CRT Display/Video Display units, Monitors and Funnels for CTV Picture tubes. At page 6 of the Annual Report, under the heading Expansion of Glass
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Shell Unit, it has been mentioned that: Your company is the only leading manufacturer of glass parts required for its manufacture of picture tubes. At para 1.2 on page 13 under Management Discussion and Analysis the Report states: with the captive manufacturing of CTV shells the Company enjoys cost advantage vis-avis the competitors. In Para V on Page 13, the Report states: The Company manufactures consumer electronic products in India in modern vertically integrated facilities. The Company by having manufacturing facilities within India, is able to reduce dependence on import, tariffs protection and which restrict its foreign competitors in their ability to import finished goods and components. In Para 4.1 on Page 14, it is mentioned: Further the Company earns a sizeable portion of its revenue from the manufacturing of Glass Shells which are used in the manufacturing of TVs. The Company has earned a revenue of Rs 2,465 Million from Glass Shell (Panels) for CTV Picture Tubes and a revenue of Rs 1,332 Million from Glass Shell (Funnels) for CTV Picture Tubes. 126.1 The Credit Analysis and Research Limited, a leading credit rating agency has commented about complex manufacturer of Videocon International Ltd. by stating as under: The Glass Shell division of VIL has facilities for the manufacture of 6 million panels of glass shells and 3.5 million funnels of glass shells. The panels and funnels are used in Colour TV picture tubes, cathode ray tube display and video display unit monitors. VIL is the only indigenous manufacturer of glass shells for colour picture tubes. 126.2 It is, therefore, seen that apart from extraordinary size, Videocon International (VIL) compared to the taxpayer had several other distinctive features or differences which materially affect performance / price of the products. Comments about difference on account of possessing research and development as also valuable intangible are applicable in this case. The taxpayer unlike VIL does not have an advantage of R&D unit or valuable intangible on which it can always expect some reasonable returns. Glass Shell Panels for CTV Picture tubes, CRT Display / Video Display units, Monitors and Funnels for CTV picture tubes are important components that are integral part for manufacturing CTV units. While Videocon manufacture them, the taxpayer has to import them for further assembly in India. The huge profit VIL is making on sale of such components has been noted above. Therefore, there is material difference between the functions carried on by VIL and the taxpayer. Infact enterprises buying components from VIL and then assembling them to make T.V for sale in the market are enterprises comparable to the taxpayer as those units (enterprise) are carrying on similar functions as are carried by the taxpayer and not VIL. In our considered opinion, Transfer Pricing Officer and on appeal CIT(Appeals) was not correct in not taking into account the huge difference between the size of VIL and taxpayer, differences in the turnover, differences in the assets, differences in the functions performed and risk undertaken by the taxpayer and the VIL. In our
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considered opinion, above differences materially affecting the performance of the enterprise could not be reasonably accurately evaluated for making suitable adjustments. Therefore, it would only be right to exclude Videocon International from the list of comparison. We direct accordingly. 127. We are also not impressed by the arguments of learned Departmental Representative that Videocon International was included in the list of comparables furnished by the taxpayer. In our considered opinion, there is sufficient material on record to show that taxpayer in proceedings before the TPO as well as before the learned CIT (Appeals) had argued that there were huge differences between the taxpayer and the Videocon International and, therefore, Videocon International should be excluded from comparison. Be that as it may, we do not see any good reasons to debar the taxpayer from raising the claim that Videocon International should be excluded from the list of comparables. For all the aforesaid reasons, we direct that Videocon International be excluded from the list of comparables. 20% deduction on account of intangibles, R&D etc. and enhancement of assessment by learned CIT (Appeals). 128. The TPO after determining mean margin of comparable companies allowed deduction of 20% therefrom on account of difference in ownership of intangibles and R&D etc. in assessment year 2002-03. However, the TPO allowed no deduction for above factor in the subsequent assessment year 2003-04. 129. The learned CIT (Appeals) noted this contradiction and with a view to maintain parity, he issued notice of enhancement dated 14.11.2006 to the taxpayer for the assessment year 2002-03. In reply to the above notice, the taxpayer contended: (a) The risks borne by the appellant are different from those borne by the comparables; (b) The significant R&D activities are conducted by the comparables as compared to the taxpayer, which resulted in significant gains accruing to the comparable companies; and (c) One of the comparable companies viz. BS Refrigerators also undertakes R&D activity and owns intangibles. The learned CIT (Appeals) agreed that there are differences between the taxpayer and the comparables. Despite the differences, it will be wrong to conclude that appellants earning was affected by absence of intangibles or brand name. Infact brand Sony was much bigger and powerful than brands of the competitors / comparables. The ownership of brand was not material as the appellant had the benefit of the brand which is owned by its AE. The learned CIT (Appeals) was of view that no adjustments are called for on this account. 129.1 However, in respect of Research and Development, the learned CIT (Appeals) agreed that there are differences between the appellant and the comparable companies and such differences has created impact on profit margin. Consequently
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adjustment was reduced to 10% against 20% allowed by the TPO in the assessment year 2002-03. 129.2 In the next year, the learned CIT(Appeal)s attention was drawn to provisions of Rule 10B(3) and appellants submission that adjustment must be made on account of difference in working capital of the appellant and other comparables. The taxpayer further claimed adjustment for the difference in terms of the sale and purchases. Taxpayer also sought inventory adjustment as its money was tied up in holding inventory which is an operating expense in an economic sense. Detailed computation of working capital carried by the appellant was claimed to have been submitted before the A.O. The appellant further sought adjustment for the risk by contending that appellant was a low end assembler and functions performed by it were comparatively lesser than the functions performed by the comparables. The appellant was dealing with AEs for procuring important components whereas comparables were required to deal with outsiders, maintain quality control and carry negotiations. For all the above factors, risk was involved for which comparables were getting returns. Therefore, adjustments were necessary for the risks stated above. 129.3 The learned CIT (Appeals) quoted para 25.3 from the order of his predecessor for assessment year 2002-03 and agreed with the view taken in assessment year 2002-03. He concluded as under: Thus after considering the fact, I allowed the reduction on the account of R&D to the extent of 10%. I had also given finding that there was no need to provide any reduction/rebate on the ground of ownership of intangibles and brand. For the sake of convenience, the relevant portion of my observation on this issue as contained in para 25.3 of the last year appellate order is quoted below. 130. The Revenue has accepted above finding of the learned CIT (Appeals). Therefore, reduction to the extent of 10% has attained finality and is no more in issue before us. The taxpayer through his representative argued that there was no justification on the part of the learned CIT (Appeals) not to allow any deduction on account of intangible and other risks like price risk, foreign exchange risk, inventory risk, vis--vis comparables. 130.1 The learned Departmental Representative submitted that TPO has already allowed adjustment for risks, R&D and intangibles which being excessive have been made reasonable by the learned CIT (Appeals). It was further argued that appellant does not participate in price fixation process and consequently bears additional price risk, foreign exchange risk, and inventory risk vis--vis the comparable companies. Therefore, these additional risks faced by the taxpayer offset the additional risk faced by comparables on account of R&D and other related issues, the D.R further added. The Departmental Representative also emphasized that taxpayer had the benefit of intangibles owned by its parent company. It was further submitted by the learned D.R. that year end data was used by the taxpayer for seeking working capital adjustment. It was not necessary that amount outstanding at the end of the year remained outstanding throughout the year. The learned D.R. further argued that comparables were also allowing credit to its customers and the fact that appellant had sold certain
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goods on credit does not imply that appellant had charged higher price. It was further argued by learned D.R. that Chinese rule prohibit the use of working capital. 131. Shri Bhutani, learned representative of the taxpayer in reply submitted that TPO had allowed adjustment of 20% but on appeal CIT (Appeals) has allowed 10% adjustment for R&D functions while adjustment for ownership of intangibles and risk etc. were denied. It was contended that learned D.Rs argument that appellant has to bear higher price/market risk, than the comparable, is without any valid finding or facts. Taxpayers participation in the determination of price while dealing with AEs is quite restricted. This was also immaterial as ALP is to be taken into consideration based on independent transaction and third party. Market risk arises when enterprise is subject to adverse sale conditions due to increase in competition in market place, adverse demand conditions or of inability to develop market or position product to service targeted customer. It was urged that comparable companies operating in the same market bear much higher risk than the appellant. These comparables are also responsible for storage and subsequent sale of finished goods and bear the risk of obsolescence /damage of its inventory. The learned representative of the taxpayer also challenged the finding of learned CIT (Appeals) that appellant had to pay no consideration towards intangibles. In fact above finding was irrelevant. The relevant thing is that appellant is not owner of any intangible whereas every tangible expects some return on account of handling intangible and, therefore, some adjustment in the case of the taxpayer not having intangibles. 131.1 As regards working capital, amount receivable and money tied up in holding inventory is an operating expenses and when the same is higher and different from those in the hands of the comparables, there is necessity to accurately evaluate the difference. This is an internationally accepted trade principle. The learned counsel for the taxpayer also challenged D.Rs observation that Chinese rule prohibit the use of adjustment of working capital. The learned counsel for taxpayer drew our attention to the detailed working available in the paper book of the differences in the working capitals of the taxpayer and the comparables. (page 367 of Paper Book No.I). 131.2 The taxpayer also sought adjustment for the higher import duty paid by the taxpayer as it was getting 80% of its raw material for assembly of TVs from abroad. Learned D.R. had argued that no third party would have made import if higher amount of import duty was payable in case of import from the AEs as compared to purchase from other related parties. She had also submitted that the taxpayer because of higher imported components was also realizing higher sale price. In reply thereto, the learned representative of taxpayer contended that it was business decision of the appellant to import goods from its AE for assembly and re-sale in India. The aforesaid business decision cannot be questioned by revenue authorities. In fact the taxpayer has earned sufficient profits because of aforesaid decision. In the present case, the taxpayer in order to ensure higher quality is making import and is paying additional customs duty as compared to the other comparables. 132. We have given careful thought to the rival submissions of the parties. As noted earlier, the learned CIT (A) has allowed adjustment of 10% against 20% allowed by the TPO in assessment year 2002-03. We are of the view that there are differences on account of no ownership of intangibles, various risks assumed etc. in the case of taxpayer as compared with other comparables. It is by no means an easy job to
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evaluate the differences for each of the factor. Taking an overall view of the matter, we are of view that order of TPO for the assessment year 2002-03 allowing deduction at 20% was fair and reasonable and should be upheld. 133. As regards the adjustment sought by the taxpayer on account of working capital, it is observed that the same was not allowed by the authorities below on the ground that the required details in this regard were not furnished by the taxpayer. Before us, the learned counsel for the taxpayer has submitted that such details were very much furnished by the taxpayer before the authorities below. In this connection, he has invited our attention to the copy of statement placed at page No.367 giving such details which have been perused by us. 134. It is no doubt true that as per the OECD Guidelines, the adjustment on account of working capital is required to be made to the operating margins of the comparables selected and even the Tribunal in the case of Mentor Graphics has accepted this proposition in principle. The question, however, is whether in the facts and circumstances of the present case, any such adjustment would be justified on account of working capital to the operating margins of the comparables. In this regard, it is observed on perusal of the working given by the taxpayer company itself that such adjustment by reducing the operating margin can be allowed only in the case of M/s Videocon Appliances and M/s B.S.Refrigerators. Even in the case of M/s Videocon International, the adjustment which is called for on the basis of the figures for 2001 is to the extent of 1.81% whereas the same comes to 0.51% on the basis of figures for the year 2000. This substantial variation in the adjustment required to be done on the basis of figures for the immediately two preceding years makes it clear that the difference in working capital requirement between the taxpayer company and M/s Videocon Appliances is not consistent on long term basis and the same is fluctuating in a wide range. In these circumstances, even if we take the simple average of these two years, the adjustment required would be 1.16% in the case of Videocon International and 0.69% in the case of B.S.Refrigerators. As against this, the adjustment which is called for on account of working capital by increasing the operating margins of the other comparables on the basis of the working given by the taxpayer company itself by taking the simple average of the relevant years comes as under :Videocon Communications Ltd. Hitachi Appliances Whirlpool of India Ltd. Carrier Aircon +0.33% +0/32% +0.65% +0.05%
135. As is evident from the above figures, the operating margin can be reduced by making working capital adjustment only in the cases of Videocon Appliances and B.S. Refrigerators to the extent of 1.16% and 0.69% whereas the same is required to be increased by 0.33%, 0.32%, 0.65% and 0.05% in the cases of Videocon Communications, Hitachi Appliances, Whirlpool and Carrier respectively. The net effect of such adjustment on account of working capital on the arithmetical mean of the operating margins of the comparables would be very marginal and in our opinion, the overall adjustment being allowed by us to the extent of 20% of the arithmetical mean on account of intangibles etc. would take care of this marginal adjustment on
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account of working capital. No separate adjustment thus would be required to be made to the operating margins on account of working capital. 136. As regards the taxpayers claim for adjustment to the operating margins of the comparables on account of higher amount of custom duty paid on imported components viz. a viz. the comparables, it is noticed that the working of such adjustment sought by the taxpayer is given on page no. 365 and 366 of the taxpayers paper book. A perusal of the said working shows that it is mainly based on proportion of imported components and the duty paid on such imported components. In our opinion, this basis adopted by the taxpayer for seeking the adjustment on account of excess custom duty borne by it is not correct inasmuch as consideration of duty payment alone would not justify such adjustment and it would be necessary to take into account the cost of components imported along with the custom duty paid thereon for the purpose of comparison with the corresponding indigenous components consumed by the comparables. Moreover, the local levies such as sales tax etc. are also required to be taken into account for such comparison. It is also pertinent to note here that if the taxpayer company has purchased the imported components after payment of custom duty at a higher price than the indigenous components purchased by the comparables, this decision must have been taken by it consciously taking into account all the commercial considerations including the obvious benefits of better quality which is bound to reflect or translate into a higher selling price of the product. This leaves hardly any scope for adjustment to the profit margins of the comparables on this count. 137. For the reasons given above, we allow deduction at 20% for various differences on account of intangibles, research and development, risk factors, working capital, etc. etc. against 10% allowed by the learned CIT (Appeals). This ground is disposed of accordingly. ITA No.1656/Del/2007 Revenues appeal for AY 2003-04 138. As regards the issue raised by the Revenue in ground No.1 relating to the addition of Rs.3,01,89,816/- made by the AO on account of brand promotion expenses, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.7 of the Revenues appeal for AY 2001-02 being ITA No.1181/Del/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No.1 of the Revenues appeal. 139. As regards the issue raised by the Revenue in ground No.2 relating to the claim of the taxpayer on account of depreciation claimed in respect of foreign exchange fluctuation, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.8 of the Revenues appeal for AY 2001-02 being ITA No.1181/Del/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No.2 of the Revenues appeal. 140. As regards the issue raised by the Revenue in ground No.3 relating to the inclusion of foreign exchange gain in the profits eligible for deduction u/s 10A/10B, it is observed that a similar issue has been decided by us in the foregoing portion of this
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order while disposing of ground No.1 of the Revenues appeal for AY 2002-03 being ITA No.1257/Del/2007. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) on this issue and dismiss ground No.3 of the Revenues appeal. 141. Ground No.4 raised by the Revenue in its appeal for AY 2003-04 relates to the transfer pricing issue which is being considered separately alongwith the relevant grounds raised by the taxpayer relating to the same issue while disposing of the appeal of the taxpayer. ITA No.820/Del/2007 Taxpayers appeal for AY 2003-04 142. Ground No.1 raised by the taxpayer in its appeal is general requiring no adjudication from us. 143. As regards the issue raised by the taxpayer in ground No.2 relating to the taxpayers claim for deduction u/s 80IA in respect of miscellaneous income and service income, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.2 of the taxpayers appeal for AY 2001-02 being ITA No.1189/Del/2005. Following our decision rendered on the said issue, we uphold the impugned order of the learned CIT(A) disallowing the taxpayers claim for deduction u/s 80IA in respect of miscellaneous income and service income and dismiss ground No.2 of the taxpayers appeal. 144. As regards the issue raised by the taxpayer in ground No.3 relating to the disallowance made on account of expenditure incurred by the taxpayer company on training of its employees, it is observed that a similar issue has been decided by us in the foregoing portion of this order while disposing of ground No.6 of the taxpayers appeal for AY 2002-03 being ITA No.819/Del/2007. Following our decision rendered on the said issue, we reverse the impugned order of the learned CIT(A) disallowing the taxpayers claim on this count and allow ground No.3 of the taxpayers appeal. 145. The next issue raised by the taxpayer in ground No.4 of its appeal for AY 2003-04 being ITA No.820/Del/2007 relates to its claim for inclusion of the following items of miscellaneous income in profits eligible for deduction u/s 10A/10B:i) ii) iii) iv) Notice pay received from employees Liabilities no longer existing written back Excess depreciation claim written back Other miscellaneous income : : : : Rs.92,121/Rs.2,36,250/Rs.3,55,673/Rs.1,56,732/-
146. After considering the rival submissions and perusing the relevant material on record, it is observed that a similar issue has already been considered and decided by us while adjudicating upon ground No.2 raised in taxpayers appeal for AY 2002-03. As held by us in this regard, notice pay received by the taxpayer company from its employees cannot be included in the profits eligible for deduction u/s 10A/10B. As regards the liabilities and depreciation written back, we are of the view that if the amounts of the said liabilities and depreciation were deducted as expenditure while computing the profits eligible for deduction u/s 10A/10B in the earlier years, the
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write-back of said amounts can appropriately/reasonably be included in the profits eligible for such deductions in the year under consideration. The AO, therefore, is directed to verify this aspect from the past records and allow appropriate relief to the taxpayer on this issue. As regards the other miscellaneous income amounting to Rs.1,56,732/-, it is observed that the details thereof are not placed on record before us and in the absence of the same, we are not in a position to decide this issue. However, in the interest of justice, we give one more opportunity to the taxpayer to furnish such details before the AO who is directed to consider the same on merits and decide this issue afresh in accordance with law. Ground No.4 of the taxpayers appeal is accordingly treated as partly allowed. Transfer Pricing Issues involved in AY 2003-04 147. Ground Nos.5 to 10 raised in the taxpayers appeal and ground No.4 raised in the Revenues appeal involve issues relating to transfer pricing and pertain to the addition made by way of adjustments under Section 92CA of the Act by determining higher arms length price than disclosed by the taxpayer in the international transactions carried with its associated enterprises AEs". 148. The taxpayer in its appeal for AY 2003-04, as far as transfer pricing is concerned, has raised the following grounds of appeal:5. That on facts and in law the CIT(A) failed to adjudicate on ground no.16 taken in the Memorandum of Appeal before him regarding the argument that the AO had only mechanically followed the order passed by the TPO without any application of mind on his part. The said ground reads as under:That on the facts and circumstances of the case, the ld. AO has erred by relying on the order passed by the ld. TPO without recording any cogent reasons for the same. 6. That on facts and in law the CIT(A) erred in upholding addition to income of Rs.400,660,016 udner Chapter X of the Income Tax Act, 1961. 7. That on facts and in law, the assumption of jurisdiction by AO/TPO to determine Arms Length Price is bad in law and void abinitio. 8. That on facts and in law the CIT(A) erred in upholding the modified Arms Length Price. 9. That without prejudice on facts and in law the AO/TPO erred and the CIT(A) inter alia erred in:
9.1 Not appreciating that the AO/TPO has erred by not applying Transactional Net Margin Method (TNMM) in the manner enunciated under Rule 10B of the Income Tax Rules, 1962.
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9.2 Observing that selection of comparables by the AO & TPO was acceptable (Para 14.9 of the impugned order) 9.3 Not appreciating that the AO/TPO has incorrectly applied Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations issued by the Organization for Economic Cooperation and Development in its July 1995 edition. 9.4 Upholding the exclusion of advertisement re-imbursement of Rs.103,189,197 for the purpose of comparison and determination of ALP vide Para 17.3 of the impugned order. 9.5 Observing that the amounts received as reimbursement were in the nature of a market support from the foreign AEs and was not connected to the operations of the appellant vide para 17.3 of the impugned order. 9.6 Observing that the advertisement expenditure for which reimbursement was received was a routine operational expenditure and was in no way dependent upon the reimbursement vide para 17.3 of the impugned order. 9.7 Adjudicating Ground no.25 taken in the Memorandum of Appeal before him for making adjustments for excessive foreign exchange losses incurred, against the appellant by observing, inter alia, in para 20.2 of the impugned order for the actual impact in profit margin rate on account of all in foreign exchange fluctuation rates could not be worked out by the appellant. 9.8 Observing that the Ground no.25 taken in the Memorandum of Appeal before him relating to adjustments for abnormal foreign exchange losses incurred by the appellant cannot be adjudicated in violation of Rule 46A of the Income Tax Rules, 1962 without appreciating the fact that the claim of adjustment did not tantamount to production of additional evidence as stipulated by Rule 46A. 9.9 Observing in Para 21.3 of the impugned order that the following items while calculating the operating margins for comparison and determination of ALP be excluded:PARTICULARS AMOUNT IN RS. (000) Provisions written back 7,916 Sales Tax/Service Tax refund 431 Notice Pay Recd/Fines & Penalties 437 from staff Membership & Subscription received 35 Other misc. income 12162
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9.10 Concluding in para 21.3 of the impugned order that miscellaneous income is non-operating since exact constitution of miscellaneous income was not known and by not soliciting such information from the appellant before drawing the aforesaid conclusion. 9.11 Not adjudicating on the argument that final assessment should be having regard to ALP and not based thereon. 9.12 Allowing for a limited reduction i.e. 10 per cent in the margin of the comparable companies to account for differences in functions, risks and assets employed by the appellant vis--vis comparable companies in para 18.2 of the impugned order and not allowing working capital adjustment, import duty adjustment, foreign exchange adjustment (para 20.2) and other adjustments on account of differences in risks undertaken, functions performed, ownership of intangibles and other business circumstances of the appellant vis--vis the comparable companies. 10. That on facts and in law the Authorities below erred in not allowing the option exercised by the appellant in determining the ALP by adjusting the arithmetical mean by 5 per cent as stipulated in the proviso to Section 92 C(2) of the Income Tax Act. 149. The Revenue, in their cross appeal, has challenged the relief allowed by ld. CIT(A) by excluding Local Area Development Tax (LADT) in computing the operating profit of the taxpayer. 150. We have heard both the parties in details and have also gone through written submissions along with the material available on record. As far as ground no. 5, 7, 9.3 and 9.11 of the taxpayer are concerned, the same have been dealt with extensively by the Special Bench of the Tribunal in the case of Aztec Software Technology Services Ltd. Vs ACIT, Bangalore 107 ITD 141 (SB) (Bangalore). We respectfully follow and apply aforesaid decision and dispose of this ground accordingly. Apart from what has been held, we have nothing to add. In fact, during the course of arguments, the ld. Counsel for the taxpayer also did not seriously press these general grounds. Therefore, no interference with the impugned order on these grounds. 150.1 We would now like to deal with the only ground raised by the revenue in their appeal relating to the exclusion of LADT while computing operating profit of the taxpayer. This issue also arose in this case in AY 2002-03 and after detailed discussion, similar order of the CIT(A) was confirmed. The facts and circumstances in the year under appeal are admitted to be identical. Therefore, order for AY 200203 is applied to assessment year under consideration also. The ground of appeal of the revenue is accordingly rejected. 151. The taxpayer in the assessment year under consideration, like in AY 2002-03, has raised several grounds. However, during the course of oral arguments as also in the written submissions filed by the taxpayers, certain specific issues are/were raised. These issues are dealt with herein below.
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Exclusion of reimbursement of advertisement expenses 152. In the period under consideration, like in AY 2002-03, the TPO has excluded reimbursement of Rs.10.31 crores received by taxpayer from its AE Soni Marketing Asia Pacific (Sony Pacific) to meet part of the expenses incurred on advertising and sale promotion. The submissions of the parties in respect of this claim were the same as advanced and fully discussed in the order for AY 2002-03. For the reasons already recorded, we hold that expenditure incurred by the taxpayer on advertisement and sale promotion were incurred to benefit its AE also and as per commitment of the AE to reimburse part of the expenditure. Therefore, the taxpayer debited net of reimbursement expenditure to the Profit & loss account. The gist of the argument of the taxpayer is noted in para 9.12 of impugned order which shows that position in the year under consideration was the same as in the last year. The argument taken by Transfer Pricing officer for rejecting the claim of the taxpayer are also same except for some isolated observations here and there, which, to our mind, do not make any material difference. 152.1 In the appellate proceedings, the ld. CIT(A) in para 17.3 of his order, posed the question whether the reimbursement received by the appellant on account of advertising expenditure should be considered as part of operating profit for purposes of comparison? Ld. CIT(A) has conceded, I find that the marketing expenditure which has been reimbursed to the appellant was nothing but a part of the operating cost of the appellant and there is no dispute on the same. We agree. However, after having accepted that expenditure incurred by the taxpayer was part of operating cost, the ld. CIT(A) raised the question whether reimbursement received should be treated as part of operational revenue. In fact, it is the case of the taxpayer that amount received from its AE was reimbursement of expenditure incurred for the benefit of the AE. Even before TPO, the contention in writing was it (taxpayer) would not have incurred the same level of advertising and market expenses if the reimbursements had not been available. So, throughout, it is the case of the taxpayer that AE has reimbursed the expenditure from which the AE had derived benefit. The taxpayer insisted on application of matching principles. The taxpayer has claimed advertisement expenditure net of reimbursement. It is not possible for us to agree with the line of reasoning adopted by the ld. CIT(A). The facts have been discussed in detail in order for AY 2002-03, which we follow. Copy of agreement to pay reimbursement for the year ending 31.3.2003 is available at pages 530 to 532 of the paper book. Accordingly, we direct that no adjustment on account of reimbursement of advertisement expenses be made while working out operating profit of the taxpayer. 152.2 The taxpayer had also shown other income in its profit & loss account under various heads. While working out operating profit, the TPO excluded certain items as was done in AY 2002-03. The details of such items excluded as available in the impugned order of CIT(A) are as under:Particulars Service Income Scrap sales Spares Sales Amount in Rs. (000) 7,824 5,263 1,442
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Damages for defective items Insurance Claim Provisions written back Sales Tax/Service Tax Refund Notice Pay Recd./Fines & Penalties from Staff Membership & Subscription Received Other misc. income Total
1,216 14,721 7,916 431 437 35 3,343 42,627
153. On appeal, the ld. CIT(A) allowed inclusion of service income, scrap sales, spare sales, damages for defective items and insurance claims for computing the operating profit. He maintained exclusion of provisions written back, sales tax/service tax refund, notice pay received/fine and penalties from staff, Membership and subscription received and other miscellaneous items. Ld. Counsel for the taxpayer, during the course of argument, contended that ld. CIT(A) excluded above items without giving any notice to the taxpayer and without any valid reasons. He made his submissions supporting the claim of the taxpayer on this issue. Ld. DR, on the other hand, submitted that a new plea was raised before the ld. CIT(A) which should not have been entertained. According to her, TPO had no occasion to examine above items. She further submitted that excluded item could not be treated as related to trading activity or trading operation. Therefore, exclusion of the said items of other income was fully justified. She further submitted that similar treatment was accorded to other comparables. The claim of the ld. DR was challenged by the ld. Counsel for the taxpayer and attention was drawn to submission dated November 29, 2005 (Page 302 of paper book No.1). It was submitted that exclusion was made by TPO and therefore such exclusion was rightly challenged before the CIT(A). 154. After hearing both the parties, we find no error in ld. CIT(A)s approach in entertaining claim of the taxpayers in respect of these items and allowing some relief. In fact, revenue has not challenged the finding of the ld. CIT(A) allowing relief to the taxpayer. Out of the items excluded by the ld. CIT(A) this year, we find that in appeal relating to AY 2002-03, we have discussed in detail and allowed provisions written back as proper inclusion while computing operating profit. Likewise, interest on delayed payment has been held to be a proper inclusion. As facts and circumstances are same, the said items are also allowed in the year under consideration as proper inclusions for computing operating profit. We order accordingly. 154.1 So far as other items like exclusion of sale tax refund/service tax refund, notice pay received/fine and penalties from staff and miscellaneous income are concerned, no detailed submissions were made except stating that claim made before the ld. CIT(A) be considered here too. The tax payer has submitted certain arguments while making similar claim in the general grounds relating to deduction u/s 80HHC. Reliance in support of such claim has been placed on the decision of Hon'ble Bombay High Court in the case of Bangalore Clothing Company (supra) wherein certain guidelines have been laid down to ascertain as to whether any item of other income represents operational income of the taxpayer. Applying the said guidelines, we have held that scrap sales, spare sales and provisions written back represent operational income of the taxpayer. Similarly, we are of the view that the receipts from damages for defective items, insurance claim and sales tax/service tax refunds can reasonably 73 http://www.itatonline.org
be treated as operational income of the taxpayer applying the said guidelines and accordingly, the same can be included in working out its operating profit. 154.2 As regards notice pay and penalties received from employees, we have, however, held that the same cannot be treated as operational income of the taxpayer applying the guidelines laid down by Hon'ble Bombay High Court. On the same analogy, membership and subscription received also cannot be included in the operating profit of the taxpayer. As regards service income, we have held in the context of deduction u/s 80HHC that the same does not represent operational income of the taxpayer. However, we may clarify that the service income has been held to be includible in the operating profit by the learned CIT(A) in the present context and the Revenue has not challenged the said decision of the learned CIT(A) in its appeal. As regards other miscellaneous income of Rs.33.43 lakhs, the taxpayer has not furnished the required details of the same to ascertain its exact nature. In the interest of justice, we allow one more opportunity to the taxpayer to furnish the said details before the AO who shall consider the same on merits. The issue relating to inclusion of other income in the operating profit is accordingly disposed off. Exclusion and Rejection of Comparables 155. In appeal for AY 2002-03, the taxpayer has vehemently challenged exclusion of Godrej Appliances Ltd., Hitachi Home & Life Solutions(India) Ltd. (Hitachi), FAL Industries Limited (FAL) and Monica Electronics Ltd. (Monica) from the list of comparables. The TPO and on appeal the ld. CIT(A) in AY 2002-03, had excluded Godrej and Hitachi from the list of comparables as they found that facts and circumstances in the year under consideration are similar. The above two companies have again been excluded from comparables taken into consideration. FAL and Monica Electronics Ltd. have been excluded in the year under consideration as their total turnover was much less than Rs.100 crore. A lower filter was adopted by the TPO to take only companies having turnover of Rs.100 crore or more. We are of the view that above filter having been universally applied, there is no justification to take FAL (Rs. 47.85 crore) and Monica Electronics Ltd. (Rs. 62.8 crore) as comparable for determining (mean of) operating profit. Hitachi, Whirlpool and Carrier Aircon Ltd. have been included by us in the list of comparable in AY 2002-03. The facts and circumstances in the year under consideration are quite identical and no distinguishing feature has been pointed out to exclude above companies in the year under consideration. Here, it may be relevant to point out that Hitachi after showing losses for some years have shown profit as per its annual account available to public in the F.Y. 2004-05. Therefore, in our opinion Hitachi could not be excluded merely because it had shown loss in certain years. Above companies were accepted to have satisfied all the filters except that of transactions with the related parties. This objection of the revenue has been thoroughly considered in AY 2002-03 and above mentioned companies have been included in the list of comparables. As facts and circumstances are similar and as transactions with the related parties, like the last year, are not likely to affect operating profit materially, these companies are included in the list of comparables this year also. 155.2 The taxpayer has again contended that Godrej Appliances Ltd. be included and Videocon International be excluded from the list of comparables in the light of directions of OECD guidelines and Indian transfer pricing regulations. The
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arguments addressed by the parties have been considered in detail and for the reasons given for the AY 2002-03, we uphold the exclusion of Godrej from the list of comparables. For the reasons given earlier in AY 2002-03, we accept taxpayers contention and direct that Videocon International be excluded from the list of comparables for the assessment year under consideration. 155.3 The Transfer Pricing Officer had allowed deduction of 20% for taxpayer in A.Y. 2002-03 to the taxpayer for not possessing any tangible R&D (research and development) facilities etc. The TPO did not allow any deduction for above factors in AY 2003-04. 156. On appeal, the CIT(A) thought it fit to restrict the deduction to 10% for some of above factors, while computing mean operational profit. The revenue has accepted above part of the directions of ld. CIT(A). The taxpayer, on the other hand, had agitated that larger percentage of deduction be allowed to the taxpayer for not possessing any intangible assets or/and R&D facilities. The taxpayer also claimed further deductions for various risks like price risk etc. It also sought deduction for working capital and for the higher custom duty the taxpayer has to pay on imports as against other comparable companies. After considering the rival submissions of the parties and the relevant material on record, it is observed that a similar deduction at 20% has been allowed by us in AY 2002-03 involving identical circumstances. The same to that extent is allowed in this year too. Application of proviso to Section 92C(2) 157. The taxpayer also claimed benefit of adjustment under proviso to Section 92C(2) which is as under:Provided that where more than one price is determined by the most appropriate method, the arms length price shall be taken to be the arithmetical mean of such prices, or, at the option of the taxpayer, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean. 158. The TPO did not allow any benefit in both the assessment years under appeal as in his view above provision was not applicable in this case. The provision would be applicable only if Arms Length Price shown by the taxpayer falls within 5% of arithmetic mean of more than one price determined by the Most Appropriate Method. As the taxpayer was not falling in above range, it was not entitled to any benefit. 159. The taxpayer carried the matter in appeal before the ld. CIT(A). It was contended that proviso to Section 92C is to be read along with provision of Section 92C(4). The representative of the taxpayer also drew CIT(A)s attention to notes on clauses of the Finance Bill 2002 wherein this provision has been explained. 159.1 It was accordingly contended that the taxpayer has the option of charging a price to its associated enterprise which may vary from the arithmetic mean of uncontrolled price determined by the TPO by 5%. Thus, adjustment to the income of the appellant should have been made after considering 5% variation from determined Arms Length Price. It was further submitted that it is mandatory for the
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TPO to calculate the Arms Length Price in the light of Sub-section (1) and subsection (2) of Section 92C of the I.T.Act. 160. After considering facts and circumstances of the case, the ld. CIT(A) found no force in the submissions advanced on behalf of the taxpayer. He was of the view that there were two limbs of the provision. Its first limb deals with the situation where the Most Appropriate Method leads to more than one Arms Length Price and in that situation the Arms Length Price should be the arithmetic mean. Second limb of the provision, provides the facility of option to the taxpayer if price varies by an amount not exceeding 5% of such mean. Thus, according to the ld. CIT(A), the option is available to the taxpayer in the case where variation in price is only upto 5% as found through arithmetic mean. If the variation in price is more than 5%, the taxpayer has no option and Arms Length Price shall be determined as per the first limb of the proviso. The ld. CIT(A) referred to Circular No. 12 of CBDT dated 23.8.01 issued in the shape of press note by the Ministry of Finance (Deptt. Of Revenue), Government of India relating to the application of transfer pricing provisions. Circular was issued in order to avoid hardship to the taxpayers in the initial years of implementation of transfer pricing provisions introduced for the first time for AY 2002-03. The press note makes its intention clear for not making any adjustment if the price adopted by the taxpayer was upto 5% less or upto 5% more than the Arms Length Price determined by the AO. In effect, transfer pricing shown by the taxpayer was not disturbed if such price fell within the range of 5% of determined price. But if the variation in the disclosed price and the determined Arms Length Price was more than the above limit, then the Circular provided that transfer price declared by the taxpayer was not to be accepted and adjustment for the variation was required to be made. 161. The ld. CIT(A) further held that provision under review was like a safe harbour i.e. if one was within the harbour i.e. within 5% limit variation, such person was entitled to exercise the option. The ld. CIT(A) further observed that proviso under consideration was not a provision like any standard deduction to the taxpayer as to enable it to opt the 5% deduction everywhere. It was not possible to accept that in all Arms Length Price computations, the AO/TPO shall be required to reduce or increase the price/expenditure by 5% irrespective of the Arms Length Price shown and arithmetic mean of Arms Length Price determined by the AO, the CIT(A) further added. According to the ld. CIT(A), such a view cannot be accepted. Reliance was placed by the ld. CIT(A) on the decision taken by his predecessor in the case of Mentor Graphics (Noida) Pvt. Ltd. Vs DCIT for AY 2002-03 where similar claim was rejected. Turning to the facts involved in two assessment years under appeal, the ld. CIT(A) found that arithmetic mean of ALP determined by the TPO in both the assessment years exceeded range of 5% from the international transaction shown in the books of account. The appellant was not entitled to any relief under the above proviso. The ld. CIT(A) accordingly upheld the action of the Assessing Officer. 162. The taxpayer being aggrieved has brought the issue in appeal before the Tribunal. During the course of hearing, ld. Representative of the taxpayer has made the following submissions:(i) Circular 12/2001 states that The Assessing Officer shall not make any adjustment to the arms length price
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determined by the taxpayer, if such price is upto 5% less or upto 5% more than the price determined by the Assessing Officer. In such cases the price declared by the taxpayer may be accepted. Hence, the circular relied upon by the learned DR simply prescribes that relief should be given to taxpayer where the arms length price determined by the taxpayer and the AO do not differ by more than 5%. However, the Circular does not provide for the manner for determination of arms length price. (ii) Moreover, the Circular was issued prior to insertion of the Proviso to Section 92(2). Hence, it would be incorrect to assume that the Circular explains the Proviso to Section 92(2). If the Proviso was intended to be in the same spirit as the Circular, the latter should have been withdrawn after introduction of the proviso. Moreover, the plain wording of the legislation at the option of the taxpayer, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean makes it amply clear that the taxpayer may exercise the option allowed under law and choose the price varying from the arithmetic mean by 5 per cent as the arms length price. It appears that the DR has interpreted the Proviso solely in light of the Circular without any regard to the wordings or the intent of the Proviso.
(iii)
(iv)
(v)
162.1 Reliance was placed on the decision of the ITAT Kolkata Bench in the case of Development Consultants Pvt. Ltd. Vs DCIT, Kolkata in ITA No. 79 & 80/KOL/08. 162.2 The ld. DR, on the other hand, relied upon the reasoning given by the ld. CIT(A). The ld. DR has further made the following submissions in writing:The adjusted mean ALP is taken as ALP by TPOs only in cases where the declared transfer price falls within + - range. Consequently, the transfer price shown by the taxpayers in such cases is accepted and no transfer pricing adjustment is made. But, in cases where the declared transfer price falls outside +5% range, the main ALP is taken as ALP and consequently, transfer pricing adjustments are made by TPOs from the mean ALP and not from adjusted mean ALP. The dispute over +5% adjustment in ALP determination is further explained by way of following example.
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Table: Dispute over +5% Adjustment in ALP Determination Item Declared Transfer Price (Sale) Mean ALP + - 5% Range Adjusted Mean ALP (-5%) ALP TP Adjustment Taxpayers View 90 100 95-105 95 95 05 (95-90) TPOs View 90 100 95-105 95 95 10(100-90)
In the above example, the declared transfer price of 90 is outside 5% range of 95-105. Therefore, the TPO takes mean ALP of 100 as ALP and consequently, transfer pricing adjustment (10) is made for the difference between mean ALP and transfer price (90). However, the taxpayer takes adjusted mean ALP of 95 as ALP and contends that transfer pricing adjustment should be made for 05 on account of difference between adjusted mean ALP (95) and transfer price (90)! In most of the transfer pricing audit cases, one of the dispute relates to 5% adjustment in ALP determination. The main reason of dispute lies in divergent interpretations of the proviso to section 92C(2) of the Act which contains relevant provisions dealing with such adjustment. In order to resolve the dispute, it may be necessary to make clarificatory amendment in the proviso which unambiguously expresses the legislative intent in respect of 5% adjustment in ALP determination. As would be seen from the discussion made hereinafter, the legislative intent for 5% adjustment in ALP determination was to accept the declared transfer price if the variation between transfer price and the mean ALP was within 5% of mean ALP. In case, the variation between the declared transfer price and the mean ALP exceeded 5% of mean ALP, the transfer price was not to be accepted and transfer pricing adjustment was to be made from mean ALP i.e. for the difference between declared transfer price and mean ALP. Section 92(1) of the Income Tax Act provides that any income arising from an international transaction shall be computed having regard to the arms length price. Section 92C(2) of the Act provides for determination of the arms length price by applying the most appropriate method in the prescribed manner. The proviso to the said Section 92C(2), as it stood originally before its amendment by the Finance Act, 2002, provided that where more than one price is determined by the most appropriate method, the arms length price 78 http://www.itatonline.org
shall be taken to be arithmetical mean of such prices. This would have resulted into addition to the total income on account of transfer pricing adjustments in all cases wherever there was any variation between the arithmetical mean arms length price (i.e. mean ALP) determined by the AO/TPO and the transfer price as shown by the taxpayers. The transfer pricing provisions were brought on the Statute by the Finance Act, 2001 w.e.f. 01.04.2001. With a view to avoid hardship to the taxpayers in the initial years of implementation of these provisions, the Govt. of India, through a Press note issued by the Ministry of Finance (Department of Revenue) on 22.8.2001, expressed its intention of not making any adjustment if the price adopted by the taxpayer was upto 5% less or up to 5% more than the arms length price determined by the AO. Immediately thereafter, the Board issued the Circular No. 12 dated 23.8.2001 specifying that the AO shall not make any adjustment to the price shown by the taxpayer if such price was up to 5% less or up to 5% more than the arms length price determined by the AO and in such cases, the price declared by the taxpayer may be accepted. In effect, the transfer price shown by the taxpayer was not to be disturbed if it was within + -5% mean ALP range i.e. upto 5% less (i.e. in case of receipts) or up to 5% more (i.e. in case of outgoings) than the arms length price determined by the AO based on the arithmetical mean of the prices. If the transfer price shown by the taxpayer was less than 5% (in case of receipts) or more than 5% (in case of outgoings) of the arithmetical mean arms length price (i.e. mean ALP) determined by the AO, then the transfer price declared by the taxpayer was not to be accepted and the adjustment was required to be made for the difference between the arms length price determined by the AO based on the arithmetical mean of the prices (i.e. mean ALP) and the transfer price shown by the taxpayer. The relaxation in transfer pricing adjustments provided by the Boards Circular No.12 dated 23.8.2001, referred to in the proceedings paragraph, was clearly intended to remove hardship to the taxpayers in whose cases the variation between the declared transfer price and the determined mean ALP was only marginal i.e. within 5% of the mean ALP. This relaxation was not intended to be provided to the taxpayers in whose cases the variation between the declared transfer price and the determined mean ALP was substantial and exceeded the permissible +5% range. Subsequently, the relaxation extended by the above Circular was, in substance, brought on the Statute by the Finance Act, 2002 by amending the proviso to section 92C(2) of the Act with retrospective effect from 01.04.2002 so as to provide that besides the arithmetical mean of the prices, the arms length price shall be a price which varies from the arithmetical mean up to 5%.
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It is, thus, evident that the legislative intent of the amended proviso to section 92C(2) of the Act is to remove hardship in cases of marginal variation up to 5% between the transfer price declared by the taxpayer and the mean ALP determined by the TPO. This is sought to be achieved by taking the arithmetical mean price after adjustment of variation up to 5% (i.e. adjusted mean ALP), as the arms length price so that in cases of marginal variation upto 5%, there would be no difference between the transfer price declared by the taxpayer and the ALP determined by the TPO. Consequently, there would be no addition on account of transfer pricing adjustment in cases of marginal variation upto 5% between the transfer price declared by the taxpayer and the mean ALP determined by the TPO. The benefit of adopting the adjusted mean ALP as the arms length price is not intended to the available to a case where the variation between the transfer price shown by the taxpayer and the mean ALP determined by the TPO exceeds 5% of mean ALP. In case, the variation between the transfer price declared by the taxpayer and the mean ALP determined by the TPO exceeds 5% of mean ALP, then the arms length price shall be taken to be mean ALP and not the adjusted mean ALP. Consequently, the transfer pricing adjustment would be made for the difference between the transfer price shown by the taxpayer and the mean ALP determined by the TPO. The view taken by TPO with regard to 5% adjustment in ALP determination, as mentioned in preceding paragraphs is, thus, found to be in consonance with the legislative intent of the proviso to section 92C(2) of the Act. 163. We have given careful thought to the rival submissions of the parties. We are of the view that Circular No. 12 dated 23.1.2001 does not help to solve the problem. The said Circular was issued prior to introduction of the proviso. It was meant to give benefit to the marginal cases in the initial years of implementation of Transfer Pricing Regulations in India. The proviso, on the other hand, is a permanent provision. It is intended to provide safe harbour to marginal cases falling within the range. However, it is a settled law that when a provision is introduced, the courts have to look at the language in which the provision is expressed. Only in cases of ambiguity, it is permitted to go beyond the language and consider the intention of the legislation. We would, therefore, like to concentrate on the language of the proviso in question. 163.1 On dissection of proviso, we find that it consists mainly of two parts (limbs):(a) Where more than one price is determined by the Most Appropriate Method, then Arms Length Price shall be taken to be the arithmetical mean of such price; OR
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(b) At the option of the taxpayer, a price which may vary from the arithmetical mean by an amount not exceeding 5% of such arithmetical mean. 163.2 As far as the first limb of above provision is concerned, the same has general application. Where, through the Most Appropriate Method, more than one price is determined, the arithmetic mean of such price shall be taken to be the Arms Length Price in relation to the international transaction. As far as first limb of the provision is concerned, there is no option with nor any sort of concession allowed to the taxpayer. The Arms Length Price so determined may be accepted or contested by the taxpayer or by any aggrieved person in accordance with the statutory provisions. It is statutory levy without any option. There is no dispute as to the interpretation of the above part or limb of the provision. 163.3 The controversy is relating to the second limb/portion of the provision where an option is given to the taxpayer to take Arms Length Price which may vary from the arithmetic mean by an amount not exceeding 5% of such arithmetic mean. Here again, there is no controversy that taxpayer can take Arms Length Price which is not exceeding 5% of the arithmetic mean. The option, as is clear from the language is to take Arms Length Price which is not in excess of 5% of the said mean. The word option as per The Law Lexicon is synonymous with choice or preference. Therefore, it is the choice of the taxpayer to take Arms Length Price with a marginal benefit and not the arithmetical mean determined as the Most Appropriate Method. The controversy is in cases where the International Price shown in related party transaction exceeds 5% of the Arithmetic mean envisaged by the provision and such Arms Length Price is contested by the taxpayer. According to the revenue, in such a situation, the second limb of the provision is not applicable. The reasons put forth in support of such a view by the revenue have already been noted. It is their contention that the second part/limb of the provision is meant to cover marginal cases only where the price shown by the taxpayer does not exceed 5% of the Arms Length price representing arithmetic mean by the Most Appropriate Method. Where the difference is much more than 5%, then taxpayer cannot have the benefit of the said provision, particularly where the taxpayer has not accepted such arithmetic mean. 163.4 The other view is the one accepted by Kolkata A Bench of the Tribunal in the case of Development Consultants (P) Ltd. Vs DCIT, Circle 2, Kolkata (ITA No.79 & 80/KOL/2008) decided on 4.4.2008. As per the said decision, the benefit of second limb of the proviso was allowed to the taxpayers although the price disclosed by it was more than 5% of arithmetic mean. The decision of the Coordinate Bench is binding on us and we are inclined to follow the same. That apart, we are of the view that Kolkata Bench of the Tribunal has taken a right view of the provision. We are to go by the language of the provision and when we do so, we do not see anything in the language to restrict the application of the provision only to marginal cases where price disclosed by the taxpayer does not exceed 5% of the arithmetic mean. In our considered opinion, the Arms Length Price determined on application of Most Appropriate Method is only an approximation and is not a scientific evaluation. Therefore, the legislature thought it proper to allow marginal benefit to cases who opt for such benefit. In the case of a taxpayer who exercises the option and accepts Arms Length Price as per the second limb of the proviso or in other words, he accepts the Arms Length Price even exceeding 5% of Arithmetic mean determined by the tax authority as correct and is ready to pay tax on the difference between price
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disclosed by him and the above Arms Length Price. We do not see any valid objection on the part of the revenue to the application of above provision to such a case. The taxpayer has exercised the option and took Arms Length Price as per the second limb as the final price without raising any dispute. Therefore, the parameters laid down as per the second limb are fully satisfied. In our opinion, the legal position cannot be different in a case where minor variation of 5% is not accepted and Arms Length price is further challenged in appeal. Mere fact of acceptance or nonacceptance of arithmetic mean can be taken to be the determining factor relating to right to contest Arms Length Price in appeal. Such inference has no support of language of the provision. In our view, both in the first as also in the second limb, implications of determined Arms Length Price are the same except for the marginal benefit allowed to the taxpayer under the second limb. Hence, we are of the view that second limb is applicable even to cases where the taxpayer intends to challenge Arms Length Price taken as arithmetic mean and determined through the Most Appropriate Method. As stated above, the second proviso is intended to give marginal relief to all taxpayers as determination of Arms Length Price is not an exact science but is an approximation. Option is given to the taxpayer as in some cases, variation not exceeding 5% of arithmetic mean might not suit the taxpayer, and, therefore, taxpayer in such cases should not be put to a prejudice. Otherwise, there is no difference between the first and the second limb of the provision as far as right of the taxpayer to challenge the determined price is concerned. The second limb only allows marginal relief to the taxpayer at his option to take ALP not exceeding 5% of the arithmetic mean. Therefore, in line with the view taken by Kolkata Bench of the Tribunal, we are of the view that benefit of the second limb is available to all taxpayers irrespective of the fact that price of international transaction disclosed by them exceeds the margin provided in the provision. 164. In the result, the appeals of the assessee for all the three years under consideration as well as appeals of the Revenue for AY 2001-02 & 2002-03 are partly allowed whereas the appeal of the Revenue for AY 2003-04 is dismissed. Decision pronounced in the open Court on Sd/(P.M.JAGTAP) ACCOUNTANT MEMBER Dated : 23.09.2008. DRS Copy forwarded to: 1. Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT Deputy Registrar September, 2008. Sd/(VIMAL GANDHI) PRESIDENT
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IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH H: NEW DELHI BEFORE SHRI VIMAL GANDHI, HONBLE PRESIDENT

Exclude those companies with sales less than 100 crores

To exclude companies having controlled party transactions

Name of the Associated Transaction Enterprise (AE) Amount (in Rs.)

Arms Length Price (79.59% of Transaction Amount) 407,637,942 480,804,211

281,359,844 30,657,400 1,352,655,163

delayed payment Other Misc. Revenue Total

1,216 14,721 7,916 431 437 35 3,343 42,627

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