Income Tax Appellate Tribunal - Hyderabad
Asst.Commissiioner Of Income Tax ... vs Dr.Reddy'S Laboratories Limited, ... on 13 June, 2018
IN THE INCOME TAX APPELLATE TRIBUNAL
HYDERABAD BENCHES "A" BENCH: HYDERABAD
BEFORE SHRI D. MANMOHAN, VICE PRESIDENT AND
SHRI S. RIFAUR RAHMAN, ACCOUNTANT MEMBER
ITA. No.1739/Hyd/2017
Assessment Year:2012-13
Dr. Reddy's Laboratories vs. ACIT,
Limited, Circle-7(1),
Hyderabad. Hyderabad.
PAN: AAACD7999Q
(Appellant) (Respondent)
ITA. No.1729/Hyd/2017
Assessment Year:2012-13
ACIT, vs. Dr. Reddy's Laboratories
Circle-7(1), Limited,
Hyderabad. Hyderabad.
PAN: AAACD7999Q
(Appellant) (Respondent)
For Assessee: Shri S.P. Chidambaram
For Revenue : Shri J. Siri Kumar, CIT-DR
Date of Hearing : 23.05.2018
Date of Pronouncement : 13.06.2018
ORDER
PER BENCH:
These cross appeals are directed against the order passed by Ld. CIT(A)-5, Hyderabad and they pertain to Assessment Year 2012-2013. In the appeal filed by the Revenue, the following grounds were urged:
"1. The Ld. CIT(A) has erred both in law and on facts of the case.
2. The Ld. CIT(A) has erred in pronouncing the interest on loans given to foreign AEs at LIBOR + 200 basis points without considering the financials and creditworthiness of the foreign AEs.2
3. The Ld. CIT(A) has erred in pronouncing the corporate guarantee given by the assessee to its foreign AE not to be an international transaction ignoring the insertion of clause (c) in the explanation (i) in section 92B(2) in Finance Act 2012 with retrospective from 01.04.2002.
4. The Ld. CIT(A) has erred in pronouncing the corporate guarantee given by the assessee to its foreign AE not to be an international transaction merely because the Corporate Guarantee is not claimed to have bearing on profit and loss account of the assessee ignoring its overall effect on the financial status of the assessee- company.
5. The Ld. CIT(A) has erred in holding that the expenditure incurred towards stock based compensation (ESOPs) is ascertained liability and hence Revenue expenditure."
2. Learned Counsel for the Assessee prepared a brief note to highlight that the issues urged in the appeal by the Revenue are covered in favour of the assessee and against the Revenue. However, the facts are briefly narrated to appreciate as to how the issues urged therein are covered by the orders passed by the ITAT in the assessee's own case for the earlier years.
3. Grounds no.1 and 6 are general in nature and therefore they need not be considered independently. Ground Nos.2 to 4 are with regard to corporate guarantee given by assessee to its AEs. It deserves to be noticed that the A.O. has made TP adjustment on account of corporate guarantee commission @ 2% resulting in an addition of Rs. 26,34,86,623/-. During the financial year 2011-12, the assessee provided guarantee towards loans obtained by various subsidiaries which are Associated Enterprises. The TPO / A.O. treated the transactions as international transactions, for the purpose of section 92B of the Act, and charged 2% commission on the said guarantee. In this regard, TPO observed that the rate of interest with recourse i.e., loan with corporate guarantee was Euribor + 0.7% whereas the interest on loan without recourse (corporate guarantee) was Euribor + 2%. According to him, as a result of corporate guarantee AE derived benefit in the form of lower interest by 1.3 basis points. The A.O. has taken 3 into consideration the OECD guidelines to hold that the tax payer has provided an intra group service which requires to be bench-marked properly. In order to find the corporate fee at Arm's Length, the most common methods used is the "yield approach" or "benefit to the borrower approach". This approach was used by the Canadian Tax Authorities and the same was upheld by the Tax Court of Canada and Federal Court of Canada. Thus, yield approach was adopted for the purpose of determining the Arm's Length fee for the corporate guarantee given by the tax-payer to the lender bank and accordingly he computed the ALP fee @ 2% per annum of the loan amount. Accordingly an adjustment was made u/s 92CA(3) of the Act to the tune of Rs. 26.34 Crs.
4. On an appeal filed by the assessee, the Ld. CIT(A) noticed that in the assessee's own case for the A.Ys 2009-10 and 2010-11 (ITA No. 294/Hyd/2014 and 458 & 463/H/2015) the Appellate Tribunal considered an identical issue wherein it was held that the corporate guarantee is not an international transaction covered by section 92B of the Income Tax Act, 1961 and therefore there cannot be any ALP adjustment. It was contended by the Counsel that the appellant has not incurred any cost to provide such guarantee and therefore it will not have any impact on profits or costs of the assessee. Ld. CIT(A), by respectfully following the decisions (cited supra), concluded as under:
"Respectfully following the decisions of the jurisdictional Tribunal in assessee's own case and the reasons cited above I hold that the Explanation to section 92B cannot be applied retrospectively and for the years under consideration the assessee having not incurred any costs in providing corporate guarantee it would not constitute "international transaction" within the meaning of section 92B of the Act and consequently, ALP adjustment is not warranted on this aspect. In the present case, we are dealing with the assessment year 2012-13. The Explanation to section 92B is stated to be clarificatory but it has been judicially held to be effective from A.Y. 2013-14. Hence, the Ground no.2 is allowed."
5. Aggrieved, Revenue is in appeal before us.
46. Learned CIT-DR merely relied upon the order passed by the Assessing Officer and has not brought anything on record to suggest that the order passed in the assessee's own case for the earlier years is bad in law. Under these circumstances, we hold that the Ld. CIT(A) having followed the decision of the Tribunal in the assessee's own case for the earlier years, the order of the Ld. CIT(A) does not call for any interference. Accordingly, grounds nos.2 to 4 urged by the Revenue are hereby rejected.
7. Vide ground no.5, the Revenue contends that the Ld. CIT(A) erred in holding that the expenditure incurred towards ESOPs is an ascertained liability and hence revenue expenditure.
8. Facts in brief are that the assessee-company instituted the plan for all eligible employees, in pursuance of the special resolution approved by the shareholders in the Annual General Meeting. As per the plan, the Compensation Committee of the Board shall administer grant of stock options to eligible employees subject to certain conditions i.e., number of options to be granted, the exercise price, the vesting period and the exercise period. In accordance with the SEBI guidelines, the excess of the market price of shares at the date of grant of options under the ESOPs over the exercise price is treated as employee compensation and amortised over the vesting period. During the financial year 2011-12 an amount of Rs. 40.33 Crs has been amortised and debited to the Profit & Loss Account which was not accepted by the A.O / TPO on the ground that it is not an ascertained liability. However, Ld. CIT(A) observed that identical issue was considered in the assessee's own case for the earlier years (AYs 2006- 07 to 2008-09) wherein it was held that the difference between the price of shares and their issuance price should be treated as an expenditure 5 in the hands of the assessee. In otherwords, it is an ascertained liability and therefore treated as revenue expenditure allowable u/s 37(1) of the Act. Aggrieved, Revenue is in appeal before the Tribunal.
9. Learned Counsel for the Assessee submitted that an identical issue was considered by the ITAT (page 78 of the case-law paper book) wherein it was held that this has to be treated as an allowable expenditure u/s 37(1) of the Act.
10. Learned DR relied upon the order passed by the Assessing Officer.
11. Having regard to the circumstances, we are of the view that the order passed by the Ld. CIT(A) does not call for any interference since the same is in consonance with the view taken by the ITAT in the assessee's own case for the earlier years. We therefore reject Ground no.5 of the Revenue.
12. In the result, appeal filed by the Revenue is dismissed.
13. In the appeal filed by the assessee-company, Grounds no.1 and 2 are relatable to determination of ALP in respect of loans given to its Associated Enterprises.
14. Assessing Officer observed that the assessee entered into loan transactions with Six of its AEs at varying rates i.e., from 0% to 9.74%. TPO observed that the assessee-company having granted loans to its AEs, within the regulatory frame-work approved by the Reserve Bank of India, such approval should serve as an yardstick to determine the Arm's Length basis. The case of the assessee was that the loans were given to its wholly owned subsidiaries and the loan was granted to support their working capital requirements. Since 100% control of its 6 entities rest with the assessee-company, there is no scope for default risk and hence there is no need to assume premium over the bench- marked interest rate which needs to be charged. However, as a best practice, the assessee-company charged the nominal premium in addition to base interest rate. A.O. however was of the opinion that the interest rate of 7% should be considered as ALP and accordingly arrived at the short-fall of Rs. 6.50 Crs and made adjustment u/s 92CA(3) of the Act.
15. The case of the assessee before the Ld. CIT(A) was that rate fixed by the LIBOR has to be considered as ALP. Ld. CIT(A) however observed that in the assessee's own case for the A.Y. 2006-07 the ITAT allowed the interest, based on LIBOR, and adopted interest rate of 7%. Similar ruling was given by the DRP in its own case for the A.Ys 2008-2009 to 2010-11.
16. The ITAT has observed that in principle LIBOR + 200 basis points can be adopted as ALP and accordingly set-aside the matter to the file of A.O. with a direction to adopt the LIBOR rate applicable for the AYs under consideration + 200 basis points to arrive at the ALP.
17. After thoroughly analysing the issue, Ld. CIT(A) concluded that LIBOR provides the basis for price and interest rates of all kinds of financial products like interest swaps, interest futures, savings account and mortgages. He accordingly held that LIBOR should be taken as bench-mark for charging interest. By respectfully following the decision of the ITAT in the assessee's own case, A.O. was directed to adopt the LIBOR rate applicable for the years under consideration + 200 basis points to arrive at the ALP.
18. Aggrieved, assessee preferred an appeal before the Tribunal.
719. Learned Counsel for the Assessee referred to pages 27 to 29 of the paper book to submit that identical issue was already considered by the Tribunal and admitted that the direction given by the Ld. CIT(A) is in consonance with the view taken therein. Under these circumstances, we uphold the order of the Ld. CIT(A) and reject Grounds no.1 and 2 of the assessee.
20. Ground no.3 is with regard to treatment of expenditure for repairs and maintenance of plant and machinery. Learned Counsel for the Assessee fairly admitted that in the earlier years this claim was rejected by the Tribunal. He also submitted that he is not pressing this ground. Under these circumstances, we uphold the order of the Ld. CIT(A) on this issue and reject Ground no.3 of the assessee.
21. Vide Ground no.4 assessee contends that the expenses incurred towards travel, stay etc., in the public conferences attended by the Doctors is to improve the knowledge of the Doctors on the latest developments and therefore the same is allowable as deduction u/s 37(1) of the Act. This issue was considered by the ITAT Hyderabad "A" Bench in the assessee's own case for the AYs 2009-10 and 2010-11 wherein - vide page 33 onwards - the Bench observed, in para 43.1, that this issue deserves to be set-aside to the file of the A.O. to verify the nature of expenditure and disallow only such expenditure which is not incurred for the business purposes of the assessee. Learned Counsel for the Assessee submits that the Tribunal has considered for the first time, with regard to the allowability of deduction, only in 2017 and therefore, in the instant case also a direction may be given to the Assessing Officer to verify the nature of expenditure.
22. Learned Departmental Representative, on the other hand, relied upon the order of the Assessing Officer.
823. Consistent with the view taken in the assessee's own case in the earlier years, we hereby direct the Assessing Officer to verify the nature of expenditure and disallow only such expenditure which was not incurred for the purpose of business of the assessee.
24. Vide Ground no.5, assessee contends that allocating corporate overheads, ESOP and Research and Development expenditure to the units eligible for deduction u/s 80-IC of the Act, overlooking the fact that the each unit is a self-sustained unit, is not in accordance with law. It was also contended that without prejudice to the above contention, allocation of gross corporate overheads instead of net corporate overheads is not justified.
25. As regards the allocation of corporate overhead expenses, Learned Counsel for the Assessee submitted that identical issue was set-aside by the ITAT in the assessee's own case for the earlier years (pages 33 to 35 of the paper book) wherein the Tribunal observed as under:
"49. We have considered the rival contentions and perused the record. In asessee's own case for the AYs 2007-08 and 2008-09 (supra), the Tribunal vide para 64 set aside the matter with the following observations:
"64. The Learned Counsel for the assessee submitted that it is only the net expenditure and not the gross expenditure which should be allocated amongst all the Units. We agree with the contention of the assessee and direct the A.O. to allocate only net expenditure of the corporate entity amongst all the units on the basis of the turnover. Thus, the alternate contention of the assessee is allowed."
50. Facts being identical in this year also, we direct the A.O. to allocate net expenditure of the corporate entity amongst all the units on the basis of turnover. This ground is disposed of accordingly."
26. We have carefully considered the rival submissions. Consistent with the view taken therein we hold that the corporate overheads should be allocated amongst all the units based on turnover of respective units 9 but while allocating the expenditure only net expenditure should be allocated on the basis of turnover. A.O. is directed to re-consider the matter in line with the view taken by us in the assessee's own case for the earlier years.
27. With regard to ESOP and R & D expenditure, the case of the Assessing Officer was that the same is on par with corporate over heads. Though the assessee relied upon the decision of Hon'ble Bombay High Court in the case of Zandu Pharmaceutical Works Ltd (350 ITR 366), the Assessing Officer rejected the contention of the assessee by observing that the work done by the R & D is a continuous process and it is for the benefit of all the units of the assessee. Therefore, merely on account of fact that one unit did not manufacture any of the products developed by R & D unit during the year it does not mean that the expenditure incurred with regard to R & D is not attributable to such unit of the assessee. In this regard, he relied upon the decision of the ITAT, Bangalore Bench in the case of Microlabs Limited vs. ACIT (ITA No.704/Bang./2008). Though he admitted that R & D as well as ESOP are indirect expenditure, he was of the view that in order to manufacture tablets and sell them at higher profit company cannot achieve it without R & D and hence the expenditure has to be allocated against the exempt units.
28. On an appeal filed by the assessee, Ld. CIT(A) affirmed the order of the Assessing Officer. His observations find place in para 10 of his order. Further aggrieved, assessee is in appeal before us.
29. We have heard the Learned Counsel for the Assessee as well as the Learned Departmental Representative and also carefully perused the record. Identical issue was considered by us in order dated 08.06.2018 (ITA. Nos.1844 to 1846/Hyd/2017) wherein we have relied upon the 10 decision of the Hon'ble Bombay High Court in the case of Zandu Pharmaceutical Works Ltd (supra) and after analysing the facts of the instant case, we observed as under:
"49. The case of the assessee, all through, was that R & D expenditure was incurred by the assessee in a separate unit known as 'IPDO', which is meant for carrying on R & D. It is also not in dispute that formulations / products arising out of it may or may not be utilised in the special units wherein the assessee is eligible for deduction / exemption. It is not controverted that formulations / products arising out of it can be sold in the open market and need not necessarily be utilised in the existing special units. The Hon'ble Bombay High Court in the case of Zandu Pharmaceuticals Limited (350 ITR 366) considered an identical issue wherein the assessee carried on business of manufacture of Ayurvedic medicines which had four units in Uttar Pradesh and Head Office separately. Each of the units had their own R & D unit equipped with laboratory. The Head Office also had their own R & D Department. The AO allocated R & D expenditure, debited to the Head Office, to the units proportionate to the turnover of the units. The Revenue could not prove that any of the units were benefited by the R & D activities pertaining to new drugs. Only on the presumption the AO sought to allocate R & D expenses to all the units, irrespective of whether there is any existing activity connected to R & D, in any of the units. Under these facts and circumstances, the Court observed that R & D activities were in relation to new products and there is nothing to indicate that in the event of assessee commercially exploiting the benefits of R & D works, the products would be manufactured by the said units. Since the Revenue's stand is based on hypothetical basis that the said products would be manufactured by each of them or any one of them, the Court concluded that it is an erroneous presumption that the benefit of any R & D activity can be exploited by an enterprise, by utilising the same in its manufacturing activity. The Court also noted that an enterprise can always assign the benefit thereof to a third party. It can grant a license in respect of any patent or design to a third party in which event the other units would not derive any benefit and thus there can be no nexus between R & D units and the units wherein the assessee is carrying on activity with regard to the existing products. Similar view was taken by the Hon'ble Madras High Court in the case of Bush Boake Allen (India) Pvt Ltd vs. ACIT (273 ITR 152) wherein the Court observed that there cannot be any presumption that any technology about new flavours or essence will automatically be utilised in other units.
50. In the case on hand, it was stated by the assessee, all through, that the expenditure incurred on R & D and ESOP cost have no nexus with the products manufactured in the exempted units, unlike Head Office overheads. It cannot be disputed that without Head Office, the Branch units also cannot run and hence overheads have to be necessarily allocated to the exempt as well as non-exempt units. Similar view was taken by the Tribunal in the assessee's own case for the earlier year. However, with regard to R & D expenses and ESOP cost, both AO as well as CIT (A) have proceeded on presumption that R & D 11 expenses will benefit the exempted units in the long run overlooking the fact that there is nothing on record to show that all the R & D inventions / patents were never sold in outside market but only captively utilised in the exempted units. Under these circumstances, by respectfully following the decision of the Hon'ble Bombay High Court (cited supra), we are of the view that the Revenue has not made out a case for apportionment of R & D expenditure and ESOP cost to the exempt units. In the result, we hold that the Tax Authorities were not justified in apportioning R & D expenditure and ESOP cost to the units which claimed exemption u/s 10B, 80IB and 80IC of the Act."
30. The Revenue, on the other hand, relied upon decision of the ITAT, Bangalore Bench (cited supra).
31. In view of the decision of Hon'ble Bombay High Court (supra) and also on careful perusal of the facts, we are of the opinion that the view taken by the Hon'ble Bombay High Court is an appropriate view and, at any cost, it is one of the possible views on the matter which requires to be taken into consideration in the light of the Apex Court decision in the case of CIT vs. Vegetable Products Ltd., (88 ITR 192). Under these circumstances, we hold that the Tax Authorities were not justified in allocating R & D expenditure and ESOP cost against the profits of other eligible units wherein assessee claimed deduction u/s 80IC of the Act.
32. In the result, appeal filed by the assessee is partly allowed.
33. To sum-up, appeal filed by the Revenue is dismissed whereas the appeal filed by the assessee is partly allowed.
Order pronounced in the open court on 13th June, 2018.
Sd/- Sd/-
(S. RIFAUR RAHMAN) (D. MANMOHAN)
ACCOUNTANT MEMBER VICE PRESIDENT
Hyderabad, Dated: 13th June, 2018.
OKK, Sr.PS
12
Copy to
1. Dr. Reddy's Laboratories Limited, 8-2-337, Road No.3, Banjara Hills, Hyderabad-500034.
2. Asst. Commissioner of Income Tax, Circle-17(1), 9th Floor, Signature Towers, Opp. Botanical Garden, Kothaguda, Kondapur, Hyderabad-500084.
3. CIT (A)-5, Hyderabad.
4. Pr. CIT-5, Hydeabad.
5. DR, ITAT, Hyderabad.
6. Guard File