Nippon Leakless Talbros Pvt. Ltd., ... vs Assessee on 28 August, 2015

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Income Tax Appellate Tribunal - Delhi

Nippon Leakless Talbros Pvt. Ltd., ... vs Assessee on 28 August, 2015

             IN THE INCOME TAX APPELLATE TRIBUNAL
                  DELHI BENCH: 'I-2' : NEW DELHI

          BEFORE SHRI I.C. SUDHIR, JUDICIAL MEMBER
                             AND
         SHRI INTURI RAMA RAO, ACCOUNTANT MEMBER

                           IT(TP)A No. 475/Del/2015
                           Assessment Year: 2010-11

Nippon Leakless Talbros              Vs.   Asstt. Commissioner of Income
Private Ltd., Plot 125 A, Sec-6,           Tax, Circle Rewari, Haryana
HSIIDC Growth Centre, Bawal
Rewari, Haryana.
(PAN: AACCN0630J)
    (Appellant)                                   (Respondent)

   Appellant by  : Sh. Ajay Vohra, Sr. Adv., Sh. Neeraj Jain, Adv. &
                   Sh. Puneet Chugh, CA
   Respondent by : Sh. Vijay Choudhary, Sr. DR

                                      Date of hearing: 12.06.2015
                                      Date of pronouncement: 28.08.2015

                                   ORDER

PER INTURI RAMA RAO, A.M.:

This is an appeal filed by the assessee company against the order passed by ACIT, Rewari, dated 31.12.2014, passed under Section 143(3) r.w.s. 144C of the Income Tax Act, 1961 (for short "the Act"). The assessee company raised the following grounds of appeal:

General:

1. That the impugned order of assessment framed by the assessing officer in pursuance of the directions of the Dispute Resolution Panel (hereinafter referred to as 'DRP') under Section 143(3) read with Section 144C of the Income-tax Act, 1961 ( 'Act'), is bad in law, violative of principles of natural justice and void ab-initio.

1.1 That assessing officer erred on facts and in law in computing the income of the appellant at Rs 14,52,23,420 against the income of Rs.10,02,94,349 returned by the appellant.

Transfer Pricing:

2. That the assessing officer/ Transfer Pricing Officer ('TPO') erred on facts and in law in making addition to the income of the appellant to the extent of Rs. 2,99,52,717 on account of the alleged difference in the arm's length price of international transactions.

2.1 That the assessing officer/ TPO erred on facts and in law in holding the arm's length price for international transaction of payment of management fee as Nil as against management fee of Rs 2,99,52,717 paid by the appellant on the ground that no benefit was derived by the appellant from payment of such fee.

2.2 That the Assessing Officer/TPO erred on facts and in law in not appreciating that significant benefits were drawn by the appellant from payment of management fee in terms of increased revenue and high profitability, even in the initial years of its business. 2.3 That the assessing officer/TPO erred on facts and in law in not appreciating that the appellant was able to achieve significant cost savings due to the management services provided by the associated enterprise. 2.4 That the assessing officer/the TPO erred on facts and in law in not appreciating that the services availed under the management agreement was distinct from the services availed for payment of royalty under the Joint Venture agreement 2.5 That the assessing officer/TPO erred on facts and in law in not appreciating that the payment of management fee was validly bench marked applying TNMM as most appropriate method and that no adverse inference could be drawn on this account.

2.6 That the assessing officer/TPO erred on facts and in law in applying CUP method for benchmarking the transaction of payment of management fee without placing on record any comparable data for comparison.

2.7 That the assessing officer/the TPO erred on facts and in law in not appreciating that the expenditure on the payment of management fee was wholly and exclusively for the purpose of business of the appellant. 3 2.8 That the assessing officer/TPO erred on facts and in law in not aggregating the transaction of payment of management fee with other interlinked international transactions and erroneously seeking to benchmark it separately.

2.9 That the assessing officer/TPO erred in law in holding that the majority of benefit is flowing from Indian joint venture company, i.e., Talbros Automotive Components Limited while the Japanese Joint Venture Company i.e. Nippon Leakless Corporation is being remunerated more.

2.10 That the DRP erred on facts and in law in upholding the adjustment made by TPO without giving any cogent and germane reasons. Corporate Tax Issues:

3. That the assessing officer erred on facts and in law in disallowing a sum of Rs 1,49,76,358 being payment made to Talbros Automotive Components Ltd. ('TACL') towards administrative services under section 40A(2) of the Act.

3.1 That the assessing officer erred on facts and in law in not appreciating that having regard to the effort involved and additional cost incurred by TACL in providing services to the assessee, the charge on account of payment for administrative services was not excessive and was commensurate with the services availed.

3.2 That the assessing officer erred on facts and in law in making the disallowance invoking section 40A(2) of the Act on mere conjecture and surmises without bringing on record any comparable evidence of market price of such services to demonstrate that the expenditure incurred by the appellant was excessive.

3.3 That the assessing officer erred on facts and in law in not appreciating that the payment for administrative services, has also suffered tax in the hands of the recipient company and there could be no allegation of any tax evasion.

3.4 That the DRP erred on facts and in law in upholding the adjustment made by assessing officer without giving any cogent and germane reasons.

4. That the assessing officer erred on facts and in law in levying interest under Section 2348 and Section 234C of the Act. 4

The appellant craves leave to add, amend, alter or vary, any of the aforesaid grounds of appeal before or at the time of hearing of the appeal and consider each of the grounds as without prejudice to the other grounds of appeal.

2. The brief facts of the case are that the appellant i.e. M/s Nippon Leakless Talbros Pvt. Ltd. is a company incorporated in India on 9 th March, 2005 in pursuance of joint venture between Talbros Automotive Components Ltd. India (TACL) and Japanese partner M/s Nippon Leakless Corporation, Japan (NLK) ON 31.01.2000. The return of income for the assessment year 2010-11 was filed on 29th September, 2010 declaring income of Rs. 10,02,94,349/-. The return was accepted under the provisions of Section 143(1) of the Income-tax Act, 1961 (for short "the Act"). However, subsequently the case was selected for scrutiny assessment as per the guidelines of CBDT. During the course of assessment proceedings, the Assessing Officer noticed the that the international transaction entered by the appellant company and therefore a reference under Section 92CA(1) of the Act was made to Transfer Pricing Officer (TPO) to determine the Arm's Length Price (ALP) in respect of such transactions. The TPO vide his order dated 24th January, 2014 held that the ALP of international transactions related to payment of management consultation fees to its AE M/s Nippon Leakless Corporation, Japan, as nil against Rs. 2,99,52,717/- claimed by the appellant on the ground that the appellant had failed to point out any comparables. The Assessing Officer based on the order of TPO passed a draft assessment order under Section 143 r.w.s. 144C of the Act. Against this drafted assessment order, the objections were filed before the DRP. The DRP vide order 5 dated 14.11.2014 upheld the order of TPO. Finally the Assessing Officer passed an order under Section 143 r.w.s. 144 of the Act dated 31.12.2004 in conformity with the direction of DRP making addition of Rs. 2,99,52,717/- on account of management fees paid to these AEs of Nippon Leakless Corporation, Japan and made further addition of Rs. 1,49,76,358/- on account of management fees paid to Talbros Automotive Components Ltd. India under the provisions of Section 40A(2)(b) of the Act. Being aggrieved the appellant had filed the present appeal before us.

3. Before us, ld. Senior Counsel for the appellant submitted that during the year under consideration, the applicant was primarily manufacturing and selling gaskets to Honda and Honda JVs in India. The applicant did not have the requisite resources, e.g., qualified and experienced personnel, and expertise to carry out product design and development to develop new models of gaskets as per specifications and requirements of the customers. For the newer models of vehicles developed and introduced by Honda, there is change in the engine design. Honda has a system of completely developing the engine in Japan and then deploying the - newly developed, engine for the Indian manufacturing operations. As a consequence of change in engine design, newer type of gaskets have to be developed. It may be noted that development of new model /variant of gaskets requires constant interaction of the technicians" with the customers to develop requisite drawing, design and specification, etc. The process of development of gaskets for engine primarily involves the following activities: 6

(i) Technical review and continuous interaction with the customers after the receipt of Request For Quotation (RFQ).

(ii) Freezing of product specification in discussion with the customers.

(iii) Agreeing on a time line of development.

(iv) Development of proto type and submission to the customers with necessary inspection report.

(v) Validation of the product by the customers on the engine by running for certain specified hours.

(vi) Feed-back based on the results of the validation and any necessary changes that may have to be incorporated in the product as a result of testing.

(vii) Re-testing I revalidation, if required.

(viii) Release of approved drawing for mass production and manufacture of necessary tooling for such mass production.

Since Honda R&D as well as the associated enterprise, under consideration were situated in Japan, involving the associated enterprise, was the most economical and efficient way of developing gaskets which were approved by Honda, Japan for being manufactured by the assessee in India, to be fitted in the engine I vehicles assembled I manufactured by Honda in India.

After the product is approved by Honda R&D and the specifications are frozen, the action shifts to India where the mass production takes place. The assessee has to co-ordinate very closely with Honda India for submission of off tool samples and plan of readiness for mass production in tune with the customer's start of production.

The aforesaid process entails intensive discussions and interaction with the customer i.e. Honda group companies. Since all the technical discussions and critical decisions with regard to Honda product development are taken by Honda R&D in Japan in consultation with the supplier, the product development cost would increase manifold if the assessee was to undertake this activity itself, since it would involve travelling each time for a meeting or discussion. In any case, the assessee did not have the expertise and resources to develop new products. Further the prototypes are to be tested and validated in house by the supplier as well as by HONDA, this requires equipment for testing and in house capability, which were not available with the assessee. Accordingly, it was imperative for the assessee to avail the services from its associated enterprises.

During the relevant previous year, the assessee commercialized 29 new products, therefore, considerable time was spent by the technical team of the associated enterprises in Japan for development of product. It would be appreciated that the cost of development of a single gasket to the associated enterprise is JPY 40,88,000 (Rs 16,35,200 per gasket) in case of metal gaskets and JPY 26,88,000 (Rs 10,75,200 per gasket) in cases of non- metallic gaskets.

It would be noted that over a period of 6 years, the associated enterprise has developed more than 100 gaskets for the assessee. The assessee, it is respectfully submitted, does not have on its payroll any technical employee possessing experienced and expertise in this field. It would be appreciated from the details of employees of the assessee that the assessee did not employe even a single personnel in the product design and developed division. The fact that the required resources were not available with the assessee is evident from the following statistics:

          Particulars    Comparable               Assessee
                         Companies
          Employee cost 10.4% to 15.5%            4.10%
          to sales ratio

In view of the aforesaid it is respectfully submitted that the assessee did not have the requisite expertise and was therefore dependent upon the associated enterprise of new product development and testing activity.

It would also be appreciated that sales of the assessee have grown to Rs 50.60 crores in FY 2009-10 from Rs. 32.18 crores in FY 2007-08. The automotive component industry is very competitive and it takes a company some time lag to get established, accepted by the customer and to break even. The assessee has not only got established in the initial years, but also has posted profits far above the breakeven point. A margin of 20.71 % at net level for auto 9 components is way above the arm's length profit and that too in the second year of full operations.

It may further be noted that during the relevant previous year the total revenue of the assessee increased to Rs. 50.60 crores from Rs. 37.26 crores in the preceding previous year i.e. an increase of 35.81 %.Itis pertinent to note that the AE has been providing the services since inception of the JV on account of the services received. the JV in a short span of 3 years has been able to become the preferred supplier of gaskets. Consequent to the support received from the AE the increasing turnover led to increase in the net profit margin to Rs. 10,48,34,509 from Rs. 8,58,91,331 in the preceding previous year resulting in year on year increase of 22.01 % in the net profit margin. 3.1 Re: Payment of royalty The TPO further held that since the assessee is paying royalty for the receipt of technical guidance, it need not have paid management fee.

In this regard, it is respectfully submitted that the development of gasket is a technologically intensive activity and requires high degree of technical knowledge and expertise. The assessee neither had the technology nor the technically qualified employees to be able to independently develop gaskets.

It would be appreciated that in terms of the joint venture agreement dated 31.01.2005, the associated enterprise provided the assessee with the right to 'use the technical knowledge/information and proprietary know- how'. Such technology is in respect of manufacturing process as well as design engineering 10 etc. On the other hand, against the payment of management fee, the associated enterprise is providing specific services of new product development, which involves inter-alia continuous interaction and discussion with the customers. Such fee is paid by the assessee for the development of specific gaskets. It is respectfully submitted that the assessee did not had the requisite resources i.e. qualified and experienced personnel as well as requisite assets to be able to absorb and apply the technology and develop the new products/gaskets itself. Such expertise can only be gained over a period of time.

In the absence of employees who are technically competent to be able to develop new gaskets, it was imperative for the assessee to engage the services of the associated enterprise for such purpose. The fact that the assessee did not have the requisite resources is evident from its low employee cost to sales and depreciation to sales ratio, as has been submitted above.

Reliance in this regard is also placed on the decision of the Hon'ble Delhi Bench of the tribunal in the case of Abhishek Auto Industries Ltd vs DCIT (ITA No 1433/Del/2009) wherein the Hon'ble Tribunal held as under:

"Whenever international transactions of such nature are undertaken, it is a combination of technical know-how, royalty, technical assistance through the deputation of ex- pat employees on the rolls of the person obtaining the technical know-how. There is merit in appellants submissions that merely by importing machinery, it cannot be said that the appellant would become competent to make use of such machinery. Technical know-how and technical assistance was needed for the use of machinery under the normal circumstances. "

It is further submitted that the TPO failed to appreciate the difference between the grant of 'right to use the technology' and provision of services which may involve/require use of such technology. In cases where a right to use the technology is granted, the licensee is required to absorb and apply the technology using its own resources viz. technically qualified employees and requisite assets. The licensor is only required to make available the technology and the proprietary know-how.

However, in the instant case, the assessee did not have the requisite resources to absorb and apply the technology. Such expertise can only be build over a period of time. Therefore, in order to capture market and build credibility, the assessee availed the services of its associated enterprises for the development of new products/gaskets.

Further, in terms of the management fee agreement, the associated enterprise is also providing the services of testing and validating indigenous raw material. Such services were not covered by the joint venture agreement and, are specifically covered by the management fee agreement

(i) Whether intra-group services have been rendered As regards the first question, the OECD states that whether or not a service has, been, rendered depends, on whether the service provides the recipient with some commercial or economic value to enhance its commercial position: Para 7,6 of the guidelines states as under:

"7.6 Under the arm's length principle, the question whether an intragroup service has been rendered when an activity is performed for one or more group members by another group member should depend on' whether the activity provides a respective group member with economic or commercial value to enhance its commercial position, This can be determined by considering whether an independent enterprise in comparable circumstances would have been willing to pay for the activity if performed for it by an independent enterprise or would have performed the activity inhouse for itself."

It is respectfully submitted that development of the gasket is the most critical part of the business of the assessee without which the assessee could not have undertaken the business of manufacture and sale of gaskets. Since, the assessee did not had the requisite technical skills to develop the gaskets it had to avail the services of its associated enterprise. As a result of services provided by the associated enterprise, during the year, the assessee commercialized 29 new products; therefore, considerable time was spent by the technical team of the associated enterprises in Japan for development of product. It would be appreciated that the cost of development of a single gasket to the associated enterprise is JPY 40,88,000 in case of metal gaskets and JPY 26,88,000 in cases of non-metallic gaskets.

Further, the senior level employees of the associated enterprise also visited India for the purpose of representing the assessee before various prospective customers as well as for the purpose of supervising the factory machinery and building of the assessee. The cost of such visits viz. gross CTC of such employees was also not recovered by the AE from the assessee company. Additionally, the cost of travel related expenses of the employees of 13 the associated enterprise in relation to such visits amounted to JPY 28,37,108 (equivalent to Rs 15,03,667). In view of the aforesaid, it is submitted that the assessee derived significant benefits from the management services provided by the associated enterprise and therefore, the services provided by the associated enterprise satisfies the first criteria as laid down by the OECD guidelines. Re: Commercial and Business expediency of incurring any expenditure It is submitted, that the assessee is free to conduct business in the manner that assessee deems fit and the commercial or business expediency of incurring any expenditure is to be seen from the assessee's point of view.

It is a settled position as laid down in the following decisions is that whether any expenditure is required to be incurred for the purpose of business and the reasonableness of the quantum thereof has to be judged from the point of view of the businessman and not of the Revenue:

- CIT v. Malayalam Plantations Limited, 53 ITR 140 (SC)

- CIT v. Walchand & Co. etc., (1967) 65 ITR 381

- J K Woollen Manufacturers v. CIT, 72 ITR 612(SC)

- CIT v. Birla Cotton Spg. And Wvg. Mills, 82 ITR 166 (SC)

- Madhav Prasad Jatia v. CIT U.P., 118 ITR 200 (SC)

- S.A. Builders Ltd. vs. CIT , 288 ITR 1 (SC)

- CIT v. Rockman Cycle Industries Ltd., 331 ITR 401 (P&H) (FB)

- CIT v. Bharti Televentures Ltd, 331 ITR 502 (Del)

- CIT vs. EKL Appliances Ltd., ITA No. 1068/2011 & 1070/2011 (Del HC) The aforesaid settled position that the quantum of expenditure required to be incurred for the purpose of business is the businessman's decision, is of universal application and cannot be given a go by on the pretext of application 14 of the arm's length test provided under the Transfer Pricing Regulations and only price of an expenditure arising being an international transaction can be determined by the TPO having regard to the arm's length test under section 92(1) of the Act.

Further, it is submitted that once expenditure on payment for management fees incurred by the assessee are accepted as having been incurred wholly and exclusively for the purpose of business and, therefore, allowable under section 37, it is not open to the Revenue to still hold part of such expenditure as not having been incurred on behalf of and/or for the benefit of the AE, calling for adjustment under section 92 of the Act.

This Hon'ble Court in the case of CIT vs. EKL Appliances Ltd., 345 ITR 241, has laid down the law in this regard, as under:

"21. The position emerging from the above decisions is that it is not necessary for the assessee to show that any legitimate expenditure incurred by him was also incurred out of necessity. It is also not necessary for the assessee to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years. The only condition is that the expenditure should have been incurred "wholly and exclusively" for the purpose of business and nothing more. It is this principle that inter alia finds expression in the OECD guidelines, in the paragraphs which we have quoted above.

xxx 22 ...............So long as the expenditure or payment has been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning. As provided in the OECD guidelines, he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the TPO is not contemplated or authorized."

Following the decision of Delhi High Court, the Bangalore Bench of the Tribunal in the case of Festo Controls Pvt. Ltd. vs DC IT (ITA No. 969/Bang/2011) held that expense incurred wholly and exclusively for the purpose of business cannot be disallowed by the TPO alleging that such expenditure does not resulted in profits to the assessee.

Recently the Hyderabad Tribunal also in case of Kirby Building Systems India Ltd vs. Addl. CIT (ITA 1975/ HYD/ 2010) affirmed the principle laid down by Hon'ble Delhi HC in Ekla Appliances and held as follows:

"19. In the guise of examining the payments under T.P. provisions, it is noticed that the TPO has not analyzed these payments either under TNMM method or under any other method which require to be analyzed as per the provisions. However, the TPO has examined the business necessity of payment of technical knowhow fee and royalty under the provisions of section 37(1) rather than under the provisions of T.P. His decision of not allowing any royalty payment or technical knowhow payment and determining the ALP at NIL cannot be sustained in view of the fact that this technical knowhow fee and royalty were agreed upon when the assessee has originally entered into agreement as on 01.04.2000 much before the TP. provisions came on statute. It may be another reason that assessee has revised the agreement and paid subsequently, partly in the impugned year, but that does not prevent assessee claiming expenditure which was necessary for its business operations in view of the agreement entered at the time of establishing the unit in India. Had there been no revision of the agreement, the payment of technical knowhow fee would have been over by the year 2002 itself. Assessee paid in a sense belatedly the same amount which was payable originally due to rescheduling in payment period. No extra amount was required to be paid. Moreover, on the entire turnover in the intervening years, assessee also would have paid royalty. However, due to business requirements, both the parties agreed to revise the royalties. TP provisions does not empower the TPO to decide about the commercial decisions and determining the ALP at NIL thereby denying the entire claim 16 instead of allowing the amount on the basis of ALP to be determined under the provisions.

20. The Hon'ble Delhi High Court in the case of CIT vs. EKL Appliances ITA.No.1068 of 2011 and 1070 of 2011 dated 29th March, 2012 considered similar issue whether the TPO has power to restrict in determining the ALP at NIL under the provisions of T.P. when he was supposed to have determined the arms length price of the international transaction ................

20.1 The Principles laid down by the Hon'ble Delhi High Court in the above said case equally applies to the facts of the case. What TPO has done in the present case is to hold that assessee need not pay any royalty or technical knowhow fee to the AE. Even though ORP has partly modified the payment of royalty, what we noticed is that they also made a mistake in allowing only 3.5% of royalty when in fact, there is no such claim in any of the earlier years. As submitted by the Ld. Counsel in the course of arguments/presentation before us assessee claimed at 7.5% in earlier year which was also allowed.

The Hon'ble Tribunal in the case of M/s. Ericsson India Pvt. Ltd. vs. OCIT (ITA No. 514110e112011), too, following the law laid down by the Hon'ble jurisdictional High Court, held that " ................. it would be wrong to hold that the expenditure should be disallowed only on the ground that these expenses were not required to be incurred by the appellant............."

In the case of Dresser Rand India Pvt. Ltd. vs. Addl. CIT (ITA No 8753/Mum/2010) the Hon'ble Mumbai bench of the Tribunal, while dealing with similar management fee paid to the associated enterprise held that benefits derived by the assessee is not a relevant criteria for determination of arm's length of an expenditure incurred by the assessee.

Recently the Hon'ble Delhi High Court in the case of CIT vs Cushman and Wakefield (India) Pvt Ltd. (ITA 475/2012) has held that the authority of the TPO is to conduct a TP analysis to determine the ALP and not to determine whether the tax payer derives a benefit from the service. The Hon'ble Delhi High Court has opined that the determination of benefit to the tax payer is in the domain of the AO. The Hon'ble High Court held as follows:

"34. The Court first notes that the authority of the TPO is to conduct a transfer pricing analysis to determine the ALP and not to determine whether there is a service or not from which the assessee benefits. That aspect of the exercise is left to the A O. This distinction was made clear by the ITAT in Dresser-Rand India Pvt. Ltd. v. Additional Commissioner of Income Tax, 2012 (13) ITR (Trib) 422.........

....... 35. The TPO's Report is, subsequent to the Finance Act, 2007, binding on the AO. Thus, it becomes all the more important to clarify the extent of the TPO's authority in this case, which is to determining the ALP for international transactions referred to him or her by the AO, rather than determining whether such services exist or benefits have accrued. That exercise - of factual verification is retained by the AO under Section 37 in this case. Indeed, this is not to say that the TPO cannot - after a consideration of the facts - state that the ALP is 'nil' given that an independent entity in a comparable transaction would not pay any amount. However, this is different from the TPO stating that the assessee did not benefit from these services, which amounts to disallowing expenditure. That decision is outside the authority of the TPO.... "

Further, in the case of LG Polymers India Pvt. Ltd vs Addl. CIT (ITA No 524/Vizag/2010), the Hon'ble Visakhapatnam Bench of the Tribunal held as under:

"13. We agree with the views of the Learned A.R on this issue. As submitted by him, it is the prerogative of the assessee to regulate its business affairs and it is not open for the department to question 18 the same. Similar views have been expressed by the Hon'ble Supreme Court in the case of Dhanrajgiriji Raja Narasingirji, referred (Supra)"

Recently in the case of SC Enviro Agro India Ltd vs DCIT (ITA No 2057 & 2058/Mum/2009) the Hon'ble Mumbai Bench of the Tribunal held that "The TPO has to examine whether the price paid or amount paid was at arm's length or not under the provisions of Transfer Pricing and its rules. The rule does not authorize the TPO to disallow any expenditure on the ground that it was not necessary or prudent for assessee to have incurred the same."

The Hon'ble Delhi Bench of the Tribunal in the case of- AWB India Pvt. Ltd vs Addl. CIT (ITA No 4454/Del/2011) held as under:

"As also settled by judicial decision (supra), the revenue authorities are not empowered to question the commercial wisdom of the assessee and it is entirely for the assessee to take such decisions as favour the advancement of the assessee's business."

Reliance in this regard is placed on the decision of Ahmadabad Bench of Tribunal in the case of KHS Machinery (P) Ltd. vs. ITO : 146 TTJ 692, wherein the Hon'ble Tribunal on the issue of similar disallowance made by the TPO of payment of royalty, has held as under:

"The appellant had not made the one-time payment but making the continuous payment to the know-how provider which has been accepted by the Department in the past. The appellant has been charging 5 per cent royalty on each and every transaction and therefore the said payment cannot be said to have been paid on the aggregate amount, as argued by learned CIT-Departmental Representative. The findings of the AO in considering the royalty charges as nil as ALP cannot be accepted since the AO in the present case has not brought on record, the ordinary profits which can be earned in such type of business. Therefore in our view the payment of royalty is not hit by the provisions of s. 92 of the Act 19 and there is no reason to hold that the expenses should not be allowed under s. 37(1) of the Act, since the expenditure has been incurred by the appellant during the course of business and is having the nexus with the business of the appellant. Therefore the payment of royalty is a business expenditure which has been incurred wholly and exclusively for the purpose of business of the appellant and same is to be allowed in toto as a matter of commercial expediency. Therefore, the case laws relied upon by the learned CIT- Departmental Representative are of no benefit to the Revenue. The reasonableness of expenditure in the present circumstances and facts of case cannot be doubted and accordingly the AOis directed to allow the claim of the appellant and the order of learned CIT(A) is reversed. Thus, ground no. 3 of the appellant is allowed. "

The Hon'ble Delhi Bench of the Tribunal in the case of Maruti Suzuki India Ltd. (ITA No. 5237/Del/2011) also held in this regard as under:

"15. Another realm of the assessee's submission is that as long as an item of expenditure has been incurred wholly and exclusively for the purpose of business of the assessee whether or not such expenditure actually benefits the assessee is an irrelevant consideration for the purpose of determination of ALP. In this regard, the case laws referred above by the assessee in its submission are germane and supports the case of the assessee.

- Hon'ble Delhi High Court decision in the case of C.I. T. vs. Ekla Appliances Ltd. (ITA No. 1070/2011)

- Mumbai Tribunal decision in the case of Dresser Rand India Pvt. Ltd. vs. Addl. C.I.T. (I. T.A. No. 8753/Mum/2010)

- Decision of Vishakhapatnam Bench of the Tribunal in the case of LG Polymers India Pvt. Ltd. vs. Addl. C.I. T. (I.T.A. No. 524/Vizag/2010).

- Decision of the Tribunal in the case of M/s Ericsson India Pvt. Ltd. vs. DCIT (I.T.A. No. 5141/Del/2011).

- Decision of the Mumbai Tribunal in the case of SC Enviro Agro India Ltd. vs. DCIT in (I.T.A. No . 2057 &2058/Mum/2009). "

Further, the Hon'ble Hyderabad bench of Tribunal in the case of TNS India Pvt. Ltd (2014-TII-24-ITAT-HYD-TP) has deleted the similar royalty 20 additions made by the TPO on the basis inter-alia that TPO cannot question the business decision. The Hon'ble Tribunal held as follows:

"16.1. Even otherwise, the role of Transfer pricing Officer is to determine the arms length price of a transaction. He cannot reject the entire payment under the provisions of sec. 92CA as held by the Delhi High Court in the case of EKL Appliances Ltd."

"17. Respectfully following the above, we are of the opinion that the TPO went beyond his jurisdiction in denying the payment out- rightly, whereas, his role is limited to determining the ALP. In the guise of determination of ALP, the TPO cannot question the business decision of payment and determine that no services were rendered. In that view of the matter, the direction of the TPO cannot be upheld at all"

In view of the aforesaid, it is respectfully submitted that whether an expense actually benefits the assessee or not is not required to be examined while determining the ALP of an international transaction.

Further the Hon'ble ITAT in the appellant's own case for AY 2008- 09 has allowed the payment of management fees and restored the matter to the file of TPO. The Hon'ble ITAT held as follows:

"We have heard the matter both the counsel and perused the records. We have gone through the additional evidences as above, in our considered opinion the consideration of these additional evidences is necessary for proper adjudication of the matter. However, we also note that these documents were not before the authorities below. In our considered opinion, interest of justice will be served, if additional evidences as sought to be placed by the assessee are remitted to the file of the assessing officer for consideration. Accordingly we admit the additional evidence and remit the same to the file of the assessing officer. The AO shall consider these grounds afresh."

The TPO while giving the appeal effect to the order of Hon'ble ITAT examined the additional evidences submitted by the assessee and deleted the addition on account of management fees vide its order dated 12.01.2015.

Further in the AY 2009-10 and AY 2011-12 also the TPO has accepted the transaction of payment of management fees as being at arm's length and did not draw any adverse inference in this regard.

Hence, the payment of management fees, therefore, is made entirely for business consideration and is an expenditure incurred wholly and exclusively for the purposes of business.

4. Disallowance of Rs. 1,49,76,358 under section 40A(2)(b) on account of payment of administrative charges:

During the relevant previous years the assessee incurred expenditure amounting to Rs. 1,49,76,358 on account of administrative charges paid to Talbros Automotive Components Ltd. ('TACL'). The assessee entered into a Shared Services Agreement with TACL for availing certain services for assistance in day to day operations and administration of assessee. In terms of the agreement the day to day managerial and administrative services are provided by TACL. The assessee paid 10% of profits before tax to Talbros for such administrative support.

The assessing officer, however, disallowed the payment of administrative charges/management fees on the alleged ground that the assessee has failed to prove the reasonableness and justification for the aforesaid amount.

It is submitted that in terms of the agreement between the assesee and TACL, the latter is required to provide the following day to day managerial and administrative services to the assessee:

(a) IT Services - All the IT related activities/services were provided by IT department of TACL and there was not a single IT employee on the payroll of TACL.

(b) Secretarial Services - The assessee company being a corporate entity has to comply with a large number of statutory requirements under the Indian Companies Act. During the year it had employed on its rolls only one junior company secretary for routine documentation and executive jobs. Being a junior he needed guidance and supervision by the team of senior professionals who managed the ultimate responsibility for activities like,

- Convening and holding board meetings and shareholders meetings

- Maintaining minutes of all the meeting

- Maintaining statutory registers and records prescribed under the law

- Timely filing statutory returns and reports

- Obtaining necessary permissions and licenses wherever required.

- Advising management on various statutory provisions and governance issues

(c) Sales and Marketing Services - As is evident from the manpower strength at the assessee company, there is no set-up for sales and marketing services. Under the current competitive scenario, this is the most important area to survive and grow. Local day to day liasioning with HONDA India was thus taken case by TACL.

The services provided by TACL broadly included:

- Regular interaction and co-ordination with the customer.

- Costing of the product in co-ordination with the technical and costing department and submission of quotations in the format prescribed the OE customers.

- Price negotiation with the customer and tracking their supply schedules on day-to day basis.

- Attending to customer complaints, if any and taking suitable corrective. actions acting as a conduit between the customer and the production line.

- Networking with customers and continuously pitching for new businesses while protecting existing businesses.

- Put up proposals for necessary price revisions depending up production cost variations due to inflationary increase in prices, exchange fluctuations or other external factors.

- Understanding customer requirements and keeping the customer satisfied all the time.

- Exploring possibilities of developing new business opportunities

- TACL team regularly participated in domestic as well as overseas trade fairs and represented the assessee without debiting any costs to the assessee

(d) Financial and Accounting Services - During the year aassesee had employed a graduate at assistant manager level, which required supervision and guidance thus the services of professionally qualified chartered accountants and cost accountant were made available by the TACL team. These services included:

- Making proposals for working capital and other financing facilities required by the company.

- Dealing with banks and financial institutions for getting these facilities sanctioned

- Mr. R. P. Grover, CFO, TACL was authorized by the board for these activities.

- Executing necessary loan/security documentation and creating charges over the company's assets to the satisfaction of the lenders

- Guidance for timely submission of required periodic returns and reports to banks and financial institutions.

- Finalization of quarterly and annual accounts as per the statutory requirements

- Ensuring due compliance of Accounting Standards and other statutory guidelines.

- Dealing with Statutory and Internal Auditors, initiating necessary corrective actions and ensuring implementations of their suggestions .

- Ensuring compliance with excise and service tax laws dealing with excise auditors and guiding and initiating corrective actions based on auditors observations.

- Dealing with sales tax department, ensuring due compliance by timely submissions of reports/returns and attending to sales tax assessments and other related issues.

- Dealing with Income tax matters, attending to tax assessments, interacting with outside consultants, wherever required.

- Costing of different work centers, production processes and final products in co-ordination with the technical team

- Ensuring maintenance of statutory cost accounting records

- Identification and implementation of ERP system, co-coordinating with outside service provider and ensuring necessary modification/customization as and when required

(e) Quality Systems

- Provide necessary guidance to formalize quality systems and procedures.

- Dealing with outside agency for quality certification

- Analyzing quality issues from time to time.

- Interacting with customer us understand and redress their quality related From the aforesaid, it would be noted that TACL is providing a wide array of services such as IT services, Accounting services, financial and taxation services etc. Further it we would like to submit that the company has about 6/7 employees for managing all the functions of the company, other than manufacturing, e.g. sourcing, vendor developments, sales promotion, dealing/ follow up with the customers, financial matters, accounting, statutory compliances, secretarial and various other administrative and commercial issues. 25 These people are at middle management and require regular support by team of professionals of TACL. At the time of setting up of assessee company, it was conscious decision taken by the joint venture partners to adopt a lean and thin management structure so as to avoid duplication of resources which might remain under-utilized at the joint venture company. In order to achieve this it was decided that majority of technical services on day today basis will be provided by Nippon Leakless Corp., Japan, through its technical staff whereas majority of the managerial and administrative services as mentioned above will be provided by TACL.

The disallowance of the payment of administrative charges (management fee) paid to TACL is, in our respectful submission, has been made without appreciation of facts and legal position in this regard and not sustainable for the reasons hereunder:

4.1 Re: Reasonableness of expenses has to be seen from the point of view of businessman:

The ld. Counsel for the appellant submitted before us that under section 37(1) of the Act, deduction is admissible for expenditure incurred wholly and exclusively for purposes of business. Expenditure justified by business considerations and incurred out of commercial expediency is allowable deduction.

The settled position of law is' that the reasonableness of the expenditure has to be seen from the point of view of businessman and not that of the Revenue, as laid down by the Supreme Court repeatedly in the following cases:

      •       CIT vs. Walchand & Co., 651TR 381 (SC)
      •       J.K. Woollen Manufacturers vs. CIT, 72 ITR 612 (SC)
      •       Aluminium Corporation of India Ltd. vs. CIT, 86 ITR 11 (SC)
      •       CIT vs. Panipat Woollen & General Mills Co. Ltd., 103 ITR 666
              (SC)
      •       J.J. Enterprises v. CIT: 2541TR 216

Reliance in this regard was placed on the decision of the Hon'ble Delhi High Court in the case of CIT v. Dalmia Cement (P.) Ltd: 254 ITR 377. In that case the assessee was a manufacturer of cement and had appointed a company CDL as its sole selling agent. The assessee paid Rs.1.75 per M.T. as commission to this agent and claimed the same as business deduction. The assessing officer held that the amount as paid was on higher side and Re.1 per M.T. would be permissible deduction as anything beyond Re.1 per M.T. was not for commercial expediency. The balance amount involved was, therefore, disallowed.

The Court while holding the amount as claimed by the assessee as allowable deduction, observed as under:

"7. It is to be noted that, in the present case, the question that has been raised by the revenue is not one relating to the expenditure being not for the purposes of the business. It is the question of an appropriate amount which would have been paid as commission. In fact, the Assessing Officer himself has allowed to the extent of Rs.4, 35, 854 holding, inter alia, "the payment of Rs. 1.75 per M. T to Cement Distributors Ltd. is very much on the excessive side". This in our view was impermissible within the framework of section 37.

The jurisdiction of the revenue is confined to deciding reality of the 27 expenditure, namely, whether the amount claimed is as deduction was factually expended or laid down and whether it was wholly and exclusively for the purpose of the business. The reasonableness of the expenditure could be gone into only for the purpose of determining whether, in fact, the amount was spent. Once it is established that there was a nexus between the expenditure and the purpose of business, the revenue cannot justifiably claim to put itself in the armchair of a businessman or in the position of the board of directors and assume the said role to decide how much is a reasonable expenditure having regard to the circumstances of the case. We need not go into any hypothetical issue in this case in view of the accepted position that the factum of services rendered by CDL has not been refuted by the revenue. It needs no reiteration that the settled position in law is that no businessman can be compelled to maximize his profits. The obvious answer to the first question is in the affirmative, in favour of the assessee and against the revenue."

The Delhi High Court in the case of CIT vs. Padmani Packaging (P) Ltd.:

155 Taxmann 268 following the decision in the case of CIT vs. Dalmia Cement (Bharat) Ltd. (supra) held as under:

"Based on the above findings and relying upon the decision of the Division Bench in CIT v. Dalmia Cement (Bharat) Ltd. [2002] 254 ITR. 377 (Delhi), the Tribunal held that the addition made by the assessing officer was not sustainable. There is, in our view, no infirmity in that view. Once on a question of fact it is found that there was a nexus between the expenditure incurred by the assessee and his business and once it was held that the genuineness of the expenditure was not in dispute or had been established, the assessing authority could not sit in the arm chair of the businessman to determine as to what commission he ought to pay to its agents for doing his business. Mr. Jolly, however, argued that the CIT (Appeals) and the Tribunal had failed to take into account the fact that there was a search at the premises of the assessee in which it was discovered that the assessee was doing some business outside the books of account. We do not think that the said circumstances, even if established, could be conclusive evidence of the fact that the commission was either not paid or that the same was excessive within the meaning of section 40(A)(2) of the Income-tax Act. No substantial question of law arises for our consideration. This appeal fails and is hereby dismissed."

The Supreme Court in the case of S.A. Builders Limited vs. CIT: 288 ITR 1, while approving the decision of the Delhi High Court in the case of CIT vs. Dalmia Cement(B) Ltd (supra) held that:

"........once it is established that there was nexus between the expenditure and the purpose of the business (which need not necessarily be the business of the assessee itself), the Revenue cannot justifiably claim to put itself in the arm-chair of the businessman or in the position of the board of directors and assume the role to decide how much is reasonable expenditure having regard to the circumstances of the case. No businessman can be compelled to maximize his profit. The income-tax authorities must put themselves in the shoes of the assessee and see how a prudent businessman would act. The authorities must not look at the matter from their own view point but that of a prudent businessman........."

To the same effect are the following decisions:

• CIT vs. Malayalam Plantations Limited: 53 ITR 140 (SC) • CIT v. Birla Cotton Spg. And Wvg. Mills Ltd., 82 ITR 166 (SC) • Madhav Prasad Jatia v. CIT U.P., 1181TR 200 (SC) . • CIT V. Bharti Televentures Ltd: 331 ITR 502 (Del HC) • CIT v. Rockman Cycle Industries Ltd., 331 ITR 401 (P&H HC) (FB) The Hon'ble Delhi High Court in the case of CIT vs EKL Appliances Ltd (ITA No. 1070/2011) while adjudicating upon the transfer pricing adjustment made by the TPO, held that as long as an expense is incurred wholly and exclusively for the purpose of business, it is irrelevant as to whether such expenditure actually results in profit or not. The Hon'ble High Court held as under:

"21. The position emerging from the above decisions is that it is not necessary for the assessee to show that any legitimate expenditure incurred by him was also incurred out of necessity. It is also not 29 necessary for the assessee to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years. The only condition is that the expenditure should have been incurred "wholly and exclusively" for the purpose of business and nothing more. It is this principle that inter alia finds expression in the OECD guidelines, in the paragraphs which we have quoted bove. .

xxx "So long as the expenditure or payment has been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning. As provided in the OECD guidelines, he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the TPO is not contemplated or authorized."

The Hon'ble Delhi Bench of the Tribunal in the case of M/s. Ericsson India Pvt. Ltd. vs. DCIT (ITA No. 5141/De1/2011), too, following the law laid down by the Hon'ble jurisdictional High Court, held that "............it would be wrong to hold that the expenditure should be disallowed only on the ground that these expenses were not required to be incurred by the ssessee........"

Further, in the case of LG Polymers India Pvt. Ltd. vs Addl. CIT (ITA No 524/Vizag/2010), the Hon'ble Visakhapatnam Bench of the Tribunal held as under "13. We agree with the views of the Learned A.R on this issue. As submitted by him, it is the prerogative of the assessee to regulate its business affairs and it is not open for the department to question the same. Similar views have been expressed by the Hon'ble Supreme Court in the case of Oh a nrajgiriji Raja Narasingirji, referred (Supra)"

Further reliance in this regard is placed on the decision of the Mumbai Bench of the Tribunal in the case of Dresser Rand India Pvt Ltd vs Addl. CIT (ITA No 8753/Mum/2010), wherein the Tribunal held as under:

"It is only elementary that how an assessee conducts his business is entirely his prerogative and it is not for the revenue authorities to decide what is necessary for an assessee and what is not."

XXX This analysis is also completely irrelevant, because whether a particular expense on services received actually benefits an assessee in monetary terms or not even a consideration for its being allowed as a deduction in computation of income, and, by no stretch of logic, it can have any role in determining arm's length price of that service. When evaluating the arm's length price of a service, it is wholly irrelevant as to whether the assessee benefits from it or not; the real question which is to be determined in such cases is whether the price of this service is what an independent enterprise would have paid for the same. "

Thus, whether or not a particular expenditure has to be incurred, depends on the perception of the businessman/assessee, and this business perception cannot be substituted by the revenue's perception of whether or not such expenditure should have been incurred.

4.2 Re: Section 40A(2):

The ld. Senior Counsel for the appellant submitted before us that section 40A(2) is the only provision in the Act which empowers the Revenue to sit in judgment about the reasonableness of a claim of expenditure incurred by the assessee if the revenue were to consider the same as excessive or unreasonable having regard to the fair market value of the services or facilities, taking into account the legitimate needs of business or the benefit derived by or accruing to the assessee. Section 40A(2) names the relationships in which the Revenue may 31 intervene to determine whether the payment by one party to another is excessive or unreasonable.

The provisions of section 40A (2) of the Act have been brought on the Statute to prevent evasion of tax through diversion of income by one entity to another related entity. The Central Board of Direct Taxes vide Circular .No.6-P dated 6.7.1968 elaborated the scope of section 40A(2) of the Act in the following terms:

"The Income-tax Officer is expected to exercise his judgment in a reasonable and fair manner. It should be borne in mind that the provision is meant to check evasion of tax through excessive or unreasonable payments to relatives and associate concerns and should not be applied in a manner which will cause hardship in bona fide cases. "

In this regard reliance is placed on the decision of the Bombay High Court in the case of CIT vs. Indo Saudi Services (Travel) (P.) Ltd., 219 CTR 562 wherein the Hon'ble Court held as under:

"............iv) The sister concern of the appellant M/s Middle East International is also assessed to tax and income assessed for the A. Y. 1991-92 is Rs. 9,38,510/- and for A. Y. 1992-93 is Rs. 14,65,880/- and the said assessment orders have been placed on record.

v) Under the CBDT Circular No. 6-P dated 6th July, 1968 it is stated that no disallowance is to be made under section 40A(2) in respect of the payments made to the relatives and sister concerns where there is no attempt to evade tax.

5. In view of the aforesaid admitted facts we are of the view that the Tribunal was correct in coming to the conclusion that the CIT (A) was wrong in disallowing half percent commission paid to the sister concern of the appellant during the Assessment Years 1991- 92 and 1992-93. The learned Advocate appearing for the appellant was also not in a position to point out how the appellant evaded payment of tax by alleged payment of higher commission to its sister concern since the sister concern was also paying tax at 32 higher rate and copies of the assessment orders of the sister concern were taken on record by the Tribunal.

6. We, therefore, answer the above question of law raised in these appeals in affirmative and dismiss the above appeals filed by the appellant. There will, however, be no order as to costs"

Further, in the case of CIT vs. Glaxo Smithkline Asia Pvt Ltd (SLP No 18121/25007) the Hon'ble Supreme Court while adjudicating upon an issue involving applicability of section 40A(2) of the Act held as under:

"Having gone through the relevant material placed before us concerning Assessment Year 2001- 2002, we are of the view that, as far as this special leave petition is concerned, no interference is called for as the entire exercise is a revenue neutral exercise. Hence, this special leave petition filed by the Department stands dismissed. " .

It has been held by the Courts that the disallowance under section 40A(2) of the Act could be considered only after a finding is recorded by the assessing officer that the expenditure was excessive or unreasonable having regard to (i) the market value of goods or services; (ii) the legitimate business needs; (iii) benefit derived by or accruing to the appellant therefrom. The onus is on the assessing officer to find out the fair market value of goods and services and bring on record comparable instances.

Reliance is further placed in this regard on the following decisions:

- Voltamp Transformers (P) Ltd. vs. CIT: 129 ITR 105(Guj.)

- Beta Naphthol P, Ltd. vs. OCIT: 50 TT J 375 (Ind)

- Hathiwala Silk Mills vs. ITO: 19 TT J 284 (Ahd)

- M & Co. vs. ITO: 23 Taxman (Mag), 27 (Ahd)

- Binit Corporation vs. ITO: 25 Taxman 238 (Ahd.) (Mag).

- Upvan International vs. ITO: 15 ITD 215 (Del)

- Rangoon Chemical Works P. Ltd. vs. ACIT: 100 Taxman (Mag) 163 (Ahd).

- Shriram Pistons & Rings Ltd. vs. IAC: 39 TT J 132 (Del).

- Vikshra Trading and Investment Private Ltd. vs. CIT: 61 TTJ 6 (Ahd.)

- Batliwala Karani vs. ACIT: (2005) 2 SOT 379 (Mumbai)

- Nestle (India Ltd (ITA No.4545/D/2000 and 2239/D/2002

- Shankar Trading Co Pvt. Ltd. vs. ACIT: ITA No.2792 to 2794/D/2004 and 2155/D/2002.

- DCIT vs. Lab India Instruments (P) Ltd: 93 ITO 120 (Pune) The provisions of section 40A(2) of the Act cannot, be applied in the present case considering that:

- No ulterior motive can be attributed to the management fees to TACL by the assessee,

- the arrangement is not to the detriment of Revenue considering that TACL has paid tax on the said amount of management fee paid by the assessee,

- there is no evasion of tax in the aforesaid arrangement.

- the Assessing Officer before disallowing the expenditure has not brought on record comparable instances to show that the expenses incurred are excessive having regard to the legitimate needs of business of the assesses.

It is submitted that management fee is paid by the assessee on the basis of the approval granted by Central Government, which implies that such payments are as per industry norms and are comparable to payment of management fee by other industries in the segment. The payment of management fee made as per the agreement approved by the Government cannot, in our respectful submission, be disallowed under section 40A (2) of the Act.

The Central Board of Direct Taxes vide Circular No. 6P dated 8.7.1968 has also clarified that where remuneration to a Director is approved by Company Law Board, there is no question of disallowance of the same holding it to be excessive and unreasonable.

The Supreme Court in the case of LIC v. Escorts Ltd (1986): 1 SCC 264 observed as under:

"As we said earlier, under the scheme of the Act, it is the Reserve Bank of India that is constituted and entrusted with the task of regulating and conserving foreign exchange. If one may use such an expression, it is the 'custodian-general' of foreign exchange. The task of enforcement is left to the Directorate of Enforcement, but it is the Reserve Bank of India and the Reserve Bank of India alone that has to decide whether permission mayor may not be granted under Section 29(1) of the Act. The Act makes it its exclusive privilege and function. No other authority is vested with any power nor may it assume to itself the power to decide the question whether permission mayor may not be granted or whether it ought or ought not to have been granted. The question may not be permitted to be raised either directly or collaterally. "

The Delhi High Court in the case of CIT v. Shriram Pistons & Rings Ltd., 181 ITR 230 held that where remuneration paid to son of a director of the assessee, was approved by the Company Law Board, no disallowance under section 40A(2) of the Act could be made by the Income-tax department on the ground that the same was excessive considering the professional qualification of the employee or the lack of it. It was observed by the Court that since the Company Law Board had decided that the remuneration paid to the employee was reasonable, it was not ordinarily open to the Income-tax authorities to regard such fixation as unreasonable.

Attention is also invited to the decision of Pune bench of the Tribunal in the case of Kinetic Honda Motors limited: 77 ITD 393, wherein the Hon'ble Tribunal deleted the disallowance on the ground that the royalty payment was as per the norms laid down by the guidelines issued by the Ministry of Industry and the same could not be said to be excessive or unreasonable 35 4.3 Re: Ad-hoc disallowance is impermissible Without prejudice, it is submitted that since the books of accounts have been audited in accordance with the provisions of the Act and has been accepted as true and correct, there is no justification to make any adhoc disallowance.

Reliance is also placed on the decision of Hon'ble Delhi High Court in the case of Jai Engineering limited: 113 ITR 389, wherein it is held as under:

"It is quite competent for the income-tax authorities not only to accept the auditors' report, but also to draw the proper inference from the same. The income-tax authorities can, therefore, come to the conclusion that, since the auditors were required by the statute to find out if the deductions claimed by the assesses in their balance- sheets and profit and loss accounts were supported by the relevant entries in their account books, the auditors must have done so and must have found that the account books supported the claims for deduction.

Where the original account books of the assessee had been destroyed in a fire it was held that the Appellate Tribunal, in allowing a deduction, could rely upon other material mainly consisting of the auditors' reports from which it could be inferred that the deductions were properly supported by the relevant entries in the account books."

Kind attention is further invited to the following decisions wherein adhoc disallowances made in absence of any specific mention of a unvouched expenditure liable to be disallowed have been held to be untenable and not called for.

      •       Dwarka Prasad Agarwal v. ITO: 52 ITD 239 (Cal)
      •       Mahendra Oil cake Industries Pvt. Ltd. v ACIT: 55 TTJ 711 (Ahd.)
      •       Rattah Mechanical Works Ltd. v ITO: 87 Taxman 288 (Mag)(Cd.)
      •       Shriram Pistons and Rings Ltd. v IAC: 39 IT J 132 (Del.)
      •       Roger Enterprises Pvt. Ltd. v. ITA : 52 TT J 198 (Del.)
      •       Ramji Das Modi v. DCIT: 110 Taxman 107 (JP) (Mag)
      •       ACIT v. Bateli Tea Co. Ltd., [2003] SOT 72.
      •       Continental Seeds & Chemicals Ltd. v. ACIT": (2003) SOT 393
                                            36

Further the Hon'ble ITAT in the appellant's own case for AY 2008- 09 has allowed the payment of management fees and restored the matter to the books of TPO. The Hon'ble ITAT held as follows:

"We have heard the matter both the counsel and perused the records. In our considered opinion the consideration of these additional evidences is necessary for proper adjudication of the issue. However, we note that these additional evidences are admitted and remitted to the files of assessing officer. In our considered opinion, interest of justice will be served, if additional evidences as sought to be placed by the assessee are remitted to the file of the assessing officer for consideration. Accordingly we admit the additional evidence and remit the same to the file of the assessing officer. The AO shall consider these grounds afresh."

The aforesaid disallowance, it is respectfully submitted, is based on mere suspicion and surmises and is devoid of any cogent reason. No evidence has been brought on record by the assessing officer to substantiate the allegation that the expenditure was excessive and unreasonable.

For the aforesaid reasons, it is respectfully submitted that the addition made by the assessing officer under section 40A(2)(b) of the Act is not sustainable and is liable to be deleted.

5. The appellant filed an application for admission of additional evidence in terms of Rule 29 of the ITAT Rules, 1963. The appellant sought to place on record the following by way of additional evidence. The approval granted by Ministry of Company Affairs, Govt. of India for payment of administrative services fee to Talbros Automotive Components Ltd. and it was submitted as under:

"The appellant seeks to place on record the following by way of additional evidence:

1. Approval granted by Ministry of Company Affairs, Government of India for payment of Administrative Services Fee to Talbros Automotive Components Ltd. Placed at pages 1 to 6

- Merits of the matter in relation to the aforesaid additional evidence are explained hereunder:

The: appellant during the relevant previous year incurred expenditure, amounting to Rs. 1,49,76,358 on account of administrative charges paid to M/s Talbros Automotive Components Ltd. (TACL) for provision of services such as sales and marketing services, secretarial services, financial and accounting services etc. In view of the thin and lean employee structure of the appellant, the accounting, marketing and day to day administration function was outsourced to Talbros. In consideration of the services, the appellant pays 10% of profits before tax to TACL, It would be appreciated that the appellant does not have the qualified employees to perform the aforesaid functions.

The assessing officer, however, disallowed the payment of administrative charges under section 40A(2) of the Act on the ground that the appellant has failed to prove the reasonableness and justification for the aforesaid amount.

It is submitted that management fee is paid by the appellant on the basis of the approval granted by Central Government, which implies that such payments are as per industry norms and are comparable to payment of management fee by other industries in the segment. The payment of management fee made as per the agreement approved by the Government cannot, in our respectful submission, be disallowed under section 40A(2) of the Act.

The Central Board of Direct Taxes vide Circular No. 6P dated 8.7.1968 has also clarified that where remuneration to a Director is approved by Company Law Board, there is no question of disallowance of the same holding it to be excessive and unreasonable.

The Supreme Court in the case of LIC v, Escorts Ltd (1986): 1 SCC 264 observed as under:

"As we said earlier, under the scheme of the Act, it is the Reserve Bank of India that is constituted and entrusted with the task of regulating and conserving foreign exchange. If one may use such an expression, it is the 38 'custodian-general' of foreign exchange. The task of enforcement is left to the Directorate of Enforcement, but it is the Reserve Bank of India and the Reserve Bank of India alone that has to decide whether permission mayor may not be granted under Section 29(1) of the ACT. The Act makes it its exclusive privilege and function. No other authority is vested with any power nor may it assume to itself the power to decide the question whether permission may or may not be granted-or whether it ought or ought not to have been granted. The question may not be permitted to be raised either directly or collaterally."

Attention is also invited to the decision of Pune bench of the Tribunal in the case of Kinetic Honda Motors Limited: 77 ITO 393, wherein the Hon'ble Tribunal deleted the disallowance on the ground that the royalty payment was as per the norms laid down by the guidelines issued by the Ministry of Industry and the same could not be said to be excessive or unreasonable. In view of the aforesaid, it is respectfully submitted that the aforesaid approvals granted by the government, placed as additional evidence before your Honors, are relevant to establish that the payment for administrative services being pursuant to a specific approval granted by the Government cannot be questioned by the assessing officer as being excessive or unreasonable. PRAYER:

It would be appreciated that this is the first appeal before the Hon'ble Tribunal against the impugned assessment order. The aforesaid additional evidences have been placed on record to rebut the conclusion arbitrarily arrived at by the lower authorities and in the interest of Justice, the same may kindly be taken into consideration while deciding the appeal. Since the evidence placed on record goes to the root of the matter, the same needs to be admitted for adjudication of the appeal.

Your Honour's kind attention is invited to the decision of the jurisdictional Delhi High Court in the case of CIT vs. Text Hundred India Pvt. Ltd.: 239 CTR 263.

In that case, their Lordships held that Rule 29, permitting the Tribunal to admit additional evidence is made to enable the Tribunal to admit any additional evidence which would be necessary to do substantial justice in the matter. Their Lordships further observed that the various procedures, including that relating to filing of additional evidence, is handmade for justice and justice should not be allowed to be choked only because of some inadvertent error or omission on the part of one of the parties to lead evidence.

The relevant observations of the Court are reproduced hereunder:

"13. The aforesaid case law clearly lays down a neat principle of law- that discretion lies with the Tribunal to admit additional evidence in the interest of justice once the Tribunal affirms the opinion that doing so would be necessary for proper adjudication of the matter. This can be done even when application is filed by one of the parties to the appeal and it need not to be a suo motto action of the Tribunal. The aforesaid rule is made enabling the Tribunal to admit the additional evidence in its discretion if the Tribunal holds the view that such additional evidence would be necessary to do substantial justice in the matter. It is well settled that the procedure is handmade of justice and justice should not be allowed to be choked only because of some inadvertent error or omission on the part of one of the parties to lead evidence at the appropriate stage. Once it is found that the party intending to lead evidence before the Tribunal for the first time was prevented by sufficient cause to lead such an evidence and that this evidence would have material bearing on the issue which needs to be decided by the Tribunal and ends of justice demand admission of such an evidence, the Tribunal can pass an order to that effect."

Reliance is also placed in that regard on the following decisions:

CIT v. Hewlett Packard India: 314 ITR 55 (Del HC) CIT v. Chandra Kant Sahu Bhai: 202 Taxman 262 (Del HC) CIT v. Betterways Finance: ITA 995 of 2009 (Del HC) Jatia Investment Co v. CIT: 206 ITR 718 (Cal HC) Electra (Jaipur) Ltd v. IAC: 26 ITO 236 (Del ITAT) Y. W. C. A. of India vs lAC: 29 ITO 620 (Del ITAT) Reliance in this regard is also placed on. the decision of the Hon'ble Pune Bench of the Tribunal in the case of Rieterlndia Pvt Ltd vs ACIT (ITA No 1374/PN/2010) wherein, the Hon'ble Tribunal while dealing with an application for admission of additional evidence, examined the powers of the Tribunal in terms of Rule 29 of the Income-tax (Appellate Tribunal) Rules, 1963 and held as under:

"9. We have heard the rival parties with respect to the preliminary prayer of the assessee seeking admission of the aforesaid additional evidence in terms of rule 29 of the Appellate Tribunal Rules. At the outset, we may reproduce hereinafter rule 29 of the Appellate Tribunal Rules which reads as under :-

"29. Production of additional evidence before the Tribunal.- The parties to the appeal shall not be entitled to produce additional evidence either oral or documentary before the Tribunal, but if the. Tribunal requires any documents to be produced or any witness to be examined or any affidavit to be filed to enable it to pass orders or for any other substantial cause, or, if the income- tax authorities have decided the case without giving sufficient opportunity to the assessee to adduce evidence either on points specified by them, or not specified by them, the Tribunal, for reasons to be recorded, may allow such document to be produced or witness to be examined or affidavit to be filed or may allow such evidence to be adduced."

A perusal of the above rule would show that the parties to the appeal before the Tribunal are not entitled to produce additional evidence, either oral or documentary, as a matter of vested right. However, if the Tribunal requires any document to be produced or any witness to be examined or any affidavit to be filed, it may permit so for the reasons to be recorded. Nevertheless, it has to be understood that the discretion vested in the Tribunal is not without fetters. We say so for the reason that the rule itself carves out situations, where the exercise of such discretionary power by the Tribunal is permissible. Shorn of other details, so far as it is relevant for the present purpose, one such situation which is prescribed is admission of additional evidence which enables the Tribunal "to pass orders or for any other substantial cause". The presence of the aforesaid expression in rule 29 of the Appellate Tribunal Rules shows that the Tribunal is competent to admit additional evidence in situation which enable to Tribunal to pass orders or for any other substantial cause.

XXX

11. In our considered opinion, all the evidences sought to be canvassed for admission are relevant and germane to appropriately determine the arm's length price of the international transactions entered by the assessee with its associated enterprises. Considering the circumstances explained by the assessee, and the bonafides of the reasons not having been assailed by the Revenue, the same deserve to be admitted. Therefore, we deem it fit and proper to admit the additional evidences having regard to the facts and circumstances of the present case:"

Further, recently in the case of Bentley Systems India Pvt Ltd vs ACIT (ITA No 6160/Del/2013) the Hon'ble Tribunal while adjudicating upon an issue involving transfer pricing adjustment on account of intra group services admitted the additional evidence, placed on record by the assessee for the purpose of substantiating the receipt of management services. The Hon'ble Tribunal held that since the evidence placed on record goes to the root of the matter, the same needs to be admitted for adjudication of the appeal. In view of the aforesaid, it is submitted that the additional evidence placed by the applicant may kindly be admitted and taken into account for disposing the present appeal.

In view of the aforesaid and in the interest of justice, it is respectfully prayed that the aforesaid additional evidence may kindly be admitted by exercising the discretion conferred on the Hon'ble Tribunal under Rule 29 of the Income Tax (Appellate Tribunal) Rules, 1963.

6. We considered the application for admission of additional evidence carefully keeping in view the judgment of the Hon'ble Jurisdictional High Court in the case of CIT Vs. Text Hundred India Pvt. Ltd., 239 CTR 263 that the additional evidence should be admitted where such additional is necessary to do substantial justice in the matter. This evidence undisputably is necessary by adjudication of the matter on hand. Following the ratio laid down in the case cited supra, we admit the additional evidence placed on record as this would be necessary to do substantial justice in the matter.

7. On the other hand, ld. CIT-DR relied on the orders of lower authorities.

8. We have heard the rival submission and perused the material on record.

First we shall deal with the Transfer Pricing Adjustment (TPA) made by the Assessing Officer. The TPO held that there were no services rendered by the AE to the appellant and hence held that ALP is nil and this was summarily rejected by the DRP vide his order dated 14.11.2014. The contention of the TPO cannot be upheld for the simple reason that there were no employees with the appellant 42 who are technically competent to be able to develop new gasket. This is evident from its low employee cost to sales as well as depreciation sales. It is imperative to refer to the OECD guidelines whether the services have been rendered or not.

Para 7.6 of the guidelines states as under:

"7.6 Under the arm's length principle, the question whether an intragroup service has been rendered when an activity is performed for one or more group members by another group member should depend on' whether the activity provides a respective group member with economic or commercial value to enhance its commercial position, This can be determined by considering whether an independent enterprise in comparable circumstances would have been willing to pay for the activity if performed for it by an independent enterprise or would have performed the activity inhouse for itself."

9. The Hon'ble Jurisdictional High Court in the case of CIT Vs. EKL Appliances Ltd., 345 ITR 241 after referring to the abovementioned OECD guidelines held as follows vide paras 19 to 22:

"19. There is no reason why the OECD guidelines should not be taken as a valid input in the present case in judging the action of the TPO. In fact, the CIT (Appeals) has referred to and applied them and his decision has been affirmed by the Tribunal. These guidelines, in a different form, have been recognized in the tax jurisprudence of our country earlier. It has been held by our courts that it is not for the revenue authorities to dictate to the assessee as to how he should conduct his business and it is not for them to tell the assessee as to what expenditure the assessee can incur. We may refer to a few of these authorities to elucidate the point. In Eastern Investment Ltd. v. CIT [1951] 20 ITR 1 (SC), it was held by the Supreme Court that "there are usually many ways in which a given thing can be brought about in business circles but it is not for the Court to decide which of them should have been employed when the Court is deciding a question under Section 12(2) of the Income Tax Act". It was further held in this case that "it is not necessary to show that the expenditure was a profitable one or that in fact any profit was earned".

In CIT v. Walchand & Co. (P.) Ltd. [1967] 65 ITR 381 (SC), it was held by the Supreme Court that in applying the test of commercial 43 expediency for determining whether the expenditure was wholly and exclusively laid out for the purpose of business, reasonableness of the expenditure has to be judged from the point of view of the businessman and not of the Revenue. It was further observed that the rule that expenditure can only be justified if there is corresponding increase in the profits was erroneous. It has been classically observed by Lord Thankerton in Hughes v. Bank of New Zealand [1938] 6 ITR 636 (HL) that "expenditure in the course of the trade which is unremunerative is none the less a proper deduction if wholly and exclusively made for the purposes of trade. It does not require the presence of a receipt on the credit side to justify the deduction of an expense". The question whether an expenditure can be allowed as a deduction only if it has resulted in any income or profits came to be considered by the Supreme Court again in CIT v.Rajendra Prasad Moody [1978] 115 ITR 519 (SC), and it was observed as under: -

"We fail to appreciate how expenditure which is otherwise a proper expenditure can cease to be such merely because there is no receipt of income. Whatever is a proper outgoing by way of expenditure must be debited irrespective of whether there is receipt of income or not. That is the plain requirement of proper accounting and the interpretation of Section 57(iii) cannot be different. The deduction of the expenditure cannot, in the circumstances, be held to be conditional upon the making or earning of the income."

It is noteworthy that the above observations were made in the context of Section 57(iii) of the Act where the language is somewhat narrower than the language employed in Section 37(1) of the Act. This fact is recognised in the judgment itself. The fact that the language employed in Section 37(1) of the Act is broader than Section 57(iii) of the Act makes the position stronger.

20. In the case of Sassoon J. David & Co. (P.) Ltd. v. CIT [1979] 118 ITR 261 / 1 Taxman 485 (SC), the Supreme Court referred to the legislative history and noted that when the Income Tax Bill of 1961 was introduced, Section 37(1) required that the expenditure should have been incurred "wholly, necessarily and exclusively" for the purposes of business in order to merit deduction. Pursuant to public protest, the word "necessarily" was omitted from the section.

21. The position emerging from the above decisions is that it is not necessary for the assessee to show that any legitimate expenditure 44 incurred by him was also incurred out of necessity. It is also not necessary for the assessee to show that any expenditure incurred by him for the purpose of business carried on by him has actually resulted in profit or income either in the same year or in any of the subsequent years. The only condition is that the expenditure should have been incurred "wholly and exclusively" for the purpose of business and nothing more. It is this principle that inter alia finds expression in the OECD guidelines, in the paragraphs which we have quoted above.

22. Even Rule 10B(1)(a) does not authorise disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same or that in the view of the Revenue the expenditure was unremunerative or that in view of the continued losses suffered by the assessee in his business, he could have fared better had he not incurred such expenditure. These are irrelevant considerations for the purpose of Rule 10B. Whether or not to enter into the transaction is for the assessee to decide. The quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the assessee has suffered continuous losses. The financial health of assessee can never be a criterion to judge allowability of an expense; there is certainly no authority for that. What the TPO has done in the present case is to hold that the assessee ought not to have entered into the agreement to pay royalty/brand fee, because it has been suffering losses continuously. So long as the expenditure or payment has been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the TPO to disallow the same on any extraneous reasoning. As provided in the OECD guidelines, he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the TPO is not contemplated or authorised."

10. The ratio that can be culled out from the above decision is that it is not necessary for the assessee to show that any legitimate expenditure incurred by him is also incurred out of necessity or the expenditure incurred by him for the purpose of business actually resulted in profit. This ratio was followed by the coordinate bench of the Tribunal in the following decisions; 45 i. Erricsson India (P.) Ltd. Vs. DCIT, [2012] 25 taxmann.com 472 (Del.) ii. Festo Controls Private Ltd. Vs. DCIT, [2013] 30 taxmann.com 16 (Bang.) iii. Fosroc Chemicals India Pvt. Ltd. Vs. DCIT, ITA(TP) No. 1256(Bang./2011 iv. AWB India Pvt. Ltd. Vs. ACIT, - TS-67-ITAT-2013 (Del)-TP v. Thysssen Krup Industries India Pvt. Ltd. Vs. ACIT (2012) 27 taxmann.com 34 (Mum-Trib.) vi. Yokogawa India Ltd. Vs. ACIT, ITA No. 1329/Bang/2011 Therefore, respectfully following the above ratio we hold that the TPO is not justified in determining the ALP on the payment made for management fees of Rs. 2,99,52,717/- at nil. Accordingly, the grounds of appeal from 2 to 2.10 are allowed.

11. That brings to the issue relating to the disallowance of Rs. 1,49,76,358/- being the amount paid to M/s Talbros Automotive Components Ltd. towards administrative services under Section 40A(2) of the Act.

12. We heard the rival submissions and perused the material on record. It appears from the assessment order that the Assessing Officer had disallowed the impugned payment to its sister concern on the ground that the appellant had not produced any evidence in support of having rendered the services by M/s Talbros Automotive Components Ltd. During the course of hearing, the appellant filed the additional evidence in support of the services rendered which was admitted by us as mentioned in paragraphs supra. This clearly establishes that the appellant had received the services from the said company. That apart, in our view, AO had not met the requirement of the provisions of Section 40A(2). A plain reading of the provisions of Section 40A(2) reveals that where an assessee incurs any expenditure in respect of which payment is required to be 46 made or has been made to any person referred to in clause (b) of section 40A(2) of the Act and the Assessing Officer is of the opinion that such expenditure is excessive or unreasonable having regard to (a) fair market value of the goods, services or facilities for which the payment is made; or (b) the legitimate needs of the business of the assessee; or (c) the benefits derived by or accruing to the assessee on receipt of such goods, services or facilities, then the Assessing Officer shall not allow as a deduction so much of the expenditure as is so considered by the Assessing Officer to be excessive or unreasonable. Therefore, it becomes apparent that the Assessing Officer is required to record a finding as to whether the expenditure is excessive or unreasonable in relation to any one of the three requirements prescribed. This opinion has to be formed by the Assessing Officer based on the material evidence available on the record. The Assessing Officer is duty bound to bring on record the comparable fair market value of the services rendered to say that the value paid by the assessee is excessive or unreasonable. We find no evidence on record to notice that the Assessing Officer made efforts in this direction. He simply made disallowance based on the surmises and conjectures.

13. We may also refer to the scope of Section 40A(2) as explain by the CBDT in Circular No. 6P, dated 06.07.1968. The CBDT clarified that while examining the reasonableness of expenditure the Assessing Officer is expected to exercise his judgment in a reasonable and fair manner. It should be borne in mind that the provision is meant to check evasion of tax through excessive or unreasonable 47 payments to relatives and associate concerns and should not be applied in a manner which will cause hardship in bona fide cases.

14. In CIT Vs. Edward Keventer (P.) Ltd. [1972] 86 ITR 370, the Calcutta High Court considering identical provision in 1922 Act, it was held that the section places two limitations in the matter of exercise of the power. The section enjoins the Assessing Officer in forming any opinion as to the reasonableness or otherwise of the expenditure incurred must take into consideration (i) the legitimate business needs of the company and (ii) the benefit derived by or accruing to the company. The legitimate business needs of the company must be judged from the view point of the company itself and must be viewed from the point of view of a prudent businessman. It is not for the Assessing Officer to dictate what the business needs of the company should be and he is only to judge the legitimacy of the business needs of the company from the point of view of a prudent businessman. The benefit derived or accruing to the company must also be considered from the angle of a prudent businessman. The term "benefit" to a company in relation to its business, it must be remembered, has a very wide connotation and may not necessarily be capable of being accurately measured in terms of pound, shillings and pence in all cases. Both these aspects have to be considered judiciously, dispassionately without any bias of any kind from the view-point of a reasonable and honest person in business.

15. The aforesaid judgement of Calcutta High Court was affirmed by the Apex Court in CIT Vs. Edward Keventer (P.) Ltd. [1978] 115 ITR 149. In the 48 same line is the judgment of Bombay High Court in the case of CIT Vs. Shtrunjay Diamonds [2003] 261 ITR 258/128, Taxmann, 759.

16. Following the ratio laid down in the above cases, we hold that in the present case also there is no warrant for disallowance of sum of Rs. 1,49,76,358/- paid to M/s Talbros Automotive Pvt. Ltd. as the Assessing Officer failed to discharge the onus that was lying upon him as per the mandate of the provisions of Section 40A(2) of the Act. Accordingly, the grounds of appeal from 3 to 3.4 are allowed.

17. Ground no. 4 is consequential in nature and does not require any adjudication.

18. In the result, appeal filed by the assessee company is allowed.

The decision is pronounced in the open court on 28thAugust, 2015.

           Sd/-                                       Sd/-
     (I.C. SUDHIR)                             (INTURI RAMA RAO)
  JUDICIAL MEMBER                             ACCOUNTANT MEMBER
Dated: 28th August, 2015.
RK/-
Copy forwarded to:
1.     Appellant
2.     Respondent
3.     CIT
4.     CIT(A)
5.     DR
                                               Asst. Registrar, ITAT, New Delhi

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Income Tax Appellate Tribunal - Delhi

Nippon Leakless Talbros Pvt. Ltd., ... vs Assessee on 28 August, 2015