Income Tax Appellate Tribunal - Bangalore
Herbalife International India Pvt ... vs Acit, Bangalore on 17 April, 2017
IN THE INCOME TAX APPELLATE TRIBUNAL
"A" BENCH : BANGALORE
BEFORE SHRI GEORGE GEORGE K, JUDICIAL MEMBER AND
SHRI INTURI RAMA RAO, ACCOUNTANT MEMBER
1. IT(TP)A No.1406/Bang/2010
Assessment year : 2006-07
2. IT(TP)A No.924/Bang/2012
Assessment year : 2007-08
M/s. Herbalife International India Pvt. Ltd., ... APPELLANT
#14, Commissariat Road,
Bengaluru-560025.
PAN : AAACH8025R
Vs.
1. Assistant Commissioner of Income-Tax, ... RESPONDENTS
Circle 11(4),
Bengaluru.
2. Deputy Commissioner of Income-Tax,
Circle-11(4),
Bengaluru.
Appellant by : Shri. Rajan Vora, CA
Respondent by : 1. Shri. Raja Sekhar Reddy, CIT-DR
2. Shri. Kamaladhar, Sd. Counsel
Date of hearing : 18.01.2017
Date of Pronouncement : 17.04.2017
IT(TP)A No.1406/Bang/2010
IT(TP)A No.924/Bang/2012
Page 2 of 13
ORDER
Per Inturi Rama Rao, Accountant Member
This appeal filed by the assessee directed against the assessment order passed under 143 r.w.s. 144C of the Act dated 8.10.2010 for the assessment year 2006-07.
2. Briefly, the facts of the case are that the assessee is a private limited company duly incorporated under the Companies Act, 1956. It is a subsidiary of HLI Inc., USA. It is engaged in the business of dealing in weight management, food and dietary supplements and personal care products. The return of income for the assessment year 2006-07 was filed declaring Nil income on 22.11.2006 after processing the said return of income under section 143(1), the case was selected for scrutiny assessment. The assessee company also reported the following international transactions with its AE in its Form 3 CEB:
Purchase of articles of 14,73,293/-
Promotional Products
Sale of Kits 70,576/-
Royalty paid 2,37,93,205/-
Cost Recharge 80,44,537/-
Payment towards stock option 2,17,262/-
Payment of Administrative Fee 5,47,91,533/-
IT(TP)A No.1406/Bang/2010
IT(TP)A No.924/Bang/2012
Page 3 of 13
3. The assessee company sought to justify the consideration paid for the above international transactions entered with its AE to be at arm's length. The assessee company also submitted transfer pricing study report adopting Transactional Net Margin Method (TNMM) which is considered to be the most appropriate method for the purpose of bench marking the above international transactions. The assessee company also adopted profit before income tax to sales as a profit level indicator. The assessee company's profit margin was computed at 5%. The assessee company claimed that the same was comparable with other companies and claimed that the payment of management fees and royalty are at arm's length. For the purpose of transfer pricing study, the assessee company has chosen comparables whose profit margin was computed at 5%. Thus it was claimed that the payments of management fees and royalty is at arm's length.
4. The AO referred the matter to the TPO for the purpose of bench marking the international transactions the assessee company had entered with AE. The TPO by order dated 16.10.2009 passed under section 92CA(3) of the Act computing the transfer pricing adjustment of Rs.7,85,84,738/- by determining the arm's length price for administrative services paid to its AE Herbalife International Inc., of Rs.5,47,91,533/- and IT(TP)A No.1406/Bang/2010 IT(TP)A No.924/Bang/2012 Page 4 of 13 the royalty payment of Rs.2,37,93,205/-. The learned TPO had treated the payment of administrative service fee at Nil on the ground that the assessee company had failed to establish that the administrative services are actually received by the assessee company and the assessee had failed to establish the benefits accrued as a result of management services and also the necessity of such expenditure. Similarly the same reasons were given by the learned TPO for treating the payment of royalty of Rs.2,37,97,205/- at Rs.Nil. The learned TPO also not agreed to the submission of the assessee company that the transaction of payment of royalty and administrative service should be aggregated with the other transactions, by holding that the aggregation of transactions is permissible only in respect of series of closely linked transactions which cannot be analysed separately. The TPO also has not accepted the calculation of margin of the assessee company at 5% which was calculated by the assessee company after deducting a sum of Rs.3,64,20,069/- that is cost towards mega event of Rs.1,73,37,669/-, rent for vacant property, administrative fee of rs.1,50,00,000/- as exceptional cost. The TPO held that without including the above cost, the margin on sales should be worked out and accordingly the TPO worked out on the said basis the margins at -3.33% and whereas accordingly the learned TPO worked out the margins of the comparables at 10.36%. The learned TPO also disallowed a sum of Rs.59,48,301/- as being 25% royalty paid to Herbalife Inc., USA as capital in nature.
IT(TP)A No.1406/Bang/2010 IT(TP)A No.924/Bang/2012 Page 5 of 13
5. Based on the TPO's order, the AO passed the draft assessment dated 24.12.2009 incorporating the transfer pricing adjustment suggested by learned TPO in his order passed under section 92CA.
6. Being aggrieved by the draft assessment order, the objections were filed before the Hon'ble DRP which upheld the TPO order. Pursuant to directions of Hon'ble DRP, the AO passed final assessment order dated 8.10.2010 incorporating the above addition.
7. Being aggrieved, the appellant is in appeal before us in the present appeal and raised the following grounds of appeal:
IT(TP)A No.1406/Bang/2010 IT(TP)A No.924/Bang/2012 Page 6 of 13
8. Ground No. 1 and 2 are general in nature, do not require any adjudication. Ground No. 3,5 & 6 challenges the addition made on account of payment of administrative services fees of Rs.5,47,91,533/- and ground No. 7 challenges the addition on account of payment of royalty to AE of Rs.2,37,93,205/-. The whole case of the TPO is that the assessee had failed to demonstrate the benefits derived out of such expenditure and also the necessity of incurring such expenditure and finally on the ground that the assessee has failed to prove that the assessee has actually received the services. The Hon'ble DRP also confirmed the addition holding that the assessee only made the submission regarding the nature of services IT(TP)A No.1406/Bang/2010 IT(TP)A No.924/Bang/2012 Page 7 of 13 received but had not been able to prove that the services are actually received by the assessee company.
9. We heard the rival submission and perused the material on record. Now the law is quite settled that it is beyond the scope and powers of TPO/AO to question the necessity of incurring the expenditure or the benefits of the expenditure incurred. The Hon'ble Delhi High Court in the case of CIT Vs. EKL Appliances 345 ITR 241 held that the TPO cannot determine the ALP at Nil by holding that there was no need of incurring such expenditure. In the said case, the Hon'ble Delhi High Court after referring to the decision of Hon'ble Apex Court in the case of CIT Vs. Walchand and Co. P. Ltd., 65 ITR 381 and Sassoon J David & Co (P) Ltd., 118 ITR 261 and CIT Vs. Rajendra Prasad Moody 115 ITR 519 held as follows:
"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 Transfer Pricing Officer. In fact, the Commissioner of Income-tax (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 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 Investments Ltd. v. CIT [1951] 20 ITR1 (SC) it was held by the Supreme Court that (page 6) "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 as earned". In CIT v. Walchand and Co. P. Ltd. [1967] 65 ITR 381 (SC), it was held by the Supreme Court that in applying the test of commercial expediency for determining whether the expenditure was wholly and exclusively laid out for the purpose of business, reasonableness of the IT(TP)A No.1406/Bang/2010 IT(TP)A No.924/Bang/2012 Page 8 of 13 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 as erroneous. It has been classically observed by Lord Thankerton in Hughes (Inspector of Taxes) v. Bank of New Zealand [1938] 6 ITR 636 (HL) at "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 (page 523):
"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 e 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 and Co. Pvt. Ltd. v. CIT [1979] 118 ITR 261 (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 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 o: 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 l0B. 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 Transfer Pricing Officer 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 conti- nuous losses. The financial health of the assessee can never be a criterion to judge allowability of an expense; there is certainly no authority for that What the Transfer Pricing Officer has done in the present case is to hold that the assessee ought not to have entered into the agreement to pay royalty/brand IT(TP)A No.1406/Bang/2010 IT(TP)A No.924/Bang/2012 Page 9 of 13 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 Transfer Pricing Officer 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 Transfer Pricing Officer is not contemplated or authorized."
10. Thus, the ratio of the above judgment is that the ALP in respect of any transaction cannot be determined at Nil by holding that there was no benefit accrued on account of incurring such expenditure nor there was any necessity of incurring such expenditure. But the matter does not end there. The onus lies on the assessee to prove that the actual services for which the administrative services fees were paid are actually rendered or the use of technical knowhow @ 5% of the domestic sales. It may be mentioned that the question of the bench marking of transaction would arise only if the assessee proves that there was actual transfer of technical knowhow to the appellant and the technical knowhow was actually used by the assessee in the manufacturing activity of the appellant. It is a matter of fact that before the lower authorities as well as before us, the assessee company had only described the nature of technical knowhow and nature of administrative services received. It does not conclusively prove that the assessee company actually received the administrative services as well as the technical knowhow which are used in the manufacturing activity of the appellant.
IT(TP)A No.1406/Bang/2010 IT(TP)A No.924/Bang/2012 Page 10 of 13
11. The appellant had not filed any additional evidences to prove the administrative services/technical knowhow are actually received by the appellant and thus the assessee company had failed to discharge this onus of proving this aspect. Therefore, even as per the provisions of Indian Evidence Act, the presumption can be drawn that the assessee has no evidence to prove this aspect. Therefore, the AO/TPO was justified in adopting the ALP in respect of payment of administrative services and royalty at Nil. Thus, the grounds of appeal in ground Nos. 2 to 7 are dismissed. In respect of the other grounds of appeal, since we held that there was no proof of receipt of administrative services as well as technical knowhow which is used in the process of manufacturing activity, the question of bundling of transaction or aggregating all other transactions does not arise.
IT(TP) A No. 924/Bang/2012 (Assessment Year 2007-08)
12. In this appeal, vide ground Nos. 4 to 7, the grounds of appeal relating to the disallowance of administrative fees and royalty payment to AE are dealt by us in ITA No. 1406 for the assessment year 2006-07. Since identical facts are involved in the present assessment year 2007-08, for the parity of the same reasoning, we uphold the ALP adjustment in respect of administrative service fees and royalty payment. Thus all the grounds of appeal relating to the royalty and administrative services have been dismissed. Then the only ground of appeal that survives is ground IT(TP)A No.1406/Bang/2010 IT(TP)A No.924/Bang/2012 Page 11 of 13 relating to uphold of disallowance on account of doubtful advance written off of Rs.1,20,16,395/-. The brief facts surrounding this addition are as under:
In the earlier years, the appellant manufactured weight management products and paid excise duty thereon and these products could not sold in the market owning to unfavourable conditions and therefore, the appellant was forced to export these products to the parent company. On account of these exports made, the company claimed duty draw back from Central Excise department for the duty already paid. The claim was rejected by the Central Excise department and this claim is now pending in the appeal stage. While the matter stood thus during the previous year relevant to the assessment year under consideration, the appellant written off this amount as a bad debt and claimed as deduction. This was rejected by the AO by holding that it is not a debt but a statutory duty recoverable from the concerned authorities unless and otherwise the issue of irrecoverability attains the finality by the decision of the appellate courts, the same cannot be allowed as deduction and the same came to be confirmed by the CIT(A) holding that the it cannot be allowed as a business loss.
13. Being aggrieved, the appellant is in appeal before us in present appeal.
IT(TP)A No.1406/Bang/2010 IT(TP)A No.924/Bang/2012 Page 12 of 13
14. We heard the rival submission and perused the material on record. The conditions necessary for allowance as a bad debt are not applicable in the present case. It is not a debt arising on account of any sale transaction and a bad debt presupposes existence of a debt and these were not a forming part of the total income in the earlier years of the appellant. Therefore, the claim cannot be allowed as a bad debt. Further, this cannot even be allowed as a business loss for the reason that the issue of irrecoverability from the department has not attained the finality as the issue is pending before the appellant authorities. This can be claimed as a deduction only if it becomes clear that it cannot be recovered as a deduction.
15. In the result, appeal filed by the assessee is dismissed.
Pronounced in the open court on this 17th April, 2017.
Sd/- Sd/-
(GEORGE GEORGE K) (INTURI RAMA RAO)
Judicial Member Accountant Member
Bangalore.
Dated: 17th April, 2017.
/NShylu/
IT(TP)A No.1406/Bang/2010
IT(TP)A No.924/Bang/2012
Page 13 of 13
Copy to:
1. Appellants 2. Respondent
3. CIT 4. CIT(A)
5. DR, ITAT, Bangalore. 6. Guard file
By order
Assistant Registrar
ITAT, Bangalore.