Income Tax Appellate Tribunal - Bangalore
M/S. Mapei Constructions Products ... vs Deputy Commissioner Of Income Tax, ... on 23 February, 2023
IN THE INCOME TAX APPELLATE TRIBUNAL
"C" BENCH : BANGALORE
BEFORE SHRI GEORGE GEORGE K., JUDICIAL MEMBER
AND
Ms. PADMAVATHY S, ACCOUNTANT MEMBER
IT(TP)A No.828/Bang/2022
Assessment year : 2018-19
M/s. Mapei Constructions Products Vs. The Deputy Commissioner
(India) Pvt. Ltd., of Income Tax,
A01 and B01, First Floor, Circle 4(1)(1),
Solutions Jain Heights, Bangalore.
1st Cross, J.C. Road,
Opp. Bangalore Stock Exchange,
Bangalore - 560 062.
PAN: AAHCM 0464A
ASSESSEE RESPONDENT
Assessee by : Shri S. Ramasubramanian, CA
Respondent by : Ms. Neera Malhotra, CIT(DR)(ITAT), Bengaluru.
Date of hearing : 16.02.2023
Date of Pronouncement : 23.02.2023
ORDER
Per Padmavathy S., Accountant Member
This appeal is against the final order of assessment passed by the Assessing Officer, Assessment Unit, Income Tax Department dated 22.7.2022 for the assessment year 2018-19.
2. The assessee is a company engaged in the manufacture and trade of construction materials such as additives, ceramic related products IT(TP)A No.828/Bang/2022 Page 2 of 30 and underground tunnelling products. The assessee filed the return of income for AY 2018-19 on 30.11.2018 declaring a total income of NIL. The return was processed u/s. 143(1) assessing the income at Rs.3,43,670 after making adjustment on account of non-deposit of PF/ESI contribution to the account of the employees on or before the due date. Subsequently the case was selected for scrutiny under CASS and notice u/s. 143(2) was duly served on the assessee. The reference to TPO was made after obtaining the necessary approvals on the basis of TP risk parameters. The TPO made a TP adjustment of Rs.2,28,66,668. The AO passed the draft assessment order incorporating the TP adjustment. Besides the TP adjustment, the AO added a sum of Rs.32,04,41,500 u/s. 68 and also disallowed a sum of Rs.2,20,85,636 u/s.37.
3. Aggrieved, the assessee filed its objections before the DRP, who confirmed the TP adjustment as well as the additions/disallowance made by the AO. Assessee is in appeal before the Tribunal against the final order of assessment in pursuance to the directions of the DRP.
4. The assessee raised grounds pertaining to the following issues:-
• Ground 1 - General • Ground 2 (2.1 to 2.3) - Validity of assessment proceedings u/s. 144C • Ground 3 (3.1 to 3,9) - Regarding comparables considered by the TPO for the purpose of TP adjustment • Ground 4 (4.1 to 4.4) - Determination of the ALP by the TPO • Ground 5 (5.1 to 5.5) - Additions u/s. 68 of the Act • Ground 6 (6.1 to 6.3) - Disallowance of fees paid to Information Technology and Corporate services received IT(TP)A No.828/Bang/2022 Page 3 of 30 • Ground 7 (7.1) - Disallowance of employee contribution to PF and ESI.
5. Ground No.1 is general. During the course of hearing, the ld AR did not press ground No.2 (2.1 to 2.3), hence the same is dismissed as not pressed.
6. Out of ground No.3, the ld AR submitted that ground Nos.3.2, 3.4 & 3.7 relate to turnover filter and if these grounds are adjudicated based on applicability of turnover filter, the rest of the grounds with regard to comparable would become academic.
7. Grounds pertaining to the turnover filter read as follows:-
3.2. That the comparable entities chosen by the learned lower authorities for the purpose of determination of Arm's Length Price (ALP) are not comparable at all as all of them are either not functionally comparable or fail the RPT filter and Turnover filter.
3.4. That the learned lower authorities erred in law and on facts in holding that the turnover filter is/not required for selecting a comparable.
3.7 Without prejudice to the generality of the above the learned lower authorities erred in law and on facts in adopting the following companies as comparable entities as functions performed by them are totally different from the functions performed by the assessee and also some of the entities do not satisfy the related party filter and turnover filter.
Sl. Name of the comparable Function Turnover RPT No. filter Filter filter 1 D H Resins & Chemicals Pvt Ltd X X 2 Jyoti Resins & Adhesives Ltd X 3 Yug Decor Ltd X 4 Henkel Adhesives Technologies X X X India Pvt Ltd IT(TP)A No.828/Bang/2022 Page 4 of 30 5 Resinova Chemie Ltd X X 6 Jesons Industries Ltd X 7 N G Adhesive Ind Pvt Ltd X 8 H B Fuller India Adhesives Pvt Ltd X 9 Mccoy Soudal Sealants Adhesives X & Foams Pvt Ltd 10 Anabond Ltd X 11 Eftec (India) Pvt Ltd X 12 Henkel Anand India Pvt Ltd X X X X = Does not satisfy the relevant filter
8. The assessee had the following international transactions during the year under consideration.
Particulars Paid/ Received/ TP Method
Payable Receivable
Purchase of raw materials 1,17,41,085 TNMM
Purchase of finished goods 18,83,86,227 TNMM
Sale of finished goods 23,93,723 TNMM
Purchase of capital asset 57,11,271 TNMM
Payment of royalty 1,93,57,418 TNMM
Receipt of research and 57,63,367 TNMM
development charges
Receipt of intragroup 10,23,676 TNMM
services -- Sales
Commission
Payment for intragroup 2,20,85,636 TNMM
services -- Legal and
Professional Fees
Interest paid on long term 95,78,716 Other Method
borrowing
Loan Paid 32,39,46,400 Other Method
Issue of Shares 2,04,41,500 Other Method
Reimbursement of 4,94,584 TNMM
expenses
IT(TP)A No.828/Bang/2022
Page 5 of 30
Trade Payables 8,51,91,813 TNMM
Trade receivable 26,16,102 TNMM
Loan Balance Outstanding 7,80,52,920 Other Method
Interest accrued and due 6,37,247 Other Method
on borrowing
Interest accrued but not 27,01,648 Other Method
due on borrowing
9. The financials of the assessee as per the TP documentation is as given below:-
Particulars Manufacturing
segment
Income
sales of finished goods 70,16,26,431
Revenue of R&D services 57,63,367
Scrap sales 20,93,60
Less: Excise duty 1,72,61,156
operating revenue 69,22,22,245
Expenditure
Cost of raw material and 39,10,58,982
component
Less:
26,40,324
Increase/decrease in Inventories
Employee benefits 11,04,67,289
other expenses 13,43,36,460
4,06,75,226
Depreciation and amortization
Operating cost 67,38,97,633
Operating profit 1,83,24,612
OP/OC 2.72%
IT(TP)A No.828/Bang/2022
Page 6 of 30
10. The TPO recomputed the margins of the assessee at 2.9% in manufacturing segment. The assessee is following TNMM as the most appropriate method and profit level indicator is considered as Operating Profit/Operating Cost. The assessee in manufacturing segment selected 11 comparables whose median margin is at 3.25% and accordingly concluded that the price charged in the manufacturing segment is at arm's length. The TPO did not accept the filters applied by the assessee and based on fresh filters applied, the TPO selected the following final list of comparables.
S.NoCompany Name Wt.
F.Year wise OP/OC (%)
Average
2015-16 2016-17 2017-18
1. D H Resins & Chemicals Pvt. Ltd. -8.82 -12.12 -14.29 -13.11
2. Jyoti Resins & Adhesives Ltd. 2.26 2.18 3.1 2.51
3. Yug Decor Ltd. 3.92 4.67 4.02 4.20
4. Henkel Adhesives Technologies India 5.84 2.83 7.56 5.14
Pvt. Ltd.
5. ResinovaChemie Ltd. -3.33 2.54 8.44 5.62
6. Jesons Industries Ltd. 3.87 6.66 6.89 5.96
7. N G Adhesive Inds. Pvt. Ltd. 5.16 6.72. 7.48 6.30
8. H B Fuller India Adhesives Pvt. Ltd. 1.75 11.72 12.19 8.67
9. MccoySoudal Sealants Adhesives & 3.11 7.51 11.94 9.72
Foams Pvt. Ltd.
10. Anabond Ltd. 13.93 12.59 15.32 13.96
11. Eftec (India) Pvt. Lt . 12.95 16.25 13.13 14.17
12. Henkel Anand India Pvt. Ltd. 22.01 22.2 20.22 21.43
35th percentile 5.62
Median 6.13
65th percentile 8.67
IT(TP)A No.828/Bang/2022
Page 7 of 30
11. Accordingly the TPO arrived at the TP adjustment in the manufacturing segment as per below working:-
Operating Revenues (a) A 69,22,22,245
Arm's Length Margin 6.13
determined by the TPO
Arm's Length Cost B=A*93.87 64,97,89,021
(ALP) @ (100-6.13)
93.87% of Operating
Revenue
Operating cost C 67,26,55,689
Adjustment to ALP D=C-B 2,28,66,668
12. On further objections raised, the DRP confirmed the TP adjustment. Before us, the ld. AR submitted that the TPO failed to apply the turnover filter exceeding 200 crores or less than 1 crore. The ld. AR submitted that the following 5 comparables whose turnover does not fall within this range, need to be excluded on the basis of turnover filter by relying on the decision of the coordinate Bench in the case of Barracuda Networks (I) P. Ltd. v. DCIT, 131 taxmann.com
337.
(a) DH Resins and Chemicals P. Ltd. - Rs.24.27 lakhs
(b) Henkel Adhesives Technologies (I) P. Ltd. - Rs.1670 crore.
(c) Henkel Anand () P. Ltd. - Rs.359.65 crores.
(d) Resinova Chemi Ltd. - Rs.396 crores.
(e) Jasons Industries Ltd. - Rs.755.29 crores.
13. The ld DR relied on the order of the lower authorities.
IT(TP)A No.828/Bang/2022 Page 8 of 30
14. We heard the rival submissions and perused the material on record. The Tribunal in the case of Barracuda Networks (supra) has considered the issue of application of turnover filter and held that -
12. On the issue of application of turnover filter, we have heard the rival submissions. The parties relied on several decisions rendered on the above issue by the various decisions of the ITAT Bangalore Benches in favour of the Assessee and in favour of the Revenue, respectively. The ITAT Bangalore Bench in the case of Dell International Services India (P) Ltd. Vs. DCIT (2018) 89 Taxmann.com 44 (Bang-Trib) order dated 13.10.2017, took note of the decision of the ITAT Bangalore Bench in the case of Sysarris Software Pvt.Ltd. Vs. DCIT (2016) 67 Taxmann.com 243 (Bangalore-Trib) wherein the Tribunal after noticing the decision of the Hon'ble Delhi High Court in the case of Chryscapital (supra) and the decision to the contrary in the case of CIT Vs. Pentair Water India Pvt.Ltd., Tax Appeal No.18 of 2015 dated 16.9.2015 wherein it was held that high turnover is a ground to exclude a company from the list of comparable companies in determining ALP, held that there were contrary views on the issue and hence the view favourable to the Assessee laid down in the case of Pentair Water (supra) should be adopted. The following were the conclusions of the Tribunal in the case of Dell International (supra):
"41. We have given a very careful consideration to the rival submissions. ITAT Bangalore Bench in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010, relying on Dun and Bradstreet's analysis, held grouping of companies having turnover of Rs. 1 crore to Rs.200 crores as comparable with each other was held to be proper. The following relevant observations were brought to our notice:-
"9. Having heard both the parties and having considered the rival contentions and also the judicial precedents on the issue, we find that the TPO himself has rejected the companies which .ire (sic) making losses as comparables. This shows that there is a limit for the lower end for identifying the comparables. In such a situation, IT(TP)A No.828/Bang/2022 Page 9 of 30 we are unable to understand as to why there should not be an upper limit also. What should be upper limit is another factor to be considered. We agree with the contention of the learned counsel for the assessee that the size matters in business. A big company would be in a position to bargain the price and also attract more customers. It would also have a broad base of skilled employees who are able to give better output. A small company may not have these benefits and therefore, the turnover also would come down reducing profit margin. Thus, as held by the various benches of the Tribunal, when companies which arc loss making are excluded from comparables, then the super profit making companies should also be excluded. For the purpose of classification of companies on the basis of net sales or turnover, we find that a reasonable classification has to be made. Dun & Bradstreet & Bradstreet and NASSCOM have given different ranges. Taking the Indian scenario into consideration, we feel that the classification made by Dun & Bradstreet is more suitable and reasonable. In view of the same, we hold that the turnover filter is very important and the companies having a turnover of Rs.1.00 crore to 200 crores have to be taken as a particular range and the assessee being in that range having turnover of 8.15 crores, the companies which also have turnover of 1.00 to 200.00 crores only should be taken into consideration for the purpose of making TP study."
42. The Assessee's turnover was around Rs.110 Crores. Therefore the action of the CIT(A) in directing TPO to exclude companies having turnover of more than Rs.200 crores as not comparable with the Assessee was justified. As rightly pointed out by the learned counsel for the Assessee, there are two views expressed by two Hon'ble High Courts of Bombay and Delhi and both are non- jurisdictional High Courts. The view expressed by the Bombay High Court is in favour of the Assessee and therefore following the said view, the action of the CIT(A) excluding companies with turnover of above Rs.200 crores from the list of comparable companies is held to correct and such action does not call for any interference."
IT(TP)A No.828/Bang/2022 Page 10 of 30
13. The Tribunal in the case of Autodesk India Pvt.Ltd. Vs. DCIT (2018) 96 Taxmann.com 263 (Banglore-Tribunal), took note of all the conflicting decision on the issue and rendered its decision and in paragraph 17.7. of the decision held as that high turnover is a ground for excluding companies as not comparable with a company that has low turnover. The following were the relevant observations:
17.7. We have considered the rival submissions. The substantial question of law (Question No.1 to 3) which was framed by the Hon'ble Delhi High Court in the case of Chryscapital Investment Advisors (India) Pvt.Ltd., (supra) was as to whether comparable can be rejected on the ground that they have exceptionally high profit margins or fluctuation profit margins, as compared to the Assessee in transfer pricing analysis. Therefore as rightly submitted by the learned counsel for the Assessee the observations of the Hon'ble High Court, in so far as it refers to turnover, were in the nature of obiter dictum.
Judicial discipline requires that the Tribunal should follow the decision of a non-jurisdiction High Court, even though the said decision is of a non-jurisdictional High Court. We however find that the Hon'ble Bombay High Court in the case of CIT Vs. Pentair Water India Pvt.Ltd. Tax Appeal No.18 of 2015 judgment dated 16.9.2015 has taken the view that turnover is a relevant criterion for choosing companies as comparable companies in determination of ALP in transfer pricing cases. There is no decision of the jurisdictional High Court on this issue. In the circumstances, following the principle that where two views are available on an issue, the view favourable to the Assessee has to be adopted, we respectfully follow the view of the Hon'ble Bombay High Court on the issue. Respectfully following the aforesaid decision, we uphold the order of the DRP excluding 5 companies from the list of comparable companies chosen by the TPO on the basis that the 5 companies turnover was much higher compared to that the Assessee.
17.8. In view of the above conclusion, there may not be any necessity to examine as to whether the decision rendered in the case of Genisys Integrating (supra) by the ITAT Bangalore Bench should continue to be followed. Since arguments were advanced on the correctness of the decisions rendered by the ITAT Mumbai and Bangalore Benches taking a view contrary to that taken in the case of Genisys Integrating (supra), we proceed to examine the said issue also. On this issue, the IT(TP)A No.828/Bang/2022 Page 11 of 30 first aspect which we notice is that the decision rendered in the case of Genisys Integrating (supra) was the earliest decision rendered on the issue of comparability of companies on the basis of turnover in Transfer Pricing cases. The decision was rendered as early as 5.8.2011. The decisions rendered by the ITAT Mumbai Benches cited by the learned DR before us in the case of Willis Processing Services (supra) and Capegemini India Pvt.Ltd. (supra) are to be regarded as per incurium as these decisions ignore a binding co-ordinate bench decision. In this regard the decisions referred to by the learned counsel for the Assessee supports the plea of the learned counsel for the Assessee. The decisions rendered in the case of M/S.NTT Data (supra), Societe Generale Global Solutions (supra) and LSI Technologies (supra) were rendered later in point of time. Those decisions follow the ratio laid down in Willis Processing Services (supra) and have to be regarded as per incurium. These three decisions also place reliance on the decision of the Hon'ble Delhi High Court in the case of Chriscapital Investment (supra). We have already held that the decision rendered in the case of Chriscapital Investment (supra) is obiter dicta and that the ratio decidendi laid down by the Hon'ble Bombay High Court in the case of Pentair (supra) which is favourable to the Assessee has to be followed. Therefore, the decisions cited by the learned DR before us cannot be the basis to hold that high turnover is not relevant criteria for deciding on comparability of companies in determination of ALP under the Transfer Pricing regulations under the Act. For the reasons given above, we uphold the order of the CIT(A) on the issue of application of turnover filter and his action in excluding companies by following the ratio laid down in the case of Genisys Integrating (supra).
14. In view of the aforesaid decision, we hold that companies listed in Sl.No.(a) to (g) of Grd.No.4 raised by the Assessee whose turnover in the current year is more than Rs.200 Crores should be excluded from the list of comparable companies.
15. We notice that the turnover of the assessee is manufacturing segment is at Rs.69.22 crores. Therefore, respectfully following the above decision of the coordinate Bench, we hold that the comparable IT(TP)A No.828/Bang/2022 Page 12 of 30 companies whose turnover does not fall within the range of Rs.1 to 200 crores should be excluded.
16. Ground No.4.1 is with regard to considering the cash profit excluding depreciation to be adopted for the purpose of PLI. In this regard, the ld. AR submitted that depreciation policy of the assessee as compared to the comparable companies is different and therefore an adjustment is required to be made while computing the comparable margins. The ld. AR also submitted that the depreciation policy of the assessee company as compared to the comparable have been submitted before the lower authorities (pg. 1753 & 1754 of PB Vol.III) which has not been considered while arriving at the ALP. The ld. AR in this regard relied on the decision of coordinate Bench of the Tribunal in the case of Rakon India (P) Ltd. v. DCIT, ITA No.1964/Bang/2017 and Rittal India (P) Ltd. v. DCIT, ITA No.2494/Bang/2017.
17. The ld. DR submitted that the assessee has not substantiated that there is significant impact to the margins due to the difference in the depreciation policy of the assessee and the comparables. The ld DR submitted that the assessee has simply provided the depreciation policy of the assessee and the comparables which may not necessarily have any significant impact in the margins and therefore the contention that only cash profit should be considered for PLI cannot be accepted. The ld. DR in this regard drew our attention to para 4.3, page 26 of DRP order.
IT(TP)A No.828/Bang/2022 Page 13 of 30
18. The ld. AR as a rebuttal submitted that the financials of the comparables are part of the documents submitted before the lower authorities from where the impact of depreciation on the margins could be arrived at which the lower authorities failed to do.
19. We heard the rival submission and perused the material on record. The coordinate Bench of Tribunal in the case of Rittal India Ltd. (supra) has considered the issue of taking cash profit for the purpose of PLI and held that -
"11. With regard to the contention of the assessee that the cash profit (profit before depreciation) should be considered as PLI, we notice that the same finds support from the decision rendered by the co-ordinate bench in the case of DCIT vs. M/s Centum Rakon India P Ltd (IT(TP)A No.472/Bang/2016 dated 20-07- 2018), wherein the co-ordinate bench has followed the decisions rendered in the case of Honeywell Technology Solutions Lab vs. DCIT (61 SOT 61)(URO)(Bang.); 24/7 Customer.com (P) Ltd vs. Dy CIT (2013)(140 ITD 344) and BA Continum India P Ltd vs. ACIT (2013)(28 ITR (Trib.) 445 (Hyd). We notice that the co-
ordinate bench has expressed the view that the profit before depreciation can be taken as PLI, if there is substantial variation in the manner of charging depreciation by the assessee and comparable companies. Accordingly we direct the AO to take into consideration the above said contention of the assessee also. We also direct the assessee to furnish the details to prove that there is substantial variation in the manner of charging depreciation."
20. We notice that the assessee has submitted the difference in the depreciation policy of the assessee and the comparable before the lower authorities. Though the financials of the comparable companies are already part of the record, the assessee had not submitted any specific workings with the impact and therefore we also see merit in IT(TP)A No.828/Bang/2022 Page 14 of 30 the contention of the ld. DR that whether the difference in the depreciation policy is having significant impact in the margin of the assessee and that of the comparables needs verification. Accordingly we remit the issue of arriving at the PLI based on cash profits back to the AO/TPO with a direction to keep in mind the decision of the coordinate Bench in the case of Rittal India Ltd. (supra). This ground is allowed for statistical purposes.
21. Through ground No.4.3, the assessee is contending the issue of restricting the TP adjustment to the international transaction related to manufacturing segment only. The ld. AR in this regard relied on the decision of the coordinate Bench in the case of Genisys Integrating Systems (I) P. Ltd. v. DCIT, ITA No.1231/Bang/2010. The ld. AR further submitted that for the purpose of ALP if the international transactions are considered, then the same would be within 3% bandwidth of book value not warranting any further adjustment. The ld. AR therefore prayed for a direction in this regard.
22. We heard the rival submissions and perused the material on record. The coordinate Bench of the Tribunal has been consistently holding that only international transactions entered into by the assessee with its AE would only be considered for the purpose of ALP adjustment. We notice that the coordinate Bench in the case of Genisys Integrating Systems (I) P. Ltd. (supra) has considered the similar issue and held that -
IT(TP)A No.828/Bang/2022 Page 15 of 30 "6.1 Having heard both the parties and having considered their rival contentions, we find that Sec.92B of the IT Act gives the meaning of 'international transactions' to mean "a transaction between two or more associated enterprises either or both of whom are non-resident..........................".
Chapter-X of IT Act relates to special provisions relating to avoidance of tax and sec.92 therein relates to computation of income from international transactions having regard to ALP. Thus, it can be seen that only international transactions between the associated enterprises either or both of whom are non-resident are to be computed having regard to ALP. This issue is also covered by the decisions relied upon by the learned counsel for the assessee. Accordingly, the AO is directed to make the transfer pricing adjustments by restricting the adjustments to the transactions of the AE only by adopting the operating revenue and operating costs of these transactions only."
23. Accordingly we direct the AO/TPO to consider only the international transactions while arriving at the ALP in the manufacturing segment.
24. The rest of the sub-grounds of Ground No.3 and 4 have become academic not warranting any adjudication. The AO/TPO is directed to re-compute the ALP in accordance with the directions given in this order.
25. Ground No.5 reads as under:-
"5. ADDITION U/S. 68 OF THE ACT RS. 32,04,41,500/-
5.1. That the learned lower authorities erred in law and on facts in confirming the addition of Rs. 32,04,41,500/- u/s. 68 of the Act on the ground that the assessee has not taken necessary approvals from the Reserve Bank of India and it amounts to violation of provisions of Foreign Exchange Management Act, 2002. (FEMA for short) ignoring the fact that the assessee is entitled to convert IT(TP)A No.828/Bang/2022 Page 16 of 30 the loan into equity under automatic route prescribed under FEMA.
5.2. That the learned lower authorities exceeded their jurisdiction in holding that the assessee has violated provisions of FEMA when the Reserve Bank of India being the authority having jurisdiction to decide such issue has acknowledged the transaction and has not taken any action in this regard 5.3 Without prejudice to the ground no. 5.2, that the learned lower authorities erred in law and on facts in holding that the assessee has violated the provisions of FEMA and such finding is contrary to the documents available on record.
5.4. Without prejudice to the ground no. 5.1 to 5.3, that the learned lower authorities erred in law and on facts in holding that the violation of provisions of FEMA curtails repatriation of investments by the investor and therefore, the same has to be added u/s 68 of the Act.
5.5. Without prejudice to the ground no.5.1 to 5.4 that the learned lower authorities erred in law and on facts in invoking provisions of section 68 of the Act when the identity and creditworthiness of the party and the genuineness of the transactions are proved and available on record and also on the ground that no amount was received during the previous year ended 31st March 2018 and the credit to share capital is a mere book entry transferring the loan to share capital."
26. The AO during the course of assessment noticed that there is an increase in the share capital of the company to the extent of Rs.32,04,41,500 and called on the assessee to furnish the details pertaining to the same. The assessee submitted before the AO that it has borrowed an amount of USD 6.2 million from its parent entity M/s. Mapei SPA Italy vide loan agreement dated 14.5.2015 [pg 793 to 795 of PB Vol.I]. The assessee further submitted that it has entered into 3 supplementary agreements dated 30.12.2015, 5.12.2016 and 20.7.2017 IT(TP)A No.828/Bang/2022 Page 17 of 30 with its AE modifying the terms of loan agreement. According to the supplementary agreement entered into on 20.7.2017 the schedule of repayment of loan was modified whereby USD 5 million was agreed to be converted to equity share capital and the balance USD 1.2 million was agreed to be repaid as per the schedule. The assessee submitted that the exchange rate of Rs.64.0124 was applied to arrive at an amount of Rs.32.04 crores and equity shares with face value of Rs.10 was issued to the AE accordingly.
27. The AO did not agree with the submissions of the assessee. The AO held that the shares should not have been issued shares at face value of Rs.10 since the company has a significant presence and is on the growth trajectory, market presence and operational capability. The AO was of the view that the assessee has violated the FEMA regulations and accordingly held that the amount converted into equity is not a genuine transaction since the same is in violation of sanctioning law and pre-requisite approval are not the determinative factor. The AO proceeded to add the amount u/s 68.
28. The DRP upheld the decision of the AO by holding that -
"5.4 Having considered the submissions of the assessee this panel verified the contention of the assessee that the loan was taken on 14.05.2015. The ECB upto USD 500 million falls under Automatic route for financial year 2015-16. The above loan also falls under automatic route and there is no requirement of specific approval from the RBI for the same. The assessee has filed Form 83 with respect to the above loan. The Banker of the assessee filed a letter dated 25.05.2015 with RBI enclosing the certified Form 83 and requesting to provide the Loan Registration Number IT(TP)A No.828/Bang/2022 Page 18 of 30 (LRN). In response to the same, vide letter dated 27.05.2015, LRN was allotted. Further, there was no communication from the RBI for any violation of FEMA in this regard. Assessee has relied on the following judicial precedence in support of its claim.
CIT vs. Kesarwani Sheetalaya 418 ITR 369 (All) P1MS Medical & Education Charitable Society Vs CIT 56 SOT 522 (Chd) CIT v. Usha Stud Agricultural Farms Ltd 301 ITR 384 (Del) Glen Williams v. DCIT (1TA No. 1078/13ang/2014) The panel has verified the contention of the assessee and judicial precedents relied upon by the assessee and found that the facts and circumstances of these cases are different from that of the assesee company. Hence the AO action is upheld. Accordingly the ground -of objection is therefore rejected."
29. Aggrieved, the assessee is in appeal before the Tribunal.
30. The ld. AR made the following submissions :-
(i) The assessee has filed FC-GPR on 29.05.2018 and the same has been accepted by RBI on 18.09.2019 (Page No. 800 to 806 of paper book). Monthly Form ECB -- 2 is also filed for financial year 2017-18 (Page No. 806 to 865 of paper book -
1). In addition to the above, the assessee has also filed annual return on Foreign Liabilities and Assets as on 31.12.2018 (Page No. 866 to 871 of paper book - 1). The above forms are acknowledged by the RBI and no action has been initiated by RBI alleging violation of Foreign Exchange Management Act (FEMA).
(ii) The finding of the assessing officer that the assessee has issued the shares at face value without any basis is factually incorrect since the assessee has filed the valuation report during the assessment proceedings.
(iii) It is submitted that the conversion of ECB into equity is a capital transaction but falls under automatic route of investment and no specific approval is needed and that the IT(TP)A No.828/Bang/2022 Page 19 of 30 assessee is filing the monthly and annual returns as per the RBI reporting requirements
(iv) The assessee has filed Form 83 with respect to the above loan with the banker. The Banker of the assessee filed a letter dated 25.05.2015 with RBI enclosing the certified Form -- 83 and requesting to provide the Loan Registration Number (LRN). In response to the same, vide letter dated 27.05.2015, LRN was allotted (Page No. 787 to 792 of paper book - 1). Further, there was no allegation made by RBI for any violation of FEMA in this regard.
(v) On identical facts, the Hon'ble Madras High Court in V. R. Global Energy (P.) Ltd. v. Income-tax Officer, Corporate Ward 3(4), Chennai - 96 taxmann.com 647 (Madras) has held that conversion of loan to equity cannot be added u/s. 68 of the Act. (Page No.1637 of PB - 2). The decision has been accepted by Hon'ble Supreme Court in Income-tax Officer v. V.R. Global Energy (P.) Ltd. - 113 taxmann.com 31 (SC) (Page No.1639 of PB - 2).
(vi) It is submitted that the provisions of section 68 of the Act can be invoked if the assessee does not prove the identity and creditworthiness of the party and genuineness of the transaction. However, in the present case, the identity of the investor is known i.e M/s. Mapei SpA, Italy. The creditworthiness of the party is also proved since the entire investment has been made through banking channel and the assessing officer has not brought any material on record to prove otherwise. The genuineness of the transactions is also proved since the existing loan has been converted into equity and the genuineness of loan received in 2015 is not in doubt.
(vii) It is a settled proposition in law that once the source is explained, the provisions of section 68 cannot be invoked. Therefore, all the ingredients of provisions of section 68 of the Act have been proved and addition cannot be made u/s. 68 of the Act
(viii) It is submitted that no amount was received during the financial year 2017-18 and it is a mere book entry therefore, provisions of section 68 are not applicable.
IT(TP)A No.828/Bang/2022 Page 20 of 30
(ix) Assuming but without admitting that there is a violation of provisions of FEMA, still it cannot be said that S.68 of the Act is attracted. As submitted in the above paragraphs, when the source is explained, it is immaterial whether such transactions are legal or illegal as far as the explanation for the source is concerned. Hence, even if there is a violation of provisions of FEMA, the explanation of the assessee regarding the source cannot be rejected. Hence, the addition u/s 68 is required to be deleted.
31. The ld AR relied on various judicial pronouncements in support of the various contentions raised herein above.
32. The ld DR submitted that the assessee has not complied with the terms of repayments as per the loan agreement. The ld DR further submitted that the utilisation of the loan whether capital or revenue have not been substantiated. The ld DR further submitted that for these reasons the AO has rightly held that the genuineness of the entire transaction has not been established by the assessee.
33. We heard the parties and perused the material on record. We will first recapitulate the facts pertaining to the impugned issue. The assessee borrowed an amount of USD 6.2 Million from its parent entity M/s.Mapei SpA, Italy, vide loan agreement dated 14.05.2015. Later, the schedule for repayment of loan was modified vide supplementary loan agreement dated 30.12.2015 and another supplementary agreement dated 05.12.2016 (Page No. 1829&1831 of paper book - 4). A third supplementary loan agreement dated 20.07.2017 (Page No. 1832 of paper book - 4) was entered into for modification of schedule for repayment of loan since USD 5 million was converted to Equity IT(TP)A No.828/Bang/2022 Page 21 of 30 share capital and in the same agreement the repayment schedule for remaining USD 1.2 million was agreed to. So the event which triggered the impugned addition is the conversion of ECB into Equity through a book entry and it is noticed that the conversion is approved by a board resolution on 22.12.2017.
34. The reasons quoted by the AO for the impugned addition is that the conversion is done at face value of Rs.10 given that the business of the assessee is growing and therefore the value of conversion not correct. In this regard we notice that the assessee has submitted a valuation report which has not been considered by the AO. The next reason quoted is that the assessee has violated the provisions of FEMA in the process of converting the ECB into equity. In this regard it is important to note that the ECB has been received under the automatic route at the time borrowing. As per circular no.15 dated 01.10.2004 issued by Reserve Bank of India (RBI) with regard to conversion of ECB into equity, a general permission has been granted for conversion of ECB into equity if the activity of the company is covered under the automatic route for Foreign Direct Investment (FDI) or the company has obtained approval. The Circular further grants general permission if the foreign equity after the conversion of debt is within the sectoral cap. As per chapter B of Foreign Exchange Management (Transfer or issue of security by a person resident outside India) Regulations, 2017, sectoral-cap for every industry segment has been prescribed for categorizing the companies eligible for automatic route or government approval. Para 4(ii) of Circular no.15 states that the partial conversion IT(TP)A No.828/Bang/2022 Page 22 of 30 of ECB to equity shall be reported in Form - FC-GPR and ECB -2. In this connection, it is noticed that the assessee has filed FC-GPR on 29.05.2018 and the same has been accepted by RBI on 18.09.2019 (Page No. 800 to 806 of paper book). Monthly Form ECB - 2 is also filed for financial year 2017-18. In addition to the above, the assessee has also filed annual return on Foreign Liabilities and Assets as on 31.12.2018(Page No. 866 to 871 of paper book - 1).
35. On perusal of AO's order we notice that the AO has also stated that the assessee has not complied with the requirements under FEMA/RBI/SEBI regulations. The relevant observations of the AO is extracted below -
"Thus it is not open to the assessee to contend that what constitutes a violation in respect to capital investment under FEMA norms is share equity under income tax proceedings the same in the absence of FIBP approval for investment, the lack of compliance with reporting requirements in respect of downstream investments and reporting requirements in terms of TISPRO regulations in respect of share transactions between residents and non residents, lack of compliance to fair valuation norms prescribed for foreign investment and instead of expansion of the equity base the assessee has acquired existing shares which too is a violation and therefore given these violations, the transaction is not genuine. In the absence of genuineness the amount is sought to be added back under sec 68 of the income tax act."
36. From the above it is clear that the AO has simply stated that there has been violation, without mentioning any specific provisions of the various regulations under which the assessee has made the violation. We also notice that the AO has quoted various case laws IT(TP)A No.828/Bang/2022 Page 23 of 30 where it is held that when there is a violation under FEMA or RBI or SEBI regulations then the expenses cannot be allowed which is distinguishable from assessee's case where the impugned issue is a capital transaction of conversion of loan into equity in which nothing is routed through the P&L account. We further notice that the AO has stated that the as the Contract Act the amount is not repatriable in view of the FEMA violations and therefore the entire transaction is to be treated as the income of the assessee. We are unable to appreciate this observation of the AO for the reason that which provisions of the Contract Act prohibits repatriation and what is the FEMA violation in assessee's case have not been clearly spelled out by the AO. Further on perusal of records, we notice that the assessee has complied with the various reporting requirements under the regulations and that the RBI even while raising a query with respect to the delay in filing the report did not mention any violation with respect to the conversion of ECB into equity. Therefore in our view, without giving any adverse finding with regard the specific provisions of the regulation under which the assessee has violated based on the facts of the case, a general remark by the AO that there is a violation and accordingly making the addition is not tenable.
37. Now coming to the issue of AO making the impugned addition u/s.68 of the Act, we will look at the relevant provisions first -
Cash credits.
68. Where any sum is found credited in the books of an assessee maintained for any previous year, and the assessee offers no explanation IT(TP)A No.828/Bang/2022 Page 24 of 30 about the nature and source thereof or the explanation offered by him is not, in the opinion of the Assessing Officer, satisfactory, the sum so credited may be charged to income-tax as the income of the assessee of that previous year :
[Provided that] where the assessee is a company (not being a company in which the public are substantially interested), and the sum so credited consists of share application money, share capital, share premium or any such amount by whatever name called, any explanation offered by such assessee-company shall be deemed to be not satisfactory, unless--
(a) the person, being a resident in whose name such credit is recorded in the books of such company also offers an explanation about the nature and source of such sum so credited; and
(b) such explanation in the opinion of the Assessing Officer aforesaid has been found to be satisfactory:
***
38. From the above provisions it is noticed that with respect to closely held companies (company in which public are not substantially interested) with respect to any sum credited being share application money, share capital, share premium or any such amount shall be deemed to be unsatisfactory unless the person in whose name such amount is recorded in the books of such company offers explanation about the nature and source of such sum credited and Assessing officer is of the opinion that such explanation is satisfactory. In assessee's case we notice that the genuineness of the transaction is questioned only from violation of FEMA/RBI regulations and not with regard to the identity of the person from whom the sum is credited or the source of credit. It is noticed that this is substantiated by the assessee before IT(TP)A No.828/Bang/2022 Page 25 of 30 the lower authorities by submitting the loan agreements and the returns filed with RBI. It is also noticed from the order of the DRP which is extracted above, the DRP has acknowledged the fact that necessary forms/returns have been filed by the assessee before the RBI.
Therefore it is clear that the addition u/s.68 is not made for the reasons as mentioned in the said section viz., no explanation about the nature and source of such credit, or the explanation offered about the nature and source of such credit about the person in whose name such amount is recorded in the books of the assessee is not satisfactory in the opinion of the AO. Further we notice that the Hon'ble Madras High Court in V.R. Global Energy P. Ltd. v. ITO [2018] 96 taxmann.com 647 (Mad) has considered the issue of whether conversion of loan to equity can be added u/s.68 and held that:-
"18. Assailing the said order, the assessee assessee has filed the present appeal raising, inter alia, the following questions of law:
(i) Whether the learned Tribunal erred in confirming the valuation of shares allotted in settlement of the pre-existing liability taxable as unexplained cash credit?
(ii) Whether the learned Tribunal erred in holding that value of shares allotted to individuals would amount to unexplained cash credit?
19. The learned counsel for the assessee assessee contended that shares were allotted to Smt. Vathasala Ranganathan and others in settlement of pre-existing liability and, therefore, it will not amount to unexplained cash credit.
20. Counsel argued, and rightly, that when there was no cash involved in the transaction of allotment of shares, provisions of Section 68 of the said Act treating it as unexplained cash credit are not attracted.
IT(TP)A No.828/Bang/2022 Page 26 of 30
21. Learned counsel for the assessee emphatically argued that inasmuch as the source of credit in which shares were allotted was clearly explainable, the same cannot be treated as unexplained cash credit. Moreover, the identity of the shareholders and the liability of the company to shareholders has been established and, therefore, the allotment of shares cannot be treated as unexplained cash credit.
22. In CIT v. Electro Polychem Ltd., [2007] 294 ITR 661 (Mad.) cited on behalf of the assessee, a Division Bench of this Court held that in case of cash credit of share application money, even if it were to be assumed that the subscribers to the increased share capital were not genuine, the amount of share capital would in no circumstances be regard as undisclosed income of the company.
23. In CIT v. Steller Investment Ltd. [2001] 251 ITR 263/115 Taxman 99 (SC) also cited on behalf of the assessee, the Supreme Court held that even if the subscribers to the increased share capital of assessee-company were not genuine, the amount could not be regarded as undisclosed income of the company.
24. The question of whether the learned Tribunal erred in confirming the valuation of shares allotted in settlement of the pre-existing liability taxable as unexplained cash credit, does not involve any question of law, far less any substantial question of law."
39. In assessee's case the increase in equity has arisen out of conversion of a pre-existing liability i.e. the ECB into equity and therefore in our view the ratio laid down by the Hon'ble Madras High Court is applicable to the assessee's case. In summary we notice that the revenue has not brought anything on record to show that the assessee has violated any specific provision of the various regulations governing the impugned transaction and also the AO has not recorded any adverse finding or that he is not satisfied with regard to the person or the source pertaining to the sum credited in the share capital IT(TP)A No.828/Bang/2022 Page 27 of 30 account. Accordingly we hold that the addition made by the AO u/s.68 treating the amount of loan converted into equity is to be deleted.
40. Through ground 6, the assessee is contending the disallowance of fees paid towards information technology and corporate services. During the course of assessment, the AO called for the details pertaining to fees for professional and technical services as in Form 3CEB. The AO made a disallowance u/s. 37 on the ground that the ledger extract, the agreement with respect to corporate services and the details of withholding tax are not being provided.
41. On objections raised, the DRP confirmed the same for the reason that the assessee has not provided the details and particulars of nature of services received/rendered.
42. Before us, the ld AR submitted that -
"5.1. The amount paid to Mapei SpA, Italy is towards Information technology services and corporate services on which tax has been deducted at source and the details were also submitted. The learned lower authorities state that the assessee has not provided the details of TDS on payments made to Mapei SpA, Italy. Therefore, the same has to be disallowed. The learned lower authorities further state that the nature of services have not been explained and therefore, the same cannot be allowed as deduction.
5.2. The learned lower authorities state that the assessee has not provided the reconciliation between the professional and legal charges of Rs. 2.68 crore debited to the profit and loss account and disallowance of Rs. 10,93,380 u/s. 40(a)(i) of the Act reported in the Form 3CD.
IT(TP)A No.828/Bang/2022 Page 28 of 30 5.3. The assessee has filed the details of TDS made and paid on the above sum of Rs. 2,23,99,465/-and therefore, the finding of the assessing officer is factually incorrect. The assessee was never asked to explain the nature of services rendered by Mapei , Italy. The query was based on deduction of tax at source and the same was already explained.
5.4. The learned lower authorities sought for the details of TDS on the payment of Rs. 2,23,99,465/-paid to Mapei , Italy and they were submitted. However, the reconciliation between the profit and loss account and Form 3CD was never sought for."
43. The ld AR further submitted that the relevant details with regard to legal & professional services have already been submitted before the authorities which have not been considered.
44. We heard the rival submissions and perused the material on record. We notice that the details of the expenses incurred along with the break-up have been submitted before the DRP [pg. 1750 to 1752 of PB Vol.II]. It is also noticed that the assessee has deducted tax on the payments made which have been disallowed by the lower authorities. We also notice that the lower authorities have not considered the details furnished and have disallowed the expenses on the ground that no evidence of services rendered are provided. We therefore remit the issue back to the AO to verify the details submitted with regard to the impugned deduction disallowed and allow the claim as per law. Needless to say that the assessee may be given an opportunity of being heard.
IT(TP)A No.828/Bang/2022 Page 29 of 30
45. Ground No.7 is with regard to disallowance of contribution of PF/ESI. In this regard, the ld AR submitted that electronic challan/return for the month of March, 2018 was uploaded on 13.4.2018 at 5.43 PM. However, due to some technical issues with the bank and 14th & 15th being Saturday & Sunday, the payment was credited only on 16.4.2018. The copy of the challan and return are available on record at page 1755 to 1760 of PB. Vol.III. The ld AR submitted that these documents are not filed before the lower authorities and accordingly prayed for admission of the same as additional evidence. The ld. AR further submitted that the date of presentation of cheque has to be considered as the date of payment when the cheque is honoured by relying on the decision of the Bombay High Court in the case of Vardhaman Chemicals v. CCEC, 263 ITR
460. It is therefore submitted by the ld. AR that there is no delay in the payment of PF/ESI and the amount disallowed should be deleted.
46. We heard the rival submissions and perused the material on record. Since the additional evidence now submitted goes to the root of the impugned issue for a proper adjudication of the issue and for substantial cause, the additional evidence is admitted and taken on record. We notice that the Hon'ble Supreme Court in the case of Checkmate Services (P.) Ltd. Vs CIT-1, [2022] 143 taxmann.com 178 (SC) has considered the issue of whether the employees contribution paid before due date for filing the return of income u/s.139(1) whether otherwise allowable u/s.43B, and has held that the same is not IT(TP)A No.828/Bang/2022 Page 30 of 30 allowable if it is not paid within the due date specified in respective Acts.
47. We notice that copies of challan and return for the month of March have not been submitted before the lower authorities. We therefore remit the issue to the AO to consider the evidence submitted with regard to the payment made for the month of March 2018 and decide the allowability of the same keeping in mind the decision of the Apex Court in the case of Checkmate (supra) and also the decision in the case of Vardhaman Chemicals (supra).
48. In the result, the assessee's appeal partly allowed.
Pronounced in the open court on this 23rd day of February, 2023.
Sd/- Sd/-
( GEORGE GEORGE K. ) ( PADMAVATHY S. )
JUDICIAL MEMBER ACCOUNTANT MEMBER
Bangalore,
Dated, the 23rd February, 2023.
/Desai S Murthy /
Copy to:
1. Assessee 2. Respondent 3. CIT 4. CIT(A)
5. DR, ITAT, Bangalore.
By order
Assistant Registrar
ITAT, Bangalore.