Income Tax Appellate Tribunal - Chandigarh
Glaxosmithkline Consumer Healthcare ... vs Assessee on 25 June, 2013
IN THE INCOME TAX APPELLATE TRIBUNAL
CHANDIGARH BENCH 'B', CHANDIGARH
BEFORE SHR I T.R.SOOD, ACCOUNTANT MEMBER
AND Ms. SUSHMA CHOWLA, JUDICIAL MEMBER
ITA No.1324 /Chd/2012
(Assessment Year : 2007-08)
M/s Glaxo Smithkline Consumer, Vs. The Addl. C.I.T.,
Healthcare Ltd., Range-IV,
DLF Plaza Towers, Chandigarh.
DLF Cit y Phase-I,
Gurgaon.
PAN: AACCS0144E
(Appellant) (Respondent)
Appellant by : Shri Ajay Vohra
Respondent by : Shri Ajay Sharma, DR
Date of hearing : 25.06.2013
Date of Pronouncement : 26.08.2013
O R D E R
Per SUSHMA CHOWLA, J.M. :
The present appeal is filed by the assessee against the order of the Assessing Officer dated 18.10.2011 passed under section 143(3) r.w.s.
1 4 4 C ( 3 ) o f t h e I n c o m e T a x A c t , 1 9 6 1 r e l a t i n g t o a s s e s s m e n t ye a r 2 0 0 8 -
09. As impugned assessment order is passed after assessee's objections against the proposed additions to the returned income having been examined by the Dispute Resolution Panel, this is a direct appeal against the assessment order.
2. The grounds of appeal raised by the assessee read as under:
1. That the assessing officer erred on facts and in law in completing the assessment under section143(3) read with section 144C of the Income-tax Act ("the Act") at an income of Rs.449,77,86,367/- as against the returned income of Rs.275,73,15,234/-.2
Transfer Pricing Issues:
2. That the assessing officer erred on facts and in law in making addition to the income of the appellant to the extent of Rs.106,44,25,680 on account of the alleged difference in the arm's length price of international transactions.
2.1 That the assessing officer erred on facts and in law in making transfer pricing adjustment amounting to Rs. 106,44,25,680 in relation to the advertisement, marketing and sales promotion expenses (hereinafter referred to as 'the AMP expenses') incurred by the appellant.
2.2 That the assessing officer/DRP erred on facts and in law in not appreciating that expenditure on advertisement and brand promotion, unilaterally incurred by the appellant, could not be regarded as a 'transaction' in the absence of any understanding / arrangement between the appellant and the associated enterprise.
2.3 That the assessing officer/DRP erred on facts and in law in not appreciating that the AMP expenses, etc., incurred by the appellant in India cannot be characterized as an international transaction as per section 92B, so as to invoke the provisions of section 92 of the Act.
2.4 That the assessing officer/DRP erred on facts and in law in not appreciating that the AMP expenses unilaterally incurred by the appellant cannot be characterized as international transaction, even after the amendment brought in byFinanceAct2012 inserting an explanation to section 92B.
2.5 That the TPO / DRP erred on facts and in law in holding that since the appellant was manufacturer - cum - distributor of products in India, it was required to incur certain routine expenditure as limited risk distributor but it has incurred certain non-routine expenditure for the AE for promoting brand in India and developing marketing intangible for the AE for which it has not been compensated.
2.6 That the TPO / DRP erred on facts and in law in concluding that the appellant had incurred huge AMP expenditure on promotion of brand / marketing intangibles owned by the associated enterprise making the same more valuable, by bearing risk and using both tangible and human assets intangibles, which led to enhanced sale of products and increase profitability of the associated enterprises and, therefore, associated enterprises were obliged to reimburse a part of the AMP expenditure.
2.7 That the assessing officer/DRP erred on facts and in law in holding that AMP expenses incurred by the appellant resulted in promotion of brand owned by the associated enterprise, thereby creating marketing intangibles whose ultimate benefit inured to the associated enterprise.
2.8 That the TPO / DRP erred on facts and in law in holding that the appellant has provided services of significant value by incurring significant and substantial cost and the AEs have received significant, economic and commercial benefit like enhanced value of 'Glaxo and Horlicks' trademark in India and development of marketing intangibles in India.
2.9 That the assessing officer erred on facts and in law in not appreciate the AMP expenses incurred by the appellant were for sale of the products manufactured by the appellant in India and the trademark 'Horlicks' was only associated with such products.
2.10 That the assessing officer erred on facts and in law in not appreciating that 3 advertisement and marketing expenses was not incurred by the appellant on behalf of or for the benefit of the AE, and the benefit to the AE, if any, is only incidental.
2.11 That the assessing officer/DRP erred on facts and in law in not appreciating that in the absence of any understanding / arrangement between the appellant and the associated enterprise, the associated enterprise was under no obligation to reimburse the AMP expenses incurred by the appellant for sale of its products.
2.12 That the assessing officer erred on facts and in law in not appreciating that the AMP expenses incurred by the appellant, did not result in creation of any marketing intangibles; much less on account of the AE.
2.13 The TPO / DRP erred on facts and in law in holding that the efforts to create marketing intangibles are in the nature of services and entrepreneurial efforts undertaken by the appellant.
2.14 That the assessing officer erred in failing to appreciate that the scheme of Transfer Pricing under Chapter-X of the Act only provides for determination of 'price' from an international transaction including any expenditure arising from an international transaction but it cannot determine the 'quantum' of international transaction or extent of business expenditure.
2.15 That the assessing officer erred on facts and in law in not appreciating that the characterization of the appellant being that of a full fledged manufacturer justifies the conduct of the appellant in incurring and bearing the cost of AMP expenditure.
2.16 That the Dispute Resolution Panel erred on facts and in law in confirming the adjustment made by the TPO with regard to the AMP expenses holding that (1) no independent person, particularly in a long term arrangement, would forego the compensation for the additional marketing activities undertaken by the appellant, (ii) the AE needs to compensate the appellant as it had been found that the appellant had incurred excessive AMP expenses, and development and promotion of a brand in India directly benefitted the AE also.
2.17 That the assessing officer/DRP erred in deeming an international transaction of provision of service allegedly applying Bright Line Test (BLT) holding that the AMP/Sales ratio of the appellant allegedly exceeds the AMP/Sales ratio of the following comparable companies:
AMP as Sr. Name of the Comparable Company %age of No. Sales
1. Nijjer Agro Foods Ltd. 0.23%
2. Crown Milk Specialties Pvt. Ltd. 1.06%
3. Priya Food Products Ltd. 6.32%
4. Modern Dames Ltd. 1.20% Mean 2.20% 2.18 The assessing officer erred on facts and hi law in not appreciating that "bright line limit"
is not a prescribed method under the purview of section 92C of the Act.
2.19 That the assessing officer erred on facts and in law in not appreciating that the power of the TPO is restricted to the determination of arm's length price of international transactions by applying any of the prescribed method and not to make disallowance of business expenses incurred by the appellant.
42.20 That the assessing officer erred on facts and in law in not appreciating that in absence of specific provision under the Transfer Pricing Regulations in India, adjustment on account of the arm's length price of advertisement and brand promotion expenses could not be made by applying BLT.
2.21 That the assessing officer erred on facts and in law in not appreciating that the AE has independently incurred substantial expenditure on AMP, to advertise and promote the brand in the overseas market which must have also benefited the appellant.
2.22 That the assessing officer erred on facts and in law hi relying upon the decision of the case of DHL Incorporated and Subsidiaries vs. Commissioner of Internal Revenue Tax Court, TCM 1998-461, aff d in part, rev'd in part 285F.3d.1285. 89AFTR2d2002-1978(CA-9,2002);and Glaxo Smith Kline Holding (Americas) Inc. vs. Commissioner, T.C.No. 5750-04 and T.C.No. 6959-05, which were rendered in the context of specific provision under the Transfer Pricing Regulations of United States of America.
2.23 Without prejudice that the assessing officer erred on facts and in law hi considering the following expenses for the purpose of calculating alleged AMP expenditure of the appellant Particulars Amount (Rs in Selling and distribution expenses lacs)1067.50 Market Research expenses 969.16 Total 2036.66 2.24 Without prejudice that the assessing officer erred on facts and in law hi not considering the following companies as comparable for benchmarking advertisement and publicity expenses:
Total Sales & Company Name Dist Expn/Sales Cadbury India Ltd. % 18.03 Gillette India Ltd. 27.12 Hindustan Unilever Ltd. 20.20 Nestle India Ltd. 9.32 Procter & Gamble Hygiene & Health Care Ltd. 19.72 18.88 2.25 The TPO / DRP erred on facts and in law hi holding that for the purpose of computing the bright line AMP expenses companies which are engaged hi brand building exercise and creating marketing intangibles for their brands cannot be taken as comparables, and only routine distributors are to be taken who are not 5 engaged in any brand building exercise creating marketing intangibles for their brands cannot be taken as comparables, and only routine distributors are to be taken who are not engaged in any brand building exercise.
2.26 That the assessing officer erred on facts and in law in rejecting the benchmarking analysis undertaken by the appellant wherein closely linked transactions were benchmarked together and instead segregating the AMP expenses for the purpose of benchmarking such transactions.
2.27 The TPO / DRP erred on facts and in law in holding that "as these comparables were selected by the taxpayer itself after undertaking a detailed search process and after doing an elaborate FAR analysis there is no reason to disregard them for the purposes of bright line determination. This is more so as the taxpayer has selected TNMM as the most appropriate method and has selected comparables who are functionally similar to it.
2.28 Without prejudice that the assessing officer erred on facts and in law, hi not appreciating that the AMP expenses incurred by the appellant was appropriately established to be at arm's length applying Transactional Net Margin Method (TNMM) on entity-wide basis.
2.29 That the assessing officer/DRP erred on facts and in law in holding that the appellant has rendered service to the AEs by incurring the AMP expense and by holding that markup has to be earned by the appellant in respect of the AMP expenses, alleged to have incurred for and on behalf of the AE.
2.30 Without prejudice, the assessing officer/DRP erred on facts and in law hi not appreciating that markup, if at all, had to be restricted to the value added expenses incurred by the appellant for providing the alleged service in the nature of brand promotion.
Corporate Tax Issues
3. That the assessing officer erred on facts and in law in disallowing consumer market research expenses of Rs. 9,69,15,622/- under section 37(1) of the Act alleging the same to be capital in nature.
4. Without prejudice, that the assessing officer erred on facts and in law in not allowing depreciation on the amount of market research expenses disallowed as capital expenditure.
4.1 That the assessing officer erred on facts and hi law in reducing the returned income by an amount of Rs. 170,88,165/-, without appreciating that the assessee had claimed a deduction of the closing balance lying in PLA amounting to Rs. 32,62,786/- and consequently added back the opening balance lying in PLA amounting to Rs. 2,03,50,951/- resulting in a net addition of Rs. 1,70,88,165/-
65. That the assessing officer erred on facts and in law in making disallowance of Rs.1,72,00,000/-, claimed in respect of liability for post retirement medical benefits to employees on the basis of actuarial valuation, in accordance with the revised Accounting Standard 15, relating to accounting of employee benefits, on the ground that same is an unascertained liability.
5.1 That the assessing officer erred on facts and in law in observing that the aforesaid provision made for post retirement medical benefits to employees has resulted in double deduction to employees inasmuch as deduction has also been claimed by the assessee in respect of medical insurance premium paid during the relevant year(s).
5.2 That the assessing officer erred on facts and in law in observing that the provision has been made by debiting the general reserves without appreciating that the said provision was made by debiting the profit and loss account and not the general reserves of the appellant.
6. That the assessing officer erred on facts and in law in disallowing expenditure aggregating to Rs.55,56,64,000, incurred by the appellant during the relevant previous year on account of royalty, holding the same to be capital in nature.
6.1 That the assessing officer erred on facts and in law in not following the binding directions of the Dispute Resolution Panel ('DRP') to re-determine the issue after verification of facts with reference to the agreement entered into by the appellant.
6.2 Without prejudice, that the assessing officer erred on facts and in law in not allowing depreciation on aforesaid expenditure incurred on account of royalty disallowed as capital expenditure.
7. That the assessing officer erred on facts and in law in disallowing interest of Rs.1,54,76,000/- as capital expenditure in terms of proviso to section 36
(l)(iii) of the Act alleging the same to have been incurred for investment made hi capital work in progress ('CWIP').
7. 1 That the assessing officer erred on facts and in law in proceeding on a factually incorrect premise that the appellant had borrowed funds which have been utilized for making investment in CWIP, without appreciating that the appellant had no borrowed funds at all.
7.2 That the assessing officer erred on facts and in law in holding/ observing that the appellant failed to furnish complete details in respect of loan funds.
7.3 That the DRP erred on facts and in law in holding that (a) the appellant was not able to establish that own funds were utilized for investment in CWIP; and (b) since common pool of funds were utilized by the appellant, the assessing officer was justified in computing proportionate interest for the purpose of disallowance.
77.4 Without prejudice, that the assessing officer erred on facts and in law hi not allowing depreciation (in the year of capitalization of the CWIP) on interest expenses of Rs. 1,54,76,000/- held to be capital in nature.
8. That the assessing officer erred on facts and in law in making further disallowance of Rs. 1,02,32,000 under section 14A of the Act, being the difference between disallowance computed as per method provided in Rule 8D of the Income Tax Rules, 1962 ('the Rules') and the amount suo motu disallowed by the appellant.
8.1 That the assessing officer erred on facts and in law in invoking Rule 8D of the Rules and computing disallowance of Rs. 1,08,39,000/- under section 14A of the Act, without appreciating that conditions precedent for applying Rule 8D as prescribed hi sub-sections (2)7 (3) of the said section were not satisfied.
8.2 That the assessing officer erred on facts and in law in attributing part of the interest expenditure incurred during the year towards earning of the exempt income, while computing disallowance under section 14A of the Act hi accordance with provisions of Rule 8D of the Rules, without appreciating that the appellant had no borrowed funds at all.
8.3 That the assessing officer erred on facts and in law in holding that the disallowance of Rs.6,06,977/- made by the appellant, suo motu, in the return of income under section 14A of the Act was incorrect.
8.4 That the assessing officer erred on facts and in law in not appreciating that even in case of mixed pool of funds, where surplus funds are more than investment made, a presumption needs to be drawn in favour of assessee that interest free funds have been utilized for investments.
9. That the assessing officer erred on facts and in law in levying interest under sections 234B and 234C of the Act.
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.
3. The assessee had made an application for enlargement of ground of appeal No.2.23 as under:
Re: Request for enlargement of grounds of appeal No. 2.23 Ground of Appeal No. 2.23 of the memorandum of appeal reads as follows:
"Without prejudice that the assessing officer erred on facts and in law in considering the following expenses for the purpose of calculating alleged AMP expenditure of the appellant 8 Particulars Amount (Rs in lacs) Selling and distribution expenses 1067.50 Market Research expenses 969.16 Total 2036.66 The appellant seeks to crave leave to enlarge the above ground of appeal, read as under:
"Without prejudice that the assessing officer erred on facts and in law in considering the following expenses for the purpose of calculating alleged AMP expenditure of the appellant Particulars Amount (Rs in lacs) Selling and distribution expenses 1067.50 Market Research expenses 969.16 Sales Promotion 4,460.21 Total 6,496.87 Less allowed by TPO 1,167.35 Balance 5,329.52 The facts in relation to the aforesaid ground of appeal are already on record. No fresh investigation in the aforesaid is called for. It is accordingly prayed that the enlargement of the ground of appeal may kindly be permitted and the same adjudicated on merits.
4. The learned A.R. for the assessee vehemently stressed that the said enlargement of ground of appeal No.2.23 may be allowed to the assessee in order to adjudicate the issue. The learned A.R. for the assessee further submitted that the said issue is squarely covered by the order of t h e T r i b u n a l i n t h e e a r l i e r ye a r . Without going into the merits of the said plea of enlargement of ground of appeal No.2.23 we are of the view that the ground of appeal raised by the assessee i.e. original ground of appeal No.2.23 takes care of the issue and there is no merit in the request made by the learned A.R. for the assessee and the same is rejected.
5. The brief facts of the case are that the assessee was engaged in the manufacturing and selling of nutritional products i.e. malted milk food products and drinks under the brands Horlicks, Boost, Maltova and Viva.
9D u r i n g t h e ye a r u n d e r c o n s i d e r a t i o n t h e a s s e s s e e a l s o e x p o r t e d m a l t e d milk food to its group companies, which were manufactured by third party vendors in India and thus acted as traders. Further it provided certain administrative support services such as marketing, sales inputs, IT support, training and accounting etc. to its group companies. The Assessing Officer noted that the assessee had entered into international transaction with associated enterprises and the amount of transaction involved was more than Rs.15 crores. The Assessing Officer referred the case to Transfer Pricing Officer (herein after refer to as TPO, Chandigarh) for determining arms' length price in relation to international transactions under section 92CA of the Act. The Addl.
Commissioner of Transfer Pricing vide order dated 21.10.2011 computed the value of international transaction under section 92CA(3) of the Act at Rs.109,22,10,830/-. The Dispute Resolution Panel thereafter issued directions under section 144C (5) of the Act dated 3.9.2012 pursuant to which the Assessing Officer had passed the order under section 143(3) r.w.s. 144C of the Act dated 3.9.2012. The assessee is in appeal against the said order of the Assessing Officer and raised several grounds of appeal.
6. The ground No.1 raised by the assessee being general is dismissed as such.
7. The ground No.2 raised by the assessee is against the transfer pricing adjustment amounting to Rs.106,44,25,680/- in relation to advertisement, marketing and sales promotion expenses (hereinafter referred to as 'AMP expenses') incurred by the assessee.
8. The ground Nos.2.1 to 2.30 relate to several aspects of transfer pricing adjustment made in the case of the assessee. Both the authorized 10 representatives appearing before us fairly admitted that the issue of transfer pricing adjustment made on account of AMP expenses now stands covered by the majority view in Special Bench of Delhi Tribunal in M/s L.G. Electronics India P. Ltd. Vs. ACIT in ITA No.5140/Del/2011 r e l a t i n g t o a s s e s s m e n t ye a r 2 0 0 7 - 0 8 , r e p o r t e d i n ( 2 0 1 3 ) 1 4 0 I T D 4 1 (Del)(SB) in which the assessee was one of the intervener, which has been applied by the Tribunal in assessee's own case relating to a s s e s s m e n t ye a r 2 0 0 7 - 0 8 i n I T A N o . 1 1 4 8 / C h d / 2 0 1 1 v i d e o r d e r d a t e d 2.4.2013.
9. The learned A.R. for the assessee has furnished on record tabulated details issue-wise being adjudicated by the Special Bench of the Tribunal vide several parts of the decision and we proceed to deal with the same in the paras hereinbelow.
10. The learned D.R. for the Revenue pointed out that the issue stands covered against the assessee by the decision of Special Bench of the Delhi Tribunal in M/s L.G. Electronics India P. Ltd. Vs. ACIT (supra).
However, in view of the directions of the Special Bench the matter has to be referred back to the Transfer Pricing Officer for computation purposes.
11. The learned A.R. for the assessee, however, pointed out that in line with the ratio laid down by the Special Bench, the issue needs to be looked at by the Transfer Pricing Officer after considering the comparables in order to compute the transfer pricing adjustment on account of AMP expenses. The plea of the learned A.R. for the assessee was that opportunity should be given by TPO to the assessee to furnish the list of relevant comparables.
1112. We have heard the rival contentions and perused the record. The brief facts of the case are that the assessee had furnished return of income declaring total income of Rs.2,75,73,15,234/-. The Assessing Officer vide letter dated 9.8.2010 and thereafter vide letter dated 27.7.2011 and further letter dated 23.8.2011 made reference to the TPO under section 92CA(1) of the Act. The details of the said communication are enlisted under paras 2.1 to 2.3 at pages 1 and 2 of the order of the TPO. The TPO after considering the business activities of the associated enterprises and holdings of the assessee company by h o l d i n g c o m p a n y, c o n c l u d e d t h a t t h e a s s e s s e e c o m p a n y i n c o r p o r a t e d under the laws of India, was 43.16% owned b y Horlicks Ltd., U.K., which in turn was part of GSK Group. The TPO thus held that it was associated enterprise within the meaning of section 92A(2)(a) of the Act.
The TPO at part of page-4 and page-5 has enlisted summary of business activities and nature of relationship with the assessee company of various associated enterprises. At page 6 of the report of the TPO it has been observed as under:
"6. Transfer pricing method adopted by the assessee:
6.1 International transactions of exports of malted food/biscuits and exports of packing material/tazzos have been separately benchmarked adopting TNMM as the appropriate method and Operating Profit at Cost as the Profit Level Indicator (PLI). The same method has been used in the preceding years by the assessee. For choosing independent comparables, the assessee has used 'Prowess' software developed by the Centre for Monitoring Indian Economy and Capitaline Plus Corporate Database. Receipt of I.T. Services and reimbursements of expenses are benchmarked using cost Plus method (mark-up).
13. The assessee had adopted TNNM method and applied certain filters for rejecting the non-comparables and had a n a l yz e d the operating profit/total cost ratio of different companies as enlisted under paras 6.2 and 6.3 of the order of the TPO and worked out arithmetic mean 12 operating profit margin earned by the said comparables at 8.90% as against operating profit margin at 20.93% declared by the assessee.
Vide para 7.2 the TPO noted that the assessee had sales turnover of Rs.138920.17 lacs and beside selling & distribution expenses of Rs.
1067.50 Lacs, had debited the following expenses :
S.No. Name of Expenses Amount
(Rs.Lacs)
1. Service charges paid to selling agent 11.16
2. Discount - sales 53.35
3. Advertisement expenses 1064.11
4. Market Research 969.16
5. Sales Promotion 4460.21
6. Development & Scientific research 244.60
Total 17447.09
14. The TPO vide para 7.5 at page 7 of the order, considered the shareholding pattern of two companies and observed that GSK Asia Pvt.
Ltd. is subsidiary of S.B. Port Louis Ltd., Mauritius, an Associated Enterprise. Similarly Glaxo Group Ltd., U.K. (an Associated Enterprise) has 35.99% share holding in GSK Pharmaceuticals Ltd.
Thus the provisions of section 92A(2)(b) of the I.T. Act are attracted.
Further the TPO vide para 7 analyzed the transfer pricing approach adopted by the assessee. The TPO further noted that the assessee was p a yi n g r o ya l t y w h i c h w a s d e e m e d i n t e r n a t i o n a l t r a n s a c t i o n b e t w e e n t h e assessee and its AE. The other aspect noted by the TPO was marketing r o ya l t y f o r u s e o f ' H o r l i c k s ' a n d t h e a s s e s s e e h a d i n c u r r e d e x p e n d i t u r e of Rs.17447.09 lacs on advertisement, marketing and promotion of the said product. As per the TPO, the assessee had created marketing intangible by incurring expenditure of Rs.17447.09 lacs on advertisement, marketing and promotion of the AE brands and products, which was not compensated for by the AE and in order to examine the arms' length price, it was necessary to compare total expenditure incurred by the assessee on behalf of the AE in India and the amount 13 paid by the assessee in India as contribution for advertisement expenditure by the AE.
15. The assessee was thus show caused as to why it should not be inferred that it had incurred both routine and non-routine advertisement and marketing expenses on brand promotion and development of marketing intangibles for the associated enterprises (in short 'AE'). The T P O a l s o a n a l ys e d t h e r e s u l t s o f c o m p a r a b l e s r e l i e d u p o n b y t h e a s s e s s e e at page 9 to page 14 of the order of TPO.
16. The TPO thereafter finally selected four companies out of list of sixteen companies selected by the assessee for benchmarking the international transaction of export of malted foods, biscuits to AEs taking into consideration the expenses incurred on selling and distribution expenses. The TPO thereafter determined the arms' length price of reimbursement for brand promotion and marketing intangible of the AE in India as per table at pages 15 and 16 of the order of the TPO and the arms' length value of subsidy was determined at Rs.1,65,49,47,320/- against which the assessee had received nil subsidy and short fall was proposed as an adjustment to the price of reimbursement for brand promotion and marketing intangible of the AE in India. The TPO under para 8 at pages 16 to 32 analyzed the reply of the assessee on various aspects and considered following issues:
Para 8.1 W h e t h e r r o ya l t y i s a n i n t e r n a t i o n a l t r a n s a c t i o n ?
Para 8.2 Whether AMP expenditure is international
transaction?
Para 8.3 Disallowance under section 37(1)?
Para 8.4 The issue relating to advertisement, marketing
and promotional expenditure.
14
Para 8.5 Concept of marketing intangible and its
application to the facts of the case of the
assessee.
Para 8.5.13 AMP expenditure pertaining to products where
brands are owned by the assessee was to be
excluded while computing AMP expenditure on
the development of marketing intangible of the
AE.
Para 8.5.21 Benchmarking of international transaction.
Para 8.6 Other contentions raised by the assessee.
Para 9 Selection of comparables for benchmarking of
routine AMP expenditure.
17. The TPO vide para 9 selected only four companies as comparables as against sixteen companies selected by the assessee. The selling and distribution expenditure of the said concern as compared to the sales were noted by the TPO and the average was worked out at 2.20%. On the other hand, the total marking expenditure incurred by the assessee d u r i n g t h e ye a r u n d e r c o n s i d e r a t i o n w a s R s . 1 7 4 4 7 . 0 9 l a c s o n g r o s s s a l e s of Rs.149745.66 lacs. The AMP expenditure of the assessee accounted for 11.65% of the income as compared to average AMP expenditure to income ratio of 2.20% for the comparables i.e. comparables under control price, selected by the TPO. The TPO thus concluded by establishing that the assessee had incurred huge non routine expenditure on development marketing intangible for the AE. The said comparability a n a l ys i s a l s o p r o v e t h a t A M P e x p e n d i t u r e i n t h e c a s e o f t h e a s s e s s e e w a s in excess of the bright line test more than routine marketing expenditure of the distributors. The TPO thus held that the expenditure which is beyond the routine marketing expenditure is for the benefit of AE. The TPO thus determined the arms' length price of reimbursement received by the assessee for the brand promotion and marketing intangible of the AE in India and computed the arms' length value of the subsid y at Rs.1,09,22,10,830/- as against nil subsidy received by the assessee. The 15 TPO thus held that an adjustment of Rs.1,09,22,10,830/- was to be made to the income of the assessee on which assessee would not be entitled to deduction under sections 10A, 10AA, 10B or under Chapter VI-A in respect of the enhanced amount.
18. The main plea of the assessee before the TPO was as under, which was rejected by the TPO:
"8.5.11 The assessee has contended that expenditure on AMP is recurring in nature, it is for the promotion of products manufactured and sold in India which has not resulted into indirect benefit to the AE and has directly benefited it.
According to it, such expenditure does not result in the creation of any asset. Alternately, it has claimed that any marketing intangible, if created were not on behalf of or transferred to the AE. The assessee has also provided data of AMP expenditure incurred by GSK Worldwide but the same is for the year 2010 and therefore no inference is drawn.
8.5.12 The assessee has pleaded that all the advertisements in print media, press or otherwise in relation to products aimed to benefit only the products sold by the assessee and any benefit accruing to the AEs was only incidental.
Assessee has claimed that all benefits of incurring expenses on selling & distribution and marketing & advertising are received by it. It is also claimed that no benefit accrues to the assessee on account of this expenditure."
19. The assessee filed its objections in form No.35A before the Dispute Resolution Panel. Directions under section 144C(5) of the Act were issued by the Dispute Resolution Panel, New Delhi vide its order dated 3.9.2012. The DRP upheld the findings of the TPO and directed the Assessing Officer to adopt the same in respect of arms' length price, expenditure incurred on Scientific Research and discount on sales.
20. The Assessing Officer during the assessment proceedings confronted the report of TPO to the assessee. The Assessing Officer observed that a reference was made to the TPO under section 92CA of 16 the Act for computation of arm's length price of the international transactions of over Rs.5 crores as per Form No.3CEB filed by the assessee. In view of the order of the TPO and DRP, the Assessing Officer recalculated the arm's length price of reimbursement received by the assessee for brand promotion and marketing intangibles of the AE in India and the difference in the amount of arm's length subsid y and the value of international transaction undertaken being more than 5%, adjustment of Rs.1,06,44,25,680/- was made to the income of the assessee, after considering the reply of the assessee on the issue.
21. The assessee is in appeal against the order of the Assessing Officer passed under section 143(3) r.w.s. 144C of the Act and has raised various grounds of appeal. Both the authorized representatives fairly admitted that the issue has been deliberated upon by the Special Bench of Delhi Tribunal in M/s L.G. Electronics India Pvt. Ltd. Vs. ACIT (supra) and majority view in the said decision is against the assessee.
Multiple grounds of appeal have been raised by way of ground Nos.,2 to 2.30. The learned A.R. for the assessee further pointed out that the ratio laid down by the Special Bench of the Delhi Tribunal in M/s L.G. Electronics India P. Ltd. Vs. ACIT (supra) has been applied by the Chandigarh Bench of the Tribunal in assessee's own case and the issue of determination of arms' length price in relation to AMP expenditure has been restored back to the file of the TPO with directions. It was also pointed out by the learned A.R. for the assessee that certain portion of the said expenditure being relatable to the brands owned by the a s s e s s e e h a d b e e n d i r e c t e d t o b e a l l o w e d b y t h e T r i b u n a l i n e a r l i e r ye a r .
22. The ground No.2 raised by the assessee is general in respect of the aforesaid adjustment made on account of AMP expenditure. The issue in ground Nos.2.1 to 2.16 is whether the transaction is an international 17 transaction. The Chandigarh Bench of the Tribunal in assessee's own c a s e r e l a t i n g t o a s s e s s m e n t ye a r 2 0 0 7 - 0 8 o b s e r v e d a s u n d e r :
21. The ground No.2 raised by the assessee is general in respect of the aforesaid adjustment made on account of AMP expenditure.
The issue in ground Nos.2.1 to 2.7 is whether the transaction is an international transaction. The Special Bench of the Tribunal in M/s L.G. Electronics India P. Ltd. Vs. ACIT (supra) vide paras 14.1 to 14.20 of the decision held as under:
14.1. Having seen that there was a transaction between the assessee and the foreign AE, now let us examine as to whether such transaction can be called as international transaction. It was submitted by the ld. counsel for the assessee and some of the interveners that even if it is treated as a transaction, but still it does not falls within the definition of `international transaction' as per section 92B of the Act. It was argued that sec. 92B refers to a transaction between two or more associated enterprises "in the nature of" purchase, sale or lease of tangible or intangible property etc. It was submitted that the expression in the nature of has been clarified by way of insertion of Explanation to section 92B by the Finance Act, 2012 with retrospective effect from 1-4-2002, but the case under consideration does not fall in any of the sub-clauses of clause (i) of the Explanation to section 92B so as to be called as an international transaction.
14.2. Coming a step ahead of actual international transaction as per section 92B(1), the ld. counsel submitted that the legislature also deems certain transactions as international transactions as per sub- sec. (2) of sec. 92B.
Elaborating sub-sec. (2) of sec. 92B, it was put forth that a transaction with a third party is deemed as an international transaction if there is a prior agreement in relation to the relevant transaction between the third person and the associated enterprise or the terms of relevant transaction are determined in substance between such third person and the associated enterprise. It was stated that the case of the assessee cannot be brought even within the purview of sub- sec. (2) because there is no allegation by the Revenue that the third parties who were paid by the assessee for defraying advertisement expenses had any understanding with the foreign AE so as to determine the terms of their agreements for advertisement with the assessee. Once a transaction is not covered under sub-sec. (1) of section 92B, the ld. AR stated that the same can be deemed as an international transaction only when it falls under sub-sec. (2) of sec. 92B. If a transaction does not satisfy the pre- requisites for inclusion either in sub-sec. (1) or sub-section (2) section 92B, it cannot be reckoned as an international transaction so as to be eligible for processing under Chapter X of the Act.
14.3. The ld. AR argued that there is always some consideration for doing any thing, without which there can be no valid agreement. It was pointed out that no consideration moved between the assessee and the foreign AE on account of the alleged brand building. The assessee incurred advertisement expenses for which the payments were made to third parties unrelated to it. Such transactions got concluded on the incurring of advertisement expenses without any direct or indirect involvement of the assessee's foreign AE. It was stated that a transaction with a third party or a part of such transaction cannot be called as transaction with the AE. As the entire advertisement expenses were incurred in India vis a vis third parties, the requirement of sec. 92B was claimed to be lacking. The ld. AR argued that there should be a first degree nexus between the incurring of advertisement expenses and the brand promotion for the foreign AE 18 so as to regard it as an international transaction. Any incidental benefit resulting to the foreign AE, out of the expenses incurred by the assessee in India, cannot be termed as international transaction. As there was no transaction between the assessee and its foreign AE insofar as incurring of AMP expenses is concerned, the ld AR argued that the same ceased to be an international transaction. It was argued that the present so-called transaction of brand building for the foreign AE by the assessee is neither covered under sub-section (1) nor (2) of section 92B and hence the same cannot be recognized as an international transaction.
14.4. The ld. DR contended that a careful look at sub-section (1) of section 92B would indicate that the term `international transaction' has been defined in widest possible manner. Normally a provision is either exhaustive or inclusive. Section 92B was claimed as a classic example of a combination of both. It was explained that the provision can be seen into three parts. First part is exhaustive as opening with : `―international transaction means a transaction ....in the nature of purchase, sale or lease of tangible or intangible property, or provision of services.....'. Second part further advances the scope of the exhaustive character by roping in `any other transaction having a bearing on the profits, income, losses or assets of such enterprises'. Third part is inclusive which provides that it `shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of...any cost or expense ...in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises.' 14.5. The ld. DR argued that the instant transaction can be viewed as international transaction not on one but on three different counts. The first being, the earlier part of sub-section (1), which is in the nature of the exhaustive part of the definition referring to.in the nature of ....provision of services'. It was stated that the authorities below have primarily viewed this transaction as in the nature of provision of a service of creating, improving or maintaining marketing intangible for the foreign AE, in lieu of which the foreign AE ought to have reimbursed the assessee.
14.6. The ld. DR contended that it can also be considered as an international transaction having a `bearing on the profits, income, losses or assets' of the assessee. Bearing on the profits of an enterprise was explained as a transaction having been recorded in such a way that the profits of the enterprise get needlessly deflated. In the present context, there can be deflation of profits of an enterprise, when the expenses pertaining to the foreign AE are also claimed as deduction by the Indian enterprise. If it amply turns out that the Indian entity has booked certain amount incurred for its AE as its own expense, this would have the effect of reducing the profit without reason, thereby depriving Indian exchequer from its rightful share of taxes. It was stated on behalf of the Revenue that the assessee incurred AMP expenses with a tacit understanding of creating the marketing intangible for its foreign AE. The assessee not only claimed deduction for the AMP expenses incurred for its own business purpose but also for the expenses towards creating or improving the marketing intangibles of the foreign entity. This excess claim of deduction was stated to have a direct bearing on the profits of the assessee, thereby bringing it within the ambit of an international transaction.
14.7. The third way of looking at this as an international transaction was its inclusion under the relevant part of section 92B(1), which runs as under : `and shall include a mutual agreement or arrangement (there is an oral understanding) between two or more associated enterprises (between the assessee and foreign AE) for the allocation or apportionment of..... any cost or 19 expense incurred or to be incurred (brand promotion expenses) in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises (benefit, service or facility of which shall be available to the foreign AE). It was stated that there is an agreement between the assessee and its foreign AE under which only the assessee was to incur all AMP expenses in India in connection with a benefit, service or facility to be provided to itself as well as its foreign AE. He argued that the excess of the AMP expenses incurred by the Indian entity over what other comparable independent entities incur in similarly placed situation, means the exclusive benefit, service or facility to the foreign AE so as to constitute the value of international transaction of brand building for it. That is how he contended that the present transaction is an international transaction from three different angles.
14.8. The ld. DR argued that the payment to third parties for advertising is not an international transaction. It has never been the case of the Revenue that the payment made to the third parties towards advertisement expenses be treated as an international transaction. He stated that rather the international transaction is restricted to the activity done by the Indian AE in relation to foreign AE for adding value to a brand (being an intangible property of the foreign AE), the payment for which made by the Indian assessee is included in the overall AMP expenses claimed as deduction by the assessee.
14.9. Replying to the ld. DR's contention that section 92B has been worded very widely to include each and every transaction between the two AEs within the pale of international transaction, the ld. counsel for some of the interveners relied on the judgment in Addtl. CIT Vs. Income Tax Appellate Tribunal & Anr. [(1975) 100 ITR 483 (AP)] to contend that simultaneous use of the words `means' and `includes' in a definition make it exhaustive and not inclusive. It was highlighted that only the transactions set out in section 92B can be considered as international transactions and nothing beyond that. As the instant transaction is not covered by section 92B, it was claimed that the same cannot be considered as an international transaction.
14.10. After considering the rival submissions in this regard, we have no doubt in our mind that only international transactions can be considered within the purview of the Chapter X of the Act. Unless a transaction is an international transaction within the meaning of sec. 92B, the same cannot be subjected to the TP provisions. The expression `international transaction' has been defined under section 92B, which has two sub-sections. The first sub-section talks of actual international transaction and the second sub-section refers to a deemed international transaction.
14.11. The case of the revenue is that it is an international transaction in terms of sub-sec. (1) of sec. 92B. Let us see the prescription of this provision, which is as under :-
"92B. Meaning of international transaction.--(1) For the purposes of this section and sections 92, 92C, 92D and 92E, "international transaction"
means atransaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in 20 connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises."
14.12. After sub-section (1), there is sub-section (2) followed by the Explanation with two clauses, inserted by the Finance Act, 2012 w.r.e.f. 1.4.2002 starting with the expression : ` For the removal of doubts'. Clause (i) of the Explanation provides that ―the expression `international transaction' shall include - ‖. Then there are five sub- clauses from (a) to (e). Clause (ii) of the Explanation provides that ―the expressions `intangible property' shall include -‖. Then there are twelve sub-clauses from (a) to (l).
14.13.1. Firstly we shall evaluate the rival contentions about the definition of 'international transaction' u/s 92B, being exhaustive or inclusive. It is noticed that such definition as per sub-section (1) uses both the words `means' and `includes' at two different places. A definition is exhaustive when it incorporates the word `means' in its opening part and thereafter lists out certain items, say A and B. In that case it will mean that only A and B form the content of the thing defined. A definition is inclusive when it uses the word `includes' in its opening part and thereafter lists out certain items, say A and B. In that case it will mean that not only A and B but also other items not listed, say C or D, can also form the content of the thing defined, if these are otherwise of the same nature. If however a definition includes both the words `means' and `includes', that is, it says that it means `A' and includes `B', then it will again mean that it is an exhaustive definition to include both A and B and not C or D etc. A definition despite being exhaustive can still be inclusive, if one or more of its components are again defined in an inclusive manner. Suppose in the definition of the third category discussed above, having both A and B by use of the words `means' and `includes', the contents of either A or B are both are further defined in an inclusive manner, this definition will again become inclusive to the extent of the definition of either A or B or both having been defined in an inclusive manner.
14.13.2. Turning to the definition of international transaction as per sub-section (1) of sec. 92B it is noticed that it uses both the words `means' and `includes'. When we examine the Explanation to this section clarifying the meaning of the expression `international transaction' and `intangible property', then it becomes clear that both have again been defined in inclusive manner. Even though sub- clauses (a) to (c) and (e) of clause (i) of the Explanation defining `international transaction' are exhaustive, but sub-clause (d) being the `provision of services' is again inclusive as `including' provision of market research, market development, marketing management,...'. It is of critical importance to observe that the expression `international transaction' itself has been defined in this Explanation only in an inclusive manner. As a result of insertion of the Explanation with retrospective effect, the otherwise exhaustive definition of `international transaction' given in sub-section (1) has been converted into an inclusive one. Clause (ii) of the Explanation also defines the expression `intangible property' in an inclusive manner. Sub-clause (a) of clause (ii) embraces `marketing related intangible assets' in the ambit of intangible property, which is again not exhaustive because of the use of the expression `such as' before `trademarks, trade names, brand names, logos'. From the above examination of section 92B in entirety, it can be easily noticed that the legislature has given very extensive and inclusive meaning to the expressions `international transaction' and `intangible property'.
14.14. When we read sec. 92B(1) it comes to fore that in order to be characterized as an international transaction, the following salient features must be present : -
21(1) There should be a `transaction' (2) Such `transaction' should be between two or more AEs and either or both of whom should be non-residents.
(3) Such transaction should be of the nature as referred to in section 92B.
14.15. In the earlier part of this order, we have held that the brand building by the assessee for its foreign AE constitutes a `transaction'. So far as the second requisite is concerned, there is no dispute on the fact that LG Korea is an associated enterprise of the assessee. Thus, there are two AEs in the present case and one of them, namely, LGK is a non-resident. This condition also stands satisfied.
14.16. The third requisite is that the `transaction' as per the first requisite must be of the nature as referred to in section 92B. All the three requisites must be cumulatively satisfied so as to make a `transaction' an `international transaction'. If there is a transaction between two AEs and one or both of whom are non-residents, it will not become an international transaction so as to fall within the domain of Chapter-X, unless it is of the nature as defined in section 92B.
14.17. It has been vigorously argued by the ld. counsel for the assessee and some of the interveners that clause (i) of Explanation to section 92B gives meaning to the expression `in the nature of international transaction' and since sub-clauses (a) to (e) of clause (i) do not refer to transaction of brand building, it cannot be considered as an international transaction. We are not persuaded by this submission. It is pertinent to note that the expression `international transaction' as per clause (i) of the Explanation has been `clarified' `include' five sub-clauses. Thus the meaning assigned to `international transaction' as per clause (i) of the Explanation is simply inclusive and not exhaustive. There is hardly any need to burden this order with the ratio decidendi emanating from a plethora of judgments that the scope of an inclusive definition always extends beyond the specified inclusions.
14.18.1. Now we will examine as to whether this transaction falls within any of the sub-clauses of clause (i) of Explanation to section 92B. The learned counsel for the assessee contended that the view point of the ld. DR that the transaction of brand building is in the nature of `provision of service', is not tenable. He submitted that Indian entity is engaged in the business of manufacturing and selling of electronic goods etc. and not in rendering services of advertisement and promotion of a brand to its customers. His contention was that in order to bring any transaction within the scope of `provision of services', it is sine qua non that the main business activity of the Indian enterprise and the nature of service provided to the foreign AE must be same. As it is not so in the present case, the ld. AR contended that the transaction cannot be held as a `provision of service'.
14.18.2. We do not find any force in this submission advanced on behalf of the assessee for the reason that the language of section 92B simply mandates the ‗provision of services' by one AE to another. It is not qualified by any words to restrict its scope only to such services as are provided by the assessee in its regular course of business. What is significant in this regard is the factum of rendition of service, which is an international transaction. Source of service is inconsequential. It can be produced by the AE as primarily engaged in the business of rendering such service or it can be produced by the Indian AE otherwise than by being primarily engaged in such business or it can be 22 outsourced. The fact that the Indian entity is rendering any service to the foreign AE, which is not its main business, would not convert the otherwise international transaction into a non-international transaction.
14.18.3. Ordinarily a service may be professional, public or a business service. Even in common parlance provision of service means the act of performing a task for a person which that person requires it in exchange for some consideration. Cl. (i) of Explanation to section 92B defining `international transaction' includes through sub-clause (d) : `provision of services, including provision of market research, market development, marketing management.....'. Clause (ii) of the Explanation defining `intangible property' includes through sub-clause (a) : `marketing related intangible assets, such as, trademarks, trade names, brand names, logos'. When we consider both these provisions together, it becomes clear that provision of services defined in an inclusive manner encompassing all the market related services including those specifically covered like market development, research and administration and the further fact that brand name and logos have been specifically considered as marketing intangibles, there remains no doubt about the brand building being a provision of service in the present context. In the light of the above discussion we are of the considered opinion that the transaction of brand building by the assessee for the foreign AE is in the nature of `provision of service'. Having held such transaction to be an international transaction in the nature of `provision of service', we do not consider it expedient to deal with the contention of the ld. DR that it is also an international transaction having a `bearing on the profits, income, losses or assets' of the assessee on one hand and/or towards allocation or apportionment of any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, on the other.
14.19. Now we take up the contention of the ld. AR that there was no transaction between the assessee and its foreign AE insofar as incurring of AMP expenses is concerned and further the assessee entered into transactions with the third parties who are advertising agencies and it is not the case of the Revenue that the terms of transactions with such third parties were determined in substance by the foreign AE. Insofar as the part of the contention of the ld. AR about the deemed international transaction u/s 92B is concerned, we find that it is nobody's case that the transaction in question is a deemed international transaction. In order to be covered under sub- sec. (2) of Sec. 92B for making a transaction with a third party as deemed international transaction, it is essential that the AE of the assessee should have influence over the third party in terms of determining the terms and conditions of such transaction. It is only in such a situation that the transaction with such third party is deemed to be an international transaction. Further it is not the case of the Revenue that the transaction of payments of AMP expenses to the third parties is an international transaction. Rather the international transaction has been taken as the value addition made by the assessee to the brand by making payment which are included in the overall AMP expenses paid to the third parties.
14.20. The further contention that there was no consideration by the foreign AE in the present case, is again of no avail. The mere fact that no consideration moved between the AEs for a transaction is not a decisive factor to have influence over its nature. Payment of consideration has not been made as a condition precedent for inclusion of any transaction within the ambit of section 92B. The transfer pricing provisions should be seen in the backdrop of the fact that these are special provisions for avoidance of tax on the transactions structured between two associated enterprises. The simple fact that the foreign AE did not pay any consideration to the Indian AE will not take the transaction 23 out of the purview of the transfer pricing provisions, if it is otherwise an international transaction.
14.21 Thus it is palpable that all the three necessary ingredients as culled out from bare reading of section 92B are fully satisfied in the present case. There is a transaction of creating and improving marketing intangibles by the assessee for and on behalf of its foreign AE; the foreign AE is non-resident; such transaction is in the nature of provision of service. Resultantly, we hold that the Revenue authorities were fully justified in treating the transaction of brand building as an international transaction in the facts and circumstances of the present case.
22. In view of the majority decision of the Special Bench in M/s L.G. Electronics India P. Ltd. Vs. ACIT (supra), we hold that the transaction in question is an international transaction which is liable to be considered under the provisions of section 92B of the Act and the Assessing Officer was justified in treating the transaction of brand building as an international transaction in the facts and circumstances of the case. The ground Nos.2.1 to 2.7 are thus dismissed.
23. The issue in the present appeal is identical to the issue raised before the Tribunal in assessee's own case and following the majority decision of the Special Bench of the Delhi Tribunal in M/s L.G. Electronics India P. Ltd. Vs. ACIT (supra) and order of Tribunal in a s s e s s e e ' o w n c a s e r e l a t i n g t o a s s e s s m e n t ye a r 2 0 0 7 - 0 8 , w e h o l d t h a t t h e transaction undertaken by the assessee is an international transaction, liable to be considered under section 92B of the Act and the Assessing Officer was justified in treating the said transaction as an international transaction. The ground Nos.2.1 to 2.16 are thus dismissed.
24. Vide ground Nos.2.17 to 2.22 the assessee is aggrieved by the application of the prescribed method for determining the arms' length price of the international transaction. As admitted by the learned A.R. for the assessee, similar issue arose before the Special Bench of the Delhi Tribunal in M/s L.G. Electronics India P. Ltd. Vs. ACIT (supra) and also before the Chandigarh Bench of the Tribunal in assessee's own c a s e r e l a t i n g t o a s s e s s m e n t ye a r 2 0 0 7 - 0 8 ( s u p r a ) w h e r e i n v i d e p a r a s 2 4 and 25 it was held as under:
2424. The next issue raised by the assessee is vide ground Nos. 2.8 to 2.13 i.e. application of the prescribed method for determining the AMP of the international transaction. The Special Bench of the Tribunal vide its majority view in paras 20.1 to 24.1 of the decision held as under:
20.1. We have noticed above that the TP provisions require two variables.
Having seen the first variable, being the cost/value of international transaction above, now we shall find the second variable, being the arm's length price of the international transaction.
TNMM applied on one transaction - Whether ALP of other transactions permissible ?
21.1. The ld. Counsel for the appellant started his contentions on this point by urging in the very beginning that no disallowance can be made out of AMP expenses by benchmarking them separately when the overall net profit rate declared by the assessee is higher than other comparable cases. It was submitted that the assessee made imports from its foreign AE which were subjected to the TP provisions under the transactional net margin method (hereinafter called the TNMM) and hence there was no warrant for making any further addition on the transaction of brand building expenses incurred by the assessee for the foreign AE. The ld. counsel stated that the overall higher net profit rate implies that, firstly, there was no advertisement by the assessee for the brand of the foreign AE and secondly, if at all it was there, the same stood compensated by the foreign AE in terms of sale of goods to the assessee at lower rates. The sale of goods at lower prices to the assessee by the foreign AE should be considered as a quid pro quo for the foreign brand building. For ascertaining as to whether or not the foreign enterprise sold goods to the assessee at a lower price, the ld. AR urged that the overall net profit rate of the assessee should be considered, which will naturally absorb the effect of incurring such brand building expenses. If the overall profit rate is higher, it will mean that the expenses incurred by the assessee on brand building were compensated by the foreign AE in terms of lower price of goods charged from the Indian AE, necessitating no separate further addition on the alleged presumption of the assessee having incurred any AMP expenses towards brand building. The ld. AR relied on the case of the Hon'ble Supreme Court in CIT Vs. Calcutta Discount Co. Ltd. [(1973) 91 ITR 8 (SC)], to canvass the view that the assessee cannot be expected to earn maximum profit. It was submitted that the action of the Revenue in firstly taxing higher rate of net profit on sales and thereafter further increasing the income by making addition on account of AMP expenses, runs contrary to the cardinal principle laid down in that case. He explained that in that case the Revenue opined that the assessee should have transferred its goods at a higher price than that declared. Rejecting this contention, the Hon'ble Supreme Court came to hold that that once a transaction is bona fide, the profit cannot be computed by taking market price, ignoring the real price fetched. In the light of this judgment it was contended that the action of the Revenue in firstly benchmarking the net profit by applying TNMM on the international transaction of imports and then making separate addition for AMP expenses is akin to the stand of the Revenue in that case, being the maximization of profit in all possible ways, which cannot be sustained. With reference to certain material from the paper book, the ld. AR submitted that the assessee's net profit rate was better than certain other comparable cases. Since the overall net profit of the assessee was relatively higher, it was pleaded that no addition was called for by separately processing any item of expense including the AMP under the TP provision. Similar arguments were advanced by the ld. counsel for some of the interveners.
2521.2. Per contra, the ld. DR strongly opposed this contention by submitting that there is no requirement under law that if one transaction has been subjected to the transfer pricing provisions by applying the TNMM then no other international transaction can be separately considered. It was accentuated that all the international transactions are required to be viewed independent of each other.
21.3. We have heard the rival submissions on this issue in the light of material placed before us and precedent relied. The crux of the ld. AR's submission in this regard is that when the international transaction of import of raw material was scrutinized by the TPO under TNMM and the overall net profit of the assessee was found to be higher than other comparables, then no other international transaction could have been processed under the TP provisions. There are two sub-arguments in this main argument of the ld. AR. First, that the international transaction of import of raw material has been processed under the TNMM on entity level and second that when on doing this exercise, the overall net profit was found to be better than other comparables, then the no addition was called for by subjecting the AMP expenses to the TP provisions.
21.4. There is a basic fallacy in the first sub-argument, which lies in not properly appreciating the modus operandi of applying the TNMM. This method provides for benchmarking of `an' international transaction by considering the operating profit from the concerned international transaction vis-à-vis certain basis as given in Rule 10B(1)(e), being total cost, sales, capital employed etc. Here it is significant to note the meaning of the term `transaction' as given in rule 10A(d). It provides that : `transaction includes a number of closely linked transactions'. Plural of transactions becomes singular when the transactions are closely linked to each other or are identical. These closely linked transactions can be processed as one transaction under any of the prescribed methods. If an Indian enterprise has made sale of similar goods to its foreign AE through several invoices and has also incurred some expenses or paid interest to it, it would mean that all the transactions of sales are closely linked and these can be processed as one unit. However the transactions of payment of interest or incurring of any other expense would be required to be separately scrutinized under Chapter-X because these are of a different nature vis-a-vis the transactions of sales.
21.5. It is undisputed that under the TNMM, it is always the operating profit from the concerned international transaction that is viewed in relation to the total cost, sales or capital employed etc. of that international transaction. It is not as if the percentage of the margin is to be determined by considering the net profit of the entity in relation to the total sales of the entity. When we consider operating profit to total costs of an international transaction, all the items of non-operating expenses and non-operating income qua such international transaction are liable to be excluded. The correct approach under the TNMM is to consider the operating profit from each international transaction in relation to the total cost or sales or capital employed etc. of such international transaction and not the net profit, total costs, sales, capital employed of the assessee as a whole on entity level. Section 92C unequivocally provides that the ALP in relation to `an' international transaction shall be determined by any of the prescribed methods. In turn, rule 10B(1)(e) also talks of the net profit margin realized by the enterprise from `an' international transaction. When the mandate of the section and the relevant rule is unambiguous so as to apply on each transaction, as is apparent from the use of the article `an', then the computation of the ALP of `an' international transaction on the entity level is inappropriate. Our conclusion that each international transaction is required to be separately scrutinized under Chapter-X also becomes apparent from the 26 language of section 92(3) as discussed infra. Thus it is clear that the sanction is for applying the TNMM only on a transactional level and not on entity level. Of course, the TNMM can be correctly applied on entity level if all the international transactions are of sale by the assessee to its foreign AE and there is no other transaction of sale to any outsider and also there is no other international transaction. But if there are several unrelated international transactions, as is the case before us and the assessee or the TPO has applied the TNMM in a wrong manner on entity level for testing any of such transactions, then the remedy lies in correcting such mistake rather than drawing legally unsustainable conclusions by taking such mistake as a correct legal position.
21.6. Now we espouse the second sub-argument that when on applying the TNMM on entity level for the transaction of import of raw material the overall net profit is better than other comparables, then no addition is called for by subjecting the AMP expenses to the TP provisions. We have held in an earlier para that when there are different unrelated international transactions, the application of TNMM on entity level for examining one of such transactions, is itself an incorrect approach. Notwithstanding that, we deem it expedient to deal with the argument of the ld. AR that if rate of net profit of the assessee is better than other comparables, then no adjustment can be done under Chapter-X. 21.7. On a specific query from the Bench, it was admitted by the ld. AR that no addition was made by the TPO on account of application of the TNMM on the imports made by the assessee from its foreign AE. In our considered opinion, there is a noteworthy difference between two situations, viz., one where the TNMM is wrongly applied on entity level and some addition is made to the overall net profit of the Indian AE while testing the international transaction of imports of raw material and also some further addition is made by applying the TP provision on AMP expenses; and the situation in which no addition is made to the overall profit on account of application of the TNMM but an addition is made by applying the TP provisions on the transaction of AMP expenses incurred towards brand building for the foreign AE.
21.8. We find no bar on the power of the TPO in processing all international transactions under the TP provisions when the overall net profit earned by the assessee is better than others. Earning an overall higher profit rate in comparison with other comparable cases cannot be considered as a licence to the assessee to record other expenses in international transactions without considering the benefit, service or facility out of such expenses at arm's length. All the transactions are to be separately viewed. This position can be seen with a simple illustration. Suppose an Indian entity is engaged in manufacturing of some products and all the sales are to its foreign AE. In such international transaction, it earns actual profit of, say, `120/-. Further suppose the arm's length profit on total sales earned in comparable uncontrolled transactions is `100. In such a case, there can be no question of making any addition on account of arm's length profit from such international transaction of sale to foreign AE because the actual overall profit is more than the arm's length profit. It may also be possible that the actual profit of the Indian AE was `140/- but the AMP expenses have been so claimed as deduction so as to include a part representing branding building for the foreign AE to the tune of `20/-. In such a case, notwithstanding the fact that the assessee's overall profit at `120/- is more than the arm's length profit earned by comparable cases at `100/-, still there will be a requirement for making adjustment of `20/- on account of advertisement expenses incurred by the assessee towards the brand building on behalf of the foreign AE. If we accept the assessee's contention that since `120/-, being the profit declared by the assessee from the international transaction is more than 27 the arm's length profit of `100/- and hence no further adjustment on account of AMP expenses should be made, then the assessee's income would stand reduced to `120/- as against the actual income of `140/-. We fail to appreciate as to how the judgment in the case of Calcutta Discount Co. Ltd. (supra) advances the case of the assessee. There cannot be any quarrel on the proposition that the assessee cannot be compelled to earn maximum profit. As it is the real profit which is to be taxed and the assessee cannot be expected to earn maximum profit, in the same way, the assessee cannot be allowed to reduce its real profit by including certain expenses which are for the benefit of the foreign AE.
21.9. It is pertinent to note that presently we are dealing with a case in which the majority of the assessee's sales is to Indian customers. Naturally the TP provisions cannot be applied in respect of sales to Indian customers because these are not international transactions. In such a case, there can be no benchmarking of the profits realized from such Indian customers so as to form a platform for contending that the TNMM has been applied on the overall profits and hence the AMP expenses should not be subjected to the TP provisions. In fact, the assessee is a manufacturer and only raw materials are imported from its foreign AE. The transaction of import of raw-material is a separate international transaction liable to be subjected to the TP provisions. Apart from such purchase of raw- material, the assessee, as a manufacturer is also required to incur several other expenses on manufacturing, financing and selling which constitute part of the total cost of product along with the cost of raw materials. Subjecting the international transaction of purchase of raw material to the TP provisions would only show that purchase price of raw-material is not unnecessarily inflated. It is self evident that net profit is not dependent only on the purchase cost. A host of other factors contribute to the earning of profit. It may be possible that a manufacturer succeeds in making economical purchases but suffers setback in incurring other expenses thereby resulting into a comparatively low profit. Similarly there can be a converse situation in which the purchases are made costly but the economies in other areas are achieved thereby leading to higher profit. The crux is that purchase cost is only one of several other important factors having a bearing on the overall profit. All other costs, including the AMP expenses are independent of such cost of import of raw material, having some correlation with the overall profit. In our considered opinion there is no logic in not applying the TP provisions on AMP expenses, if the international transaction of import of raw-material from the foreign AE has been subjected to the TP provisions. As the transactions of import of raw- material and AMP expenses are distinct from each other, having independent effect on the overall net profit of the Indian AE, both are required to be separately processed as per the TP provisions.
21.10. It was also contended on behalf of the assessee that if the overall profit of the Indian entity is more than the comparable cases then it should be presumed that the foreign enterprise supplied goods at relatively low price to make up for the AMP expenses incurred in India towards brand promotion. In our considered opinion there are no roots for such a presumption. In order to take benefit of such a contention the assessee is required to directly prove the fact of cheap purchases de hors the overall higher net profit rate. This fact can be established by demonstrating that the foreign AE charged a specially low price from the assessee in comparison with that charged for the similar goods supplied to other independent entities dealing with it in India or in case there is no other independent entity in India, then the price charged for similar goods from other foreign parties. It can also be proved by showing that goods with identical features are available in the Indian market at a higher price. The fact that the assessee has a better net profit rate in comparison with other comparable entities is not decisive in itself of the assessee having purchased the 28 goods at a concessional rate from its foreign AE as a compensation for its incurring AMP expenses towards the promotion of their brand.
21.11. At this stage, it is relevant to note sub-section (1) of section 92, which provides that : `Any income arising from an international transaction shall be computed having regard to the arm's length price.' Similarly it is pertinent to take stock of sub-section (3) of section 92, which provides that : `The provisions of this section shall not apply in a case where the computation of income under sub- section (1) or the determination of the allowance for any expense or interest under that sub-section, or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under sub-section (2), has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in which the international transaction was entered into'. On a careful perusal of sub-section (3) in combination with sub- section (1), it transpires that if the computation of income having regard to ALP of an international transaction has the effect of reducing the income chargeable to tax computed on the basis of entries made in the books of account, then the provisions of section 92 will be ignored. It can be understood by way of a simple example. If the arm's length price of an international transaction in the nature of expense is `100 and the amount of actual expense recorded in the books of account is `80/-, then the arm's length price of such expense at `100 will be ignored, because acting upon such ALP will lead to lowering of the total income by `20, which isn't permissible as per sub-section (3). If however the ALP of such expense turns out to be lower at `60, then sub-section (1) of section 92 will apply and the total income of the assessee will be computed by considering the ALP of expense at `60, making a northwards sojourn to the total income by `20.
21.12. We have noticed above that sub-section (1) of section 92 read with rule 10B requires computation of income from `an' international transaction having regard to its arm's length price. It means that each international transaction is required to be subjected to the TP provisions distinctly. What is relevant to note on a conjoint reading of sub-section (1) and sub-section (3) of section 92 is that if there are two distinct international transactions and the determination of ALP in respect of the first transaction leads to an increase in total income as per sub- section (1) but no adjustment is called for in respect of the second transaction as per sub-section (3) because of the ALP on the negative side, then the ALP in respect of the first transaction shall be considered in computing the total income, but the ALP of the second transaction shall be ignored. There is no provision which permits set off of negative adjustment with the positive adjustment to the income on account of different international transactions. The outcome of both the transactions has to be given effect distinctly. It, therefore, divulges that two or more international transactions are required to be separately processed under the TP provisions. The contention that if TNMM has been applied on one international transaction, then it would oust the jurisdiction of the TPO to process other international transactions under Chapter-X, really does not stand in the scheme of the provisions. Further, it this contention is taken to logical conclusion, then sub-section (3) of sec. 92 will become redundant to some extent.
21.13. There is one more way of fortifying our above conclusion. TNMM is one of the five recognized methods for determining the ALP of an international transaction. Such ALP can be determined inter alia by comparable uncontrolled price (CUP) method or Cost Plus method or even by the TNMM. All the five methods, as prescribed under section 92(1) and rule 10B, aim at determining the ALP of an international transaction in one way or the other. First is the CUP 29 method, by which the price charged or paid for property transferred etc. in a comparable uncontrolled transaction is identified. Such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transaction. The adjusted price arrived at is taken as ALP in respect of the property transferred etc. in the international transaction. In the like manner all the methods including TNMM provide for determining the ALP of an international transaction. The main focus of the ld. AR was on restricting the application of the provisions of Chapter-X to other international transactions when one transaction has been processed under the TNMM. It has been argued so on the ground that under the TNMM, the net profit of the entity is considered which includes the effect of all other transactions also. The natural consequence of the ld. AR's argument on this issue is that if the ALP of an international transaction is determined by the TNMM then no other international transaction can be subjected to the TP provisions. From here it follows that if any other method, such as CUP or Resale price method etc., is applied for determining the ALP of an international transaction, then the processing of the other international transactions is permissible. The irrationality of the contention can be measured from this factor alone. As all the five methods are aimed towards one end, being the determination of ALP of an international transaction, it is but natural that the consequences of application of each such method qua the other international transactions cannot be varying. It is not possible to hold that if one method is employed for determining the ALP of an international transaction then it is open to the TPO to process other international transactions through the TP provisions, but if some other method is so used, then all other international transactions are immune from such processing. The ld. AR could not draw our attention towards any such provision in the Act. At best, the application of any method including TNMM shows that the said transaction is at ALP. In our considered opinion, the requirement of benchmarking all other international transactions of expenses including AMP, also needs to be scrupulously done, apart from testing one international transaction under the TNMM.
22.1. Notwithstanding his argument that the when the TNMM is applied to international transaction of imports, no addition can be made by processing any other international transaction, the ld. AR then contended that the addition by way of adjustment made is not sustainable because the determination of ALP in this case is not based on any of the methods prescribed under the transfer pricing regulations. Referring to sec. 92C, the ld. AR submitted that five methods have been listed in specific and there is a general clause i.e. (f), which states - ―such other methods as maybe prescribed by the Board‖. It was stated that such other method as per clause (f) of sec. 92C(1), has been brought into existence by means of Notification dated 23-5-2012 through Income-tax sixth Amendment Rules 2012 coming into force on first day of April 2012, applicable from the A.Y. 2012-13. Relying on the judgment of the Hon'ble jurisdictional High Court in the case of Maxopp Investment Ltd. & Ors. Vs. CIT [(2012) 247 CTR (Del.) 162], the ld. AR contended that Rule 10AB, specifying the sixth method, cannot have retrospective operation when it has been made applicable from A.Y. 2012-13.
22.2. Coming back to his point, it was argued that the TPO/DRP have determined ALP in respect of AMP expenses by applying the bright line test, which is not one of the five recognized methods under the Indian legislation. As determination of ALP has not been done as per any of the methods u/s 92C, the ld. AR contended that the same should be set aside. He relied on an order passed by the Mumbai Bench of the Tribunal in CA Computer Associates Pvt. Ltd. Vs. DCIT dated 28-1-2010, in which the assessee paid royalty to its parent company. The TPO rejected the ALP of royalty payment as shown by the 30 assessee on the ground that some of the sales did not materialize for various reasons and the same were written off by the assessee in the same financial year. It was opined that there was no question of paying royalty on such sales merely on the basis of raising invoices. The Tribunal rejected the Departmental stand by holding that the ALP was not determined by the TPO as per any of the methods prescribed in Rule 10B. To this extent the action of TPO was set aside. The said order passed by the Tribunal has been upheld by the Hon'ble Bombay High Court in the case of CIT Vs. CA Computers Pvt. Ltd. vide its judgment dated 3-7-2012. In view of this legal position, the ld. AR contended that since the bright line method adopted by the authorities below is not a recognized method, the determination so made should be set aside and the matter need not be restored for a fresh determination. It was also contended that the Revenue cannot be allowed to have second innings for its own fault. The ld. AR further submitted that the TPO did not confront the assessee with the computation of the ALP by applying the bright line test, which goes against the principles of natural justice.
22.3. The learned Counsel for one of the interveners submitted that any contract for purchase/service involves two elements viz. quantity and price. Chapter-X of the Act only touches price aspect and not quantity aspect. By adopting the bright line method, the learned counsel contended that the TPO has impinged on the quantum aspect of the advertisement expenses which cannot fall within the purview of Chapter-X. He submitted that by applying the bright line method, the TPO/AO have taken a view that the assessee should not have incurred so much expenses on AMP. He also contended that Chapter-X of the Act is a complete code in itself inasmuch as it includes not only the substantive but also the machinery provisions. If machinery provision cannot be applied then the subject matter goes out of the tax net. In support of this contention, he relied on the judgment of the Hon'ble Supreme Court in the case of CIT v. B.C.Srinivasa Setty [(1981) 128 ITR 294 (SC)] and another judgment of the Hon'ble Supreme Court in the case of PNB Finance Limited v. CIT [(2008) 307 ITR 75 (SC)]. In the light of these judgments it was submitted that the Hon'ble Supreme Court has clearly held that where machinery provision fails, the charge cannot be attracted under the substantive provision. Since the Revenue's case hinges on the computation of ALP of AMP expenses on the basis of a bright line method which is not prescribed u/s 92C, the ld. AR contended that the entire exercise must fail.
22.4. Per contra, the ld. DR emphasized on the word ―any‖ as used in sub- section (1) of section 92C(1). His contention was that the word ―any‖ in sub- section (1) cannot be read as restricting itself to any one of the five methods but it may also be a combination of two or more of such methods. He relied on certain tribunal orders to buttress his point that the ALP can be determined be any method even though it is not specifically one of such five methods. He invited our attention towards an order passed by the Bangalore Bench of the Tribunal in which it has been held that Excess Earning Method (EEM) should be applied for determination of ALP which is nothing but enlargement of the CUP method. He also referred to another order passed by the Bangalore Bench of the Tribunal in which scope of the CUP method has been enlarged. In this case the Tribunal directed the determination of ALP by computing written down value of the asset as against the value as per the Registered Valuer's report, which was adopted by the TPO. The learned DR contended that the main thrust of the TP provision is on the determination of ALP and methods are only means to achieve this end result. He argued that if there is an international transaction and the ALP cannot be determined by any of the prescribed methods, then there can be no fetters on the powers of the TPO to adopt any other method for determining ALP.
3122.5. Without prejudice to his above submission, the learned DR contended that the action of the DRP in enhancing the cost/value of the international transaction of `161.21 crore by a mark-up of 13% led to the implicit application of the `cost plus method'. It was submitted that merely because there is no express mention of the use of cost plus method, the reality and the substance of the application of such method cannot be denied.
22.6. Replying to the contention raised on behalf of the assessee for cancelling the assessment itself for the reason of application of a non-prescribed method, the learned Departmental Representative contended that the DRP applied cost plus method. Even if in any case there is a wrong application of method by the authorities, the right course is to send the matter back to the AO/TPO for correcting the deficiency instead of taking away the jurisdiction itself.
22.7. In rejoinder, the learned AR found fault with the argument of the ld. DR on the application of the cost plus method by contending that this method cannot be applied as the transaction is not in the nature of rendering of service. His contention was that unless an assessee itself is regularly engaged in the provision of service which is provided to the AE, the cost plus method u/s 10B(1)(c) cannot apply.
22.8. We have considered the rival submissions. Before proceeding further it is imperative to note that we have dealt with the contention of the ld. AR about the application of bright line test by the authorities below by holding that such method has been employed to determine the cost/value of international transaction and not its ALP. Another contention has been raised by the ld. AR that unless an assessee itself is regularly engaged in the business of providing services, there can be no provision of service to the other AE. This contention has also been dealt with and rejected by holding that the present international transaction is in the nature of `provision of service'. Now we will proceed to see if it has to be any of the prescribed methods or it can even be a combination thereof and further if an inappropriate method is applied by the authorities below then what are the consequences.
22.9. Section 92(1) of the Act provides that any income arising from an international transaction shall be computed having regard to the arm's length price. Computation of arm's length price has been set out in section 92C. Sub- section (1) provides that the ALP of an international transaction shall be be determined by any of the following methods, being the most appropriate method. Five methods are distinctly prescribed u/s 92C(1) and then there is clause (f) which talks of any other method as may be prescribed. Since sixth method has been prescribed under rule 10AB through the Income-tax (6th Amendment) Rules, 2012 which has been made applicable from the A.Y. 2012-13, the same cannot apply to the assessment year under consideration in view of the judgment of the Hon'ble jurisdictional High Court in Maxopp Investment Ltd. (supra). Rule 10B provides the modus operandi for the computation of ALP under these five methods. Sub-section (1) of section 92C starts with : ―The arm's length price in relation to an international transaction shall be determined by any of the following methods, being most appropriate method ................ In our considered opinion, the contention of the ld. DR laying emphasis on the word `any' for propelling his point of view that the method for determining the ALP can also be a combination of the prescribed methods, is devoid of force. There is no doubt that the word ―any has been used u/s 92C(1) which would have ordinarily implied that any specific or non-specific method or even a combination of one or more prescribed methods is sufficient. However it is relevant to note that the scope of the word ―any is circumscribed by the succeeding words ―of the following methods being the most appropriate 32 method. The ambit of the word ―any in sub-section (1) has been restricted by the `following' five specific methods given in the later part of the provision. Rule 10B also provides in the same manner that ―.... the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method........ Here also the word `any' is succeeded by the word `following', which implies that it can be any of the five methods prescribed in the following part of the rule. When we read sub- section (1) of section 92C in entirety along with Rule 10B(1), there remains no doubt that the arm's length price is required to be determined by any single method out of the five prescribed methods. It is further pertinent to note the prescription of Rule 10C which deals with the determination of most appropriate method to be applied for determining ALP. Sub- rule (1) provides that the most appropriate method for the purpose of section 92C(1) shall be the method which is best suitable to the facts and circumstances of each case. Sub- rule (2) which assumes significance in the present context provides that : ―In selecting the most appropriate method as specified in sub-rule (1), the following factors shall be taken into account........... Use of the definite article ―the in sub-rule (2) along with the most appropriate method, makes it abundantly clear that it can be any of the methods given in sub-rule (1), that, in turn, draws strength from section 92C(1), which refers to the five methods. In our considered opinion the general and a non- case specific argument advanced by the ld. DR that there can also be a combination of the one or more of the five methods for determining the ALP, is not correct.
22.10. As regards the contention that methods are tools for determining the ALP, we find that there is no dispute that the main purpose of Chapter X is to determine the ALP of an international transaction, but such determination can be done only by way of the methods specified by the statute. When the legislature has specifically enshrined a provision u/s 92C requiring the computation of ALP by any of the prescribed methods, it does not fall in the realm of the TPO or for that matter any other authority to breach such mandate and apply or direct to apply any other method. Going by the dictate of the provision as subsists under sub-section (1) of section 92C, there can be absolutely no doubt on adoption of any single method out of those set out in section.
22.11. Rule10B has specified a set procedure to be followed for determining the ALP distinctly under the five methods. It is equally not permissible to invent a new procedure and try to fit such procedure within any of the existing procedures prescribed as per these methods. No one is authorized to add one or more new steps in the prescribed procedure or to substitute any other mechanism with the one prescribed under the rule. It is neither possible to invent a new method nor to substitute a new methodology in place of the one prescribed in the rule.
23.1. We have noticed from the orders of the authorities below that there is no express reference to any method employed for determining the ALP of the international transaction. This factor in itself, cannot be considered as detrimental to the computation of the ALP, if in substance it has actually been computed by any of the prescribed methods. In our considered opinion the DRP as well as AO in passing the impugned order were right in applying the spirit of the `cost plus method' to the facts of the instant case by firstly identifying the cost/value of service provided to the assessee and thereafter adding mark-up. The mere fact that DRP did not specifically mention it in so many words, will not ipso facto mean that it did not apply the cost plus method, when the essence of the working matches with the methodology provided in that method.
3323.2. At this stage it will be apt to note the directive of `cost plus method' as per rule 10B(1) (c), which is as under :- "(c) cost plus method, by which,--
(i) the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined ;
(ii) the amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined ;
(iii) the normal gross profit mark-up referred to in sub- clause (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market ;
(iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii) ;
(v) the sum so arrived at is taken to be an arm's length price in relation to the supply of the property or provision of services by the enterprise ;"
23.3. Going by the cost plus method as per rule 10B(1)(c), we find that the first step is to determine the cost of services provided by an enterprise to its associated enterprise. We have noticed above that the authorities below have computed the cost/value of the service provided to the foreign AE at `161.21 crore. It is this amount which constitutes the first step under the cost plus method. The second step is to determine the amount of normal gross profit mark-up to such costs arising from the provision of similar service by an unrelated enterprise in an uncontrolled comparable transaction. The third step under the cost plus method is to adjust the gross profit mark-up as determined under the second step to take into account the functional or other differences between the comparable uncontrolled transaction and the international transaction. The DRP determined 13% profit mark-up. The adoption of 13% constitutes steps 2 and 3 of the cost plus method. Step 4 talks of increasing the cost as determined under step 1 by such adjusted profit mark-up. In this case, the DRP increased cost of `161.21 crore under step 1 with 13% as determined under steps 2 and 3 to find out the amount as per 4 th step at `182.71 crore. Step 5 declares that the figure computed under step 4 should be taken as an arm's length price for the provision of services by the enterprise. Thus it is vivid that the DRP determined a sum of `182.71 crore as the ALP under the cost plus method of the international transaction in the nature of provision of service with its cost/value at `161.21 crore.
23.4. It is relevant to note that under second and third steps what is required to be determined is the rate of normal gross profit mark-up as arising to the enterprise from an uncontrolled transaction or to an unrelated enterprise in a similar situation. Here it is significant to note that a comparable uncontrolled transaction to be considered for benchmarking the normal gross profit mark-up has to be similar to the international transaction under consideration. Consequently, the profit mark-up under steps 2 and 3 should in the present case be the rate which an independent third party earns for creating marketing intangible for and on behalf of the foreign enterprise. In the present case, the DRP suggested 13% mark-up. The DRP went wrong in applying steps 2 and 3 34 by arbitrarily determining the rate of mark-up at 13% without showing as to how much an independent comparable entity has earned from an international transaction similar to one which is under consideration.
23.5. At this juncture we consider it expedient to refer clause (ii) of section 92F which defines ―arm's length price to mean ―a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions. Rule 10A of the Income-tax Rules, 1962 gives meaning to ―uncontrolled transaction under clause (a) as ―a transaction between enterprises other than associated enterprises, whether resident or non- resident‖. It is this expression ―uncontrolled transaction‖ which has been used in Rule10B(1) inter alia in clause (c) i.e. cost plus method. A reading of section 92F(ii) with Rule 10A(a) and 10B(1)(c) in unison clearly points out that the arm's length price is a price which is applied in a transaction between non-AEs in uncontrolled conditions. Steps 2 and 3 of rule 10B(1)(c) contemplate the determination of normal gross profit mark-up of a comparable uncontrolled transaction, which would mean a transaction between non-AEs. One has to necessarily pass through these steps for determining ALP under the cost plus method. When these steps unequivocally provide for determining normal gross profit mark-up from the provision of similar services by an unrelated enterprise in a comparable uncontrolled situation, what is required to be done is to first find out some comparable uncontrolled transaction; then ascertain the profit mark-up of such comparable uncontrolled transaction; and then adjust it to bring it at par with the international transaction under consideration by removing the effect of factors of non-comparability. The cost plus method under Rule 10B(1)(c) does not provide for assuming a hypothetical profit mark-up under steps 2 and 3 for determining ALP. It has to be a profit mark-up of a comparable uncontrolled transaction. The DRP suggested 13% mark- up without showing such mark-up in a comparable uncontrolled transaction. This course of action cannot be sanctioned. When the rule prescribes a particular method to be followed and the steps so given are unambiguous, it is impermissible to substitute such steps with any other mode. Accordingly we do not approve the action taken by the A.O. in implementing the direction of the DRP to mark-up 13% on the cost/value of international transaction.
23.6. We have held earlier in this order that the TPO was not justified in restricting himself only to the two comparable cases as against certain other comparable cases cited by the assessee without verifying or discussing the comparability or otherwise of such cases cited by the assessee. These observations have been made in the context of determining the cost/value of international transaction which was worked out by the authorities below at `161.21 crore. Certain relevant factors have also been discussed by us in that part of the order which should be taken into consideration before determining the cost/value of the transaction. Resultantly, we have set aside the cost/value of international transaction at `161.21 crore and restored the matter to the file of AO/TPO for determining such value afresh after allowing a reasonable opportunity of being heard to the assessee. This determination would provide the figure of first step as per the cost plus method, being the cost/value of the international transaction. As the DRP also did not correctly proceed to compute the correct rate of mark-up as per law, in our considered opinion the ends of justice would adequately meet if the process of determining normal profit mark- up as per steps 2 and 3 of Rule 10B(1)(c) as against 13% applied by the DRP/AO, is also restored to the file of the AO/TPO so that he may determine the cost/value of international transaction in the first instance and then the ALP of this international transaction.35
24.1. We do not find any substance in the contention of the learned AR that since the authorities below did not apply any of the recognized methods, their orders be declared as void ab initio without requiring any restoration for fresh determination. The obvious reason is that, even if it is presumed that the contention of the ld. AR is correct, which is otherwise not because of the application of the essence of the cost plus method by the DRP/AO in the present case, it would at the most be a case of defect in application of the procedural provision in the sense that the ALP has not been computed strictly as per the force of the prescribed methods. It would not be a case that the authorities lacked jurisdiction to determine ALP or their action was barred by the limitation period. In that sense it would be a case of irregularity. Once an irregularity intervenes at a particular stage of the proceedings, the requirement is to take the hands of clock back to such stage and then make the necessary correction. Any proceedings become nullity when these are taken without any jurisdiction or beyond the limitation period. The test to determine as to whether the order passed is invalid or irregular is to see whether there is a lack of jurisdiction or a procedural default. Coming back to our context, we find that the lapse came in applying the procedure of determining ALP correctly. Such a lapse coupled with the fact that there was otherwise valid jurisdiction and the action was well within the time limit, cannot in our considered opinion lead to the declaration of the order as a nullity. There occurred an irregularity due to such lapse which can very well be cured by correcting it from the stage at which such lapse occured. In view of the foregoing discussion, we are of the considered opinion that there is no merit in the contention of the learned AR that the entire proceedings be declared as null and void simply because of some procedural lapse in determining the ALP of the international transaction.
25. In view of the above said ratio laid down by the majority view in the Special Bench of the Tribunal and in view of the issue being set aside to the TPO and the issue before us being identical, we respectfully following the ratio laid down by the Special Bench of the Tribunal (majority view) in M/s L.G. Electronics India (P) Ltd. Vs. ACIT (supra) also set aside the present issue for adoption of the prescribed method for determining arms' length price in relation to the AMP expenditure to the file of the TPO. The TPO while deciding the issue as directed by the Special Bench would give reasonable opportunity of hearing to the assessee. The assessee is at liberty to furnish complete list of comparables before the TPO in order to adjudicate the issue afresh. Consequently, ground Nos.2.8 to 2.13 are allowed for statistical purposes.
25. The issue raised vide ground Nos.2.17 to 2.22 is identical to the issue raised before the Special Bench of the Tribunal (majority view) in M/s L.G. Electronics India (P) Ltd. Vs. ACIT (supra) and also before Chandigarh Bench of the Tribunal in assessee's own case where the issue has been set aside to the file of the Assessing Officer/TPO. In view thereof, following the majority view of the Special Bench of the Tribunal (majority view) in M/s L. G. Electronics India (P) Ltd. Vs. 36 ACIT (supra) and the Chandigarh Bench of the Tribunal in assessee's o w n c a s e r e l a t i n g t o a s s e s s m e n t ye a r 2 0 0 7 - 0 8 , w e s e t s i d e t h e p r e s e n t issue also back to the file of the Assessing Officer/TPO for adoption of prescribed method for determining the arms' length price in relation to AMP expenditure. The Assessing Officer/TPO would provide reasonable opportunity of hearing to the assessee, who in turn is at liberty to furnish fresh list of comparables before the TPO in order to adjudicate the issue afresh. Thus the ground Nos.2.17 to 2.22 raised by the assessee are allowed for statistical purposes.
26. The issue in ground No.2.23 is an alternate ground of appeal raised by the assessee without prejudice to the above said and the contention of the assessee is that while calculating AMP expenditure, the expenditure relating to selling and distribution expenses, marketing and other allied expenses are to be excluded from the alleged AMP expenditure, being not relatable to advertisement and marketing expenditure. The assessee in its reply dated 29.12.2011 filed before the Assessing Officer had elaborately commented upon the report of the TPO which is reproduced at pages 73 to 102 of the assessment order. The assessee had furnished tabulated details before the Assessing Officer under which the following details were considered to be AMP expenditure:
Nature Amount Amount
(Rs.Lacs) (Rs.Lacs)
- Discount - sales 53.35
- Market research 969.16
- Sales promotion 4,460.21
- Scientific research & 244.60
development
- Selling & distribution 1,067.50
- Advertising 10,641.11
- Service charges to selling 11.16
agents
17,447.09
_______
37
27. The plea of the assessee was that out of the total expenditure of Rs.17447.09 lacs expenses totaling Rs.2345.77 were not in the nature of advertisement and sales promotion and the break up of the said expenditure was as under:
Nature Amount Amount
(Rs.Lacs) (Rs.Lacs)
- Discount - sales 53.35
- Market research 969.16
- Selling & distribution 1,067.50
- Scientific research & 244.60
development
- Service charges to selling 11.16
agents
- Total _______ 2,345.77
28. Further plea of the assessee was that the expenses incurred for the brand owned by the assessee company totaled to Rs.4122.18 lacs and while taking AMP expenses which included the expenditure incurred on market research at Rs.969.16 lacs, sale promotion expenses of Rs.4460.21 lacs and selling and distribution expenses of Rs.1067.50 lacs, had to be excluded. The learned A.R. for the assessee has sought permission to move an application for enlargement of ground of appeal 2.23 as in the original ground of appeal it has referred to only two expenses i.e. selling and distribution expenditure and marketing research expenditure, whereas even sales promotion were considered as part of AMP expenses.
29. The learned D.R. for the Revenue had no objection to inclusion of sales promotion expenses as part of ground No.2.23.
30. The learned A.R. for the assessee further pointed out that the Tribunal in assessee's own case vide paras 26 to 29 in the appeal r e l a t i n g t o a s s e s s m e n t ye a r 2 0 0 7 - 0 8 h a d d i r e c t e d t h e A s s e s s i n g O f f i c e r to exclude expenditure incurred on marketing research, sales promotion 38 and selling and distribution as not being linked to the brand promotion of products of AE. The learned A.R. for the assessee fairly pointed out that though out of total sales promotion expenses of Rs.4460.21 lacs the TPO had already excluded expenses relating to local brands to the tune of Rs.1167.35 lacs and had considered the balance sales promotion of international brands. The DRP had directed exclusion of expenses incurred on Scientific Research and discount on sales and the balance expenses considered by the Assessing Officer was Rs.17149.14 lacs.
31. We find that similar issue arose before the Tribunal in assessment year 2007-08 and the Tribunal vide paras 26 to 29 observed as under:
26. The next set of grounds of appeal are ground Nos.2.14 to 2.16 wherein the assessee has raised the issue that the expenditure relating to market research service charges paid to selling agents and discount on sales are to be excluded from the alleged AMP expenditure as being not relatable to advertisement and marketing expenditure. The claim of the learned A.R. for the assessee is that the said issue is also covered by the decision of Special Bench of the Tribunal (majority view) in M/s L.G. Electronics India (P) Ltd. Vs. ACIT (supra) vide paras 18.5 and 18.6 of the decision.
The relevant paras are as under:
18.5. We do not find any force in the contention of the learned DR made in this regard. The logic in the exercise of finding out the AMP expenses towards creation of marketing intangibles for the foreign AE starts with the expenses which are otherwise in the nature of advertisement, marketing and promotion. If an expenditure itself is not in the nature of advertising, marketing or promotion, that ought to be excluded at the very outset. We, therefore, reject this contention raised by the learned DR.
18.6. As we are presently considering the term `advertisement marketing and promotion expenses', which is analogous to, if not lesser in scope than the term `advertisement, publicity and sales promotion' as employed in the erstwhile sub-
sec. (3B) of sec. 37, all the judgments rendered in the context of sub-sec. (3A) & (3B) of sec. 37 will squarely apply to the interpretation of the scope of AMP expenses. We, therefore, hold that the expenses in connection with the sales which do not lead to brand promotion cannot be brought within the ambit of ―advertisement, marketing and promotion expenses‖ for determining the cost/value of the international transaction.
27. The plea of the assessee before us was that expenses aggregating Rs.5500.86 lacs are expenses incurred in connection with sale and do not lead to brand promotion as held by the Special Bench. After excluding the aforesaid selling expenses aggregating to Rs.5500.86 lacs, the remaining expenses of Rs.8679.75 lacs (constituting 6.87% of the total sales) only is 39 required to be considered for the purpose of benchmarking analysis as undertaken by the TPO. The learned D.R. for the Revenue placed reliance on the orders of the authorities below.
28. We have heard the rival contentions and perused the records. The claim of the assessee is that the total AMP expenditure considered by the TPO while determining the ALP included certain expenses which are in relation to the sales made by the assessee and are not related to the brand promotion. The claim of the assessee is with regard to the expenses totaling Rs.5500.86 lacs as tabulated below:
S.No. Name of Expenses Amount
(Rs.Lacs)
1. Discount - sales 60.52
2. Market Research 664.24
3. Sales Promotion 3939.90
4. Selling and distribution 826.17
5. Service charges paid to selling agent 10.03
Total 5500.86
29. We find that the Special Bench of the Tribunal (majority view) in M/s L.G. Electronics India (P) Ltd. Vs. ACIT (supra) held that the expenses in connection with the sales do not lead to brand promotion and thus cannot be brought within the ambit of advertisement, marketing and promotion expenses for determining the cost/value of the international transaction. In view thereof, we direct the Assessing Officer to exclude the expenses incurred by the assessee in connection with the sales totaling Rs.5500.86 lacs as the same do not fall within the ambit of AMP expenses and hence not to be considered for computing the cost/value of international transaction. The assessee vide ground No.4 had raised the issue against disallowance of consumer market research expenses of Rs.567.49 lacs. In view of our decision in allowing the claim of the assessee being relatable to sales promotion expenses, this ground of appeal is thus allowed. The ground Nos.2.14 to 2.16 and ground No.4 are thus allowed.
32. The issue before us is identical to the issue arising before the T r i b u n a l i n e a r l i e r ye a r a n d f o l l o w i n g t h e s a m e p a r i t y o f r e a s o n i n g w e direct the Assessing Officer to exclude the following expenditure as the same do not fall within the AMP expenditure and thus these are not to be considered for computing the cost/value of international transactions.
The expenditure are as under:
40 Nature Amount Amount
(Rs.Lacs) (Rs.Lacs)
Market Research Rs. 969.16
Sales Promotion Rs.3292.86 3292.86
(Rs.4460.21 - Rs.1167.35)
Selling & Distribution expenses Rs.1067.50
33. The assessee vide ground No.3 has raised the issue against
disallowance of consumer market research expenses of Rs.969.16 lacs in view of our decision in allowing the claim of the assessee being relatable to sales promotion expenses this ground of appeal is thus allowed. The ground Nos.2.23 and 3 are thus allowed.
34. The next issue raised b y the assessee is vide ground of appeal Nos.2.24 to 2.30 wherein the assessee is aggrieved by the order of the Assessing Officer in not considering certain companies as comparables for benchmarking, advertisement and publicity expenses. The next grievance of the assessee is that both the TPO and DRP had held that for the purpose of computing the bright line test, AMP expenses of companies which are engaged in brand building exercise and creating marketing intangibles for their brands cannot be taken as comparables, and only routine distributors are to be taken who are not engaged in any brand building exercise. The next contention of the assessee was that t h e A s s e s s i n g O f f i c e r h a d e r r e d i n r e j e c t i n g t h e b e n c h m a r k i n g a n a l ys i s undertaken by the assessee wherein closely linked transactions were benchmarked together and instead segregating the AMP expenses for the prupose of benchmarking such transactions. The assessee was also aggrieved by the findings of the Assessing Officer/DRP that it had rendered service to the AEs by incurring the AMP expense and by holding that markup had to be earned by the assessee in respect of the AMP expenses, alleged to have incurred for and on behalf of the AE.
4135. We find that similar issue arose before the Tribunal in assessee's o w n c a s e r e l a t i n g t o a s s e s s m e n t ye a r 2 0 0 7 - 0 8 a n d t h e T r i b u n a l v i d e paras 30 and 31 had considered the issue and held as under:
30. The assessee vide ground Nos.2.17 and 2.18 had raised the issue of taking into consideration the comparable companies for benchmarking the advertisement and publicity expenses.
Admittedly the same issue has been deliberated upon by the Special Bench of the Tribunal (majority view) in M/s L.G. Electronics India (P) Ltd. Vs. ACIT (supra) vide para 17.6 of the majority view and observed as under:
17.6. In principle, we accept the contention of the ld. AR about the necessity of choosing properly comparable cases in the first instance before starting the exercise of making comparison of the AMP expenses incurred by them for finding out the amount spent by the assessee for its own business purpose.
However the way in which such comparable cases should be chosen, as advocated by the ld. AR, is not acceptable. He submitted that only such comparable cases should be chosen as are using the foreign brand. We find that choosing cases using the foreign brand ex facie cannot be accepted. It is but natural that the AMP expenses of such cases will also include contribution towards brand building of their respective foreign AEs. In such a situation the comparison would become meaningless as their total AMP expenses will stand on the same footing as that of the assessee before the exclusion of expenses in relation to brand building for the foreign AE. The correct way to make a meaningful comparison is to choose comparable domestic cases not using any foreign brand. Of course when effect will be given to the relevant factors as discussed above, it will correctly reflect the cost/value of international transaction.
31. The plea of the assessee in this regard was that the expenditure was incurred on foreign brand name i.e Horlicks and also on domestic brands such as Boost, Viva, Maltova, etc., and the expense as a percentage on sales of foreign brand was 10.37% and on domestic brand was 14.02%. Consequently the AMP expenditure incurred on foreign brand being lower than what is incurred on domestic product, no transfer pricing adjustment is to be made. As the issue of determining the transfer pricing adjustment in relation to AMP expenses incurred by the assessee being set aside to the file of TPO for redetermining the ALP of international transaction after considering the comparables companies, we direct the TPO to consider the aspect raised by the assessee in this regard and redetermine the value of arms' length price in relation to the AMP expenditure incurred by the assessee for the brand promotion of the foreign brand and also following the directions given by the Special Bench of the Tribunal (majority view) in M/s L.G. Electronics India (P) Ltd. Vs. ACIT (supra) in this regard. The ground Nos.2.17 and 2.18 are thus allowed for statistical purposes.
36. As the issue of determining the transfer pricing adjustment in r e l a t i o n t o A M P e x p e n s e s i n c u r r e d b y t h e a s s e s s e e d u r i n g t h e ye a r u n d e r 42 consideration had been sent to the file of the Assessing Officer/TPO as per our directions in the paras hereinabove, we direct the TPO to consider the present aspect raised by the assessee also in this regard and redetermine the value of arms' length price in relation to AMP expenses incurred by the assessee for brand promotion of foreign brand in turn following the observations of the majority view of the Special Bench of the Tribunal (majority view) in M/s L.G. Electronics India (P) Ltd. Vs. ACIT (supra). The assessee is at libert y to file list of fresh comparables in this regard before the Assessing Officer/TPO in line with the majority view of Special Bench of the Tribunal in M/s L.G.Electronics India P. Ltd. Vs. ACIT (supra). The ground Nos.2.24 to 2.30 are thus allowed for statistical purposes.
37. The issue in ground No.3 has been adjudicated by us alongwith ground No.2.23 in paras hereinabove and the said ground of appeal No.3 is thus allowed. In view of our allowing ground No.3 the ground No.3.1 raised by the assessee being without prejudice to the same thus becomes infructuous and the same is dismissed.
38. The issue raised vide ground No.4 is against the disallowance made under section 43B of the Act in relation to the deduction claimed t o w a r d s t h e c l o s i n g b a l a n c e a m o u n t i n g t o R s . 3 2 , 6 2 , 7 8 6 / - l yi n g i n P r o f i t & Loss Account. The second aspect of the issue is vide ground No.4.1 by which the assessee is aggrieved by the order of Assessing Officer in reducing the returned income by reducing sum of Rs.170.88 lacs, though t h e a s s e s s e e h a d c l a i m e d d e d u c t i o n o f t h e c l o s i n g b a l a n c e l yi n g i n P r o f i t & Loss Account amounting to Rs.32,62,786/-.
39. The brief facts relating to the issue are that the assessee during the year under consideration had claimed deduction at Rs.32,62,786/- on 43 account of difference in excise duty deposited/balance with the Excise D e p a r t m e n t a t t h e e n d o f c u r r e n t f i n a n c i a l ye a r a n d p r e v i o u s f i n a n c i a l year. The Assessing Officer vide para 2.5 at page 4 of the assessment order observed as under:
2.5 This year, the total deposit with Excise Authorities as on 31-03-2008 was Rs.32,62,786/-whereas the same amount as on 31-03-2007 was Rs.2,03,50,951/- and accordingly, the assessee has reduced its income by Rs.1,70,88,165/- (i.e. difference between Opening Excise Balance of Rs.32,62,786/- and Closing Excise Balance of Rs.2,03,50,951/-) in the return. Since the claim for deduction of Rs.36,87,481/- was not accepted in the previous year, therefore, in order to V" maintain judicial consistency in the stand taken by the Department in the earlier years in the assessee's own case, the addition of Rs.1,70,88,165/- is not called for in the current year which is subject to rectification u/s 154 as per decision of Appellate Authorities for earlier assessment years. Accordingly, the returned income will decrease by the said amount of Rs.1,70,88,165/-.
40. The Assessing Officer disallowed the claim of the assessee in view of the appeal pending before the appellate authority on this issue.
41. The learned A.R. for the assessee pointed out that similar issue a r o s e b e f o r e t h e T r i b u n a l i n a s s e s s e e ' s o w n c a s e i n t h e p r e c e d i n g ye a r and the Tribunal vide paras 38 to 41 allowed the claim of the assessee in turn following the ratio laid down by the Special Bench of the Tribunal in assessee's own case in ITA No.343/Chd/2005 relating to assessment year 2001-02 reported in 107 ITD 343 (Chd)(SB). We find that identical issue arose before the Tribunal in assessee's own case in e a r l i e r ye a r w h e r e i n c o n t e n t i o n o f t h e a s s e s s e e w a s a s u n d e r :
36. The learned A.R. for the assessee pointed out that the issue stands covered in favour of the assessee by the decision of the Special Bench of the Tribunal in assessee's own case relating to assessment year 2001-
02, reported in 107 ITD 343 (Chd)(SB). The learned A.R. for the assessee pointed out that the Tribunal in assessment years 1998-99 to 2000-01 and 2002-03 to 2006-07 had followed the order of the Special Bench of Tribunal and allowed the relief to the assessee.
Further reliance was placed in CIT Vs. Raj & Sandeeps L t d . [ 2 9 3 I T R 1 2 ( P &H )] , C I T V s . M o d i p o n L t d . [ 3 3 4 I T R 1 0 6 ( D e l )] a n d C I T V s . M a r u t i S u z u k i I n d i a L t d .
44[ 2 5 0 C T R 1 4 0 ( D e l )] . The learned A.R. for the assessee further pointed out that the Hon'ble Supreme Court in CIT Vs. Shri Ram Honda Power Equipment Corporation in Civil Appeal No.5721 of 2012 vide judgment dated 19.9.2012 had laid down that the credit of the excise duty paid was to be allowed. The learned A.R. for the assessee further referred to the ratio laid down by the Hon'ble Delhi High Court in CIT Vs. Maruti Suzuki India Ltd. (supra) and pointed out that the only issue raised was in connection with the excess payment made on account of excise duty, which was lying in the PLA Account .
42. The Tribunal vide paras 38 to 42 held as under:
38. We have heard the rival contentions and perused the record.
The issue arising vide ground of appeal No.3 is against disallowance made under section 43B of the Act on account of excess payment made on account of excise duty. The assessee during the year under consideration had claimed expenditure of Rs.36,87,481/- being the difference between the excise deposit with the excise department i.e. the balance in the central excise lying in PLA Account as on 31.3.2007 and as on 31.3.2006. The said sum of Rs.36,87,481/- represents the excess payment made to the excise authorities, which as per the assessee could be used to offset the payment of excise duty on the final products. The difference in the total balance of two accounts i.e. on 31.3.2007 and 31.3.2006 of Rs.36,87,481/- was claimed by the assessee as a deduction under the provisions of section 43B of the Act. The present issue raised vide ground No.3 stands covered in favour of the assessee by the order of the Special Bench of the Chandigarh Tribunal in assessee's own case relating to assessment year 2001-02, reported in 107 ITR 343 (Chd)(SB) (supra). The said deduction had been consistently allowed in the case of the assessee i.e. in the preceding years 1998-99 to 2000-01 and thereafter in assessment years 2002-03 to 2006-07. The Tribunal in ITA No.1238/Chd/2010 relating to assessment year 2006-07 - order dated 25.1.2012 vide para 49 allowed the claim of the assessee in turn following the ratio laid down by the Hon'ble Punjab & Haryana High Court in CIT Vs. Raj & Sandeeps Ltd. (supra) observing as under:
"49. The present issue is covered by the decision of Special Bench in the case of the assessee itself.
Further the Jurisdictional High Court in Raj & San Deeps Ltd. (supra) has held that where the assessee had deposited the excise duty payable in advance in account-current, after the goods were manufactured, such amount was deductible.
Following the same, we direct the Assessing Officer to allow the claim of the assessee in respect of incremental balance amounting to Rs.25,23,710/- lying in PLA Account, under section 43B of the Act. The ground No.4 is allowed."45
39. The Hon'ble Punjab & Haryana High Court in Ran & Sandeeps Ltd. (supra) held as under:
Held, that it was found as a fact by the Tribunal that duty as per the statutory provisions became payable, the moment goods were manufactured and the assessee was under an obligation to deposit that amount in the "account-current" and the amount so deposited in the "account-current" being non refundable, there was no reason for the Revenue to deny the benefit of deduction in the year in question when the goods were manufactured and the amount was deposited in the "account- current". The expense would certainly relate to the year in which the goods were manufactured and the amount was deposited, which the goods were manufactured and the amount was deposited, which could not possible be treated as an advance. The amount was deductible.
40. Further the Delhi High Court in CIT Vs. Modipon Ltd. (supra) had allowed similar claim of excise duty paid in advance under the provisions of section 43B of the Act and held as under:
(ii) That with regard to the deduction of Rs. 14,71,387/- on account of excise duty paid in advance as business expenditure, the procedure envisaged for payment of excise duty envisages such duty to be deposited in advance with the treasury before the goods were removed from the factory premises. The duty, thus, already stood deposited in the accounts of the assessee maintained with the treasury and the amount, thus, stood paid to the State.
The submission of the Department that it was only on removal of the goods that the amount credited to the personal ledger account could be claimed as deductible under section 43B of the Income Tax Act, 1961, could not be accepted.
41. Further the Hon'ble Delhi High Court in CIT Vs. Maruti Suzuki India Ltd. (supra) also deliberated upon the payment made towards excise duty in Personal Ledger Account and consequent allowance under section 43B of the Act and held as under:
A plain reading of s. 43B clarifies that : (a) deduction claimed by the assessee must be "otherwise" allowable under the other provisions of the Act; (b) the deduction must relate to any sum payable by way of tax, duty, cess or fee; (c) the assessee must have incurred liability in respect of such tax, duty, etc. On fulfilling these conditions, the assessee's claim can be allowed in the year in which actual payment is made, notwithstanding the year in which liability is incurred. The term "liability to pay such sum was incurred by the assessee" together with the words "a sum for which the assessee incurred liability" in Expln. 2 underline that payment must relate to the incurred liability to be called 'any sum payable'. In the present case, the assessee had no option, but to keep the account, in respect of each excisable product (evident from the mandate in r. 173G that it "shall keep an account current"). The latter part of the main rule makes it clear beyond any doubt that the assessee has no choice in the obligation, and cannot remove the goods manufactured by it, unless sufficient amounts are kept in credit. The Revenue's contention that the amounts in credit also relate to goods not manufactured, and therefore, not relatable to any "liability Incurred" is without any basis.. The arrangement prescribed by the rule is both a collection mechanism -- dictated by convenience, as well 'as mandatory. It is convenient, for the reason, that if the assessee were to be asked to pay the exact amount, through some other method, by deposit, as a precondition for clearance, that would have been cumbersome to it as well as the Revenue; it would also have led to problems of storage of goods and slow down their supply and distribution. The rule-makers pragmatically directed that "sufficient" amounts ought to be maintained in the account, to cover the removals. Therefore, at any given point of time, there had to be an excess in 46 the account, if the assessee were to remove the goods. Each clearance mentions the- quantum of goods and the duty amount, which is apparently reconciled at the end of the period, and shortfalls if any are appropriated from the account. The excess credit is likewise adjusted for the next day's clearances. The point to be underlined, is that there is no choice, and the amounts relate to the assessee's duty liability, falling within the description under s. 43B. The Tribunal was therefore justified in holding that the amounts deposited by the assessee in the Excise Personal Ledger Account could not be disallowed under s. 43B.--CIT vs. Shri Ram Honda Power Equipment Corporation (Civil Appeal No. 5721 of.2012, dt. 19th Sept., 2012) followed; CIT vs. C.L Gupta & Sons (2003) 180 CTR (All) 530 : (2003) 259 ITR 513 (All) concurred with.
42. The Hon'ble Delhi High Court in CIT Vs. Maruti Suzuki India Ltd. (supra) in turn relied upon the ratio laid down by the Hon'ble Supreme Court in CIT Vs. Shri Ram Honda Power Equipment Corporation (supra), wherein it has been laid down that the PLA credit was excise duty paid. The said observation was made where the assessee was following net method of valuation of closing stock. In view of the above said ratio laid down by the Hon'ble Delhi High Court in CIT Vs. Maruti Suzuki India Ltd. (supra), CIT Vs. Modipon Ltd. (supra), Hon'ble Punjab & Haryana High Court in Raj & San Deeps Ltd. (supra) and also the Special Bench of the Tribunal in assessee's own case, we direct the Assessing Officer to allow the claim of expenditure of Rs.36,87,481/- claimed under the provisions of section 43B of the Act. The ground No.3 raised by the assessee is thus allowed.
43. Following the above said parity of reasoning we direct the Assessing Officer to allow expenditure of Rs.32,62,786/-. Further the second plea of the assessee in respect of the addition of Rs.1,70,88,165/-
is not warranted. However, the Assessing Officer shall verify the claim of the assessee in this regard and after affording reasonable opportunity of hearing shall work out the consequential effect. The ground No.4 raised by the assessee is allowed and ground No.4.1 is allowed for statistical purposes.
44. The ground Nos.5 to 5.2 relate to the addition made on account of disallowance of Rs.1.72 crores in respect of liability of post retirement m e d i c a l b e n e f i t s t o e m p l o ye e s . The learned A.R. for the assessee pointed out that similar issue arose before the Tribunal in assessment year 2007-08 and the same had been decided in favour of the assessee.
Another aspect which was pointed out by the learned A.R. for the 47 a s s e s s e e t h a t i n t h e p r e c e d i n g ye a r , t h e s a i d a m o u n t w a s d e b i t e d t o t h e reserve account, however during the year under consideration the said amount had been debited to the Profit & Loss Account.
45. T h e b r i e f f a c t s r e l a t i n g t o t h e i s s u e a r e t h a t d u r i n g t h e ye a r u n d e r consideration the assessee had claimed expenditure of Rs.1.72 crores on a c c o u n t o f m e d i c a l r e i m b u r s e m e n t t o t h e e x - e m p l o ye e s o n t h e b a s i s o f actuarial valuation. The assessee during the preceding year had charged the said amount to the general reserve. H o w e v e r , d u r i n g t h e ye a r u n d e r consideration the said amount was debited to the Profit & Loss Account and said fact has been noted by the Assessing Officer vide paras 7.1 at page 15 of the assessment order. The Assessing Officer rejecting the explanation filed by the assessee in respect of the deductibility of the said expenditure proposed disallowance of the claim of Rs.1.72 crores, which in turn was confirmed by the DRP and consequent order was passed by the Assessing Officer. We find that similar issue arose before t h e T r i b u n a l i n a s s e s s e e ' s o w n c a s e r e l a t i n g t o a s s e s s m e n t ye a r 2 0 0 7 - 0 8 and the Tribunal vide paras 51 to 63 held as under:
51. We have heard the rival contentions and perused the record.
The assessee was providing benefit of medical assistance/reimbursement of medical expenses to the employees post retirement. The said benefit was being allowed by the assessee in terms of the employment agreed upon between the company and the employees at the time of their appointment. In order to meet the said liability of providing medical benefits/assistance to its employees post retirement, the assessee was contributing towards the insurance policy taken for the said purpose. The assessee prior to the year under consideration had claimed and was allowed deduction in respect of the premium paid for keeping afloat the medical insurance policy taken for the benefit of employees from year to year. Such medi-claim insurance policies were taken by the assessee in order to provide medical assistance post retirement to the employees. However, during the year under consideration the Institute of Chartered Accountants revised the Accounting Standard-15 which is reproduced at pages 29 to 31 of the assessment order under which the Institute issued revised accounting standard for accounting the employees' medical benefit post retirement. As per the assessee, the ICAI made the said Accounting Standard to be followed compulsorily w.e.f.48
1.4.2006 i.e. assessment year 2007-08 i.e. the year under appeal.
The gist of the revised Accounting Standard-15 is reproduced at pages 29 to 31 of the assessment order. However, the copy of the Accounting Standard-15 is enclosed at pages 836 to 902 of the Paper Book. The objective of the revised Accounting Standard-15 is to prescribe the accounting and disclosure for employee benefits. The Standard requires an enterprise to recognize:
(a) Allowability when an employee has provided service in exchange for employee benefits to be paid in the future; and
(b) An expenses when the enterprise consumes the economic benefit arising from service provided by an employee in exchange for employee benefits.
52. The scope of the said Accounting Standard-15 was mandatorily to be applied by an employer in accounting for all employee benefits, except employee share-based payment. Clause- 4 defines employee benefits include:
(a) Short-term employee benefits, such as wages, salaries and social security contributions (e.g., contribution to an insurance company by an employer to pay for medical care of its employees), paid annual leave, profit-sharing and bonuses (if payable within twelve months of the end of the period) and non-monetary benefits (such as medical care, housing, cars and free or subsidized goods or services) for current employees;
(b) Post-employment benefits such as gratuity, pension, other retirement benefits, post-employment life insurance and post-employment medical care;
(c) Other long-term employee benefits, including long-
service leave or sabbatical leave, jubilee or other long- service benefits, long-term disability benefits and, if they are not payable wholly within twelve months after the end of the period, profit-sharing, bonuses and deferred compensation.
53. Clause 7.3 of Revised AS-15 defines that post-employment benefits are employee benefits (other than termination benefits) which are payable after the completion of employment. Clause 24 of Revised AS-15 provides post-employment benefits include:
(a) Retirement benefits, e.g., gratuity and pension; and
(b) Other benefits, e.g., post-employment life insurance and post-employment medical care.
Arrangements whereby an enterprises provides post-
employment benefits are post-employment benefit plans. An enterprises applies this Standard to all such arrangements whether or not they involve the establishment of a separate entity to receive contributions and to pay benefits.
4954. Under clause 73 of Revised AS-15 it has been laid down that actuarial assumptions are to be worked out and should be more than unbiased and mutually compatible. Further the method of working actuarial benefits is to be laid down under Accounting Standard-15. Further in respect of termination benefits, as per clause 133 it is provided that the termination benefits are to be treated separately from other employee benefits as the event which gave rise to the obligation is the termination rather than employee service. Under clause 134 it is laid down that an enterprise should recognize termination benefits as a liability and an expense when, and only when:
(a) The enterprise has a present obligation as a result of a past event;
(b) It is probable that an outflow of resources embodying economic benefits will be required to settle the obligation;
and
(c) A reliable estimate can be made of the amount of the obligation.
55. Clause 137 of Revised AS-15 provides that termination benefits are recognized as an expenses immediately. Under clause 138 it is provided that where an enterprise recognizes termination benefits, the enterprise may also have to account for a curtailment of retirement benefits or other employee benefits.
56. The assessee admittedly followed the revised Accounting Standard-15. In view thereof the assessee obtained an actuarial valuation certificate which reads as under:
ACTUARIAL VALUATION CERTIFICATE - MEDICAL Ref:Actval/m/gsk_0307 GlaxoSmithKline Consumer Healthcare Limited.
Re: Actuarial Valuation - Post Retirement Medical Assistance as on 31.03.2007.
The actuarial value of liability of the Company towards post retirement medical assistance to the retired /retiring officers as per the Company's Scheme upto the date of valuation mentioned above has been calculated and the results of valuation are as given below:
1. BASIS:
(a) Discount Rate - 8.00 % p.a.
(b) Mortality - L.I.C. (1994-96) Ult.
(c) Rate of Withdrawal - As applicable to the group.
(d) Projected Unit Credit Method adopted.
2. DETAILS OF STAFF:
50The individual details in respect of 366 officers covered by these benefits & 140 retired officers have been made available for the purpose.
3. BENEFITS:
The medical assistance is granted for due to accident or sickness and is limited as under:
Directors: Rs1,50,000 per year
Managers: Rs.1,50,000 per year
Executives: Rs.1,00,000 per year
The Company has assured the benefits with National Insurance Company and pays premium annually. Such premium and any increase of the same has been duly considered.
4. VALUATION RESULTS:
THIS IS TO CERTIFY THAT as per the ACTUARIAL VALUATION the total value of the post retirement Medical assistance benefit under the above assumptions works out to:-
Rs. 11,73,99,623.00p.
5. The purpose of this valuation is to make incremental provision in the Books of Account. The valuation has been carried out keeping in view the provisions of AS-15 ( R ) as an on going concern basis. (A.D.GUPTA)
57. The auditors vide notes to the accounts vide note No.6 had reported as under:
"6. (a) The Company has during the year adopted Accounting Standard 15 (Revised 2005) 'Employees Benefits'. Accordingly, the transitional adjustment aggregating to Rs.11,37.19 Lakhs (net of deferred tax asset rsNil) has been charged against the Opening General Reserves. The details of the transitional adjustment is as follows -
- Post Employment Medical Assistance Scheme Rs.11,09.90 Lakhs - Leave Encashment/Compensated Rs.27.29 Lakhs Absences for workers (Earned/Sick Leave)(Also Refer Scheme 2)
58. The assessee accordingly made a provision of Rs.1636.20 lacs on account of employees benefits which included the provisions for post retirement medical benefits to employees at Rs.11.09 crores. The above said amount was booked as an expenditure for computation of income in compliance to the mandatory revised Accounting Standard-15. The claim of the assessee in respect of the above said expenditure was as under:
(a) The said deduction has been claimed for the first time during the relevant assessment year, in view of compliance of mandatory revised Accounting Standard-15.
(b) Since the provision was made by the assessee on the basis of actuarial valuation in respect of an accrued liability for the entitlement earned by the employees while in service, the same was clearly allowable as deduction.51
(c) Under the mercantile system of accounting, deduction of expenditure is allowable in the year in which liability is quantified and accrued, notwithstanding that the same has to be discharged at a later date.
(d) Further, the aforesaid liability incurred towards medical benefits was only an incremental liability after considering/reducing the amount of medical insurance premium paid to insurance companies. The said liability incurred, thus, did not include the amount of premium paid for which deduction was already claimed.
(e) The deduction was claimed because of change in the method of accounting and where there is a bonafide change in the method of accounting, the claims on the basis of the changed method, even if pertaining to earlier years, would be allowable deduction in the year of change, more so since the liability in regard thereto has not been claimed deduction in such earlier years.
(f) Since the liability on account of medical assistance pertaining to services rendered in the earlier years has been accounted or claimed in the relevant year for the first time, in view of the bonafide change in the method of accounting (pursuant to mandatory AS-15 (Revised), for which no deduction was claimed in the earlier years nor would be claimed again in the year of payment, the said liability is allowable deduction in the relevant year itself.
The deduction on account of liability towards medical reimbursement expenses aggregating to Rs.11.09 crores being actuarial valuation in respect of subsisting liability has been correctly claimed by the appellant.
(g) The Assessing Officer had disallowed the claim of the assessee observing that;
(a) The amount of liability, which was incurred on the basis of actuarial valuation, was made on the basis of certain assumption and, thus, the same cannot be said to be ascertained liability.
(b) The assessee has claimed double deduction in respect of same liability, viz., once at the time of payment of premium of insurance companies and secondly, at the time of creating the impugned provision for medical benefits.
59. The first aspect of the issue raised before us is whether the recognition of the liability in view of the revised Accounting Standard-15 which is a notified accounting standard by the ICAI is to be recognized while computing the income of the assessee in line with the method of accounting regularly followed by the assessee. The second aspect of the issue is whether such expenditure is to be allowed as a deduction though the liability has been recognized in 52 the year under consideration but the same has to be incurred in the succeeding year.
60. Their lordship of Hon'ble Supreme Court in Bharat Earth Movers Vs. CIT (supra) held that the provision made for meeting liability of leave encashment scheme is to be allowed as deduction, observing as under:
The law is settled : if a business liability has definitely arisen in the accounting year, the deduction should be allowed although the liability may have to be quantified and discharged at a future date. What should be certain is the incurring of the liability. It should also be capable of being estimated with reasonable certainty though the actual quantification may not be possible. If these requirements are satisfied the liability is not a contingent one. The liability is in praesenti though it will be discharged at a future date. It does not make any difference if the future date on which the liability shall have to be discharged is not certain.
In Metal Box Company of India Ltd. vs Their Workmen ( 1969 ) 73 ITR 53 ( SC ), the appellant-company estimated its liability under two gratuity schemes framed by the company and the amount of liability was deducted from the gross receipts in the profit and loss account. The company had worked out on an actuarial valuation its estimated liability and made provision for such liability not all at once but spread over a number of years. The practice followed by the company was that every year the company worked out the additional liability incurred by it on the employees putting in every additional year of service. The gratuity was payable on the termination of an employee's service either due to retirement, death or termination of service - the exact time of occurrence of the latter two events being not determinable with exactitude before hand. A few principles were laid down by this court, the relevant of which for our purpose are extracted and reproduced as under :
(i) For an assessee maintaining his accounts on the mercantile system, a liability already accrued, though to be discharged at a future date, would be a proper deduction while working out the profits and gains of his business, regard being had to the accepted principles of commercial practice and accountancy. It is not as if such deduction is permissible only in the case of amounts actually expended or paid;
(ii) Just as receipts, though not actual receipts but accrued due are brought in for income-tax assessment, so also liabilities accrued due would be taken into account while working out the profits and gains of the business;
(iii) A condition subsequent, the fulfilment of which may result in the reduction or even extinction of the liability, would not have the effect of converting that liability into a contingent liability;
(iv) A trader computing his taxable profits for a particular year may properly deduct not only the payments actually made to his employees but also the present value of any payments in respect of their services in that year to be made in a subsequent year if it can be satisfactorily estimated.
So is the view taken in Calcutta Co. Ltd. vs CIT ( 1959 ) 37 ITR 1 ( SC ) wherein this court has held that the liability on the assessee having been imported, the liability would be an accrued liability and would not convert into a conditional one merely because the liability was to be discharged at a future date. There may be some difficulty in the estimation thereof but that would not convert the 53 accrued liability into a conditional one; it was always open to the tax authorities concerned to arrive at a proper estimate of the liability having regard to all the circumstances of the case.
Applying the abovesaid settled principles to the facts of the case at hand we are satisfied that the provision made by the appellant-company for meeting the liability incurred by it under the leave encashment scheme proportionate with the entitlement earned by employees of the company, inclusive of the officers and the staff, subject to the ceiling on accumulation as applicable on the relevant date, is entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability. The liability is not a contingent liability. The High Court was not right in taking the view to the contrary.
The appeal is allowed. The judgment under appeal is set aside. The question referred by the Tribunal to the High Court is answered in the affirmative, i.e., in favour of the assessee and against the Revenue.
61. In the facts of the present case before us the assessee had recognized and accounted for the post retirement benefit due to its employees, in terms of the scheme of employment and also in terms of the revised/change in Accounting Standard-15 issued by ICAI which was to be followed during the year, is an allowable deduction in the hands of the assessee. The said claim being based on the valuation of the actuary is both scientific and one of the recognized method of accounting and quantifying the said post retiremental medical benefits. In such cases though actual and exact quantification may not be possible, however, the liability so recognized by the assessee could not be said to be unascertained and contingent. The assessee having followed the mercantile system of accounting was compulsorily required to account for the said post retirement medical benefits as the same was quantified and had accrued during the year. The claim of the assessee was thus allowable irrespective of the fact that the assessee had made a provision in the books of account but had claimed the said deduction in the computation of income. It is well settled proposition that the way in which entries are made by the assessee in its books of account is not determinative of the question whether the assessee had earned any profit or suffered any loss as held by the Hon'ble Apex Court in Sutlej Cotton Mills Ltd. Vs. CIT (supra). It was further held by the Hon'ble Apex Court that what is necessary to be considered is the true nature of transaction and whether in fact it has resulted in profit or loss to the assessee. Further the said deduction was claimed during the year under consideration and the claim being bonafide is to be allowed in the year in which the same accrues though the said liability is to be discharged at a later date.
62. Identical issue arose in Bokaro Power Supply Co. (P) Ltd. Vs DCIT (supra) of allowability of claim of deduction of post retirement medical benefits on the basis of actuarial valuation and the same was held to be not an unascertained liability and was held as allowable, observing as under:
5. We have heard both the sides on the issue. We have also perused the order of authorities below. The assessee company of was liable to pay for medical expenses of 54 its retired employees in accordance with the terms of employment. Prior to this year, the assessee was claiming these expenses in the year of expenditure. Due to the change in the Accounting Standard in respect of the accounting of post retirement benefits, the assessee got done the actuarial valuation of these liabilities and started claiming the same on that basis. It is claimed in view of the Accounting Standard, AS-15. This claim was based on the valuation of liability on actuarial and scientific basis. In such cases, the actual and exact quantification may not be possible, however, liability cannot be said to be a contingent one. Since the provision has been made on scientific basis and the assessee is following mercantile system of accounting, therefore, in our considered view, the CIT (A) was justified in deleting the addition while deciding ITA No.149/Del/2012. A liability which has already accrued though discharged on a future date would be entitled for deduction. While working out the profit & gain of the business the accrued receipts are brought to the tax, similarly, accrued liabilities due would also be entitled for deduction while working out the profit and gain of the business of the year. Computation of taxable profit for a particular year can be worked out only by deducting the actual payments made to the employees and present value of any payment in respect of the services in that particular year to be made in subsequent year. In view of this, we find the order of CIT (A) in ITA No.149/Del/2012 in order.
We set aside the order of CIT (A) in ITA No.4921/Del/2010. For doing so, we also get support from the following decisions of Hon'ble Supreme Court and Hon'ble Delhi High Court. 5.1 Hon'ble Supreme Court in the case of Metal Box Company of India Ltd. vs. Their Workmen - 73 ITR 53 has held as under :-
" Contingent liabilities discounted and valued as necessary, can be taken into account as trading expenses if they are sufficiently certain to be capable of valuation and if profits cannot be properly estimated without taking them into consideration. An estimated liability under a scheme of gratuity, if property ascertainable and its present value is discounted, is deductible from the gross receipts while preparing the profit and loss account. This is recognised in trade circles and there is nothing in the Bonus Act which prohibits such a practice. Such a provision provides for a known liability of which the amount can be determined with substantial accuracy. It cannot, therefore, be termed a "reserve". Therefore, the estimated liability for the year on account of a scheme of gratuity should be allowed to be deducted from the gross profits. The allowance is not restricted to the actual payment of gratuity during the year. Where the fixed assets are revalued and the difference between its cost and the value fixed on such revaluation is credited to the capital reserve, unless the Tribunal finds that the revaluation is mala fide, the interest on the amount of the reserve should be allowed as a deduction from the gross profits.
From the provisions of section 6(c) and section 7 of the Bonus Act, it is evident that the Tribunal must first estimate the amount of direct taxes on the balance of gross profits as worked out under sections 4 and 6, but without deduction bonus, then work out the quantum of taxes thereon at rates applicable during the year to the income, profits and gains of the employer and, after deducting the amount of taxes so worked out, arrive at the available surplus. This will be consistent with the rule laid down by courts and tribunals before the Act was enacted, that the bonus amount should be calculated after provision for tax was made and not before, from which Parliament does not appear to have made a departure."
Hon'ble Supreme Court in the case of Bharat Earth Movers Limited vs. CIT - 245 ITR 428 = (2002-TIOL-123-SCrm has held as under :-
"Held, reversing the decision of the High Court, that the provisions made by the assessee-company for meeting the liability incurred by it under the leave encashment scheme proportionate with the entitlement earned by the employees of the company, inclusive of the officers and the staff, subject to the ceiling on accumulation as applicable on the relevant date, was entitled to deduction out of the gross receipts for the accounting year during which the provision is made for the liability. The liability is not a contingent liability."55
Hon'ble Delhi High Court in the case of CIT vs. Insilco Limited - 197 Taxman 55 has held as under :-
"Similarly it was held by the Hon'ble Delhi High Court in the case of CIT vs. Insilco Ltd. that where the provisions were estimated on the basis of actuarial calculations, the deduction claimed by the assessee has to be allowed. The relevant extracts of the decision is reproduced below for ready reference:- "6. In the case of Shree Sajjan Mills Ltd (supra), the Supreme Court was examining the provision-made by the assessee towards gratuity under the Income Tax Act, 1961. The Supreme Court, after noticing the judgment in Metal Box Company (supra), crystallized its analysis at page 599 and made the following observations:- "It would thus be apparent from the analysis aforesaid that the position till the provisions of section 40A(7) were inserted in the Act in 1973 was as follows:- 1 xxxx 2 xxxx 3 xxxx 4 xxxx 5. Provision made in the profit and loss account for the estimated present value of the contingent liability properly ascertained and discounted on an accrued basis as falling on the assessee in the year of account could be deductible either under Section 28 or section 37 of the Act." ITA 873/2008 & 1156/2008 Page 6 of 25
7. The Division Bench of this Court, while considering deductibility of a provision for warranties made by an assessee, which dealt in computers in the case of CIT vs Hewlett Packard India (P) Ltd, by its judgment passed in Appeal No. ITA 486/2006 dated 31.03.2008, upheld the deductibility of the provision for warranty on the ground that it was made on the basis of actuarial valuation being covered by the principle set out in Metal Box Company (supra). In view of the aforesaid decisions and given the fact that the provision was estimated based on actuarial calculations, we are of the opinion that the deduction claimed by the assessee had to be allowed. We find no fault with the reasoning of the Tribunal. No substantial question of law arises for our consideration." 5.2 Considering the facts of the assessee's case and also the decision of Hon'ble Supreme Court and Hon'ble jurisdictional High Court, we sustain the order of CIT (A) in ITA No.149/Del/2012 on this issue. We allow ITA No. 4921'/Del/2010 and dismiss revenue's appeal on this ground.
63. In view thereof, we direct the Assessing Officer to allow the deduction of Rs.11.09 crores on account of post retirement medical benefits. The ground Nos.5 and 6 raised by the assessee are thus allowed.
46. The issue arising before us is identical to the issue arose before the Tribunal in assessee's own case and following the same parity of reasoning, we direct the Assessing Officer to allow the claim of the assessee in respect of the post retirement medical benefits to the e m p l o ye e s c l a i m e d a t R s . 1 . 7 2 c r o r e s . T h e g r o u n d o f a p p e a l N o s . 5 t o 5 . 2 raised by the assessee are thus allowed.
47. The ground Nos. 6 to 6.2 raised by the assessee are against disallowance of expenditure aggregating Rs.5556.64 lacs incurred by the a s s e s s e e o n a c c o u n t o f r o ya l t y.
5648. The brief facts relating to the issue are that the assessee had c l a i m e d e x p e n d i t u r e o n r o ya l t y a t R s . 5 5 5 6 . 6 4 l a c s d u r i n g t h e ye a r u n d e r consideration. The claim of the assessee was that it had entered into an agreement dated 7.2.1997 with M/s GlaxoAmithKline Asia Pvt. Ltd.
(GSKAP), which provided a non exclusive right to use the trademarks upon or in relation to the Contract Products (as listed in the schedule to the agreement) for sale in India, Nepal and Bhutan during the term of the a g r e e m e n t . S u c h r o ya l t y w a s p a i d a t t h e p r e s c r i b e d r a t e o n t h e n e t s a l e s value of the contract products sold. The Assessing Officer vide para 9.2 h a d o b s e r v e d t h a t t h e s a i d r o ya l t y w a s b e i n g p a i d b y t h e a s s e s s e e f r o m y e a r t o ye a r @ 5 % o f t h e n e t s a l e s o f t h e p r o d u c t s b e a r i n g t r a d e m a r k 'Horlicks' and claiming the same as revenue expenditure. The reply of the assessee is incorporated under para 9.3 at pages 29 to 41 of the assessment order. The Assessing Officer proposed disallowance of the c l a i m o f r o ya l t y h o l d i n g t h e s a m e t o b e c a p i t a l i n n a t u r e o n t h e g r o u n d that the similar issue had been raised by the Revenue in the case of Swaraj Engines Ltd., [309 ITR 443(SC)] wherein the matter had been r e m i t t e d b a c k t o t h e H o n ' b l e P u n j a b & H a r ya n a H i g h C o u r t b y t h e Hon'ble Apex Court. The DRP directed the Assessing Officer to redetermine the issue observing as under:
"We have carefully considered this issue. It is seen that this issue is covered by the judgment of the Supreme Court in the case of Swaraj Engines Ltd. 309 ITR 443 (SC). The AO is directed to re-determine this issue after verification of facts with the references to the agreement in questions entered into by the assessee with M/s Glaxo Smithkline Asia Ltd. on 7/2/97, in view of he directions of he Hon'ble SC in their aforesaid judgment."
49. The Assessing Officer on perusal of judgment of Hon'ble Supreme Court in the case of Swaraj Engines Ltd. (supra) held as under:
579.7 Perusal of the judgement shows that the basic issue as to whether the royalty paid is revenue or capital in nature has been remitted back and depending on the answer to that question, the issue of applicability of section 35AB of the Income Tax Act, 1961 is to be decided by the Hon'ble Courts. The Hon'ble Supreme Court has also held that the High Court is to decide whether the expenditure is revenue or capital in nature after construing the agreement between the parties.
9.8 Hence, it is seen that the Hon'ble Supreme Court has remitted the issues for fresh consideration by the High Court. In view of the discussion above, it is clear that the issue has not been settled and is not finalized in the case of M/s Swaraj Engines (supra). Accordingly, no action as a result of this judgement can be taken in this case.
9.9 Accordingly, in order to have a consistent stand, the expenditure aggregating to Rs.55,56,64,000/- incurred by the assessee on account of royalty is held to be capital in •attire and disallowed subject to the final outcome in the case of M/s Swaraj Engines (supra). Penalty proceeding u/s 271(l)(c) of the Income Tax Act are initiated separately for furnishing inaccurate particulars of income to the tune of Rs.55,56,64,000/-.
50. The learned A.R. for the assessee pointed out that the said e x p e n d i t u r e o n a c c o u n t o f r o ya l t y h a d b e e n a l l o w e d t o t h e a s s e s s e e f r o m year to ye a r and only during the ye a r under consideration, said expenditure had been held to be capital in nature though the assessee was incurring expenditure for use of the trade mark and not for acquisition of trade mark. It was further pointed out by the learned A.R. for the assessee that the Assessing Officer vide paras 9.7 and 9.8 at page 43 of the assessment order had applied the provisions of section 35AB of the Act and disallowed the claim of the assessee. The next contention of the learned A.R. for the assessee was that the provisions of section 35AB w e r e n o t a p p l i c a b l e t o t h e ye a r u n d e r c o n s i d e r a t i o n . Another plea was raised by the learned A.R. for the assessee that there was no dispute w h e t h e r r o ya l t y w a s e x c e s s i v e o r n o t , a s t h e A s s e s s i n g O f f i c e r h i m s e l f said that it was not excessive. The only issue to be considered was whether the said expenditure was revenue or capital in nature. Our attention was drawn to the observations of the Assessing Officer at para 9.2 at page 41 of the assessment order wherein the Assessing Officer himself had observed that the said expenditure was being claimed from y e a r t o ye a r . The learned A.R. for the assessee placed reliance on the 58 principle of res- judicata and pointed out that the said expenditure is to be allowed as an expenditure.
51. In respect of ground No.6.1 raised by the assessee it was pointed out by the learned A.R. for the assessee that after directions of the DRP, there was limited mandate available for the Assessing Officer to re-
determine the issue after verification of facts with reference to the agreement entered upon by the assessee. In respect of ground No.6.2 raised by the assessee it was pointed out that the said claim was made without prejudice to the issue raised vide ground Nos.6 and 6.1.
52. The learned D.R. for the Revenue placed reliance on the orders of the authorities below.
53. We have heard the rival contentions and perused the record. The issue arising vide the above said ground of appeal Nos.6 and 6.1 is in relation to the expenditure claimed by the assessee on account of p a ym e n t o f r o ya l t y t o t h e G S K A P . A d m i t t e d l y t h e a s s e s s e e w a s p a yi n g t h e s a i d r o ya l t y f r o m ye a r t o ye a r a s p e r t h e t e r m s o f a g r e e m e n t d a t e d 7.2.1997. As per the terms of the said agreement the payment was made for the licence/rights to use trade mark provided by GSKAP. The copy of the agreement is placed at pages 1 to 17 of the Paper Book and as per clause-12 it is provided as under:
"12. In consideration of the right to use the Trade Marks granted herein, SBCH shall pay to SB Asia a royalty of upto five (5) percent of the "Net Sales Value" of the Contract Products sold under the Trade Marks. "Net Sales Value" for the purpose of this Clause shall mean sales net of returns/allowances and net of excise duty."
54. T h e i s s u e a r i s i n g i n t h e p r e s e n t a p p e a l i s w h e t h e r s u c h r o ya l t y p a i d by the assessee is in the nature of capital or revenue expenditure. The Assessing Officer and DRP had considered the allowability of the 59 expenditure in view of the judgment of the Hon'ble Supreme Court in the case of CIT Vs. Swaraj Engines Ltd. (supra) wherein the issue was the a p p l i c a b i l i t y o f s e c t i o n 3 5 A B o f t h e A c t i n t h e c o n t e x t o f r o ya l t y p a i d as percentage of the net sale price being revenue and capital in nature.
The Hon'ble Supreme Court held that after insertion of section 35AB of the Act, providing for allowance of expenditure on know-how as revenue or capital, would be a substantial question of law and the issue was set aside to the Hon'ble High Court for fresh consideration. The appeal b e f o r e t h e H o n ' b l e S u p r e m e C o u r t r e l a t e d t o t h e a s s e s s m e n t ye a r a s o n 30.12.1991. However, the provisions of section 35AB of the Act were a p p l i c a b l e t i l l a s s e s s m e n t ye a r 1 9 9 7 - 9 8 a n d a r e n o t a p p l i c a b l e t o t h e y e a r u n d e r c o n s i d e r a t i o n i . e . t h e a s s e s s m e n t ye a r 2 0 0 8 - 0 9 . In view thereof, ratio laid down by the Hon'ble Supreme Court in the case of CIT Vs. Swaraj Engines Ltd. (supra) is not applicable to the facts of the present case. We find no merit in the order of the Assessing Officer in this regard.
55. N o w c o m i n g t o t h e a s s e s s a b i l i t y o f e x p e n d i t u r e o f r o ya l t y i n c u r r e d by the assessee, the perusal of the report of the TPO also reflects that b o t h T P O a n d A s s e s s i n g O f f i c e r h a d n o t e d t h a t t h e s a i d p a ym e n t s h a d b e e n m a d e i n t h e e a r l i e r ye a r s . The agreement entered into by the assessee is dated 7.2.1997 and following the principle of consistency where the said expenditure has been allowed in the hands of the assessee f r o m ye a r t o ye a r , t h e s a m e m e r i t s t o b e a l l o w e d i n t h e ye a r u n d e r consideration also.
56. Further the expenditure has been incurred for the right to use the trade mark which does not result into acquisition of any rights of enduring nature and the same cannot be held to be an expenditure of 60 capital in nature. The assessee had not acquired title to the said trade mark as is apparent from the perusal of the terms of agreement entered between the assessee and GSKAP. T h e r o ya l t y w a s b e i n g p a i d a t prescribed percentage of the net sale value of the contracted product and hence was linked to the sales made by the assessee. The said expenditure was duly allowable in the hands of the assessee. Reliance is placed on the ratio laid down by the Delhi High Court in Sharda Motor Industrial Ltd. [319 ITR 109 (Del)] wherein it was held that royalty paid on the basis of rate per unit of production is revenue expenditure and could not be considered as capital expenditure. Another aspect to be k e p t i n m i n d i s t h a t t h e i s s u e o f p a ym e n t o f r o ya l t y w a s a l s o r e f e r r e d t o t h e T P O d u r i n g t h e ye a r u n d e r c o n s i d e r a t i o n , b e i n g d e e m e d i n t e r n a t i o n a l transaction and after fully scrutinizing the transaction, the TPO has a c c e p t e d t h e a r m s ' l e n g t h p r i c e o f t h e t r a n s a c t i o n f o r t h e ye a r u n d e r consideration. A c c o r d i n g l y, w e d i r e c t t h e A s s e s s i n g O f f i c e r t o a l l o w t h e c l a i m o f r o ya l t y p a i d a t R s . 5 5 5 6 . 6 4 l a c s . The ground Nos.6 and 6.1 raised by the assessee are thus allowed.
57. The ground No.6.2 being without prejudice to ground Nos.6 and 6.1 is dismissed in view of our allowing the ground Nos.6 and 6.1.
58. The issue in ground No.7 raised by the assessee is against disallowance of interest in terms of proviso to section 36(1)(iii) of the Act amounting to Rs.1,54,76,000/-.
59. T h e b r i e f f a c t s r e l a t i n g t o t h e i s s u e a r e t h a t d u r i n g t h e ye a r u n d e r consideration the assessee had shown investment in fixed deposits as closing work-in-progress(CWIP in short). The opening balance of CWIP as on 1.4.2007 was Rs.767.17 lacs and the closing balance of CWIP as on 31.3.2008 was Rs.18.12.21 lacs. The Assessing Officer noted that the 61 assessee had paid interest on deposits at Rs.290.06 lacs, interest to bank at Rs.83.71 lacs and interest to others at Rs.100.30 lacs. The total interest paid by the assessee was Rs.474.07 lacs. The assessee was show caused to explain as to why the provisions of proviso to section 36(1)(iii) of the Act be not applied. The Assessing Officer in the absence of complete details being furnished by the assessee with regard to utilization of cash credit limit, long term loan and short term loan, in the assessment order passed pursuant to the directions issued by the DRP applied the provisions of proviso to section 36(1)(iii) of the Act and disallowed sum of Rs.1,54,76,000/-.
60. The plea of learned A.R. for the assessee before us was that the total expenditure incurred by the assessee was Rs.,474.07 lacs which i n c l u d e d t h e i n t e r e s t o n h o u s i n g l o a n t o e m p l o ye e s w h i c h h a s b e e n excluded by the DRP. As against the interest expenditure, the assessee had earned interest income of Rs.608.44 lacs. The plea of the learned A.R. for the assessee was that the above said interest was paid on compulsion but no borrowings were made for business purposes. The main plea of the learned A.R. for the assessee was that there was no investment out of borrowed fund into work-in progress, which the Assessing Officer wants to disallow under the proviso to section 36(1)(iii) of the Act. The interest on deposits from dealers/wholesalers p a i d d u r i n g t h e ye a r u n d e r c o n s i d e r a t i o n a m o u n t i n g t o R s . 2 9 0 . 0 6 l a c s w a s b r o u g h t f o r w a r d f r o m t h e e a r l i e r ye a r s a n d n o f r e s h d e p o s i t s w e r e received from the above said dealers/wholesalers. The next aspect of the interest paid to bank on cheque discounting amounting to Rs.83.71 lacs cannot be said to be in relation to any borrowed fund.
61. The learned D.R. for the Revenue placed reliance on the order of the Assessing Officer.
6262. We have heard the rival contentions and perused the record. The a s s e s s e e d u r i n g t h e ye a r u n d e r c o n s i d e r a t i o n h a d m a d e i n v e s t m e n t i n fixed assets which were reflected as CWIP in its Balance Sheet. The closing balance as on 31.3.2008 was Rs.1812.21 lacs as against closing balance as on 31.3.2007 reflected at Rs.767.17 lacs. In view of the increase in the closing CWIP balance and in view of the assessee having incurred interest expenditure of Rs.474.07 lacs , the Assessing Officer was of the view that the interest relatable to the assets which have not been put to use as the amount had been shown as CWIP, merits to be disallowed in view of the provisions of proviso to section 36(1)(iii) of the Act. The assessee had furnished details of interest expenditure totaling Rs.474.07 lacs which is as under:
DETAILS OF INTEREST EXPENSE Rs.In Lacs
Interest on Deposits from Dealers/Wholesalers 290.06
Interest on Cheque discounting with banks 83.71
Differential Interest on Housing Loan to 96.95
e m p l o ye e s
Interest on Others 3.35
TOTAL 474.07
63. Out of the above said list of interest paid, the differential interest o n h o u s i n g l o a n t o e m p l o ye e s a t R s . 9 6 . 9 5 l a c s h a d b e e n e x c l u d e d o n t h e instructions of the DRP by the Assessing Officer. However, as the net interest expenditure paid by the assessee was over and above the interest relatable to CWIP balance as on 31.3.2008, the disallowance of Rs.154.76 lacs was made by the Assessing Officer.
64. The assessee company during the year under consideration had s h o w n s a l e s o f R s . 1 3 8 9 c r o r e s , n e t o f e x c i s e d u t y. Further the assessee had deposits with bank at Rs.5750.00 lacs as against Rs.1650.00 lacs alongwith reserves and surplus at Rs.66248.2 lacs. The assessee had s h o w n i n c o m e o f i n t e r e s t e a r n e d b y i t d u r i n g t h e ye a r a t R s . 6 0 8 . 4 4 l a c s .
The perusal of the interest expenditure incurred by the assessee reflects 63 that the major portion as on interest on deposits from dealers/wholesalers at Rs.290.06 lacs, which is being paid by the assessee due to the business compulsion. No fresh deposit has been r e c e i v e d d u r i n g t h e ye a r . Further interest was paid to the bank on cheque discounting at Rs.83.71 lacs and such interest cannot be said to have been incurred on such borrowed funds which in turn could be presumed to have been parked as investment in CWIP. The balance interest is paid to other at Rs.3.35 lacs. In the totality of the above said facts and in view of the assessee having earned interest income of Rs.608.44 lacs as against the interest expenditure of Rs.474.70 lacs and in the absence of any borrowings made by the assessee for running the business, we find no merit in the disallowance made by the Assessing Officer under the proviso to section 36(1)(iii) of the Act. The basic condition for applying the provisions of proviso to section 36(1)(iii) of the Act is that money should have been borrowed for the purposes of investment in capital assets on which interest had been paid by the assessee, then such interest as relatable to the investment in capital assets is to be disallowed. However, in the absence of any borrowings made by the assessee, we find no merit in the disallowance made by the Assessing Officer under the proviso to section 36(1)(iii) of the Act.
A c c o r d i n g l y, w e d e l e t e t h e a d d i t i o n o f R s . 1 5 4 . 7 6 l a c s . The ground Nos.7 to 7.2 raised by the assessee are thus allowed.
65. The ground No.7.3 raised by the assessee was without prejudice to ground Nos.7 to 7.2 and in view of our allowing the ground Nos.7 to 7.2, ground No.7.3 is dismissed.
66. The last issue raised by the assessee is by way of ground Nos.8 to 8.4 relating to disallowance of expenses under section 14A of the Act read with Rule 8D of Income Tax Rules.
6467. T h e b r i e f f a c t s r e l a t i n g t o t h e p r e s e n t i s s u e a r e t h a t d u r i n g t h e ye a r under consideration the assessee had received dividend income of Rs.1954.70 lacs on mutual fund, which in turn was claimed as exempt under section 10(34) of the Act. The assessee in the return of income had disallowed expenditure of Rs.6,06,977/- which is claimed to have been incurred in relation to earning of exempt dividend income. The A s s e s s i n g O f f i c e r , h o w e v e r , a p p l yi n g t h e p r o v i s i o n s o f s e c t i o n 1 4 A o f the Act read with Rule 8D of Income Tax Rules computed disallowance both on account of interest expenditure and administrative expenditure resulting in disallowance of Rs.102.32 lacs.
68. After hearing both the authorized representatives and after perusing the record, the first aspect of the issue is whether the provisions of section 14A of the Act read with Rule 8D of Income Tax Rules are applicable? T h e a s s e s s e e d u r i n g t h e ye a r u n d e r c o n s i d e r a t i o n had received dividend on mutual funds amounting to Rs.1954.70 lacs.
The assessee on its own motion had disallowed expenditure of Rs.6,06,977/- being relatable to earning of the exempt income. In other words, the assessee had admitted that it had incurred certain expenditure for earning the said exempt income. The claim of the assessee is that it had worked out all the disallowance in a scientific manner by making disallowance out of salaries and other heads involved in the investment activity and also out of administration and other expenses. The second aspect of the issue was that no borrowed funds were available with the a s s e s s e e c o m p a n y. There was no merit in the disallowance under Rule 8D(ii) of Income Tax Rules on account of such interest ex penditure. In view of our decision in the paras hereinabove in relation to the disallowance of interest under proviso to section 36(1)(iii) of the Act, we hold that no disallowance of interest expenditure being relatable to 65 the investment in such funds on which the assessee had earned tax free income, is merited. A c c o r d i n g l y, w e d i r e c t t h e A s s e s s i n g O f f i c e r t o delete the disallowance computed under Rule 8D(ii) of Income Tax Rules. The second aspect of the issue is disallowance under Rule 8D(iii) of Income Tax Rules on account of administrative expenses.
A d m i t t e d l y, t h e a s s e s s e e i s n o t m a i n t a i n i n g s e p a r a t e a c c o u n t s i n r e s p e c t of its investment activity and in view thereof the provisions of Rule 8D of Income Tax Rules are squarel y applicable and disallowance is to be computed in accordance with the said provisions of Rule 8D of Income Tax Rules for working out disallowance under section 14A of the Act.
A c c o r d i n g l y, w e u p h o l d t h e o r d e r o f t h e A s s e s s i n g O f f i c e r i n t h i s r e g a r d .
However, the assessee is entitled to the set off of the amount surrendered at Rs.6,06,977/-. In view thereof, ground Nos.8 to 8.4 raised by the assessee are partly allowed.
69. The ground No.9 raised by the assessee is against charging of interest under section 234B and 234C of the Act, which is consequential.
Hence ground of appeal No.9 raised by the assessee is dismissed.
70. In the result, the appeal of the assessee is partl y allowed Order pronounced in the open court on this 26th day of August, 2013.
Sd/- Sd/-
(T.R.SOOD) (SUSHMA CHOWLA)
ACCOUNTANT MEMBER JUDICIAL MEMBER
Dated : 26 t h August, 2013
*Rati*
Copy to: The Appellant/The Respondent/The CIT(A)/The CIT/The DR.
Assistant Registrar, ITAT, Chandigarh 66