2019 (6) TMI 1738 - AT - Income Tax

TP Adjustment - correctness of the cost plus method as not the most appropriate method (MAM) - HELD THAT - We find it is now settled legal proposition in favour of the assessee that the comparison of profit margin of export market segment with that of the domestic market segment is not proper. Thus the cost plus method adopted by the TPO stands rejected and held unsustainable. Accordingly ground no. 1 raised by the Revenue is dismissed. Revenue nature of IT services charges incurred by the assessee - AO held that these expenses are capital in nature - HELD THAT - Allowability of I.T. charges expenses is the identical issue came up before the Tribunal for the assessment year 2012-13 and the Tribunal remanded the issue to the file of the Assessing Officer for fresh verification. The direction given by the Tribunal to assessment year 2008-09 are required to be followed. Considering the same and perusing the said order of the Tribunal (supra) we are of the opinion the said issue is remanded with identical direction to the file of the Assessing Officer for fresh adjudication. AO shall decide the issue afresh after granting reasonable opportunity of being heard to the assessee. Accordingly ground raised by the Revenue is allowed for statistical purposes. Disallowance u/s 14A - Mandation of recording of satisfaction by the Assessing Officer before applying provisions of Rule 8D - HELD THAT - In the facts of the present case the Assessing Officer has failed to record any satisfaction before making the aforesaid disallowance and in the absence of recording of satisfaction the provisions of section 14A of the Act cannot be invoked as the AO has failed to come to a finding as to why the disallowance made by the assessee under section 14A is incorrect. Decided in favour of assessee.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal filed by the Revenue against the order of CIT(A) for the assessment year 2013-14 are as follows:

(i) Whether the domestic market segment and the export market segment are distinct and not comparable, and consequently, whether the application of the cost plus method (CPM) by the Transfer Pricing Officer (TPO) as the most appropriate method (MAM) for benchmarking international transactions was correct.

(ii) Whether the IT service charges amounting to Rs. 2,82,35,265/- incurred by the assessee are of revenue nature and hence allowable as deduction, or are capital in nature and thus disallowable.

(iii) Whether the deletion of disallowance of IT service charges by the CIT(A) is justified, especially in light of a similar issue for assessment year 2008-09 where the Tribunal had remanded the matter to the Assessing Officer (AO) for fresh verification.

(iv) Whether the deletion of disallowance of Rs. 7,85,222/- under section 14A of the Income Tax Act, 1961 (the Act) was justified despite the AO's recorded dissatisfaction with the quantum of expenses allocated by the assessee against exempt income.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Applicability of Cost Plus Method vis-`a-vis Transactional Net Margin Method (TNMM) for Transfer Pricing Benchmarking

Relevant Legal Framework and Precedents: The Transfer Pricing provisions under section 92CA of the Act require that international transactions be benchmarked using the Most Appropriate Method (MAM) to determine the Arm's Length Price (ALP). The methods include Cost Plus Method (CPM), Transactional Net Margin Method (TNMM), among others. The choice of MAM depends on functional comparability and availability of reliable data.

Precedents in the assessee's own case for earlier years (assessment years 2008-09 to 2011-12) have held that TNMM is the MAM for the equipment division's international transactions, rejecting the CPM applied by the TPO. The Tribunal has consistently found that comparing profit margins of the export market segment with the domestic market segment is improper due to lack of comparability.

Court's Interpretation and Reasoning: The Tribunal examined the TPO's application of CPM using domestic segment margins at 136.15% PLI versus export segment margins at 46.02% PLI and found this to be inappropriate. The Tribunal relied on its earlier detailed findings that the domestic and export market segments are distinct and not comparable. It noted that the assessee aggregated international transactions and applied TNMM, which was upheld in prior years.

The Tribunal further scrutinized the selection of comparables, directing exclusion of certain companies not functionally comparable or with differing accounting periods. After exclusion, the average margin of comparables was 14.01% against the assessee's margin of 25.27%, negating the need for adjustment.

Key Evidence and Findings: The Transfer Pricing Study Report, prior orders of the Tribunal for assessment years 2008-09 to 2011-12, and the functional analysis of comparables were pivotal. The TPO's reliance on domestic segment margins was found flawed.

Application of Law to Facts: Applying the principle of functional comparability and the MAM, the Tribunal held that TNMM is the correct method and CPM is unsustainable in this context.

Treatment of Competing Arguments: The Revenue's reliance on the TPO's findings was considered but rejected in light of consistent Tribunal precedents and the functional non-comparability of domestic and export segments.

Conclusions: The Tribunal dismissed the Revenue's ground challenging the CIT(A)'s order on this issue, affirming that the cost plus method adopted by the TPO was incorrect.

Issue 2 & 3: Nature and Allowability of IT Service Charges

Relevant Legal Framework and Precedents: The distinction between capital and revenue expenditure is fundamental in income tax law. Capital expenditure is generally disallowed as a deduction, whereas revenue expenditure is allowable. The Tribunal's earlier decisions in the assessee's own case for assessment years 2008-09 and 2010-11 remanded similar issues relating to IT service charges for fresh verification by the AO.

Court's Interpretation and Reasoning: The Tribunal noted that the identical issue was pending adjudication with directions for verification. The CIT(A) had deleted the disallowance on the basis that the IT service charges were revenue in nature. However, the Tribunal found that the matter required fresh examination by the AO, consistent with earlier Tribunal directions.

Key Evidence and Findings: The Tribunal relied on the procedural history and previous orders remanding the issue for verification. No fresh evidence was adduced to conclusively determine the nature of the expenditure.

Application of Law to Facts: The Tribunal remitted the issue to the AO for fresh adjudication after granting reasonable opportunity to the assessee, thereby ensuring compliance with principles of natural justice and proper fact-finding.

Treatment of Competing Arguments: The Revenue sought to uphold the disallowance, while the assessee requested remand for verification. The Tribunal sided with the need for remand, in line with precedent.

Conclusions: Grounds relating to IT service charges were allowed for statistical purposes, with the matter remanded to the AO for fresh verification.

Issue 4: Disallowance under Section 14A of the Act

Relevant Legal Framework and Precedents: Section 14A read with Rule 8D mandates that before making a disallowance of expenditure incurred in relation to exempt income, the AO must record objective satisfaction. The Pune Bench of the Tribunal in the assessee's own case for earlier years held that failure to record such satisfaction renders the disallowance untenable.

Court's Interpretation and Reasoning: The Tribunal observed that the AO failed to record any objective satisfaction regarding the correctness of the assessee's claim on expenses related to exempt income. The AO's mere statement that the disallowance was "not acceptable" was insufficient. The Tribunal emphasized that detailed submissions by the assessee were not addressed by the AO.

Key Evidence and Findings: The Tribunal examined the assessment order and found no reasons given by the AO for rejecting the assessee's allocation of expenses. Prior Tribunal decisions on the same issue were relied upon.

Application of Law to Facts: The Tribunal applied the mandatory precondition under section 14A(2) and Rule 8D, requiring recorded satisfaction before disallowance. The absence of such satisfaction led to deletion of the disallowance.

Treatment of Competing Arguments: The Revenue could not demonstrate legally sustainable satisfaction on record. The assessee's submissions were accepted.

Conclusions: The Tribunal upheld the CIT(A)'s deletion of the disallowance under section 14A and dismissed the Revenue's ground on this issue.

3. SIGNIFICANT HOLDINGS

On the issue of transfer pricing method, the Tribunal held:

"Considering the above, we find it is now settled legal proposition in favour of the assessee that the comparison of profit margin of export market segment with that of the domestic market segment is not proper. Thus, the cost plus method adopted by the TPO stands rejected and held unsustainable."

On the IT service charges, the Tribunal stated:

"Respectfully following the decision of our Co-ordinate Bench, ITAT in assessee's own case, these two grounds are remitted back to the file of Assessing Officer for verification. Accordingly, grounds No. 3 and 4 raised by the Revenue are allowed for statistical purposes."

Regarding disallowance under section 14A, the Tribunal observed:

"In the present case, the Assessing Officer has failed to record any satisfaction before making the aforesaid disallowance and in the absence of recording of satisfaction, the provisions of section 14A of the Act cannot be invoked... Accordingly, we uphold the order of CIT(A). The ground of appeal No. 4 raised by the Revenue is thus, dismissed."

Core principles established include:

• The necessity of functional comparability and appropriate selection of the MAM in transfer pricing matters, rejecting the use of domestic segment data to benchmark export transactions.
• The procedural requirement that disputes regarding the nature of expenditure (capital vs revenue) must be properly verified by the AO, with opportunity to the assessee.
• The mandatory precondition under section 14A and Rule 8D that the AO must record objective satisfaction before making disallowance related to exempt income expenditures.

Final determinations were that the Revenue's appeal was dismissed on issues of transfer pricing method and section 14A disallowance, while the appeal was partly allowed for statistical purposes with remand on the issue of IT service charges.