2023 (4) TMI 1415 - AT - Income Tax

TP Adjustment - international transaction relating to export of goods - MAM selection - HELD THAT - As relying on own case 2018 (4) TMI 41 - ITAT MUMBAI we hold that TNMM method as adopted by the Assessee was the most appropriate method for benchmarking the international transaction of sale/exports of goods. Accordingly transfer pricing adjustment made by the AO is set aside and the issue is remanded back to the file of AO for determination of ALP of the transaction of export of finished goods by the Appellant to its AE (i.e. Omni Active Health Technologies Inc. USA) as per TNMM method as adopted by the Appellant. It is clarified that no transfer pricing addition would be made in case the submission of the Appellant that the Appellant s margins in AE Segment are higher than the margins in non-AE Segment is found to be correct. In terms of the aforesaid Ground No. 1 to 1.4 are allowed for statistical purposes. Disallowance of the weighted deduction claimed u/s 35(2AB) on Research Development Expenses - HELD THAT - The amendments made to the provisions of Section 35(2AB) and Rule 6 clearly being out the legislative intent to allow deduction for expenditure approved by the Prescribed Authority. Therefore we reject the contention advanced on behalf of the Appellant that only Rule 6 was amended without making any amendment to the provisions contained in Section 35(2AB) of the Act. The conflict as perceived by the Appellant in the provisions contained in Section 35(2AB) of the Act and Rule 6 which in our view is non-existent can in any case be resolved by way of harmonious interpretation of the provisions contained therein instead of adopting the interpretation as proposed by the Appellant which would render otiose the provisions contained in Rule 6 and Section 35(2AB) of the Act which were brought in effect by way of specific amendments. Judicial precedents relied upon by the Appellant also do not advance the case of the Appellant as the same are not applicable to the facts of the present case. In the judicial precedents cited by the Appellant there was repugnancy between the provisions of statute and the rules made thereunder whereas in the case before us there is no such conflict. Absent any irreconcilable conflict between the applicable provisions contained in Section 35(2AB) and Rule 6 the judicial precedents cited by the Appellant have no application to the facts of the present case. No merit with the submissions advanced on behalf of the Appellant in this regard. Further we find that the directions issued by the DRP are in line with the provisions of Section 144C(8) of the Act which provide that DRP may confirm or enhance the variations proposed in the Draft Assessment Order. Accordingly Ground No. 2 to 2.5 raised in the appeal are dismissed. Disallowance u/s 14A - HELD THAT - As Appellant has not earned any exempt income and therefore the addition made by the Assessing Officer u/s 14A of the Act read with Rule 8D of the Rules was not warranted as per the above decision of the Tribunal in the case of the Assessee. To same effect is the decision of Kohinoor Project Pvt. Ltd. 2020 (1) TMI 1161 - BOMBAY HIGH COURT . Accordingly disallowance u/s 14A made by AO is deleted. Ground raised by the Appellant are allowed. Book Profit under Section 115JB of the Act on account of disallowance u/s 14A - HELD THAT -Since we have deleted the disallowance of INR 2, 00, 201/- made under Section 14A of the Act while computing income under the normal provisions of the Act the question of making addition of the same while computing book profits under Section 115JB of the Act does not arise. Accordingly addition made by the Assessing Officer while computing the Book Profits under Section 115JB of the Act is deleted. Assessing Officer directed to compute the amount of disallowance under Section 14A of the Act to be added to the Book Profits in terms of Section 115JB of the Act read with Explanation 1(f) thereto as per the decision of the Special Bench of the Tribunal in the case of Assistant Commissioner of Income Tax Circle 17(1) Delhi vs. Vireet Investments Ltd. 2017 (6) TMI 1124 - ITAT DELHI on the basis of audited financial statements of the Appellant. In terms of the aforesaid Ground raised by the Appellant are allowed for statistical purposes. Addition to Book Profits u/s 115JB on account of disallowance of weighted deduction under Section 35(2AB) - HELD THAT - Disallowance under Section 35(2AB) of the Act does not fall under any of the permissible addition specified in Explanation 1 to Section 115JB of the Act. Therefore the Assessing Officer would not be entitled to tinker with the approved audited accounts as per the judgment of Apollo Tyres Limited reported 2002 (5) TMI 5 - SUPREME COURT . Accordingly the addition made by the Assessing Officer to Book Profits (as computed by the Appellant) under Section 115JB of the Act is deleted. Appeal preferred by the Assessee is partly allowed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The appeal raised the following core legal questions:

(a) Whether the Transfer Pricing Officer (TPO) was justified in rejecting the Transactional Net Margin Method (TNMM) and adopting the Comparable Uncontrolled Price (CUP) method for determining the Arm's Length Price (ALP) in relation to international transactions of export of goods, resulting in an upward transfer pricing adjustment of INR 16,59,51,699/-.

(b) Whether the disallowance of weighted deduction of INR 98,93,734/- claimed under Section 35(2AB) of the Income Tax Act, 1961 ("the Act") for Research & Development (R&D) expenditure was justified, particularly in light of the approval requirements by the prescribed authority and amendments to Rule 6 of the Income Tax Rules.

(c) Whether the additional disallowance of INR 2,00,201/- under Section 14A of the Act, read with Rule 8D, was warranted in the absence of exempt income earned by the appellant.

(d) Whether the addition to Book Profits under Section 115JB of the Act on account of disallowance under Section 14A of the Act was justified.

(e) Whether the addition to Book Profits under Section 115JB on account of disallowance of weighted deduction under Section 35(2AB) was justified, particularly in view of the nature of expenditure debited to the Profit & Loss Account and applicable legal provisions.

2. ISSUE-WISE DETAILED ANALYSIS

(a) Transfer Pricing Adjustment - Rejection of TNMM and Adoption of CUP Method

Legal Framework and Precedents: Section 92C of the Act prescribes that ALP in international transactions must be determined by the most appropriate method among those specified, including TNMM and CUP. The choice of method must be based on the nature of the transaction and other relevant factors. Consistency in the choice of method over assessment years is emphasized by judicial precedents, including the Apex Court's decision in Radhasoami Satsang, which holds that a consistent method should not be changed without cogent reasons.

Court's Interpretation and Reasoning: The TPO rejected the TNMM method, previously accepted in earlier assessment years (2010-11, 2011-12, 2012-13 to 2014-15), and applied the CUP method based on internal comparable uncontrolled transactions. The appellant contended that the CUP method was inappropriate due to differences in geographical location, volume, currency, and marketing expenses. The DRP upheld the TPO's rejection of TNMM without providing cogent reasons.

The Tribunal analyzed the facts and found that the TPO and DRP failed to provide any substantial reason for rejecting the consistently applied TNMM method. The Tribunal noted that the updated margin under TNMM showed the appellant's margins in the AE segment were higher than those in the non-AE segment, indicating arm's length pricing. The Tribunal held that the change in method without change in facts or law was unjustified and amounted to trial and error in finding a method for addition.

Key Evidence and Findings: The appellant's audited segmental profitability statements and benchmarking reports showed consistent application of TNMM with favorable margins. Earlier years' orders and Tribunal decisions supported the continued use of TNMM.

Application of Law to Facts: The Tribunal applied the principle of consistency and the statutory mandate to select the most appropriate method. Since TNMM was consistently accepted and no cogent reason was given for its rejection, the Tribunal restored the use of TNMM for determining ALP.

Treatment of Competing Arguments: The Department's reliance on CUP method and case law favoring CUP was distinguished on facts, as no error was shown in earlier acceptance of TNMM. The appellant's reliance on OECD Guidelines and prior rulings was accepted.

Conclusion: The transfer pricing adjustment of INR 16,59,51,699/- based on CUP method was set aside. The matter was remanded to the Assessing Officer to determine ALP using TNMM as adopted by the appellant. No addition would be made if the appellant's margins in the AE segment were higher than those in the non-AE segment.

(b) Disallowance of Weighted Deduction under Section 35(2AB)

Legal Framework and Precedents: Section 35(2AB) allows weighted deduction (200%) for expenditure on scientific research incurred in an in-house R&D facility approved by the prescribed authority. Rule 6 of the Income Tax Rules prescribes the procedure for approval and certification, including Form 3CL, which post-amendment (effective 01/07/2016) requires the prescribed authority to quantify the eligible expenditure. Judicial precedents, including decisions of the Tribunal in the appellant's earlier assessment years and Cummins India Ltd., have interpreted these provisions.

Court's Interpretation and Reasoning: The Assessing Officer disallowed weighted deduction for R&D expenditure of INR 86,72,367/- on the ground that the prescribed authority had not approved the quantum of expenditure, only the facility. The DRP upheld this disallowance but allowed deduction under Section 37(1) for the verified revenue expenditure.

The Tribunal examined the legislative amendments and found that prior to the amendment effective 01/07/2016, the prescribed authority was required only to approve the facility, not the quantum of expenditure. The amendment introduced a procedure for quantification of expenditure by the prescribed authority in Form 3CL. Since the assessment year under consideration was 2017-18 (post-amendment), both facility and expenditure needed approval.

The Tribunal rejected the appellant's contention that only facility approval was required, holding that the legislative intent was to allow deduction only for expenditure approved by the prescribed authority. The appellant's reliance on earlier judicial precedents was distinguished as those pertained to pre-amendment provisions and did not address the amended framework.

Key Evidence and Findings: The prescribed authority's certificate did not quantify the full R&D expenditure claimed. The Assessing Officer allowed deduction under Section 37 for verified revenue expenditure.

Application of Law to Facts: The Tribunal applied the amended provisions harmoniously, holding that weighted deduction under Section 35(2AB) requires approval of both facility and expenditure by the prescribed authority as per amended Rule 6 and Form 3CL.

Treatment of Competing Arguments: The appellant's argument that the amendment to Rule 6 did not override the Act was rejected. The Department's interpretation was accepted as consistent with legislative intent and procedural requirements.

Conclusion: The disallowance of weighted deduction of INR 98,93,734/- was upheld. Deduction under Section 37 was allowed for verified expenditure. Grounds challenging this disallowance were dismissed.

(c) Disallowance under Section 14A of the Act

Legal Framework and Precedents: Section 14A read with Rule 8D allows disallowance of expenditure incurred to earn exempt income. Judicial precedents establish that no disallowance is warranted if no exempt income is earned.

Court's Interpretation and Reasoning: The appellant had made a suo-moto disallowance of INR 1,90,992/-. The Assessing Officer recomputed and disallowed an additional INR 2,00,201/-. The DRP upheld the disallowance following earlier orders for the appellant's prior assessment year.

The Tribunal noted that the appellant had not earned any exempt income during the relevant year. The Tribunal referred to its earlier decision for the appellant and the Bombay High Court decision holding that disallowance under Section 14A is not warranted in absence of exempt income.

Key Evidence and Findings: No exempt dividend income was earned by the appellant during the year under consideration.

Application of Law to Facts: The Tribunal applied the principle that disallowance under Section 14A requires existence of exempt income and accordingly deleted the additional disallowance.

Treatment of Competing Arguments: The Department's reliance on Rule 8D and earlier DRP orders was rejected in light of absence of exempt income.

Conclusion: The additional disallowance of INR 2,00,201/- under Section 14A was deleted. Grounds challenging this disallowance were allowed.

(d) Addition to Book Profits under Section 115JB on account of Section 14A Disallowance

Legal Framework and Precedents: Section 115JB requires computation of book profits for Minimum Alternate Tax (MAT) purposes. Additions to book profits are made as per Explanation 1(f) to Section 115JB, which includes disallowances under Section 14A.

Court's Interpretation and Reasoning: Since the disallowance under Section 14A was deleted for normal income computation, the corresponding addition to book profits was also unwarranted. The Tribunal directed the Assessing Officer to compute disallowance for book profits in accordance with audited financial statements and relevant Special Bench decisions.

Key Evidence and Findings: The disallowance under Section 14A was not sustained; hence, addition to book profits lacked basis.

Application of Law to Facts: The Tribunal applied the principle of consistency between normal income and book profits computation.

Treatment of Competing Arguments: None specifically noted as the decision flowed from the deletion of Section 14A disallowance.

Conclusion: Addition to book profits under Section 115JB on account of Section 14A disallowance was deleted. Grounds were allowed for statistical purposes.

(e) Addition to Book Profits under Section 115JB on account of Disallowance of Weighted Deduction under Section 35(2AB)

Legal Framework and Precedents: Additions to book profits under Section 115JB are governed by Explanation 1 to that section. The Hon'ble Apex Court in Apollo Tyres Ltd. held that the Assessing Officer cannot tinker with audited accounts approved under Companies Act provisions.

Court's Interpretation and Reasoning: The Assessing Officer disallowed weighted deduction under Section 35(2AB) and increased book profits by INR 98,93,734/-. The appellant's audited accounts showed R&D expenditure debited to the Profit & Loss Account of INR 86,72,367/-, with INR 74,51,000/- allowed under Section 37 as revenue expenditure. The balance INR 12,21,367/- was capital in nature and not debited to Profit & Loss Account as per Companies Act provisions.

The Tribunal held that since the capital expenditure was not debited to Profit & Loss Account, and the weighted deduction disallowance does not fall under permissible additions in Explanation 1 to Section 115JB, the Assessing Officer could not make additions to book profits. The Tribunal relied on the Apex Court's decision in Apollo Tyres Ltd. to support this conclusion.

Key Evidence and Findings: Audited financial statements and compliance with Companies Act provisions were key evidentiary bases.

Application of Law to Facts: The Tribunal applied the principle that book profits computation must be based on audited accounts and permissible additions only.

Treatment of Competing Arguments: The Department's addition was rejected as inconsistent with statutory provisions and judicial precedents.

Conclusion: Addition to book profits of INR 98,93,734/- was deleted. Grounds were allowed.

3. SIGNIFICANT HOLDINGS

"The Transfer Pricing Officer has rejected the consistently applied TNMM method without bringing on record any cogent reason. It is the settled law that the consistent method followed can be changed only if there is a change of facts or law... We do not find that any case has been made out by the Transfer Pricing Officer or the DRP that there was an error committed earlier when the TNMM method was chosen and approved... By no means it is justified to keep on finding a method for addition by trial and error method."

"The amendments made to the provisions of Section 35(2AB) and Rule 6 clearly being out the legislative intent to allow deduction for expenditure approved by the Prescribed Authority... The conflict as perceived by the Appellant in the provisions contained in Section 35(2AB) of the Act and Rule 6, which in our view is non-existent, can, in any case, be resolved by way of harmonious interpretation of the provisions contained therein."

"It is now decided by various high courts including the Hon'ble Jurisdictional High Court that no disallowance u/s.14A is required when no exempt income has been earned."

"Disallowance under Section 35(2AB) of the Act does not fall under any of the permissible addition specified in Explanation 1 to Section 115JB of the Act. Therefore, the Assessing Officer would not be entitled to tinker with the approved audited accounts as per the judgment of the Hon'ble Apex Court in the case of Apollo Tyres Limited."

The Tribunal's final determinations were:

• Transfer pricing adjustment based on CUP method was set aside; TNMM method reinstated as the most appropriate method.
• Disallowance of weighted deduction under Section 35(2AB) upheld due to lack of prescribed authority's approval of expenditure post-amendment; deduction under Section 37 allowed for verified expenditure.
• Disallowance under Section 14A deleted as no exempt income was earned.
• Addition to book profits under Section 115JB on account of Section 14A disallowance deleted.
• Addition to book profits on account of disallowance of weighted deduction under Section 35(2AB) deleted, respecting audited accounts and statutory provisions.