2022 (10) TMI 1281 - AT - Income Tax

Disallowance made u/s 14A r.w.r 8D - CIT(A) deleted addition as AO had failed to record his satisfaction - HELD THAT - Identical issue is decided in favour of the assessee in 2020 (3) TMI 1418 - ITAT MUMBAI as observed that the AO has only noted in the assessment order that disallowance is not correct as the same is not in accordance with the provisions of section 14A rule 8D. A reading of the said order reveals that the AO has failed to record any satisfaction with respect to suo moto disallowance and how the disallowance as calculated by the Tax Auditor in the Tax Audit Report in Form 3CB in terms of section 44A of the Act is wrong having regard to the book of accounts. In our view recording of satisfaction is a pre-requisite under the provisions of section 14A(2) before invoking the provisions of section 14A Rule 8D which the AO has failed to do. Disallowance of depreciation on intangibles representing acquisition of business contracts - HELD THAT - Identical issue is decided in favour of the assessee in 2020 (3) TMI 1418 - ITAT MUMBAI it is also a fact that such acquisition took place by virtue of an agreement executed on 13th January 2004. It is also a fact on record that in assessment year 2004 05 the assessee for the first time claimed depreciation by treating the capitalized value of the amount paid towards acquiring M/s. Town and Country Assistance Ltd. as an intangible asset and claimed depreciation @ 25%. Notably the AO while completing assessment under section 143(3) of the Act also allowed assessee s claim of depreciation. However CIT revised the assessment order under section 263 of the Act. Subsequently while deciding assessee s appeal against the said 29 WNS Global Services Pvt. Ltd. order the Tribunal quashed the order passed under section 263 of the Act and restored the assessment order. Thus in effect assessee s claim of depreciation in respect of intangible asset became final. In any case of the matter there is no dispute that by acquiring M/s. Town and Country Assistance Ltd. the assessee has also acquired contractual rights which no doubt is a valuable commercial right. Therefore it comes within the meaning of intangible asset as per section 32(1)(ii) r/w Explanation 3(b) of the Act. Hence depreciation claimed by the assessee is allowable. Depreciation adjustment on purchase of business rights - HELD THAT - Identical issue is decided in favour of the assessee in 2020 (3) TMI 1418 - ITAT MUMBAI as held that as specifically provided in the provisions of section 92C(1) that TPO is duty bound to determine the arm s length price of the international transaction only by following any one of the method prescribed. However in the present case the TPO has not followed any of those methods which is not a curable defect and goes to the root of the matter. Under these circumstances we are of the considered view that the addition made by the TPO cannot be sustained. We further note that the DRP has also erred in not following any of the prescribed method and agreed with the incremental benefit approach adopted by the TPO by taking the actual figures up to A.Y. 2014-15 and for subsequent year directing the TPO to deflate the projected revenue figures by applying average rate of 22.68%. We find merit in the contention of the learned AR that valuation of an intangible requires expertise and knowledge in the domain of valuation principles markets and business. Even if the TPO/DRP were not in agreement with the variables assumed/valuation undertaken by the independent valuer they ought to have desisted from their own exercise of adhoc valuation without having appointed a valuation expert to determine the value of the MSA. Notional foreign exchange loss from option contract to be as part of the profits for deduction u/s 10AA - HELD THAT - Identical issue is decided in favour of the assessee in 2020 (3) TMI 1418 - ITAT MUMBAI as held forex gain resulting from the settlement of derivative contract is part of the profit from export activity and eligible for deduction u/s. 10A. Besides as held in a series of decisions referred to by learned counsel for the assessee that loss or gain derived from forward contracts entered into by an assessee engaged in export activity should be eligible for deduction. Appeals filed by the revenue are dismissed and appeal filed by the assessee is allowed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in these appeals relate to:

(a) Whether the disallowance under section 14A of the Income Tax Act was validly made by the Assessing Officer (AO) in absence of recording satisfaction as mandated by law;

(b) Whether depreciation claimed on customer contract rights, treated as intangible assets under section 32(1), was allowable;

(c) Whether the transfer pricing adjustment on account of depreciation claimed on business and commercial rights acquired from an associated enterprise (AE) was justified;

(d) Whether the adjustment made by AO and upheld by Transfer Pricing Officer (TPO) and Dispute Resolution Panel (DRP) on the arm's length price (ALP) of the transaction involving purchase of business rights was sustainable, especially considering the valuation report submitted by the assessee and the methodology adopted;

(e) Whether the TPO was justified in not following the prescribed transfer pricing methods under section 92C and instead adopting an incremental benefit approach;

(f) Whether the valuation report based on projections could be substituted by actual results for determining the ALP;

(g) Whether the notional foreign exchange loss/gain from option contracts should be considered part of profits for deduction under section 10AA;

(h) Procedural issues regarding the methodology adopted by TPO and the applicability of section 292B for curing defects;

(i) Interpretation of the term "shall" in section 92(1) and section 92C(1) regarding mandatory application of transfer pricing methods.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Validity of Disallowance under Section 14A

Legal Framework and Precedents: Section 14A read with Rule 8D mandates that before disallowing expenditure in respect of income not includible in total income, the AO must record satisfaction that such expenditure is not allowable. The Bombay High Court and Supreme Court have emphasized the need for AO to record objective satisfaction (Godrej & Boyce Manufacturing Co. Ltd.; Maxopp Investment Ltd.; Supreme Court decision at 91 taxmann.com 154 (2018)).

Court's Interpretation and Reasoning: The Tribunal noted that the AO failed to record any satisfaction before making the disallowance and merely noted disagreement with the assessee's calculation. This procedural lapse was fatal.

Key Evidence and Findings: The Tribunal relied on identical findings in the assessee's own case for earlier years where similar disallowance was deleted.

Application of Law to Facts: Since AO did not comply with mandatory precondition of recording satisfaction, disallowance under section 14A was not sustainable.

Treatment of Competing Arguments: Revenue accepted the submissions and the Tribunal followed coordinate bench decisions.

Conclusion: Disallowance under section 14A was deleted.

Issue 2 & 3: Allowability of Depreciation on Customer Contract Rights Treated as Intangible Assets

Legal Framework and Precedents: Section 32(1)(ii) allows depreciation on intangible assets. Explanation 3(b) includes commercial rights within intangible assets. Tribunal's earlier decisions in assessee's own case (A.Y. 2005-06, 2007-08, 2009-10, 2011-12, 2012-13) held customer contracts as intangible assets eligible for depreciation.

Court's Interpretation and Reasoning: The Tribunal reiterated that acquisition of customer contracts constitutes acquisition of intangible assets. The depreciation claim was consistent with prior rulings and allowed.

Key Evidence and Findings: The assessee acquired contractual rights through agreements and capitalized the cost, which was accepted in earlier assessments.

Application of Law to Facts: No new facts or legal principles warranted a different conclusion.

Treatment of Competing Arguments: Revenue accepted the submissions and the Tribunal followed coordinate bench precedents.

Conclusion: Depreciation on customer contract rights was allowable.

Issue 4 to 11: Transfer Pricing Adjustment on Purchase of Business Rights and Methodology for ALP Determination

Legal Framework and Precedents: Section 92C(1) mandates determination of ALP using prescribed methods (Comparable Uncontrolled Price (CUP), Resale Price Method, Cost Plus Method, etc.). The TPO must apply one of these methods. The Tribunal referred to decisions including Tecumseh Products India (P) Ltd., Social Media India Ltd., Firmenich Aromatics India (P) Ltd., and judicial pronouncements by the Delhi High Court and Supreme Court emphasizing adherence to prescribed methods and rejecting adhoc or incremental benefit approaches.

Court's Interpretation and Reasoning: The Tribunal found that the TPO did not apply any prescribed transfer pricing method but adopted an incremental benefit approach, which is not a recognized method under section 92C(1). This was a fundamental jurisdictional error.

The valuation report submitted by the assessee, prepared by an independent valuer, was based on accepted valuation principles and projections as at the valuation date. The Tribunal held that valuation cannot be substituted by actual results retrospectively (hindsight) and that the TPO/DRP had no basis to reject the valuation without appointing an independent valuer.

Key Evidence and Findings: The incentive payment of GBP 80 million (USD 159.45 million) paid by WCIL to Aviva Singapore for securing the contract was amortized over the contract period, with an unamortized portion of USD 106.83 million at the time of purchase by the assessee. The assessee paid USD 110 million to WCIL, which the Tribunal found to be at arm's length.

Application of Law to Facts: Since the price paid was supported by an independent valuation and there was no contrary valuation by TPO, the price paid was accepted as ALP. The Tribunal also rejected the TPO's approach of using actual incremental benefits without considering the entire contractual relationship and renewal benefits.

Treatment of Competing Arguments: Revenue argued for application of incremental benefit approach and challenged the valuation projections as inflated. The Tribunal rejected these arguments, emphasizing the need to follow statutory methods and respect expert valuation.

Conclusion: The transfer pricing adjustment was deleted, and depreciation on the capital asset was allowed.

Issue on Procedural and Methodological Aspects of Transfer Pricing

The Tribunal discussed the interpretation of the word "shall" in sections 92(1) and 92C(1), referencing Supreme Court and High Court decisions that "shall" need not always be mandatory and may be read as "may" in certain contexts. However, the Tribunal emphasized that the TPO is bound to apply one of the prescribed methods for ALP determination and cannot resort to non-prescribed methods or adhoc approaches.

The Tribunal also noted that procedural defects in the TPO's order, such as failure to mention methodology, are curable under section 292B and do not vitiate the order if the substantive correctness is established.

Issue on Foreign Exchange Gain/Loss from Derivative Contracts and Deduction under Section 10AA

Legal Framework and Precedents: Section 10AA provides deduction for profits from export activities. The issue was whether notional foreign exchange gain/loss from derivative contracts entered into by the assessee qualifies as part of export profits eligible for deduction.

The Tribunal relied on coordinate bench decisions in the assessee's own case for earlier years and Bombay High Court decisions (Radhasoami Satsang, CIT vs. Darius Pandole, CIT vs. Gem Plus Jewellery India Ltd., PCIT vs. Jindal Drugs Ltd., CIT vs. Symantec Software (P) Ltd.) holding that forex gain/loss on forward contracts entered into for export activity is part of export profits/losses for section 10AA purposes.

Court's Interpretation and Reasoning: The Tribunal applied the principle of consistency and res judicata, holding that in absence of any material change in facts, the treatment of forex gain/loss should remain consistent and eligible for deduction.

Key Evidence and Findings: The AO had not made any adjustment in earlier years and treated forex gains as part of export profits. No material change justified a different view.

Application of Law to Facts: The Tribunal directed AO to treat forex gain as profits for deduction under section 10AA.

Treatment of Competing Arguments: Revenue accepted the submissions and the Tribunal followed coordinate bench decisions.

Conclusion: Forex gain from derivative contracts was held eligible for deduction under section 10AA.

3. SIGNIFICANT HOLDINGS

"Recording of satisfaction is a pre-requisite under the provisions of section 14A(2) before invoking the provisions of section 14A Rule 8D, which the Assessing Officer has failed to do."

"By acquiring customer contracts, the assessee has acquired contractual rights which come within the meaning of intangible assets as per section 32(1)(ii) read with Explanation 3(b) of the Act. Hence, depreciation claimed by the assessee is allowable."

"Section 92C(1) of the Act provides that the international transaction between the assessee and AE has to be on the basis of any of the method being the most appropriate method having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe. The TPO is duty bound to determine the arm's length price of the international transaction only by following any one of the methods prescribed."

"The TPO has not followed any of those methods, which is not a curable defect and goes to the root of the matter. Under these circumstances, we are of the considered view that the addition made by the TPO cannot be sustained."

"Valuation of an intangible requires expertise and knowledge in the domain of valuation principles, markets and business. Even if the TPO/DRP were not in agreement with the variables assumed/valuation undertaken by the independent valuer, they ought to have desisted from their own exercise of adhoc valuation without having appointed a valuation expert."

"The unamortised portion of the MSA incentive payment as on the date of purchase of MSA by the assessee was USD 106.83 million and the assessee was to be benefitted by the higher hourly charge outs agreed with Aviva Singapore. This payment is akin to the cost incurred by the assessee in acquiring/securing customer contract and remains attributable over the unexpired period of the MSA. The USD 110 million paid by the assessee to WCIL is at arm's length standard."

"The valuation has to be done on the basis of certain parameters or forecasts made as at the point of time of valuation. Any future happening based to the date of valuation cannot be foreseen. Therefore, the valuation report needs no further adjustment based on actuals."

"The forex gain resulting from the settlement of derivative contract is part of the profit from export activity and eligible for deduction under section 10AA."

"The principle of consistency and res judicata applies; unless there is a material change justifying a different view, the Revenue shall not take a contrary position."

Final determinations:

- Disallowance under section 14A was deleted for lack of recorded satisfaction by AO.

- Depreciation on customer contract rights treated as intangible assets was allowed.

- Transfer pricing adjustments on purchase of business rights were deleted as TPO failed to apply prescribed methods and valuation report by independent valuer was accepted.

- Forex gain/loss from derivative contracts was held eligible for deduction under section 10AA.

- Procedural defects in TPO orders were held curable under section 292B and did not vitiate substantive correctness.