2022 (12) TMI 1564 - AT - Income Tax

TP Adjustment - partial disallowance of depreciation - HELD THAT - This issue has already been settled in favour of assessee for A.Ys. 2011-12 and 2012-13 2020 (3) TMI 1418 - ITAT MUMBAI - In these two years ITAT Mumbai observed that since price paid by assesses is determined to be at arm s length depreciation has to be allowed to the assessee. We further observed that this transaction originally took place in A.Y. 2011-12 and there is no international transaction in A.Y. 2016-17 in relation to the business and commercial rights purchased by assessee hence no addition on this ground also can be made merely consequential to the adjustments made by the TPO in A.Y. 2011-12. In the result Ground No. 3 to 6 of the appeal raised by assessee is allowed and AO is directed to delete the disallowance made on account of depreciation of business rights. Adjustment in relation to the purchase of equity shares of an associate enterprise (AE) and treating the alleged excessive payment for purchase of equity shares as deemed loan and imputing notional interest on the same - HELD THAT - As we found force in the contentions of the assessee that Projections can t be substituted by actual and hindsight ought not to effect a valuation report without prejudice to this even if it is assumed otherwise for the time being in force if projections are to be relied up on all events that have occurred till that date should be considered. Moreover reference to TPO on this issue is un-warranted hence bad in law. As transaction of purchase of equity shares is a capital transaction and the same is not falling in the category of International Transaction as defined in section 92 of the Act as there is no income arising on account of such transactions. In the light of these observations we set aside the action of authorities below and allow ground raised by the assessee. Disallowances of depreciation claimed on intangible assets - HELD THAT - The commercial rights acquired by the Assessee would fall within the scope of the expression business or commercial rights of a similar nature under Section 32(1) (1) of the Act and hence depreciation should be allowed on their written down value. With regards to depreciation claimed on the contract acquired from WNS UK the said issue was examined in detail for AY 2004-05 in WNS India s own case wherein all the details had been furnished and the learned AO had accepted the tax depreciation on such intangibles for AY 2004-05 while concluding the assessment under Section 143(3) of the Act. Given that there are no changes in facts and circumstances and law there is no reason for denying the depreciation in later years. Without prejudice to the objection raised against disallowance of depreciation on intangible assets acquired by the Assessee the learned AO erred in making a double disallowance of depreciation on intangible assets to the extent of INR 13, 60, 00, 936 first by learned TPO in its order wherein depreciation of INR 13, 60, 00, 936 has not been allowed as it pertains to alleged excess consideration paid in AY 2011-12 and second by learned AO in the draft order wherein the entire depreciation of INR 39, 03, 28, 049 (including INR 13, 60, 00, 936 supra) as entire depreciation is not eligible on customer contract u/s 32 - Allow ground raised by the assessee. Disallowance made u/s 14A and addition of the same to the book-profit calculated u/s 115JB - HELD THAT - No disallowance under rule 8D (2)(i) can be made as there is no direct expense in the case of assessee still assessee itself offered Rs. 9, 29 819/-. Disallowance under rule 8D (2)(ii) Can t be made at all as assessee is using its own funds and no borrowed funds were utilised and disallowance under rule 8D (2)(iii) Also must be limited to the extent of Rs. 54 Lacs only as worked out by the assessee reliance is placed on the recent ITAT decision in the case of Tata Projects Limited 2021 (1) TMI 393 - ITAT MUMBAI wherein the ITAT has accepted the above method of apportionment and disallowance computed by the assessee under Section 14A of the Act. The Tribunal held that on perusal of the method adopted by assessee it could be stated that the method of computing disallowance was very fair reasonable and scientific. Disallowance under section 14A can t be considered for the purposes of section 115JB of the Act as the same has been settled in plethora of judgements passed by various Hon ble High Courts and benches of ITAT.

Summary

The core legal questions considered in this appeal pertain primarily to the determination of total taxable income, transfer pricing adjustments, depreciation disallowances on intangible assets, valuation of equity shares of an associated enterprise (AE), applicability of transfer pricing provisions to capital transactions, and disallowance under Section 14A of the Income Tax Act, 1961 (the Act) read with Rule 8D of the Income Tax Rules, 1962 (the Rules). Specifically, the issues include:

1. Whether the Assessing Officer (AO) erred in determining the total taxable income higher than that declared by the appellant.

2. Legality and correctness of the reference to the Transfer Pricing Officer (TPO) and the subsequent transfer pricing adjustments made, including adjustments related to the valuation of business and commercial rights purchased from AE.

3. Whether depreciation disallowance on intangible assets, particularly business and commercial rights acquired in earlier years, was justified.

4. Applicability of transfer pricing provisions to the purchase of equity shares of an AE, including the validity of recharacterizing excess payment as a deemed loan and imputing notional interest thereon.

5. Validity of the valuation methods and the rejection of the appellant's independent valuation report by the TPO.

6. Whether the AO and TPO erred in not providing the appellant with adequate opportunity of being heard before making adjustments.

7. Appropriateness of disallowance under Section 14A read with Rule 8D regarding expenses related to exempt income and its addition to book profits under Section 115JB.

8. Initiation of penalty proceedings under Section 271(1)(c) of the Act.

These issues were examined in the context of detailed factual and legal submissions, relevant statutory provisions, prior judicial precedents, and the appellant's own prior assessment years' decisions.

Issue-wise Detailed Analysis

1. Determination of Total Taxable Income and Reference to TPO

The appellant challenged the AO's determination of taxable income at Rs. 573.07 crores against the return filed at Rs. 485.66 crores. The AO's order incorporated directions from the Dispute Resolution Panel (DRP) and transfer pricing adjustments. The appellant contended that the AO erred in making the reference to the TPO and the subsequent adjustments, especially without proper jurisdiction or appreciation of facts. The Court noted that Grounds 1 and 2 were general and did not warrant specific adjudication beyond the detailed transfer pricing and depreciation issues addressed later.

2. Partial Disallowance of Depreciation on Business and Commercial Rights (Grounds 3 to 6)

The appellant contended that the disallowance of depreciation of INR 13.60 crores on business and commercial rights purchased from AE in AY 2011-12 was erroneous, especially since the Tribunal had earlier deleted such adjustments for AY 2011-12 and AY 2012-13. The AO and TPO had made disallowances based on adjustments to the value of these rights, which the appellant argued were not international transactions in the current year and thus outside Chapter X of the Act.

The Tribunal analyzed prior orders and found that the TPO/DRP did not follow prescribed methods for determining arm's length price (ALP) and had erred in substituting projections with actuals and applying hindsight. The valuation was based on an independent expert report, which was not properly challenged. The Tribunal emphasized that since the original international transaction occurred in AY 2011-12 and was adjudicated, no further transfer pricing adjustment could be made for AY 2016-17. Consequently, the disallowance was held to be unjustified and was deleted.

3. Transfer Pricing Adjustment Relating to Purchase of Equity Shares of AE (Grounds 7 to 17)

This issue involved the TPO's adjustment of the valuation of equity shares purchased by the appellant from its AE, leading to an alleged excess payment treated as a deemed loan with imputed interest. The appellant challenged the applicability of transfer pricing provisions to this capital transaction, the arbitrary revision of share valuation by the TPO, failure to follow prescribed valuation methods, and denial of opportunity to be heard.

The Tribunal considered the appellant's submission that purchase of equity shares is a capital transaction not giving rise to taxable income and thus outside the scope of Chapter X. It relied on binding decisions of the jurisdictional High Court holding that transfer pricing provisions apply only to international transactions giving rise to income or expenditure and not to capital transactions like share purchases. The Tribunal found that the TPO's rejection of the independent valuation report lacked cogent reasons and was arbitrary, especially since the TPO did not appoint a valuation expert of its own.

Regarding the deemed loan and imputed interest, the Tribunal noted that recharacterization of share purchase as a loan is not supported by law and was contrary to judicial precedents. The TPO's adoption of an interest rate of 6-month LIBOR plus 600 basis points was held to be ad hoc and unsupported by any credit rating analysis or comparable transactions. The appellant's contention that the interest rate should be LIBOR plus 100 basis points as per the Advance Pricing Agreement (APA) was accepted. Further, interest computation for the entire year instead of the actual outstanding period was found incorrect.

The Tribunal also held that the TPO failed to issue a specific show cause notice before making these adjustments, violating principles of natural justice.

Accordingly, the Tribunal set aside the transfer pricing adjustments relating to the purchase of equity shares and the imputed interest.

4. Disallowance of Depreciation on Intangible Assets (Grounds 18 to 22)

The appellant claimed depreciation on intangible assets acquired from WNS UK and WNS Capital Investment Private Limited, Mauritius, representing business rights and customer contracts. The AO disallowed depreciation contending that these did not qualify as intangible assets under Section 32(1) of the Act. The appellant relied on prior favorable ITAT orders for earlier assessment years and argued that such commercial rights fall within the ejusdem generis category of "business or commercial rights of similar nature."

The Tribunal agreed with the appellant, holding that acquisition of customer contracts confers commercial rights entitling depreciation at 25% on written down value basis. It noted that the intangible assets facilitate the appellant's business and represent assured economic benefits. The Tribunal also found that the AO had made a double disallowance by disallowing depreciation once in the transfer pricing order and again in the final assessment order.

In light of consistent prior favorable rulings and the absence of any material change in facts or law, the Tribunal allowed the depreciation claimed on intangible assets.

5. Disallowance under Section 14A read with Rule 8D (Ground 23)

The AO disallowed Rs. 3.47 crores under Section 14A read with Rule 8D, pertaining to expenses related to exempt income (dividend income from mutual funds). The appellant contended that only actual expenditure incurred directly in relation to exempt income can be disallowed and that it had suo-moto disallowed Rs. 9.29 lakhs. Further, the appellant argued that borrowed funds were not used for investments yielding exempt income, and it had sufficient own funds to cover such investments.

The Tribunal noted that the AO failed to record satisfaction as required under Section 14A(2) before invoking Rule 8D, which is mandatory. It relied on judicial precedents holding that disallowance under Section 14A requires proximate cause and actual expenditure in relation to exempt income. The Tribunal accepted the appellant's fund flow analysis demonstrating that investments were made from own funds and that interest expense on borrowed funds was for specific business purposes, not for earning exempt income.

The Tribunal also held that disallowance under Section 14A cannot be made for computing book profits under Section 115JB, as Section 115JB is a self-contained code with specific provisions for adjustments.

Accordingly, the Tribunal restricted the disallowance to the appellant's own calculation of Rs. 63.29 lakhs, rejecting the AO's higher disallowance.

6. Initiation of Penalty Proceedings (Ground 24)

This ground was held to be premature and was not adjudicated upon by the Tribunal.

Significant Holdings

"The Tribunal emphasized that since the original international transaction took place in AY 2011-12 and the arm's length price was determined by the learned TPO, no transfer pricing adjustment can be made for AY 2016-17 merely consequential to the earlier adjustment."

"The Tribunal held that purchase of equity shares of an AE is a capital transaction which does not give rise to income chargeable to tax under the Act and therefore, transfer pricing provisions are not applicable to such transactions."

"The recharacterization of excess payment for shares as a deemed loan and imputing notional interest thereon is not supported by any provision of law and is invalid."

"The Tribunal found that the TPO's rejection of the appellant's independent valuation report without cogent reasons and without appointing an expert was arbitrary and unsustainable."

"The Tribunal held that depreciation on intangible assets, including business and commercial rights acquired by the appellant, is allowable under Section 32(1)(ii) of the Act as these constitute 'business or commercial rights of a similar nature'."

"Disallowance under Section 14A read with Rule 8D requires recording of satisfaction by the AO, which was absent; further, disallowance cannot be made on a notional basis without proximate cause and actual expenditure incurred."

"Disallowance under Section 14A cannot be added for computation of book profits under Section 115JB, as the latter is a self-contained charging provision."

"Principles of natural justice require that the AO/TPO must provide specific show cause notice and opportunity of hearing before making adverse transfer pricing adjustments."

In conclusion, the Tribunal allowed the appeal on all substantive grounds relating to transfer pricing adjustments, depreciation disallowances, and Section 14A disallowance, directing the AO to delete the impugned additions and adjustments accordingly.