2025 (5) TMI 193 - AT - Income Tax

Validity of final order of assessment passed u/s 143(3) r.w.s 144C (13) r.w.s. 144B with no conformity with the directions issued by the DRP u/s 144C(5) - HELD THAT - AO as per law was required to pass the final order of assessment dated 12/7/2024 for asst. year 2020-21 u/s 143(3) r.w.s 144C (13) r.w.s. 144B of the Act in conformity with the directions issued by the DRP u/s 144C(5) of the Act which are binding on him as per section 144C(10) thereof and within the time prescribed u/s 144C(13) of the Act. We find that instead of passing the final order of assessment as required by law the Ld. AO passed the impugned final order of assessment which as contended by the Ld AR against the direction of the DRP related the issues IGS fees and franchise fees. In view of the provisions of the Act and respectfully relied on the ruling of ESPN Star Sports Mauritius S.N.C. ET Compagnie 2016 (4) TMI 45 - DELHI HIGH COURT and the ruling of Olympus Medical Systems Pvt. Ltd. 2022 (1) TMI 886 - ITAT DELHI Global One India (P.) Ltd. 2019 (12) TMI 503 - ITAT DELHI and Software Paradigms Infotech (P.) Ltd. 2018 (1) TMI 1550 - ITAT BANGALORE we find that the Ld. AO is required to pass the final assessment order in conformity with the DRP directions. In the present case since the final assessment order passed by the Ld. AO is not in conformity with the DRP directions In the present appeal since the impugned assessment order passed by the Ld. AO is not in conformity with the DRP directions the same is bad in law and therefore should be quashed. Adjustment on account of disallowance of franchisee fees - Rights granted under Franchisee Agreement - Considering the ALP of its international transaction pertaining to payment of Franchisee Fees the assessee had undertaken and maintained contemporaneous documentation. A methodical process for the purpose of comparability analysis for the determination of the ALP was undertaken wherein the CUP was selected as most appropriate method and an arm s length range of 8% to 10% with a median of 9.5% was determined. Based on the same payment of Franchisee Fees was concluded to be at arm s length. TPO determined the ALP of the international transaction pertaining to franchisee fees as Nil. However while arriving at the said ALP the Ld. TPO has not followed the mandatory statutory procedure as laid down under Rule 10B(1)(a) and Rule 10C of the Rules to identify the most appropriate method and in its application. AR argued that DRP/Ld. AO/Ld. TPO by not identifying any comparable uncontrolled transaction and by considering the benchmark price of the said international transaction as Nil has violated the explicit provisions of the Indian TP regulations. In our considered view the issue is squarely covered by assessee s own case 2023 (2) TMI 903 - ITAT MUMBAI We direct to delete the adjustment as proposed in relation to franchise fees. Disallowance of deduction claimed u/s 80G - The provisions of section 80G permits deduction for the contributions made by an assessee to specified relief funds and charitable institutions except where CSR expenditure is made towards donation to Swachh Bharat Kosh or Clean Ganga Fund. Respectful reliance is placed on judicial precedents where it was held that CSR expenditure is eligible for deduction u/s 80G of the Act subject to satisfaction of the conditions mentioned in the said section. We respectfully relied on the order of M/s Naik Seafoods Pvt. Ltd. 2021 (11) TMI 1168 - ITAT MUMBAI as held assessee has a valid point to claim the deduction u/s. 80G of the Act and we observe that nowhere assessee has claimed deduction u/s. 37 of the Act. It is clear that the restriction given in section 37 of the Act is restricted to CSR expenses but similar restrictions are not given in section 80G of the Act. We remand the matter to the file of the Ld. AO with direction to allow the deduction U/s 80G subject to fulfilment of requisite conditions.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal are:

• Whether the final assessment order passed by the Assessing Officer (AO) under section 143(3) read with sections 144C(13) and 144B of the Income-tax Act, 1961 ("the Act") is valid, particularly whether it conforms to the directions issued by the Dispute Resolution Panel (DRP) under section 144C(5) of the Act;
• Whether the AO erred in enhancing the income of the assessee by disallowing the payment of franchisee fees made to Associated Enterprises (AEs) on the ground that such transactions do not satisfy the arm's length principle, including the procedural compliance with Rule 10B(1)(a) and Rule 10C of the Income Tax Rules, 1962 ("the Rules");
• Whether the AO and Transfer Pricing Officer (TPO) erred in disallowing payment for intra-group services without following statutory procedures and without proper appreciation of the commercial necessity and benchmarking analysis;
• Whether the DRP erred in enhancing the disallowance of intra-group services from 50% to 100% based on a misinterpretation of the TPO's order and the need-benefit test;
• Whether the alternate disallowance of franchisee fees and intra-group service charges under section 37(1) of the Act as proposed by the DRP is sustainable;
• Whether the AO erred in disallowing deduction claimed under section 80G of the Act on account of donations made, particularly in light of Corporate Social Responsibility (CSR) expenditure under the Companies Act, 2013;
• Whether the AO erred in the computation of total income and in initiating penalty proceedings under section 270A of the Act for alleged under-reporting of income.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Validity of Final Assessment Order vis-`a-vis DRP Directions (Ground No. 2)

Relevant legal framework and precedents: Section 144C(5) mandates the DRP to issue binding directions to the AO, who is then required under section 144C(10) to pass the final assessment order in conformity with those directions within the prescribed time under section 144C(13). The AO's failure to comply renders the order void ab initio. Precedents include Olympus Medical Systems Pvt. Ltd. v. ACIT (ITAT Delhi), Global One India (P.) Ltd. v. DCIT (Delhi Tribunal), Software Paradigms Infotech (P.) Ltd. v. ACIT (ITAT Bangalore), and ESPN Star Sports Mauritius S.N.C. v. UOI (Delhi High Court).

Court's interpretation and reasoning: The Tribunal found that the AO did not comply with the DRP's directions, particularly the alternate disallowance under section 37(1) for franchisee fees and intra-group service charges. The final assessment order merely reiterated the draft order without incorporating the DRP's additional grounds and directions.

Key evidence and findings: Extracts from the DRP order directed the AO to assess income succinctly in accordance with the "Nil" arm's length price (ALP) determination and also to provide an alternate disallowance under section 37(1), avoiding double addition. The AO failed to do so.

Application of law to facts: The AO's non-compliance with binding DRP directions contravened the statutory mandate under sections 144C(10) and 144C(13). The Tribunal held that the final order is thus bad in law and liable to be quashed.

Treatment of competing arguments: The Revenue sought remand for reconsideration, but the Tribunal emphasized the binding nature of DRP directions and the statutory timeline, rejecting the AO's approach.

Conclusion: The final assessment order is quashed for non-compliance with DRP directions.

Issue 2: Disallowance of Franchisee Fees (Ground No. 5)

Relevant legal framework and precedents: Transfer pricing provisions under Chapter X of the Act, Rules 10B and 10C for determination of Most Appropriate Method (MAM), and judicial pronouncements such as Sony Ericsson Mobile Communications v. CIT and EKL Appliances v. CIT. The CUP (Comparable Uncontrolled Price) method is recognized for benchmarking franchise fees.

Court's interpretation and reasoning: The Tribunal noted that the TPO determined the ALP of franchisee fees as "Nil" without following the mandatory procedural requirements of identifying comparable uncontrolled transactions and applying the MAM. The assessee had maintained contemporaneous documentation and benchmarking analysis showing an arm's length range of 8% to 10% with a median of 9.5% using CUP method.

The Tribunal also analyzed the franchise agreement, which granted the assessee a "bundle of rights" including IP rights (manufacturing and marketing), trademarks, marketing support, and services, which justified the payment of franchisee fees.

Key evidence and findings: The franchise agreement defining "System" rights, benchmarking reports, and the assessee's prior successful appeal for AY 2016-17 on the same issue where the adjustment was deleted by the ITAT Mumbai.

Application of law to facts: The TPO's approach to benchmark the franchise fee at nil without comparable data was contrary to the statutory provisions and judicial precedents. The Tribunal relied on the assessee's own prior case and the detailed benchmarking analysis to hold the franchise fees as at arm's length.

Treatment of competing arguments: The Revenue's contention that the franchise fee payment was a "colourable aggressive term" and that the right to sell products was embedded in supply agreements was rejected, as the purchase price did not cover the rights granted under the franchise agreement.

Conclusion: The disallowance of franchisee fees is deleted and the appeal on this ground is allowed.

Issue 3: Disallowance of Intra-group Service Charges (Ground Nos. 6 and 7)

Relevant legal framework and precedents: Transfer pricing provisions and Rules 10B and 10C, along with judicial pronouncements emphasizing the need to follow statutory procedures and the commercial rationale for intra-group services.

Court's interpretation and reasoning: The Tribunal found that the TPO and AO arbitrarily disallowed 50% of intra-group service charges without following the mandated procedures and without appreciating the commercial necessity of such services. The DRP's enhancement of disallowance from 50% to 100% was based on a misinterpretation of the TPO's order and an incorrect conclusion that the need-benefit test was entirely failed.

Key evidence and findings: Service agreements, documentary evidence of services rendered, and benchmarking analysis corroborating the arm's length nature of charges.

Application of law to facts: The Tribunal held that the commercial decision of the assessee to avail services from AEs is legitimate, and the benchmarking analysis supported the arm's length pricing. The disallowance was thus unsustainable.

Treatment of competing arguments: The Revenue's assertion that third-party services could have been availed at a lower cost was not supported by cogent evidence and was rejected.

Conclusion: The disallowance of intra-group service charges is deleted and the appeal on these grounds is allowed.

Issue 4: Alternate Disallowance under Section 37(1) of the Act (Ground No. 8)

The Tribunal found this ground to be rendered unnecessary in view of the findings on grounds 2, 5, 6, and 7, where the disallowances were deleted. Hence, this ground is dismissed as redundant.

Issue 5: Disallowance of Deduction under Section 80G of the Act (Ground No. 9)

Relevant legal framework and precedents: Section 80G allows deduction for donations to specified funds and charitable institutions. CSR expenditure under section 135 of the Companies Act, 2013 is not allowable as business expenditure under section 37(1) per Explanation 2, but no restriction is imposed on claiming deduction under section 80G for donations made pursuant to CSR.

Court's interpretation and reasoning: The Tribunal noted that the CSR expenditure was disallowed under section 37(1) but the donations forming part of CSR expenditure are eligible for deduction under section 80G subject to conditions. The Explanatory Memorandum to the Finance Bill clarified the non-allowability of CSR expenditure under section 37(1) but did not restrict section 80G deductions.

Key evidence and findings: The assessee claimed Rs. 1,925,834 as donation under section 80G, of which Rs. 962,917 (50%) was disallowed. The Tribunal relied on a coordinate bench decision in M/s Naik Seafoods Pvt. Ltd. v. Pr. CIT that upheld deduction under section 80G for CSR donations.

Application of law to facts: The Tribunal remanded the matter to AO with directions to allow deduction under section 80G subject to fulfillment of conditions.

Treatment of competing arguments: The Revenue's reliance on disallowance was rejected based on statutory interpretation and precedents.

Conclusion: The appeal on this ground is allowed for statistical purpose with directions to allow deduction under section 80G.

Issue 6: Other Grounds (Ground Nos. 1, 3, 4, 10, and 11)

Grounds 1, 3, and 4 were general in nature without specific averments and were dismissed. Grounds 10 and 11, relating to computation of total income and penalty under section 270A, were consequential and not adjudicated.

3. SIGNIFICANT HOLDINGS

"The Assessing Officer is required to pass the final assessment order in conformity with the directions issued by the Dispute Resolution Panel under section 144C(5) of the Act, which are binding on him as per section 144C(10) thereof and within the time prescribed under section 144C(13) of the Act. Failure to do so renders the final order bad in law and liable to be quashed."

"The Transfer Pricing Officer cannot determine the arm's length price of an international transaction, such as franchisee fees, as 'Nil' without following the mandatory statutory procedure of identifying comparable uncontrolled transactions and applying the most appropriate method as prescribed under Rule 10B(1)(a) and Rule 10C of the Income Tax Rules."

"The 'bundle of rights' granted under the franchise agreement, including IP rights, marketing support, trademarks, and services, constitute significant benefits to the assessee, justifying the payment of franchisee fees at arm's length."

"Disallowance of intra-group service charges without proper application of transfer pricing principles and ignoring commercial/business necessity and benchmarking analysis is unsustainable."

"CSR expenditure is not allowable as business expenditure under section 37(1) of the Act; however, donations made pursuant to CSR activities are eligible for deduction under section 80G, subject to conditions."

Final determinations:

• The final assessment order not conforming to DRP directions is quashed.
• The disallowance of franchisee fees is deleted.
• The disallowance of intra-group service charges is deleted.
• The alternate disallowance under section 37(1) is rendered unnecessary.
• The deduction under section 80G is allowed subject to conditions.
• Other general and consequential grounds are dismissed.