2025 (5) TMI 1077 - AT - Income Tax

TP Adjustment - comparable selection - HELD THAT - Accropetal Technologies Ltd and Cross Domain Solutions Pvt.Ltd. - Merely because TNMM is adopted cannot be the reason to consider a company which is not functionally similar with that of assesse. It is necessary for the comparable to be similar qualitatively in functions in order to determine the comparability. In the present facts of the case admittedly the assessee is a low risk captive service provider only rendering services to its AEs whereas this company is a high and KPO and entrepreneur in itself. We therefore direct the TPO to exclude Accropetal Technologies Ltd and Cross domain solution Pvt.Ltd form the final list. TPO bench marked the reimbursement of expenses with the mark up based on the transfer pricing order passed by the predecessor for preceding assessment year - It is an admitted fact that expenses has been incurred by the assessee on behalf of its AE and the same is allocated using allocation key consistently followed by the assessee. In so far as the services rendered by the assessee are concerned they are simplicitor business process outsourcing services without any involvement of skill knowledge. Further these are pass through costs and hence no mark up is required to be charged. Respectfully following the view taken by the co-ordinate bench in assessee s own case for A.Y. 2007-08 we direct the Ld.AO/TPO to delete the adjustment made in this regard. Disallowance of mark to market loss on forex derivatives - There is no dispute that such contracts have been entered into by assessee in order to protect its interest against fluctuation in foreign currency in respect of consideration for export proceeds which are revenue in nature. Thus in our view consequent effect of this accounting treatment is to recognized as exchange fluctuation gain or loss in the profit and loss account as on the valuation date. Hon ble Supreme Court in case of CIT us Woodward Governor India (P) Ltd. 2009 (4) TMI 4 - SUPREME COURT Hon ble Supreme Court established a precedent regarding the tax treatment of foreign exchange losses on both revenue and capital account transactions. Hon ble Court held that transaction in which a legal liability is incurred before it is actually disbursed would be regarded as revenue in nature. In the present facts of the case assessee incurred foreign exchange loss for year under consideration towards dealing in forex derivatives it is directly attributable to business of assessee which is an allowable expenditure. We direct the Ld.AO to allow the deduction in respect of marked to market losses earned by the assessee. Disallowance computed u/s 14A relating to the exemption claimed by the assessee u/s 10(15) 10(34) 10(35) - HELD THAT - It is noted that assessee suo moto disallowed of Rs.11.94 crores however for the year under consideration 14A disallowance has to be computed as per Rule 8D. AO is directed to verify the same and to consider the disallowance in accordance with law. Disallowance bad debt written off - HELD THAT - As in the present facts of the case it is noted that the Ld.AO/CIT(A) did not verify the issue based on the ratio laid down in case of TRF Ltd. vs CIT 2010 (2) TMI 211 - SUPREME COURT and Vijaya Bank Ltd. 2010 (4) TMI 46 - SUPREME COURT We accordingly direct the Ld.AO to verify the claim of assessee in the light of the ratios by Hon ble Supreme Court in the above referred decisions in accordance with law. Disallowance of business loss and other expenses - We direct the Ld.AO to carry out fresh examination of the based on the documents furnished by the assessee in respect of the loan given to the individual customers and the nature of the assets repossessed and the sale value of the repossessed assets. Assessee is directed to furnish all relevant details in respect of the same. Ld.AO is directed to consider the claim in accordance with law. Needless to say that proper opportunity of being hurt must be granted to assessee. Disallowance of provision of expenses - HELD THAT - It is an admitted fact that in the kind of business carried out by the assessee most of the times the bills are not received by 31 st March of the financial year relevant to the assessment year under consideration. In such cases the year and provision are made on an estimate basis and subsequently are reversed in the books of account on the 1st day of the next year upon receipt of their invoices. It is also not disputed that in the subsequent financial year the payments made by the assessee has been subjected to TDS. Further various courts and Hon ble Supreme Court in case of Eli Lilly Co 2009 (3) TMI 33 - SUPREME COURT and GE India Technologies 2010 (9) TMI 7 - SUPREME COURT held that if the income component itself is not embedded in the amount provided then there cannot be any liability to deduct tax at source even though TDS is a vicarious liability. Thus we are of the opinion that year end provision was made on estimate basis by the assessee cannot be denied in such facts as observed herein above. Disallowance of contribution to pension and that it is paid on account of Sanghli Bank Ltd. - Admittedly the claim was raised by the assessee during the assessment proceedings and no revised return was. The authorities below under such circumstances do not have the power to examine a claim is does not form part of the return of income. However Hon ble Supreme Court in case of Goetz India Ltd . 2006 (3) TMI 75 - SUPREME COURT Disallowance of discount expenses claimed by the assessee on bonds - We direct the Ld.AR to allow the claim of the assessee on proportionate basis. Short grant of relief under section 90 - Admittedly assessee made additional claim during assessment proceedings against which the TDS certificate was been submitted. The Ld.AO is directed to verify the same and consider the claim of assessee in accordance with law. MAT - applicability of provision of section 115 JB - This issue is no longer res integra as it has been held by Hon ble Bombay High Court and Hon ble Supreme Court that provisions of 115 JB of the act is not applicable to banking institutions. Respectfully following the view we do not find any merit in the applicability of section 115 JB of the act to the facts of the present assessee. Claim of depreciation on leased assets - As no new lease transaction has been entered into by the assesse we do not find any infirmity in the view taken by the Ld. CIT(A). Club membership fees being allowed as expenditure under section 37 by CIT(A) - In assessee s own case for assessment in 2007-08 2024 (2) TMI 101 - ITAT MUMBAI this Tribunal followed the ratio of Hon ble Bombay Court in case of Otis elevators company India Ltd. 1991 (4) TMI 53 - BOMBAY HIGH COURT We therefore do not find any infirmity in the view taken by the Ld.CIT(A) and the same is upheld.

Summary

The core legal questions considered by the Tribunal in this appeal pertain to multiple issues arising under the Income-tax Act, 1961, primarily involving transfer pricing adjustments, disallowance of certain expenses and losses, applicability of provisions related to bad debts, depreciation claims, and tax treatment of derivatives and exempt income. The principal issues are:

1. Whether the Transfer Pricing Officer (TPO) was justified in making an adjustment to the arm's length price for back office support and business support services under section 92CA(3).

2. Whether the disallowance of mark-to-market (MTM) losses on forex derivatives as notional and hence non-deductible was correct, and the corresponding treatment of MTM gains.

3. Whether expenses apportioned against exempt income under sections 10(15), 10(34), and 10(35) should be disallowed under section 14A read with Rule 8D.

4. Whether the entire bad debts written off could be disallowed for failure to establish that the debts had become bad, in light of amendments to section 36(1)(vii) and judicial precedents.

5. Whether disallowance of business losses and other expenses related to repossessed assets and fraud was justified.

6. Whether provisions for expenses created in March but reversed in the next year without tax deduction at source could be disallowed.

7. Whether contributions to pension and gratuity in respect of a merged entity could be allowed when claimed during assessment proceedings but not via revised return.

8. Whether issue and discount expenses on bonds could be allowed as deduction despite not being dealt with in the assessment order.

9. Whether additional relief under section 90 was correctly denied for not arising from the assessment order.

10. Whether interest under sections 234B and 234D was rightly levied.

11. Whether provisions of section 115JB (Minimum Alternate Tax) apply to the assessee.

12. Revenue's appeal issues on depreciation on leased assets and club membership fees.

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustment on Back Office and Business Support Services

The legal framework involves section 92CA(3) and Transfer Pricing Guidelines requiring arm's length pricing of international transactions. The assessee provided back office and business support services to associated enterprises (AEs) and benchmarked these using the Transactional Net Margin Method (TNMM) with selected comparables.

The TPO rejected the assessee's comparables, applying filters and selecting a different set with higher margins, resulting in an upward adjustment. The assessee challenged the inclusion of certain comparables on grounds of functional dissimilarity.

The Tribunal examined the functions, assets, and risks borne by the assessee versus the comparables, noting the assessee's captive, low-risk BPO nature versus high-end Knowledge Process Outsourcing (KPO) or companies with different business models and scale. The Tribunal relied on coordinate bench decisions for the immediately preceding assessment year, which excluded specific comparables such as Accentia Technologies Ltd., Coral Hubs Ltd., Eclerx Services Ltd., Infosys BPO Ltd., and others for being functionally dissimilar or having significantly different scale.

Further, the Tribunal held that pass-through costs incurred on behalf of AEs and reimbursed without value addition do not warrant a markup. The TPO's adjustment of 11.93% markup on such expenses was deleted, following the coordinate bench's earlier ruling.

Accordingly, the Tribunal directed the TPO to recompute the arm's length price excluding the dissimilar comparables and deleting the markup on pass-through costs.

2. Disallowance of Mark-to-Market Losses on Forex Derivatives

The issue arose whether MTM losses on interest rate, forex, and credit derivatives are allowable deductions under the Act. The AO and CIT(A) disallowed these losses as notional, relying on CBDT instructions and the premise that unrealized losses do not constitute deductible expenditure.

The assessee contended that dealing in derivatives is part of normal banking business, and gains and losses must be accounted on accrual basis as per Accounting Standard 11 and RBI guidelines. The assessee consistently recognized MTM gains as income and MTM losses as expenditure, which should be treated symmetrically. Reliance was placed on the Supreme Court decision in Woodward Governor India (P) Ltd., which held that notional foreign exchange losses are allowable as business losses. The Special Bench of the Mumbai Tribunal in Bank of Bahrain and Kuwait further supported this view, emphasizing the binding obligation arising upon entering forward contracts and the consistency of accounting methods.

The Tribunal followed these precedents, allowing the MTM losses as deductible expenses and directed the AO to reconsider the order under section 154 to bring back the corresponding MTM gains to tax.

3. Disallowance under Section 14A and Rule 8D for Expenses Related to Exempt Income

The AO disallowed a substantial sum under section 14A read with Rule 8D, on the ground that expenses were incurred in relation to exempt income under sections 10(15), 10(34), and 10(35). The assessee submitted that investments were made from cost-free funds, and only minimal administrative expenses were incurred, which were already disallowed voluntarily.

The Supreme Court decision in Rajasthan State Warehousing Corporation v. CIT was relied upon to argue that where an assessee carries on an indivisible business yielding both taxable and exempt income, the entire expenditure is allowable without apportionment.

The Tribunal noted that the assessee had furnished computations under Rule 8D and directed the AO to verify and consider the disallowance in accordance with law, allowing the ground partly for statistical purposes.

4. Disallowance of Bad Debts Written Off

The AO disallowed the entire bad debts claimed on the ground that the assessee failed to establish that the debts had become bad, citing lack of details as required under section 36(1)(vii) read with section 36(2). The CIT(A) upheld this disallowance.

The assessee relied on the Supreme Court decisions in TRF Ltd. and Vijaya Bank, which clarified that after the 1989 amendment to section 36(1)(vii), it is sufficient that the debt is written off as irrecoverable in the books of account without needing to prove actual irrecoverability. The CBDT Circular No. 12/2016 was also cited, confirming the legislative intent to eliminate litigation on this issue.

The Tribunal observed that the AO and CIT(A) did not apply these precedents and directed the AO to verify the claim afresh in light of the settled legal position, allowing the ground partly for statistical purposes.

5. Disallowance of Business Loss and Other Expenses (Loss on Repossessed Assets)

The assessee claimed business losses arising from sale of repossessed assets due to default on loans. The AO disallowed these losses relying on earlier assessment years where the claim was rejected for lack of proof.

The Tribunal noted that the coordinate bench had remanded the issue in the immediately preceding year for detailed examination of the computation of loss, including loan amounts, sale proceeds, and outstanding balances. The assessee was directed to furnish complete details, and the AO was directed to examine the claim in accordance with law, granting the assessee proper opportunity.

6. Disallowance of Provision for Expenses

The AO disallowed provisions made for expenses in March 2008 on the ground that these were contingent and unascertained liabilities, and no tax was deducted at source (TDS). The provisions were reversed in the next financial year when actual bills were received, and TDS was deducted then.

The Tribunal relied on the mercantile system of accounting and judicial precedents including the Karnataka High Court decision in Subex Ltd. vs DCIT, which held that provisions made on estimate basis and reversed subsequently cannot be disallowed merely because TDS was not deducted at the time of provision. The AO was directed to allow the provisions as per the accounting treatment followed.

7. Disallowance of Contribution to Pension and Gratuity Paid on Account of Merged Entity

The assessee claimed deduction for pension and gratuity contributions made on account of Sangli Bank Limited, a merged entity, during assessment proceedings but did not file a revised return. The AO disallowed the claim, upheld by CIT(A), relying on Supreme Court decision in Goetz India Ltd., which held that claims not made in the return cannot be entertained during assessment.

The Tribunal observed that while the AO cannot entertain claims outside the return, the Income Tax Appellate Tribunal has wider powers under section 254 to entertain points of law if facts are on record. The issue was remanded to AO for verification of the claim based on the documents furnished, with opportunity to the assessee.

8. Claim of Issue and Discount Expenses on Bonds

The assessee claimed deduction for issue and discount expenses on Rupee and Foreign Currency Bonds, which the AO did not deal with in the assessment order. CIT(A) dismissed the claim on this ground.

The Tribunal noted that in earlier assessment years, the Tribunal had allowed such expenses to be spread over the tenure of the bonds following the Supreme Court decision in Madras Industrial Investment Corporation. The AO was directed to allow proportionate expenditure relatable to the year under consideration, spreading the balance over the bond tenure.

9. Short Grant of Relief under Section 90

The assessee claimed additional relief under section 90 (relief for tax paid in foreign countries) during assessment proceedings. The AO did not deal with the claim, and CIT(A) rejected it as not arising from the assessment order.

The Tribunal directed the AO to verify and consider the claim in accordance with law, allowing the ground for statistical purposes.

10. Charging of Interest under Sections 234B and 234D

The CIT(A) treated the interest levied as consequential and did not delete it. The Tribunal observed that since these are consequential, separate adjudication was not required.

11. Applicability of Section 115JB (MAT) to the Assessee

The CIT(A) dismissed the ground on the basis that the AO had not dealt with it in the assessment order. The assessee contended that the AO had computed book profits under section 115JB. The Tribunal noted that the issue is no longer res integra, as the Bombay High Court and Supreme Court have held that section 115JB does not apply to banking institutions. The ground was allowed accordingly.

Departmental Appeal Issues:

1. Depreciation on Leased Assets

The AO disallowed depreciation on leased assets on the ground that the assessee did not have ownership and the transactions were financial leases. CIT(A) allowed the claim following precedents in the assessee's own case for preceding years.

The Tribunal noted no new lease transactions were entered into during the year, and no new facts were brought by the revenue. Following coordinate bench decisions, the Tribunal upheld CIT(A)'s order allowing depreciation on leased assets.

2. Club Membership Fees

The AO disallowed club membership fees as capital expenditure. CIT(A) allowed it following earlier orders and the Bombay High Court decision in Otis Elevators Company India Ltd., which held such expenses allowable if incurred for business promotion.

The Tribunal upheld CIT(A)'s order, dismissing the revenue's appeal.

Significant Holdings and Legal Principles:

"After 1.4.1989, for allowing deduction for the amount of any bad debt or part thereof under section 36(1)(vii) of the Act, it is not necessary for assessee to establish that the debt, in fact has become irrecoverable; it is enough if bad debt is written off as irrecoverable in the books of accounts of assessee." (CBDT Circular No. 12/2016; Supreme Court in TRF Ltd.)

"The MTM losses on forward foreign exchange contracts are allowable as deduction as soon as a binding obligation arises on the assessee and consistent accounting methods are followed; the timing of taxation of loss/profit is the only issue." (Special Bench Mumbai Tribunal in Bank of Bahrain and Kuwait; Supreme Court in Woodward Governor India)

"Expenses incurred as pass-through costs on behalf of associated enterprises without value addition do not warrant markup under transfer pricing." (Coordinate bench decisions)

"Where an assessee carries on an indivisible business yielding both taxable and exempt income, entire expenditure is allowable without apportionment under section 14A." (Supreme Court in Rajasthan State Warehousing Corporation)

"Provisions made on estimate basis and reversed in the subsequent year upon receipt of bills, with TDS deducted then, are allowable deductions." (Karnataka High Court in Subex Ltd.)

"Depreciation on leased assets is allowable where the assessee has claimed it consistently and no new lease transactions are entered into, following coordinate bench decisions."

"Club membership fees incurred for business promotion are allowable as revenue expenditure." (Bombay High Court in Otis Elevators)

Final Determinations:

• The transfer pricing adjustment was set aside with directions to exclude functionally dissimilar comparables and delete markup on pass-through costs.
• MTM losses on derivatives were allowed as deductible expenses, with directions to bring corresponding gains to tax.
• Section 14A disallowance was directed to be recomputed considering the assessee's submissions and computations.
• Bad debts written off were allowed subject to verification in light of Supreme Court precedents and CBDT Circular.
• Business losses on repossessed assets were remanded for detailed factual verification.
• Provisions for expenses made on estimate basis were allowed.
• Contribution to pension and gratuity was remanded for verification.
• Issue and discount expenses on bonds were allowed proportionately over the bond tenure.
• Additional relief under section 90 was directed to be considered.
• Interest under sections 234B and 234D was not disturbed.
• Section 115JB was held not applicable to the assessee.
• Revenue's appeals on depreciation on leased assets and club fees were dismissed.