2025 (5) TMI 1707 - AT - Income Tax

TP Adjustment - Interest on advances given to AEs - HELD THAT - Bench accepted the assessee s internal CUP benchmarking and rejected the external CUPs relied upon by the TPO. It was further held that no ad-hoc addition of 100 basis points towards forex risk was warranted as there was no evidence of significant forex risk affecting the assessee s transactions. Following the binding precedent laid down in assessee s own case for Assessment Year 2013 14 2023 (11) TMI 196 - ITAT AHMEDABAD and there being no distinguishing facts brought on record for the year under consideration we respectfully apply the same ratio to the present case. Consequently we hold that the benchmarking done by the assessee based on internal CUP is valid and the adjustment made by the TPO and confirmed by the CIT(A) on account of alleged undercharging of interest on advances to AEs is unsustainable. We accordingly direct the deletion of the addition. TP Adjustment - Notional Interest on Outstanding Receivables from AEs - HELD THAT - It is not in dispute that the assessee applied TNMM for benchmarking the sale transactions working capital adjustment was made to the profit level indicator (PLI) and no contrary decision has been cited by the DR. It was also noted that the assessee submitted the documentary evidence before lower authorities relating to instances of transactions with non-AEs of not charging interest on late realisations of receivables. Respectfully following the decision of own case for A.Y. 2013-14 2023 (11) TMI 196 - ITAT AHMEDABAD we hold that the receivables are merely an extension of the main international transaction of sale of goods and do not constitute a separate international transaction warranting independent adjustment. We therefore direct deletion of the addition made towards notional interest on delayed receivables from AEs. Disallowance of Weighted Deduction u/s 35(2AB) - allowability of revenue expenditure as approved by the DSIR for weighted deduction purposes - HELD THAT - As held that the Form 3CL merely reflects intimation of cost of in-house R D facility to the Income Tax Department and is not a statutory approval of allowable expenditure. It has also been held that in the absence of any statutory requirement for the DSIR to quantify or approve each expense prior to 01.07.2016 the claim of weighted deduction u/s 35(2AB) cannot be restricted to the amount mentioned in Form 3CL. On merits we also find that the nature of disallowed expenditure has been explained by the assessee to be integrally related to scientific research. The expenditure on exhibit batches was incurred for the purpose of regulatory filings and validation studies essential for commercialisation and has been consistently held to be eligible in earlier years. As expenditure disallowed by the Assessing Officer and confirmed by the CIT(A) is eligible for weighted deduction under section 35(2AB). Disallowance being Depreciation of Goodwill - primary contention of the Revenue is that the goodwill was artificially created in the books of the amalgamated company without any actual commercial basis and that the valuation was not based on the Net Asset Value (NAV) method - HELD THAT - We are unable to accept the DR s argument that the goodwill lacks substance merely because the business of ILPL was functionally integrated or wholly dependent on the assessee. The principles of commercial reality as recognised in Smifs Securities 2012 (8) TMI 713 - SUPREME COURT Urmin Marketing 2020 (11) TMI 47 - ITAT AHMEDABAD and Zydus Wellness Ltd 2017 (10) TMI 373 - GUJARAT HIGH COURT support the view that goodwill may arise even in intra-group amalgamations when excess consideration is paid and booked transparently. We thus uphold the conclusion of the CIT(A) that the goodwill so recognised constitutes a valid depreciable asset within the meaning of section 32(1)(ii) and that depreciation claimed thereon is allowable in law subject only to the proportionate restriction in respect of the Dehradun unit as correctly computed and sustained by the first appellate authority. Disallowance on Account of Allocation of Common Expenses - CIT(A) in deleting the disallowance as made by allocating a portion of common research and development (R D) expenses to units of the assessee claiming deduction under sections 10AA 80-IC and 80-IE - HELD THAT - While computing the profits eligible for deduction under sections 80IC 80IE and 10AA it is essential to confine the computation to those expenses which have a direct and proximate nexus with the operations of the eligible undertaking. Any attempt to allocate general or common expenses that are not specifically relatable to the activities of such undertaking would distort the true profits derived therefrom. The principle that governs such computation is one of factual linkage and unless the expense can be clearly identified as incurred for the functioning of the eligible unit it cannot be brought into the computation for the purposes of determining the deduction under the said provisions. No infirmity in the conclusion of the learned CIT(A) in deleting the disallowance on account of allocation of common expenses to the Dehradun Sikkim and SEZ units. The accounting treatment adopted by the assessee is based on separate books and verifiable entries and the disallowance made by the AO is not sustainable in the facts and circumstances of the case. Disallowance of Interest u/s 36(1)(iii) - assessee had made substantial additions to capital work-in-progress (CWIP) during the year but no proportionate interest cost was capitalised in its books - AO noted that the assessee had not established the day-to-day availability of interest-free funds and the nexus between surplus funds and utilisation for CWIP - HELD THAT - In the present year as well the AO has not brought any material to demonstrate that borrowed funds were actually utilised for CWIP. CIT(A) after recording detailed facts and after following the settled legal position as also the earlier appellate orders in assessee s own case for A.Ys. 2011 12 to 2014 15 has deleted the disallowance made u/s 36(1)(iii). The assessee has also placed reliance on its consistent accounting policy to capitalise interest cost only when directly attributable to acquisition of qualifying capital assets which has been accepted in earlier years and remains unchanged. In light of the overwhelming factual matrix demonstrating availability of substantial own funds and in view of consistent judicial precedents on the issue including the detailed findings of the Co-ordinate Bench in assessee s own case for A.Y. 2013 14 we find no infirmity in the decision of the learned CIT(A) in deleting the disallowance made by the AO u/s 36(1)(iii) of the Act. Decided in favour of assessee. Disallowance u/s 14A r/w Rule 8D and corresponding adjustment to book profits u/s 115JB - HELD THAT - We uphold the deletion of the disallowance made by CIT(A) u/s 14A r/w Rule 8D including both components under Rule 8D(2)(ii) and 8D(2)(iii). Consequently the adjustment made by the AO to the book profit u/s 115JB on account of section 14A disallowance is also directed to be deleted. The grounds of appeal raised by the Revenue are therefore dismissed. TDS u/s 195 - Disallowance u/s 40(a)(ia) of the Act being commission paid to non-resident - CIT(A) deleted addition - HELD THAT - Revenue has not brought any material on record to establish that the agents had a business connection in India within the meaning of section 9(1)(i) or that services were rendered in India. The mere fact that the contracts were executed in India does not render the commission taxable in India when the source of income namely the activity of soliciting and securing export orders occurred entirely outside India. The situs of income in such cases is the place where the services are rendered as consistently held in judicial precedents. We uphold the well-reasoned order of the Ld. CIT(A) as disallowance made under section 40(a)(i) on account of commission paid to non-resident agents without deduction of TDS is therefore not sustainable. Accordingly this ground raised by the Revenue is dismissed.

Summary

The core legal questions considered by the Appellate Tribunal (AT) in these cross-appeals arising from the assessment year 2015-16 include:

1. Whether the transfer pricing adjustments made by the Assessing Officer (AO) and confirmed by the Commissioner of Income Tax (Appeals) [CIT(A)] on (i) interest on advances given to Associated Enterprises (AEs) and (ii) notional interest on outstanding receivables from AEs are sustainable.

2. Whether the disallowance of weighted deduction claimed under section 35(2AB) of the Income-tax Act, 1961 (the Act) on certain research and development (R&D) expenses, particularly clinical trial and exhibit batch expenses, is justified.

3. Whether the disallowance of depreciation claimed on goodwill arising from amalgamation is legally sustainable.

4. Whether the disallowance of allocation of common expenses to tax-exempt units is justified.

5. Whether disallowance of interest capitalisation to Capital Work-in-Progress (CWIP) under section 36(1)(iii) is warranted.

6. Whether disallowance under section 14A read with Rule 8D of the Income-tax Rules relating to expenditure incurred in relation to exempt income is sustainable.

7. Whether disallowance under section 40(a)(ia) for commission paid to non-resident agents without deduction of tax at source (TDS) is justified.

8. Ancillary issues including the allowability of deduction for education cess under section 40(a)(ii), and challenges to penalty proceedings under section 271(1)(c).

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustments on Interest on Advances and Notional Interest on Receivables from AEs

Legal Framework and Precedents: Transfer pricing provisions under Chapter X of the Act, particularly sections 92CA and 92B, require international transactions with AEs to be benchmarked at arm's length price (ALP). The Transfer Pricing Officer (TPO) and AO rely on comparable uncontrolled prices (CUP) or Transaction Net Margin Method (TNMM) for benchmarking. Judicial precedents emphasize that internal comparables are preferred if reliable, and ad-hoc additions require evidentiary basis.

Court's Interpretation and Reasoning: The AO and CIT(A) upheld upward adjustments on interest on advances and notional interest on receivables, relying on external CUPs and adding 100 basis points for forex risk. The CIT(A) also rejected the assessee's contention of commercial expediency and internal CUP benchmarking based on a loan quotation from Bank of Nova Scotia, Singapore.

Key Evidence and Findings: The assessee had advanced loans to multiple AEs charging interest at 3.22%, benchmarked internally using a loan quotation. The TPO found this internal CUP not comparable across jurisdictions and preferred external CUPs. For receivables, the TPO treated delayed payments beyond 180 days as deemed loans and imputed interest accordingly.

Application of Law to Facts: The Tribunal referred to a binding Coordinate Bench decision in the assessee's own case for AY 2013-14, which held that the internal CUP based on the bank quotation was a valid comparable. The Tribunal emphasized that the quotation was from a reputable international bank, authentic, and that the external CUPs lacked parity. The Tribunal also rejected the ad-hoc forex risk addition due to lack of evidence. Regarding receivables, the Tribunal held that where TNMM with working capital adjustment is applied to the primary sale transaction, no separate adjustment for notional interest on receivables is warranted to avoid double taxation, relying on the Delhi High Court decision in Pr. CIT v. Kusum Healthcare Pvt. Ltd.

Treatment of Competing Arguments: The Revenue relied on CIT(A) and TPO findings; the assessee relied on binding Coordinate Bench decisions and judicial precedents disallowing double adjustments. The Tribunal accepted the latter.

Conclusion: The Tribunal deleted the upward transfer pricing adjustment of Rs. 53,93,893/- on interest on advances and Rs. 14,64,47,827/- on notional interest on receivables.

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

Legal Framework and Precedents: Section 35(2AB) allows weighted deduction for in-house scientific research expenses approved by the Department of Scientific and Industrial Research (DSIR). Prior to the amendment of Rule 6(7A) effective 01.07.2016, DSIR's role was limited to approval of R&D facilities, not quantification of expenses. Judicial precedents affirm that clinical trial expenses and related regulatory costs form part of eligible R&D expenditure.

Court's Interpretation and Reasoning: The AO disallowed Rs. 65.09 crore for expenses not certified by DSIR in Form 3CL, including clinical trials outside factory premises and exhibit batches. The CIT(A) allowed clinical trial expenses following binding precedents but upheld disallowance of exhibit batch expenses and other costs not supported by DSIR certification.

Key Evidence and Findings: The assessee maintained separate books for DSIR-approved R&D units and submitted detailed justifications for the nature and necessity of the expenses. The valuation and recognition of clinical trial expenses as integral to R&D was supported by earlier appellate decisions.

Application of Law to Facts: The Tribunal followed the Coordinate Bench decision for AY 2013-14, holding that DSIR approval of the facility suffices and that disallowance merely due to non-quantification in Form 3CL is not warranted. The Tribunal also relied on High Court decisions affirming the allowability of such expenses.

Treatment of Competing Arguments: The Revenue relied on DSIR certification requirements and prior disallowances; the assessee emphasized judicial precedents and the nature of R&D expenses. The Tribunal sided with the assessee.

Conclusion: The Tribunal deleted the disallowance of Rs. 11,24,98,182/- sustained by the CIT(A).

3. Disallowance of Depreciation on Goodwill Arising on Amalgamation

Legal Framework and Precedents: Section 32(1)(ii) allows depreciation on intangible assets including goodwill. Explanation 3(b) to section 32(1) includes "any other business or commercial rights of similar nature." Section 2(1B) defines amalgamation for tax purposes. Judicial precedents including the Supreme Court's decision in CIT v. Smifs Securities Ltd. hold that goodwill arising on amalgamation is eligible for depreciation. Accounting Standard 14 (AS-14) permits recognition of goodwill under purchase method.

Court's Interpretation and Reasoning: The AO disallowed depreciation on the ground that goodwill was self-generated, not recorded in the amalgamating company's books, and represented merely excess consideration without identifiable assets. The AO relied on Explanation 7 to section 43(1) and Explanation 2 to section 43(6) to treat cost as nil. The CIT(A) reversed this, relying on binding Supreme Court and High Court decisions, the court-sanctioned scheme of amalgamation, and professional valuation reports. The CIT(A) held that goodwill arose as a determinable cost and qualifies as a depreciable intangible asset.

Key Evidence and Findings: The amalgamation was approved by the Gujarat High Court with statutory notices served to the Income Tax Department, which raised no objections. The excess consideration over net book value was recognized as goodwill in the books following AS-14 purchase method. A detailed valuation by KPMG supported the goodwill amount. The goodwill was allocated between tax-exempt units in Dehradun and Sikkim.

Application of Law to Facts: The Tribunal upheld the CIT(A)'s detailed reasoning, emphasizing that the goodwill was not self-generated but arose from a valid, court-sanctioned transaction with independent valuation. The Tribunal rejected Revenue's contention that absence of independent clientele or business in ILPL negated goodwill. The Tribunal also accepted the allocation of goodwill and the proportional restriction of depreciation disallowance related to the Dehradun unit.

Treatment of Competing Arguments: The Revenue argued artificial creation of goodwill, lack of commercial substance, and absence of actual cost. The assessee relied on statutory provisions, judicial precedents, court approval, and valuation reports. The Tribunal sided with the assessee, following binding Supreme Court and High Court rulings.

Conclusion: The Tribunal upheld the CIT(A)'s deletion of the disallowance of Rs. 227.92 crore on depreciation of goodwill, subject to proportionate restriction related to tax-exempt units.

4. Disallowance of Allocation of Common Expenses to Tax-Exempt Units

Legal Framework and Precedents: Deductions under sections 10AA, 80-IC, and 80-IE require computation of profits attributable to eligible units. Allocation of common expenses is permissible only if there is a direct nexus. Judicial precedents caution against mechanical allocation without factual basis.

Court's Interpretation and Reasoning: The AO disallowed Rs. 10.19 crore by allocating common R&D expenses to exempt units. The CIT(A) deleted the disallowance, finding that the assessee maintained separate books for eligible units, and common expenses were not debited to exempt units. The CIT(A) held that mechanical allocation without nexus results in distortion.

Key Evidence and Findings: The assessee's books showed separate accounting for units, with direct expenses allocated appropriately. No evidence was produced by AO to show double claim or nexus of common expenses with exempt units.

Application of Law to Facts: The Tribunal agreed with the CIT(A) that the disallowance was not sustainable as it lacked factual and legal basis. The Tribunal emphasized the principle of factual linkage in allocation.

Treatment of Competing Arguments: Revenue relied on AO's mechanical allocation; assessee relied on accounting records and precedents. Tribunal accepted assessee's position.

Conclusion: The Tribunal upheld deletion of disallowance of Rs. 10.19 crore on allocation of common expenses.

5. Disallowance of Interest Capitalisation under Section 36(1)(iii)

Legal Framework and Precedents: Section 36(1)(iii) allows deduction of interest on borrowed capital except proportionate interest capitalised to qualifying assets. Judicial precedents hold that disallowance under this section requires demonstration that borrowed funds were utilised for capital assets.

Court's Interpretation and Reasoning: The AO disallowed Rs. 11.29 crore by proportionate formula without establishing nexus between borrowed funds and CWIP. The CIT(A) deleted the disallowance, noting substantial interest-free funds available in excess of CWIP balances.

Key Evidence and Findings: Audited financials showed own funds far exceeding CWIP. The assessee's consistent accounting policy did not capitalise interest but claimed it as revenue expenditure.

Application of Law to Facts: The Tribunal followed Coordinate Bench decisions and Supreme Court precedents that in absence of nexus and presence of sufficient interest-free funds, disallowance under section 36(1)(iii) is not sustainable.

Treatment of Competing Arguments: Revenue relied on formulaic disallowance; assessee relied on fund flow and judicial precedents. Tribunal accepted assessee's submissions.

Conclusion: The Tribunal upheld deletion of disallowance of Rs. 11.29 crore under section 36(1)(iii).

6. Disallowance under Section 14A read with Rule 8D

Legal Framework and Precedents: Section 14A disallows expenditure incurred in relation to exempt income. Judicial precedents hold that disallowance under section 14A is not sustainable in absence of exempt income.

Court's Interpretation and Reasoning: The AO disallowed Rs. 8,70,747/- on account of expenditure related to investments in group companies. The CIT(A) deleted the disallowance, noting no exempt income was earned and investments were strategic and longstanding.

Key Evidence and Findings: No exempt income earned during the year; investments were old; no fresh expenditure incurred for earning exempt income.

Application of Law to Facts: The Tribunal followed binding High Court and Coordinate Bench decisions that no disallowance under section 14A is warranted without exempt income.

Treatment of Competing Arguments: Revenue relied on AO's findings; assessee relied on judicial precedents and factual matrix. Tribunal accepted assessee's arguments.

Conclusion: The Tribunal upheld deletion of disallowance of Rs. 8,70,747/- under section 14A and corresponding book profit adjustment under section 115JB.

7. Disallowance under Section 40(a)(ia) for Commission Paid to Non-Resident Agents

Legal Framework and Precedents: Section 195 requires deduction of tax at source on payments to non-residents chargeable to tax in India. Section 9(1)(i) defines income deemed to accrue or arise in India. The Supreme Court in CIT v. Toshoku Ltd. held that commission paid to non-resident agents for services rendered outside India does not accrue or arise in India and is not taxable.

Court's Interpretation and Reasoning: The AO disallowed Rs. 23.71 crore for non-deduction of TDS on commission payments to non-resident agents, holding income accrued in India. The CIT(A) deleted the disallowance, finding that services were rendered outside India, agents had no business connection or permanent establishment in India, and income did not accrue in India.

Key Evidence and Findings: The assessee submitted details of agents, nature of services, tax residency certificates, and prior acceptance by International Taxation wing. The CIT(A) relied on Supreme Court and High Court decisions.

Application of Law to Facts: The Tribunal followed the binding Coordinate Bench decision in assessee's own case for AY 2013-14, affirming that commission paid to non-resident agents for services rendered abroad is not taxable in India, and no TDS obligation arises.

Treatment of Competing Arguments: Revenue relied on AO's order and deeming provisions; assessee relied on judicial precedents and factual evidence. Tribunal accepted assessee's position.

Conclusion: The Tribunal upheld deletion of disallowance of Rs. 23.71 crore under section 40(a)(ia).

8. Ancillary Issues

The assessee's ground challenging initiation of penalty proceedings under section 271(1)(c) was dismissed as premature since no penalty order was passed. The claim for deduction of education cess under section 40(a)(ii) was raised but not adjudicated in detail in the present order.

Significant Holdings:

"The internal CUP adopted by the assessee, based on the quotation received from Bank of Nova Scotia, Singapore, constituted a valid and authentic comparable."

"Where TNMM has been applied with working capital adjustment, no separate upward adjustment is warranted for notional interest on outstanding receivables."

"Goodwill arising pursuant to a scheme of amalgamation sanctioned by the High Court, supported by independent valuation and purchase consideration paid, qualifies as an intangible asset eligible for depreciation under section 32(1)(ii)."

"Disallowance under section 35(2AB) cannot be restricted merely on the basis of non-quantification of expenditure in DSIR Form 3CL prior to amendment of Rule 6(7A)."

"Disallowance under section 36(1)(iii) requires demonstration of nexus between borrowed funds and capital expenditure; availability of sufficient interest-free funds negates such disallowance."

"Disallowance under section 14A read with Rule 8D is not sustainable in absence of exempt income."

"Commission paid to non-resident agents for services rendered outside India does not accrue or arise in India and is not taxable; hence, no TDS obligation arises under section 195."

The Tribunal partly allowed the assessee's appeal by deleting the transfer pricing additions on interest on advances and notional interest on receivables, and by deleting the disallowance under section 35(2AB). It dismissed the Revenue's appeal, upholding the allowance of depreciation on goodwill, deletion of disallowance on allocation of common expenses, interest capitalisation, section 14A disallowance, and commission paid to non-residents.