TMI Blog2016 (6) TMI 100X X X X Extracts X X X X X X X X Extracts X X X X ..... India. In our opinion, the interest income was an inherent an integral part of the assessee is business activity and same was rightly considered as an operating income for the purpose of calculation of operating margin, by the FAA. So, we endorse the views of the FAA that the interest income emanated from MTA and that same could not be excluded from calculating the operating margin of such activities for the purpose of section 92 of the Act. Thus held that the assessee’s international transactions of MTA were at arm’s length - Decided in favour of assessee Addition with regard to import of raw material and related issues including the treatment to be given to the segmental accounts - Held that:- TPO had made an adjustment of ₹ 48. 65 crores to the entire segment of manufacturing activities instead of making the adjustment to only international transactions, that it had an effect of reducing the import price by 54. 27%, that the FAA had reworked the adjustment after considering the extra ordinary items that would affect the profit margin of the assessee for the year under consideration, that the factors like underutilisation of capacity and non-operating expenditure was giv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not be treated capital expenditure Disallowance of expenditure incurred on land and site development - Held that:- As no further amounts were incurred during the previous year relevant to AY. 2006-07, that the onus was on the appellant to produce evidence if it claimed deduction on any item that same was not produced, that it had made general arguments without any reference to specific material data or evidence. Thus we confirm the disallowance. Disallowance of premium on payment of leasehold land - Held that:- A lump sum was paid at the time of obtaining a lease. We are of the opinion, that it is a capital expenditure by its nature itself. The lease was for a period of twenty years. So, we are not inclined to disturb the findings of the FAA and hold it to be a capital expenditure. However, we want to allow the alternate claim made by the assessee i. e. allowing depreciation as per the provisions of section 32 of the Act Disallowance of provision towards obsolete stores - Held that:- We find that though the assessee had claimed that it had followed a scientific method with regard to the obsolete stores, but it has not furnished any documentary evidence before the AO or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Returned Income(Rs. ) Assessment dt. Assessed Income(Rs. ) Dt. of orders of CIT(A) 2005-06 31. 10. 2005 40, 61, 95, 550/- 29. 12. 2008 5, 94, 20, 21, 732/- 11. 05. 2009 2006-07 29. 11. 2006(revised return on 11. 3. 2008) 8, 03, 99, 566/- (declrg taxable income at ₹ 7, 84, 42, 338/-) 15. 12. 2009 41, 96, 97, 240/- 17. 01. 2011 2007-08 12. 11. 2007(revised return on 26. 03. 09 (-) 9, 28, 09, 353/- 23. 12. 2010 1, 04, 23, 69, 746/- 29. 11. 2011 ITA/4336/Mum/2009, AY. 2005-06 2. During the assessment proceedings, the AO found that the assessee had entered into international transactions with its associated enterprises(AEs), as stipulated by the provisions of section 92A of the Act. He made a reference to the transfer pricing officer(TPO)for computing the arm s length price(ALP)of the transaction. During the transfer p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d the provisions of section 80 HHC in his support. The TPO observed that interest on FDRs was income from other sources as per the provisions of section 56 of the Act, that the interest could not be considered under the head business income, that L/C charges, amounting to ₹ 20. 29 crores were incurred for the purpose of earning operate profit from business activities, that no part of such expenditure could be relatable to earning FDR interest income, that all those expenses were directly related to business activity of merchanting trade, that the assessee had drawn the accounts for MTA by including direct expenditure i. e. purchase cost and value of sales, that for the TP purposes the assessee had amended the audited accounts by excluding the cost of purchase for calculating operating cost of MTA, that the operating cost included both direct and indirect expenditure, that the assessee had excluded direct expendi - ture while computing the operating cost, that it was not entitled to amend the basic structure of the audited financials of MTA by excluding the direct cost of purchase, that the purchase and sale invoices were in the name of the assessee. Accordingly, the operat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ric ton spread on the export/import pricing would allow it to earn a sufficient profit, that it transacted with its AE s on and instantaneous basis, that the purchase and sale of various agricultural commodities were undertaken at the same time without carrying out any marketing activities, that it did not play any role in deciding the price of the purchase/sale, that no legal consequences had to be suffered by the assessee as a result of failure/default on part of the either of the parties of the transactions, that the AEs made the assessee risk mitigated Trader, that the AEs were involved in the import and export of various agricultural commodities as agreed upon the terms and conditions(price, ports, legal consequences) without the assessee s intervention at all, that the AEs were responsible for failure/default with regard to such transactions, that the assessee would identify and participate in such trade flows only after evaluating the potential to earn interest on the cash flows linked to such transactions, that it had a role limited to preparation of necessary trade documents in the overall trade flow, that it would enter into such purchase and sale transactions without tak ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ning of interest on the advances received by it, that same were directly related to the earning of interest income on the funds available, that the incurring of L/C charges, hedging expenses etc. would not arise if there was no earning of interest income, that the other operating expenditures of the assessee were insignificant, that its role in MTA was restricted to that of a facilitator and the functions performed by it were more in the nature of support service, that the purchase and sales had to be admitted at arm s length and should not be disregarded in arriving at the operating margin. 4. During the appellate proceedings, the FAA called for a remand report from the TPO. In his remand report, dated 5/5/ 2009, the TPO reiterated his arguments on various issues regarding MTA including the exclusion of interest income for the purpose of computing the ALP. The TPO submitted, in his report, that the assessee had not claimed that interest income on FDR was an international transaction in its form number 3CEB, that interest income of ₹ 26. 70 lakhs only was shown as international transaction, that the direct source of interest income was FDRs, that the assessee could not t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it was clear that the sales invoices showed earning of $ . 10/metric ton, that overall the assessee had earned profit, that almost all the transactions were with the AEs, that it could not be inferred that assessee had incurred loss in trading operation with its AEs, that the computation of the TPO gave distorted figure, that operating cost could not be reduced from the sale price, that to compute the gross margin only the import price of goods from the export rights of the goods had to be reduced, that the assessee had earned gross margin of ₹ 2. 15 crores, that the TPO had wrongly concluded that no advance was received against future sale of goods, that all the advances received had been invested in FDRs, that the advance received served two purposes, that it was placed in FDR, that the FDRs acted as a security and Lien against the L/C to be issued to the supplier, that the L/C on maturity was adjusted against the sale proceeds of the first leg though the advance still remained in form of FDRs, that the assessee had merely changed economic analysis of the MTA, that the inherent business model of the assessee did not change-it remained that of a Trader, that even post-merge ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... activity and not to it being taxed under a particular head of income. He further held that what was to be considered while benchmarking the MTA of the assessee as a Trader and that the relevant factors for arriving at the arm s length price with regard to an international transaction with its AE s was the business model, the appropriate comparables and the computation of the correct operating income of the assessee for benchmarking the MTA. 5. Before us, the Departmental Representative (DR) contended , that the assessee had not produced any evidence to show that there was an agreement with the suppliers regarding credit period of 180/360 days, that there was no direct nexus between the earning of interest and MTA, that the AO had rightly excluded the interest income for making TP adjustments. He heavily relied upon the order of the TPO along with the remand report sent to the FAA during the appellate proceedings. The Authoried Representative(AR)submitted that while carrying out MTA the assessee would enter into back-to-back purchase and sale transactions instantaneous-without the goods physically entering India, that the interest received by it was an integral part of MTA and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ind that with a view to benchmark the international transactions of the MTA, the assessee had carried out detailed comprehensive benchmarking analysis, that it had selected TNMM is the most appropriate method(MAM), that it carried out a search process on capitaline database for identifying the comparables, that the search resulted into identification of eight companies engaged in support system activities, that the operating profit margin of comparables was found to be 6. 44% on operating costs, that it selected operating profit to value added cost as the applicable PLI, that while computing the operating cost it excluded the sale and purchase price, that the assessee calculated its operating profit margin from its MTA@489. 28%, that the TPO had carried out detailed analysis for determining the ALP, that considering the support service nature of the functions performed by the assessee, he compared its margin with the margins of comparable companies engaged in support service activities, that he had proposed the adjustments of ₹ 501. 51crores, that the adjustment was as arrived at by computing the operating profit margin by taking total costs as operating cost and total income ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... - The OP/Sales Ratio 1. 29% The OP/Operating Cost 1/31% Operating Cost Your OP/OC comes to 1. 31% while the mean for the Comparables filed by you comes to 6. 44%. Why should this not be benchmarked against the Comparables and adjustment made. From the adjustment calculation, made by the TPO about international transactions, it is clear that the interest portion was not considered for determining ALP. We fail to understand as to how the TPO can make an adjustment without informing the assessee about exclusion of an item-especially when the same was not excluded in the show cause notice. No assessee can be taxed unwarned. Principles of natural justice demand that the assessees should be given a fair chance of hearing before due taxes are collected. The TPO, being a representative of the State, cannot behave like a mere tax gatherer. Collection of DUE taxes presupposes fair play and adhering to principles of affording a reasonable opportunity of hearing to the members of Subject of the State i. e. to the tax-payer. In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the nexus of interest on MTA was explained to the TPO in the submissions made on 10/9/2008 and 13/8/2008. It is observed that the TPO had not considered the above replies filed by the assessee, while framing the final order or while forwarding the remand report. He continued to benchmark the operating margin of the MTA with that of support service comparables. But the margin(@2. 36%)was reflective of the complete value chain activities comprised in manufacturing, conversion, marketing and selling. In other words the TPO had considered the comparables of manufacturing and trading companies having mean operating margin of 2. 36%. When it appeared that the margin was within the range of +/-5%, the TPO excluded the interest income while making final adjustment. Thus, the operating margin of the assessee from MTA (including interest income) is 1. 31% on cost, as appearing in the show cause notice of the TPO(dated 16/10/2008), as compared to the trading comparable mean margin of 0. 94% on cost (as submitted to the TPO by the assessee in its submission dated 20/10/2008). As it is higher, so it could safely be concluded that assessee s inter - national transactions of MTA were at arm s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ith deleting of additions by the FAA with regard to import of raw material and related issues including the treatment to be given to the segmental accounts. During the TP proceedings, the TPO found that the assessee had entered into International Transaction relating to import of soyabean oil, palm oil and Palmoline oil as well as export of soya bean meal and rapeseed meal, that it had used CUP method with regard to the international transactions. However, the TPO was of the opinion that CUP was not the MAM. So, he applied TNMM. He drew segmented account and examined the performance of segment other that MTA and other incomes. According to the TPO s working operating profit of the assessee was(-)6. 94%. For applying TNMM he took 26 comparables but later on excluded 5. In response to the show cause notice issued by TPO, the assessee contended that it had correctly used the CUP method, that in the earlier two years TPO had accepted the said method for determining the ALP, that the rates of CUP with regard to import of crude oil could not be compared to rates of merchantingtrade of the same commodity. The TPO observed under the TP Regulation ALP of a transaction could vary year to yea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s by about ₹ 5. 46crore, that the depreciation on tangible assets and under utilisation resulted in higher loss of ₹ 2. 20crore, that the deferred revenue expenditure of ₹ 1. 05 crores resulted in a reduction of operating expenses by ₹ 1. 05 crores, that the claim made by the assessee to accept revised margin of 1. 07% was not conceded by the TPO. The FAA held that the computation of revised margin was not considered by the TPO, that TPO was not correct in his remand report that no reasons were given by the assessee for taking segmental results of six companies whereas whole company results for remaining 20 companies, that for rejecting the CUP method TPO had given valid reasons, that TNMM was more appropriate method with regard to adjustment to be made. The FAA held that the TPO in the remand report had summarily concluded that non operating expenses, resulting from abnormal items, were correctly accounted for, that the contention of the TPO was not factually correct, that the TPO had allowed, while considering the claim for reduction of operating expenditure, due to unutilised capacity as abnormal depreciation on tangible assets, that he had adopted 50% ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... od, that the adjustment had no consonance to the reality of the situation, that the TPO had approached an incorrect method, that the application of CUP analysis showed that fluctuation in prices of agricultural commodities was at maximum 5%, that adjust - ment of high discount of 54% or lower could not be said to be in justifiable, that transfer pricing was not an exact science, that it was an art wherein principles of law, economics and business were applied to achieve equitable results, that application of CUP and TNMM gave very wide variation, that TNMM led to adjustment of 31. 15% even after allowance of partial relief as compared to an adjustment under CUP of about 5%, that assessee was justified in claiming that while applying TNMM totality of the operations should be considered, that the exercise should not be centered on international transactions. After making above observations, the FAA reworked the ALP of international transaction of import of goods in manufacturing activity as under: Rupees Adjusted operating expenses of the assessee shown in (E) above. 7, 90, 44, 26, 285 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nufacturing activities instead of making the adjustment to only international transactions, that it had an effect of reducing the import price by 54. 27%, that the FAA had reworked the adjustment after considering the extra ordinary items that would affect the profit margin of the assessee for the year under consideration, that the factors like underutilisation of capacity and non-operating expenditure was given due importance by the FAA, that the assessee had he calculated revised margin of the 20 comparables selected by the TPO, that the arithmetic mean arrived at by the assessee was not considered by him, that FAA had held that TPO was incorrect in not considering the revised caL/Culation of margins, that the FAA had objected to the treatment given to the six comparable where the TPO had not taken the segments based on their economy profile, that the FAA had mentioned that revised margin (1. 07%) had to be adapted for determining adjustments and the resultant ALP. In our opinion, the TPO was not justified in making adjustment to the entire segment of manufacturing activity and not restricting the same to the international transactions. We find that in the cases of Tara Jewels ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat interests earned by the assessee had no connection with the business activity, that same was rightly taxed under the head income from other sources, that the assessee had parked its extra money to earn interest. The AR contended that the company would receive advance against the delivery to be made within 180/360 days, that it would approach a local bank to open L/C for payment at 180 days from the date of the L/C for the import leg of transaction, that the L/C issuing bank would mandate the company to place funds in the FDRs to act as security and Lien against the issue of L/C, the company would place the export advance in FD, that the bank would issue 180 days L/C for the import leg of the transaction, that the maturity date of L/C and FD did not coincide, that there would be a time lag of a few days between the maturity of L/C and FD wherein the L/C would mature a few days before the FD, that the sale proceeds received would be utilised to retire the L/C. He relied upon the cases of Karnal Co-operative Sugar Mills Ltd. (243 ITR 2), Lok Holdings (308 ITR 356). 14. We have heard the rival submissions and perused the metal before us. We find that while adjudicating the fir ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion over the period of 5 years. Considering the non-compete payment as revenue expenditure in the return of income the assessee company claimed a deduction of ₹ 81. 66 lakhs. The assessee relied upon the case of Madras Industrial Investment Ltd. (225ITR802). The AO directed the assessee to justify as to how such expenses could be claimed as revenue expenditure. In its reply, the assessee contended that the non-compete fee paid to HLL had been considered as miscellaneous expenditure whereas the payment made to PFL has been considered as fixed asset. After considering the submission of the assessee the AO held that the assessee would derive benefit from payments made to HLL and PFL for a very long period, that expenses incurred by it could not be allowed as revenue expenditure. Finally, he made disallowance of ₹ 2. 45 crores. 16. Aggrieved by the order of the AO, the assessee preferred an appeal before the FAA. After considering the available material, he held that by making payments under the heads non-compete fee to HLL and PFL the assessee had debarred the competitors to do business in some limited areas for 5 years, that the benefit derived by it was could not be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hile confirming the order of the Ld. CIT(A), we direct the AO not to allow as business expenditure the amount of non compete fee which may be determined by him. 32. Addl. Ground No. 2: The Ld. Counsel of the assessee submitted that even if the non compete was held to be of capital nature, even then same has to be construed as intangible asset and accordingly depreciation has to be allowed and in this regard he relied on the decision of Chennai Tribunal in the case of ACIT vs. Real Image Tech (P) Ltd. [120 TTJ 983]. 33. On the other hand, Ld. DR submitted that this issue was never adjudicated by the AO or Ld. Counsel of the assessee. CIT(A). Therefore, matter may be set aside to the file of the AO. 34. We have considered the rival submissions carefully and find that in case of ACIT vs. Real Image Tech (P) Ltd. [supra], after analyzing the provisions of sec. 32[1][ii] it was held that non compete fee would constitute capital asset and depreciation was ultimately held to be allowable. However, we find that the AO vide para-8 of his order has observed that non compete fee was not mentioned in the agreement as a separate payment. Therefore, he should find out the amoun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 985). 21. After hearing the rival submissions we are of the opinion that the expenditure incurred by the assessee on market research was a revenue expenditure and that it could not be treated capital expenditure. The fact that the assessee has two incur expenditure for research every month in itself proves that the span of life of the survey is very short. We find that in the case of Ananda Bazar Patrika (P) Ltd. , the Hon ble Calcutta High Court has held as under: the market survey would give information about the circulation of the newspaper at a given point of time. There was no evidence to show that the readership would remain constant over a large number of years. Hence, the expenditure incurred on market survey could not be said to have brought into existence anything of an enduring benefit to the assessee. It was allowable as revenue expenditure. Respectfully following the above judgement, ground number six is decided against the AO. CO/29/M/2010, AY. 2005-06 : 22. The effective ground of appeal, filed by the assessee , in the CO(GOA 1-3), is about application of cup for determining ALP relating to import of oil. While deciding the appeal for th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion claim may be allowed for the expenditure. The DR supported the order of the FAA. We have considered the rival submissions and perused the material before us. In our opinion the order of the FAA does not suffer from any legal infirmity. So, confirming his order, we decide third ground against the assessee. 31. Next ground is about disallowance of ₹ 14. 05 lakhs incurred on premium on payment of leasehold land. During the assessment proceedings, the AO found that the assessee had claimed an expenditure of ₹ 14. 05 lakhs under the head premium paid for land. The assessee had enclosed a note with the return of income wherein it was claimed that during the year 2002-03 the company had leased certain land at Pitampur for period of 20 years, that it had paid an amount of ₹ 2. 81 crores as upfront premium for acquiring the land, that the amount in question was being claimed on proportionate basis over the lease period of 20 years, that annual lease payment of ₹ 19. 58 lakhs was a revenue expenditure. The AO directed the assessee to justify the claim. After considering the submission of the assessee it was held that land was capital asset, that expenditu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... res. During the assessment proceedings, the AO found that the assessee had made a provision for the said amount under the head provision for obsolete stores. He directed the assessee to file details in that regard. But, no explanation or details were filed in that regard. So, he disallowed the claim made by the assessee. 36. Aggrieved by the order of the AO, the assessee preferred an appeal before the FAA. After considering the order of the AO and the submissions of the assessee, he held that under the Act, the deduction was generally and mainly allowed on actual basis, that the assessee had claimed that provision to obsolete stores had been made on scientific basis, that no material evidence was produced by it in that regard. Upholding the order of the AO, he dismissed the ground raised by the assessee. 37. Before us, the AR contended that the assessee had furnished a detailed scientific evaluation of the obsolete stores, that the store items were unusable, that same had to be impaired in compliance with the requirements of mandatory provisions contained in the companies Act -Schedules VI, that if a current assets did not have a value on realisation in the ordinary cours ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... made towards obsolete stores is the subject matter of ground 7. Following our order for the earlier year, we decide ground no. 7 against the assessee. 42. Ground eight deals with disallowance of expenses of ₹ 30. 5 lakhs, being provision made for Employee Stock Option Plan(ESOP). During the assessment proceedings, the AO found that the parent company had raised debit note on the assessee for the amount payable on account of ESOPs, that it had made a provision of ₹ 30. 5 lakhs in the profit and loss account and had claimed the same as an allowable expenditure. The AO held that the expenditure could not be allowed as per the provisions of section 37 of the act. In the appellate proceedings, the FAA upheld the order of the AO. 43. Before us, the AR contended that the provisions in the accounts were made in conformity with the mandatory accounting standards and as per SEBI regulations, that upon the ESOP grant provision was required to be made in the books of accounts, that the assessee would make the payment to the parent company towards the debit notes, that the ESOPs were granted to the eligible employees of the group company in accordance with the equity incen ..... X X X X Extracts X X X X X X X X Extracts X X X X
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