Expenditure incurred by car-manufacturer on gifts of cars to State police department was held not an eligible expenditure under section 37(1) as it was found not incidental to carrying on business and there was no commercial expediency in incurring this expenditure
IN THE ITAT CHENNAI BENCH ‘B’ (THIRD MEMBER)
Hyundai Motor India Ltd.
v.
Deputy Commissioner of Income-tax, Large Tax Payer, Chennai
D. MANMOHAN, VICE-PRESIDENT (AS A THIRD MEMBER)
A. MOHAN ALANKAMONY, ACCOUNTANT MEMBER
AND V. DURGA RAO, JUDICIAL MEMBER
IT APPEAL NO. 2157 (MDS.) OF 2011
[ASSESSMENT YEAR 2007-08]
AUGUST 7, 2015
R.Vijayaraghavan and S.P. Chidambaram, Advocate for the Appellant. N. Rengaraj and Pathlavath Peerya, JCIT DRfor the Respondent.
ORDER
A. Mohan Alankamony, Accountant Member – This appeal is filed by the assessee, aggrieved by the order of the ld. Assessing Officer dated 31/10/2011 pursuant to the order of the T.P.O in accordance with the directions of the Learned Members of the D.R.P.
2. The Assessee has raised twelve elaborate grounds in its appeal however the crux of the issues are that:
Transfer Pricing Issues:—
(i)
The assessee has challenged the show cause notice issued in respect to brand promotion activity undertaken by the assessee and advertisement expenses, which was treated as international transaction. (However, at the time of hearing the Ld. A.R. did not press this ground and therefore, it is dismissed as such.)
(ii)
The Ld. Assessing Officer /DRP erred in confirming the order of the Ld. TPO who had held that the appellant ought to have received fees for brand promotion activity undertaken by the assessee to the extent of Rs. 82,12,54,41,380/- from its parent company viz. HMC Korea and the same was added to the income of the assessee under provisions of Section 92C of the Act.
(iii)
Ld. A.O/DRP has erred in confirming the order of the Ld.TPO, who has held that the expenditure incurred on advertisement was in excess to the extent of Rs. 76.63 crores when compared with other comparable companies in an international transactions and thereby added the excess expenditure to the income of the assessee under provisions of section 92B of the Act.
(iv)
Ld. A.O/DRP has erred in determining the ALP for royalty payable by the assessee to its AE at Rs. 265.50 crores as against the actual amount paid Rs. 369.77 crores, which was confirmed by the TPO and thereby addition to the extent of Rs. 104,27,36,417/- was made.
Corporate Tax Issues:—
(v)
The DRP has erred in confirming the order of the Assessing Officer who had reduced the capital subsidy granted by SIPCOT from the cost of the assets of the assessee and consequently disallowed depreciation amounting to Rs. 7,91,060/-
(vi)
The DRP has erred in confirming the order of the Ld. Assessing Officer in disallowing a sum of Rs. 5,29,910/- U/s. 14A of the Act by applying the provisions of Rule 8D of Income Tax Rules, 1961.
(vii)
The DRP has erred in confirming the order of the Ld. Assessing Officer in disallowing expenditure of Rs. 5,20,97,000/- on providing 100 cars to the Tamilnadu Police Department.
(viii)
The DRP has erred in confirming the order of the Ld. Assessing Officer in treating the export incentives on account of target plus scheme and focus market scheme amounting to Rs. 5,52,26,335/- and Rs. 3/- crores respectively as the income of the assessee for the assessment year 2007- 08, though the same has not accrued to the assessee during the relevant assessment year.
(ix)
The DRP has erred in confirming the order of the Ld. Assessing Officer in disallowing the additional depreciation amounting to Rs. 8,52,500/- in respect of assets used in its regional offices.
(x)
The Ld. Assessing Officer erred in not granting the credit for the tax deducted at source amounting to Rs. 39,90,609/-.
(xi)
The Ld. Assessing Officer has erred in levying interest U/s. 234B & 234D of the Act.
3. The brief facts of the case are that the assessee is engaged in the business of manufacturing, selling and servicing of passenger vehicles and related spare parts/CKD parts in the domestic market as well as overseas. The assessee had field its e-return for the assessment year 2007-08 on 31.10.2007 declaring its total income as Rs. 815,75,84,340/-. Initially the return was processed U/s.143(1) of the Act and subsequently the case was taken for scrutiny and the assessment was completed U/s.143(3) read with section 92CA & 144C of the Act wherein the Ld. Assessing Office made the additions following the direction of the Ld. Members of the DRP.
Transfer Pricing issues:—
4.1. Ground No.2 – Upward adjustment due to brand promotion expense attributable to the assessee’s holding company being Rs. 82,12,54,41,380/- :—
The Ld.TPO analysed the issue of brand development services extended by the assessee company to its holding company by observing as under:—
“India is a vast market for auto makers. India has a huge percentage of middle and upper middle class population that has enough surplus income to buy such movable and immovable assets such as House, cars etc. Further banks have liberally sanctioned auto loans on equated monthly instatement basis to the buyers. It is also relevant to note that India has got a big percentage of population which is not only young but also earns handsome money especially soft ware boom in India. This section of the society is influenced by the brand name. In India in expanding auto market the share of Hyundai is increasing year after year. This has been discussed in Company Profile and Industrial over view given above. In this market, Hyundai brand and Logo has become quite popular. It is due to brand value development on account of efforts made by the assessee company. So far as the Hyundai technology is concerned it is the latest technology and it cannot be said that old technology has been dumped in Indian market. It has promising future that will earn the holding company in coming years huge income by way of royalty on know how supplied by it to the assessee company. It is not an old technology about which it may be said that it does not have bright future and hence the sales will decrease and therefore brand development will not be advantageous to the holding company. It would like to stay ahead of its competitors in the Indian market by ensuring the quality of product as well as by spreading the brand awareness. The Holding company has given to the assessee the exclusive rights of producing the cars in this territory. Each car produced by the assessee becomes the carrier of holding company’s brand name and logo. Holding company has neither engaged any other entity to provide the services for brand name and logo development in India nor spending any amount on its own for this purpose. On the other hand assessee-company is producing the quality product that is a must for brand development. It provides excellent after sales service to the satisfaction of the customers. As mandated by the Holding Company the assessee has agreed to use brand name and logo of the holding company on its products. It has not developed its own brand name and logo. The assessee could have developed its own brand name and the logo could have generated huge income by use of intangible asset owned by the assessee legally and economically. There is no piggy backing kind of strategy adopted by the assessee for development of its own Brand name and logo. Instead its entire efforts are devoted towards developing the brand value of the holding company. Assessee on one hand had sacrificed development of its own brand name and logo, on the other hand using its resources for the development of the Brand name and the logo that belongs to the Holding company.
Since the sale of the vehicle produced by the assessee company is ever increasing looking to the expanding market share of Hyundai produced in this territory even low rate of royalty on the net sales of cars would be a reasonable compensation to the assessee for providing the services of brand development services to the Holding company. Therefore, it would be reasonable to hold that the Holding Company must compensate the assessee company by paying an amount @ 1% of the sales made during the relevant previous years. The assessee company has made sales for Rs. 87,62,49,09,000/- during the relevant previous year and therefore, @ 1% of the sales, amount receivable is calculated at Rs. 87,62,49,09,000/-. Therefore, Arms Length Price of the International transaction is determined at Rs. 87,62,49,09,000/-. As nothing has been paid on this account by the Holding company to the assessee, addition of Rs. 87,62,49,09,000/- in total income of the assessee is called for in A.Y 2007-08.”
Thereafter the Learned Members of the DRP confirmed the contentions of the Ld.TPO, however, directed the TPO to exclude the revenue receipts of CKD/Spare parts from value of the sales while computing the notional brand fee @ 1% and thereby upheld the upward revision to Rs. 82,12,54,41,380/-.
4.2 The Ld. A.R. submitted before us that:—
(i)
The assessee company did not undertake any brand promotion for its parent company M/s.HMC Korea.
(ii)
The ad hoc rate of 1% on sales adopted by the Revenue is not an accepted method in transfer pricing matters.
(iii)
The benefit of using the brand name “Hyundai” has resulted in increase of turnover of the appellant. Consequently the profits have also increased which have been offered to tax. The parent company M/s. HMC Korea did not maintain the appellant company to use their brand name as misconstrued by the Ld. TPO.
(iv)
There was no contractual obligation between the appellant company and its parent company regarding any brand building services to be rendered by the assessee company.
(v)
The appellant company had only incurred products specific advertisement expenses for promoting the sales of the vehicles manufactured by the assessee.
(vi)
No expenses were incurred by the assessee company for promoting the brand of its Holding Company.
(vii)
The agreement between the assessee company and its Holding Company only indicates that the appellant company has the right to use the brand name “Hyundai”.
(viii)
There is no finding by the Ld. TPO that excess AMP expenses incurred by the assessee, which would suggest that the assessee has incurred brand promotion expenses benefitting the Holding Company.
(ix)
The appellant also relied in the case of LG Electronics India (P.) Ltd v. Asstt. CIT [2013] 140 ITD 41/29 taxmann.com 300 (Delhi) (SB) and Ford India (P.) Ltd. v. Dy. CIT [2013] 59 SOT 221/34 taxmann.com 50 (Chennai)
(x)
The only appropriate method that can be adopted to arrive at the brand promotion expense will be based on excessive AMP.
4.3 Ld. D.R reiterated the findings of the Ld.TPO and the learned Members of the DRP and argued in support of the same.
4.4 We have heard the rival submissions and carefully perused the materials available on record. The main grouse of the Revenue is that the appellant company being the user of the Holding Company’s brand name and logo indirectly benefits the Holding Company. The appellant company instead of promoting its own brand has been promoting the brand logo of the Holding company. Thereby the Holding Company is benefited because of the increase in sales of the appellant company. It was only due to the efforts put in by the assessee company and the relevant expenditure incurred for promoting its products the brand value of the Holding Company has proportionately increased. Therefore, the Revenue opined that one percent (1%) of sales excluding the sale of CKD/spare should be attributed for determining the Arm’s Length Price (ALP) in this international taxation issue and thereby made an upward adjustment towards brand promotion expense for Rs. 82,12,54,41,380/-. At this juncture we must say that as pointed out by the Ld. A.R, the Ld.TPO and the Ld. Members of the DRP has not adopted any of the five methods prescribed U/s.92C of the Income Tax Act in order to determine the ALP for brand fees which ought to have been received by the assessee company for the usage of the Holding company’s brand “Hyundai”. The 1% on sales adopted by the Revenue in determining the ALP is purely adhoc and without any basis. It is pertinent to mention here as pointed out by the Ld. A.R. that the Delhi Special Bench of the Tribunal in the case of LG Electronics India (P.) Ltd.(supra), mentioned supra has held that Bright-Line- Test (BLT) is the only method to be adopted to arrive at the value of brand development expense receivable by the assessee company from its Holding Company with respect to the promotion of brand of the assessee’s Holding Company.
4.5 The brief gist of the case is summarized herein below for reference.
‘Facts:
♦
L.G. Electronics India Private Limited (“the assessee”) is a subsidiary of L.G. Electronics Inc., Korea (“the AE”). Pursuant to Technical Assistance and Royalty agreement, the assessee obtained a right from the AE to use technical information, designs, drawings and industrial property rights for the manufacture, marketing, sale and services of agreed products, for which it agreed to pay royalty @ 1 per cent. The AE allowed the assessee to use its brand name and trademarks to products manufactured in India “without any restriction”.
♦
The Transfer Pricing Officer (“TPO”) concluded that the assessee was promoting LG brand as it had incurred expenses on AMP to the tune of 3.85% of sales vis-à-vis 1.39% incurred by a comparable. Accordingly, TPO held that the assessee should have been compensated for the difference.
♦
Applying the Bright Line Test, the TPO held that the expenses in excess of 1.39 % of the sales are towards brand promotion of the AE and proposed a transfer pricing adjustment.
♦
The Dispute Resolution Panel (“DRP”) not only confirmed the approach of the TPO, but also directed to charge a mark-up of 13 % on such AMP expenses towards opportunity cost and entrepreneurial efforts.
Issues:
♦
Whether transfer pricing adjustment can be made in relation to advertisement, marketing and sales promotion expenses incurred by the assessee?
♦
Whether the assessee ought to have been compensated by the AE in respect of such AMP expenses alleged to have been incurred for and on behalf of the AE?”
Observations & Ruling
The Tribunal has held as follows:
♦
Confirmed validity of jurisdiction of the TPO by observing that the assessee’s case is covered u/s. 92CA(2B) of the Income Tax Act, 1961 (‘the Act’) which deals with international transactions in respect of which the assessee has not furnished report, whether or not these are international transactions as per the assessee.
♦
The incurring of AMP expenses leads to promotion of LG brand in India, which is legally owned by the foreign AE and hence is a transaction. The said transaction can be characterised as an international transaction within the ambit of Section 92B(1) of the Act, since (i) there is a transaction of creating and improving marketing intangibles by the assessee for and on behalf of its AE; (ii) the AE is non-resident; and (iii) such transaction is in the nature of provision of service.
♦
Accepted Bright Line Test to determine the cost/ value of the international transaction, in view of the fact that the assessee failed to discharge the onus by not segregating the AMP expense incurred on its own behalf vis-à-vis that incurred on behalf of the AE.
♦
The transfer pricing provisions being special provisions, override the general provisions such as section 37(1) / 40A(2) of the Act.
♦
For determining the cost/value of international transaction, selection of domestic comparable companies not using any foreign brand was relevant in addition to other factors.
♦
The Supreme Court of India in Maruti Suzuki’s case examined the issue of AMP expenses where it directed the TPO for a de novo determination of ALP of the transaction. The direction by the Supreme Court recognises the fact of brand building for the foreign AE, which is an international transaction and the TPO has the jurisdiction to determine the ALP of the transaction.
♦
The expenses incurred “in connection with sales” are only sales specific. However, the expenses “for promotion of sales” leads to brand building of the foreign AE, for which the Indian entity needs to be compensated on an arm’s length basis by applying the Bright Line Test.
♦
With regard to the DRP’s approach, of applying a mark-up on cost for determining the ALP of the international transaction, on the ground that the same has sanction of law under Rule 10B(1)(c)(vi) of the Income Tax Rules, 1962 was accepted.
♦
The case was set aside and the matter was restored to the file of the TPO for selection of appropriate comparable companies, examining effect of various relevant factors laid down in the decision and for the determination of the correct mark-up.’
4.6 Further, in the case Ford India (P.) Ltd cited by the Ld. A.R. (supra), the Chennai Bench of the Tribunal followed the Special Bench ruling in the case of LG Electronics India (P.) Ltd. (supra) in applying Bright line Test (BLT) to arrive at the adjustment towards excess AMP expenditure. The Tribunal also ruled that the expenditure directly in connection with sales had to be excluded in computing the AMP adjustment. Thereafter, the Tribunal deleted the hypothetical brand development fee adjustment computed at 1% of sale made by the TPO. The Tribunal has disregarded the concept of add on brand value on normal sales and add on brand value on additional sales brought by the tax department to justify two additions in relation to brand building, and deleted the brand development fees computed at 1% of sales.
4.7 Considering the facts of the case which is identical to the case decided by the Special Bench of the Tribunal and the Chennai Bench of the Tribunal cited supra, we hereby direct the Ld. Assessing Officer to delete the adhoc addition of 1% on sales which is treated as brand development fee by following the decision of the Tribunal cited supra. The aforesaid decisions of the Tribunal has also held that Bright Line Test would be the best method for determining developer of the intangible property, which the Ld. A.R. claimed that such test was made on the assessee by the Ld.DRP; however no additions were made because on the computation of the same it was found not warranted. The same was also not controverted by the Ld. D.R. Therefore, we hereby restrain ourselves from remitting back the matter for the computation of bright line test. Thus, this issue is decided in favour of the assessee.
5.1 Ground No.3 Addition on account of advertisement and sales promotion expenses which ought to have been receivable from the assessee’s holding company amounting to Rs. 76.63 crores U/s.92B of the Act.
The Ld. TPO had held that the assessee had incurred advertisement expenses on behalf of the parent company and therefore, considered the same as international transaction invoking the section 92B of the Act, in the same footing as the brand development expenses discussed supra. Accordingly, the Ld.TPO made comparison of the advertisement expenses incurred by the other five comparable companies in the same line of business and worked out the ratio of advertisement expenses to the total sales and determined the average ratio of the comparable at 2.566% as against 3.44% worked out by the assessee. Thus, the excess advertisement expenses incurred over and above the average of the comparables was determined at Rs. 76,63,00,000/- which the Ld. TPO held it to be recoverable from the assessee’s parent company.
5.2. Before the DRP, it was argued by the assessee that the advertisement expenses contains certain non advertisement relates expenses being trade discount and therefore, the same has to be excluded from the advertisement expenditure worked out by the Ld.TPO while arriving at the addition of Rs. 76.63 crores. In support of the argument the assessee relied on the Jurisdictional of Madras High Court in the case of CIT v. India Pistons Ltd. [2001] 250 ITR 279/119 Taxman 384 & in the case CIT v. Tuticorin Alkali Chemicals & Fertilizers [2003] 261 ITR 80/[2004] 136 Taxman 625 (Mad.). The Members of the DRP after considering the issue, held in agreement with the claim made by the assessee by observing as under:—
“104.3 The contention of the assessee is carefully considered. The trade and volume discount are essentially given to push the quantum of sales and as an incentive to dealers to increase sales. These discounts may or may not be passed on to the direct customers. Also, the very nature of volume and trade discount is not in the nature of advertisement expenses. In fact, as pointed out by the assessee, some of the companies chosen as comparables have netted out the trade discounts from the sales itself.
104.4. Also, we are examining the nature of advertisement expenses as those expenses that could be attributed to brand promotion and promotion of business of the parent holding company. Viewed in that context, the volume discount and trade discount can at best be attributed to the increase in business of the assessee and not to that of the parent holding company.
104.5 In view of the above, the Assessing Officer/TPO is directed to exclude volume discount and Trade discount from advertisement expenses, while working out the ratio of advertisement expenses to sales. The objection of the assessee is allowed.”
5.3 Subsequently, the Ld. TPO giving effect to the Order of the DRP deleted the addition of Rs. 76.63 crores with the following computation:—
“Adjustment on account of Advertisement Expenses incurred by the assessee on behalf of AE:
The TPO in her order compared the ratio of advertisement expenses to the sales between the assessee and the comparables. This ratio in the case of the assessee is worked out at (Rs. 3,01,62,71,870/Rs. 87,62,49,09,000) = 3.44% (page 43 of TPO’s order). The break-up of advertisement expenses considered by TP (as in page 43 of TPO’s order) is as under:
Expenses in the nature of advertisement cost
Rs. 155,59,99,015
Special Trade Discount
Rs. 142,81,11,086
Volume Discount
Rs. 3,25,81,721
Rs. 3,01,62,71,820
3.1. The DRP directed the TPO to recomputed the ratio of advertisement expenses to sales after excluding the volume discount and trade discount. The revised ratio is (Rs.155,59,99,013/Rs.87,62,49,09,000) = 1.776%. In view of the ratio being lower than that of the comparables considered by TPO at 2.566% (see page 50 of TPO’s order), no adjustment arises under this head.”
5.4. Before us the Ld. AR submitted that the Ld.TPO had adopted the Bright Line Test and thereby made addition of Rs. 76.63 crores towards excess advertisement and market promotion expenditure being expenses attributable towards Assessee’s Holding Company for the tangible benefit derived. Ld. A.R. further submitted that the Members of the DRP though agreed with the concept of such addition, directed the Ld.TPO to exclude volume discount and trade discount from advertisement expenditure while working out the ratio of the advertisement expenses to sales. The Ld. TPO subsequently giving effect to the order of the DRP had deleted the addition of Rs. 76.63 crores because the same was not warranted when the volume discount and trade discount were excluded from the advertisement expenses. Ld. AR further admitted that since the addition of Rs. 76.63 crores was deleted, this ground raised by the assessee need not be considered and dismissed as such. The Ld. D.R conceded to the aforesaid facts presented by the Ld. A.R.
5.5 After hearing both sides and perusing the orders of the Tribunal cited by the Ld. A.R supra, we hereby accept the concept of Bright Line Test (BLT) as held by our predecessors with respect to the concept of Bright Line Test for distinguishing between the routine and non-routine expenditure incurred on advertisement and brand promotion wherein advertisement and marketing promotion expenses to the extent incurred by uncontrolled comparable distributors is to be regarded within the “Bright Line Limit” of the routine expenses and the advertisement and market promotion expenses incurred by the distributors beyond such “Bright Line Unit” constituted non-routine expenditure resulting in creation of economic ownership in the form of marketing intangibles which belong to the owner of the brand. However, in this case even after computing the ALP by following the Bright Line Test the Ld.TPO has deleted the addition Rs. 76.63 crores. Accordingly, this ground raised by the assessee is dismissed.
6.1. Ground No.4 Disallowance of Rs. 104,27,36,417/- being royalty paid by the assessee to its Holding Company M/s.HMC Korea.
The appellant company had entered into technical knowhow agreement with its Holding Company for all the models of the cars manufactured by it. In view of this agreement, the appellant company paid royalty of 5% on its domestic sales and 8% on its export sales. The assessee company made an analysis under transfer pricing, since the payment of royalty was directly linked with its manufacturing activity and arrived at the method to be followed as Transaction Net Margin Method (TNMM). The assessee further justified the percentage of royalty paid to its Holding Company as it was approved by Reserve Bank of India (RBI). However, the Ld.TPO not accepting the justification of the percentage of royalty paid to the assessee’s Holding Company, held that, separate bench marking analysis should be made and arrived at the following analysis:—
Comparables
Royalty expenses (Rs. Crore)
Net Sales (Rs. Crore)
Royalty/ Net sales
General Motors India Pvt Ltd.
31.37
1844.10
1.70%
Ford India Pvt Ltd
36.63
2,191.79
1.67%
Honda Siel Cars India Ltd
136.99
3,873.23
3.54%
Maruti Suzuki India Ltd
367.30
14,592.20
2.53%
Average
2.36%
HMIL
369.77
8,763
4.22%
Difference
1.86%
Thus arriving at the difference of 1.86%, the Ld.TPO recommended the disallowance of Rs. 165 crores as excess royalty paid to the Holding Company while deciding the ALP of royalty payment. When the matter reached the DRP, the Ld. Members of the DRP accepted the contention of the Ld. TPO that, separate bench marking analysis is necessary for determining ALP of royalty payment, by not accepting the argument of the assessee that the percentage of royalty payment made to the assessee’s Holding Company is justifiable since RBI has approved the transaction. However, the Ld. Members of the DRP rejected the comparables viz. General Motors Pvt Ltd & Ford India Pvt Ltd., because while selecting the comparables the Related Party Transactions (RPT) were more than 25% and accordingly directed the Ld.TPO to rework the adjustment after removing these two companies from the comparables. Thus, the addition was restricted to Rs. 104.27 crores as against Rs. 165.05 crores.
6.2 Ld. AR argued before us by stating as follows:—
(i)
The Ld.TPO /DRP were not justified in holding that the royalty payment should be bench marked separately. It was contended that the appellants “whole entity” approach of bench marking royalty payments along with all other transactions by adopting TNM method at the entity level is justifiable.
(ii)
Since the operating margin of the appellant company was 7.61% which is higher than the comparable companies selected in the TP study being 2.90%, there was no necessity for addition on account of excess royalty.
(iii)
The royalty paid by the comparable company’s viz. Maruthi Suzki India Ltd., is only for ”imparting technology” while as the royal paid by the appellant company is for the use of “brand” as well as ”technology”.
(iv)
The royalty paid at the rate of 5% on domestic sales and 8% on export sales by the appellant company is in accordance with the rules prescribed under Rule 10B (2)(d) of the Income Tax Rules and also as per the approval granted by RBI.
(v)
The learned TPO in her TP study for adhoc adjustment on account of brand at the rate of 1% had herself observed that in automobile sector the average rate of royalty is 4.7%, which is higher than the appellant’s average rate of royalty being 4.22%. Therefore, royalty paid by the appellant should be accepted as arm’s length price.
(vi)
The comparable companies selected by TPO which is further confirmed by the Ld. Members of the DRP viz; Honda Seil Cars India Limited and Maruthi Suzuki India Limited has controlled transactions therefore the benchmarking analysis’s made by the Ld. TPO is unreliable and requires to be rejected.
(vii)
The Ld. TPO has taken into account of the royalty payment made by the assessee company which is inclusive of fee for technical know-how and use of brand whereas for comparable companies the Ld. TPO had selected was the royalty payment was only for use of technology.
6.3 The Ld. DR on the other hand relied on the orders of the Ld. TPO/DRP and argued in support of the same.
6.4 We have heard both the parties and carefully perused the materials available on record and decisions cited by the assessee viz. (i) Dy. CIT v. AIR Liquide Engineering India (P.) Ltd. [2014] 43 taxmann.com 299/[2015] 152 ITD 257 (Hyd.)(ii) Lumax Industries Ltd. v. ACIT [IT Appeal No. 4456 (Delhi) of 2012 (paper book page No.394) and (iii) ThyssenKrupp Industries India (P.) Ltd. v. Addl. CIT [2013] 33 taxmann.com 107 (Mum.) (paper Book page 433). Further the assessee has relied on the Rule 10B(2)(d) of the Income Tax Rules, 1962 which stipulates as under:—
“Rule 10B(2) For the purposes of sub-rule(1), the comparability of an international transaction with the uncontrolled transaction shall be judged with reference to the following, namely:—
(a) to (c)**
**
**
(d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.”
6.5 Further perusing the order of the Ld. TPO in page 40 in para Nos.25 & 26 the Ld. TPO herself observed that in respect of royalty payment in automotive sector from the study of 35 licenses, the average works out to 4.7% and the median works out to 4% which is higher than the appellant’s average rate of royalty payment of 4.22%. Further the Ld. TPO has observed that the assessee company has been bestowed with the latest technology by its Holding Company and it cannot be said that old technology has been dumped in the Indian market (para 27 of the TPO’s order). The relevant portion of the Ld. TPO’s order is extracted herein below for reference:—
“26 In the table given above it is seen that in automotive sector on study of 35 licenses in respect to royalty payment minimum royalty payment was 1% maximum was 15% royalty payment. Average comes to 4.7% and the median royalty rate was 4.0%.
27. In the case of the assessee what will be the right percentage of royalty that would compensate the assessee suitably. In this connection it is relevant to discuss certain relevant facts. As discussed earlier, India is a vast market for auto makers. India has a huge percentage of middle and upper middle, class population that has enough surplus income to buy such movable and immovable assets such as House, cars etc. Further banks have liberally sanctioned auto loans on equated monthly installment basis to the buyers. It is also relevant to note that India has got a big percentage of population which is not only young but also earns handsome money especially soft ware boom in India. This section of the society is influenced by the brand name. In India is expanding auto market the share of Hyundai is increasing year after year. This has been discussed in Company Profile and Industrial over view given above. In this market, Hyundai brand and Logo has become quite popular. It is due to brand value development on account of efforts made by the assessee company. So far as the Hyundai technology is concerned it is the latest technology and it cannot be said that old technology has been dumped in Indian market. It has promising future that will earn the holding company in coming years huge income by way of royalty on know how supplied by it to the assessee company. It is not an old technology about which it may be said that it does not have bright future and hence the sales will decrease and therefore brand development will not be advantageous to the holding company. It would like to stay ahead of its competitors in the Indian market by ensuring the quality of product as well as by spreading the brand awareness. The Holding Company has given to the assessee the exclusive rights of producing the cars in this territory. Each car produced by the assessee becomes the carrier of holding company’s brand name and logo – – – – – – – – – – – – – – – – – – – – – – – – –
**
**
**”
Facts being so, it is apparent that the Ld. TPO has herself accepted the high-tech technology passed on to the assessee company by its Holding Company and also after details study of 35 licenses arrived at a conclusion that the royalty payment of 4.7% is prevalent in the automotive sector. Therefore from these circumstances, we do not find it appropriate on the part of the Revenue to make addition on account of ALP of royalty payment. Therefore, we hereby delete the addition of Rs. 104,27,36,417/- made by the Ld. TPO following the directions of Ld. Members of the DRP.
Corporate Tax Issues:—
7.1 Ground No.(v) Disallowance of depreciation on capital subsidy amounting to Rs. 7,91,060/—
It was observed by the Ld. Assessing Officer that the assessee has received 100 lakhs subsidy from State Industries Promotion Corporation of Tamilnadu (SIPCOT) during the previous year 2003-04. The assessee claimed that the subsidy was not related to any fixed assets; however the assessee has not produced the purpose for which the above subsidy was received. Therefore, the explanation offered by the assessee was not accepted by the Ld. Assessing Officer in the relevant previous year and also for the earlier previous years. Accordingly, the Ld. Assessing Officer reduced the capital subsidy granted by SIPCOT from the cost of the assets installed in the plant and allowed depreciation only on the reduced WDV for all the earlier years. Similarly for the relevant assessment year also, the Ld. Assessing Officer disallowed the depreciation amounting to Rs. 7,91,060/-.
7.2 Before us, the Ld. A.R. submitted that for the assessment year 2003- 04 the Ld. CIT (A) has directed the Ld. Assessing Officer to re-examine the issue in the light of Supreme Court decision Sahney Steel & Press Works Ltd. v. CIT [1997] 228 ITR 253/94 Taxman 368 and CIT v. P.J. Chemicals Ltd. [1994] 210 ITR 830/76 Taxman 611 (SC). Ld. A.R. further submitted that as on date the Ld. Assessing Officer is yet to give effect to the order of the Ld. CIT (A). Therefore Ld. A.R pleaded that for the relevant assessment year also the matter may be remitted back to the file of Ld. DRP with similar direction. Ld. D.R strongly opposed to the submissions of the Ld. A.R. and relied on the orders of the Ld. Members of the Ld. DRP and the Ld. Assessing Officer.
7.3 After hearing both sides, we are of the opinion that the matter requires a categorical finding as to how the cash received as subsidy from SIPCOT has been utilized by the company in order to address merits of the case. Therefore, we hereby remit the issue back to the file of Ld.DRP in order to examine the complete facts of the issue in the light of the various decisions cited by the Ld. A.R and pass appropriate order as per merits and law.
8.1 Ground No.(vi) Disallowance U/s.14A of the Act for Rs. 5,29,910/-.
The assessee had contested before the Members of the Ld. DRP against the disallowance of Rs. 5,29,910/- U/s. 14A of the Act by applying the provisions of Rule 8D of the Income Tax Rules, 1962. The argument put up by the assessee before the Revenue was that the assessee had made investment out of its revenue reserves of 1709.22 crores and therefore disallowance was not called for. It was further contended that the Rule-8D would not be applicable as it had come into force only w.e.f assessment year 2008-09 and not retrospectively. However, the Ld. DRP found the view of the Ld. Assessing Officer to be fortified by the decision in the case of ITO v. Daga Capital Management (P.) Ltd. [2009] 117 ITD 169/26 SOT 603 (Mum.) (SB) wherein it was held that the sub-section (1) of Section 14A is only a clarificatory and retrospective. Before us, the Ld. A.R relied on the order of the Chennai Bench of the Tribunal in the case of EIH Associated Hotels Ltd. v.CIT [IT Appeal No.1503(Mds.) of 2012] Paper book Page Nos.465 & 466. On perusing the order of the Tribunal, we find that in that case the Tribunal had come to such conclusion because the investment was made by the assessee in its subsidy company. However, in the present case before us, the details of investment made were not brought before us. But as pointed out by the assessee Rule 8D was introduced by the Income Tax Fifth Amendment Rules, 2008 with effect from 24.03.2008. Therefore, it would not be applicable to the case of the assessee for the assessment year 2007-08. Moreover under such circumstances, various judicial authorities have held that 2% to 5% of the dividend earned may be disallowed in order to justify the provisions of Section.14A of the Act. However, in the present case before us, the Ld. A.R. has claimed that the assessee had not received any dividend during the year, which has not been rebutted by the Ld. D.R. Therefore, we hereby hold that disallowance of Section 14A of the Act for Rs.5,29,910/- is not warranted and accordingly, we direct the Ld. Assessing Officer to delete the same.
9.1 Ground No.(vii) Disallowance of expenditure of Rs. 5,20,97,000/- towards 100 cars given to Police Department
The assessee had contested before the Revenue for disallowance of expenditure of Rs. 5,20,97,000/- being the cost of 100 cars gifted by the assessee to the Tamil Nadu Police Department. The assessee had justified the action as fulfilment of obligation towards “Corporate Social Responsibility”. It was further claimed that the use of these vehicles by the Police Department would help the assessee to assess the reliability of the vehicles and also help the public at large. It will also help the assessee as an advertisement to promote sales and also assistance to the Research & Development Department of the assessee company. Considering these aspects it was argued that these expenditures may be treated as allowable expenses U/s. 37(1) of the Act. However, the Ld. Members of the Ld. DRP relying on the decision of the Tribunal case in MRF Ltd.v. Dy. CIT [IT Appeal Nos. 1374 to 1377(Mds.) of 2010, dated 11-3-2011] wherein it was held that the expenditure incurred to the tune of Rs. 1.59 crores for the promotion of MRF Phase Foundation which is a body promoting and grooming pace bowlers in India were disallowed, since the same could not be treated as expenditure for business activity. However we do not agree with this view of the Ld. Members of the DRP in the present case before us. In the case relied upon by the Ld. DRP the issue was with respect to expenditure incurred by M/s.MRF Ltd, a tyre manufacturing company, towards promotion of Cricket Spot which is not a related activity with the business of the assessee. In the case of the present assessee before us, the assessee has provided with 100 cars to the Police Department by which the public at large would be benefited. In fact, the taxes earned from the Revenue of the assessee company by various government authorities are only spent for the benefit of the public at large. Moreover by extending such gestures by the assessee company would directly or indirectly obtain the following benefits as pointed out by the Ld. A.R.
(i)
It will help the assessee company to test the performance of the cars manufactured by it.
(ii)
The extensive usage of the vehicles manufactured by the assessee company will be noticed by the public at large and it will build up the image of the assessee and also Act as advertisement for its products.
(iii)
The Police Department being over burdened by the large traffic movement in and around the assessee’s factory will be at ease for being provided with fast moving vehicles by the assessee company and that will also enhance their efficiency and also soothen the discomfort cause to the public.
(iv)
It will also help the assessee to fulfil its obligations towards “Corporate Social Responsibility”.
9.2 Further the assessee has also relied on the decision of Hon’ble Apex Court in the case of Sri Venkata Satyanarayana Rice Mill Contractors Co. v. CIT [1997] 223 ITR 101/[1996] 89 Taxman 92 wherein it was held that:
“The principles for determining whether the payment of the kind made by assessee could be regarded as a business expenses are well settled. What is to be seen is not whether it was compulsory for the assessee to make the payment or not but the correct test is that of commercial expediency. As long the payment which is made is for the purposes of the business, and the payment made is not by way of penalty for infraction of any law, the same would be allowable as a deduction. The contribution which was made by the assessee could under no circumstances be regarded as illegal payments or payments which were opposed to public policy. This was not a case where the assessee was paying any bribe to any person nor is this a case where money was being contributed to any private fund or for the benefit of any individual which could be regarded as a form of illegal gratification. By a voluntary scheme, with which the District Collector was associated, the District Welfare Fund had been established for the benefit of the general public. The payment to such a fund which was openly made by all the millers and which fund was being used for public benefit could not be regarded as being opposed to public policy. Requiring payment to be made for a just cause which would entitle a businessman to obtain a license or permit cannot be regarded as being against the public policy. Any contribution made by an assessee to a public welfare fund which is directly, connected or related with the carrying on of the assessee’s business or which results in the benefit to the assessee’s business has to be regarded as an allowable deduction U/s. 37(1). Such a donation whether voluntary or at the instance of the authorities concerned, when made to a Chief Minister’s Drought Relief Fund or a District Welfare Fund established by the District Collector or any other Fund for the benefit of the public and with a view to secure benefit to the assessee’s business, cannot be regarded as payment opposed to public policy. It is not as if the payment in the present case had been made as an illegal gratification. There is no law which prohibits the making of such a donation. The mere fact that making of a donation for charitable or public cause or in the public interest results in the Government giving patronage or benefit can be no ground to deny the assessee a deduction of that amount U/s. 37(1) when such payment had been made for the purpose of assessee’s business. Therefore, the payment made by the assessee in the instant case was allowable as deduction.”
9.3 In these circumstances, we are of the opinion that such gestures of the corporate houses have to be appreciated and encouraged which will benefit the public at large. Further, since these expenditures have directly or indirectly benefitted the assessee company for its image building and promotion of sales of its products, it should be treated as allowable expenditure U/s. 37(1) of the Act because of the existence of commercial expediency in the conduct of the assessee. Therefore relying on the decision of Hon’ble Apex Court supra, we hereby direct the Ld. Assessing Officer to allow the expenditure of Rs. 5,20,97,000/- incurred by the assessee for providing 100 cars to the Tamil Nadu Police Department.
10.1 Ground No.(viii) Addition on account of export incentives accrued to the assessee on target plus scheme Rs. 5,52,26,335/- and focus market scheme Rs. 3 crores.
On examining the P&L a/c for the relevant to assessment year it was observed by the Ld. Assessing Officer that the assessee had shown income by way of export incentives towards target plus scheme amounting to Rs.5,52,26,325/- and focus market scheme Rs.3 crores, however while computing tax the assessee had excluded these amounts. On query by the Ld. Assessing Officer, the assessee explained as follows:—
“The objective of the scheme is to accelerate growth in exports by rewarding Star Export Houses who have achieved a quantum growth in exports. High performing Star export houses shall be entitled for a duty credit based on incremental exports substantially higher than the general annual export target fixed.
HMIL has accrued for Rs.26 crores as on 31.03.2006 pertaining to exports benefits under the target plus scheme for the financial year 2005-06 exports. This amount was revised during the current financial year i.e. in 2006-07 to Rs.31.52 crores and accordingly, a further accrual of Rs.5.52 crores pursuant to filing the application with the authorities for the same. Therefore, an amount of Rs.31.52 crores was shown as export benefits under the loans and advances for the financial year ending 31.03.2007. The License for the above amount has not yet been received by HMIL as at 31.03.2007.
HMIL has also further estimated and accrued Rs.3 crores as export benefits under the Focus Market Scheme for the financial year 2006-07 exports. As on 31.03.2007, the company was in the process of applying for the license. As on the date of balance sheet, HMIL has neither applied nor received or utilized the above license.
Based on the principle fo commercial prudence, since the target plus license was received in the financial year 2007-08 and license for the focus market scheme was received in the financial year 2008-09, we have correctly excluded the above amount from the computation of total income for the financial year 2006-06.”
The Ld. Assessing Officer after examining the reply of the assessee rejected the same because of the following reasons:—
” (i)
It is observed from the details of exports incentives like Duty Draw Back and DFCE Benefits, Target Plus Scheme, Focus Market Benefits, which have been accrued to the assessee at the time of exports and its subsequent realization that the assessee has received entire exports incentives accrued without any adjustment/reduction by the Central Excise and Customs Department. (The detail of the same is enclosed as per annexure-1) Therefore, the contention of the assessee that, the above said export incentives cannot be considered as income unless relevant licenses received from the concerned authorities cannot be accepted.
(ii)
It is noticed that the assessee has been claiming the expenditure on warranty on provision basis by relying on the decision of Hon’ble Supreme Court in the case of M/s. Rotark Control India Private Ltd. v. CIT whereas, in the issue of export incentive scheme, even though the same has been accrued, the same has not been offered to the tax even though the same was received completely in the subsequent year.
(iii)
Reliance is also placed on the ratio laid down by the Hon’ble Kerala High Court in the case of CIT v. Southern Cables & Engineering Works (289 ITR 167). The relevant part of the decision is being reproduced as under:—
“We are of the view since the assessee was following the mercantile system of accounting, the assessee should have accounted for the penalty by deducting in the accounting year 1989-90 itself to maintain a claim. The Kerala State Electricity Board had made a deduction towards penalty from bills for delayed supplies and the penalty deduction related to the accounting year 1989-90 relevant to assessment year 1990-91. The fact would show that the Kerala State Electricity Board had deducted a sum of Rs.4,24,851/- from supply bills for delay in supply during the year 1989-90. Subsequently, the Board refunded a sum of Rs.2,18,529/- to the assessee during the accounting period 1990-91. The liability for the penalty accrued during the accounting period 1989-90 relevant to the assessment year 1990-91. Even if it is true that part of the amount was refunded by the Electricity Board, the actual liability relates only to the assessment year 1990-91. The assessee was following the mercantile system of accounting. Hence, the assessee should have claimed the same in the year 1989-90. The contention that the assessee was trying their best to get the penalty waived by the Kerala State Electricity Board and only after exhausting all steps the assessee could claim deduction cannot be sustained. Mere protest or opposition by a subject to the levy of tax or other duties payable to the Government cannot carry with it the implication that there is no proper levy legally recoverable till such protest or opposition ceases or is silenced. So long as the assessee is following the mercantile system of accounting, in our view, the assessee should have claimed deduction in the year 1989-90 accounting year. Therefore, the Tribunal was not justified in interfering with the order passed by the appellate authority. Consequently, the appeal is allowed and the order of the Tribunal is set aside to that extent.”
For the above said reasons, the Ld. Assessing Officer opined that the export incentives received towards target plus scheme and focus market scheme has to be treated as income accrued to the assessee for relevant to assessment year. The Ld. Members of the DRP confirmed the view of the Ld. Assessing Officer and thereafter, the Ld. Assessing Officer finalized the draft assessment order treating the same as the income accrued to the assessee during the relevant to assessment year.
10.2 The Ld. A.R. cited the decision of the Hon’ble Supreme Court in the case of CIT v. Excel Industries Ltd. [2013] 358 ITR 295/219 Taxman 379/38 taxmann.com 100 and argued stating that the export incentives received has to be tax in the year when the license was received and not in the year the export was made. Ld. D.R. relied on the orders of the Revenue and argued in support of the same.
10.3 We have heard both the parties and carefully perused the materials available on record. In the case cited by the Ld. A.R supra, the advance license benefit receivable by the assessee being the entitlement of Duty Free import of raw materials under the import and export policy were excluded from the total income by the assessee in its statement for computation of income since it was opined by the assessee that such income cannot be treated as accrued until the imports were made by the assessee and consumed. However, the Ld. Assessing Officer treated the same as the income of the assessee while framing the assessment. When the matter came up before the Apex Court, the issued was decided in favour of the assessee. The relevant para of the order is reproduced herein below for reference:—
’19. This Court further held, and in our opinion more importantly, that income accrues when there “arises a corresponding liability of the other party from whom the income becomes due to pay that amount.”
20. It follows from these decisions that income accrues when it becomes due but it must also be accompanied by a corresponding liability of the other party to pay the amount.
Only then can it be said that for the purposes of taxability that the income is not hypothetical and it has really accrued to the assessee.
21. In so far as the present case is concerned, even it if it is assumed that the assessee was entitled to the benefits under the advance licenses as well as under the duty entitlement pass book, there was no co