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Income Tax Appellate Tribunal, “B” BENCH : BANGALORE
Before: SHRI CHANDRA POOJARI & SMT. BEENA PILLAI
Per Chandra Poojari, Accountant Member This appeal is directed against the assessment order passed u/s. 143(3) r.w.s. 144C(13) r.w.s. 144B of the Income-tax Act, 1961 [the Act] dated 30.4.2021.
The assessee was incorporated on 18.05 2015, as a wholly owned subsidiary of Tyco Electronics Singapore Pte Ltd, Singapore, and is engaged in providing ITeS in the nature of shared services in the areas of Information Technology, Finance back-office, Human Resource, customer support, etc. to the TE Group entities across the globe.
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Ground Nos.1, 2 & 2.1 are general in nature and do not require adjudication.
Ground Nos.2.3 to 2.4 are as follows:-
“2.3 Rejecting the computation of Tested Party margin as undertaken by the Appellant and recomputing the margin considering amortisation of goodwill amounting to INR 91,371,302 as operating in nature. 2.4 Applying the provisions of Rule 10b(5) read with Rule 10CA(2) and Rule 10CA(4) of the Income-tax Rules, 1962 [‘the Rules’] while undertaking the fresh benchmarking analysis.” 5. The ld. AR submitted that goodwill was recorded by the Applicant pursuant to the acquisition of the 'Shared Services Business' of TE Connectivity Global Shared Services Pvt Ltd ("TECGSS"), on a slump sale basis on 30.6 2015. It therefore represents a part of the consideration actually paid by the Appellant for the said acquisition (i.e., the excess of purchase consideration paid, over the fair value of net assets taken over). The said goodwill represents a payment the made by an acquirer (the Appellant) in anticipation of future economic benefits. These benefits are not immediate but generally accrued over a period of time.
It is submitted that the said goodwill as an intangible asset, was not recorded or recognised by the Transferor, i.e., TECGSS, prior to the said acquisition but arose pursuant to the acquisition on account of the significant premium paid for the business. It is therefore a cost associated with the purchase of the business and it is not a tool deployed in business. Unlike assets such as plant and machinery, office equipment, computers, laboratory equipment, etc., which are purchased and used for undertaking the normal day-to-day operations, "goodwill" is the price paid for acquiring an on-going business. The same is amortized/ impaired in the books of
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account, over a period as required by the accounting standards, and such period does not necessarily coincide with the actual period over which the business will reap benefits from such payment. Hence, the purchase of goodwill cannot be equated to other capital assets used for running the business.
He submitted that the ability of the business to generate revenue does not immediately go up, merely because a high premium is paid is amortized over 5 years in the books of account. If the Revenue's contention were to be accepted, the ability of the business to generate profits should go up immediately after every acquisition. The said amortization is only an accounting effect given in the books in accordance with the prevailing accounting standards and practice. It is therefore not an operating expense in the regular course of business but is the cost of acquisition and an extraordinary item and should not be considered as operating in nature for computing the Appellant's margin on cost.
The ld. AR submitted that the requirement to exclude extraordinary items for benchmarking and determination of ALP is a well settled law. Even the Safe Harbour Rules allow for exclusion of extra-ordinary items while computing the operating expenses and the same is also provided in the OECD TP Guidelines 2010, as extracted below:
"2.80. Non-operating items such as interest income and expenses and income taxes should be excluded from the determination of the net profit indicator. Exceptional and extraordinary items of a non-recurring nature should generally also be excluded..." 9. Reliance in this regard is also placed on the following judicial precedents, which upheld the view that goodwill amortization is an extraordinary item and ought to be excluded from the operating cost for benchmarking purpose:-
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Continental Automotive Components (India) Pvt. Ltd., Bang.Trib. DHR Holding India Pvt Ltd. Tribunal, TS-370-ITAT-2021 ST-Ericsson India Pvt Ltd Tribunal, Delhi ITA No.609 & 168/Del/2015 Imsofer Manufacturing India Pvt Ltd, ITA No.5158/Del/2015 & ITA No.1049/Del/2016
Comparable companies do not have Goodwill or Amortisation thereof
The ld. AR further submitted that the final set of comparable companies considered for the purpose of benchmarking and determination of ALP do not have similar amortization and accordingly, exclusion of amortisation in determining the Appellant's margin on cost is warranted, to bring consistency in comparison. This is demonstrated by way of a comparative chart. The requirement for the said adjustment is also supported by the Income Tax Rules, 1961 and the OECD guidelines cm transfer pricing, as summarized below:-
• The Rule 10C(2)(e) of the Income-tax Rules, 1962 ("the Rules") states that in selecting the most appropriate method, the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction and the comparable uncontrolled transaction or between the enterprises entering into such transactions must be taken into consideration. • Reliance is also placed on para 2.75 of the OECD TP Guidelines 2010, which states as follows: "2.75 Another important aspect of comparability is measurement consistency. The net profit indicators must be measured consistently between the associated enterprise and the independent enterprise..."
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Further reliance is placed on the following decisions, which uphold the comparability principles to be adopted for the purpose of benchmarking, in support of exclusion of amortization of G/W from the operating cost for benchmarking:-
Rakhra Technologies (P.) Ltd., 347 ITR 484 (P&H) B.A. Continuum India Pvt Ltd. ITA 440 of 2014 (Telangana) ICON Clinical Research India Pvt. Ltd. ITA No.1034/Mds/2014 Qual Core Logic Ltd., ITA No.893/Hyd/2014 Schefenacker Motherson Ltd.,, 123 TTJ 509 Philips Medical Systems (P.) Ltd., 98 taxmann.com 296
Profit arising from goodwill
It was submitted that the Appellant had agreed to pay a premium, i.e., goodwill, in anticipation of benefits from the acquired business in the long-term. The Appellant cannot be expected to recoup the benefits/profits from goodwill within a short period of 5 years, merely because the Accounting standard requires for amortization within such period, as argued by the Revenue. If such argument of the Revenue is accepted and the said amortisation is considered as an operating expense, it would be entirely inappropriate, and it would further require the Appellant to earn the entire premium, along with a mark-up, within 5 years, irrespective of the industry in which it operates as well as the business realities. If such proposition is to be extended to its logical conclusion, it would mean that every acquirer, regardless of whether it is in ITES or the IT industry or pharma or real estate or infrastructure or aerospace, who amortize the acquisition cost over 5 years as per accounting practice, would be at arm's length profit only if they recoup the cost along with margin thereon within the said 5 years.
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The said assumption would result in a thumb-rule that the payback period of an acquisition ought to 5 years always, regardless of any business dynamics, which is patently an incorrect proposition under law.
In light of the above, the Appellant cannot be expected to recover 14. the premium paid towards acquisition of the business along with a mark-up by the end of the 5-year period, by carrying on the same business that was undertaken by the transferor prior to such acquisition. The Appellant cannot be expected to earn double or multiple times the margin earned by the transferor or any other company in the same business, merely on account of payment of a premium for acquiring the said business. This proposition is impractical and absurd since no customer will be willing to pay an additional price for the same product / service even in an arms' length transactions, merely because the business is acquired by another party who is continuing to offer the same product / service. He referred to the illustration in Pg. 629 of the Case Law Compilation.
Business Activity remains constant pre and post the acquisition:
The ld. AR submitted that the margin computation by the Appellant, by excluding the amortisation from the operating costs is in line with the manner of benchmarking that was undertaken for such business when considered independently or prior its acquisition. When the ALP of the revenue generated by a business is determined at a stated range, when considered independently and in the absence of any acquisition, the same ought to be accepted even post acquisition if the same business activity continues as it was earlier.
In this regard, he relied on the following decisions, wherein the principle that a similar transaction undertaken by another taxpayer in the past would serve as a benchmark for the said transaction being carried out
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by the Appellant in the succeeding years, in the absence of any factual differences. Applying this principle, the transaction tested in the case of the Appellant is the revenue from rendering ITES. This transaction was undertaken by the TECGSSIPL prior to acquisition of the said business by the Appellant. The margin computation for benchmarking, in the hands of TECGSSIPL, did not include any element of G/W amortisation, and such margin is acceptable to the Revenue. Given that the Appellant is merely continuing the said business post acquisition as a going concern, the margin of the Appellant for the purpose of benchmarking ought to be computed in the same manner as that of TECGSSIPL.
Cable & Wireless Networks India Pvt Ltd., IT(TP)A No.1549/Bang/2014 Kalyani Hayes Lemmerz Ltd., ITA No. 999 & 1000/PUN/2013
Goodwill — Already considered:
He further submitted that at the time of acquisition, the business was valued based on the projected revenues over a period, using Discounted Cash Flow Method and Market Approach Method. The value of goodwill was determined based on the said valuation of the business, as the excess over the fair value of net assets. Therefore, the consideration paid towards G/W is already imbedded in the revenue earned by the Appellant post- acquisition.
He submitted that the arguments of the revenue authorities to include the amortised cost of goodwill as a part of the operating cost base, and requiring a mark-up thereon would amount to double whammy, as the effect of the said cost of G/W and the corresponding mark-up thereon is already factored in the Appellant's revenue.
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Position of ALP considering amortisation of goodwill as non- operatinq
The ld. AR submitted that in the event that the submissions of the Appellant in relation to the treatment of amortisation of G/W as a non- operating item for determining its margin, is accepted by this Tribunal, the international transaction of provision of ITES by the Appellant would be at arm's length, without any further adjustments in relation to the inclusion/exclusion of comparable companies and grant of working capital adjustment.
The ld. DR submitted that amortization of goodwill is an operative expenditure and it could not be removed while calculating PLI of the company or comparable. He further submitted that the assessee was incorporated on May 18, 2015 as a wholly owned subsidiary of Tyco Electronics Singapore Pte Ltd, Singapore having its registered office at Bangalore. On 30.6.2015, assessee (TECSIPL) purchased the shared services business of the CommScope Connectivity India Private Limited [erstwhile T11 Connectivity Global Shared Services India Private Limited ('TECGSS')] that supported the business operations (excluding Broadband Network Solutions segment) of TB Group. The business was, purchased on slump sale basis for an amount or INR 68.55 crores and according to the assessee, the goodwill has arisen out of such purchase consideration paid. Amortization of goodwill amounting to INR 9,13,71,302 was charged to P&L account.
The ld. DR further submitted that amortization of goodwill is the process of expensing the cost of a goodwill over the projected life of the asset for tax or accounting purposes. The intangible assets, such as goodwill, patents and trademarks are amortized into an expense account whereas tangible assets are instead written off through depreciation. For
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tax purposes, the cost basis of an intangible asset is amortized over a specific number of years, regardless of the actual useful life of the asset, In the years in which the asset is either acquired and sold, the amount of amortization deductible for tax purposes is pro-rated on a monthly basis, Intangible assets are non-physical assets that can be assigned an economic value. The process of amortization allows the company to write off annually a part of the value of that intangible asset according to a defined schedule. When companies amortize expenses over time, they help tie the cost of using an intangible asset to the revenues it generates in the same accounting period and this is in accordance with generally accepted accounting principles (GAAP). The intangible assets such as goodwill are used by businesses to generate revenue and produce net income, Over a period of time, the costs related to the assets are moved into an expense account. By recognizing an expense for the cost of the asset, the company is complying with Generally Accepted Accounting Principles (GAAP) which require the matching of revenue with the expense incurred to generate the revenue. Thus, amortization of goodwill like depreciation falls under the category or operating expenses. Depreciation is an expense that takes into account the estimated useful life of plant and equipment. Amortization works the same way but pertains to intangible assets such as goodwill, patents and copyrights.
He submitted that National Court Denmark in the case of Denmark vs Pharma Distributor A AIS, March 2020, Case No SKM2020.105.0LR has ruled that that amortization of goodwill is an operating expense.. The results in a Danish company engaged in distribution of pharmaceuticals were significantly below the arm's length range of net profit according to the benchmark study. but by disregarding annual goodwill amortization of DKK 57.1 million, the results were within the arm's length range. The goodwill being amortized in Pharma Distributor A A/S had been determined under a
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prior acquisition or the company, and later — due to a merger with the acquiring (tallish company — booked in Pharma Distributor A A/S. The main question in the case was whether Pharma Distributor A A/S were entitled to disregard the goodwill amortization in the comparability analysis. The national tax court had ruled in favour of the company, but the national court reached the opposite result. Thus, the National Court found that the goodwill in question had to be regarded as an operating asset, and therefore the amortisation of goodwill had to be regarded as operating expenses for comparability purposes.
We have heard both the parties and perused the material on record. Similar issue came for consideration before in IT(TP)A No.713/Bang/2017 dated 24.11.2021 wherein it was held as under:-
“45. We have heard both the parties and perused the material on record on this issue. This issue was considered by the Tribunal in the case of ST-Ericsson India Pvt. Ltd. v. DCIT in IT(TP)A No.609 & 168/Del/2015 dated 3.7.2018 and it was observed as follows:- “15. Assessee has challenged the findings returned by TPO/DRP treating amortization of goodwill as not extra ordinary in nature. It is the case of the assessee that goodwill is on account of acquisition of units through slump sale under Business Transfer Agreement and in these circumstances, amortization of goodwill is an extra ordinary item and is not pertaining to the regular operation of the taxpayer, hence non-operating in nature. 16. Ld. AR for the assessee contended that ld. DRP in assessee's own case in AYs 2011-12 and 2012-13 and ld. TPO in AY 2013-14 ITA No.168/Del./2015 has already amortized goodwill as extra ordinary in nature by excluding the same by computing operating margin of the taxpayer and order thereof is available at pages 2681 to 2695, 2696 to 2713 and 2718 and 2764 of the paper book. It is also not in dispute that there is no change in the facts of AYs 2010-11, 2011-12, 2012-13 and 2013-14. Perusal of the order passed by ld. DRP available at page 2681
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relevant portion at page 2691, shows that amortization of goodwill is an extra ordinary item and is not pertaining to the regular operation of the assessee, and hence non- operating in nature. So, in these circumstances, we direct the TPO to verify the facts and treat the amortization of the goodwill as non-operating expenditure in order to compute the operating margin of the assessee. So, ground no.7 is determined in favour of the assessee.” 46. Following the above cited decision of the Delhi Tribunal, this issue is decided in favour of the assessee.” 24. In view of the above order of the Tribunal, the issue is remitted to the AO/TPO with similar directions.
The next ground No.2.5 reads as follows:-
The DRP erred in : 2.5 Conducting a fresh comparability analysis by rejecting certain filters applied by the Appellant in the TP documentation and applying additional/ modified filters. The Learned AO and the Hon'ble Panel further erred in: • Accepting companies without considering the turnover and size of the Appellant vis-a-vis comparable companies; • Rejecting companies having different financial year ending or data of the company not falling within the 12 month period although being functionally comparable with the Appellant; • Accepting companies lacking segmental data and engaged in diversified operations; and • Rejecting companies by applying persistent loss filter wherein the comparable companies had losses only in two out of latest three years. 26. The ld. AR submitted that the TPO has applied a lower turnover filter of INR 1 Crore, however, did not consider an upper limit of turnover
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filter. It is a well-settled principle that an upper limit of turnover filter ought to be applied for comparability analysis for the purpose of benchmarking. It has been held in various judicial precedents that Companies with a huge turnover of multiple times the turnover of the taxpayer or with a turnover of more than INR 200 Crores, ought to excluded in the selection of comparable companies for benchmarking as such companies cannot be equated to the small players on account several differentiating factors due to the differences in their size and scale of operations, that have a direct impact on the profitability. Reliance in this regard is also placed on the following judicial precedents, including the decisions rendered by this Hon'ble Tribunal, wherein the application of an upper turnover filter of INR 200 crores as an appropriate filter:-
Pentair Water India Pvt Ltd., TS-566-HC-2015 Fulcrum Fund Services (India) Pvt Ltd., IT(TP)A No.2521/Bang/2017 Autodesk India Pvt Ltd., TS-62-ITAT-2013 Cenduit India Services Pvt Ltd., TS-19-ITAT-2022 Software Paradigms Infotech Pvt. Ltd., TS-676-ITAT-2021 Entercoms Solutions Pvt Ltd. TS-548-ITAT-2021
The ld. DR submitted that some of the comparables selected by the TPO are challenged on grounds of size and level of operations and also on account of its high profit margins. With regard to the issue of high/low turnover, the Department's stand has consistently been that turnover is not a relevant filter in the software industry. In the software, industry size has no influence on the margins earned by the company. Economies of scale are relevant only in capital intensive companies which have substantial fixed assets in the form of plant & machinery. In the service industry, size does not matter, what matters is the human capital. The TPO applied only the lower limit of turnover filter of excluding companies < 1 crore since the margins earned by these companies fluctuate to extremes because of narrow base and they lack competitive strength, operational efficiencies
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and human resources. They often escape the eyes of regulators too, Hence, appropriate, lower turnover filter is applied by the TPO to select companies. Many tax payers also apply such filter, However, the issue arises as to whether any upper turnover limit also need to be applied in the selection of comparables. In this regard, an empirical analysis was made which clearly indicated that margins do not show a proportionate increase with increase in the turnover. He relied on the order of the DRP.
We have heard both the parties and perused the material on record. The issue of turnover filter has been considered by this Tribunal in Autodesk India Pvt. Ltd. in IT(TP)A No.1108(Bang/2010 and by order dated 31.1.2013 and it was held to exclude the comparables with the following observations:-
“20. In this regard we find that the provisions of law pointed out by the ld. counsel for the assessee as well as the decisions referred to by the ld. counsel for the assessee clearly lay down the principle that the turnover filter is an important criteria in choosing the comparables. The assessee’s turnover is RS. 47,46,66,638. It would therefore fall within the category of companies in the range of turnover between 1 crore and 200 crores (as laid down in the case of Genesis Integrating Systems (India) Pvt. Ltd. v. DCIT, ITA No.1231/Bang/2010) . Thus, companies having turnover of more than 200 crores have to be eliminated from the list of comparables as laid down in several decisions referred to by the ld. counsel for the assessee. Applying those tests, the following companies will have to be excluded from the list of 26 comparables drawn by the TPO viz., Turnover Rs. (1) Flextronics Software Systems Ltd. 848.66 crores (2) iGate Global Solutions Ltd. 747.27 crores (3) Mindtree Ltd. 590.39 crores (4) Persistent Systems Ltd. 293.74 crores (5) Sasken Communication Technologies Ltd. 343.57 crores (6) Tata Elxsi Ltd. 262.58 crores
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(7) Wipro Ltd. 961.09 crores. (8) Infosys Technologies Ltd. 13149 crores.” 29. Accordingly, we direct the AO/TPO to consider the comparability of the companies in terms of the above order of the Tribunal and decide the issue.
Ground Nos. 2.8 and 2.9 read as under:-
The DRP erred in : “2.8 Including the following companies even though such companies are functionally different (such as engaged in KPO activities, diversified activities with no segmentation, extra ordinary event, etc.) from the Appellant: • Tech Mahindra Business Services Limited; • Infosys BPM Limited; and • SPI Technologies India Private Limited. 2.9 Excluding Ace BPO Services Pvt Ltd even though the same is functionally comparable to the Appellant.” 31. The assessee has also raised additional grounds on this issue with the submission that these grounds are purely on a legal and jurisdictional issue and does not require examination of any new material or facts which are borne on the record of the revenue authorities. The ld AR relied on the Supreme Court judgment in the case of M/s National Thermal Power Co. Ltd. Vs. CIT, 229 ITR 383 (SC) for admission of the additional ground.
The additional grounds are as follows:-
“1. The Final Order of Assessment dated April 30, 2021, under section 143(3) read with sections 144C(13) and 144B of the Act ("Impugned Order"), passed by the Ld. AO, to the extent it is not in conformity with the directions issued by the Hon'ble Dispute Resolution Panel ("Hon'ble DRP') under section 144C(5) of the Act ("DRP Directions"), is beyond jurisdiction, in contravention of the provisions of the Act and invalid.
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The Ld. AO erred in passing the Impugned Order without giving effect to the relief granted to the Appellant by the Hon'ble DRP in relation to the transfer pricing adjustment, in Para 5.5 of the DRP Directions, to include Microgenetic Systems Ltd. as a company comparable to the Appellant for determination of ALP.” 33. We have heard both the parties and are of the opinion that the additional grounds are legal grounds and do not require any fresh investigation into facts. Hence following the Supreme Court decision in National Thermal Power Co. Ltd. Vs. CIT (supra), we admit the additional grounds for adjudication.
Exclusion of Companies with a high turnover of more than INR 200 Crores
The ld. AR submitted that in view of the submissions made in connection with Ground No. 2.5, the following 4 companies whose turnover is higher than INR 200 Crores, ought to be excluded from the final set of comparable companies adopted for benchmarking, given that the turnover of the Appellant for the corresponding period is only INR 44.85 Crores.
(Amounts in INR Crores) S.No. Company Turnover Tech Mahindra Business Services 1. 703 Ltd. 2. Infosys BPM Ltd. 2,849 3. SPI Technologies India Pvt Ltd. 336 4. Capgemini Solutions Ltd. 297
Reliance was placed on the decision of Hyderabad ITAT in Infor India Pvt. Ltd., TS-499-ITAT -2021 wherein for the same assessment year, i.e., AY 2016-17, the Tribunal held that the said companies (S.No. 1 to 3) ought to be excluded in view of their high turnover of over INR 200 Crores. The same ratio would be applicable to the company at S.No. 4 above.
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As discussed in para 28, this issue is remitted to the AO/TPO with similar directions.
Inclusion of comparable companies
The ld. AR submitted that the. TPO erroneously excluded Ace BPO Services Pvt. Ltd. on the sole ground that it is a 'persistent loss-making company'. In this regard, it is submitted that said company incurred a loss only for FY relevant to the Impugned AY, but recorded profits during the preceding two FYs (i.e., FY 2013-14 and 2014-15) and therefore cannot be considered as a persistent loss-making company.
He submitted that it has been settled by several jurisprudence on the subject, that incurrence of loss in a single year cannot be the basis for considering the said company as a 'persistent loss-making company'. Loss making companies are part of the market and an entity's ability to make profits and losses is contingent upon market conditions. Profit or loss considered at random and in isolation of other business conditions based on the facts and circumstances of the case, does not by itself have any bearing on the profitability of such company. Therefore, merely because an otherwise functionally comparable company has incurred losses, it should not be rejected.
In order to be so classified as a persistent loss-making company, it must incur losses in at least 2 out of 3 years, and further, should have other indications such as negative net worth or a pattern of events that indicate that the company is not in a position to turnaround and make profits., or other similar factors. In support of the above, he relied on the following judicial precedents:-
Goldman Sachs (India) Securities (P.) Ltd., 69 taxmann.com 19 Welspun Zucchi Textiles Ltd., 391 ITR 211
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Quark Systems (P.) Ltd., 38 SOT 307 Brigade Global Services (P.) Ltd. 28 ITR(T) 411 Sella Synergy India (P.) Ltd., 75 taxmann.com 286
As rightly pointed out by the ld. AR, this issue was considered by the Tribunal in the case of Brigade Global Services P. Ltd. v. ITO, 33 taxmann.com 618 (Hyd. Trib) and Sella Synergy India P. Ltd. v. DCIT, 75 taxmann.com 286 (Chennai Trib) wherein it was held as under:-
Brigade Global Services P. Ltd. (supra) “26. We have heard both the parties on these comparables. The contention of the assessee is that the loss making companies were not to be taken out from the comparables while determining the ALP. We find merit in the argument of the assessee's counsel. Determining of ALP is depend upon the comparables of identical or similar in controlled transactions in similar or comparable circumstances and thereafter suitable adjustment has to be made to set off the difference to make the transaction commercially comparable. Upon careful consideration of the assessee's counsel plea, we find ourselves in agreement with the assessee's contention that only abnormal loss making companies are to be taken out from the comparables. The judgement relied on by the assessee's counsel in Quark Systems (P.) Ltd. (supra) supports the assessee's counsel arguments. Being so, for proper comparables these three companies viz., items at 11, 13 and 14 are to be included in the comparables if their loss is on account of normal business reasons and segmental turnover is above Rs. 1 crore. This view of ours is also supported by the order of the Tribunal Delhi Bench in the case of Sapient Corporation (P.) Ltd. v. Dy. CIT [2011] 46 SOT 56/11 taxmann.com 69, Genisys Integrating Systems India (P.) Ltd. v. Dy. CIT [2012] 53 SOT 159/20 taxmann.com 715 (Bang.) wherein held that when companies which are loss making are excluded from comparables, then super profit making companies are also to be excluded from the comparables for determining the ALP. Being so, in our opinion, the Assessing Officer has to recalculate the ALP after excluding only the data of the companies which have losses due to extraordinary reasons. In other words, if there is loss in ordinary
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course of business which is normal/nominal cannot be excluded from the comparables. However, we make it clear that if there is any abnormal loss or if there is continuous loss year by year, in such situation that company data cannot be considered as comparable with the assessee company. For example, F.I. Sofex Ltd., Vans Information Ltd. and Mukund Engineers Ltd. and these companies are to be excluded from the comparables.” Sella Synergy India P. Ltd. (supra) “6.17 We heard the rival submissions, perused the material on record and judicial decisions cited. The ld. TPO has wrongly excluded said comparables company as a persistent loss making company. Whereas the said company has earned net profit both in preceding and subsequent year. But the comparable turnover to be current financial year is less than Rs. 1 crores is respect of income from software development, product and services of domestic region as against the turnover of assessee company Rs. 22.71 crores. Accordingly, in our opinion turnover is small compared to assessee's company and the comparable is rejected.” 41. Accordingly, we remit this issue to AO/TPO to include the comparables, if the comparables are not incurring the losses continuously in 2 out of 3 assessment years. Ordered accordingly.
Inclusion of companies accepted by the DRP:
The ld. AR submitted that the. AO failed to give effect to the DRP directions to include the Microgenetics as a comparable in the final list of comparable companies by erroneously stating that the Appellant has not been provided any relief by the DRP in relation to the additions made on account of TP issues. It is therefore submitted that the DRP's directions ought to be given full effect to in the impugned Order, as the said directions are binding on the TPO/AO as per section 144C(10) of the Act. In light of the above, it is submitted that Microgenetics ought to be included in the final set of comparable companies adopted for benchmarking, and the TP adjustment ought to be determined accordingly.
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We have heard both the parties and perused the material on record. In our opinion, the AO is bound by the directions of DRP and he has to pass the final assessment order in conformity with the directions of the DRP. Ordered accordingly.
Ground No.2.10 is with regard to working capital adjustment for determining the ALP.
The ld. AR submitted that the Appellant reserved the option to make an adjustment for the difference in the levels of working capital employed by it vis-à-vis that of the comparable companies, along with the reasoning for the requirement of such adjustment in its TP Study. During the course of TP scrutiny, the Appellant furnished a detailed computation towards the said adjustment (Pg. 998 to 1002 of the Paperbook-Part B). However, the. TPO erroneously rejected the Appellant's claim for the said adjustment. It is a settled law that an adjustment for the differences in the levels of working capital ought to be made, to for a proper comparability analysis. It is essential to adjust for differences in the levels of working capital between the Appellant and comparable companies, as the variance in the said levels directly impacts margins.
The claim for the said adjustment is also supported by Rule 1oB(1)(e)(iii) of IT Rules provides that the net profit margin arising in comparable uncontrolled transactions should be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions which could materially affect the amount of net profit margin in the open market. Further support can also be drawn from Rule 1oB(3)(ii) of the IT Rules, which provides that reasonably accurate adjustments can be made to eliminate the material effects of differences between the Appellant and comparable companies. The need
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for working capital adjustment is supported by the OECD guidelines as well.
The grant of economic adjustments such as working capital adjustment was also allowed by the Hon'ble Karnataka High Court, in the case of Novell Software Development (India) Pvt. Ltd., 126 taxmann.com 29 upon considering Rule 10B of the Rules. Reliance is also placed on the following decisions, which have upheld the working capital adjustment:-
Novell Software Development (India) Pvt. Ltd., 126 taxmann.com 29 Philips Software Centre Pvt. Ltd., 95 taxmann.com 214 Philips Software Centre Pvt. Ltd., 26 SOT 226 Yahoo Software Development India P. Ltd., 115 taxmann.com 60 First Advantage Global Operating Centre Pvt. Ltd., TS-830-ITAT-2019 Inflow Technologies Pvt Ltd., ITA No.3338 & 3339/Bang/2018
The ld. DR submitted that it cannot be accepted that the assessee does not bear any significant risk. The assessee bears single customer risk, as its entire business activity and survival depends on the AEs. As per the agreement, the AE can refuse to make payment if the work delivery is not on the expected requirement. If the technology and the products developed, for which the taxpayer provides services, fails in the market, it would also directly impact the assess= as it would not get further contract. On the assessee’s contention that the taxpayer is remunerated at cost, it does not bear any of these risks, it was submitted that the taxpayer also to an extent bear credit and collection risk. If the AE fails to make the payment within the credit period it will have a direct and heavy impact on the sustenance of the assessee. If the employees were not paid in time, it will affect the existence of the taxpayer itself, and its performance in the long run. In addition to the reasons given by the TPO, as the three year weighted average margin of the various comparables and the defined median was only considered for ALP determination, such differences on
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account of risks, if any gets evened out. Further, no such adjustment is permissible unless the assessee establishes that such difference has a material effect on the margin of the comparable companies and such computation could be made based on reliable data, in view of sub-rule 10B of Income Tax Rules. Hence the plea of the assessee is to be rejected.
We have heard both the parties and perused the material on record. This issue came for consideration before the Tribunal in the case of M/s. Inflow Technologies P. Ltd. in ITA Nos.3338 & 3339/Bang/2018, order dated 4.8.2021 wherein it was observed as under:-
“7.4 We have heard rival submissions and perused the material on record. The solitary reason assigned by the TPO which was endorsed by the DRP is that the assessee had not demonstrated the impact of working capital adjustment on profit margin of assessee as well as the comparable companies. In this context, we find on identical facts, the Bangalore Bench of the Tribunal in the case of Yahoo Software Development India Pvt. Ltd. v. JCIT (supra) had held that when the details required for working capital adjustment has been provided by the assessee, the Revenue Authorities were not justified in denying the claim of the assessee for deduction. The relevant finding of the Bangalore Bench of the Tribunal, reads as follow:- “14. We have heard the rival submissions. The relevant provisions of the Act in so far as comparability of international transaction with a transaction of similar nature entered into between unrelated parties, provides as follows: Determination of arm's length price under section 92C . 10B . (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction [or a specified domestic transaction] shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :— (a) to (d)......
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(e)transactional net margin method, by which,— (i) the net profit margin realised by the enterprise from an international transaction [or a specified domestic transaction] entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction [or the specified domestic transaction] and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in subclause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction [or the specified domestic transaction]; (f)...... (2) For the purposes of sub-rule (1), the comparability of an international transaction [or a specified domestic transaction] with an uncontrolled transaction shall be judged with reference to the following, namely:— (a) the specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions;
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(c) the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (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. (3) An uncontrolled transaction shall be comparable to an international transaction [or a specified domestic transaction] if— (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. 15. A reading of Rule 10B(1)(e)(iii) of the Rules read with Sec.92CA of the Act, would clearly shows that the net profit margin arising in comparable uncontrolled transactions has to be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market. 16. Chapters I and III of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (hereafter the “TPG”) contain extensive guidance on comparability analyses for transfer pricing purposes. Guidance on comparability adjustments is found in paragraphs 3.47-3.54 and in the Annex to Chapter III of the TPG. A revised version of this guidance was approved by the Council of the OECD on 22 July 2010. In paragraph 2 of these guidelines it has been explained as to what is comparability adjustment. The
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guideline explains that when applying the arm’s length principle, the conditions of a controlled transaction (i.e. a transaction between a taxpayer and an associated enterprise) are generally compared to the conditions of comparable uncontrolled transactions. In this context, to be comparable means that: • None of the differences (if any) between the situations being compared could materially affect the condition being examined in the methodology (e.g. price or margin), or • Reasonably accurate adjustments can be made to eliminate the effect of any such differences. These are called “comparability adjustments. 17. In Paragraphs 13 to 16 of the aforesaid OECD guidelines, need for working capital adjustment has been explained as follows:- “13. In a competitive environment, money has a time value. If a company provided, say, 60 days trade terms for payment of accounts, the price of the goods should equate to the price for immediate payment plus 60 days of interest on the immediate payment price. By carrying high accounts receivable a company is allowing its customers a relatively long period to pay their accounts. It would need to borrow money to fund the credit terms and/or suffer a reduction in the amount of cash surplus which it would otherwise have available to invest. In a competitive environment, the price should therefore include an element to reflect these payment terms and compensate for the timing effect. 14. The opposite applies to higher levels of accounts payable. By carrying high accounts payable, a company is benefitting from a relatively long period to pay its suppliers. It would need to borrow less money to fund its purchases and/or benefit from an increase in the amount of cash surplus available to invest. In a competitive environment, the cost of goods sold should include an element to reflect these payment terms and compensate for the timing effect. 15. A company with high levels of inventory would similarly need to either borrow to fund the purchase, or
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reduce the amount of cash surplus which it is able to invest. Note that the interest rate July 2010 Page 6 might be affected by the funding structure (e.g. where the purchase of inventory is partly funded by equity) or by the risk associated with holding specific types of inventory) 16. Making a working capital adjustment is an attempt to adjust for the differences in time value of money between the tested party and potential comparables, with an assumption that the difference should be reflected in profits. The underlying reasoning is that: • A company will need funding to cover the time gap between the time it invests money (i.e. pays money to supplier) and the time it collects the investment (i.e. collects money from customers) • This time gap is calculated as: the period needed to sell inventories to customers + (plus) the period needed to collect money from customers – (less) the period granted to pay debts to suppliers.” 18. Examples of how to work out adjustment on account of working capital adjustment is also given in the said guidelines. The guideline also expresses the difficulty in making working capital adjustment by concluding that the following factors have to be kept in mind (i) The point in time at which the Receivables, Inventory and Payables should be compared between the tested party and the comparables, whether it should be the figures of receivables, inventory and payable at the year end or beginning of the year or average of these figures. (ii) the selection of the appropriate interest rate (or rates) to use. The rate (or rates) should generally be determined by reference to the rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. The guidelines conclude by observing that the purpose of working capital adjustments is to improve the reliability of the comparables. 19. In the present case the TPO held that no adjustment should be made to the profit margins on account of working capital differences between the tested party and the comparable companies for the following reasons:-
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(i) The daily working capital levels of the tested party and the comparables was the only reliable basis of determining adjustment to be made on account of working capital because that would be on the basis of working capital deployed throughout the year. (ii) Segmental working capital is not disclosed in the annual reports of companies engaged in different segments and therefore proper comparison cannot be made. (iii) Disclose in the balance sheet does not contain break up of trade and non-trade debtors and creditors and therefore working capital adjustment done without such break up would result in computation being skewed. (iv) Cost of capital would be different for different companies and therefore working capital adjustment made disregarding this different based on broad approximations, estimations and assumptions may not lead to reliable results. 20. The TPO also placed reliance on a decision of Chennai ITAT in the case of Mobis India ITA No.2112/Mds/2011 (2013) 38 taxmann.com. That decision was based on the factual aspect that the Assessee was not able to demonstrate how working capital adjustment was arrived at by the Assessee. Therefore, nothing turns on the decision relied upon by the CIT(A) in the impugned order. In the matter of determination of Arm’s Length Price, it cannot be said that the burden is on the Assessee or the Department to show what is the Arm’s Length Price. The data available with the Assessee and the Department would be the starting point and depending on the facts and circumstances of a case further details can be called for. As far as the Assessee is concerned, the facts and figures with regard to his business has to be furnished. Regarding comparable companies, one has to fall back upon only on the information available in the public domain. If that information is insufficient, it is beyond the power of the Assessee to produce the correct information about the comparable companies. The Revenue has on the other hand powers to compel production of the required details from the comparable companies. If that power is not exercised to find out the truth then it is no defense to
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say that the Assessee has not furnished the required details and on that score deny adjustment on account of working capital differences. Regarding applying the daily balances of inventory, receivables and payables for computing working capital adjustment, the Delhi Bench of ITAT in the case of ITO Vs. E Value Serve.com (2016) 75 taxmann.com 195 (Del-Trib) has held that insisting on daily balances of working capital requirements to compute working capital adjustment is not proper as it will be impossible to carry out such exercise and that working capital adjustment has to be based on the opening and closing working capital deployed. The Bench has also observed that that in Transfer Pricing Analysis there is always an element of estimation because it is not an exact science. One has to see that reasonable adjustment is being made so as to bring both comparable and tested party on same footing. Therefore there is little merit in TPO/DRP’s objection on working adjustment based on unavailable daily working capital requirements data. There is also no merit in the objection of the TPO/DRP regarding absence of segmental details available of working capital requirements of comparable companies chosen and absence of details of trade and non-trade debtors of comparable companies as these details are beyond the power of the Assessee to obtain, unless these details are available in public domain. Regarding absence of cost of working capital funds, the OECD guidelines clearly advocates adopting rate(s) of interest applicable to a commercial enterprise operating in the same market as the tested party. Therefore this objection of the TPO/DRP is also not sustainable. 21. In the light of the above discussion, we are of the view that the revenue authorities were not justified in denying adjustment on account of working capital adjustment. We may also add that the complete working capital adjustment working has been given by the Assessee and a copy of the same is at page 186 to 200 of the Assessee’s paper book. No defect whatsoever has been pointed out in these working by the CIT(A). We may also further add that in terms of Rule 10B(1)( e) (iii) of the Rules, the net profit margin arising in comparable uncontrolled transactions should be adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions which
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could materially affect the amount of net profit margin in the open market. It is not the case of the TPO/DRP that differences in working capital requirements of the international transaction and the uncontrolled comparable transactions is not a difference which will materially affect the amount of net profit margin in the open market. If for reasons given by the revenue authorities working capital adjustment cannot be allowed to the profit margins, then the comparable uncontrolled transactions chosen for the purpose of comparison will have to be treated as not comparable in terms of Rule 10B(3) of the Rules, which provides as follows:- “(3) An uncontrolled transaction shall be comparable to an international transaction if— i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged to paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences.” 22. In such a scenario there would remain no comparable uncontrolled transactions for the purpose of comparison. The transfer pricing exercise would therefore fail. Therefore in keeping with the OECD guidelines, endeavor should be made to bring in comparable companies for the purpose of broad comparison. Therefore the working capital adjustment as claimed should be allowed. We hold and direct accordingly. 23. As we have already observed, the assessee in the present case has given all the details required for working capital adjustment and the revenue authorities were not justified in denying the claim of assessee for deduction. The TPO/AO is directed to allow working capital adjustment in the light of the material already available on record, after affording opportunity of being heard to the assessee. 24. The TPO/AO is directed to compute the ALP in the light of directions as given above, after affording opportunity of being heard to the assessee.”
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7.4.1 In the instant case, we find that the assessee has provided the detailed working capital adjustment working before AO / TPO and the DRP. The working capital adjustment worked out by the assessee are enclosed at page 105 of the paper book filed by the assessee. No defect with regard to the assessee’s working capital adjustment was pointed out by the AO / TPO nor by the DRP. In terms of Rule 10B(1)(e)(iii) of the I.T.Rules, the net margin arising in comparable uncontrolled transactions should be taken into account the differences, if any, between the international transaction and the comparable uncontrolled transactions which could materially affect the amount of net profit margin in the open market. It is not the case of the TPO / DRP that differences in working capital requirements of the international transactions and the uncontrolled comparable transactions is not a difference which will materially affect the amount of net profit margin in the open market. If for reasons given by the Revenue Authorities working capital adjustment cannot be allowed to the profit margin, then the comparable uncontrolled transactions chosen for the purpose of comparison will have to be treated as not comparable in terms of Rule 10B(3) of the I.T.Rules. 7.4.2 As mentioned above, the assessee in the present case has given all the details required for working capital adjustment. Therefore, the Revenue Authorities were not justified in denying the claim of the assessee for deduction. Hence, the AO / TPO is directed to allow the working capital adjustment in the light of the material placed on record, after affording a reasonable opportunity of hearing to the assessee. It is ordered accordingly.” 50. In view of the above order of the Tribunal, we remit this issue to the AO/TPO with similar directions.
Ground Nos. 3 to 8 are as follows:-
Disallowance of depreciation claimed by the Assessee on Intangible assets on account of slump purchase 3. That on the facts and circumstances of the case, the Learned AO / DRP erred in disallowing depreciation on various intangibles including but not limited Goodwill arising on account
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of slump purchase amounting to INR 15,22,85,504 claimed by the Assessee during the year. The Learned AO has ignored that intangibles comprise of various assets. 4. The Learned AO / DRP erred in invoking the sixth (originally fifth proviso) to section 32(1)(ii) of the Act and disallowing the claim of depreciation under section 36 of the Act (a) despite having admitted in page no. 7 of the order that the said proviso does not deal with slump purchase and (b) disregarding that proviso applies only to assets transferred during amalgamation and not to assets arising due to amalgamation. 5. The Learned AO / DRP erred in not appreciating the generally accepted accounting principles for the purpose of calculation of goodwill. 6. The Learned AO / DRP erred in rejecting DCF method and brushing aside the valuation report of the business acquired by the Assessee as duly submitted by the Assessee for determination of goodwill by merely providing general comments on DCF Method without citing any particular error in the said report. Learned DRP has further erred in alleging that the assessee failed to furnish empirical data etc while it was (a) evident from valuation report and (b) nothing specific was ever called for. 7. The Learned AO / DRP erred in making an arbitrary comparison between the projected numbers of revenue and profit along with the actual figures and challenging the sanctity of the projections. 8. That without prejudice to the above, the quantum of disallowance is excessive and unreasonable. 52. The ld. AR Submitted that on June 3o, 2015, the Appellant purchased the Shared Service Business of TECGSS (other than the Broadband Network service business) on a slump purchase basis vide a BTA entered with TECGSS. In this connection, the Appellant paid a purchase consideration of INR 68.55 Crores to TECGSS. The said consideration was determined based on a valuation report obtained from
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independent valuer, wherein the business acquired by the Appellant was valued using a combination of two internationally accepted methods, i.e., the Discounted Cash Flow ("DCF") and the Comparable Market Multiple Method. The value of the business was determined as the weighted average of the values determined under both the said methods, by assigning equal weights to both the said methods.
The said acquisition was accounted in the books of the Appellant by recording the assets and liabilities taken over at fair values. The value of net assets taken over was INR 7.64 Crores. The excess purchase consideration over the said value of net assets, amounting to INR 60.91 Crores was recorded as goodwill. The accounting for the said acquisition is detailed under Note No. 33 of the audited financial statements. The said goodwill was amortised by the Appellant, in its books of account, over a period of 5 years, in line with the accounting standards and general practices. The goodwill amortisation in the books of the Appellant for the Impugned AY amounted to INR 15.23 Crores. Subsequently, in determining the taxable income for the Impugned Year, the Appellant claimed depreciation on goodwill at the rate of 25% u/s. 32(1)(ii) of the Act, in its Return of Income furnished for the Impugned AY.
The AO rejected the valuation report and the value of goodwill recorded by the Appellant, by erroneously alleging that the said valuation was undertaken using the DCF method which is not an acceptable method in the present case. He failed to appreciate that DCF is only one of the methods adopted, and the final valuation is the weighted average of the two methods as stated above.
In light of the above, the AO concluded that the genuineness and the claim of Purchase Consideration is questionable as it is fixed at an abnormally high value, in comparison to the net asset value of the
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business. On this basis, the Ld. AO rejected the Purchase Consideration paid, and fixed the same at the book value of Net Assets acquired, in order to eliminate the premium paid (i.e., goodwill) for acquiring the said business. Consequently, the depreciation claim thereon was rejected. The Hon'ble DRP confirmed the said disallowance.
The ld. AR submitted that the basis for rejection of the valuation report obtained from the independent valuer was that DCF method of valuation is not acceptable for valuing the business acquired by the Appellant (on the premise that only DCF method was adopted); and huge variations between the projections used for the said valuations, and the actual revenues earned by the Appellant for the corresponding period. The Appellant's reliance on the decision of the Hon'ble Supreme Court in the case of Smifs Securities Limited, 348 ITR 302 was rejected on the ground that in the present case it is the valuation that is challenged and not the eligibility of depreciation on goodwill as a principle settled by the Hon'ble SC.
The AO rejected the value of goodwill by invoking the sixth proviso to Section 32(1) of the Act and holding that the said acquisition is a colourable device to reduce tax liability, on the allegation that the Appellant failed to furnish any details in relation to goodwill valuation.
The gist of contentions against the said disallowance are as follows.
Valuation report/ methodology cannot be disregarded by the AO
It was submitted that the AO failed to consider that DCF is only one of the methods adopted by the valuer for valuing the acquired business. Without any regard to the facts, the Ld. AO merely alleges that the valuation was undertaking based on DCF method, and that the said method is not acceptable since DCF is predominantly based on projections
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and critical assumptions, and sensitive to even a minor change in such assumptions; and, the projections used for DCF valuation were at variance with the actual revenues subsequently earned.
The AO did not identify or record any findings of errors/deficiencies with the said valuation report, but merely stated some generic inherent aspects/issues of DCF method for rejecting the said valuation. Further, the allegation that the details were not furnished by the Appellant is blatantly incorrect, as the entire basis, documents used, assumptions and reasoning behind the assumptions etc., are provided in the valuation report furnished by the Appellant. Further, the Appellant furnished all the details and documents called for by the Ld. AO during the course of the assessment. Again, the TPO merely made a generic allegation that the details were not furnished, without recording a finding as to which details were not called for but not furnished.
In light of the above, the Appellant submits that the AO cannot simply disregard the valuation reports obtained from an expert independent valuer, without establishing that the said valuation is materially flawed based on the opinion of an export. Further, the examination of the AO ought to be confined to identification of any errors in the valuation, that is undertaken based on the method employed by the valuer. The AO cannot reject the valuation methodology in itself.
Further, DCF is an internationally recognized, which is also recognized and accepted by the RBI, ICAI as well as under the provision of the Act. Hence, the rejection of such an established method by the AO merely because it involves assumptions, is without any basis. A valuation exercise in itself, irrespective of the method adopted, is not an exact science and can never be done with arithmetic precision and involves several assumptions.
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vi. Further, it is a settled principle of law that a hindsight comparison of the projections with the actual revenues cannot be a basis for rejecting any valuation. The Appellant relies on the following judicial precedents, wherein the said principle was reiterated and upheld:
Town Essential (P) Ltd., 191 ITD 55 Innoviti Payment Solutions (P.) Ltd., 102 taxmann.com 59 Cinestaan Entertainment P. Ltd., 106 taxmann.com 300 Rockland Diagnostics, TS-114-ITAT-2021-DEL India Today Online P. Ltd., 176 ITD 459 Rameshwaram Strong Glass P. Ltd., 96 taxmann.com 542 Credtalpha Alt. Inv. Advisors Pvt Ltd., 7056/mum/2019
AO cannot reject the purchase consideration paid by the Assessee
The Appellant submits that the AO merely alleging that the slump sale is a colourable device for reducing the Appellant's tax liability, rejected the valuation and the purchase consideration actually paid by the Appellant. The AO failed to demonstrate and record any reasons or basis for such contention. Further, he fixed the purchase consideration at the book value of the net assets acquired, and therefore reduced the 'actual cost' in an attempt to eliminate recording of goodwill, thereby reducing the 'actual cost' of the assets recorded by the Appellant pursuant to the acquisition under a slump sale model.
However, the AO did not invoke the provisions of Explanation 3 to section 43(1) of the Act, which empower the AO to determine the actual cost of an asset that was previously used by any other person prior to their acquisition, subject to the twin conditions of recording his satisfaction that main purpose of the said acquisition was to reduce taxes by claiming depreciation on the enhanced cost and obtaining the prior approval of the prescribed authority. In the present case, the AO neither satisfied the said twin conditions nor invoked the said provision.
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Without prejudice to the above, it is submitted that the said provision cannot be invoked in the present case, to the lumpsum amount of 'Purchase Consideration' paid for an acquisition under the slump sale model, since the same is applicable only in relation to the 'assets acquired by a taxpayer, that were used by another person at any time for the purpose of their business, prior to their acquisition'. In the present case, the AO is essentially rejecting the 'actual cost' of G/W recorded pursuant to slump sale, and the said goodwill at the time of acquiring the business by paying a premium and is not an asset that was previously used for business and thereafter transferred.
In light of the above, the ld. AR submitted that in the absence of invocation of the above mentioned provision, the AO is not empowered under the Act, to determine the 'actual cost' of an asset, which is defined under section 43(1) of the Act to mean the actual cost of the assets to the Assessee, reduced by that portion of the cost thereof, if any, as has been met directly or indirectly by any other person or authority. In the present case, the 'actual cost' for acquiring the business is the Purchase Consideration paid by the Appellant, and the same cannot be rejected and determined by the AO. Reliance was placed on the decision of Ashwin Vanaspati Industries, 255 ITR 26 (Guj).
Further, it was submitted that the lower authorities questioned the genuineness of transaction, without appreciating that the seller of the business i.e., FECGSS paid capital gain tax on the said slump sale transaction by adopting the said purchase consideration of INR 68.55 Crores as sale consideration. The same was also accepted by the Revenue in completing the assessment of the seller for the Impugned AY [Pg. 304 and 338 of the Paperbook — Part A]. The lower authorities failed to appreciate that this establishes that the slump sale transaction is bona fide,
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and the said purchase consideration based on the valuation of business, ought to be accepted as genuine.
Goodwill arising on slump sale — eligible for depreciation
The ld. AR submitted that while the AO did not principally contend against the position of the Appellant, that the goodwill recorded by it is an intangible asset eligible for depreciation under Section 32(1) of the Act, the Appellant submits its contentions in support of its claim, on a conservative basis as follows:-
i. The said goodwill is in the nature of any other commercial or business right under the category of an intangible asset that is eligible for depreciation under section 32 of the Act. The issue whether Goodwill arising on amalgamation is eligible for depreciation or not, is no longer Res-Integra, and has been settled by the Hon'ble SC in the case of Smifs Securities (Supra). The position of law held by the Hon'ble SC constitutes the law of the land and is binding on all the lower authorities, in terms of Article 141 of the Constitution of India. ii. In this regard, the Appellant places further reliance on the decision of the Hon'ble Karnataka High in the case of Manipal Universal Learning P. Ltd., 255 ITR 26, the facts and circumstances of which are similar to the present case, wherein the Hon'ble HC allowed the claim of depreciation on goodwill arising on acquisition of business under slump sale model, reiterating the decision of the Hon'ble SC in the case of Smifs Securities (Supra). iv. The Appellant places further reliance on the following decisions, wherein it was principally held that goodwill is an intangible asset eligible for depreciation under section 32 of the Act in the context of business transfer through slump sale: Areva T & D India Ltd., 345 ITR 21 Triune Energy Services (P.) Ltd., 65 taxmann.com 238
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Toyo Engineering India Limited, TS-811-HC-2012 Volvo India Pvt. Ltd., TS-391-ITAT-2019 Dorma India Pvt Ltd., TS-735-ITAT-2019 Erroneous invocation of the sixth proviso to section 32(1) of the Act
The ld. AR submitted that invoking the sixth proviso to Section 32(1) of the Act by the. AO in the present case is totally misplaced and not justified. The said proviso does not restrict the claim of depreciation on goodwill arising pursuant to a slump sale. It is intended only for apportioning the amount of depreciation between the predecessor company and the successor company, based on the respective periods of the use of an asset during the previous year.
The sixth proviso is therefore applicable, only in case of assets already existing in the books of predecessor company on which predecessor company was claiming depreciation before slump purchase, and it is not applicable on assets recognized only by successor company pursuant to such slump purchase. The legislative intent behind the introduction of the said proviso was to curb the practice of claiming' depreciation on the 'same assets' by both the predecessor company and the successor company. This evident from the memorandum explaining the provisions of Finance Bill, 1996, which introduced the sixth proviso (erstwhile fifth proviso) to section 32(1) of the Act [S.No./5 — Pg. 187 of the Case Law Compilation]. Thus, a commonality of assets should exist between predecessor and the successor goodwill arising pursuant to acquisition belongs only to successor company.
He submitted the Hyderabad Tribunal, in the case of Mylan Laboratories Ltd.. 113 taxmann.com 6, upheld the position discussed above and rejected the invocation of the said proviso to disallow depreciation on Goodwill. Further, reliance in this regard is placed on the
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decision of the same bench in the case M/s Krishna Drugs Ltd., ITA No.198/Hyd/2011.
Further, he submitted that the Ahmedabad Bench of the Tribunal, in the case of Urmin Marketing Pvt. Ltd., 122 taxmann.com 40 rejected invocation of the said proviso and held that the same is not applicable in a case where goodwill is recorded pursuant to a merger, on the basis of purchase consideration paid (which is determined based on a valuation report), and no goodwill from the books of the transferor is recorded by the transferee.
He submitted that the AO relied on the decision of the Bangalore Bench of the Tribunal, in the case of United Breweries Ltd., 76 taxmann.com 103 49 [S.No.14 - Pg. 175 of the Case Law Compilation], for invoking the said proviso. He submitted that the facts and circumstances in the present case are distinguishable from those in the case of United Breweries (Supra). Further, the reliance on the said decision was rejected in the case of Mylan Laboratories (Supra), citing differences in facts of the case. The said decision was also distinguished and rejected by the Delhi Bench of the Hon'ble ITAT in the case of Aricent Technologies (Holdings) Ltd 109 taxmann.com 47 while allowing depreciation on goodwill.
The ld. AR submitted that in the case of United Breweries (Supra), UB acquired the shares of KBDL from its shareholders, at the value of INR 180.52 Crores. In the immediately following previous year (year under appeal), KBDL merged with UB. G/W, as an asset pre-existing in the books of KBDL, which was valued at INR 7.45 Crores, was recorded by UB at an enhanced value of INR 62.3o Crores upon amalgamation. The enhanced value of goodwill in the books of account was said to be on account of revaluation of assets. In view of this, the depreciation thereon was
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restricted to actual cost of asset, having regard to Explanation 3 of section 43(1).
Additionally, 6th proviso to section 32(1) of the Act was invoked. It was observed that the transferor KBDL had not claimed any depreciation on G/W prior to the transfer and hence, applying said proviso, it was concluded that no depreciation shall be allowed in the hands of UB, since the transferor did not claim any depreciation thereon. It was therefore concluded that the amalgamated company cannot claim such depreciation that was never claimed by the amalgamating company.
The above basis formed the twin grounds on which the depreciation was denied to the UB. However, it is important to note that the Tribunal has clarified at para 15 of the decision that goodwill is a depreciable asset having regard to the Supreme Court judgment in Sniffs Securities (Supra).
Amendment by Finance Act 2021 clarifies the position on Goodwill depreciation
The Finance Act, 2021, inserted a series of amendments in relation to the allowance of depreciation on Goodwill. Post such amendments, no depreciation is allowable to an Assessee on goodwill. However, it has been specifically provided that the aforementioned amendments will take effect from April 01, 2021 and will, accordingly, apply in relation to AY 2021-22 and subsequent AYs.
Further, amendments were made in section 55 of the Act, in relation to the meaning of 'cost of acquisition' etc. This amendment recognizes that depreciation on goodwill in relation to the years prior to April 1, 2021 may have been claimed and allowed and provides for a mechanism for the adjustment of such depreciation claimed and allowed, for determining the cost of acquisition.
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It is therefore submitted the intention of the legislature is that depreciation on goodwill is allowable prior to the said Amendments, is manifest from the adjustment mechanism. If the legislative intention was to deny depreciation for the past years as well, then there was no need for any adjustment to the cost of acquisition of the goodwill. Such an interpretation would lead to a provision of the law being redundant or otiose and such interpretation should be rejected.
The ld. DR submitted that the AO has assailed the DCF method adopted for valuation based on a series of fallacies listed there under. Hon'ble Supreme Court in the case of Dr. Mrs. Renuka Datla vs Solvay Pharmaceutical B.V. & Ors. SLP (Civil) 18035 of 2000 dated 30 October, 2003 held that if the valuation was made on a fundamentally erroneous basis, the Valuation Report can be rejected. The valuation made by the assessee is fundamentally erroneous.
Further, as held by the Bangalore Tribunal in the case of M/s. Innoviti Payment Solutions Pvt. Ltd. Vs ITO ([TAT Bangalore) ITA No. 1278/Bang/2018 Dated: 09/01/2019, the primary onus to prove the correctness of the valuation Report lies on the assessee as it has special knowledge and it is privy to the facts of the company and that only it has opted for this method. Thus, the assessee has to satisfy about the correctness of the projections, Discounting factor and Terminal value etc. with the help of Empirical data or industry norm if any and/or Scientific Data, Scientific Method, scientific study and applicable Guidelines regarding DCF Method of Valuation. None of these are produced by the assessee either before the department. Therefore, the Valuation report in question cannot be relied upon and as such is liable for rejection.
We have heard both the parties and perused the material on record. Similar issue came for consideration before the Delhi Tribunal in the case
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of Rockland Diagnostics Services P. Ltd. in ITA No.316/Del/2019. The Tribunal vide order dated 25.2.2021 remitted the issue to the AO with the following observations:-
“5.0 We have heard the rival submissions and have also perused the material on record. So far as the issue of addition of Rs.1,07,82,453/- is concerned, it is seen that the Assessing Officer has disregarded the valuation report mainly on the ground that valuation of equity shares was based on projection of revenue which did not match with the actual revenue during the subsequent years. In addition, the Assessing Officer has also adopted the Fair Market Value of the shares at Rs.10/- being the price paid by the Rockland Hospital Limited to acquire shares of erstwhile shareholders in the month of November, 2014. Apparently, the Assessing Officer has proceeded on mere assumptions and surmises while disregarding the valuation report submitted by the assessee. The assessee has applied the DCF method for the purposes of valuation of shares and has relied on the valuation report of the Chartered Accountant in this regard. There is settled law on the issue that as per Sec. 56(2)(viib) of the Act read with Rule-11 UA of the Income tax Rules, 1962, every assessee has an option to do valuation of shares and determine its Fair Market Value either by DCF method or NAV method, and that the Assessing Officer cannot examine or substitute his own value in place of the value so determined. The ITAT Delhi Bench in the case of Cinestaan Entertainment (P.) Ltd. vs. ITO, reported in [2019] 106 taxmann.com 300 (Delhi Tribunal), has held as under: ‘“32. Section 56 (2) (viib) is a deeming provision and one cannot expand the meaning of scope of any word while interpreting such deeming provision. If the statute provides that the valuation has to be done as per the prescribed method and if one of the prescribed methods has been adopted by the assessee, then Assessing Officer has to accept the same and in case he is not satisfied, then we do not we find any express provision under the Act or rules, where Assessing Officer can adopt his own valuation in DCF method or get it valued by some different Valuer. There has to be some enabling provision under the Rule or the Act where Assessing Officer has been given a power to
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tinker with the valuation report obtained by an independent valuer as per the qualification given in the Rule 11U. Here, in this case, Assessing Officer has tinkered with DCF methodology and rejected by comparing the projections with actual figures. The Rules provide for two valuation methodologies, one is assets based NAV method which is based on actual numbers as per latest audited financials of the assessee company. Whereas in a DCF method, the value is based on estimated future projection. These projections are based on various factors and projections made by the management and the Valuer, like growth of the company, economic/market conditions, business conditions, expected demand and supply, cost of capital and host of other factors. These factors are considered based on some reasonable approach and they cannot be evaluated purely based on arithmetical precision as value is always worked out based on approximation and catena of underline facts and assumptions. Nevertheless, at the time when valuation is made, it is based on reflections of the potential value of business at that particular time and also keeping in mind underline factors that may change over the period of time and thus, the value which is relevant today may not be relevant after certain period of time. ... 33. In any case, if law provides the assessee to get the valuation done from a prescribed expert as per the prescribed method, then the same cannot be rejected because neither the Assessing Officer nor the assessee have been recognized as expert under the law.” 5.1 Similarly, it has been held that where a valuation report is to be rejected, the authority should pinpoint any specific inaccuracies or short comings in the DCF valuation report. In the case of Intelligrape Software Pvt. Ltd., vs. ITO in ITA No.3925- Del2018 (Delhi Trib.), it has been held as under: ‘“23. The AO was not able to pinpoint any specific inaccuracies or short comings in the DCF valuation report of the Chartered Accountant/Valuer other than stating that year-wise results as projected are not matching with the actual results declared in the final accounts. Before the Id. CIT (A), reasons for variation between projected and actuals were duly explained. The Ld. CIT (A) has accepted such explanation but rejected the DCF valuation report as
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submitted by the assessee. Accordingly, in the absence of any defect in the valuation of shares arrived by the assessee on the basis of DCF method, impugned addition as made on the basis of net asset value method is liable to be deleted. The rejection is unjustified as the valuation report is required under Rule 11UA of The Income Tax rules is based on the future aspects of the company at the time of issuing the shares, it may vary from the actual figures depending on the market condition at the present point of the time. 24. Thus, keeping in view the entire facts of the case, the reports of the valuer, the comparison of the actual and projected revenues, provisions of Section 56(2)(viib) and keeping in view the order of Co-ordinate Bench of ITAT in the case of Cinestaan Entertainment Pvt. Ltd. 177 ITD 809 wherein it has been held that the Assessing Officer cannot substitute his own value in place of the value determined either on DC” method or NAV method, the appeal of the assessee is hereby allowed.’ 5.2 Thus, it has been held by the Co-ordinate Bench of the Tribunal that in absence of any specific inaccuracies or short comings in the DCF valuation report other than stating that yearwise results as projected are not matching with the actual results declared in the final accounts, the Assessing Officer cannot substitute his own value in place of the value determined either on DCF method or NAV method. Therefore, we are of the considered opinion that the Lower Authorities were not justified in rejecting the valuation report as submitted by the assessee in this regard. We also note that the observation of the Ld. CIT (A) that the Chartered Accountant has relied on the data supplied by the assessee in this regard is irrelevant in as much as the Chartered Accountant has carried out the valuation in accordance with the prescribed method as per Rule-11UA of the Income Tax Rules, 1962 and, therefore, such valuation report, in absence of specific defects being pointed out, has a binding value. We note that neither the Ld. CIT (A) nor the Assessing officer have evaluated the valuation report in light of the relevant material but have only rejected the same on assumptions and presumptions and the same cannot be upheld. In our considered view the Assessing officer should examine the issue afresh after giving
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due opportunity to the assessee to present its case in this regard. Thus, this ground is allowed for statistical purposes.” 83. Following the above order of the Tribunal, this issue is remitted to the Assessing Officer with similar directions.
In the result, the appeal by the assessee is partly allowed for statistical purposes.
Pronounced in the open court on this 26th day of April, 2022.
Sd/- Sd/-
( BEENA PILLAI ) ( CHANDRA POOJARI ) JUDICIAL MEMBER ACCOUNTANT MEMBER
Bangalore, Dated, the 26th April, 2022. /Desai S Murthy /
Copy to: 1. Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR, ITAT, Bangalore.
By order
Assistant Registrar ITAT, Bangalore.