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Income Tax Appellate Tribunal, COCHIN BENCH, COCHIN
Per CHANDRA POOJARI, ACCOUNTANT MEMBER:
The assessee filed appeal against the order of the Assessing Officer dated
16/01/2015 passed u/s. 143(3) r.w.s. 144C of the Act with reference to direction
of Dispute Resolution Panel (DRP), Bengaluru u/s. 144C(5) of the I.T. Act dated
29/12/2014 for the assessment year 2010-11. The Revenue filed appeal against
the direction of the DRP u/s. 144C(5) dated 29/12/2014 in terms of section
253(2A) of the I.T. Act.
We shall first take the assessee’s appeal in ITA No.190/Coch/2015. The
facts of the case are that the assessee carried on the business as jewelers and
retail dealer of textile goods. For the assessment year under consideration, the
assessee had entered into international transaction with associate enterprise.
Hence, a reference was made by the Assessing Officer to the Transfer Pricing
Officer (TPO) to determine the arms length price (ALP). The TPO vide order
dated 27/01/2014 passed u/s. 92CA(3) made a recommendation towards TP
adjustment of Rs.3,69,19,518/- to the value of international transactions. The
Assessing Officer passed draft assessment order on 25/03/2014 proposing other
additions also under normal provisions. The assessee filed objections before
DRP, Bengaluru on 25/04/2014. The DRP vide its direction u/s. 144C(5) dated
29/12/2014 upheld some of the additions proposed in the draft assessment
order. The Assessing Officer passed the final assessment order u/s. 144C r.w.s.
I.T.A. Nos.151 & 190/C/2015
143(3) of the Act dated 16/01/2015. The Assessing Officer made the following
disallowances:
Upward revision towards TP 4,58,99,641 adjustment with Associated Enterprises Notional interest on borrowings for 92,28,405 capital work in progress
Against this, the assessee has raised the following grounds before the
Tribunal:
The Dispute Resolution Panel went wrong in treating foreign exchange loss as part of operating cost for arriving at the profit margin to determine the ALP of in the international transaction. The Dispute Resolution Panel failed to note that the TPO in her order in Page 15 had accepted the appellant's argument and excluded the foreign exchange loss as part of operating cost following the principle of consistency. If the consistency rule is not applied, the logic of arguments may lead to opposite findings for different assessment years on the same of set of facts. The Dispute Resolution Panel also failed to note that the definition of 'operating cost' and 'operating income' in the Safe Harbour Rules does not consider the foreign loss / gain as part of operating cost / operating income. The Safe Harbour Rules are indicative of legislative intent and should have been followed.
The Dispute Resolution Panel failed to note that as per section 92C(2), as applicable to the relevant year, if the variation between ALP and the price at which the international transaction had been undertaken is less than 5%, then no adjustment towards ALP is called for.
The Assistant Commissioner of Income Tax / Dispute Resolution Panel is not justified in treating interest of Rs. 92,28,405/- on working capital loans availed from banks as incurred for acquisition of assets and disallowing the same under proviso to section 36(1)(iii) on notional basis. The improvements to leasehold properties was considered as a revenue expenditure and hence the proviso to section 36(1) (iii) was not applicable at all. The Assessing officer / Dispute Resolution Panel failed to consider that the ITAT in appellant's own case in IT(TP) 6/coch/2013 dated
I.T.A. Nos.151 & 190/C/2015
9.5.2014 for the assessment year 2007-08 has deleted the disallowance and the department has accepted the same and the hence, addition should not have been made.
2.1 Ground Nos. 2 & 3 were not pressed by the Ld. AR as these grounds are
not arising out of the DRP’s directions dated 29/12/2014 or in the order of the
Assessing Officer. Hence, he made an endorsement to the effect that these
grounds are not pressed. Thus these grounds are dismissed as not pressed.
2.2 Ground No. 4 is with regard to disallowance of notional interest of
Rs.92,28,405/- on working capital loans availed from banks as incurred for
acquisition of assets and the same was disallowed u/s. 36(1)(iii) of the Act.
The facts of the case are that the Assessing Officer treated interest of
Rs.92,28,405/- on working capital loans availed from banks as incurred for
acquisition of assets and disallowed the same under proviso to section 36(1)(iii).
The Assessing Officer reasoned that as per proviso to sec. 36(1)(iii), any amount
of interest paid in respect of capital borrowed for acquisition of asset for
extension of existing business for any period beginning from the date on which
the capital was borrowed till the date on which such asset was first put to use
shall be capitalized along with the cost of such asset. The Assessing Officer held
that since at the end of the year, the assets showed under capital WIP had not
been put to use, interest on borrowed capital incurred for acquisition of such
assets was required to be capitalized.
I.T.A. Nos.151 & 190/C/2015
The contention of the Ld. AR is that the assessee had not acquired any
capital assets but only carried out improvements to the lease hold premises to
carry on its business more effectively and efficiently. The Ld. AR submitted that
the assessee had not taken any loan for acquisition of capital asset. It was
submitted that the interest paid on the loan raised for running a business for day
to day requirement is a revenue expenditure and proviso to section 36(1)(iii) is
not applicable. Further, it was submitted that the addition to work in progress is
out of the profits of the assessee and not out of the borrowings.
4.1 The Ld. AR drew our attention to the earlier order of the Tribunal in
assessee’s own case in IT(TP)A No. 06/Coch/2013 dated 09/05/2014 wherein it
was observed as under:
“This tribunal in the first round of litigation in IT(TP)A No. 02/Coch/2012 found that the expenditure incurred by the assessee for renovating the premises taken on lease to set up a new show room is capital expenditure. In respect of the interest on borrowed funds the assessee contended before the Tribunal that the borrowed funds were not used for renovation of leasehold premises. In the absence of any material this Tribunal remanded back the matter to the file of the Assessing Officer to find out the availability of interest free funs and the extent of loan taken and thereafter decide the issue afresh. In the meantime the assessee filed appeal before the High Court against the order of this Tribunal in IT(TP)A No. 02/Coch/2012. The High Court found that the expenditure incurred for renovation of the premises taken on lease to set up a new show room is a revenue expenditure incurred by the assessee the question whether the borrowed funds are used for renovation or no borrowed funds were used is irrelevant. Therefore there is no question of any disallowance of notional interest on the borrowed funds. In other words in view of the judgment of the Kerala High Court holding that the expenditure incurred on renovation of the leasehold premises for setting up a new show room is revenue expenditure the interest on such borrowing has to be allowed as revenue expenditure. Hence there is no question of any
I.T.A. Nos.151 & 190/C/2015
disallowance. Accordingly, the order of the lower authority is set aside and the entire addition on account of disallowance of notional interest is deleted.”
4.2 The Ld. AR submitted that the expenditure was incurred with regard to
renovation of leasehold premises shown in the books of account as capital work
in progress. However, for income tax purpose, it was claimed as revenue
expenditure. It was further submitted by the Ld. AR that the assessee is having
own funds in the form of share capital and also internal generation of funds
which was used for the purpose of acquisition of fixed assets and according to
him, by any stretch of imagination, there cannot be any disallowance u/s.
36(1)(iii) of the Act towards notional interest incurred by the assessee on the
amount spent on acquisition of capital work in progress.
On the other hand, the Ld. DR submitted that the assessee was paying
interest on borrowed funds and it has been utilized for Capital WIP and the
assessee could not substantiate the fact that no interest bearing funds were used
for such capital WIP. The Ld. DR submitted that no day to day fund flow was
furnished and in the absence of such fund flow the assessee’s claim that no
interest bearing funds were used for capital WIP remains unsubstantiated. It
was submitted that it is settled legal position that it is the onus of the assessee
who claimed any expenditure to prove that the said expenditure, including the
expenditure claimed u/s. 36(1)(iii), was for business purposes and not for the
acquisition of capital asset.
I.T.A. Nos.151 & 190/C/2015
We have heard the rival submissions and perused the record. In this case
the assessee’s counsel main plea is that the interest expenditure was revenue in
nature as the amount was spent on capital work in progress and according to
him, it is renovation of leasehold premises as it is revenue expenditure for
income tax purposes, though it was treated as capital work in progress in the
books of account. It was submitted that actually it was revenue expenditure in
view of the judgment of the Jurisdictional High Court in the assessee’s own case
in ITA No. 230/2013 dated 20/01/2014 for the assessment year 2007-08.
However, the assessee has not placed any evidence that the capital work in
progress actually was related to the renovation of the leasehold building which
was allowed as a business expenditure in the assessment year under
consideration. In the absence of any evidence to show that the said capital work
in progress was claimed and allowed as deduction in the nature of business
expenditure in the assessment year under consideration, we are not in a position
to appreciate the said argument of the Ld. AR. Notwithstanding the above
argument, the Ld. AR made a plea that the assessee is having enough non
interest bearing funds and reserves to spend on capital work in progress and no
interest bearing funds were used towards capital work in progress. However,
the DRP mentioned in its order that the assessee is paying interest and has
utilized a part of the funds for capital work in progress and the assessee was not
able to substantiate that no interest bearing funds were used for capital work in
progress.
I.T.A. Nos.151 & 190/C/2015
6.1 It was also observed by the Assessing Officer in his draft assessment order
and gave a finding that as per the cash flow statement forming part of Annual
Report, net cash generated from operating activities was negative viz.
(Rs.17,22,62,076). According to the Assessing Officer the cash generated from
investing activities was also negative viz. (Rs.28,61,84,579). However, the
Assessing Officer found that cash generated from financing activities was a huge
positive viz. Rs.37,16,36,584/- which was only because the assessee-company
had availed a huge loan of Rs.63,00,06,705/- during the year. Despite this, it
was noticed that the net increase in cash and cash equivalent for the year was
negative and only because of the opening cash balance of Rs.31,78,37,651/-
there was a net cash in hand at the end of the F.Y. The Assessing Officer found
that the cash generated from the operations was negative not because of selling
below cost but because of the huge stock pile-up of Rs.19.30 crores during the
financial year. Therefore, it was found that the assessee had no funds left to
meet its obligation towards opening new stores. According to the Assessing
Officer, the only conclusion possible was that the funds had come from the fresh
loans of Rs.63 crores taken during the financial year. Accordingly, on an average
basis of the opening capital work in progress and closing work in progress,
interest @11%, the Assessing Officer worked out the disallowance of interest as
under:
Opening capital work in progress : Rs. 2,26,10,066/- Opening capital work in progress : Rs.14,51,79,105/- Average capital work in progress : Rs. 8,38,94,586/-
I.T.A. Nos.151 & 190/C/2015
Interest @11% on Rs.8,38,94,586 Rs.92,28,405/-
The Assessing Officer held that a disallowance of Rs.92,28,405/- was therefore
made out of interest of Rs.26,80,08,523/- debited to the P&L account, as
attributable to amounts invested in capital work-in-progress. The assessee was
not able to place any evidence contrary to this. In view of this, we are not in a
position to appreciate the argument of the Ld. AR. Thus this ground of appeal is
dismissed. Accordingly, the appeal of the assessee in ITA No. 190/Coch/2015 is
dismissed.
ITA No. 151/Coch/2015 : Revenue’s appeal
The Revenue has raised the following grounds:
Whether the learned Dispute Resolution Panel, Bangalore was right in holding that the average mark-up earned by the companies engaged in distribution of jewellery was to be fixed at 2.18% instead of (-) 0.02% determined by the TPO and in directing that the ALP of the assessee’s non-AE segment was to be fixed at 4.18% instead of 7.5% determined by the TPO.
Whether the facts and in the circumstances of the case, the learned Dispute Resolution Panel, Bangalore was right in holding that the expenditure incurred by the assessee for renovation of the lease hold premises for setting up a new show room is revenue expenditure which is otherwise a capital expenditure, the interest on such borrowings has to be allowed as revenue expenditure?
The facts of the case are that the assessee declared a total income of
Rs.102,33,29,393/-. The TPO vide order dated 27/01/2014 u/s.92CA determined
the TP adjustment to Arm's Length Price to the extent of Rs.369,19,518/- out of
I.T.A. Nos.151 & 190/C/2015
the assessee’s international transactions of sale of gold jewellery (Rs. 56.80
crores) with Joy Alukkas Gold Jewellery LLC, Dubai (AE) which was declared by
the assessee at 1.01% of the operating cost of Rs. 56.23 crores. Assessee in its
TP study adopted TNMM method and selected 12 comparable companies with
three years average margin of 3.59%. The TPO in his order has compared the
Non-AE segment (Rs.1616 crores sales) profit margin at 6.36% and AE segment
(Rs. 56.80 crores) margin at 1.01%. The TPO selected 10 comparables
companies out of the TP study accept/reject matrix of the assessee for which
current year data was available and computed net mean margin of (-) 0.02%. In
case of assessee, the operating profit was at Rs. 56,84,544/- which after
considering the forex loss of Rs. 2,60,87,316/- came to be computed as
operating loss of Rs. 2,04,02,772/- and operating margin was arrived at (-)
3.62%. The TPO further selected MD Overseas Ltd as comparable which
qualified all filters with a PLI (Operating Revenue/Operating Cost) of (-) 1.14%,
and compared with operating margin of NON-AE (domestic) segment of assessee
at 6.36% and arrived at adjusted margin of NON-AE jewellery segment at 7.5%
(-1.14+6.36%) in respect of the assessee.
8.1 As mentioned in the show cause notice to assessee the TPO selected 10
comparables companies out of the TP study accept/reject matrix of the assessee
for which current year data was available and computed net mean margin of (-)
0.02%, and compared operating profit of AE segment of assessee at Rs.
I.T.A. Nos.151 & 190/C/2015
56,84,544/- which after considering the forex loss of Rs. 2,60,87,316/- came to
be computed as operating loss of Rs. 2,04,02,772/- with operating margin at (-)
3.62%. After adjusting the margin for distribution function (-0.02%) of the
comparables, the PLI of domestic sales (Non-AE segment) at 6.36% was
determined at 6.38% and adjustment @ 10% (-3.62 + 6.38) of the operating
cost or Rs. 5,62,36,962/- was arrived at.
8.2. The assessee had adopted TNMM method and selected 12 comparables and
used three years data to arrive at mean margin of 3.59% and claimed that in
view of its operating margin was 1.01% the same was at arm's length. The
assessee had raised this objection to reject the TP documentation maintained by
the assessee under section 92C (3) of the Act. The TPO rejected the TP study of
the assessee on the grounds of inappropriate method (TNMM) in the facts of the
case considering the FAR profile of the assessee, use of multiple year data for
benchmarking the ALP, and inappropriate filters.
8.3 While doing so, the TPO considered the mark-up earned by the non-AE
jewellery segment at ALP as follows:
I.T.A. Nos.151 & 190/C/2015
ASSESSEE TPO
A COMPOSITE MARGIN OF NON-AE 6.36 6.36 SEGMENT
B DISTRIBUTION MARGIN OF NON- 2.18 (-) 1.14 AE SEGMENT
C MANUFATURING MARGIN OF 4.18 7.5 NON-AE SEGMENT (A-B)
D MANUFACTURING MARGIN OF 1.01 1.01 AE SEGMENT
E ADJUSTMENT (C-D) NIL 6.49
8.4 The mark up determined by the TPO was objected by the assessee before
the DRP. The DRP disposed of this issue by observing as under:
3.1.6.4 “Having said that we find that the average mark-up earned by the companies engaged in distribution of jewellery at 2.18% at page 12 of the TPO is a good example of the margins in distribution. Merely because the companies selected were engaged in distribution of diamond jewellery also does not make them bad comparables as the assets and risk involved are the same. Thus the mark up attributable to the manufacturing activity fo Non-AE jewellery segment of the assessee has been rightly computed at 4.18% which should be the benchmark or the arm’s length price for the manufacturing activity for the AE segment of the assessee, where the PLI (OP/OC) of the assessee is (-) 3.62% (Page 14 of the TPO’s order) and the difference comes to 7.8%. No further exercise is required to determine the ALP of manufacturing activity of the assessee’s AE segment. The Assessing Officer/TPO is directed accordingly. Objection of the assessee is rejected.”
I.T.A. Nos.151 & 190/C/2015
Against this, the Revenue is in appeal before us.
We have heard the rival submissions and perused the record. The TPO has
considered the mark up of MD Overseas Ltd. as comparable and PLI was worked
out at (-)1.14%. Since non AE jewellery segment margin was computed by the
assessee at 6.36%, the assessee had to get the non AE jewellery segment
margin at 6.36%. Hence by balancing the figure by adding (-)1.14% of the
above, the Assessing Officer got the adjusted margin of assessee’s non AE
jewellery segment at 7.5% and made the addition on that basis. In our opinion,
it is not appropriate to balance in such a way without making proper TP study on
the issue. Accordingly, we remit this issue to the file of the Assessing Officer to
refer the matter afresh to the TPO for further TP study and decide accordingly.
This ground of appeal is partly allowed for statistical purposes.
Regarding Ground No. 3, in similar to issue came up before the
Jurisdictional High Court in assessee’s own case for the assessment year 2007-08
in ITA No.230/2014 dated 20/01/2014. The High Court had decided the issue in
favour of the assessee by observing that expenditure incurred by the assessee
on renovation of leasehold building is revenue expenditure and not a capital
expenditure, though it was of enduring benefit or advantage unless at the end of
the term of lease, the items on which expenditure was spent could be retrieved
by the assessee. Being so, following the above judgment of the Jurisdictional
I.T.A. Nos.151 & 190/C/2015
High Court (supra), we decide the issue in favour of the assessee. This ground
of appeal of the Revenue is dismissed.
In the result, the appeal of the assessee is dismissed and the appeal of the
Revenue is partly allowed for statistical purposes. Order pronounced in the open Court on this 10th April, 2018.
sd/- sd/- ( GEORGE GEORGE K.) (CHANDRA POOJARI) JUDICIAL MEMBER ACCOUNTANT MEMBER
Place: Dated: 10th April, 2018 GJ Copy to: 1. M/s. Joy Alukkas (India) Ltd., Marine Drive, Shanmugham Road, Kochi-682 031. 2. The Assistant Commissioner of Income-tax, Corporate Circle-1(2), Kochi. 3. Dispute Resolution Panel-1, HMT Bhavan, 59, Ganganagar (3rd Floor), Bellary Road, Bengaluru-560 001. 4. The Pr. Commissioner of Income-tax, Kochi 5. D.R., I.T.A.T., Cochin Bench, Cochin. 6. Guard File. By Order
(ASSISTANT REGISTRAR) I.T.A.T., Cochin