NEOTISS PRIVATE LIMITED,MEDAK vs. ACIT, CIRCLE 8(1), HYDERABAD

During the course of assessment proceedings, the AO on the basis of information submitted by the assessee observed that during the year, the assessee made outward remittances towards royalty on domestic sales, export sales and scrap sales to its holding company M/s Vallourec Heat Exchanger Tubes, France. On perusal of the audited profit and loss account, it is seen that the assessee company realized Rs.2,07,34,727/- from the sale of scrap and the assessee company debited an amount of Rs.1,73,82,142/- as royalty on sales. On perusal of the working submitted for the royalty calculation, it is seen that the royalty on scrap sales is calculated at 5% of the sales. The AO has issued notice u/s 142(1) dated 04.07.2018 and called upon the assessee to explain as to how the royalty payment on scrap sales is an allowable deduction. In response, the assessee submitted that the royalty agreement mainly relates to sharing of knowhow of the parent with the Indian subsidiary. The AO after considering the relevant submissions of the assessee observed that, the question is as to whether royalty is attracted on sale of scrap as scrap involves no trademark, brand name and knowhow of the holding company, which is otherwise more related to the production process, manufacturing quality and end product that is sold. So the concept of royalty on scrap is more like an arrangement to plough back funds to the holding company, while at the same time benefiting from the expenditure claim on the royalty payment. Therefore, rejected the arguments of the assessee and made addition of Rs.10,36,736/- towards royalty on scrap sales. The AO further noted that on perusal of return of income, it is seen that the carry forward of losses in the previous years are as per the returned loss claimed in those years. Therefore, the carry forward of losses is restricted as per the assessed losses in the previous years as per the order passed u/s 143(3) of the Act.

Aggrieved by the assessment order, the assessee preferred an appeal before the CIT(A). Before the Ld.CIT(A), the assessee challenged the additions made by the AO towards disallowance of royalty and recomputation of carry forward of business losses, in light of limited scrutiny taken up for verifying three issues and contended that the AO travelled beyond the scope of limited scrutiny powers, in light of the Circulars issued by the CBDT. The assessee had also challenged the disallowance of royalty, in light of the royalty agreement between the assessee and its parent company. The assessee has made a fresh claim of deductions towards royalty expenses and SAP maintenance expenses u/s 40(a) of the Act, on the ground that the said expenditure has been disallowed in earlier assessment years for non-deduction of TDS and the same has been claimed in the year under consideration upon deduction of TDS. The assessee had also challenged the restriction of carry forward losses on the basis of assessed losses as per the orders passed u/s 143(3) of the Act. The Ld.CIT(A), after considering the relevant submissions of the assessee, rejected the arguments in respect of royalty payment on the scrap sales and held that it is clearly not an allowable expenditure, because, royalty agreement between the parties is only on sharing of technical knowhow of the parent, but not on sale of scrap. The Ld.CIT(A) had also rejected the ground, which has been taken up by the assessee on the issue of royalty expenses and SAP maintenance expenses and held that the above two grounds are not borne from the order appealed hence dismissed. The Ld.CIT(A) had also dismissed the ground taken up, challenging the reworking of carry forward losses on the basis of assessment order passed u/s 143(3) of the Act.

Aggrieved by the order of the Ld.CIT(A), the assessee is now in appeal before the Tribunal.

The learned counsel for the assessee, Shri Sashank Dundu submitted that the Ld.CIT(A) is erred in rejecting the explanation of the assessee with regard to disallowance of royalty payment on scrap, even though the said royalty payment is based on the agreement between the assessee company and its parent company. The learned counsel for the assessee, further referring to order of the Tribunal for the A.Y.2009-10, 2011-12 and 2014-15 in to 262/Hyd/2023, submitted that the issue of disallowance of royalty expenses and SAP maintenance expenses has been remitted back to the file of the CIT(A), with a direction to consider the inter-play of DTAA and the domestic laws vis-à-vis the accounting treatment given by the assessee for the expenditure incurred towards the payment of royalty and SAP maintenance expenditure. Since the assessee has claimed expenditure towards expenses for the year under consideration towards disallowance made for earlier assessment year and for earlier assessment year, the issue has been set aside to the file of the Ld.CIT(A) and further, the issue of deduction towards the said expenditure for the year under consideration is fully dependent on the outcome of the pending appeals before the CIT(A), the present appeal filed by the assessee may be set aside to the file of the Ld.CIT(A) for reconsideration. He further submitted that the Ld.CIT(A) had also rejected the ground taken up by the assessee on the issue of carry forward of losses and the same may be set aside to the file of the Ld.CIT(A) to consider, in light of pending appeals filed for the earlier assessment years. The learned counsel for the assessee, further referring to the issues taken up for limited scrutiny submitted that, the additions made by the AO in the assessment order are entirely different from the issues considered for limited scrutiny. As per the Circulars issued by the CBDT, in case of limited scrutiny, if the AO wants to assess any other income, then, the same can be considered after conversion of limited scrutiny into complete scrutiny with the approval of the competent authority. Since the AO made additions to other issues, which are different from the issues considered for limited scrutiny without any approval from the competent authority, the additions made by the AO cannot be sustained.

The learned Sr.AR, Shri Siva Prasad SV, on the other hand, supporting the order of the Ld.CIT(A) submitted that the first argument of the assessee that the AO travelled beyond the scope of limited scrutiny is devoid of merit, going by the issues taken up for limited scrutiny and the additions made by the AO. Further, royalty payment on scrap is not an allowable deduction, going by the agreement between the parties. In so far as the ground taken up by the assessee on royalty expenditure and SAP maintenance expenses, the said issue is not emanating from the assessment order, therefore, the Ld.CIT(A) had rightly rejected the ground taken up by the assessee. Likewise, the Ld.CIT(A) rejected the grounds taken up by the assessee on the issue of carry forward of losses, because the AO has rightly set off of losses on the basis of assessed income/loss as per the order passed u/s 143(3) of the Act. Therefore, he submitted that there is no error in the order passed by the Ld.CIT(A) and the same needs to be upheld.

We have heard both the parties, perused the material available on record and gone through the orders of the authorities below. There is no dispute with regard to the fact that the case has been selected for limited scrutiny under CASS for verifying three issues, i.e., to examine (i) whether receipt of foreign remittance has been correctly offered for tax (ii) whether sales turnover/receipts has been correctly offered for tax and (iii) whether outward foreign remittance is from disclosed sources and appropriate withholding and reporting obligations have been complied with. If we consider the issues for limited scrutiny assessment and the additions made by the AO towards disallowance of royalty expenses, it was stemmed from sales turnover/receipts that has been correctly offered for tax, because the assessee had claimed deduction towards royalty expenses against the receipts/sales turnover from sale of scrap. Further, the other issue considered by the AO, i.e. carry forward of losses of earlier years on the basis of assessed income/loss as per the order passed u/s 143(3) is also stemmed from the issues taken up for limited scrutiny, because, once the total income has been determined for any assessment year, on the basis of assessment order passed by the AO, then the consequent brought forward losses if any has to be allowed in accordance with the provisions of section 71 to 72 of the Act. Therefore, we are of the considered view that there is no merit in the arguments of the assessee that the AO has travelled beyond the scope of limited scrutiny and made additions towards other issues. Thus, we reject the ground taken up by the assessee.

Having said so, let us come back to the issues of additions made towards disallowance of royalty and restriction of carry forward losses of earlier assessment years as per the order passed u/s 143(3) of the Act. In so far as the disallowance of royalty payment, it was the argument of the counsel for the assessee that the said payment is as per the agreement between the assessee company and the parent company and to this effect, the learned counsel for the assessee referred to Section 1, Definitions in the agreement and claimed that royalty payment also includes other products, which means any product including by-products and scrap generated out of manufacturing activity and therefore, payment of royalty against scrap sales is as per agreement between the parties. In our considered view, the scope of products defined in Section 1, Definitions of the agreement between the parties and more particularly another product, whether by virtue of being a component part or raw material or otherwise cannot be extended to a scrap generated during the course of manufacturing process, because the scrap is not a by-product or any other product arises in the course of manufacturing activity. Therefore, we are of the considered view that there is no merit in the arguments of the assessee. Thus, royalty payment on scrap is covered by the agreement between the parties and thus, we reject the ground taken up by the assessee on the issue of disallowance of royalty.

Coming back to the issue of rejection of ground No.3 and 4 by the Ld.CIT(A) on the issue of royalty expenses and SAP maintenance expenses. It was the argument of the learned counsel for the assessee that the said expenses have been incurred for earlier assessment years and because of the non- deduction of tax, the same has been disallowed for the earlier assessment years. Further, since the assessee has deducted and remitted the said payment in the current assessment year, the same is allowable as deduction u/s 40(a) of the Act. No doubt, if any expenditure is disallowed u/s 40(a) for non- deduction of taxes for any earlier assessment years, then the same can be allowed as deduction in the year in which TDS has been deducted on the said expenditure. To this extent, we are in agreement with the argument of the learned counsel for the assessee. But the fact remains that as argued by the learned counsel for the assessee, the issue of disallowance of royalty expenses and SAP maintenance expenses for the earlier assessment year 2009-10, 2011-12 and 2014-15 was set aside to the file of the CIT(A) by the ITAT on 23.11.2023 and the matter is pending for adjudication. Since the issue involved for the year under consideration is having nexus with the appeals filed by the assessee for the A.Y.2009-10, 2010-11 and 2014-15 and pending before the Ld.CIT(A), as per the order of the Tribunal in to 262/Hyd/2023 dated 23.11.2023, in our considered view, this issue needs to be set aside to the file of the Ld.CIT(A) for reconsideration. Thus, we set aside the order of the Ld.CIT(A) on this issue and restore the issue back to the file of the Ld.CIT(A) with a direction to reconsider the issue along with the issue of disallowance of royalty expenditure and SAP maintenance expenses pending in the appeal filed by the assessee for the A.Y.2009-10, 2011-12 and 2014-15.

Coming back to the issue of restriction of carry forward losses. The AO has restricted the carry forward losses on the basis of assessed income/losses as per the orders passed u/s 143(3) of the Act for the earlier assessment years. In our considered view, there is no error in the reasons given by the AO for restricting the losses as per the assessment order. However, the fact remains that, since the assessee has challenged the additions made towards various expenditure for the earlier assessment years, which is the reason for restriction in brought forward losses, in our considered view, unless the issue reaches finality in the appellate proceedings, the correct loss to be carried forward to subsequent years cannot be determined. Therefore, we are of the considered view that this issue also needs to go back to the file of the Ld.CIT(A) for reconsideration. Thus, we set aside the order of the Ld.CIT(A) on this issue and restore the matter back to the file of the Ld.CIT(A) to reconsider the issue in accordance with law.

In the result, appeal filed by the assessee is partly allowed for statistical purpose.