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Facts
The assessee company filed an appeal against the order of the CIT(A) which confirmed additions made by the Assessing Officer concerning Transfer Pricing (TP) adjustments, disallowance of depreciation, and disallowance of weighted deduction. The Revenue also filed a cross-appeal.
Held
The Tribunal decided several issues including TP adjustments, interest on Compulsory Convertible Debentures (CCDs), interest on External Commercial Borrowings (ECBs), interest on delayed trade receivables, and weighted deduction for R&D expenditure. Some issues were set aside for re-examination, some were decided in favor of the assessee, and some in favor of the Revenue.
Key Issues
The primary issues involved transfer pricing adjustments, eligibility of weighted deduction for R&D expenditure, disallowance of interest expenditure under section 14A, and benchmarking of interest on ECBs and delayed receivables.
Sections Cited
92CA, 144C, 143(3), 32, 14A, 35(2AB), 8D(2)(ii), 8D(2)(iii), 10(34)
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Income Tax Appellate Tribunal, HYDERABAD “B” BENCH: HYDERABAD
Before: SHRI VIJAY PAL RAO & SHRI MANJUNATHA G
ORDER PER MANJUNATHA G.: This appeal has been filed by the Assessee- Company as well as cross-appeal filed by the Revenue against the order dated 30.09.2022 of the learned CIT(A), Hyderabad-10, Hyderabad, relating to the assessment year 2016-2017.
Brief facts of the case are that, the appellant is a public limited company, engaged in the business of manufacturing Active Pharmaceutical Ingredients [in short “API”], Finished Dosage Formulations [in short “FDF”] and high quality generic injectable products. The appellant company undertakes Product Research and Development activities [in short “PDS”]. These activities are pointed-out into separate segments. The appellant company has entered into Advance Pricing Agreement on 31.03.2014 [in short “APA”] for sale of FDF. For assessment year 2016-2017, sales of FDF to AE's was covered under the FDF APA. The appellant company had also entered into APA for injectables
3 ITA.Nos.663 & 708/Hyd./2022 sold to certain AE's. Injectable APA was entered into on 20.03.2023 after conclusion of the assessment, and after the filing of appeal before the ITAT, for assessment year 2016-17, sale of injectables to certain AE's is covered under the Injectables APA.
The appellant company has filed its return of income for the assessment year 2016-2017 on 30.11.2016 declaring total loss of Rs.1143,75,70,959/- under normal provisions of the Income Tax Act, 1961 [in short “the Act”] and book loss of Rs.306,42,31,817/- under Section 115JB of the Act. The case of the appellant company was selected for scrutiny under CASS. During the course of assessment proceedings, a Reference u/sec.92CA of the Act was made to the Transfer Pricing Officer [in short “TPO”] for determination of the Arms Length Price [in short “ALP”] of international transactions of the appellant company with it’s AEs.
3.1. During the course of TP proceedings, the TPO noticed that, as per Form-3CEB report, the appellant
4 ITA.Nos.663 & 708/Hyd./2022 company has reported various international transactions with its AEs for purchase of raw materials, sale of bulk drugs, sale of finished dosage formulations, sale of WHC formulations, provision of market support services, receipt of advance licence fee and other transactions. The Assessing Officer further noted that the appellant company has adopted hybrid method of selecting most appropriate method for different transactions and has adopted CPM, TNMM, CUP and Other Method for benchmarking different transactions with different AEs. The TPO has analysed the TP documentation report submitted by the appellant company in light of segmental financial accounts certified by the Cost Accountant. In the cost audit report, the API segment has been further divided into regulated and non- regulated markets. The regulated markets have been further divided into AEs and non AEs. The taxpayer has benchmarked these transactions by using cost plus method and an internal comparison of the gross profit margin earned by the appellant company from sale to AEs, and sales to non-AEs has been carried-out and it was claimed
5 ITA.Nos.663 & 708/Hyd./2022 that, the sale of bulk drugs transaction is at ALP. The taxpayer has benchmarked sale of injectable formulations by using ‘Other Method’. It was treated by the taxpayer that, during the financial year 2015-2016, it has acquired two entities namely Agila Specialities Private Limited [in short “ASPL”] and Onco Therapies Limited [in short “OTL”] from Stride Arcolab Limited. Prior to the acquisition, these two entities were engaged in manufacturing and sale of injectable formulations to various third parties and customer Pfizer Inc. After acquisition of both ASPL and OTL, it has started selling the same product to the AE’s using the same pricing model, which was entered with Pfizer Inc, which is an uncontrolled third party. Accordingly, during the financial year the taxpayer has manufactured and sold same injectable formulations to AEs using the same pricing model adopted in a third party arrangement with Pfizer and it was concluded that, the sale of bulk drug transactions is at ALP.
3.2. The TPO after considering the relevant submissions of the appellant company and also taken note
6 ITA.Nos.663 & 708/Hyd./2022 of the business model of appellant company, has rejected the TP documentation report submitted by the appellant company by using different methods, for benchmarking different transactions, and has aggregated all the transactions into one basket on the ground that, the business segment carried out by the appellant company are interlinked to each other which cannot be separated and, therefore, the most appropriate method for benchmarking the transactions of the appellant company with its AEs is TNMM. Therefore, the TPO made fresh search by applying certain filters and has finally selected 12 comparables with a weighted average OP/OC of 16.01%. Since the TP documentation report submitted by the appellant company is not in accordance with law, the TPO issued show cause notice and called-upon the appellant company to file its objections, if any, of proposed rejection of TP documentation and selection of TNMM as the most appropriate method. In response, the appellant company has filed it's objections vide letter dated 24.12.2019 and raised objections for rejecting TP documentation report submitted by the 7 ITA.Nos.663 & 708/Hyd./2022 appellant company and selection of TNMM as the most appropriate method. The appellant company has also raised objection for aggregating of transactions under one basket and applying TNMM as the most appropriate method. The TPO after considering relevant submissions of appellant company and also taken note of various facts, has rejected the objections filed by the appellant company and has adopted TNMM as the most appropriate method and has selected final set of 12 comparables with median of 16.75%. The TPO while rejecting the TP documentation report submitted by the appellant company under hybrid method observed that, as per OECD guidelines and UNTP manual do not rigidly mandate transaction-by-transaction approach for ALP determination and further, the guidelines recognised that, even if the transaction-by-transaction approach is ideal, it is not appropriate in all cases. It also provides that, where there is no related transaction or where related transactions are not relevant to the determination of the reasonableness of price in issue, a transaction-by- transaction approach may be appropriate. Further, as per
8 ITA.Nos.663 & 708/Hyd./2022 the principles laid down by UNTP model with regard to aggregation approach to TP, although, general rules recognised by the UNTP model is that, TP analysis should be made on transaction-by-transaction basis. However, they have recognised certain exceptions, where a product or service cannot be supplied without being clubbed, then aggregation is the only option. The Assessing Officer had also referred to BEPS provisions and after considering certain judicial precedents held that, going by the business model of the appellant company, it is difficult to segregate functions performed by standalone basis for benchmarking and there is lack of comparability for such each transactions carried-out by the appellant company and thus, has adopted TNMM as the most appropriate method. The TPO had also recomputed operating cost of the appellant company by including depreciation on goodwill by holding that, depreciation on goodwill is operating in nature because, the goodwill created by the appellant company in its books of accounts, has an asset on acquisition of certain companies is having direct nexus with business of appellant
9 ITA.Nos.663 & 708/Hyd./2022 company and, therefore, it partakes the nature of asset employed in the business and thus, when the appellant company has claimed depreciation on such goodwill and charging to P & L A/c, then, it should be considered as operating in nature for the purpose of computing PLI of the appellant company. Therefore, after considering the relevant facts, has suggested TP adjustment of Rs.858,69,60,000/- towards AE sales in respect of APA segment, FDF AEs and non-AEs covered transactions, Product Development Services [in short “PDS”], AE segment, Injectable AE segment. The TPO had also made TP adjustment of Rs.239,42,19,272/- in respect of interest paid on CCDs by applying an ad-hoc interest rate of 4.75% being 50% of coupon rate of 9.5% paid by the appellant company on CCDs. Similarly, the TPO had also made adjustment of Rs.69,23,12,130/- towards interest paid on External Commercial Borrowings [in short “ECBs”] by adopting LIBOR plus 200 basis points as against LIBOR plus 500 basis points interest paid by the appellant company. Likewise, the TPO has also made TP adjustment of 10 ITA.Nos.663 & 708/Hyd./2022 Rs.24,62,73,306/- towards interest on delayed trade receivables from AEs by applying SBI short term deposit rate after allowing standard credit period of 60 days.
The Assessing Officer, in pursuance to TP adjustment as suggested by the TPO under section 92CA(3) of the Income Tax Act, 1961, dated 31.10.2019, has passed Draft Assessment Order under section 144C of the Income Tax Act, 1961 on 31.12.2019 and determined the total income of the appellant company at Rs.1446,55,55,275/- by making TP adjustment as suggested by the TPO under section 92CA(3) of the Act for Rs.1191,97,64,708/-, disallowance of depreciation claimed on goodwill arising out of amalgamation at Rs.1371,56,42,098/-, disallowance of depreciation of non-compete fee of Rs.2,22,932/- and disallowance of expenditure claimed on weighted deduction under section 35(2AB) of the Act for Rs.19,10,91,910/-.
The appellant company did not make application under section 144C(2) of the Income Tax Act, 1961 against the Draft Assessment Order passed by the Assessing Officer. Therefore, the Assessing Officer has passed Final 11 ITA.Nos.663 & 708/Hyd./2022 Assessment Order under section 143(3) r.w.s. 144C on 26.02.2020 and determined the total income of the appellant company at Rs.1446,55,55,275/-.
Being aggrieved by the assessment order, the appellant company preferred an appeal before the learned CIT(A) and contested all additions made by the Assessing Officer including TP adjustment as suggested by the TPO under section 92CA(3) of the Act, disallowance of depreciation on goodwill u/sec.32; disallowance of depreciation on non-compete fee, disallowance of expenditure u/sec.14A and disallowance of excess weighted deduction claim u/sec.35(2AB) of the Act.
The learned CIT(A), after considering the relevant submissions of the appellant company, in his order passed u/sec.250 of the Income Tax Act, 1961, dated 30.09.2022 has confirmed the additions made by the Assessing Officer towards TP adjustment in respect of sale and other closely linked transactions, disallowance of interest on External Commercial Borrowings and disallowance of interest on 12 ITA.Nos.663 & 708/Hyd./2022 Compulsory Convertible Debentures [in short “CCDs”]. However, partly allowed the grounds taken by the appellant company towards addition on account of interest on delayed trade receivables from AEs and directed the Assessing Officer to compute interest on delayed receivables from AEs by applying USD LIBOR plus 200 basis points after considering credit period of 90 days. The learned CIT(A) had also deleted addition made towards disallowance of depreciation on goodwill and depreciation of non-compete fee. However, sustained the addition made by the Assessing Officer towards disallowance of excess deduction claimed under section 35(2AB) of the Act and disallowance u/se.14A of the Act.
Aggrieved by the order of the learned CIT(A), the appellant company and the Revenue are now in appeal before the Tribunal.
The first issue that came-up for consideration from grounds of appeal of the appellant company is, TP adjustment in respect of sale of API segment and Project Development Segment [in short PDS].
13 ITA.Nos.663 & 708/Hyd./2022 10. CA Padamchand Khincha, learned Counsel for the Assessee referring to the profile of the appellant company submitted that, the appellant company is engaged in performing of diversified activities. For the purpose of benchmarking of all these diversified activities, the appellant company classified into following three segments i.e., API segment, FDF segment Injectable segment and PDS segment and certain other operating revenue. The operating results in each of these segments are prepared on the basis of generally accepted cost accounting principles and audited by an independent Cost Accountant. In the TP study, as per the TP audit report, the margins of each of these segments were benchmarked separately while arriving at the ALP. Learned Counsel for the Assessee further submitted that, the transactions entered by the appellant company under multiple segments were aggregated by the TPO. The benchmark was done on an entity level. This aggregation was done on the basis of functional profile of the appellant company as manufacturing of pharmaceuticals. The learned TPO alleged that the diversified activities were actually 14 ITA.Nos.663 & 708/Hyd./2022 integrated, interlinked and mutually dependent. The TPO adopted TNMM as the most appropriate method and identified comparable companies for the entity level benchmarking. The ALP was computed at 16.75%. Further, the TPO held that, entity to be operating in one segment, but has excluded the entire FDF segment both covered and un-covered transactions on the basis that, the AE transactions in the FDF segment was covered by FDF-APA. Assuming for a moment, the approach of entity level benchmarking done by the TPO is correct, the FDF segment [to the extent not covered under APA] ought to have been included in the entity level segment considered for benchmarking. The learned Assessing Officer cannot ignore the uncovered transactions in FDF segment. This conclusive finding by him that, all the transactions undertaken by the appellant company including manufacturing of FDFs were interlinked.
10.1. Learned Counsel for the Assessee without prejudice to the above submitted that, the appellant company has undertaken AE benchmarking at the segment 15 ITA.Nos.663 & 708/Hyd./2022 level. This approach of benchmarking is carried-out by the appellant company owing to the difference in the functions, assets and risk related to each segment. The appellant company has followed this approach consistently. The segment level benchmarking is accepted by the ITAT in appellant’s own case for the assessment year 2008-2009. It was also accepted by the TPO in the earlier assessment years 2012-2013, 2013-2014, 2014-2015 and 2015-2016. The appellant company has also entered into API with respect to some of it’s segments. In the API segment, amount as certified by the Cost Accountant have been directed to be adopted. Therefore, if the Bench conclude that, the entity level benchmarking is acceptable, then, the benchmarking of the diversified transactions entered by the appellant company with it’s AEs must be done having regard to the various segments. Learned Counsel for the Assessee further submitted that, the appellant company has prepared segmental results on the basis of independent Cost Accountant report. The TPO rejected the audited segmental results on the ground that, there are some 16 ITA.Nos.663 & 708/Hyd./2022 discrepancies. However, the discrepancies noticed by the TPO in the audited results are incorrect. Therefore, the Department having accepted segmental results for earlier assessment years, are not accepting for the year under consideration, when there is no change in the facts nor in the accounting methodology followed by the appellant company in the present year in respect of these segments. Therefore, he submitted that, rejection of the audited segmental results is inconsistent as it deviates from the position adopted for benchmarking of some segments in earlier years.
10.2. Learned Counsel for the Assessee further referring to benchmarking of API segment submitted that, the appellant company has adopted cost plus method for benchmarking API segment. The appellant company has considered non-AE transactions as an internal comparables as the margins in API-AE segment is higher than the API non-AE segment. Therefore, he submitted that, the API-AE claim should be held to be arm’s length based on the aforesaid benchmarking.
17 ITA.Nos.663 & 708/Hyd./2022 10.3. Learned Counsel for the Assessee further referring to the Product Development Services [“PDS”] segment submitted that, the TPO has adopted TNMM as the most appropriate method. The appellant company adopted profit over total cost as the Profit Level Indicator [“PLI”] and identified comparable transactions and claimed that, it's transactions are at ALP. This approach of benchmarking was approved by the TPO in earlier assessment years. Therefore, without there being any change in facts, the different method has been followed and needs to be accepted as claimed by the appellant company.
10.4. Learned Counsel for the Assessee referring to computation of PLI submitted that, amortization of goodwill cannot be considered as part of operating cost because, goodwill is not an asset employed directly in the business of the appellant company. Further, the goodwill in the present case arise from acquisition of Women Healthcare Business [“WHB”] from a third party. The acquisition of WHB is at a higher value than carrying value of the underlying net assets would not by itself bring about a change in the 18 ITA.Nos.663 & 708/Hyd./2022 functions, assets and risk pertaining to this business. The mere change in the ownership would not constantly make their customers pay more for the products, than, they would have paid under the erstwhile ownership. Since the acquisition of goodwill did not bring any change in the operational results, amortization of goodwill cannot be treated as operating cost. In this regard, he relied upon decision of ITAT Delhi Bench in the case of ST-Ericsson India Pvt. Ltd., vs., DCIT in ITA.No.609/Del./2015 and DHR Holding India Pvt. Ltd., JCIT [2021] 133 taxmann.com 519 (Bangalore-Trib.).
10.5. Learned Counsel for the Assessee, in the alternative, submitted that, ‘Cash PLI’ may be adopted. The appellant’s ratio of tangible fixed assets, to the intangible fixed assets is 35 : 73. Intangible assets has substantial portion of the appellant company’s non-current asset. As such, high proportion of intangible asset is not present in any of the comparable companies selected by the learned TPO. Therefore, if at all, goodwill is to be considered as 19 ITA.Nos.663 & 708/Hyd./2022 operating in nature, a suitable adjustment may be provided for the PLI of comparables or a Cash-PLI may be adopted.
10.6. Learned Counsel for the Assessee further referring to cash flow hedge revenue submitted that, the appellant company has considered Rs.3811.75 million cash flow hedge revenue as part of operating income. The TPO has considered cash flow head revenue as non-operating in nature. Although, the learned TPO has held that it is non- operating, but in his computation, he has considered cash flow hedge revenue as operating income. The appellant company has significant exports denominated in USD. The appellant company entered into forward contracts with Bankers for hedging foreign exchange fluctuations arising from it’s exports. The forward contracts entered into with the Bankers are professionally linked to the exports. In a sense, the appellant company submitted that, all the profit and loss from cash flow hedges are attributable to export sales only. Therefore, the same partakes the nature of operating in nature and should be considered as operating revenue. In this regard, he relied upon the decision of ITAT, 20 ITA.Nos.663 & 708/Hyd./2022 Mumbai Bench in the case of Rushab Diamonds vs., ACIT [2013] 34 taxmann.com 160 (Mum.) and the decision of Cochin Bench of ITAT in Navigant BPM (India) P. Ltd., vs., ACIT [2019] 102 taxmann.com 539 (Cochin).
MS. M. Narmada, learned CIT-DR, on the other hand, supporting the order of the learned CIT(A) submitted that, the appellant company has adopted hybrid method for benchmarking of it’s different transactions by adopting different method, although, the appellant company is operating under one segment of manufacturing bulk drugs. Further, the transactions of the appellant company with it’s AEs are interlinked and indispensable. Therefore, benchmarking different transactions by adopting different methods is incorrect. The TPO after considering the relevant facts, has rightly rejected the benchmarking approach followed by the appellant company and has selected TNMM as the most appropriate method at entity level. Further, non-AEs, FDF transactions cannot be considered for operating margin because, the FDF segment is under APA. Although, APAs for few AEs, but, going by the agreement of 21 ITA.Nos.663 & 708/Hyd./2022 the appellant company under this segment, it should be excluded for the purpose of benchmarking. Learned DR further, referring to various arguments of the Learned Counsel for the Assessee submitted that, the appellant company has not prepared it’s segmental results with relevant evidences which is evident from the observation of the TPO. Further, although, the segmental benchmarking has been accepted for earlier years, but, there is no res judicata in income tax proceedings and each year has to be examined separately with relevant facts. In the present case, the TPO has given valid reasons for rejecting the hybrid method followed by the appellant company for benchmarking different transactions with AEs. Therefore, there is no merit in the contention of the appellant company that, segmental results as audited by an independent Cost Accountant should be considered. Further, the appellant company has followed cost plus method for API segment and claims that, in the earlier years the said approach has been accepted by the TPO, but, the fact remains that, API segment is interlinked or inseparable with other segments of 22 ITA.Nos.663 & 708/Hyd./2022 the appellant company. Therefore, as per the OECD guidelines and UNTP model, although, the transactions-by- transaction method is appropriate for benchmarking transactions, but, there are certain exceptions where the transactions are inseparable, then, the aggregation method is suitable for benchmarking the transactions. The TPO after considering the relevant facts, has rightly followed aggregation method and, therefore, the order of the TPO should be upheld.
11.1. The Learned CIT-DR further referring to the computation of PLI submitted that, the appellant company has amortized goodwill and debited to P & L A/c. Goodwill has been arising on account of acquisition of two business from a third party. The appellant company has recognized excess net assets over consideration paid for acquisition of business as goodwill and amortized over a period. The acquisition of goodwill is inextricably linked with business of the appellant company and, therefore, it partakes the nature of asset employed in the business. Since the appellant company itself has amortized goodwill and debited 23 ITA.Nos.663 & 708/Hyd./2022 to P & L A/c, for the purpose of computation of PLI, it cannot be exclude as non-operating in nature just because, it is one time transaction. Further, although, the appellant company seeks for adoption ‘Cash-PLI’, but, there is no evidence has been furnished to prove that, whether similar transactions are entered into by comparable companies or not ? Therefore, on this aspect, the matter may be set-aside to the file of TPO for verification and to decide the same in accordance with law.
11.2. Learned DR further referring to cash flow hedge revenue as operating income submitted that, as per safe harbour rules, foreign currency loss is not operating in nature. Therefore, once foreign currency loss is not operating in nature, then, foreign currency gain also should be treated as non-operating in nature. The TPO and the learned CIT(A) after considering all the relevant facts has rightly treated foreign exchange gain as non-operating in nature. Therefore, the order of the learned CIT(A) should be upheld.
24 ITA.Nos.663 & 708/Hyd./2022 12. We have heard both the parties, perused the material on record and gone through the orders of the authorities below. We have also carefully considered the relevant arguments of the Learned Counsel for the Assessee in light of reasons given by the learned TPO and upheld by the learned CIT(A) for rejecting the TP documentation study report submitted by the appellant company. We have also carefully considered the relevant case laws cited by the Learned Counsel for the Assessee in support of it’s contentions. There is no dispute with regard to the fact that, the appellant company is engaged in the business of manufacturing and marketing generics and branded drugs. The appellant company has treated it’s activities in four segments i.e., (1) API segment (2) FDF segment (3) Injectable segment (4) PDS segment and certain other operating revenue. The operating results of each of these segments has been benchmarked by using different methods. The appellant company has adopted Cost Plus Method [in short “CPM”] for sale of bulk drugs. For sale of finished dosage formulations, it has adopted TNMM method. Similarly, for 25 ITA.Nos.663 & 708/Hyd./2022 sale of Injectable formulations, it has adopted ‘Other Method’ on the ground that this segment has been acquired from third parties and on the basis of the third party agreement with outsiders, the appellant company has continued to sell the products and, therefore, claimed that it’s transactions with AEs are comparable with third party and thus, are at ALP. The TPO has rejected the benchmarking analysis carried-out by the appellant company by adopting different methods for different segments activities and has aggregated all the activities into one segment of manufacturing of pharmaceuticals and has adopted TNMM as most appropriate method. According to the TPO, the diversified activities claims to have been carried-out by the appellant company were highly integrated and interlinked and mutually dependent and, therefore, only TNMM method on entity level is most appropriate method for benchmarking the transactions of the appellant company with it’s AEs. Therefore, the TPO rejected the TP documentation report submitted by the appellant company and has conducted a fresh TP study by selecting TNMM as 26 ITA.Nos.663 & 708/Hyd./2022 most appropriate method and has selected 12 comparables having similar nature of business. The TPO also computed ALP at 16.75% and then, compared with the operating cost of the appellant company to make TP adjustment in respect of sale of APA, FDF, PDS and Injectable segments. However, the TPO while benchmarking the transactions of the appellant company with it’s AEs at entity level by applying TNMM as most appropriate method, has excluded the FDF segment in total including covered under APA and not covered under APA. The TPO also excluded Injectable segment covered under APA.
We have given our thoughtful consideration to the various arguments of the Learned Counsel for the Assessee in light of the reasons given by the TPO to reject the hybrid method followed by the appellant company for benchmarking it’s transactions with AEs and in our considered view, we are fully subscribed to the reasons given by the TPO for the simple reason that, when the transactions are highly integrated, interlinked and mutually dependent, only TNMM is suitable for benchmarking the 27 ITA.Nos.663 & 708/Hyd./2022 transactions instead of benchmarking transaction-by- transaction as claimed by the appellant company. No doubt, as per the TP regulations including OECD and UNTP manuals, transaction-by-transaction approach for ALP determination is appropriate method, however, the very same guidelines recognise that, even if transaction-by- transaction approach is ideal, but, it does not appropriate in all cases. Transaction-by-transaction approach is possible, if there is a Comparable Uncontrolled Price [“CUP”] available in the public domain which shall be a difficult proposition. It also provides that, where there is no related transaction or where related transactions are not relevant to the determination of the reasonableness of price in issue, a transaction-by-transaction approach may be appropriate. Further, going by the business model of the appellant company and segments in which the appellant company is dealing with, in our considered view, it is difficult to go by transaction-by-transaction approach because, the activities carried-out by the appellant company are highly integrated, interlinked and mutually dependent. Further, the TPO had 28 ITA.Nos.663 & 708/Hyd./2022 also given valid reasons for rejecting the hybrid approach followed by the appellant company by adopting different methods by identifying lacunas in the documentation maintained by the appellant company for each segment-wise activity. According to the TPO, although, the appellant company claims to have maintained separate accounts on the basis of generally accepted cost accounting principles and audited by an independent Cost Accountant, but, the Cost Accountant certificate is silent about the allocation method for segment revenue. Further, regarding cost, it was mentioned in allocation methodology that, raw material cost and factory facilities direct selling costs were identified to the reported segment at actual. Nothing was mentioned about the allocation method between AE and non-AE segment. Further, although, the appellant company contends that the Cost Accountant certificate has been accepted under APA and cannot be rejected under these proceedings, but, the fact remains that at the APA proceedings, TPO has approved certain transactions under the category of ‘FDF-segment’ but, not all the segments.
29 ITA.Nos.663 & 708/Hyd./2022 Therefore, it cannot be said that TPO has accepted all the segmental finances of other segments. Therefore, observed that, the appellant company has failed to file relevant evidences including the basis for allocation of various factory overheads and selling costs to different segments with actual details. In our considered view, when the appellant company is not able to file relevant evidences to the satisfaction of the Assessing Officer regarding it’s segmental results, the TPO is at liberty to reject the TP documentation report submitted by the assessee. Further, as narrated by the TPO in it’s order, the transactions of the appellant company are highly integrated, interlinked and inter-dependent and, therefore, it is difficult to segregate the transactions under each segment for the purpose of benchmarking. Further, in Injectable Segment, the appellant company has considered internal comparable for benchmarkingd these transactions by using ‘other method’. The taxpayer stated that, during the financial year 2015- 2016, it has acquired two entities and after acquisition of both entities, started selling the same products to the AE’s 30 ITA.Nos.663 & 708/Hyd./2022 using the same pricing model entered with Pfizer Inc., which is an un-controlled third party. Since the appellant company has sold to AE as per the pricing model with third party, it claimed that, the sale of Injectable formulations are at ALP. First of all, the appellant company has considered internal comparable from it’s own entities which has been acquired from a third party. Further, the appellant company has failed to file any other evidences to prove that, the price charged to it’s AE is at ALP when compared to third party. Further, in absence of any third party comparables which can be compared with the price charged by the appellant company to it’s AE, the internal comparables selected by the appellant company for benchmarking it’s transactions with AEs cannot be accepted. Similarly, the appellant company has benchmarked API segment with cost plus method. The segmental results of non-AE transactions were adopted by the appellant company as internal comparable as the margin in API-AE segment is higher than the API-non-AE segment. The API-AE segment was concluded to be arms length. The appellant company claims that, this approach of 31 ITA.Nos.663 & 708/Hyd./2022 benchmarking was approved by the ITAT in assessment year 2008-2009 and further, the learned TPO has accepted the very same method for earlier assessment years 2012-2013, 2013-2014, 2014-2015 and 2015-2016. In our considered view, once again the appellant company fails to make-out a case that, it’s internal comparable is an appropriate method for benchmarking the transactions with it’s AEs because, the appellant company has not filed relevant evidences to prove that, the price charged to the AEs is at par with third party transactions. Further, in the segmental results, there is no basis for allocation of various expenditure to AE segment and non-AE segment. Although, the appellant company placed reliance on the Cost Accountant report, but, as noted by the TPO, there is no basis provided by the Cost Accountant for allocation of various expenses and revenue. Therefore, in our considered view, the arguments of the Learned Counsel for the Assessee in light of the report of Cost Accountant for accepting the internal comparables is devoid of merit and cannot be accepted.
32 ITA.Nos.663 & 708/Hyd./2022 14. Having said so, let us come back to the method followed by the learned TPO. The learned TPO has aggregated all the transactions of the appellant company with it’s AE including API segment, FDF segment, PDS segment and Injectable Formulations Segment. The TPO has aggregated the transactions of these segments with it’s AE and applied TNMM as the most appropriate method and then, compared with PLI of comparables. The TPO while aggregating all the transactions in one basket, has excluded FDF segment in total. It was the argument of the Learned Counsel for the Assessee that, although, FDF segment is covered under APA, but, only few AEs are covered under APA, but, not entire transactions. Similarly, the TPO has excluded transactions covered under Injectable APAs. In our considered view, once the TPO has adopted aggregation method, then, he should consider all the segments at entity level, but he cannot exclude the entire segment which includes transactions covered under APA and transactions not covered under APA. In our considered view, once the aggregation method is followed for benchmarking, then 33 ITA.Nos.663 & 708/Hyd./2022 transactions not covered under APA, should be considered for the purpose of benchmarking and computation of PLI. Learned Counsel for the Assessee referring to the chart filed for this purpose submitted that, if the approach of entity level benchmarking done by the TPO is accepted, then, FDF segment to the extent not covered under APA should be excluded in the entity level segment considered for benchmarking. After considering this aspect, if the benchmarking done by the TPO is taken forward, then, as per the working submitted during the course of hearing, the appellant company’s PLI at entity level is at ALP. Learned Counsel for the Assessee further submitted that, once the FDF transactions under APA are excluded along with transactions covered under Injectable APAs are excluded, then, the remaining transactions at entity level are at ALP. We find that, the appellant company has filed certain charts explaining the computation of PLI at entity level by excluding FDF-APA transactions and Injectable-APA transactions and claimed that, entity level PLI computed as per the directions of the TPO are at ALP even if amortisation 34 ITA.Nos.663 & 708/Hyd./2022 of goodwill for WHC segment was considered as operating cost. In our considered view, once the TPO is following aggregation method for benchmarking all the transactions under TNMM as the most appropriate method, then, he should only exclude transactions covered under APA, but, not entire transactions of that segment. Since the TPO has excluded entire transactions of FDF segment, even though under API it has covered only few transactions, in our considered view, the matter needs to be re-examined by the TPO in light of revised working submitted by the appellant company. Thus, we set-aside the issue to the file of Assessing Officer/TPO with a direction to re-consider the issue of aggregation method by excluding only FDF transactions covered under APA and Injectable transactions under APA and then, compute the PLI at entity level by considering the remaining transactions at entity level.
Coming back to the computation of Profit Level Indicator [“PLI”]. Learned TPO has computed PLI by considering amortization of goodwill as operating cost. According to the TPO, the appellant company has claimed 35 ITA.Nos.663 & 708/Hyd./2022 depreciation on ‘Goodwill’ and debited to P & L A/c under normal provisions of the Act on the ground that goodwill is an intangible asset and used in the business of the appellant company. It was the argument of the Learned Counsel for the Assessee that, goodwill is not an operating cost. An operating cost should be distinguished from a business asset and only the depreciation of the later should be considered for TP purposes. Goodwill in the present case arise from the acquisition of WHC business from a third party. Therefore, it is a one time and an extraordinary item cannot be considered as an asset employed in the business of the appellant company to treat it as operating cost.
We find that, the appellant company has claimed depreciation on goodwill and debited to P & L A/c under normal provisions of the Act. Further, the appellant company has created goodwill in the books of accounts towards excess consideration paid over and above the net assets taken-over from two companies which are in similar line of business and, therefore, in our considered view, once the assessee has paid excess consideration considering the 36 ITA.Nos.663 & 708/Hyd./2022 value of the entity, then, the said excess consideration partakes the nature of goodwill being an intangible asset and it definitely gives advantage to the appellant company. Therefore, the same can be treated as an asset employed in the business of the appellant company. Further, treatment of amortization of goodwill in the TP analysis will depend on the details of functional assets and risk analysis including variation of the impact that, such goodwill may have on the business of the taxpayer along with actual valuation of goodwill. Treatment of such goodwill by the taxpayer who allows the amortization of the same by the tax authorities. However, it is practically difficult to ascertain whether the finances of the comparable companies having similar depreciation on intangible assets. Therefore, normally while computing PLI, only those assets which are used in the business of the assessee needs to be considered for the purpose of benchmarking. However, where in a case that, the appellant company itself has treated goodwill as an intangible asset used in the business of the appellant and further, the appellant company itself has treated 37 ITA.Nos.663 & 708/Hyd./2022 amortization of goodwill is an allowable expenditure under normal provisions of the Act, then, in our considered view, for the purpose of benchmarking analysis, the same cannot be treated as non-operating in nature. In the present case, the learned TPO after considering the accounting treatment of the appellant company, has rightly treated the amortization of goodwill as operating in nature. However, the fact remains that, whether similar depreciation on intangible asset is there in the financials of the comparable companies and suitable adjustment has been made or not while computing PLI by the TPO is not forthcoming from the order of the TPO. In case, the finances of comparables does not have any expenses relatable to amortization of goodwill or depreciation on intangible assets, then, a suitable adjustment needs to be given for PLI on comparables. In the present case, going by the ratio of tangible fixed assets to intangible asset, the appellant company is having high proportionate of intangible assets which is almost unique going by the other comparables. Since there is no details with regard to comparable financial statements on the issue 38 ITA.Nos.663 & 708/Hyd./2022 of amortization of goodwill and other intangibles and further, the appellant company is having high proportionate of intangible assets, in our considered view, a suitable adjustment needs to be given before considering the goodwill as operating in nature. Further, the assessee had also made an alternative plea that, if at all, it is difficult to ascertain the proportion of intangible to tangible assets going by the ratio of assets held by the appellant company, then, ‘Cash-PLI’ may be adopted. In our considered view, adoption of ‘Cash-PLI’ would eliminate the necessity of making such adjustment and further it gives reasonable accuracy. The adoption of ‘Cash-PLI’ would then making comparison of margins more meaningful. In case, the TPO would not have identified the amortization of goodwill and intangible from the comparable, then, he may consider ‘Cash-PLI’ for the purpose of computing the margins of the appellant company and also the comparable companies selected for benchmarking the transactions. Thus, we set this issue also to the file of AO/TOP.
39 ITA.Nos.663 & 708/Hyd./2022 17. Coming back to the cash flow hedge revenue. The appellant company has considered cash flow hedge revenue as part of operating income. According to the appellant company it has significant exports denomination in USD and the same has been hedged by entering into forward contracts with Bankers against loss sustained from foreign exchange fluctuations [within currency risk] arising from it’s exports. The contracts are entered on the basis of forecasted export sales. The forward contract entered with the Banks provide for settlement of receipts at spot-exchange rate plus on certain fixed premium determination based on marketing exploitations. The appellant company has considered forward cash flow hedge revenue as operating in nature because, it is directly linked to export sales. In our considered view, any loss or gain on account of fluctuation in foreign exchange is not directly linked to the business operations of the appellant company. Further, a similar item of expenditure/income may or may not be available in the case of the comparable companies. Therefore, it is difficult to accept the arguments of the appellant company that, 40 ITA.Nos.663 & 708/Hyd./2022 foreign exchange gain is operating in nature only on the ground that it linked to export sales because, the same expenditure/income may not be there in case of all comparables. Further, Safe Harbour Rules excludes foreign currency losses from the definition of ‘operating cost’. Once loss on foreign exchange is excluded, then, revenue also needs to be excluded. Since the cash flow hedge revenue not directly related to the business operations of the appellant company, in our considered view, the same cannot be considered as operating in nature. Learned TPO and the learned CIT(A) after considering all the relevant facts, has rightly excluded cash flow hedge revenue from operating revenue. Thus, we are inclined to uphold the findings of the learned TPO/CIT(A) and reject the grounds taken by the appellant company.
The next issue that came-up for consideration from grounds of appellant company is benchmarking of interest on Compulsory Convertible Debentures [in short “CCDs”].
41 ITA.Nos.663 & 708/Hyd./2022 19. The appellant company has issued CCDs of face value of Rs.335/- each to it’s AEs Mylan Luxembourg in October, 2013. The coupon rate for CCD was 9.5% p.a. The CCDs were liable to be converted to equity shares at 1:1. ratio. The CCDs would be converted to equity shares at the end of their term i.e., 18 years from date of allotment. The appellant company has paid 9.5% rate of interest which is below the SBI PLR rate. The TPO estimated 4.75% rate being 50% interest cost on the ground that the appellant company has got double benefit one by payment of interest and another by conversion of CCDs into equity shares at par with face value.
CA Padamchand Khincha, Learned Counsel for the Assessee submitted that, the appellant company has paid interest @ 9.5% which is below SBI PLR which is at 14% during the relevant financial year. The appellant company had also entered into APA with CCDs from assessment year 2017-2018 and as per APA, the rate agreed was 9.25%. The TPO accepted the interest paid by the appellant company on coupon rate for assessment year 42 ITA.Nos.663 & 708/Hyd./2022 2014-2015 to 2015-2016. Since the CCDs are for more than 5 years and appellant company had paid interest which is below the SBI PLR rate, the TPO ought not to have estimated 50% of interest paid by the appellant company as appropriate rate of interest for benchmarking the payment. In this regard, he relied upon the Special Bench decision of ITAT, Hyderabad Bench in the case of Hyderabad Infratech Private Limited vs., DCIT reported in [TS-54-ITAT-2018 (HYD)-TP].
MS. M. Narmada, learned CIT-DR for the Revenue, on the other hand, supporting the order of the learned CIT(A) submitted that, RBI master circulars specifies interest on Government securities which is appropriate rate of interest for benchmarking CCDs. The appellant company has paid coupon rate of 9.5% which is more than the rate of interest applicable to Government securities. The TPO and the learned CIT(A) after considering all the relevant facts has rightly benchmarked the interest and, therefore, the order of the learned CIT(A) should be upheld.
43 ITA.Nos.663 & 708/Hyd./2022
We have heard both the parties, perused the material on record and gone through the orders of the authorities below. There is no dispute with regard to the fact that the appellant company has issued CCDs in the year 2013 and paid coupon rate of interest at 9.5% p.a. the TPO has accepted the coupon rate paid by the appellant company for earlier assessment years. Further, for the year under consideration, the TPO has arbitrarily estimated 50% of interest being 4.75% without there being any change in facts and circumstances. Further, it is well settled principle of law by the decision of ITAT, Hyderabad Special Bench in the case of Hyderabad Infratech Private Limited vs., DCIT (supra), where the appellant was one of intervener, the Tribunal held that interest on rupee denomination loan shall be benchmarked against the PLR rate. Further, at the time of issuance of CCDs in the year 2013, the PLR rates were above 14%. Hence, interest on CCDs paid by the assessee at 9.5% is at ALP going by the PLR rates. Although, the Learned DR referred to RBI master circulars for benchmarking interest as per Government securities, but, 44 ITA.Nos.663 & 708/Hyd./2022 the fact remains that the Government securities are risk free while same is not the case with the CCDs issued by the appellant company. Therefore, we are of the considered view that, TPO erred in arbitrarily estimating 50% of coupon rate paid by the appellant company being appropriate rate of interest for benchmarking CCDs. The learned CIT(A) without appreciating the relevant facts has imply sustained the addition made by the Assessing Officer. Thus, we set-aside the order of the learned CIT(A) on this issue and direct the Assessing Officer to delete the addition.
The next issue that came-up for consideration from appellant company’s appeal is interest on External Commercial Borrowings [in short “ECBs”].
The ld. Counsel for the Assessee submitted that, the appellant company has borrowed ECBs from it’s AEs MP Laboratories (Mauritius) Ltd., The appellant company has borrowed 05 loans on different dates, and the term of each loan is more than 05 years and up-to 07 years. The appellant company has paid interest on ECBs at six months USD LIBOR plus 500 bps. On one ECB loan, the appellant 45 ITA.Nos.663 & 708/Hyd./2022 company has paid interest @ six months USD LIBOR plus 300bps. The learned TPO has benchmarked interest on ECBs at USD LIBOR plus 200 bps. Learned TPO has relied on the decision of ITAT, Hyderabad Bench in the case of Dr. Reddy Laboratories Ltd., ACIT in ITA.No.2229/ Hyd./2011. In earlier assessment year 2012-2013, the TPO has accepted LIBOR plus 500 bps and LIBOR plus 350 bps as per the RBI circular and held that, interest paid is at arm’s length. Similar decision has been taken for the assessment years 2013-2014 and 2014-2015. Since the TPO has accepted the interest paid by the appellant company which is at par with RBI circulars and accepted by the TPO for earlier assessment years, erred in benchmarking by applying USD LIBOR plus 200 bps.
MS. M. Narmada, learned CIT-DR for the Revenue, on the other hand, submitted that, the interest paid or payable on ECBs should be of all costs which includes other charges also. Although, the appellant company claims to have paid interest which is at par with RBI circular rate, but, there is no clarity as to whether the 46 ITA.Nos.663 & 708/Hyd./2022 said interest is includes all costs or not. Therefore, she submitted that, the matter may be remitted back to the file of TPO/AO for further verification.
We have heard both the parties, perused the material on record and gone through the orders of the authorities below. There is no dispute with regard to the terms and conditions of ECBs borrowed by the appellant company from it’s AEs and in fact, all ECBs are long term loans having repayment period of 05 years and above. The appellant company has paid interest @ 06 months USD LIBOR plus 500 bps and for one ECB paid 06 months LIBOR plus 350 bps. Further, the TPO has accepted the said rate of interest paid by the appellant company for earlier assessment years and has not made any adjustment. In the present assessment year also, the appellant company has paid rate of interest on the basis of identical functions, assets and risk. Therefore, interest paid on similar rate of USD LIBOR plus 500 bps should have been held at arms length. Further, the RBI issued circular no.26 which provides that interest in ECBs shall be determined where 47 ITA.Nos.663 & 708/Hyd./2022 the term is ‘03 years or up-to 05 years’, the currency LIBOR plus 300 bps. Further, where the term is ‘more than 05 years and above’, the currency LIBOR plus 500 bps. The determination of ALP interest on ECB with reference to the RBI circular is upheld by the ITAT, Hyderabad Bench in DCIT vs., Devgen Seeds & Crop Technology Pvt. Ltd., [2017] 80 taxmann.com 58 [Hyd.-Tribu.]. The Mumbai Bench of ITAT in Ion Exchange (I) Ltd vs. Addl. CIT in ITA.No.5109/MUM/2013 and the Bangalore Bench of ITAT in Tuppadahalli Energy India (P.) Ltd. vs. DCIT [2017] 87 taxmann.com 62 [Bangalore-Tribunal] has held that, interest on ECBs should be considered to be at arm's length, if it is within the limits provided in the RBI guidelines in Circular No.26. Since the interest paid by the appellant company on ECBs is within the limits provided by the RBI in Circular no.26, in our considered view, the TPO erred in benchmarking by applying USD LIBOR plus 200 bps. The learned CIT(A) without considering the relevant facts simply sustained the addition made by the Assessing Officer. Thus, we set aside the order of the learned CIT(A) on 48 ITA.Nos.663 & 708/Hyd./2022 this issue and direct the Assessing Officer/TPO to delete the addition made towards disallowance on interest on ECBs.
The next issue that came up for consideration from the Assessee as well as the Revenue appeal is, interest on delayed trade receivables.
The appellant company has trade receivables from it’s AE. The learned TPO held that, trade receivable from AEs are separate international transactions and are liable to be benchmarked separately. The TPO considered AEs receivables other than balances attributable to FDF segment and allowed credit period of 60 days and impugned interest on delayed receivables at SBI short deposit rate. On appeal, the learned CIT(A) held that, credit period of 90 days be allowed and interest be computed at USD LIBOR plus 200 bps.
CA Padamchand Khincha, Learned Counsel for the Assessee submitted that, the appellant company had receivables from AEs and non-AEs. The workings were already submitted during the assessment proceedings. As 49 ITA.Nos.663 & 708/Hyd./2022 per the workings, the balances receivable from AEs as on 31.03.2016 before considering any effect of the APA is Rs.1380 crores. On the other hand, balance receivable from non-AEs as on 31.03.2016 is Rs.1746 crores. The receivables from non-AEs are higher than the receivables from AEs even at the pre-APA nos. These facts goes more favourably, if the AE debtors covered by APAs are excluded from the figure of gross debtors for the purpose of computation. The APAs provides for a separate treatment for receivables on APA segment. In this regard, he relied on the decision of ITAT, Bangalore Bench in the case of Msource (India) Pvt. Ltd., vs., ACIT in IT(TP).A No.617/Bang./2016 wherein it has been held that, when there is parity in the overall quantum between the AE and non-AE receivables, interest not being charged on non-AE receivables is a good comparable and no interest adjustment should be imputed. Without prejudice, the Learned Counsel for the Assessee further submitted that, the AE receivables from Injectable Segments are covered under the APA. Hence, it should now be excluded for computation of interest adjustment. The 50 ITA.Nos.663 & 708/Hyd./2022 credit period of 90 days should be considered because the ITAT Hyderabad Bench in the case of OSI Systems Pvt. Ltd., Hyderabad in 2017 held that, credit period of 90 days is reasonable. Further, the recently concluded Injectables APA provides a credit period of 90 days for a significant portion of the receivable balances covered. In so far as rate of interest, since receivables are from AEs and denominated in foreign currency, the appropriate rate of interest should be at USD LIBOR plus 200 bps as considered by the learned CIT(A). Therefore, he submitted that, direction may be given to the TPO to re- consider the issue in light of the latest developments including the Injectable APAs and compute the interest on actual period of delay in realisation of the receivables.
MS. M. Narmada, learned CIT-DR, referring to the decision of ITAT, Bangalore Bench in the case of Msource (India) Pvt. Ltd., vs., ACIT (supra), submitted that, the said decision is not applicable to the facts of the present case. In the above case, the assessee has filed details with regard to the outstanding period of receivable from AEs and non-AEs 51 ITA.Nos.663 & 708/Hyd./2022 and after considering the fact that, assessee has provided similar credit period to non-AEs, the ITAT, Bangalore Bench held that, the assessee not charging interest on non-AEs, then, there is no question of charging interest on AEs. In the present case, there is no details with regard to credit period allowed to AEs and non-AEs. Further, on the basis of opening and closing balances of receivables, credit period allowed to AEs and non-AEs cannot be decided. There is a difference between covered transactions as per APA and appellant company. Therefore, there is no reason to consider the APA for giving credit period. Therefore, she submitted that, there is no merit in the arguments of the appellant company and accordingly, the order of the TPO in imputing interest should be upheld.
We have heard both the parties, perused the material on record and gone through the orders of the authorities below. There is no dispute with regard to the legal position that receivable from AE is an international transaction after amendment to the definition of “International Transactions’ by the Finance Act, 2012 where 52 ITA.Nos.663 & 708/Hyd./2022 the receivables has been treated as international transactions. Once it is international transactions, then, same needs to be benchmarked to ascertain the ALP of transaction of appellant company with it’s AE. Therefore, we do not agree with the arguments of the appellant company that, it is not an international transaction. Having said so, let us come back to the arguments of the Counsel for the Assessee that, it has receivable from AE and non-AE and in fact, the receivable from non-AE is higher than the AE and the same could be considered as internal comparable and no interest should be computed. In our considered view, the amount of receivable from AE and non-AE does not decide the credit period given to the AE. The question of imputing interest arises only when the appellant provides extra credit period to AE. In the present case, there is no dispute with regard to the fact that, the appellant has allowed more credit period to AE and at the same time not filed any details to prove similar credit period has been given to non- AE or not, except stating that receivable from AE and non- AE are at par or the receivable from AE is less than the 53 ITA.Nos.663 & 708/Hyd./2022 receivable from non-AE. Since the interest is imputed on credit period, in our considered view, on the basis of outstanding receivable from non-AE, it cannot be held that, appellant company is providing similar credit period to non- AE.
Having said so, let us come back to the benchmarking analysis carried-out by the TPO. The TPO considered the outstanding receivable from AE and has allowed 60 days credit period after excluding FDF receivable covered under APA. It was the argument of the Counsel for the Assessee that, now receivable from Injectable segment are also covered under APA and same needs to be excluded. In this regard, the assessee has referred to relevant APA entered into with the AE. In the said APA, the appellant has accepted credit period of 90 days for receivable from AE. Since the appellant itself has accepted credit period in APA towards receivable from AE in certain segments, in our considered view, the credit period allowed by the learned CIT(A) on the basis of the decision of ITAT, Hyderabad Bench in the case of OSI Systems Pvt. Ltd., Hyderabad 54 ITA.Nos.663 & 708/Hyd./2022 (supra), is in accordance with law. Therefore, we direct the TPO/Assessing Officer to adopt credit period of 90 days to impute interest. Further, when it comes to rate of interest, since the receivable is from the AEs which are situated outside India and also repayable in currency other than the Indian currency, in our considered view, the suitable rate of interest for benchmarking interest is USD LIBOR plus 200 bps and the learned CIT(A) after considering the relevant facts and also by following decision of ITAT, Hyderabad Bench in the case of Macromill Research India LLP vs., DCIT ITA.No.2116/Hyd./2017 and ITA.No.2289/Hyd./2018 has directed the TPO to adopt USD LIBOR plus 200 bps. Therefore, we direct the TPO to adopt USD LIBOR plus 200 bps. In so far as interest computed for the entire period, in our considered view, the learned TPO erred in computing the interest for the entire year after giving credit period of 60 days instead of computing interest for the actual period of delay in realisation of receivables. Therefore, the TPO is directed to verify the evidences filed by the appellant 55 ITA.Nos.663 & 708/Hyd./2022 company and compute interest for the actual delay in realisation of receivables.
The next issue that came of our consideration from appellant company’s appeal is disallowance of weighted deduction of expenditure incurred for scientific and research amounting to Rs.19,10,91,910/- under section 35(2AB)of the Act.
The appellant company has claimed weighted deduction on R & D expenditure under section 35(2AB) at Rs.398,36,53,820/-. As per Form-3CL issued by the DSIR, the Competent Authority has certified R and D expenditure under section 35(2AB) of the Act at Rs.360,14,70,000/-. The appellant company has claimed excess amount of weighted deduction of Rs.38,21,83,820/-. Since the Competent Authority for certifying eligible amount of deduction under section 35(2AB) is DSIR, the Assessing Officer has allowed deduction under section 35(2AB) as per Form-3CL issued by the Competent Authority and excess weighted deduction claimed by the appellant company at Rs.19,10,91,910/- has been disallowed.
56 ITA.Nos.663 & 708/Hyd./2022 35. Learned Counsel for the Assessee submitted that, the facility been approved by the DSIR and Certificate issued for the year under consideration which is available at page-525 of the paper book. The Assessing Officer has disallowed un-approved expenditure, even though, as per Rule 6(7)(a) which came from 01.07.2016, the necessity of quantification of expenditure by the DSIR has been introduced. Prior to this amendment, the only requirement is to approve in house R and D facility and once facility is approved, the appellant company can claim deduction and, therefore, sec.35(2AB) cannot be invoked. In this regard, he relied upon decision of ITAT, Pune Bench in the case of Garware Technical Fibres Ltd., vs., DCIT [2025] 171 taxmann.com 302 [Pune-Trib.].
MS. M. Narmada, learned CIT-DR for the Revenue, on the other hand, supporting the order of the learned CIT(A) submitted that, provisions of section 35(2AB) has been amended w.e.f. 01.04.2016 and as per the said amendment, unless the appellant company fulfils such conditions with regard to maintenance of accounts and 57 ITA.Nos.663 & 708/Hyd./2022 audit thereof and furnishing report in such a manner as may be prescribed, deduction cannot be allowed. Although, Rule 6(7)(b) came into effect from 01.07.2016, but, as per the said Rule DSIR is the Competent Authority. Once DSIR certified the eligible amount for deduction, then, there is no power to the Assessing Officer to tinker with the said Certificate and if at all, the Assessing Officer is having any dispute over the eligibility, then, he may refer the matter back to the Board for reconsideration. In this regard, she relied upon the decision of Hon’ble High Court of Karnataka in the case of Tejas Networks Ltd., vs., DCIT [2015] 233 Taxman 426 (Kar.) (HC).
We have heard both the parties, perused the material on record and gone through the orders of the authorities below. As per the provisions of section 35(2AB), where a company is engaged in the business of manufacturing or production of any article or thing, not being article or thing specified in the list of XI-Schedule, incurs any expenditure on scientific and research on in- house research development facility as approved by the 58 ITA.Nos.663 & 708/Hyd./2022 Prescribed Authority, then, there shall be an allowable deduction a sum equal to one and one-half times of the expenditure so incurred. As per Rule 6(7)(a), the Competent authority to certify the facility and amount incurred for in- house R & D purposes is, DSIR. In the present case, there is no dispute with regard to the fact that, in-house R & D facility has been approved by the Competent Authority and a certificate in Form-3CL has been issued certifying the eligible amount of deduction of Rs.360,14,70,000/-. The appellant company has claimed deduction under section 35(2AB) of Rs.398,36,53,820/-. The Assessing Officer disallowed excess weighted deduction claimed for Rs.19,10,91,910/- on the ground that the said amount is not approved by the Competent Authority. In our considered view, the Competent authority for approving the facility and certifying the amount is DSIR. Once DSIR is certified the amount, then, the Assessing Officer is required to allow deduction as per the said Certificate without modifying the claim of the appellant company. In case, the Assessing Officer is having any clarification on the issue of eligibility of 59 ITA.Nos.663 & 708/Hyd./2022 the appellant company for amount of deduction, then, he may refer to the Board for re-clarification from the Board. However, he cannot allow excess or short deduction, once the amount is quantified by the DSIR and Form-3CL is issued. This legal position has been upheld by the Hon’ble Karnataka High Court in the case of Tejas Networks Ltd., vs., DCIT (supra).
Having said so, let us come back to the arguments of the Learned Counsel for the Assessee in light of decision of ITAT Pune Bench in the case of Garware Technical Fibres Ltd., vs., DCIT (supra). Learned Counsel referring to the above decision submitted that, Rule 6(7)(b) has been amended w.e.f. 01.07.2016 which requires quantification of expenditure by the Competent authority i.e., DSIR and that the said amendment does not applicable to the assessment year 2016-2017. In this regard, we find that, the provisions of section 35(2AB) has been amended w.e.f. 01.04.2016 and as per sub-section (3), no company shall be entitled for deduction under clause (ii), unless it entered into an agreement with the Prescribed Authority for 60 ITA.Nos.663 & 708/Hyd./2022 cooperation of such research and development facility and fulfil said conditions with regard to maintenance of accounts and audit thereof and furnish a report in such a manner as maybe prescribed. Going by the amendment to section 35(2AB) and subsequent amendment to Rule 6(7)(b) the Competent Authority for certifying the eligible amount for deduction under section 35(2AB) is DSIR alone. Once DSIR IS certified eligible amount, then, the Assessing Officer is bound to allow deduction as per the said certificate without any modification. Since the Assessing Officer has allowed deduction as per Form-3CL issued by the Competent Authority, in our considered view, the argument of the Learned Counsel for the Assessee in light of the decision of ITAT, Pune Bench in the case of Garware Technical Fibres Ltd., vs., DCIT (supra), is devoid of merit and cannot be accepted. The learned CIT(A) after considering relevant facts, has rightly concluded that, there is no error in the reasons given by the Assessing Officer to disallow excess deduction claimed under section 35(2AB) of the Act. Thus, we are inclined to uphold the findings of the 61 ITA.Nos.663 & 708/Hyd./2022 learned CIT(A) and reject the ground taken by the appellant company.
The next issue that came-up for consideration from grounds of Appellant-Company and the Revenue are disallowance of expenditure under section 14A read with Rule 8D of I.T. Rules, 1962.
The Assessing Officer noted that, as per the balance sheet, the appellant company has shown investment of Rs.23,30,000/- and Rs.162,79,00,000/- under the Heads “Non-Current Investment and Current Investment” respectively. The appellant company has earned dividend income of Rs.8,83,50,000/- for the assessment year 2016-2017 which is exempt from tax under the Act. The appellant company has a shown total borrowing of Rs.10638,56,00,000/-, on which, it has paid interest expenditure of Rs.716,45,95,000/-. The Assessing Officer after considering the relevant facts and also by considering the provisions of section 14A, has worked-out disallowance contemplated under section 14A at Rs.7,64,07,586/- and added back to the total income of the appellant company.
62 ITA.Nos.663 & 708/Hyd./2022 41. CA Padamchand Khincha, Learned Counsel for the Assessee, referring to the financial statements for the year under consideration submitted that, appellant company has not made any fresh investments for the year under consideration. Further, the investment made by the appellant company are out of it’s own funds and no borrowing funds has been used for making investments. Therefore, interest expenditure cannot be disallowed. Further, the Assessing Officer has considered all investments which includes investment, which yielded no exempt income for the purpose of computing disallowance of other expenses. Therefore, he submitted that, interest expenditure disallowed by the Assessing Officer should be deleted and in so far as other expenditure, only those investments, which yielded exempt income, should be considered.
MS. M. Narmada, learned CIT-DR for Revenue, on the other hand, supporting the order of the learned CIT(A) submitted that, the appellant company has not contested disallowance under Rule 8D(2)(iii). In so far as disallowance 63 ITA.Nos.663 & 708/Hyd./2022 of interest expenditure, the appellant company does not provide relevant evidence to prove availability of own funds. In absence of relevant details, the Assessing Officer and the learned CIT(A) are rightly considered the investments made by the appellant company and consequent borrowings and interest paid on loans, to disallow expenditure under section 14A in terms of Rule 8D(2)(ii) of I.T. Rules, 1962 and, therefore, the order of the learned CIT(A) should be upheld.
We have heard both the parties, perused the material on record and gone through the orders of the authorities below. There is no dispute with regard to the fact that, the appellant company has earned dividend income of Rs.8,83,50,000/- which has been claimed as exempt under section 10(34) of the Income Tax Act, 1961. It is also not in dispute that, appellant company has not made any suo motu disallowance towards expenditure relatable to exempt income under section 14A read with Rule 8D of I.T Rules, 1962. The Assessing Officer has computed disallowance under section 14A by applying Rule 8D(2)(ii) and (iii) and disallowed interest expenditure and other expenditure. It is 64 ITA.Nos.663 & 708/Hyd./2022 the argument of the Counsel for the Assessee that, investment in shares and securities which gives dividend income are out of own funds and no borrowed funds has been utilised. We do not find any merit in the arguments of the Learned Counsel for the Assessee for the simple reason that, except showing the financial statements with reference to the investments and the amount of share capital and reserves, the appellant company has not filed any cash flow statement to prove the availability of own funds to explain the amount of investments in shares and securities. Further, it is an admitted fact that, appellant company is having huge borrowings and paid interest on said borrowings. Although, the appellant company claims that, said borrowings are for the purpose of business of the appellant company, but, in absence of relevant cash flow to prove availability of own funds, in our view, the possibility regarding utilization of borrowed funds for the purpose of investments cannot be ruled out. Thus, we reject the ground of appellant company and upheld the reasons given by the 65 ITA.Nos.663 & 708/Hyd./2022 learned CIT(A) to sustain the disallowance of interest expenditure under Rule 8D(2)(ii) of I.T. Rules 1962.
In so far as disallowance of other expenditure @ half percent of average value of investments, in our considered view, this issue is settled by the decision of ITAT Special Bench in the case of ACIT vs., Vireet Investments Private Limited [2017] 82 taxmann.com 415 (Del.) (SB) (Tribu.) wherein it has been clearly held that, for the purpose of computing ‘other expenditure’ as per Rule 8D(2)(iii) of the I.T Rules, 1962, only those investments which yielded exempt income needs to be considered. In the present case, it is the argument of the Learned Counsel for the Assessee that, Assessing Officer has considered all investments including investments which does not yield exempt income. Therefore, we are the considered view that, Assessing Officer was erred in considering total investments for the purpose of computing half percent of average value of investments in terms of Rule 8D(2)(iii) of I.T. Rules, 1962. Thus, we set aside the findings of the learned CIT(A) on this issue and direct the Assessing Officer to consider only those 66 ITA.Nos.663 & 708/Hyd./2022 investments which give dividend income for the year under consideration, for the purpose of computing other expenditure in terms of Rule 8D(2)(iii) of I.T. Rules 1962.
In the result. appeal of the Assessee is partly allowed for statistical purposes and appeal of Revenue is partly allowed for statistical purposes.