DCIT, BANGALORE vs. M/S TATA COFFEE LIMITED, BANGALORE

The assessee has filed two appeals and the revenue has filed one appeal for assessment year 2010-11. The appeal filed by the assessee in IT(TP)A 568/Bang/2015 and the appeal of the revenue are directed against the assessment order passed by the AO u/s IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru

Page 2 of 16 143(3) r.w.s. 144C (13) of the Income-tax Act,1961 ['the Act' for short] in pursuance of directions given by Ld Dispute Resolution Panel (DRP). The other appeal of the assessee is directed against the rectification order passed by the AO. All these appeals are disposed by this common order, for the sake of convenience.

5.1 The facts relating to the above said transaction are that the assessee has shown a sum of Rs.9,44,00,714/- as an international transaction under the title “Reimbursement of expenses received from its AE named “Campestress Holdings Ltd”. Initially, the IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru

Page 3 of 16 assessee mentioned the above said amount as “Refund of Advance”. Accordingly, it was submitted that the above said receipt does not have any impact on the Profit and Loss account and hence no bench marking is required. However, the assessee changed the version before TPO and claimed that the above said amount is “Reimbursement of Expenses”.

5.2 It was submitted that the assessee intended to acquire a company named “OOO Sunty Limited, Russia. In that process, it has incurred expenses on carrying due-diligence exercises to the extent of Rs.9,44,00,714/-. The above said expenses were incurred by the assessee from March, 2007 to August, 2009. However, due to certain business reasons, the above said acquisition of OOO Sunty Limited was shelved. We notice that the assessee has titled this transaction as “Project Kremlin”. Subsequently, the AE of the assessee M/s Campestress Holdings Ltd acquired the above said company “OOO Sunty Limited”. Hence the assessee raised a debit note dated 31st August, 2009 upon M/s Campestress Holdings Ltd (CHL) for a sum of Rs.9,44,00,714/-, being pre-acquisition expenses incurred by the assessee on due diligence exercises. It appears that M/s Campestress Holdings Ltd has accepted the debit note and paid the amount to the assessee.

5.3 Under these set of facts, the TPO concluded as under:-

“8. To conclude the Tax payer itself gave wrong submission in 3CEB Report about the amounts received AS REFUND OF AN ADVANCE, Later on changed the nature of receipt as REIMBURSEMENT OF EXPENSES. The details submitted by the Tax payer do not show any intra group services being rendered by the AEs to the Taxpayer which requires the reimbursed. The Tax payer was independently pursuing the acquisition of 000 Sunty Russia for which it had incurred certain expenditure. This expenditure has nothing to do with the AEs. The AEs have transferred the funds to Tata Coffee in the name of reimbursement of expenses. On detailed study of the material available on record, submission made by the Assessee and TPO's in depth study of the issue it is IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru

Page 4 of 16 clear that there is a transfer of funds to the tax payer from the AEs in the name of reimbursement of expenses. The nomenclature of Reimbursement is used to not to include the receipts in the Total Revenues which is Taxable.

The Arm's Length Price determinations for the reimbursement of expenditure of Kremlin Project is as follows. The Total amount of expenditure incurred under CUP method is NIL. The Arm's Length Price adjustment under CUP method is Rs.96,076,131/- To sum up the Total ALP adjustment is Rs.96,076,131/-.

The above amount of Rs. 96,076,131/-. is treated as transfer pricing adjustment u/s 92CA in respect of reimbursement of expenditure of Kremlin Project of the taxpayer's international transactions.”

It is pertinent to note that the assessee had also declared international transactions by way of reimbursement of expenses of Rs.16,75,417/- and hence the TPO has made adjustment to the tune of Rs.9,60,76,131/-, which is inclusive of above said amount. The Ld DRP deleted the TP adjustment of Rs.16,75,417/- and hence the facts relating to net amount of TP adjustment of Rs.9,44,00,714/- are discussed here.

5.4 The Ld DRP held that the TPO was not right in making TP adjustment of entire amount on the reasoning that there was no intra-group services between the AEs. The Ld DRP held that the TP adjustment should be restricted to mark-up amount of the amount spent by the assessee. Accordingly, the Ld DRP directed the TPO to determine the mark-up @ 10% and accordingly issued the direction. The observations made by Ld DRP are extracted below:-

4.3 The tax payer's objections as above have been examined along with the facts of the case. The fact that the tax payer had misrepresented the nature of transaction in the 3CEB report as "refund of an advance" and later, when the TPO called for details, categorized its nature as "reimbursement of expense" is not in dispute. From the sequence of events it is clear that when

IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru

Page 5 of 16 the impugned expenses were being incurred by the tax payer from March,2007 to August, 2009 in pursuit of its intended acquisition of the Russian company it was incurring the expenditure on its own since CHL then was not on the scene in the context of this acquisition. CHL did not even have an agreement or understanding with the tax payer then that this stage of work/activities would be carried out by the tax payer and the subsequent stages taken over by the CHL. Once the group decision was taken for the project to the acquired by CHL and not Tata Coffee Ltd., the subsequent activities became the responsibility of CIIL. However, the expenditure in the initial phases totaling Rs.9.44 crore could not have been taken into the books of CHL as expenditure for ground work already done in the acquisition process if the relationship between the two entities had been uncontrolled. If the tax payer was passing on the benefit of its ground work done for an acquisition project to an uncontrolled party, it would have charged a mark up in the normal course of business since its resources, infrastructure, skills, time etc., were invested in the activities and a mark up for the same was justified. A reimbursement at the level of cost does not represent an uncontrolled business transaction as per normal commercial practices. In fact, the entire range of pre-acquisition activities conducted by the tax payer for the acquisition of Sunty Ltd, which was finally acquired by CHL, clearly represents a service performed by the tax payer for CHL since the latter did not have to duplicate efforts and resources for these activities. The TPO's understanding that there was no intra-group service between the AEs is, therefore, erroneous.

4.4 The tax payer's operating profit to operating expenses is at 11.05% as evident from its financial results at page 3 of the TPO's order. The ratio of operating profit to sales is 9.95%. in view of the facts and circumstances related to the impugned transactions a mark-up of 10% is considered reasonable. The TP adjustment, therefore, is directed to be restricted to this amount. The objections are partly acceptable.

5.5 The Ld. A.R. submitted that there is “no income” element in this transaction. In the absence of any income element, the Ld. DRP was not justified in making TP adjustment to the extent of 10% of the reimbursement of amount received by the assessee. He further submitted that the Ld. DRP has determined the rate of 10% on the basis of operating profit of the assessee, which is not recognized method of bench marking prescribed in the I.T. Rules.

IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru

Page 6 of 16 Accordingly, he submitted that the entire TP adjustment sustained by the Ld. DRP should be deleted.

5.6 The Ld. DR on the contrary submitted that the assessee has incurred expenditure in the process of acquisition of M/s OOO Sunty Limited. Since the assessee has spent money and also performed pre-acquisition activities and thus, relieved of the subsequent buyer (AE of the assessee) from pre-acquisition exercises, the same would represent services performed by the assessee to CHL. Accordingly, the Ld. D.R. submitted that the Ld. DRP was justified in estimating the markup at 10% of the investment made by the assessee.

5.7 We heard rival contentions on this issue and perused the record. Admittedly, the assessee has spent Rs.9.44 crores from March, 2007 to August, 2009 in connection with proposition of acquisition of OOO Sunty Limited, Russia, which was titled as “Project Kremline”. Subsequently, on account of change in strategy by Tata Group, the above said M/s. OOO Sunty Limited, Russia was acquired by another A.E. now M/s. Campestress Holdings Ltd. Hence, the assessee raised a debit note of Rs.9.44 crores on 31.8.2009 upon M/s. Campestress Holdings Limited requiring reimbursement of the expenditure incurred by the assessee on due diligence (pre-acquisition) exercises towards acquisition of M/s. OOO Sunty Limited, Russia.

5.8 The assessee has claimed that it is a case of mere reimbursement of expenses. We have earlier noticed that the assessee has initially claimed same as refund of advance and later changed its version as reimbursement of expenses. Since the assessee had initially intended to acquire M/s. OOO Sunty Limited, Russia, in our view, it cannot be held that the expenses of Rs.9.44 crores were incurred by the assessee on behalf of M/s. Campestress

IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru

Page 7 of 16 Holdings Ltd. i.e., it is not a case where M/s. Campestress Holdings Limited intended to acquire the Russian company from the beginning and the assessee was incurring expenditure on behalf of M/s. Campestress Holdings Ltd.

5.9 On the contrary, it is the assessee, which has spent the amount of Rs.9.44 crores on its own account and subsequently, due to change in the strategy of the business group to which assessee belong to, the above said Russian company was acquired by M/s. Campestress Holdings Ltd. Hence, in our view, the Ld. D.R.P. was right in observing that in an uncontrolled transaction when the assessee is transferring the benefit of ground work done by it on acquisition project to an uncontrolled party, it would have charged a mark up in the normal course since its resources, infrastructure, skills, time, etc. were invested in the said activities. Hence we are unable to accept the contentions of Ld A.R that this transaction itself would fall outside the scope of transfer pricing provisions in the absence of any income element. Accordingly, we are of the view that the Ld. DRP was justified in holding that the transfer pricing adjustment by way of a markup on the amount spent by the assessee and claimed back from CHL is required to be made.

5.10 We have noticed earlier that the Ld. DRP has determined the markup rate at 10% on the basis of financial results of the assessee company. It is well settled proposition that the bench marking of international transactions have to be made under any one of the recognized methods prescribed in the I.T. Rules. Apparently, the Ld. DRP has adopted CUP method for bench marking the international transactions. However, it has not brought on record any external supporting material to substantiate the mark-up rate of 10%. We have noticed earlier that the Ld DRP has arrived at the rate of 10% on the basis of the internal profits declared by the IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru Page 8 of 16 assessee. What is required to be shown is that under same set of facts, what would have been the mark-up if the transactions were between unrelated parties. Accordingly, we are of the view that the determination of rate of markup requires fresh examination. Accordingly, we modify the order passed by Ld. DRP on the issue determination of percentage of markup and restore the same to the file of the A.O./TPO for examining it afresh. After affording adequate opportunity of being heard to the assessee, the AO/TPO may take appropriate decision in accordance with law.

Power & Fuel—R&D 387,269 Repairs To Bldgs-Wages-R&D 57,847 Repairs To Buildings -Stores—R&D 9,603 Repairs To Machinery- Wages-R&D 8,272 Repairs To Machinery -Stores-R&D 3,986

Repairs To Machinery -Others-R&D 4,115 Insurance-R&D Exps 83,693 241,442 Miscellaneous Expenses-R&D Exps Cos contri SAS to R&D Off 138.508

Medical expenses-officers R&D 111,486 Medical expenses-staff & artisen - R&D 130 Travelling expenses-air/bus/train/auto fare - R&D 13,083 Travelling Expenses-R &D . 51,771

Biological Control Laboratory 1,103

6,331 Library Books & Periodicals-R&D Coffee Plants Plot Exprnt Exps-R&D 2,500 4,295 176 'Total

IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru Page 9 of 16 6.1 Before the A.O., the assessee submitted that these expenses have been incurred in connection with the routine business activities carried on by it on the following activities:

Soil Nutrient Index o Varietal trial of Coffee, Pepper and Cardamom o Bio-Control Research o Pests and Disease Control Research o Coffee effluent Treatment o Compost-Vermicompost Experiment o Quality Analysis of Coffee & Pepper o Analysis of Agro-inputs for quality standards o Water management Research – Drip irrigation for coffee o Crop diversification.

Accordingly, it was submitted that this expenditure is revenue in nature and allowable as deduction u/s 37(1) of the Act. In the alternative, it was submitted that the assessee has obtained approval from Department of Scientific & Industrial Research, Government of India and hence, these are allowable u/s 35 r.w.s. 43(4)(ii) of the Act. It was submitted that this expenditure does not create any rights. The A.O. however, took the view that incurring of R&D expenses results in creation/acquisition of rights to the assessee. Accordingly, he disallowed the above said amount of Rs.42.95 lakhs incurred by the assessee. The Ld. DRP also concurred with the view taken by the A.O.

6.2 The Ld. A.R submitted that the assessee has been incurring expenditure on research & development activities in a routine manner year after year and it has not developed any “copy right” as presumed by the A.O. He further submitted that the capital expenditure incurred in connection with the R&D activities have been duly capitalized by the assessee and details of the same have IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru

Page 10 of 16 been reported in the annual report of the assessee. He submitted that revenue expenses have been charged to profit and loss account. He further submitted that major portion of the R&D expenses is the expenditure incurred on salaries & wages paid to its staff. He submitted that the assessee is constrained to maintain “R & D department” in the normal course in order to meet the competition and to remain upto date with the changes in the market. Accordingly, the Ld. A.R. submitted that there is no justification for treating this expenditure as capital in nature.

6.3 On the contrary, the Ld. D.R. submitted that the assessee has not been able to substantiate before the A.O. that it has obtained approval from DSIR, Govt. of India. The assessee also failed to establish that this expenditure does not create any rights.

6.4 We heard the rival contentions on this issue and perused the record. From the details of expenditure furnished by the assessee, we notice that the assessee has claimed salary & wages expenses, repairs expenses, etc. under the head “R & D expenses”. From the annual report furnished by the assessee, we notice that the assessee has duly capitalized the capital expenditure incurred by it. We also noticed that the A.O. has observed that these expenses have resulted in creation of copy right in the hands of the assessee. However, the A.O. has not brought any material on record to show that these expenses has resulted in creation “copy right”, meaning thereby, the A.O. has made his observations on surmises and conjectures. We also agree with the contentions of Ld A.R that it is a business necessity to maintain R & D department in order to meet the competition and changing business circumstances. Unless it is established that the R & D department has undertaken a mission to invent something new which would give a copy right to the assessee, in our view, routine expenses cannot be considered as capital in nature. Accordingly, we are of the view that the A.O. was IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru

Page 11 of 16 not justified in treating the above expenses as capital in nature. Accordingly, we direct the A.O. to delete the addition.

7.1 The Ld. D.R. on the contrary, submitted that the assessee has not demonstrated that the investments have been made out of surplus funds in the past. Further, the assessee is maintaining its IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru

Page 12 of 16 accounts in a consolidated manner, whereby all funds and receipts are intermingled in a common pool. Hence, it will be difficult to relate the investment to a particular receipt. Accordingly, the Ld. D.R. submitted that the A.O. was justified in making disallowance out of interest expenses under rule 8D(2)(ii).

7.2 We heard the parties on this issue and perused the record. We notice that the issue of disallowance under rule 8D(2)(ii) out of interest expenses have been restored to the file of the A.O. by the coordinate bench in the assessee’s own case for assessment years 2006-07 to 2008-09. It is the submission of the Ld. A.R. that the investments have been made by the assessee in the past out of surplus funds and these aspects have been verified by the A.O. in the restored the said proceedings. Accordingly, the A.O. did not make any disallowance out of interest expenditure in the above said year. In view of the above said facts, we are of the view that, consistent with the decision taken by the coordinate bench in the assessee’s own case, the issue of disallowance of interest expenditure under rule 8D(2)(ii) requires fresh examination at the end of the A.O. Accordingly, we set aside the order passed by the A.O. on the above said issue and restore the same to the file of the A.O. for examining it afresh. The disallowance made under rule 8D(2)(iii) was out of administrative expenses shall stand sustained. While giving effect, the AO shall give set off of the disallowance voluntarily made by the assessee.

Page 13 of 16 the Bangalore bench of Tribunal has passed an order recently in the case of Ittiam Systems Pvt. Ltd. (ITA No.2464 & 2465/Bang/2017 dated 13.1.2021), wherein the issue of foreign tax credit has been analysed in detail. Accordingly, the Ld. A.R. submitted that the A.O. may be directed to allow full credit of foreign tax credit claimed by the assessee by following the decision rendered by the Tribunal in the case of Ittiam Systems Pvt. Ltd.

8.1 We heard Ld. D.R. and perused the record. As submitted by Ld. A.R., the A.O. has not given any reasons as to why he has restricted the foreign tax credit to Rs.3.89 crores as against Rs.5.43 crores claimed by the assessee. The Ld. A.R. has submitted that issue relating to foreign tax credit has been explained well in the case of Ittiam Systems Pvt. Ltd. by the Bangalore bench of Tribunal. Accordingly, we are of the view that the claim of the assessee requires fresh examination at the end of the A.O. Accordingly, we restore this issue to the file of the A.O. with the direction to follow the principles laid down by the Bangalore bench in the case of Ittiam Systems Pvt. Ltd. and accordingly, allow credit of foreign tax credit.

10.1 The facts relating to the above issue are stated in brief. During the year under consideration, the assessee had sold Rosewood, Silver Oak, Eucalyptus and other trees. The assessee

IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru

Page 14 of 16 computed capital gain on sale of Rosewood &Silver Oak after considering indexed cost of acquisition by taking fair market value as on 1.4.1981. In respect of Eucalyptus and other trees 70% of the sale consideration was considered as the cost of acquisition based on the decision rendered by Hon’ble Kerala High Court in the case of Pullangode Rubber Produce Company Ltd. 189 ITR 580. Accordingly, the assessee declared a capital loss of Rs.30.67 lakhs. The A.O. took the view that the activities carried on by the assessee in nurturing/growing and selling of trees is normal business activities of the assessee. Accordingly, the AO took the view that the gain arising on sale of trees should be assessed as normal business income. The Ld. DRP however, accepted the contentions of the assessee that the income arising from sale of trees is Capital gains in the hands of the assessee on noticing that the Hon’ble Karnataka High Court has upheld the view of the assessee in its own case relating to assessment years 1997-98 to 1999-2000 and 2001-02 reported in 27 Taxmann.com 98. Accordingly, the Ld. DRP directed the A.O. to compute capital gains adopting fair market value of the asset as on 1.4.1981. Aggrieved, the revenue has filed this appeal.

10.2 We heard the parties on this issue and perused the record. We notice that the Ld. DRP has decided the issue in favour of the assessee with the following observations:

“8.3 The tax payer disagreed with the above treatment and submitted that these trees are maintained as shade trees for the coffee bushes since shade trees are absolutely essential for the protection of coffee bushes. It is not possible to grow coffee in India without the necessary shade trees. It was submitted that amongst other trees only Silver oak is converted into stock in trade and transferred to the value addition division for processing and manufacture of plywood's. As regards other trees, the subsequent treatment is tabulated below: Rosewood Compulsorily sold through Government auction jungle Wood Compulsorily sold after Government approval Eucalyptus Sold to third parties Miscellaneous timber Internally consumed by the company

IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru Page 15 of 16 To protect the coffee bushes, the company cuts the old shade trees. Usage of such cut trees (alter than rosewood and Eucalyptus) in its timber division was claimed to be incidental to Its coffee plantation business.

8.4 It was submitted that sale of rosewood to government depot and transfer of silver oak and other trees to Timber division is shown as sale of capital asset and offered to tax as capital gains. Further, sale of marine plywood, fire retardant plywood, phenol formaldehyde black board, commercial plywood produced in timber division are shown as business income. It was submitted that the reason for the different treatment is the difference in characterization of the item of sale i.e., trees. As regards Rosewood, Eucalyptus and other trees which are used for shade of coffee bushes are in the nature of capital assets and hence, income/loss from their sale is computed under the head "Capital gains" once the income is recognized in the books of the company based on its accounting As regards, Silver Oak the income is computed under the head "Capital gains" upon their conversion into stock in trade of timber value addition division. The subsequent sale in the timber division is of the stock in trade of the business of the timber division and hence, income from their sale is computed under the head "Business income".

8.5 The following case laws were relied upon by the assessee: • Decision of Honourable Karnataka High Court in Assessee's own case for AY 1997-98, 1998-99, 1999-2000 and AY 2001-02 reported in 27 taxmann.com 98 • Decision of Honourable Karnataka High Court in Assessee's own case for AY 2003-04 and AY 2004-05 in and 111 of 2009 • Emerald Valley Estates Ltd. [1996] 222 ITR 799 (Karnataka HC) • Travancore Tea Estates vs. CIT [1974] 93 ITR 314 (Kerala HC) • State of Kerala vs. Karimtharuvi Tea Estate Ltd. [1964] 51 ITR 129 (Kerala HC) • C. Hanumantharao (Deceased) vs. CIT (Madras HC) (Tax case appeal No.44/2004) • The Honourable Bangalore Tribunal in the assessee's own case for AY 2006-07, 2007-08 and 2008-09 [ITA 1462 to 1464/Bang/2012] • CIT v. Pullangode Rubber Produce Company Limited (189 ITR 580)

8.6 We have considered the submissions as above and find that the facts regarding treatment of shade trees as capital assets is squarely covered by the decision of the Hon'ble jurisdictional High Court in the tax payer's own case apart from the Hon'ble ITAT's order cited. The computation of capital gains and the fair market value of the asset as on 01.04.1981 will be considered by the AO in this regard.”

IT(TP)A Nos.568, 190 & 729/Bang/2015 Tata Coffee Limited, Bengaluru Page 16 of 16 10.3 We notice that the Ld. DRP has followed the binding decision rendered by Hon’ble Karnataka High Court in the assessee’s own case referred (supra). Under these circumstances we do not find any infirmity in the directions so given by Ld. DRP.