HAMON SHRIRAM COTTRELL P. LTD,MUMBAI vs. ITO 9(2), MUMBAI

Aforesaid appeal by assessee for Assessment Year [AY] 2009-10 contest final assessment order dated 30/12/2013 passed by Ld. Deputy Commissioner of Income Tax-9(2), Mumbai [AO] u/s 143(3) read with Section 144C(13) pursuant to the directions of Ld. Dispute Resolution 2 M/s Hamon Cooling Systems Private Limited Assessment Year: 2009-10 Panel-1, Mumbai [DRP] u/s 144C(5) dated 13/12/2013. The only grounds urged by Ld. Counsel for assessee are Ground Numbers B,C,D & F which read as under: - B) Disallowance of Management Fees – Rs.49,73,410/- 4. The Ld.AO erred on facts and in law in disallowing the entire management fees of Rs.49,43,410/- as per the directions of the learned DRP.

The material facts are that the assessee being resident corporate assessee is stated to be engaged in the business of manufacturing, designing, engineering and supplying cooling towers etc. Since it carried out certain international transactions with its Associated Enterprises (AE), the same were referred to Ld. Transfer Pricing Officer (TPO) u/s 92CA(1) for determination of Arm‟s Length Price (ALP). The adjustment proposed by Ld. TPO, in its order dated 27/12/2012 u/s 92CA(3), were incorporated in draft assessment order dated 12/03/2013 which was subjected to further challenge before Ld. DRP. The Ld. DRP issued directions u/s 144C (5) on 13/12/2013 pursuant to which final assessment order was passed on 30/12/2013. Aggrieved by certain adjustments/ additions in the final assessment order, the assessee is in further appeal before us. The same could be tabulated as under: - No. Nature Amount (Rs. In Lacs) TP Adjustments 1. Disallowance of Management Fees Rs.49.73 Lacs 2. Disallowance of Research & Rs.74.13 Lacs Development Costs Non-TP Additions 3. Interest disallowance u/s 36(1)(iii) Rs.35.28 Lacs 4. Provision for erection charges Rs.138.53 Lacs 4 M/s Hamon Cooling Systems Private Limited Assessment Year: 2009-10

Transfer Pricing Adjustment 4.1 The assesse paid Research & Development (R&D) expenses of Rs.74.13 Lacs to its AE namely M/s Hamon Belgium. As per contractual terms, the same was to be computed @1% of turnover in case of Joint- venture project and @1.5% in case the assessee took the project on its own. The Ld. TPO noted that the assesse was paying R & D expenses on total revenue from contracts after excluding revenue pertaining to Air Pollution Control for which the assessee was separately paying royalty. However, the assessee has not done any exercise to examine the anticipated benefits by making the said payment. The AE had no role in execution of the project and the assesse could not explain benefit arising out of said payment. Further, the ALP of similar payment made by the assessee in AY 2007-08 was held to be Nil by Ld. DRP in that year. Following the same, the ALP was similarly determined as Nil. 4.2 The assessee paid management fees at the rate of 0.75% of total turnover to its AE and accordingly, it was directed to demonstrate the receipt of intra-group services from its AE. Upon perusal, it was noted that the services were in the nature of use of e-mail, training of employees and promotional material. The Ld. TPO held that the promotional material was about the products of its AE and therefore, it had no benefit to the assessee. The training services were such that no independent enterprise in comparable circumstances would be willing to pay. Lastly email services did not provide any direct benefit to the assessee. Accordingly, the ALP of 5 M/s Hamon Cooling Systems Private Limited Assessment Year: 2009-10 this transaction was also determined as Nil as confirmed by Ld. DRP in AY 2007-08. Both these adjustments were confirmed by Ld. DRP and the same were incorporated in final assessment order. Aggrieved, the assessee is in further appeal before us.

We find that both these adjustments have been dealt with by coordinate bench of this Tribunal in assessee‟s own case for AYs 2007-08, 2010-11 & 2011-12. The bench, inter-alia relying upon the decision of Hon‟ble Bombay High Court in CIT V/s Lever India Exports Ltd. (78 Taxmann.com 88), deleted the adjustment vide paragraph 7 to 10 of the order. The relevant findings of the bench were as under: - 7. The adjustment proposed by the TPO has been on anything but the arm‟s length price consideration. As a matter of fact he has not even disputed the arm‟s length price for the management services but has suggested the ALP adjustment on the ground that a part of the payment is pertaining to provision for another year. The DRP has confirmed the ALP adjustment by observing that „receipt of benefit in lieu of payment of service charges is sine qua non to allow the deduction for such payment to compute the income‟. It is also noted that “we also hold that the assessee has failed to explain and justify the allowability of R&D charges of prior years on merits and has also failed to show that it has benefit for such charges in the earlier years though the provision has been made in this year, and also failed to explain why the provision for the same was not made in the respective earlier years”. On tender fees, the ALP is not disputed and yet ALP adjustment is confirmed on the ground that the evidences furnished by the assessee are not sufficient to establish that any services were actually rendered and that the assessee has indeed benefited from these services, and that the expenses pertained to the previous years and that these expenses cannot be disallowed in the present year. What is, however, completely lost sight of is what was before the DRP was an ALP adjustment and that they have, even going by their own words, “enhanced” the ALP adjustments determined by the TPO, on the grounds which are wholly irrelevant for determination of the ALP by the TPO. It is not the case that the DRP has cancelled the ALP adjustments and taken up the matter, on altogether different ground, afresh. They have only approved the action of the TPO and enhanced the quantum of disallowance. While on this subject, it is useful to bear in mind the observations made by Hon‟ble jurisdictional High Court, in the case of CIT Vs Lever India Exports Ltd [(2017) 78 taxmann.com 88 (Bombay)], as follows:

The Court first notes that the authority of the TPO is to conduct a transfer pricing analysis to determine the ALP and not to determine whether there is a service or not from which the assessee benefits. That aspect of the exercise is left to the AO. This distinction was made clear by the ITAT in Dresser-Rand India (P.) Ltd. v. Addl. CIT [2011] 47 SOT 423/13 taxmann.com 82 (Mum.): "8. We find that the basic reason of the Transfer Pricing Officer's determination of ALP of the services received under cost contribution arrangement as 'NIL' is his perception that the assessee did not need these services at all, as the assessee had sufficient experts of his own who were competent enough to do this work. For example, the Transfer Pricing Officer had pointed out that the assessee has qualified accounting staff which could have handled the audit work and in any case the assessee has paid audit fees to external firm. Similarly, the Transfer Pricing Officer was of the view that the assessee had management experts on its rolls, and, therefore, global business oversight services were not needed. It is difficult to understand, much less approve, this line of reasoning. It is only elementary that how an Assessee conducts his business is entirely his prerogative and it is not for the revenue authorities to decide what is necessary for an Assessee and what is not. An Assessee may have any number of qualified accountants and management experts on his rolls, and yet he may decide to engage services of outside experts for auditing and management consultancy; it is not for the revenue officers to question Assessee's wisdom in doing so. The Transfer Pricing Officer was not only going much beyond his powers in questioning commercial wisdom of Assessee's decision to take benefit of expertise of Dresser Rand US, but also beyond the powers of the Assessing Officer. We do not approve this approach of the revenue authorities. We have further noticed that the Transfer Pricing Officer has made several observations to the effect that, as evident from the analysis of financial performance, the assessee did not benefit, in terms of financial results, from these services. This analysis is also completely irrelevant, because whether a particular expense on services received actually benefits an Assessee in monetary terms or not even a consideration for its being allowed as a deduction in computation of income, and, by no stretch of logic, it can have any role in determining arm's length price of that service. When evaluating the arm's length price of a service, it is wholly irrelevant as to whether the assessee benefits from it or not; the real question which is to be determined in such cases is whether the price of this service is what an independent enterprise would have paid for the same. Similarly, whether the AE gave the same services to the assessee 8 M/s Hamon Cooling Systems Private Limited Assessment Year: 2009-10 in the preceding years without any consideration or not is also irrelevant. The AE may have given the same service on gratuitous basis in the earlier period, but that does not mean that arm's length price of these services is 'nil'. The authorities below have been swayed by the considerations which are not at all relevant in the context of determining the arm's length price of the costs incurred by the assessee in cost contribution arrangement. We have also noted that the stand of the revenue authorities in this case is that no services were rendered by the AE at all, and that since there is No. evidence of services having been rendered at all, the arm's length price of these services is 'nil'."

The TPO's Report is, subsequent to the Finance Act, 2007, binding on the AO. Thus, it becomes all the more important to clarify the extent of the TPO's authority in this case, which is to determining the ALP for international transactions referred to him or her by the AO, rather than determining whether such services exist or benefits have accrued. That exercise - of factual verification is retained by the AO under Section 37 in this case. Indeed, this is not to say that the TPO cannot - after a consideration of the facts - state that the ALP is 'nil' given that an independent entity in a comparable transaction would not pay any amount. However, this is different from the TPO stating that the assessee did not benefit from these services, which amounts to disallowing expenditure.

In the present case, the ALP adjustment has been made by the TPO and the DRP has “enhanced” the same. In the DRP order itself, it has been stated that “the TPO has suggested that the adjustment/ disallowance [Emphasis, by underlining, supplied by us now] of ……….. is justified”. That, however, is factually incorrect and legally unsustainable in law. Neither the ALP adjustments can be equated with disallowances of expenses, even though effect may be same, nor the TPO has the authority to disallow the expenses. Clearly, the impugned ALP adjustments are vitiated in law for this short reason alone. In any case, the observations with respect to the lack of evidence in support of the benefits is based on sweeping generalizations and is incapable of sustaining legal scrutiny.

In the light of the above discussions, as also bearing in mind entirety of the case, all the three ALP adjustments – namely (a) Research & Development expenses – Rs. 47,72,982/-; (b) Management fees – Rs. 22,52,219/; and (c) Tender cost – Rs. 28,61,598 stand deleted. The assessee gets the relief accordingly.

Interest disallowance u/s 36(1)(iii) 6.1 The Ld. AO invoked the provisions of Sec. 36(1)(iii) since it was noted that the assessee had closing capital work-in-progress for Rs.562.63 Lacs. Though the assessee submitted that it had used own funds to fund the same, however, noticing that the assessee had interest bearing loans of more than Rs.1358.33 Lacs, Ld. AO computed interest disallowance of Rs.35.28 Lacs. The same was based on the fact that interest expenditure amounted to Rs.85.19 Lacs and the capital WIP was 41.42% of total loan amount. Accordingly, 41.42% of interest expenditure was disallowed. In the absence of any evidences forthcoming from the assessee, Ld. DRP chose to confirm the same. 6.2 Before us, Ld. AR submitted that interest expenditure has different components, one of which is interest on working capital loan and other interest pertaining to day-to-day operational activities. Therefore, the same should be excluded from the computations. The Ld. CIT-DR submitted that this fact may be verified by Ld.AO. Accordingly, we direct Ld. AO to verify the interest expenditure incurred by the assessee and exclude interest on working loan and other interest relating to day-to-day operational activities while working out disallowance u/s 36(1)(iii). This ground stand partly allowed for statistical purposes.

Provision for Erection Charges / compensation 7.1 It transpired that the assessee made provision for erection charges for Rs.138.53 Lacs which was stated to be payable to joint venture partner M/s 10 M/s Hamon Cooling Systems Private Limited Assessment Year: 2009-10 Shriram EPC. It was submitted that the assessee took contract from M/s Shriram EPC for a sum of Rs.136.77 Lacs and following proportional method of accounting, the liability was accounted for in the books. The attention was drawn to the fact that the assessee accrued an equal amount of revenue as sales and therefore, the said provision would have no impact on the taxable profits. However, in the absence of satisfactory evidences, the said provision was disallowed by Ld. AO which was confirmed by Ld. DRP. 7.2 The Ld. AR reiterated the position and submitted that the assessee undertook back-to-back contact from its associated entity M/s Shriram EPC. The revenue was accrued in the books as sales and an equal sum was debited in the books and therefore, the transactions would have no impact on taxable profits. The ld. CIT-DR, on the other hand, submitted that the assesse failed to produce any documentary evidences / relevant agreements before lower authorities and therefore, the matter may be remitted back to the file of Ld. AO.

After going through the relevant material on record, we concur with Ld. CIT-DR that this issue would require re-adjudication by Ld. AO in the light of facts submitted by Ld. AR before us. Therefore, the issue is set-aside to the file of Ld. AO for re-adjudication with a direction to the assessee to substantiate his claim. This ground stand allowed for statistical purposes.