AGC NETWORKS LTD,MUMBAI vs. DCIT CIR 14(1)(2), MUMBAI

This appeal by the assessee is directed against the order of the Assessing Officer dated 31.1.2017 passed u/s. 143(3) read with section 144C of the Act pursuant to the direction the of learned Dispute Resolution Panel (DRP) dated 29.1.2016.

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Transfer Pricing adjustment 4. The Transfer Pricing officer asked for the detail of international transaction of reimbursement of expenses amounting to Rs. 6,52,58,171/-. The TPO was not satisfied that the same was reimbursement of expenses. After further examination the TPO came to the following conclusion :- I. Assessee does not dispute service and support rendered to AE across the verticals of Sales, Pre-Sales, Supply Chain, Marketing, Finance and Legal in all his submissions. Assessee's only contention is that they are on a cost to cost basis and in the nature of reimbursement.

II. Cost reimbursement cannot be only of salary cost. All other costs incurred by Assessee towards such support services have to factored in.

III. Assessee itself has accepted that the service rendered spreads on to Sales, Pre-sales, Supply Chain, Marketing, role of CEO& CSO , Finance and Legal Assistance to AE. After offering wide and complete business and sales support to AE. Assessee can by stretch of imagination call it a stewardship activity.

IV. Assessee has changed its allocation key from order sales ratio to employee ratio without any reason and substantiating documents. There's no proof to substantiate the claim of the Assessee that only 51 employees are involved in rendering services to AE. Neither AE books nor AE s employee profile was furnished to substantiate the veracity of claim of the Assesssee. The fresh claim of assessee to consider employee ratio is clearly an afterthought in nature. Moreover, obtaining a ratio of Assessee's employees of 51 of 1124 is incorrect as the assessee's employee profile is spread across two segments and the support services rendered to AE cannot be benchmarked on the ratio of Employee of the Assessee. The same is illogical as it does not capture the role played by Assessee in AE's business. 1124 is the entire employee strength of service and goods segment. This base will lead to absurd results when used. Using the employee ratio of Assessee in NO WAY CAPTURES the benefit flowing to AE. Hence, employee ratio is rejected.

V. Assessee failed to furnish any documents pertaining to AE to show why the cost allocation be not made on the basis of Sales revenue.

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Mere explanation without substantiating documents cannot be a ground to reject sales revenue as ratio to determine costs.

VI. The very bifurcation furnished by assessee clearly displays the fact that the Assessee is providing support services to its AE.

VII. It is observed that the costs allocated by the Assessee are in the nature of sales related costs which cannot be considered to be in the nature of shareholders costs by any stretch of imagination. It is purely in the nature of service provided by the Assessee to the AE. Hence, assesse's own allocation key of sales order ratio of 12.5% is relied upon to be the cost driver for the support services rendered by Assessee to its AE.

8.6 In view of the above defects and others which are evident from the discussion above, the price paid in the international transaction has not been determined in accordance with sub-section (1) and (2) of 92C and the information as well as the data used in computation of the arms length price is. not, reliable and correct. The provisions of Sec. 92C(3)(a) & (c) are invoked and the TP documentation is rejected.

The Transfer Pricing officer made further observed that based on the above and the profit and loss account, costs for the traded goods segment have been derived at as follows:

Head of expenses Rs. in Less (expenditure Total Crores pertaining to services)

Employee's Benefit Expenses 107.00 44.7 62.30 Other Expenses 154.80 97.7 57.10 Exceptional items 0.90 0.90 Depreciation and amortization expenses 8.20 8.20 Finance cost 6.30 6.30 Total product sales expenditure 134.80 Cost allocated on the basis of 12.5% 16.85

Sr.No. Name of the company Margin(%) OP /OC 24.45% 1 Apitco Limited 2 Killick Agencies and Marketing Limited 9.04% 4 AGC Networks Limited

3 BVG India Limited 24.22% 4 Axis Integrated Systems Limited 10.27% 5 Marketing Consultants & Agencies Limited 10.32% Grand Average 15.66%

10.2 Even at any point the comparables are rejected, it is brought on record that the Assessee has claimed 9.87% as industry average for marketing support services.

10.3 ADJUSTMENT WORKING Based on the working in para 9 above, the cost allocated Rs.16.85 crores. to this segment works out to Add : Mark up of 15.66% as per above benchmarking Rs.2.64 crores Total Rs. 19.49 Less: Remuneration already offered by the Assessee as Rs.6.52 crores cost to cost recovery Adjustment to ALP = Rs. 12.97 crores (Rs. 19.49 crores - 6.52 crores)

11 In view of the above discussion after considering the submissions of the assessee and facts of the case, an adjustment of Rs.12.97 crores is made to the Assessee case.

“We have considered the submission of the assessee. The claim of the assessee that few of the employees of the assessee were involved in monitoring and guidance to AGC Singapore team while performing the sales activities in system and that the assessee merely monitored such activities and did not render any service with respect to AE's trading activity is contrary to facts mentioned in the transfer pricing report, the submission dated 2/12/2015 and working of the 'cost to be recovered' filed by the assessee alongwith the submission dated 2/12/2015. Similarly, the claim of the assessee that only 51 employees were involved in such activities is also contrary to the submission made before the TPO vide letter dated 2/12/2015. It is clearly an afterthought because if this was the actual position then the assessee had no business to allocate cost on the basis of products sales order ratio over the entire sales team, pre sales team, supply chain team and marketing team. However, in principle we are in agreement with the claim of the assessee that costs which are directly attributable to trading activity being conducted by the assessee should not be allocated to the AE. The AO/TPO shall exclude the expenses which are directly linked

5 AGC Networks Limited with the trading business of the assessee on furnishing of necessary supporting evidences. Prima facie such expenses are as under:- a) Exceptional Item (INR 9 millions) b) Consumption of stores and spares (INR 1 million) c) Rates and taxes (INR 15 millions) d) legal and professional fees (INR 13 millions) to the extent they are for assessee's business e) Advertisement and sales promotion (INR 13 millions) f) Outward freight, clearing and forwarding charges (INR 34 millions) g) Commission to others (INR 9 millions) h) Payment to auditor (INR 5 millions) to the extent they are for assessee's business i) Exchange differences net (INR 30 millions) j) Provision for doubtful debts and advances (INR 68 millions) k) Bank Charges (INR 31 millions} l) interest so far it relates to fixed assets

Pro rata allocation of following expenses is upheld because possibility of them being related to sales team, pre-sales team and supply chain team cannot be ruled out :- a) Travelling and conveyance (INR 124 millions) b) Other expenses (INR 37 millions) c) interest so far it relates to working capital.”

directions of the DRP is illegal and bad in law and hence needs to be quashed and set aside.” b. As per section 92 of the Income tax Act, 1961 ('the Act'), income has to be computed having regard to the arm's length price when- i. There is an international transaction; and ii. Income arises from an international transaction.

In the present case, no income arises from any international transaction as the receipt is in the nature of reimbursement. It is an undisputed position that there is no mark-up charged. In this regards relevance is placed on A. P. Moller Maersk A S (2017) 392 ITR 186 (SC) in para 11, page no.

c. Apart from the salary cost as allocated by the appellant, the TPO has also proportionately allocated the other expenses comprising of power and water charges, rent, repair and maintenance, travelling, telephone, printing and stationery etc. depreciation and amortization cost and finance cost (see para 9 at page i 1 of the TPO's order)

As explained at the time of hearing, these expenses have not been incurred for the subsidiary but relates to the appellant's business. Most glaring amongst this is the finance cost. This cost has been incurred to meet the appellant's requirement of funds for carrying on its business in India. There is not even a remote use of these borrowed funds for the business of the subsidiary. Hence, the TPO erred in allocating expenses other than salary cost to the subsidiary. d. For arriving at the mark-up to be charged by the appellant on the reimbursement of cost, the TPO identified the following comparables considering the appellant as providing sales support services working out the mark-up as 15.66 % (see para 10.1 at page 15 of the TPO's order).

Sr. Name of Company Margin (%) No. OP/OC 1 Apitco Limited 24.45% 2 BVG India Limited 24.22% 3 Killick Agencies & Marketing Limited 9.04% 4 Axis Integrated Systems Limited 10.27%

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5 Marketing Consultants and Agencies Limited 10.32% Arithmetic mean of companies considered 15.66% comparable Of the above, the DRP has directed deletion of BVG India Ltd. resulting into arm's length mark-up of 13.53 %. The appellant submits that Apitco Ltd. is not comparable as it is a Government company. See CIT v. Thyssen Krupp Industries India Private Limited. (2016) 385 ITR 612. In any event, the business of the said entity is also not functionally comparable as they are carrying business in capacity as a government enterprise. Further, this company is engaged in providing services such as asset reconstruction and management, cluster allotment for mega footmarks and environment services, energy related services, infrastructure planning and development, energy audit etc. and undoubtedly this company is a high- end consultancy service provider. In this regard, reliance is placed on Philip Morris Services India SA ruling by the Hon'ble Delhi Court, decision dated 18 December 2018 (Income Tax Appeal No. 1468/2018. If Apitco Ltd. is excluded the arm's length mark-up would work out to 9.88%.”

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16. Next issue relates to disallowance of provision for expenditure. A sum of Rs. 2,16,73,001/- was disallowed by the Assessing Officer holding them to be contingent. The DRP direction in this regard is as under :- “We have considered the submission of the assessee. There is no doubt that provisions for expenses will have to be allowed if they have been actually incurred but bills are yet to be received and corresponding income has been offered for taxation during the year or the work under consideration is a part of the closing stock. The assessee has not demonstrated the same. It is also seen that year after year, the provision made by the assessee is on the higher side only and by doing this, the assessee is postponing its tax liability. Accordingly, the AO is directed to allow the expenditure to the extent of the bills the next year and disallow the balance amount provided the assessee furnishes evidence to show that the responding income has been offered during the previous year under consideration or the corresponding work is part of the closing stock shown by the assessee.”

record that in respect of some goods/services received/availed by the assessee towards the end of the financial year, the bills/invoices were not raised by the concerned parties within the financial year but were raised in the subsequent year. However, since the assessee is following mercantile system of account, the expenditures incurred during the year have to be accounted for in the books of account. Therefore, in absence of bills/invoices raised by the vendors, the assessee made provision for such expenditure in its books of account. There is no dispute that the provision made by the assessee is on estimate basis. Therefore, it has to be seen whether such estimate of provision made by the assessee is on reasonable and scientific basis and in accordance with business prudence. As could be seen from the facts discussed earlier, the assessee had made provision for expenditure under three distinct heads. While the Assessing Officer has added back the difference between the provision made and actual expenditure incurred under all the three heads, learned Commissioner(Appeals) has restricted such disallowance only in respect of provision made for sundry creditors relating to sales commission, promotion, advertisement, etc. Therefore, it requires consideration whether the provision made can be stated to be in accordance with AS-1 r/w section 145(2) of the Act. In this context, learned Authorised Representative has specifically referred to Para-16 and 17 of AS- 1. For ease of reference, we reproduce the aforesaid paragraph herein below:-

"Considerations in the Selection of Accounting Policies

17. For this purpose, the major considerations governing the selection and application of accounting policies are:--

a. Prudence In view of the uncertainty attached to future events, profits are not anticipated but recognised only when realised though not necessarily in cash. Provision is made for all known liabilities and losses even though the amount cannot be determined with certainty and represents only a best estimate in the light of available information. b. Substance over Form The accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form. c. Materiality Financial statements should disclose all "material" items, i.e. items the knowledge of which might influence the decisions of the user of the financial statements."

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13. A careful reading of the aforesaid paragraphs would reveal that as per Para-16 of AS-1, the Accounting Policy to be selected by the enterprise should represent a true and fair view of the state-of-affair of the enterprise as at the Balance Sheet date and of the profit. Para-17(a) provides that for all known liabilities and losses, which cannot be determined or quantified with certainty, the enterprise by using business prudence can make provision in the light of available information on the basis of a best estimate. Thus, a reading of AS-1 makes it clear that the liability for expenditure incurred during the year if cannot be determined with certainty, the assessee can make a provision for such liability on best estimate on the basis of available information. Thus, though, there cannot be any doubt that for expenditure incurred during the year which cannot be determined with certainty, since the vendors have not raised bills/invoices, the assessee is entitled to make provision on estimate basis, however, such estimate has to be a best estimate. It transpires from record, the assessee is following the aforesaid method of accounting in respect of unbilled expenditure from past years and it has never been disputed by the Department. Additionally, AS-1 provides for creating provision for expenditure on estimate basis keeping in view business prudence and information available. In fact, learned Commissioner (Appeals) also not only recognizes the necessity of making provision for expenditure but has also allowed provision for expenditure not exceeding 10% of the actual expenditure. In our view, there is no such thumb rule either in Accounting Standards or elsewhere to restrict the provision to within the range of 10% of the actual expenditure. It is worth mentioning; the assessee has reversed the provision in the subsequent year and offered to tax. This fact has not been disputed by the Department. Therefore, the ratio laid down in case of CIT V/s Excel Industries Ltd. would apply. More so, when the assessee is consistently following this accounting method from past years. In view of the aforesaid, we hold that the part disallowance sustained by learned Commissioner (Appeals) also deserves to be deleted. Therefore, learned Commissioner (Appeals) direction to grant consequential relief in subsequent assessment year becomes infructuous. This ground is allowed.” 18. We find that the facts are same. Accordingly, following the above said Tribunal decision, we direct that this disallowance be deleted.

“20. We have considered rival submissions and perused the material on record. We have also applied our mind to the decisions relied upon. The issue before us is, whether the expenditure incurred by the assessee towards

12 AGC Networks Limited repair/renovation of leased premise is of capital or revenue nature. On a perusal of the details of expenditure incurred, as submitted in the paper book, we are of the view that by incurring such expenditure, the assessee has not brought into existence any capital asset of enduring nature. A reference to Explanation-1 to section 32(1) of the Act, would reveal that it speaks of capital expenditure incurred towards construction of any structure or renovation or extension or improvement to the building. Thus, on a reading of the aforesaid provisions, it becomes clear that if any expenditure is incurred for construction of any structure or extension or improvement of the building taken on lease would be treated as capital expenditure. The nature of expenditure incurred by the assessee in respect of the leased premises and more particularly the premises at Hyderabad and Bangalore are not of the nature of constructing new structure, extension or improvement of building. Therefore, Explanation-1 to section 32(1) of the Act would not be applicable to the facts of the present case. Though, there cannot be any quarrel with regard to the proposition laid down in the decisions cited before us, however, the nature of expenditure incurred by the assessee with reference to facts of each case would decide whether it is capital or revenue in nature. In the facts of the present case, after examining the details of expenditure incurred by the assessee, we are of the view that it is of revenue nature, hence, has to be allowed. Accordingly, we do so. The decision of learned Commissioner (Appeals) on this issue is, therefore, set aside. Ground raised is allowed.

This ground is consequential on the basis of the adjudication made for allowability of renovation expenses in the earlier years. The status of the earlier years is as under:

- Renovation expenses have been held by the ITAT to be revenue in nature in the above order passed for assessment years 2005-06 to 2009-10; - Assessment year 2010-11 is pending before the Commissioner of Income Tax (Appeals): and - Assessment year 201 1-12 is pending before the ITAT.

13 AGC Networks Limited has been restored by the ITAT to the file of the Assessing Officer in the above said order. We note that in the above said order the ITAT by dealing with the issue has considered the issue elaborately in para 41 to 45. The Tribunal had remitted the issue to the file of the Assessing Officer with certain directions. We have gainfully refer to the Tribunal order as under :-

“41. We have considered rival submissions and perused the material on record. We have also carefully applied our mind to the decisions relied upon before us by both the parties. The factual matrix clearly reveals that the assessee has not changed mercantile system of accounting consistently followed by it from the past years. However, it has changed its revenue recognition policy in the impugned assessment year. It is evident, in the past years, the assessee was recognising revenue on the basis of invoices raised for sales effected and service rendered. However, in the impugned assessment year, the assessee has adopted a new system under which it recognizes revenue on the basis of completion of project and on receiving completion certificate from the customers. Undisputedly, due to the change in revenue recognition policy as aforesaid, quite a substantial part of the revenue, which otherwise would have been shown in the impugned assessment year as per the revenue recognition policy consistently followed, has been deferred to subsequent assessment years which resulted in less profit shown of Rs. 22.83 crore. To justify the change in revenue recognition policy, it is the contention of the assessee that in the year under consideration it has shifted its focus from providing specific voice equipment solutions to converged communication solutions as per the business strategy adopted by its Head Office in USA. It is also submitted that the new revenue recognition policy adopted by the assessee is in tune with similar policy adopted by the Head Office and which is also followed by various other reputed organizations/entities. As per section 145(1) of the Act, income chargeable under the head profits and gains of business and profession has to be computed by employing either cash or mercantile system of accounting regularly employed by the assessee. Of course, sub-section (2) of section 145 of the Act prescribes the Accounting Standards to be followed by any class of assessee or any class of income has to be notified by the Central Government. Whereas, sub- section (3) of section 145 of the Act prescribes that if the Assessing Officer is not satisfied with the correctness or completeness of the accounts of the assessee or where the method of accounting provided in sub-section (1) has not been regularly followed by the assessee or income has not been computed in accordance with Accounting Standard notified under sub-section (2), he may proceed to make an assessment to the best of his judgment as provided under section 144 of the Act.

14 AGC Networks Limited for such change except stating that accounts are to be prepared as per global standard. Further, he has observed that the assessee has not produced any documentary evidence regarding the global standards allegedly followed by it and how it is relevant in the context of Indian Accounting Standard. It is also crucial to bear in mind, as regards Sales Tax and Service Tax the assessee is complying to the statutory requirement in terms with the earlier practice followed by it. In other words, it is paying Sales Tax and Service Tax on the basis of invoices raised towards sales and services.

15 AGC Networks Limited must observe, though it may be a fact that the assessee might have offered or may be offering the income on completion of projects in future years, however, as per assessee's own contention, it is completely dependent upon the completion certificate to be issued by the customers. As regards the decision of the Hon'ble Supreme Court in Excel Industries Ltd. (supra), as could be seen from the facts involved in the aforesaid decision, the income which the revenue wanted to assessee is benefit of duty entitlement to be received by the assessee on certain imports which has not taken place in the relevant assessment year but took place in the subsequent assessment years. The Hon'ble Supreme Court while dealing with the issue of accrual income laid down the following three tests:- i) Whether the income accrued to the assessee is real or hypothetical; ii) Whether there is a corresponding liability of the other party to pass on the benefits of duty free import to the assessee even without any imports having been made; and iii) The probability or improbability of realization of the benefits by the assessee considered from a realistic and practical point of view.

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Order has been pronounced in the Court on 14.1.2020.