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Income Tax Appellate Tribunal, “J” Bench, Mumbai
Before: Shri Pramod Kumar & Shri Ravish Sood
O R D E R
PER RAVISH SOOD, JM
The present appeals filed by the assessee company are directed against the respective orders passed by the A.O under Sec. 143(3) r.w.s.144C(13) of the Income Tax Act, 1961 (for short ‘Act’) for A.Y 2011-12 and A.Y 2012-13. As certain common issues are involved in the said appeals, therefore, they are being taken up together and disposed off by way of a common order. We shall first advert to the appeal of the assessee for A.Y 2011-12. The assessee has assailed the impugned order on the following effective grounds of appeal
before us:- “The appellant objects to the order of the learned Assessing Officer ('AO') dated 30 December 2015 (received on 1 January 2016) passed under Section 144C (13) of the Income tax Act, 1961 ("the Act") read Section 143(3) of the Act, for the aforesaid assessment year on the following among other grounds:
1. Adjustment /Addition to Total Income INR 7,880,245 On the facts and in the circumstances of the case and in law, the learned Transfer Pricing Officer ('TPO') and the learned AO erred in proposing and the Hon'ble Dispute Resolution ITA 995/Mum/2016 – A.Y 2011-12 2 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT Panel ('DRP') further erred in confirming the proposed addition of INR 7,880,245 to the Appellant's total income of INR 198,044,775.
2. Transfer pricing adjustment of INR 68,63,889 on account of royalty shortfall in connection with the international transaction of provision of technical assistance and advisory services 2.1 On the facts and in the circumstances of the case and in law, the learned TPO /AO erred in proposing and the Hon'ble DRP further erred in confirming the proposed addition of INR 68,63,889 to the arm's length price determined by the appellant in respect of the international transaction of provision of technical assistance and advisory services. 2.2. The learned TPO / AO has erred in rejecting and the Hon'ble DRP erred in upholding the action of the learned TPO / AO in rejecting the royalty computation of the Appellant followed consistently over the years as per the legal agreements and in conjunction with the letter of understanding. 2.3 The learned TPO / AO erred in making recomputation and the Hon'ble DRP erred in confirming the action of the learned TPO / AO of recomputing the royalty without appreciating that the methodology followed by the Appellant has been accepted in the previous assessment years by the tax authorities. 2.4 The learned TPO / AO and the Hon'ble DRP failed to appreciate that the margins earned by the Appellant from provision of said services is better than the margin earned by the comparable companies as per the TP documentation. Accordingly, the transaction is at arm's length and no further adjustment is warranted. 2.5 The learned TPO/AO and the Hon’ble DRP failed to appreciate that the Appellant being and Indian multinational ploughs back the money into India. 2.6 The learned TPO / AO and the Hon'ble DRP erred in not appreciating that the learned TPO erred in passing the Transfer Pricing Order' without following the principles of natural justice.
3. Transfer pricing adjustment of INR 10,16,356 on account of shortfall in recovery of supplying samples needs to be deleted: 3.1 On the facts and in the circumstances of the case and in law, the learned TPO /AO erred in proposing and the Hon'ble DRP further erred in confirming the proposed addition of INR 10,16,356 to the arm's length price determined by the appellant in respect of recovery of supplying samples. 3.2 The learned TPO / AO erred in comparing and the Hon'ble DRP erred in confirming the approach of the learned TPO / AO of comparing the activity of recovery towards samples not picked up / purchased by the Associated Enterprise (AE) with routine trading business activity. 3.3. The learned TPO / AO and the Hon'ble DRP failed to appreciate that the Appellant being an Indian multinational ploughs back the money into India. 3.4 The learned TPO / AO has erred in comparing and the Hon'ble DRP erred in confirming the approach of the learned TPO / AO of comparing margins of controlled transactions i.e., mark-up on cost of samples (fabrics) charged to AE with the gross profit on cost earned by Appellant from its AE trading segment. 3.5 The learned TPO /AO and the Hon'ble DRP failed to appreciate that even if the recovery of samples were to be considered as routine trading activity, the same should be merged with normal trading activity of AE segment for the purpose of benchmarking.
ITA 995/Mum/2016 – A.Y 2011-12 3 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT 4. Initiation of penalty proceedings under section 271(1)(c) of the Act The learned AO has erred in both in laws and on facts, in initiating penalty proceedings under section 271(1)(c) of the act against the appellant. 5. Each one of the above grounds of appeal is without prejudice to the other.
6. The appellant reserves the right to amend, alter or add to the grounds of appeal.”
2. Briefly stated, the assessee company which is engaged in the business of manufacturing and trading of clothing and cloth accessories viz. shirts, neckties, trousers, accessories like cufflinks, belts, wallets etc. had e-fled its return of income for A.Y 2011-12 on 30.11.2011, declaring its total income at Rs. 19,80,44,775/-. The return of income filed by the assessee was processed as such under Sec. 143(1) of the Act. Subsequently, the case of the assessee was selected for scrutiny assessment under Sec. 143(2) of the Act.
During the course of the assessment proceedings the A.O made a reference under Sec. 92CA(1) of the Act to the Additional Commissioner of Income-tax (Transfer Pricing)–4(3), Mumbai (for short. ‘TPO’). On a perusal of the TP Study report, it was observed by the TPO that the assessee had during the year entered into the following international transactions with its Associated Enterprise (for short, ‘AE’) :
Sr. No. Nature of Transaction Amount Method used by assessee (in Rs.) 1. Export of finished goods 33,00,87,561/- TNMM 2. Export of traded goods 9,12,59,010/- TNMM 3. Technical Know-How received (royalty) 1,41,46,995/- TNMM 4. Payment of Marketing Services (Commission) 1,10,33,766/- CUP 5. Recovery of expenses 86,16,123/- ----- 6. Reimbursement of expenses 82,58,353/- -----
It was observed by the TPO that the assessee during the year had received technical know-how fees from its AE viz. M/s Zodiac Clothing Company, UAE LLC. On a perusal of the financials of the AE, it was noticed by the TPO that technical know-how fees was charged by the assessee only on the manufacturing sales of the AE. Further, it was gathered by the TPO that the ITA 995/Mum/2016 – A.Y 2011-12 4 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT assessee had not charged any technical know-how fees on the manufacturing sales (as per the buyers specifications) and trading sales. On a perusal of the ‘agreement’ of the assessee with its AE for provision of technical know-how services, it was observed by the TPO that it nowhere provided that the fees was only to be charged on the manufacturing sales of the assessee. On being called upon to explain as to why such fees was not charged in respect of the other items of income of the AE, the assessee filed with the TPO a letter dated 02.01.2003 of the AE. As per the letter, it was stated by the AE that it would not require technical assistance/services/advice as regards its supply to the local market in the middle east. As such, it was stated that the royalty was to be paid only for manufacturing sales to other markets only. However, the TPO was not inclined to accept the aforesaid explanation of the assessee. Observing, that while for the letter relied upon by the assessee was dated 02.01.2003, the royalty ‘agreement’ submitted during the course of the proceedings was signed on 04.04.2008, it was noticed by the TPO that there was no mention in the ‘agreement’ about the exclusion of any area or services as was claimed by the assessee before him. On the basis of his aforesaid deliberations, the TPO worked out the ‘royalty’ @3% on the entire sales of Rs. 700,362,813/- of the AE. Accordingly, the TPO worked out an adjustment of Rs. 68,63,889/- towards shortfall in ‘royalty’ charged by the assessee on its AE.
Further, in the course of the proceedings it was observed by the TPO that the assessee had recovered from its AE. viz. M/s Zodiac Clothing Company, UAE LLC an amount of Rs. 86,16,123/-, of which Rs. 56,08,743/- was on account of cost of samples and the balance amount was towards freight cost. On a perusal of the records, it was observed by the TPO that the assessee company on a regular basis was buying fabrics for samples on behalf of its AE. It was noticed by the TPO, that the assessee had charged 7.5% on cost of samples (after recovering the salvage value) as mark-up on the said transactions. Observing, that gathering of samples which was a pre-requisite for a successful textile business which was the main/core activity of the assessee company, the TPO was of the view that the assessee should have charged an appropriate mark-up. On a perusal of the segmental profitability of the trading segment (AE) of the assessee, it was noticed by the TPO that the gross profit on cost earned by the assessee was 26.98%. The TPO observing that the assessee was by way of regular transactions buying fabrics ITA 995/Mum/2016 – A.Y 2011-12 5 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT for samples on behalf of its AE, therefore, was of the view that the gross profit (on trading segment) of 26.98% of the assessee could safely be applied for determining the ALP of the aforesaid transaction under consideration. Accordingly, the TPO by applying a gross margin rate of 26.98%, carried out an adjustment of Rs. 10,16,356/- towards shortfall of the amount recoverable by the assessee on account of supplying of samples to its AE.
The A.O after receiving the order of the TPO under Sec. 92CA(3) of the Act, dated 30.01.2015, therein passed a draft assessment order under Sec. 144C(1) r.w.s 143(3), dated 25.02.2015. After inter alia proposing a TP adjustment of Rs. 78,80,246/- [Rs. 68,63,889/- (+) Rs. 10,16,356/-], the A.O assessed the income of the assessee company at Rs. 22,38,66,940/-.
Aggrieved, the assessee objected to the aforesaid proposed TP adjustments before the Dispute Resolution Panel-2, Mumbai (for short, ‘DRP’). The DRP not finding favour with the contentions advanced by the assessee, therein inter alia vide its order passed u/s 144(5), dated 29.10.2015 upheld the TP adjustments that were proposed by the A.O/TPO.
The A.O after receiving the order passed by the DRP under Sec. 144(5), dated 29.10.2015, therein passed the final assessment order under Sec. 144C(13) r.w.s 143(3), dated 30.12.2015, and assessed the income of the assessee company at Rs. 22,38,66,940/-.
Aggrieved, the assessee has assailed the final assessment order passed by the A.O under Sec. 144C(13) r.w.s 143(3), dated 30.12.2015 in appeal before us. We have heard the authorised representatives for both the parties, perused the orders of the lower authorities and the material available on record. Our indulgence in the present appeal has been sought by the assessee to adjudicate the sustainability of the orders of the lower authorities on two aspects, viz (i). that, as to whether the A.O/TPO are right in working out the ‘royalty’ @3% on the entire sales of Rs. 700,362,813/- of the AE, therein resulting into an adjustment of Rs. 68,63,889/- towards shortfall in ‘royalty’ charged by the assessee from its AE; and (ii). that, as to whether the A.O/TPO are justified in adopting the gross margin rate of 26.98% (trading segment-AE) of the assesee and making an ITA 995/Mum/2016 – A.Y 2011-12 6 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT adjustment of Rs. 10,16,356/- towards shortfall of the amount recoverable by the assessee on account of supply of samples to its AE.
We shall first advert to the working of the ‘royalty’ @3% on the entire sales of Rs. 700,362,813/- of the AE by the TPO, which therein had resulted into an adjustment of Rs. 68,63,889/- towards shortfall in ‘royalty’ charged by the assessee from its AE. As is discernible from the orders of the lower authorities, the assessee during the year had provided technical assistance and services to its AE, viz. M/s Zodiac Clothing Company, UAE LLC. In the course of providing of the aforesaid services the assessee had carried out certain functions viz. (i). participation in meetings with customers, if required; (ii). display of products at international fairs and exhibitions; (iii). product development; (iv). preparation and approval of samples and prototypes of garments and fabrics; (v). sourcing/vendor development; (vi). advice on production systems; (vii). providing patterns and optimum fabric utilisation drawings; (viii). advice on quality control; (ix). advice for banking, forex transactions and documentation; (x). advice for financial control systems; and (xi). providing any other technical assistance as may be required in the course of the manufacturing of readymade garments. As observed by the TPO, the assessee was in receipt of technical know-how fees only on the manufacturing sales of the AE, viz. M/s Zodiac Clothing Company, UAE LLC. On being called upon to explain that as to why ‘royalty’ was not received in respect of the other items of income of the AE viz. manufacturing sales (as per the buyers specifications) and trading sales, the assessee had drawn support from a letter dated 02.01.2003 of the AE. In the letter, it was stated by the AE that it would not require technical assistance/services/advice as regards its supply to the local market in the middle east. As the royalty ‘agreement’ that was submitted during the course of the proceedings was signed on 04.04.2008, therefore, the TPO declined to take cognizance of the aforesaid letter dated 02.01.2003 of the AE. Observing, that there was no mention in the aforesaid ‘agreement’ about the exclusion of any area or services as was claimed by the assessee before him, the TPO worked out the ‘royalty’ @3% on the entire sales of Rs. 700,362,813/- of the AE and made a consequential adjustment of Rs. 68,63,889/- in the hands of the assessee.
ITA 995/Mum/2016 – A.Y 2011-12 7 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT 11. It is the claim of the ld. A.R, that the assessee had initially entered into an ‘agreement’, dated 09.11.2002 with its AE ,viz. M/s Zodiac Clothing Company, UAE LLC, as per which the assessee was to provide technical know-how services for efficient carrying on and running of the activities of manufacturing of readymade garments by its AE. Accordingly, royalty was to be charged only on the manufacturing sales and not on trading sales. For the sake of clarification, the assessee also had a letter of understanding dated 02.01.2003 with its AE ,viz. M/s Zodiac Clothing Company, UAE LLC, wherein it was clarified that the AE did not require technical assistance/services/advice for supply to the local market in the Middle East (gulf region i.e GCC Countries), since the local customers provided the specifications, technical control and quality control. As such, it was the claim of the ld. A.R that the assessee based on the ‘agreement’ dated 09.11.2002 and the letter of understanding dated 02.01.2003 was consistently over the years in receipt of the fees for technical assistance and advisory services rendered by it to its AE. It is the claim of the ld. A.R, that after the expiry of the five year period of the ‘agreement’ dated 09.11.2002, the assessee had renewed the ‘agreement’ on 05.04.2008, with the same terms and conditions. Further, the assessee had revised the ‘royalty’ rates from 2.5% to 3% vide a letter dated 06.05.2008, with the same terms and conditions. As observed by us hereinabove, the assessee during the year under consideration was in receipt of ‘royalty’ of Rs. 1,41,46,995/- [@3% of Rs. 46,71,99,282/- i.e the manufacturing sales-export].
We have given a thoughtful consideration to the issue before us and find substantial force in the contentions advanced by the ld. A.R. In our considered view, there is substance in the claim of the ld. A.R that the ‘agreement’ dated 04.04.2008 between the assessee and its AE, viz. M/s Zodiac Clothing Company, UAE LLC, was merely an extension of the earlier ‘agreement’ dated 09.11.2002, with the same terms and conditions. Also, we are persuaded to subscribe to the claim of the ld. A.R that the letter of understanding dated 02.01.2003 between the assessee and its AE, viz. M/s Zodiac Clothing Company, UAE LLC., was valid and was required to be considered in conjunction with the ‘royalty’ agreement dated 04.04.2008, which clearly provided that the ‘royalty’ was to be received by the assessee on the AE’s manufacturing sales to other markets i.e excluding the gulf region. In fact, as claimed, the ‘royalty’ was consistently being received by the assessee on ITA 995/Mum/2016 – A.Y 2011-12 8 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT the manufacturing sales-exports of its AE, viz. M/s Zodiac Clothing Company, UAE LLC. On the basis of our aforesaid deliberations, we are of the considered view that on a conjoint reading of the ‘agreement’ dated 04.04.2008 (which is a renewal of the earlier ‘agreement’ dated 09.11.2002) and the letter of understanding dated 02.01.2003, the ‘royalty’ /fees for technical know-how was to be received by the assessee only on the manufacturing sales (export) of Rs. 46,71,99,283/-[i.e AED 3,79,66,396/-]. Accordingly, we direct the A.O/TPO to delete the TP adjustment of Rs. 68,63,889/- that was made in the hands of the assessee on account of ‘royalty’ shortfall in respect of its international transaction of provision of technical assistance and advisory services to its AE, viz. M/s Zodiac Clothing Company, UAE LLC.
We shall now advert to the claim of the Ld. A.R, that the A.O/TPO had erred in adopting the gross margin rate of 26.98% (trading segment-AE) of the assessee and making an adjustment of Rs. 10,16,356/- towards shortfall of the amount recoverable on account of supply of samples to its AE. As observed by us hereinabove, the assessee company on a regular basis was buying fabrics for samples on behalf of its AE. It was noticed by the TPO, that the assessee had charged 7.5% mark-up on the cost of samples (after recovering the salvage value). .Being of the view, that gathering of samples which was a pre-requisite for a successful textile business, was the main/core activity of the assessee company, the TPO held a conviction that the assessee should have charged an appropriate mark-up. Observing, that the assesse’s trading segment revealed a gross profit on cost of 26.98%, the TPO was of the view that the same could safely be adopted for determining the ALP of the aforesaid international transaction of the assessee. Accordingly, the TPO applied the gross margin rate of 26.98% and carried out an adjustment of Rs. 10,16,356/- towards shortfall of the amount recoverable by the assessee on account of supply of samples to its AE.
As is discernible from the records, the assessee procured the fabrics from third party in India for its AE in UAE. If the fabrics were not exported to the AE, it would be sold to a third party in India and the difference, if any, would be recovered from the AE. For carrying out the sampling activity, the costs therein involved would be recovered by the assessee from the AE, for which the assessee would raise a mark-up of 7.5% (after recovering the salvage value) on its AE. The ITA 995/Mum/2016 – A.Y 2011-12 9 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT assessee would recover the cost plus mark-up of 7.5% on the cost of the samples (after recovering of the salvage value), that were not picked up by the AE. During the year under consideration, the assessee had recovered from its AE, viz. M/s Zodiac Clothing Company, UAE LLC an amount of Rs. 86,16,123/-, of which Rs. 56,08,743/- was on account of sale of samples and the balance amount was towards freight cost.
We have given a thoughtful consideration to the aforesaid issue before us and are unable to persuade ourselves to subscribe to the comparison of mark-up of 7.5% on cost of samples (fabrics) charged by the assessee on its AE with the segmental profitability of trading segment i.e gross profit on cost of 26.98%(average) earned by the assessee from its AE segment. In our considered view the 7.5% mark-up (after recovering the salvage value) of the samples that were not picked up by the AE was charged by the assessee to cover the cost involved in the sampling activity or as a penalty. Be that as it may, no feasible comparison could have been made between the mark-up of 7.5% on cost of samples (after recovering salvage value) and the segmental profitability of trading segment of 26.98% i.e gross profit on cost, for determining the ALP of the aforesaid transaction. Apart from that, we find that the TPO had erroneously compared the margins of the controlled transaction i.e mark-up of 7.5% on cost of samples (fabrics) charged to A.E with the segmental profitability of the trading segment of 26.98% (average) of the AE segment. Aforesaid comparability analysis carried out by the TPO, wherein he has compared the margins of controlled transactions is fundamentally incorrect and defeats the very purpose of determining the arm’s length price. In fact, the TPO was obligated to have made a comparison between controlled transactions and uncontrolled transactions i.e margins from transactions with AE and margins from transactions with third parties i.e non-AE’s, which we find he had failed to do. Accordingly, in our considered view for both of the aforesaid reasons the adjustment of Rs. 10,16,356/- made by the A.O/TPO towards shortfall of the amount recoverable by the assessee on account of supply of samples to its AE cannot be sustained and is liable to be vacated. We thus in terms of our aforesaid observations direct the A.O/TPO to delete the addition of Rs. 10,16,356/-. The Ground of appeal No. 3 is allowed.
ITA 995/Mum/2016 – A.Y 2011-12 10 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT 16. The assessee has assailed before us the initiation of penalty proceedings under Sec. 271(1)(c) of the Act. As the Ground of appeal
No. 4 assailing the initiation of penalty u/s 271(1)(c) is premature, therefore, the same is dismissed.
17. The Grounds of appeal Nos. 5 & 6 being general in nature are dismissed as not pressed.
18. Resultantly, the appeal of the assessee for A.Y 2011-12 in is allowed in terms of our aforesaid observations. A.Y 2012-13
19. We shall now advert to the appeal of the assessee for A.Y 2012-13. The assessee has assailed the impugned order on the following grounds of appeal : “The Appellant objects to the order of the learned Assessing Officer ('AO') dated 31 October 2016 (received on 10 November 2016) passed under Section 143(3) read with Section 92CA and Section 144C (13) of the Income tax Act, 1961 ("the Act"), for the aforesaid assessment year on the following among other grounds:
1. Adjustment /Addition to Total Income INR 93,871,430 On the facts and in the circumstances of the case and in law, the learned Transfer Pricing Officer ('TPO') and the learned AO erred in proposing and the Hon'ble Dispute Resolution Panel ('DRP') further erred in confirming the proposed addition of INR 9,795,413 to the Appellant's total income of INR 84,076,020.
2. Transfer pricing adjustment of INR 9,297,422 on account of royalty shortfall in connection with the international transaction of provision of technical assistance and advisory services 2.1 On the facts and in the circumstances of the case and in law, the learned TPO / AO erred in proposing and the Hon'ble DRP further erred in confirming the proposed addition of INR 95297,422 to the arm's length price determined by the Appellant in respect of the international transaction of provision of technical assistance and advisory services to Associated Enterprise's ('AE') 2.2. The learned TPO / AO has erred in rejecting and the Hon'ble DRP erred in upholding the action of the learned TPO / AO in rejecting the royalty computation of the Appellant followed consistently over the years as per the terms of agreements and read in conjunction with the letter of understanding. 2.3. The learned TPO / AO erred in making recomputation and the Hon'ble DRP erred in confirming the action of the learned TPO / AO of recomputing the royalty without ITA 995/Mum/2016 – A.Y 2011-12 11 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT appreciating that the methodology followed by the Appellant had been accepted in the previous assessment years by the tax authorities.
2.4. The learned TPO / AO and the Hon'ble DRP failed to appreciate that commercial expediency / requirement of the AE business needs to be considered.
2.5. The learned TPO/AO and the Hon’ble DRP failed to appreciate that the margin earned by the appellant from provision of said services is better than the margin earned by the comparable companies as per the Transfer Pricing (‘TP’) documentation. Accordingly, the transaction is at arm’s length and no further adjustment is warranted. 2.6. Without prejudice to the above, the learned TPO/AO erred in computing the royalty in respect of sale of garments not manufactured by the AE. 2.7. The learned TPO / AO and the Hon'ble DRP failed to appreciate that the Appellant being an Indian multinational ploughs back the money into India.
2.8. The learned TPO / AO and the Hon'ble DRP erred in not appreciating that the learned TPO erred in passing the Transfer Pricing Order without following the principles of natural justice.
3. Corporate Tax adjustment of INR 497,991 on account of disallowance under Section 14A 3.1. The learned AO has erred in disallowing and the Hon'ble DRP erred in upholding the action of the learned AO in disallowing amount of INR 8,54,221/- u/s l4A read with Rule 8D as against INR 3,56,230/- offered for disallowance by the Appellant. 3.2 The learned AO erred in applying Rule 8D and the Hon'ble DRP erred in confirming the action of the learned AO in applying Rule 8D without giving any finding by the AO to the effect that he was not satisfied with the correctness of the amount offered for by the Appellant for disallowance u/s. 14A of the Income Tax Act, 1961. 3.3. The learned AO erred in making and the Hon'ble DRP erred in confirming the action of the learned AO in recomputing the disallowance uls.14A without appreciating that the methodology followed by the Appellant has been accepted in the previous assessment years by the tax authorities.
4. Initiation of penalty proceedings under section 271(1)(c) of the Act The learned AO has erred in both in law and on facts, in initiating penalty proceedings under section 271(1)(c) of the Act against the Appellant.
5. Each one of the above grounds of appeal
is without prejudice to the other
6. The appellant reserves the right to amend, alter or add to the ground of the appeal.”
ITA 995/Mum/2016 – A.Y 2011-12 12 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT 20. Briefly stated, the assessee company had e-fled its return of income for A.Y 2012-13 on 30.11.2012, declaring a total income of Rs. 8,40,76,020/-. Subsequently, the case of the assessee was selected for scrutiny assessment under Sec. 143(2) of the Act.
During the course of the assessment proceedings, the A.O made a reference under Sec. 92CA(1) of the Act to the Additional Commissioner of Income-tax (Transfer Pricing)–4(3), Mumbai (for short. ‘TPO’). On a perusal of the TP Study report, it was observed by the TPO that the assessee had during the year entered into the following international transactions with its AE :
Sr. No. Nature of Transaction Amount (in Rs.) 1. Export of finished goods 32,35,15,126/- 2. Export of traded goods 9,77,65,316/- 3. Technical Know-How received (royalty) 1,41,49,621/- 4. Payment of Marketing Services (Commission) 1,36,85,494/- 5. Recovery of expenses 1,14,67,404/- 6. Reimbursement of expenses 13,79,669/-
The TPO vide his order passed under Sec. 92CA(3), dated 18.01.2016, made an adjustment of Rs. 92,97,422/- to the ALP of the fees for technical know-how received by the assessee from its AE, viz. M/s Zodiac Clothing Company UAE LLC.
The A.O after receiving the order of the TPO under Sec. 92CA(3) of the Act, dated 18.01.2016, therein passed a draft assessment order under Sec. 143(3) r.w.s 144C(1), dated 31.03.2016. The A.O proposed a TP adjustment of Rs. 92,97,422/- towards the ALP of the fees for technical know-how received by the assessee from its AE, viz. M/s Zodiac Clothing Company UAE LLC. Also, the A.O sought to make a further disallowance u/s 14A of Rs. 4,97,991/-. On the basis of his aforesaid deliberations the A.O proposed to assess the income of the assessee company at Rs. 9,38,71,430/-.
Aggrieved, the assessee objected to the aforesaid proposed TP adjustments before the Dispute Resolution Panel-2, Mumbai (for short, ‘DRP’). The DRP not finding favour with the ITA 995/Mum/2016 – A.Y 2011-12 13 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT contentions advanced by the assessee, therein inter alia vide its order passed u/s 144(5), dated 29.10.2015 upheld the TP adjustment proposed by the A.O/TPO. Also, the disallowance u/s 14A made by the A.O was also affirmed by the DRP.
The A.O after receiving the order passed by the DRP under Sec. 144(5), dated 29.09.2016, therein passed the final assessment order under Sec. 143(3) r.w.s 144C(13), dated 31.10.2016 and assessed the income of the assessee company at Rs. 9,38,71,430/-. 26. Aggrieved, the assessee has assailed the final assessment order passed by the A.O under Sec. 143(3) r.w.s 144C(13), dated 29.09.2016, in appeal before us. 27. We have heard the authorised representatives for both the parties, perused the orders of the lower authorities and the material available on record. As regards the adjustment of Rs. 92,97,422/- made by the A.O/TPO to the ALP of the fees for technical know-how received by the assessee from its AE viz. M/s Zodiac Clothing Company UAE LLC, we find, that as the facts and the issue therein involved remains the same as were there before us in the appeal of the assessee for the immediately preceding year i.e A.Y 2011-12, therefore, our order therein passed while disposing off the ‘Ground of appeal No. 2’ in the said appeal, would apply mutatis mutandis for the disposal of the Ground of appeal No. 2 in the present appeal of the assessee for A.Y 2012-13 in ITA No. 106/Mum/2013. Accordingly, the Ground of appeal No. 2 is allowed on the same terms.
28. We shall now advert to the claim of the assessee that the A.O had erred in working out the disallowance under Sec.14A at Rs. 8,54,221/-. On a perusal of the orders of the lower authorities, we find, that the assessee company had received an exempt dividend income of Rs. 2,13,32,278/- during the year under consideration. In its return of income for the year under consideration, the assessee had on a suo-motto basis offered a disallowance of an amount of Rs. 3,56,230/- under Sec. 14A of the Act. As claimed by the assessee, the aforesaid disallowance u/s 14A of Rs. 3,56,230/- comprised of viz. (i). salary of one employee : Rs. 3,09,765/-; and (ii). administrative expenses: Rs. 46,465/-. However, the A.O in the course of the assessment proceedings was not inclined to accept the aforesaid claim of disallowance of the assessee. Observing, that the disallowance u/s 14A was to be worked out as per the methodology prescribed in Rule 8D of the ITA 995/Mum/2016 – A.Y 2011-12 14 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT Income-tax Rules, 1963, the A.O worked out the same at Rs. 8,54,221/-. The disallowance of Rs. 8,54,221/- worked out by the A.O under Sec. 14A r.w Rule 8D comprised of viz. (i). disallowance of interest expenditure U/rule 8D(2)(ii) : Rs. 3,19,476/-; and (ii). disallowance of administrative expenses U/rule 8D(2)(iii) : Rs. 5,34,745/-. Objection of the assessee as regards working of the aforesaid disallowance under Sec. 14A r.w Rule 8D was rejected by the DRP.
29. Aggrieved, the assessee had assailed the substitution of the disallowance under Sec. 14A of Rs.3,56,230/- that was on a suo motto basis offered by the assessee in its return of income, by an amount of Rs. 8,54,221/- by the A.O. It was submitted by the ld A.R, that as the assessee had sufficient own funds which justified the source of the investments made in the exempt income yielding assets, therefore, no disallowance of any part of the correlating interest expenditure was called for under Sec. 14A r.w Rule 8D(2)(ii). In order to drive home his aforesaid contention, the ld. A.R had relied on the judgment of the Hon’ble High Court of Bombay in the case of CIT Vs HDFC Bank Ltd. (2014) 366 ITR 505 (Bom).
30. Per contra, the ld. D.R relied on the orders of the lower authorities. It was submitted by the ld. D.R that the A.O had rightly worked out the disallowance under Sec. 14A as per the methodology prescribed in Rule 8D.
We have given a thoughtful consideration to the aforesaid issue before us and find substantial force in the claim of the ld. A.R. As observed by us hereinabove, it is the claim of the ld. A.R that as the assessee had sufficient own funds which would justify the investments made in the exempt income yielding assets, therefore, no disallowance of any part of the correlating interest expenditure was called for under Sec. 14A r.w Rule 8D(2)(ii). In our considered view, the aforesaid claim of the ld. A.R is principally fortified by the order of the Hon’ble High Court of Bombay in the case of CIT Vs HDFC Bank Ltd. (2014) 366 ITR 505 (Bom). In the said case, it was observed by the Hon’ble High Court that where the assesse's capital, profit reserves, surplus and current account deposits were higher than the investment in tax-free securities, it would have to be presumed that investment made by the assessee would be out of the interest-free funds available with assessee and no disallowance would be warranted u/s 14A. Although we are principally in ITA 995/Mum/2016 – A.Y 2011-12 15 TP(A) 106/Mum/2017- A.Y 2012-13 Zodiac Clothing Company Limited vs. ACIT agreement with the aforesaid claim of the ld. A.R, however, in the absence of the facts and figures in support of the said claim, we refrain from adjudicating the same. Accordingly, we restore the issue to the file of the A.O, who shall after verifying the veracity of the aforesaid claim of the assessee, therein readjudicate the same. In case, the assesse's capital, profit reserves, surplus and current account deposits are found to be higher than its investment in tax-free securities, then the disallowance of the interest expenditure made by the A.O under Sec. 14A r.w Rule 8D(2)(ii) shall stand vacated. Needless to say, the A.O shall in the course of the ‘set aside’ proceedings afford a reasonable opportunity of being heard to the assessee. The Ground of appeal
No. 3 is allowed for statistical purpose.
32. The assessee has assailed before us the initiation of the penalty proceedings under Sec. 271(1)(c) of the Act. As the Ground of appeal No. 4 assailing the initiation of penalty u/s 271(1)(c) is premature, therefore, the same is dismissed.
33. The Grounds of appeal Nos. 5 & 6 being general in nature are dismissed as not pressed.
34. Resultantly, the appeal of the assessee for A.Y 2012-13 in is allowed in terms of our aforesaid observations.
The appeal of the assessee for A.Y 2011-12 in is allowed, while for that for A.Y 2012-13 in is allowed for statistical purposes in terms of our aforesaid observations.