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Income Tax Appellate Tribunal, “A” BENCH : BANGALORE
Before: SHRI N. V. VASUDEVAN & SHRI JASON P. BOAZ
Per Jason P. Boaz, Accountant Member
These are cross appeals, by the assessee and Revenue, directed against the final order of assessment dated 19.01.2015 for Assessment Year 2010-11 passed u/s 143(3) r.w.s. 144C of the Income Tax Act, 1961 (in short ‘the Act’), pursuant to the directions issued by the Dispute Resolution Panel-II (DRP), Bangalore, under section 144C(5) of the Act on 26.12.2014.
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 2 of 24 2. Briefly stated, the facts of the case are as under:
2.1 The assessee is a company engaged in the business of design and manufacture of servo control and precision components for its Associated Enterprises (AE) which are used in aviation industry, space industry and industrial controls divisions, etc. For Assessment Year 2010-11, the assessee filed its return of income on 07.10.2010 declaring a loss of (-)Rs.1,83,75,992/-. The return was processed under section 143(1) of the Act and the case was subsequently taken up for scrutiny for this Assessment Year. A reference under section 92CA of the Act was made by the Assessing Officer (AO) to the Transfer Pricing Officer (TPO) for determination of the arms length price (ALP) of the international transactions entered into by the assessee in the year under consideration. The TPO passed an order under section 92CA of the Act dated 30.01.2014 proposing an adjustment of Rs.7,26,12,896/- to the international transactions in the manufacturing segment of the assessee company. After receipt of the TPO’s order under section 92CA of the Act, the AO passed the draft order of assessment under section 144C of the Act dated 10.03.2014 wherein the assessee’s income was determined at Rs.5,87,24,278/- by making various additions / disallowances, including the TP adjustment of Rs.7,26,12,896/-.
2.2 Aggrieved by the draft order of assessment dated 10.03.2014 for Assessment Year 2010-11, the assessee filed its objections thereto before the DRP. The DRP issued its directions thereon under section 144C(5) of the Act dated 26.12.2014 and pursuant thereto, the AO passed the final order of assessment under section 143(3) r.w.s. 144C of the Act dated 19.01.2015 wherein the assessee’s income was determined at Rs.5,50,37,765/-.
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 3 of 24 3. Both, the assessee and Revenue, being aggrieved by the final order of assessment dated 19.01.2015 for Assessment Year 2010-11, have filed cross appeals to the extent issues have been held against them. These cross appeals are being disposed off hereunder in seriatim.
Assessee’s appeal in IT(TP)A No.412/Bang/2015 for Assessment Year 2010-11 4.1 In its appeal, the assessee has raised the following grounds of appeal:-
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 4 of 24
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 5 of 24 Additional ground of appeal No.6A 4.2.1 Vide letter dated 11.06.2019, the assessee filed a petition for admission of additional ground No.6A which reads as under:-
“6A The learned Transfer Pricing Officer (TPO) and Hon’ble Dispute Resolution Panel (DRP) has erred in computing the capacity utilized by the Appellant”.
4.2.2 In its petition seeking admission of the aforesaid additional ground No.6A (supra), the assessee has assigned the following reasons for raising the same; which are extracted hereunder:-
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 6 of 24 4.2.3 Per contra, the learned DR for Revenue opposed the admission of additional ground No.6A.
4.2.4 We have considered the rival contentions / submissions in respect of the assessee’s plea for admission of additional ground No.6A on the issue of adjustment towards capacity utilization and the erroneous manner of computation thereof in addition to ground No.6 on the issue of adjustment towards capacity utilization. Taking into account the facts and circumstances of the case on the issue of admission of additional ground raised in respect of the erroneous computation of capacity under utilization made by the TPO, we
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 7 of 24 are of the view that the same is to be admitted for consideration and adjudication as it is both a factual and legal issue which can be disposed off on the basis of material already available on the records of the Department. In this view of the matter and respectfully following the principles laid down by the Hon’ble Apex Court in the case of NTPC Ltd., Vs. CIT (229 ITR 383) (SC), we admit this additional ground No.6A for consideration and adjudication in this appeal.
TRANSFER PRICING (TP)
5.0 Before proceeding to dispose off the grounds of appeal, the brief facts related to ‘TP’ issues are summarized hereunder:-
5.1 The assessee, a company engaged in the design and manufacture of servo control mechanisms and precision components, reported two segments of operation, namely; (1) manufacturing segment and (2) software developing services segment reporting margins of (-) 7.45% and 14.10% respectively. The TPO, on examination thereof, accepted the margins of the international transactions in the Software Development Services segment as being at arms length.
5.2 In respect of the manufacturing segment, the assessee had conducted a TP Analysis / Study and selected 4 companies as comparables with the average margin of 13.71%. After computing capacity utilization adjustment, the assessee concluded that its margins in the manufacturing segment were at arms length. The TPO accepted the TP Analysis of the assessee and also the set of comparable companies selected by the assessee; except for 1 company i.e., NGEF (Hubli) Ltd., which was rejected because it was a government company. The TPO also rejected the assessee’s claim of capacity utilization adjustment
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 8 of 24 and computed a TP adjustment of Rs.7,26,12,896/-. The DRP upheld the action of the TPO and therefore the assessee is in appeal before us.
Ground Nos.1 to 5 and 8 (TP issues)
6.1 At the outset of appeal proceedings, the learned AR for the assessee submitted that out of the eight grounds raised on TP issues, the assessee would only be pressing ground Nos.6, Additional ground No.6A related to capacity utilization and ground No.7 exclusion of the company NGEF (Hubli) Ltd., as a comparable company. In these circumstances, as laid out above, ground Nos.1 to 5 and 8. (supra), not being pressed by the assessee in its appeal, are rendered infructuous and are accordingly dismissed as not pressed.
Ground No.6 Under utilization of capacity Additional Ground No.6A 7.1.1 In these grounds / additional ground (supra), the assessee contends that the TPO erred in not appreciating the fact that the losses incurred by the assessee in the manufacturing segment was mainly due to under utilization of capacity and that both the TPO and DRP had erred in computing the capacity utilized by the assessee.
7.1.2 According to the learned AR, the TPO had denied the assessee capacity utilization adjustment, not because it was not applicable, but because the TPO found that the capacity utilization of the assessee, as given in Appendix – 9 of the TP Study was 72.40% as against 76.43% of the comparable companies and since there was not much difference between the two, capacity utilization adjustment was not warranted. In this regard, the learned AR submitted that the TPO has misunderstood the chart at Appendix – 9 of the TP Study and IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 9 of 24 misinterpreted the same. It was submitted that the chart at Appendix – 9, contained the details of three products, out of which motors is the main product manufactured by the assessee and the other two, namely Coils and Parts are incidental products as can be seen from the price of these products. The installed capacity of all three products put together is 5,00,000 units; out of which the installed capacity of motors was only 38,000 units and the actual production was 14,108 units, which amounts to capacity utilization of only 37.13%. The capacity utilization of Coils and Parts was 68.12% and 76.80% respectively. It is submitted that while the average mean of the three was 72.40%, the weighted mean of the same was 41.40%.
7.1.3 The learned AR submitted that the TPO was wrong in applying the average mean of the capacity utilization of all the three, thereby assigning equal weightage to all the three main products i.e., motors, coils and the parts which are incidental. The learned AR contends that the capacity utilization of motors only should have been considered or at best, the weighted mean of the products should have been considered by the TPO.
7.2 Per contra, the learned DR for Revenue vehemently supported the action / treatment of the TPO with regard to the issue of capacity utilization. According to the learned DR, the installed capacity as given in the Notes to the Annual Report is 5,00,000 units and the break-up as given in the chart at Appendix – 9 of the assessee’s TP study is not verifiable from the Annual Report and is therefore not reliable. It was also submitted that the under utilization of capacity gets reflected in non-absorption of costs which is not ascertainable from the details in the Annual Report and hence the assessee’s claim of capacity utilization adjustment is not verifiable.
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 10 of 24 7.3.1 We have considered the rival contentions and perused the material on record. It is a settled principle, upheld in the decisions of several Hon’ble Courts / Tribunals, that adjustment for under utilization of capacity can be granted; provided the under utilization of capacity viz-a-viz the comparable companies is established with evidence. In the case on hand, admittedly, the assessee has given the details of capacity utilization of the assessee and that of its comparable companies at Appendix – 9 and 10 of its TP Study. The TPO has examined the same, in the course of proceedings referred to him under section 92CA of the Act and has apparently accepted the veracity of the numbers mentioned therein, as he has quoted from the above Charts / Appendix (supra). Since the TPO has himself accepted the figures / numbers stated in the Appendix – 9 and 10, the figures stated therein cannot be doubted at this stage.
7.3.2 In our view, the only difference between the contentions of the assessee and the TPO was on whether the mean average of capacity utilization should be adopted or whether the capacity utilization of only Motors should be adopted. In the factual matrix of the case, as discussed above, we find merit in the contentions put forth by the learned AR of the assessee that the capacity utilization of only the main product, i.e., the Motors, should be considered. The other two components, namely, coils and parts, in our considered opinion, are only incidental components and cannot by any stretch of imagination be equated and treated on par with the main product, i.e., Motors. The installed capacity of Motors, Coils and Parts are 38,000, 80,000 and 3,82,000 respectively, whereas the price of these are Rs.18,426/- per motor, Rs.312/0 per coil and Rs.172/- per part. In these factual circumstances, as narrated above, assigning of equal weightage to motors, coils and parts and taking the mean average for computing the capacity utilization will clearly result in distortion of the real picture on this issue. In this view of the matter, we hold and direct the TPO that the weighted mean of the capacity utilization should be adopted for computing the adjustment
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 11 of 24 for under utilization of capacity, as was taken by the assessee. Consequently, ground No.6, additional ground No.6A raised by the assessee are allowed.
Ground No.7 – Exclusion of NGEF (Hubli) Ltd; (NGEF)
8.1 This company ‘NGEF’ was selected as a comparable company by the assessee. While the TPO accepted the assessee’s TP study and the other comparables chosen by the assessee, he rejected ‘NGEF’ as a comparable on the ground that it is a government company. The DRP upheld the TPO’s action.
8.2 Before us, the learned AR of the assessee submitted that the comparability of a company is decided based on filters and other economic parameters applied and consequently, a company which is otherwise found to be functionally comparable, as per the filters applied, cannot be rejected / excluded only because it is a government company. In support of this contention, the learned AR placed reliance on the decision of the Co-ordinate Bench of this Tribunal in the case of IKA India (P) Ltd., Vs. ACIT (2019) 101 taxmann.com 276 (Bang – Trib). It is submitted that in this cited case (supra), Artificial Limb Manufacturing Corporation of India, which was a comparable company chosen by the TPO, was challenged as not comparable on the ground that it was a government company. The Co-ordinate Bench rejected this contention in view of the decision of the Hon’ble Madras High Court in the case of CIT Vs. Same Duetz Fahr India (P) Ltd., (2018) 405 ITR 345 (Mad).
8.2 Per contra, the learned DR for Revenue submitted that, as far as his knowledge goes, this company, ‘NGEF’ is a loss making company. It is submitted that even if this company is to be included as a comparable, whether it satisfies all the normal filters or not is to be examined. Therefore, the learned DR contended that the TPO should get the opportunity to examine whether or IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 12 of 24 not this company ‘NGEF’ satisfies all the filters that are normally applied in comparability analysis.
8.3.1 We have considered the rival contentions and perused the material on record; including the judicial pronouncements cited. We find that the TPO has rejected this company, ‘NGEF’, on the ground that it is a government company; which proposition has been negated by the decision of this Tribunal in the case of IKA India (P) Ltd., Vs. ACIT (supra); wherein the Co-ordinate Bench at para 17 of its order; following the decision of the Hon’ble Madras High Court in the case of Same Deutz Fahr India (P) Ltd., (2018) 405 ITR 345 (Mad), held that there is no reason why a government company cannot be treated as a comparable if it passes the filters adopted.
8.3.2 In the case on hand, however, it is not ascertainable as to whether this company, ‘NGEF’ has satisfied all the filters applied by the TPO. In this factual matrix of the case, we concur with the plea of the learned DR for Revenue that the comparability of this company, ‘NGEF’, needs to be tested on the touchstone of satisfying all the filters that have been applied for ascertaining the comparability of all other companies. In this view of the matter, we remand the issue of comparability of ‘NGEF’ back to the file of the TPO for fresh consideration. Needless to add, the TPO shall accord the assessee adequate opportunity to put forth its contentions / submissions in the matter, which shall be duly considered before deciding the issue of comparability of ‘NGEF’. We hold and direct accordingly. Consequently, ground No.7 of assessee’s appeal is treated as allowed for statistical purposes.
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 13 of 24 9. Ground Nos.9 to 12- Disallowance fo Software Expenses 9.1.1 In these grounds (supra), the assessee assails the orders of the authorities below in disallowing expenses incurred on availing licences for operating ERP software and other software which are in the nature of application software or on availing software maintenance services; by treating these as capital expenditure.
9.1.2 Before us, the learned AR submitted that the payment of Rs.16,91,755/- debited as ‘computer software expenses’ in the profit and loss account were infact payments towards licence fee for usage of leased licences and are revenue in nature. The learned AR further submitted that the Co- ordinate Bench of this Tribunal in its decision in the assessee’s own case for Assessment Year 2009-10 in IT(T)A No.551/Bang/2015 dated 27.11.2015 has allowed these expenses as revenue in nature and this decision of the Tribunal has been upheld by the Hon’ble Karnataka High Court in dated 30.07.2018. In support of the above, the learned AR placed on record copies of the aforesaid decisions of the Co-ordinate Bench of ITAT – Bangalore and the Hon’ble High Court in the assessee’s own case for Assessment Year 2009-10.
9.2 Per contra, the learned DR for Revenue relied on the orders of the authorities below.
9.3.1 We have considered the rival contentions and perused the material on record; including the judicial pronouncements cited and relied on (supra). The facts of the matter, as emerge from the record, are that in the course of assessment proceedings the AO noticed that the assessee had debited Rs.16,91,755/- to the profit and loss account as “computer software expenses’.
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 14 of 24 The AO was of the view that this expenditure was capital in nature and therefore disallowed the same and allowed depreciation @50% thereon. The DRP upheld the AO’s view.
9.3.2 On a perusal of the judicial pronouncements cited by the learned AR (supra), we find that a Co-ordinate Bench of this Tribunal in its order in IT(TP)A No.551/Bang/2015 dated 27.11.2015 has considered the issue and held that these software expenses are revenue in nature; at paras 30 to 44 of its order which is extracted hereunder:-
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 15 of 24 IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 16 of 24 IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 17 of 24 IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 18 of 24 IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 19 of 24
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 20 of 24 9.3.3 We also find that the Hon’ble Karnataka High Court in its order in dated 30.07.2018 in the assessee’s own case has upheld the order of the ITAT – Bangalore Bench for Assessment Year 2009-10 (cited and extracted at para 9.3.2 of this order). The question framed for consideration by Revenue before the Hon’ble High Court at para 3 is extracted hereunder for reference:-
“2. Whether on the facts and in the circumstances of the case, the Tribunal is right in law in setting aside the disallowance of software expenses claimed by the assessee even though the said expenditure is capital in nature?”
9.3.4 At para 6 of its order (supra), the Hon’ble High Court, while dismissing Revenue’s ground raised on this issue, citing its own earlier decision
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 21 of 24 in the case of CIT Vs. IBM India Ltd., (2013) 357 ITR 88 (Kar), rejected Revenue’s stand; holding as under:-
“6. In view of the aforesaid decision rendered by this Court treating the computer or software expenses as revenue expenditure, no substantial question of law arises for our consideration.”
9.3.5 Respectfully following the decision of the Hon’ble Karnataka High Court in dated 31.07.2018 in the assessee’s own case for Assessment Year 2009-10, we also hold that these software expenses of Rs.16,91,755/- incurred towards payments towards licence fees for usage of leased licences and application are revenue in nature and are to be allowed as deduction. While giving effect to this order, the AO is also directed to withdraw the depreciation allowed by him to the assessee on this issue in impugned order of assessment. We and direct the AO accordingly. Consequently, grounds 9 to 12 of assessee’s appeal are allowed.
In the result, the assessee’s appeal for Assessment Year 2010-11 is partly allowed.
Revenue’s appeal in IT(TP)A No.425/Bang/2015 for Assessment Year 2010-11 11.1 In its appeal, Revenue has raised the following grounds:-
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 22 of 24 11.2 The learned Departmental Representative was heard in support of the grounds raised.
11.3 The learned Authorized Representative for the assessee submitted that there was no error on the part of the learned CIT (Appeals)-1, in allowing the assessee's claim for deduction under Section 10A of the Act by relying on the judgment of the Karnataka High Court in the case of CIT vs. Tata Elxsi Ltd. (349 ITR 98)(Kar). It was further submitted that this issue is now covered in favour of the assessee by the decision of the Hon'ble Apex Court in the case of CIT V. HCL Technologies Ltd. (2018) 93 taxmann.com 33 (SC).
11.4.1 We have heard the rival contentions and perused and carefully considered the material on record; including the judicial pronouncement cited. he jurisdictional High Court of Karnataka in the case of CIT v Tata Elxsi Ltd (349 ITR 98) (Kar) has held that when certain expenses are excluded from the export turnover for the purposes of computing deduction admissible under the Act; like u/s. 10A of the Act, such expenses are also to be excluded from total turnover, as export turnover is a part of total turnover. The decision in the case of Tata Elxsi Ltd (supra) has also been followed by the Hon'ble Court in its order in the case of DCIT v Motor Industries Co. Ltd., (ITA No. 776/2006, 744/2007 and 1155/2006 dated 13.06.2014), holding that if any expenditure is sought to be removed from export turnover, then it should also be reduced from total turnover for the purposes of computing the eligible deduction u/s. 10A of the Act. This issue is no longer res integra, and has been decided in favour of the assessee and against revenue by the decision of the Hon'ble Apex Court in the case of CIT V. HCL Technologies Ltd. (2018) 93 taxmann.com 33 (SC); wherein at paras 19 to 21, it has been held as under :-
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 23 of 24 "19. In the instant case, if the deductions on freight, telecommunication and insurance attributable to the delivery of computer software under Section10A of the IT Act are allowed only in Export Turnover but not from the Total Turnover then, it would give rise to inadvertent, unlawful, meaningless and illogical result which would cause grave injustice to the Respondent which could have never been the intention of the legislature.
Even in common parlance, when the object of the formula is to arrive at the profit from export business, expenses excluded from export turnover have to be excluded from total turnover also. Otherwise, any other interpretation makes the formula unworkable and absurd. Hence, we are satisfied that such deduction shall be allowed from the total turnover in same proportion as well.
On the issue of expenses on technical services provided outside, we have to follow the same principle of interpretation as followed in the case of expenses of freight, telecommunication etc., otherwise the formula of calculation would be futile. Hence, in the same way, expenses incurred in foreign exchange for providing the technical services outside shall be allowed to exclude from the total turnover."
11.4.2 In this legal and factual matrix of the case, as discussed above, and respectfully following the decision of the Hon'ble Apex Court in the case of CIT Vs. HCL Technologies L td. (supra) , we direct the AO to allow assessee’s claim for deduction under Section 10A of the Act. Consequently, the grounds raised by revenue are dismissed.
IT(TP)A No. 412/Bang/2015 IT(TP)A No. 425/Bang/2015 Page 24 of 24 12. In the result, Revenue's appeal for Assessment Year 2010-11 is dismissed.
Pronounced in the open court on 14th August, 2019.