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Income Tax Appellate Tribunal, DELHI BENCH ‘I-2’ : NEW DELHI
Before: SHRI N.K. SAINI & SHRI KULDIP SINGH
(PAN : AAACM0070D) (APPELLANT) (RESPONDENT) ASSESSEE BY : Shri Ajay Vohra, Advocate REVENUE BY : Shri H.K. Choudhary, CIT DR Date of Hearing : 03.10.2017 Date of Order : 22.11.2017
O R D E R
PER KULDIP SINGH, JUDICIAL MEMBER :
The Appellant, M/s. Munjal Showa Limited (hereinafter referred to as ‘the taxpayer’) by filing the present appeal sought to set aside the impugned order dated 10.02.2014, passed by the AO in consonance with the orders passed by the ld. DRP/TPO under section 143 (3) read with section 144C of the Income-tax Act, 1961 (for short ‘the Act’) qua the assessment year 2009-10 on the grounds inter alia that :-
“1. That the assessing officer erred on facts and m law in completing the assessment under section 144C/143(3) of the Income-tax Act, 1961 ('the Act') at an income of Rs.58,11,30,568 as against the returned income of Rs.35,35,93,957.
That the assessing officer erred on facts and in law in making an addition of Rs.22,23,19,866 on account of the alleged difference in the arm's length price of the 'international transactions' of payment of royalty and technical fees entered into by the appellant with its associated enterprise, on the basis of the order passed under section 92CA(3) read with section 144C( 5) of the Act by the Transfer Pricing Officer ("the TPO").
2.1 That the assessing officer / DRP erred on facts and in law in proposing an adjustment of Rs.22,23,19,866 to the arm's length price of the 'international transactions' of payment of royalty, technical fees and drawing and design fees, on the basis of the order passed under section 92CA(3) of the Act by the TPO.
2.2 That the assessing officer / DRP erred on facts and in law in determining the arm's length price of payment of royalty, technical fees and drawing and design fees at Rs. Nil as against the payment of Rs.22,23,19,866 made by the appellant.
2.3 That the assessing officer/ DRP erred on facts and in law in concluding that no recognizable benefit is derived by the appellant from payment of royalty, technical fees and drawing and design fees, and hence, the arm's length price of aforesaid payment is determined at Nil.
2.4 The assessing officer / DRP erred on facts and in law in determining the arm's length price of international transaction of royalty / technical fee and drawing and design fee to be NIL without applying any of the methods prescribed in Transfer Pricing regulations under the Act.
2.5 Without prejudice that the assessing officer/DRP erred on facts and in law, in not appreciating that the international transaction of payment of technical fees and drawing and design fees was appropriately established to be at arm's 'length applying Transactional Net Margin Method (TNMM).
2.6 That the assessing officer / DRP erred on facts and in not appreciating the comparables placed on record by the appellant for benchmarking the international transactions of royalty and technical fees, applying CUP method.
3 That the assessing officer erred on facts and in law in treating expenditure incurred on account of royalty of Rs. 22,02,48,509 and technical fees of Rs.20,71,357 as capital expenditure.
3.1 Without prejudice, the assessing officer / DRP erred on facts and in law in disallowing 100% expenditure incurred on account of royalty and technical fees, as opposed to 25% thereof being treated as capital expenditure in earlier years, which was, in any case, excessive.
4. That the assessing officer erred on facts and in law in disallowing expenses to the extent of Rs.52,16,745 invoking section 14A of the Act, alleging the same to be attributable towards earning the exempt dividend income.
4.1 That the assessing officer erred on facts and in law in not appreciating that only expenditure incurred having direct relation to the earning of exempt income could be disallowed under section 14A of the Act.
4.2 Without Prejudice, that the assessing officer erred on facts and in law in not appreciating that no part of expenditure was disallowable in terms of sub- section (2) of section 14A of the Act, even applying Rule 8D of the Rules.”
Briefly stated the facts necessary for adjudication of the controversy at hand are : M/s. Munjal Showa Limited, the taxpayer is into the business of manufacturing and sale of shock absorbers for transport vehicles, which is a joint venture between Showa Corporation, Japan and Hero Group of companies. Showa Corporation is a world leader in the manufacture and marketing of high precision components for transport vehicles including shock absorbers and has substantial experience and know-how for manufacture of automobile components.
The taxpayer has made payment of Rs.22,02,48,509/-, Rs.20,71,357 & Rs.78,75,944/- totaling Rs.23,01,95,810/- on account of payment of royalty, technical fees and design & drawing fee respectively to its Associated Enterprises (AE), Showa Corporation. The taxpayer has benchmarked these transactions by adopting Transactional Net Margin Method (TNMM). The taxpayer has also aggregated related transaction as the same are closely linked with other transactions under TNMM and found the same at arm’s length. However, the TPO has rejected the TNMM adopted by the taxpayer relating to payment of royalty under TNMM after aggregating the same with other transactions on the ground that the royalty payment being a separate class of transaction requires to be benchmarked separately. However, TPO proposed to apply the Comparable Uncontrolled Price (CUP) method and in case, no such CUP was available then the taxpayer should have benchmarked the transaction by following the well accepted valuation method like income approach viz. Discounted Cash Flow method which could be taken up as CUP. However, on failure of the taxpayer to provide requisite information, TPO proceeded to benchmark the transaction by applying the “benefit test” and consequently determined the Arm’s Length Price (ALP) of royalty at nil and made adjustment u/s 92CA of the Act to the tune of Rs.23,01,95,810/-.
AO made disallowance of expenses u/s 14A read with Rule 8D of the Income-tax Rules, 1962 (for short ‘the Rules’) to the tune of Rs.52,16,745/- for earning dividend income.
The taxpayer carried the matter by way of filing objections before the ld. DRP, which have been rejected. Feeling aggrieved, the taxpayer has come up before the Tribunal by way of filing the present appeal.
We have heard the ld. Authorized Representatives of the parties to the appeal, gone through the documents relied upon and orders passed by the revenue authorities below in the light of the facts and circumstances of the case.
GROUND NO.1
Ground No.1 is general in nature and does not require any adjudication.
GROUND NO.2 TO 2.6
Undisputedly, the assessee has made payment on account of royalty for technical collaboration as per agreement dated 11.03.2002 to the tune of Rs.22,02,48,509/- to its AE. The taxpayer benchmarked its transaction qua payment of royalty to the tune of Rs.22,02,48,509/- for use of technical know-how, design and drawing fee with regard to comparable uncontrolled transactions and found its transactions qua payment of royalty at arm’s length by applying CUP method. The taxpayer further adjusted the payment of Rs.23,01,95,810/- on account of payment of royalty, payment of technical fees and payment of design & drawing fee by aggregating transactions along with international transactions based on TNMM and selected 4 comparables whose arithmetic mean OP/Sales comes at 2.90% vis-à-vis OP/Sales margin of the taxpayer at 4.48%.
However, TNMM used by the taxpayer for benchmarking international transactions qua payment of royalty after aggregating the same with other transactions has been rejected by the TPO and who has proceeded to benchmark the same separately as royalty payment as other transactions are not closely linked. So, TPO adopted CUP method. The ld. TPO on failure of the taxpayer to furnish certain vital information viz. how the royalty rate was determined along with the basis thereof, what cost benefit was analyzed; what is the royalty rate paid by other AE or independent persons, what is the industry rate; what is the cost incurred by the AE for developing the intangible; what is expected benefit from the use of the intangible, applied the “benefit test” and proceeded to determine the value of royalty in uncontrolled condition as nil under CUP.
Ld. AR for the taxpayer contended that the issue as to payment of royalty and technical fee by the taxpayer to its AE has already been decided in favour of the taxpayer pursuant to the decision rendered by the Tribunal in taxpayer’s own case in & ITA No.4242/Del/2011 for AYs 2006-07 and 2007-08 respectively.
Coordinate Bench of the Tribunal in assessee’s own case for AYs 2006-07 and 2007-08 (supra) remitted the case back to the TPO to decide afresh in view of the decision rendered by the Tribunal in taxpayer’s own case for AY 1993-94 to 1995-96 and for AYs 2002-03 and 2004-05 by returning the following findings:-
“27. Ground 4 to.4:3 relates to the disallowance of royalty and technical fee.
28. The assessee's case is that it had limited right to Use the technology of Showa Japan. The ownership / property rights in technical know how continue to be vested in Showa and the appellant has no authorized approval of company to transfer the know how or any technical information to any third party. There is no explicit or implicit authority to transfer or create ownership in the technology, know how/technical information in the appellant. The expenditure of royalty or technical fee did not result with capital asset or a benefit of enduring nature much less in the capital field. The Appellate Tribunal in the case of the assessee for the asstt. Year 1993-94 to 1995-96 and for Asstt. Yea, 2002-03 and 2004-05 have deleted the similar disallowance. Revenue appeal for asstt. Year 2Q02-03 and 2004-05 stands dismissed by the Delhi High Court vide its order dated 6.9.2010 in 95 & 96/Del/2014.
29. Heard parties. In the peculiar fact-situation and the judgment of the Hon'ble Delhi High Court in the earlier years in assessee's own case of which, the AO did not have benefit at the time when he passed the order, we consider it appropriate to remit the matter back to him and take decision afresh, in accordance with law by having regard to the aforesaid judgment. Needless to say the assessee may be granted effective opportunity of being heard.”
Pursuant to the decision rendered by the Tribunal, TPO accepted the international transactions relating to royalty and technical fees by the taxpayer to its AE at arm’s length and adjustment made in the original order for AYs 2007-08 and 2008- 09 has been deleted.
When the issue as to payment or royalty and technical fee by the taxpayer to its AE has already been decided in its favour in AYs 2002-03 and 2004-05 by the Tribunal, an appeal preferred by the Revenue before the Hon’ble Delhi High Court has already been dismissed, we are of the considered view that the ld. TPO is to decide the issue qua payment of royalty and technical fees qua AY 2009-10 in accordance with the decision taken in earlier years in taxpayer’s own case. So, we remit the case to the TPO to decide afresh after providing an opportunity of being heard to the taxpayer. So grounds no.2 to 2.6 are determined in favour of the taxpayer for statistical purposes.
GROUNDS NO.3 & 3.1
AO by treating an amount of Rs.22,02,48,509/- and Rs.20,71,357/- as intangible assets and capital expenditure and made disallowance thereof, paid by the taxpayer to its AE on account of payment of royalty and technical fees respectively, but provided depreciation @ 25% u/s 32 to the tune of Rs.5,55,79,967/- in case of intangible assets and made addition to the tune of Rs.16,67,39,899/-. Ld. DRP also upheld the finding returned by AO.
Ld. AR for the taxpayer contended that agreement between the taxpayer and Showa, Japan is categoric enough to grant the taxpayer an indivisible and non-transferable non-exclusive right and license to manufacture, assemble, sell and distribute the products and parts during the terms of the agreement within the specified territory.
This issue has also been determined in favour of the taxpayer by the Tribunal in assessee’s own case for AYs 1993-94 to 1995- 96 which has been affirmed by the Hon’ble Delhi High Court in ITA 56/2009, ITA 85/2009 & ITA 86/2009 Judgment dated 06.09.2010.
Hon’ble High Court while deciding the issue in controversy in favour of the taxpayer returned the following findings :-
“12. In the case at hand, the know-how was granted by the foreign company solely for the purpose of manufacture, assembly and sale of products during the term of the contract and the licensee was to pay royalty to the licensor. The drawings and designs which were supplied by the licensor only enabled the assessee to manufacture the goods, namely, the shock absorbers. The assessee was required to change the design of such shock absorbers from time to time for which new drawings and designs were required. For the aforesaid purpose, the training of the personnel of the assessee was imperative. If the agreement is read in entirety in a purposeful manner, there can be no trace of doubt that the know-how acquired relates to the process of manufacturing and for a tenure and the documents, designs and specifications which have been supplied by the licensor are only for facilitating the said purpose of manufacturing. This is basically in the realm of technical support and thus, the decisions in T.E.I. Technologies P. Ltd., (supra) and Shriram Pistons And Rings Ltd. (supra) get squarely attracted to the case at hand.”
So, following the decision rendered by the Tribunal and affirmed by Hon’ble High Court in taxpayer’s own case for AYs 1993-94 to 1995-96 which has further been followed in AYs 2002- 03, 2003-04, 2004-05, 2006-07, 2007-08 and 2008-09, we are of the considered view that when the agreement between the taxpayer and its AE is to grant indivisible and non-transferable non- exclusive right and licence to manufacture and assemble sale land distribute the product within the specified territory, it falls in the category of technical support and is not of enduring benefit of any kind to the taxpayer, so the addition made on account of royalty and technical fee is not sustainable, hence Grounds No.3 & 3.1 ordered to be determined in favour of the assessee.
GROUND NO.4
Undisputedly, the taxpayer has earned exempt dividend income to the tune of Rs.14,092/- from its investment made in mutual fund. AO made disallowance on account of expenses to the amount of Rs.52,16,745/- by invoking the provisions contained u/s 14A by applying ad hoc rate of 12% on the investment purchased and sold during the year. Undisputedly, the AO has not invoked Rule 8D but has only calculated the interest on the investment purchased and sold during the year under assessment.
Ld. AR for the taxpayer contended that since the taxpayer has used surplus fund for investment to earn the dividend income, no disallowance can be made u/s 14A. The ld. AR for the taxpayer further contended that when there is a mixed pool of funds, presumption has to be raised in favour of the taxpayer.
Ld. AR for the taxpayer further contended that the Revenue has failed to prove the nexus between the expenses incurred and income earned and in case of mixed pool of funds, no disallowance can be made.
However, on the other hand, ld. DR for the Revenue contended that working made out by the taxpayer was not before the AO to know the surplus fund available with the taxpayer and since it is a case of huge circulatory funds, some disallowance requires to be made as there must be some expenditure incurred by the taxpayer to earn the dividend income.
First of all, perusal of balance sheet of the taxpayer, available at page 113 of the paper book, shows that the taxpayer is having share capital of Rs.7,99,92,500/- and reserves & surplus of Rs.1,57,29,81,001/- as on March 31, 2009.
Now, the next question arises for determination in this case is :-
“as to whether the surplus funds have been used to make investment ?” 27. Assessee has provided details of making investment, available at pages 201 to 211 of the paper book. From the details, it is apparent that there has always been a credit balance with the taxpayer in the bank out of surplus money which shows that the taxpayer has used its own money to purchase the mutual fund.
Moreover, when there is no closing and opening balance, Rule 8D cannot be applied. Furthermore when AO has not invoked Rule 8D, the Revenue cannot challenge the findings of the AO before the Tribunal.
Perusal of page 24 of the assessment order shows that the AO has made categoric observation that, “The assessee controlled its investment activities in such a way that the opening and closing balance of investment was ZERO though there were total transactions of Rs.384,15,00,000/- during the whole year. The onus lies upon the assessee to come forward with the source of fund arranged and if any interest has been paid on such funds, the same should have been disallowed u/s 14A of the Act. However, the assessee deliberately tried to mislead the department and failed to furnish any working in this regard.”
Aforesaid observation made by the AO shows that the entire working otherwise, available at pages 201 to 211 of the paper book, showing investment by the taxpayer was with AO and in these circumstances, it was imperative for the AO to prove that the investment was not made out of the surplus fund or interest free borrowed fund. Nor the AO has established any nexus between borrowed funds and investment made.
From the working available at pages 201 to 211 of the paper book given by the taxpayer, it is proved that the taxpayer was having mixed pool of funds and in such situation, onus is on the Revenue to establish direct nexus between borrowed funds and investment. Reliance in this regard is placed on the judgment of Hon’ble Delhi High Court in case of HT Media Ltd. vs. Pr. CIT- IV, New Delhi – (2017) 85 taxmann.com 113 (Delhi) wherein the Hon’ble High Court has decided the identical issue in favour of the taxpayer by making following observations :-
“51. In the present case, the Assessee has been able to demonstrate that the AO has failed to establish any direct nexus between the investments made by the Assessee and the interest expenditure incurred. On the other hand, the Assessee was able to show that any interest expenditure incurred was in respect of various bank loans during the course of the AY in question. The AO also failed to deal with the assertion of the Assessee that it had sufficient own funds and, as such, had no occasion to use borrowed interest bearing funds for that purpose.”
So, when the AO has failed to establish the direct nexus between the investment made by the taxpayer and the interest expenditure incurred particularly in the face of the fact that the taxpayer has demonstrated that it has sufficient own surplus funds to make the investment to earn dividend.
Furthermore in case of mixed pool of funds as in the case of taxpayer, a presumption has to be raised in favour of the taxpayer that surplus funds have been utilized to make an investment.
Moreover when perusal of the balance sheet shows that there is no investment by the taxpayer in the end of the year, no disallowance can be made as has been held by Hon’ble Delhi High Court in HT Media Ltd. (supra).
Hon’ble Bombay High Court in CIT vs. Reliance Utilities and Power Ltd. - (2009) 313 ITR 340 (Bom.) held that in case the assessee has mixed pool of funds and investment has been made to earn interest free income then a presumption would arise that the investment has been made out of interest free funds generated or available with the company by making following observations :-
“Held, dismissing the appeal, that if there were funds available both interest-free and overdraft and/or loans taken, then a presumption would arise that investments would be out of the interest-free funds generated or available with the company, if the interest-free funds were sufficient to meet the investments. In this case this presumption was established considering the finding of fact both by the Commissioner (Appeals) and the Tribunal. The interest was deductible.” 34. Hon’ble Supreme Court in case of CIT vs. Walfort Share & Stock Brokers (P.) Ltd. [2010] 326 ITR 1 (SC) held that basic principle of taxation is to tax net income and this principle applies for the purpose of section 14A and expenses towards non-taxable income must be excluded.
In Godrej and Boyce Mfg. Co. Ltd. V. DCIT - 328 ITR 81, Hon’ble Bombay High Court also held that in case the assessee has sufficient surplus fund and the AO has failed to determine any direct nexus between the borrowed funds and investment, there is no question of invoking the provisions contained u/s 14A of the Act.
AO has failed to record his objective dissatisfaction as required u/s 14A(2) as to the facts demonstrated by the taxpayer that the taxpayer has sufficient surplus funds and there is no direct nexus of borrowed funds with investments.
So, in the given circumstances, when the entire working has been brought on record by the taxpayer during assessment proceedings as to availability of the surplus funds with the taxpayer and there has always been a credit balance in the bank of the taxpayer on every day, it goes to prove that taxpayer has used its own funds to purchase the mutual funds to earn interest free income and the taxpayer has not used loan or overdraft funds to make investment.
Aforesaid facts have not been controverted by the AO by recording objective satisfaction that the taxpayer has used borrowed funds to purchase mutual funds. In these circumstances, contention of ld. DR that, “in case of huge circulatory fund, some disallowance should be there as there must be some expenditure” is not tenable. This contention is also not tenable in the face of the fact that AO has not invoked Rule 8D of the Act. So, we are of the considered view that disallowance made by the AO to the tune of Rs.52,16,745/- is not sustainable in the eyes of law, hence ordered to be deleted. Ground No.4 is determined in favour of the assessee. 39. Resultantly, the appeal filed by the assessee is partly allowed for statistical purposes. Order pronounced in open court on this 22nd day of November, 2017.