DCIT, NEW DELHI vs. M/S. HCL COMNET LTD., NEW DELHI

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH “C” NEW DELHI BEFORE SHRI S.V. MEHROTRA : ACCOUNTANT MEMBER AND SHRI C.M. GARG : JUDICIAL MEMBER ITA nos. 321/Del/2012 (Asstt. Yr. 2004-05) 5651/Del/2012 (Asstt. Yr. 2006-07) 6142/Del/2012 (Asstt.Yr: 2009-10) ACIT, Circle 12(1), Vs. M/s HCL Comnet Ltd., New Delhi. 806, Siddhartha, 96 Nehru Place, New Delhi. PAN: AAACH 9667 H

And

ITA nos. 5907/Del/2010 (A.Y. 2006-07) (U/s 263 of the Act.) 5898/Del/2012 (A.Y. 2009-10) M/s HCL Comnet Ltd., Vs. ACIT, Circle 12(1), New Delhi. New Delhi. (Appellant) ( Respondent) Department by : Shri A.K. Saroha CIT(DR) & Shri Amrit Lal Sr. DR Assessee by : Shri Ajay Vohra Sr. Adv. & Shri Aditya Vohra Av.

Date of hearing : 27/07/2016. Date of order : 19/08/2016.

O R D E R PER S.V. MEHROTRA, A.M: All the captioned appeals were heard together and are being disposed of this composite order, for the sake of convenience.

ITA no. 321/Del/2012 ( Revenue’s appeal for AY 2004-05):

the business of designing, delivering, installation and commissioning of net

working solution and providing professional services for management and

maintenance of net working solution.

4.1. The assessee had filed return of income declaring income of Rs.

15,28,572/-. The assessment was completed u/s 143(3) at an assessed

income of Rs. 75,43,775/-. Thereafter, ld. CIT passed an order dated

17.3.2009 u/s 263 setting aside the assessment on the limited issue for

carrying out necessary verification and cross inquiry to determine true

nature, correctness and allowability of the following issues: “i) The assessee had made a payment for AMC of Rs. 255.58 lacs on which no tax was deducted at source. Since these payments were made to the non residents, tax was required to be deducted at source on the same.

ii) The assessee has claimed and was wrongly allowed expenditure of Rs. 1,54,02,000/- towards provision for warranty. Since this was an unascertained liability it should have been disallowed and added to the income of the assessee.

4.2. The AO, after considering the assesse’s submissions, made following disallowances: a. Disallowance on account of non-deduction of TDS on AMC contract Rs. 2,55,57,990/- b. Addition on account of provision for warrantee Rs. 1,54,02,000/-. 4.3. Apropos non-deduction of TDS in respect of AMC payments, ld.

CIT(A) held that the same was not taxable in the hands of non-resident payee, because that was business income of the non-residents and since they had no PE in India, therefore, in terms of the provisions of relevant DTAA,

the same was not taxable in the hands of non-resident assessee. He further held that the AMC payment could not be held to be in the nature of fee for technical services and, therefore, not taxable u/s 9(1)(vii). He, accordingly, held that the provisions of section 195 were not attracted in respect of AMC

payments and consequently there was no question of disallowance u/s 40(a)(i). He, therefore, deleted the addition of Rs. 2,55,57,990/-,. 4.4. As regards disallowance of provision for warranty amounting to Rs.

1,54,02,000/-, ld. CIT(A) referred to the decision of the ITAT in ITA no. 2195/Del/2008 wherein vide order dated 8.10.2010, the Tribunal had set aside the order of CIT passed u/s 263 in respect of provision for warranty

after following the decision of the Hon’ble Supreme Court in the matter of Rotork Controls India Pvt. Ltd. 314 ITR 62 (SC).

“Whether ld. CIT(A) was correct on facts and circumstances of the case and in law in deleting the addition of Rs. 2,55,57,990/- made by the AO on account of payment under AMC contract”.

5.1. Brief facts apropos this issue are that ld. CIT in his order passed u/s

263 dated 18.3.2009 contained at page 131 onwards of the paper book, noted from the Notes to Account that assessee had made payment of AMC of Rs. 255.58 lakhs on which no tax was deducted. This payment was made to

following persons:

Particulars Country Amount paid (Rs) Gilat Satellite Networks Limited Israel 17,700,589 Telesystems International USA 2,769,374 Corporation Agilis Communication Singapore 4,673,272 Technologies Pte Ltd. Gilat Satellite Networks Limited Holland 113,150 Miscellaneous 301,586 Total 25,557,971

5.2. Ld. CIT passed order u/s 263 primarily on the ground that this issue had not been examined by the AO. AT his juncture we may point out that

Tribunal vide its order dated 8.10.2010 has upheld the action of ld. CIT on this count. Accordingly the AO has passed the impugned assessment order.

5.3. Before AO, the assessee, vide its letter dated 15.10.2009, submitted that the payment for AMC has been made by HCL to various parties

belonging to various countries. The payment for AMC contract comprised payment for warranty charges and extended warranty charges, which are in the nature of repair/ replacement of equipments. Under the contract,

equipments are sent outside India for any repair/ replacement and are re- imported in India. 5.4. After considering the aforementioned submissions of assessee, the AO observed that in view of specific provisions laid down u/s 40(a)(i) of the I.T.

Act, 1961, deduction could not be allowed as the payment had been made without TDS. He, accordingly, made a disallowance of Rs. 2,55,57,990/-. 5.5. Before ld. CIT(A) the assessee, inter alia, submitted as under: (a) AO has not analyzed the taxability of AMC payments under the provisions of the Act and Double Taxation Avoidance Agreements (hereinafter referred to as “DTAA”), entered between India and respective foreign country and summarily disallowed the entire AMC payments by merely stating that since these payments were made to the non-residents, tax was required to be deducted at source on the same. (b) The assessee referred to the agreement with Gillette Israel . Ld. CIT(A) in para 9 has noted the various services provided to assessee and has pointed out in para 10 that the extended maintenance agreement entered into with Gillette Israel covers services relating to

routine maintenance of the equipments including product repairs and replacements. Thus, there was no technical service provided to the assessee. The services were provided outside India. (c) The assessee further submitted that the provisions of section 40(a)(i) of the Act would apply, inter alia, if: i) Any interest, royalty, fees for technical services (“FTS”) or other sum chargeable under this Act, which is payable outside India, or to a non resident in India; ii) On which tax has not been deducted. iii) In accordance with the provisions of Chapter XVII-B. 5.6. As regards the applicability of section 195 of the Act, the assessee submitted

that as per Chapter XVIIB, section 195 of the Act is the applicable section for payments made by an assessee to a non-resident outside India. Therefore, in order to examine whether payments made by assessee required deduction of tax at

source, in terms of section 195 it has to be examined whether the sum paid to the non-resident payee is chargeable to tax in India in the hands of non-resident payee or not. The applicability of section 195 will be decided accordingly. Reliance was

placed on the decision of Hon’ble Supreme Court in the case of Gee India Technology Vs. CIT 327 ITR 456. 5.7. As regards the chargeability of income under the provisions of the Act in

relation to a sum paid to the non-resident assessee, the assessee pointed out that the same is to be determined on the basis of provisions of the Act as well as the

provisions of DTAA and the provisions of the Act or the provisions of the DTAA,

whichever is more beneficial can be resorted to by the assessee. In this regard

reliance was placed on the decision of Hon’ble Supreme Court in the case of

Hindustan of India and another vs. Azadi Bachao Andolan & another 263 ITR 706.

The assessee submitted that the said services being in the nature of routine repairs/

replacement and maintenance, were not in the nature of FTS since there was no

technical, managerial or consultancy services, which was being provided by

Gillette Israel to the assessee. Therefore the payment did not fall within the

provisions of Explanation to section 9(1)(vii) .

5.8. In this regard reliance was placed on the order of the ITAT in the case of

Lufthansa Cargo India (P) Ltd. Vs. DCIT (2004) 91 ITD 133 (Del.), wherein it

was, inter alia, held that overall repairs involved routine maintenance repairs and,

therefore, it could not be said that foreign company rendered any managerial,

technical or consultancy service to the assessee. The assessee also made detailed

submissions in regard to taxability under the provisions of relevant tax treaty/

Double Tax Avoidance Act and pointed out that since these services were in the

nature of routine repairs and maintenance and did not make available any technical

knowledge, skill, experience, know how etc. to the assessee or its employees,

therefore, the services did not come within the purview of the technical services

envisaged under Article 13 of the DTAA read with protocol thereof, meaning

thereby that the payments towards any such services in the form of AMC were not

taxable as FTS as defined under paragraph 3 of Article 13 of the DTAA between

India and Israel and, therefore, there was no liability to with-hold tax u/s 195 of

the Act. Similarly, submissions were made in respect of other contracts, which

have been noted by ld. CIT(A) in detail in his order.

5.9. After considering all these submissions ld. CIT(A) concurred with the

submissions of assessee and held that no tax was deductible u/s 195 of the act and

consequently there was no element of disallowance u/s 40(a)(i).

rendered through communication in India, therefore, ld. CIT(A) was not right in

holding that services were rendered outside India. He referred to page 28 of the

PB, wherein the extended maintenance agreement is contained and referred to the

recital relating to maintenance support service for all the Gillette hub station

equipment. He referred to the second covenant wherein the nature of services to be

rendered by Gillette Israel are contained and referred to following clauses:

“2.3.3 Buyer agrees and acknowledgos that Gilat may in Gllat's absotule discretion, dispatch to Buyer's hub station site Gilat's Emergency Personnel as Gilat may deem necessary from time to lime for the purpose of assisting the Buyer to remedy the Major Degradation. If Gilat dispatches such a person, Buyer shall provide to such person access to the Hub Station Equipment and all assistance necessary or desirable to overcome the Major Degradation.

2.6 Product Replacement and Repair: Throughout the tern of this agreement, Gilat shall repair or replace any failed or defective part or parts of the Hub Station Equipment in accordance with the provisions of Sub-Paragraphs 2.6.1 through 2.6.4.

2.6.2 The time within which the 'Buyer must send to Gilat Hub Station Equipment in accordance with Sub Paragraph 2.6.1 is the earlier of (i) the Buyer accumulating defective parts consisting of twenty five percent (25%) of the Buyer's stock of spare parts, and (ii) sixty (60) days of the Buyer discovering a defect in the Hub Station Equipment or any parts thereof.

2.6.3 Upon receipt by Gilat of such defective Hub Station Equipment Gilat shall repair or replace such Hub Station Equipment or parts thereof found by Gilat to be defective. Gilat shall deliver to Buyer each repaired or replacement unit of Hub Station Equipment accompanied by a written "failure analysis" setting forth a description of the fault found and the corrective action taken by Gilat. Gilat shall bear the cost of returning to the Buyer of Mumbai, India the repaired or replacement Hub Station Equipment within thirty (30) days of Buyer delivering such equipment to Gilat (CIF Tel Aviv), provided that if Gilat determines that such equipment is not defective, Buyer shall pay Gilat all costs of handling, transportation and labor at Gilat’s then prevailing rates.

6.1. By referring to these covenants ld. CIT(DR) submitted that delivery is at CIF

Mumbai. He, therefore, submitted that the amounts were taxable in India.

submitted that in view of the decision in the case of Gee Technologies the

provisions of section 195 were not attracted.

case. The extended maintenance agreement has been entered into with Gilat

Satellite Networks Ltd., a Israel company, with the assessee for warranty granted

to assessee for the equipment supplied by Gilat Satellite Networks Ltd. The

second recital of the agreement reads as under:

“Whereas, according to the terms and conditions of purchase thereof, the warrantee granted to buyer (assessee) for such equipment expired and buyer (assessee) has the right to purchase annual maintenance support services on the expiration thereof”.

8.1. Thus, it is evident that primarily this agreement had been entered into for

annual maintenance support services.

8.2. Ld. CIT(DR) has referred to the various services, covenants and pointed out

that services had been rendered by communication only in India. Ld. CIT(DR)’s

contention cannot be accepted in view of specific covenant contained in the

agreement, which, inter alia, includes covenant no. 2.6, which deals with product

replacement and repair as per which Gillette shall repair or replace any failed or

defective part or parts of the hub station equipment in accordance with the

provisions of sub para 2.6.1 to 2.6.4. Therefore, it is not correct to say that the

entire services were rendered in India. As a matter of fact the replacement could be

effected only by Gillette. It is not the case of AO that the non-resident payee had

any PE in India and, therefore, the business income in the hands of non-resident

payee could not be taxed in India. Further, we are in agreement with the detailed

analysis carried out by ld. CIT(A) in holding that no technical services were

provided to the assessee and the services were in the nature of normal

maintenance/ repairs/ replacement etc., performed outside India. Therefore, such

payments did not fall within the purview of Explanation 2 to section 9(1)(vii) of

the Act. Further, we are in agreement with ld. CIT(A)’s conclusion regarding

taxability under the provisions of relevant tax treaty/ DTAA, wherein after

elaborate discussion he has concluded that no technical knowledge was made

available to assessee. From the above it is clear that the amount paid by the

assessee to non-resident was not chargeable to tax in terms of the provisions of the

Act or DTAA.

8.3. In view of above discussion, the revenue’s appeal is dismissed.

ITA 5907/Del/2010 (Assessee’s appeal for AY 2006-07 u/s 263): 9. This appeal, preferred by the assessee, arises out of CIT, Delhi-IV’s order

dated 30.09.2010 passed u/s 263 of the Income-tax Act, 1961, relating to AY 2006-

07.

assessee had filed return of income declaring income of Rs. 22,83,76,292/- which

was subsequently revised at an income of Rs. 44,18,870/-. The assessment was

completed after making following three additions:

(i) Disallowance u/s 14A (ii) Addition on account of difference in creditors balance (iii) Wrong claim of depreciation. 10.1. Ld. CIT examined the assessment records of assessee from which it transpired that the assessee had written off Rs. 458.13 lacs on account of cost of

goods of more than 365 days on notional basis as a policy on the ground of their having nil market value at the end of that period. 10.2. Ld. CIT observed that since the loss claimed was only notional loss, not based on any actual valuation, therefore, should have been disallowed and added

back to the income of the assessee. This mistake resulted in under-assessment of Rs. 458.13 lacs involving tax effect of Rs. 205.09 lacs including interest. Ld. CIT observed that these aspects were never considered by the AO while framing the

assessment order. He further observed that no inquiry/ investigation appeared to have been carried out with regard to this aspect. Thus, he observed that it was a case of lack of inquiry/ investigation, apart from the under assessment of income.

Thus, the order of the AO was erroneous as well as prejudicial to the interests of revenue. Ld. CIT issued show cause notice in response to which assessee’s representative filed the written submissions. However, since the same was found to

be inadequate, therefore, ld. CIT(A) again gave opportunity to assessee to explain its position. However, none appeared and, therefore, ld. CIT proceeded to pass the

revisional order u/s 263. Ld. CIT has reproduced the written submissions filed by

assessee, in which primarily assessee demonstrated how the sum of Rs. 458.14 lacs

was written down under the head purchases in the P&L a/c as per Schedule 16 and

also referred to the queries raised by AO and assessee’s reply in this regard.

Assessee pointed out that it was explained to the AO that the method of writing off

of the inventories was in line with the normal accounting practice followed by the

industry and in line with accounting practice of writing off the inventories

consistently followed by the assessee in the earlier assessment years also. The

assessee submitted that assessment u/s 143(3) was completed without drawing any

adverse inference in this regard. The assessee further pointed out that an amount of

Rs. 561.92 lacs (which was charged to P&L A/c under the head “Cost of goods

and services”), represented only 25% of the cost of spares and accessories, which

was written off during the financial year under consideration. Further an amount of

Rs. 103.78 lakhs (which had been written off in the earlier year), was written back

(i.e. it was offered as income), during the financial year and, hence, it was only the

net amount of Rs. 458.13 Lakhs, which was ultimately charged to the P&L A/c.

The assessee further explained as under: “The Customer Care Organization (company known as “CCO”) spares comprise of various small value items (such as cables, router and modem parts, VSAT components) that are required for the purpose of servicing the original equipments located at customers’ locations and also located at HCL’s premises. The CCO inventory comprises of small value items

but is numerous in quantity, and widely issued to various locations, departments and regions. The main equipment for which such spares are maintained, it is earnestly submitted, has a useful life of 4/5 years.”

valuation of inventories rested with the assessee. Further, it was submitted that even if two views were possible about the tax deductibility of the written down of the value of the spares and accessories @ 25% only reduced from carrying value to the realizable value, the view taken by the AO was possible view. The assessee had

placed reliance, inter alia, o the decision of Hon’ble Supreme Court in the case of Malabar Industries Vs. CIT 243 ITR 83. Ld. CIT after considering the assessee’s submission did not accept the same for the following reasons: (a) Although AO collected the details from the assessee during the course of assessment proceedings but did not record that he examined the matter on the issue of allowability of the amount as claimed. He pointed out that AO did not critically examined the same with reference to the appropriate legal provision and, therefore, the assessment order was erroneous in the eyes of law. (b) As regards the assessee’s claim that AO had taken one possible view, ld. CIT pointed out that since the issues were never considered by the AO during the course of assessment proceedings, there was no question of AO’s taking any view on that issue.

(c) It is essential for the parties to know the reasons that had weighed with the adjudicating authorities in coming to a conclusion. The order passed by the AO should be self contained order, giving the relevant facts and reasons for coming to the conclusion passed on those facts and laws. Ld. CIT relied on various case laws on this issue. Ld. CIT concluded that absolute silence of the AO as to why he allowed the assessee’s claim in this regard would mean that there was no application of mind at his level. He should have recorded reasons for allowing the claim. He, accordingly, set aside the order of AO to his file for reconsideration of the same on the disputed issue alleged in the notice. 11.1. Ld. counsel for the assessee pointed out that it is well settled law that the

way the assessment order is drafted is not within the assessee’s control. He relied

on the decision of Hon’ble Punjab & Haryana High Court in the case of Hari Iron

Trading Co. Vs. CIT 263 ITR 437 (P&H). He further relied on the decision in the

case of CIT Vs. Eicher Ltd. 294 ITR 310 (Del.), wherein it was held that when all

the material facts were disclosed by assessee and AO applied his mind then failure

to record finding in assessment order does not entitle the AO to issue notice for

reassessment. Ld. counsel referred to page 28 of the PB, wherein the assessee’s

reply dated 3.12.2008 to the AO in connection with the queries raised is contained

in which assessee had given justification for writing off of stock as per the books

of a/c as under:

The breakup of the write off as indicated under schedule 16 to the financials is follows Break up of write down Amount Description Depreciation of spares 56,191,665.00 Note 1 below Provision of inventory -10,378,048.00 Note 2 below pertaining to more than 365 days

Note 1: An amount of R.s 5.61 crores, represent the write off of spares and accessories required to service the main equipment that has been installed at Customer sites across India .These stores and spares are purchased in bulk and kept in the stores, and the company follows a policy of writing off25% of the costs of these spares ,on a YOY basis .Since these spares had already been depreciated by 75% as on lst April-05, the remaining 25% of depreciation on these spares had been charged to COGS and it is the value has been included in the 4.85 crores . Note 2: It is a well known fact that IT equipment are subject to obsolescence on account of rapid change in technology and methods. On account of the above, the hardware ,software and other components unsold for more than 365 days are subject to write off's on account of their being rendered obsolete due to technology and market change and on account of their having nil market value at the end of that period. This policy of write off's has been followed year after year by the company and has been accepted by the A.O in the assessment of the earlier years. The breakup of the region wise write off's is as per Annexure No 8 to this note”.

11.2. Ld. counsel further referred to the copy of audited accounts,

contained at pages 68 to 91 of the PB and referred to Schedule 16 to P&L

A/c of the cost of goods and services wherein note in regard to loss on

writing of inventories to net realizable value was given. Ld. counsel

further submitted that on merits also the issue is covered in favour of

assessee. In this regard he referred to the order of Delhi Bench of the

Tribunal in the case of Hughes Network Systems India Ltd. Vs. DCIT

rendered in ITA nos. 4611 and 4595/Del/2010 dated 26.12.2011,

contained at pages 105 to 127 of PB. Ld. counsel pointed out that Hughes

Network Systems India Ltd. was engaged in the business of market

VSAT equipment and providing telecom related services in India, as

assessee. He pointed out that in this case also ground raised before the

Tribunal was regarding sustenance of part disallowance to the extent of

25% of total disallowance made by the AO on account of provision for

impairment of stock. Ld. counsel referred to paras 10 & 11 of the order,

wherein the Tribunal has observed as under: “10. The department is in appeal against the CIT(A)’s order in granting a relief of Rs. 18,19,034/- out of the total addition of Rs. 24,25,379/- made by the Assessing Officer while the assessee is in appeal in sustaining the disallowance to the extent of 25% of the total disallowance made by the AO.

11.3. Ld. counsel referred to para 17 of the Tribunal’s order wherein the

Tribunal had taken note of various decisions relating to valuation of stock-

in-trade at cost or market price, whichever is lower, and, had deleted the

disallowance of assessee’s claim to the extent of 25% sustained by ld.

CIT(A) and allowed the assessee’s total claim made in the return of income.

Ld. counsel furth4er referred to the decision of Hon’ble Delhi High Court in

the case of M/s Hughes Communication India Ltd., wherein also the issue

before the Hon’ble Delhi High Court was whether ld. ITAT erred in deleting

the addition of Rs. 90,35,298/- made by the AO on account of provisions for

impairment of stock. Ld. counsel referred to para 7 of the decision, wherein

the Hon’ble High Court, inter alia, observed that on a question of valuation

of the closing stock any alleged difference or discrepancy tends to balance

itself out over a period of years if the same method is consistently followed.

This is because the closing stock of one year becomes the opening stock of

the succeeding year and any addition made to the valuation of the closing

stock to increase the profits for that year automatically gets neutralized when

the same figure of closing stock is taken as the opening stock of the

succeeding year. What is, therefore, more important to be seen is whether

the same method of valuation of stock is followed consistently by the

assessee so that there is no distortion of profit.

11.4. With reference to these decisions, ld. counsel submitted that the

assessment order cannot be said to be erroneous since the same is in

consonance with the judicial precedents. In this regard ld. counsel relied on

the decision in the case of K.N. Agrawal Vs. CIT 189 ITR 769, wherein it

was, inter alia, held that ITO is bound to follow the order of appellate

authority and, therefore, the said order cannot be held to be erroneous

empowering Commissioner to revise the same. He also relied on the

decision of Hon’ble Calcutta High Court in the case of Russel Properties

Pvt. Ltd. Vs. A. Choudry Addl. CIT 109 ITR 229for the same proposition.

stock but of service stock. He submitted that the basis adopted by assessee

for determining the net realizable value is not correct because market does

not fluctuate 25% every time.

12.1. ld. CIT(DR) pointed out that assessee’s claim is negated by the fact

that next year assessee had itself written back 1.03 crores in respect of

inventory exceeding one year. He submitted that this negates the assessee’s

contention regarding 25% fall in the value of inventory. ld. CIT(DR) further

submitted that assessee had not given any supporting evidence regarding net

realizable value of stock.

12.2. Ld. CIT(DR) referred to the decision of Hon’ble Delhi High Court in

the case of Hughes Communication India Ltd., contained at pages 150 to

156 of the PB, wherein in para 7 the Hon’ble High Court, inter alia, has

observed as under: “7. The findings recorded by the Tribunal are not challenged. In fact the learned standing counsel fairly stated that the assessee can value the stock at the lower of the cost or the net realizable value as it is a recognized and accepted method. He, however, submitted that the claim of the assessee was not supported by any details. But this submission is contrary to the finding of the Tribunal which has referred to the assessee’s letter dated 27.12.2006 submitted before the assessing officer along with the necessary details in support of the valuation. These details have also been extracted by the Tribunal in para 11 of its order. We are, therefore, unable to accept the contention of the revenue that the claim of the assessee remains unsupported.”

12.3. Referring to the aforementioned observations, ld. CIT(DR) submitted

that in original assessment proceedings, AO should have discussed

supporting evidence for valuation of stock. The valuation could not be made

on ad hoc basis. Thus, assessment order has been passed without due

application of mind.

12.4. Ld. CIT(DR) relied on the decision of Hon’ble Supreme Court in the case of Malabar Industries and also referred to the decision in the case of

NIIT 60 Taxman.com 313, wherein it has been held that merely raising of query would not be sufficient without proper application of mind and whether proper application of mind is there or not, is to be decided keeping

in view the level of enquiry expected from an authority, conversant with nuances of law. 13. Ld. Sr. counsel, in the rejoinder referred to page 80 of the PB, wherein significant accounting policies are contained in which, as regards inventory,

it is stated as under: “Inventories are valued at lower of cost and net realizable value. The cost is calculated on the basis of weighted average price method and includes share of allocable overheads. The net realizable value is determined with reference to selling prices of goods. The comparison of cost and net realizable value is made on an item by item basis.”

13.1. He further referred to the tax audit report contained at page 36 of the

PB, wherein at serial no. 11, it is stated as under:

immediately preceding year. previous year. c) If answer to (b) above Not applicable is in the affirmative, give details of such change and the effect thereof on the profit or loss. d) Details of deviation, There is no deviation in the if any, in the method of method of accounting employed accounting employed in in the previous year from the the previous year from accounting standards prescribed accounting standards under section 145 of the prescribed under section Income-tax act, 1961. 145 and the effect thereof on the profit or loss.

13.2. Ld. counsel submitted that there is no change in the method followed.

He pointed out that since consistent method is being followed, therefore, the same is revenue neutral and cannot be disturbed in one year. He pointed out that assessee has estimated the net realizable value after taking into

consideration the usage of spares as determined by management. He pointed out that selling price has been estimated by management. No addition has been made in earlier year and the valuation adopted is in line with industries

practice. He referred to the ITAT Delhi Bench ‘C’ order dated 28.11.2008 in the case of Samsung India Electronics Ltd. Vs. JCIT rendered in ITA nos. 3164/Del/2000 and others, contained at pages 75 to 80 of the PB, wherein in

para 32 the Tribunal has observed as under:

13.3. Ld. counsel further referred to page 142 of the PB wherein the

decision of Hon’ble Delhi High Court in the case of CIT Vs. Samsung India

Electronics Ltd. is contained and pointed out that in para 15 the Hon’ble

High Court has, inter alia, observed that the method of valuation of closing

stock can be disturbed only if it is found that the method of valuation is such

that true profits and gains cannot be deduced there from. In this regard

Hon’ble Delhi High Court has referred to the decision in the case of CIT Vs.

Bharat Commercial and Industrial Ltd. 240 ITR 256 wherein the loss arising

out of the reduced valuation of slow moving raw material on the basis of

estimated realizable value was held allowable.

13.4. Ld. counsel further referred to page 77 of PB, to point out that out of the total revenue of Rs. 2538368049, the revenue from service was Rs. 754735740/- which was 1/3rd of the total value. The assessee had to keep spares for service to cater its requirement of rendering services. 13.5. Ld. counsel submitted that ld. CIT lost of consistent method being

followed by assessee. 14. We have considered the rival submissions and have perused the record of the case. It is well settled law that if there is no application of mind by AO in respect of an issue, then non-application of mind makes the order

erroneous. There is no gain saying that mere erroneous order does not empower ld. CIT to exercise his powers u/s 263 unless the order is also prejudicial to the interests of revenue.

14.1. In the present case the assessee’s reply dated 3.12.2008 is contained at pages 28 to 30, the contents from which, in regard to justification for writing off of stock as per the books of a/c, have been reproduced earlier. From the

said reply it is evident that assessee in its note had pointed out that amount of Rs. 5.61 crores represented the write off of spares and accessories required to service the main equipment that had been installed at Customers

sites across India. These stores and spares were purchased in bulk and kept in the stores and the company followed a policy of writing off 25% of the

costs of these spares on a YOY basis. It was further stated in the note that

since these spares had already been depreciated by 75% as on 1.4.2005, the

remaining 25% of depreciation on these spares had been charged to COGS.

This note should have prompted the AO to examine as to the basis on which

net realizable value of the inventories had been arrived at because as rightly

pointed out by ld. CIT(DR) there could not be 25% fall in the market value

of inventories every year. Moreover, this policy had the effect of writing off

entire value of spares in 4 years whereas it is evident from the assessee’s

own account that in next year assessee had realized the value of the spares to

the extent of Rs. 1.03 crores. This should have prompted the AO to examine

the basis for arriving at net realizable value of asset and how the

management had arrived at the useful life of spares. As per significant

accounting policy, reproduced earlier, the net realizable value was

determined with reference to selling price of goods and the comparison of

cost and net realizable value was made on an item by item basis. However,

as per notes to account impairment in stock was determined @ 25%. Both

these statements on same accounts cannot be reconciled.

14.2. Ld. counsel has relied on the decision in the case of M/s Hughes

Network Systems (supra). In this case in para 18 the Tribunal has noted that

the assessee had furnished the details of inventory with their respective net

realizable value as at the end of the year. The AO had not pointed out any

defect or irregularity in the details of rate adopted by the assessee for valuing

the stock at net realizable value by making any query or by undertaking

exercise to ascertain the net realizable value as at the end of the irrespective

year. Further, AO failed to point out any specific item in respect of which

the net realizable value adopted by the assessee was found to be not justified

or excessive having regard to the nature of the item and the cost incurred by

the assessee. Thus, in this case specific details regarding net realizable value

of inventory was made available by assessee. Therefore, this decision is not

applicable to the facts of the case because in the present case the assessee

has simply reduced 25% valuation considering the same as to reduce the

value of inventory to net realizable value. No proper estimate was produced

before AO so that he could arrive at proper conclusion regarding net

realizable value of spare. Further, in the case of Hughes Communication

India Ltd., Hon’ble Delhi High Court in para 4 has, inter alia, noted that the

claim was made on the footing that the net realizable value of the stock had

fallen below even the cost price and in respect of the valuation the assessee

submitted the basis of the estimate which was prepared by its technical

department. Certain details were also submitted regarding certain items of

stock together with their realizable rate as on 31.3.2003 and 31.3.2004.

Therefore, this decision is also not applicable to the present set of facts.

Accordingly, the assessment order was erroneous on account of non-

application of mind to relevant aspect of arriving at net realizable value.

14.3. Now coming to the issue regarding assessment order being prejudicial

to the interest of revenue or not. Assessee’s plea is that the whole exercise is

revenue neutral because the closing stock of one year will be the opening

stock of subsequent year, therefore neutralizing the effect of addition in one

year by increasing the cost in subsequent year. It is well settled law that the

method of accounting employed by an assessee should be such from which

true profits of an year can be deduced. Merely because the assessee is

following a regular method of accounting but the effect of which is not

deducing true profits from business, then it cannot be said that correctness of

method can be ignored by AO, as has been held by Hon’ble Supreme Court

in the case of British Paints 188 ITR 44, wherein it has been held as under: “that even if the assessee had adopted a regular system of accounting, it was the duty of the Assessing Officer under section 145 of the Income-tax Act, 1961, to consider whether the correct profits and gains could be deduced from the accounts so maintained. If he was of the opinion that the correct profits could not be deduced from the accounts, he was obliged to have recourse to the proviso to section 145 of the Income-tax Act, 1961.”

14.4. Therefore, it cannot be said that by adopting an ad hoc method of

arriving at net realizable value by impairing the value of service stock by

25%, in the absence of any detailed technical estimate, the assessee had

resorted to correct method of valuation. Under such circumstances, the

assessment order was prejudicial to the interests of revenue.

Ld. CIT(A) completely overlooked the fact that true profits of an year could

not be deduced without resorting to proper technical estimate of net

realizable value. He failed to appreciate that spares had no shelved life of 4/5

years inasmuch as assessee itself had written back considerable sum by way

of write back.

It is true that in the long run this exercise will be revenue neutral keeping in

view the concept of going concern of an organization but the main object of

employing correct method of accounting is to determine the true profits of

an year.

We, accordingly, uphold the order passed by ld. CIT u/s 263.

New Delhi’s order dated 24.08.2012 in appeal no. 233/11-12 relating to AY

2006-07.

the method of accounting regularly employed u/s 145 shall be allowed to the assessee continuously, therefore, the assessee’s claim should have been accepted. iii. All the accounting standard and accounting policies never prescribed any presumptive loss when the goods were actually in use. iv. The assessee’s case did not fall under any of the approved accounting standard of method of accounting.

17.3. After elaborately considering section 145, the AO further concluded as under: (a) As per proviso to section 145, the method employed by assessee should be such from which, in the opinion of AO, the income could properly be deduced and it is the duty of the AO to examine whether the method of accounting regularly employed by the assessee, was correct and from that method the income, profits and gains could be correctly deduced or not. The AO relied on the decision of Hon’ble Supreme Court in the case of CIT Vs. British Paints India Ltd. 188 ITR 44 for the proposition that it is incorrect to say that the officer is bound to accept the assessment and accounting regularly employed by assessee, the correctness of which had not been questioned in the past. (b) Where accounts are prepared without disclosing the real written down value albeit notional loss on written down value, it is duty of AO to determine the taxable income by making such computation as he thinks fit.

17.4. The AO, after detailed discussion made the addition of Rs. 458.13 lakhs, inter alia, observing that the loss claimed by assessee was on account

of presumptive write off of goods. 17.5. Ld. CIT(A) after considering detailed submissions, as reproduced in his order, deleted the addition for following reasons:

(i) The inventory used for the purpose of servicing original equipment comprised of small value items but enormous in quantity issued to various locations, departments and regions. The assessee valued such inventory at the lower of cost or net realizable value, which ever was less every year in accordance with the accounting standard II, issued by the Institute of Chartered Accountants of India. (ii) The assessee estimated 4-5 years as usual academic life of these spare parts as per industry norms and, accordingly, every year 25% of the value of these spare parts was written down to the P&L A/c. (iii) As per AS-2, issued by the Institute of Chartered Accountants of India, net realizable value is the estimated selling price in the ordinary course of business less the estimated cost of completion and the estimated cost necessary to make the same. (iv) The assessee had followed this method consistently. The assessee operated in a highly sophisticated and technological place wherein, owing to rapid technical advances, the obsolescence was very high and the value of spares of a few year ago, were rendered worthless because of technological changes.

(v) No fault could be found with the method adopted by the assessee which was an accepted practice in the industry to value the inventory of net realizable value. (vi) As per the proviso of section 145(3) as substituted by the Finance Act, 1995 w.e.f. 1.4.1997, there were two options available to the AO, either to accept the books of a/c maintained by the assessee or alternatively to reject the books of a/c maintained by assessee if the case of the assessee falls within the eventuality as envisaged in sub-section (3) of section 145 of the Act and do the best judgment assessment u/s 144. (vii) The AO could not reject the valuation of these inventories and otherwise accept the book results declared by assessee. This is permissible in law, in support of which he referred to the judgment of the Hon’ble Madras High Court in the case of CIT Vs. SAS Hotel & Enterprises Ltd. 334 ITR 194.

have backed its claim by some evidence regarding net realizable value. Thus, he pointed out that the valuation is not based on any proper technical estimation.

which was prevalent in the industry and, therefore, assessee’s claim should

have been allowed. He relied on the decisions which have been referred in

the appeal relating to challenge of the 263 proceedings.

perused the record of the case. We have discussed in detail the decisions

relied upon by ld. counsel for the assessee, from which it is evident that the

claim was advanced in both th cases on the basis of proper estimation on

technical basis resorted by assessee and not on ad hoc basis as has been done

in the present case. We are in agreement with the contention of ld. counsel

for the assessee that the AO’s conclusion that there was no fall at all in the

value of spares also is not correct because it cannot be held that there was

no decline in the net realizable value of spares. However, estimation should

have proper technical backing.

20.1. We are in agreement with the contention of ld. CIT(DR), in view of

the decision of Hon’ble Supreme Court in British Paints (supra), that if a

method employed by assessee is not resulting into computation of true

profits of business of an year then the same can be ignored by AO. In view

of section 145(3), the AO is required to examine the correctness of method

employed by assessee in preparation of its accounts. The method employed

by assessee should be such from which true profits of an year can be

deduced. However, in the present case since the assessee has debited the

P&L a/c merely on presumptive basis, therefore, we restore the matter to the

file of AO for providing the assessee an opportunity to furnish the details of

net realizable value of spares backed with proper evidence in order to

substantiate its claim.

Delhi’s order dated 17.09.2012 in appeal no. 232/11-12, relating to AY

2009-10.

carried on the same business as was in earlier year. Assessee had filed return

of income declaring income of Rs. 19,31,49,431/- including short term and

long term capital gains of Rs. 3,86,61,878/- and Rs. 1,58,29,030/-

respectively. AO noticed that assessee had earned tax free income and for

the purpose, the company had made investment of Rs. 109,71,54,427/-. He

further noticed that company had paid interest amounting to Rs.

4,52,44,722/-. He show caused the assessee to explain as to why

disallowance u/s 14A not made.

23.1. After considering the assessee’s submissions, the AO computed the

disallowance under Rule 8D at Rs. 1,06,61,713/-. Apart from this, the AO

also disallowed the assessee’s claim of loss of Rs. 4,72,76,410/- on account

of writing off of inventory.

23.2. Ld. CIT(A) while partly allowing the assessee’s appeal, deleted the

disallowance on account of write down of inventories and partly allowing the

assessee’s claim regarding disallowance made u/s 14A. Being aggrieved, both the

assessee and the department are in appeal before us. First we take up the assessee’s

appeal, wherein following grounds are raised:

1.1 That in the facts & circumstances of the case the Ld. Commissioner of Income tax (Appeals) erred in law in confirming the disallowance under section 14A of the Act without appreciating the fact that no expense was incurred in connection with earning of tax free dividend income.

1.2 That in the facts & circumstances of the case the Ld. Commissioner of Income-tax (Appeals) erred in law in ignoring the fact that while making the disallowance under Sections 14A (2) and 14A (3) of the Act read with Rule 8D, the assessing officer has failed to discharge the statutory onus of recording

the finding that any expense was, in fact, incurred in connection with earning of tax free dividend income.

1.3 That in the facts & circumstances of the case the Ld. Commissioner of Income-tax (Appeals) erred in law in sustaining the disallowance u/s 14A read with Rule 8D despite the fact that the calculation of disallowance as per the formula prescribed under Rule 8D would be 'NI L'

1.4 Without prejudice to the above grounds and in the alternative, the Ld . Commissioner of Income-tax (Appeals) erred in law, in the facts & circumstances of the case in sustaining the disallowance of Rs. 27,42,886/- by ignoring the fact that in no view of the matter, the maximum amount of disallowance by considering the average of the value of the relevant investments, should not exceed Rs. 7,50,000/- only.

AO u/s 14A ld. CIT(A) restricted the disallowance to Rs. 27,42,886/- being 0.5%

of average investment of Rs. 54,85,77,213/- holding that the disallowance was

warranted under Rule 8D(2)(iii).

dividend income earned was Rs. 4,10,000/- and, therefore, disallowance should be

restricted to Rs. 4,10,000/- only as the same cannot exceed the dividend income,

which is exempt u/s 10(34).

Delhi High Court in the case of Joint Investments P. Ltd. Vs. CIT, rendered in ITA

no. 117/2015 dated 25.2.2015, disallowance is to be restricted to Rs. 4,10,000/-. In

the result, assessee’s appeal is partly allowed.

6142/Del/2012 (Department’s appeal for AY 2009-10):

Category Nature of Amount Amount Related interest Purpose for which loan Supporting Loan taken outstanding outstanding cost incurred was taken Documents as on as on during the 31.10.2008 31.10.2009 relevant FY (Rs. / Lacs) (Rs. / Lacs) under consideration (Rs./Lacs) 1 Loan taken 841.93 4757.38 219.00 Loan was taken in Details of the Loans from CISCO connection with one of outstanding as on SYSTEMS the projects of the 31.3.2008 and (INDIA) appellant called “NSE 31.03.2009 along PRIVATE (National Stock with the sample LIMITED Exchange) Project”. relevant Loan Since the moneys so Agreements are borrowed were utilized enclosed as wholly and exclusively “ANNEXURE-2” for the business purpose only, interest cost associate with these loans is not warranted to be considered for the purpose of making any disallowance u/s 14A of the Act. II Short Term 4,799.29 NIL 52.48 These loans were taken Details of the Loans Foreign in foreign currency and outstanding as on Currency the same, being in the 31.03.2008 and Loan taken nature of buyers’ credit, 31.03.2009 are from HSBC were utilized for the enclosed as and Societe business purpose. As a “ANNEXURE-2” Generale result, no part of interest cost associated with these loans can be deemed to have been incurred in connection with exempt dividend income. III Interest free 9,085.44 18,4111.84 No interest cost was - loan taken incurred by the appellant from the in respect of this loan Holding and as such, it is not Company (i.e. liable to be considered. HCL Comnet Systems & Services Limited) IV Finance Lease 34.52 25.47 3.20 Since the loan was taken - Obligations and utilized exclusively for he purpose of purchasing the vehicles, interest cost associated with these lease obligation cannot be considered for the purpose of making any disallowance u/s 14A of the Act. Total 14,761.18 23,194.69 274.68(*)

31.1. From this he observed that the interest of Rs. 274.68 lakhs was paid for the loans taken from Cisco Systems and HSBC for utilization of the same for NSE project and for business purposes. The assessee also paid interest of Rs. 3.20 lakhs for vehicles taken on lease. Apart from the above, the assessee had paid Rs. 147.47 lakhs on account of bank charges during the period. He pointed out that none of the financial charges were related to the investment made by the assessee and investment in dividend yielding assets was made out of assessee’s own funds or funds borrowed from the holding company and no part of the interest expenditure could be held as incurred for earning exempt income. This specific finding of ld. CIT(A) has not at all been controverted by the department by bringing any evidence on record and, therefore, we confirm the findings of ld. CIT(A) in deleting the disallowance of Rs. 79,18,827/- made on account of interest expenditure relatable to earning of exempt income by AO. In the result this ground is dismissed. 32. In the result, appeal is partly allowed for statistical purposes.

Order pronouncement in open court on 19/08/2016.

Sd/- Sd/- ( C.M. GARG ) (S.V. MEHROTRA) JUDICIAL MEMBER ACCOUNTANT MEMBER Dated: 19/08/2016. *MP* Copy of order to: 1. Assessee 2. AO 3. CIT 4. CIT(A) 5. DR, ITAT, New Delhi.