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Income Tax Appellate Tribunal, “C” BENCH : KOLKATA
Before: Hon’ble Sri N.V.Vasudevan, JM & Dr.Arjun Lal Saini, AM]
ITA Nos.531&335/Kol/2014-M/s. Akzo Nobel India Limited A.Y.2009-10 1
IN THE INCOME TAX APPELLATE TRIBUNAL “C” BENCH : KOLKATA
[Before Hon’ble Sri N.V.Vasudevan, JM & Dr.Arjun Lal Saini, AM]
I.T.A No. 531/Kol/2014 Assessment Year : 2009-10
M/s. Akzo Nobel India Limited -vs.- D.C.I.T., Circle-10, Kolkata Kolkata [PAN : AAACI 6297 A] (Appellant) (Respondent) I.T.A No. 335/Kol/2014 Assessment Year : 2009-10
D.C.I.T., Circle-10, -vs- M/s. Akzo Nobel India Limited Kolkata Kolkata [PAN : AAACI 6297 A] (Appellant) (Respondent)
For the Assessee : Shri S.P.Singh & Shri Manoneet Dalal (AR) For the Department : Shri G.Mallikarjuna, CIT(DR)
Date of Hearing : 05.04.2017. Date of Pronouncement : 03.05.2017.
ORDER Per N.V.Vasudevan, JM
ITA No.531/Kol/2014 is an appeal by the Assessee while ITA No.335/Kol/2014 is an appeal by the Revenue. Both these appeals are directed against the fair order of assessment dated 31.1.2014 of DCIT, Circle-10, Kolkata (AO) passed u/s.143(3) of the Income Tax Act, 1961 (Act) read with Sec.144C of the Act relating to AY 2009-10.
Akzo Nobel India Limited, the Assessee in this appeal was earlier known as ICI India Limited. The Assessee will hereinafter be referred to as 'Akzo Nobel India' or ‘ANI’ or 'assessee'. The Assessee is engaged in the business of manufacturing and marketing of paints, speciality chemicals and starch. It has two business divisions - Paints Business Division (PBD) and National Starch and Chemicals Division (NSC).
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First we shall take up for consideration issues raised by the Assessee and the Revenue arising out of application of the provisions of Sec.92 of the Income Tax Act, 1961 (Act), viz., Transfer Pricing Regulations.
Akzo Nobel group, of which the Assessee is a part, operates through subsidiaries in various countries. Akzo Nobel N.V. is the ultimate holding company. Akzo Nobel Paints (Asia Pacific) Pte Ltd. (hereinafter referred to as ‘ANPAP’) is another company belonging to the Akzo Nobel group. ANPAP provides to Akzo Nobel group companies in various countries support services in the field of human resources, marketing support, information technology and similar other areas. Under an Agreement dated 8.12.2006 which is titled as “Service Level Agreement” (hereinafter referred to as SLA) between the Assessee and ANPAP, ANPAP agreed to render services set out in Schedule to the SLA to the Assessee. The services set out in the Schedule to the Agreement relates to (i) Advise/support in the area of human resources to attain functional excellence (ii) Advise and assistance on operation relating to Plant (iii) Advise and Support on strategies to optimise cost structures in purchasing (iv) Provide a range of market support services; (v) provide range of services in Information Technology; (vi) Advise and Assistance on reporting/accounting, financial control and planning activities and (vii) other anciliary services in support of Assessee’s business, including public affairs advise or public relations. Clause 4 of the SLA provides that the consideration payable for services to be rendered by ANPAP shall be the actual cost incurred by ANPAP for providing services to the Assessee plus a margin of 5% of such cost. The issue in the Assessee’s appeal is as to whether the payment made by the Assessee under SLA is at Arm’s Length as required under the provisions of Sec.92 of the Act.
Akzo Nobel Decorative Coating B.V. (hereinafter referred to as ‘ANDC’) is another company belonging to the Akzo Nobel group. Under an Agreement dated 23.3.2010, which is titled as ‘Trinity Service Agreement’ (hereinafter referred to as TSA), ANDC was to provide SAP software implementation programme during the
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period 2008-2010 to all Akzo Nobel Group companies belonging to the business area of Decorative Paints. As per TSA costs incurred are recorded, categorised and recharged based on the principles set out in Schedule 1 to 4 of the TSA which classifies costs as Expended costs, Capitalized Costs, Start up Costs and Local Akzo Nobel Own Account Costs. The issue in Revenue’s appeal is as to whether the DRP was justified in coming to the conclusion that the payment made by the Asssessee to ANDC under TSA was at Arm’s Length.
Consequent to globalization, multinational enterprises ("MNEs") set up their subsidiaries in various tax jurisdictions. For reasons of costs and efficiency, one member of the MNE group provides services to the other member/members of the MNE group and enter into various intra-group arrangements for providing or receiving services which may relate to technical, financial, administration and managerial. The costs incurred for providing such centralised services are allocated. Such allocation requires scrutiny by the Tax Authorities of the countries whose tax residents make payment for such services as well as the countries whose tax residents receive payment for such services, to ensure that there is no shifting of profits from one jurisdiction to the other in the garb of payments or receipts for intra group services. Therefore it is necessary to examine MNE groups' pricing and transaction structures in respect of allocation of common costs. Section 92 (1) of the Act provides that any income arising from an international transaction shall be computed having regard to the arm’s length price (ALP). Sec.92(2) of the Act provides that where in an international transaction, two or more associated enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arm’s length price of such benefit, service or facility, as the case may be. Arm’s Length Price has not been defined in the Act but Section 92C(1) provides that the arm’s length price in relation
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to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely :— (a) comparable uncontrolled price method; (b) resale price method; (c) cost plus method; (d) profit split method; (e) transactional net margin method; (f) such other method as may be prescribed by the Board. Section 92B (1) of the Act lays down that for the purposes of Section 92 of the Act, “international transaction” means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. 7. There is no specific mention of allocation of common cost in the Act. Services rendered are generally intangible and therefore difficult to identify the services actually received/rendered. In the first place it has to be proved that services were rendered. Secondly it has to shown as to how benefits were received by the entity paying. It is a settled principal in the Indian tax law and has been ruled out in various adjudications like EKL Appliances Limited [(2012) 209 Taxman 200 by the Hon’ble Delhi High Court, that the commercial expediency is not be questioned by the tax authorities.
In CIT v. Cushman & Wakefield (India) (P.) Ltd. 367 ITR 730(Del), the Hon'ble Delhi High Court observed that whether a third party - in an uncontrolled transaction with the Taxpayer would have charged amounts lower, equal to or greater than the
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amounts claimed by the AEs, has to perforce be tested under the various methods prescribed under the Indian TP provisions. In the context of cost sharing arrangement, the Hon'ble High Court opined that concept of base erosion is not a logical inference from the fact that the AEs have only asked for reimbursement of cost. This being a transaction between related parties, whether that cost itself is inflated or not only is a matter to be tested under a comprehensive transfer pricing analysis. The basis for the costs incurred, the activities for which they were incurred, and the benefit accruing to the Taxpayer from those activities must all be proved to determine first, whether, and how much, of such expenditure was for the purpose of benefit of the Taxpayer, and secondly, whether that amount meets ALP criterion.
The following aspects would require consideration in order to identify intragroup services requiring arm's length remuneration:
- Whether services were received from related party. - Nature of services including quantum of services received by the related party. - Services were provided in order to meet specific need of recipient of the services. - The economic and commercial benefits derived by the recipient of intragroup services. - In comparable circumstances an independent enterprise would be willing to pay the price for such services? - An independent third party would be willing and able to provide such services? Whether payment made to AE meets ALP criterion will be determined, keeping in mind all the above factors, as well.
Another aspect to be seen is as to whether the nature of services rendered should not in the nature of ‘shareholder services’. If services are in the nature of ‘share holder services’, then such services should not bear a charge, as the benefits from shareholding activities ought to be received by the provider of the services rather than the recipient. What constitutes a shareholder activity. The current OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, 2010 (amended since 1995), lists the following as shareholder activities:
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costs of activities relating to the juridical structure of the parent company itself, such as parent company shareholder meetings, issuing shares in the parent company and supervisory board costs; costs relating to reporting requirements of the parent company, including the consolidation of reports; and costs of raising funds for acquisition by its participants 11. Furthermore, in relation to activities which concern more than one enterprise of an MNE, the OECD Guidelines state that shareholder activities should be distinguished from the broader concept of stewardship activities which include the following:
Stewardship activities cover a range of activities by a shareholder that may include the provision of services to other group members, for example services that would be provided by a coordination centre. These latter types of non- shareholder activities could include detailed planning services for particular operations, emergency management or technical advice (troubleshooting), or in some cases assistance in day to-day management. Thus, in the case of central coordination and control activities, the focus has changed from the nature of the activity to the willingness to pay in an independent scenario. It follows implicitly from the OECD Guidelines that coordination activities (stewardship activities) qualify as services, unless a particular subsidiary does not need the activity and would not be willing to pay an unrelated party to perform it.
The Transfer Pricing Officer (TPO) in the present case in his order passed u/s.92CA(3) of the Act dated 30.1.2013 discussed the OECD guidelines & US Regulations on shareholder activity. The Assessing Officer is required under the provisions of Sec.92CA of the Act, wherever ALP has to be determined to make a reference to TPO to determine ALP of an international Transaction. The gist of all these discussion by the TPO in his order is that MNEs prefer centralising common services and costs and doing so has an economic rationale. A taxpayer should be able to show that intra group services have been rendered and that the Indian taxpayer has received an economic or commercial benefit that has enhanced commercial position of the recipient. This test, known as the benefit test, has to be satisfied. The transaction related to the provision of services would be at arm’s length only where a benefit is
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provided to an entity by way of provision of services, and there should be a real connection between the operation of the enterprise which is providing services and the enterprise which is expected to pay for the same. In other words, the tests laid down by the Hon’ble Delhi High Court in the case of Cushman & Wakefield (supra) should be satisfied.
Another aspect which the TPO has highlighted in his order is the decision of the Hon’ble Supreme Court in the case of DIT (IT) Vs. Morgan Stanley & Co. (2007) 162 Taxman 165 (SC). According to the TPO the Hon’ble Supreme Court has laid down in the aforesaid decision that by rendering stewardship activities a holding company was merely protecting its own interest and therefore the holding company rendering services should not charge for such services from its subsidiary company. We wish to clarify that the ruling in the aforesaid decision, in our view, has no application to the facts of the present case. Firstly, the observations were rendered in the context of an admitted factual position by the applicant before the Authority for Advance Ruling (AAR) that certain services were in the nature of stewardship services. Secondly the observations were made by the Hon’ble Supreme Court as to whether stewardship activity rendered by the holding company for the Indian subsidiary in India would constitute a Permanent Establishment (PE) within the meaning of Article 5(2)(l) of the DTAA between India and USA. In the present case the factual dispute is as to whether the nature of services rendered by ANPAP was in the nature of stewardship services or not. To this extent we have to conclude that the reference to the decision of the Hon’ble Supreme Court in the case of Morgan Stanley (supra) by the TPO in his order has to be held as not relevant.
Keeping in mind the principles emanating from the aforesaid discussion, we shall now proceed to examine the grounds of appeal of the Assessee and the Revenue in so far as it relates to issues arising out of Transfer Pricing Reglations.
First we shall take up for consideration, appeal by the Assessee. The main issue for consideration in this appeal is as to whether the consideration paid by the Assessee to ANPAP under the SLA is at Arm’s Length.
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The following are the criteria to determine ALP of the payment made by the Assessee to ANPAP under SLA: - Whether services were received from related party. - Nature of services including quantum of services received by the related party. - Services were provided in order to meet specific need of recipient of the services. - The economic and commercial benefits derived by the recipient of intragroup services.
The claim of the Assessee was that services provided by ANPAP to it under SLA are support services provided by ANPAP to several Akzo Group companies across the world and relate to support services in the field of human resources, marketing support, information technology and similar other areas. According to the Assessee, such services enable the worldwide Akzo Group entities to have a full access to the extensive resources and expertise available in these specific functional areas for the benefit of the Akzo Group. Such a policy enables the Akzo Group entities to anticipate commercial developments on a global basis and to apply them effectively to business situations. In addition, it gives substantial savings in total costs when compared with those that would otherwise be incurred if they were organized by individual Akzo Group companies in various countries. The nature of the support services provided by ANPAP and their functional categories were described by the Assessee as give below:
• Information Technology The assessee receives assistance in a range of services which include support in development and implementation of IT plans and strategies, monitoring of IT services, provides training to understand various IT interfaces, assist in developing contents of websites, provides onsite/ remote support services to resolve issues associated with configuring applications, antivirus and IT security from outside threats. AE also provides various applications/ software, shares global IT systems to integrate workplace and service desk for quick resolve to any IT concerns.
• Human Resource
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The recruitment, retention and development of talented / highly specialized technical personnel are critical to any organization's survival and success. The assessee is dependent on its personnel for leadership competencies and specialized technical skills. These services include advice/support to the assessee to attain functiona1 excellence in the area of Human Resource and assisting in maintaining proper employee records, relevant job/project codes for respective employees, continuous personnel training and development on employee database (Peoplesoft).
• Operations Supply chain and production management is a very critical factor in the assessee's business operations. This ensures that the flow of goods within the supply chain is performed in a cost-effective manner. The AE provides advice and assistance on plant activities including assistance in adherence to engineering and technical standards, assisting in forecasting projections in line with plant capacity, undertaking workshops, assistance in utility, waste and environmental management. In addition, AE also provides assistance and guidance on various cost saving mechanisms and assists in capturing market trends and uncertainties.
• Purchasing The assessee receives services in the nature of advice and support on strategies to optimise cost efficiencies including processes involving leveraging prices from suppliers, assisting on inventory planning, etc. Further as a part of the Akzo group's suppliers support programme, the AE along with the assessee visit suppliers to leverage their global standing and achieving on cost efficiencies and to have effective control on product's quality and standards.
• Marketing Support The assessee's overall performance depends on realizing its growth ambitions. It is exposed to markets with high complexity and faces intense competition from local companies as well as other global players for retaining / increasing its market share in India. Accordingly, the assessee needs to understand developments in end-user preferences to stay competitive in the market. The AE provides a range of marketing support services covering assistance in the nature of formulating and implementing of marketing strategies and policies, updating on global market trends and indices, assisting on developing and conducting product awareness programmes - with implementation personnel, assisting in building up new product demand, assisting in effective designing, advertising, brand development, promotion campaigns, training and coaching programmes.
• Finance and Planning The assessee is exposed to various compliance risks in the course of its ordinary activities. Its image and reputation may be adversely impacted by non-compliance with the various data privacy and product security laws. Compliance procedures have
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been adopted by the assessee to ensure that the use of resources is consistent with laws, regulations and policies, and that resources are safeguarded against waste, loss and misuse. Ineffective compliance procedures relating to the safeguarding of assets could have an adverse effect on the financial results. The AE provides a various services in the field of finance and planning which includes advice and assistance on reporting/ accounting, financial control and planning activities, internal audit reviews and process improvements, tax and treasury assistance.
Evidence in support of rendering of services by ANPAP and the benefit received by the Assessee: The Assessee in support of the services having been rendered by ANPAP filed copies of sample e-mail communications between ANPAP and the Assessee. The communications are placed at page 354 to 756 of the Assessee’s paper book. The gist of the services and the category in which those services fall, the nature of services rendered, the e-mail in support of the Assessee’s claim that ANPAP provided those services through e-mails and the benefit the Assessee received as a result of those services was given by the Assessee before the TPO in the form of a chart with cross reference to the page number of the paper book. The same is given as an annexure “A” to this order.
In the Transfer Pricing Study filed by the Assessee before the AO, the Assessee has not done individual analysis of international transactions but has combined all international transactions and compared the overall profits of the Assessee with comparable companies and claimed that all international transactions were at Arm’s Length. This approach of aggregation is not correct and against the provisions of the Act. Therefore, it would not be worthwhile to discuss the Transfer Pricing Study of the Assessee filed in Form No.3CEB. However the Assessee made up for this deficiency by filing along with its submission dated 5.11.2012 before the TPO report dated 30.6.2009 of Pricewaterhouse Coopers LLP, Chartered Accountants. In such a report a search for similar independent service providers providing services that were provided by ANPAP under SLA was identified and it was found on such analysis that similar services provided by and to unrelated parties were at an average margin of cost
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+ 5.1% and it was opined that the cost + 5% margin for similar services paid by the Assessee to its AE should be regarded as confirming to the ALP. This report is at pages 769 to 791 of the Assessee’s paper book. The Assessee also filed a certificate of KPMG, LLP, Singapore, an independent third party accounting expert, certifying the basis of cost allocation by ANPAP for the various services rendered by the Assessee based on the evidence of services rendered by ANPAP to the Assessee. This certificate is at pages 792 to 801 of the Assessee’s paper book.
The TPO has not disputed the above cost allocation as well as the fact that the comparative cost charged by unrelated parties for similar services was at a margin of 5.1% of the cost. The TPO did not consider this aspect at all because he proceeded on the basis that the nature of services rendered were in the nature of stewardship activity and therefore no charges ought to have been paid by the Assessee. He therefore held that the entire sum paid by the Assessee to ANPAP had to be added to the total income of the Assessee. The relevant observation of the TPO in this regard is found in para-21 at page-67 of his order, which reads as follows: “21. It can be seen from the above that the services performed by the AEs of the Assessee (directly or through other AEs) fall into the category of stewardship activity as defined by Hon’ble Supreme Court of India (to say nothing about the charge for such services being not in consonance with the type of services provided).”
Therefore, in this appeal, the question we need to decide is as to whether the services rendered by ANPAP can be said to be stewardship services. If the answer is in the negative, then we need not go into the question regarding rendering of services, benefit received by the Assessee, ALP of the price paid by the Assessee, as these have not been disputed by the TPO and hence we have to proceed on the basis that the TPO was otherwise satisfied that the price paid under SLA was at Arm’s length.
As we have already stated the TPO concluded that the services were in the nature of stewardship services/activities and therefore no consideration was payable for such services and therefore whatever consideration was paid by the Assessee should be
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added to the total income of the Assessee as Arm’s Length Price was nil. The DRP was of the view that the services were rendered by ANPAP to the Assessee and that the Assessee benefitted from such services. Having held so, the DRP contradicted its own finding by holding that majority of the services helped the parent company in supervising and controlling subsidiary company and therefore the services were in the nature of “Stewardship Services”. The DRP also concluded that some benefit would have accrued to the Assessee as a result of such services but such services cannot be determined with certainty and therefore the conclusion of the TPO should be upheld. The following were the conclusions of the DRP in this regard.
“1.4.4. The evidences and other information submitted by the assessee before the TPO have been gone through. It is evident that the services received form Akzo Nobel Paints (Asia Pacific) Pte Ltd have benefitted the Indian assessee also. But the assessee has not discussed the aspect of how these services have been useful and benefitted the parent also in executing its supervisory and control responsibilities.
1.4.5. Significant portion of services rendered across various verticals significantly helped the parent in supervising and controlling the subsidiary company. To this extent, these services would fall under the definition of “stewardship services”. The TPO has extensively drawn from the literature of OECD, USIRS, International judicial decisions, etc. To discuss the nature of stewardship services and how the services availed from Sika services fall under that category. The TPO has also referred to the decision of Hon’ble Supreme Court in the case of DIT vs Morgan Stanley and Company (2007) 292 ITR 416 (SC) to discuss the nature of stewardship services. To this extent, this judicial decision is relevant to the case of the asessee though the business model may be different.
1.4.6. Thus, the services provided by Akzo Nobel Paints (Asia Pacific) Pte Ltd benefit the parent as well as the assessee in India. To the extent the services have helped the parent to exercise supervision and control over the group entities, it amounts to stewardship services. The remaining services have benefitted both the parent and the subsidiary in India. How much of the benefit can be attributed to the parent and to the unit in India is a subjective matter and the dividing line lies in between. The assessee has not even attempted to discuss this aspect of the services provided from Akzo Nobel Paints (Asia Pacific) Pte Ltd.
1.4.7. From the foregoing discussion, it is evident that the benefit out of intra group services has accrued to the assessee in India as well as to the group
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parent also. However, the proportion of benefits accruing to each party remains indeterminate. In view of this, we are of the opinion that no interference is called for in the determination made by the TPO.
Aggrieved by the order of the AO incorporating the directions given by the DRP in the fair assessment order, the Assessee has preferred appeal being ITA No.531/Kol/2014. The grounds of appeal raised by the Assessee before the Tribunal reads thus:
“1. That on the facts and in the circumstances of the case, the order of the Transfer Pricing Officer (hereinafter referred to as "Ld. TPO") passed u/ s 92 CA(3) of the Income-tax Act, 1961, (hereinafter referred to as the 'Act'), subsequently confirmed in part by the Dispute Resolution Panel, Kolkata (hereinafter referred to as "Ld. Panel") and consequently incorporated by the Deputy Commissioner of Income Tax (hereinafter referred to as "Ld. AO") in the assessment order u/s 143(3) r/w section 144C(13) of the Act, is erroneous on facts and bad in law.
That on the facts and in the circumstances of the case, Ld. Panel erred in confirming the adjustment of Rs. 39,411,875/- to the international transactions of the appellant with its Associated Enterprise (hereinafter referred to as 'AE') Akzo Nobel Paints (Asia Pacific) Pte. Ltd., Singapore.
That on the facts and in the circumstances of the case, the Ld. Panel on perusing through the nature of services, evidences of services, ensuing benefits and pricing of services, had acknowledged the receipt of benefits to the appellant in its business operation but still grossly erred in disallowing the entire payment without any basis.
That on the facts and in the circumstances of the case, Ld. Panel while acknowledging the receipt of benefit to the appellant in its business operation, had erred in not providing due cognizance to the audited cost allocation statement showing segregation of cost incurred by AE in supervisory and control function benefitting the parent and other functions benefitting the service recipients (including appellant) in its overall day to day business operation and failed to provide due cognisance to the fact that cost incurred by AB in relation to stewardship activities (supervisory and control) were separately identified and eliminated while allocating service costs to the appellant.
That on the facts and in the circumstances of the case, Ld. Panel and consequently the Ld. AO have grossly erred in rejecting the transactional level economic analysis (selecting AE as the tested party) undertaken by the appellant for the said transaction in accordance with the Income-tax Rules, 1962 for the
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determination of the Arm's Length Price Further, Learned Panel and consequently the Ld. AO erred in not giving any reason to reject the transactional level economic analysis.
That the appellant craves leave to add to and/ or amend, alter, modify or rescind the grounds hereinabove before or at the time of hearing of the appeal.
The learned counsel for the Assessee reiterated submissions made before the DRP/TPO and drew our attention to the evidence in support of the services received by the Assessee from its AE, the rationale/need for services so received vis-à-vis the business of the Assessee, benefit received by the Assessee, the benchmarking approach adopted by the Assessee from recipient’s perspective and also from the service provider’s perspective, manner of allocation of costs by the service provider vis-à-vis the Assessee. He also explained the meaning of nature of stewardship services and as to how the payment made by the Assessee to its AE, are not in the nature of stewardship services. He drew our attention to certain decided cases of Hon’ble High Courts in India and various Benches of Income Tax Appellate Tribunal on the approach that should be adopted in determining ALP in cases of intra group services received from group companies (AE). We will make a reference to these decisions later.
The learned DR supported the order of the DRP/TPO. According to him the conclusions drawn by the DRP/TPO are just and proper and calls for no interference.
We have given a careful consideration to the rival submissions. As per the OECD Guidelines paragraph 7.2: Nearly every MNE group must arrange for a wide scope of services to be available to its members, in particular administrative, technical, financial and commercial services. Such services may include management, coordination and control functions for the whole group. (emphasis added) The U.S. regulations define an intra-group service in the following manner (Treas. reg. § 1-482-9(1)(1)):
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Controlled services transaction - (i) In general. A controlled services transaction includes any activity (as defined in paragraph (1)(2)of this section) by one member of a group of controlled taxpayers (the renderer) that results in a benefit (as defined in paragraph (1)(3) of this section) to one or more other members of the controlled group (the recipient(s)).
Thus, as per this definition of services, first there should be an activity performed by one of the members of a group of related parties which lies within the ambit of definition of activity (the 'activity test') and second, that activity should result in a benefit (the 'benefit test') to one or more members of that group of related entities. The OECD Guidelines also concur with this view in paragraph 7.5: There are two issues in the analysis of transfer pricing for intra-group services. One issue is whether intra-group services have in fact been provided. The other issue is what the intra-group charge for such services for tax purposes should be in accordance with the arm's length principle. (emphasis added) 27. The Assessee does not have a full capacity to provide a range of services to its business and to the personnel working for it. In the interests of economy and efficiency the assessee desired to obtain these services from its associated enterprise ANPAP. ANPAP has expert resources in commercial, financial, accounting and other matters which would be employed for the benefit of the individual companies of the Akzo group. The group companies would have access to the resources and would pay appropriate consideration which would be commensurate with the amount paid to third party service providers. These support services relate to certain functional categories which have set out in the earlier part of this order and hence, we do no wish to repeat the same. As we have already observed in the earlier part of this order, the practice of multinational enterprises providing intra group services is a global practice wherein, various activities are frequently concentrated for the benefit of the entire group. Since, the multinational group operates globally, such concentration is essential to be able to react in the most flexible and cost effective manner. According to the assessee the benefits derived from availing the above services outweigh the cost incurred in receiving such services. It is also the claim of the Assessee that with the help of such centralized services it achieved substantial cost efficiencies and hence it
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would be incorrect to categorise such services to be in the nature of stewardship services. It is the claim of the Assessee that the above services are essential for the operations of the Assessee and had it not received the access to the above information, it would have been required to perform them by itself (in-house) or by hiring experienced service providers. The OECD Guidelines in this regard (para 7.6) lays down the following: Under the arm's length principle, the question whether an intragroup service has been rendered when an activity is performed for one or more group members by another group member should depend on whether the activity provides a respective group member with economic or commercial value to enhance its commercial position: This can be determined by considering whether an independent enterprise in comparable circumstances would have been willing to pay for the activity if performed for it by an independent enterprise or would have performed the activity inhouse for itself. If the activity is not one for which the independent enterprise would have been willing to Pay or perform for itself, the activity ordinarily should not be considered as an intra-group service under the arm's length principle. (emphasis added) 28. As we have already observed the question we need to decide is as to whether the services rendered by ANPAP can be said to be stewardship services. If the answer is in the negative, then we need not go into the question regarding rendering of services, benefit received by the Assessee, ALP of the price paid by the Assessee, as these have not been disputed by the TPO and hence we have to proceed on the basis that the TPO was otherwise satisfied that the price paid under SLA was at Arm’s length. The TPO’s observation on the nature of services rendered by ANPAP was that it was in the nature of Stewardship activity. According to him Stewardship expenses means those expenses resulting from either 'shareholder activities' or 'duplicative activities' as defined in the Section 482 regulations. The TPO has referred to the US Regulations which describe stewardship expenses as expenses that result from oversight functions undertaken for a corporation's own benefit as an investor in related corporations. He has also referred to US regulations under Section 861 that adopts the 'sole effect' standard for shareholder activities, meaning that stewardship expenses resulting from shareholder activities include expenses of only those activities whose sole effect is to protect the parent company's capital investment in the related corporation and/or to
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facilitate compliance with legal requirements applicable specifically to the parent company. The TPO has highlighted the following as stewardship activity based on the decisions of US Courts:
Description Nature of service Requirements and procedures to maintain Stewardship activity confidentiality on account of world- wide operations Requiring the subsidiary/related entity to -Do- act according to the quality control specifications Briefing of the staff of the subsidiary/related entity to ensure that -Do- the output meets the requirements of the parent company/group Overall monitoring of the operations of the subsidiary/related entity (other than -Do- day-to- day management)
The TPO based on the decisions of the US Courts, has also culled out list of supervisory or stewardship activities, for which the recipients should not have been charged even when they benefitted from the services. Reference Service Details Remarks
Para 83 Seeing to it that the Services not managerial subsidiary (service but stewardship recipient)develops materials to the satisfaction(in other words, seeing to it that the subsidiary produces or provides goods or services which are up to the standards expected of the parent) Para 84 Visiting the subsidiary's -Do- clients, on the spot supervision
Para 86 Making presentations for -Do- getting new business; getting third parties to
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give business to subsidiaries in particular markets Para 88 To make certain that the -Do- various offices maintained plaintiff’s production standards and that the subsidiaries perform their duties to their client’s satisfaction Para 89 Deciding to consolidated General supervisory foreign Offices; travelling to services offices; such offices to solve travelling to such offices personnel problems. in attempt to control to solve personnel problems activities of subsidiaries
Specific services considered in decisions of the US Courts on stewardship activity, monitoring and supervisory activity and ‘direct and proximate benefit test’, has also been highlighted by the TPO in his order:
Service Type Reference Diligent efforts to provide the subsidiary Merck & Co. V. United States, 24 with highest feasible sales revenues, Cl.Ct.73 (1991) including shutting down a U.S. plant in order to keep the subsidiary in production; The establishment of artificial and unreasonably high prices to help the subsidiary in production; and The provision of personnel who served as members of the board of directors and officers of the subsidiary Audits by the parent H Group Holding Inc. V. Commissioner, Reporting requirements of the parent, TCM 1999-334 (1999) Reviewing of contracts by the parent, Providing for consistency of accounting systems etc Business development activities
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As far as the Intra group services rendered by ANPAP are concerned, expertise in the field of HR, Operations and Purchasing, IT, Marketing, Finance and Planning areas have been developed and with a view to enable the Akzo group companies to have full access to this extensive knowledge and expertise, ANPAP provides these services to the various group companies of Akzo group. Besides expertise, there has been substantial savings in total costs when compared with those which would otherwise be incurred if they were borne by the individual companies in various countries. It is not disputed by the TPO that had the assessee not received such support from ANPAP, it would need to perform the functions in-house, or hire experienced and trained service providers. Such services are thus not in the nature of simply oversight functions, which have been performed by ANPAP to protect its investment in the company. With regard to the services received from ANPAP, the company has submitted detailed evidences to the Ld. TPO in the form of emails, communications and reports which evidence the rendering of services and the ensuing benefits. These have been given in Annexure-“A” to this order. Nature of service i.e. Information Technology, Human Resource, Operations, Purchasing, Marketing Support, Finance and Planning has been evidenced by way of such communication/ documents. It was neither disputed by the TPO that apart from services which are received in the form of emails, reports, documents etc. from ANPAP, the assessee also received constant and continuous information over calls, audio-video conferences, personal visits etc. Therefore, the benefits received in the above form ought to have been given due consideration. Hence, for the purpose of demonstration and explanation, the assessee has submitted documents evidencing the regular flow of valuable commercial services. From the above details submitted by the assessee it has been amply demonstrated that the benefits generated by the said services during the relevant financial year have undeniably added economic / commercial value to enhance the commercial position of the assessee and such services are received by the assessee on a continuous basis across its operational areas. Hence it is erroneous to classify the services to be in the nature of stewardship services.
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The TPO in his observations on each of the items of service set out in Annexure “A” to this order commented that the services were in the nature of control, supervisory, monitoring functions. By way of illustration let us take item No.1 of the list of services, which were claimed by the Assessee to be relating to Marketing. The Assessee has referred to a mail from Anton (Singapore) providing access to internet site and enable configuration for all users to facilitate distribution of campaign information. This was in connection with the new guidelines for Teaser Campaign (must be for a new product launch). The benefit was to enable group companies to utilize marketing strategies uniformly so that commercially all group companies benefit. This was named as “Control, supervisory, monitoring function” by the TPO. Similarly item No.2 of the list of services given in Annexure “A” to this order, which is a function relating to “Information Technology”, makes a reference to a mail for updation of country level lotus note user headcount by each entity to Singapore personnel. This was to enable creation of a data back for all users and enable carrying out planning and strategic activities for IT services. This was termed as “Control, supervisory, monitoring function” by the TPO. Annexure “A” list contains about 69 items of services and all have been branded as “Control, supervisory, monitoring function” by the TPO. This approach of the TPO was not correct. None of the services listed in Annexure “A” could be termed as either shareholder activity or stewardship activity, applying the guidelines referred to earlier for considering an activity as “Shareholder activity” or “Stewardship activity”.
The DRP in its order has accepted that the findings of the TPO are not correct. The DRP was of the view that the services were rendered by ANPAP to the Assessee and that the Assessee benefitted from such services. Once this conclusion is arrived at then the case of the TPO that the nature of services were shareholder activity or stewardship activity cannot be sustained. Having held so, the DRP contradicted its own finding by holding that majority of the services helped the parent company in supervising and controlling subsidiary company and therefore the services were in the nature of “Stewardship Services”. The DRP has not spelt out as to what were the
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services that benefited the Assessee and what were the services that benefitted the parent company. The DRP also concluded that some benefit would have accrued to the Assessee as a result of such services but such services cannot be determined with certainty and therefore the conclusion of the TPO should be upheld. Without pointed out how services rendered cannot be segregated as benefiting the parent company and that benefiting the group companies, the DRP could not have come to such a conclusion.
We therefore conclude that the assessee has established the nature of services including quantum of services received from ANPAP, that services were provided in order to meet specific need of the assessee for such services, the economic and commercial benefits derived by the assessee from intra group services. In its submission dated 5.11.2012 filed before the TPO, the Assessee filed report dated 30.6.2009 of Pricewaterhouse Coopers LLP, Chartered Accountants. In such a report a search for similar independent service providers providing services that were provided by ANPAP under SLA was identified and it was found on such analysis that similar services provided by and to unrelated parties were at an average margin of cost + 5.1% and it was opined that the cost + 5% margin for similar services paid by the Assessee to its AE should be regarded as confirming to the ALP. The Assessee also filed a certificate of KPMG, LLP, Singapore, an independent third party accounting expert, certifying the basis of cost allocation by ANPAP for the various services rendered by the Assessee based on the evidence of services rendered by ANPAP to the Assessee. The TPO has not disputed the above cost allocation as well as the fact that the comparative cost charged by unrelated parties for similar services was at a margin of 5.1% of the cost. In view of our conclusion that the TPO and the DRP were in error in holding that the nature of services rendered by ANPAP were in the nature of stewardship activity or shareholder activity, we hold that the TPO’s conclusion no charges ought to have been paid by the Assessee. The charges paid by the Assessee to ANPAP are held to be at Arm’s Length. Consequently, the addition made by the
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revenue authorities in this regard are directed to be deleted and the appeal of the Assessee ITA No. 531/Kol/2014 is allowed.
We shall now take up for consideration the Transfer Pricing issue that arises for consideration in the appeal by the Revenue. We have already seen that ANDC another company belonging to the Akzo Nobel group under TSA provided SAP software implementation programme during the period 2008-2010 to all Akzo Nobel Group companies belonging to the business area of Decorative Paints. The Assessee made payment for its share of services received from ANDC. The TPO held that services so received were in the nature of “Control, Supervisory, monitoring function” and therefore no consideration ought to have been paid by the Assessee to ANDC. The entire sum paid was added to the total income as adjustment to the Arm’s Length Price of the international transaction. The DRP deleted the addition made by the TPO. The issue in Revenue’s appeal is as to whether the DRP was justified in coming to the conclusion that the payment made by the Asssessee to ANDC under TSA was at Arm’s Length.
Services received by the Assessee from “ANDC”: Under TSA ANDC a group company of 'AkzoNobel group' implemented SAP programme in all the participating group companies. The Assessee also participated in the said programme known as “Project Trinity”. The above arrangement refers to the support received for installation of SAP ERP in the locations of the assessee and other group companies. The above arrangement i.e. SAP implementation is exclusively for Akzo Nobel N. V. group of companies and services similar to above have not been provided to any third party. In relation to SAP deployment and implementation, ANDC acts as a cost pooling and recharging centre wherein the costs are recharged to the Akzo Nobel N.V. group of companies on the basis of principles defined in the agreement for each category of cost by ANDC and under each stage from deployment of SAP to its final implementation i.e. go-live. The costs recharged primarily include third party costs or
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costs incurred by ANDC. As per the agreement, the costs are recorded, categorised and recharged based on principles which can be summarised as given below.
Schedule 1 - Expensed Costs These costs include deployment specific costs and operational IT support cost. Schedule 2 - Capitalized Costs These costs include kernel enhancing assets or assets on which the system operates and are deemed to be global in nature and not able to be assigned directly to an individual country/ deployment. From the date of go-live the costs are allocated for a period of 5 years on a per user basis to each country. Schedule 3 - Start up Costs These costs would be incurred and expensed via invoices from third party suppliers and would be allocated on a per user basis to a deployment country as a one-time start lip fee at the point of go-live. Schedule 4 - Local Akzo Nobel Own Account Costs The costs referred to hereinabove would be incurred and expensed directly by the local deployment country with no recharge taking place to the central Trinity project. SAP system is ERP software which is required for the day-to-day running of the business. It improves alignment of strategies and operations and helps in achieving corporate objectives by aligning workforce and organizational objectives. Implementation of SAP leads to improved productivity and reduce costs through increased flexibility. It also helps in increased profitability, improved financial control, and management of risk as well as optimization of IT spending.
The assessee also submitted evidence of communication, training manuals and other documents shared which evidence the valuable assistance provided by ANDC as well as the nature of services received under the TSA framework. The Details of benefits emanating from receipt of services was explained by the assessee as embedded in the fact that ANDC is a recharging entity for the costs incurred with respect to the implementation of SAP Platform in participating entities. The assessee,
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through execution of the TSA, has effectively subscribed to a cost effective means of implementation of SAP Platform which would lead to an increase in its operational, accounting and management reporting efficiencies. SAP system is ERP software which is required for the day-to-day running of the business. It improves alignment of strategies and operations and helps in achieving corporate objectives by aligning workforce and organizational objectives. Implementation of SAP leads to improved productivity and reduce costs through increased flexibility. It also helps in increased profitability, improved financial control, and management of risk: as well as optimization of IT spending.
The TPO determined the value of the international transaction to be nil, and held that the provision of services by ANDC were in the nature of stewardship functions. The TPO challenged the commercial expediency and wisdom of the assessee in installation of SAP software based on the legitimate business requirements of the assessee and concluded that the assessee's operation levels do not justify SAP implementation. The TPO refused to accept the plea of the Assessee that SAP implementation was meant to augment the operational efficiency of assessee and consequently concluded that the entire process is a part of quality control, supervision and monitoring function of the group.
Before DRP the Assessee reiterated submissions made before the TPO. In particular, it was highlighted that the following services were provided by ANDC to the assessee, viz., : - • Resources - Deployment of SAP for the users of the assessee including establishing a central deployment team and training of local resources to provide support at hand to the assessee. • Training - The AE also conducts training of users to enable them to adapt to the new system once it is implemented. • Infrastructure support - Once the SAP system is implemented i.e. from the 'Go live' date the AB provides support in setup and maintenance of software infrastructure.
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• Improvement in functionality - A team is setup comprising of technical and business resources who are involved in enhancing the SAP kernel, including implementing new functionality and extending/enhancing current functionality. • Identification of resources - Separately, the AE identifies and employs resources and external consultants for assistance in upgrading the system implementing various functionalities.
It was reiterated that in relation to SAP deployment and implementation, ANDC acted as a cost pooling and recharging centre wherein the costs are recharged to the Akzo Nobel N.V. group of companies on the basis of principles defined in the agreement for each category of cost by ANDC and under each stage from deployment of SAP to its final implementation i.e. go-live. The costs recharged primarily include third party licensing costs or costs incurred by ANDC (which include reimbursement costs and other expenses incurred by ANDC). It was reiterated that the TPO has erred in judging the commercial expediency of the transaction of installation of SAP by viewing that the decision was not feasible from the point of view of a company with turnover similar to the assessee's. Reliance was placed on the decision of the Hon’ble Delhi High Court in the case of EKL Appliances (supra) wherein it was held that Rule 10B(l)(a) does not authorise disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same or that in the view of the Revenue the expenditure was unremunerative or that in view of the continued losses suffered by the assessee in his business, he could have fared better had he not incurred such expenditure. These are irrelevant considerations for the purpose of Rule 10B. Whether or not to enter into the transaction is for the assessee to decide. The quantum of expenditure can no doubt be examined by the TPO as per law but in judging the allowability thereof as business expenditure, he has no authority to disallow the entire expenditure or a part thereof on the ground that the assessee has suffered continuous losses. The financial health of assessee can never be a criterion to judge allowability of an expense; there is certainly no authority for that. It was submitted that the TPO is expected to examine the international transaction as he
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actually finds the same and then make suitable adjustment but a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the TPO is not contemplated or authorised.
It was submitted that evidence of communications, training manuals and other documents and evidence of valuable assistance provided by ANDC as well as the nature of services received under the framework were fully explained. The same is also given in the form of a chart and given as Annexure “B” to this order.
After considering the submissions made before it, the DRP deleted the addition made by the TPO for the following reasons: “2.5.1 The assessee through execution of this agreement, has subscribed to a cost effective means of implementation of SAP Platform: which would lead to an increase in its operational accounting and. management 'reporting efficiencies.
2.5.2 The assessee has submitted, evidences of communications, training manuals and other documents shared which evidence; the valuable assistance provided by ANDC as well as the nature of services received' under the framework. .
2.5.3 Further, the assessee submitted that it runs SAP hosted through the head office at Gurgaon. The SAP system is used by the following teams of the assessee spread across India:
60 depots: of the assessee, which are spread across the country for sales order and billing, sales return, material receipt from factories, inter depot stock transfer payment receipting and adhoc requisition
4 regional sales Offices for credit management,' bank reconciliation, bill booking, accounts payable and journal voucher
3 factories for back-end operations like manufacturing, shop floor control, purchasing, accounts payable etc.
Head office for master data management (customer, vendor, product, price), bill booking and .accounts payable, asset accounting, journal voucher and overall Controlling. SAP is used for Product costing and Finished products stock valuation. The' data related to production quantities and values as .well as RM/PM consumption values and
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quantities are down loaded from BPCS running in the three factories and all stock , movement data from Depots are down loaded from SAP for this purpose. The company has used the said software for integrating the processes at the above varied locations of the business. This ensures that there is one version of the data available at all locations thereby providing huge benefits to the accounting and manufacturing processes at the assessee's business.
2.5.4 Apart from: the above, SAP uses for the assessee include
• Planning and Manufacturing processes - The assessee: can perform-demand planning and, dispatch requirement planning systems used by Supply Chain function to generate production plans, dispatch plans at each depot. Such, plans 'can be created for each SKU and specific for each depot '
• Approval processes - The SAP system helps to implement a Lotus Notes based system for approvals in various areas as well as for all master data uploads e.g. customer master, material master, vendor master uploads in SAP.
• The Lotus Notes workflow tool sends out mails to different people in the hierarchy and helps them in, forwarding for approval, approving or rejecting the exceptions / .blocks happening in the SAP system. It uses Lotus' Enterprise Integrator-product to pull / push data from SAP. The system is used in credit approval, material returns approval, adhocs approval and cheque dishonor workflow support for SAP.
All-the above system are seamlessly integrated with each other through a set of complex interface programs, which run automatically without any manual interventions in most of the cases.
2.5.5 Thus, the top five benefits of SAP include:
1) Information available across organisation as a whole rather than 'multiple versions of the truth’ 2) Better financia1 reporting:. ' 3) Less duplication' and time wasting across the board 4) Better aligned Cross-departmental processes 5) Enabling better regulatory compliance
2.5.6 The observation of the TPO that SAP is not feasible for the assessee considering its turnover' is very subjective and not supported by any criteria. Nor he mentioned the level of turnover which would justify the implementation of SAP.
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2.5.7 Further, reference is drawn to paragraph 7.9. of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations OECD Guidelines - Chapter on Intra-group services), which provides that: ‘In a narrow range of such cases, an intra group activity may be performed relating to group members even though those group members do not need the activity (and would not be; willing to pay for it were they independent enterprises), Such an activity would be one that a group member (usually the parent company or a regional holding company) performs solely because of its ownership interest in one or more other group members, i. e. in its capacity as shareholder. This type of. activity would not .justify a charge to the' recipient companies. It may be referred to as a ‘shareholder activity’.
In view of the nature of services being; received by the assessee, we are of the opinion that had the assessee not received such support from its AE, it would to perform the functions In-house, or hire experienced and trained service providers. Hence, such services are not in the nature of simply oversight ions, which' have been performed by ANDC to protect its investment in the company.
2.5.8. SAP system is ERP software which is required for the day-to-day running of the business. In view of the above facts, we are of the opinion that it improves alignment of strategies and operations and helps in' achieving corporate objectives by aligning workforce and organizational objectives. Implementation of SAP. leads to improved productivity and reduce costs through increased flexibility. It also helps in increased profitability, improved financial Control, and management of risk as well as optimization of IT spending. Hence it would be erroneous to classify the services to be in the nature of stewardship services. Hence, it should be judged to be legitimate business expenditure of the assessee.
2.5.9. The assessee has undertaken the bench marking study of international transaction, payment of management fee, at a overall company level profitability wherein the assessee has selected itself as the tested party and compared its operating profit level with similar uncontrolled comparable companies. The average of margins earned by functionally comparable companies is 8.29%. The profitability of the company after taking into account the payments for intra-group services is:9.54% which is as per the arm's length standard.
2.5.10. The nature of services received from the AE are in conjunction with its primary and only business segment i.e. manufacturing and selling ·of paints. These services are continuous in nature to the primary and only business segment of the assessee. Owning to, this fact and business reality of the
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assessee it has also benchmarked the prices of this international transaction by undertaking entity level bench marking. Even after considering the payment of management service charge, the, assessee's net margin . is greater than its comparable companies.
2.5.11. In view of the above this panel holds this issue in favour of the assessee and the grounds raised in this regard are allowed.
Aggrieved by the order of the DRP deleting the addition made consequent to determination of ALP as above, the revenue has preferred Gr.No.3 before the Tribunal in its appeal. Gr.No.3 raised by the Revenue reads as follows: “3. That is the facts and in law of the case the Ld. Members of the DRP erred in admitting the fact that the support services received by the assessee company from its associated groups located in USA had no untoward adjustment made by the TPO. In the second adjustment as well, the ld. Members of the DRP had failed to provide sound reasons behind the deletion of TP adjustment of Rs. 3,75,20,000/-which is beyond doubt that the TPO had classified every details of the support services with subtlety.”
The learned DR relied on the order of the TPO. The learned counsel for the Assessee reiterated submissions made before DRP and relied on the order of the DRP and drew our attention to the evidence in support of benefits received by the Assessee, manner of cost allocation and the bench marking approach adopted by the Assessee. We have considered the rival submissions.
We have considered the rival submissions. A voluminous set of documentary evidence such as sample evidences of communications, training manuals, and other relevant documents was submitted with the transfer pricing officer vide Annexure 1 to submission dated 15 January 2013 ( page 907 - 2305 of the paperbook). The documentary evidence shows valuable commercial services received from ANDC. It is also not disputed that the SAP implementation services was rendered exclusively for Akzo Nobel N.V group of companies and that services similar to this was not provided to any third party. The commercial essence of Trinity agreement is embedded in the fact that ANDC was a recharging entity for the costs incurred with respect to implantation of SAP platform in participating entities and thus, the Assessee
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through execution of the agreement had subscribed to a cost effective means of implementation of SAP platform which led to an increase in its operational, accounting and management reporting efficiencies. SAP system is ERP based software which is required for day to day running of business. It improves alignment of strategies and operations and helps in achieving corporate objectives by aligning workforce and organizational objectives. It is not disputed that implementation of SAP leads to improved productivity and reduce costs through increased flexibility. It also helps in increased profitability, improved financial control, and management of risk as well as optimization of IT spending. The DRP panel has acknowledged that the Aseessee runs SAP hosted through head office at Gurgaon and that the system is used by the following teams of the Assessee spread across India: 1. 60 depots of the Assessee across India, for sales order and billing, sales return, material receipt from factories, inter depot stock transfer, etc.; 2. 4 regional sales offices for credit management, bank reconciliation, bill booking, accounts payable and journal voucher; 3. 3 factories for back-end operations like manufacturing, shop floor control, purchasing, accounts payable, etc; 4. Head office for master data management (customer, vendor, product, price). It is used for product costing and finished products stock valuation.
Thus, the fact that the Assessee had used SAP software for integrating the process at the above varied locations for the business stands established. This ensures that one version of the data is available at all locations thereby providing huge benefits to accounting and manufacturing processes of the Assessee's business. Apart from above, the use of SAP by the Assessee in its business includes: 1. Planning and manufacturing processes; 2. Approval processes 3. Application of Lotus Notes workflow tool All the above systems are seamlessly integrated with each other through a set of complex interface programs, which run automatically without any manual intervention in most of the cases. It is also not disputed that the Assessee also receives constant and continuous information over calls, audio-video conferences, personnel visits, etc. The
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Ld. TPO did not consider the plethora of facts, justifications, details and arguments as presented by the Assessee and proceeded on the basis that because the Group decided to implement SAP, the Assessee had to bear the cost allocated to it and thus implementation of SAP is part of quality control, supervision and monitoring function of the Group (through group entities) which integrates all information and data on one system and therefore the services should be construed as Stewardship services. The This approach of the TPO was erroneous. Assessee has substantially grown in the highly competitive market and with the help of operational efficiency achieved has been able to post a robust revenue growth. The same is evident from the table presented underneath:
Particulars FY 2007-08 FY 2008-09 FY 2009-10 FY 2010-11 Sales 8,988 9,970 9,909 11,732 Operating Margin 9.25% 10.73% 12.96% 10.08%
As per Trinity Agreement costs were recorded, categorized and recharged based on principles which have already been given while discussing the facts and circumstances under which the issue in question arise for consideration. Suffice it to say that the manner of allocation of cost is scientific and correct. We may add that the basis of determination of cost has not been disputed by the TPO. Therefore we presume that the TPO has no grievance in so far as the manner of arriving at the cost for SAP implementation and that the cost is at Arm’s Length. Thus based on the above, the payment towards SAP deployment services are in accordance with transfer pricing regulations of India. We therefore dismiss Gr.No.3 raised by the Revenue.
Gr.No.1 & 2 raised by the revenue reads as follows: “1.That is the facts and in law of the case the Ld. Members of the DRP erred in not considering the unallocable interest not attributable to exempt/non-exempt income comes under the purview of Rule 8D computation.
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That is the facts and in law of the case the Ld. Members of the DRP erred in not taking the fact into account that the assessee company failed to prove the identical amount claimed for bad debt which otherwise turns .squarely reverse.”
The Revenue has filed an application seeking to raise the following additional ground of appeal. “That in the facts and in law of the case Ld. Members of the DRP erred in consideration of sale of rubber chemical business of the company as slump sale in lieu of itemized sale of assets and thereby disallowing the adjustment of sale consideration with the block of assets and thereby lowering the WDV of the block of assets.”
As far as ground no.1 raised by the revenue is concerned the same relates to the disallowance u/s 14A of the Act. During the relevant previous year, the Assessee earned income of Rs. 10,27,44,063/- which is not chargeable to tax under Chapter III of the Act, which deals with income which does not form part of the total income. Sec.14-A of the Act provides that no expenditure which is incurred for the purpose of earning income which does not form part of the total income under the Act, shall be allowed as a deduction in computing total income. Rule 8D of the Income Tax Rules, 1962 (Rules) provides the manner in which disallowance u/s.14A of the Act has to e made. The Assessee made a suo-moto disallowance of Rs.2,41,131/- in the computation of total income as expenditure incurred in earning income which does not form part of the total income under the Act. The disallowance was made by the Assessee on the basis of its estimate of proportionate manpower cost and operating cost incurred during the relevant previous year. The Assessee estimated it’s operating Cost at Rs.20,000/- per month on stationery, fax, postage, telephone, conveyance etc., at made disallowance of Rs.2,40,000/-. For computation of proportionate manpower cost, the Assessee estimated total manpower cost at Rs. 17,36,078/-. Thereafter, assessee has computed average of opening and closing of total investments and similarly average of investments yielding exempt income and offered manpower cost as disallowance in proportion to the proportion of investments yielding exempt income to average total investments. The figure of proportionate manpower cost comes to Rs. 1,131/-.
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The AO however was of the view that the expenditure offered by the assessee under section 14A by the above methodology was not acceptable. He proceeded to apply Rule 8D of the Rules by estimating operating cost of Rs.1,00,000 per month and manpower cost Rs.29,36,078/- which was the total expenditure debited to the profit and loss account by the Assessee under this head. The Assessee did not disallow any interest expenditure because there was no borrowed funds on which interest was paid that were used to make investments that yielded tax free income. The AO however proceeded to compute disallowance u/s.14A of the Act, as follows:
Rule 8D(i) (as discussed) 2,936,078 Rule 8D(ii) A.Interest Expenses 29,300,000 B.Avg. value of investment, income 5,237,725 from which does not form part of total income C.Total Assets as per computation 12,442,200,000 below A*B/C 12,334 Rule 8D(iii) 0.5. of Avg. Value of investments 26,189 Total 2,974,601 Avg. total assets 31.03.2009 31.03.2008 Fixed Assets 1,346,800,000 1,437,200,000 Investments 9,152,100,000 6,926,000,000 Current Assets, Loans and Advances 2,826,000,000 3,196,300,000 13,324,900,000 11,559,500,000 Average of op and closing assets 12,442,200,000
Particulars of exempt investments 31.03.2009 31.03.2008 6.75% Government of India Tax free 6,204,630 bonds ICICI Bank Limited 2,135,410 2,135,410 Total 2,135,410 8,340,040 Average Investments 5,237,725
Since total expenses disallowable under section 14A works out to Rs. 29,74,601/- (Rs.29,36,078 under Rule 8D(2)(i), + Rs.12,334/- under Rule 8D(2)(ii) + and Rs.26,189/- under Rule 8D(2)(iii)) and since assessee has already suo motto
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disallowed Rs.2,41,131/- the balance amount of Rs.27,33,470/- was disallowed by the AO and added to the total income of the Assessee.
Before the DRP the assessee submitted that there was no borrowed funds on which interest was paid that was used to make investments which yielded tax payable income and that the entire investments were made out of assessee’s own funds. The assessee accordingly prayed that there can be no disallowance of interest expenses in terms of Rule 8D(2)(i) & (ii) of the Rules. As far a disallowance of expenses under Rule 8D(2)(iii) is concerned the assessee submitted that the manner of estimation of operating cost for earning tax free income and the manner of determination of man power cost to earn tax free income as done by the assessee was reasonable and the computation done by the AO was arbitrary.
The above argument found favour with CIT(A) and the DRP deleted the addition made by AO observing as follows :- “4.5 The AO has taken the help of the method of computation made by the assessee and merely enhanced the amount of. operating cost from ·Rs. 20,000 per month to Rs.1,00,000 per month and disregarded the bifurcation of salary cost attributable to taxable income and that attributable to non-taxable Income. This shows that the AO has not disputed the method of computation made by the assessee. In this regard, the AO is not satisfied with the computation made by the assessee, then he has to give cogent reasons for the same. Merely stating that he is not satisfied with the correctness of the .claim would not suffice.
4.6: Further, while applying Rule 8D, only unallocable interest expense needs to be taken into account for computing disallowance u/s 14A. However; the AO erred in allocating the interest expenses to the exempt income earned. whereas there were no interest expenses incurred by the assessee during the F.Y. 2008- 09. The amount disclosed as interest was mainly on account of bill discounting charges and cheque collection charges paid to the banks for conducting the business operations of the assessee.”
4.7. In view of the aforesaid, application of Rule 8D is not warranted and direction is given to the AO to accept the computation of assessee.”
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Aggrieved by the order of DRP the revenue has raised ground no.1 before the Tribunal. The Ld. DR reiterated the stand of the revenue as reflected in ground no.1.
We find in the light of the admitted factual position that no loan funds were in the books of accounts of the company, there cannot be any question of payment of interest against the loan funds and consequently disallowance of interest expenses in terms of Rule 8D(2)(i) or (ii) of the Rules. Since there is no unallocable interest the DRP has rightly held that no interest expenses can be disallowed. We find no grounds to interfere with the order of the DRP. Consequently ground no.1 raised by the revenue is dismissed.
As far as ground no.2 raised by the revenue is concerned the facts are that the assessee claimed deduction on account of bad debts written off of a sum of Rs.3,24,04,575/-. The assessee filed party-wise break up of the bad debts written off during the previous year. The AO however disallowed the claim of the assessee for deduction on account of bad debts for the reason that the assessee failed to provide the evidence in support of write off of bad debts. In other words, the AO was of the view that the debt in question has not been established by the assessee to have become bad and therefore deduction on account of bad debts written off cannot be allowed.
On objections by the assessee against the above order of the AO, the DRP allowed the claim of the assessee observing as follows :- “6.2. With the amendment to 36(1)(vii) and 36(2) vide Direct tax laws (Amendment) Act, 1987, there is no more requirement to prove that the debt has actually gone bad. It is enough in case the debts are written off as bad in the account of the assessee. 6.3. Further, attention is invited toward Circular No.551 dated 23-01-1990 (1990) 183 ITR St 37 issued by CBDT wherein the provisions of Section 36(1)(vii) was explained post the amendment brought vide Direct Tax laws (Amendment)Act, 1987. The circular reads as under : Amendments to sections 36(1)(vii) and 36(2) to rationalise provisions regarding allowability of bad debts- The old provisions of clause (vii) of sub-section (1) read with subsection (2) of the section laid down conditions necessary for allowability of bad debt. It was provided
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that the debt must be established to have become bad in the previous year. This led to enormous litigation on the question of allowability of bad debt in a particular year, because the bad debt was not necessarily allowed by the Assessing Officer in the year in which the same had been written off on the ground that the debt was not established to have become bad in that year. In order to eliminate the disputes in the matter of determining the year in which a bad debt can be allowed and also to rationalise the provisions, the Amending Act, 1987 has amended clause (vii) of subsection (1) and clause (i) of sub-section (2) of the section to provide that the claim for the bad debt will be allowed in the year in which such a bad debt has been written off as irrecoverable in the accounts of the assessee. 6.4. In as much as the assessee in the annual accounts for FY 2008-09 has written off an amount of Rs.3,24,04,575/- as bad debts which was claimed in the return of income the AO is directed to allow the claim of the assessee as it is in accordance with the law.”
Aggrieved by the order of DRP the revenue has raised ground no.2 before the Tribunal. The Ld.DR reiterated the stand of the revenue as reflected in the grounds of appeal. We are of the view that there is no merit in ground no.2 raised by the revenue. The DRP has placed reliance on the amendment to the law and the CBDT Circular. The amendment to the law and CBDT circular which were considered by the DRP was also considered by the Hon’ble Supreme Court in the case of TRF Ltd. Vs CIT 323 ITR 397 (SC) and it was held by the Hon’ble Supreme Court that w.e.f. 01.04.1987 it is no longer necessary for a claim for deduction on account of bad debts written off that the assessee should establish that the debt in question has become bad. In view of the above legal position we dismiss ground no.2 raised by the revenue.
Ground no.3 has already been decided while deciding the transfer pricing issues in the earlier part of this order.
As far as the additional ground of appeal raised by the revenue is concerned the facts are that the Assessee sold its Rubber Chemical business to M/s PMC Rubber Chemicals on slump sale basis during the previous year relevant to AY 2006-07. However, in the order passed u/s 143(3) for AY 2006-07, the Assessing Officer did
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not accept that there was a slum sale and treated the sale as an item wise sale of assets u/s 41(2) of the Act. Consequently, the Assessing Officer did not accept the value of opening written down value (wdv) of block of assets as claimed by the Assessee, which he determined at a lower figure consequent to his finding that there was itemised sale of assets and not a slump sale. The action of the AO resulted in disallowance of depreciation in AY 2006-07 and consequently the WDV of the depreciable assets also was shown at a lesser figure. The depreciation claimed by the Assessee in this year as per the return of income was also substantially reduced because of the lower WDV on which depreciation was to be allowed as a consequence of the action of the AO in AY 2006-07. This resulted in lower allowance of income- tax depreciation amounting to Rs. 2,60,93,160/-.
Before DRP, it transpired that against the order of the AO for AY 2006-07 on the issue, an appeal was filed before the CIT(A). In the appeal for AY 2006-07, Ld. Commissioner of Income-tax (Appeals) has passed the order dated 11-03-2013 u/s 251 for AY 2006-07 wherein the treatment adopted by the assessee that the sale of the unit was a slump sale was accepted. Based on his own order for AY 2006-07, the Ld. CIT(A) has also granted relief to the assessee for AY 2007-08, in which year addition similar to the one made in the present AY was made by the AO. The DRP held that the claim of the assesee is allowable and the AO was directed to allow depreciation accordingly.
Aggrieved by the order of DRP the revenue has raised the additional grounds of appeal before the Tribunal.
The additional grounds of appeal is admitted for adjudication as it arises out of the order of DRP /AO. As rightly observed by the DRP the determination of depreciation is dependent on the outcome of the view taken by the revenue for A.Y.2006-07 treating the sale of rubber chemical business as not slump sale. In view of the decision of CIT(A) for A.Y.2006-07 holding that the sale in question was a
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slump sale, the disallowance of depreciation by the AO in the present A.Y.2009-10 which was a fall out of the finding of the AO in AY 2006-07 was rightly deleted by DRP. We however wish to add that this issue is consequential and dependent on the ultimate outcome on the question whether the same is a slump sale or not in A.Y.2006-07. With these observations we dismiss the additional ground of appeal raised by the revenue.
In the result appeal by the Revenue is dismissed.
In the result, appeal by the Assessee is allowed and appeal by the Revenue is dismissed.
Order pronounced in the Court on 03.05.2017.
Sd/- Sd/- [Dr.Arjun Lal Saini] [ N.V.Vasudevan ] Accountant Member Judicial Member
Dated : 03.05.2017. [RG PS]
Copy of the order forwarded to: 1. M/s. Akzo Nobel India Limited, Geetanjali Apartment, 1st Floor, 8-B, Middleton Street, Kolkata-700071. 2. D.C.I.T., Circle-10, Kolkata. 3. DRP Cell, Kolkata 4. CIT(DR), Kolkata Benches, Kolkata.