AHLSTROM FIBER COMPOSITES (I) P. LTD.,,MUNDRA (KUTCH) vs. THE ASSTT. COMMR. OF INCOME TAX, GANDHIDHAM CIRCLE,, GANDHIDHAM

Ground no.1 raised by the assessee reads as under:

Brief backgroundof the case is that the assessee, M/s Ahlstrom Fiber Composites India Pvt. Ltd. (AFCIPL), was incorporated in 2008 and is a subsidiary of Ahlstrom Corporation, Finland. The assessee is engaged in the production of variety of non-woven fabrics. It started commercial production from April 5, 2010 and the Asst.Year 2011-12, the impugned year before us, was the first year of production of the assessee. During the impugned year, due to certain technical issues, it could not manufacture the desired products, being anti-static/alcohol repellent treated advanced non-woven, and therefore in order to utilize its large production capacity, the assessee produced certain untreated intermediate products i.e. SS/SSM untreated non-woven fabrics, some of which wassold to its Associate Enterprise(AE). Besides sale of the goods, several other international transactions were entered into with its AEs as listed at para-3 of the TPO’s order as under:

The assessee had benchmarked the said international transaction using Cost Plus Method (CPM) and taking its own segmental data of exports to AE and non-AE segments, treating the non-AE segment as an internal comparable, the assessee had demonstrated that its markup to cost in the AE segment, at 9.84%, exceeded that of its internal comparable non-AE segment, at (-) 9.37%, thus demonstrating that its international transaction of sales to its AE was at ALP. The TPO rejected the segmental accounts of the assessee and also the CPM method selected as the Most Appropriate Method (MAM) for benchmarking the transactions and treating Transactional Net Margin Method (TNMM) as the MAM, he selected comparables and determined their average margin of operating profit to operating cost, OP/OC, at 5.41%. Applying this to the proportionate operating cost of the AE segment of the assessee, he determined ALP of the sales made to the AE at Rs.68,94,57,783/- as opposed to Rs.53,11,37,045/- shown by the assessee; resulting in proposed adjustment of Rs.15,893,20,738/ on account of determination of ALP of the international transactions of sales. The assessee objected to the aforesaid proposed adjustment before the DRP who dismissed all the objections of the assessee, and accordingly, the adjustment of Rs.15.83 crores was made to the international transaction of sales, in the order passed under section 143(3) of the Act.

During the course of arguments before us, the ld.counsel of the assessee began by challenging rejection of the segmental accounts of the assessee by the TPO. His contentions before us were to the effect that by virtue of segmental accounts the assessee had taken an internal comparable for the CPM selected by it for benchmarking international transaction and that the ld.TPO had rejected the segmental accounts on frivolous basis, without pointing out any specific defect in the same. Thatfurther the DRP had failed to adjudicate the objections of the assessee before it in this regard. He drew our attention to the show cause notice issuedby the TPO during TP proceedings, reproduced at page no.3 of the order of the TPO, pointing out therefrom the basis with the TPO for rejecting the segmental accounts of the assessee as being;

He thereafter drew our attention to the reply of the assessee, pointing out that the segmental analysis was done based on actual/ allocation keys and was further reviewed by the independent auditors. The submission of the assessee to this are reproduced at para 4.2 of the order. He thereafter drew our attention to the finding of the TPO while rejecting the assessee’s contentions contained in para 8, wherein he pointed out that TPO had reiterated the basis mentioned in his show cause notice for rejecting the segmental accounts, as audited accounts mentioning no segment and segmental data having been audited by CAs who had not audited the final accounts. The ld.counsel for the assessee pointed out that without going into the basis of preparation of the segmental accounts, which the assessee had reiterated had been prepared based on actual allocation keys, the TPO had summarily rejected the same merely on frivolous basis. He contended that for the purpose of reporting in the audited annual accounts the segments identified are totally different; that Accounting standard prescribed by the Institute of Chartered accountants of India for reporting on segments,Accounting Standard -17(AS-17), requires reporting of financial information or result about different types of products and services that the concerned business segment produces which includes the different geographical areas of business operation. This being the criteria since the assessee produced only one product, there was no requirement of furnishing any segmental data as per the AS-17 in the audited accounts; but for the purpose of benchmarking of international transaction on sales, the assessee

To this, the ld.DR countered by stating that segmental accounts prepared by the assessee were not reliable since they reflected huge difference between the profits of the AE export segments and the non-AE export segments which was as high as 19.21%; that segmental analysis by the assessee was cryptic and there was no notes or explanation to justify allocation of expenditure between two segments nor any material was produced before the TPO; that even prima facie, it was evident from a very simple test applied to these segmental analysis that it was not based on any logical reasoning. Submissionsin writing,dated 5.1.2023, to this effect were submitted by the ld.DR before us. In the written submission, the ld.DR had produced a chart to justify his contention that the allocation key adopted by the assessee for preparing segmental data was not uniform.

At this juncture, agreeing with the Ld.Counsel for the assessee that the basis of rejecting the segmental accounts by the TPO was totally frivolous and agreeing with him that what mattered for accepting these accounts was whether they had been prepared on a just and reasonable basis and noting the fact that the assessee had not been given an opportunity to submit its justification for the basis of preparation of its segmental accounts, nor was it examined

Since the entire basis of the TPO for rejecting benchmarking analysis done by the assessee and proposing the adjustment to the international transactions of sale by adopting TNMM method, began with the rejection of the segmental accounts of the assessee, we deem it fit to restore this issue to the file of the TPO.The entire issue relating to the determination of ALP of international transaction of the sale is restored back to the TPO, to be determined afresh after first dealing with the aspect of justifiability of segmental data submitted by the assessee alongwith the MAM adopted by it for determining the ALP of the transaction. Needless to add the assessee be provided due opportunity of hearing in this regard.

Ground no.2 raised by the assessee reads as under:

The facts relating to the issue are that expenditure amounting in all to Rs.1,60,83,722/- incurred on account of the following were disallowed under section 37(1) of the Act:

All the above were paid to the assessee’s group concern, M/s Ahlstrom Corporation and were paid as management fees.Disallowance was proposed by the AO in his draft order holding that it was not incurred wholly and exclusively for the purpose of business of the assessee on finding that the assessee failed to establish business necessity for incurring the expenses. The assessee’s objection before the DRP to this proposed addition was dismissed by the DRP, and accordingly, the disallowances of the aforesaid expenses were made by the AO in his order passed u/s 143(3) of the Act.

During the course of hearing before us, the ld.counsel for the assessee drew our attention to the order of the DRP dismissing the assessee’s objections to the proposed disallowance of the impugned expenses from page no.16 to 19 of the order as under:

Referring to the same, he pointed out that the DRP in substance had agreed with the finding of the AO that since the assessee had failed to establish the necessity for availing services in connection with the expenses incurred and benefit thereto was not proved, therefore, the expenses were liable to be disallowed under ITA (TP)No.97/RJT/2016 and 2 Others 13 section 37(1) of the Act. He pointed out that the DRP had relied on various case laws in support of his finding as above.

The ld.counsel for the assessee argued that the finding of the DRP in this regard were not in accordance with law. His contention primarily was to the effect that –

With regard to his contention on the nature of services received by virtue of these expenses being established to the AO, he drew our attention to the facts noted by the DRP inits order as reproduced above vis-à-vis these expenses, and pointed out that the payment for management fee and SAP & Opti-mill service charges had been made in lieu of agreement entered into by the assessee with M/s Ahlstrom Corporation dated 1.1.2001 for intra- group Service arrangement for management and advisory services in the field of human resource, IT, legal, risk management, finance, etc and for receiving software support with respect to SAP and Opti- mill business IT system (inventory management software) . That the ITA (TP)No.97/RJT/2016 and 2 Others 14 charges were based on actual cost incurred by Ahlstrom Corporation plus markup of 10%; that these services were rendered to all group companies; that the business area service fee was incurred for sharing costs and benefits of the joint management and advisory function of the business area in which the assessee operated i.e. food and medical business area. The business area team with the Ahlstrom Group from time to time rendered certain functions like management, advisory functions and some other services, which were required by the assessee and the actual direct and relevant indirect costs of the business area were allocated to the companies belonging to the business area based on each company’s share of the business area’s external net sales. The ld.counsel for the assessee pointed out from the draft order of the AO and that of the DRP also the factum of rendering of services by the group companies was never doubted and the disallowance hinged only on the finding that the assessee was unable to establish the necessity for availing these services or benefit that accrued to it. The ld.counsel for the assessee pointed out that the AO arrived at this finding of no necessity for incurring the expenses noting, from the details of the payment of management charges made during the year furnished by the assessee, that the services were not rendered for all the months of the year, and were rendered only for fourth quarter 2010 and first quarter of 2011. From the same, the AO inferred that there were periods during which all activities of the assessee had been carried out even without services for which a sum of Rs.1.60 crores was paid. He pointed out from the details of sales made in each quarter, which showed an increasing trend, the AO questioned the assessee as to why only the services were required in the last two quarters. The ld.counsel for the assessee contended that the doubts raised by the AO in his draft order were clarified pointing out that the services were actually rendered for the ITA (TP)No.97/RJT/2016 and 2 Others 15 entire year, but the group company had waived off charges for the first two quarters as a matter of business prudence and in support of this contention an illustrative chart reflecting management services rendered for the first two quarters of the year were also filed. He also pointed out that it was explained to the DRP that no services were availed by the assessee from the group concern in relation to routine business activities to run business operation and the services received had no direct linkage to the sales or the revenue, and therefore, insistence on benefit accrued to the assessee on account of incurrence of expenses was demonstrated to be misplaced.

The ld.counsel for the assessee further pointed out the finding of the AO that the expenses incurred under the head “management charges” could not be stated to be wholly and exclusively for the purpose of business, since in addition to these expenses, the assessee had incurred office expenses, misc. expenses was also demonstrated to the DRP to be misplaced. He contended that it was pointed out to the DRP that payment for management services rendered by the Ahlstrom Corporation was completely different from the administrative expenses incurred by the assessee under the head “office expenses” and “Misc. Expenses”, pointing out that office expenses included expenditure incurred on account of purchases of office consumables, cleaning, books & periodicals etc. whereas management charges were for general management, business development, financial advisory services etc. He drew our attention to the submissions explaining anomaly pointed out to the DRP from para 4.8.22 to 4.8.32 and 4.8.43 as under:

He further contended that in various judgments it has been laid down that for expenses incurred relating to the business of the assessee, the assessee cannot be questioned on the purpose for incurrence of such expenses, that whether any expenses are ITA (TP)No.97/RJT/2016 and 2 Others 17 required or not is a matter of business prudence. In this regard, he drew our attention to the following decisions:

The ld.DR, on the other hand, relied on the order of the AO/DRP.

We have carefully heard contentions of both the parties and gone through orders of the AO and the DRP, and we find merit in the contention made by the ld.counsel for the assessee. Before us, the issue relates to disallowance of intra-group service expenses incurred by the assessee amounting in all to Rs.1.60 crores, the details of which find mention in the earlier part of our order. The fact that these expenses qualified as international transactions and were accepted to be at ALP by the TPO is not disputed. The said facts emanate from the order of the TPO who categorically states

In the light of the above facts, we are in agreement with the ld.counsel for the assessee that the said expenses could not be held as not having been incurred wholly and exclusively for the purpose of business of the assessee. As rightly pointed out by the ld.counsel for the assessee, there are several judgments including that of Apex Court laying down the principle to be applied for determining allowability of expenses under section 37(1) of the Act and this principle have emerged over years by virtue of judicial interpretation of expression “wholly and exclusively” for the purpose of business appearing in section 37(1) of the Act. Broadly, the principle laid down are – i. the term “wholly and exclusively” for the purpose of business is of a wider import, wider than the expression “for the purpose of earning profit”;

On the touch-stone of jurisprudence regarding interpretation of the term “wholly and exclusively” for the purpose of business, we find that no case has been made out by the Revenue showing that the assessee does not fulfill the required parameter to qualify for deduction under section 37(1) of the Act. The only basis being that the assessee was unable to establish necessity of incurring the expenses and benefit accrued to it, which has been outrightly ruled out by Courts for establishing commercial expediency of incurrence of the expenditure, the basis with Revenue authorities therefore for disallowing the impugned expenditure of Rs.1.60 crores in the present case is found to be not in accordance with law.

Even otherwise, we have noted from the order of the DRP that it has heavily relied on OECD commentary and various case laws for emphasizing the establishment of necessity of incurring expenses for their allowability u/s 37(1) of the Act,which decisions/ commentary we find have been rendered in the context of the determination of ALP of transaction by the TPO, wherein on finding, the assessee failing to qualify the benefit test, it was held that the ALP in such circumstances of international transactions could be treated as NIL. All the case laws and even OECD commentary relied upon by the DRP while upholding the order of the AO on the issue are in the context of determination of ALP of international transaction entered into with the associated enterprise. In the present case, the TPO in his order clearly found the impugned transaction to be at ALP. The TPO being an officer specially

Ground no.3 reads as under: Ground No. 3: Disallowance on reimbursement of Bank guarantee commission 3.1 On the facts and in the circumstances of the case and in law, the Ld. AO under the directions of Hon'ble DRP, erred in disallowing amount paid towards reimbursement of Bank guarantee commission amounting to Rs. 1,12,29,8977- u/s. 37(1) by holding it to be a prior period expense. 3.2 On the facts and in the circumstances of the case and in law, the Ld. AO under the directions of Hon'ble DRP, erred in disallowing amount paid towards reimbursement of Bank guarantee commission amounting to Rs. 1,12,29,8977- u/s. 4Oa(i). While doing so, he erred in the following:

The issue raised in the above grounds relates to disallowance of bank guarantee commission paid by the assessee amounting to Rs.1,12,29,897/-. The facts relating to the issue are that the assessee had paid a sum of Rs.1,12,29,897/- towards bank guarantee commission to its related party, Ahlstrom Corporation, Finland. The same was paid by the assessee as reimbursement of bank guarantee commission. The facts leading to the reimbursement of bank guarantee commission to Ahlstrom Corporation, Finland, being that the assessee had entered into an agreement with ICICI Bank Ltd. for a term loan facility of Rs.171.50 crores on 6.5.2009. As a condition to availing the facility, Pohjola Bank Plc, Finland, had issued a bank guarantee to the tune of 25 million EURO as a security for performance of the company obligation under the aforementioned term loan agreement. Pohjola Bank Plc charged Ahlstrom Corporation, Finland for the commission cost and expenses relating to the guarantee which Ahlstrom Corporation, Finland re-invoiced to the assessee, in terms of an agreement for reimbursement of guarantee expense entered into between the assessee and Ahlstrom Corporation, Finland. The bank guarantee commission therefore paid by the assessee to its related entity was claimed as reimbursement of such expenses charged by Pohjola Bank Plc without any mark-up.

The AO in his draft order proposed a disallowance of this expense for two alternate reasons viz. that since it related to prior period, it is disallowable under section 37(1) of the Act;

Before us, ld.counsel for the assessee pointed out that the finding of the DRP in this regard were in total disregard to the arguments and contentions made by the ld.counsel for the assessee before it. He contended that it had been demonstrated to the DRP that the impugned expenses could not be categorized as prior period expenses, as pointing out that they related to the commission paid for the impugned year evidenced with bills/invoices issued by the Ahlstrom Corporation, Finland to the assessee, demonstrating the said facts and that in any case, since the invoices were raised on the assessee during the impugned year itself, the liability for the expenses had crystalised during the impugned year, and therefore,

He further drew our attention to the order of the DRP pointing out that the DRP had not even dealt with submissions made by the assessee before it.

On the issue of disallowance of bank guarantee commission expenses made under section 37(1) of the Act, we have heard both the parties and also gone through orders of the DRP/AO, and we find merit in the contentions of the assessee that the DRP has upheld the findings of the AO in the draft order that the impugned expenses were disallowable as prior period expenses without taking note of the submissions of the assessee before it. A bare perusal of the submissions made by the assessee before the DRP coupled with the evidence filed to the DRP which was also placed before us in PB, reveals the assessee had sufficiently demonstrated that the ITA (TP)No.97/RJT/2016 and 2 Others 28 impugned expenses were not prior period expenses, but pertained to the impugned year itself. The assessee had filed copies of invoices raised by the Ahlstrom Corporation, Finland for the bank guarantee commission which described thealleged prior period commission expenses raised as pertaining to the impugned year. Even otherwise, we find that the invoices were raised by the Ahlstrom Corporation, Finland on the assessee during the impugned year itself. These facts are all evident from the copies of invoices which were placed before us also in the paper book at page no. There is no iota of doubt, therefore, that the expenses pertained to the impugned year alone and could not be categorized as prior period expenses. We have noted that basis for the AO for treating it as prior period expenses was that the loan agreement entered into by the assessee with the ICICI Bank, which was guaranteed by Pohjola Bank Plc.,and commission expenses reimbursed from the assessee to the Ahlstrom Corporation, Finland, was dated 8.5.2009. From the same, we deduced that the bank guarantee commission pertained to the financial year 2009-10 relating to the Asst.Year 2010-11, the preceding year. The assessee has sufficiently demonstrated before us that the invoices were raised during the year by Ahlstrom Corporation, Finland on the issue and related to the bank guarantee commission for the impugned year alone. In view of the same, we have no hesitation in holding that the bank guarantee expenses paid by the assessee pertained to the impugned year, and could not disallowed as prior period expenses under section 37(1) of the Act. The order of the DRP/ AO holding so, is accordingly set aside.

We take up now the alternate reason for disallowing bank guarantee expenses, as being disallowable in terms of section 40(a)(i) of the Act for non-deduction of tax at source. As is evident

The contention of the Ld.Counsel for the assessee was that extensive arguments were made to the DRP against the applicability of Article 21 of the DTAA between India and Finland which were not even considered by the DRP.Ld.Counsel for the assessee drew our attention to the arguments made which were to the following effect and are reproduced in the submissions made to the DRP–

Ld.Counsel for the assessee pointed out that despite exhaustive contentions raised by the assessee against the applicability of Article 21 of the DTAA between India and Finland to the transaction of reimbursement of Bank guarantee commission, the DRP held Article 21 applicable without dealing with the contentions of the assessee.

As far as other appeals of the assessee for the Asst.Year 2012- 13 and 2013-14 are concerned, as stated in the aforementioned para-2, the grounds and issues raised in these appeals are identically worded except variation in the quantum, and for the reasons, observations and findings given by us in the for Asst.Year 2011-12, appeals for the Asst.Year 2012-13 and 2013-14 are allowed for statistical purposes.

In the result, the appeals of the assessee are allowed for statistical purposes.