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CASE LAWS

2016-TII-59-HC-AHM-TP

PR CIT Vs SUN PHARMACEUTICAL INDUSTRIES LTD:GUJARAT HIGH COURT (Dated: August 09, 2016)

Income tax - Section 92C

Keywords: ALP, Commission & TP Adjustment.

Whether when the Tribunal's decision is based on facts and appreciation of record on the issue of commission paid by the assessee to its AE, no interference is warranted - YES: HC

The assessee & Revenue both are in appeal against the Tribunal's decision. The Tribunal had noted that the Assessing Officer had made additions on the ground that the commission paid by the assessee to associated enterprise was not at arm's length. In appeal, the Commissioner deleted substantial portion of such addition, but retained it in part.

On appeal, the HC held that,

+ the relevant part of the Tribunal's decision would demonstrate that the entire issue was based on facts and appreciation of record. The Tribunal noted that the assessee had given justification for the payment of the commission and why it was at arm's length. It was pointed out that the commission paid by the assessee to the Associated Enterprise was at the rate of 7.84% as against 11% paid to unrelated party. It was found that the rate of commission ranged from 0.38% to 33.33% whereas the assessee's rate came to 3%. The Tribunal noted that the Revenue authority did not bring any comparable case on record to show that the payment of commission by the assessee to the associated enterprise was not at arm's length.

Revenue's case dismissed

2016-TII-195-ITAT-DEL-INTL

ACIT Vs HCL COMNET LTD: DELHI ITAT (Dated: August 19, 2016)

Income Tax - Sections 9(1)(vii), 40(a)(i), 143(3), 195 & 263.

Keywords: provision for warranty - FTS - AMC - non resident assessee - PE - non deduction of TDS - rejection of books - estimation of profit - revenue neutral exercise.

Whether when no technical services were provided to the assessee and the services were in the nature of normal maintenance or repairs or replacement, performed outside India, the same can be considered as FTS on which TDS is liable to be deducted - NO: ITAT

Whether even if in a case it is clear that in the long run, an exercise would become revenue neutral keeping in view the concept of going concern of an organization, the main object of employing correct method of accounting to determine the true profits of an year, can be underestimated - NO: ITAT

Whether if the assessee has debited the P&L a/c merely on presumptive basis, in that case it is better to restore the matter to AO for providing the assessee an opportunity to furnish the details of net realizable value backed with proper evidence in order to substantiate its claim - YES: ITAT

The assessee company was engaged in the business of designing, delivering, installation and commissioning of net working solution and providing professional services for management and maintenance of net working solution. It had filed return of income declaring income of Rs. 15,28,572/-. The assessment was completed u/s 143(3) at an assessed income of Rs. 75,43,775/-. Thereafter, CIT passed an order dated 17.3.2009 u/s 263 setting aside the assessment on the limited issue for carrying out necessary verification and cross inquiry to determine true nature, correctness and allowability of issues relating to issue of TDS and provision for warranty. AO made disallowances on account of non-deduction of TDS on AMC contract and addition on account of provision for warrantee. Regarding non-deduction of TDS in respect of AMC payments, CIT(A) held that the same was not taxable in the hands of non-resident payee, because that was business income of the non-residents and since they had no PE in India, therefore, in terms of the provisions of relevant DTAA, the same was not taxable in the hands of non-resident assessee. It had further held that the AMC payment could not be held to be in the nature of FTS and, therefore, not taxable u/s 9(1)(vii). CIT(A), accordingly, held that the provisions of section 195 were not attracted in respect of AMC payments and consequently there was no question of disallowance u/s 40(a)(i). CIT(A), therefore, deleted the addition of Rs. 2,55,57,990/-. As regards disallowance of provision for warranty, CIT(A) referred to the decision of the ITAT, wherein the Tribunal had set aside the order of CIT passed u/s 263 in respect of provision for warranty after following the decision of SC in the matter of Rotork Controls India Pvt. Ltd. 2009-TIOL-64-SC-IT. CIT in his order passed u/s 263 noted from the Notes to Account that assessee had made payment of AMC of Rs. 255.58 lakhs on which no tax was deducted. CIT passed order u/s 263 primarily on the ground that this issue had not been examined by the AO.

The assessment was completed after making addition on account of disallowance u/s 14A, addition on account of difference in creditors balance and wrong claim of depreciation. CIT examined the assessment records of assessee from which it transpired that the assessee had written off Rs. 458.13 lacs on account of cost of goods of more than 365 days on notional basis as a policy on the ground of their having nil market value at the end of that period. CIT observed that since the loss claimed was only notional loss, not based on any actual valuation, therefore, should have been disallowed and added back to the income of the assessee. This mistake resulted in under-assessment of Rs. 458.13 lacs involving tax effect of Rs. 205.09 lacs including interest. CIT observed that these aspects were never considered by the AO while framing the assessment order. He further observed that no inquiry/ investigation appeared to have been carried out with regard to this aspect. Thus, he observed that it was a case of lack of inquiry/ investigation, apart from the under assessment of income. Thus, the order of the AO was erroneous as well as prejudicial to the interests of revenue. CIT issued show cause notice in response to which assessee's representative filed the written submissions. However, since the same was found to be inadequate, therefore, CIT(A) again gave opportunity to assessee to explain its position. However, none appeared and, therefore, CIT proceeded to pass the revisional order u/s 263. CIT has reproduced the written submissions filed by assessee, in which primarily assessee demonstrated how the sum of Rs. 458.14 lacs was written down under the head purchases in the P&L a/c as per Schedule 16 and also referred to the queries raised by AO and assessee's reply in this regard. Further an amount of Rs. 103.78 lakhs, was written back (i.e. it was offered as income), during the financial year and, hence, it was only the net amount of Rs. 458.13 Lakhs, which was ultimately charged to the P&L A/c.

AO passed the assessment order u/s 143(3) read with section 263 determining total income at Rs. 29,36,07,013/- as against the returned income of Rs. 22,83,76,292/-. The assessment order has been passed in pursuance to the order of ld. CIT u/s 263 dated 30.9.2010, setting aside the assessment. 17.2. The main issue for which the assessment was set aside, was regarding writing down of inventories of Rs. 458.14 lakhs by assessee, which was on the basis of impairment in the value of inventory by 25% of the cost of spares and accessories. The AO, after detailed discussion, disallowed the assessee's entire claim of Rs. 458.13 lakhs. AO, after detailed discussion made the addition of Rs. 458.13 lakhs, inter alia, observing that the loss claimed by assessee was on account of presumptive write off of goods. On appeal, CIT(A) deleted the addition.

Having heard the matter, the Tribunal held that,

+ the extended maintenance agreement has been entered into with Gilat Satellite Networks Ltd., a Israel company, with the assessee for warranty granted to assessee for the equipment supplied by Gilat Satellite Networks Ltd. Thus, it is evident that primarily this agreement had been entered into for annual maintenance support services. CIT(DR) has referred to the various services, covenants and pointed out that services had been rendered by communication only in India. CIT(DR)'s contention cannot be accepted in view of specific covenant contained in the agreement, which, inter alia, includes covenant no. 2.6, which deals with product replacement and repair as per which Gillette shall repair or replace any failed or defective part or parts of the hub station equipment in accordance with the provisions of sub para 2.6.1 to 2.6.4. Therefore, it is not correct to say that the entire services were rendered in India. As a matter of fact the replacement could be effected only by Gillette. It is not the case of AO that the non-resident payee had any PE in India and, therefore, the business income in the hands of non-resident payee could not be taxed in India. Further, we are in agreement with the detailed analysis carried out by CIT(A) in holding that no technical services were provided to the assessee and the services were in the nature of normal maintenance/ repairs/ replacement etc., performed outside India. Therefore, such payments did not fall within the purview of Explanation 2 to section 9(1)(vii) of the Act. Further, we are in agreement with CIT(A)'s conclusion regarding taxability under the provisions of relevant tax treaty/ DTAA, wherein after elaborate discussion he has concluded that no technical knowledge was made available to assessee. From the above it is clear that the amount paid by the assessee to non-resident was not chargeable to tax in terms of the provisions of the Act or DTAA. In view of above discussion, the revenue's appeal is dismissed;

+ coming to the issue regarding assessment order being prejudicial to the interest of revenue or not. Assessee's plea is that the whole exercise is revenue neutral because the closing stock of one year will be the opening stock of subsequent year, therefore neutralizing the effect of addition in one year by increasing the cost in subsequent year. It is well settled law that the method of accounting employed by an assessee should be such from which true profits of an year can be deduced. Merely because the assessee is following a regular method of accounting but the effect of which is not deducing true profits from business, then it cannot be said that correctness of method can be ignored by AO, as has been held by SC in the case of British Paints 188 ITR 44, wherein it has been held that even if the assessee had adopted a regular system of accounting, it was the duty of the AO u/s 145, to consider whether the correct profits and gains could be deduced from the accounts so maintained. If he was of the opinion that the correct profits could not be deduced from the accounts, he was obliged to have recourse to the proviso to section 145. Therefore, it cannot be said that by adopting an ad hoc method of arriving at net realizable value by impairing the value of service stock by 25%, in the absence of any detailed technical estimate, the assessee had resorted to correct method of valuation. Under such circumstances, the assessment order was prejudicial to the interests of revenue. CIT(A) completely overlooked the fact that true profits of an year could not be deduced without resorting to proper technical estimate of net realizable value. He failed to appreciate that spares had no shelved life of 4/5 years inasmuch as assessee itself had written back considerable sum by way of write back. It is true that in the long run this exercise will be revenue neutral keeping in view the concept of going concern of an organization but the main object of employing correct method of accounting is to determine the true profits of an year. We, accordingly, uphold the order passed by CIT u/s 263. In the result, assessee's appeal is dismissed;

+ we have discussed in detail the decisions relied upon by counsel for the assessee, from which it is evident that the claim was advanced in both the cases on the basis of proper estimation on technical basis resorted by assessee and not on ad hoc basis as has been done in the present case. We are in agreement with the contention of counsel for the assessee that the AO's conclusion that there was no fall at all in the value of spares also is not correct because it cannot be held that there was no decline in the net realizable value of spares. However, estimation should have proper technical backing. We are in agreement with the contention of CIT(DR), in view of the decision of SC in British Paints, that if a method employed by assessee is not resulting into computation of true profits of business of an year then the same can be ignored by AO. In view of section 145(3), the AO is required to examine the correctness of method employed by assessee in preparation of its accounts. The method employed by assessee should be such from which true profits of an year can be deduced. However, in the present case since the assessee has debited the P&L a/c merely on presumptive basis, therefore, we restore the matter to the file of AO for providing the assessee an opportunity to furnish the details of net realizable value of spares backed with proper evidence in order to substantiate its claim. In the result, appeal is allowed for statistical purposes.

Case remanded

2016-TII-194-ITAT-DEL-INTL

ION GEOPHYSICAL CORPORATION Vs DCIT: DELHI ITAT (Dated: August 19, 2016)

Income Tax - Sections 143(3), 144C(13), 148 & 195(2) -India-US DTAA - Articles 5(2)(j) & (k), 7 & 12.

Keywords - Stay application - Supply of equipment - Reassessment proceedings - TDS - Training.

Whether order passed u/s 195 can be equated with assessment proceedings u/s 143(3) - NO: ITAT

Whether a contract cannot be construed as a composite contract if the whole contract is divisible into different components and the consideration for which is separately contemplated in the contract itself - YES: ITAT

Whether no income can be taxed in India when no portion of the offshore supplies was carried out in India - YES : ITAT

Whether no profit can be attributed to the activity where assessee only reimbursed the third party costs which supplied the material directly to its indentor - YES: ITAT

The assessee, a tax resident of USA, was engaged in the business of manufacture and sale of equipments, used in the seismic industry. During the year under consideration, the assessee was engaged in execution of contract with M/s ONGC Ltd. Under this contract, the assessee had made supplies to ONGC of equipment, material, general stores and services, as specified in the contract. As per the contract, certain indigenous items were also to be supplied in respect of each unit supplied by the assessee. These items were procured and supplied from India to ONGC at its various locations. The contract also included installations and commissioning of equipment supplied along with necessary hardware and software by third party in respect of both indigenous and foreign items, provision of training to the employees and engineers of ONGC at supplier's premises in USA and followed by training at ONGC site at Dehradun, Jorhat and Kolkata. The assessee company filed return for relevant AY but did not offer any revenue/receipts from the said contract. The assessee had not offered to tax the supply of goods from the outside India under the claim that income had not accrued/ arisen or deemed to accrue or arisen in India of such sales of goods. The training receipts in respect of training imparted at assessee's premises had also not been offered to tax. Therefore, notice u/s 148 was issued requiring the assessee to file its return of income.The assessee stated that return filed originally may be treated as return in response to notice u/s 148. The AO after disposing off the assessee's objections in regard to the reasons recorded, analyzed the contract and concluded that it was a composite contract given on trunkey basis and the off shore supply of the equipment was nothing but essential material required for execution of the project, which was shown to have been supplied by the assessee to the ONGC to bring the same to India for use by the assessee itself for the purposes of execution of the subject contract. He computed the income @ 25%. DRP approved the AO's draft order, but directed for computing the profits attributable to PE @ 15%. Being aggrieved, both the assessee as well as the Revenue filed appeal before the Tribunal.

Assessee's appeal

The assessee challenged the reassessment proceedings. Assessee submitted that it had no PE in India. Only the contract was signed in India. The assessee also filed copy of order passed u/s 195(2) in course of hearing wherein ONGC was, directed to deduct TDS after applying DPR 2% on gross value of the supply of material inside India. However, ONGC was also directed to deduct TDS after applying DPR 105% on the installation and commissioning of 15% (including necessary chart) on 3rd party inspection charges, training charges inside India under the DTAA. Further, it was directed that no deduction of tax at source on the gross value of the supply of material outside India and training outside India. Thus, he pointed out that the AO had duly applied his mind and allowed the payment to be released without deduction of TDS in respect of supply of material outside India and training outside India. Hence now reopening of assessment on this ground was mere change of opinion.

Another ground for assessee's appeal was that contract in question was not a composite contract, as held by AO. Counsel pointed out that all the items were related to supply of equipment and installations and commissioning and training. Therefore, it was not a trunkey contract. The order was for supply/purchase of equipment as contract refers to supplier and indentor.According to assessee services were merely incidental or ancillary to main supply. He, therefore, submitted that it was not at all a case of composite contract but a pure supply contract or in the alternative a divisible contract, because payment of consideration for various activities was not dependent on the completion of other activities or whole contract.

Next ground of assessee's appeal was that as far as onshore supply of equipment was concerned, it was sub-contracted to third party namely HGS (India) Sales and Services Private Limited ("HGS India"). Counsel pointed out that HGS India supplied goods directly to ONGC amounting to USD 589,010. The same amount of invoices was raised by HGS India to the assessee company and by the assessee company to ONGC, hence, no profit was earned on this transaction. Counsel for Revenue relied on the order of AO and submitted that AO had not examined the assessee's claim of no profit being involved in the transaction.

Revenue's appeal

The Revenue was aggrieved by the finding of DRP in applying a profit rate of 15% on the gross contractual receipts of the assessee from M/s ONGC as against the proposed action of the AO to apply an estimated profit rate of 25% for computing the taxable income of the assessee.

After hearing parties, Tribunal held that,

+ we have considered the submissions of both the parties and have perused the record of the case. In our opinion, the order passed u/s 195 only prima facie determines the income chargeable for the purposes of TDS. This cannot be equated with assessment proceedings u/s 143(3). It is only in case where AO has formed an opinion while framing assessment u/s 143(3) that reassessment proceedings cannot be initiated on mere change of opinion. We, therefore, do not find any merit in the technical objection raised by assessee on initiation of reassessment proceedings. In the result ground no. 2 is rejected;

+ from the various covenants, reproduced above, it is evident that assessee had entered into a single contract with multiple scope of work and, therefore, it could not be considered as a composite contract where the consideration for the contract as a whole is contemplated. From the terms of contract it is evident that the whole contract was divisible into different components, the consideration for which was separately contemplated in the contract itself. Further, from the assessment order it is evident that AO had aggregated the income from various streams and had not adopted any specific value of the contract;

+ admittedly no portion of the offshore supplies involved any activities in India as all the activities in relation to the earning of income from offshore supplies took place outside India. Now even assuming that on account of contract being signed in India, a business connection had been established, still we have to examine the issue from India US DTAA point of view as the assessee was eligible to claim benefit under the treaty. As per Article 7(1) of the India US DTAA, the business income of a US entity can be taxed in India only if it had PE in India. The AO held that assessee had PE in India for installation and commissioning and supply which also included the indigenous supply and presence of its personnel/ entities for providing training to ONGC personnel. These observations are primarily with reference to the contract being treated as a composite contract and does not refer to which PE as per Article 5 of the India-US treaty was there. Admittedly the assessee had no fixed place of business in India and its employees only gave training for proper execution of the project. Further, assessee company did not take the services of any person in India except for supply of indigenous parts and, theefore, there was no dependent agent PE in India also. The AO has not brought on record any evidence to substantiate that the income from offshore supplies was attributable to alleged PE;

+ further, if we consider the AO's view that there was installation PE, then too as per Article 5(2)(j)&(k), there should have been presence for more than 120 days then only installation PE could be considered. The AO has not commented on this aspect. Therefore, the entire findings of AO on the issue relating to PE are without any basis. Therefore, considered from all perspectives no income can be attributed to the offshore supply. In the result ground nos. 3 & 4 are allowed;

+ we have considered the submissions of both the parties and have perused the record of the case. The assessee's contentions were not appreciated by lower revenue authorities owing to the fact that they proceeded on the assumption that it was a composite contract and, thus, taxed the revenues from all the streams irrespective of the true nature of contract. If the assessee only reimbursed the third party cost which supplied the material directly to its indentor then no profit can be attributed to this activity. Counsel has referred to various invoices on this count, but since this aspect has not at all been examined by AO, therefore, it would be in the interest of justice that this matter is restored back to the file of AO for examining the assessee's contention and if it is found that no profit was earned out of this activity, then no income can be attributed to this aspect. In the result ground no. 5 is allowed for statistical purposes;

+ we have decided this issue vide ground nos. 8 & 9 of assessee's appeal and have upheld the estimation of 15% being income attributable to alleged PE only in respect of installation and training in India. This will, of course, be subject to AO's finding on PE being there or not, in terms of our observations made earlier. In the result, ground raised by department is dismissed;

Case Remanded

 

2016-TII-437-ITAT-DEL-TP

COPAL RESEARCH INDIA PVT LTD Vs DCIT: DELHI ITAT (Dated: August 16, 2016)

Income Tax - Sections 143(3) & 144C

Keywords - IT enabled services - comparable - TNMM.

Whether a KPO can be equated as a comparable to a low-end ITES-enabled service provider - NO: ITAT

Whether exclusion of a comparable can be done despite owning of significant IPRs brands and impact on the net profitability of the said comparable - Yes: ITAT

The assessee is engaged in IT-enabled services and software development services to its group companies as per the TP study made available by the taxpayer. It was primarily engaged in the provisions of Information Technology (IT) enabled back office support services in the nature of customized business/financial research support to Copal Group. In return for rendering these services the assessee was remunerated on an arm's length cost plus basis i.e. costs plus a mark-up thereon. The assessee selected TNMM as the most appropriate method selecting Profit Level Indicator (PLI) as Operation profit/Total Cost (OP/TC) in its transfer pricing study report. Selecting 15 comparables therein the assessee it was submitted claimed that its transaction was within arms length price as using multiple year data the mean margin of the 15 comparables was 14.27% and the assessee's margin was 18.29%. The TPO objected to the use of multiple year data and directed that a fresh search using the data from F.Y.2009-10 be made. In the fresh search carved out the assessee applied the certain filters for conducting the comparable analysis in the benchmarking process. The comparable companies were selected in the fresh search process applying the quantitative filters which were analyzed qualitatively including examination of related party transactions to exclude companies with RPT greater than 10%. The economic analysis in the TP study as well as the fresh search undertaken by the assessee was objected to by the TPO who issued a show cause notice and proposed to substitute the results of the assessee's economic analysis with the results of fresh search undertaken by himself applying his own set of quantitative and qualitative filters. Assessee contended with regard to the comparables included/excluded by the TPO. Pursuant to the order of the TPO, a draft assessment order was issued proposing the adjustment recommended by the TPO.

Apart from the said grievance it was submitted that the addition by way of adjustment of Rs.3.30 lacs to the income of the assessee is assailed. It was submitted that for the delay in receipt of payment for services rendered to the AE, the TPO charged rate of 14.88% interest per annum for the period of delay in receipt of payments from the AE's beyond the time stipulated in the service agreement. Addressing the said ground it was submitted that the TPO in its order has ascertained that payment for invoices raised by the Appellant has not been received within the stipulated time as provided in the service agreement and accordingly, has treated delayed payments as an unsecured loan facility advanced to the AEs. The rate of interest charged was also alleged to be was very high.

These issues were agitated by way of objections before the DRP. DRP issued directions to the TPO to verify the amount of receivable: (i) incase the aggregate amount of receivables from the AEs does not exceed Rs.50 crores, apply Prime Lending Rate of SBI as on June 30 of the relevant previous year plus 150 basis points (ii) in case the aggregate amount of receivables from the AEs exceeds Rs.50 crores, apply Prime Lending Rate of SBI as on June 30 of the relevant previous year plus 300 basis points. The said direction of the DRP was not carried out. With respect to the finally set up comparables companies selected by the TPO, it was submitted that certain comparables were objected to and the objections to the comparables were not being pressed.

The assessee has two fold requests that is the exclusion of the 7 (now six) specific comparable companies introduced by the TPO and inclusion of 6 new comparable companies which have not been included by the TPO or the DRP.

After hearing the parties, the Tribunal held that,

+ despite the Ld. CIT DR's objecting to the assessee's arguments, no effort was made by the assessee to revise his position by praying that the ground assailing the filter is being pressed. Thus it was found that the assessee has attempted to argue the issue without a specific ground in the face of the departmental opposition. Thus, the arguments in these peculiar facts without a ground or a prayer cannot be permitted. We further find that the assessee had not cared to advance any argument making out a case that the application of the said filter is inappropriate in the facts of the present case. Accordingly in the facts as they stand the prayer of the assessee for the inclusion of the 6 comparable cannot now be accepted. This exclusion, we find has been based on the basis of speaking reasons justifying the action wherein no infirmity has been pointed out by the assessee.;

+ addressing the exclusion of the 6 comparables which have been retained by the DRP and introduced by the TPO, we find that as far as the law is concerned, it is very clear in as much as Knowledge Process Outsourcing cannot be equated to a low-end ITES enabled service provider. The Delhi High Court in the case of Rampgreen Solutions Pvt. Ltd. vs CIT held that a company who is providing routine call centre services cannot be equated to a KPO. The Court held that KPO indicates the involvement of advance skills; the services provided may include analytical services, legal research, engineering and design services, intellectual managements etc. A KPO is understood as a high-end value added process chain wherein the processes are dependent on advanced skills, domain knowledge and the experience of the persons carrying on such processes;

+ also where segmental have not been made available necessitate that the said comparable should be excluded. Instances where the services are shown to be outsourced or services are performed off-site and it can be shown that the net profitability of the company is impacted would again necessitate their exclusion. Similar would be the position where related party transactions filter is not fulfilled would justify its exclusion. Instances where the assessee can demonstrate that the comparable has undergone an extraordinary event by way of amalgamation/Acquisition etc wherein net profitability of the specific comparable company has been impacted or by inclusion of financials of the amalgamating subsidiary having any extraordinary abnormality have also been included has impacted the net profitability prayer for exclusion is justified.

+ there is also precedent available to seek exclusion of a comparable despite owning significant IPRs brands etc as a result of impacting the net profitability of the said comparable. This is notwithstanding the fact that the Revenue at times had been able to argue and insist upon the reasoning being recorded that unless and until the impact on net profitability is demonstrated, the comparable company should not be excluded as merely because it owns IPRS and has access to brands and is considered to be thus commanding high bargaining power for services rendered in terms of prices on account of the availability of in-house IPRs or brands then the costs incurred for the usage of the IPRs and brands impacting the gross returns would be addressed in the net profitability which is what a TNMM addresses.

Case remanded