Where the assessee was rendering captive contract software development services to its’ associated enterprises on a “cost plus” basis and its profits enjoyed exemption u/s 10A and the question arose whether the AO/TPO were justified in rejecting the assessee’s transfer pricing study and substituting it with their own, HELD allowing the appeal that:

(i) While the motive of tax avoidance need not be shown at the time of initiating transfer pricing provisions, the same is required to be shown at the stage of making the assessment. The AO has to show that the assessee manipulated prices to shift profits outside India. In view of the fact that the assessee enjoyed exemption u/s 10A, the transfer pricing provisions ought not to have been applied;

(ii) The AO/TPO have to satisfy and communicate to the taxpayer which one of the four conditions prescribed in s. 92C (3) are satisfied before applying the transfer pricing provisions and the failure to demonstrate this to the assessee renders the transfer pricing order void;

(iii) The assessee’s selection of the Cost Plus Method (CPM) using the Capitaline database as the most appropriate method could not be substituted by the AO/TPO with the Transactional Net Margin Method (TNMM) using the Prowess database without showing how the assessee’s method was erroneous;

(iv) For purposes of making a comparability analysis it is essential that (a) the data should relate to the financial year and (b) be contemporaneous i.e. exist on the specified date. If one of the conditions is not fulfilled, the data should not be included for comparison;

(v) In view of the definition of “uncontrolled transaction” in Rule 10A (a), for purposes of comparability analysis, the comparables should not have any transactions with its associated enterprises. A company having even a single rupee of related party transaction cannot be considered as a comparable transaction;

(vi) Adjustment needs to be made to the margins of the comparables to eliminate differences on account of different functions, assets and risks and in particular for (a) differences in risk profile (b) difference in working capital position and (c) differences in accounting policies;

(vii) The profits of super profit companies should not be “normalized”; instead they should be excluded from the list of comparables;

(viii) The proviso to section 92 C (2) provides a standard deduction of 5% to the taxpayers at their option.

See Also: Sony India vs. DCIT (ITAT Delhi), E-Gain Communication vs. ITO (ITAT Pune) and Development Consultants vs. DCIT (ITAT Kol)

Where pursuant to action u/s 132, the assessee made a declaration of income u/s 132 (4) and opted to pay taxes from out of the seized shares and securities and requested that the shares be expeditiously disposed of and the sale proceeds there from be appropriated towards taxes and the revenue did not act on this request and thereafter the assessee applied for waiver of interest under section 220(2A) on the ground that the failure of the department to sell the shares had caused “genuine hardship”, HELD:

(i) Levy of interest is for compensating the revenue from loss suffered by non-deposit of tax by the assessee within the time specified therefor. This principle should also be applied for determining whether any hardship had been caused or not. A genuine hardship means a genuine difficulty. It cannot be concluded that a person having large assets would never be in difficulty as he can sell those assets and pay the amount of interest levied.

(ii) A person cannot take advantage of his own wrong. A statutory authority on receipt of a request from the assessee top sell the shares could not have kept mum and should have taken action and responded to the prayer of the assessee. It would have been in the interests of the revenue to do so;

(iii) U/s 220 (2A), the CIT has the discretion not to waive interest but that discretion must be judiciously exercised. He has to arrive at a satisfaction that the three conditions laid down therein have been fulfilled before passing an order waiving interest.

(iv) As the issue had not been considered by the CIT in the proper perspective, matter remanded.

Where the Transactional Net Margin Method (TNMM) was accepted as the method for determining the Arm’s Length Price and the taxpayer was taken as a tested party and the Operating profit margin on sales had been chosen as the profit level indicator and disputes arose as to how the operating profit had to be computed and what parties had to be taken as comparables, HELD

(i) Under Rule 10B (2) (c) the comparability of an international transaction with an uncontrolled transaction has to be judged with reference to the contractual terms. Accordingly, the actual transaction, as entered into between the parties, has to be considered and the authorities have no right to re-write the transaction unless it is held that it is sham or bogus or entered into by the parties in bad faith to avoid and evade taxes.

(ii) Where the assessee had received moneys towards reimbursement of advertisement expenses under an agreement with the Associated Enterprise and the genuineness of the same was not disputed, the TPO was not justified in treating the said funds as a windfall and bounty. The same had to be treated as a part of the normal operating profit of the assessee and could not be ignored in computing the comparable margins.

(iii) Other amounts received by way of reimbursement of cost, provision written back, balances written back, interest received from customers and other miscellaneous revenue receipts also constitute a part of the operating profit and could not be ignored in computing the operating profit.

(iv) Statutory levies paid to the State Govt. had to be ignored in computing the operating profits of the taxpayer as other enterprises taken into account by the TPO were not subjected to such levy.

(v) For purposes of determining what parties should be considered for purposes of comparison under Rule 10B (3), what is to be judged is the impact of the related party transaction vis-à-vis sales and not just profit since profit of an enterprise is influenced by large number of other factors. The facts and circumstances surrounding the company in question that should determine its status as a comparable and not its financial result. The cumulative effect of all factors have to be considered.

(vi) While comparing controlled and uncontrolled transactions or enterprises, one has to look for the differences and whether such differences are likely to affect the price, cost charged or paid or profit arising from the transaction in the open market. It has further to be examined whether a reasonable accurate adjustment can be made to eliminate the material effect of the differences between the transactions or entities. If a reasonable accurate adjustment for the difference to eliminate material effect of the differences cannot possibly be made, then such comparables (uncontrolled) have to be rejected.

(vii) The proviso to s. 92C (2) consists of two limbs. Under the first limb, where, through the Most Appropriate Method, more than one price is determined, the arithmetic mean of such price has to be taken to be the Arm’s Length Price in relation to the international transaction. The second limb gives “an option” to the taxpayer to take Arm’s Length Price which may vary from the arithmetic mean by an amount not exceeding 5% of such arithmetic mean. This option is applicable even to cases where the taxpayer intends to challenge the Arm’s Length Price taken as arithmetic mean and determined through the Most Appropriate Method. The argument of the Revenue that where the difference is much more than 5%, then the taxpayer cannot have the benefit of the said provision, particularly where the taxpayer has not accepted such arithmetic mean, is not correct.

See Also: E-Gain Communication vs. ITO (ITAT Pune) and Development Consultants vs. DCIT (ITAT Kol)

Provision for bad and doubtful debts cannot be added to the “book profits” for purposes of section 115JA because they merely represent the dimunition in the value of an asset and are not a provision for an unascertained liability.

Note: The judgements in Echjay Forgings 251 ITR 15 (Bom), Amines & Plasticizers 296 ITR 727 (Gau) and Usha Martin 104 ITD 249 (Kol) (SB) stand impliedly approved while that in Beardsell 244 ITR 256 (Mad) stands impliedly overruled.

Where the assessee, a US company, claimed that non-grant to it of deduction u/s 80HHE on the ground that it was a non-Indian company violated the non-discrimination provision in Article 26 of the India-USA DTAA, HELD, rejecting the claim that:

(i) In order to attract the non-discrimination clause in Article 26, mere differential treatment is not enough. The assessee has to show that not only has it been subjected to differential treatment vis-à-vis others but also that the ground for this differentiation in treatment is unreasonable, arbitrary or irrelevant and that the basis of differentiation lacks any coherent relationship with the object sought to be achieved by that provision.

(ii) Though s. 80HHE is available only to Indian companies and not to foreign companies, the differentiation is on the basis of residential status of the assessee and not on the place of incorporation. Further, though other fiscal incentives for exports like ss. 10A and 10B as well as deductions u/ss 80-I and 80-HH are available to non-residents as well, the denial of deduction u/s 80HHE cannot be said to be unreasonable. The differentiation on the basis of residential status cannot be said to be arbitrary or irrelevant and it has a reasonable relationship with the object sought to be achieved by the incentive deduction. Accordingly, though there is a differentiation, there is no discrimination.

(iii) The OECD Model Convention Commentary has a limited role to play in view of the Technical Explanation on the India-USA DTAA. The Technical Explanation is of significant persuasive value and is the best guide for interpreting this DTAA. If there is a conflict between the OECD Commentary and Technical Explanation, the latter will prevail.

(iv) The fact that different tax treaties have different words and phrases does not necessarily mean that a different interpretation is warranted in view of the fact that treaties are, unlike a statute, the result of bilateral negotiations and the wordings thereon depend on the comfort levels of the treaty partners.

As the 3rd Provio to s. 245 (2A) {restricting the right of the Tribunal to grant stay beyond 365 days even if the delay is not attributable to the assessee} comes into force on 1.10.2008, there is no bar on the Tribunal before that date to grant stay beyond 365 days.

Note: Narang Overseas 295 ITR 22 (Bom) was followed.

Where the assessee bought units of a mutual fund, received tax-free dividend thereon and immediately thereafter redeemed the units and claimed the difference between the cost price and redemption value as a loss and the same had been upheld by a Five Member Special Bench of the Tribunal as a genuine loss, HELD affirming the order of the Special Bench that:

(i) S. 94(7) was inserted prospectively w.e.f. 1.4.2002 to disallow dividend stripping losses. If the argument of the Revenue that even transactions prior to s. 94(7) can be disallowed is accepted, it will render s. 94(7) redundant and also lead to anomalous results.

(ii) CBDT Circular No. 14 of 2001 makes it clear that prior to s. 94(7) the loss was allowable. This Circular is binding on the revenue and they cannot argue contrary to that.

(iii) Even otherwise it was not established that the motive was to earn a loss. The allegation that there was complicity between the mutual funds, the brokers and the assessee was also without merit. Mc Dowell 154 ITR 148 (SC) and Azadi Bachao Andolan 263 ITR 706 (SC) considered.

(iv) The alternative argument that the loss should be treated as expenditure incurred to earn dividend and disallowed u/s 14A is also without merit.

While computing normal profits which do not involve Ch VI-A relief, an assessee is entitled not to claim depreciation. However, where deduction under Ch VI-A is claimed depreciation is mandatory.

Vahid Paper Mills 98 ITD 165 (SB) (Ahd) approved.

See also: Scoop Industries (Bom-Goa).

Where the Government formulated a scheme of subsidy to encourage the setting up of sugar factories and to make them viable under which new sugar factories were entitled to a subsidy in the form of enhancement of free sale sugar quota and excise duty rebate thereon which could only be used for repayment of loans taken for the unit and the question arose whether such subsidy was taxable HELD, in determining whether the subsidy is capital or revenue, the “purpose” test had to be adopted. The source of the subsidy, its form and the point of time when it is paid are irrelevant. On facts, held, following Sahney Steel 228 ITR 253 that the subsidy was capital in nature.

Where the assessee had filed a SLP in the Supreme Court to challenge the ruling of the AAR without first filing a writ petition in the High Court, it was directed to withdraw the SLP and file a writ petition.

Note: In other challenges to AAR rulings in the past, the SC had entertained SLPs without insisting that the High Court route be exhausted.

Click here for the ruling of the AAR.