(73.2 KiB, 1,692 DLs)

Despite Third Proviso to s. 254(2A), Tribunal has power to extend stay beyond 365 days if delay not attributable to assessee

The Third Proviso to s. 254(2A), as amended w.e.f. 1.10.2008, provides that if the appeal filed by the assessee is not disposed off within the period of stay granted by the Tribunal (which cannot exceed 365 days), the order of stay shall stand vacated even if the delay in disposing of the appeal is not attributable to the assessee. The assessee filed a stay application requesting stay of demand for penalty of Rs. 369 crores. On the expiry of 365 days of stay, the assessee asked for extension of stay relying on the Tribunal’s order in Ronak Industries where, stay had been granted beyond 365 days relying on the judgement of the Bombay High Court in Narang Overseas 295 ITR 22 (Bom). As it was felt by the Tribunal that the reliance in Ronak Industries on Narang Overseas was misplaced in view of the amendment to the Third proviso to s. 254(2A) w.e.f. 1.10.2008, the question whether the Tribunal had jurisdiction to extend stay beyond 365 days referred to the Special Bench. HELD by the Special Bench:

(i) In Ronak Industries, the Tribunal held, relying on Narang Industries, that the Tribunal has the power to extend stay beyond 365 days. This decision of the Tribunal was challenged by the department in the Bombay High Court by specifically raising a question as to the applicability of the Third Proviso to s. 254(2A) as amended w.e.f 1.10.2008. The High Court, vide order dated 22.10.2010, dismissed the department’s appeal. As such, the Tribunal’s order holding that there was power to extend stay even after 365 days stood affirmed;

(ii) The department’s argument that the High Court’s order in Ronak Industries should be treated as per incuriam on the ground that the amendment made by the FA 2008 was not considered by it is not acceptable because (a) In Narang Overseas (rendered prior to the amendment) a wider view was taken as regards the power to grant stay, (b) In the appeal filed by the department in Ronak Industries a specific question with regard to the effect of the Third Proviso was raised and so it cannot be said that the High Court had not taken cognizance of the amendment, (c) the Tribunal cannot ignore a High Court’s decision on the ground that a provision of law was not considered by the High Court and (d) the fact that there is no discussion in the High Court’s order in Ronak Industries does not mean that does not lay down any ratio decidendi;

(iii) However, the recovery of the arrears by the AO on the expiry of 365 days of stay cannot be ordered to be refunded because on the date of recovery the stay had expired and the application for extension was pending before the Special Bench. The AO’s act was bona fide and as the recovery was by adjustment of refunds, it was not a “coercive measure” (RPG Enterprises 251 ITR (AT) 20 (Mum) & other cases holding that the AO must refund taxes collected during the pendency of a stay application distinguished).

(126.3 KiB, 1,032 DLs)

Transfer Pricing: If ALP determined by arithmetical mean, 5% deduction allowable

In determining the arms’ length price for transfer pricing purposes in respect of international transactions relating to ‘procurement Support Services’, the TPO considered 61 comparable prices and finally relied on 3 prices to arrive at the arithmetic mean. However, he did not give a deduction from the arithmetic mean as required by the first proviso to s. 92C(2). On appeal to the Tribunal, HELD:

(i) The First proviso to s.92C(2) (pre amendment by F (No 2) Act 2009 w.e.f. 1.10.09) which provides that “where more than one price is determined by the most appropriate method, the arms length price shall be taken to be the arithmetical mean of such prices or at the option of the assessee, a price which may vary from the arithmetical mean of an amount not exceeding five per cent of such arithmetical mean” is clear that the assessee has an option when there is arithmetical mean involved while computing the ‘arm’s length price’ and it happens only if more than one price is determined by the most appropriate method. The First Proviso becomes operational where more than one comparable price is determined. The assessee at his option can make claim of deduction out of the arithmetic mean not exceeding 5%.

(ii) All the judicial pronouncements (SAP Labs 6 ITR (Trib) 81 (Bang), Sony 315 ITR (AT) 150 (Del), UE Trade Corp (Del), Essar Steel (Vizag) & Perot Systems 130 TTJ 685 (Del) are uniform in making the proposition that where arithmetic mean is involved, the assessee obtains the eligibility for claim of deduction out of such arithmetic mean. It is commonsense that the statistical concept of arithmetic mean arises only when there exists more than one price data. Such concept is irrelevant to the data with only one variable. In the assessee’s case, as there were three comparable price data, the assessee was entitled for deduction not exceeding 5% out of the arithmetic mean.

(118.8 KiB, 2,092 DLs)

Direct Stay Application to Tribunal maintainable. Not necessary that lower authorities must be approached first

The assessee filed a stay application before the AO, Addl CIT & CIT but none of the authorities dealt with it. The assessee also filed a stay application before the Tribunal which was opposed by the Department on the ground that the application was not maintainable without there first being a rejection by the lower authorities. HELD dismissing the department’s objection:

(i) It is settled law that a Direct Stay Application filed before the Tribunal is maintainable and it is not the requirement of the law that assessee should necessarily approach the CIT before approaching the Tribunal for grant of stay. It does not make any difference whether the assessee filed any application before the Revenue and not awaited their decisions before filing application before the Tribunal or directly approached the Tribunal without even filing the applications before the Revenue authorities, when there exists threat of coercive action by the AO;

(ii) In deciding a stay application, the following aspects have to be considered: (i) liquidity of the funds of the assessee to clear the tax arrears out of own funds at the relevant point of time based on the assessee’s financial status at the time of the stay petition hearing; (ii) creditworthiness of the assessee to outsource the funds to clear the departmental dues; (iii) prima facie views on the likely decision of the Tribunal on the issues raised in the appeal; (iv) departmental urgencies in matters of collection and recovery; (v) guarantees provided by the assessee to safe guard the interest of the revenue etc.

(288.4 KiB, 2,541 DLs)

No s. 14A disallowance of interest on borrowed funds used to buy shares for trading purposes

The assessee, engaged in trading and investment of shares, received tax-free dividend income of Rs. 2.98 crores in AY 2004-05. The AO invoked s. 14A and disallowed the interest on borrowings, administrative and other expenses on proportionate basis. In appeal, the CIT (A) upheld the disallowance but directed that it should be computed as per Rule 8D. On appeal to the Tribunal, HELD:

(a) Rule 8D does not apply prior to AY 2008-09 (Godrej & Boyce 328 ITR 81 (Bom) followed);

(b) The expression “in relation to” in s. 14A means dominant and immediate connection or nexus with the exempt income. In order to disallow expenditure u/s 14A, there must be a live nexus between the expenditure incurred and the tax-free income. Disallowance cannot be made on presumptions and estimation by the AO. Notional expenditure can be apportioned for the purpose of earning income if there is no actual expenditure incurred “in relation to” the tax-free income;

(c) On facts, the business of the assessee predominantly was trading in shares though it also had investments in shares. The AO has not disputed the assessee’s claim that the dividend had been received on shares purchased for trading purposes. Interest on borrowed funds used for trading activity is allowable u/s 36(1)(iii) and it cannot be treated as expenditure for earning dividend income which is incidental to the trading activity. If the real purpose was to use borrowed funds for trading purposes and incidentally there is tax-free dividend, it cannot be said that the interest has been incurred for earning the dividend income (Wallfort Share & Stock Brokers 326 ITR 1 (SC), Godrej & Boyce 234 DTR 1 (Bom), Emraid 284 ITR 586 (Bom), Leena Ramchandranan (Ker) & Eicher 101 TTJ (Del) 369 followed);

(d) Though, as held in Godrej & Boyce 234 DTR 1 (Bom), it is implicit within s. 14A that expenditure incurred for an indivisible purpose has to be apportioned, this principle of apportionment is applicable only where it is not possible to determine the actual expenditure incurred “in relation to” tax-free income. When it is possible to determine the actual expenditure “in relation to” the exempt income or where no expenditure is incurred “in relation to” the exempt income, the principle of apportionment embedded in s 14A has no application;

(e) As regards the disallowance of administrative expenditure, the AO’s basis of disallowance based on the ratio of taxable income and dividend is wrong because the expenditure did not depend on the profit or loss arising from the business activity. If the expenditure is apportioned on the basis of income, then in the case of no income, no expenditure can be assigned. In case of transaction of purchase and sale of shares, the reasonable basis for apportionment of administrative expenditure should be the volume and nature of the transaction under different activities. There cannot be an equal basis for apportionment of admin expenses between delivery based transactions and non-delivery based transactions etc.

(142.7 KiB, 1,298 DLs)

S. 14A disallowance cannot be made for “depreciation”

The assessee, a partner in a firm of solicitors, received Rs 14 lakhs towards remuneration as a working partner and Rs 46 lakhs towards share of profit in the partnership. The question arose whether, given that the remuneration was taxable as business profits, disallowance u/s 14A could be made in respect of (a) depreciation and (b) deduction u/s 80D in respect of health insurance premium. HELD by the Tribunal:

(a) S. 14A permits a disallowance of “expenditure incurred by the assessee” and not of “allowance admissible” to him. There is a distinction between “expenditure” and “allowance”. The expression “expenditure” does not include allowances such as depreciation allowance. Accordingly, depreciation cannot be the subject matter of disallowance u/s 14A (ratio of Nectar Beverages 314 ITR 314 (SC) followed);

(b) Similarly, the deduction u/s 80D is not expenditure for earning tax-free income but is a permissible deduction from gross total income under Chapter VIA.

(181.1 KiB, 1,324 DLs)

Transfer Pricing: Prior Years’ data cannot ordinarily be relied upon to justify ALP. Non-operating income & expenditure should be excluded while comparing

The assessee, a courier company, paid Rs. 43.46 crores to its holding co in Netherlands towards the reimbursement of cost in transport of consignments. The TPO & CIT (A) adopted the TNMM and claimed that as the operating profit /operating income of the comparables was higher than that earned by the assessee, an adjustment had to be made. It was also claimed that the assessee was not entitled to rely on the data of earlier years. On appeal to the Tribunal, HELD:

(a) In respect of FY 2001-02, the assessee used data pertaining to AYs 1999-2000 & 2000-01. While the argument that at the time of TP study, the data relating to relevant comparable for FY 2001-02 is acceptable, the assessee has to adopt the data available for the TP study at the time of filing of the return. By the time of filing of return, the data relevant to FY 2001-02 was available. Further, prior year data is relevant only if the assessee is able to prove that the pricing pattern of the assessee for the relevant financial year has been influenced by the market conditions/business cycle/product life cycle of the earlier years (which is not there in the courier business). The OECD guidelines are not of binding nature and even the Proviso to Rule 10B (4) provides that any subsequent year data cannot be considered. The contemporaneous data of relevant financial year is to be used for making the comparable analysis for arriving at the ALP unless it is proved otherwise;

(b) For arriving at the net margin of operating income, only operating income and operating expenses for the relevant business activity of the assessee has to be taken into consideration. Other income, such as dividend income, profit on sale of assets, donations as well as non-operating expenses which are included in the operating incomes of other comparable companies should be excluded as it effects the net margin of the operating profits of the comparables. Working capital adjustments also have to be considered while arriving at the operating net margins.

(c) The assessee is entitled to a standard deduction of 5% as provided under proviso to s. 92C (2) before making adjustments of the transfer price. (Schefenacker Motherson 123 TTJ (Del) 509 and SAP Labs 6 ITR 81 (Bang)(Trib) followed)

(153.0 KiB, 1,141 DLs)

Transfer Pricing: For TNMM, interest on surplus & abnormal costs to be excluded

The assessee, a subsidiary of a Japanese company, received commission for agency and market research services. For Transfer pricing purposes, the assessee adopted the Transactional Net Margin Method (TNMM) and chose the Operating Profit Margin on Operating Cost (OP/OC) as the PLI and treated itself as the tested party. As the assessee’s margins were higher than that of comparables (9% vs. 8.37%), the transactions were claimed to be at arms’ length. The TPO & CIT (A) held that in computing the Operating Profit (a) interest income and (b) abnormal costs had to be excluded. On appeal to the Tribunal HELD:

(a) Even if interest on surplus funds is assessed as “business income”, it has to be excluded in computing the ‘operating profits’ because if it is included, one is computing the “return on investment” which is an inappropriate profit level indicator for a service provider. As the PLI is the Operating Margin on Cost, neither the interest income nor interest expenses is a relevant factor. The essential element is the cost incurred for the operating activity which has to be taken into account;

(b) In computing the ALP, abnormal expenses which are not of a routine nature as well as those of a personal nature have to be excluded;

(c) Compensation for closure of certain units, though not a regular phenomena, has a direct link with the international transaction. The assessee was receiving certain charges at cost plus 10%. By closing down certain branches, the cost to the AE was reduced and so such receipts would always be considered as operating expenses. The cost of closure cannot be excluded in computing the operating expenses;

(d) The current year data should be used for comparison purposes and not the data of preceding two years;

(e) The argument that as the assessee did not take any financial risk while providing agency services and as it also did not have a patent etc, there must be an adjustment for the “functional and risk level difference” is not acceptable because no evidence as required by Rule 10D to show the risk born by comparables is shown. The assessee has to demonstrate “exact details, exhibiting the risk born by the comparable vis-à-vis the risk in running the assessee’s business” (Sony India 114 ITD 448 (Del) where a 20% adjustment was permitted distinguished);

(f) The argument that there is a “general recession” in the international market and so an adjustment should be made is not acceptable because the comparables adopted by the TPO takes into consideration the general factor available to the assessee vis-à-vis to the comparable in the market. No ad-hoc separate adjustment can be made for the general conditions of the market at the relevant point of time;

(g) The benefit of +/- 5% adjustment is not a ‘standard universal deduction’. This option is available only when assessee is computing the ALP and not when the AO/TPO is computing the ALP.

(179.3 KiB, 1,163 DLs)

Transfer Pricing: Despite “Implicit support” by holding company, subsidiary entitled to pay holding company at arms’ length for “explicit support”

The assessee, a wholly-owned subsidiary of General Electric Capital US (GECUS), was in the business of providing financial services and took loans for this purpose in the form of commercial paper and unsecured debentures. Between 1988 and 1995, GECUS provided to the assessee, at no cost, an explicit guarantee for its debt issuances. From 1996, GECUS began charging a fee equal to 1% of the face amount of the assessee’s debt issuances for that same guarantee which amounted to about $135.4 million. The assessee’s claim for deduction of the fee was denied by the tax department u/s 69(2)/247(2) (transfer pricing provisions) on the ground that as there was “implicit support” by GECUS to the assessee, the payment of the guarantee fee was “superfluous” and not at arms’ length. This was reversed by the Tax Court on the basis that by the explicit guarantee from the holding company, the assessee had a better rating and had to pay lower interest and received a benefit which was valued at 1.83%. As the fee paid for the benefit was only 1%, it was at arms’ length. On appeal by the department, HELD dismissing the appeal:

(i) In determining the arms length price, all economically relevant factors (including the “implicit support” that the subsidiary enjoys from the holding company) have to be considered. The explicit guarantee by the holding company also has a value to the subsidiary (Para 1.6 of the OECD Commentary on Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations referred). The question is how much an arm’s length party, benefiting from the implicit guarantee would be willing to pay for the explicit guarantee;

(ii) The “yield method” can be adopted which requires a comparison between the credit rating which an arm’s length party, in the same circumstances as the assessee, would have obtained and the credit rating which would have been obtained without the explicit guarantee. On facts, it was shown that the assessee would have enjoyed a lower credit rating without the explicit guarantee from the holding company and would have had to pay a higher interest than it did with the explicit guarantee. The incremental cost that the assessee would have had to pay if it did not have the explicit guarantee was valued at 1.83% and so the guarantee fee was at arms length.

(404.1 KiB, 952 DLs)

Capital asset treated as stock-in-trade of proprietary business has to be valued at market value

The assessee, a partner of a firm, received stock-in-trade on dissolution of the firm. The stock was used by the assessee to start a proprietorship business. In the assessment of the firm, the Tribunal held, following ALA Firm 189 ITR 285 (SC), that the option to value stock at the lower of cost or market was available only to a going concern and as the firm had dissolved, the stock had to be valued at the market value. However, in the assessment of the assessee’s proprietorship business, it was held that as the proprietorship concern had acquired the stock from the dissolved firm and continued the same business, the opening stock could not be valued at a price higher than the book value as the assessee had not paid anything in excess of the said amount. On appeal to the High Court, HELD allowing the appeal:

When a partnership firm is dissolved and the erstwhile partner receives stock, it is a capital asset in his hands. When that asset is introduced into a business as stock, it gets converted into stock-in-trade. The value of this stock will have to be the market value on the date of introduction. The Tribunal’s reasoning that the assessee cannot value the stock introduced in the business at market value because that was not the price she paid for it is flawed because if the assessee on having received her distributed share of stock of jewellery from the dissolved firm had sold it, and thereafter commenced her proprietorship business of jewellery again; within short span; by buying the jewellery from the market from the proceeds of stock sold on dissolution of the erstwhile firms, the stock of the proprietorship concern would without doubt be valued at market value. The same principle would apply if the assessee used her share of the stock obtained from the dissolved firm in the new business.

(140.3 KiB, 720 DLs)

S. 40A(3) Disallowance can be made in Block Assessment even if GP estimated

Pursuant to a search, the AO passed a block assessment order u/s 158BC in which he made a disallowance u/s 40A(3) in respect of cash payments exceeding Rs. 20,000. The CIT (A) & Tribunal struck down the disallowance on the ground that s. 40A(3) could not be invoked in a case where a block assessment was by estimate on the basis of GP rate. On appeal by the department, HELD reversing the Tribunal:

(i) Though the provisions of block assessment are special, the argument that they are a complete Code and the other provisions cannot apply is not acceptable. S. 40A(3) applies to block proceedings. Suresh Gupta 297 ITR 322 (SC) & M. G. Pictures 185 CTR (Mad)185 followed; Cargo Clearing Agency 218 CTR (Guj) 541 not followed;

(ii) The argument that if income is assessed by estimation on GP rate, no other disallowance can be made is not of universal application. If expenditure which is legally not permissible has been taken into account that can certainly be disallowed even where income is estimated.