When I became a father :

October 2nd 2012 has become special for lifetime , as along with the Father of the Nation’s Birthday it’s a day when I became a father as well . I thought I could share some of my initial experiences of fatherhood and hence is this blog .

Since my childhood , my mom’s favorite phrase when I was not allowed to do something that I liked and use to get upset and angry, was “you will realise this only when you become a father” and now finally I became one.

I still remember way back in February 2012 when the news got confirmed, my first reaction , was age is catching up , you gonna be a father .

But slowly as the days passed , I could feel how blessed is the experience of motherhood as I was seeing my wife Chitra go through it and with each day I use to think and tell my mother that “you would have gone through the same when you had me “ and was seeking forgiveness for my unacceptable behavior . Its amazing to see the love , affection and care with which a mother brings her child to the world and it’s an ongoing process ever after I guess. I have always loved my parents the most , but I don’t take them for granted anymore as now I realise what they would have undergone in parenting.

I could also see that we had some wonderful people around (colleagues / friends and their families ), always giving us advises on what to do , how to do , whom to consult which helped us go through these 9 months without any major issues . Finally on October 1st night wherein I got the call from Kerala where I had dropped her in the 7th Month “ I feel the d day is tomorrow ” and I rushed in and till the moment I reached by her side early morning on 2nd October , I did not know what was happening around and felt more nervous than the professional Exams which has always been nightmarish .

On 2nd October in the evening , when the baby arrived the world had changed there were wishes and happiness all around and its one of the best days in my life and would remain so . When I first saw her outside the labour room , I saw a tiny little angel with her eyes closed may be trying to tell me Dad I have arrived…

Penalty under Service Tax

Penalty should not be imposed for if Assessee Paid service tax along with interest and late fee deposited before issue of Show Cause Notice

Saraswati Engineering v. CCCES (Cestat) – If the assessee has discharged the service tax liability on his own ascertainment or on the basis of ascertainment by the Central Excise officers and inform the Central Excise officer of payment of such service tax then, no notice under sub-section (1) in respect of the amount so paid shall be served. In the instant case, the assessee discharged the tax liability for the period April to September, 2007 in August 2007 and May 2008. Interest amounting to Rs. 10,049/- was paid on 05/05/2008. They had filed the return due on 25/10/2007 by 09/05/2008. They also paid the late fee of Rs. 2,000/- for the delayed filing of the return as per the instructions of the officer who received the return. The above conduct of the assessee make it abundantly clear that there was no wilful misstatement or suppression of fact on the part of the assessee. Therefore, the provisions of sub-section (3) of Section 73 is clearly attracted in the facts of the case and issuance of a show-cause notice for demand of service tax and imposition of penalties was not at all warranted.

CESTAT, MUMBAI BENCH

Saraswati Engineering

v.

Commissioner of Customs, Central Excise & Service Tax, Nagpur

ORDER NO. A/294/11/SMB/C-IV

APPEAL NO. ST/305/2009

JULY 20, 2011

ORDER

1. This appeal is directed against the Order-in-Appeal No: SR/195/NGP/2009 dated 07/09/2009 passed by the Commissioner of Customs & Central Excise (Appeals), Nagpur.

2. Briefly stated the facts of the case are as follows:

2.1 The appellant, K.G.K. Nair, proprietor of M/s. Saraswati Engineering, Gadchandur, Distt. Chandrapur is a small-scale contractor engaged in providing Maintenance and Repair Services and holds Service Tax Registration No. 263/MRS/CND/2003-04. During the period from April to September, 2007 the appellant provided the said services to M/s. Manikgarh Cement, Gadchandur. The value of the taxable service so provided amounted to Rs. 19,11,058/-. The service tax payable thereon amounted to Rs. 1,98,724/-. The appellant collected service tax from the recipient of the service but did not remit the same immediately to the credit of the Revenue. The appellant paid an amount of Rs. 83,820/- towards service tax on 21/08/2007 and paid the balance amount of Rs. 1,14,904/- on 05/05/2008. The appellant also discharged the interest amount of Rs. 10,049/- for the late payment of service tax. The appellant filed the service tax return for the said period on 09/05/2008 after a lapse of about 6 months and was directed to pay the late fee of Rs. 2,000/- for the delayed filing, which was also paid by the appellant.

2.2 The jurisdictional Assistant Commissioner issued a show-cause notice dated 20/10/2008 alleging non-payment of service tax for the said period and also proposing imposition of penalties under Sections 76, 77 and 78 of the Finance Act, 1994. The appellant did not file any reply to the show-cause notice. Therefore, the adjudicating authority passed an ex parte order dated 30/03/2009 wherein he confirmed the service tax amount of Rs. 1,98,724/-, interest on the said amount under Section 75 and imposed an equivalent amount of penalty both under Section 76 and under Section 78 of the Finance Act, 1994 and a further penalty of Rs. 1,000/- under Section 77.

2.3 The appellant-assessee filed an appeal before the Commissioner (Appeals) and submitted before the said authority that they had discharged the service tax liability and interest thereon much before the issue of the show-cause notice and had also filed the service tax return for the relevant period before the issuance of the notice. They also informed that they had also deposited late fee of Rs. 2,000/- for the delayed filing of the return and, therefore, they pleaded that as per the provisions of Section 73 of the Finance Act, 1994, no notice could have been issued against them for demanding service tax and also for imposition of penalties. Therefore, they prayed for setting aside the penalties imposed. However, the learned Commissioner (Appeals) did not consider their pleas and passed the impugned order upholding the confirmation of service tax and imposition of penalties and rejected the appeal completely.

2.4 The appellant is before me against the said order.

3. The learned advocate for the appellant submits that in spite of the submissions made before the lower appellate authority that in view of the provisions of sub-section (3) of Section 73, no notice could have been issued on the appellant and no penalty could have been imposed. The lower appellate authority did not consider this plea and merely confirmed the order of the lower adjudicating authority. When the show-cause notice itself is not maintainable in view of the above provisions of law, the orders of the adjudicating and appellate authorities are bad in law and not sustainable.

4. The learned SDR, on the other hand, reiterates the findings given by the lower authorities. However, he fairly concedes that the appellate authority has not given any finding on the pleas made by the appellant and, therefore, the matter be sent back to the lower appellate authority for reconsideration.

5. I have carefully considered the submissions. From the records it is seen that the appellant had discharged the service tax liability of Rs. 1,98,724/- along with interest thereon well before the issue of show-cause notice. They had also paid the late fee of Rs. 2,000/- for the delayed filing of the service tax return. In spite of this the department has chosen to issue a show-cause notice in October 2008. Sub-section (3) of Section 73 reads as follows:

“(3) Where any service tax has not been levied or paid or has been short-levied or short-paid or erroneously refunded, the person chargeable with the service tax, or the person to whom such tax refund has erroneously been made, may pay the amount of such service tax, chargeable or erroneously refunded, on the basis of his own ascertainment thereof, or on the basis of tax ascertained by a Central Excise Officer before service of notice on him under sub-section (1) in respect of such service tax, and inform the Central Excise Officer of such payment in writing, who, on receipt of such information shall not serve any notice under sub-section (1) in respect of the amount so paid:

Provided that the Central Excise Officer may determine the amount of short payment of service tax or erroneously refunded service tax, if any, which in his opinion has not been paid by such person and, then, the Central Excise Officer shall proceed to recover such amount in the manner specified in this section, and the period of “one year” referred to in sub-section (1) shall be counted from the date of receipt of such information of payment.

Explanation. – (1): For the removal of doubts, it is hereby declared that the interest under section 75 shall be payable on the amount paid by the person under this subsection and also on the amount of short payment of service tax or erroneously refunded service tax, if any, as may be determined by the Central Excise Officer, but for this sub-section.

Explanation - (2) For the removal of doubts, it is hereby declared that no penalty under any of the provisions of this Act or the rules made thereunder shall be imposed in respect of payment of service-tax under this sub-section and interest thereon.”

6. A plain reading of the above provisions makes it abundantly clear that if the assessee has discharged the service tax liability on his own ascertainment or on the basis of ascertainment by the Central Excise officers and inform the Central Excise officer of payment of such service tax then, no notice under sub-section (1) in respect of the amount so paid shall be served. In the instant case, the assessee discharged the tax liability for the period April to September, 2007 in August 2007 and May 2008. Interest amounting to Rs. 10,049/- was paid on 05/05/2008. They had filed the return due on 25/10/2007 by 09/05/2008. They also paid the late fee of Rs. 2,000/- for the delayed filing of the return as per the instructions of the officer who received the return. The above conduct of the assessee make it abundantly clear that there was no wilful misstatement or suppression of fact on the part of the assessee. Therefore, the provisions of sub-section (3) of Section 73 is clearly attracted in the facts of the case and issuance of a show-cause notice for demand of service tax and imposition of penalties was not at all warranted.

7. Learned advocate is only challenging the imposition of penalties and not any other amount paid by his client. In view of the above legal provisions I hold that the imposition of penalties under Sections 76, 77 and 78 in this case was not at all warranted and therefore, I set aside the same. Thus the appeal is allowed with consequential relief, if any.

“Royalty” Still Not Taxable as DTAA prevails over the retro law.

Despite Retro Law By Finance Act 2012, “Royalty” Not Taxable as DTAA prevails

The assessee, a Mauritius company, made payment to Panamsat, USA, for hire of a “transponder satellite”. The AO held that the said hire charges constituted “royalty” and that the assessee ought to have deducted TDS u/s 195 and that as it had not done so, the amount was to be disallowed u/s 40(a)(ia). Before the Tribunal, the department argued that though as per Asia Satellite 332 ITR 340 (Del), the hire charges were not assessable as “royalty”, this verdict was no longer good law in view of the amendment to s. 9(1)(vi) by the Finance Act 2012 w.r.e.f. 1.4.1976 to provide that such hire charges shall be assessable as “royalty”. HELD by the Tribunal:

(i) In Asia Satellite 332 ITR 340 (Del) it was held that in order to constitute “royalty”, the payer must have the right to control the equipment. A payment for a standard service would not constitute “royalty” merely because equipment was used to render that service. A similar view was taken in Skycell Communications 251 ITR 53 (Mad). In De Beers (Kar) & Guy Carpenter (Del) it was held that to “make available” technical knowledge, mere provisions of service was not enough and the payer had to be enabled to perform services himself. The department’s argument that the amendments by the Finance Act, 2012 changes the position is not acceptable because there is no change in the DTAA between India and USA and the DTAA prevails where it is favourable to the assessee;

(ii) Even otherwise as the payment is made from one non-resident to another non-resident outside India on the basis of contract executed outside India, s. 195 will not apply as held in Vodafone International Holdings B.V. 341 ITR 1 (SC). As s. 195 did not apply, no disallowance can be made u/s 40(a)(i);

(iii) Further, as prior to the insertion of s. 40(a)(ia) in AY 2004-05, payments to a resident did not require TDS, under the non-discrimination clause in the DTAA, the disallowance u/s 40(a)(i) in the case of non-residents cannot be made as held in Herbalife International 101 ITD 450 (Del), Central Bank of India & Millennium Infocom Technologies 21 SOT 152 (Del).



Interest paid by PE of foreign bank to H.O. is deductible in hands of PE, same interest is not taxable in hands of H.O.

While interest paid by PE of foreign bank to H.O. is deductible in hands of PE, same interest is not taxable in hands of H.O.

The assessee, a Japanese bank, carrying on business through a PE in India, paid interest of Rs. 5 crores to its H.O. & other branches. The assessee, in computing the profits assessable to tax in India, claimed that while the interest received by the H.O. & other branches from the PE was not chargeable to tax in India on the principle that the PE & H.O. were one & the same entity, the PE was entitled to claim a deduction under Article 7 of the DTAA. The AO held that the PE & the H.O. were deemed to be separate entities and that while the interest received by the H.O. from the PE was taxable under Article 11, deduction for that interest could not be allowed to the PE u/s 40(a)(i) as it had failed to deduct TDS. The CIT (A) followed the verdict of the Special Bench in ABN Amro Bank 98 TTJ 295 (Kol) (partly affirmed in ABN AMRO 198 TM 376) and held that the interest was neither chargeable to tax nor allowable as a deduction. On appeal to the Tribunal, the matter was referred to a 5 Member Special Bench. HELD by the Special Bench:

(i) On the question whether the interest paid by the PE to the H.O. is deductible, while such interest is not deductible under the Act because the payer & payee are the same person, Article 7(2) and 7(3) of the DTAA & its Protocol makes it clear that for the purpose of computing the profits attributable to the PE in India, the PE is to be treated as a distinct and separate entity which is dealing wholly independently with the general enterprise of which it is a part and deduction has to be allowed for, inter alia, interest on moneys lent by the PE of a bank to its H.O.

(ii) On the question of taxability of the interest received by the H.O. from the PE, such interest is not taxable under the Act as both are, under the Act, the same person and not separate entities & one cannot make profit out of himself. The fiction created in Article 7(2) of the DTAA treating the PE as separate and independent entity does not extend to Article 11. Also, the interest paid by the PE is not interest paid in respect of debt claims forming part of the assets of the PE so as to attract Article 11(6). The DTAA, even assuming that it does create a liability, cannot be applied u/s 90(2) as it is contrary to the Act and less favourable to the assessee (Q whether the interest paid by the PE should be netted off against the interest received left open).

Finance Lease – Lease equalization charge is allowable

Finance Lease – Lease equalization charge as per ICAI Guidelines is allowable

CIT vs. Virtual Soft Systems Ltd (Delhi High Court) – Lease rental in monetary terms is a sum total of the financing charge and the amount embedded in it in the form of the capital sum. What the assessee needs to do, while offering for tax income derived from lease is, to separate the financing charge from the amount recovered towards capital, that is, the capital recovery amount. The financing change is determined by applying the IRR to the net investment made in the asset. The assessee also needs to provide for depreciation, on the capital value embedded in the lease rental. The fourth element which is the lease equalization charge is the result of the adjustment, which the assessee has to make whenever, the amount put aside towards capital recovery is not equivalent to the depreciation claimed by the assessee. The assessee, may claim depreciation based on the provisions of the IT Act or, may even adopt the method of depreciation provided under the Companies Act. In the event, the depreciation claimed is less than the capital recovery, the difference is debited in the profit and loss account in the form of lease equalization charge, and similarly if, for any reason the depreciation claimed is more than capital recovery then, the difference is credited, once again, in the form of lease equalization charge to the profit and loss account. Therefore, the assessee in effect debits or credits its profit and loss account with a lease equalization charge depending on whether or not the depreciation claimed is, less or more than the capital recovery. The capital recovery can be known, as is evident, on deduction of financing charges from the lease rentals. In sum and substance, lease equalization charges is a method of re-calibrating the depreciation claimed by the assessee in a given accounting period. The method employed by the assessee, therefore, over the full term of the lease period would result in the lease equalization amount being reduced to a naught, as the debit and credits in the profit and loss account would square off with each other. Hence, the contention of the revenue that it is a claim in the form of a deduction which cannot be allowed, as there is no provision under the I.T. Act is, in our view, a complete misappreciation of what constitutes a lease equalization charge. In our opinion, as long as the method employed for accounting of income meets with the rudimentary principles of accountancy, one of which, includes offering only revenue income for tax, we cannot find fault with the assessee debiting lease equalization charges in the AYs in issue, in its profit and loss account. This represents true and fair view of the accounts; a statutory requirement under Section 211(2) of the Companies Act. As explained by us above, the rationale is that over the entirety of the lease period the said debit would work itself out.

Therefore, for the reasons given hereinabove, in our opinion, the method of accounting followed by the assessee enabled, it to determine the real income, which was offered for tax in the instant case. The assessing officer, by disallowing the deduction has added to the taxable income of the assessee that, which is not, part of its income, but only an adjustment of the amount claimed as depreciation.

HIGH COURT OF DELHI

judgment delivered on: 07.02.2012

ITA Nos. 216/2011. 398/2011.

403/2011. 404/2011 & 680/2011

CIT

Vs

VIRTUAL SOFT SYSTEMS LTD.

ORDER

RAJIV SHAKDHER. J

1. The captioned appeals lay challenge to a common judgment of the Income Tax Appellate Tribunal, Delhi Bench, New Delhi (in short the Tribunal) passed on 19.02.2010. The only point raised in the captioned appeals is: whether an assesse‟s leased rental income could be allowed to be reduced by taking recourse to lease equalization charges.

2. It is relevant to note that before the Tribunal the assessment years (in short AY) in issue were: AYs 1996-97 to 2000-01. Thus, the Tribunal, by virtue of the impugned judgment dealt in all with five (5) appeals being ITA Nos. 117, 118, 119, 120 & 2292/Del/2006&04. In so far as the first appeal was concerned, that is, the one relating to 1996-97, the challenge before the Tribunal was laid vis-a-vis the order dated 26.03.2004, passed by the Commissioner of Income Tax (in short CIT) under Section 263 of the Income Tax Act, 1961 (in short the I.T. Act). The issue on merits was the same as indicated hereinabove by us. As regards the remaining four (4) appeals, what was challenged before the Tribunal was a common order of the Commissioner of Income Tax (Appeals) [in short the CIT(A)] dated 15.09.2003 pertaining to AY 1997-98 to 2000-01. In these appeals as indicated in the judgment of the Tribunal, there were two issues raised. The first issue, pertained to the validity of the re-assessment proceedings carried out in the case, while the second issue, on merits, was the same as indicated above by us.

3. It is in this factual background that the Tribunal, in the first instance, dealt with the issue on merits and, having come to the conclusion that the contention of the assessee had to be sustained, the validity of the order passed in AY 1996-97 under Section 263 of the IT Act or, the validity of the re¬assessment proceedings, in so far as, the remaining four assessment years were concerned, was not examined, as they had become, according to the Tribunal, “of academic interest”.

4. It is in this background that the Revenue has come up in appeal to this court.

ASSESSMENT YEAR 1996-97

4.1 In respect of AY 1996-97, the original assessment was completed, on 30.03.1999, under Section 143(3) of the IT Act. The said assessment was set aside by CIT(A). Consequently, an order under Section 143(3) read with Section 152 of the IT Act was passed on 19.03.2002. This order led to a determination of, a negative income, qua the assessee, which was, pegged at (-) Rs 11,02,255. The said order of assessment dated 19.03.2002, was set aside by the CIT in exercise of its power under Section 263 of the IT Act vide order dated 26.03.2004. By this order the CIT, directed inclusion of a sum of Rs 33,77,830/- in the assessee‟s income, on account of lease rental. Consequent thereto, the assessee was issued a notice under Section 143(2) of the IT Act and, after hearing the representative of the assessee, the total assessable income of the assessee was re-computed, by the order dated 09.03.2005 as follows.

Income as per Order u/s 250/143(3)

dated 19-03-2002 (-) 11,02,255/-

Add: Lease Rental 33,77,830/-

Total Assessable income 22,75,575/-

4.2 The asessee‟s income was thus assessed at Rs. 22,75,575/-, interest was also levied under Section 234B and Section 234C of the IT Act; orders were also issued for initiation of penalty proceedings under Section 271(1)(c) of the IT Act.

4.3 The assessee being aggrieved, impugned the substantive order of the CIT dated 26.03.2004 passed under Section 263 of I.T. Act in appeal before the Tribunal, which culminated in the impugned judgment.

ASSESSMENT YEAR 1998-99 TO 2000-01

4.4 In so far as the remaining four assessment years were concerned the assessing officer appears to have passed separate orders of even date, i.e., 28.01 .2005.A perusal of the order would show that a common thread flows through the said assessment orders.

4.5 The assessment‟s were re-opened for the said years, by the assessing officer, after taking recourse to the provisions of section 147/148 of the IT Act. Notices were issued to Show Cause as to why lease equalization charges debited to the profit and loss account should not be disallowed and, thereupon added to the assessee‟s income.

4.6 The assessee, filed his reply and objected to the assessment being re-opened as, according to it, there was no reason to believe that income had escaped assessment. On merits, the assessee had submitted that it had relied upon the Guidance Note dated 20.09.1995 (in short the Guidance Note) issued by the Institute of Chartered Accountants of India (in short ICAI), in respect of, Accounting for Leases. It was also submitted that the Central Government on 25.01.1996, had already issued an Accounting Standard qua Section 145 of the IT Act, which mandated that accounting policy of the assessee should be such so as to represent true and fair view of the affairs of the assessee‟s business.

4.7 The assessing officer, however, rejected the submission of the assessee, and came to the conclusion that the taxable income of the assessee had to be determined as per the IT Act and, that the said Guidance Note of the ICAI only provided guidelines for preparation of financial statements for the purposes of accounting. This apart, the assessing officer relied upon the order of the CIT(A) dated 27.07.2004 passed in the assessee‟s own case, for AY 2001-02. The sum and substance of the order passed by the CIT(A), in AY 2001-02, was that the lease equalization charge, was a notional charge on the profits of an assessee. The said lease equalization charge, represented an amount set aside out of profits of the assessee to equalize the imbalance between lease rental and depreciation created over a period of time. The lease equalization charge was thus, a provision, and not an expense incurred by the lessor, i.e., the assessee. This provision was similar to that made for depreciation. Therefore, a mere provision made for gauging the profitability of a business venture could not be claimed as a deduction under the IT Act. It may be worthwhile to note that eventhough the order of the CIT(A) denied to the assessee the deduction, it recognized the fact that lease equalization charge was a provision for additional depreciation, crafted to reflect true and correct picture of the profitability of the assessee. Relying on the order of the CIT(A), for the AY 2001-02, the assessing officer, disallowed the sum attributed to lease equalization charges, and consequently, added the same to the assessee‟s income. The disallowance, in each of the assessment years is as follows: (i) AY 1997-98 Rs. 67,02,745/-; (ii) AY 1998-99 Rs. 66,50,755/-; (iii) AY 1999- 00 Rs. 1,65,12,077/- and (iv) AY 2000-01 Rs.1 ,14,47,407/-

4.8 The assessment orders were carried in appeal to the CIT(A). The CIT(A) in respect of the aforementioned four assessment years passed a common order dated 15.09.2005. The CIT(A), in so far as re-opening of the assessment proceedings was concerned came to the conclusion that since, in the first instance, no definitive finding with regard to lease equalization charges had been given, it could not be said that there was a change of opinion on the part of the assessing officer. The CIT(A) held, that based on a consideration of the facts, the assessing officer had come to the conclusion that the lease equalization charges had been wrongly claimed as deduction and hence, there was occasion to initiate proceedings under Section 147 read with Section 148 of the IT Act. The CIT(A), was thus of the view, that the assessing officer‟s action of re-assessment had to be sustained.

4.9 On the merits, the CIT(A) followed his own order dated 27.07.2004 passed in the assessee‟s case in AY 2001-02 and sustained the addition. He briefly held that, the Guidance Note issued by the ICAI itself, indicated that income of the assessee had to be determined as per the prevalent tax laws, and that the Guidance Note was evolved only for the purposes of finalization of the accounts of the assessee. As noticed by us above, the assessing officer had followed the order of the CIT(A) for AY 2001-02.

5. The assessee being aggrieved by both the order of the CIT dated 26.03.2004 passed under Section 263 of the IT Act pertaining to AY 1996-97, and the common order passed by the CIT(A) dated 15.09.2003 vis-à-vis AY 1997-98 to 2000-01, preferred appeals to the Tribunal. The Tribunal, by the impugned judgment dated 19.02.2010, allowed the appeals of the assessee, on merits.

6. The revenue being aggrieved, has preferred the captioned appeals before us. In these appeals, the predecessor bench had framed the following common questions of law by an order dated 06.07.2011.

(a) Whether on the facts and circumstances of the case, the ITAT erred in law and on merits in allowing the deduction of lease equalization charges from lease rental income?

(b) Whether the Guidance Note issued by ICAI for presentation of accounts would override the statutory provisions of the Income Tax Act, 1961?

6.1 By a subsequent order passed on 10.01.2012, the second question of law was reformulated with the consent of counsels for the assessee and revenue. The reformulated question of law reads as follows:

(b) Whether in determination of the real income of the assessee recourse can be taken by the assessee to the Guidance Note issued by ICAI.

SUBMISSION OF COUNSEL

7. Before us arguments on behalf of the revenue were advanced by Ms Rashmi Chopra, while on behalf of the assessee submissions were made by Mr S. Krishnan.

7.1 Ms Rashmi Chopra, in her submissions largely relied upon the orders passed by the assessing officer and the order of the CIT(A) dated 15.09.2003. It was Ms Chopra‟s submission that the assessee could not take recourse to the Guidance Note issued by the ICAI qua Accounting for Leases in determination of its income, and therefore in that regard, whether a particular deduction ought to be allowed or disallowed, one would only have to look to the provisions of the IT Act. Ms Chopra contended that, the debit made to the profit and loss account by the assessee in the AYs under consideration towards lease equalization charge was rightly disallowed by the assessing officer as, there was no provision in the IT Act for such a deduction. Ms Chopra, further submitted that, in any event, there had been no determination whatsoever by the assessing officer, as to whether the lease transactions in issue could be categorized as a finance lease. Ms Chopra stated that the issue pertaining to this aspect of the matter was pending in another appeal being ITA No. 142/2007, titled CIT vs Goodwill India. For these reasons, Ms Chopra argued that the view taken by the Tribunal, was erroneous and ought to be reversed.

7.2 On the other hand, Mr Krishnan contended that, regard may be had to the fact that the assessee was entitled to change its accounting policy which it had done, by taking recourse to the provisions of the Guidance Note issued by the ICAI, while accounting for lease transactions. The method of accounting which the assessee had followed was based what has been provided in paragraphs 11 and 22 of the Guidance Note. Mr Krishnan submitted that, the courts had accepted the recommendations issued by the ICAI from time to time, with respect to the manner and mode of reflecting transactions in books of accounts, in a number of judgments, pronounced by both the High Courts‟ as well as the Supreme Court. In this regard he placed reliance on the judgment of this court in the case of CIT vs Woodward Governor India Pvt. Ltd. (2007) 294 ITR 451 (Delhi) and the Judgment of the Supreme Court in the case of Collector of Central Excise Etc. Vs Dai Lchi karkaria Ltd (1999) 156 CTR 172 (SC).

7.3 Mr Krishnan, further submitted that, what is provided in the Guidance Note stands transcended into an Accounting Standard (in short „A.S.‟) issued by the ICAI, in 2001.

7.4 In this regard Mr Krishnan placed reliance on A.S. 19 issued by the ICAI. Mr Krishnan, also placed reliance on two judgments of different benches of the Tribunal in the case of Indian Railways Finance Corporation Ltd. Vs JCIT (Delhi Tribunal) ITA Nos. 699, 359, 3357 & 2109/Del/04 and JCIT vs Pact Securities & Financial Ltd 86 ITD 115 (Hyd.). The latter being extensively referred to in the former judgment of the Tribunal.

7.5 It was Mr Krishnan‟s contention that lease equalization charge was nothing but a method of adjusting the depreciation claimed in the books of accounts to enable the assessee to represent its real income by adopting an accounting methodology which, even though not mandatory, had surely the seal of approval of a professional body, such as, the ICAI. Mr Krishnan submitted that the Tribunal, had rightly come to the conclusion that the lease equalization charge could not be disallowed and hence, could not be added to the assessee‟s income on the ground that there was no provision in the IT Act as, over the entire lease period of the asset, the debits and credits made in the profit and loss account would square off with each other. In other words the ultimate effect of such a charge was reduced to a naught.

7.6 Reliance was also placed by Mr Krishnan, on the provisions of Section 211(3C) of the Companies Act, 1956 (in short Companies Act), to contend that the ICAI was mandated with the task of formulating A.Ss from time to time for acceptance by the Central Government.

REASONS

8. Having heard the learned counsels for the parties and perused the record, what emerges is as follows: However, before we proceed further, we may indicate that, we would be answering the questions of law framed; in the reverse order, in as much as, the second question would be answered first and then, we would take up the other question of law.

8.1. The foremost aspect which, thus arises for consideration in this case is: whether the method of accounting employed by the assessee to determine the real income evidently derived from lease of assets, could be given a go-by. In determining its income and its presentation, the assessee took recourse to the Guidance Note, issued by the ICAI, on Accounting For Leases. The ICAI‟s publication on the subject indicates that the Guidance Note on accounting of leases was issued by it, for the first time, in 1988, which was, then revised in 1995. The hiatus between the date when it was first issued, and its revision, appears to be on account of an interim order granted by the Madras High Court in a case, which was, disposed of on, 14.07.1995. It appears that the case was dismissed as withdrawn.

8.2 We may also note that our discussion is prefaced by the fact that on 01.04.2001, the ICA I did publish A.S. 19 in respect of leases. The said A.S. 19, is applicable, in respect of, assets leased during accounting periods commencing on or after 01.04.2001. The periods, which are under consideration, in the present appeals, are prior to 01 .04.2001.

9. In this background what is required to be considered is whether the books of accounts could be rejected by the assessing officer merely for the reason that recourse to the Guidance Note was taken by the assessee. In this regard, we would be required to examine the provisions of Section 145 of the I.T. Act. Section 145 of the I.T. Act adverts to the method of accounting followed by an assessee. Sub-section (1) of Section 145 provides that income chargeable under the head “profits and gains of business or profession” or “income from other sources” shall be computed either on cash basis or on mercantile system, whichever method being regularly employed by the assessee. This provision is, however, subject to the Central Government notifying A.S. in respect of any class of assessee or class of income. Sub-section (3) of Section 145, empowers the assessing officers to disregard the books of accounts submitted by the assessee only if he is not satisfied with: the correctness or completeness of the accounts of the assessee or, the method of accounting employed by the assessee or on account of A.S. notified under sub¬section (2), not being particularly followed by the assessee. In this particular case, the assessing officer has disregarded, in substance, the method of accounting followed by the assessee qua lease rentals without basing it on the grounds provided in Section 145 of the IT Act. The fact that the assessee justified its method of accounting, by taking recourse to the Guidance Note issued by the ICAI in that behalf, was disregarded, on what we would term as, a disjointed reading of the provisions of the said Guidance Note. Both the assessing officer as well as the CIT(A) have adverted to paragraph 2 of the Guidance Note to come to, what we consider an erroneous conclusion in as much as they have held that in determining as to whether deduction on account of lease equalization charges ought to be allowed or not, what has to be borne in mind is ultimately the provisions of the IT Act. In our view, such an observation in paragraph 2 of the Guidance Note is really saying the obvious. Therefore, even if this Guidance Note was silent on this aspect the provisions of the I.T. Act would undoubtedly still apply. Thus, as to what is the impact of provision of para 2 of the Guidance Note will be considered by us as we progress further with our judgment.

9.1 However, what is important at this stage is to first address ourselves to the aspect as to whether the assessing officer could have disregarded the method of accounting followed by the assessee in respect of lease rentals. In our view, the assessing officer could not have do so, as the method of accounting was based on a guideline commended for adoption by a professional body such as the ICAI. The Guidance Note reflects the best practices adopted by accountants the world over. The fact that, at the relevant point in time, it was not mandatory to adopt the methodology professed by the Guidance Note issued by the ICAI, is irrelevant, for the reason that, as long as there was a disclosure of the change in Accounting Policy in the accounts, which had a backing of a professional body such as the ICAI, it could not be discarded by the assessing officer. This is specially so, since the ICAI is, recognized as the body vested with the authority to recommend A.Ss for ultimate prescription by the Central Government in consultation by the National Advisory Committee of Accounting Standards, for presentation of financial statements. The provisions of section 211(3C) of the Companies Act are quite clear on this aspect. As a matter of fact, the proviso to the said sub¬section, quite clearly specifies that till such time the Central Government prescribes the accounting standards the accounting standards issued by the ICA I, shall be deemed to be the relevant accounting standards. The relevant provision reads as follows:

“211(3C) For the purposes of this section, the expression “accounting standards” means the standards of accounting, recommended by the Institute of Chartered Accountants of India constituted under the Chartered Accountants Act, 1949 (30 of 1949), as may be prescribed by the Central Government in consultation with the National Advisory Committee on accounting Standards established under sub-Section (1) of Section 201A.

Provided that the standards of accounting specified by the Institute of Chartered Accountants of India shall be deemed to be the accounting standards until the accounting standards are prescribed by the Central Government under this sub-section.”

10. In this context it would be important to note that AS1 pertaining to Disclosure of Accounting Policies has already been notified by the ICAI as having attained mandatory status for periods commencing on or after 01.04.1991. It is not, the Assessing Officer‟s case, that the accounting policy with regard to lease rentals was not disclosed by the assessee. The assessing officer seems to have taken umbrage to the change in accounting policy having been brought about only with effect from AY 1996-97. In our view, as long as there was a disclosure of the factum of change in the accounting policy and its effect, in the accounts, no fault could be found with the change in accounting policy merely on account of the fact that it was employed for the first time in AY 1996-97. The change in accounting policy, as noticed by us above, had the imprimatur of a duly recognized professional body, i.e., the ICAI. Therefore, notwithstanding the fact that the opinion of the ICAI was expressed in a Guidance Note which had not attained a mandatory status, would not, in our view, provide a basis to the assessing officer to disregard the books of accounts of the assessee and in effect method of accounting for leases, followed by the assessee.

11. This brings us to the next crucial question as to whether the Tribunal had erred in allowing the deduction on account of lease equalization charges. In order to adjudicate upon this issue, it may be relevant to first understand as to how lease transactions operate in the commercial world. Traditionally, the term lease was confined to an immovable property such as building and/or land. Lease therefore came to be defined as: A conveyance of land or of the use of a building or a part of a building from one person (lessor) to another (lessee) for a specified period of time, in return for rent or other compensation. (See Dictionary for Accountants, Eric L. Kolher 1978, 5th edition). This traditional view, underwent a change over a period of time when, parties and/or entities entered into lease transactions even qua movable assets, such as, plant, machinery and various other assets, which also included vehicles; to name some of them. The Oxford Dictionary of Accounting (New Edition), 1999 represents that change. The definition of lease contained therein, is indicative of the shift. For the sake of convenience the definition of lease as appearing in the said dictionary is also extracted hereinbelow:

“Lease: A contract between the owner of a specific asset, the lessor, and another party, the lessee, allowing the latter to hire the asset. The lessor retains the right of ownership but the lessee acquires the right to use the asset for a specific period of time in return for the payment of specific rentals or payments. Statement of Standard Accounting Practice, 21 Accounting for Leases and Hire Purchase Contracts, classifies leases into operating leases and finance leases with differing accounting treatments.”

12. A perusal of the definition would show that a lease represents an arrangement, which more often than not dons a form of a contract, whereby party „A‟ confers upon party „B‟ the right to use an asset, for a consideration, which ordinarily is labelled as lease rentals.

12.1 Over a period of time, the transactions stood refined, in the sense, a lessor need not necessarily have created or even bought an asset with his own funds. Therefore, you could have a lease transaction where “A” was the lessor of an asset, which was financed by “C”, i.e., a lender, and which, ultimately, was leased to party “B” ,i.e., the lessee. A lease transaction therefore attained several forms, depending on the comfort level of the parties entering into a transaction and, the purpose with which the transaction was entered into, bearing in mind, the nature of the asset and, the risk bearing capacity of the parties. Therefore, you could today execute a finance lease, or an operating lease, or evolve a sale and lease back arrangement, or a leveraged lease, or even, employ a direct leasing arrangement.

12.2 We do not intend to get into the various forms in which, a lease transaction may be executed by parties, but what is important, is that, all these transactions exhibit a facet by which access is provided to an asset, by separating ownership, risk and the provision of finance to achieve this goal. Since, we are concerned in this matter with a lease, which is, ordinarily known as, a finance lease, or even capital lease; an attempt would be made to articulate as to what such a transaction would entail.

13. The Guidance Note of the ICAI defines a finance lease as: “a lease under which the present value of the minimum lease payments at the inception of the lease exceeds or is equal to substantially the whole of the fair value of the lease assets”.

13.1 As the definition would indicate the lease arrangement of a finance lease is one, whereby the lease rentals are so configured that over a period of time they enable the lessor to recover a substantial portion of the fair value of the assets.

13.2 Therefore, generally the attributes of such a lease are: (a) it is a long term lease; which is ordinarily irrevocable and, the minimum present value of the lease rental decided at the commencement of the lease, which is spread over a period of time, facilitates recovery of a substantial part of the fair value of the leased assets. While fixing the lease rentals and the lease period, the economic life of leased asset is borne in mind. The lease period is normally shorter than the economic life of the asset. The other attribute of such a transaction is that the risk of breakdown or technological obsolescence is transferred to the lessee, who therefore ordinarily would bear the cost of maintenance, repairs and insurance of the leased assets. The ownership, however, is retained with the lessor.

14. The Tribunal, in the captioned cases, has returned a finding of fact after examining transaction at hand that it is a finance lease. Being a final fact finding authority we do not intend to disturb this finding; which in any case cannot be disturbed except on the ground of perversity. The learned counsel for the revenue though, did attempt to argue before us, that there is no determination by the assessing officer as to whether the lease transactions in issue were in the nature of a finance lease; we tend to disagree as the Tribunal quite categorically in paragraph 9 of the impugned judgment has come to a conclusion that the transactions in issue were in the nature of a finance lease. The relevant portion is extracted hereinafter for the sake of convenience:

“9. As per the guidance notes, operating lease has been defined as lease other than the finance lease. If the entire value of asset was not recovered by the assessee in the case of Goowi ll India Ltd. (supra) during the period of lease, it cannot be a finance lease and hence guidance notes of the ICA I cannot be applicable to such an assessee. In the present case, in the sample working submitted before us, it is shown that as against amount financed by the assessee of Rs.677,645/-, the assessee has recovered Rs.654,944/- as depreciation and the balance amount of Rs.22,799/- has been explained as residual value of the leased asset. This is only 3.36% of the amount financed and hence it is reasonable claim that this balance amount is residual value. In the case of Goodwill India Ltd. (supra) relied upon by the learned DR of the revenue, as per example noted by the tribunal on page 37 of 306 ITR, against cost of the asset of Rs.100/-, only Rs.66/- was recovered depreciation and the unrecovered amount is 34%. This cannot be said to be residual value. In view of this vital difference in facts, we are of the considered opinion that this Tribunal decision is not applicable in the present case because in the present case, the assessee is recovering full financed amount of the lease asset during the lease period in the form of depreciation and residual value. No defect is pointed out by the learned counsel of the revenue in this chart and it is also not the case of the revenue that the facts of the present case are different than the position depicted in this chart. Since, the facts are different; the Tribunal decision cited by Ld. Counsel of the revenue rendered in the case of Goodwill India Ltd. (supra) is not relevant in the present case. We would also like to point out that in the present case, it is not the case of the revenue that the leases in question are not finance lease as per the guidelines issued by ICAI. The case of the revenue as per the orders of the authorities below and as per written submissions of learned counsel of revenue before us is that the guidelines of ICAI are not decisive and no deduction is allowable as per any provision of Income Tax Act on account of Lease Equalisation charges and still we have obtained sample working from the assessee by refixing the case for clarification to satisfy ourselves that the leases in question in the present case is finance leases and as per the discussion above, we have noted that in the present case, the leases are finance lease whereas in the case of Goodwill India Ltd. (supra), the lease was not finance lease as per the facts noted by the tribunal in that case.”

(emphasis is ours)

14.1 A perusal of the grounds of appeal would show that there is no averment whatsoever that such a finding of fact recorded by the Tribunal, was perverse. Therefore, we would have to accept that the Tribunal examined the record, and came to a correct conclusion.

14.2 The Tribunal having found that the lease in issue is a finance lease we would be required to consider whether the method employed by the assessee with regard to determination of the real income is a correct method. Paragraph 11 and 12 of the Guidance Note of the ICAI read with the appendix attached to it is, quite instructive in this regard. Therefore, paragraph 2 of the Guidance Note on which great stress is laid on behalf of revenue has to be read with paragraphs 11 and 12. We do not wish to burden the judgment with the extract of the said paragraphs, however, it is sufficient to note that the paragraphs adverts to the following four elements, which arise, for consideration for treatment of the amount received as lease rentals by the lessee, in order to bring to tax what is his real income and, present a true and fair view of the transaction in issue. The four elements which are considered are: lease rentals; the implicit rate of return (IRR); depreciation; and lease equalization charge.

14.3 Lease rental in monetary terms is a sum total of the financing charge and the amount embedded in it in the form of the capital sum. What the assessee needs to do, while offering for tax income derived from lease is, to separate the financing charge from the amount recovered towards capital, that is, the capital recovery amount. The financing change is determined by applying the IRR to the net investment made in the asset. The assessee also needs to provide for depreciation, on the capital value embedded in the lease rental. The fourth element which is the lease equalization charge is the result of the adjustment, which the assessee has to make whenever, the amount put aside towards capital recovery is not equivalent to the depreciation claimed by the assessee. The assessee, may claim depreciation based on the provisions of the IT Act or, may even adopt the method of depreciation provided under the Companies Act. In the event, the depreciation claimed is less than the capital recovery, the difference is debited in the profit and loss account in the form of lease equalization charge, and similarly if, for any reason the depreciation claimed is more than capital recovery then, the difference is credited, once again, in the form of lease equalization charge to the profit and loss account. Therefore, the assessee in effect debits or credits its profit and loss account with a lease equalization charge depending on whether or not the depreciation claimed is, less or more than the capital recovery. The capital recovery can be known, as is evident, on deduction of financing charges from the lease rentals. In sum and substance, lease equalization charges is a method of re-calibrating the depreciation claimed by the assessee in a given accounting period. The method employed by the assessee, therefore, over the full term of the lease period would result in the lease equalization amount being reduced to a naught, as the debit and credits in the profit and loss account would square off with each other. Hence, the contention of the revenue that it is a claim in the form of a deduction which cannot be allowed, as there is no provision under the I.T. Act is, in our view, a complete misappreciation of what constitutes a lease equalization charge. In our opinion, as long as the method employed for accounting of income meets with the rudimentary principles of accountancy, one of which, includes offering only revenue income for tax, we cannot find fault with the assessee debiting lease equalization charges in the AYs in issue, in its profit and loss account. This represents true and fair view of the accounts; a statutory requirement under Section 211(2) of the Companies Act. As explained by us above, the rationale is that over the entirety of the lease period the said debit would work itself out.

15. Therefore, for the reasons given hereinabove, in our opinion, the method of accounting followed by the assessee enabled, it to determine the real income, which was offered for tax in the instant case. The assessing officer, by disallowing the deduction has added to the taxable income of the assessee that, which is not, part of its income, but only an adjustment of the amount claimed as depreciation.

16. Therefore, both questions of law are answered in favour of the assessee and against the revenue. The appeals of the revenue are, accordingly, dismissed.

FEBRUARY 07, 2012

DTAA Vs Domestic Tax Laws

Assessee to whom DTAA applies, the provisions of Income Act shall applied to the extent they are more beneficial to the assessee

Intelsat Corporation Vs. ADIT (International Taxation) - In this case , there is a distinguishable feature namely that the assessee has received payments from persons residents in India. However, the receipts have been taxed u/s 9(1)(vii), Explanation 2, Clause (vi) thereunder. The decision in the case of Asia Satellite Telecommunications Company Limited is to the contrary and in favour of the assessee. It is also a matter of fact on record that the assessee is a tax resident of USA and, therefore, the provisions contained in the DTAA are applicable. However, we are of the view that we need not go into the provisions of the DTAA because of the provision contained in Section 90(2) of the Act. This provision provides that where the Central Government has entered into an agreement with the Government of any country outside India under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall applied to the extent they are more beneficial to that assessee. The assessee is found to have incurred no liability to tax under the Act. Therefore, even if the provisions of the treaty go against the assessee, it has to be granted the benefit of the Act under which no liability to tax can be fastened on the assessee

INCOME TAX APPELLATE TRIBUNAL, DELHI

ITA No.5393/Del/2011 – Assessment Year : 2008-09

M/s Intelsat Corporation

Vs.

Assistant Director of Income Tax, International Taxation

ORDER

PER G.D.AGRAWAL, VP :

This appeal of the assessee is directed against the order of learned Dispute Resolution Panel-1, New Delhi dated 23rd September, 2011.

2. The learned CIT-DR, vide application dated 31st January, 2012, has requested for adjournment of the appeal.

3. The learned counsel for the assessee submitted that the issue involved in this appeal is covered in favour of the assessee by the decision of the Tribunal in assessee’s own case for AY 2006-07 and 2007-08 and also of Hon’ble High Court for AY 2007-08. In support of his submission, he has filed copies of the orders of the Tribunal in ITA No.4662/Del/2011 for AY 2006-07 and in ITA No.5443/Del/2010 for AY 2007-08 and of Hon’ble High Court for AY 2007-08 in the form of a paper book.

 

4. We have heard the submissions of the learned counsel for the assessee and perused the material placed before us. In view of the submission of the learned counsel for the assessee that the issue involved is covered in favour of the assessee by the earlier decisions of the Tribunal in assessee’s own case for AY 2006-07 and 2007-08 and also the decision of Hon’ble Jurisdictional High Court for AY 2007-08, we have rejected the application of the learned CIT-DR requesting for adjournment and proceeded to decide the appeal of the assessee exparte qua the Department.

5. We find that the issue involved in this appeal is covered by the aforementioned decisions of the Tribunal. The Tribunal, vide its order dated 4th March, 2011 in ITA No.5443/Del/2010 for AY 2007-08, has held in paragraph 4 as under:-

“4. We have considered the facts of the case and submissions made before us. We have already mentioned that there is a distinguishable feature namely that the assessee has received payments from persons residents in India. However, the receipts have been taxed u/s 9(1)(vii), Explanation 2, Clause (vi) thereunder. The decision in the case of Asia Satellite Telecommunications Company Limited is to the contrary and in favour of the assessee. It is also a matter of fact on record that the assessee is a tax resident of USA and, therefore, the provisions contained in the DTAA are applicable. However, we are of the view that we need not go into the provisions of the DTAA because of the provision contained in Section 90(2) of the Act. This provision provides that where the Central Government has entered into an agreement with the Government of any country outside India under sub-section (1) for granting relief of tax, or as the case may be, avoidance of double taxation, then, in relation to the assessee to whom such agreement applies, the provisions of this Act shall applied to the extent they are more beneficial to that assessee. The assessee is found to have incurred no liability to tax under the Act. Therefore, even if the provisions of the treaty go against the assessee, it has to be granted the benefit of the Act under which no liability to tax can be fastened on the assessee. Accordingly, ground Nos.1 to 5 are allowed.”

6. The above order of the Tribunal dated 4th March, 2011 has been followed by the Tribunal in its order dated 16th January, 2012 in ITA No.4662/Del/2011 for AY 2006-07. The learned counsel for the assessee further submitted that the said order of the Tribunal dated 4th March, 2011 was also the subject-matter of appeal by the Department before Hon’ble Delhi High Court. Hon’ble Delhi High Court, vide its order dated 19th August, 2011 in ITA No.977/2011, has dismissed the appeal filed by the Department and confirmed the order of the Tribunal. Copy of the said order of Hon’ble Delhi High Court has also been placed in the paper book filed by the assessee. Their Lordships of Delhi High Court have decided the said issue by holding as under:-

“Learned Counsel for the Revenue could not dispute the position that issues raised in this appeal are directly covered by the judgment of this Court in the case of Asia Satellite Telecommunications Ltd. Vs. Commissioner of Income Tax (ITA 131/2003 decided on 31.01.2011). In that judgment, a categorical view is taken that the income received from the activities undertaken by the respondent/assessee would not be eligible to tax in India. Following that judgment, this appeal is dismissed.”

7. Respectfully following the aforesaid judgment of Hon’ble Delhi High Court and the decisions of the Tribunal for AY 2006-07 & 2007-08 cited supra, we reverse the directions under Section 144C(5) of the IT Act, 1961 passed by the Dispute Resolution Panel and allow the appeal of the assessee.

8. In the result, the appeal filed by the assessee is allowed.

Decision pronounced in the open Court on conclusion of hearing on 2nd February, 2012

Santa Biotech-Sanofi (Sale of shares of Foreign Company by Non Resident to Non Residents )

Gains arising on sale of shares of foreign company by NR to NR taxable in India if the foreign co only held Indian assets

Two French companies named “Murieux Alliance” (‘MA’) and “Groupe Industrial Marcel Dassault” (“GIMD”) held shares in another French company named “ShanH”. MA & GIMD acquired shares in an Indian company named “Shantha Biotechnics Ltd” (“Shantha”). The shares in Shantha were transferred to ShanH. MA and GIMD subsequently sold the shares in ShanH to another French company named “Sanofi Pasteur Holding”. The assessees filed an application for advance ruling claiming that as the two French companies had sold the shares of another French company to a third French company, the gains were not chargeable to tax in India. The department opposed the application on the ground that ShanH was formed with no purpose other than to hold the shares of the Indian company and that the transaction was taxable in India. HELD upholding the department’s plea:

(i) Azadi Bachao Andolan, though binding on the AAR, may not be the final word because under the proviso to s. 245R(2), the AAR is entitled to disallow an application if the question raised therein relates to an issue which is designed, prime facie, for the avoidance of income-tax. The AAR is entitled to see whether the steps taken were a device to avoid liability to tax. Also it is difficult to accept the arguments based on Azadi Bachao Andolan because that judgement appears to proceed on the basis that the views expressed by Chinnappa Reddy, J. were his own and did not represent the view of the Court as a whole. The view that has emerged is that notwithstanding the legal validity of a transaction or a set of transactions, if the purpose was to create a legal smoke screen to avoid the payment of tax that would legitimately be due as having arisen on the basis of a transaction or an event, the legal effect of the transaction in the context of the taxing statute, has to be considered, notwithstanding its reality or validity;

(ii) On facts, the French company’s (ShanH) only asset were the shares in the Indian company & it had no other business. When its shares were sold, what really passes were the underlying assets and the control of the Indian company. A gain was generated by the transaction. If the transaction is accepted at face value, control over Indian assets and business can pass from hand to hand without incurring any liability to tax in India. Such transactions have to be treated as ineffectual. It is not necessary to ignore the existence of ShanH to come to a conclusion that what is put up is a facade in the context of the tax law and would amount to a scheme for avoidance of tax;

(iii) Under Article 14(5) of the India-France DTAA, gains from the alienation of shares representing a participation of at least 10% in an Indian company may be taxed in India. Here, though the shares being transferred are that of a French company, the situs of the underlying assets & controlling interest cannot be ignored. What is involved in the transaction is an alienation of the assets and controlling interest of an Indian company. Consequently, even though such interest is not an alienation of the shares of an Indian company, still, on a purposive construction of Article 14(5), the capital gains is taxable in India.

Exclusion of Telecommunication Expeneses from both ET & TT for Sec 10A.

DCIT vs M/s Intel Technology India Ltd, (ITAT Bangalore)

Assessing Officer has by referring to clause (iv) of Explanation 2 to section 10A of the Act, reduced telecommunication expenses/leaselines charges from the export turnover but did not reduced such charges from the total turnover. On Appeal CIT (A) directed the AO to recompute deduction u/s 10A of the Act after excluding expenditure incurred on up-linking charges out of telecommunication expenses from both export turnover and the total turnover. Revnue has gone in appeal against the order of Honorable ITAT which held as under :-

In the case of Sak Soft Ltd. (supra), the assessee was engaged in the business of exporting computer software and claimed deduction u/s 1oB of the Act. In completing the assessment u/s 143(3) of the Act, the AO reduced the expenditure incurred in foreign exchange in providing the technical services outside India, from the export turnover without corresponding reduction from total turnover, thereby reducing the deduction claimed by the assessment u/s 10B of the Act.

1o.2 In light of the above facts, the Special Bench held as under:-

“For the above reasons, we holdthat for the purpose of applying the formula under sub-section (4) of section 1oB, the freight, telecom charges or insurance attributable to the delivery of articles or things or computer software outside India or the expenses, if any, incurred in foreign exchange in providing the technical services outside India are to be excluded both from the export turnover andfrom the total turnover, which are the numerator and the denominator respectively in the formula. The appeals filed by the department are thus dismissed’.

Although the order of Special Bench is in the context of section 1oB of the Act, the ratio laid down in the above decision applies to section 1oA of the Act as well, as the provisions of sections 1OA and 1OB are identical on all material aspects. More particularly, both the sections define only export turnover but not total turnover and sub-section (4) of both the sections prescribe an identical formula for computing the export profits.

10.3 In the light of the above reasoning, we uphold the orders of the CIT(A) and direct the AO to exclude the above mentioned expenses both from the export turnover as well as from the total turnover while calculating deduction u/s 10A of the Act.

Pygmies Not Comparable With Giants: ITAT Hyd

Transfer Pricing: Important Principles on comparability & +/-5% adjustment stated

DCIT vs. Deloitte Consulting India Pvt. Limited (ITAT Hyderabad)

The Tribunal had to consider the following transfer pricing issues: (i) whether the use of multi-year data for determining ALP is permissible? (ii) Whether +/-5% adjustment is a “standard deduction”? (iii) Whether companies with minor differences can be treated as non-comparable? (iv) Whether a company with turnover 20 times that of the assessee can be said to be comparable? (v) Whether as the assessee was operating in a “risk-free environment”, adjustment for valuable intangibles and entrepreneurial risk borne by the comparables has to be made? (vi) Whether the TPO/AO need to demonstrate the assessee’s motive to shift profits outside India by manipulating prices charged in international transactions? HELD:

(i) The expression “shall” in Rule 10B(4) makes it clear that it is mandatory to use the current year data first and if any circumstances reveal an influence on the determination of ALP in relation to the transaction being compared than other data for period not more than two years prior to such financial year may be used. If the current year’s data of comparables is not available at the time of filing the ROI a fresh search of comparables during the transfer pricing proceedings is permissible;

(ii) The +/-5% tolerance band in s. 92C is not a standard deduction. If the arithmetic mean falls within the tolerance band, then there should not be any ALP adjustment. If it exceeds the said tolerance band, ALP adjustment is not required to be computed after allowing the deduction at 5%. That means, actual working is to be taken for determining the ALP without giving deduction of 5%;

(iii) The argument that a company with employee-cost of 1.38% of its revenue and with intangible property is not comparable because the assessee has an employee-cost of 52.12% and has no intangible property is not acceptable because the differences do not materially affect the price or profit earning. No two comparable companies can be replicas of each other. Rule 10B has to be applied not with technical rigor, but on a broader prospective;

(iv) A company with 20 times turnover (Wipro BPO) more than the assessee is not at all comparable because the assessee is a pygmy compared to a giant. Accordingly Wipro BPO has to be excluded from the list of comparable companies;

(v) There are several factors such as market risks, environmental risk, entrepreneurial risk and functional risk etc., which affect this matter and which ultimately affect the results of the company. These factors make it impracticable to find out exact duplicate of the assessee as comparable. Some variation is bound to exist. The TPO had identified comparables whose functions were similar to the assessee by applying quantitative and qualitative filters to eliminate differences between the assessee and the comparable to neutralize the risk factors. The assessee’s argument that it is a “low end performer” operating in “risk-free environment” and that suitable adjustment should be made is not acceptable;

(vi) The transfer pricing rules apply when one of the parties to the transaction is a non-resident, even if the transaction takes place within India. There is no need to find out the legislative intent behind the transfer pricing provision when the provisions were unambiguous. The existence of actual cross border transactions or motive to shift profits outside India or to evade taxes is not a pre-condition for transfer pricing provisions to apply.

Related Judgements

1. Symantec software Solutions Pvt Ltd vs. ACIT (ITAT Mumbai)

While in principle, comparables having an abnormal difference of turnover and distorted operating profits have to be excluded for determining the ALP, the claim that as the assessee revenue is about Rs. 20 crores, comparables having more than 50 crores and less than 5 crores of turnover should be…

2. Philips Software vs. ACIT (ITAT Bangalore) (4 MB)

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

3. Marubeni India Private Ltd vs. ACIT (ITAT Delhi)

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…

Internal comparability to be given preference over external comparables

Destination of the World (Subcontinent) Pvt. Ltd.,-vs.- Asstt. CIT (ITAT Delhi) The Tribunal held that in the first instance, the attempt should be made to determine arm’s length price of controlled transactions by comparing the same with internal uncontrolled transactions undertaken in same or similar economic scenario.

The Tribunal relied on the following in arriving at this conclusion :

- OECD Transfer Pricing Guidelines in paragraph 3.26 suggest preference for internal comparables, and suggest use of external independent enterprises only when such internal comparison is not possible.

- The Tribunal ruling in the case of UCB India Pvt. Ltd. (above), indirectly concludes that internal comparables are preferable to external comparables. Also, in the case of Birlasoft (India) Ltd. (above), the Tribunal ruled that the taxpayer was justified in undertaking internal comparison.

- Internal comparison is valid under all methods.

- In the current case, the Revenue had not made a case for economic scenarios of controlled and uncontrolled transactions to be different.

Destination of the World (Subcontinent) Pvt. Ltd.,-vs.- Asstt. CIT

C. L. Sethi (JM) & K.G. Bansal (AM)

ITA No. 5534(Del)/2010

Date of Decision – 08th July 2011

PER K.G. BANSAL : AM

The facts of the case are that the assessee filed its return on 22.11.2006 declaring loss of Rs. 2,86,62,238/-. The return was processed u/s 143(1) of the Income-tax Act, 1961, on 01.03.2008, and thereafter it was taken up for scrutiny by serving notice u/s 143(2) dated 27.09.2007 by post. Another notice under section 143(2) was served on the assessee by hand on 11.11.2008. The assessee-company has been carrying on the business of out-bound and in-bound travel services. It undertook international transactions with the Associated Enterprises (“AEs” for short) of the value of more than Rs. 5.00 crore. Therefore, reference was made to the Transfer Pricing Officer (“TPO” for short) for determining arm’s length value of the international transactions undertaken with the AEs. In order dated 15.10.2009, the TPO suggested upward revision in the value recorded in the books by an amount of Rs. 2,07,07,267/-. This revision was incorporated in the draft order. The assessee objected to the upward revision on this ground before the Dispute Resolution Panel-I, New Delhi (“the DRP” for short). In order dated 09.09.2010, the ld. DRP approved the draft order. Consequently, the assessment order was passed on 16.09.2010 determining the loss at Rs. 79,30,570/-as under:

Loss as per return of income 2,86,62,838/-

Add: On account of arm’s length price 2,07,07,267/-

Add: on account of ROC expenses 25,000/- 2,07,32,267/-

Total Loss: 79,30,571/-

Rounded off u/s 288A (-) 79,30,571/-

2. Coming to the order of the TPO, it is mentioned that the assesseecompany is a wholly owned subsidiary of Destination of the World Holding Establishment, Liechtenstein. The assessee started its operations in June, 2005, with the main objects of rendering in-bound, out-bound and domestic travel services in the territories of India, Nepal and Bangladesh. The in-bound services comprise of car rentals, airport transfers, site tours, travel insurance and customized packages. The domestic travel services are rendered through online reservation system to individuals and groups. The out-bound services comprise of meetings, conferences, exhibitions and travel to various destinations of the world. In this year, the assessee has undertaken following international transactions:

S.No. Description of transaction Method Value (In Rs.)

1 Outbound travel related services RPM 93803233

2 Outbound travel related services CPM 10017466

3 Charge back of expenses by assessee - 565599

4 Charge bank of expenses to assessee - 1402521

5 Counter Guarantee of cash credit limit - 1300000

2.1 The assessee has used re-sale price method in respect of out-bound travel with gross profit margin on sales as the profit level indicator (“the PLI” for short). In order to prove that such transactions with the AEs are at arm’s length, the assessee has drawn segmental accounts in the transfer pricing report. Further, the PLIs in respect of uncontrolled and controlled transactions have been worked out. Re-sale price method has been justified on the ground that the assessee does not add any value in this segment. The PLI in respect of controlled transactions has been shown at 10.87% against 11.84% in uncontrolled transactions. Thus, it is contended that if option of reduction by 5% is exercised, such transactions are at arm’s length.

2.2 In regard to in-bound travel services, the assessee has applied cost plus method with the PLI being gross margin as a percentage of cost. Segmental account has been drawn for this purpose, which has been segregated into controlled and uncontrolled transactions. The PLI in respect of controlled transactions is 6.66% against 8.93% in respect of uncontrolled transactions. Therefore, following the earlier argument regarding reduction by 5%, it has been contended that the transactions are at arm’s length.

2.3 The TPO examined the FAR analysis furnished in the transfer pricing report. It is mentioned that the report does not distinguish between in-bound and out-bound segments and, therefore, it can be concluded that functions performed and assets utilized in both the segments are similar. The report has not furnished the risk analysis in the two segments. It is further mentioned that the auditors have not certified that segmental accounts have been maintained. Therefore, it has been held that such segregation is a convenient devise to canvass that the controlled transactions have been undertaken at arm’s length.

2.4 Further, the TPO has examined the segmental accounts, which have been prepared from the consolidated annual accounts. It is mentioned that segmental accounts have not been maintained separately for transfer pricing purposes. In this connection, references have been made to the tax audit report, which show various discrepancies, namely, that

(a) only on set of accounts are maintained for the whole business;

(b) the segmental accounts have been prepared by arbitrarily allocating cost; and

(c) the basis of allocation between the two segments has not been disclosed or explained.

2.5 In view of the aforesaid deficiencies or discrepancies, it is concluded that the segmental accounts have been drawn with the sole purpose of justifying the price of international transactions undertaken with the AEs. Although the assessee has shown overall loss, the segmental accounts prepared have been manipulated to camouflage the loss at entity level, but reporting profits at the segmental level. In view of these conclusions, the arm’s length price is determined at the entity level. For this purpose, TNMM has been used. In order to apply this method at entity level, two comparable cases have been cited, namely, Indo-Asia Leisure Services Ltd. and Shree Raj Travels & Tours Ltd. Their results have been tabulated as under:

OP/TC OP/Sales

1. Indo Asia Leisure Services Ltd. 6.84% 6.40%

2. Shree Raj Travels & Tours Ltd. 23.97% 19.33%

Mean(OP/TC) 15.40% 12.86%

2.6 Accordingly, the mean of the PLI at 12.86% has been applied to the controlled international transactions. The methodology of computing PLI in the case of the assessee has been aligned with the results of the aforesaid comparable cases and the corresponding revenue in case of the assessee from controlled international transactions has been computed at Rs. 8,24,96,107/-. The corresponding cost has been worked at Rs. 7,30,95,666/-. The assessee booked international transactions of Rs. 9,38,03,233/-. Thus, the difference has been worked out at Rs. 2,07,07,267/-, which constituted 22.07% of the international transactions. Adjustment of Rs. 2,07,07,267/-has been worked out as under:

S.No. International transaction Book

value Difference loaded Arm’s

length

price Difference

(%)

1. Purchase of tours 93803822 18709273 75094549 19.95%

2. Sale of tours 10017466 1997994 12015460 19.95%

Total 103821288 20707267

3. The assessee has challenged the aforesaid adjustment on various grounds mentioned in various paragraphs of ground no. 2, which read as under:

2. “That the Assessing Officer/TPO erred on facts and in law in making adjustment of Rs. 2,07,07,267 to the income of the appellant on account of alleged difference in the arm’s length price of the international transactions undertaken during the relevant previous year.

2.1 That the assessing officer/TPO erred on facts and in law in disregarding the internal benchmarking undertaken by the appellant for determining the arm’s length price of the international transactions applying Resale Price method (“RPM”) in respect of international transaction of outbound travel related services and Cost Plus Method “CPM”) in respect of international transaction of inbound travel related services.

2.2 That the assessing officer/TPO erred on facts and in law in disregarding RPM and CPM as the most appropriate method and arbitrarily applying TNMM by comparing the net operating profit margin of the appellant with net operating profit margin of comparable uncontrolled companies.

2.3 That the assessing officer/TPO erred on facts and in law in not appreciating that with respect to the international transactions of inbound and outbound travel related services, the appellant was only acting as an intermediary/reseller and benchmarking analysis is to be undertaken applying RPM/CPM considering gross profit margin from such international transactions.

2.4 That the assessing officer/TPO erred on facts and in law in holding that the appellant has artificially bifurcated its account in two segments, inbound and outbound, without appreciating that the functions performed by the appellant in both the segments were entirely difference.

2.5 That the assessing officer/TPO erred on facts and in law in disregarding the segmental analysis of profitability of inbound travel related services in the Transfer Pricing documentation, holding as under:

a. The assessee has not maintained separate audited financials for these segments;

b. The segmental information has been credited to arbitrarily to allocate the costs and thereby reduce losses;

c. Since as per tax auditor report, the assessee has not maintained segmental account for two different alleged lines of business (as claimed in transfer pricing report), the allocation of expenditure between these two segments. Without any explained or disclosed allocation key cannot be relied upon to determine correct segmental results.

d. The FAR profile of the segments is identical and hence both the segments are similar.

2.6 That the assessing officer/TPO erred on facts and in law in considering the following companies as comparable companies without appreciating that the same are not functionally similar to the appellant and hence not comparable:

OP/TC% OP/Sales%

(i) Indo Asia Leisure Services Ltd. 6.84% 6.40%

(ii) Shree Raj Travels & Tours Ltd. 23.97% 19.33%

Mean 15.40% 12.86%

2.7 That the assessing officer/TPO erred on facts and in law in considering the said companies as comparable companies without appreciating that they follow B2C (i.e., business to customer) business model as compared to the appellant which is into B2B (i.e., business to business) business model.

2.8 That the assessing officer/TPO erred on facts and in law in holding Shree Raj Travels & Tours Ltd. as a comparable and not appreciating that the net income (after reducing cost of purchase) has been recorded as income in the profit and loss account, instead of reflecting sales/revenue from the tours and the cost of sales separately in the profit and loss account while the appellant on the other hand had accounted sales revenue from tours/travels in the credit side of profit and loss account and corresponding cost of sales are shown as the expenditure in the profit and loss account.

2.9 That the assessing officer/TPO erred on facts and in law in not appreciating that because of the above difference in the method of accounting and sales revenue, the operating profit margin computed by the assessing Officer of Shree Raj Travels & Tours Ltd. was not comparable with that of the appellant.

2.10 That the assessing officer/TPO erred on facts and in law in holding Indo Asia Leisure Services Ltd. as a comparable and not appreciating that the company is earning revenue from sale of products which is dissimilar to the services rendered by the appellant.

2.11 That the assessing officer/TPO erred on facts and in law in holding the abovementioned companies as comparables without appreciating that the companies have been in existence for a long time as against the appellant which is a start up enterprise.

2.12 Without prejudice that the TPO erred in law in not allowing variation to the extent of (+/-) 5%, while determining the arm’s length price of the ‘international transactions’.”

The grounds inter-alia include the arguments in support of the main ground that the AO was not justified in making the aforesaid adjustment of Rs. 2,07,07,267/-to the loss declared by the assessee. These grounds are disposed off on the basis of submissions made by the ld. counsel for the assessee and the ld. CIT, DR before us.

4. The ld. counsel furnished the brief background about the functioning of the assessee-company. It is submitted that it is a wholly owned subsidiary company of Destination of the World Holding Establishment, Liechtenstein, and it is engaged in the business of providing in-bound, out-bound and domestic travel services. The business is based on business to business (“B2B” for short) platform as against business to customers (“B2C”) platform utilized by other travel agents. In the inbound services, a customer coming to India from a foreign destination makes booking through the travel agent for hotel reservation and other services. The agent makes the booking at the DOTW’s office on the basis of the rate reflected in the website. The DOTW office in turn buys services from the Indian offices of DOTW as reflected in its website. DOTW India in turn buys these services in bulk from hotels and other suppliers. Coming to out-bound services, it is submitted that a customer traveling from India to overseas destination approaches a travel agent for booking the hotel, site seeing, transfers etc. The travel agent buys these services from DOTW India. DOWT India in turn buys these services from the foreign office of DOTW at the rates reflected in the website. The foreign office in turn purchases bulk reservations and services from the hotels or suppliers, as the case may be. In respect of domestic travel services, it is submitted that the same are rendered through online reservation systems to individuals and groups.

4.1 The in-bound and out-bound travel related services have been undertaken with the AEs and non-AEs. The aggregate value of outbound travel services has been recorded at Rs.9,38,03,233/-in the books of account, and in-bound travel services have been recorded at Rs. 1,00,17,466/-. Apart from that, there are other international transactions, which have not been disturbed in respect of their valuation by the TPO. The assessee has applied re-sale price method in respect of out-bound travel services and cost plus method in respect of in-bound travel services. These are the most appropriate methods under Rule 10B. The reason is that the assessee does not add any value in respect of out-bound services. However, in respect of in-bound services cost plus method has been employed in the transfer pricing study report.

4.2 Segmental accounts have been drawn in respect of both kinds of services. The position in respect of out-bound services is as under:

Particulars Segment A (AE) Segment B

(Non-AE)

Net sales (Net of taxes) 106,725,795 42,354,272

Cost of sales (tours purchased) 95,109,233 37,341,416

Gross Margin 11,618,562 5,012,856

Gross margin as a % of sales 10.89% 11.84%

The position in respect of in-bound services is as under:

Particulars Segment A Segment B

Net Sales (Net of taxes) 9,624,775 41,468,947

Cost of sales (tours purchased) 9,023,920 38,069,266

Gross Margin 600,856 3,399,682

Gross margin as a% of cost 6.66% 8.93%

4.3 The TPO rejected the internal comparison by mentioning that:

(a) the assessee had not maintained separate audited accounts for the two segments;

(b) the segmental information has been created arbitrarily with the purpose of hiding the loss at entity level;

(c) the TP report submitted by the assessee contains FAR analysis which does not distinguish between in-bound and out-bound segments and, therefore, the services rendered in the two segments stand at par; and

(d) the transactions with associated enterprises and other enterprises are so closely inter-linked that they cannot be evaluated separately.

4.4 In view of the aforesaid the AO rejected the report and applied TNMM by choosing two comparables, namely, -(i) Indo Asia Leisure Services Ltd., and (ii) Shree Raj Travels & Tours Ltd. Accordingly, adjustment of Rs. 2,07,07,267/-has been suggested.

4.5 Coming to the functioning of the assessee and maintenance of accounts, it is submitted that there is no obligation cast on it for maintaining segmental information in the audited accounts. In this connection, reliance has been placed on the decision in the case of Birlasoft (India) Ltd. Vs. DCIT in ITA No. 3839(Del)/2010, a copy of which has been placed before us. It is further submitted that a customized ERP system has been installed in various offices of DOTW all over the world which records and allocates the cost. Thus, there is no scope of any manual intervention, which means that no manipulation could have been done. It is also submitted that even under TNMM, internal uncontrolled comparable transactions are to be preferred over external comparables as mentioned in paragraph no. 3.26 of the OECD guidelines and as held in the case of UCB India Pvt. Ltd. Vs. ACIT, (2009) 30 SOT 95. Therefore, it is argued that the findings of the TPO regarding manipulation of segmental accounts for hiding entity level loss are misplaced and he ought to have utilized internal comparables rather than external comparables. The assessee has rightly applied re-sale method for outbound services as no value addition is made. Similarly, cost plus method was rightly applied in respect of in-bound services. It is also submitted that on the basis of annual accounts of the comparables selected by the TPO, the PLI of the assessee and the comparables are as under:

Particulars DOTW Indo Asia Shree Raj Travels

Sales Value 2,025.78 4,720.93 1,510.07

Operating Income 18.12 38.91 -

Total Operating income 2,043.90 4,759.83 1,510.07

Other income - 4.35 4.23

Total income 2,043.90 4,764.18 1,514.30

Employee cost 285.33 214.20 252.67

Operating expenses 2,019.25 4,188.15 1,060.52

Preliminary expenses written off 13.25

Depreciation 27.41 91.75 39.76

Non-operating expenses - - 11.00

Total expenses 2,345.24 4,494.10 1,363.95

Profit before tax (301.35) 270.09 150.35

Operating profit (301.35) 265.74 157.12

Operating profit % to total sales -14.88% 5.63% 10.41%

4.6 Before concluding the submissions of the ld. counsel, we may reproduce paragraph no. 3.26 of the OECD guidelines, which read as under:

“3.26 The transactional net margin method examines the net profit margin relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realizes from a controlled transaction or transactions that are appropriate to aggregate under the principles of Chapter I). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particulars that the net margin of the taxpayer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of Chapter I) should ideally be established by reference to the net margin that the same tax payer earns in comparable uncontrolled transactions. Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise may serve as a guide. A functional analysis of the associated enterprise and, in the latter case, the independent enterprise is required to determine whether the transactions are comparable and what adjustments may be necessary to obtain reliable results”. (emphasis supplied)

5. In reply, the ld. DR referred to the reasons recorded by the AO/TPO for rejecting transfer pricing report submitted by the assessee and justification provided for applying TNMM. It is submitted that the lower authorities have not analyzed the data for working out the PLI of uncontrolled transactions by applying TNMM. Therefore, the computation provided by the assessee regarding gross margin in respect of combined in-bound and out-bound transactions now require scrutiny. The computation is as under:

Inbound services (CPM) Outbound Services (RPM) Consolidated

AE Non-AE Total AE Non-AE Total AE Non-AE

Net sales (tours purchased 9624775 41468947 51093722 106727795 42354272 149082067 116352570 83823219

Cost of sales (tours purchased) 9023920 38069266 47093186 95109233 37341416 132450649 104133153 75410682

Gross margin 600855 3399681 4000536 11618562 5012856 16631418 12219417 8412537

Gross margin (% sales) 6.24% 8.20% 7.83% 10.89% 11.84% 11.16% 10.50% 10.04%

Gross margin (% cost) 6.66% 8.93% 8.49% 12.22% 13.42% 12.56% 11.73% 11.16%

6. We have considered the facts of the case and submissions made before us. On the basis of the same, the first question which requires decision according to us is-whether, the AO was justified in taking recourse to external comparables when internal comparables were available?

6.1 Briefly, the facts are that the assessee is carrying on the business of providing services for in-bound, out-bound and local travels. The dispute is in regard to in-bound and out-bound travel services. The assessee maintains consolidated accounts. Segmental accounts have not been maintained separately in respect of various kinds of services. However, in respect of both in-bound and out-bound services segmental accounts have been culled out. Thereafter, in respect of each segment, controlled and uncontrolled transactions have been segregated. In so far as in-bound travels are concerned, the assessee had utilized cost plus method to justify the arm’s length value of controlled transactions, comparing them with the value of uncontrolled transactions undertaken by it. However, in respect of out-bound travel services, Resale method has been employed on the ground that no value addition is made in respect of these services. The objection of the AO is that while the assessee has incurred loss, the expenses in respect of in-bound and out-bound travel services have been so arranged as to show that the PLIs are comparable with uncontrolled transactions. In other words, the accounts cannot be segregated as separate books of account have not been maintained. On the other hand, the case of the ld. Counsel is that internal comparables are preferable to external comparables because of difference in business environment. The assessee has utilized a system for maintenance of accounts which is not amenable to manual manipulation and, therefore, the charge of manipulating the accounts is not justified. Having considered these matters, we find that OECD guidelines, reproduced in paragraph no. 4.6 (supra), mention that net margin of the tax payer from the controlled transactions should be established with reference to net margin which the same taxpayer earns in comparable uncontrolled transactions. Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise may serve as a guide. Thus, these guidelines suggest preference for internal comparables and reference has to be made to the results of independent enterprises only when former course of action is not possible. The ld. counsel has also relied on the decision of UCB India Pvt. Ltd. (supra), a copy of which has been placed before us. In this case, the assessee wanted to support the value of controlled transactions by comparing with external comparables. However, it appears that the same could have been compared by having recourse to internal comparables of the parent company, for which the data was not furnished on the ground that the two companies are separate entities. The Tribunal did not find favour with this line of argument, which indirectly leads to a conclusion that internal comparables should be preferred to external comparables. Further, in the case of Birlasoft (India) Ltd. (supra), it has been clearly held that the assessee was justified in undertaking internal comparison on stand alone basis by placing on record working of operative profit margin from international transactions with AEs and transactions with uncontrolled parties undertaken in similar functional and economic scenario. Such internal comparison is valid in all the methods. Therefore, it is held that in the first instance, the attempt should be made to determine arm’s length price of controlled transactions by comparing the same with internal uncontrolled transactions undertaken in same or similar economic scenario. No argument has been made by the ld. DR that economic scenarios of controlled and uncontrolled transactions were different. Therefore, it is held that the transfer pricing analysis should have been done by taking recourse to internal uncontrolled transactions.

6.2 The second question is-whether, the method employed by the assessee should have been accepted by the AO? The case of the ld. DR is that segmental accounts have not been maintained and the TPO has given a clear finding that segmental accounts have been drawn in such a manner as to hide the entity level loss. We find that no particular fact has been mentioned in this regard except that there is a loss incurred by the assessee in the overall transactions. The other arguments of the ld. DR is that separate segmental accounts have not been maintained, which leaves a scope for justifying the transactions on cost plus and re-sale method. Such a situation will not arise if TNMM is used, which means that the profitability of controlled and uncontrolled transactions have to be examined in respect of both the segments. The case of the ld. counsel in this connection is that even under this method, the value of controlled transactions placed by the assessee in the books stands justified. We have tabulated the results in respect of both the segments in paragraph no. 5 (supra) of this order. Having considered these facts and submissions, we are of the view that the assessee has not been able to show, on the basis of FAR analysis, that there are material difference in in-bound and outbound services. However, the profitability in the two segments may be different due to geographical area of the service. Therefore, we are of the view that it will be more appropriate on the facts of this case to compute arm’s length price in respect of two segments separately on TNMM. The figures furnished in the table in paragraph no. 5 have not been vetted by the AO or the ld. CIT(Appeals). In view thereof, the matter is restored to the file of the AO to examine the figures supplied by the assessee and thereafter arrive at the arm’s length price after hearing the assessee.

7. In the result, the appeal is treated as allowed for statistical purposes.

The order was pronounced in the open court on 8 July, 2011.