The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has held that the omission of related-party expenditure covered by Section 40A(2)(b) from the scope of “specified domestic transactions” under Section 92BA of the Income Tax Act operates prospectively from Assessment Year 2017-18.
The bench of Satbeer Singh Godara (Judicial Member) and Manish Agarwal (Accountant Member) refused to invalidate a transfer-pricing adjustment of ₹5.12 crore made in relation to transactions undertaken during Assessment Year 2013-14. It, however, granted substantial relief on the merits by directing the Transfer Pricing Officer (TPO) to reconsider the adjustment after changing the set of comparable companies.
The bench directed a fresh computation of the disallowance under Section 14A and allowed the deduction of ₹34.61 lakh incurred on an abandoned proposal to manufacture and market LED lights.
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The assessee was engaged in manufacturing audio-visual electronic products in India. During the relevant financial year, it entered into transactions involving the purchase of goods and payment of job charges, rent and other expenditure to persons covered by Section 40A(2)(b).
At the relevant time, such transactions fell within the scope of specified domestic transactions under Chapter X of the Income Tax Act.
The assessee selected the Transactional Net Margin Method to demonstrate that its transactions were undertaken at arm’s length. It declared an operating-profit-to-sales margin of 1.65%.
The TPO rejected the assessee’s benchmarking analysis and determined an average operating margin of 4.70%. On that basis, an upward transfer-pricing adjustment of ₹5,12,70,379 was proposed.
The Dispute Resolution Panel affirmed the adjustment through directions issued on July 31, 2017. The Assessing Officer subsequently incorporated the adjustment in the final assessment order dated August 28, 2017.
Before the ITAT, the assessee raised an additional legal ground challenging the validity of the entire transfer-pricing exercise.
It argued that the Finance Act, 2017 had omitted clause (i) of Section 92BA, which brought expenditure incurred in transactions with persons specified under Section 40A(2)(b) within the transfer-pricing regime.
According to the assessee, the effect of the omission was that the provision had to be treated as though it had never existed. It was therefore contended that the reference to the TPO and the resulting transfer-pricing adjustment could not survive even for earlier assessment years.
Reliance was placed on the Karnataka High Court’s judgment in Principal Commissioner of Income Tax v. Texport Overseas Private Limited. In that case, the High Court held that the omission of Section 92BA(i), in the absence of an applicable saving clause, rendered the earlier transfer-pricing proceedings unsustainable.
The assessee also relied on the Supreme Court’s decision in Kolhapur Canesugar Works Limited v. Union of India concerning the consequences of the unconditional omission or repeal of a statutory provision.
The Income Tax Department accepted that clause (i) of Section 92BA had been omitted but opposed its retrospective application.
The Revenue referred to the explanatory memorandum accompanying the Finance Act, 2017 and CBDT Circular No. 2 of 2018. Both clarified that the amendment would take effect from April 1, 2017 and apply from Assessment Year 2017-18 onwards.
It argued that the legislature had expressly stipulated the date from which the amendment would operate. The omission, therefore, could not be extended to Assessment Year 2013-14 by treating it as retrospective.
The Department also relied on the principles governing the strict interpretation of taxation statutes, including the Supreme Court’s rulings in Commissioner of Customs v. Dilip Kumar and Company and Director of Income Tax v. American Express Bank Limited.
The ITAT accepted the Revenue’s interpretation and held that the statutory amendment did not cover Assessment Year 2013-14.
The Bench observed that Parliament had expressly made the omission applicable from April 1, 2017, corresponding to Assessment Year 2017-18 and subsequent years. The amendment could not, therefore, invalidate proceedings relating to earlier assessment years up to Assessment Year 2016-17.
Distinguishing the Supreme Court’s ruling in Kolhapur Canesugar Works, the Tribunal observed that the legislature had made the prospective operation of the present omission explicitly clear.
The ITAT also declined to treat the Karnataka High Court’s judgment in Texport Overseas as binding on the Delhi Tribunal. Referring to the Bombay High Court’s ruling in CIT v. Thane Electricity Supply Company Limited, the Bench said that a High Court judgment is binding on courts and tribunals falling within its territorial jurisdiction. Outside that jurisdiction, it ordinarily has persuasive value.
The Tribunal further observed that the strict principles governing the interpretation of tax statutes had not been discussed in the judicial precedents cited by the assessee.
It accordingly rejected the assessee’s request to quash the assessment and the transfer-pricing adjustment on the ground that Section 92BA(i) had subsequently been omitted.
The ITAT concluded that the assessment and transfer-pricing proceedings concerning specified domestic transactions did not suffer from any legal defect.
Although it upheld the legal validity of the transfer-pricing proceedings, the Tribunal granted relief to the assessee on the selection of comparable companies.
The assessee contended that Asia Electronics Limited and Blue Star Limited had been wrongly excluded from the final set of comparables.
Asia Electronics was rejected by the lower authorities because its net worth had declined from year to year due to accumulated losses. The Tribunal held that a company could not be excluded merely because it had accumulated losses or earned abnormal profits.
Relying on the Delhi High Court’s judgment in Chryscapital Investment Advisors (India) Private Limited v. Deputy Commissioner of Income Tax, the ITAT observed that Rule 10B contemplates making suitable adjustments when differences exist. Such differences do not automatically justify the outright rejection of an otherwise comparable company.
In the case of Blue Star, the authorities had objected to its inclusion because the company operated in different business segments and separate segmental information was allegedly unavailable.
The assessee pointed out that Blue Star’s electronics and mechanical projects, packaged air-conditioning systems, cooling products and professional electronics segments involved manufacturing activities comparable to its operations.
Accepting the assessee’s submissions in principle, the Tribunal directed the TPO to include Asia Electronics and Blue Star while carrying out the consequential computation.
The assessee also challenged the inclusion of Mold-Tek Packaging Limited and National Plastic Technologies Limited.
It argued that these companies were functionally different because they were engaged in manufacturing plastic containers, PET bottles, blow-moulded products and other plastic goods for consumers.
The Tribunal found merit in this objection. It held that the Revenue could not justify retaining these two entities as comparables when their business activities were materially different from the assessee’s electronic-product manufacturing operations.
The TPO was consequently directed to exclude Mold-Tek Packaging and National Plastic Technologies from the comparable set.
The ₹5.12 crore adjustment was thus not deleted outright. Its amount will have to be recomputed after including Asia Electronics and Blue Star and excluding Mold-Tek Packaging and National Plastic Technologies.
The second issue concerned a disallowance of ₹3,17,289 under Section 14A read with Rule 8D.
The assessee had earned exempt income of ₹11,10,545 from its associated company, My Box Technology Private Limited. It voluntarily disallowed ₹55,585, representing 5% of the exempt income, towards administrative expenditure connected with earning that income.
The assessee argued that the tax authorities had mechanically invoked Rule 8D without recording the satisfaction required under Section 14A(2) after examining its books of account.
The Tribunal rejected this legal objection, observing that the assessee had failed to justify the basis for estimating its expenditure at 5% of the exempt income during the proceedings before the lower authorities.
However, the ITAT found that it was unclear whether the authorities had restricted the computation to investments that actually yielded exempt dividend income.
Relying on the Delhi High Court’s judgment in ACB India Limited v. Assistant Commissioner of Income Tax, the Tribunal directed the Assessing Officer to recompute the disallowance after considering only the relevant dividend-yielding investments.
The final dispute related to the disallowance of ₹34,61,300 described as preliminary expenditure.
The assessee, which manufactured electronic appliances such as washing machines and set-top boxes, had held discussions with the Life Science Group for jointly manufacturing and marketing LED lights in India.
It incurred expenditure while exploring the proposed venture, but the project did not ultimately materialise.
The Assessing Officer disallowed the amount on the ground that it was not connected with the assessee’s regular business or the expansion of its existing business.
The ITAT disagreed with this conclusion. It observed that the expenditure was incurred while exploring the possibility of establishing a business project that was eventually abandoned.
Following the Delhi High Court’s judgment in Indo Rama Synthetics India Limited v. Commissioner of Income Tax, the Tribunal held that expenditure incurred on an abandoned business proposal was allowable as revenue expenditure in the circumstances of the case.
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