By TIOL News Service

NEW DELHI, JAN 20, 2016: THE issue is - Whether disallowance of the proportionate interest expenditure u/s 14A of Act can be made when there is no fresh investment towards domestic companies. NO is the answer.

Facts of the case

The assessee is a pharmaceutical company, who manufactures pharmaceutical products, over-the-counter drugs and nutraceuticals. It filed return for relevant AY. The assessee claimed deduction in respect of research and development expenses incurred at New Mangalore and KRS Gardens research centre. During assessment process, AO made disallowance for excess deduction claimed u/s 35(2AB) of the Act on the ground that recognition u/s 35(2AB) from the DSIR ( Department of Scientific and Industrial Research) had been received after end of the AY and that agreement as contemplated by section 35(2AB) had not been entered into. Aggrieved assessee filed appeal to CIT(A), who confirmed the order of AO. Assessee filed appeal before Tribunal and submitted that deduction could not be denied merely because approval was granted by the competent authority at a later date. During assessment process, AO noted that the assessee had invested into shares of India Company. The assessee explained that no borrowed capital was used for purpose of investment in such shares but AO was not satisfied and he disallowed the proportionate interest expenditure u/s 14A of Act. Matter reached to the Tribunal, where counsel of assessee submitted that similar issue came up before the Tribunal wherein it had been held that no disallowance of interest was required. Being aggrieved, the assessee contested the matter before the CIT(A), wherein relying upon his earlier order for some AY, CIT(A) confirmed part disallowance of the proportionate interest. Being aggrieved, the assessee contested appeal before the Tribunal on this issue. During the assessment proceedings it was observed by AO that assessee had invested into shares of subsidiary companies/joint venture companies and overseas companies out of borrowed funds. It was explained by the assessee that investment was made for the purposes of the business of the assessee, and it was made out of capital and free reserves of the assessee, and that part of such investment was made out of exports proceeds kept in EEFC account and hence no disallowance was warranted. But the AO was not satisfied with the submissions of the AO and he disallowed the interest. Being aggrieved, the assessee contested the matter before CIT(A), who granted relief to the assessee u/s 57(iii) of the Act, but rejected the claim of the assessee u/s 36(1)(iii) of the Act. Revenue filed appeal before Tribunal.

In the relevant year, the assessee exported pharmaceutical products manufactured by it to its AE i.e. M/s Strides Inc., USA, and compared it with sales made by it to unrelated party i.e. Cellopharm, Brazil, to demonstrate that transactions with AE was at ALP. The difference pertaining to profit margin earned form sales made to AE and Cellopharm was explained based on certain factors which were narrated in details in the transfer pricing documentation. However the TPO used the same comparable for making an upward adjustment in respect of exports sales made by it to its AE. Being aggrieved, the assessee carried the matter before the CIT(A) wherein detailed submissions were made by the assessee showing that the adjustment was uncalled for as per law and facts and detailed analysis were made to counter action of the AO/TPO. The CIT(A) held that price charged by the assessee company to its AE was reasonable and thus, there was no transfer of profit, and therefore, there was no requirement of upward revision and therefore, addition made by the AO/TPO was deleted. Being aggrieved, the Revenue contested this matter before Tribunal.

After hearing parties, Tribunal held that,

++ the delay, in the given facts, cannot be attributed to the assessee. In fact, the assessee had no say in this regard. It is further noted by us that the approval has been granted by the competent authority after taking the application of the assessee as a base. In our considered view, under these circumstances, the approval would relate back to the date of the application. In other words, under these circumstances, it can be taken as if the approval was granted on 28.03.2001 i.e. the date of application made by the assessee. Thus, in our view, the grievance raised by the Revenue on this issue is not sustainable. It is further noted by us that this issue is no more res-integra. We can take help of judgment of Delhi High Court in the case of CIT vs. Sandan Vikas (India), wherein their lordships have held, following the judgments of Gujarat High Court in the case of CIT vs. Claris Lifesciences Ltd., that assessee would be eligible for deduction even if the approval is granted by the competent authority subsequent to the expiry of the previous year;

++ thus, taking into accounts all the facts and circumstances of the case as well as aforesaid judgments, we find that the assessee is eligible for deduction u/s 35(2AB) and the same was wrongly denied to the assessee, and therefore, we direct the AO to grant the benefit of deduction u/s 35(2AB). Ground no.1 of the assessee's appeal is allowed;

++ it has been submitted that in this year no fresh investment has been made. Our attention has been drawn on investment schedule of the balance sheet available at pages 22 to 23 of the paper book. It is noted from the perusal of the said schedule that there is no fresh investment towards investment of domestic companies. Only one entry is appearing in the name of addition of shares of BDH Industries Ltd. for an amount of Rs. 2,25,220/-. It has been brought to our notice that during the year, the assessee has acquired shares of this company at book value on account of amalgamation of Bombay Drugs & Pharma Ltd. into itself. It is further brought to our notice that no cash outflow was required for acquiring these shares. Thus, in fact no amount has been invested for making any fresh investment during the year. Thus, the facts remain identical to the assessment year 2001-02, and therefore, the benefit of decision taken by the Tribunal in aforesaid year shall also be available in the impugned year. Therefore, respectfully following the judgment of the Tribunal in A.Y. 2001-02, we allow Ground no.2 of assessee's appeal, deleting the disallowance made by the AO in toto;

++ before us, it has been submitted by the Ld. Counsel that assessee would be satisfied if claim is allowed u/s 57(iii). We find force in the alternative submissions of the Ld. Counsel. Ld. CIT(A) has rightly allowed the claim u/s 57 of the Act, therefore, we uphold the order of Ld. CIT(A) on this ground and therefore, ground nos. 1 & 2 of Revenue's appeal are dismissed;

++ it is noted by us that Ld. CIT-DR is factually correct in submitting that CIT(A) has deleted the addition without following the correct approach. The issues with regard to transfer pricing adjustment have to be resolved following a mechanism and complying with the provisions as contained in chaper X, dealing with the transfer pricing issues as contained in sections 92-92F and connected rules as contained in Rules 10A,10B,10C,10D and 10E of Income Tax Rules 1962. These sections and rules prescribe various methods that may be employed to establish arm's length price, explaining applicability of each method, the documentation required to be maintained and form of the certificate to be issued by auditors in this regard. These regulations provide that any income arising from the international transactions shall be determined having regard to the arm's length price. This issue has now been decided in various courts that where international transactions are involved with AE, then arm's length price has to be determined in line with the aforesaid provisions. It is noted by us that CIT(A) has decided this issue without taking into account the effect of these provisions. Therefore, in our considered view, this issue needs to be sent back. On the other hand, the assessee has also made a grievance that the TPO has not made proper analyses while bench marking the transactions to compute arm's length price. It has been further suggested that TNMM method will be most appropriate method. No objection has been raised by the CIT-DR, in this regard. Therefore, keeping in view all the facts and circumstances of this case, we deem it appropriate to send this issue back to the file of the TPO who shall carry out afresh search and make fresh analysis and shall also keep in view the aforesaid objections raised by the assessee.

(See 2016-TIOL-125-ITAT-MUM)