Analysis of ITAT Ruling: Section 14A Disallowance and Transfer Pricing Comparables (AY 2010-11)

“6. Disallowance of transmission and up-linking charges u/ s 40(a)(i) amounting to Rs. 7,81,23,855/-

Assessee had paid the above amount to Intelsat Corporation, a company incorporated in USA for using transponder capacity, to make the signals available for the cable operators. The AO has disallowed this sum because no TDS was made. Assessee has contended that in the case of Intelsat Corporation, the Hon’ble High Court of Delhi vide order dated 28.09.2012 has held that no tax was payable by the company on account of the revenue of transmission and up-linking facilities. In view of this, there is no question of TDS on the amounts payable to Intelsat Corporation. DRP has considered the argument of the assessee. In view of the binding decision coming from jurisdiction Delhi High Court, the contention of the assessee is accepted. The AO is directed to drop the proposed disallowance.”

59. Before us the ld DR relied upon the draft assessment order whereas the ld AR vehemently submitted that the issue is squarely covered by the decision of Hon’ble Delhi High Court in case of Intelsat Corporation dated 28.09.2012. He therefore stated that there is no error in the order of the ld DRP.

60. We have carefully considered the rival contentions and also perused the facts of the case as well as the decision of the Hon’ble Delhi High Court. We are convinced with the argument of the ld AR that the issue is squarely covered by the decision of Hon’ble jurisdictional high court. The ld DR could not controvert that how this issue is not squarely covered in favour of the assessee and he also could not show us any other judicial precedent so as to persuade us to disagree with the views of the ld DRP. Further merely because the revenue has filed an SLP before the hon’ble Supreme Court against the decision of Delhi High Court cannot be a reason for sustaining the disallowance. In view of this we do not find any infirmity in the direction of the ld DRP in directing the ld Assessing Officer to delete the disallowance transmission and up linking charges paid to Intelsat Corporation USA of Rs. 78123855/- In the result the ground No. 2 of the appeal of the Revenue is dismissed. ”

“61. Ground No. 3 of the appeal of the Revenue is against direction of the ld DRP to delete the disallowance of Rs. 8245612/- on account of software expenses. During the year the assessee has incurred expenditure of Rs.32435619/- on software expenses and claimed the same as revenue expenditure. The ld Assessing Officer was of the view that it is capital in nature and therefore depreciation @60% thereon is allowable and not the whole expenditure. After considering the submission of the assessee ld Assessing Officer held that computer software expenses to the extent of Rs. 20614030/-shown by the assessee is disallowable as it is capital expenditure. Therefore he allow depreciation @60% on Rs. 20614030/- amounting to Rs. 12368618/- and thus disallowed a sum of Rs. 8245612/-. The Assessing Officer was of the view that assessee has purchased accounting software and its upgradation and also on software such as google earth, pro Microsoft server calls are purchased which gives the assessee an advantage of enduring nature. The assessee aggrieved with the order of the ld Assessing Officer preferred objection before the ld DRP who directed the ld Assessing Officer delete the above disallowance vide para No. 8 of its order as under:—

‘8. Disallowance of software expenses amounting to Rs. 82,45,612/-

The assessee regularly purchases softwares which are used for its programming purposes. The AO has treated it as capital expenditure. This issue was litigated in the earlier years and Commissioner of Income Tax(Appeals) has made the following observation on the same issue for the AY2007-08 which is reproduced below:

“From the submission of the appellant it is clear that the appellant has capitalized certain software purchases on its own. The up-grcidci1ion of software’ and under the head ‘other software1 were treated as capital in nature by the AO and depreciation at the rate of 60% was allowed by him. However, on going through the details, it is noticed that these software need regular up-gradation or change as per the requirements of fast changing broadcasting industry. The life of these software are for a shorter period and therefore it cannot be said the same is providing enduring benefit to the appellant. For the AY 200607 also, my predecessor CIT(A)-XVI has allowed such expenditure as revenue expenditure in para 3.2 of the appeal order dated 30.09.2011 in appeal no. 228/08-09. The nature of software purchased and the business of the appellant for which the software so purchased were applied remains the same. In view of this, the expenditure under the head upgradation of software and other software amounting to Rs. 2,07,009/- and 5,58,006/- respectively is held as allowable deduction during the year. AO is directed to delete the addition made in this regard. ”

Therefore, DRP is also of the view that these expenditures are revenue in nature and hence allowable. AO is directed not to make this addition in assessment order. Objection 1 is treated as disposed off.”

62. The ld DR relied upon the order of the ld Assessing Officer whereas the ld AR relied upon the orders of the ld DRP.

63. We have carefully considered the rival contentions. The assessee has been allowed the identical claim in earlier years by the Id CIT(A) and based on that decision the Id DRP was also of the view that the above expenditure incurred by the assessee is revenue in nature. The Id DR could not controvert that why the order of the Id DRP is erroneous. In view of this we do not find any infirmity in the direction issued by the Id DRP. In the result we confirm the direction of the DRP. In view of this ground No. 3 of the appeal of the revenue is dismissed.”

“2. Learned counsel for the assessee appearing on advance notice, on the other hand, urges that there is no infirmity with the approach of the Income-tax Appellate Tribunal and that this Court had on July 12, 2016 given reasons for not entertaining the appeal which was not dismissed merely on the ground of delay. The previous order of the Court records inter alia as follows :

“7. As far as this issue is concerned, it is pointed out by the learned counsel for the assessee that the issue stands covered in favour of the assessee and against the Revenue by the order of this Court dated August 18, 2015 in I.T.A. No. 107 of 2015 (CIT v. Lemon Tree Hotels Ltd.). The Court had affirmed the order of the Income-tax Appellate Tribunal deciding the issue in favour of the assessee in the said case where the addition made by the Assessing Officer by way of disallowance of the expenses debited as cost of ESOP in profit and loss account was deleted by the Income-tax Appellate Tribunal.

8. In the present case, the Income-tax Appellate Tribunal has by the impugned order restored the matter to the file of the Assessing Officer for re-adjudication. The impugned order of the Income-tax Appellate Tribunal is consistent with what has been held by this Court in Lemon Tree Hotels (supra). Consequently, no substantial question of law arises as far as this issue is concerned.”

3. In Lemon Tree Hotels Ltd. (supra) (referred to by the previous order), the court had relied upon a ruling of the Division Bench of the Madras High Court in CIT v. PVP Ventures Ltd. In PVP Ventures Ltd. (supra), the Madras High Court, after considering the SEBI’s claim held as follows (page 314 of 1 ITR-OL) :

“As regards the second issue which is now canvassed before this Court, viz., On the issue of expenditure of Rs. 66.82 lakhs towards the issue of shares to the employees stock option is concerned, the Tribunal pointed out that the shares were issued to the employees only for the interest of the business of the assessee to induce employees to work in the best interest of the assessee. The allotment of shares was done by the assessee in strict compliance with SEBI regulations, which mandate that the difference between the market prices and the price at which the option is exercised by the employees is to be debited to the profit and loss . . . the Tribunal in its order stated that it was a benefit conferred on the employee. So far as the company is concerned, once the option was given and exercised by the employee, the liability in this behalf got ascertained. This was recognised by the SEBI and the entire employees stock option plan was governed by the guidelines issued by the SEBI. On the facts thus found, the Tribunal held that it was not a case of contingent liability depending on the various factors on which the assessee had no control. The expenditure in this behalf was an ascertained liability, thus the expenditure incurred being on lines of the SEBI Guidelines, there could be no interference in the relief granted by the assessing authority for the expenditure arising on account of the employees’ stock option plan. This expenditure incurred as per the SEBI Guidelines and granted by the Officer could not be considered as erroneous one calling for the exercise of jurisdiction under section 263 of the Act.” 4. The Special Bench ruling in Biocon Ltd. (supra) considered the matter rather elaborately and also examined all the previous decisions. It scrutinised different accounts of ESOPs and the points of time when they could have vested. The observations of the Special Bench in this regard, inter alia, are as follows (page 623 of 25 ITR (Trib)) :

“When we consider the facts of the present case in the backdrop of the ratio laid down by the Hon’ble Supreme Court in Bharat Earth Movers v. CIT [2000] 245 ITR 428 and Rotork Controls India (P.) Ltd. v. CIT [2009] 314 ITR 62 (SC) , it becomes vivid that the mandate of these cases is applicable with full force to the deductibility of the discount on incurring of liability on the rendition of service by the employees. The factum of the employees becoming entitled to exercise options at the end of the vesting period and it is only then that the actual amount of discount would be determined, is akin to the quantification of the precise liability taking place at a future date, thereby not disturbing the otherwise liability which stood incurred at the end of the each year on availing of the services.

As regards the contention of the learned Departmental representative about the contingent liability arising on account of the options lapsing during the vesting period or the employees not choosing to exercise the option, we find that normally it is provided in the schemes of ESOP that the vested options that lapse due to non-exercise and/or unvested options that get cancelled due to resignation of the employees or otherwise, would be available for grant at a future date or would be available for being re-granted at a future date. If we consider it at micro level qua each individual employee, it may sound contingent, but if view it at macro level qua the group of employees as a whole, it loses the tag of ‘contingent’ because such lapsing options are up for grabs to the other eligible employees. In any case, if some of the options remain unvested or are not exercised, the Page | 11 discount hitherto claimed as deduction is required to be reversed and offered for taxation in such later year. We, therefore, hold that the discount in relation to options vesting during the year cannot be held as a contingent liability.

C. Fringe Benefit

. . . Act 2005, with effect from April 1, 2006. Memorandum explaining the provisions of the Finance Bill, 2005 highlights the details of the fringe benefits tax. It provides that : ‘Fringe benefits as outlined in section 115WB, mean any privilege, service, facility or amenity directly or indirectly provided by an employer to his employees (including former employees) by reason of their employment’. Charging section 115WA of this Chapter provides that : ‘In addition to the Income-tax charged under this Act, there shall be charged for every assessment year . . .’fringe benefit tax in respect of fringe benefits provided or deemed to have been provided by an employee to his employees during the previous year’. Section 115WB gives meaning to the expression ‘fringe benefits’. Sub-section (1) provides that for the purposes of this Chapter, ‘fringe benefits’ means any consideration for employment as provided under clauses (a) to (d). Clause (d), which is relevant for our purpose, states that: ‘any specified security or sweat equity shares allotted or transferred, directly or indirectly, by the employer free of cost or at concessional rate to his employees (including former employee or employees)’ shall be taken as fringe benefit. The Explanation to this clause clarifies that for the purposes of this clause,—(i) ‘specified security’ means the securities as defined in clause (h) of section 2 of the Securities Contracts (Regulation) Act, 1956 (42 of 1956) and, where employees’ stock option has been granted under any plan or scheme thereof, includes the securities offered under such plan or scheme. Thus it is discernible from the above provisions of the Act that the Legislature itself contemplates the discount on premium under ESOP as a benefit provided by the employer to its employees during the course of service. If the Legislature considers such discounted premium to the employees as a fringe benefit or ‘any consideration for employment’, it is not open to argue contrary. Once it is held as a consideration for employment, the natural corollary which follows is that such discount (i) is an expenditure; (ii) such expenditure is on account of an ascertained (not contingent) liability; and (iii) it cannot be treated as a short capital receipt. In view of the foregoing discussion, we are of the considered opinion that discount on shares under the ESOP is an allowable deduction.

II. If yes, then when and how much ?

Having seen that the discount under ESOP is a deductible expenditure under section 37(1), the next question is that ‘when’ and for ‘how much’ amount should the deduction be granted ?

The assessee is a limited company and hence it is obliged to maintain its accounts on mercantile basis. Under such system of accounting, an item of income becomes taxable when a right to receive it is finally acquired notwithstanding the fact that when such income is actually received. Even if such income is actually received in a later year, its taxability would not be evaded for the year in which right to receive was finally acquired. In the same manner, an expense becomes deductible when liability to pay arises irrespective of its actual discharge. The incurring of liability and the resultant deduction cannot be marred by mere reason of some difficulty in proper quantification of such liability at that stage. The very point of incurring the liability enables the assessee to claim deduction under mercantile system of accounting. We have noticed the mandate of the Hon’ble Supreme Court in Bharat Earth Movers [2000] 245 ITR 428 that if a business liability has definitely arisen in an accounting year, then the deduction should be allowed in that year itself notwithstanding the fact that such liability is incapable of proper quantification at that stage and is dischargeable at a future date. It follows that the deduction for an expense is allowable on incurring of liability and the same cannot be disturbed simply because of some difficulty in the proper quantification. A line of distinction needs to be drawn between a situation in which a liability is not incurred and a situation in which the liability is incurred but its quantification is not possible at the material time. Whereas in the first case, there cannot be any question of allowing deduction, in the second case, deduction has to be allowed for a sum determined on some rational basis representing the amount of liability incurred.” 5. Having regard to the above discussion, especially that the previous order dated July 12, 2016 in ITA No. 366 of 2016 had considered the same items of expenditure, under section 34, we are of the opinion that no question of law arises. The appeal is accordingly dismissed. ”

“8. On going through the records and also the submissions made by the assessee it is found that the APITCO provides numerous services which are not provided by the assessee, the assessee is not involved in to skill development entrepreneurship development and training, research studies, asset reconstruction and management Services. Energy Related Service, Tourism Infrastructure Development and Environmental Management. Further, by going through the financial statement of the company for the Financial Year 201112. it is found that the APITCO is held by public share holder whereas the assessee is held by Private Limited Company. Services description suggests that APITCO works predominantly on government initiative project. Thus, the ratio laid down in the following judgments suggests that the APITCO cannot be a good comparable.

It is submitted that the assessee is providing only simple support services whereas the services provided by APITCO Ltd., are very diverse and high-end ones rendering APITCO Ltd., non-comparable with the assessee.

“43. In our view, the aforesaid approach would not be apposite. In so far as identifying comparable transactions/entities is concerned, the same would not differ irrespective of the transfer pricing method adopted. In other words, the comparable transactions/entities must be selected on the basis of similarity with the controlled transaction entity. Comparability of controlled and uncontrolled transactions has to be judged, inter alia, with reference to comparability factors as indicated under rule 10B(2) of the Income Tax Rules, 1962. Comparability analysis by the transactional net margin method may be less sensitive to certain dissimilarities between the tested party and the comparables. However, that cannot be the consideration for diluting the standards of selecting comparable transactions/entities. A higher product and functional similarity would strengthen the efficacy of the method in ascertaining a reliable arm’s length price. Therefore, as far as possible, the comparables must be selected keeping in view the comparability factors as specified. Wide deviations in profit level indicator must trigger further investigations/analysis.

44. Consideration for a transaction would functions performed, the significant activities the assets or resources used/consumed, assumed. Thus, comparison of activities /functions performed is important for determining the comparability between controlled and uncontrolled transactions/entity. It would not be apposite to ignore functional dissimilarity only for the reasons that its impact may be reduced on account of using arithmetical mean of the profit level indicator.”

“The Ld. AR submitted at the outset that the question proposed for consideration and decision before this special bench does not arise in the present appeal. He submitted that the assessee only gave an undertaking and not a corporate guarantee for the Bonds issued by its Associated Enterprise. To fortify the point, he referred to certain clauses of the Agreement. This was opposed by the Ld. DR.

c. BECAUSE the net effect of first the Regular Bench making a reference to the Special Bench and then Special Bench by way of the impugned order dated 23.08.2017 is that the Revenue would never get to argue the matter on merits and would be precluded from placing and referring to the material on record to demonstrate as to how in the facts of the present case. Corporate guarantee provided by the Assessee though couched on an “undertaking” wat an international transaction warranting transfer pricing adjustment as per provisions of Chapter X of the Act. In this regard, it is pertinent to point out that after the passing of Order dated 23.08.2017, the Regular Bench would be bound by the order of the Special Bench and would never go into the peculiar facts of the Present case, on merits.”

“VII. THAT, the Hon’ble High Court ought to have appreciated that the learned Special Bench had rendered certain findings which were not correct and therefore, the Department had filed the Writ Petition for getting the findings corrected However, in the absence of suitable clarification by the Hon’ble High Court, the learned Division Bench of the ITAT may get swayed/impacted by the observations/findings of the Special Bench and in the said event, the case of the Department may get prejudiced.”

“9 . Mr. Jolly, learned senior counsel, who appeared for the appellant principally contended that once the Special Bench of the Tribunal had come to hold that the transaction was not a corporate guarantee, there was clearly no occasion or justification for the matter being remanded to the TPO. According to Mr. Jolly, the nature of the international transaction having already been ruled upon, there was no uccasion for the mater being remitted and it was tho incumbent upon the Tribunal itself to examine the issue

10. Mr. Rai, learned counsel appearing for the respondents however, draws our attention to the conclusions which were ultimately rendered by the Special Bench and which had held that while the transaction did not answer the attributes of a corporate guarantee, it was liable to be viewed as the incurring of an obligation by giving an undertaking. Whether the incurring of an obligation by giving an undertaking would amount to an international transaction, as envisaged under Section 928 of the Act, according to Mr. Rai, is an issue which would necessarily have to be examined and evaluated by the TPO.

11. However, and as we view Para 63 of the order of the Tribunal, we find that the same does not render any clarity on this aspect. A bare reading of Para 63 indicates that the Tribunal’s terms of remit are couched in extremely broad terms and evidently fail to clarify that the solitary question which remained for consideration was whether the obligation incurred by giving on undertaking would amount to an international transaction and if the answer to the above be in the affirmative the consequential transfer pricing adjustments that may be warranted.

12. While it was suggested by Mr. Jolly that in view of the above, the matter may be examined by the Tribunal itself, we find that the same may not be the appropriate or prudent process to adopt since the authorities below would in the first instance have to firstly examine and render a finding as to whether the obligation which the Special Bench spoke of amounts to an international transaction.

13. In our considered opinion, therefore, the end of justice would merit that the matter being remanded to the AO with the clarification that the remit shall be confined to examining whether the undertaking of the obligation in question amounts to an international transaction, to he answered first and at the outset. The aforesaid question would have to be examined and considered by the AO after giving an opportunity to the appellant.

14. Mr. Rai, learned counsel representing the respondents, submits that the AO would, in light of the direction framed by the Court, undertake such an exercise and only once it comes to a conclusion that the obligation amounts to an international transaction, consider transmitting the matter to the TPO. The statement so made is recorded and accepted.

15. We, consequently, and for the aforesaid reasons, set aside the order of the Tribunal to the aforesaid extent. The appeal shall stand disposed of in terms of the directions referred to above, All rights and contentions of respective parties on merits are kept open.

16. While parting with this appeal we were informed that in the absence of any order of restraint operating on this appeal, the AO had in fact transmitted the matter for the consideration of the TPO for examining whether the transaction would foll within the ambit of Section 928 of the Act and that pursuant to the above, and acting in terms of the directions framed by the Tribunal, a final order came to be passed by the TPO which led to the drawl of a draft assessment order by the AO.

17. We had in terms of order of 11 Jamary 2022 provided that the aforesaid exercise would abide by the final result on the instant appeal. Since we have set aside the principal direction of remit framed by the Tribunal and a de novo exercise in liable to be undertaken by the AO. the order of the TPO as well as the draft assessment order, shall also consequently stand set aside.”