Change in Pricing policy vis-a-vis no change in FAR - Impact + Need-benefit for Reimbursement of expenses - Mumbai Tribunal in case of Sony Pictures Netwroks India Private Limited

Background 

Recently, the Mumbai tribunal has pronounced a judgement in case of Sony Pictures Networks India Private Limited. 

A copy of aforesaid judgement can be accessed by clicking link here.

The judgement specially inter alia deals with following aspects;

1. Where there is change in pricing policy for a particular transaction - can the transaction can be considered as a simple transaction? 

2. Whether need-evidence-benefit test is required to be fulfilled for reimbursement of cost to cost transactions?

Facts of the case

Revenue Sharing arrangement

• Assessee is engaged in business of commissioning and marketing of sports program and distribution of TV channels. 
• Assessee had a revenue sharing agreement with its Associated Enterprises. 
• For first part of the year, the revenue sharing was 25:75 between Assessee:AE respectively. 
• For second part of the year, the revenue sharing was revised to 14:86 between the Assessee:AE. 
• Accordingly the net effective revenue earned by the Assessee during the year from the said transaction was 19.77% and had remitted 80.23% to the AE.
• For benchmarking purpose, the entire transaction is considered as a single transaction and CUP method was adopted as Most Appropriate Method. For CUP method, similar transaction between the AE and entities located in Nepal and Pakistan was considered whereby the revenue sharing was 15% retained by Nepal and 20% retained by Pakistan entity.
• Basis the aforesaid analysis, the amount retained by the Assessee was considered to be at Arm's Length. 

Reimbursement of expenses

• In addition to above the Assessee had reimbursed certain expenses to the AE which was incurred by the AE on behlaf of the Assessee merely due to administrative convinience.
• Assessee submitted copy of invoices raised by AE as well as Independent third party. 

Before Tranfer Pricing officer (TPO)

TPO held:

For Revenue sharing agreement

• No reason is provided by the Assessee for reduction in the revenue share.
• In the comparable transaction adopted, there is no change in pricing policy during the year
• The comparable transaction of Nepal - had minimum guarantee clause which is absent in the Assessee's agreement with the AE. 

Basis the same, the transaction undertaken for the second part of the year (i.e., 14:86) was considered as a seperate international transaction, and further made adjustment as taking Pakistan's revenue share of 20% as ALP.

For Reimbursement of expenses

• Assessee has not proved whether any benefit was received or not, entire reimbursement was considered as NIL.

Before ITAT

Assessee raised the following arguments;

• Transaction cannot be seggregated only on the basis of period - the TPO has erred in making an distinction on the basis of change in revenue model without there being any change in the FAR.
• The distribution ratio was initially higher in order to capture the market in India. Upon establishing the Indian market and due to substantial increase in cost, revenue and subscribers the revenue sharing ratio was further revised.
• In case of Reimbursement of transactions - these costs are incurred by the AE on behalf of the Appellant and are reimbursed on cost-to-cost basis without any addition of mark-up and relevant supporting have been provided to the TPO.

Decision of the ITAT

For Revenue sharing transaction

• During the entire year - no change in the FAR analysis - but Revenue sharing of the assessee and its AE has substantial changed.
• The claim of assessee that both transaction should be considered as a single transaction as there is no change in the far analysis is devoid of any merit. 
• If there is no change in the FAR - circumstances leading to reduction in revenue share of the assessee is not justified. 
• The comparable transaction provided i.e., 20% retained by Pakistan entity, clearly shows that for second half the transaction is not at Arm's Length
• Both the transactions are separate transactions, and the same cannot be clubbed.

Basis the above discussion, the action of the TPO is upheld and ground raised by Assessee is dismissed.

For Reimbursement of expenses -  As assessee has failed to show any need, benefit of such expenditure incurred, the action of the TPO in making the adjustment is upheld. 

Thoughts

It is interesting to evaluate whether change in pricing policy is justified where there is no change in Functions performed, Assets Utilised and Risk assumed. There may be certain business and commercial rationale for such changes in the pricing policy. It is very much relevant to capture and delinieat the FAR analysis with such business and commercial rationale. 

Further for reimbursement of expenses - apparently the requirement to justify the Need-benefit test can open new avenues for further analysis, which are often overlooked under the veil of 'Cos-to-Cost' reimbursement without any markup. 

Interestingly every case is unique, and has to be decided on its merit. However the above judgement will have certain amount of bearing on similar pricing policy. 

Views are personal. Your views/ comments are invited. 

Intragroup services TP adjustment- Reliance on assessment proceedings of AE - Pune tribunal judgement analysis in case of Benteler automotive India Private Ltd

Background 

Recently, the Pune tribunal has pronounced a judgement in case of Benteler Automotive India Private Limited. 

A copy of aforesaid judgement can be accessed by clicking link here.

The judgement specially deals with adjustment made towards intragroup services availed by Indian entity and impact of assessment in case of non-resident associated enterprises for the Indian  company.

Facts of the case

• Benteler Automotive India Private Limited (BAIPL, Assessee) availed Intra Group Services (IGS) from Benteler Automotive China Investment ltd. (AE).
• Services mainly pertained to Management Support, finance, Human Resources, facility management, etc.
• Assessee aggregated the aforesaid transaction with other international transactions and benchmarked under TNMM

Before Tranfer Pricing officer (TPO)

TPO held that 

• Assessee has not furnished any evidences in relation with services availed.
• No chargeable intra group services were received by Assessee
• Determined the ALP as NIL and entire transaction amount was added back as adjustment amount

Before Dispute Resolution Panel

The extract reproduced from the DRP direction is quite notable as it gives a sense to the dept of scrutiny made by the revenue authorities.

As per the extract of DRP direction it appears that Assessee had already provided copy of invoices, agreement etc. before the revenue authorities. 

The DRP observed that as per the intra company agreement provides for 'maintaining of true and accurate books and records of the cost incurred for providing the services by AE'.

Considering the Assessee failed to furnish the details of cost incurred by the AEs and the financial statements of AE, which forms the basis of fee payable to the AE, no credence could be attributed to the agreements and invoices submitted by the Assessee. Further DRP derived that if the above terms and conditions are followed by the group, services rendered would have been refelcted in the books of accounts of the AE and the same should have been identifiable.

The aforesaid documents were held as mere self serving and cannot be accepted as conclusive documents. Further it can be concluded that no services have actually being rendered by the AE.

Before ITAT

• Assessee initially discussed the copy of invoices, agreement, including the basis of cost allocation, allocation keys, etc.
  
• Futher Assessee discussed copy of order passed by AO in case of AE. As per the order it was worded clearly stating Benteler China had provided various managerial services including the aforesaid types of services, hence the payment received by Benteler China is taxable in India as fees for technical services. 
• Considering above Assessee pleaded that the receipt of services has already being established. And where TNMM is adopted for benchmarking other international transactions, TPO cannot pick one single transaction and benchmark seperately.

ITAT observed that TPO findings specifically mentions that the AE had not provided any chargeable services. 
However once the AO has held that the AE has provided the services, the findings of the TPO on aforesaid basis becomes erroneous. Hence the adjustment stands deleted.

Thoughts

It is quite interesting to see various nuances coming up in dealing with TP adjustment issue of intra group services. For those of interest; IGS issue has seen its ups and downs (i.e. range of judgements starting from no NIL ALP determination, TPO cannot step in shoes of Assessee, need-benefit test not relevant, to Rendition tests mandatory, and recent judgements requiring demonstrating 5 tests (Need, Benefit, Rendition, Shareholder services,duplication test) in recent case of Mondon Investment - Mumbai Tribunal.

I am of the view that each and every case is unique, and has to be decided on its merit. However all the related judgements will have certain amount of bearing on the pending IGS issue. 
Views are personal. Your views/ comments are invited. 

GloBE Rules Series - Blog 1 - Analysis on the "scope of GloBE rules" and its applicability

Introduction

OECD has issued Global Ant-Base Erosion Model Rules (under Pillar Two of BEPS 2.0) (a.k.a GloBE Rules). Further commentary on the Rules along with examples are also provided for better understanding which was released by OECD. 

The Rules issued by the OECD can be accessed by clicking on the link here. 

The commentary to the rules as issued by the OCED can be accessed by clinking on the link here

GloBE Rules mainly refers to Income Inclusion Rule ('IIR') and Under Taxed Payment Rule ('UTPR') out of the BEPS 2.0 - Pillar two framework. The GloBE Rules are introduced with an intention to ensure that MNE(s) pay minimum level of tax on the income arising in each of the jurisdictions in which they operate.

This blog series aim to cover and summarize the GloBE rules while focusing on each part to the reader.  

Current blog article mainly cover the scope of GloBE rules i.e. to understand the trigger points for applicability of the rules in a Multinational Group (MNE).

Scope of GloBE Rules

Plainly speaking if the consolidated revenue of an MNE group is equal to or more than EURO 750 million in at least two out of four Fiscal year immediately preceding to the fiscal year for which the evaluation is to be made (current year).; then GloBE Rules will be applicable to each of the Constituent Entities (generally referred to as group entities) of such MNE group.

Certain points to be noted;

• Current year is excldued and evaluation of the prior four year's turnover is to be made so that the MNE group is aware about the applicability of the GloBE rules at the start of the tested fiscal year itself.
• An Entity is defined (Article 10) to include any legal person, arrangement that prepares separate financial accounts (partnerships, trusts) excluding natural persons.
• The Revenue threshold is kept in line with the revenue threshold for Country-by Country documentation to easily monitor the compliance and reduce incremental compliance cost.

For Computation of revenue threshold, following aspects should be considered. 

• In certain cases consolidated turnover may not be available for last four years. This may happen mainly due to two reasons
• Reason 1 - Group may have been recently created - where no financial statements exists for prior years - In such cases third year of operation will be the first tested year for testing applicability of GLoBE Rules as there would be prior two years to test the revenue threshold. 
• Reason 2 - Where the entities were in earlier years standalone entity which are not required to consolidate, and due to certain acquisition a group is formed in the tested year - In such cases the revenues of standalone entity is to be considered in last four years and summed to examine the threshold of EUR 750 million
• Consolidated Revenue should be the ones as reflected in the consolidated Financial statements and should not be reduced by the amount attributable to minority interest holders.
• Threshold is to be applied on the consolidated revenue and not on the aggregate of each of the revenue of the group entities. (To ensure that revenue derived due to intra-group transactions are eliminated from the revenue threshold test)
• Turnover of the excluded entity (discussed later in this article) are also to be considered for determination of Revenue threshold.
• Where the Fiscal year of a group is other than 12 months; the threshold of EUR 750 million is to be computed for pro-rata basis vis-a-vis the period of operation.

Ultimate Parent Entity

For determination of Ultimate Parent Entity ('UPE'), two tests are prescribed, to be tested in an MNE group;

1. An entity should either directly or indirectly own a 'controlling interest' in another entity. 

2. If an entity passes the above criteria, another criteria is that no other entity should own the controlling interest in the tested entity. 

Simply stated, entity is not considered as UPE of the group if there is another Entity higher in the ownership chain, which requires the tested entity to be consolidated.

For determination of a 'controlling interest' usage of consolidation test is to be undertaken - i.e if an entity is required to consolidate assets, liabilities, income, expenses, cash flows of other entity on line by line item basis as per the Acceptable Financial Accounting Standards ('AFAS'). AFAS are defined in article 10 as IFRS and Generally Accepted Accounting Principles ('GAAP') of various countries involving major geographies of India, USA, UK, etc.

MNE Group includes group entities as well as Permanent Establishments (PEs / Branches)

MNE Group should comprise of two or more entities. 

Globe Rules are applicable to Contituent Entities of an MNE group. Whether two or more entities form a group is determined based on consolidation test (i.e. whether the constituent entities are consolidated in the consolidated financial statements). 

GloBE rules are also applicable to an entity which is not member of any group, but has one or more foreign branches / Permanent Establishment will meet the definition of the group and MNE group. Further the main entity here will be treated as Ultimate Parent entity. Only exception is where the entity has only stateless PE as defined in the Rules, as such PEs are not recognized under the laws of any other jurisdiction.

Further a PE would be treated as a separate constituent entity from the main entity and any other PEs of of such entity. The PE is defined in Article 10, whereby it is based on identification of PE as recognized for taxation purpose.

Financial Year, Financial Statements

A fiscal year is referred to as the annual accounting period of the Ultimate Parent Entity. This reference is in line with the test used in the Country by Country regulations. In case where reporting currency of an entity is other than Euros, for the purpose of computation of revenue threshold, the exchange rate as applicable as on start of the 'tested fiscal year' of the MNE group, should be considered. 

The rules also provide for cases where for computation of the threshold for the previous years and such fiscal years involves a period of other than that of 12 months. Cases may include where the MNE group is newly incorporated in either of the preceding four years, where it was operational for part of the fiscal year in any one of the preceding fiscal year. The rules provide that revenue should be proportionally recalculated. For the purpose of recalculation no specific method is prescribed. However an example is demonstrated in the commentary wherein 'number of months' are used as a method for computing proportionate threshold.

In some cases consolidated financial statements of the group may not be available. This could happen in two situations;

1. In case of newly setup MNE group, consolidated financial statements may not be available for prior four fiscal years immediately preceding the fiscal year for which the applicability of the GloBE rules is to be tested. Hence, irrespective of the revenue in the first two fiscal years, the consolidated turnover for the first two years is to be tested for applicability of the GloBE rules in the third fiscal year. Stated in other words GloBE rules will not apply to newly formed MNE group for the first two years post incorporation irrespective of the revenues crossing more than the set limit of EUR 750 million for both the years. 

2. In case of entities forming the group where standalone entities are not required to be consolidated, where the standalone entities are bought under the common control of the group in the current year. In this situation, Article 6.1.1(b) prescribes that consolidated turnover for the previous years should be computed by adding up the standalone turnover of each of such entity to determine whether the consolidated turnover of the group in the earlier years is equal to or greater than 750 million.

There can be cases whereby MNE groups are not required to prepare Consolidated Financial Statements ('CFS'). This mainly involves an entity having foreign branches which are treated as Permanent establishments and are engaged in cross border transactions. These entities are required to prepare CFS which otherwise are not required by law to prepare such financial statements ('deemed consolidated test'). In such cases the the definition of the Consolidated Financial statements in Article 10 requires preparation of financial statements in accordance with 'Acceptable Accounting Financial standards' ('AFAS'). 

It is notable that in case of a single entity having at least one branch (PEs) / subsidiary in foreign jurisdiction will trigger the applicability of the GloBE rules to the said entity, irrespective of the the fact that the subsidiary / PE does not earn any income.

The commentary also highlights that the scope as formulated is been kept in mind to keep pure domestic companies and smaller groups to remain unaffected.

In case the group consists of Joint Operations (Joint Ventures) and for consolidation purpose only a portion of the assets, liabilities, Income, expenses, cash flows, etc. are included in the Consolidated Financial Statements. In such cases only such portion of assets, liabilities, revenue, etc. shall be taken into consideration for the purpose of GLoBE Rules (eg. the consolidated revenue threshold computaiton) 

Where certain entities are not consolidated due to reasons such as materiality, held for sale, etc. such entities are also considered as part of the MNE group as long it remains under the control of UPE as per Acceptable Financial Accounting Standard. 

Excluded Entities

• GLoBE Rules are applicable to constituent entities, except Excluded entities. 
• Attributes of excluded entities for various computaiton under GloBE rules except for computation of consolidated threshold for applicability of threshold. 
• Excluded entities have no obligations to file returns (under GloBE Rules) and information in relation with such entities are not required to be included in the GloBE information Return. 

Article 1.5 of the GloBE rules lists the Excluded entities which are as follows;

1. Government entity
2. International Organisation
3. Non-Profit Organisation
4. Pension Fund
5. Investment Fund (which is an UPE)
6. Real Estate Investment vehicle (Which is an UPE)

Further excluded entities also include following entities;

Category 1

• Entity in which 95% of the value of the entity is owned by the excluded entities (other than Pension services Entity) either directly / indirectly through chain of excluded entities.

AND

• Operates almost exclusively to hold assets / invest funds for benefit of Excluded Entities; or
• only carries out activities that are ancillary to those carried out by Excluded entities.

Category 2

• Entity in which at least 85% of the value of entity is owned by the excluded entities (other than Pension services Entity)  either directly / indirectly through a chain of excluded entities.

AND

• Substantially all of the income of an entity is excluded dividends / equity gains or loss as per Article 3.2.1.(b) or (c) for the computation of GloBE Income or Loss.

A careful look at the excluded entities and the commentary provided, it appears that the main intention to enlist the excluded entities is to exclude the UPEs who are basically formed merely as an SPVs, etc. Hence GloBE rules may not apply to such UPEs and the applicability of the GloBE rules will pass on to next entity in the ownership chain. 

In some cases, an MNE Group could be formed only of Excluded Entities. For example, an Investment Fund may be required to consolidate the assets, liabilities, income and expenses of separate investment vehicles that it controls. However, if those investment vehicles all meet the above conditions, such MNE Group would be excluded from the GloBE Rules as a whole because the Group would not include any Constituent Entities as per the charging provisions of Chapter 2 or comply with the administrative provisions of the rules. 

Article 1.5.3. provides an five year election where the group want's to consider excluded entity as Constituent Entity, and GloBE Rules shall apply accordingly. 

The Views expressed in this blog are those of the author and do not reflect the official policy or position of any other Agency, employer, organization or company.

TP - Comparable companies issue - Business Process Outsourcing - Tech Mahindra Business Services

Summary

In a recent judgement of the Hon'ble Mumbai ITAT in the case of Tech Mahindra Business Services Limited ('TMBSL'); two Transfer Pricing issues were identified, discussed and concluded;

1. Rejection of Comparable companies selected by TPO which are not functionally comparable
2. Treating of Forex gain on re-stating of outstanding debtors as operating items

The case law can be accessed on the website of the Hon'ble ITAT from here.

Brief facts of the case;

Relevant AY - 2009-10

TMBSL is engaged in the business of providing ITES - call centre operations. TMBSL is a 100% subsidiary of HWP Investment Holding (India) Ltd., and provides voice based customer contact centre services (ITES) to its Associated Enterprises (AEs). 

The Assessee is characterized as a low risk service provider. The benchmarking of the international transaction pertaining to provision of voice based services, was undertaken by the Assessee by adopting Transaction Net Margin Method ('TNMM'); whereby OP/OC ('NCP') was adopted as the Profit Level Indicator ('PLI').

Rejection of Comparable companies selected by TPO which are not functionally comparable:

The Transfer Pricing Officer ('TPO') selected following comparable companies to be added in the list of comparable companies of the Assessee. Further the Hon'ble ITAT has rejected the following comparable companies and held that they are not comparable to the Assessee' s business of providing BPO / Call centre services.

• Accentia Technologies Limited - engaged in medical transcription services
• Acropetal Technologies Limited - providing Engineering design services
• Coral Hubs Limited - engaged in providing data processing services
• Cosmic global limited - engaged in translation business
• Eclerx Limited - engaged in data analytics Knowledge Process Outsourcing ('KPO')
• Genesys International corporation Ltd. - Company is a specialised geospatial  service provider

Hence, due to the reasons mentioned above, the Hon'ble ITAT concluded that the above comparable companies are not comparable to an entity engaged in providing BPO / call center services.

Treating Forex gain on re-statement of outstanding debtors:

The Hon'ble ITAT provided that forex fluctuations on re-statement of outstanding debtors should be considered as operating items. Further, it is also pertinent to note that the ITAT observed that the Assessee had not resorted to any hedging transactions.

Further DR also raised a contention that forex gains / loss in case of comparable companies should also be considered as operating. However, whether the forex gains / loss earned by comparable companies can be evaluated to be as operating or non-operating? Usually it is seen that the companies as a part of the disclosure requirements also disclose various information in relation with Forex Exposure as on year end, Forex movement on financing activity, forward contracts entered into, hedging activities, foreign exchange risk, etc.

All such above details should ideally also be evaluated to consider the whether in case of a specific comparable company, the forex gains / loss can be treated as operating / non-operating and to what extent.

*The Views expressed in this blog are those of the author and do not reflect the official policy or position of any other Agency, employer, organization or company.

  

Transfer of Jurisdiction - 143(2) Notice issued by Previous AO; Assessment Order [143(3)] passed by Current AO - Validity of such order

Summary 

This article is based on a recent judgement in relation with Eversafe Securities Private Limited  (Kolkata Tribunal - ITA 604 / Kol / 2020).

Brief facts of the case are that the Assessee had filed return of Income for AY  2012-13. Assessee received notice u/s. 143(2) of the Income Tax Act, 1961 ('the Act'). from an Assessing Officer ('AO'), who did not had any jurisdiction over the Assessee.

The Assessee objected to the jurisdiction of the said notice; subsequent to which the case was transferred to the Jurisdictional AO. During the Assessment Proceedings the Jurisdictional AO did not issue a separate 143(2) notice, and proceeded to complete the Assessment by passing Assessment Order under section 143(3) of the Act.

Before the Hon'ble Income tax Appellate Tribunal, the Assessee raised ground of appeal in relation with the jurisdiction of the Current AO to frame the Assessment in case where no 143(2) notice was issued by him / her.

The learned Department Counsel, defended and kept very valid points such as dynamic change in jurisdiction,  Curability of notice issued under section 292BB of the Act, etc.

Hon'ble ITAT's Judgement

The Hon'ble ITAT has referred to various case laws through which have through which it derives the following conclusions;

• If the Department's system fails to correctly transfer the return to the jurisdictional AO and transfer the same to a Assessing Officer who has no jurisdiction as per the CBDT's notification,, such mistake cannot confer the jurisdiction on such an Assessing Officer. Jurisdiction can be conferred only by notification u/ s 120(1) and 120(2) of the Act only
• The transfer of files from one previous AO to jurisdictional AO itself establishes that revenue realized that the previous AO did not have any jurisdiction.
• The notice issued by the previous AO under section 143(2) of the Act is without jurisdiction and hence non-est in law
• The Assessment order passed by the Jurisdictional AO under section 143(3) of the Act without issuance of a valid notice u/s. 143(2) is bad in law (reliance on Hotel Blue Moon)
• Section 292BB merely deals with correction of notice and does not intended to cure complete absence of notice.  (Reliance on Supreme court judgement on CIT vs. Laxman Das Khandelwal).

Case laws referred to 

•  Hillman Hosiery Mills Pvt. Ltd., Kolkata vs. D.C.I.T.,Circle-11(1), Kolkata in ITA 2634/KOL/2019 dated 12.01.2021
• K.A.Wires Ltd., Kolkata vs. I.T.O.,Ward-8(3), Kolkata in ITA 1149/KOL/2019 dated 22.01.2020.
• ACIT & Anr. Vs. Hotel Blue Moon: 321ITR 362 (SC)
• CIT vs. Laxman Das Khandelwal reported in [2019] 108 taxmann.com 183 (SC)

*The Views expressed in this blog are those of the author and do not reflect the official policy or position of any other Agency, employer, organization or company.

Depreciation expenses - Can it be excluded while computing operating margin? - Indian Transfer Pricing Perspective

Depreciation and Amortisation expenses - Can the same be excluded while computing operating margin for transfer pricing purpose?

Introduction

Profit Level Indicator

A Profit Level Indicator (‘PLI’) serves as a benchmark while computing arm’s length price in relation with comparing the international transactions carried out with the Associated Enterprises with the comparable companies. Most popular PLIs used are as follows;

• Net Cost-Plus (‘NCP’) Method (where the ratio of operating profits to total cost is considered),
• Net Profit Margin (‘NPM’) Method (Where ratio of operating profits to operating sales are considered),
• Berry Ratio (where operating profits to value added expenses are considered). Berry Ratio is used in cases where an entity incurs substantial pass through costs.

Profit before Depreciation Interest and Tax

There have been various situations where it can be debated that depreciation expenses arising in the profit and loss account should be considered for computing margins as mentioned above or whether a new PLI, where instead of operating profits, Profit Before Depreciation, Interest and tax – ‘PBDIT’ can be used.

‘Operating profits’ referred to in most cases, consists of Profit before Interest and Taxes (PBIT). There are cases where apart from interest and tax portion, other expenses such as CSR, other income, etc.  can also be treated as non-operating and is to be computed based on facts of each case. Apart from above, in case depreciation and amortization expenses are to be excluded from computing profitability; the resultant ratios can be computed as follows;

• Operating Profits (without deducting Depreciation / Amortization) to Operating costs (excluding D/A).
• Operating Profits (excluding D/A) to Operating revenue.

After excluding depreciation, in most cases, operating profits also equals Cash Profits. But this assertion might not be true in all cases.

Case Law Analysis 

‘Excluding depreciation during computation of PLI’ is a debatable issue. However, a glimpse of the following favourable case laws can be looked into; which have decided in Assessee’s favour in order to exclude the depreciation expenses;

• BA Continuum India Pvt. Ltd. (ITA 1154/Hyd/2011)
• Erhardt+Leimer (India) Private Limited (ITA 3298/Ahd/2011 and 2880/Ahd/2012)
• Market Tools Research Pvt. Ltd. (ITA 2066/Hyd/2011)
• Qual core Logic Ltd. (I.T.A. No. 893/Hyd/2011)
• Reuters India Private Limited (ITA 9177/Mum/2010)
• Schefenacker Motherson Ltd. (4459 & 4460/Del/2007)
• Aerzen Machines (India) Pvt. Ltd. (ITA No. 111/AHD/2016)

In all the above judgements, the Hon’ble Income Tax Appellate Tribunal (‘ITAT‘) has ruled that depreciation can be excluded while computing the margin ratios as mentioned above. Following is a mere effort of summarizing the conclusion of the Hon'ble ITAT, justifications, and other essential points to be considered .

Situations wherein depreciation claim can be excluded / ignored

In following situations, the Hon’ble ITAT has held that depreciation can be excluded/ignored while computing the margins;

1. Where the average rate of Depreciation expense are significantly different than the depreciation rate adopted by the comparable companies;
2. Where there exists a difference in the depreciation method adopted by the Assessee as against the comparable companies, (e.g. Assessee has followed Straight Line Method (‘SLM’) and comparable companies have followed ‘WDV’ Method) resulting in a significant difference in the depreciation claim of the Assessee vis-a-vis the Comparable companies.
3. Where the Assessee is in the initial years of operations where the claim of depreciation is higher; in such cases, the claim of depreciation can be ignored to be able to make the company comparable with other companies.
4. Where in a particular year, the Assessee has incurred huge/ substantial / material capital expenditure in relation with fixed Assets / plant and machinery.

However, it would be beneficial for the Assessee where the above claim can be supported by various documentary evidences. The same can include, disclosures in the financial statements, annual reports, Auditor’s report, Management’s message, news article, etc. In the above cases, the Hon’ble ITAT has relied on some of he above mentioned basis for concluding that depreciation is to be excluded.

Justification for excluding / ignoring depreciation

However, justification provided by the Hon’ble ITAT for excluding the depreciation claim for computing Profit level indicator are vital to be considered. The same are summarized as under;

• All facts which impact the financial result of comparable companies should be considered.  Accordingly, reasonable adjustments should be made to eliminate any differences in the financial results of comparable companies.
• From the existing statutory provisions, it is evident that nowhere it is provided that claim of depreciation is must.  "Net profit" used in Rule 10B can be taken to mean commercial profit. There is no formula which would be applicable universally and in all circumstances. "Net profit" used in Rule 10B can be taken to mean commercial profit.
• Where the assessee pleads that profits be taken without deduction of depreciation as depreciation was leading to large differences in margins computed. Also the Assessee demonstrated that depreciations was making huge difference and required suitable adjustment. If as per the revenue, the depreciation claim does not lead to any difference, its exclusion is immaterial. There is no way to dislodge the claim of the taxpayer.
• There is no embargo in the Act against using ratio of cash profits as against the other Operating profits.
• Depreciation has to be considered on actual basis by which the assets of business got depleted between the two dates separated by a year. It cannot be depreciation under Income Tax or companies rules or as per policy of the company. Depreciation, which can have varied basis and is allowed at different rates, is not such an expenditure which must be deducted in all situations. It has no direct connection or bearing on price, cost or profit margin of the international transactions.  (Discussed in Qual Core Judgement, mentioned above)
• There are differences between the Assets employed by the taxpayer and other comparable concerns which is reflected in amount and percentage of depreciation claimed. How this variation and difference could be ignored under TP Regulations. (Discussed in Qual Core Judgement, mentioned above)
• Depreciation is nothing but an annual loss in the cost/value of various capital assets due to causes like age–use of asset etc., ultimately leading to retirement of the asset. Depreciation is depletion (actual or notional) in the value of a capital asset. Therefore, allowance of depreciation, being capital in nature should find no place in the computation of profit where only revenue receipts and revenue expenditure are taken into consideration. (Discussed in Schefenacker Motherson judgement mentioned above)
• Depreciation in such a case must be the actual value by which the asset has suffered depletion and not a notional amount under tax or company law or some policy or statutory provision. (Discussed in Schefenacker Motherson judgement mentioned above)

Defence of the Revenue / Department

Following essentional defences / grounds by the department are notable. However, the same did not succeed.

• Where the Assessee is in initial years of operations resulting in higher depreciation claim; the resulting repairs and maintenance expenses are lower. Whereas in subsequent years, where depreciation claim is lower, the repairs and maintenance expenses are on a higher side. Accordingly, the claim of the Assessee should be rejected. (In Aerzen Machines judgement as mentioned above). 
  
  Against above, ITAT held that repairs and maintenance expenses cannot be equated/compared with the depreciation. These are two independent items of expenses. There is no guarantee that if the depreciation is higher then, the repair and maintenance expenses will be lower or vice versa.
  
  
• When the assessee fixes the price, it has considered all costs incurred by it, both direct cost and indirect cost. Under this circumstance, i.e., when the assessee gets to set the price, covering all costs incurred by it, the assessee cannot claim exclusion of depreciation for the purpose of computing operating profit. (In Qual Core Judgement, mentioned above)

Trust you might find the above analysis helpful. Happy to discuss in case of any query. You can comment on this post below; or can also reach out to me on christopher.rebello5@gmail.com

Finance Bill 2021 - 7. Higher TDS / TCS in case of non-filing of Income Tax Returns - Proposed Amendment

Higher TDS / TCS in case of non-filing of the Income Tax Returns

Source: The Income Tax Act, 1961, Finance Bill 2021 and the memorandum to the finance Bill, 2021.

Introduction

Currently, as the Income Tax Act is today, there are adequate measures taken to charge higher rate of TDS in case Permanent Account Number ('PAN') is not furnished by the Recipient. The provisions for the same is summarized as under;

• The Recipient of any amount shall provide the PAN to the payer / deductor, 
• Failing which the TDS shall be deducted at minimum of 20% or the rate prescribed in the Act / Rates in force, whichever is higher. (except where the payment is to be made by any e-commerce operator to e-commerce participant, the minimum rate to be charged is 5% instead of 20%)
• The PAN is to be mentioned in all the communications, bills, vouchers, etc.
• Further where the PAN provided is treated to be invalid or not that of the Deductee, it will be deemed that no PAN has been submitted.
• The above section is not applicable to Non-resident Assessee other than company and a foreign company in case of specified payments

Further in order to encourage the filing of income tax returns by those persons in whose case the TDS / TCS has been deducted / collected, a new amendment is proposed to be inserted in the Income Tax Act, 1961.

Proposed Amendment to encourage the tax return filing in case of the Recipient where TDS has already been deducted

A new section 206AB is proposed to be inserted in relation with higher TDS to be deducted in case of recipient being a non-filer of Income Tax Return. The summary of the proposed section is as under;

• The non-filer recipient is defined as 'Specified Person' for the purpose of this section. 'Specified Person is defined as 
• Not filed the returns of income for two assessment years where the time limit for filing return of income has been expired, immediately preceeding the year in which the TDS is to be deducted; AND
• The aggregate TDS and TCS is Rs. 50,000 or more in each of those previous two years.
• It does not include a non-resident not having PE in India
• Where any amount is to be paid to such 'Specified Person'; the tax shall be deducted at the higher of the following rates
• Twice the rates in force 
• Twice the rates as prescribed in the Provisions of Income Tax Act
• at the rate of 5%
• Where the person have not provided PAN / does not have PAN (i.e. where it falls under section 206AA), and also where such person qualifies to be a Specified Person, the TDS rate applicable in such cases will be higher of those mentioned in Section 206AA and 206AB.
• Further certain TDS sections are kept out of the purview of the current proposed high TDS rate. Some of the same are as follows;
• TDS on Salary / payment out of Provident funds (under section 192, 192A)
• TDS on lottery / crossword puzzle / horse races (under section 194B, 194BB)
• TDS on income from securitization trust (under section 194 LBC), etc.

Similar provisions are proposed in case of higher rate for TCS, in case of amount collected from non-filers.

The above provisions will be in effect from 1 July 2021 

Conclusion and thoughts

The amendments proposed as above, can cast doubts over the practicality of the section. 

• The Primary concern of the taxpayers (deductors / collectors) will be about how to ensure the Income Tax returns have been filed by the Recipient / Payer (in case for TDS and TCS respectively). Needless to say, it would not be preferable to share the copy of Return of Income filed for the last year / last two years with each and every party one transacts with. One possible way is that by obtaining a declaration from the recipient / payer respectively.
• Further another issue that can crop up is to the extent of reliance that can be placed on such declarations. In case of false declarations, the onus of non-deduction of tax / non-collection of tax will entirely lay upon the genuine taxpayers.

Let me know your concerns / views in relation with the same in the comments below.