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Johnson and Johnson Limited Vs. Commissioner of Income Tax-ltu - Court Judgment

LegalCrystal Citation
CourtIncome Tax Appellate Tribunal ITAT Mumbai
Decided On
Case NumberI.T.A. No.83 of 2011
Judge
AppellantJohnson and Johnson Limited
RespondentCommissioner of Income Tax-ltu
Excerpt:
b.r. mittal, jm. assessee has filed this appeal against order of assessing officer dated 27.10.2010 passed u/s 143(3) r.w.s.144c(13) of the income tax act, 1961 (the act). 2. brief facts giving rise to this appeal are that assessee is an indian company and it is a subsidiary of johnson and johnson inc. us who is holding 75% shares and the balance 25% are held by deputy medical private limited, india. the assessee-company is dealing in various products which are either manufactured by assessee or traded on account of local purchases or foreign purchases. 3. before we proceed to adjudicate this appeal, we consider it relevant to state that, we heard the appeal on 14.10.2013. however, while going through the order of tpo, it was observed that tpo in his order for the assessment year under.....
Judgment:

B.R. Mittal, JM.

Assessee has filed this appeal against order of Assessing Officer dated 27.10.2010 passed u/s 143(3) r.w.s.144C(13) of the Income Tax Act, 1961 (the Act).

2. Brief facts giving rise to this appeal are that assessee is an Indian Company and it is a subsidiary of Johnson and Johnson Inc. US who is holding 75% shares and the balance 25% are held by Deputy Medical Private Limited, India. The assessee-company is dealing in various products which are either manufactured by assessee or traded on account of local purchases or foreign purchases.

3. Before we proceed to adjudicate this appeal, we consider it relevant to state that, we heard the appeal on 14.10.2013. However, while going through the order of TPO, it was observed that TPO in his order for the assessment year under consideration and while suggesting adjustments to be made in respect of the payment of royalty by the assessee on technical know-how as well as brand usage etc stated that similar disallowances were also made by him in his orders for assessment years 2003-04 to 2005-06 and on similar lines suggested the disallowances in the assessment year under consideration i.e. assessment year 2006-07; which are being disputed by the assessee in ground Nos.12 to 17, as mentioned hereinabove. In view of above, the matter was fixed for clarification on 30.10.2013. Ld. AR submitted that appeals for assessment years 2003-04 to 2005-06 are still pending before ld. CIT(A) but the appeal for the assessment year under consideration i.e. assessment year 2006-07 has come up to the Tribunal because this appeal is arising out of order of DRP and whereas in the preceding assessment years there was no constitution of DRP and the appeals were to be filed before ld. CIT(A). In view of above, a query was raised to ld. DR if the appeal for assessment year 2006-07 is decided by the Tribunal, it may be possible that the appeals for earlier assessment years i.e. assessment years 2003-04 to 2005-06 pending before ld. CIT(A) on similar issues and on identical facts may become infructuous. Therefore, whether, it would be advisable to adjudicate this appeal for assessment year 2006-07, pending appeals for assessment years 2003-04 to2005-06 before ld. CIT(A). Ld. DR sought time to seek clarifications from the department and the matter was adjourned. Finally, on the 2.12.2013, ld. DR filed a copy of letter dated 27.11.2013 from Commissioner of Income Tax (LTU), Mumbai stating that department has no objection that appeal for assessment year 2006-07 being proceeded with, while the appeals for assessment years 2003-04 to 2005-06 are pending with CIT(A). A copy of the said letter was filed before us by ld. DR at the time of hearing on 02.12.2013 along with letter dated 27.11.2013. Pursuant thereto we completed the hearing after seeking certain clarifications from the ld. Representatives of the parties. It is also relevant to state that the ld. AR also filed a written note in respect of his submissions made.

4. In Ground No.1 of the appeal, the assessee has disputed the order of Assessing Officer to disallow an expenditure of Rs.45,520,504/- incurred on production of advertisement films comprising of expenditure on purchase cost of films and other production materials on the ground that the expenditure is capital in nature.

4.1 During the year, the assessee “company debited a sum of Rs.116.90 crores towards publicity expenses. AO has stated that on examination of publicity expenses claimed by assessee, it is seen that it includes expenses towards purchase cost of films and other production expenses for producing advertisement films and commercials to be used as TV spots for advertisement. The assessee furnished details of these expenses vide letter dated 3.11.2009, the total of which comes to Rs.4,55,20,504/-. AO has stated that similar issue was involved in assessment years 1993-94 and 1995-96 to 2003-04 and the AO considered the said expenses as capital in nature. He has stated that CIT(A) had deleted the addition for assessment years 1993-94 and 1995-96 to 2001-02 and the department had not accepted the decision of ld. CIT(A) and the appeal filed before Tribunal is pending. He has stated that in order to keep the issue alive the expenses are being treated as capital expenses. DRP also confirmed the action of AO on the ground that the issue has not attained finality. Hence, this appeal by the assessee.

4.2 At the time of hearing, the ld.AR submitted that the Tribunal in assessees own case for assessment years 1997-98, 1998-99 and 1999-2000 in ITA Nos.145/Mum/2001, 2054/Mum/2003 and 2055/Mum/2003, respectively, by a common order dated 18.1.2013 by relying on its own decision in the case of assessee itself for assessment year 1991-92 in ITA No.1146/Mum/1997 has held that the said expenditure is revenue expenditure. He submitted that similar issue on identical facts again came before Tribunal for assessment years 2000-01 and 2001-02 in ITA Nos.2774/Mum/2004 and 9106/Mum/2004 and the Tribunal by its order dated 15.2.2013 decided the issue in favour of the assessee by following its earlier order in assessees own case. He submitted that the same issue again came up before the Tribunal on identical facts for assessment year 2002-03 in ITA No.4070/Mum/2007 and the Tribunal by order dated 28.8.2013 held that the said expenditure is revenue in nature by following orders in assessees own case for earlier years. Ld. AR placed copies of said orders before the Tribunal to substantiate his submissions. Ld. DR has not disputed above submissions of ld. AR. He has also not brought any other distinguishing facts on records.

4.3 We have considered above submissions of Ld. Representatives and have perused earlier orders of the Tribunal (supra) in assessees own case and observe that similar expenditures have been considered by Tribunal and held that they are revenue in nature. Since no distinguishing facts have been brought on record and the AO has also followed only the earlier assessment orders to consider the said expenditure as capital in nature, we respectfully following decisions of the Tribunal in assessees own case (supra) hold that the said expenditure on production of advertisement films aggregating to Rs.45,520,504/- is revenue in nature. Hence Ground No.1 of the appeal taken by assessee is allowed by reversing the order of AO.

5. Ground No.2 of appeal of assessee reads as under:

œ2. The AO erred in law and in facts by making an addition of Rs.38,815,192/- being the proportionate MODVAT credit attributable to the closing stock as on 31 March 2006. Without prejudice to the above, the Honble DRP has erred in law and in facts by not passing a reasoned order with respect to the above ground and accordingly, the order should be quashed.

5.1 AO has stated that assessee has not increased closing stock by value of Modvat credit available at close of accounting year relevant to assessment year 2006-07. Assessee stated before the AO that the valuation of closing stock as adopted is in accordance with Accounting Standards as prescribed by Institute of Chartered Accountants of India and the same is consistently being followed by the assessee since introduction of Modvat credit available on purchase of materials. Assessee stated that if the value of closing stock is increased, then cost of material debited should also be increased by corresponding excise duty. AO stated that in assessment year 2001-02, the Modvat credit of Rs.1,16,58,282/- available for AY 2001-02 was added to the closing stock and accordingly the income declared by assessee was increased by the said amount and the ld. CIT(A) also confirmed the said addition. The DRP in its direction given to the AO stated that the issue is settled by the decision of various courts and the AO is directed to adjust opening stock of purchase and closing stock by including various duties and re-work out the disallowance. AO while passing assessment order added an amount of Rs.3,88,15,192/- to the total income of the assessee-company. Hence, assessee is in appeal before the Tribunal.

5.2 During the course of hearing, ld. AR submitted that the assessee follows exclusive method of accounting to determine the value of cost of goods sold. Hence, excise duty paid on closing stock is a part of inventories in the balance sheet. The AR submitted that similar issue was considered by Tribunal in the assessees own case for assessment years 2000-01 and 2001-02 vide order dated 15.2.2013 (supra) and the Tribunal by considering its own order for AY 1999-2000 in ITA No.2680/Mum/2003 dated 18.1.2013 restored the matter to AO. He submitted that the issue for this assessment year be restored to the AO to decide it afresh as per direction of the Tribunal in respect of assessment year 1999-2000. Ld. DR has not disputed the above submission of ld. AR.

5.3 We have considered the submission of ld. Representatives of the parties and the orders of authorities below. We have also considered Tribunal order dated 18.1.2013 placed at pages 643A to 643BV of the paper book in ITA No.2680/Mum/2003. We observe that vide para 96, the Tribunal has held as under:

œRival contentions heard. After hearing both the parties, we find that though this issue is similar to the issue raised in earlier years, however, provisions of section 145A, has been brought on statute w.e.f. 1st April 1999. Therefore, the same will be applicable in the assessment year 1999-2000. Consequently, we set aside the impugned order passed by the ld. Commissioner (Appeals) and restore the issue back to the file of the AO for denovo adjudication in the light of the provisions of section 145A. The AO is also directed to give corresponding benefit in the opening stock in view of the judgment of jurisdictional High Court in CIT V/s Mahalaxmi Glass Works P.Ltd (2009) 318 ITR 116(Bom) and the judgment of Delhi High Court in Mahavir Alluminium Ltd. (2008) 297 ITR 077 (Del). Thus, ground No.2 is allowed for statistical purposes.?

We respectfully following the above order of Tribunal, restore this issue to the file of AO with a direction to decide the same afresh after giving due opportunity of hearing to the assessee. Hence Ground No.2 of the appeal taken by assessee is allowed for statistical purposes.

6. Ground No.3 of appeal of assessee reads as under:

œ3. The AO erred in law and in facts by disallowing the amount of reserve for cash discount aggregating to Rs.1,815,938/-. Without prejudice to the above, the ld.AO erred in law and in facts in not giving relief in respect of reserve for cash discount disallowed for the previous AY 2005-06 and written back during the year.

6.1 Assessee made provisions for cash discount of Rs.1,815,938/- in its books during the relevant previous year. AO stated that the reserve for cash discount is an unascertained contingent liability, which is dependent upon the happening of certain contingencies in future. Hence, the same cannot be allowed as deduction from the business of the current year. AO after considering the assessment order for assessment year 1999-2000 disallowed the said claim of Rs.1,815,938/-. However, DRP directed the AO that actual cash discount allowed by the assessee should be allowed. Accordingly, AO finally, disallowed the sum of Rs.3,69,230/-. Hence, this appeal by the assessee.

6.2 At the time of hearing, ld. AR conceded that the above issue is covered against the assessee and the amount of cash discount is allowed to the assessee on actual basis by the Tribunal in the preceding assessment years. In view of above submissions of ld. AR, Ground No.3 of the appeal taken by assessee is rejected.

7. Ground No.4 of appeal of assessee reads as under:

œ4. The AO erred in law and in facts by disallowing 10% of the payments made to Crawford Bailey and Co. aggregating to Rs.107,373 under section 40A(2)(b) of the Act on the ground that they are excessive and unreasonable. Without prejudice to the above, the Honble DRP has erred in law and in facts in by not passing a reasoned order with respect to the above ground and accordingly, the order should be quashed.

7.1 AO, on perusal of tax audit report, observed that the assessee company paid to Crawford Bailey and Co. aggregating to Rs.10,73,728/- and stated that it falls within the definition of persons referred to under section 40A(2)(b) of the Act. AO by following the assessment order of previous year, disallowed 10% of the said amount which comes to Rs.1,07,373/- u/s 40A(2)(b) of the Act. He has stated that DRP has also confirmed the disallowance in its direction. Hence, this appeal by the assessee.

7.2 At the time of hearing, the ld.AR submitted that similar issue came up for hearing before the Tribunal in assessment year 2001-02 in ITA No.9106/Mum/2004, and the Tribunal by its order dated 15.2.2013 deleted the disallowance made u/s 40A(2)(b) of the Act after observing that it is for the AO to bring on record some material to indicate that the payment was in fact excessive having regard to the fair market value of goods or services for the legitimate needs of the business. He submitted that similar disallowance made in assessment year 2002-03 by AO was deleted by ld. CIT(A) and the Tribunal in the appeal filed by department in ITA No.4070/Mum/2007 by its order dated 28.8.2013 confirmed the order of ld. CIT(A) by following its order for assessment year 2001-02. He submitted that the facts and issue are identical to the assessment year under consideration and the said disallowance is not justified. Ld. DR has not disputed above submissions of ld. AR, save and except relying on the order of AO.

7.3 We have considered the orders of authorities below and the submission of ld. Representatives of the parties as also orders of Tribunal in assessees own case (supra). We find that during the year under consideration, AO has disallowed 10% of the payment i.e. Rs.1,07,373/- by invoking provisions of section 40A(2)(b) of the Act on fee paid for legal counsel. We observe that in the earlier assessment year, ld. CIT(A) deleted the addition holding that for the payments for legal counseling, it is futile to think of comparables because counsels may not charge standard fee but may charge according to the issue involved. However, it was observed, if the AO wanted to disallow on the ground of excessive payment, he ought to have established excessiveness of the payment. The same has not been done.

7.4 Considering the decision of Tribunal in the assessees own case and in the absence of any distinguishing facts brought on record, we delete the disallowance of Rs.1,07,373/- made by AO by allowing Ground No.4 of the appeal taken by assessee.

8. Ground No.5 of appeal of assessee reads as under:

œ5. The learned AO erred in law and in facts by disallowing on ad-hoc basis an amount of Rs.32,750,973, being 5% /10% of total traveling expenditure on the ground that the same have not been incurred for purposes of business. Without prejudice to the above, the Honble DRP has erred in law and in facts by not passing a reasoned order with respect to the above ground and accordingly, the order should be quashed.?

8.1 AO has stated that the assessee had debited to profit and loss account a sum of Rs.42,46,34,000/- under the head œTravelling Expenses?. Assessee was asked to give proof of payments made. That assessee filed its reply vide letter dated 18.12.2009, the details of which are given by AO at page 20 of the assessment order. AO, disallowed entire expenditure on the ground that the assessee has not provided complete details of the expenditure to find out the personal element and the genuineness of expenditure. In the objection filed before DRP, the assessee contended that AO never demanded bills and vouchers, which were available with the assessee. That same were produced before DRP. DRP after considering the details, filed by assessee, observed that element of personal use and that some expenses not having any connection with the business activity of the assessee could not be ruled out and accordingly directed the AO to sustain the disallowance under different heads as under:

S.No.ParticularsAmount (Rs.)% of disallowance confirmed
1Business meals15,8285%
2Conference Travel and conveyance3,59,9715%
3Hotel expenses1,21,34,59810%
4Hotel Expenses-visitors78,76410%
5Local Conveyance1,94,44,6295%
6Travel fare internal20,15,91,80810%
7Travel overseas10,37,94,35510%
In view of above, the AO worked out disallowance aggregating to Rs.3,27,50,973/-.

Hence this appeal by the assessee.

8.2 Ld.AR stated that similar disallowances were made by AO in assessment year 2001-02 but ld. CIT(A) deleted the said addition by considering that it was a case of company and no disallowance was called for by placing reliance on the decision of Honble Gujarat High Court in the case of Sayaji Iron and Engg. Co.(253 ITR 749). He submitted that the Tribunal by its order dated 15.2.2013 in ITA No.9106/Mum/2004 confirmed the action of ld. CIT(A). He submitted that similar disallowance made by AO in assessment year 2002-03 were also deleted by ld. CIT(A) and the Tribunal by its order dated 28.8.2013 confirmed the action of Ld. CIT(A) in ITA No.4070/Mum/2007. He submitted that the issue is covered in favour of the assessee and the assessee being a company, the disallowance as made by AO on adhoc basis by considering that possibility of personal element and some expenses not in connection with business activity cannot be justified. Ld DR has not disputed above submissions of ld. AR, save and except relying on the order of AO.

8.3 The case was fixed for clarification on 2.12.2013 and the assessee stated that in the subsequent assessment years to the assessment years under consideration, i.e. assessment years 2007-08 and 2008-09, the disallowance has been made at the rate of 1% and the appeals are pending before the ld. CIT(A) for assessment year 2007-08 and before the Tribunal for assessment year 2008-09, inspite of the fact that the expenditure claimed under the head œtrading expenses? were more than the expenditure incurred in the assessment year under considerations.

8.4 We have considered the submissions of ld. Representatives of the parties and orders of authorities below as well as earlier orders of the Tribunals (supra). We agree that the disallowance on the ground that the expenditure being personal in nature cannot be made in the case of a company, in view of the decision of the Honble Gujarat High Court in the case of Sayaji Iron and Engg. Co (supra) and also in the case of Dinesh Mills Ltd. V/s VIT (2004) 268 ITR 502 (Guj). However, we observe that DRP has also stated that some of the expenditure claimed are not connected with business activity of the assessee. However, DRP has not pointed out the expenses which are not in connection with business activity of the assessee inspite of facts that the details were filed by assessee before DRP, as mentioned in the order of DRP itself. In view of above said adhoc disallowance of Rs.3,27,50,973/- out of travelling expenses claimed by assessee is not justified. Accordingly, we delete the same by allowing Ground No.5 taken by assessee.

9. Ground No.6 of appeal of assessee reads as under:

œ6. The learned AO erred in law and in facts by disallowing on ad-hoc basis 50% of the expenditure incurred towards professional sponsorship amounting to Rs 115,563,298 on the ground that the same have not been incurred for the purpose of business.?

10. AO has stated that on scrutinizing the details of miscellaneous expenses, it is seen that assessee-company incurred expense of Rs.23,11,26,595/- towards professional sponsorship. The assessee was asked to provide details and nature of the expenses. The assessee vide letter dated 18.12.2009 furnished the details. AO has stated that the assessee has given details of expenditures stating the name of organizers without their addresses. The assessee stated vide letter dated 24.12.2009 that the said expenses were incurred for sponsoring eminent doctors to attend international conferences so that they could participate in the lectures and seminars covering recent developments in the areas of medicines and surgery; that they could acquaint themselves with the usages of products marketed by assessee-company; that assessee sponsored reputed surgeons to various international conferences where they could get first hand information and also to get the opportunity to witnesses live surgeries. The assessee also stated that it follows strict guidelines for selection of doctors/surgeons. However, the AO has stated that assessee has not given purpose of their sponsorship and how the expenses are related to business of the assessee. He has further stated that assessee-company indulged in tactics which has been objected by Medical Counsel of India. The assessee has not been able to discharge the onus that lies upon it to prove genuineness of expenses incurred and also to prove that expenses are incurred due to business exigency. That the assessee is not in a position to prove that the professional sponsorship has increased its business, and assessee company is totally relying on a statement, which it could not corroborate. In view of above, the AO has stated that the assessee totally failed to fulfill prime responsibility and suggested in the draft assessment order to disallow the entire expenditure of Rs.23,11,26,595/- claimed by assessee under the head professional sponsorship.

10.1 However, DRP after considering submissions of the assessee, which are stated at pages 19-20, of its order, has stated that details furnished by assessee to justify the said expenditure aggregating to Rs.23,11,26,595/- do not reveal the complete details of the expenses and purpose of expenses. That the assessee has not produced any proof from the doctors and various other persons sponsored by the assessee for foreign visits as to how it was related to assessees business. DRP has stated that keeping in view scanty details provided by assessee before the AO as well as before the DRP, DRP is of the view that unproved expenses cannot be considered for business purposes. However, DRP has stated that it cannot be denied that some of the expenses are necessary for the purposes of business and accordingly suggested to make disallowance of 50% of such expenses. Therefore, the AO was directed to allow 50% of the expenses claimed by assessee. Accordingly, AO inconfirmity with the direction of DRP added Rs.11,55,63,298/- to the total income of the assessee. Hence, assessee is in further appeal before us.

11. During the course of hearing, ld. AR referred pages 754 to 787 of the paper book and submitted that division wise detailed break-up of expenditure incurred for professional sponsorship was furnished before the AO. The ld. AR further submitted that there are guidelines for sponsoring the doctors to attend the conferences etc and referred pages 788 to 800 of the paper book which is a copy from the extract of Health Care Business Integrity Guide. Ld. AR submitted that similar issue was considered by the Tribunal in assessees own case in Addl.CIT V/s Johnson and Johnson Limited in ITA No.9106/Mum/2004 (AY-2001-02) dated 15.2.2013 and the Tribunal vide paras 44-45 allowed the expenditure incurred by assessee and even 10% claim of expenses disallowed by AO was deleted by CIT(A) and the order of ld. CIT(A) was confirmed by the Tribunal. He further submitted that similar expenditures incurred by the assessee in the assessment year 2002-03 was allowed by ld. CIT(A) and the appeal filed by the department before the Tribunal being ITA No.4070/Mum/2007, dated 28.8.2013, was rejected by following its order for the assessment year 2001-02. He further submitted that the said expenditure was incurred for commercial exigency and the same cannot be disallowed by AO. He further submitted that the assessee also paid fringe benefit tax on the travelling expenditure incurred and accordingly the expenditure cannot be disallowed. The assessee also referred the following decisions :

i) CIT V/s Panipat Woolen and General Mills Co.Ltd. (1976) 103 ITR 66(SC)

ii) CIT V/s Dhanrajgirji Raja Narasingirji. [1973] 91 ITR 544 (SC)

iii) CIT V/s Sales Magnesite (P.) Ltd. [1995] 214 ITR 1 (BOM.)

iv) CIT V/s Raman and Raman Ltd., [1969] 71 ITR 345 (Mad)

v) CIT V/s Gobald Motor Services Pvt.Ltd 100 ITR 242(Mad)

vi) CIT V/s Chandulal Keshavlal and Co. [1960] 38 ITR 601 (SC)

vii) Bombay Steam Navigation Co. V/s CIT [1965] 56 ITR 52 (SC)

viii) Om International (ITA No.2310/M/2012) dated 25.4.2013  (Mumbai Tribunal)

ix) Hansraj Mathuradas (ITA No.2397/Mum/2010) dated 16.9.2010

x) J.K.H.Exports (35 CCH 108) (Mumbai).

11.1 In reply to a clarification, when the matter was fixed on 2.12.2013, ld.AR submitted that in subsequent assessment years to the assessment years under consideration, the expenditure in assessment years 2007-08 and 2008-09 were disallowed at the rate of 1% and the appeals for assessment year 2007-08 is pending before the ld. CIT(A) and the appeal for the assessment year 2008-09 is pending before the Tribunal disputing the disallowance made under the above head.

12. On the other hand, ld. DR supported the order of AO. He submitted that the assessee could not file details of the expenditure and accordingly the disallowance made by AO be confirmed. He also relied on decision of ITAT in ITA No.925/Mum/2007 dated 19.7.2013 in the case of Merck Ltd V/s Dy.CIT.

13. We have carefully considered the orders of authorities below and also the submissions of the ld. Representatives of the parties. We have also considered the earlier orders of the Tribunal dated 15.2.2013 relating to assessment year 2001-02 and dated 28.8.2013 relating to assessment year 2002-03 (supra). We have also considered the cases referred to by assessee in its note. There is no dispute to the fact that the assessee could not file requisite details to justify that expenditure incurred by the assessee aggregating to Rs.23,11,26,595/- was wholly and exclusively for business purposes of the assessee. We observe that the assessee has placed reliance on the earlier orders of the Tribunal that similar expenses were allowed by Tribunal by confirming the deletion of 10% disallowance made by AO and deleted by ld. CIT(A). However, we observe that in the assessment year 2001-02 the total expenses incurred by assessee was Rs.2.23 crores and in assessment year 2002-03 it was Rs.4.36 crores under the head œProfessional Sponsorship?; and whereas in the assessment year under consideration the total expenditure incurred is of Rs.23,11,26,595/-. We observe that DRP has also stated that assessee filed only scanty details of the foreign visits of doctors etc. It is also not in dispute that the addresses of doctors and the organizers have not been given in the details filed by assessee even before us. On perusal of details, we agree with DRP that the assessee was not able to justify with documentary evidence that entire expenditures had been incurred by the assessee for the purpose of its business. Therefore, the earlier orders (supra) as referred to by ld. AR could not be considered as precedent in the assessment year under consideration. Since the assessee has not been able to establish that entire expenditure has been incurred for the purpose of business and due to commercial expediency, we are of the considered view that it will be fair and reasonable to make an adhoc disallowance of 2% of the expenditure claimed by assessee which comes to Rs.46,22,500/- as against Rs.11,55,63,298/- disallowed by AO. We may also state that the cases referred to by the assessee (supra) are also not applicable to the facts of the present case as in those cases it was held that expenditure incurred was for business purposes and/or was incurred due to business exigency. Further, payment of fringe benefit tax does not establish the fact that the expenditure has been incurred by assessee wholly and exclusively for the purposes assessees of business and therefore the said contention of Ld.AR has no merit. Hence payment of FBT does not establish that expenditure was for business purpose. In view of above ground No.6 of the appeal taken by assessee is allowed in part by restricting the disallowance of Rs.46,22,500/-.

14. Ground No.7 of the appeal taken by assessee relates to disallowance of bonus provision of Rs.24,26,021/-.

15. At the time of hearing, ld. AR submitted that above ground is not press for. Hence, Ground No.7 of the appeal taken by assessee is rejected as not pressed for.

16. Ground No.8 of the appeal taken by assessee is as under:

œThe ld. AO erred in law and in facts by disallowing the depreciation claimed on testing equipment under section 32 of the Act amounting to Rs.63,69,962/- on the ground that the said fixed assets are not used by the appellant for the purpose of their business as they are located at different pathological laboratories, hospitals etc across the country?

17. We have heard ld. Representatives of the parties and have perused the orders of authorities below. We observe that the assessee claimed depreciation in respect of testing equipments installed at various laboratories, doctors clinics and hospitals etc for the purpose of their own business / profession. AO has stated that the said equipments installed by assessee at the clinics of doctors, laboratories etc could not be considered being used by assessee for the purpose of its business and accordingly disallowed the claim of depreciation of Rs.63,69,962/-, which was also confirmed by DRP in its direction.

18. At the time of hearing, the ld. AR referred the decision of the Tribunal in assessees own case for assessment years 2000-01 and 2001-02, order dated  15.2.2013 (supra), and also Tribunal decision for assessment year 2002-03 dated 28.8.2013 (supra), wherein the Tribunal considered similar issue on identical facts and by following the decision in the case of N R Jet Enterprises Ltd in ITA No.4474/Mum/2004, Mumbai Tribunal, dated 28.5.2008, a sister concern of the assessee, wherein the depreciation was allowed on the testing equipments provided to laboratory and hospitals as in the case of assessee. Ld. DR has not disputed the contention of ld. AR that the facts in the assessment year under consideration are identical and similar issue has been decided by the Tribunal in favour of assessee in the earlier assessment years. In view of above, and respectfully following earlier orders of the Tribunal in assessees own case (supra), we allow depreciation of Rs.63,69,962/- on the testing equipment by setting aside orders of authorities below. Hence, Ground No.8 of the appeal taken by assessee is allowed.

19. Ground Nos.9 and 10 of the appeal taken by assessee is as under:

œ9. The ld. AO erred in law and in facts by making an addition of the profits attributable to the assessees Sri Lanka b ranch aggregating Rs.65,995,771/- in view of the Article 7 of the Double Taxation Avoidance agreement between India and Sri Lanka (India-Sri Lanka Tax Treaty);

Without prejudice to the above, the Honble DRP has erred in law and in facts by not passing a reasoned order with respect to the above ground and accordingly, the order should be quashed;

10. The ld. AO erred in law and in facts by making an addition of the profits attributable to the assessees Bangladesh Branch aggregating to Rs.5,29,555/- in view of the Article 7 of the Double Taxation Avoidance agreement between India and Bangladesh (India-Bangladesh Tax Treaty);

Without prejudice to the above, the Honble DRP has erred in law and in facts by not passing a reasoned order with respect to the above ground and accordingly, the order should be quashed;

20. At the time of hearing, ld. AR submitted that above grounds of appeal viz Ground Nos.9 and 10 are not pressed for as the assessee is satisfied with the direction of DRP that the tax paid by assessee in Sri Lanka and Bangladesh will be allowed credit as per tax treaties. In view of above, Ground Nos.9 and 10 of the appeal taken by assessee are rejected.

21. Ground No.11 of the appeal taken by assessee is as under:

œ11. The ld. AO erred in law and in facts by disallowing on adhoc basic 75% of the expenditure incurred towards free samples distributed amounting to Rs.118,503,996/- by treating it as non business expenditure. Without prejudice to the above, the Honble DRP has erred in law and in facts by not passing a reasoned order with respect to the above ground and accordingly, the order should be quashed;

22. The AO has stated that the assessee was asked to furnish details of production and sale of items manufactured by the assessee company. It was noticed that there is a variation in actual amount of production, its sales and closing stock. That on being asked to furnish reasons for short fall, the assessee stated that it was due to distribution of various types of samples. The AO has stated that the reply of the assessee was evasive and to investigate the matter further, further details/explanations were asked from the assessee. The AO has stated that the assessee vide letter dated 18.12.2009 furnished the details but they were not filed division-wise, nor the details of the persons, institution, agents with address, samples and amount were filed. The AO has stated that genuineness of distribution of samples was not established. Therefore, the assessee was asked to submit details of total sales, free samples and link with purchase or production to establish the difference. The AO has stated that the assessee filed its reply vide letter dated 24.10.2009; which has been stated by AO at pages 33 to 36 of the Assessment Order. It is observed that the assessee interalia stated that free samples were distributed to promote sales and it is an accepted commercial practice. That the expenses on account of it should be allowed as business expenditure. The assessee also placed its reliance on the decision of the Honble Bombay High Court in the case of Brihan Maharashtra Sugar Syndicate Ltd. V/s DCIT (226 CTR 160)(Bom), wherein the Honble High Court has held as under:

œIt is an accepted commercial practice that the sale of any product would not increase unless the consumers are made aware about its qualities or specialities either by dissemination of information regarding the product by advertisement or actually allowing them the use of the products by way of free samples?.

The assessee also referred the decision of the Honble Apex Court in the case of Smithkline Beecham Pharmaceuticals (India) Ltd. V/s CIT (2000) 245 ITR 116 (SC) wherein Their Lordships has held as under:

œthe object, we have no doubt, of distribution of the samples of the drugs to the doctors is to make them aware that such drugs are available in the market in relation to the cure of a particular affliction and, therefore, to persuade them to prescribe the same in appropriate cases. So doing is, tantamount to publicity and sales promotion.?

22.1 The assessee also stated that the said expenditure of free samples is allowable u/s 37(1) of the Act as the expenditure was incurred due to commercial expediency and for business purposes.

22.2 However, the AO has stated that the assessee is claiming distribution of samples which has resulted in short fall in production and sale of items but the assessee is not in a position to corroborate its contention by producing any convincing documents/records. The details filed by assessee is very incomprehensive and general in nature. The AO has stated that onus lies on the assessee to prove the genuineness of its claim. Since the assessee has failed to discharge the onus, AO stated that expenditure claimed on account of distribution of free samples is not acceptable. The AO proposed in draft assessment order, the disallowance of the entire claim of the assessee of Rs.15,80,05,328/-. However, DRP after considering submissions of the assessee stated that some of the samples have been given by assessee as part of various sales promotion schemes, which has certainly helped in increasing the sales. Therefore, DRP restricted the disallowances to 75% of the expenditure claimed by assessee and directed the AO accordingly.

23. In view of above, AO made disallowance of Rs.11,85,03,996/- being 75% of the claim of the assessee of Rs.15,80,05,328/-. Hence, assessee is in appeal before the Tribunal.

24. Ld. AR submitted that the assessee filed division-wise break-up of free samples distributed and the details of which are also placed at pages 806 to 1014 of the paper book. He submitted that distribution of free samples is one of the promotional avenues to promote the product. That it is a normal trade practice. He submitted that there is a sufficient control in regard to distribution of free samples. Ld. AR referred the decision of Honble Bombay High Court in the case of Brihan Maharashtra Sugar Syndicate Ltd. (supra) and the decision of Honble Apex Court in the case of in the case of Smithkline Beecham Pharmaceuticals (India) Ltd. (supra) and submitted that free samples were given due to commercial exigency. He submitted that the assessee has also paid Fringe Benefit Tax in respect of the said expenditure incurred and therefore the expenditure cannot be disallowed. The ld. AR placed reliance on the following decisions:

i) Om International (ITA No.2310/M/2012) dated 25.4.2013 (Mumbai ITAT)

ii) Hansraj Mathuradas (ITA No.2397/Mum/2010) dated 16.9.2010

iii) J.K.H.Exports (35 CCH 108) (Mumbai).

He submitted that in the subsequent assessment years i.e. assessment years 2007-08 and 2008-09 the disallowance was made at the rate of 1% of the expenses claimed by assessee. Ld. AR filed a chart stating that for assessment year 2008-09 DRP itself restricted the disallowance of 1% of the expenses claimed by assessee of Rs.24,48,20,332/-. Therefore, the disallowance made in the assessment year under consideration of 75% of the claim of the assessee is excessive and the same may be deleted.

24.1 However, the ld. DR supported the order of AO. He further submitted that in the case of Merck Limited V/s DCIT in ITA No.925/Mum/2007 (AY-2003-04), the Tribunal vide order dated 19.7.2013 while considering similar issue restored the matter to the AO for detailed examination and to verify the details about names, addresses of the doctors etc to whom free samples were given. He submitted that since the assessee failed to furnish the requisite details, AO as per direction of DRP has restricted disallowance to 75% of the claim of assessee which is reasonable. He submitted that the order of AO be confirmed.

25. We have carefully considered the orders of AO as well as the order of DRP and have also considered the cases relied upon by the ld. Representatives of both parties. There is no dispute to the fact that in order to claim expenditure, the assessee is required to furnish requisite details to the satisfaction of AO to justify that the expenditure has been incurred for business purpose. The Honble Delhi High Court has also held in the case of Goodyear India Ltd. V/s CIT (2000) 246 ITR 116 (Delhi) that œthe details of expenditures, which are not substantiated by vouchers and assessee was unable to furnish the detail to justify the claim, the disallowance made by AO is justified and availability of tax audit report does not preclude AO from calling for supporting materials?. The Honble Madras High Court has also held in the case of CIT V/s Southern Sea Foods Ltd. [1995] 215 ITR 176 (MAD.) that œa person who claims that he has made certain expenditures incurred, is expected to have documentary evidence. In the absence of above, he is expected to say how he incurred the expenditure and why there is no documentary proof for such expenditure.? We agree with the ld. AR that it is a commercial practice in the line of business of the assessee, to give free samples to promote its product. However, the assessee is expected to maintain details to enable the AO to verify as to whether the said samples had been given by assessee wholly and exclusively in connection with its business. On perusal of the details placed at pages 805 to 1014 of the paper book, we observe that the names with address are not given and therefore on the basis of details placed, AO could not verify genuineness of claim of the assessee. Further the contention of the assessee that it has paid Fringe Benefit Tax (FBT) and therefore no disallowance be made, has no merits. Payment of Fringe Benefit Tax (FBT) does not establish that expenditure has been incurred by the assessee for its business purpose. In view of above and considering the details placed before us and the decisions relied upon by ld. AR, we are of the considered view that on the facts and in the circumstances it will be fair and reasonable to restrict disallowance to 2% of the claim of assessee which comes to Rs.31,61,000/-as against Rs. Rs.11,85,03,996/- disallowed by AO. Hence, Ground No.11 of the appeal taken by assessee is allowed in part.

26. We propose to consider ground Nos.12 to 17 of the appeal taken by assessee together which are as under:

œ12. The ld. AO/TPO (learned Additional Commissioner of Income-tax (Transfer Pricing) -1(4) (hereinafter referred to as the œld.TPO?) has erred in law and in facts by disallowing the taxes borne by the Appellant in respect of brand usage royalty paid to Johnson and Johnson, USA (JandJ US) on the ground that the appellant is required to deduct tax out of the payment of brand usage royalty made to JandJ US and not bear the same as per the agreement entered into between the appellant and JandJ US.

13. The ld. AO/TPO has erred in law and in facts by disallowing the service tax paid by the appellant on brand usage royalty;

14. The ld. AO/TPO has erred in law and in facts by disallowing the knowhow royalty paid by the Appellant on sale of traded finished goods;

15. The ld. AO/TPO has erred in law and in facts by holding that the knowhow royalty paid by the appellant on manufactured products be restricted to 1% on net sales;

16. The ld. AO/TPO has erred in law and in facts by disallowing the corresponding withholding tax and RandD cess on disallowed know-how royalty on traded finished goods and manufactured products; and

17. The ld. AO/TPO has erred in law and in facts by disallowing the service tax paid by the appellant on know-how royalty Without prejudice to the above, the ld. AO/TPO has erred in law and in facts by not restricting the disallowance to the amount proportionate to disallowed knowhow royalty and have disallowed the entire service tax?

27. Since facts giving rise to above grounds are interconnected, we deal with these grounds together. AO made a reference u/s 92CA(1) of the Act to Transfer Pricing Officer (TPO) to determine Arms Length Price (hereinafter to be referred as ALP) in relation to the International Transactions.

27.1 Assessee is a Multi-Divisional Company and TPO has segmented its operation into three divisions viz Customer Care, Pharmaceuticals and Medical Products. Assessee company in respect of international transactions with its Associated Enterprises (AE), computed Arms Length Price (ALP) by using Transactional Net Margin Method (TNMM). Assessee has paid Technical know-how-royalty at the rate of 4% and Brand Royalty at the rate of 2%, net of taxes on net sales.

27.2 The TPO has stated that the assessee company set up its operation in India in the year 1957. TPO has stated that the assessee has paid technical know-how royalty at the rate of 4% for its product, in spite of the fact that some of the products were introduced by the assessee company long ago and the technology is fully adapted for such products. That only updating to technology, if available with its AE Johnson and Johnson, USA (hereinafter to be referred as JandJUS) would be required. He has stated that the assessee company is having full-fledged Government approved Research and Development Facilities (RandD) which are not only being used for adopting the technology but the improvement of products and also for developing the process, which resulted into making products suitable in the Indian climate/conditions. That R and D facilities of the assessee-company are so advanced that the same are being shared with group entities. He has stated that the assessee company had entered into an agreement with its AE, JandJ US to pay royalty for know-how received from its AE JandJ US at the rate of 2% on sales vide agreement entered into on November 21, 1994 and it covered only certain specific drugs and pharmaceuticals. The royalty under this agreement was paid by the assessee to its AE, JandJ US from June 1, 1994 to May 31, 2001. Thereafter and pursuant to liberalization of Foreign Exchange Regulations, the assessee company started paying technical know-how fee for the consumer segment also from July 1, 2001 at the rate of 2% and this was enhanced to 4% with effect from 1st July, 2002 onwards. He has stated that the assessee is also bearing tax on the said payment at the rate of 15%. Therefore, on net sales, the effective rate of royalty would be more than what the assessee has reported ostensibly. He has further stated that assessee company is paying technical know-how fee not only on the products manufactured by it in its facilities but also on the products got contract manufactured by it. He has stated that if the products can be got contract manufactured, it indicates that, the technology available with the assessee company only would be passed on to contract manufacturers. He has further stated that the assessee company is paying technical know-how royalty not only on manufactured products but also on traded products , which is not required to be paid at all. That the assessee company is paying technical know-how royalty on traded products in an unauthorized manner.

27.3 The TPO has further stated that the assessee company is using trade-mark since 1957. The assessee is a part of JandJ US since inception. Therefore, the group brands could be used freely by assessee even in the absence of license contracts and due to this only “company was using the brand/trademark without paying royalty. That JandJ products have acquired a reputation for quality before the conclusion of the Royalty agreement. That the royalty agreement did not make anything available to assessee-company that it did not already have or had not brought about on its own in the past. It is relevant to state that the assessee-company paid brand usage royalty at the rate of 1% net of taxes to its AE JandJ US. The TPO has stated that by entering into an agreement by assessee company with JandJ US for payment of brand royalty, it did not get any economic benefit. That the value of brand/trade mark have not been created or manufactured by JandJ US. He has stated that the assessee company bearing all the expenses for marking and promotion of branded products which are more than 10% of sale value. The business power of brand name/trade mark is not only because of ownership of these with JandJ US, but the actual efforts of the assessee-company.

27.4 The TPO has stated that if the expenses on technical services fee, trade mark fee, RandD facilities and sales promotion expenses are considered together, the assessee company viz JandJ India is spending about 15% of the turnover towards these expenses. The TPO relying on his orders for assessment years, 2003,04, 2004-05 and 2005-06 has stated that if these expenses are considered together, the assessee is not required to make any payment for the use of trade mark/ brand name.

27.5 Further, TPO has stated that the assessee-company did not submit the informations regarding Technical services fees and trade mark fee charged by JandJ US to other manufacturing/trading entities of the group in the Asia Pacific and European Countries. That in the absence of these details, it is not possible to factually verify whether the royalties paid by assessee-company are in line with what is paid by other entities. He has stated it is not known whether other entities even if those are paying royalties are incurring any expenses on the RandD facilities. He has stated that the assessee started paying royalty at the rate permitted under automatic route of the Government of India. The royalty is prescribed in the automatic route are for the use of fresh technology and also for the use of trademarks for the first time. Since the assessee company is not getting any fresh technology in relation to old products being manufactured by it since years which have been adapted to the Indian circumstances by use of technology developed by it, royalty rates should certainly be less than prescribed under the automatic route. He has stated that automatic route means no permission regarding payments is required by the government but the quantum/appropriateness of the amounts paid as royalty should certainly satisfy the principles of Arms Length. The TPO has stated that he has considered this issue in the assessment years 2003-04, 2004-05 and relied upon the order for assessment year 2005-06 which he has stated at page 9 of his order as under:

œIn the FMCG Sector, most of the big companies in India, are part of Multi-National Enterprises, and their transactions would certainly be the controlled

transactions. There would be very few companies, in the FMCG Sector other

than Multi National Companies, wherein, any royalty is paid by them to unrelated

parties. The details regarding any such company could not be found on the

website of SIA/RBI www.siadipp.nic.in/publicat/newsltr?meaning thereby in FMCG sector, such royalty payments are not approved. From the details available on this website, in the pharmaceutical sector, the unrelated parties have paid royalty @1.5% to the foreign collaborators for which approvals were received in FY 1999-2000, Montan Hydraulik India Pvt. Ltd, Cadland Pharma Pvt Ltd. A.S.R. Pharmatech (India) Ltd, Sudman Laboratories Ltd, got approval from SIA for payment of royalty @ 1.5% of domestic sales for a period of 5 years for manufacturing drugs and medicines. The royalty was payable to the foreign collaborators in Germany, Netherlands, USA and Gibraltor respectively. Therefore, it can be said that the royalty rates in the Pharma sector are 1.5%?

27.6 The TPO has stated that if the results at segment level are compared, it is difficult to justify that a payment of royalty which is Rs.58.37 crores is at Arms length considering the volume of the transactions of the assessee. That the total sales of the assessee are Rs.1381.46 crores and the expenses are Rs.1271.53 crores. The contribution of royalty in the total expenses is about 4.21%. The assessee company has paid trademark license fee and technical service fee for all the business divisions which have international transactions. In the TNMM, if the controlled transactions are not benchmarked separately, it will be difficult to say that the transactions are at Arms Length or not. The TPO has summarized the discussions on the issue of payment of royalty in para 6.1.1 and thereafter he has stated that on the basis of order for assessment year 2005-06, the payment of technical know how fee at the rate of 1% for all the manufactured product for the consumer segment, pharmaceutical segment and medical devices and brand royalty at the rate of 1% would be the Arms Length royalty payable by assessee company. He has stated that this view is supported from the fact that from 1.6.1994 to 30.6.2002, the assessee had been paying technical know-how royalty at the rate of 2% only and no brand royalty was being paid though the assessee was using the brand name all through since 1957. He has stated that royalty for the use of technical know-how subsumes royalty for use of brand name also. In this regard, he has stated that this has been clarified by the Government of India, Department of Industrial Policy and Promotion, Secretariat for Industrial Assistances Press Release No. 8(2) 2001-FC-I dated 3.1.2002. He has further stated that, the assessee company is not required to bear tax at the rate 15% (and the corresponding cess/sur-charge) on the royalty which the assessee has born and made payment to JandJ US on net of taxes. The TPO has further discussed the relevant article of the agreement and has stated that even Article 13 of the Technical Services Fees Agreement and Royalty for Trademark, if are compared with the royalty for trademark, the Technical services fees agreement provide for payment net of taxes but does not so provide in the brand names/Trademarks Royalty Agreement. The TPO has stated that Reserve Bank of India approval is relevant only for limited purpose of foreign exchange in flow/outflow. The Reserve Bank of India does not come into examining whether international transactions are taking place at arms length. He has stated that it fails to logic that technical service fee should be paid for traded goods, that too, when brand royalty is also being paid . Technical know-how royalty is not required to be paid for the traded products. Technical know-how fee is paid for using technology for manufacturing product.

27.7 In view of above, the TPO has calculated technical know “how royalty as well as brand royalty paid by assessee which is to be disallowed, details of which he has given at page 21 of the impugned order. The TPO has stated that at Arms Length Price payment of royalty comes to Rs.17.10 crores as against Rs.58.37 crores paid/payable by the assessee and suggested the disallowance of Rs.41.26 crores (including disallowance of Income “tax, RandD cess and service tax borne by assessee). The assessee filed objections before DRP.

28. The DRP after considering the submissions of assessee has agreed with the TPO/AO and accordingly the AO finally disallowed the above amount. Hence, the assessee is in appeal before the Tribunal.

29. The ld. AR submitted that assessee entered into agreement with AE JandJ US to pay royalty for technical know-how, at the rate of 2% on sales vide agreement dated 21.11.1994. The said agreement covered certain specific products as mentioned in the agreement. Subsequently, the assessee entered into a fresh agreement on 14.3.2002 and as per that agreement the scope was enhanced to cover various new products dealt by assessee-company and also some additional technical /marketing assistance was included. Ld. AR submitted that the additional technical /marketing assistance included under the agreement dated 14.3.2002 relates to marketing plan and strategy, the distribution net work, technological solution and programmes for information management etc. He submitted that copies of agreements dated 21.11.1994 and 14.3.2002 are placed in the paper book No.1 at pages 128 to 149 and at pages 150 to 175 respectively. Ld. AR submitted that it was proposed to revise technical know “ how royalty from 2% to 4% and RBI accorded its approval vide letter dated 26.6.2002, copy placed at pages 179 of the paper book. He submitted that thereafter the assessee entered into a supplemental Technical know-how agreement on 29.8.2002 enhancing the royalty payable to its AE, JandJ US from 2% to 4% on sales, and copy of the said agreement is placed at pages 176 to 178 of the paper book. Ld.AR submitted that TPO while making transfer pricing adjustment by disallowing technical know-how royalty relied on its own Transfer Pricing Order of assessment years 2003-04 to 2005-06 and the assessee has filed appeals before ld. CIT(A) which are yet to be decided.

29.1 Ld. AR submitted that royalty at the rate of 4% was paid by assessee to JandJ US as per formula prescribed by RBI vide its letter dated 29.11.2001, copy placed at pages 172 to 175 of the paper book. He submitted that as per RBI formula, landed cost of imported components including ocean freight, insurance, customs duties etc and cost of standard bought out components is reduced from the net sales for the purposes of computing net sales on which royalty is payable. The ld. AR submitted that in the assessment year 2002-03, TPO disallowed marketing royalty payment but CIT(A) allowed and the Tribunal by its order dated 28.8.2013 in ITA No.4092/Mum/2007 allowed payment of royalty on both i.e trading as well as marketing. He submitted that copy of the said order of Tribunal is placed at pages 92 to 119 of the paper book and the relevant paras are 43 to 49 thereof. However, in reply to a query, the ld. AR submitted that in the said assessment year viz assessment year 2002-03 technical know-how royalty was increased from 1% to 2% and in the assessment year under consideration it is 4%. He submitted that TPO has not considered the submissions of the assessee and allowed 1% technical know-how royalty and DRP also confirmed the action of AO. Ld.AR further submitted that the royalty payment by the assessee meets Arms Length Text and therefore disallowance is not justified.

29.2 Ld. AR further submitted that besides, the payment of technical know-how royalty the assessee also paid brand royalty and the said payment of brand royalty is paid at the rate of 1% net of taxes and the same has been accepted in the assessment year under consideration and even in the subsequent years. However, only dispute is in regard to tax borne by assessee on brand royalty. The ld. AR submitted that similar disallowance of taxes was made in the assessment year 2002-03 but the Tribunal in ITA No.4092/Mum/2007 vide order dated 28.8.2013, copy placed at pages 92 to 119 of the paper book(relevant para 34 is at pages 104 of paper book), after considering its decision in the case of Dresser Rand India P. Ltd. V/s DCIT in ITA No.3509/Mum/2008 (Assessment Year: 2004-05), order dated 31.7.2012 held that the royalty is to be remitted net of taxes and deleted the disallowance made by AO/ld. CIT(A). He submitted that the said issue is covered in view of the order of Tribunal in assessees own case.

29.3 Ld AR further submitted that the TPO also suggested the disallowance of service tax paid by assessee. He submitted that service tax paid is not an international transaction and the same is out side the purview of International Transaction and therefore, the TPO was not justified to disallow service tax paid by assessee on the royalty paid to JandJ US. Ld. AR referred the decision of ITAT, Mumbai Bench in the case of DCIT V/s Starlite [2010] 40 SOT 421 (MUM.) and submitted that the Tribunal has held that adjustment if any arising due to computation of ALP are to be restricted only to International Transaction and not to be applied to entire turnover of the assessee. He submitted that the payment of service tax on the royalty paid by assessee to JandJ US is not international transaction and therefore, the same is outside the scope of TPO to make adjustment by suggesting disallowance. He further submitted that royalty is also to be paid net of taxes, the payment of service tax even otherwise is the responsibility of the assessee and no adjustment under ALP is justified.

29.4 Ld. AR further submitted that in respect of disallowance of taxes and RandD cess paid on technical know-how royalty, similar issue was considered by ITAT, Pune Bench in the case of Kirloskar Ebara Pumps Ltd. V/s DCIT (2011) 138 TTJ(Pune) 211 and it was held by Tribunal that cess on royalty is payable to Central Government by an industrial concern which imports technology, as per section 3(2) of Research and Development Cess Act, 1986. The Tribunal held that Research and Development Cess is payable by the assessee which is importing technology and therefore no adjustment could be made for the same in the computation of ALP. It is also held that there is no legal basis for TPO's inference to the effect that the research and development cess is the liability of the foreign concern who is receiving royalty. Ld. AR further submitted that similar issue was also considered by ITAT, Mumbai Bench in assessees own case for assessment year 2002-03 in ITA No.4092/Mum/2007 vide its order dated 28.8.2013 (relevant para 42) and the Tribunal deleted the disallowance made by TPO on that account. He submitted that the Tribunal also observed that the said payment had been made in the light of the agreement with JandJ US and as per approval /guidelines of RBI. Ld. AR submitted that disallowance of tax and RandD Cess paid on technical know-how royalty is not justified.

30. On the other hand, ld. DR supported the disallowances made on account of tax and service tax paid on payment of royalty on brand usage as well as on technical know-how and also RandD Cess paid and relied on the order of TPO/DRP. However, in respect of technical know-how royalty paid, ld. DR submitted that TPO has not applied any particular method while making disallowance and therefore the matter may be sent back to AO/TPO to apply a particular method as applicable to the assessee, as per section 92C and determine ALP. He submitted that the disallowances made by AO be confirmed.

31. In the note submitted on 2.12.2013 Ld. AR has stated that the assessee has adopted CUP method to benchmark its international transaction of payment of knowhow royalty. For analyzing the comparability of royalty payments made by the assessee to JandJ US, a reference was made to the website http://dipp.nic.in/(the website), a website of the Secretariat of Industrial Assistance (SIA). The website contains details of royalty approvals granted by the SIA and the RBI. A search was conducted on the website to identify approval granted by the SIA/RBI in respect of royalty payments made between third parties in consideration for provision of technical know-how/marketing know-how for consumer healthcare products, pharmaceutical products and medical devices. Based on the analysis, the average royalty rate for the comparable technical know-how/marketing know-how approvals worked out to 4.84% on sales. Based on such analysis and the fact that royalty of 4% paid by assessee to JandJ US was lower than the arms length rate of 4.84%. Hence royalty paid by the assessee to JandJ US meets the arms length text.

32. We have considered the submissions of ld Representatives of the parties and the orders of authorities below as well as the material placed on record. We have also carefully considered earlier order of Tribunal in assessees own case for assessment year 2002-03 (supra) and also the cases placed on paper book.

33. We observe that the assessee is a subsidiary of Johnson and Johnson Inc. US who is holding 75% shares and the balance 25% are held by DePuy Medical Private Limited, India. The assessee has computed ALP in respect of International Transactions by using TNMM. The assessee paid royalty net of taxes on net sales for the use of Brands Trade mark and for the Technical/Marketing know-how as per terms of agreement entered into between the assessee and JandJ US. The assessee stated before the TPO that it paid royalty in respect of its three segments i.e. Consumer, Pharmaceuticals and Medical device as approved by RBI. We observe that the TPO stated that there was no basis for payment of royalty for use of trade mark/brand name as the products sold by the assessee-company had already acquired a reputation of quality before the conclusion of the royalty agreement. He has further stated that Reserve Bank of India approval cannot be considered to be Arms Length Bench Mark as the same is merely an approval in the exchange control policy of the Government of India for in-flow/out-flow of foreign exchange. He has further stated that technical know-how royalty paid by assessee at the rate of 4% on the basis of agreement dated 29.08.2002 for all the products and that too net of taxes is not at Arms Length. To substantiate his finding, the TPO stated that some of the products were introduced by the assessee long ago and technology is fully adapted and for such products only updated technology available with JandJ US is required and for getting such updated technology it would require payment of royalty at a reduced rate. He has further stated that there was no necessity to pay royalty on traded products and the same is required to be only on manufactured products. As mentioned hereinabove TPO allowed payment of technical know-how fee at the rate of 1% for all the products manufactured by assessee company and trademark/brand name product at 1% considering it to be at Arms Length. During the course of hearing, ld. AR submitted

that there was understanding between the assessee-company and JandJ US that the assessee company is required to pay net of taxes technical know-how royalty on manufactured and trading goods as per technical know-how and service agreement and to substantiate his submissions refer page 230 of the paper book which is a copy of letter from JandJ US dated 3.1.2007. During the hearing, it was pointed out that TPO cannot dictate to the assessee as to how assessee should conduct its business and the assessee can incur expenditure. It is a fact that a similar issue was considered by ITAT in assessees own case for assessment year 2002-03 vide order dated 28.8.2013 (supra) and the Tribunal held (vide para 49) that the agreement between the assessee-company and JandJ US for payment of royalty is to be considered in the light of approval of RBI. The Tribunal has also observed that there is no substance in the findings of the TPO that there is no need for paying royalty for technical/marketing know-how and accordingly confirmed the order of ld. CIT(A) by dismissing the ground of appeal taken by department before Tribunal on similar facts except that technical know-how royalty paid in the assessment year 2002-03 was at the rate of 2% whereas in the assessment year under consideration it is at the rate of 4% on sales. However, it was contended that payment of royalty at the enhanced rate of 4% is paid as per agreement entered into between the assessee-company and JandJ US dated 29.8.2002, copy placed at pages 176 to 178 of the paper book. That it was submitted that payment of royalty at the rate of 4% is as per RBI formula and the average royalty rate for comparable technical know-how /marketing know-how approval worked out to 4.84% on sales and therefore royalty of 4% paid by assessee to JandJ US is lesser than Arms Length of 4.84%. The said fact has not been disputed by ld. DR at the time of hearing except that the TPO while making the disallowance and considering the Arms Length adjustment did not apply any particular method and therefore it be sent back to TPO to apply a particular method to determine Arms Length Price. Since assessee has placed relevant material on record and the same has not been disputed by ld. DR that the payment of technical know-how royalty by assessee is as per RBI formula and the same is lower than the average royalty rate for the comparable technical knowhow/marketing know-how royalty for consumer, healthcare products, pharmaceutical products and medical device, we are of the considered view that no disallowance can be made by TPO the basis that there was no necessity by the assessee to pay royalty at the enhanced rate of 4% as it was excessive and unnecessary. We are of the considered view that Rule 10B(1) of Income Tax Rules, 1962 does not authorize the TPO to make disallowance of any expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same or that in the view of Revenue, the expenditure was un-remunerative. Such kind of observations and thereafter to make disallowance by TPO while considering the price at Arms Length are outside his purview. Whether or not to enter in to the transactions for making a particular payment is for the assessee to decide. There is no doubt that the quantum of expenditure can be examined by TPO as per law but in judging the allowbility thereof as business expenditure, TPO has no authority to disallow the entire expenditure or part thereof on the ground that the said expenditure is excessive. We observe that what the TPO has done is to hold that the assessee need not pay the royalty on the traded products or at the rate as agreed to between the assessee and JandJ US on the basis of his presumptions and assumptions. The TPO has to examine whether price paid or the amount paid was at Arms length under the provisions of Transfer Pricing and its Rules. The Rules do not authorize the TPO to disallow the expenditure on the ground that it was not necessary or prudent for the assessee to have incurred the same. It is relevant to state that the Ld.AR stated that the average royalty paid by assessee is comparable and it is lower than the Arms Length rate of 4.84% as per information available on œwebsite? of SIA which provides rate which is approved by SIA/RBI. We are of the considered view that the TPO cannot suggest the disallowance merely because as per his assumption it is excessive though the payment is at Arms length. In view of above, we are of the considered view that the disallowance suggested by TPO and confirmed by DRP/AO of the royalty paid by assessee, when he has not found that the payment is not at arms length/excessive under any of the method as prescribed u/s 92C(1) of the Act, can not be made under the Transfer Pricing Provisions. Therefore, we direct to delete the same and consequential Ground Nos.14 and 15 of the appeal taken by assessee are allowed.

34. In respect of Ground taken by assessee for making disallowance on account of tax, service tax paid by assessee on the payment of royalty, we observe that the said issue has already been considered by Tribunal in assessees own case for the assessment year 2002-03 (supra) and the Tribunal has held after considering the agreements entered into between the assessee and JandJ US and also the decision in the case of Dresser Rand India P. Ltd. (supra) that the taxes were liability of the assessee-company under the terms of agreements and accordingly disallowance made by AO were deleted. Further, we also observe that liability of payment of service tax is of recipient of services and since assessee is the receiver of services, it is the liability of the assessee company to bear service tax. Hence we hold that TPO was not justified to state that liability of bearing service tax was of assessee-company. In view of above, we hold that disallowances made by TPO on account of taxes, services tax is not justified and we direct to delete the same. Hence, Ground Nos.12, 13 and 17 of the appeal taken by assessee are allowed.

35. In respect of disallowance of tax and RandD cess paid on technical know-how royalty on traded finished goods and manufactured products, we observe that the said issue was also considered by Tribunal in assessees own case for the assessment year 2002-03 and the Tribunal (vide para 42 of the order) held that said payments have been made by assessee in the light of agreement with JandJ US and as per approval/guidelines of RBI and accordingly directed the AO to delete the disallowance/tax and RandD cess paid on technical royalty. Respectfully following the above order of the Tribunal in assessees own case and also considering the alternative contention of assessee that RandD cess and service tax cannot be treated as International transaction, in view of the decision of ITAT, Pune Bench in the case of Kirloskar Ebara Pumps Ltd(supra), we delete the disallowance made by AO/DRP of tax and RandD cess paid on technical know-how royalty on traded goods and manufactured products by allowing ground No.16 of the appeal taken by the assessee.

36. Ground No.18 of appeal taken by assessee reads as under:

œ18. The ld.AO/TPO has erred in law and in facts by disallowing part of publicity and sales promotion expenses on the ground that such expenses benefits JandJ US in the form of higher royalty on increased sales. Without prejudice to the above, since the expenditure incurred on production of advertisement films, professional sponsorship and on free samples has been separately disallowed by the AO, transfer pricing adjustment should be made only on the allowed publicity and sales promotion expenses.

37. Relevant facts are that the TPO has stated that the assessee incurred publicity and sales promotion expenses of Rs.163.27 crores during the relevant financial year. The TPO has stated that said expenses on publicity and sales promotion has resulted into higher sales on which correspondingly higher royalty has been paid to the parent company JandJ US. Therefore, the benefit of higher publicity and sales promotion expenses are accrued to the parent company JandJ US but the cost thereof is not apportioned to the parent company. The TPO sought explanation from the assessee as to why the cost of arrangement as emanating from the records, is resulting into the benefit to the parent AE, but not apportioned as per section 92(2) of the Act. The TPO stated that the assessee and the parent company JandJ US should have shared sales promotion expenses in the ratio of royalty to sales or would have renegotiated a lower royalty rate. The assessee filed its reply stating interalia that assessee is engaged in the business of distributing the products in the Indian Market on its own account. It was also contended that the advertisement and marketing expenses are incurred in India only for promoting sales by assessee of its products in India and it is not in any way benefited to JandJ US. That JandJ US is not directly involved in the business of manufacturing or trading of said goods in India either of its own or through any of its subsidiary. Hence, the entire advertisement and marketing expenses incurred are purely for assessees own benefit and there is no element of any service being rendered to JandJ US. It was also stated that assessee-company is an independent risk bearing entity and any cost incurred towards advertisement and marketing would be for the sole benefit of assessee-company, as it enjoys the increased sales of products as a result of such marketing activities. The assessee also furnished details of publicity and sales promotion expenses before TPO. However, TPO did not accept the contention of the assessee and stated that the said growth in net sales so achieved through higher and higher publicity and sales promotion and expenses have resulted into higher payment of royalty which the assessee is paying at a fixed percentage of sales to its parent company. Thus, there is a co-relation between the royalty payment and sales on the one hand and publicity and sales promotion expenses on the other hand and it is not a matter of coincidence. The TPO after considering the submissions of assessee has stated that JandJ US, the parent company of the assessee is reaping the benefit of higher royalty year after year as a result of higher sales realized by assessee through higher and higher expenses by way of publicity and sales promotion undertaken by assessee without the overseas AE bearing any cost thereto He stated that it constitutes arrangement between the two entities wherein the entire cost is borne by assessee, whereas the parent company JandJ US is getting its share of benefit from those increased sales. The TPO worked out the cost at the rate of 4.22 % of the publicity and sales promotion expenses which comes to Rs.6.88 crores. However, the TPO stated that the cost is restricted to 200.82 lakhs (being 1.23% of Rs.163.27 crores) in view of disallowance/adjustment in income made on account of royalty on technical know-how, the income tax, RandD cess and service tax paid thereon aggregating to Rs.41.27 crores out of total payment of Rs.58.37 crores. Hence, TPO disallowed Rs.200.82 lakhs from the publicity and sales promotion expenses incurred towards cost allocable to parent company. DRP after considering the submissions of the assessee company confirmed the action of the TPO. Accordingly the AO disallowed a sum of Rs.200.82 lakhs while making assessment. Hence, assessee is in appeal before the Tribunal.

38. During the course of hearing, ld. AR submitted that it was an adhoc disallowance made by TPO and relied on the decision of Mumbai Bench of Tribunal in the case of Kodak India Pvt. Ltd. V/s Addl. Commissioner of Income Tax in ITA No.7349/Mum/2012 (AY 2008-09) dated 30.04.2013 and submitted that the Tribunal deleted similar kind of adjustment suggested by TPO on the ground that TPO cannot make a disallowance which is not within the precinct of specific method prescribed under section 92C(1) of the Act. He submitted that no adhoc disallowance can be made under the Transfer Pricing provisions.

39. On the other hand, ld. DR supported the order of AO/TPO and submitted that to consider marketing expenses the cost plus method could be applied. Since TPO has not followed any specific method as 2006-07 is the first year, the matter could be restored to TPO to decide it afresh after considering the guidelines laid down by Special Bench (Delhi) in the case of L.G. Electronics India (P.) Ltd. V/s ACIT (2013)140 ITD 41(Del) (SB). He submitted that the AE, parent company of the assessee should reimburse the expenses as assessee company has created brand in India which is owned by parent company by incurring the expenditure.

40. We have considered the order of the TPO/AO and the submissions of ld. Representatives of the parties. We observe that the TPO has suggested disallowance on the ground that the AE of the assessee viz JandJ US is reaping the benefit of higher royalty amount as a result of higher sales realized by assessee by incurring higher expenses by way of publicity and sales promotion undertaken by assessee and therefore the parent company of the assessee-company should share some of the expenses. It is a fact that TPO while suggesting any disallowance/adjustment has to state that the transactions between the assessee-company and its AE is not at Arms Length. The TPO is to determine the Arms length by following one of the method and /or most appropriate method as prescribed in section 92C(1) of the Act. The TPO cannot suggest adjustment/disallowance on the basis of his assumptions that the payment is excessive though it is at arms length. Similar issue was also considered by ITAT Mumbai Bench in the case of Kodak India Pvt. Ltd.(supra). Further, Rule 10B specifically provides the procedure to be followed for determining Arms Length Price. We observe that the TPO while suggesting the disallowance of 200.82 Lakhs out of the expenses incurred by assessee on publicity and sales promotion has not followed any of the method and therefore the said adjustment/disallowance suggested by TPO is outside its jurisdiction. During the course of hearing, ld. DR submitted that the matter could be restored to TPO to decide afresh after considering the guidelines laid down by Special Bench (Delhi) in the case of L.G. Electronics India (P.) Ltd. (supra). Since no specific submissions were made and considering the fact that the assessee justified the payment of technical know-how royalty at the rate of 4% of net sales which is lower than Arms length rate of 4.84% and the said fact, we have also discussed herein above in para 33 of this order, that the payment of royalty by assessee to its parent company is at Arms Length, we do not find any justification to make the said disallowance of Rs.200.82 lakhs as suggested by TPO towards the shares to be contributed by AE of the assessee-company. Therefore, we delete the said disallowance made by AO by allowing ground No.18 of the appeal taken by assessee.

41. Ground No.19 of the appeal taken by assessee is in respect of charging of interest u/s 234B and 234D of the Act.

42. Since charging of interest is consequential one no specific adjudication is required, therefore dismissed.

43. In Ground No.20, the assessee has stated that AO has erred in initiating the penalty proceedings u/s 274 r.w.s. section 271 of the Act.

44. Since the said ground is premature and hence the same is rejected.

45. In the result, the appeal of the assessee is allowed in part.


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