Whether when assessee, an SSI with value of plant worth less than Rs 1 Cr, excludes costs of spares, Revenue is justified to take aggregate value of all equipments to deny assessee Sec 80IB benefits - NO: ITAT

THE issues before the Bench are - Whether when the assessee, claiming to be a small scale unit, with value of plant and machinery under Rs 1 crore, had excluded the cost of equipments such as tools, jigs, dies, moulds and spare parts for maintenance and the cost of consumable stores while determining value of its plant and machinery, the Revenue is justified to take the aggregate value of plant and machinery of the business as a whole to disqualify the assessee as a small scale unit and make a disallowance of the deduction claimed under section 80IB and Whether when the assessee had paid royalty to its AE for knowhow imparted to the assessee at the rate of 5 per cent of the net ex-factory selling price, which was a small fraction of the assessee’s turnover, the Revenue is justified to disallow the royalty payment. And the verdict partly goes in favour of the assessee.

Facts of the case

The assessee was a majority joint venture of M/s KHS AG of Germany. The assessee was in the business of manufacturing bottling equipment and machinery for filling and packaging of beverages. However, the assessee had a 100 per cent outsourced manufacturing model, and it was only doing the job of assembly and testing for its clients.

The assessee had an agreement for provision of technical know with M/s KHS Maschinen and Anlagenbau AG, Germany (KHS Germany) entered in the year 1997. The agreement, for a duration of seven years from the date of commencement of manufacturing or ten years from the date of execution of the contract, whichever was earlier, was duly approved by SIA. Under the agreement, M/s. KHS Germany had provided know-how technology, designs, information, training for a variety of different machines as required by various industries, with upgradations and improvements in technology being imparted to the assessee. As part of the obligation, KHS Germany had assisted the assessee in understanding the requirements of the customers and getting newer designs. The agreement also contemplated the use of the ‘KHS’ trade name and trademark, in relation to various products, which had provided significant benefits to the assessee. The know-how was provided in phases. The assessee had been helped to build up its turnover many times over.

A) The assessee claiming to be a small scale unit had claimed deduction under section 80IB. According to the assessee, its investment in plant and machinery would be less than the stipulated Rs. 1 crore if items of exclusion were considered as per Notification issued under section 11B of IDR Act, that is, tools, jigs, dies, moulds, fixture, patterns and spare parts for maintenance and the cost of consumable stores, were excluded. The assessee had also claimed that the computer hardware and software, installed in its offices, had to be excluded.

The AO considered that the manufacturing of all the parts of large machines, racks, etc were outsourced by the assessee, and were only being assembled and tested as per client specifications, at the factory of the assessee. Therefore, the plants, machines and tools, by which the job of assembly and testing was accomplished, became the main equipments of the assessee-company. The AO also observed that although the assessee had itself categorized a portion of the plant and machinery as tools and jigs, it had then tried to re-categorize a large number of important components in its business, such as tools, jigs, disc, moulds etc. out of plant and machinery, office equipments and factory equipments, which was not correct and not admissible because this equipment, the actual main tools of its business could not be treated as peripheral or subsidiary tools, meant for the purpose 'maintenance' or 'consumable items'. The AO thus considered that the total value of the assessee's investment in plant and machinery was more than Rs 1 crore, and did not qualify under the norms stipulated by the government for a small scale unit, whereby the assessee's income from sale of spares, service income and other income were excluded from the profits of the industrial undertaking for the purpose of section 80IB. The AO disallowed the deduction under section 80IB at the rate of 30 per cent, on the total of the assessee’s trading profit, interest income and other income.

The AO also observed that the CIT(A) for the previous assessment year 2003-04 had also confirmed the disallowance of claim under section 80IB. In fact, the CIT(A) had also added the vehicles as part of plant and machinery. Hence the AO held that the assessee was not a small scale unit and not eligible for deduction under section 80IB.

B) Under the agreement with its associated enterprise, the assesse had made a payment of royalty, which was calculated at the rate of 5 per cent, based on the net ex-factory selling price exclusive of statutory levies like sales tax, excise and excluding cost of standard bought out components. The assessee has made the computation not with respect to individual transaction but the transactions had been grouped as a whole. The royalty expenditure had been allowed as deduction in the earlier year. However, in the current year, royalty provision was made. According to the assessee, as withholding tax in respect thereof was paid in the subsequent year, the expenditure, if admissible as an eligible expenditure in the computation of income, was to be actually deducted in A.Y.2004-05.

However, in the transfer pricing assessment, the TPO took the view that the assessee need not have paid any royalty to the know-how provider during the current year.

The AO disallowed the claim for royalty payment by the assessee to its associated enterprise as the TPO had determined the arms' length price of royalty paid at nil. The knowhow was held to have no value or insignificant value. The AO also inferred that M/s KHS Germany not having charged any royalty from its wholly owned subsidiaries outside India, was an indication that the knowhow had nil or insignificant value. The AO also surmised that the cost of development of know-how for the German company was nil and hence even under cost plus method, ALP was nil. Thus, the expenses claimed by the assessee in the profit and loss account were disallowed.

In appeal, the CIT(A) confirmed the action of the AO.

In appeal before the Tribunal, the assessee submitted that in calculating the value of plant and machinery, the cost of equipment such as tools jigs, dies, moulds, spare parts for maintenance and cost of consumable stores had to be excluded as per the CBDT notification. Regarding royalty, the assessee submitted that the amount of royalty actually paid was a very small fraction of the amount of total sales, whereby the payment was of a reasonable amount and was allowable. Also, as the technical knowhow was made available only to the assessee, other group entities were not paying any royalty and no comparison could be made.

The Revenue contended that technically the issue should be decided in favour of Revenue as the assessee had not deducted the Tax at Source during the assessment year 2003-04 and the assessee itself had made the disallowance in the computation. Also, the Transaction Net Margin Method (TNMM) was not the correct method for computation of arms length price.

Having heard the parties, the Tribunal held that,

A) ++ both the parties relied upon the decision of the ITAT in the assessee's own case for A.Y. 2003-04.

++ the Tribunal in the assessee's own case had considered that the AO declined to exclude the actual cost of tools jigs, dies, moulds and spare parts on the ground that these are used in the process of assembly and testing in its business and these are not for maintenance. Such equipments are main tools in the business of the taxpayer. The CIT(A) has not adverted to the aspect of tools jigs, dies moulds and spare parts in his order and only concentrated on value of vehicles and computers and held that value of plant and machinery exceeded Rs.1 crore. Since clause (i) in note 2(b) specifically excludes cost of tools, jigs, dies, moulds and spare parts for maintenance and the cost of consumable is not justified in not excluding the same while determining the value of pm in our opinion, the word maintenance is suffixed to only spare parts and not to the other items such as tools, jigs, dies and moulds as also consumables. Accordingly, the AO is directed to exclude the cost of equipments such as tools, jigs, dies, moulds and spare parts for maintenance and the cost of consumable stores while determining value of pm in order to ascertain the status of industrial undertaking of the taxpayer.

++ the Tribunal also considered that there was no finding in the order of either the AO or the CIT(A) as to whether or not all the computers are installed in office. The CIT(A) observed that since computers have not been excluded in the note 2(b) of the notification dated 10.12.1999, accordingly these have to be considered for determining the value of plant and machinery;

++ the Tribunal had considered the decision of the High Court that for determining the value on plant and machinery for ascertaining the status of industrial undertaking as SSI, the actual cost of plant and machinery which is installed in the industrial undertaking, and used for the purpose of business of the undertaking, has to be adopted. The provision does not stipulate taking the aggregate value of plant and machinery of the business as a whole, but limits the same to the plant and machinery relatable to the industrial undertaking. Following this decision, the Tribunal had therefore directed the Revenue to ascertain as to whether or not all the computers are installed in office or as to whether some of these are installed for the purpose of manufacturing bottling plants in the industrial undertaking and thereafter, determine the status of industrial undertaking as an SSI and consequently entitlement to deduction under section 80IB, in accordance with law.

++ regarding vehicles, the Tribunal followed the decision of the AP High Court holding that 'since there is an independent definition in the context of defining a small-scale industrial undertaking, section 43(3) is not applicable to the definition of a small-scale industrial undertaking. If section 43(3) defining plant including vehicles is not applicable, the value of the vehicles cannot be added to the value of the plant and machinery installed excluding those items mentioned in the said Explanation'. The Tribunal held that vehicles have to be excluded while determining the value of plant and machinery for the purpose of determining the status of industrial undertaking as an SSI and consequently for entitlement of deduction under section 80IB. The Tribunal directed that the AO shall recompute the value of the plant and machinery installed in the industrial undertaking of the taxpayer for the purpose of the business of the undertaking as on the last day of the previous year. If the value so worked out is below Rs. One crore, the industrial undertaking should be treated as small scale industrial undertaking and the deduction under s. 80IB of the Act may be allowed in accordance with law to it."

++ following the ITAT order in assessee's own case… the AO is directed to exclude the cost of equipments such as: tools, jigs, dies, moulds, spare parts for maintenance and cost of consumables sources while determining value of plant and machinery in order to ascertain the status of industrial undertaking of the assessee. As regards computers software, we restore the matter to the file of AO with the direction to ascertain as to whether or not all the computers are installed in office or as to whether some of these are installed for the purpose of manufacturing the bottling plants in the industrial undertaking and thereafter determining this status of industrial undertaking as an SSI and consequently entitlement to deduction under section 80IB of the Act in accordance with law after allowing sufficient opportunity of being heard to the assessee. As regards vehicles the same have to be excluded while determining the value of plant and machinery for the purpose of determining the status of industrial undertaking as SSI and consequently for entitlement of deduction under section 80IB. The Assessing Officer accordingly shall re-compute the value of the plant and machinery installed in the industrial undertaking of the assessee for the purpose of business of the undertaking as on the last day of the previous year. If the value so worked out is below Rs.1 crore, the industrial undertaking should be treated as SSI and the deduction under section 80IB may be allowed in accordance with law. Thus, this ground was allowed for statistical purpose;

B) ++ Regarding royalty, we are of the view that for a transaction to come under section 92, it is necessary to establish that the course of business between resident and non-resident is so arranged that the business transacted between them provides to the resident either (i) no profits or (ii) less than ordinary profits which might be expected to arise in the business. In the present case, the assessee had declared income and therefore it is not a case of "no profit". So as regards the adequacy of profits vis-a-vis ordinary profits which might be expected to arise in the business, the same can be found out only, when exercise is done to compare the income of the assessee with other comparable enterprises in India. In the present case, the TPO observed that no royalty was charged by other group entites and accordingly the Arms Length Price for royalty charges was inferred as nil. The AO accordingly disallowed the royalty payment. As argued, the technical know-how was provided to the assessee only and the same was not comparable with other entities of the group. The assessee had not made the one-time payment but is making the continuous payment to the know-how provider which has been accepted by the Department in the past. The assessee has been charging 5 per cent royalty on each and every transaction and therefore the said payment cannot be said to have been paid on the aggregate amount, as argued by Revenue. The findings of the AO in considering the royalty charges as nil as arms length price cannot be accepted since the AO in the present case has not brought on record, the ordinary profits which can be earned in such type of business. Therefore in our view the payment of royalty is not hit by the provisions of Section 92, and there is no reason to hold that the expenses should not be allowed under section 37(1), since the expenditure has been incurred by the assessee during the course of business and is having the nexus with the business of the assessee. Therefore the payment of royalty is a business expenditure which has been incurred wholly and exclusively for the purpose of business of the assessee and same is to be allowed in toto as a matter of commercial expediency. The reasonableness of expenditure in the present circumstances and facts of case, cannot be doubted and accordingly the AO is directed to allow the claim of the assessee and the order of CIT(A) is reversed. This ground of the assessee is allowed.