Penalty should not be imposed if full disclosure of the fact

The Delhi Bench of the Income – tax Appellate Tribunal (Delhi Tribunal), in the case of Vertex Customer Services (India) Pvt. Ltd. (the taxpayer) held that exclusion of provision of doubtful debts from the operating expenses being a debatable issue and considering full disclosure made by the taxpayer; the taxpayer could not be held liable for penalty.

Facts of the Case

    * The taxpayer was engaged in the business of running call centre. From the financial services provided, the taxpayer incurred a loss to the tune of Rs. 4.27 crores on account of costs related to excess capacity, costs incurred being first year of operations and also aprovision of doubtful debts of Rs. 2.3 crores.
    * The provision for doubtful debts pertained to the net costs of services rendered by the taxpayer to the parent company which was ultimately wound up.
    * The debatable issue was whether the provision for doubtful debts should be considered as a part of the operating expenses.
    * The transfer pricing officer (TPO) did not accept the exclusion of provision for doubtful debts from the computation of operating expenses and made an addition of Rs. 2.5 crores and initiated penalty proceedings under Section 271(1)(c) of the Indian Income –tax Act, 1961 (the Act) on the grounds that the taxpayer had not disclosed true operating costs as well as comparable profit margin which resulted in suppression of income and higher claim of loss

Tax Payer’s Contentions

    * In the penalty proceedings, the taxpayer contended that it had made full disclosure of the facts of the case and in the return filed and theprovision for doubtful debts had been excluded in the computation of income.
    * Accordingly, there was no concealment of income or furnishing inaccurate details

Commissioner of Income Tax (Appeals) (CIT (A))’s contentions

    * CIT (A) considering the fact that the details of provision for doubtful debts were disclosed to the revenue authorities and the nature of the provision for doubtful debts being an extra ordinary item; observed that the conditions necessitating initiation of penalty provisions per Explanation 7 to Section 271 (1)(c) of the Act were not satisfied.
    * There was no evidence to prove that computation of transaction price was done by the taxpayer without good faith or due diligence.
    * There was only a difference of opinion between the taxpayer and the TPO as regards the exclusion of provision for doubtful debts from the computation of operating expenses.
    * Hence, penalty should not be levied on the taxpayer.

Revenue’s Contentions

    * The only question to be addressed in this case was whether provision for doubtful debts was an extra ordinary item which could be excluded from computation of operating costs.
    * Since the nature of the provision of doubtful debts was not extra ordinary, it should not be excluded from the operating costs.
    * The case squarely falls within the ambit of the provisions of Section 271 (1)(c) of the Act and hence penalty proceedings were justified.

Delhi Tribunal Ruling

    * Per Explanation 7 to Section 271(1)(c) of the Act, in case of any transfer pricing adjustment by the revenue authorities it shall be deemed that particulars were concealed or inaccurate particulars were furnished unless the taxpayer proved to the satisfaction of the revenue authorities that the transaction price had been computed in accordance with the provisions of Section 92(C) of the Act in the manner prescribed and in good faith with due diligence.
    * The taxpayer had computed the arm’s length price per the transaction net margin method (TNMM) and conducted comparability analysis.
    * The taxpayer had taken services of a reputed firm for the transfer pricing review.
    * Considering the nature of the provision for doubtful debts in this case and the Accounting Standard 5 issued by the Institute of the Chartered Accountants of India, whether the saidprovision could be termed as extra ordinary justifying exclusion from operational costs was a debatable point.
    * The Delhi Tribunal also observed that the formation expenses owed by the taxpayer to the parent were adjusted against the amounts due by the parent to the taxpayer for the services rendered, thereby reducing the taxpayers’ costs.
    * There was full disclosure by the taxpayer of all the relevant facts; hence the computation could not be termed as not done in good faith or without due diligence.
    * Considering the facts and circumstances of the case, the taxpayer could not be held liable for penalty under Section 271(1)(c) ofthe Act since its conduct was not malafide; accordingly the appeal filed by the revenue should be dismissed.

Our Comments

This decision brings into focus the nature of transfer pricing litigation that is being faced by the taxpayers in India. Revenue authorities in India are following an aggressive approach to increase their tax base, leading to a phenomenal increase in thetransfer pricing adjustments made and penalties routinely levied during transfer pricing audits. It reinforces basic transfer pricing principles laid down in the Indian tax laws which states that penalty proceedings could not be levied on the taxpayer when the computation of the transfer price is done in accordance with the relevant provisions of the Indian transfer provisions in good faith and with due diligence. Again, this decision should be helpful to the taxpayers in the sense that merely because the Assessing Officer is not satisfied or disagrees with the taxpayer on a debatable issue, it could not be construed as a ground to levy penalty under the statute.

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