No disallowance for Marketing Expenses incurred on Issuance of Mobile phones free of cost
While computing the profit and gains from business or profession, there are certain expenditures which are disallowed. This means that the income tax department does not allow the benefit of such expenditures and the assessee’s are required to pay taxes on such expenditures by adding it back to the net profits. There are two primary reasons for disallowance of any expenditure:
- The tax amount required to be deducted on certain expenditures are not deducted while making the payment.
- The expenditure does not implicitly relate to the conduct of such business or profession
Let us refer to the case of Nokia India Pvt. Ltd. Vs ACIT (ITAT Delhi) wherethe issue under consideration is whether the marketing expenditure incurred on account of issuance of handsets on free of cost basis is allowed as business expense or not?
Facts of the Case
- The assessee company was a wholly owned subsidiary of Nokia Corporation, Finland.
- The company was primarily engaged in the business of trading and manufacturing of mobile handsets, spare parts and accessories. The company also undertook contract software development for its associated enterprises.
- The case was selected for scrutiny and during the course of assessment proceedings, the assessee was directed to get its account audited u/s 142(2A) of the Act.
- The assessee’s case was also referred to the Transfer Pricing Officer (TPO) to determine the Arm’s Length Price in respect of the international transactions entered into by the assessee during the year under consideration.
- The draft assessment order was passed wherein the assessee’s income was enhanced. Against the draft assessment order, the assessee filed objections before the Disputes Resolution Panel (DRP) and subsequent to the directions of the DRP the final assessment order was passed against which the assessee appealed before the Income Tax Appellate Tribunal (ITAT).
Grounds of Appeal before ITAT
- The AO and DRP have wrongly disallowed expenses incurred by the appellant on trade offers provided by it to its distributors under Section 40(a)(ia)
- AO and DRP have wrongly disallowed an amount incurred by the appellant on account of trade price protection paid to distributors as compensation for reduction in prices of the handsets, and in ignoring all the evidence (including confirmations from dealers) submitted by the appellant in this regard.
- The AO and DRP have wrongly disallowed marketing expenditure incurred by way of issuance of handsets on a free of cost (FOC) basis to employees, dealers and After Marketing Service Centres (AMSC’s) on the ground that the same would give enduring benefit and cannot be claimed as revenue expenditure.
- The AO and the DRP wrongly disallowed current year depreciation in respect of the FOC phones given to AMSC’s for warranty purposes and to dealers for promotional purposes even though these expenses were treated as capital expenses.
- The AO has also erred in not allowing earlier years’ depreciation in respect of the FOC phones, despite the DRP’s directions in this regard.
Observations of ITAT on Disallowance made u/s 40(a)(ia) on account of trade offers provided to the distributors
- Assessee submitted that Department had held these trade offers to be liable to the provisions of withholding tax u/s 194H on the ground that they were in the nature of commission.
- He submitted that this disallowance was identical to the disallowance made in AY 2010-11 which was deleted by the ITAT in assessee’s own case. In view of the ITAT ruling in AY 2010-11 in assessee’s own case in assessee’s favour, the disallowance also deserved deletion.
- ITAT was in agreement with the contention of the assessee that the issues were earlier covered in favour of the assessee.
- ITAT in AY 2010-11 held that it could be seen from the “Agreement for the Supply of Cellular Mobile Phones” between HCL and the assessee that relationship between the assessee and HCL was that of principal to principal and not that of principal to agent.
- The discount which was offered to distributors was given for promotion of sales. This element cannot be treated as commission.
- There is absence of a principal-agent relationship and benefit extended to distributors cannot be treated as commission under Section 194H.
- As regards to applicability of Section 194J of the Act, the AO had not given any reasoning or finding to the extent that there is payment for technical service liable for withholding under Section 194J.
- Marketing activities were undertaken by HCL on its own. Merely making an addition under Section 194J without the actual basis for the same on part of the AO was not just and proper.
- The Department’s contention that discounts were given by way of debit notes and the same were not adjusted or mentioned in the invoice generated upon original sales made by the assessee, did not seem acceptable after going through the invoice and the debit notes.
- Following the order of the Co-ordinate bench in assessee’s own case in the immediately preceding year, on identical facts, ITAT deleted the disallowance.
Observations of ITAT on Disallowance on account of trade price protection extended to the distributors against reduction in prices of handsets
- Assessee submitted that this disallowance had been made on the ground that the assessee had failed to justify the commercial expediency of the expenditure.
- This disallowance had also been made on the same ground in AY 2010-11 which was also deleted by the ITAT in assessee’s own case. It was prayed that on identical facts, this year’s disallowance also needed to be deleted.
- The relevant observations of the ITAT in AY 2010-11 was that it was a market practice that if there was any change in prices of handsets by competitors, change in life of mobile model, change in market demand of particular model which affects the sales, the distributor was protected by the Trade Price Protection.
- This was actually a commercial expediency in modern day technological changes.
- Besides, Trade Price Protection was offered to distributors on handsets which were not subject to trade offers/discounts.
- During the course of hearing in AY 2008-09, even the AO had allowed the deduction for the instant like expenditure.
- In AY 2008-09, the matter was remanded back to the file of the AO, who had allowed the deduction with respect to the expenditure, where confirmations was obtained from the recipients.
- As far as the instant year was concerned, ITAT already noted that the requisite confirmations were filed before the AO.
- Thus, the expenditure was allowable as revenue expenditure under Section 37(1) as it was incurred wholly and exclusively for business and same could not be questioned by the AO.
- Following the Tribunal’s order for AY 2010-11 in assessee’s own case, ITAT deleted this disallowance also.
Observations of ITAT on Disallowance of marketing expenditure incurred on account of issuance of handsets on free of costs basis
- Assessee submitted that this disallowance had been made on the ground that handsets given as free costs were in the nature of capital assets and the same could not be treated as Revenue expenditure.
- He submitted that this disallowance had also been deleted by the ITAT in assessee’s own case in the immediately preceding AY 2010-11 and it was submitted that on identical facts the disallowance in this year also required to be deleted.
- The assessee’s appeal also challenged the action of the Lower Authorities in not allowing current year depreciation in respect of free of costs phones given to the distributors and dealers even though the expenditure was treated as capital expenditure.
- Assessee submitted that if the disallowance of marketing expenditure was allowed, this ground would not survive.
- In AY 2010-11, ITAT had observed that the assessee was engaged in manufacture, import and sale of mobile handsets.
- The assessee has given mobile handsets to its employees, dealers, sale personnel etc. for free of cost and thus no longer owned the said handsets.
- Thus, the said cost was rightly taken as business expenditure by the assessee and was rightly reduced from the inventory.
- This issue is decided in favour of the assessee for A.Ys. 2003-04 by the Tribunal and this was also affirmed by the High Court.
- On similar facts, following the order of the Co-ordinate Bench in assessee’s own case, ITAT directed the deletion of disallowance of marketing expenditure incurred on account of issuance of handsets on free of costs basis
Thus the ITAT held that the Assessing Officer (AO) erred in disallowing marketing expenses incurred by Nokia India on the purchase of mobile phones and accessories. The cost was rightly taken as business expenditure by the assessee and was rightly reduced from the inventory.