IN THE INCOME TAX APPELLATE TRIBUNAL
MUMBAI BENCHES "L", MUMBAI
Before Shri D Karunakara Rao, AM & Shri Amit Shukla, JM
ITA No.387/Mum/2013
Assessment Year : 2005-06
M/s. Lloyd's Register Asia (India The Asst. CIT 8(3) (OSD),
Branch Office) Mumbai
63-64 Kalpataru Square, Vs.
6th Floor, Kondivita Lane,
Off Andheri Kurla Road,
Andheri (E),Mumbai- 400 059
PAN AAACL9741J
(Appellant) Respondent)
ITA No.517/Mum/2013
Assessment Year : 2005-06
The Asst. CIT 8(3) (OSD), M/s. Lloyd's Register Asia
Mumbai (India Branch Office)
Vs. Mumbai- 400 059
(Appellant) Respondent)
Assessee By : S/Shri S E Dastur,Nitesh Joshi,
Vispit Shah
Revenue By : S/Shri S D Srivastava & Vivek Permpurna
Date of Hearing :01.04.2015 Date of Pronouncement : 10.06.2015
ORDER
Per Amit Shukla, Judicial Member
The aforesaid cross appeals have been filed by the either parties against the
impugned order dated 15.10.2012, passed by the CIT(A) II, Mumbai, for the
quantum of the assessment passed u/s. 143(3) for the A.Y. 2005-06.
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2. At the outset, the learned senior counsel, Shri S E Dastur submitted that
ground no.3 as raised by the assessee in the memorandum of appeal is not arising
out of the order of the CIT(A), therefore, the same is not pressed. Accordingly,
ground no.3 is dismissed as not pressed.
3. The effective grounds taken by the assessee reads as under:
"1. On the facts and in the circumstances of the case and in law the
learned CIT(A) has erred in holding the transaction of License fee,
Management charges and IT Recharge as being considered
between the head office and branch. In doing so he has not
appreciated the fact that Lloyd's Register-UK is not a Head Office
of the appellant and Lloyd's Register UK has filed its income tax
return in India declaring the above source of income received from
the appellant. He ought not to have done so.
2. A. Without prejudice to ground no.1, on the facts and in the
circumstances of the case an din law the learned CIT(A) has erred
in holding that 50% of the total Management charges of INR
4,42,92,316/- paid to Lloyd's Register-UK i.e.Rs.2,21,46,158/- are
covered in the definition of Head Office Expenditure as per section
44C of the Act and thereby restricting the allowance to the extent
of INR 46,73,263/- and disallowing the balance INR 1,74,72,895/-.
He ought not to have done so.
B. The learned CIT(A) has not appreciated the fact that the
assessing officer erred in taxing a PE of a UK company by placing
restrictions on deduction of Head office expenditure under section
44C. The said restriction is not applicable in case of resident
companies thereby discriminating by giving unfavourable tax
treatment. He ought not to have done so."
4. The grounds raised by the Revenue are also on the same issue, therefore,
are reproduced here under:
"1. On the facts and circumstances of the case and in law, the
Ld. CIT(A) erred in allowing 100% relief on account of addition
made by the A.O. u/s. 44C on account of Licence Fees and
allowing 50% relief on the addition made by the A.O. u/s. 44C on
account of Management charges ignoring the finding given by AO
in his assessment order.
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2. On the facts and circumstances of the case and in law, the
Ld. CIT(A) erred in deleting the interest charged u/s. 234B of the
I.T.Act as the issue has not been decided on merit."
5. Briefly stated the facts of the case are that, Lloyd's Register U K is having a
subsidiary in the name Lloyd's Register Asia UK, which has an Indian branch in
India. In other words, the assessee is an Indian branch of Lloyd's Register Asia UK,
which in turn is a subsidiary of Lloyd's Register UK. The main holding company is
into the business of survey and inspection of ships, industrial inspection activity and
drawing appraisal. Earlier Lloyd's Register UK was operating in India through its
branch. From the relevant financial year (i.e. A Y 2005-06), it floated a subsidiary
company, Lloyd's Register Asia and all the Indian operations thereafter are being
carried out through branch of this entity. Lloyd's Register UK entered into a license
agreement on 16.07.2003 with all its subsidiaries all over the world, including Lloyds
Register Asia UK, whereby it has granted license to use the brand "Lloyd's Register"
i.e. use of trademark and trade name owned by Lloyd's Register UK. Besides this,
the licensor (Lloyd's Register UK) also provides general, technical and marketing
support services to all its products, which have been referred in the license
agreement as "Intellectual Property Rights". The royalty and the license fees was
payable as per Schedule VI of the license agreement, which has been incorporated
at page 3 of the appellate order and also at page 23 of the paper-book. As per the
worldwide policy, the invoices are sent from Lloyd's Register UK to Lloyd's Register
Asia UK which in turn, allocates the royalty attributable to its Indian branch. The
Indian branch pays the same to Lloyd's Register Asia UK, which in turn pays Lloyds
Register UK. Further, another "Management Services Agreement" dated 16.07.2003
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was entered into between Lloyd's Register UK and Lloyd's Register Asia UK for
providing services such as :
· Corporate communications,
· Corporate finance and group reporting services,
· Group quality assurance,
· Human resources,
· Information technology,
· Integrated business system (IBS project)
· Internal audit services
· Legal services
· Operational management and reporting (mainly provided by regional and
area management centres)
· Risk management and secretarial services and
· Taxation and treasury services.
The determination of management service fees has been enumerated in Schedule 4
of the Management Service agreement, the relevant portion of which has been
incorporated by the CIT(A) at pages 3 & 4. During the relevant assessment year,
the assessee has paid `management charges' and `license fees' of Rs.18,32,12,834/-
to Lloyd's Register Asia UK i.e. its head office, which in turn has been given to
Lloyd's Register UK. The break-up of the management and license fees were as
under:
Particulars Amount in Rs.
Management Charges 4,42,92,396
License Fees 13,89,20,438
Total 18,32,12,834
6. In response to the show cause notice by the AO as to why these expenses
should not be treated as Head office expenses u/s. 44C, the assessee filed detailed
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submissions, which has been incorporated at pages 2 to 6 of the assessment order.
The sum and substance of the assessee's submission was that, firstly, it is not a
transaction between the head office and the branch but between Lloyd's Register
UK and Lloyd's Register Asia (India Branch office). The payment is only routed
through the head office i.e. Lloyd's Register Asia UK. Lloyd's Register UK is filing
separate income tax return in India for the said income. These transactions have
also been verified by the Transfer Pricing Officer and held that it was at arm's length
and, therefore, provisions of section 44C do not arise. Secondly, the license fees
and management fees cannot be held to be covered with the definition of `head
office expenses' as defined in section 44C of the Act, as the said section is only
applicable to general and administration expenditure as referred to in Explanation
(iv) to section 44C, because the head office expenditure includes only executive and
general administration expenditure of the nature enumerated in clause (a) to (d).
7. However, the learned AO rejected the assessee's contention and held that
what is relevant to see here is, who has incurred the expenses and who has
accounted for it as their expenses. In this case the expenses were incurred by
Lloyd's Register UK for various group companies, which were reimbursed through
Lloyd's Register Asia UK and these expenses are very much in the nature of head
office expenses for the purpose so far as assessee is concerned. Lloyd's Register
Asia UK i.e. head office is only the intermediary for the accounting purpose and it
will not change the real nature of expenses. After going through the management
service and license agreement, the learned AO held that both the payments are
covered within the definition of head office expenditure as defined under section
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44C. Thus he restricted the management and license fees to 5% of the adjusted
total income. The addition was made by the AO in the following manner:
"Thus, Rs.18,32,12,834/- of Management and License Fees is restricted to 5%
of the adjusted total income, which is Rs.35,65,954/- (i.e. 5% of total income
of Rs.7,13,19,080/-) The difference of Rs.17,96,46,880/- is added to the total
income of the assessee. Penalty proceedings u/s. 271(1)(c) initiated for
furnishing of inaccurate particulars of income. "
8. In the first appeal, the learned CIT(A) after considering the elaborate
submissions made by the assessee, which has been discussed by him from para 4.7
to 4.10, held that so far as royalty or license fees is concerned, the same is not hit
by the definition of head office expenditure as provided in section 44C.
Accordingly, he directed the AO not to consider royalty or license fees expenditure
incurred by the assessee as head office expenditure. Thus, the amount of Rs.
13,89,20,438/- was directed not to be considered for disallowance as per section
44C. Regarding management fees, he held that 50% of such expenditure is hit by
section 44C and the balance is not covered by Section 44C being the expenditure of
the branch office. For arriving at this conclusion, he has referred to the CIT(A)'s
order in the case of Lloyd's Register India Office, i.e. the holding company, for A.Y.
2005-06. Thus, half of the amount of management charges of Rs.4,42,92,396/-
was held to be covered u/s. 44C and the balance half as expenditure of branch
office.
9. Before us, the learned senior counsel, Shri Soli Dastur, after explaining the
entire facts of the case submitted that here in this case, it needs to be seen,
whether the payment made by the Indian branch to Lloyd's Register Asia UK, which
in turn has been paid to Lloyd's Register UK, can be set to be hit by provisions of
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section 44C. The definition of "head office expenditure" envisages that such an
expenditure must have been incurred by the assessee outside India. Here the
assessee Lloyd's Register Asia UK, has not incurred any such expenditure but has
only passed on to Lloyd's Register UK. This is evident from internal debit notes
placed at pages 58 and 59 of the paper-book. The transaction is between two
different entities i.e. Lloyd's Register UK and Lloyd's Register Asia UK. The services
are rendered by Lloyd's Register UK and not by Lloyd's Register Asia UK therefore, it
cannot be held that expenses has been incurred by the assessee. Whenever
income has been earned by Lloyd's Register UK in the form of license fees etc., the
same is being taxed in India. Hence, at the face of it, the provisions of section 44C
does not arise at all, as there is no transaction between the head office and the
branch. The second limb of the argument was that, the license fees at the face of it
do not fall within the definition of section 44C. The royalty has been paid by Lloyd's
Register Asia UK to Lloyd's Register UK and the branches of Lloyd's Register Asia UK
have been apportioned charges on proportionate basis through an internal debit
note and is reimbursed by the branch to the Lloyd's Register Asia UK. If one goes
by the definition in clause (iv) to section 44C, then such a payment of said license
fees/royalty does not fall within the ambit of head office expenditure. Hence, the
learned CIT(A) has rightly held that the license fees is not in the nature of head
office expenditure and was legally correct in directing the AO not to consider
`royalty' or `license fees' as expenditure incurred by the assessee as head office
expenditure. He drew our attention to Schedule 6, which provides the license fees
payable as per the agreement and also the recitals of the license agreement dated
16.07.2003 in support of his contentions. Thus, such a payment he submitted that,
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is definitely not covered u/s. 44C. Regarding management charges, he drew our
attention to the agreement dated 16.07.2003, which has been placed in the paper-
book from page 25 onwards and also the various types of services provided by
Lloyd's Register, which have been elaborated in Schedule 3 (appearing from pages
48 to 52 of the paper-book). He submitted that looking to the nature of services it
can be seen that these are very specialized services and does not fall in the
category of expenses as enumerated in Explanation to section 44C which are of
general and executive expenses. In support of his contention, he relied upon the
CBDT Circular No.202 dated 05.07.1976 as reported in (1976) 105 ITR (ST) 17.
Even otherwise also, he submitted that if the overall expenditure incurred by the
assessee is to be seen, then out of Rs.31,91,70,684, the management charges and
license fees is Rs.18,32,12,834/-, which is much more than half of the total
expenditure. Such a huge quantum of expenditure can never be held to be head
office expenditure as mentioned in section 44C, because Section 44C contemplates
expenditure to the tune of generally 5%. Definitely such an amount of expenditure
cannot be held to be of head office expenditure as contemplated in section 44C.
10. By way of an alternative argument, Shri Dastur submitted that, it cannot be
disputed that the Indian branch being Permanent Establishment of Lloyd's Register
Asia UK, the business profits has to be determined under Article 7 of the India - UK
DTAA. Para 5 of the Article 7 clearly provides that in determination of the profits of
permanent establishment, expenses incurred for the purpose of business including
executive and general administrative expenses shall be allowed as deduction subject
to the limitation of domestic law of the contracting state in which the permanent
establishment is situated. However, para 7 of Article 7 provides that it will not apply
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in the case of reimbursement of actual expenses. Here in this case, it has not been
disputed that payment of license fees and management services are in the nature of
reimbursement. This is not only evident from the observations of the AO in the
case of the assessee but has also been held by the AO in the case of Lloyd's
Register UK in the assessment order passed u/s. 143(3) for A.Y. 2005-06. A copy of
the said order has been filed separately at the time of hearing. Thus, by virtue of
Article 7(7), the restriction of Article 7(5) of limitation clause of the domestic law will
not apply and, therefore, no disallowance can be made under the DTAA.
11. Lastly, again by way of an alternative argument, Shri Dastur submitted that
the provisions of section 44C will not apply in view of Article 26, which is a non
discrimination clause, as it discriminates the foreign residents. In support of this
proposition he relied upon the decision of Metchem Canada Inc. vs. DCIT (2006)
100 ITD 251, wherein it has been held that limitation on deduction of head office
expenditure as set out in section 44C would not apply in case of non-resident
companies in light of non-discrimination clause in DTAA, wherever such clause is
provided.
12. On the other hand, the learned DR submitted that section 44C was brought
in the statute to overcome the difficulty to scrutinize and verify the claim of head
office expenses, particularly in the absence of account books of the head office
which are kept outside India. The said section was brought to curb the mischief of
the companies having branches in India to reduce the incidence of tax in India by
inflating their claims in respect of head office expenses. So far as the nature of
expenses like license fees and management charges is concerned, one has to see,
whether such expenditure are in the nature of head office expenditure or not. From
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the recitals of the license agreement, it can be seen that the licensor is providing
general, technical and marketing support services, which can be attributable as
head office expenditure. Similarly, in the management services there are wide
range of activities carried out by the head office covering areas such as
administration, legal, accounting, human resources, information technology,
marketing, management and strategy, which in fact concerning head office
expenses. Thus, the AO has rightly considered these expenses in the nature of
head office expenditure. So far as managerial services, she submitted that the
learned CIT(A) though has stated 50% of the expenditure to be in the nature of
head office expenditure but the balance 50% is definitely in the nature of fees for
technical service (FTS) and such an expenses has to be seen from the angle,
whether they are in the nature of FTS or not. She further submitted that the
decision of Metchem Canada Inc.(supra) relied upon by the learned counsel has not
considered the true purport of section 44C and the mischief it sought to curb. Thus,
she strongly relied upon the order of the AO and submitted that the AO has rightly
considered these expenses u/s. 44C and in any case part of these payments will
definitely fall with the purview of head office expenses, which should be directed to
be considered by the AO.
13. We have heard the rival submissions, perused the relevant findings given in
the impugned orders. The sole issue before us is, whether the payment of `license
fees' and `management services' for sums aggregating to Rs.18,32,12,834/- are in
the nature of `head office expenses' with the ambit of section 44C or not, so as to
make the disallowance under the said section. The assessee here is an Indian
branch of UK based, Lloyd's Register Asia, which in turn is a subsidiary of a holding
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company, Lloyd's Register UK. The said companies are into business of survey and
inspection of the ships. Lloyd's Register UK had entered into license agreement
dated 16.07.2003 with various legal entities, which included Lloyd's Register Asia,
who have been referred to as licensees. The licensor (i.e. Lloyd's Register UK) owns
trademark and trade name and other business intangible, which has been referred
to as intellectual property rights. It also provides general, technical and market
support services to all the licensees. For the use of intellectual property rights and
the technical & marketing support services, license fees (which is royalty) is payable
by the licensee to the licensor, as per the details given in Schedule 6, which reads
as under:-
"The amount of licensee fees chargeable to an individual licensee will be
calculated on the residual profit split method according to the table as set out
below. The residual profit percentages are the relevant profits before tax
before charging the applicable licence fees ("PBT")
PBT percentages Licence Fee
a) No PBT No charge
b) Up to 1% Amount of PBT
c) 1 to 5% 1% of net sales price of external sales
d) 5 to7.5% The result in c) plus 50% of PBT over 5%
e) 7.5% to 9% The result in d) plus 2/3 of PBT over 7.5%
f) In excess of 9% The result in e) plus 75% of PBT over 9%
The Lloyd's Register Asia has allocated the royalty attributable to its Indian branch
and the Indian branch pays the same to Lloyd's Register Asia, which in turn has
been paid to Lloyd's Register UK. Apart from this, management service agreement
dated 16.07.2003 between Lloyd's Register and Lloyd's Register Asia had been
entered into for providing host of specialized services under the following heads:-
· Corporate communications
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· Corporate finance and group reporting services
· Group quality assurance
· Human resources
· Information technology
· Integrated business system (IBS project)
· Internal audit services
· Legal services
· Operational management and reporting (mainly provided by regional and
area management centres)
· Risk management and secretarial services and
· Taxation and treasury services.
The determination of fees has been enumerated in Schedule 4 of the said
management services agreement. Now in the light of these facts, we have to
examine, whether the aforesaid nature of expenses can be said to be in the nature
of head office expenditure within the ambit of section 44C. If such expenditures do
not fall within section 44C, then other limbs of the arguments as raised by the
earned Senior Counsel before us, will become purely academic.
14. Section 44C, is a non obstante clause stating that "notwithstanding anything
to the contrary contained in sections 28 to 43A in the case of an assessee, being
non-resident, no allowance shall be made in computing the income chargeable
under the head "Profits and gains of business or profession", in respect of so much
of expenditure in the nature of head office expenditure as is in excess of the
amount computed as an amount equal to five percent of the adjusted total income ;
or the amount of so much of the expenditure in the nature of head office
expenditure incurred by the assessee as is attributable to the business or profession
of the assessee in India, whichever is less". The meaning of the term "head office
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expenditure" for the purpose of section 44C has been enumerated in clause (iv) of
Explanation to section 44C. The said clause reads as under:
"iv) "head office expenditure" means executive and general
administration expenditure incurred by the assessee outside India,
including expenditure incurred in respect of -
(a) rent, rates, taxes, repairs or insurance of any premises outside
India used for the purposes of the business or profession;
(b) salary wages, annuity, pension, fees, bonus, commission, gratuity,
perquisites or profits in lieu of or in addition to salary, whether
paid or allowed to any employee or other person employed in, or
managing the affairs of, any office outside India;
(c) travelling by any employee or other person employed in, or
managing the affairs of, any office outside India; and
(d) such other matters connected with executive and general
administration as may be prescribed.
From the aforesaid definition/illustration of the scope of head office expenditure, it
is evident that it is in the nature of executive and general administration
expenditure incurred by the assessee outside India. The nature of such expenditure
has been illustrated to include certain kinds of expenditure. From the nature of
expenditure as enumerated in sub clause (a) to sub clause (c) of the aforesaid
Explanation and if compared with the nature of expenditure incurred by the
assessee branch, then it will be seen that none of the expenditure under the head
"license fees" falls within this category, even remotely. The payment of `license fee'
is purely for using of brand/trademark and other business intangibles, which are in
the nature of intellectual property. Nowhere such types of expenditure fall within
the scope of "head office expenditure" as illustrated in clause (iv). So far as
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general, technical and marketing support services are concerned, they are in the
following nature:
- Provision of sales and marketing materials including brochures and product
factsheet.
- Provision of market research data and analysis
- Provision of training and standards for use by operations and their clients in
training surveyors, inspectors and assessors
- Technical support and advice on the technology documents including
product updates and the marketing and sale thereof
- Specialised technical services such as Ship Emergency Response procedures,
Condition Assessment Programme procedures and Fuel and Lubricant
Analysis procedures
- Co-ordination function for marketing and sales activities in relation to major
contract opportunities and/or quotations for specialized industrial sectors
- Sales support in respect of global customer accounts.
These again are neither in the nature of rent, rates, taxes, repairs, insurance,
salary, wages, bonus, commission, etc., or travelling by any employee. Expenditure
under the "License fee" have nothing to do with these kind and nature of
expenditures. Thus, the entire payment of license fees do not fall within the ambit
of section 44C as illustrated in clauses (a) to (c) of the Explanation and, therefore,
the learned CIT(A) has rightly held that royalty or license fees expenditure cannot
be treated as head office expenditure.
15. Now coming to the nature of head office expenditure under clause (d) of the
Explanation i.e. "such other matters connected with executive and general
administration as may be prescribed". Such an exercise for illustrating the said
expenditure under the said sub clause has to be prescribed by the CBDT. However,
no such illustration has been given or prescribed by the Board, atleast nothing has
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been brought before us that CBDT has issued any Circular or clarification illustrating
"such other matters connected with executive and general administration".
Therefore, it cannot be held that the nature of expenses under the head license fees
falls even under sub clause (d).
16. Now coming to the "management charges", it can be noticed from the nature
of expenses as elaborated in Schedule 3 of management services agreement dated
16.07.2003, prima facie they are specialized services under various heads as
enumerated above in para 13. None of these services are in the nature of head
office expenditure as illustrated in sub clause (a) to (d). For computing the
deduction of head office expenditure, it is sine-qua-non that the nature of head
office expenses must fall within the illustration given in clause (iv) of Explanation. If
any expenditure itself is beyond the scope of head office expenditure, then needless
to say that, it cannot be brought within ambit of section 44C. The learned CIT(A)
has held that the 50% of management fees is hit by section 44C, without even
analyzing the nature of expenses, as how or how much they fall within the scope
and ambit of nature of head office expenditure as defined in Section 44C. In the
appellate order of Lloyd's Register India office, which has been followed by the
learned CIT(A), it is seen that 50% of the management charges has been treated as
taxable fees for technical services and balance 50% as head office expenses.
However, the learned CIT(A) in the impugned case of the assessee has merely
stated that 50% of the management fees is hit by section 44C, whereas for the
balance he has not held that it is in the nature of FTS and here it is not the case of
the AO. Even in the revenue's grounds of appeal, it has not been challenged that
50% of the management charges/license fees are in the nature of FTS. Thus, we
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need not go on the issue of FTS as neither it is a case of the AO nor the case of the
CIT(A). Otherwise also, the technical fees are not covered under the head office
either executive or general administration expenditure as specified in section 44C.
This aspect of the matter has been clarified vide Board Circular no.649 dated
31.03.1993, reported in (1993) 200 ITR (ST) 230. Lastly, fees for technical services
in the case of a non-resident companies has to be seen in accordance with the
DTAA read with I T Act, which here in this case need not be gone into as it is not
the case of the revenue.
17. Thus, in our conclusion, neither the payment of "license fees" nor the
"management charges", falls within the ambit and purview of section 44C and,
accordingly, the nature of adjustment to the total income for the purpose of
disallowance is not required.
18. As regards the other arguments of the learned senior counsel Shri Dastur,
that these expenditure are in the nature of reimbursement and hence in view of
Article 7 read with para 5 & 7, no disallowance of head office expenditure in the
present case can be made, though prima facie, we agree with the contention of
Shri Dastur, however, in view of our finding given above, this plea has become
purely academic. All the other arguments as raised by the learned senior counsel
have also become purely academic and are left open.
19. Accordingly, in view of our finding given above, we hold that "license fees"
and "management charges" do not fall in the nature of head office expenses u/s.
44C and accordingly, the disallowance made by the AO and partly confirmed by the
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CIT(A) stands deleted. As a consequence, the assessee's grounds are treated as
allowed and the revenue's grounds are dismissed.
20. In the result, the assessee's appeal is allowed and the revenue's appeal is
dismissed.
Order pronounced in the open court on this day of 10th June 2015.
Sd/- Sd/-
(D Karunakara Rao) (Amit Shukla)
ACCOUNTANT MEMBER JUDICIAL MEMBER
Mumbai; Dated : 10th June, 2015.
SA
Copy of the Order forwarded to :
1. The Appellant.
2. The Respondent.
3. The CIT(A), Mumbai.
4. The CIT
5. The DR, `L' Bench, ITAT, Mumbai
BY ORDER,
//True Copy//
(Dy./Asstt. Registrar)
Income Tax Appellate Tribunal, Mumbai
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