2013 (8) TMI 701 - AT - Income Tax

Disallowance u/s 36(1)(ii) - Interest expenses on borrowed funds - loan/ advances to subsidiary companies - Held that - AO made disallowance of interest of Rs.5,74,25,564/- in assessment year 2002-03 for similar reasons as stated in the assessment year under consideration. We observe that the ld. CIT(A) confirmed the action of AO. But the Tribunal in further appeal after considering the submissions of the assessee vide para 11 at page 9 of the order allowed the claim of the assessee. It is relevant to state that the Tribunal has stated that ld. CIT(A) in the next assessment year viz assessment year 2003-04 himself allowed the relief to the assessee. Tribunal allowed the claim of the assessee in AY 2002-03 after observing that in case business of subsidiary is collapsed it will have severe repercussions on the assessee company. That the synergies of the business operation of the assessee company and its subsidiaries were re-aligned and the functions of the various companies were made complimentary and supplementary to each other, so as to avoid duplication of interest and deriving maximum value in its operation. That each company is inter dependent on the other. That the survival of assessee is also at stake, if the subsidiaries fail. The Tribunal also observed that section 14A of the Act would also not come in the way for the reasons that the majority of the subsidiaries are foreign subsidiaries and the question of section 14A being applied for dividend received from them does not arise. The Tribunal also held that section 14A and section 36(1) (iii) operate in different fields - investment in shares in e-Capital Solution were through Share Swap and not shares investment were made in cash. That the assessee acquired shares in e-Capital Solution not by payment of cash but by issue of its own shares to the sellers of the said shares after taking approval from Reserve Bank of India. Thus, question of using of borrowed funds for acquiring shares in e-Capital Solution does not arise - there is no infirmity in the order of ld. CIT(A) in deleting the disallowance of interest expenditure made by AO - Decided against Revenue. Transfer Pricing adjustment - CIT deleted addition - Held that - issue requires reconsideration by TPO and therefore matter be restored to AO to determine ALP including applicability of method to be adopted. Hence, the orders of authorities below is set aside and the matter is restored to the file of AO to determine ALP of transactions of the assessee with Associated Enterprises afresh after giving due opportunity of hearing to the assessee by a reasoned order and in accordance with law - Decided in favour of Revenue.

Issues Involved:
1. Disallowance of Interest Expenses
2. Transfer Pricing Adjustment

Detailed Analysis:

1. Disallowance of Interest Expenses:

The primary issue in this appeal was whether the interest expenses of Rs.7.98 crores paid on borrowings by the assessee should be allowed. The Assessing Officer (AO) disallowed these expenses, arguing that the assessee failed to establish the commercial expediency of the funds advanced to its subsidiaries and employees. The AO noted that the assessee's own funds were wiped out due to accumulated losses, and thus, the interest-bearing funds were used for non-business purposes.

The assessee contended that the interest expenditure was incurred purely for business purposes and out of commercial expediency. It was argued that the investments in subsidiaries were crucial for the survival of the assessee's business, and the funds were advanced to protect its business interests. The assessee also argued that the investments were made from its own resources or interest-free funds available with the company.

The Commissioner of Income Tax (Appeals) [CIT(A)] agreed with the assessee, stating that the interest expenditure was incurred out of commercial expediency. The CIT(A) noted that the investment in e-Capital Solution was made through a share swap and not in cash, and the investment in Applisoft Inc. (USA) was for business purposes. The CIT(A) relied on various judicial precedents, including the Supreme Court's decision in S.A. Builders Ltd. v. CIT (288 ITR 1), which held that interest-free loans given to subsidiaries for commercial expediency do not give rise to any interest disallowance.

The Tribunal upheld the CIT(A)'s decision, noting that similar disallowances were deleted in earlier years for the same reasons. The Tribunal observed that the investments in subsidiaries were made for commercial considerations and were crucial for the survival of the assessee's business. Therefore, the Tribunal upheld the deletion of the disallowance of interest expenses.

2. Transfer Pricing Adjustment:

The second issue involved the addition of Rs.73,92,756/- made by the AO based on the Transfer Pricing Officer's (TPO) determination of the Arm's Length Price (ALP) using the Transactional Net Margin Method (TNMM). The assessee had initially used the Comparable Uncontrolled Price (CUP) method to determine the ALP.

The assessee argued that the TPO erroneously resorted to the TNMM method despite the availability of direct comparables using the CUP method. The CIT(A) accepted the assessee's contention and deleted the addition made on account of transfer pricing adjustment.

The Department argued that the assessee did not furnish external CUP data before the TPO and that the CIT(A) accepted additional evidence without referring it to the TPO. The Department also contended that the standards of comparability for the CUP method are stringent and should be accurate.

Both parties agreed that the matter should be reconsidered by the TPO. The Tribunal set aside the orders of the authorities below and restored the matter to the AO to determine the ALP afresh, including the applicability of the method to be adopted, after giving due opportunity of hearing to the assessee.

Conclusion:

The Tribunal upheld the deletion of the disallowance of interest expenses, agreeing with the CIT(A) that the interest expenditure was incurred out of commercial expediency. However, the Tribunal set aside the transfer pricing adjustment and restored the matter to the AO for fresh determination of the ALP, including the applicability of the method to be adopted. The appeal of the department was allowed in part for statistical purposes.

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