2014 (11) TMI 845 - AT - Income Tax

Rate to be taken for computing arm s length interest - Primary lending rate or LIBOR rate Held that - Identical issue has been considered in Aurionpro Solutions Ltd. Versus Additional Commissioner of Income-tax, Range - 4(3), Mumbai 2013 (11) TMI 806 - ITAT MUMBAI wherein it has been held that the underlining principle of determining the ALP is based on the transaction between the unrelated parties - The income of the assessee should not be effected as reduced and it is compared with the income or expenditure as the case may be earned or incurred by the assessee, if it would have been between the assessee and the unrelated parties - the assessee is a tested party and economic/commercial as well as geographical condition in which the assessee is doing business are relevant to be considered for the purpose of determining the arm s length price the AO/TPO is directed to determine the arm s length price by considering the LIBOR 2% on the loan given to the AE. Addition of Notional Interest - Loan Given to Subsidiaries/Associate Enterprise Held that - Assessee has submitted that when no interest was charged by the assessee as per the agreement on moratorium for one year, then no notional interest can be added under transfer pricing adjustment - The transaction of loan given to the AE is an international transaction and subjected to ALP as per the transfer pricing provisions of Income Tax Act - The assessee has raised an alternative plea that even in case the transfer pricing provisions are applicable in respect of the non charging of interest on loan given to AE, it is not taxable in India as per the provisions of Article 11 of Indo-Mauritius DTAA because the said interest was not paid to the assessee - the provisions of Article 11 are applicable in the case of interest arising in the contracting state and paid to the resident of another contracting state. It is contemplated under Article 11 of DTAA that the payment is a condition for taxing the interest only in the circumstances when the interest is arising in the contracting state and accrued to the resident of another contracting state and, it is subjected to tax in the other state when it is paid - the provisions of Article 11 defers the taxability of the interest arising but not received and, therefore, it is taxed only when it is received - Article 11 does not exempt the interest arising in a contracting state and accrued to a resident of other contracting state but it makes the same taxable on the event of payment - when the assessee has not even admitted the interest arised and accrued to the assessee on the loan given to the AE for the AY under consideration, therefore, the provisions of Article 11 of Indo-Mauritius treaty cannot be pressed into service. Adjustment of interest on share application money in overseas subsidiary Held that - Following the decision in Bharti Airtel Limited Vs. Addl. CIT 2014 (3) TMI 495 - ITAT DELHI - there is no finding about what is the reasonable and permissible time period for allotment of shares, and even if one was to assume that there was an unreasonable delay in allotment of shares, the capital contribution could have, at best, been treated as an interest free loan for such a period of inordinate delay and not the entire period between the date of making the payment and date of allotment of shares - Even if ALP determination was to be done in respect of such deemed interest free loan on allotment of shares under the CUP method, as has been claimed to have been done in this case, it was to be done on the basis as to what would have been interest payable to an unrelated share applicant if, despite having made the payment of share application money, the applicant is not allotted the shares - it was unreasonable and inappropriate to treat the transaction as partly in the nature of interest free loan to the AE - Since the TPO has not brought on record anything to show that an unrelated share applicant was to be paid any interest for the period between making the share application payment and allotment of shares, the very foundation of impugned ALP adjustment is devoid of legally sustainable merits - the authorities below were in error in treating the payment of share application money, as partly in the nature of interest free loans to the AEs, and, accordingly, ALP adjustment based on that hypothesis was devoid of legally sustainable merits thus, the matter is to be remitted back to the AO/TPO for reconsideration. Equity investment in overseas subsidiary Transaction treated as international and full amount added to assessee s income Held that - The assessee has not produced any valuation or other material to show that the investment made in the subsidiary at par is at arm s length - The assessee has placed reliance on the valuation report of KPMG based of DCF method - in case of investment in the 100% subsidiary of the assessee, the valuation has to be future prospective earning on the capital and should not be based on the present net worth of the subsidiary - Since the investment is for long term and not for earning the capital gain, the valuation should have been based on the discounted cash flow method (DCF) - Since no such report was produced by the assessee before the TPO/AO thus, the matter is to be remitted back to the AO for reconsideration Decided in favour of assessee. Secondary transfer pricing adjustment - Capital infused by the assessee in its subsidiary Held that - The adjustment on account of notional interest on the additional capital infused by the assessee in the subsidiary is over and above, the adjustment of the entire capital investment amount - it is not an alternative but it is an adjustment of over and above of the entire amount of capital investment DRP was rightly of the view that the transfer pricing adjustment on account of the additional capital infusion has already been made and approved - The transfer pricing provisions in the Act does not envisage the concept of secondary transfer pricing adjustment and as a concept secondary adjustment is alien to the Indian transfer pricing law the order of the DRP is upheld Decided against revenue.

Summary

Issues Involved:
1. Addition of notional interest on account of loan given to Associate Enterprise (AE).
2. Treating share application money in an overseas subsidiary as an international transaction and adding notional interest income.
3. Treating equity investment in an overseas subsidiary as an international transaction and adding to the total income.
4. Secondary transfer pricing adjustment in respect of capital infused in the subsidiary.
5. Violation of the principle of natural justice regarding the reference to the Transfer Pricing Officer (TPO).

Issue-wise Detailed Analysis:

1. Addition of Notional Interest on Account of Loan Given to AE:
The assessee contested the addition of Rs. 1,14,01,627/- on account of notional interest charged on loans advanced to its subsidiaries, arguing that the interest charged was higher than the LIBOR rate and thus at arm's length. The TPO, however, determined the arm's length interest rate to be 15% by considering the borrowing rate of the assessee from its bankers plus a 3% markup due to the lack of security on the loans. The DRP upheld this view, stating that the LIBOR rate is not applicable for funds lent from India. The Tribunal, following previous decisions, directed the TPO to determine the arm's length interest by considering LIBOR + 2%.

2. Treating Share Application Money in Overseas Subsidiary as an International Transaction:
The assessee argued that the share application money should not be treated as a loan and thus not subject to notional interest. The TPO had re-characterized the share application money as a loan due to the delay in share allotment and computed notional interest. The Tribunal referred to the decision in Bharti Airtel Limited vs. Addl. CIT, which held that re-characterizing a capital contribution as a loan is not permissible unless it is a sham transaction. The Tribunal remitted the issue back to the TPO to reconsider the arm's length interest based on the actual delay in share allotment.

3. Treating Equity Investment in Overseas Subsidiary as an International Transaction:
The TPO treated the entire investment of Rs. 14,15,00,170/- in the subsidiary as an international transaction and added it to the total income, arguing that the book value of the shares was negative. The DRP confirmed this adjustment. The Tribunal noted that the valuation should be based on the discounted cash flow method (DCF) rather than the net worth method and remitted the issue back to the TPO for reconsideration based on the DCF valuation.

4. Secondary Transfer Pricing Adjustment in Respect of Capital Infused in the Subsidiary:
The TPO made an additional adjustment of Rs. 87,71,641/- on account of notional interest on the capital infused in the subsidiary. The DRP directed the deletion of this adjustment, stating that secondary adjustments are not envisaged under Indian transfer pricing law. The Tribunal upheld the DRP's decision, noting that secondary adjustments are not permissible.

5. Violation of the Principle of Natural Justice:
The assessee raised an additional ground, arguing that the Assessing Officer violated the principle of natural justice by not providing an opportunity of hearing before referring the issue to the TPO. The Tribunal dismissed this ground, stating that the provisions of section 92CA do not mandate an opportunity of hearing before making a reference to the TPO.

Conclusion:
The Tribunal partly allowed the assessee's appeal, directing the TPO to reconsider certain adjustments based on the LIBOR rate and DCF valuation. The revenue's appeal was dismissed, and the additional ground raised by the assessee regarding the principle of natural justice was also dismissed.