2014 (12) TMI 428 - AT - Income Tax

Determination of ALP - Adjustment of stated value of international transaction with AE - determination of income arising from an international transaction Held that - As per the assessee all the advances made to the associated enterprises are not in the nature of loans and it is canvassed that even if an adjustment for non-charging of interest is to be made the same ought to be made with reference to the LIBOR rate and not in the manner made by the TPO the amount of share application money is outstanding as the investee company has not issued shares to the assessee till the close of the previous year under consideration - the action of the TPO in changing the characteristic of the transaction of payment of share application money as an interest-free loan is unwarranted and beyond his jurisdiction which carrying out the transfer pricing proceedings - There is no provision of law which enables the TPO to change the character of a transaction while subjecting it to the process of determination of arm s length price - The TPO was required to benchmark such transactions against a similarly placed transaction and not deem the transaction to be a lending or borrowing transaction - a transaction of advancing loans is within the purview of transfer pricing mechanism and the arm s length price computed thereof is includible in the assessable income of the assessee. Where the character of payment is towards share application money thereby reflecting a capital investment and the same not having been disputed by the TPO such a transaction cannot be subject to an arm s length price adjustment under the plea of it being a transaction of lending or borrowing - the TPO was not justified in treating the aforesaid transaction as being an interest-free lending transaction entered with the associated enterprise - the transaction would have entailed charging of interest for the period between payment of share application and the date of allotment of shares - the approach of the authorities below in the context of the aforesaid amount of 9, 91, 39, 000/- by treating it to be a transaction in the nature of interest-free lending transaction per se and subjecting it to an arm s length price adjustment is erroneous and unwarranted. Amount converted into interest free loan Unrealized consideration of sales Held that - A transaction of interest free lending is liable to be subject to arm s length price adjustment so however where the lending has occurred on the last day of the previous year no adjustment would be necessary for the relevant year there was no determination by the TPO or the AO regarding assessee s plea that outstanding debtor s balance has been converted into loan on the last day of previous year thus the matter is to be remitted back to the AO. Loan advanced to TTD which is the opening balance Held that - The plea of the assessee is quite justified because the transaction is not a lending or borrowing between two domestic entities - The transaction is between two cross-border entities and is in foreign currency and therefore such a transaction is bound to be examined in the context of the prevailing lending practices in the international market - the domestic bank rate is not a sound basis and instead internationally accepted rate of LIBOR is certainly a better benchmark in order to compute the arm s length price interest rate in respect of the impugned transactions the AO is directed to cull out the average of the LIBOR rate and thereafter compute appropriate arm s length price adjustment with respect to interest component of the transactions of advancing interest-free loans to associated enterprises Decided in favour of assessee. Disallowance of interest expenses Held that - Interest expenditure is allowable u/s 36(1)(iii) of the Act so long as the corresponding funds have been utilized for the purposes of business - the addition has been made in disregard to the plea of the assessee that the Finance costs are relatable to funds used for the purposes of business - there is nothing to suggest that the same is for non-business purposes and the addition has been made by the AO mechanically - the action of the AO cannot be sustained in disallowing the expenditure thus the matter is remitted bak to the AO for fresh disposal Decided in favour of assessee.

Summary

Issues Involved:
1. Adjustment to the stated value of international transactions to bring them to arm's length price.
2. Disallowance of interest expenditure.
3. Additional ground of appeal regarding notional corporate guarantee fee.

Issue-wise Detailed Analysis:

1. Adjustment to the Stated Value of International Transactions:
The primary dispute is the addition of Rs. 2,38,00,879/- by the Assessing Officer (AO) due to adjustments made to the value of international transactions with associated enterprises to align them with the arm's length price as per Section 92(1) of the Income Tax Act, 1961. The transactions included export of engineering services, loans and advances to associated enterprises, and conversion of debtors into loans.

The AO referred the matter to the Transfer Pricing Officer (TPO), who determined an adjustment of Rs. 2,38,00,870/- for non-charging of interest on loans and advances. The Dispute Resolution Panel (DRP) upheld this adjustment. The assessee argued that the loans were given out of internal accruals and interest-free loans from promoters/directors, and that no real income had accrued since no interest was charged. However, the tribunal found that the plea of commercial expediency was not a valid defense against transfer pricing adjustments. The TPO's rejection of the assessee's plea was justified, following the precedent set by the Delhi Bench of the Tribunal in Perot Systems TSI (India) Ltd. vs. DCIT.

The tribunal also addressed the assessee's argument that adjustments should be based on the LIBOR rate rather than the domestic interest rate of 14.75%. The tribunal agreed, directing the AO to use the LIBOR rate to compute the arm's length price adjustment.

2. Disallowance of Interest Expenditure:
The AO disallowed Rs. 80,01,223/- of interest expenditure, stating that the assessee failed to justify the interest expenditure with documentary evidence. The DRP upheld this disallowance. The assessee contended that the finance cost represented interest on various business-related loans and advances made in the course of business. The tribunal found that the addition was made mechanically without considering the assessee's explanation and supporting evidence. The tribunal set aside the AO's order and directed a reappraisal of the factual matrix, allowing the assessee an opportunity to present material and submissions in support of its claim.

3. Additional Ground of Appeal - Notional Corporate Guarantee Fee:
The assessee raised an additional ground challenging an arm's length price adjustment of Rs. 11,57,367/- on account of notional corporate guarantee fee determined by the TPO. However, this adjustment was not reflected in the final assessment order. The tribunal dismissed this ground as premature and infructuous, noting that adjudication at this stage would be a mere academic exercise in the absence of any determined tax liability.

Conclusion:
The tribunal directed the AO to re-compute the arm's length price adjustment using the LIBOR rate and to reappraise the disallowance of interest expenditure, allowing the assessee to present further evidence. The additional ground regarding the notional corporate guarantee fee was dismissed as premature. The appeal was partly allowed.