2016 (2) TMI 196 - AT - Income Tax

Transfer pricing adjustment - advance to subsidiary - addition on interest charged on advances to the subsidiaries - Held that - It cannot be said that the advance to subsidiary, at 247 basis points above the LIBOR, is not at an arm s length price. In any event, once DRP itself states that the Indian banks are charging 250 basis above LIBOR on similar loans, even though this interest rate could reach upto 400 basis points in some cases, there cannot be any good reason for holding that loan advanced to a subsidiary at 247 basis points above the LIBOR rate is not at an arm s length price. That apart, as noted earlier in this order, once Hon b;le Delhi High Court, observes that the assessee advanced monies to the subsidiaries which were under its management and control, which in fact substantially reduced the risk and in these circumstances there was no rationale of adjusting any amount of higher basis , it cannot be open to the transfer pricing authorities to contend that this loan should be treated as a high risk loan on which high interest rate should be charged even within the range of interest rates charged by the Indian banks generally. In view of these discussions, as also bearing in mind entirety of the case, we uphold the grievance of the assessee and direct the Assessing Officer to delete this arm s length price adjustment in respect of interest charged on advances to the subsidiaries. Disallowance under section 14A - Held that - Having noted the uncontroverted claim of the assessee that borrowed funds are not used in investments yielding the tax exempt in question, we are of the considered view that no part of the interest could be disallowed under rule 8D. The question of allocation of interest could arise only in a situation in which at least a part of borrowed funds are used in investments resulting in tax exempt income. That s not the case here and none of the authorities even allege that. Accordingly, the disallowance under rule 8D remains restricted to 0.5% of the average value of investments resulting in tax exempt income. The Assessing Officer will, accordingly, recompute the disallowance under section 14A r.w.r. 8 D.

Summary

Issues Involved:
1. Arm's Length Price (ALP) adjustment of Rs. 74,20,785 in respect of interest charged on a loan advanced to a subsidiary abroad.
2. Disallowance of Rs. 38,35,298 under section 14A of the Income Tax Act.
3. Disallowance of Rs. 3,98,750 as capital expenditure in respect of the purchase of FWP (fixed wireless phone) equipment.

Issue-wise Detailed Analysis:

1. Arm's Length Price (ALP) Adjustment:
The assessee had advanced a loan of US $1,08,50,000 to its subsidiary in Cyprus at an interest rate of 7% p.a. The Transfer Pricing Officer (TPO) considered the subsidiary financially weak and high-risk, justifying an interest rate of 17.26% p.a. The Dispute Resolution Panel (DRP) disagreed with the TPO's use of rupee-denominated loan rates but agreed on a BB credit rating and suggested a rate of 4% above LIBOR, leading to an ALP adjustment of Rs. 74,20,785.

The Tribunal noted no dispute on the LIBOR rate (4.53%) and observed that the assessee's rate (7%) was within an acceptable range above LIBOR. The Tribunal referenced the Bharti Airtel case, where a similar adjustment was deleted, and the High Court upheld that loans to subsidiaries under management control reduce risk. The Tribunal found the DRP's approach flawed and directed the deletion of the ALP adjustment of Rs. 74,20,785.

2. Disallowance under Section 14A:
The assessee received tax-exempt dividends of Rs. 21,47,983 and claimed no borrowed funds were used for the investments yielding this income. The Assessing Officer applied Rule 8D, resulting in a disallowance of Rs. 38,35,298, upheld by the DRP.

The Tribunal, referencing the Champion Commercial case and the Delhi High Court's decision in Bharti Overseas, held that Rule 8D should only apply to common interest expenses. Since the investments were not from borrowed funds, no interest disallowance was warranted. The Tribunal directed the Assessing Officer to recompute the disallowance under section 14A, restricting it to 0.5% of the average value of the investments.

3. Disallowance as Capital Expenditure:
The assessee contested the disallowance of Rs. 3,98,750, arguing it was not capital expenditure. The Tribunal noted a lack of clear findings on whether the expenditure was for security deposits or WLL phones and remitted the matter back to the Assessing Officer for fresh adjudication.

Conclusion:
The appeal was partly allowed, with the ALP adjustment deleted, the section 14A disallowance to be recomputed, and the capital expenditure issue remitted for fresh adjudication.