2016 (3) TMI 1337 - AT - Income Tax

Disallowance of proportionate interest on capital work-in-progress u/s 36(1)(iii) - assessee had not established availability of interest free funds for making advances for purchase of units at Bharat Diamond Bourse and Gujarat Hira Bourse - Held that - As relying on assessee s own case for the assessment years 2006-07 and 2007-08 deduction was allowable since the loan taken was working capital on which the interest was paid and no interest has been paid on the loan taken from Directors/shareholders/ex-partners. Claim of deduction u/s 10AA made by the assessee in respect of the profits arising out of trading activity - whether trading is covered within the definition of services under the SEZ Rule - Held that - As relying on assessee s own case for the assessment years 2006-07 and 2007-08 CIT(A) had allowed deduction u/s.10AA on goods exported and imported from SEZ. It was also observed that no such benefit should be given for the local purchase and sale made by the appellant. The AO is directed to follow the direction of the Hon ble ITAT and delete the disallowances after due verification. Further, the effect of the disallowance upheld with reference to FD interest as discussed also has to be taken into account while giving effect to this order TPA - arm s length price adjustment in respect of realization of export proceeds beyond 180 days from the AEs - Recharcaterization of transaction as an unsecured loan - Held that - This is uncontroverted stand of the assessee that he has not charged interest on delay in realization of debts in non AE situations as well. Once it is not in dispute, as is the case before us, that no interest is charged from the non AEs, i.e. independent transactions, as well, there cannot be any occasion to make an ALP adjustment, for notional interest, on delay in realization of trade debts from the AEs. The very purpose of the arm s length price adjustments is to neutralize the impact of intra AE relationship on commercial transaction, but, given the above facts, there is no impact of intra AE relationship in the above case. As regards, the rechracterization of transaction as an unsecured loan, we find that CIT Vs EKL Appliances Limited 2012 (4) TMI 346 - DELHI HIGH COURT has held that recharacterization of a transaction is possible in only two situations i.e. (i) where the economic substance of a transaction differs from its form and (ii) where the form and substance of the transaction are the same but arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner. None of these conditions is satisfied in the present case. The form and substance of the transactions are the same. The Transfer Pricing Officer has not brought on record any material to demonstrate and establish that the form and substance of transactions are different. It is not, and it cannot be, the case of the Transfer Pricing Officer that the export transaction was a sham transaction to finance the AE. The assessee has also behaved in a commercially rational manner inasmuch as whatever are the terms of realization of his exports proceeds, the same are the terms of realization of exports from the non AEs. Recharcaterization of this transaction, therefore, is not permissible. The very foundation of the Transfer Pricing Officer is thus wholly unsustainable in law. - Decided in favour of assessee.

Issues Involved:
1. Deletion of disallowance of proportionate interest on capital work-in-progress under section 36(1)(iii) of the Income Tax Act.
2. Deduction under section 10AA for profits arising from trading activity.
3. Arm’s length price adjustment for delayed export payments received from Associated Enterprises (AEs).

Detailed Analysis:

1. Deletion of Disallowance of Proportionate Interest on Capital Work-in-Progress:
The Assessing Officer (AO) contested the CIT(A)’s decision to delete the disallowance of proportionate interest on capital work-in-progress under section 36(1)(iii) of the Income Tax Act. The AO argued that the assessee had not established the availability of interest-free funds for making advances for the purchase of units at Bharat Diamond Bourse and Gujarat Hira Bourse. However, the Tribunal noted that this issue was directly covered by decisions of the co-ordinate benches in the assessee’s own case for the assessment years 2006-07 and 2007-08. The CIT(A) had followed these decisions, directing the AO to delete the disallowance. Respectfully following the co-ordinate bench's views, the Tribunal upheld the CIT(A)’s conclusions and dismissed the AO’s ground.

2. Deduction Under Section 10AA for Profits Arising from Trading Activity:
The AO argued that the CIT(A) erred in allowing the claim of deduction under section 10AA for profits arising from trading activities, asserting that trading does not fall within the definition of 'services' under the SEZ Rule. The CIT(A) had allowed the deduction following the decisions of the co-ordinate bench in the assessee’s own case for the assessment years 2006-07 and 2007-08. The Tribunal, respecting the views taken by the co-ordinate bench, saw no reason to take a different view and upheld the CIT(A)’s decision, directing the AO to delete the disallowances after due verification. Consequently, the AO’s appeal on this ground was dismissed.

3. Arm’s Length Price Adjustment for Delayed Export Payments:
The assessee contested the arm’s length price adjustment of ?1,17,00,000 made by the AO for delayed export payments received from AEs beyond 180 days. The Transfer Pricing Officer (TPO) had proposed this adjustment, treating the extra credit period as a loan given to the AE and computed the adjustment based on 18% per annum interest. The Tribunal noted that the assessee did not charge interest on delayed realization from non-AEs, which was an uncontroverted stand. Citing the Delhi High Court’s decision in CIT Vs EKL Appliances Limited, the Tribunal stated that recharacterization of a transaction is permissible only when the economic substance differs from its form or the arrangements would differ from those adopted by independent enterprises behaving in a commercially rational manner. Neither condition was satisfied in this case. The Tribunal also referred to its own decision in the case of Rusabh Diamonds Vs. ACIT, where it held that no separate adjustment for delay in realization of debts is warranted when the sale is benchmarked on TNMM basis. The Tribunal concluded that the TPO’s adjustment was unsustainable in law and directed the AO to delete the impugned ALP adjustment of ?1,17,00,000. Consequently, the assessee’s appeal was allowed.

Conclusion:
The appeal filed by the Assessing Officer was dismissed, and the appeal filed by the assessee was allowed. The Tribunal upheld the CIT(A)’s decisions on all grounds, following the precedents set by co-ordinate benches and relevant judicial decisions. The judgment was pronounced in the open court on 31st March 2016.

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