2016 (11) TMI 1671 - AT - Income Tax

TP Adjustment - upward adjustment of notional guarantee fees made by AO u/s 92CA - HELD THAT - We find that this issue is now covered, in favour of the assessee, by a decision of the coordinate bench in the case of Siro Clinpharm Pvt Ltd Vs DCIT and vice versa 2016 (5) TMI 633 - ITAT MUMBAI . While holding that no arm s length price adjustment can be made in the hands of the assessee, on respect of corporate guarantees issued without incurring any costs, As amendment in Section 92B, at least to the extent it dealt with the question of issuance of corporate guarantees, is effective from 1st April 2012. The assessment year before us being an assessment year prior to that date, the amended provisions of Section 92 B have no application in the matter. For this reason also, the impugned ALP adjustment must stand deleted. See ANSAL LAND MARK TOWNSHIP (P) LTD. 2015 (9) TMI 79 - DELHI HIGH COURT - Decided in favour of assessee. Disallowance u/s 14A - as per assessee no expenditure was incurred to earn such exempt income - HELD THAT - We are inclined to accept the plea of the assessee to the extent that no part of interest expenses can be disallowed under section 14A inasmuch as the assessee indeed had interest free funds much in excess of investments yielding tax exempt income. Because of an inherent flaw in the formulae set out in rule 8D(ii), as noted by a coordinate bench in the case of ACIT Vs Champion Commercial Co Ltd 2012 (10) TMI 24 - ITAT, KOLKATA and as approved by Hon ble Delhi High Court in the case of PCIT Vs Bharti Overseas Pvt Ltd 2015 (12) TMI 1423 - DELHI HIGH COURT application of this formulae does give incongruous result inasmuch as when no part of interest bearing funds are employed in investments yielding tax exempt income, there cannot be any disallowance of interest expenses. When assessee an has interest bearing as also interest free funds available to him, as long as interest free funds are cover to such investments, it cannot be assumed that interest bearing funds are used for the purpose of tax exempt investments. The presumption thus is in favour of the assessee as a matter of routine, and unless it is proved to be incorrect. Accordingly, disallowance is to be deleted. - Decided in favour of assessee. Disallowing advances written off as bad debts in the books - HELD THAT - AO has proceeded on the assumption that the deduction is claimed as bad debts, and it was for this reason that he disallowed the claim on the ground that the related income is not shown to have been included in income of the earlier years. These small amounts have stated to become unrecoverable in the course of carrying on of the business. Given the facts of this case, and clear position that deduction was claimed for the business loss, the objection taken by the Assessing Officer was clearly unwarranted. The impugned disallowance cannot, therefore, be sustained - bearing in mind smallness of the amounts written off, we deem it and proper to delete the impugned disallowance. - Decided in favour of assessee.

Summary

Issues Involved:
1. Computation of notional interest on loans to a subsidiary.
2. Upward adjustment of notional guarantee fees.
3. Disallowance under Section 14A for exempt income.
4. Disallowance of advances written off as bad debts.

Detailed Analysis:

1. Computation of Notional Interest on Loans to a Subsidiary:
The assessee, engaged in manufacturing pigments and agrochemicals, had granted interest-free unsecured loans to its US-based subsidiary. The Transfer Pricing Officer (TPO) noted that in an arm's length situation, interest should have been charged, leading to an arm's length price (ALP) adjustment. The TPO adopted LIBOR plus a margin and risk rate, computing the ALP at 9.08%. The CIT(A) reduced this to 8.5%, considering the prime lending rate in the US and a profit margin. The Tribunal referenced the case of UFO India Movies Limited Vs ACIT, where LIBOR plus 4% was deemed arm's length. The Tribunal held that the ALP should be computed using LIBOR as the base rate plus a 1% margin, resulting in a rate of 5.86%. The AO was directed to recompute the interest based on this rate.

2. Upward Adjustment of Notional Guarantee Fees:
The assessee had provided corporate guarantees to its associated enterprise in Belgium without charging any fees. The TPO, relying on the Tax Court of Canada's decision in GE Capital Canada Inc Vs Her Majesty The Queen, computed the ALP adjustment based on the difference in credit ratings between the assessee and its subsidiary. The CIT(A) upheld this adjustment. However, the Tribunal, referencing the case of Siro Clinpharm Pvt Ltd Vs DCIT, held that no ALP adjustment could be made for guarantees issued without incurring any costs. The Tribunal emphasized that such guarantees are often shareholder activities and not services, thus not falling under the definition of international transactions requiring ALP adjustments. The adjustment of ?16,98,410 was directed to be deleted.

3. Disallowance Under Section 14A for Exempt Income:
The AO disallowed expenses under Section 14A, computing the disallowance using Rule 8D. The CIT(A) upheld this. The Tribunal, however, noted that the assessee had sufficient interest-free funds to cover the investments yielding tax-exempt income. Citing the case of ACIT Vs Champion Commercial Co Ltd and PCIT Vs Bharti Overseas Pvt Ltd, the Tribunal held that no part of interest expenses could be disallowed when interest-free funds are available. The disallowance of ?18,42,035 was deleted, but the disallowance of ?6,25,000 under Rule 8D(ii) was upheld.

4. Disallowance of Advances Written Off as Bad Debts:
The AO disallowed amounts written off as bad debts, arguing they were not included in the income of earlier years, invoking Section 36(2). The CIT(A) upheld this. The Tribunal noted that the amounts were claimed as business losses, not bad debts, and thus the inclusion in earlier years' income was not a prerequisite. The disallowance of ?4,40,331 was deleted.

Conclusion:
The Tribunal allowed the appeal partly, directing the AO to recompute the ALP interest on loans using LIBOR plus 1%, delete the ALP adjustment for notional guarantee fees, and delete the disallowance of interest expenses under Section 14A to the extent of ?18,42,035. The disallowance of advances written off as bad debts was also deleted.