2016 (7) TMI 760 - AT - Income Tax

Transfer pricing adjustment - interest free advances granted by the assessee to its Indian AE - base erosion theory - Held that - We are not inclined to accept the base erosion argument, in principle, nor do we find anything in the facts on record to even support the factual elements embedded in the plea of the assessee. We reject this plea. The intervener has picked up an aspect of the matter totally divorced from its context and proceeded to treat the same as a full exposition of law on a question when the question did not even fall to be answered in that judgment . The approach adopted by the learned counsel for the intervener, therefore, does not merit our approval. The commercial expediency of a loan to subsidiary is wholly irrelevant in ascertaining arm s length interest on such a loan. There is indeed no bar on anyone advancing an interest free loans to anyone but when such transactions are covered by the international transactions between the associated enterprise, Section 92 of the Act mandates that the income from such transactions is to be computed on the basis of arm s length price. The assessee is not really correct in contending that when the assessee has not reported any income from a particular international transaction, the ALP adjustment cannot compute the same. The computation of income on the basis of arm s length price does not require that the assessee must report some income first, and only then it can be adjusted for the ALP. Section 92(1) is not an adjustment mechanism; it is a computation mechanism. The arm s length price principle requires that an arm s length price is assigned to the transactions between the associated enterprise, and if the income in computed, if any, on the basis of the arm s length price so assigned. The ALP adjustments cannot be treated as income per se. However, the assessee does not derive any support from this decision since consideration for a loan, i.e interest, is inherently in the nature of income. There is no, and there cannot be any, dispute or controversy about this character of income. The point of dispute is whether zero interest, or no interest, is good enough for computing the income or whether an arm s length interest must substitute this zero interest. The answer is obvious. As long as the transaction is an international transaction between the AEs, the computation of income has to be on the basis of arm s length interest. Therefore, in our considered view, even when no income is reported in respect of an item in the nature of income, such as interest, but the substitution of transaction price by arm s length price results in an income, it can very well be brought to tax under Section 92. This plea of the assessee is also, therefore, unsustainable in law. In view of the above we reject the contention of the assessee that, in principle, no arm s length price adjustments can be made in respect of the interest free advances granted by the assessee to its Indian AE, i.e. Datex Ohmeda India Pvt Ltd. However, so far as quantification of the arm s length price adjustment is concerned, the same will have to be dealt with the division bench as no arguments, with respect to the quantification part, were advanced before us. It is also open to the parties to take up any other issue, not specifically dealt with above, before the division bench in accordance with law.

Summary

Issues Involved:
1. Arm's Length Rate of Interest on Loan.
2. Relevance of CBDT Circular No.14 of 2001 and Australian Taxation Ruling TR 2007/1.
3. Impact on Government Exchequer due to Non-Assessment of Interest Income.

Detailed Analysis:

1. Arm's Length Rate of Interest on Loan:
The core issue was whether an arm's length price (ALP) adjustment was required for the interest-free loan granted by the non-resident assessee to its wholly-owned subsidiary in India. The assessee, Instrumentarium Corporation Limited (ICL-Finland), provided an interest-free loan of ?36 crores to Datex-India. The Assessing Officer (AO) insisted on an ALP adjustment, arguing that the interest-free loan was not at an arm's length price and required adjustment to the income of ICL-Finland. The Tribunal decided that the commercial expediency of a loan to a subsidiary is irrelevant in determining the arm's length interest on such a loan. The Tribunal rejected the assessee's argument that the loan was a shareholder service and should not be subject to ALP adjustments. The Tribunal concluded that the ALP adjustment was justified and necessary.

2. Relevance of CBDT Circular No.14 of 2001 and Australian Taxation Ruling TR 2007/1:
The assessee argued that the CBDT Circular No.14 of 2001 and the Australian Taxation Ruling TR 2007/1 should exempt the interest-free loan from ALP adjustments. The Tribunal noted that while the CBDT circular indicates the intent of the legislature, it is not an order or direction binding the field authorities. The Tribunal emphasized that the provisions of Section 92 must be applied unless explicitly excluded by Section 92(3). The Tribunal found that the Australian Taxation Ruling was not applicable as the Indian and Australian laws are not in pari materia. The Tribunal held that the CBDT circular and the Australian ruling do not preclude the application of ALP adjustments in this case.

3. Impact on Government Exchequer due to Non-Assessment of Interest Income:
The AO argued that not applying ALP adjustments would result in a real loss to the Indian tax revenue, as Datex-India was a loss-making entity and would not benefit from the interest deduction. The Tribunal agreed, stating that the non-application of ALP adjustments would indeed erode the Indian tax base. The Tribunal rejected the assessee's argument that the potential future profits of Datex-India could offset the losses, noting that such benefits are hypothetical and cannot be considered in the current assessment.

Conclusion:
The Tribunal concluded that the ALP adjustment for the interest-free loan was necessary and justified. The CBDT circular and the Australian Taxation Ruling were not applicable to exempt the transaction from ALP adjustments. The non-application of ALP adjustments would result in a real loss to the Indian tax revenue. The Tribunal directed the division bench to deal with the quantification of the ALP adjustment.