2019 (8) TMI 1226 - AT - Income Tax

TP Adjustment - direction of the CIT(A) to compute the arm's length price (ALP) of the rate of interest charged by the assessee on loan advanced to its Associated enterprise (AE) situated in Germany by adopting the average EURIBOR rate of 4.42% as applicable to the assessment year 2007-08 - HELD THAT - The Hon'ble Bombay High Court in CIT Vs. The Great Eastern Shipping Company Ltd. . 2017 (6) TMI 1207 - BOMBAY HIGH COURT has reiterated that the arm's length rate of interest is to be considered with reference to the country in which the loan is received and not from where it is paid. In view of these precedents, it is palpable that the view point of the AO in considering the rate of interest prevalent in India, being, the lender country, as determinative of the ALP of rate of interest charged by the assessee, is not correct. To this extent, we uphold, in principle, the view canvassed by the ld. CIT(A) that the rate of interest prevalent in Germany, being, the country in which the loan was consumed, is determinative of the arm's length rate of interest charged by the assessee-lender. Determination of the arm's length rate of interest - CIT(A) has held that average EURIBOR for the A.Y. 2007-08 should be considered as a benchmark - HELD THAT - While calculating EURIBOR, 15% of the lowest and 15% of the highest interest rates collected by a panel of European banks are eliminated and the remaining 70% form the basis for its calculation. In such circumstances, EURIBOR, being, not an average rate at which the loans are advanced by European banks to borrowers, cannot per se be characterized as a comparable uncontrolled rate of interest at which loans are advanced in Germany. On lines of EURIBOR, there is LIBOR (London Inter-bank Offered rate), another rate which is applied on behalf of British Bankers Association. Similar to EURIBOR, LIBOR is also a rate at which major global banks lend to one another in the international inter-bank market on short-term basis. In calculation of LIBOR, 25% of lowest and 25% of the highest values are eliminated and the remaining 50% are considered for determining LIBOR. LIBOR, as such, can also not be construed as a comparable uncontrolled transaction - in CIT Vs. Aurionpro Solutions Ltd. 2017 (6) TMI 1087 - BOMBAY HIGH COURT approved the action of the Tribunal in considering LIBOR 2% as the arm's length rate as against the TPO applying LIBOR plus 3%. Drawing an analogy from this position, we hold that EURIBOR 2% should be considered as arm's length rate of interest for determining the ALP of the international transaction of interest received by the assessee from Mascot Systems GmbH, Germany. Before parting with this issue, we would like to clarify that the CIT(A) has considered 4.42% as EURIBOR applicable for the assessment year under consideration by relying on an order of the Tribunal, in which the average LIBOR was considered at this level. Equality of LIBOR and EURIBOR could not be substantiated from any material on record. In the given circumstances, we set-side the impugned order and remit the matter to the file of the AO for considering EURIBOR 2% as arm's length rate of interest to be applied on loan advanced by the assessee to Mascot Systems GmbH, Germany. In case EURIBOR 2% turns out to be lower than 4.42% as directed to be applied by the ld. CIT(A) on the understanding of the same being EURIBOR simplicitor, then the addition should be restricted with reference to 4.42% rate of interest, as the assessee is not in appeal on this issue. In the otherwise scenario, the relief allowed by the ld. CIT(A) will be restricted pro tanto. Computation of deduction u/s.10A - HELD THAT - There cannot be any dispute on the correctness of the proposition put forth on behalf of the Revenue. However, it is found on facts that the AO has nowhere held that some eligible units having profits had any linkage with some other eligible units suffering losses. Neither it has been the contention of the assessee at any stage. In such circumstances, we cannot permit the ld. DR to set up a new case. We, therefore, approve the view taken by the ld. CIT(A) on this issue and dismiss this ground of appeal. Exclusion of telecommunication charges and payment to employees at foreign branches from the amount of export turnover in the computation of deduction u/s.10A - HELD THAT - Since the amount of telecommunication charges etc. has been held by the AO himself as not forming part of export turnover', the sequitur is that the same would also not form part of total turnover', as there cannot be two different figures of export turnover', one as an independent numerator in the formula and the other constituting part of total turnover in the denominator. To put it simply, telecommunication expenses etc. which have been excluded by the AO from the ambit of export turnover' would also require exclusion from total turnover'. Apart from the Hon'ble Karnataka High Court in Tata Elxsi Ltd. 2011 (8) TMI 782 - KARNATAKA HIGH COURT , the Hon'ble Delhi High Court in CIT Vs. Genpact India 2011 (11) TMI 119 - DELHI HIGH COURT has also held that communication expenses reduced from export turnover should also be reduced from total turnover for the purpose of deduction u/s.10A. Computation of deduction u/s.10A - as contended that since income from DTM and onsite services was not derived from export of computer software, the same did not qualify for the benefit of deduction - HELD THAT - The expression 'profits of the business of the undertaking' as used in sub-section (4), in fact, gives meaning to the expression derived from export of computer software' as used in sub-section (1) and amplifies the scope of the latter by mitigating the rigor and making the provision liberal and more inclusive. There is no gainsaying that profits of the business of the undertaking' are not only the profits derived from the export of computer software but also those which are attributable to the business of undertaking. So long as there exists a direct link between the eligible undertaking and some income, the same is profit of the business of undertaking, even if may not be derived from the export of computer software etc. Without accepting, even if we presume the contention of the ld. DR as correct that income from DTM and onsite software services rendered abroad cannot be considered as derived from the export of computer software, it, in any case, will have to be regarded as profits of the business of the undertaking'. In view of the foregoing discussion, we uphold the impugned order on this score. Disallowance u/s. 14A - HELD THAT - The Hon'ble Supreme Court in CIT Vs. Essar Teleholdings Ltd. 2018 (2) TMI 115 - SUPREME COURT has held that Rule 8D is prospective. In view of this precedent, we accord our imprimatur to the conclusion drawn by the ld. CIT(A) on non-applicability of Rule 8D to the year under consideration. As regards the quantum of disallowance u/s.14A, it is found that for the preceding year the AO made disallowance at 25% of salary paid to Financial Controller as attributable to the exempt income, which came to be countenanced up to the Tribunal level. If the same yardstick is applied, 25% of salary paid to the Financial Controller for the year under consideration comes to ₹ 10,16,255/-. In addition to this, the assessee himself offered disallowance at ₹ 54,000/-. The sustenance of addition by the CIT(A) at ₹ 10,70,255/- on this score is in order, which does not warrant any further interference. This ground is, therefore, not allowed. Discount on lapsed ESOPs taken to General Reserve instead of transferring it to the Profit and loss account in the computation of book profit' u/s.115JB - HELD THAT - It is evident that, firstly, the accounts are required to be made in accordance with Parts II and III of Schedule VI to the Companies Act and secondly, once the accounts are drawn in such a way and then approved in the Annual General Meeting, then the AO is bound to accept the amount of net profit as shown in the Profit and loss account, as starting point for computing book profit as per Explanation 1 to section 115JB of the Act. Now let us examine the treatment to be given in accounts on reversal of lapsed ESOPs. It is found that the SEBI guidelines, as clarified, and ICAI Guidance Note now provide for taking such amount to General Reserve Account. Initially, there was some non- meeting point between the SEBI guidelines and the ICAI Guidance Note on the treatment to discount on lapse of the ESOPs. Vide para (ii)(b) of its letter No. SEBI/CFD/DIL/ESOP/4/2008/04-08, dated 04-08-2008, the SEBI has clarified the position by amending the SEBI guidelines with immediate effect so that it is in line with the accounting treatment provided by ICAI. This position has been discussed by the ld. CIT(A) in para 256 of the impugned order, which has remained uncontroverted. Thus, it is seen that both the SEBI and ICAI guidelines are now alike and provide that the amount of discount on lapse of ESOPs should be credited to the General Reserve Account. We see no reason in not approving the action of the ld. CIT(A) in holding that such amount of ₹ 57,71,000/- was righty taken to the General Reserve Account instead of crediting it to the Profit and loss account and hence the same cannot be added to the amount of net profit shown by the assessee for computing book profit' u/s 115JB of the Act. In so far as the argument of ld. DR to the applicability of clause (b) of Explanation 1 to section 115JB is concerned, the same, in our opinion, does not advance the case of the Revenue because what is required to be added to the net profit is the amount carried to any reserve which is otherwise debited to the Profit and loss account. Since the amount in question was not debited to the Profit and loss account for the year, the same cannot be added to the net profit for computing book profit' u/s.115JB of the Act. We, therefore, approve the view taken by the CIT(A) on this score. Thus, the ground concerning section 41(1) is allowed and that concerning section 115JB is not allowed.

Summary

Issues Involved:
1. Determination of Arm's Length Price (ALP) for interest on loans to Associated Enterprises (AEs).
2. Computation of deduction under Section 10A of the Income Tax Act.
3. Exclusion of telecommunication charges and payments to employees at foreign branches from export turnover.
4. Reduction of income from Deputation of Technical Manpower (DTM) and onsite activities from eligible income under Section 10A.
5. Disallowance under Section 14A of the Income Tax Act.
6. Treatment of discount on lapsed Employee Stock Option Plans (ESOPs) in the computation of book profit under Section 115JB and applicability of Section 41(1).

Detailed Analysis:

1. Determination of Arm's Length Price (ALP) for Interest on Loans to AEs:
The primary issue was the appropriate rate of interest to be charged on loans advanced by the assessee to its AE in Germany. The TPO determined the ALP based on the interest rate in India, which was 14%. The CIT(A) and Tribunal concluded that the rate of interest should be based on the EURIBOR rate applicable in Germany, as the loan was denominated in Euros. The Tribunal held that EURIBOR + 2% should be considered as the arm's length rate of interest, rather than the 4.42% rate adopted by the CIT(A). The matter was remitted to the AO to compute the ALP using EURIBOR + 2%, with a cap at 4.42% if EURIBOR + 2% is lower.

2. Computation of Deduction under Section 10A of the Income Tax Act:
The assessee operated six STPI units, with some units incurring losses and others generating profits. The AO aggregated the profits and losses from all units, while the CIT(A) allowed deduction on a standalone basis for profitable units. The Tribunal upheld the CIT(A)'s decision, relying on the Supreme Court's judgment in CIT Vs. Yokogawa India Ltd., which mandates computing deduction for each eligible unit independently without offsetting losses from other units.

3. Exclusion of Telecommunication Charges and Payments to Employees at Foreign Branches from Export Turnover:
The AO excluded telecommunication charges and payments to employees at foreign branches from the export turnover without making corresponding adjustments to the total turnover. The CIT(A) and Tribunal, relying on the Karnataka High Court's judgment in CIT Vs. Tata Elxsi Ltd., held that such exclusions should also be made from the total turnover to maintain consistency in the computation formula for deduction under Section 10A.

4. Reduction of Income from DTM and Onsite Activities from Eligible Income under Section 10A:
The AO reduced the deduction under Section 10A by attributing a portion of the income to DTM and onsite activities, which he deemed unrelated to STP undertakings. The CIT(A) reversed this decision, and the Tribunal upheld it, stating that onsite development and DTM activities are integral to the overall software development projects and should be eligible for deduction under Section 10A. The Tribunal emphasized the importance of maintaining a direct link between onsite activities and the software development projects to qualify for the deduction.

5. Disallowance under Section 14A of the Income Tax Act:
The AO applied Rule 8D to compute disallowance under Section 14A, which was not applicable for the assessment year in question (2007-08). The CIT(A) restricted the disallowance to 25% of the salary paid to the Financial Controller, as upheld in the previous year. The Tribunal confirmed this approach, agreeing that Rule 8D is prospective and not applicable to the assessment year under consideration.

6. Treatment of Discount on Lapsed ESOPs in the Computation of Book Profit under Section 115JB and Applicability of Section 41(1):
The AO added the discount on lapsed ESOPs to the book profit under Section 115JB, which the CIT(A) reversed. The Tribunal upheld the CIT(A)'s decision, stating that the amount should be credited to the General Reserve as per SEBI and ICAI guidelines. However, the Tribunal agreed with the CIT(A) that the amount should be taxed under Section 41(1) in the year of lapse, as it represents cessation of liability.

Conclusion:
The appeal was partly allowed, with specific directions on each issue, particularly emphasizing the correct determination of ALP for interest on loans to AEs, computation of deduction under Section 10A, and appropriate treatment of ESOPs and disallowances under Section 14A and Section 115JB.