2022 (12) TMI 500 - AT - Income Tax

TP Adjustment - assessee did not exercise the option of converting the accumulated interest and the bad debts into equity - as argued transfer pricing adjustment proposed without resorting to any transfer pricing exercise as per any of the methods prescribed in section 92C (1) to determine the ALP, is bad in law and has to be deleted - HELD THAT - We fail to understand how merely conversion of the accumulated interest and bad debts into equity would amount to their recovery. It is the settled principle of law that the Revenue officers cannot sit in the armchair of the businessman, while taking the decisions basing on the business expediency. It s not out of place at this juncture to refer to the observations of the Hon ble Bombay High Court in the case of Harshad J Choksi 2012 (8) TMI 710 - BOMBAY HIGH COURT wherein it was held that if an amount cannot be deducted as a bad debt in view of non-compliance of the conditions precedent as provided under section 36(2) of the Act, the same will not prevent the assessee from claiming deduction of the same as business loss incurred in the course of carrying on the business. It is not in dispute that the interest that is written off was in fact shown in the P L Account on accrual basis and such interest income was assessed as business income in the earlier assessment years, or that the bad debts written off were already offered as part of sales during the earlier assessment years. It is also not in dispute that when the interest in the earlier years was offered as business income, the same was accepted by the Department. In these circumstances, it is not known how the writing off of such amounts would affect the ALP of the transaction. Apart from that, it is also not in dispute that the Ld. TPO did not refer to any particular method prescribed in section 92C(1) of the Act. When the Revenue accepted the TNMM in respect of the sales and purchases, and CUP method in respect of the interest received on loans and reimbursement of expenses, the writing off of these two amounts are subsumed into the transactions of receipt of interest on loans, and it does not necessitate any separate benchmarking. Viewing from any angle, we find it difficult to sustain the addition made on account of the writing off by the assessee of the dues from Aurobindo (Datong) Bio Pharma Co. Ltd., China and bad debts from ZAO Aurobindo Pharma Ltd., Russia and accordingly allow the grounds of appeal.

Summary

Issues:
Transfer pricing adjustment on accrued interest and bad debts written off.

Analysis:
1. The case involved an appeal by the assessee against the order passed by the Deputy Commissioner of Income Tax for the assessment year 2009-10, under various sections of the Income Tax Act, 1961, following directions from the Dispute Resolution Panel.

2. The assessee, engaged in manufacturing pharmaceutical products, initially declared income which was later revised to include short term capital loss. Subsequently, a reference was made under section 92CA post a search, leading to a transfer pricing adjustment by the Transfer Pricing Officer (TPO) regarding accrued interest on loans and bad debts.

3. The draft assessment order proposed a significant increase in taxable income, which the assessee objected to before the Dispute Resolution Panel. The DRP partially upheld the proposed additions, leading to the current appeal.

4. The assessee contended that the authorities did not properly benchmark the international transaction, citing relevant case laws to support the argument that transfer pricing adjustments without following prescribed methods are invalid.

5. Another argument by the assessee was that the written off interest income and bad debts should be allowed as deductions under relevant sections of the Act, supported by judicial precedents emphasizing the deductibility of such amounts.

6. The Revenue argued that the TPO rightly examined the accrued interest and bad debts, highlighting that the assessee had the option to convert the accrued interest into equity and that the TPO's approach was in line with determining the ALP.

7. The Tribunal noted the background of the case, including the subsidiary's financial struggles and the assessee's decision to write off accrued interest and bad debts, which were previously offered as income.

8. The TPO treated the ALP of the written off amounts as nil, leading to significant additions to the taxable income. However, the Tribunal observed that the TPO did not follow prescribed methods under section 92C(1) to determine the ALP, rendering the adjustments unsustainable.

9. Judicial decisions were cited to support the assessee's position that the TPO's approach was flawed, emphasizing the need for proper benchmarking and adherence to statutory provisions.

10. The Tribunal highlighted that the TPO's criticism of the assessee not converting the amounts into equity did not justify the adjustments, as the decision to write off such amounts should not be equated with recovery.

11. The Tribunal referred to various court decisions supporting the allowance of bad debts based on book entries, without requiring actual proof of bad debt, emphasizing the business loss aspect under the Act.

12. Ultimately, the Tribunal found that the written off amounts were previously accepted as income and the TPO's failure to follow prescribed methods rendered the adjustments unsustainable, leading to the allowance of the assessee's appeal.

13. The Tribunal concluded that the writing off of amounts did not impact the ALP of the transactions, especially considering the acceptance of TNMM and CUP methods for other transactions, and allowed the appeal, overturning the additions made by the TPO.

This detailed analysis covers the issues involved in the legal judgment comprehensively, highlighting the arguments presented by both parties and the Tribunal's reasoning leading to the final decision.