2016 (2) TMI 1393 - AT - Income Tax

TP Adjustment - interest charged on receivable - payment was right from the initial stage towards subscription for shares - whether this transaction is clearly hit by the provision of section 92(2) of the I.T. Act 1961? - HELD THAT - Allotment of shares does not make any change to the position of the assessee as the subsidiary is admittedly a wholly owned subsidiary of the assessee. A delay in allotment of shares by the subsidiary company as long as the subsidiary is a wholly owned subsidiary does not prejudice the interests of the assessee. It is therefore wrong to even allege that an assessee does not behave in a commercially rationale manner as expected in an arm s length situation when the assessee does not ask for payment of interest for the period of delay in allotment of shares. The assessee has behaved in a commercially rational manner inasmuch as whether the new shares are allotted at x point of time or y point of time it does not make a difference to the position of the shareholder so far as the subsidiary is wholly owned by a single shareholder- as is the factual position in this case. The nominal value of shares as long as all the shares are held by the assessee is entirely benefit neutral from a commercial point of view. The very foundation of the adjustment made by the Assessing Officer is therefore wholly devoid of legally sustainable merits and factually correct assumptions. Thus we hold that the adjustment on account of notional interest on the share application money which has been recharacterized as loan is not sustainable in law. We therefore direct the Assessing Officer to delete the same. Assessee appeal allowed.

Summary

ISSUES PRESENTED and CONSIDERED

The judgment addresses several interconnected issues arising from the directions of the Dispute Resolution Panel (DRP) concerning the assessment under section 143(3) read with section 144C(13) of the Income Tax Act, 1961 for the assessment year 2009-10. The core legal questions considered are:

1. Whether the DRP was justified in deleting the interest charged on receivables, given the provisions of section 92(2) of the Income Tax Act.

2. Whether the order of the Assessing Officer (AO) and Transfer Pricing Officer (TPO) was valid, considering the alleged non-compliance with the mandatory conditions of Section 92CA(3) read with Section 92C(3) of the Act.

3. The appropriateness of an upward transfer pricing adjustment concerning the share capital subscription into the associated enterprise (AE), Sterling Global Oil Resources Pvt. Ltd. (SGPL).

4. The correctness of re-characterizing a share subscription transaction as a loan transaction, and the resulting arm's length price (ALP) adjustments.

5. The validity of adopting the State Bank of India (SBI) Prime Lending Rate (PLR) for benchmarking deemed outbound foreign currency loans instead of the London Interbank Offered Rate (LIBOR).

6. The appropriateness of considering a 60-day interest-free period instead of the 180 days permitted under FEMA Regulations.

7. The denial of the benefit of the arm's length range of +/- 5% provided in the proviso to section 92C(2) of the Act for computing the transfer pricing adjustment.

ISSUE-WISE DETAILED ANALYSIS

1. Deletion of Interest on Receivables

The DRP deleted the adjustment concerning interest on receivables, noting that SGPL had not accepted the liabilities for various reasons, including that some expenses pertained to a period before SGPL's incorporation. The Tribunal upheld the DRP's decision, stating there was no basis for making an ALP adjustment since the amounts were no longer recoverable, and the expenses were akin to shareholder services, which do not accrue interest.

2. Compliance with Mandatory Conditions

The assessee contended that the AO/TPO's order was invalid due to non-compliance with Section 92CA(3) and Section 92C(3) of the Act, as no show cause notice was served. However, this issue was not elaborated upon in the judgment, suggesting it was either resolved or deemed irrelevant to the final decision.

3. Transfer Pricing Adjustment on Share Capital Subscription

The TPO made an ALP adjustment by re-characterizing the share subscription as a loan, using the SBI PLR plus a risk premium for benchmarking. The Tribunal found that the shares were indeed issued in October 2010, and the payment was for share allotment, not a loan. The Tribunal referenced the Bharti Airtel Limited case, emphasizing that capital contributions cannot be deemed loans merely due to delayed share allotment.

4. Re-characterization of Share Subscription as Loan

The Tribunal rejected the re-characterization of the share application money as a loan. It noted that the transaction was genuine, with RBI approval for capital contribution. The Tribunal emphasized that re-characterization is only permissible if the transaction is a sham or substantially different from its stated form, which was not the case here.

5. Benchmarking Interest Rates

The Tribunal criticized the use of the SBI PLR for benchmarking, noting that the LIBOR rate would be more appropriate for foreign currency transactions. However, this point became moot as the re-characterization itself was deemed unsustainable.

6. Interest-Free Period

The Tribunal found the 60-day interest-free period adopted by the TPO unjustified, as the FEMA Regulations permit a 180-day period. However, this issue was rendered academic by the decision against re-characterization.

7. Arm's Length Range Benefit

The Tribunal did not specifically address the +/- 5% arm's length range benefit, as the primary issue of re-characterization was resolved in favor of the assessee.

SIGNIFICANT HOLDINGS

The Tribunal held that the adjustment on account of notional interest on share application money, re-characterized as a loan, was not sustainable in law. It concluded that:

"The authorities below were in error in treating the payment of share application money, as partly in the nature of interest-free loans to the AEs, and, accordingly, ALP adjustment based on that hypothesis was indeed devoid of legally sustainable merits."

The Tribunal emphasized that re-characterization is permissible only when the transaction is a sham or differs substantially from its stated form, which was not the case here. It also highlighted that the economic substance of the transaction matched its form, and the assessee acted in a commercially rational manner as a sole shareholder.

In conclusion, the Tribunal dismissed the appeal of the Assessing Officer and allowed the appeal of the assessee, directing the deletion of the adjustment on account of notional interest on the share application money.