2025 (4) TMI 1256 - AT - Income Tax

TP adjustment - interest payment on external commercial borrowing ( ECB ) - assessee company entered into three ECB transactions vide three separate loan agreements with its Associated Enterprises( AEs ) - TPO has determined the ALP of interest on ECB by adopting LIBOR 200 basis points for bench marking the interest paid by the assessee at LIBOR 500 basis and consequently proposed adjustment - HELD THAT - By following the earlier decisions of this Tribunal in the case of DCIT Vs. Devgen Seeds Crop Technology (P) Ltd. 2017 (3) TMI 1333 - ITAT HYDERABAD we hold that the interest payment of ECB @ LIBOR 500 basis is at arms length and consequently no adjustment is warranted. Hence the TP adjustment made and confirmed by the DRP on this account is deleted. TP adjustment on account of royalty payment - assessee owned and developed engineering and technical know-how and information experience and expertise in respect of manufacture marketing and sale of different kinds of high speed doors -only reason given by the TPO for determining the ALP at Nil is that the assessee failed to substantiate with any documentary evidence the benefit derived by it in quantifiable term - HELD THAT - A consistent view has been taken by the Tribunal on the point that when the payment is made as per the legally binding agreement between the parties which is duly approved by the RBI for the purpose of remittance of royalty then the tax authority cannot intervene in the realm of intricacies of commercial expedience involving in the arrangements between the parties. By following the order of M/s Aban Offshore Ltd 2016 (10) TMI 807 - ITAT CHENNAI we hold that applying the benefit test by the TPO and determining the ALP of royalty at Nil is highly arbitrary and unjustified. Consequently addition / adjustment made on this account is deleted. TP adjustment towards interest on receivable - AR contended that when the payables are almost 4 times more than the receivables and the assessee is not paying any interest on the payables to the AE then adjustment made by the TPO on account of trade receivables without considering the trade payables is not justified - HELD THAT - The outstanding receivables and payables are not in dispute though the receivables and payables are from different AEs. The assessee has stated that the payables are in respect of the purchases made by the assessee from AEs which was subsequently sold to another AE and therefore the transactions are inter connected and when the assessee is not paying any interest on the payables to the AEs which are more than the receivables from the AEs then the adjustment made on this account is uncalled for. Tribunal in assessee s own case 2021 (5) TMI 356 - ITAT HYDERABAD held that it will be appropriate for netting off the notional interest with respect to debit and credit transaction with the assessee s AEs and only on the net receivables the notional interest can be benchmarked for transfer pricing purpose. We further note that when the assessee is purchasing raw material from the AEs and selling the goods to the AEs then the transactions of purchase and sale are directly connected with each other. Therefore it will be appropriate to consider both the trade receivables as well as payables from the AEs while bench marking the transactions of notional interest on the receivables. By following the earlier order of this Tribunal adjustment made by the TPO/AO on this account is deleted as the payable for the year under consideration is substantially higher than the receivables. TP adjustment on account of trade receivables for the year under consideration - HELD THAT - As it is clear that the trade payable in the year under consideration is 7 times more than the trade receivables from the AEs. This issue is common as raised the for the A.Y.2017-18 and in view of our finding on this issue for A.Y.2017-18 the addition made by the TPO/AO on this account is deleted. Scrutiny assessment - adjustment made by the CPC while processing the return u/s 143(1) - suo-moto disallowance made by the assessee - HELD THAT -The assessment was taken up for scrutiny by issue of notice u/s 143(2) on 23.09.2019 whereas the CPC has processed the return u/s 143(1) vide order dated 02.12.2019 and therefore once the assessment proceedings were already pending the assessee was not supposed to challenge the intimation u/s 143(1) separately. Even otherwise processing of return merges with the assessment proceedings and therefore once the assessee has objected to the adjustments made by the CPC the AO ought to have examined and verified the same from the relevant record. It is the duty of the AO to ensure that there should not be any double addition even on account of adjustment made by the CPC. Therefore in the facts and circumstances of the case and in the interest of justice we set aside these non TP issues where the CPC has made adjustment to the record of the AO to verify about suo-moto disallowance made by the assessee and determine the correct amount of disallowance if any. Disallowance made on account of belated payment towards employees contribution though this issue is decided by the DRP in favour of the assessee however the AO has not given effect to the directions of the DRP. Now this issue is covered by the judgement of Checkmate Services Pvt. Ltd. 2022 (10) TMI 617 - SUPREME COURT and therefore the AO is directed to verify and decide this issue as per law.

Summary

The core legal questions considered by the Tribunal in these appeals pertain primarily to the determination of Arm's Length Price (ALP) under transfer pricing regulations for the assessment years 2017-18 and 2018-19. The key issues include:

1. Whether the Transfer Pricing Officer (TPO) and Assessing Officer (AO) erred in making adjustments to the interest paid on External Commercial Borrowings (ECB) from Associated Enterprises (AEs), including the appropriate benchmark interest rate to be applied.

2. Whether the royalty payments made to the AE for use of technical know-how and trademarks were at arm's length and whether the ALP adjustment made by the TPO/AO was justified.

3. Whether the TPO/AO was justified in making transfer pricing adjustments on the interest on outstanding trade receivables from AEs, including the question of whether interest on receivables constitutes a separate international transaction and the appropriateness of netting payables against receivables.

4. Various procedural and substantive issues related to the application of Section 92C of the Income Tax Act, 1961 (the Act) concerning the computation of ALP and the adherence to the directions of the Dispute Resolution Panel (DRP).

5. Additional issues relating to various disallowances and additions made by the AO/CPC during assessment proceedings, including compliance with DRP directions and the applicability of specific provisions of the Act concerning exempt income, disallowances under sections 37, 40A(3), 43B, 40(a)(ia), and payments related to Provident Fund and Employee State Insurance.

6. Jurisdictional and limitation issues concerning the validity of assessment orders passed under Section 143(3) read with Section 144C of the Act, vis-`a-vis the time limits prescribed under Section 153.

Issue-wise Detailed Analysis

Interest on External Commercial Borrowings (ECB)

Legal Framework and Precedents: The ALP determination for interest on ECB is governed by Section 92C of the Act and related transfer pricing rules. The Reserve Bank of India (RBI) Master Circular No.12/2013-14 dated 01.07.2013 and RBI FED Master Direction No.5/2015-16 prescribe all-in-cost ceilings for ECB interest rates based on loan tenure. The relevant rates are LIBOR plus 500 basis points for loans exceeding five years and LIBOR plus 350 basis points for loans between three and five years. Judicial precedents, including decisions of coordinate benches of the Tribunal, have consistently held that LIBOR-based rates are the appropriate benchmark for foreign currency international transactions rather than domestic bank rates.

Court's Interpretation and Reasoning: The Tribunal observed that the loans in question (ECB-I and ECB-II) had a tenure of eight years (96 months), exceeding five years, and the assessee paid interest at LIBOR + 500 basis points, consistent with RBI guidelines. The TPO had made an adjustment by benchmarking the interest at LIBOR + 200 basis points, which was challenged. The DRP modified this to LIBOR + 250 basis points, considering the tenure as less than five years based on the period from the loan agreement date to the assessment year, which the Tribunal found arbitrary and unjustified.

Key Evidence and Findings: The loan agreements, RBI circulars, and prior assessment year orders where the same transactions were accepted at LIBOR + 500 basis points were crucial. The Tribunal relied on earlier decisions such as DCIT Vs. Devgen Seeds & Crop Technology (P.) Ltd. and other coordinate bench rulings affirming the use of LIBOR-based rates and the RBI prescribed ceilings.

Application of Law to Facts: Since the loan tenure was contractually for more than five years and there was no foreclosure or prepayment, the Tribunal held that the interest rate paid by the assessee was at arm's length. The TPO and DRP's deviation from this established position was not warranted.

Treatment of Competing Arguments: The Revenue's argument regarding uncertainty about foreclosure was rejected due to lack of evidence. The assessee's contention that the RBI prescribed rate ceilings should be accepted as ALP was upheld.

Conclusion: The Tribunal deleted the transfer pricing adjustment made on interest on ECB for both assessment years.

Royalty Payment

Legal Framework and Precedents: Section 92C of the Act governs ALP determination for royalty payments. The benefit test and the requirement of tangible and direct benefits for royalty payments are often considered. However, judicial precedents such as the Supreme Court decision in Radhasaomi Satsang and Tribunal decisions in Air Liquid Engineering India P. Ltd. and Aban Offshore Ltd. emphasize that legally binding agreements duly approved by regulatory authorities cannot be disregarded without cogent reasons.

Court's Interpretation and Reasoning: The TPO and DRP rejected the royalty payment on the ground that the assessee failed to establish tangible benefits. The Tribunal found this approach arbitrary and unjustified, noting that the royalty was paid as per a valid agreement, supported by invoices and ledger entries, and had been accepted in previous years without adjustment.

Key Evidence and Findings: The royalty agreement, payment records, and prior acceptance of the arrangement were significant. The Tribunal also noted that the royalty payments were subject to withholding tax under Section 195, negating the possibility of profit shifting.

Application of Law to Facts: The Tribunal applied the principle that commercial expediency and legally binding agreements cannot be lightly disturbed by tax authorities. The failure to demonstrate quantifiable benefits did not justify disregarding the agreement.

Treatment of Competing Arguments: The Revenue's insistence on the benefit test was rejected in light of binding precedents and the factual matrix.

Conclusion: The Tribunal deleted the ALP adjustment on royalty payments for both years.

Interest on Outstanding Trade Receivables

Legal Framework and Precedents: Section 92B defines international transactions, and Section 92C governs ALP computation. The question arises whether interest on trade receivables constitutes a separate international transaction. Precedents establish that trade receivables and payables are separate transactions but may be interconnected, and notional interest adjustments should consider netting off receivables and payables where appropriate. The Tribunal's earlier orders in the assessee's own case and other decisions support netting of receivables and payables for notional interest computation.

Court's Interpretation and Reasoning: The Tribunal noted that the assessee had significant payables to AEs, exceeding receivables by multiples, and no interest was charged or paid on either. The TPO's adjustment on gross receivables without considering payables was found unjustified. The Tribunal emphasized that sales to AEs include embedded interest elements and that working capital adjustments account for credit terms.

Key Evidence and Findings: The outstanding balances of receivables and payables from different AEs, the absence of interest charges on payables, and the assessee's policy of not charging interest on receivables were material. Prior Tribunal orders on similar facts were relied upon.

Application of Law to Facts: The Tribunal applied the principle of netting receivables and payables and rejected the notion of separate interest adjustment on receivables when payables were substantially higher and interest was not charged on either side.

Treatment of Competing Arguments: The Revenue's argument that receivables and payables are separate international transactions was rejected based on the interconnected nature of transactions and consistent judicial approach.

Conclusion: The Tribunal deleted the transfer pricing adjustment on interest on receivables for both years.

Other Additions and Disallowances

Legal Framework: Provisions of the Act relating to exempt income, disallowances under sections 37, 40A(3), 43B, 40(a)(ia), and compliance with DRP directions under Section 144C were relevant.

Court's Interpretation and Reasoning: The Tribunal noted that certain adjustments were made by the CPC while processing returns under Section 143(1) after assessment proceedings had commenced under Section 143(2), leading to potential double additions. The AO was directed to verify the assessee's suo-moto disallowances and ensure no double taxation. The Tribunal also directed the AO to comply with DRP directions, especially regarding disallowances related to Provident Fund and Employee State Insurance payments, citing the Supreme Court decision in Checkmate Services Pvt. Ltd. Vs. CIT.

Application of Law to Facts: The Tribunal set aside these issues for fresh adjudication by the AO after proper verification of records and compliance with DRP directions.

Conclusion: Grounds relating to these additions/disallowances were remitted to the AO for fresh consideration.

Jurisdiction and Limitation Issues

Legal Framework: Sections 153 and 144C of the Act prescribe time limits for assessment completion. The question was whether assessment orders passed beyond the prescribed time under Section 153 are valid.

Court's Interpretation and Reasoning: The issue of limitation was left open pending adjudication by the Hon'ble Supreme Court in a related matter. The AO was directed to decide the issue in accordance with the Supreme Court's eventual ruling.

Significant Holdings

On the issue of interest on ECB, the Tribunal held:

"Once the tenure of the loan as per the agreement between the assessee and the AE is more than 5 years, then this view of the DRP, considering the tenure of the loan from the effective date of agreement till the assessment year under consideration is highly arbitrary and unjustified. The tenure of the loan as agreed between the parties is clearly manifested from the agreement itself and therefore, there is no reason to alter the tenure of the loan, when there is no payment or foreclosure of the loan during the year under consideration."

Further, it concluded:

"Accordingly, in the facts and circumstances of the case and by following the earlier decisions of this Tribunal... we hold that the interest payment of ECB @ LIBOR+500 basis is at arms length and consequently no adjustment is warranted."

On the royalty payment issue, the Tribunal emphasized:

"When the payment is made as per the legally binding agreement between the parties, which is duly approved by the RBI for the purpose of remittance of royalty, then the tax authority cannot intervene in the realm of intricacies of commercial expedience involving in the arrangements between the parties."

It held that:

"Applying the benefit test by the TPO and determining the ALP of royalty at Nil is highly arbitrary and unjustified."

Regarding interest on receivables, the Tribunal stated:

"It will also be appropriate for netting off the notional interest with respect to the debit and credit transaction with the assessee's AEs because when notional interest is charged on receivables the same should also be charged on payables."

And accordingly:

"By following the earlier order of this Tribunal, adjustment made by the TPO/AO on this account is deleted as the payable for the year under consideration is substantially higher than the receivables."

On procedural issues related to disallowances and compliance with DRP directions, the Tribunal held that the AO must verify the records to avoid double additions and comply with binding DRP directions, particularly citing the Supreme Court ruling in Checkmate Services Pvt. Ltd.