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TMI Blog2016 (2) TMI 196X X X X Extracts X X X X X X X X Extracts X X X X ..... and; finally, whether or not the Assessing Officer was justified in disallowance of Rs. 3,98,750, as capital expenditure, in respect of purchase of FWP (fixed wireless phone) equipment. We will take up these three issues one by one. 3. So far as ALP adjustment of Rs. 74,20,785 is concerned, the relevant material facts are like this. During the course of proceedings before the Transfer Pricing Officer, it was noted that the assessee had advanced a loan of US $ 1,08,50,000 to its subsidiary Edridge Limited, Cyprus, on an interest @ 7% p.a. The TPO was of the view that "the AE is not of such a financial health that it could have got the loan on its own", that "one can reasonably conclude that this company (i.e. the AE) is at best a conduit" as the funds were used by the said to have been used for giving loans to the step down subsidiaries which, in turn, had purchased equipment with the money so received, that given the fact that it's a one off transaction and that the assessee is not lending money in the regular course of business, "it can be stated that there is high level of risk borne by you (i.e. the assessee) in this transaction", and since the assessee has not received any pri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be taken at 4.53%, as the TPO himself has, pursuant to the directions of the DRP to adopt ALP at LIBOR+4%, taken the ALP at 8.53%. The order dated 19th March 2013, a copy of which was placed before us at pages 426 and 427 of the paper-book, clearly evidences this factual position. There is also no dispute that the assessee has advanced the loan to the subsidiary at 7% per annum. Clearly, therefore, as long as the comparable uncontrolled price of the US $ denominated lending is less than 247 points (i.e.700-453) above the LIBOR rate, the transaction entered into by the assessee with its subsidiary cannot be said to be at less than arm's length price. The Transfer Pricing Study filed by the assessee, however, does not throw much light on this aspect of the matter beyond stating, in rather vague terms, that "a study revealed that around 100 basis points increase in the LIBOR rate is considered appropriate for lending to corporates", and that "therefore, the adjusted interest percentage is to be taken the arm's length interest rate i.e. 5.53%". Such sweeping generalizations and vague justifications as inherent in the above comment in the TP study, in support of LIBOR+100 basis points a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... adjustment of 177.60 points, as balancing figure, towards lack of security and lender not being in the business of borrowing and lending money. This adjustment is justified by the TPO on the following ground: 7.10 Adjustment between a banker and non-banker As the taxpayer is not in the business of lending and borrowing money, his risk is higher in advancing loan to a single customer than a bank, which spreads its risk among its various customers. Thus, the difference between banker and nonbanker is to be kept in mind while arriving at the arm's length CUP rate based on bank rates. 7.11 Adjustment for security Usually, bankers extending loans in foreign currency also insist on sufficient security. In this case, no security is offered by the AE. Keeping in view the financial health of the subsidiary, it may not be in a position to offer security. Thus an adjustment is required to be made for not offering a security. This may be computed as the difference between the interest rates prevailing for the bonds of equivalent credit rating of the AE and sovereign government bonds in the country in which the AE is located. This can also be considered as the guarantee cost payable t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 11. This Court is of the opinion that the reasoning of the ITAT on each of the heads which went into the adjustment of Rs.10,11786/- is reasonable and justified and does not call for any interference. (Emphasis, by underlining, supplied by us) 9. That was also a case in which the lender parent company was taken as the tested party, the loan was advanced to a subsidiary company without much to the credit of its financial credentials and the loan was treated as a high risk loan resulting in adopting the maximum LIBOR rate on which dollar loans were advanced. Yet, Hon'ble High Court specifically approved the Tribunal's reasoning that the "assessee advanced monies to the subsidiaries which were under its management and control, which in fact substantially reduced the risk and in these circumstances there was no rationale of adjusting any amount of higher basis". When such are the views of Their Lordships, it is futile to suggest that the loans advanced by the parents to subsidiary can indeed be taken as BB to D grade investments which refers to, as noted by the TPO himself at page 28 of the order, investments with serious risks of inadequate safety, investments of high risk, investm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... also bearing in mind entirety of the case, we uphold the grievance of the assessee and direct the Assessing Officer to delete this arm's length price adjustment of Rs. 74,20,785 in respect of interest charged on advances to the subsidiaries. 12. Ground nos. 1 to 5, which pertain to the ALP adjustment in respect of interest charged on interest to sib subsidiaries, are thus allowed in the terms indicated above. 13. The next issue in this appeal, in ground no. 6, is with respect to disallowance of Rs. 38,35,298 under section 14A. 14. So far this disallowance is concerned, the relevant material facts are as follows. During the relevant previous year, the assessee had received the e=tax exempt dividend of Rs. 21,47,983. The uncontroverted stand of the assessee all along has been that no part of the investments in HDFC mutual fund units, which has resulted in the tax exempt dividend of Rs. 38,35,298, was out of borrowed funds, and, as such, disallowance under section 14A was uncalled for. The Assessing Officer, however, rejected this submission on the ground that once a formula for computation for disallowance under section 14A has been set out in rule 8D, which is applicable in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the expenditure attributable to tax exempt income, (ii) and where there is common expenditure which cannot be attributed to either tax exempt income or taxable income then a sum arrived at by applying the formula set out thereunder. What the formula does is basically to "allocate" some part of the common expenditure for disallowance by the proportion that average value of the investment from which the tax exempt income is earned bears to the average of the total assets. It acknowledges that funds are fungible and therefore it would otherwise be difficult to allocate the sum constituting borrowed funds used for making tax-free investments. Given that Rule 8 D (2) (ii) is concerned with only 'common interest expenditure' i.e. expenditure which cannot be attributable to earning either tax exempt income or taxable income, it is indeed incongruous that variable A in the formula will not also exclude interest relatable to taxable income. This is precisely what the ITAT has pointed out in Champion Commercial (supra). There the ITAT said that by not excluding expenditure directly relatable to taxable income, Rule 8D (2) (ii) ends up allocating "expenditure by way of interest, which is not ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... been filed on behalf of the Revenue an explanation has been provided of the rationale underlying Rule 8D. In the written submissions which have been filed by the Addl. Solicitor General it has been stated, with reference to R.8D(2) (ii) that since funds are fungible, it would be difficult to allocate the actual quantum of borrowed funds that have been used for making tax-free investments. It is only the interest on borrowed funds that would be apportioned and the amount of expenditure by way of interest that will be taken (as 'A' in the formula) will exclude any expenditure by way of interest which is directly attributable to any particular income or receipt (for example- any aspect of the assessee's business such as plant/machinery et.)..... The justification that has been offered in support of the rationale for R.8D cannot be regarded as being capricious, perverse or arbitrary. Applying the tests formulated by the Supreme Court it is not possible for this Court to hold that there is writ on the statute or on the subordinate legislation perversity, caprice or irrationality. There is certainly no 'madness in the method". (vii) Therefore the Court is unable to agree with the Rev ..... X X X X Extracts X X X X X X X X Extracts X X X X
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