9911796707
TMI Blog2016 (5) TMI 719X X X X Extracts X X X X X X X X Extracts X X X X ..... Rs. 33,73,86,850/- on account of interest accrued in respect of Non- Performing Assets ("NPAs"); (iv) Ground No.IV -Levy of interest under section 234A. (v) Ground No.V -Levy of interest under section 234B and 234D of the Act. 2. The brief facts qua the first issue of Transfer Pricing Adjustment are that, the assessee, that is, India Debt Management Pvt. Ltd. (IDM) is a company incorporated in India on 16th August, 2005 as a non-banking finance company (NBFC). It is subsidiary of Mauritius Debt Management Ltd. (MDM) which holds 75% of equity share capital in IDM. The assessee is primarily engaged in the business of identifying investment opportunities in financially distressed companies which otherwise have an inherently viable business proposition. Its business strategy is to acquire and invest in medium sized enterprises that are either very high risk investments or are in financial distress which makes the investment as a very "high-risk" venture and therefore, its credit rating was also quite low. The funding of these investments are primarily through intra-group financing, wherein IDM raises money through debt instruments from group companies in the form of Compulsory Conv ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ainst average interest rate of 11.3% paid by the assessee. Alternative, the assessee also carried out corroborative search process using Bombay Stock Exchange (BSE) data on INR denominated debt issuances. After various qualitative analysis and keep into consideration the credit rating of the borrower and the time of issuance, two comparable transactions were identified and after carrying out tenor adjustment to factor-in long term nature of the tested transaction, an arm's length interest paid of 15.01% was arrived at. The details of these two comparables were as under:- S. No. Data Source Issuer Coupon rate Tenor Adjustment (bps) All in Rate after Adjustments (bps) 1 BSE Starlight Systems Private Limited 15% 0.97% 15.97% 2 BSE Share Microfin Limited 13.75% 0.30% 15.01% Not only that, the assessee in its TP Study Report to justify its payment of interest @ of 11.30% also assimilated information on the cost of borrowing for the assessee assuming a case, where it had to take loan from the lenders in the Indian market. For this purpose, interest rates quoted by various public sector banks on their websites as per there external credit ratings scale were con ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... external commercial borrowings are available in India and if the AE is taken as a "tested party", then, assessee should have used geographical data where AE is located and the external data of AEs' location could have been used for benchmarking of the interest rate. The assessee has neither look for comparable companies in India or the comparables from the region where AE is located. The assessee has taken the data for the bond rates used in different geographical locations, other than the AE and thereafter has made various adjustments which give skewed results. As regards the reliance of data available from BSE site for identifying the comparable transactions which had issued debt instruments (in INR), he observed that, there are hardly any company which has a credit rating below "A". Further, the company has identified two companies namely, Straight System Private Limited and Share Microfin Limited; however, no data for these two comparable were available on the website for the financial year 2009-10. 4. After rejecting the assessee's benchmarking of the interest rate paid to the AE, he proceeded to analyse the arm's length price of the interest paid/payable to the AE. First of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s' DealScan, and Bloomberg Database and also from the website of Bombay-Stock-Exchange, submitted that looking to the high risk investment in which assessee is involved and being a Schedule BBB(-) rating company, the payment of average interest rate 11.30% on CCDs issued is fully justified and is ALP. Thereafter, the assessee explained the rationale behind the need for economic adjustments while arriving at arm's length rate to weed out the differences in external comparable sets and the tested transaction on account of currency risk, country risk, tenor risk and credit rating of the borrower. Further, the tested transaction is in INR denominated debt with a fixed coupon rate, therefore, benchmarking with the foreign currency bonds rates or ECBs rate on FCNR loans cannot be made applicable. The base rate on which interest rate depends is directly related to the currency of denomination of the issuance. A debt i.e. denominated in a specific currency should be compared to a debt that is, denominated in the same currency. Supply and demand for funds in a specific currency affects the price, that is, the interest rate. Accordingly, the reference rate used for NIR denominated debt shoul ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in which has identical or similar facts as that of the assessee. Regarding external CUP used by assessee for using external data like Thomson Reuters' DealScan and Bloomberg data base for comparable transactions, the DRP held that, since number of adjustments have been carried out, therefore, the resultant comparable figures cannot be said to be free from defects and it could not be said that final determination of the ALP of comparables was the ideal figure, specifically when the assessee himself admitted that no comparables were available in Indian domain in the aforesaid databases. Regarding data obtained from BSE also, the DRP observed that the data was not available for FY 2009-10 and the assessee selected the comparables from the data of the year 2013 from which it has made adjustments of time of issuance and tenor. Such an analysis also is not free from defects and will result into incorrect determination of the ALP. Lastly, benchmarking of interest rate by determining the cost of borrowing where it had to take loan from the Indian market and adopting the rates quoted by various public sector on their websites, is also devoid of merits as the transactions undertaken by the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nario. Though, here the assessee has tried to benchmark the interest rate by using external CUP method, however, the only dispute between the assessee and the Department is arm's length rate of interest paid by the assessee to the AE and not the method as such, that is, CUP is the accepted MAM. The TPO in his order has rejected the entire TP exercise of the assessee including selection of the external comparables and has tried to benchmark firstly, by using external commercial borrowings data as per RBI circular and websites of banks giving ECBs on LIBOR plus certain bps points, whereby he arrived at arm's length rate of 8.5% and secondly, by adopting US Bond Rate and arrived at an average arm's length rate of 5.68%. The whole exercise done by the TPO is incorrect, because what is required to be benchmarked is the interest rate applicable in India that to be in INR and not in terms of any foreign currency, which makes the entire finding erroneous. This fallacy permeates in his entire approach and finally in making the adjustments. If one goes by the rate of 8.5% arrived at by the TPO, it is net of withholding tax and if same is considered on gross basis rate then it would be approx ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rate of interest of more than 15% and hence in such a situation, the assessee's benchmarking of payment of rate of interest at 11.30% has to be treated at arm's length price. He further filed a copy of public issue of secured & non-secured debentures issued by Shriram Transport Finance Co. Ltd. and Tata Capital Ltd. in the year 2009, wherein for AA and AA+ credit rating, the average yield of interest is ranging from 11% to 12%. Thus, assessee being BBB (-), the average rate of interest 11.30% is definitely far within the range of arm's length. Thus, no TP adjustment at all is required in the case of the assessee. 10. On the other hand, the Ld. CIT DR submitted that it is not a case of plain vanilla loan, but of compulsory convertible debentures. Earlier the rate of interest paid by the assessee was around 7%. The reset of interest in this year was @ 9.75% which within the same year as swelled to 14%. Thus, there is a huge difference of interest rate in the same financial year itself from 9.75% to 14%., which is an increase of around 43% in one year. Once there is no fresh borrowing in this year then how in the course of one year there has been such a huge increase. This factum it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ainly on account of increase of non-performing assets (NPA) during the year which has risen from INR 1603.44 million to INR 5249 million. This increase in default risk has necessitated the reset of interest rate which has been offered on the borrowings. In its transfer pricing study report, the assessee, applied CUP method (external) to benchmark the transaction in line with the international practices. For this purpose, it first analyzed itself by way of credit estimation exercise of the borrowing entity by using S&P Corporate Rating criteria. Based on such rating, it carried out external comparable of transactions from international data from Thomson Reuters' DealScan, and Bloomberg Databases to identify comparable transactions with the debt of the assessee. Since no INR denominated debt were available on these databases, the assessee shortlisted some of comparable transactions and after making qualitative analysis, certain adjustments on account of country risk, currency risk and tenor adjustment was made. After such an exercise arm's length interest rate of 14.51% was arrived at. The second analysis was done by undertaking comparable debt issuances from BSE data which resulted ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lation does not laid down any specific procedure or guidelines for choice of "tested party", however, OECD provides that, as a general rule, tested party should be the one to which transfer pricing method can be applied in most reliable manner and for which most reliable comparables can be found. In other words, the tested party ought to be the enterprise that offers high degree of comparability and requires least amount of adjustment. It should be, most often the one that has least complex functional analysis. Under CUP method, what is required to be seen is the price at which a controlled transaction is carried out as compared to the price obtained in a comparable uncontrolled transaction under similar conditions. Thus, it is a direct method for determination of Arm's length price. Product Comparability is the main 'key factor'. Whereas, in the other methods, like Cost Plus, Resale Price or Transactional Net Margin Method, financial indicators like markup on costs, gross margin or net profit indicator is tested and analyzed with an appropriate base. Thus, under these methods, the choice of the "tested party" becomes far more imperative. That is why, in United Nations Practice Man ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e concept of "tested party" is that, the transaction which is being benchmarked is interest payment by assessee to its AE, that is, transaction undertaken by the assessee and not vice-versa. Had it been the transaction undertaken by AE, then perhaps, similar transaction by AE with the third party or independent similar transaction in the place of AE could have been analyzed to come to an ALP. The DRP while incorporating the same paragraphs from these guidelines has grievously omitted to incorporate the operating three lines of the same paragraph. Thus, there is no support of the premise or conclusion arrived by the TRP as well as by the DRP in holding that entire transfer pricing and benchmarking analysis done by the assessee is vitiated simply because the assessee has not identified the "tested party". Accordingly, we are unable to subscribe to the views and the reasoning given by the TPO as well as by the DRP qua the selection of "tested party" and thereby conducting benchmarking analysis based on external country data or foreign currency bond/interest rates. 13. Now coming to the issue, whether the arm's length interest rate arrived at by the TPO and endorsed by the DRP by adop ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... States should be applied, for the borrower was a resident and an assessee of the said country, in our considered opinion, must be answered by adopting and applying a commonsensical and pragmatic reasoning. We have no hesitation in holding that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. Interest rates should not be computed on the basis of interest payable on the currency or legal tender of the place or the country of residence of either party. Interest rates applicable to loans and deposits in the national currency of the borrower or the lender would vary and are dependent upon the fiscal policy of the Central bank, mandate of the Government and several other parameters. Interest rates payable on currency specific loans/ deposits are significantly universal and globally applicable. The currency in which the loan is to be re-paid normally determines the rate of return on the money lent, i.e. the rate of interest. Klaus Vogel on Double Taxation Conventions (Third Edition) under Article 11 in paragraph 115 states as under:- x x x x x x x x x x x x x x x x x x x x x x x ... 40. The aforesa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arables namely; Starlight Systems Private Limited and Share Microfin Limited which have a coupon rate of 15% and 13.75%. Since these data belong to year 2013, the assessee had made minor tenor adjustment to factor the time period to arrive at interest rate of 15.97% and 14.05% giving a mean rate of 15.01%. Though the assessee was required to benchmark its transaction by taking the financial year data for year 2009-10, but, if such a data were not available then it cannot be held that such a tenor adjustment for taking into time period cannot be made under CUP, if it has been made quite accurately taking into account the material factors relating to time of the transaction affecting the price. We though agree that, a high degree of comparability is required under CUP, but in absence of such a comparable data, a minor adjustment can be made to eliminate the material effect of time difference for arriving at a comparable uncontrolled price. Now before us, the assessee had filed two comparable transactions for the year 2009, that is, for the same financial year in the case of Shriram Transport Financial Company Ltd. and Tata Capital Ltd., wherein, for credit rating of AA Enterprises th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 3 (Del), no disallowance should be made once there is no exempt income and therefore, the disallowance as made by the AO should be deleted. 20. Ld. DR, strongly relying upon the order of the DRP submitted that, what is required to be looking into whether such investments are capable of earning exempt income or not; if they are then, needless to say that, disallowance under section 14A should be made. 21. After considering the rival submissions and on perusal of the impugned order, we find that, it is an admitted fact that assessee has not earned any exempt income. Once that is so, now in the wake of decision of Hon'ble Delhi High Court in the case of Cheminvest Ltd. (supra), no disallowance under section 14A can be made. This decision of Hon'ble Delhi High Court is being followed in various cases by this Tribunal. Moreover, in this case, it has been submitted before us that, investee companies are loss making entities incapable of declaring dividend and, therefore, there is no possibility of earning of any dividend income in the future also. Thus, respectfully following the ratio of Hon'ble Delhi High Court decision in the case of Cheminvest Ltd (supra) we hold that no disallowan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Thus, in sum and substance, the assessee's submission was that the income on these loan/debt instruments were booked in financial year 2010-11 due to regulatory norms prescribed by RBI and accordingly, were offered to tax in that year but these parties had provided for the interest in the financial year 2009-10 and deducted the tax accordingly. Thus the difference is mainly a timing difference that gets reversed in the previous year 2010-11. Moreover as per RBI directions income/interest on NPA shall be recognized only when it is realized and not earlier.However, the AO held that in a mercantile system of accounting, the revenues are to be recognized on accrual basis and hence, postponement of revenue recognition is not justified. The interest income has to be accounted for during year under consideration following the matching principles since the related expenses have been claimed during the year under consideration. Accordingly, he taxed the entire interest income of Rs. 33,73,86,850/-. 24. The assessee's case before the DRP was that in the notes of accounts in the financial statements for the financial year 2009-10 it was duly reported/stated as under: "Interest income is acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nciple, since the related expenses are claimed during the year under consideration. The basic argument of the assessee that interest pertains to NPAs is itself fallacious as the assessee has itself declared the same in the succeeding year in respect of three parties and in respect of the other party i.e. Kitply Industries Ltd, the assessee has not demonstrated as to how its investment can be said to be NPA. In view of these facts therefore, these decisions cited by the assessee will not apply to the issue at hand. Therefore, we uphold the action of the AO to tax the interest income on mercantile basis at Rs. 33,73,86.850/-. The objection No. 4 is accordingly rejected". 25. Before us, Mr. J D Mistry submitted that the interest on NPA has been offered to tax on receipt basis as per the RBI Prudential norms which assessee is bound to follow being a NBFC. Now there are umpteen numbers of decisions including that of Hon'ble jurisdictional High Court that, interest of NPA is to be offered to tax in the year of receipt. Two such decisions relied upon by him are as under:- a) CIT vs. KEC Holdings Ltd, Income-tax Appeal No.221 of 2012 judgment and order dated 11th June, 2014 (Bombay High ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ized before the asset became nonperforming and remaining unrealized shall be reversed." (Effective from May 12, 1998) Thus, the assessee has recognized the revenue of interest on NPA as per the RBI guidelines which envisages for on realization basis. Now this aspect of the matter has been dealt by the Hon'ble jurisdictional High Court in the case of CIT vs KEC Holdings Ltd. (supra), wherein their Lordships have relied upon the decision of Delhi High Court in the case of Vasisth Chay Vyapar Ltd. (supra). In the case before the Hon'ble Bombay High Court, the substantial question of law related to same issue that is, addition of accrued interest on non-performing-assets. The Tribunal in that case has held that same has to be taxed on realization basis even if the interest income is shown on accrual basis after it is not realized, because the banking institutions or NBFC following mercantile system of accounting are permitted to treat the same income as doubtful and they are permitted to keep the same in Suspense Account and it is not necessary that it is brought to Profit & Loss Account of the assessee. After detailed discussion, the Hon'ble High Court concluded in the following man ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pal of sum of Rs. 120 crores in financial year 2012-13, that is, in subsequent financial years. If such a contention of the assessee is correct then no interest income can be taxed simply on the basis of accrual. On this account also the above ratio laid down by Hon'ble Bombay High Court and also the RBI guidelines will apply. Since, this aspect of the matter has not been considered either by the AO or by the DRP, therefore, same needs verification from the end of the AO to see whether the contention of the assessee is correct that the portfolio was sold at a huge loss in the financial year 2012-13 and no interest has been recovered. Thus, in view of our finding the decision of the AO in compliance with the direction of the DRP is reversed and the ground No. 3 as raised by the assessee is treated as partly allowed for statistical purposes in the manner indicated above. 27. So far as grounds relating to levy of interest under sections 234A, 234B and 234D, no argument have been raised before us. Accordingly, the same is treated as dismissed as not pressed. Accordingly, ground no. 4 & 5 are treated as dismissed. 28. In the result, appeal of the assessee is partly allowed. Order pro ..... X X X X Extracts X X X X X X X X Extracts X X X X
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