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TMI Blog2016 (11) TMI 1671X X X X Extracts X X X X X X X X Extracts X X X X ..... spread. Ld. CIT (A) ought to have quashed this part of order by deleting addition." 3. Briefly stated, the relevant material facts are as follows. The assessee before us is engaged in manufacturing of pigments and various types of agrochemicals. During the course of proceedings before the Transfer Pricing Officer, it was noticed that the assessee has granted interest free unsecured loans to its US based subsidiary, namely Meghamani Organics Inc, and the closing balance, as on 31st March 2008, in respect of these interest free loans was Rs. 1,08,59,459. It was explained by the assessee that since the said company is a fully owned subsidiary, there was no need of security to cover the loans. The TPO noted that since in an arm's length situation, the assessee ought to have charged interest on loans granted to an independent enterprise, an arm's length price adjustment is required to be made in this regard. He further noted that since "No credit rating or other information about the AE is provided by the assessee.......these entities are pegged conservatively at BBB+ level even though the AEs may fall much below this level". With these observations, he proceeded to hold that that "LI ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the corresponding bank in the other country and the lender bank would have no profit margin left if it charged only the LIBOR rate. 4.2 It is also seen that the Assessing Officer has assumed that the credit rating of the associated enterprise at BBB(+) (since no data about the AE was provided by the appellant). However, after calculating the prime lending rate in the US he has added another guarantee fee of 2%. The above computation has resulted in a higher interest rate calculation. The bench mark rate to be charged as notional rate of interest is LIBOR plus a markup which would be the profit arising to the bank or credit institution. The contention of the appellant that a LIBOR rate should be charged as a bench mark rate is not correct. In the case of DCIT Circle2(3), Mumbai vs. Tech Mahendra Ltd. reported in (2011) 12 taxmann.com 132 (Mum.). The 'E' Bench of ITAT, Mumbai has upheld that the bench mark rate has to be LIBOR rate plus a marker which acts as a spread for the bank. In that case, since, the transaction was between two associated enterprises, the ITAT held that the bench mark rate should be the LIBOR rate plus a markup which in that case was determined that 8 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at 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 arms 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 as ALP, cannot meet any judicial approval. 6. What is important, however, is that even after this stated ALP of LIBOR + 100 basis points, there is still a cushion of further 147 basis points before the interest charged can be said to more than the arm's length price, and it is an old matter. It is, therefore ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng 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 non-banker 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 to the taxpayer for giving guarantee for equivalent amount of loan given to the AE i.e. the rate differential for the difference in interest spread between the credit rating of the taxpayer and the AE. Thus after the above analysis, the equivalent interest rate is the interest rate including the tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rent 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, Honble High Court specifically approved the Tribunals 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, investments of substantial risk and investments of default. The approach adopted by the DRP cannot, therefore, meet our approval. 10. Similarly, the DRPs observation to the effect that "Generally, Indian banks are charging interest rate of 2.5% to 5% above the LIBOR/EURIBOR for foreign currency loan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h Court, in the unreported judgment dated 25th February 2015 of PCIT Vs Bharti Airtel Ltd (supra), and in the case of unsecured loans to a subsidiary, held that LIBOR plus 1.5% can be accepted to be an arm's length interest. As a matter of fact, learned CIT(A) has accepted the margin at 1% but then he has taken the base rate of 7.5% by observing that "In view of the above and keeping in mind that the prime lending rate in US on an average rate" which "during the period, has been worked out by the assessee at 7.5%". It is on this basis, the CIT(A) has held the ALP interest @ 8.5%. However, once Hon'ble High Court is pleased to accept the LIBOR as a basis of computing arm's length price, and that is the standard practice approved by numerous decisions of this Tribunal as well, there is no need to turn to any other parameter. We hold that while the margin adopted by the CIT(A), which is 1% in this case, can indeed by accepted, but the ALP is to be computed by adopting LIBOR as the foundational basis.. There is, however, some variation in figures of LIBOR as set out in the judicial precedents referred to above vis-à-vis as per records of this case. That, however, is not necessar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 89% of US $ 2,000,000), which was taken as equivalent to INR 16,98,410, was made by the TPO. The AO, accordingly, made an addition to the returned income on this basis. Aggrieved, assessee carried the matter in appeal before the CIT(A) but without any success. Learned CIT(A), while upholding the stand of the TPOI, observed as follows: "6. I have gone through the assessment order and submission of the A.R. of the appellant carefully. It is seen that though the TPO has not mentioned the specific method which he has adopted for making the adjustments in this case, it is seen that the Assessing Officer has taken a bench mark rate and as calculated the upward adjustments on the basis of the difference between the rate applied by the appellant. This deals in this case and the bench mark rate. Intact, in para 6.24, the TPO has clearly mentioned that he has applied the external CUP method for working out the adjustment. In view of the above, the reliance of the appellant on the decision of Amadeus India Pvt. Ltd. (Delhi High Court) reported in 246 CTR 333 (Delhi) and Genom Biotech Pvt. Ltd. (Mumbai ITAT) (2012) reported in 21 taxman.com 315 (Mum.) is not right because the Assessing Offic ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ternational transaction' first. The expression 'international transaction' is a defined expression. Section 92B defines the expression 'international transaction' as follows: '92B - Meaning of international transaction (1) For the purposes of this section and sections 92, 92C, 92D and 92E, "international transaction'' means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to anyone or more of such enterprises. (2) A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be a transaction enter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ings; (d) data processing related intangible assets, such as, proprietary computer software, software copyrights, automated databases, and integrated circuit masks and masters; (e) engineering related intangible assets, such as, industrial design, product patents, trade secrets, engineering drawing and schematics, blueprints, proprietary documentation; (f) customer related intangible assets, such as, customer lists, customer contracts, customer relationship, open purchase orders; (g) contract related intangible assets, such as, favourable supplier, contracts, licence agreements, franchise agreements, non-compete agreements; (h) human capital related intangible assets, such as, trained and organised workforce, employment agreements, union contracts; (i) location related intangible assets, such as, leasehold interest, mineral exploitation rights, easements, air rights, water rights; (j) goodwill related intangible assets, such as, institutional goodwill, professional practice goodwill, personal goodwill of professional, celebrity goodwill, general business going concern value; (k) methods, programmes, systems, procedures, campaigns, surveys, studies, forecasts, estimate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nternational transactions'. 28. The first two categories of transactions, which are stated to be included in the scope of expression 'international transactions' by the virtue of clause (a) and (b) of Explanation to Section 92B, are transactions with regard to purchase, sale, transfer, lease or use of tangible and intangible properties. These transactions were anyway covered by 2 (a) above which covered transactions 'in the nature of purchase, sale or lease of tangible or intangible property'. The only additional expression in the clarification is 'use' as also illustrative and inclusive descriptions of tangible and intangible assets. Similarly, clause (d) deals with the "provision of services, including provision of market research, market development, marketing management, administration, technical service, repairs, design, consultation, agency, scientific research, legal or accounting service" which are anyway covered by 2(b) and 3 above in "provision for services" and "mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ore us, it is an undisputed position that corporate guarantees issued by the assessee to the Deutsche Bank did not even have any such implication because no borrowings were resorted to by the subsidiary from this bank. 31. In this light now, let us revert to the provisions of clause (c) of Explanation to Section 92B which provides that the expression 'international transaction' shall include "capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business". In view of the discussions above, the scope of these transactions, as could be covered under Explanation to Section 92B read with Section 92B(1), is restricted to such capital financing transactions, including inter alia any guarantee, deferred payment or receivable or any other debt during the course of business, as will have "a bearing on the profits, income, losses or assets or such enterprise". This precondition about impact on profits, income, losses or assets of such enterprises is a precondition embedded in Section 9 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uch a nature as to have "bearing on profits, income, losses or assets" of the enterprise, and there was not even an effort to discharge this onus. Such an impact on profits, income, losses or assets has to be on real basis, even if in present or in future, and not on contingent or hypothetical basis, and there has to be some material on record to indicate, even if not to establish it to hilt, that an intraAE international transaction has some impact on profits, income, losses or assets. Clearly, these conditions are not satisfied on the facts of this case.' 23. Learned Departmental Representative submits that this decision is no longer good law in the light of Everest Kanto Cylinders Ltd. decision (supra) and Vodafone India Services (P.) Ltd. decision (supra) by Hon'ble Bombay High Court. 24. As for Hon'ble High Court's judgment in the case of Everest Kanto Cylinders Ltd. (supra), it is necessary to appreciate the fact the assessee was charging a .5% commission on issuance of corporate guarantees, on behalf of the AEs, and it could not, therefore, be said that the transaction will have no impact on "profits, incomes, losses or assets of such enterprise". This as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , however, when they are Commercial banks that issue bank guarantees which are treated as the blood of commerce being easily encashable in the event of default, and if the bank guarantee had to be obtained from Commercial Banks, the higher commission could have been justified. In the present case, it is assessee company that is issuing Corporate Guarantee to the effect that if the subsidiary AE does not repay loan availed of it from ICICI, then in such event, the assessee would make good the amount and repay the loan. The considerations which applied for issuance of a Corporate guarantee are distinct and separate from that of bank guarantee and accordingly we are of the view that commission charged cannot be called in question, in the manner TPO has done. In our view the comparison is not as between like transactions but the comparisons are between guarantees issued by the commercial banks as against a Corporate Guarantee issued by holding company for the benefit of its AE, a subsidiary company. In view of the above discussion we are of the view that the appeal does not raise any substantial question of law and it is dismissed." 25. We are unable to see, in the judgment of Hon& ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ghts having been categorised as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India. 216. Two aspects of a transfer are clarified - the asset itself and the manner in which it is dealt with. The asset is no longer restricted to the asset per se or a right therein, but also extends to "any interest therein". Prior to the amendment, the words "any interest therein" were absent. Further, the nature of the disposal is also expanded. It now includes the creation of any interest in any asset. Moreover, the disposal of or creation of any interest in the asset may be direct or indirect, absolute or conditional, voluntary or involuntary. It may be by way of an agreement or otherwise. Further, the concluding words constitute a non-obstante provision. It provides that the transfer contemplated therein would be notwithstanding that it has been characterised as being effected or dependent upon or flowing from the transfer of a share or shares of a company registered or incorporated outside India. It would be evident, therefore, that a lot more must now be seen and considered than before while arriving at a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch it may not have done earlier. 220. These are important issues. There is no justification for withdrawing the proceedings from the channel provided by the Incometax Act, bypassing the Tribunal and considering all these questions in exercise of the High Court's extraordinary jurisdiction under Article 226.' (Emphasis supplied) 27. Revenue's emphasis is on the last two sentences in paragraph No 213 which state that "The effect of the amendment would have to be considered. It cannot be brushed aside" but in doing so what it overlooks is the subsequent observations highlighted above which recognize the fact that merely because a subsequent Explanation is introduced by the legislature, it is not an open and shut case against the assessee or the revenue, and that all these observations are in the context that "there is no justification for withdrawing the proceedings from the channel provided by the Income-tax Act, bypassing the Tribunal and considering all these questions in exercise of the High Court's extraordinary jurisdiction under Article 226". When Their Lordships have made it clear that they would not like to bypass the channels under the Income-tax Act and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nder consideration by this Court, to support their reasoning" It was also recalled that in Madhav Rao Jivaji Rao Scindia Bahadur v. Union of India AIR 1971 SC 530, Hon'ble Supreme Court had cautioned that "It is not proper to regard a word, clause or a sentence occurring in a judgment of the Supreme Court, divorced from its context, as containing a full exposition of the law on a question when the question did not even fall to be answered in that judgment." That precisely, however, has been the approach of the revenue authorities in placing reliance on Vodafone India Services (P.) Ltd. (supra) decision. We reject this approach. 28. For the reasons set out above, learned Departmental Representative's reliance on Hon'ble Bombay High Court's judgments in the cases of Everest Kanto (supra) and Vodafone India Services (supra) is wholly misplaced and devoid of any merits. As for coordinate bench decision in the case of Hindalco Industries (supra), all it does is to follow the Everest Kanto decision by Hon'ble Bombay High Court, but then, as we have seen earlier, that was a case in which Their Lordships were in seisin of a situation in which guarantee commission was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o interesting to note that as a sequel to this Tax Court of Canada decision, the transfer pricing legislation was amended, to bring greater clarity on the issue and as a measure of abundant caution, and section 247 (7.1), granting specific exemption to guarantee fees, was introduced. This amendment is as follows: (7.1) Sub-section (2) does not apply to adjust an amount of consideration paid, payable or accruing to a corporation resident in Canada (in this sub-section referred to as the "parent") in a taxation year of the parent for the provision of a guarantee to a person or partnership (in this sub-section referred to as the "lender") for the repayment, in whole or in part, of a particular amount owing to the lender by a non-resident person, if (a) the non-resident person is a controlled foreign affiliate of the parent for the purposes of section 17 throughout the period in the year during which the particular amount is owing; and (b) it is established that the particular amount would be an amount owing described in paragraph 17(8)(a) or (b) if it were owed to the parent. (http://www.fin.gc.ca/drleg-apl/ita-lrir-dec12-l-eng.pdf) 31. It is also important to bear in mind the f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oes not derive any advantage from the Tax Court of Canada's decision in the case of GE Capital Canada. There are many more aspects which make this decision wholly irrelevant in the present context but suffice to say that relevant legal provisions and context being radically different, the reliance of this decision must be rejected for this short reason alone. 32. As we take note of the above legal position in Canada, it is appropriate to take note of the concept of 'shareholder activities' in the context of corporate guarantees which provides conceptual justification for exclusion of corporate guarantees, under certain conditions, from the scope of transfer pricing adjustments. Taking note of these proposed amendments, 'Transfer Pricing and Intra Group Financing - by Bakker & Levvy, IBFD publication (ISBN- 978-90-8722-153-9)' observes that "Proposed subsection 247(7.1) of the ITA provides that the transfer pricing rules will not apply to guarantees provided by Canadian parent corporations in respect of certain financial commitments of their Canadian controlled foreign affiliates to support the active business operations of those affiliates". As to what could b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d in the assessment order itself, that "said guarantees were in the form of corporate guarantees/quasi-capital and not in the nature of any services". In other words, these guarantees were specifically stated to be in the nature of shareholder activities. The assessee's claim of the guarantees being in the nature of quasi-capital, and thus being in the nature of a shareholder's activity, is not rejected either. The concept of issuance of corporate guarantees as a shareholder activity is not alien to the transfer pricing literature in general. On the contrary, it is recognized in international transfer pricing literature as also in the official documentation and legislation of several transfer pricing jurisdictions. The 'OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations' itself recognizes the distinction between a shareholder activity and a provision for services, when, contrasting the shareholder activity with broader term "stewardship activity" and thus highlighting narrow scope of shareholder activity, it states that "Stewardship activities covered a range of activities by a shareholder that may include provision for services t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f transfer pricing legislation by taking refuge of the best practices recognized by the OECD work. 35. While dealing with "special consideration for intra-group services", the 'OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations' has noted that there are two fundamental issues with respect to the intra-group services- first, whether intragroup services have indeed been provided, and, second- if the answer to the first question is in positive, that charge to these services should be at an arm's length price. Dealing with the first question, which is relevant for the present purposes, these Guidelines (2010 version) state as follows: '7.6 Under the arm's length principle, the question whether an intragroup service has been rendered when an activity is performed for one or more group members by another group member should depend on whether the activity provides a respective group member with economic or commercial value to enhance its commercial position. This can be determined by considering whether an independent enterprise in comparable circumstances would have been willing to pay for the activity if performed for it by an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... services that would be provided by a coordinating centre. These latter types of non-shareholder activities could include detailed planning services for particular operations, emergency management or technical advice (trouble shooting), or in some cases assistance in day-to-day management. 7.10 The following examples (which were described in the 1984 Report) will constitute shareholder activities, under the standard set forth in paragraph 7.6: (a) Costs of activities relating to the juridical structure of the parent company itself, such as meetings of shareholders of the parent, issuing of shares in the parent company and costs of the supervisory board; (b) Costs relating to reporting requirements of the parent company including the consolidation of reports; (c) Costs of raising funds for the acquisition of its participations. In contrast, if for example a parent company raises funds on behalf of another group member which uses them to acquire a new company, the parent company would generally be regarded as providing a service to the group member. The 1984 Report also mentioned "costs of managerial and control (monitoring) activities related to the management and protectio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... definition discussed above. As a matter of fact, David S Miller, in a paper titled 'Federal Income Tax Consequences of Guarantees; A Comprehensive Framework for Analysis' published in the 'The American Lawyer Vol. 48, No. 1 (Fall 1994), pp. 103- 165 (http://www.jstor.org/stable/20771688), has stated that a guarantee is not a service. The following observations, at pages 114, are important: The position that guarantees are services has been discredited by the courts with good reason38. Guarantee fees do not represent payments for services any more than payments with respect to other financial instruments constitute payment for services39. A guarantor does not arrange financing for the debtor, but merely executes a financial instrument in its favour. 38. See. e.g., Centel Communications Co. v. Commissioner, 92 T.C. 612, 632 (1989), aff d, 920 F2d 1335 (7th Cir. 1990); Bank of Am. v. United States, 680 F.2d 142, 150 (Cl. Ct. 1982). The Service's current position on the characterization of guarantee fees as payment for services under section 482 is inconsistent with its treatment of guarantee fees under other provisions. See P.L.R. 9410008 (Dec. 13, 1993). 39. But ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er the same. 38. One more thing which is clearly discernable from the above discussions is that the tests recognized by these guidelines are interwoven twin tests of benefit and arm's length. Benefit test implies the recipient group member should get "economic or commercial value to enhance its commercial position". The benefit test is interlinked with the an arm's length test in the sense that it seeks an answer to the question whether under a similar situation an independent enterprise would have been willing to pay for the activity concerned, or would have performed the activity in-house for itself. So far as the benefit test is concerned, as we have noted earlier, it is alien to the definition of international transaction' under the Indian transfer pricing legislation. So far as arm's length test is concerned, it presupposes that such a transaction is possible in arm's length situation. However, in a situation in which the subsidiary does not have adequate financial standing of its own and is inadequately capitalized, none will guarantee financial obligations of such a subsidiary. 39. The issuance of financial guarantee in favour of an entity, which does ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to meet his financial commitments and the bank is called upon to make the payments, the bank will seek a compensation for the action of issuing the bank guarantee, and for the risk it runs inherent in the process of making the payment first and realizing it from the underlying security and the client. Even when such guarantees are backed by one hundred per cent deposits, the bank charges a guarantee fees. In a situation in which there is no underlying assets which can be realized by the bank or there are no deposits with the bank which can be appropriated for payment of guarantee obligations, the banks will rarely, if at all, issue the guarantees. Of course, when a client is so well placed in his credit rating that banks can issue him clean and unsecured guarantees, he gets no further economic value by a corporate guarantee either. Let us now compare this kind of a guarantee with a corporate guarantee. The guarantees are issued without any security or underlying assets. When these guarantees are invoked, there is no occasion for the guarantor to seek recourse to any assets of the guaranteed entity for recovering payment of defaulted guarantees. The guarantees are not based on the c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nks. No material, indicating to the contrary, is brought on record in this case. Going by the OECD Guidance also, it is not really possible to hold that the corporate guarantees issued by the assessee were in the nature of 'provision for service' and not a shareholder activity which are mutually exclusive in nature. In the light of these discussions, we are of the considered view, and are fully supported by the OECD Guidance in this, that the issuance of corporate guarantees, in the nature of quasi-capital or shareholder activity-as is the uncontroverted position on the facts of this case, does not amount to a service in which respect of which arm's length adjustment can be done. 42. As observed by Hon'ble Delhi High Court in the case of CIT v. EKL Appliances Ltd. [2012] 345 ITR 241/209 Taxman 200/24 taxmann.com 199 (Delhi) = 2012-TII-01-HC-DEL-TP, a re-characterization of a transaction is indeed permissible, inter alia, in a situation "(i) where the economic substance of a transaction differs from its form and (ii) where the form and substance of the transaction are the same but arrangements made in relation to the transaction, viewed in their totality, differ fr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... h could be compounded by double taxation created where the other tax administration does not share the same views as to how the transaction should be structured. 1.37 However, there are two particular circumstances in which it may, exceptionally, be both appropriate and legitimate for a tax administration to consider disregarding the structure adopted by a taxpayer in entering into a controlled transaction. The first circumstance arises where the economic substance of a transaction differs from its form. In such a case the tax administration may disregard the parties' characterization of the transaction and recharacterise it in accordance with its substance. An example of this circumstance would be an investment in an associated enterprise in the form of interest-bearing debt when, at arm's length, having regard to the economic circumstances of the borrowing company, the investment would not be expected to be structured in this way. In this case it might be appropriate for a tax administration to characterize the investment in accordance with its economic substance with the result that the loan may be treated as a subscription of capital. The second circumstance arises wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lines discourage re-structuring of legitimate business transactions. The reason for characterisation of such re-structuring as an arbitrary exercise, as given in the guidelines, is that it has the potential to create double taxation if the other tax administration does not share the same view as to how the transaction should be structured. 18. Two exceptions have been allowed to the aforesaid principle and they are (i) where the economic substance of a transaction differs from its form and (ii) where the form and substance of the transaction are the same but arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner.' 43. It is thus clear that even if we accept the contention of the learned Departmental Representative that issuance of a corporate guarantee amounts to a 'provision for service', such a service needs to be recharacterized to bring it in tune with commercial reality as "arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rch, market development, marketing management, administration, technical service, repairs, design, consultation, agency, and scientific research, legal or accounting service or coordination services. As a matter of fact, even in the Explanation to Section 92Bwhich we will deal with a little later, guarantees have been grouped in item 'c' dealing with capital financing, rather than in item 'd' which specifically deals with 'provision for services'. When the legislature itself does not group 'guarantees' in the 'provision for services' and includes it in the 'capital financing', it is reasonable to proceed on the basis that issuance of guarantees is not to be treated as within the scope of normal connotations of expression 'provision for services'. Of course, the global best practices seem to be that guarantees are sometimes included in 'services' but that is because of the extended definition of 'international transaction' in most of the tax jurisdictions. Such a wide definition of services, which can be subject to arm's length price adjustment, apart, "Transfer Pricing and Intra-Group Financing - by Bakker ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... as a service or not". That's not factually correct. We are unable to see any merits in learned Departmental Representative's contention, particularly as decision categorically noted that not only before the Tribunal, but this issue was also raised before the DRP- as evident from the text of DRP decision. We now take up the issue with respect to specific mention of the words in Explanation to Section 92B which states that "For the removal of doubts, it is hereby clarified that (i) the expression "international transaction" shall include........ (c) capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business." There is no dispute that this Explanation states that it is merely clarificatory in nature inasmuch as it is 'for the removal of doubts', and, therefore, one has to proceed on the basis that it does not alter the basic character of definition of 'international transaction' under Section 92B. Accordingly, this Explanation is to be read in conjunction wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n has no bearing on profits, incomes, losses or assets of such enterprise, the transaction will be outside the ambit of expression 'international transaction'. This aspect of the matter is further highlighted in clause (e) of the Explanation dealing with restructuring and reorganization, wherein it is acknowledged that such an impact could be immediate or in future as evident from the words "irrespective of the fact that it (i.e. restructuring or reorganization) has bearing on the profit, income, losses or assets of such enterprise at the time of transaction or on a future date". What is implicit in this statutory provision is that while impact on " profit, income, losses or assets" is sine qua non, the mere fact that impact is not immediate, but on a future date, would not take the transaction outside the ambit of 'international transaction'. It is also important to bear in mind that, as it appears on a plain reading of the provision, this exclusion clause is not for "contingent" impact on profit, income, losses or assets but on "future" impact on profit, income, losses or assets of the enterprise. The important distinction between these two categories is that whil ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... porate guarantee provided by the assessee company does not fall within the definition of international transaction. The TP legislation does not stipulate any guidelines in respect to guarantee transactions. In the absence of any charging provision, the lower authorities are not correct in bringing aforesaid transaction in the TP study. In our considered view, the corporate guarantee is very much incidental to the business of the assessee and hence, the same cannot be compared to a bank guarantee transaction of the Bank or financial institution." 47. However, within less than four months of this decision having been rendered, the Finance Act 2012 came up with an Explanation to Section 92B stating that "for the removal of doubts", as we have noted earlier in this decision, "clarified" that international transactions include, inter alia, capital financing by way of guarantee. This legislative clarification did indeed go well beyond what a coordinate bench of this Tribunal held to be the legal position and we are bound by the esteemed views of the coordinate bench. We are, therefore, of the opinion that the Explanation to Section 92B did indeed enlarge the scope of definition of ' ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... #39;international transaction' under section 92B of the Act. We have also held, taking note of the insertion of Explanation to Section 92B of the Act, that the issuance of corporate guarantees is covered by the residuary clause of the definition under section 92B of the Act but since such issuance of corporate guarantees, on the facts of the present case, did not have "bearing on profits, income, losses or assets", it did not constitute an international transaction, under section 92B, in respect of which an arm's length price adjustment can be made. In this view of the matter, and for both these independent reasons, we have to delete the impugned ALP adjustment. The question, which was raised in Bharti Airtel's case (supra) but left unanswered as the assessee had succeeded on merits, reamins unanswered here as well. However, we may add that in the case of Krishnaswamy SPD v. Union of India [2006] 281 ITR 305/151 Taxman 286 (SC) = 2006-TIOL-12-SC-IT, wherein Their Lordships had, inter alia, observed that "the law does not compel a man to do what he cannot possibly perform. The law itself and its administration is understood to disclaim as it does in its general aphorisms ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... given decision on the said issue, were wholly academic. It cannot be open to refer the academic questions to the special bench. No doubt, some decisions of the coordinate benches which have reached the different conclusions. There is, however, no conflict in the reasoning. Four Soft Ltd. decision (supra) had decided the issue in favour of the assessee but that was with respect to the law prior to insertion to Explanation to Section 92B. As for the postamendment law and the impact of amendment in the definition of 'international transaction', the matter was again decided in favour of the assessee by Bharti Airtel Ltd. decision (supra) on the peculiar facts of that case. The decisions like Everest Kento Cylinders Ltd. (supra) and Aditya Birla Minacs Worldwide (supra) were decisions in which the assessee had charged the fees and, for that reason, such cases are completely distinguishable as discussed above. In Prolific' Corp Ltd. case (supra), as indeed in any other case so far, it was not the case of the assessee that corporate guarantees are quasi-capital, or shareholder activity, in nature, and, for that reason, excludible from chargeable services, even if these are hel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rporate guarantees issued by the assessees, can never be overemphasized. The sweeping generalizations, vague statements and evasive approach in the transfer pricing study reports, which are quite common in most of the transfer pricing reports, cannot do good to a reasonable cause. When judicial calls on the complex transfer pricing issues are to be taken, utmost clarity in the legislative framework and a comprehensive analysis of relevant facts, in the transfer pricing documentation, are basic inputs. Unfortunately, both of these things leave a lot to be desired. We can only hope, and we do hope, that things will change for better." 7. We are in considered agreement with the views so expressed by the coordinate bench. Learned Departmental Representative's well researched arguments donot persuade us to deviate from the stand so taken by us. Let us deal with these arguments in little detail. 8. Learned Departmental Representative, in his written note, accepts that "the legislature brought in amendment (in Section 92B) by the Finance Act, 2012, after the decision of Four Soft Ltd dated 14/09/2011". He points out that the decision of the Tribunal, in the case of Bharti Airtel ( ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es or assets or income of the assessee. In Advanta decision (supra), this aspect of the matter and the distinguishing feature has been discussed at considerable length. Learned Departmental Representative has then invited our attention to the fact a substantial question of law has been admitted by Hon'ble Delhi High Court in ITA No. 607/2014 against the order passed by the Tribunal in the case of Bharti Airtel (supra). While no doubt the matter is now pending before Hon'ble High Court for the judicial scrutiny by Their Lordships, that fact by itself does not reverse the stand taken by the Tribunal in the order so impugned. As regards the decision of Bharati Airtel being on its own peculiar facts, there can be no denial of this position but that does not mean that the so far as issues of general application are concerned, the stand of the Tribunal cannot hold good. Learned Departmental Representative then takes us through the Explanation to Section 92 B to explain its true scope and through Bharti Airtel decision as to how fallacious is its logic. Its emphasized that the impact of issuance of bank guarantees, on the profits, income, losses or assets of such enterprises, is & ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alt with in paragraph 46 and 47 of this decision, which has been reproduced earlier in this order, at considerable length. It assumes even more significance in the light of a new judicial development that we will deal with in a short while now. In the present case, we are dealing with a situation in which the amendment was made with retrospective effect and it covered certain issues which were already subjected to a judicial interpretation in a particular manner. Learned Departmental Representative does not even dispute it. He is candid enough to place on record the fact, by way of a written note, that the one of the reasons of insertion of Explanation to Section 92 B was to nullify the Four Soft decision (supra). The judicial interpretation so given was certainly not the end of the road. The matter could have been carried in appeal before higher judicial forums. If the decision of a judicial body does not satisfy the tax administration, nothing prevents them from going to the higher judicial forum or from so amending the law, with prospective effect, that there is no ambiguity about the intent of legislature and it is conveyed in unambiguous words. 10. Nullifying a judicial inte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... de in Section 263 in the very first full budget of the present Government. 11. What has, however, been done in the case before us is to amend the law with retrospective effect. Of course, it happened much before the current awareness about the evils of retrospective taxation having been translated into action. 12. Dealing with such a situation, Hon'ble Delhi High Court has, in the case of DIT vs New Skies Satellite BV [TS-64- HC -DEL (2016)] = 2016-TII-06-HCDEL-INTL, observed as follows: 30. Undoubtedly, the legislature is competent to amend a provision that operates retrospectively or prospectively. Nonetheless, when disputes as to their applicability arise in court, it is the actual substance of the amendment that determines its ultimate operation and not the bare language in which such amendment is couched........ 36. A clarificatory amendment presumes the existence of a provision the language of which is obscure, ambiguous, may have made an obvious omission, or is capable of more than one meaning. In such case, a subsequent provision dealing with the same subject may throw light upon it. Yet, it is not every time that the legislature characterizes an amendment as re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... benefit of guidance of Their Lordships, the views articulated by a coordinate bench of this Tribunal, in the case of Bharti Airtel (supra) were of a somewhat similar opinion when it was observed that, "Undoubtedly, the scope of a charging provision can be enlarged with retrospective effect, but an antiavoidance measure, that the transfer pricing legislation inherently is, is not primarily a source of revenue as it mainly seeks compliant behaviour from the assessee vis-à-vis certain norms, and these norms cannot be given effect from a date earlier than the date norms are being introduced". We may add that right now we are only concerned with the question of retrospective amendment in the transfer pricing legislation, which has, as we will see, its own peculiarities and significant distinction with normal tax laws which simply impose tax on an income. 14. Legislature may describe an amendment as 'clarificatory' in nature, but a call will have to be taken by the judiciary whether it is indeed clarificatory or not. This determination, i.e. whether the amendment in indeed clarificatory or is the amendment to overcome a judicial precedent, assumes great significance beca ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ersed by a higher judicial forum. However, if the 2012 amendment does increase the scope of international transaction under section 92B, as is our considered view, there is no way it could be implemented for the period prior to this law coming on the statute i.e. 28th May 2012. The law is well settled. It does not expect anyone to perform an impossibility. Reiterating this settled legal position, Hon'ble Supreme Court has, in the case of Krishnaswamy S Pd Vs Union of India [(2006) 281 ITR 305 (SC)] = 2006-TIOL-12-SC-IT, observed as follows: The other relevant maxim is, lex non cogit ad impossibilia-the law does not compel a man to do what he cannot possibly perform. The law itself and its administration is understood to disclaim as it does in its general aphorisms, all intention of compelling impossibilities, and the administration of law must adopt that general exception in the consideration of particular cases. [See : U.P.S.R.T.C. vs. Imtiaz Hussain 2006 (1) SCC 380, Shaikh Salim Haji Abdul Khayumsab vs. Kumar & Ors. 2006 (1) SCC 46, Mohammod Gazi vs. State of M.P. & Ors. 2000 (4) SCC 342 and Gursharan Singh vs. New Delhi Municipal Committee 1996 (2) SCC 459]. 18. It is f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he reasoning adopted by the bench, speaking through one of us, was as follows: 8. With the benefit of this guidance from Hon'ble Delhi High Court, in view of legislative amendments made from time to time, which throw light on what was actually sought to be achieved by this legal provision, and in the light of the above analysis of the scheme of the law, we are of the considered view that section 40(a)(ia) cannot be seen as intended to be a penal provision to punish the lapses of non deduction of tax at source from payments for expenditure-particularly when the recipients have taken into account income embedded in these payments, paid due taxes thereon and filed income tax returns in accordance with the law. As a corollary to this proposition, in our considered view, declining deduction in respect of expenditure relating to the payments of this nature cannot be treated as an "intended consequence" of Section 40(a)(ia). If it is not an intended consequence i.e. if it is an unintended consequence, even going by Bharti Shipyard decision (supra), "removing unintended consequences to make the provisions workable has to be treated as retrospective notwithstanding the fact that the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not result in any loss to the exchequer. Now that the legislature has been compassionate enough to cure these shortcomings of provision, and thus obviate the unintended hardships, such an amendment in law, in view of the well settled legal position to the effect that a curative amendment to avoid unintended consequences is to be treated as retrospective in nature even though it may not state so specifically, the insertion of second proviso must be given retrospective effect from the point of time when the related legal provision was introduced. In view of these discussions, as also for the detailed reasons set out earlier, we cannot subscribe to the view that it could have been an "intended consequence" to punish the assessee's for non deduction of tax at source by declining the deduction in respect of related payments, even when the corresponding income is duly brought to tax. That will be going much beyond the obvious intention of the section. Accordingly, we hold that the insertion of second proviso to Section 40(a)(ia) is declaratory and curative in nature and it has retrospective effect from 1st April, 2005, being the date from which sub clause (ia) of section 40(a) was i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... February, 2016. However, as that is not the decisive factor so far as our conclusions are concerned and it is only an additional factor in support of our conclusion, that does not matter really. 14. We are in considered agreement with the views so expressed by the coordinate bench. All the arguments raised by the revenue authorities, in the impugned orders as also in the submissions before us, have been elaborately dealt with above, and we concur with the views of the co-ordinate bench on the same. Accordingly, we direct the Assessing Officer to delete this arm's length price adjustment of Rs. 16,98,410. 15. Ground no. 2 is thus allowed. 16. In ground no. 3, the assessee has raised the following grievance: "3. Ld. CIT (A) erred in law and on facts in confirming disallowance made by AO of Rs. 24,69,035/- invoking provisions of section 14A of the Act ignoring submissions of the appellant that no expenditure was incurred to earn such exempt income. Ld.. CIT(A) ought to have deleted disallowance made by AO in a mechanical manner in absence of recording satisfaction." 17. During the course of assessment proceedings, it was noticed by the Assessing Officer that the assessee has rec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... bad debts in the books. Ld. CIT(A) ought to have deleted such disallowance of irrecoverable advances being loss incidental to the business of the appellant." 21. So far as this grievance of the assessee is concerned, the relevant material facts are as follows. During the course of the assessment proceedings, the Assessing Officer noted that out of total write off, claimed as a deduction in the profit and loss account, amounting to Rs. 25,76,276 following amounts, aggregating to Rs. 4,40,331, can be allowed as deduction since these amounts are not found to have been included in the income of the earlier yeas. The Assessing Officer invoked the provisions of Section 36(2) and stated that these conditions are not fulfilled. It was in this background that the following amounts were disallowed: Rs. Total income as per return 23,03,84,600 Additions/Disallowance: As per para-2 23,18,957 As per para-3 24,69,035 As per Para-4 4,40,331 Total Assessed Income 23,56,12,923 22. Aggrieved, assessee carried the matter in appeal before the CIT(A). It was submitted that the assessee was ever put to notice in respect of the above disallowance. It was also submitted tha ..... X X X X Extracts X X X X X X X X Extracts X X X X
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