2013 (9) TMI 204 - AT - Income Tax

Bank guarantee treated as taxable benefit under transfer pricing; Section 92 guarantee fee fixed at 0.5% and LIBOR interest deleted

ITAT held that a bank guarantee constitutes a chargeable service and benefit to Associated Enterprises, so guarantee commission must be at arm's length; ... International transaction - arm's length price - Comparable Uncontrolled Price (CUP) method - transfer pricing adjustment - comparability and qualitative factors - continuing debit balance and its treatment for TP - Explanation to section 92B (retrospective effect) - disallowance under section 14A and Rule 8D applicabilityInternational transaction - arm's length price - Comparable Uncontrolled Price (CUP) method - transfer pricing adjustment - Whether guarantee(s) given by the assessee to its Associated Enterprises constitute an international transaction requiring an arm's length guarantee commission and, if so, the arm's length rate to be applied. - HELD THAT: - The Tribunal held that parent-company guarantees to third-party lenders for subsidiaries involve performance of a service covering default risk and therefore are international transactions for which a price must be charged. The commercial expediency asserted by the assessee did not amount to a specific business strategy that would justify treating the guarantees as gratuitous. The TPO's use of CUP was appropriate, but on the question of rate the Tribunal preferred the reasoning and factual parity with the co-ordinate Bench decision in M/s Everest Kanto Cylinder Ltd. over reliance on the French Societe Carrefour decision. Applying that co-ordinate-bench precedent and considering the range of bank guarantee rates relied upon by the TPO, the Tribunal held that the arm's length fee should be recomputed at 0.5% of the guaranteed amounts and directed the Assessing Officer to recompute accordingly. [Paras 9, 10]Transaction is an international transaction; CUP method appropriate; A.O. to recompute guarantee commission at 0.5% as the arm's length price.Entertainment software expenditure - opportunity to verify evidence - Whether the deletion by the CIT(A) of the A.O.'s disallowance of entertainment/software production expenditure should be sustained or the matter remitted for verification. - HELD THAT: - The Tribunal observed that the assessee produced details of television entertainment software before the CIT(A) for the first time and the Assessing Officer was not given an opportunity to verify those details. Given the absence of opportunity for verification by the A.O., the Tribunal found it appropriate to set aside the CIT(A)'s deletion on this issue and restore the matter to the file of the A.O. for fresh adjudication after verification of the particulars furnished. [Paras 13]Impugned deletion set aside; matter restored to the A.O. for fresh decision after verification of the software expenditure details.Arm's length interest on intra-group loan - mathematical/calcultion correction - Whether the addition for undercharged interest on a loan to an Associated Enterprise (difference arising from calculation) was justified. - HELD THAT: - There was no dispute that the interest rate of 3.26% was at arm's length. However, a calculation error was established: interest at 3.26% actually amounted to a higher sum than booked by the assessee. The assessee accepted the computational mistake. The Tribunal therefore saw no reason to interfere with the A.O./CIT(A) confirmation of the addition representing the shortfall. [Paras 16]Addition confirmed; ground of the assessee's appeal dismissed.Continuing debit balance and its treatment for TP - comparability under CUP for overdue receivables - Explanation to section 92B (retrospective effect) - Whether the transfer pricing adjustment for not charging interest on outstanding receivables (continuing debit balance) from an Associated Enterprise is sustainable. - HELD THAT: - The Tribunal examined prior orders in the assessee's own cases and concluded that a continuing debit balance is not per se an independent international transaction but reflects the commercial transaction giving rise to the debt; terms of payment are integral to the transaction. The TPO's application of LIBOR (a lending/borrowing benchmark) to overdues was inappropriate for commercial receivables. In the absence of internal or appropriate external CUP comparables for overdue commercial receivables, and following the Tribunal's earlier reasoning for the assessee, the impugned addition based on LIBOR was found unsustainable and deleted. [Paras 20]Addition deleted; grounds allowing the assessee's appeal on this issue.Disallowance under section 14A - Rule 8D applicability - Whether the disallowance computed under Rule 8D in respect of expenditure attributable to exempt dividend income should be sustained for the year under consideration. - HELD THAT: - Both parties accepted that the Bombay High Court in Godrej and Boyce held Rule 8D to be prospective from A.Y. 2008-09; for prior years disallowance under section 14A must be computed on a reasonable basis. The Tribunal therefore directed that the matter be restored to the A.O. for recomputation of the disallowance under section 14A on a reasonable basis, taking into account that substantial investments were in foreign shares yielding dividends not exempt in India. [Paras 23]Issue remitted to the A.O. to recompute the section 14A disallowance on a reasonable basis; treated as partly allowed.Final Conclusion: Both appeals are partly allowed: guarantee-fee TP addition is sustained but re-quantified by directing recomputation at 0.5%; software-expenditure deletion is set aside and remitted to the A.O. for verification; interest undercharge addition is confirmed; addition for non-charging of interest on continuing debit balances is deleted; section 14A disallowance is to be recomputed by the A.O. on a reasonable basis. Issues: (i) Whether providing bank guarantees to Associated Enterprises is an international transaction attracting transfer pricing adjustment and the arm's length rate for guarantee commission; (ii) Whether disallowance of television entertainment software expenditure should be sustained; (iii) Whether the interest shortfall on loan to an Associated Enterprise (calculation error) is correctly added; (iv) Whether continuing debit balances/overdues with Associated Enterprises constitute international transactions requiring interest adjustment and whether such addition is sustainable; (v) Applicability of section 14A and Rule 8D for disallowance of expenditure attributable to exempt dividend income.Issue (i): Whether guarantee to Associated Enterprises is an international transaction and what is the arm's length rate for guarantee commission.Analysis: The transaction of providing a financial guarantee exposes the guarantor to the risk of default and confers an economic benefit on the beneficiary AE; therefore it falls within the ambit of international transaction under section 92B. The CUP method is an appropriate benchmarking method where reliable comparables exist. The TPO applied CUP using bank guarantee fees (HSBC) and arrived at an arithmetic mean of 1.5%; the first appellate authority adopted 0.25% relying on foreign precedent; the Tribunal found facts materially similar to a co-ordinate Tribunal decision accepting 0.5% and preferred that precedent over the foreign decision.Conclusion: Guarantee to Associated Enterprises is an international transaction; arm's length rate for guarantee commission is fixed at 0.5% and the Assessing Officer is directed to recompute the commission accordingly (ruling partly favouring Revenue over the first appellate reduction).Issue (ii): Whether the disallowance of television entertainment software expenditure should be sustained.Analysis: The assessee produced details of software expenditure before the first appellate authority for the first time; the Assessing Officer was not given an opportunity to verify those details. The appellate authority deleted the disallowance on merits, but the Tribunal finds that the AO must be afforded the opportunity to verify the newly produced material before a conclusive decision is made.Conclusion: Deletion by the first appellate authority is set aside and the matter is restored to the Assessing Officer for fresh adjudication after verification (ruling in favour of Revenue for statistical purpose).Issue (iii): Whether the interest shortfall on loan to an Associated Enterprise arising from a calculation error is correctly added.Analysis: There is no dispute that the agreed/benchmarked rate (3.26%) is at arm's length; the discrepancy arose from an arithmetical mistake in computing the interest amount. The mistake was acknowledged and the numerical difference corresponds to undercharged interest.Conclusion: The addition on account of undercharged interest (difference of Rs. 3,20,288) is sustained (ruling against the assessee on this point).Issue (iv): Whether continuing debit balances/overdues with Associated Enterprises are subject to transfer pricing adjustment for interest and whether the addition is sustainable.Analysis: A continuing debit balance is not necessarily an independent international transaction but may reflect terms of the underlying commercial transaction; where the TPO applies CUP for overdue balances, comparables must be dues recoverable from debtors (internal or external CUP) rather than lending LIBOR-based comparables. No internal or external CUP exercise was performed in the present year, and a co-ordinate Tribunal decision in the assessee's earlier year deleted a similar addition on such grounds.Conclusion: The addition of Rs. 12,98,048 on account of interest on overdue balances is deleted (ruling in favour of the assessee on this issue).Issue (v): Whether Rule 8D is applicable for computing disallowance under section 14A for the year under consideration.Analysis: The jurisdictional High Court has held Rule 8D to be prospective from A.Y. 2008-09; for earlier years a reasonable basis must be used to compute the disallowance under section 14A. The assessee's substantial investments in foreign shares (whose dividends may not be exempt) are a factor to be considered by the Assessing Officer in recomputation.Conclusion: The issue is restored to the Assessing Officer to recompute the section 14A disallowance on a reasonable basis (partial relief to the assessee subject to recomputation).Final Conclusion: On the composite appeal record, some transfer pricing additions are upheld with modification (guarantee commission recomputed at 0.5%; interest undercharge sustained), while other additions are deleted or remitted for verification or recomputation (television software expenditure restored to AO; continuing debit balance addition deleted; section 14A disallowance remitted for recomputation), resulting in both appeals being partly allowed.Ratio Decidendi: Where a group member provides a financial guarantee that confers tangible creditworthiness benefits on an Associated Enterprise, the guarantee is an international transaction requiring arm's length compensation; CUP benchmarking is appropriate where reliable bank guarantee fee comparables exist and the arm's length rate must be determined by reference to relevant and comparable precedents or co-ordinate Tribunal decisions, with reassessment or recomputation directed where verification or comparable selection is inadequate.