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; ... Transfer price adjustment - Bank guarantee commission - Details of the creditworthiness of the AEs not given - CIT upheld partial adjustment of arm's length price - Held that:- A financial loan guarantee is a commitment entered into by the assessee company with a third party lender of its Associated Enterprises which obliges the assessee company to cover the risk of default by its Associated Enterprise and this act thus involves performance or carrying out of service to cover the risk of default for which 'price' has to be charged. Even the OECD Transfer Pricing Guidelines 2010 supports this view in para 7.13 where it is explained that where higher credit rating of Associated Enterprise is due to a guarantee by another group member, such association positively enhances the profit making potential of that Associated Enterprise. There was a clear benefit accrued to the Associated Enterprises by the guarantee provided by the assessee and when such benefit was passed on by the assessee to the said Associated Enterprises, guarantee commission should have been charged at arm's length price. The commercial relationship between the assessee and its Associated Enterprises is distinct and separate from the transactions of giving guarantee and such transactions have to be considered and examined independently in order to determine the arm's length price. - Decided against the assessee. Rate of guarantee commission - Arm's length price of guarantee commission was determined by the TPO by applying CUP method and the arithmetic mean of 1.5% of the guarantee commission charged by the HSBC Bank in the range of 0.15 to 3% was taken as arm's length price - CIT(A) upheld the CUP method applied by the TPO but adopted the rate of 0.25% of guarantee fee as arm's length price - Held that:- The universal application of rate of 3% for guarantee commission cannot be upheld in every case as it is largely dependent upon the terms and conditions, on which loan has been given, risk undertaken, relationship between the bank and the client, economic and business interest are some of the major factors which has to be taken into consideration - A.O. is directed to recompute the commission for guarantee given by the assessee to its Associated Enterprises @ 0.5% being the arm's length price - Decided partly in favour of Revenue. Disallowance of software expenses - Amortised the entertainment software expenses - Held that:- details of television entertainment software expenses were not furnished by the assessee before the A.O. and the same furnished for the first time before him were relied upon by the ld. CIT(A) to give relief to the assessee on this issue without giving any opportunity to the A.O. to verify the same - Decided in favour Revenue. Arm's length price - The assessee did not charge any interest on overdue payments - After a period of time of normally 30 days, would be the expected normal arm's length price - The quantification of notional interest was done by adopting interest at 2.19 % LIBOR on overdue amount beyond 30 days - A continuing debit balance, in our humble understanding, is not an international transaction per se, but is a result of the international transaction - What can be examined on the touchstone of arm's length principles is the commercial transaction itself, as a result of which the debit balance has come into existence, and the terms and conditions, including terms of payment, on which the said commercial transaction has been entered into - It appears that the TPO has adopted interest @ 2.19% LIBOR on balances which exceed 30 days, but LIBOR rate is relevant only in the case of lending or borrowing of funds, and not in the case of commercial overdues – the impugned addition of ₹ 12,51,175 is unsustainable in law – Decided against Revenue. 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.