2013 (9) TMI 204 - AT - Income Tax

Partial Transfer Pricing Adjustment Upheld for Bank Guarantee Commission Under Section 92C, Software Expense Disallowance Confirmed

Assistant Commissioner of Income-tax - 11 (1) Versus Nimbus Communications Ltd.

The ITAT Mumbai upheld the partial transfer pricing adjustment for bank guarantee commission, recognizing that the assessee's guarantee to Associated ... 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 Involved:1. Addition on account of Transfer Pricing (T.P.) adjustment for bank guarantee commission.2. Addition on account of software expenses.3. Addition by way of T.P. adjustment for the difference in interest on loan to Associated Enterprises (AEs).4. Addition by way of T.P. adjustment for not charging interest on outstanding balance with AEs.5. Disallowance under Section 14A of the Income Tax Act read with Rule 8-D of the Income Tax Rules.Detailed Analysis:1. Addition on account of T.P. adjustment for bank guarantee commission:The common issue in both the appeals relates to the addition of Rs. 1,18,27,350/- made by the A.O. by way of T.P. adjustment on account of bank guarantee commission. The TPO determined the arm's length value of the international transaction involving the provision of guarantee by applying the Comparable Uncontrolled Price (CUP) method, taking a rate of 1.5%. The CIT(A) modified this adjustment to 0.25%, relying on a French case, Societe Carrefour. However, the Tribunal preferred to follow the decision in M/s Everest Kanto Cylinder Ltd., directing the A.O. to recompute the commission at 0.5%.2. Addition on account of software expenses:The A.O. disallowed the entire entertainment software expenditure claimed by the assessee, amounting to Rs. 4,21,13,290/-. The CIT(A) deleted the disallowance, noting that similar expenses were allowed in previous years. The Tribunal found that the A.O. was not given an opportunity to verify the details furnished before the CIT(A) and remanded the matter back to the A.O. for fresh verification.3. Addition by way of T.P. adjustment for the difference in interest on loan to AEs:The A.O. added Rs. 3,20,288/- due to a calculation mistake in the interest charged on a loan to the AE, which was accepted by the assessee. The CIT(A) confirmed the addition, and the Tribunal found no reason to interfere, dismissing the ground of the assessee's appeal.4. Addition by way of T.P. adjustment for not charging interest on outstanding balance with AEs:The TPO made an adjustment of Rs. 12,98,048/- for not charging interest on outstanding balances with AEs. The CIT(A) confirmed the addition, relying on earlier appellate orders. The Tribunal, referring to its decision in the assessee's own case for A.Y. 2004-05, held that the addition was not sustainable, as the TPO had not carried out the necessary exercise to compare with independent enterprises and deleted the addition.5. Disallowance under Section 14A read with Rule 8-D:The A.O. disallowed Rs. 25,07,118/- under Section 14A, applying Rule 8D. The CIT(A) confirmed the disallowance. The Tribunal, following the Bombay High Court's decision in Godrej and Boyce Mfg. Co. Ltd., held that Rule 8D is applicable prospectively from A.Y. 2008-09 and restored the issue to the A.O. to recompute the disallowance on a reasonable basis, considering the substantial investment in shares of foreign companies.Conclusion:Both the assessee's and the Revenue's appeals are partly allowed. The Tribunal provided specific directions for recomputation and verification, emphasizing the need for an arm's length approach and reasonable basis for disallowances.