Arm's Length Pricing on Loan Interest and Guarantee Fees Remanded; Software Cost Not Royalty Under DTAA

The ITAT Hyderabad restored the issue of arm's length pricing on interest charged on loans for fresh adjudication, directing the AO to calculate differential interest for the relevant period only. It set aside the matter of guarantee fees charged to a US subsidiary for determination of appropriate corporate guarantee rates. The purchase cost of software was held as trading goods cost, not royalty under the India-Netherlands DTAA, and no withholding tax was required, favoring the assessee. Technical consultancy payments to UK and USA subsidiaries were not fees for technical services under DTAA, decided in favor of the assessee. Communication expenses were not to be deducted from export turnover, with the issue remanded for fresh consideration. Foreign exchange gains on export business were held as eligible for deduction under section 10A, affirming they constitute trading profit or loss, decided in favor of the assessee.

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Issues Involved:
1. Adjustment of Arms Length Price (ALP) for loan interest.
2. Corporate guarantees as international transactions.
3. Characterization of software purchase as royalty.
4. Disallowance of technical consultancy charges.
5. Exclusion of communication expenses from export turnover.
6. Treatment of foreign exchange fluctuation gain.
7. Disallowance of picnic expenses.

Issue-Wise Detailed Analysis:

1. Adjustment of Arms Length Price (ALP) for loan interest:
The assessee contested the Dispute Resolution Panel's (DRP) decision to grant relief of only Rs.9,03,674/- from the ALP determined by the Transfer Pricing Officer (TPO) at Rs.27,68,740/- for interest on a loan to its subsidiary. The TPO adopted the Indian rate of interest under the Comparable Uncontrolled Price (CUP) Method, determining the ALP at 14% p.a. The DRP partially adjusted this to 7.247%. The Tribunal directed the Assessing Officer (AO) to adopt a reasonable rate of LIBOR + 2% and calculate differential interest for the relevant period, not the entire year.

2. Corporate guarantees as international transactions:
The assessee argued against the addition of Rs.12,78,695/- for corporate guarantees issued to City Bank India for its US subsidiary. The DRP and TPO considered it an international transaction under section 92B. The Tribunal noted that the benefit of the guarantee was for the US subsidiary, thus rendering a service for which fees must be charged at arm's length. The Tribunal set aside the issue to the TPO to decide the quantum of corporate guarantee rates as per the method in Glenmark Pharmaceuticals vs. ACIT.

3. Characterization of software purchase as royalty:
The assessee objected to the disallowance of Rs.52,55,881/- under section 40(a)(i), arguing that the payment to GE Network Solutions for 'Small World Software' was not royalty but a purchase of a copyrighted article. The Tribunal agreed, noting that the software was bundled with the assessee's own software and sold to customers without obtaining any license. The Tribunal concluded that the payment was for trading goods, not royalty, and hence, no tax withholding was required.

4. Disallowance of technical consultancy charges:
The AO disallowed Rs.19,48,02,907/- paid to foreign subsidiaries under section 40(a)(i), citing business connection and technical services. The Tribunal found that the assessee had not habitually secured orders for its subsidiaries but had only parcelled out work. The Tribunal held that section 9(1)(i) was inapplicable and that the retrospective amendment to section 9(1)(vii) could not justify disallowance under section 40(a)(i). The Tribunal also noted that under the India-USA and India-UK treaties, the payments did not fall under Fees for Technical Services (FTS) due to the "make available" clause.

5. Exclusion of communication expenses from export turnover:
The AO excluded Rs.1,16,67,429/- of communication expenses from the export turnover. The Tribunal directed the AO not to reduce this amount from the export turnover, referencing the decision in Patni Telecom Pvt. Ltd. vs. ITO, which distinguished between technical services and software development services.

6. Treatment of foreign exchange fluctuation gain:
The DRP held that the foreign exchange fluctuation gain of Rs.8,52,831/- should be reduced from both the "profit of the business" and the "total turnover." The Tribunal disagreed, citing the decision in Sanyo LSI Technology India Private Ltd. vs. DCIT, which treated such gains as part of business profits eligible for deduction under section 10A.

7. Disallowance of picnic expenses:
The AO disallowed Rs.8,40,444/- for picnic expenses due to the non-production of vouchers. The Tribunal set aside this issue to the AO, directing to give the assessee another opportunity to substantiate its claim.

Conclusion:
The appeal in ITA No. 115/Hyd/2011 was partly allowed for statistical purposes, and ITA No. 2184/Hyd/2011 was allowed for statistical purposes. The Tribunal provided detailed directions for each issue, ensuring a thorough examination and appropriate relief based on the merits of each case.

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