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Issues: (i) Whether disallowance under section 14A in respect of exempt income could be made by applying rule 8D for assessment years prior to its applicability, and if not, what was the proper basis of disallowance; (ii) whether interest paid to the head office or overseas branches was deductible where corresponding interest on Nostro accounts and overseas placements was brought to tax; (iii) whether transfer pricing adjustment in respect of external commercial borrowings arranged by overseas branches was to be made by attributing interest as well as fees and charges, or only fees and charges, and at what rate; (iv) whether loss on revaluation of unmatured forward exchange contracts was allowable; and (v) whether business income of the assessee, a foreign company, was liable to be taxed at the rate applicable to foreign companies.
Issue (i): Whether disallowance under section 14A in respect of exempt income could be made by applying rule 8D for assessment years prior to its applicability, and if not, what was the proper basis of disallowance
Analysis: Rule 8D was held inapplicable to years prior to assessment year 2008-09. In the assessee's own earlier years, a reasonable estimate had been adopted, and the Tribunal followed the same approach for the years under appeal. The administrative expenditure attributable to exempt income was therefore required to be determined on a reasonable basis consistent with earlier orders.
Conclusion: The disallowance under section 14A was restricted to 2% of the exempt income. The issue was partly decided in favour of the assessee.
Issue (ii): Whether interest paid to the head office or overseas branches was deductible where corresponding interest on Nostro accounts and overseas placements was brought to tax
Analysis: The additional claim was admitted and allowed following the assessee's own case for earlier assessment years. The deduction was granted on the same footing as the taxability of the corresponding interest receipt.
Conclusion: The deduction of interest paid to the head office or overseas branches was allowed. The issue was decided in favour of the assessee.
Issue (iii): Whether transfer pricing adjustment in respect of external commercial borrowings arranged by overseas branches was to be made by attributing interest as well as fees and charges, or only fees and charges, and at what rate
Analysis: The Tribunal followed its earlier view that interest could not be attributed for the service element and that only fees and other charges received by the foreign branches were relevant for adjustment. In the absence of suitable comparables, the earlier estimate of 20% on such fees and charges was treated as reasonable and was applied consistently.
Conclusion: The transfer pricing adjustment was confined to fees and other charges at 20%. The issue was partly decided in favour of the assessee.
Issue (iv): Whether loss on revaluation of unmatured forward exchange contracts was allowable
Analysis: The Revenue's challenge was rejected by following the assessee's own earlier years and the principle approved in the governing precedent on foreign exchange valuation losses.
Conclusion: The loss on revaluation of unmatured forward exchange contracts was held allowable. The issue was decided in favour of the assessee.
Issue (v): Whether business income of the assessee, a foreign company, was liable to be taxed at the rate applicable to foreign companies
Analysis: The Tribunal followed its earlier orders in the assessee's own case and held that the business income had to be subjected to the rate applicable to foreign companies for the relevant year.
Conclusion: The business income was liable to be taxed at the rate applicable to foreign companies. The issue was decided against the assessee.
Final Conclusion: The appeals were disposed of by applying earlier year decisions in the assessee's own case, resulting in a mixed outcome: relief was granted on the section 14A disallowance, the deduction claim, the transfer pricing adjustment being limited to fees and charges, and the foreign exchange contract loss, while the foreign-company tax rate was sustained.
Ratio Decidendi: For assessment years prior to the statutory applicability of rule 8D, disallowance under section 14A must be made on a reasonable basis; in transfer pricing matters involving overseas branch activity, only the service-fee element, and not interest, can be attributed for adjustment where the loan funds are not provided by the assessee; and foreign exchange revaluation losses on unmatured contracts are allowable on mercantile principles when consistently recognised.
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