2016 (11) TMI 1671 - AT - Income Tax

Tribunal directs recalculating arm's length interest, removes adjustment for guarantee fees, and overturns disallowance of interest expenses.

Meghmani Organics Limited Versus Asstt. Commissioner of Income Tax Central Circle – 1 (1), Ahmedabad

Meghmani Organics Limited Versus Asstt. Commissioner of Income Tax Central Circle – 1 (1), Ahmedabad - TMI Issues Involved:1. Computation of notional interest on loans to a subsidiary.2. Upward adjustment of notional guarantee fees.3. Disallowance under Section 14A for exempt income.4. Disallowance of advances written off as bad debts.Detailed Analysis:1. Computation of Notional Interest on Loans to a Subsidiary:The assessee, engaged in manufacturing pigments and agrochemicals, had granted interest-free unsecured loans to its US-based subsidiary. The Transfer Pricing Officer (TPO) noted that in an arm's length situation, interest should have been charged, leading to an arm's length price (ALP) adjustment. The TPO adopted LIBOR plus a margin and risk rate, computing the ALP at 9.08%. The CIT(A) reduced this to 8.5%, considering the prime lending rate in the US and a profit margin. The Tribunal referenced the case of UFO India Movies Limited Vs ACIT, where LIBOR plus 4% was deemed arm's length. The Tribunal held that the ALP should be computed using LIBOR as the base rate plus a 1% margin, resulting in a rate of 5.86%. The AO was directed to recompute the interest based on this rate.2. Upward Adjustment of Notional Guarantee Fees:The assessee had provided corporate guarantees to its associated enterprise in Belgium without charging any fees. The TPO, relying on the Tax Court of Canada's decision in GE Capital Canada Inc Vs Her Majesty The Queen, computed the ALP adjustment based on the difference in credit ratings between the assessee and its subsidiary. The CIT(A) upheld this adjustment. However, the Tribunal, referencing the case of Siro Clinpharm Pvt Ltd Vs DCIT, held that no ALP adjustment could be made for guarantees issued without incurring any costs. The Tribunal emphasized that such guarantees are often shareholder activities and not services, thus not falling under the definition of international transactions requiring ALP adjustments. The adjustment of Rs. 16,98,410 was directed to be deleted.3. Disallowance Under Section 14A for Exempt Income:The AO disallowed expenses under Section 14A, computing the disallowance using Rule 8D. The CIT(A) upheld this. The Tribunal, however, noted that the assessee had sufficient interest-free funds to cover the investments yielding tax-exempt income. Citing the case of ACIT Vs Champion Commercial Co Ltd and PCIT Vs Bharti Overseas Pvt Ltd, the Tribunal held that no part of interest expenses could be disallowed when interest-free funds are available. The disallowance of Rs. 18,42,035 was deleted, but the disallowance of Rs. 6,25,000 under Rule 8D(ii) was upheld.4. Disallowance of Advances Written Off as Bad Debts:The AO disallowed amounts written off as bad debts, arguing they were not included in the income of earlier years, invoking Section 36(2). The CIT(A) upheld this. The Tribunal noted that the amounts were claimed as business losses, not bad debts, and thus the inclusion in earlier years' income was not a prerequisite. The disallowance of Rs. 4,40,331 was deleted.Conclusion:The Tribunal allowed the appeal partly, directing the AO to recompute the ALP interest on loans using LIBOR plus 1%, delete the ALP adjustment for notional guarantee fees, and delete the disallowance of interest expenses under Section 14A to the extent of Rs. 18,42,035. The disallowance of advances written off as bad debts was also deleted.