LIBOR-based transfer pricing, section 14A relief, and no notional interest on share application money in associated enterprise transactions

Interest on delayed receivables from an associated enterprise was benchmarked at LIBOR plus 0.5%, and the higher transfer pricing adjustment was reduced. Interest on margin money was treated as business income, while interest on bank deposits and inter-corporate deposits was assessed as income from other sources. Disallowance under section 14A read with Rule 8D was held unsustainable in the absence of exempt income, including for book profit under section 115JB. The addition for provision for income tax recoverable was sustained in normal computation but deleted for book profit. No notional interest could be imputed on share application money advanced to an associated enterprise absent evidence of a sham arrangement.

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Issues: (i) whether interest on outstanding receivables from an associated enterprise was to be computed by applying LIBOR plus 0.5%; (ii) whether interest on margin money, bank deposits and inter-corporate deposits was assessable as business income or income from other sources; (iii) whether disallowance under section 14A read with Rule 8D was sustainable in the absence of exempt income, including while computing book profit under section 115JB; (iv) whether provision for income tax recoverable was to be added under normal computation and while computing book profit; (v) whether notional interest could be imputed on share application money advanced to an associated enterprise.

Issue (i): whether interest on outstanding receivables from an associated enterprise was to be computed by applying LIBOR plus 0.5%.

Analysis: The issue was treated as covered by the assessee's own case for the earlier assessment year. The same line of reasoning was followed, namely that interest on delayed receivables from an associated enterprise is to be benchmarked by reference to LIBOR with an appropriate spread, and the Tribunal declined to uphold the higher rate adopted by the transfer pricing authorities.

Conclusion: In favour of the assessee. The adjustment was directed to be recomputed at LIBOR plus 0.5%.

Issue (ii): whether interest on margin money, bank deposits and inter-corporate deposits was assessable as business income or income from other sources.

Analysis: The Tribunal followed its earlier decisions in the assessee's own case. It accepted that interest earned on margin money retained the character of business income, while interest earned on bank deposits and inter-corporate deposits was taxable as income from other sources.

Conclusion: Partly in favour of the assessee. Interest on margin money was directed to be assessed as business income, and interest on bank deposits and inter-corporate deposits as income from other sources.

Issue (iii): whether disallowance under section 14A read with Rule 8D was sustainable in the absence of exempt income, including while computing book profit under section 115JB.

Analysis: The Tribunal applied the principle that disallowance under section 14A cannot be made where no exempt income has been earned during the relevant year. On the same footing, the corresponding adjustment was held unsustainable while determining book profit under section 115JB.

Conclusion: In favour of the assessee. No disallowance under section 14A read with Rule 8D was warranted, and the addition while computing book profit was also deleted.

Issue (iv): whether provision for income tax recoverable was to be added under normal computation and while computing book profit.

Analysis: The Tribunal distinguished between the two computations. It followed the earlier view against the assessee for normal computation, but accepted the assessee's contention for book profit computation and directed deletion of the addition under section 115JB.

Conclusion: Partly in favour of the revenue and partly in favour of the assessee. The addition under normal computation was sustained, but the corresponding addition in book profit was deleted.

Issue (v): whether notional interest could be imputed on share application money advanced to an associated enterprise.

Analysis: The Tribunal relied on its earlier decisions holding that share application money is an equity-linked investment and cannot be recharacterized as a loan merely because there was a delay in allotment of shares. In the absence of material showing a sham or disguised lending arrangement, no notional interest adjustment was permissible.

Conclusion: In favour of the assessee. The transfer pricing adjustment on account of notional interest on share application money was deleted.

Final Conclusion: The appeal succeeded on the principal transfer pricing and related book profit issues, while the addition relating to provision for income tax recoverable under normal computation was sustained; the appeal was therefore allowed in part.

Ratio Decidendi: Interest on delayed receivables may be benchmarked using LIBOR-based pricing, section 14A disallowance fails in the absence of exempt income, and share application money cannot be recharacterized as a loan for imputation of notional interest without evidence of a sham transaction.

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