2016 (4) TMI 163 - AT - Income Tax

Tribunal rules in favor of assessee, rejects interest re-characterization and notional interest adjustment.

Income Tax Officer, Ward 9 (3) (2), Mumbai Versus Sterling Oil Resources (P.) Ltd

The Tribunal dismissed the AO's appeal and allowed the assessee's appeal. It upheld the DRP's deletion of interest on receivables and rejected the ... Interest charged on receivable deleted - recharacterization of a transaction - arm's length price adjustment at the rate of SBI prime lending rate plus 3% premium, in respect of the amounts shown as share application money against which share are not issued - Held that:- What the TPO and DRP have overlooked is that since the assessee was only shareholder of the subsidiary company, the fruits of this investment belong to the assessee only and in entirety. On giving this money to the subsidiary and on use of this money by the subsidiary, the assessee, in its capacity as sole owner of the subsidiary, is beneficiary of all the gains of the subsidiary company. Whether the assessee was allotted these shares or not, the assessee was the only shareholder of the subsidiary company and beneficial owner of all the earnings and all the assets of the company. Non allotment of these shares, during the period of payment of share application money till the actual date of allotment, did not, therefore, prejudice assessee's position anyway. All the earnings of the subsidiary company belonged to the assessee in any situation. For example, if the funds available for dividend distribution for this year were say ₹ 1,00,000 and the assessee had 100 shares before new allotment of shares and 1000 shares after the allotment, the assessee would be entitled to ₹ 1,00,000 only the either way- whether as ₹ 1,000 per share for 100 in pre new allotment situation or whether as ₹ 100 per share for 1,000 shares in post new allotment situation. In absolute terms, the dividends remain the same. Whether the assessee is allotted more shares or not is wholly academic as the assessee is a single shareholder of the subsidiary company and the face value of shares does not affect the actual benefits of the assessee, the percentage of ownership is the only material factor- which remains at 100% pre new allotment as also post new allotment. The assessee has behaved in a commercially rational manner inasmuch as whether the new shares are allotted at x point of time or y point of time, it does not make a difference to the position of the shareholder so far as the subsidiary is wholly owned by a single shareholder- as is the factual position in this case. The nominal value of shares, as long as all the shares are held by the assessee is entirely benefit neutral from a commercial point of view. The very foundation of the adjustment made by the Assessing Officer is, therefore, wholly devoid of legally sustainable merits and factually correct assumptions. Thus we hold that the adjustment on account of notional interest on the share application money, which has been recharacterized as loan, is not sustainable in law. We, therefore, direct the Assessing Officer to delete the same. As the recharacterization itself is held to be unsustainable in law and on facts of this case, all other issues raised in the assessee's appeal are rendered academic. - Decided in favour of assessee Issues Involved:1. Deletion of interest charged on receivables.2. Validity of the order passed without serving a written show-cause notice.3. Upward transfer pricing adjustment for share capital subscription.4. Re-characterization of share subscription transaction as a loan.5. Adoption of SBI PLR rate instead of LIBOR for benchmarking interest rate.6. Consideration of interest-free period based on MCA Notification versus FEMA Regulations.7. Non-allowance of arm's length range of +/- 5% for transfer pricing adjustment.Issue-wise Detailed Analysis:1. Deletion of Interest Charged on Receivables:The Assessing Officer (AO) questioned the deletion of interest on receivables by the Dispute Resolution Panel (DRP), arguing it was covered under section 92(2) of the Income Tax Act, 1961. The DRP deleted the adjustment, noting that the subsidiary SGPL had not accepted the liabilities due to various reasons, including some expenses being from before its incorporation. The DRP concluded that interest does not accrue when the receivable has gone bad and directed the AO not to charge notional interest. The Tribunal upheld the DRP's decision, stating that the amounts recoverable were no longer legally enforceable and were in the nature of shareholder services, thus no interest could accrue.2. Validity of the Order Passed Without Serving a Written Show-Cause Notice:The assessee argued that the order was bad in law as it was passed without serving a written show-cause notice as mandated by sections 92CA(3) and 92C(3) of the Income Tax Act. The Tribunal did not specifically address this procedural issue in the detailed analysis, focusing instead on the substantive issues of transfer pricing adjustments and re-characterization.3. Upward Transfer Pricing Adjustment for Share Capital Subscription:The AO/TPO made an upward adjustment of Rs. 8,41,67,965 for the assessee's international transaction of share capital subscription into its associated enterprise SGPL. The TPO re-characterized the share subscription transaction as a loan due to the delay in share allotment and applied an interest rate of 12.25% (SBI PLR rate). The Tribunal found that the shares were eventually allotted and the remittance was approved by RBI as capital contribution. The Tribunal held that the delay in allotment did not justify treating the transaction as a loan and deleted the adjustment.4. Re-characterization of Share Subscription Transaction as a Loan:The TPO re-characterized the share subscription transaction as a loan because the subsidiary used the funds for advancing loans to a step-down subsidiary. The DRP upheld this re-characterization, stating that the delay in allotment indicated the funds were not intended for equity financing. The Tribunal disagreed, noting that the transaction was always intended as a capital contribution and the delay did not change its nature. The Tribunal cited the Bharti Airtel case, emphasizing that capital contributions cannot be deemed as loans merely due to delays in share allotment.5. Adoption of SBI PLR Rate Instead of LIBOR for Benchmarking Interest Rate:The TPO adopted the SBI PLR rate of 12.25% for benchmarking the interest rate on the deemed loan. The assessee argued that the LIBOR rate should have been used. The Tribunal did not specifically address this issue separately but implied that the re-characterization itself was incorrect, rendering the interest rate benchmarking moot.6. Consideration of Interest-Free Period Based on MCA Notification versus FEMA Regulations:The TPO considered an interest-free period of only 60 days based on an MCA Notification, whereas the assessee argued for 180 days as per FEMA Regulations. The Tribunal did not specifically address this issue separately, as it found the entire re-characterization of the transaction as a loan to be unsustainable.7. Non-Allowance of Arm's Length Range of +/- 5% for Transfer Pricing Adjustment:The assessee contended that the benefit of the arm's length range of +/- 5% was not allowed. The Tribunal did not specifically address this issue separately, as it held that the re-characterization of the share application money as a loan was incorrect, thus nullifying the need for any transfer pricing adjustment.Conclusion:The Tribunal dismissed the AO's appeal and allowed the assessee's appeal. It upheld the DRP's deletion of interest on receivables and rejected the re-characterization of share application money as a loan. The Tribunal directed the AO to delete the notional interest adjustment and concluded that the procedural and substantive grounds raised by the assessee rendered the transfer pricing adjustments unsustainable.