2016 (11) TMI 1031 - AT - Income Tax

Tribunal reclassifies, sets interest rate, emphasizes true nature, directs AO on disallowance, deems penalty premature.

DLF Hotel Holdings Ltd. Versus DCIT, Circle-10 (1), New Delhi

The Tribunal allowed the appeal, rejecting reclassification by the TPO and DRP and determining the interest rate. It emphasized respecting the ... Existence of international transaction - tpa - interest free loans given to AE - Held that:- If the tax payer claims it is an interest free loan as a share holding activity, to be utilized by the AE for acquiring and increasing its portfolio and on utilization and fulfilling the internal and external requirements by way of permissions and procedures of the regulatory authority etc. it is to be converted into equity and that too at a premium then it is the correctness of this claim which is to be specifically addressed and decided. Merely because it is shown as an international transaction itself will not decide the claim. The consistent objection posed by the assessee that the act of advancing interest free loan as “quasi equity” for the stated purpose was supported by documents and hence not an “international transaction”, cannot be ignored on the specious plea that disclosure was made by the tax payer in its Form 3CEB There is nothing on record to support the conclusion that the interest free loan must necessarily be deemed to be an interest earning activity and not an activity to capitalize the opportunity cost for investing in new territories. We hold that for the tax authorities to consider re-characterizing the transaction the tax authorities must necessarily demonstrate that the transaction as claimed and documented is a sham or on the basis of facts and evidences is at a substantial variance with the stated form. In the absence of any such exercise the tax authorities are entering at their peril in the realm of arbitrariness. In the facts of the present case there is not even a whisper of a suggestion that it was a bogus transaction, as admittedly shares have been allotted. There is nothing in the provisions of the Act which empowers the tax authorities to insist that the interest free loan towards its AE for capitalization the opportunity of cost of entering in new territories must necessarily by modified and re-characterized into a loan simplicitor and considered to be an activity for earning interest. The tax authorities must bring on record facts and evidences impacting the veracity of the claim of the assessee and demonstrate the hollowness of the assessee’s claim. No such exercise has been done to counter the consistent claim of the assessee demonstrated by facts on record that the intention was to capitalize the opportunity cost and not to encash the opportunity to best utilize the available funds. - Decided in favour of assessee Disallowance u/s 14A - Held that:- Considering the judicial precedent cited and in the absence of any rebuttal on the material facts that these constituted strategic investments for the assessee, we direct the AO to examine the correctness of the computation placed on record by the assessee which as per the calculation sheet at page 19 is shown to be working out to ₹ 91,021/-, when it is compared with the suo moto disallowance of ₹ 2,28,777/- made by the assessee we find no further disallowance on facts is warranted. The fact of suo moto disallowance is evident from the second last page of the AO itself. Accordingly, we hold no further disallowance need be made subject to the verification of the calculation placed on record. Issues Involved:1. Classification of interest-free short-term advance as loan or quasi-equity.2. Determination of Arm's Length rate of interest on the interest-free advance.3. Conversion of only 20% of the advance into equity and interest on the balance amount.4. Consideration of LIBOR rate for interest calculation.5. Relevance of CRISIL determined interest rates.6. Arm's Length Price determination as per section 92C and rule 10C.7. Reclassification of transaction from quasi-capital to loans.8. Disallowance under section 14A read with Rule 8D.9. Validity of the AO's order.10. Initiation of penalty proceedings under section 271(1)(c).Issue-wise Detailed Analysis:1. Classification of Interest-Free Short-Term Advance as Loan or Quasi-Equity:The assessee argued that the interest-free advances given to its subsidiary were intended to be converted into equity, thus classifying them as quasi-equity. The Tribunal accepted this argument, noting that the advances were indeed converted into equity within three months, demonstrating the true intention behind the transaction. The Tribunal referenced judicial precedents, including the ITAT decision in Soma Textiles & Industries and the Bombay High Court judgment in Vodafone India, to support the classification of such advances as quasi-equity rather than loans.2. Determination of Arm's Length Rate of Interest on the Interest-Free Advance:The Tribunal found that the Transfer Pricing Officer (TPO) and the Dispute Resolution Panel (DRP) erred in applying a 17.26% interest rate on the interest-free advances. The Tribunal noted that the interest rate should reflect the nature of the transaction and the financial health of the subsidiary. The Tribunal referenced the Delhi High Court's decision in CIT vs. Cotton Naturals P. Ltd., which supports the application of the LIBOR rate for foreign currency loans, suggesting that the LIBOR rate plus a margin would be more appropriate.3. Conversion of Only 20% of the Advance into Equity and Interest on the Balance Amount:The Tribunal rejected the TPO's arbitrary decision to consider only 20% of the advance as equity and charge interest on the remaining amount. The Tribunal emphasized that the entire advance was intended for equity conversion, and the actual conversion within three months supported this intention. The Tribunal found no rationale for the 20% conversion rate applied by the TPO.4. Consideration of LIBOR Rate for Interest Calculation:The Tribunal agreed with the assessee's alternative plea that, if interest were to be charged, it should be based on the LIBOR rate prevailing at the time of advancing the money. The Tribunal referenced the judicial acceptance of the LIBOR rate in the Delhi High Court's decision in CIT vs. Cotton Naturals P. Ltd. and the ITAT's decision in Bharti Airtel Ltd., which support the use of LIBOR plus a margin for foreign currency loans.5. Relevance of CRISIL Determined Interest Rates:The Tribunal found that the interest rates determined by CRISIL, which were used by the TPO, were not appropriate comparables for international transactions involving quasi-equity to a 100% subsidiary. The Tribunal noted that CRISIL rates are determined for different purposes and cannot be directly applied to the assessee's transactions.6. Arm's Length Price Determination as per Section 92C and Rule 10C:The Tribunal held that the determination of Arm's Length Price (ALP) by the TPO and DRP did not comply with the provisions of section 92C read with rule 10C. The Tribunal emphasized the importance of considering the 'class of AE' and the specific nature of the transaction when determining the ALP. The Tribunal found that the TPO's approach did not adequately reflect these considerations.7. Reclassification of Transaction from Quasi-Capital to Loans:The Tribunal rejected the reclassification of the transaction from quasi-capital to loans by the TPO and DRP. The Tribunal emphasized that the transaction's true nature, as evidenced by the conversion of advances into equity, should be respected. The Tribunal referenced the OECD guidelines and judicial precedents to support the position that the transaction should not be reclassified arbitrarily.8. Disallowance under Section 14A Read with Rule 8D:The Tribunal found that the AO's disallowance under section 14A read with Rule 8D was not justified. The Tribunal noted that the investments made by the assessee were strategic and did not yield any exempt income during the relevant period. The Tribunal referenced the Delhi High Court's decision in ACB India to support the exclusion of strategic investments from the disallowance calculation. The Tribunal directed the AO to verify the assessee's computation and make necessary adjustments.9. Validity of the AO's Order:The Tribunal found that the AO's order was flawed and did not adequately address the assessee's arguments and supporting evidence. The Tribunal emphasized the importance of a fair and transparent assessment process and criticized the mechanical disregard of the assessee's explanations and evidence.10. Initiation of Penalty Proceedings under Section 271(1)(c):The Tribunal did not find it necessary to adjudicate on the initiation of penalty proceedings under section 271(1)(c), as it was deemed premature at this stage.Conclusion:The Tribunal allowed the appeal of the assessee, rejecting the TPO and DRP's approach to reclassifying the transaction and determining the interest rate. The Tribunal emphasized the importance of respecting the true nature of the transaction and applying appropriate comparables and rates. The Tribunal also directed the AO to verify the computation of disallowance under section 14A read with Rule 8D and make necessary adjustments.