Corporate guarantee fees ruled international transactions under Section 92B, rate reduced from 1.04% to 0.50% based on bank comparables

ITAT Chennai-AT decided multiple transfer pricing and tax issues. Corporate guarantee fees were held to constitute international transactions under Section 92B, with guarantee commission fixed at 0.50% instead of AO's 1.04% rate based on commercial bank comparables. Interest expenditure disallowance on borrowed funds for subsidiary investment was remitted to AO following consistency principle from prior years. TDS under Section 195 on offshore services was remitted for fresh examination considering twin criteria of service rendering and utilization in India. Tax credit denial under Section 90 was remitted to AO for re-examination. Forex loss disallowance was set aside and remitted for reconsideration with proper documentation. Section 14A disallowance was remitted for fresh examination regarding borrowed funds utilization. Long-term capital loss disallowance on subsidiary share buyback was remitted to AO for proper examination of transaction details. Professional consultancy services disallowance was remitted to verify recipient's tax treatment and service details.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal are:

• Whether the Corporate Guarantee fee paid by the Assessee to its Associated Enterprises (AEs) constitutes an international transaction under Section 92B of the Income Tax Act, 1961, and if so, the appropriate arm's length price (ALP) to be adopted for such guarantee fee.
• Whether the interest expenditure incurred on borrowed funds used for investment in wholly owned foreign subsidiaries is allowable as a deduction under Section 36(1)(iii) of the Income Tax Act, 1961 or should be capitalized or disallowed.
• Whether tax deduction at source (TDS) was required to be made on professional and consultancy fees paid to non-resident entities for services rendered outside India and the tax implications thereof.
• Whether TDS was required on payments made for drilling services and management fees to foreign entities and the taxability of such payments under Section 9(1)(vii) of the Income Tax Act, 1961.
• Whether the assessee is entitled to foreign tax credit under Section 90 of the Income Tax Act, 1961 for withholding tax deducted in Singapore on interest income earned from its foreign subsidiary.
• Whether the loss on forward contracts entered into by the Assessee to hedge foreign exchange risk is allowable as business expenditure or should be disallowed as speculative loss under Section 37 of the Income Tax Act, 1961.
• Whether disallowance under Section 14A read with Rule 8D of the Income Tax Act, 1961 is justified in respect of expenses relating to exempt dividend income.
• Whether the long-term capital loss claimed on sale of shares of wholly owned foreign subsidiary is allowable, especially considering the subsequent reinvestment in the same shares shortly after the sale.
• Whether the professional and consultancy fees paid to a domestic financial services company for business restructuring are allowable deductions under Section 37(1) of the Income Tax Act, 1961.

2. ISSUE-WISE DETAILED ANALYSIS

Corporate Guarantee Fee

Legal Framework and Precedents: Section 92B of the Income Tax Act, 1961 defines "international transaction" and includes guarantees given by an enterprise on behalf of its Associated Enterprises (AEs). The Finance Act, 2012 inserted an explanation to Section 92B retrospectively from 1st April 2002 to include guarantees within the scope of international transactions. The Bombay High Court in Commissioner of Income Tax Vs. Everest Kentor Cylinder Limited held that corporate guarantees issued by a holding company for its AE subsidiary constitute international transactions but distinguished such guarantees from bank guarantees for ALP benchmarking.

Court's Interpretation and Reasoning: The Tribunal accepted that the corporate guarantee given by the Assessee to its AEs is an international transaction under Section 92B. However, it disagreed with the Assessing Officer's adoption of a 1% guarantee fee based on comparables from commercial banks, considering the Bombay High Court's observation that such comparisons are not appropriate. The Tribunal, therefore, fixed the guarantee commission at 0.50%, following the principle that corporate guarantees for AEs should be benchmarked differently.

Key Evidence and Findings: The outstanding guarantee amount was Rs. 152.57 crores. The Assessing Officer's rate of 1% was based on commercial bank comparables. The Tribunal relied on judicial precedent to adjust this rate.

Application of Law to Facts: The Tribunal applied the retrospective explanation to Section 92B and judicial precedent to hold the guarantee fee as an international transaction but modified the ALP to 0.50%.

Competing Arguments: The Assessee argued no cost was incurred and thus no adjustment was needed or alternatively a lower rate of 0.25% should apply. The Department supported the 1% rate. The Tribunal found the 1% rate excessive and fixed 0.50%.

Conclusion: The ground was partly allowed, directing the Assessing Officer to adopt 0.50% as the guarantee commission rate.

Interest Expenditure Disallowance

Legal Framework and Precedents: Section 36(1)(iii) allows deduction of interest on borrowed funds used for business or profession. The Supreme Court and Tribunal decisions clarify that interest incurred before acquisition of shares can be capitalized as part of cost, but interest after acquisition is revenue expenditure. The Tribunal's earlier orders in the Assessee's own case for AYs 2010-11, 2011-12, and 2012-13 were relied upon.

Court's Interpretation and Reasoning: The Tribunal noted that borrowed funds were invested in wholly owned subsidiaries to acquire or maintain controlling interest, which promotes the Assessee's business. The Assessing Officer's disallowance was based on the view that the investment aided subsidiary business, not the Assessee's. However, the Tribunal held that if the investment is for controlling interest and business promotion, interest should be allowed under Section 36(1)(iii). The issue was remitted to the Assessing Officer for fresh consideration with directions to verify the purpose of investment and allow proportionate benefit.

Key Evidence and Findings: The Assessee's capital structure showed mixed funds; the borrowed funds were used for investments in subsidiaries. The Assessing Officer had earlier disallowed the entire interest on the ground of lack of commercial expediency.

Application of Law to Facts: The Tribunal applied the principle that interest on borrowed funds used for business purposes is deductible and remitted the issue for detailed verification of the business purpose and controlling interest.

Competing Arguments: The Assessee argued the interest was for business expediency and controlling interest in subsidiaries; the Department relied on Supreme Court decision in Maxopp Investment Ltd. to contend that interest on funds advanced to sister concerns is not deductible.

Conclusion: The ground was partly allowed and remitted for fresh adjudication.

Non-Deduction of Tax on Professional and Consultancy Fees

Legal Framework and Precedents: Section 195(2) requires TDS on payments to non-residents if income is chargeable to tax in India. Section 9(1)(vii) deals with income deemed to accrue or arise in India from technical services. The Supreme Court decision in GE India Technology Centre Pvt. Ltd. and Tribunal decisions were cited.

Court's Interpretation and Reasoning: The Tribunal observed that the services were rendered and utilized outside India (Dubai branch), and thus no income accrued or arose in India. The twin conditions of rendering and utilization of services in India are necessary to attract tax liability under Section 9(1)(vii). The Assessing Officer's addition without examining Section 195(2) was set aside. The matter was remitted to the Assessing Officer to examine afresh in light of the DTAA and judicial precedents.

Key Evidence and Findings: Payments totaling Rs. 2.48 crores were made to various foreign entities for consultancy services utilized outside India.

Application of Law to Facts: The Tribunal applied the principle that offshore services utilized outside India do not attract TDS under Section 195 or tax under Section 9(1)(vii).

Competing Arguments: The Assessee argued non-applicability of TDS and tax as services were outside India; the Department supported the Assessing Officer's order.

Conclusion: The ground was allowed for statistical purposes and remitted for fresh consideration.

Disallowance of Tax on Drilling Services and Management Fee

Legal Framework and Precedents: Similar to the previous issue, Section 9(1)(vii) and Section 195(2) apply.

Court's Interpretation and Reasoning: Following the coordinate Bench's earlier decision for AY 2012-13, the Tribunal held that payments for services rendered and utilized outside India do not attract tax or TDS in India. The matter was remitted for fresh examination.

Conclusion: Ground allowed for statistical purposes with remand.

Denial of Tax Credit under Section 90

Legal Framework and Precedents: Section 90 provides relief from double taxation by allowing credit for foreign taxes paid. The Tribunal's earlier decisions in the Assessee's own case were relied upon.

Court's Interpretation and Reasoning: The Tribunal held that since the income from the foreign subsidiary was offered to tax in India, the Assessee is entitled to credit for tax withheld in Singapore. The matter was remitted to the Assessing Officer to grant credit accordingly.

Conclusion: Ground partly allowed with remand.

Disallowance of Loss on Forward Contracts

Legal Framework and Precedents: Section 37 allows deduction of expenses incurred wholly and exclusively for business. Forex derivatives used for hedging are recognized risk management tools. The Tribunal relied on Essilor India Pvt. Ltd. decision.

Court's Interpretation and Reasoning: The Assessing Officer disallowed the loss treating it as speculative due to lack of evidence of underlying exposure and risk analysis. The Tribunal observed that the Assessee's business involves foreign currency transactions and hedging is a prudent business decision. The matter was remitted for fresh consideration after verifying details and risk analysis.

Conclusion: Ground allowed for statistical purposes with directions for fresh adjudication.

Disallowance of Expenses Related to Exempt Income under Section 14A r.w. Rule 8D

Legal Framework and Precedents: Section 14A disallows expenditure incurred in relation to exempt income. Rule 8D provides a method to compute such disallowance. The Tribunal relied on the Delhi Special Bench decision in Vireet Investments.

Court's Interpretation and Reasoning: The Assessing Officer disallowed a small amount based on assumed expenditure related to exempt dividend income. The Tribunal held that the Assessee failed to establish non-utilization of borrowed funds for investments. However, the issue was remitted for fresh examination considering judicial precedents.

Conclusion: Ground allowed for statistical purposes with remand.

Disallowance of Long Term Capital Loss

Legal Framework and Precedents: Capital loss is allowable if genuine. The Assessing Officer relied on Madras High Court decision in Premier Synthetic Industries holding that transactions lacking genuineness are not allowable. The Assessee relied on Supreme Court and Delhi High Court decisions supporting business decisions and bona fide losses.

Court's Interpretation and Reasoning: The Assessing Officer doubted genuineness due to sale and reinvestment in the same shares within a short period and lack of supporting minutes of meeting. The Tribunal noted that the buyback decision was taken in FY 2013-14 and partly allowed in AY 2014-15. The Tribunal held that the Assessing Officer and DRP did not properly examine facts and remitted for fresh consideration.

Conclusion: Ground allowed for statistical purposes with remand.

Disallowance of Professional and Consultancy Services

Legal Framework and Precedents: Section 37(1) allows deduction of expenses incurred wholly and exclusively for business. The Supreme Court decisions in India Cements Limited and S.A. Builders Ltd. were cited.

Court's Interpretation and Reasoning: The Assessing Officer disallowed the expenditure due to non-furnishing of details and suspicion of capital nature. The Tribunal observed that the Assessee engaged consultancy services for financial restructuring, deducted TDS, and the payments were reflected in Form 26AS of the service provider. The Tribunal held that the Assessing Officer could not sit in judgment over business decisions without proper examination and remitted the issue for verification whether the service provider had offered the income to tax.

Conclusion: Ground allowed for statistical purposes with remand.

3. SIGNIFICANT HOLDINGS

"The Finance Act, 2012 has inserted, an explanation to Section 92B with retrospective effect from 1st April, 2002 to include the term guarantee within the definition of international transaction."

"Corporate Guarantee by an entity on behalf of its AEs a subsidiary company is an international transaction. However, while arriving at a rate, the Assessing Officer has taken comparables from commercial banks to arrive at mean margin of 1.04% and adopted such rate to determine the ALP of corporate guarantee issued by the Assessee. The Hon'ble Mumbai High Court has confirmed the order of the Tribunal wherein the Tribunal estimated the guarantee commission at the rate of 0.50%. We therefore... fix the guarantee commission at the rate of 0.50%."

"If the money was borrowed for purchase of shares of subsidiary company for the purpose of acquiring controlling interest and acquisition of such controlling interest was of the business of the assessee and it resulted in promote the business of the assessee as well as helpful to the assessee for having management control over said such subsidiary company, then the interest expenditure should be allowed u/s.36(1)(iii) of the Act."

"The twin criterion of rendering of services in India and utilization of services in India become evidently necessary condition to deduct tax under Section 9(1)(vii). However, in respect of the said payments, the rendering of services being purely off shore and outside India, the whatever paid towards the said services does not attract tax liability."

"Once the income is included either in the Profit & Loss Account or in the return of income, the corresponding tax credit on the same income has to be given."

"Forward contracts entered into for hedging foreign exchange risk in the course of business are business decisions and losses suffered thereon are allowable as business expenditure."

"Section 14A disallows expenditure incurred in relation to exempt income. However, the disallowance must be based on proper examination of facts and evidence."

"Where shares are sold and subsequently repurchased shortly thereafter without valid commercial reasons, the genuineness of the loss is doubtful and requires detailed examination."

"Expenditure incurred for consultancy services wholly and exclusively for business purposes and where TDS is deducted and the service provider has offered income to tax, is allowable under Section 37(1)."

"The Assessing Officer cannot sit in judgment over bona fide business decisions without proper examination and evidence."

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