2024 (1) TMI 151 - AT - Income Tax

Corporate guarantee fees above 0.25% arm's length price rejected; royalty valuation and VAT subsidy rulings confirmed

ITAT Kolkata upheld CIT(A)'s decision on corporate guarantee fees, finding assessee's 0.30% rate exceeded the tribunal's previously established 0.25% ... Application of the rule of consistency in transfer pricing - application of Weighted Average Cost of Capital (WACC) for valuation of intangibles - acceptability of cost of equity as discount rate vis-a -vis WACC in intangible valuation - treatment of corporate guarantee fee as arm's length price - Rule 8D computation of disallowance under Section 14A limited to investments yielding exempt income - characterisation of government VAT/sales-tax reimbursement as capital receipt under industrial policy - special computation of capital gain on sale of depreciable assets under Section 50 and its effect on concessional tax rate - non-application of Double Taxation Avoidance Agreement rate to a domestic company's liability under Section 115-O - deductibility of upfront lease premium as revenue expenditure under Section 37(1) (as held by the jurisdictional High Court)Treatment of corporate guarantee fee as arm's length price - application of the rule of consistency in transfer pricing - Deletion of upward adjustment made by AO/TPO in respect of corporate guarantee fee. - HELD THAT: - The Tribunal found that the assessee had consistently dealt with the corporate guarantee transaction in earlier years and that this Tribunal had earlier (Assessment Year 2012-13) held corporate guarantee fee at 0.25% to be arm's length. In the year under consideration the assessee offered corporate guarantee income at 0.30%, which is higher than the previously accepted ALP. There being no change in the factual matrix, the ld. CIT(A)'s deletion of the addition was held to be consistent with the prior view and accordingly sustained. The revenue's ground for interference was rejected. [Paras 7, 8]Addition for corporate guarantee fee deleted; revenue's ground dismissed.Application of Weighted Average Cost of Capital (WACC) for valuation of intangibles - acceptability of cost of equity as discount rate vis-a -vis WACC in intangible valuation - Deletion of upward adjustment to royalty income where TPO applied cost of equity but assessee used WACC. - HELD THAT: - The Tribunal examined OECD guidance and held that OECD does not rule out use of WACC; selection of discount rate depends on case-specific risks. Maintaining a brand is a risky, ongoing activity and therefore WACC is an appropriate method for valuation of the brand under the facts. The assessee had computed ALP on WACC at 11.30% and had offered royalty income higher than that amount; the TPO's application of a higher cost of equity (21.84%) to compute ALP was not sustained. In view of consistent past practice and the facts, the ld. CIT(A)'s deletion of the upward adjustment was upheld. [Paras 10, 11, 12]Upward adjustment to royalty income deleted; revenue's ground dismissed.Rule 8D computation of disallowance under Section 14A limited to investments yielding exempt income - Validity of AO's disallowance under Section 14A computed under Rule 8D without bifurcation of investments yielding exempt income. - HELD THAT: - The ld. CIT(A), following the jurisdictional High Court's reasoning in M/s Ashika Global Securities Ltd, directed recomputation so that the Rule 8D(2)(iii) rate (0.5%) is applied only to that portion of average investments which actually yielded exempt dividend income. The Tribunal found no infirmity in this approach and sustained the direction to recompute the disallowance accordingly. [Paras 12, 13, 14]AO directed to recompute disallowance under Section 14A applying Rule 8D only to investments that yielded exempt income; revenue's ground dismissed.Characterisation of government VAT/sales-tax reimbursement as capital receipt under industrial policy - Whether VAT subsidy received from State Governments is revenue or capital receipt. - HELD THAT: - Having examined the Industrial Policies of the States and relevant precedents (including the Supreme Court and jurisdictional High Court decisions relied upon by the ld. CIT(A)), the Tribunal concluded the subsidy was an incentive to induce industrialisation, encourage setting up of business and employment in the State and was linked to capital expenditure in establishing operations. The amendment to the definition in Section 2(24)(xviii) was prospective from AY 2016-17 and therefore not applicable. On these facts the subsidy was properly characterised as a capital receipt and the ld. CIT(A)'s deletion of the addition was sustained. [Paras 15, 16, 17]VAT subsidy held to be capital receipt; revenue's ground dismissed.Special computation of capital gain on sale of depreciable assets under Section 50 and its effect on concessional tax rate - Whether gain on sale of depreciable assets forming part of a block of assets and held for more than three years is taxable at concessional long-term capital gains rate under Section 112. - HELD THAT: - The Tribunal observed that Section 50 is a special provision for computation of capital gain on depreciable assets and operates notwithstanding other definitions; consequently, even if the asset was held for more than three years, where it is part of a block of depreciable assets (on which depreciation has been allowed), the gain is deemed to be short-term under Section 50. Section 112 concessional rates apply only to long-term capital assets as defined; therefore the concessional rate could not be applied. The Tribunal allowed the revenue's ground. [Paras 18, 19, 20]Gain on sale of depreciable assets treated as short-term capital gain under Section 50 and taxable at normal rates; revenue's ground allowed.Non-application of Double Taxation Avoidance Agreement rate to a domestic company's liability under Section 115-O - Whether tax payable by the domestic company under Section 115-O should be computed at the DTAA rate applicable to the non-resident shareholder. - HELD THAT: - Following the Special Bench decision in DCIT v. Total Oil India Pvt. Ltd., the Tribunal held that additional tax payable by the domestic company under Section 115-O is to be at the rate specified in that provision and not at the rate applicable to the non-resident shareholder under a DTAA, unless the Contracting States have expressly extended treaty protection to the domestic company paying the tax. Applying that principle, the assessee's claim for computation under DTAA rates was rejected. [Paras 24, 25]Section 115-O liability to be computed as per that provision; claim to apply DTAA rate rejected.Deductibility of upfront lease premium as revenue expenditure under Section 37(1) (as held by the jurisdictional High Court) - Allowability of deduction for amortisation of upfront lease premium paid for lease-hold factory land. - HELD THAT: - Relying on the jurisdictional High Court decision in Balmer Lawrie & Co. Ltd v. CIT, which held that upfront lease premium for lease-hold land is akin to advance rent and not capital expenditure, the Tribunal directed the AO to allow the deduction for the lease premium paid. Both lower authorities had denied the claim, but the Tribunal applied the binding High Court precedent to allow the deduction for AY 2014-15. [Paras 26]Deduction for upfront lease premium allowed; cross-objection ground allowed.Final Conclusion: The revenue's appeal is partly allowed only on the question of taxability of gain on sale of depreciable assets (treated as short-term under Section 50); all other revenue grounds (corporate guarantee fee, royalty valuation, Rule 8D disallowance recomputation, VAT subsidy character, and Section 115-O contention) were dismissed. The assessee's cross-objection is partly allowed by permitting deduction for upfront lease premium for Assessment Year 2014-15. Issues Involved:1. Deletion of adjustment towards corporate guarantee and royalty income.2. Disallowance under Section 14A.3. Classification of VAT subsidy as capital receipt.4. Taxation rate on short-term capital gains from the sale of depreciable assets.5. Deduction claims in the cross-objection.Summary:1. Deletion of Adjustment towards Corporate Guarantee and Royalty Income:The Tribunal addressed the revenue's appeal against the deletion of adjustments made by the Assessing Officer/TPO regarding corporate guarantee fees and royalty income. The Tribunal upheld the CIT(A)'s decision, noting that the corporate guarantee fee of 0.30% charged by the assessee was consistent with previous years and higher than the 0.25% deemed reasonable by the Tribunal in earlier cases. For royalty income, the Tribunal found that the assessee's use of the Weighted Average Cost of Capital (WACC) method to determine the Arm's Length Price (ALP) was appropriate. The Tribunal dismissed the revenue's argument that the cost of equity should be used instead, affirming that the royalty income declared by the assessee was higher than the ALP computed using WACC.2. Disallowance under Section 14A:The Tribunal considered the revenue's challenge to the CIT(A)'s direction to re-compute the disallowance under Section 14A by applying 0.5% only to the average investment that yielded exempt income. The Tribunal upheld the CIT(A)'s decision, which was based on the judgment of the Hon'ble Jurisdictional High Court in the case of M/s. Ashika Global Securities Ltd.3. Classification of VAT Subsidy as Capital Receipt:The Tribunal evaluated whether the VAT subsidy received by the assessee should be treated as a capital receipt or revenue receipt. The CIT(A) had classified it as a capital receipt, relying on judicial precedents, including the Supreme Court judgment in CIT v/s. Chaphalkar Brothers Pune. The Tribunal agreed with the CIT(A), noting that the subsidy was intended to encourage industrialization and generate employment, thus qualifying as a capital receipt.4. Taxation Rate on Short-Term Capital Gains from the Sale of Depreciable Assets:The Tribunal addressed whether the gains from the sale of depreciable assets held for more than three years should be taxed at concessional rates under Section 112. The Tribunal concluded that, according to Section 50, such gains are deemed short-term capital gains and should be taxed at normal rates, not the concessional rates applicable to long-term capital gains.5. Deduction Claims in the Cross-Objection:- Education Cess: The assessee's claim for deduction of education cess was dismissed as not pressed.- Dividend Distribution Tax (DDT): The Tribunal held that the DDT should be taxed as per Section 115-O, irrespective of the DTAA rates.- Amortization of Lease Premium: The Tribunal allowed the assessee's claim for deduction of lease premium, following the Hon'ble Jurisdictional High Court's decision in Balmer Lawrie & Co. Ltd Vs CIT.Conclusion:The Tribunal partly allowed the revenue's appeal for statistical purposes and partly allowed the assessee's cross-objection. The order was pronounced on 27th October 2023 in Kolkata.