2024 (7) TMI 1623 - HC - Income Tax

Legal Battle Over Transfer Pricing and Interest Deductibility Resolves with Nuanced Interpretation of Business Expansion and Accounting Standards

Pr. Commissioner of Income Tax, Delhi-1 Versus AT M/s. AT & T Communication Services India Pvt. Ltd.

HCTAX ruled on multiple transfer pricing and tax deduction issues. The court largely upheld the Tribunal's decision, finding no substantial legal ... TP adjustments under the head of intra-group services - HELD THAT:- Issue would no longer survive in light of our order dated 13 August 2019 and which had recorded the Transfer Pricing Officer having undertaken the requisite Arm’s Length Price exercise. Circuit accrual - year of assessment - The lower authorities allow the entire claim of expenditure in the next year when such reversals are made. Thus, we are of the view that this practice of disallowing the claim of circuit accrual in the year of creation and allowing it in the next year is nothing but a timing difference. The fact that the expenses are allowed in the subsequent year also proves that the lower authorities have not disputed the incurrence of such expenses. Hence, in accordance with the mercantile provisions it should be allowed in the year of creation itself. The assessee has also drawn reference to the principles laid down in the case of M/s Rotork Controls India (P) Ltd [2009 (5) TMI 16 - SUPREME COURT] and M/s Bharat Earth Movers [2000 (8) TMI 4 - SUPREME COURT]. According to us the provision for circuit accruals is made in compliance of accounting standards issued by the Institute of Chartered Accountants of India and also on a proper scientific basis backed by documentation. Therefore, we hold that the circuit accruals are created on scientific basis and thus needs to be allowed in the year of creation on accrual basis. No substantial question of law. We consequently admit these appeals on the following question: “1. Whether on the facts and circumstance of the case, the Tribunal was correct in law in deleting the disallowance of interest incurred on ECBs and short-term loans respectively, availed during the year, holding the same to be for 'expansion' and not 'extension' of existing business in terms of proviso to section 36(1)(iii) of the Act?” Let the matters be called again on 18.10.2024. ISSUES PRESENTED and CONSIDEREDThe core legal questions considered in the judgment are as follows:A. Whether the Tribunal was correct in law in deleting the addition made by the Transfer Pricing Officer (TPO)/Dispute Resolution Panel (DRP) on account of payment of service charges for intra-group services, holding that such payment was for commercial expediency.B. Whether the Tribunal was correct in law in holding that the TPO had re-characterized the intra-group service transactions.C. Whether the Tribunal was correct in law in deleting the disallowance of interest incurred on External Commercial Borrowings (ECBs) and short-term loans, holding the same to be for 'expansion' and not 'extension' of existing business in terms of proviso to section 36(1)(iii) of the Income Tax Act, 1961.D. Whether the Tribunal was correct in law in deleting the disallowance of circuit accrual charges, in violation of the ratio laid down by the apex Court in the case of Rotork Controls India Pvt. Ltd. v. CIT, without appreciating that provision was made on an estimate basis.E. Whether the order of the Tribunal is perverse and based on incorrect appreciation of facts and legal principles.ISSUE-WISE DETAILED ANALYSISIntra-Group Services (Issues A and B)The relevant legal framework involves the assessment of intra-group services under the Transfer Pricing regulations, requiring transactions to be at Arm's Length Price (ALP). The Tribunal had previously concluded that the TPO had undertaken the requisite ALP exercise, rendering further consideration of these issues unnecessary in light of a prior order dated 13 August 2019.The Court acknowledged this prior determination, indicating that the questions regarding intra-group services adjustments do not survive due to the completion of the ALP exercise by the TPO. Thus, no substantial question of law arises from these issues.Interest on ECBs and Short-term Loans (Issue C)The core legal question revolves around the interpretation of 'expansion' versus 'extension' of business under section 36(1)(iii) of the Income Tax Act, which allows for the deduction of interest on borrowed capital for business purposes.The Tribunal's interpretation favored the taxpayer, holding that the interest incurred was for the 'expansion' of the business, which is deductible, rather than an 'extension', which may not be. The Court found this issue significant enough to warrant further consideration and admitted the appeal on this question.Circuit Accrual Charges (Issue D)The Tribunal's findings highlighted that the provision for circuit accruals was made in compliance with the mercantile system of accounting and accounting standards issued by the Institute of Chartered Accountants of India. The Tribunal noted the automated process for capturing circuit details and the practice of reversing or expensing off provisions in subsequent years.The Tribunal also referenced the principles laid down by the Apex Court in Rotork Controls India Pvt. Ltd. and Bharat Earth Movers, supporting the view that the provision was made on a scientific basis and should be allowed in the year of creation. The Court found no substantial question of law in this issue, agreeing with the Tribunal's reasoning.Order's Perversity and Legal Principles (Issue E)The Court did not find the Tribunal's order to be perverse or based on incorrect appreciation of facts and legal principles. The Tribunal's conclusions were supported by evidence and legal precedents, and the Court did not identify any substantial question of law arising from this issue.SIGNIFICANT HOLDINGSThe Court preserved the Tribunal's reasoning regarding the circuit accrual charges, emphasizing the compliance with accounting standards and the scientific basis for provisions:'According to us, the provision for circuit accruals is made in compliance with accounting standards issued by the Institute of Chartered Accountants of India and also on a proper scientific basis backed by documentation. Therefore, we hold that the circuit accruals are created on a scientific basis and thus need to be allowed in the year of creation on an accrual basis.'The Court admitted the appeal on the question of the disallowance of interest on ECBs and short-term loans, indicating the necessity to further explore the distinction between 'expansion' and 'extension' of business.Overall, the Court found that no substantial question of law arose from the issues regarding intra-group services and circuit accrual charges, while the interpretation of section 36(1)(iii) warranted further examination.