2023 (12) TMI 1458 - AT - Income Tax

Revenue transfer pricing adjustments upheld; guarantee fee fixed at 2.45% p.a.; LIBOR+450bps confirmed; s.35(2AB) remitted; s.14A upheld under Rule 8D

Synthite Industries (P) Limited Versus The Deputy Commissioner of Income-tax, Corporate Circle 2 (1) Kochi.

ITAT, Cochin (AT) upheld the Revenue's TP adjustments in principle but modified the corporate guarantee fee to 2.45% p.a. (gross), allowing partial ... TP adjustment u/s.92CA - corporate guarantee - rate to be applied - HELD THAT:- It has not even stated the standard/rake rate of Axis Bank, i.e., as does the Revenue for others. How, then, can Axis Bank be not regarded as falling on the mean of the scale afore-mentioned, and the average guarantee fee charged by the Banks ascribed as the fee rate it would charge a normal customer? The only infirmity and, therefore, correction therein we find is that the fee rate of 3% (p.a.) appears twice. Representing an extreme rate, it is to be counted once to provide a more representative rate, which would reduce the average from 2.56% to 2.45% p.a. Reducing the amount actually charged by the assessee from it’s subsidiary, i.e. Rs.44.64 lakhs, the balance amount is liable to be confirmed as a shortfall in the ALP of the transaction, found at 2.2% by the DRP. The assessee’s reliance on the SHR is also not opposite. R.10TD(2A), as amended by Income Tax (12th Amendment) Rules, 2017, w.r.e.f. 01.04.2017, clearly speaks of a rate not less than 1% p.a. for an amount in excess of Rs.100 crores where the credit risk of the AE is of adequate to highest safety. Firstly, it provides a base rate of 1% p.a., which would then be required to be scaled up on the basis of the credit rating, not provided, of the AE. That apart, as afore-noted, the corporate guarantee issued in the instant case can, inasmuch as it enables the issue of bank guarantee, only rightly be regarded as a variant thereof. We, for the reasons afore-stated, subject to the modification in the ALP rate to 2.45% p.a. (gross), validate the Revenue’s case in principle. We decide accordingly, and the assessee gets part relief. TP adjustment is qua interest on trade receivables - rate of interest to be applied on the amount representing excess credit upon benchmarking the normal credit period - The same has been applied at 6-month Libor + 450 basis points (as per RBI master circular on external commercial borrowings and trade credits), including 100 basis points toward currency risk arising from fluctuation in the foreign exchange rate being borne by the assessee. The same is stated as consistent with SHR providing for interest at SBI base rate plus 300 basis points for receivables exceeding Rs.50 crores. We find no infirmity therein, nor was any pointed out to us during hearing. We accordingly confirm the same. Rather, as we observe, the six-month Libor (1.475% p.a.) would be lower than the SBI base rate. Packing credit interest rate in the assessee’s case has no application inasmuch as the Libor rate is for six months. Disallowance u/s. 35(2AB) - weighted deduction basis at 150% in view of the prescribed authority there-under (DSIR) not approving expenditure - alternate claim arising only on account of it being granted approval u/s. 35(2AB) for a lower sum - The claim, it may be appreciated, could not be made at the time of filing the return on 29.11.2018 inasmuch as Form 3CL stands issued only on 23.10.2020. The matter shall accordingly travel to the file of the AO for consideration and adjudication on merits the assessee’s case, i.e., in accordance with law, after affording due opportunity to the assessee to state it’s case, and on whom lies the burden to prove it’s claims, per a speaking order. We decide accordingly. Disallowance u/s. 14A - amount disallowed suo motu by the assessee, against, principally, dividend income claimed tax-exempt - Rule 8D stands substituted w.e.f. 02.06.2016, not providing for apportionment of interest expenditure where both taxable and non-taxable assets of the business are being financed through a common pool of funds. The said rule, which would therefore apply for the current year, provides for only two limbs, i.e. for direct and indirect expenditure; the latter being statutorily estimated at a gross of 1% p.a., and without reference to interest expenditure, if any, incurred per common financing of all assets, i.e., yielding taxable and non-taxable incomes. No disallowance qua interest expenditure, clearly, stands made u/r. 8D(2)(i). On what basis, then, one may ask, does the assessee contend that estimation of indirect expenditure u/r. 8D(2)(ii) includes interest expenditure? The argument advanced is misconceived for an assessee, as the appellant, who claims sufficient own capital, so that the entire application of borrowed funds is for taxable assets, resulting in no disallowance, since accepted, u/r. 8D(2)(i). The condition for applicability of common expenditure in respect of interest, claimed as not met, resulting in claim and allowance of entire interest expenditure against business income, since accepted, could not lead to any cause for grievance.We decide accordingly, upholding the impugned disallowance. ISSUES PRESENTED AND CONSIDERED 1. Whether a corporate guarantee issued by the assessee in favour of a bank enabling issuance of a bank guarantee to its foreign associate enterprise constitutes an 'international transaction' under section 92B and, if so, what is the arm's length price (ALP) (rate of guarantee fee) applicable. 2. Whether the guarantee fee actually charged and recovered by the assessee from the AE (Axis Bank's charge to the assessee) is the appropriate comparable uncontrolled price for benchmarking the corporate guarantee. 3. Whether the Transfer Pricing Officer's method of benchmarking (averaging guarantee-fees of multiple banks) and the specific averaging treatment (treatment of duplicate extremes) is valid, and what modification, if any, to the ALP is warranted. 4. Whether interest on trade receivables arising from extended credit to an AE is an international transaction under section 92B and, if so, whether the rate applied by the TPO (6-month LIBOR + 450 bps including 100 bps currency risk) is acceptable. 5. Whether amounts disallowed by the assessing officer under section 35(2AB) for lack of DSIR approval can be alternatively allowed under section 35(1) or section 37(1), and whether the appellate authority can remit the matter for fresh adjudication. 6. Whether indirect expenditure attributable to tax-exempt dividend income should be disallowed under section 14A read with Rule 8D, including the scope of investments to be excluded (investments generating taxable income, strategic investments, investments not yielding income in the year) and whether Rule 8D(2)(ii)'s 1% rule properly applies. ISSUE-WISE DETAILED ANALYSIS Issue 1-3: Characterisation and valuation of corporate guarantee as an international transaction; ALP rate Legal framework: Section 92B (as amended) defines 'international transaction'; transfer pricing principles require testing such transactions at arm's length. Safe harbour rules (r.10TD(2A)) provide indicative rates (base 1% for guarantees above Rs.100 crore, with scaling by credit quality). Precedent treatment: Tribunal and High Court decisions have treated guarantee transactions as international transactions and have applied varying ALP rates (commonly 1.8%-3.5%). Safe harbour rates and CBDT guidance have been relied on for baseline rates but are not determinative when facts differ. Interpretation and reasoning: The Court accepts that the guarantee (being a demand guarantee indemnifier arrangement enabling a bank guarantee) is an international transaction and akin to a bank guarantee given its immediate-on-demand liability. The argument that the guarantee is a shareholder activity or costless service was rejected as unsupported. The relevant comparable is the rate a bank would charge the AE (the ultimate beneficiary), not the lower rate the assessee pays to its own banks. Banks' published guarantee rates vary due to differing risk appetites, funding costs and competitive strategy; market averages can serve as a proxy for ALP if properly constructed. The TPO's use of an average of five banks' guarantee-fees was acceptable in principle but the duplication of an extreme 3% rate twice made the average unrepresentative. SHR provide a floor (1% for >Rs.100 crore where credit risk is high) but must be scaled to credit rating, which was not supplied by the assessee. Ratio vs. Obiter: Ratio - guarantee here is an international transaction requiring ALP testing; relevant comparable is the fee charged to the AE by a bank; averaging of bank rates is an acceptable benchmarking approach subject to representative treatment of outliers. Obiter - discussion on banks' market behavior and risk-appetite dynamics explaining rate dispersion. Conclusion: The transaction is to be benchmarked against bank guarantee rates. The Tribunal modifies the TPO's average by treating the duplicated extreme rate once, reducing the gross ALP from 2.56% to 2.45% p.a., and confirms an addition (after credit for fee recovered) consistent with the ALP ultimately upheld (DRP had found 2.2% but Tribunal validates 2.45% gross, giving part relief). Issue 4: Interest on trade receivables as international transaction and appropriate interest rate Legal framework: FA 2012 clarified that deferred payment/receivable or other debt arising during business are international transactions. Benchmarking requires a market-based interest rate; RBI master circular on ECBs and trade credits provides guidance. Precedent treatment: Courts and tribunals have accepted treatment of deferred payments as international transactions and application of market benchmarks such as LIBOR or domestic base rates plus spread, with adjustments for currency risk. Interpretation and reasoning: The Tribunal accepts that trade receivables constitute an international transaction. The applied rate (six-month LIBOR + 450 bps, including 100 bps for currency risk) aligns with RBI master circular guidance and is consistent with safe-harbour comparisons (SBI base + 300 bps for large receivables). Picking LIBOR (six-month) is appropriate for the tenor; SBI base rate or packing credit concepts were inapplicable or higher, and no infirmity in the method was shown. Ratio vs. Obiter: Ratio - confirmability of interest benchmarking using 6-month LIBOR + spread (including currency risk) for extended trade credits to AE; packing credit or domestic base rate not necessarily relevant. Obiter - comparison note that LIBOR may be lower than SBI base rate in the factual scenario. Conclusion: The ALP adjustment for interest on trade receivables at 6-month LIBOR + 450 bps (including 100 bps currency risk) is confirmed. Issue 5: Disallowance under section 35(2AB) and alternative allowance under section 35(1)/37(1) Legal framework: Section 35(2AB) provides weighted deduction subject to DSIR approval; alternative claims under other sections may be raised but are subject to timing and factual/supporting documentary requirements; appellate authority has power to remit for fresh adjudication with directions. Precedent treatment: Supreme Court and High Court precedent recognize appellate authority's power to remit matters for consideration on merits; Goetze India Ltd. was relied upon but does not preclude appellate reconsideration where permissive. Interpretation and reasoning: The assessee's weighted-deduction claim was reduced due to partial DSIR non-approval; the assessee sought alternative deduction under section 35(1) or 37(1). The Tribunal finds the Revenue's rejection unsustainable and notes that the alternative claim arose only after DSIR's partial approval (Form 3CL issued later than return filing). The appellant did not make a new claim at return time because documentary approval was not then available. Given appellate powers and applicable precedents, the Tribunal remits the matter to the Assessing Officer for fresh adjudication on merits, with opportunity to the assessee to prove its claim and onus on the assessee to furnish evidence; AO to pass a speaking order. Ratio vs. Obiter: Ratio - appellate remand for fresh consideration of alternative claims under ss. 35(1)/37(1) is appropriate when approval timelines prevent initial filing; assessee bears burden of proof. Obiter - commentary on interplay with cited authorities clarifying scope of appellate powers. Conclusion: Matter remitted to AO for adjudication of alternative deduction claims, after affording opportunity and onus on assessee to prove entitlement; disallowance under s.35(2AB) set aside to extent indicated and to be reconsidered. Issue 6: Disallowance under section 14A and applicability of Rule 8D(2)(ii) 1% computation Legal framework: Section 14A disallows expenditure incurred in relation to income not includible in total income; Rule 8D prescribes methodology for computation where accounts do not provide necessary information (direct and indirect expenditures; indirect expenditure statutorily estimated at 1% of average investment for investments yielding exempt income). Precedent treatment: Apex Court decisions (Godrej & Boyce; Maxopp; Walfort; South Indian Bank; Reliance apportionment jurisprudence) have upheld the principle that expenditure relating to exempt income must be disallowed; dominant-purpose or strategic motivations do not negate applicability of s.14A; Rule 8D as substituted provides statutory estimation rules and excludes apportionment in certain circumstances. Interpretation and reasoning: The Tribunal holds that investments yielding taxable income or taxable bonds must be excluded when computing the base under r.8D; AO to verify and assessee bears burden. The assertions that (i) strategic investments should be excluded and (ii) only investments that actually yielded exempt income in the year should be included are rejected: Section 14A and Rule 8D operate by reference to the nature of income that may arise (includible or not), not to the quantum actually earned in the year, and motivation (dominant purpose) is irrelevant. Rule 8D(2)(ii)'s 1% of average investment is the statutory proxy for indirect expenditure in absence of particulars and does not depend on apportionment of interest where express conditions (common pool financing) are not met. The assessee's contention that indirect expenditure estimate should exclude interest is misconceived where no direct expenditure disallowance under r.8D(2)(i) is made; the statutory 1% applies unless specific exclusions (taxable investments) are established and verified by AO. Ratio vs. Obiter: Ratio - s.14A disallows expenditure relating to non-taxable income based on character of investments; Rule 8D(2)(ii) 1% estimation is valid and applicable; dominant-purpose/strategic intent is immaterial. Obiter - historical and doctrinal exposition of the rationale for s.14A and supporting circulars and case law. Conclusion: Disallowance under section 14A (computed under Rule 8D as 1% of average investment after excluding investments whose income is taxable) is upheld; matter remitted to AO for verification of excluded investments and valuation (lower of cost or market) with burden on assessee to prove exclusions.