Internal comparables, block-of-assets depreciation, and amended unabsorbed depreciation rules determined relief on core tax issues.

A contemporaneous internal comparable uncontrolled transaction can support the CUP method for interest on external commercial borrowing, and where the assessee's rate is lower than the associated enterprise's own borrowing cost, the transfer pricing adjustment fails. Depreciation cannot be denied on impaired or retired assets merely because a specific item is not in active use if it remains within an existing block of assets used for business. Post-amendment unabsorbed depreciation is carried forward and set off without the earlier eight-year restriction. Penalty proceedings were treated as premature, so no substantive penalty survived.

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Issues: (i) Whether the transfer pricing adjustment on interest paid on External Commercial Borrowings was sustainable, (ii) whether depreciation on impaired and retired assets forming part of the block of assets could be disallowed, (iii) whether unabsorbed depreciation of earlier years could be denied carry forward beyond eight years, and (iv) whether initiation of penalty proceedings was premature.

Issue (i): Whether the transfer pricing adjustment on interest paid on External Commercial Borrowings was sustainable.

Analysis: The interest rate charged by the associated enterprise to the assessee was benchmarked against an internal comparable uncontrolled transaction, namely the borrowing cost of the associated enterprise from an unrelated bank. That internal comparable was treated as a reliable benchmark for applying the CUP method. Since the assessee's rate was lower than the associated enterprise's own borrowing cost, the arm's length character of the transaction was established.

Conclusion: The adjustment on account of interest on External Commercial Borrowings was deleted, in favour of the assessee.

Issue (ii): Whether depreciation on impaired and retired assets forming part of the block of assets could be disallowed.

Analysis: Depreciation under the block of assets concept is allowable with reference to the block as a whole and not on each individual asset in isolation. Once an asset has entered the block and the block continues to exist for business purposes, non-use of a particular item in a later year does not by itself justify denial of depreciation on that item. The earlier year precedent on the same facts was followed.

Conclusion: The disallowance of depreciation was deleted, in favour of the assessee.

Issue (iii): Whether unabsorbed depreciation of earlier years could be denied carry forward beyond eight years.

Analysis: The amended regime governing section 32(2) was applied in the light of the binding precedent holding that, after the legislative change, unabsorbed depreciation available at the commencement of the amended provision merges with the current depreciation and is available for carry forward and set-off without the earlier eight-year restriction.

Conclusion: The carry forward of unabsorbed depreciation was allowed, in favour of the assessee.

Issue (iv): Whether initiation of penalty proceedings was premature.

Analysis: The penalty issue was treated as premature at this stage and no substantive levy was upheld in the order under appeal.

Conclusion: The penalty ground failed.

Final Conclusion: The assessee succeeded on the substantive additions/disallowances in dispute, and the appeal was disposed of by granting relief on the core tax issues while rejecting the penalty challenge.

Ratio Decidendi: For transfer pricing, a contemporaneous internal comparable uncontrolled transaction may provide the best benchmark under the CUP method; depreciation is governed by the block of assets concept; and post-amendment unabsorbed depreciation is carried forward under the amended section 32(2) without the prior eight-year limit.

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