Transfer pricing on corporate guarantees and AE loan interest, plus NBFC loan credits and property brokerage-major additions deleted

The dominant issues concerned transfer pricing adjustments and disallowances/additions under the IT Act. On SBLC/corporate guarantee, the TPO's external CUP based on bank guarantee commission was held legally inapposite because bank guarantees are not comparable to corporate guarantees/SBLCs and the analysis proceeded on incorrect facts; applying HC precedent affirmed by SC, the assessee's "Other Method" benchmarking was accepted and the adjustment was deleted. On interest on AE loan, CUP using the host-country central bank rate was preferred over LIBOR plus 400 bps, since the AE could borrow locally at comparable rates; interest charged at 3.55% was held at ALP and the adjustment was deleted. On s.68, the assessee proved identity, genuineness, and creditworthiness of an RBI-registered NBFC lender; the addition under s.68 r.w.s. 115BBE was deleted. Deduction u/s 35(2AB) was restricted to DSIR-certified figures. Brokerage on property sale was allowed as transfer expense based on proved services and tax compliance. Under s.14A, disallowance was confined to dividend-yielding investments, partly allowing the ground.

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1. ISSUES PRESENTED AND CONSIDERED

(i) Whether a transfer pricing adjustment could be made by imputing guarantee commission on issuance of a Standby Letter of Credit (SBLC) for an associated enterprise, particularly where the SBLC charges were reimbursed on a cost-to-cost basis, and whether bank guarantee rates could be used as CUP for benchmarking such transaction.

(ii) Whether interest charged on a foreign currency loan advanced to an associated enterprise at a rate linked to LIBOR plus spread / comparable local central bank lending rate should be accepted as arm's length, and whether a higher rate adopted by the TPO based on credit-rating concerns was justified.

(iii) Whether loan receipts from an RBI-registered non-banking financial company could be treated as unexplained cash credit under section 68, and whether consequential taxation under section 115BBE could be sustained, when identity, creditworthiness, and genuineness were evidenced and the lender complied with notice under section 133(6).

(iv) Whether interest paid on such accepted genuine loan was allowable, in the absence of any finding of diversion of borrowed funds for non-business purposes.

(v) Whether deduction under section 35(2AB) could be denied by the Assessing Officer where the prescribed authority (DSIR) had certified eligible in-house R&D expenditure in Form 3CL, and the Assessing Officer did not follow the statutory procedure for any disagreement.

(vi) For computation of long-term capital gains, whether full brokerage/commission paid for transfer of a leasehold industrial plot was allowable as transfer expense despite exceeding an asserted "market trend" percentage, where services rendered and tax compliance by payees were not disputed.

(vii) Whether disallowance under section 14A was to be computed by considering only dividend-bearing investments, and not all investments, while applying the adopted percentage-based method.

2. ISSUE-WISE DETAILED ANALYSIS

(i) TP adjustment on SBLC / guarantee commission

Legal framework (as discussed): The Tribunal examined benchmarking of an international transaction relating to SBLC charges and the TPO's adoption of CUP using bank guarantee rates.

Interpretation and reasoning: The Tribunal found the TPO's analysis factually flawed because it proceeded on an incorrect presumption that the assessee had not recovered SBLC charges from the associated enterprise, whereas record showed reimbursement of the SBLC charges on a cost-to-cost basis. The Tribunal further held that bank guarantee commission charged by banks could not be equated with, nor used as a benchmark for, issuance of SBLC/corporate guarantee by a non-bank entity, and therefore adoption of external bank guarantee rates for CUP benchmarking was not justified on the facts considered.

Conclusions: The Tribunal accepted the assessee's benchmarking under the "Other Method" as the arm's length price and deleted the guarantee commission adjustment. The safe harbour contention was held infructuous since the adjustment itself did not survive.

(ii) TP adjustment on interest on loan advanced to associated enterprise

Legal framework (as discussed): Arm's length determination for interest on an international loan transaction using CUP; comparison basis adopted by assessee and TPO.

Interpretation and reasoning: The Tribunal noted the assessee charged interest at 3.55% computed with reference to USD LIBOR plus spread, and also justified it with reference to the lending rate reflected by the central bank for the borrower's jurisdiction. The Tribunal reasoned that where the assessee adopted CUP by comparing to the central bank lending rate applicable to companies in the borrower's jurisdiction, it represented an appropriate and realistic benchmark because, absent the related-party loan, the borrower could have borrowed at that rate. The Tribunal rejected the higher rate adopted by the TPO (and modified through DRP directions) which was primarily premised on lack of credit rating details, holding it not acceptable in the given factual matrix.

Conclusions: Interest charged at 3.55% was held to be at arm's length and the transfer pricing adjustment on interest was deleted.

(iii) Addition under section 68 (and section 115BBE) on loan from NBFC

Legal framework (as discussed): Section 68 requirements of proving identity, creditworthiness, and genuineness; evidentiary value of confirmations, bank trails, financials, and third-party compliance to section 133(6) notice.

Interpretation and reasoning: The Tribunal held that the assessee had produced requisite material establishing the lender's identity (as an RBI-registered NBFC), the genuineness of the transaction (banking channels, confirmations), and the lender's creditworthiness (financial statements and bank statements). A notice issued to the lender under section 133(6) was complied with directly by the lender confirming the loan and its reflection in the lender's books. On these findings, the Tribunal held that the addition as unexplained cash credit could not be sustained, and the Inspector-related adverse narrative did not override the documentary and third-party statutory confirmations relied upon by the Tribunal.

Conclusions: The section 68 addition on the loan amount was deleted; consequential treatment under section 115BBE did not survive.

(iv) Allowability of interest on the accepted loan

Legal framework (as discussed): Deductibility of interest on borrowed funds when the borrowing is genuine and not shown to be diverted for non-business purposes.

Interpretation and reasoning: Since the Tribunal accepted the loan as genuine, and there was no case made by the revenue that borrowed funds were diverted for non-business purposes, the interest paid on such borrowing was held allowable.

Conclusions: Disallowance of interest on the said loan was deleted.

(v) Deduction under section 35(2AB) based on DSIR certification

Legal framework (as discussed): The Tribunal relied on the statutory scheme that where the prescribed authority (DSIR) certifies eligible expenditure for section 35(2AB), the Assessing Officer cannot disregard the certification and, if in doubt, must follow the procedure contemplated for reference rather than substitute his own view.

Interpretation and reasoning: The Tribunal found that DSIR had certified eligible R&D expenditure for the relevant year in Form 3CL. The Tribunal held that once such certification existed, the Assessing Officer could not go beyond it to re-characterize the certified expenditure, and if the Assessing Officer disagreed, he was required to follow the procedure contemplated under the Act (as referred to by the Tribunal) which was not done. Therefore, denial of the deduction on the basis that expenses resembled regular business expenditure was not sustained in the presence of DSIR certification.

Conclusions: The deduction under section 35(2AB) was allowed to the extent certified by DSIR; the disallowance was deleted.

(vi) Brokerage/commission as transfer expenses in capital gains computation

Legal framework (as discussed): Allowability of expenses incurred wholly and exclusively in connection with transfer, evaluated on actual services and evidence rather than an assumed market percentage.

Interpretation and reasoning: The Tribunal held that the revenue did not dispute the rendering of brokerage services, and payments were made through banking channels with tax deducted at source; the recipients disclosed the income in returns. The Tribunal rejected the disallowance made merely by applying an asserted "normal practice" of 2% commission, noting that the brokers' services included not only identification/negotiation but also persistent coordination with the relevant authority for obtaining approval/NOC for transfer, which was found to be a cumbersome process and not disputed.

Conclusions: The entire brokerage/commission paid was allowed as transfer expenses while computing long-term capital gains; the disallowance was deleted.

(vii) Scope of investments to be considered for section 14A disallowance

Legal framework (as discussed): The Tribunal applied the principle that disallowance under section 14A is to be computed with reference to dividend-bearing investments.

Interpretation and reasoning: Although the Assessing Officer computed disallowance by applying a percentage (1%) to the average value of all investments, the Tribunal held that only dividend-bearing investments should be considered. Accordingly, it directed recomputation on that basis while maintaining the adopted percentage approach.

Conclusions: The section 14A disallowance was not sustained as computed; the Assessing Officer was directed to recompute considering only dividend-bearing investments, resulting in partial relief.

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