Corporate guarantee, bad debts and lease rentals: transfer pricing and tax deductibility principles applied by ITAT.

Corporate guarantee given to an associated enterprise is treated as a distinct international transaction requiring arm's length benchmarking, and the adoption of a 1% guarantee fee was upheld on the basis of internal comparables and jurisdictional precedent. Bad debt deduction depends on actual write-off in the accounts after the amendment to section 36(1)(vii); the disallowance was deleted because irrecoverability need not be separately proved. For leased assets, the principal component of EMI paid by a lessee remains allowable as revenue expenditure where ownership does not pass to the lessee, and the book treatment as a finance lease does not control the tax result.

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Issues: (i) Whether the upward adjustment made towards corporate guarantee by adopting 1% of the guarantee value as arm's length price was sustainable; (ii) Whether the disallowance of bad debts written off was liable to be deleted on the basis of actual write-off; (iii) Whether the principal component of EMI paid on leased assets was allowable as revenue expenditure.

Issue (i): Whether the upward adjustment made towards corporate guarantee by adopting 1% of the guarantee value as arm's length price was sustainable.

Analysis: Corporate guarantee to an associated enterprise was treated as a separate international transaction and not as a mere shareholder activity. The Authority relied on the retrospective inclusion of corporate guarantees within the transfer pricing framework and on the jurisdictional precedent holding that providing such guarantee involves risk and confers commercial benefit on the associated enterprise. The assessee had also charged 1% guarantee fee in respect of comparable guarantees extended to other overseas associates, which supported the adoption of an internal comparable.

Conclusion: The adjustment at 1% was upheld and the issue was decided against the assessee.

Issue (ii): Whether the disallowance of bad debts written off was liable to be deleted on the basis of actual write-off.

Analysis: After the amendment to section 36(1)(vii) of the Income-tax Act, 1961, the assessee is required to establish actual write-off in the accounts and need not further prove irrecoverability. The Tribunal followed the settled position that the allowability of bad debt depends on the write-off in the books, and the jurisdictional precedent had applied the same rule.

Conclusion: The deletion of the disallowance was affirmed and the issue was decided in favour of the assessee.

Issue (iii): Whether the principal component of EMI paid on leased assets was allowable as revenue expenditure.

Analysis: The lease arrangement was treated as a finance lease for accounting purposes, but tax treatment was held to depend on the Income-tax Act, 1961 rather than book entries. Under the Act, depreciation belongs to the owner of the asset, while lease rentals paid by a lessee without acquiring ownership are allowable as revenue expenditure. The Tribunal followed the view that the legal ownership remained with the lessor and that the principal component of lease rental could not be disallowed merely because the assessee had capitalised the asset in its books under accounting standards.

Conclusion: The deletion of the disallowance was affirmed and the issue was decided in favour of the assessee.

Final Conclusion: The assessee succeeded on the revenue's challenge to the two disallowances, but failed on the transfer pricing dispute relating to corporate guarantee; the cross appeals were therefore not interfered with and stood dismissed.

Ratio Decidendi: Corporate guarantee to an associated enterprise is a distinct international transaction requiring arm's length benchmarking, while bad debt deduction turns on actual write-off in the accounts and lease rentals paid by a lessee without transfer of ownership are allowable as revenue expenditure.

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