Real income limits notional interest adjustments where OFCD recovery and associated-enterprise receivables are commercially improbable.
Transfer-pricing rules do not support imputed interest on OFCD investments or associated-enterprise balances where income has not accrued in real terms, recovery is commercially improbable, and amounts are irrecoverable; OFCDs with conversion rights may be quasi-equity, while corporate-guarantee payments are not necessarily loans. Inventory must be valued at cost or net realisable value, whichever is lower, and a consistently applied net realisable value method cannot be replaced by average purchase cost without evidence that it is incorrect. For AY 2015-16, absent an enabling provision, fair market value could not replace actual share-transfer consideration in computing capital loss. Parent corporate guarantees are not comparable to bank guarantees; a 0.5% commission benchmark was treated as appropriate on the stated facts.
Issues: (i) Whether a transfer-pricing adjustment for notional interest could be made on investment in OFCDs despite uncertainty of recovery; (ii) Whether notional interest could be imputed on amounts due from associated enterprises where recovery was improbable, including a payment under an invoked corporate guarantee and an advance to a dissolved enterprise; (iii) Whether closing stock could be revalued at average purchase cost despite the assessee's net realisable value valuation; (iv) Whether fair market value could replace actual consideration for computing capital loss for AY 2015-16; (v) Whether corporate-guarantee commission should be benchmarked above 0.5%.
Issue (i): Whether a transfer-pricing adjustment for notional interest could be made on investment in OFCDs despite uncertainty of recovery.
Analysis: The OFCDs carried a 2% coupon and an option for conversion into equity, giving the instrument the character of quasi-equity. Recovery was uncertain, interest was not recognised in accordance with recognised accounting principles, and the investment was subsequently written off. The real income doctrine and the arm's length principle did not permit taxation of hypothetical interest where income had not accrued in real terms; the agreed rate was also above the relevant LIBOR rate.
Conclusion: No notional interest adjustment was warranted on the OFCDs, and the addition was deleted in favour of the assessee.
Issue (ii): Whether notional interest could be imputed on amounts due from associated enterprises where recovery was improbable, including a payment under an invoked corporate guarantee and an advance to a dissolved enterprise.
Analysis: The payment under the corporate guarantee arose after the associated enterprise had entered bankruptcy and was not a lending transaction. The other advance was made from own funds, recovery was uncertain, and the associated enterprise subsequently ceased to exist. In both cases, the amounts were treated as irrecoverable. Transfer-pricing provisions could not be applied to impute interest on income that had not accrued and was commercially incapable of recovery.
Conclusion: No transfer-pricing adjustment for notional interest was warranted on either amount, and both additions were deleted in favour of the assessee.
Issue (iii): Whether closing stock could be revalued at average purchase cost despite the assessee's net realisable value valuation.
Analysis: Inventory must be valued at cost or net realisable value, whichever is lower, and a consistently followed valuation method cannot be displaced unless shown to be incorrect. The assessee demonstrated depressed market conditions, stock deterioration and reduced realisability, while the Revenue produced no contrary evidence disproving the adopted net realisable value.
Conclusion: The revaluation at average purchase cost was unsustainable, and the closing-stock addition was deleted in favour of the assessee.
Issue (iv): Whether fair market value could replace actual consideration for computing capital loss for AY 2015-16.
Analysis: Section 50CA of the Income-tax Act, 1961 was not applicable to AY 2015-16. No enabling provision then authorised substitution of actual sale consideration with fair market value for the share transfer; consequently, the assessee was entitled to compute the capital loss using the actual consideration.
Conclusion: Fair market value could not replace the actual consideration, and the disallowance of long-term and short-term capital losses was deleted in favour of the assessee.
Issue (v): Whether corporate-guarantee commission should be benchmarked above 0.5%.
Analysis: A corporate guarantee issued by a parent company is not comparable to a bank guarantee. The 0.5% benchmark had consistently been adopted in earlier orders concerning the same assessee, while the higher rate relied on by the Revenue rested on distinguishable facts.
Conclusion: The 0.5% corporate-guarantee commission rate was upheld, deciding the issue in favour of the assessee and against the Revenue.
Final Conclusion: The substantive additions for notional interest, inventory valuation and capital losses lacked a sustainable legal or factual basis, while the 0.5% benchmark for corporate-guarantee commission remained valid.