TaxTMI 
TaxTMI 
2014 (11) TMI 845
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....t arm's length price as per the provisions of Chapter X of the Act. 2. The Ld. DRP and the Ld. AO (following the directions of the DRP) failed to appreciate and ought to have held that: (i) the Appellant had charged interest on the loans advanced to its AE's at the rate that was significantly higher than the London Inter Bank Borrowing Rate ("LIB OR") and other international benchmarking rates which is used as the international standard for lending and borrowing of funds and considering the direct commercial interest of the Company no addition was justifiable on loan given to PMP Bakony and PMP Mauritius. (ii) Without prejudice to the above, under Article 11 of the Double Taxation Avoidance Agreement ("DTAA") since no interest is "paid", the question of making any adjustment does not arise. GROUND II: TREATING SHARE APPLICATION MONEY IN OVERSEAS SUBSIDIARY AS AN INTERNATIONAL TRANSACTION AND ADDING NOTIONAL INTEREST INCOME BY RE-CHRACTERIZING THE SHARE APPLICATION MONEY AS A LOAN -Rs.l,24,69,920/- 1. On the facts and in the circumstances of the case and in law, the Ld. DRP and the Ld. AO (following the directions of the DRP) erred in treating the investments ....
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.... TPO determined the arm's length interest chargeable at the rate of 15% and made adjustment on account of interest chargeable on the loans and advances to AE. Similarly the TPO has taken the arm's length interest in respect of the loan of Euro 8,23,875 equivalent to Rs. 5,26,95,045/- to its wholly owned subsidiary namely PMP Bakony, Hungary, on which the assessee charged interest at the rate of 8% per annum. By applying arm's length rate of 15% on both loans given by the assessee to its AEs at Mauritius and Hungary the TPO made the adjustment of Rs. 1,14,01,627/- 3. The assessee challenged the action of TPO/Assessing Officer before the DRP by filing objections and contended that the assessee charged interest to its AE at Hungary which is more than the LIBOR rate and, therefore, the same is at arm's length and no adjustment was required to be made in respect of the loan given to its subsidiary. As regards the loan given to the Mauritius based AE, the assessee contended that no interest has accrued to it during the period under consideration on account of moratorium agreed upon with the AE and further in terms of Article 11 of DTAA with Mauritius, interest 'paid' alone could be su....
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.... (v) Cotton Naturals (I) Pvt. Ltd. (ITA no. 5855/Del/2012) (Del) (vi) Siva Industries Ltd. & Holding Ltd. Vs. ACIT (11 Taxmann.com 404) (Chen) (vii) Aithent Technologies (P) Ltd. Vs. ITO (17 Taxmann.com 59) (Del) (viii) Siva Ventures Limited Vs. ACIT (ITA No. 2161/Mum/2011) (Chen) 5. He has further contended that in these decisions the Tribunal has held that the LIBOR rate with an appropriate markup is the right parameter to be applied as against the rate of interest prevailing in India. 6. On the issue of non charging of interest on the loan given to the Mauritius based AE, the Ld. Authorized Representative of the assessee has submitted that when no interest was charged by the assessee as per the agreement on moratorium for one year, then no notional interest can be added under transfer pricing adjustment. Alternatively, the Ld. Authorized Representative has submitted that as per the DTAA between India and Mauritius, unpaid interest is not taxable in terms of Article 11 of the Treaty. He has referred Article 11 of the Indo Mauritius DTAA and submitted that the Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed ....
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....r transaction with unrelated third party and thereby the income of the assessee would have earned from a similar transaction with an uncontrolled party. Thus, the same income is expected or deemed to have been earned from the transaction with the AEs. The underlining principle of determining the ALP is based on the transaction between the unrelated parties. The income of the assessee should not be effected as reduced and therefore, the same is compared with the income or expenditure as the case may be earned or incurred by the assessee, if it would have been between the assessee and the unrelated parties. Therefore, tested party for the purpose of determination of ALP is the assessee and not the AEs. 8.8 In the case in hand, the assessee has advanced loans to the AEs without charging any interest; therefore, the transaction has to be tested with a situation, had the assessee invested or advanced or deposited the said amount with an unrelated third party and thereby the income, which would have been earned by the assessee is expected to have been earned from the transaction of advancing loans to the AEs. 8.9 Thus, on principle, we do agree with the DRP on the point of the test....
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....upra); therefore, to maintain the rule of consistency, we follow the decision of the coordinate Benches of this Tribunal, and accept LIBOR for benchmarking interest on interest free loans to AEs. Since the LIBOR is a rate applicable in the transactions between the banks and further the loans advanced by the bank to clients are secure by security and guarantee; therefore, a loan which has been advanced without any security or guarantee as in the case of the assessee has to be benchmark by taking the Arm's Length interest rate as LIBOR plus. Though the TPO took ALP as LIBOR + 3%; however, in our view, the appropriate rate would be LIBOR plus 2%. We accordingly, direct the AO/TPO to determine the Arm's Length interest by considering the LIBOR plus 2% on the monthly closing balance of advances during the financial year relevant to the AY under consideration." 9. On principle, we do concur with the view of the co-ordinate bench in the abvoe said decision that the assessee is a tested party and economic/commercial as well as geographical condition in which the assessee is doing business are relevant to be considered for the purpose of determining the arm's length price. Howeve....
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.... advancing loans to the AEs falls under the ambit of international transactions as per the terms of Sec 92B whereby the "international transaction" means a transaction between two or more associated enterprises, inter alia lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises............................. 8.2 Thus, the transaction of advancing loans to the AEs undoubtedly falls within the meaning of international transaction as per section 92B. Even otherwise, the Tribunal in the case of Tata Autocomp Systems Ltd(supra) as relied upon by the assessee held in paras 16 & 17 as under: 16. Interest free loan extended to the associated concerns as at arm's length lending or borrowing money between two associated enterprises comes within the ambit of international transaction and whether the same is at arms length price has to be considered. The question of rate of interest on the borrowing loan is an integral part of arms length price re-determination in this context. The fact that the loan has the RBI's approval does not put a seal of approval on the true character of the transaction from the pers....
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....the thin capitalization rules, no deduction was allowable to the Hungary entity for payment of interest therefore, there existed impossibility of performance with regard to payment of Hungary entity. Economic circumstances of the subsidiaries did not warrant the charging of interest from subsidiaries. The ld. Counsel for the assessee further relied upon the Apex Court decision in the case of M/s S.A. Builders Ltd. v. CIT(Appeals) and others 288 ITR 1 (SC). 9.1 The ld. DR for the revenue on the other hand relied upon the orders of the ld. CIT(A), he claimed that the ld. CIT(A)'s order was a speaking order and it has rebutted all the arguments of the assessee. 10. We have carefully considered the submissions and perused the records. The primary contention before us, as submitted by the ld. Counsel of the assessee is that it was commercially expedient for assessee to advance interest free loans to the AEs and that since no interest has actually been charged, there is no real income exigible to tax. As observed by the ld. CIT(A) the agreements show that these are loan amount given by the assessee to Associated Enterprises (AEs). This in fact is an admitted position. There is ....
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....sessee is a matter which we will examine in the subsequent paragraphs." 8.3 Accordingly, we do not have any doubt in mind that the transaction in question is an international transaction and subjected to the ALP as per the Transfer Pricing Regulations. 10. Therefore, it is clear that the transaction of loan given to the AE is an international transaction and subjected to ALP as per the transfer pricing provisions of Income Tax Act. The assessee has raised an alternative plea that even in case the transfer pricing provisions are applicable in respect of the non charging of interest on loan given to AE, it is not taxable in India as per the provisions of Article 11 of Indo-Mauritius DTAA because the said interest was not paid to the assessee. We note that the provisions of Article 11 are applicable in the case of interest arising in the contracting state and paid to the resident of another contracting state. For the sake of ready reference, we quote Article 11 of Indo-Mauritius DTAA as under:- "ARTICLE 11 Interest 1. Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, subject to the....
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....ting State or not, has in a Contracting State a permanent establishment in connection with which the indebtedness on which the interest is paid was incurred, and such interest is home by that permanent establishment, then such interest shall be deemed to arise in the Contracting State in which the permanent establishment is situated. 8. Where, by reason of a special relationship between the payer and the recipient or between both of them and some other person, the amount of the interest paid, having regard to the debt-claim for which it is paid, exceeds the amount which would have been agreed upon by the payer and the recipient in the absence of such relationship, the provisions of this Article shall apply only to the lastmentioned amount. In that case, the excess part of the payments shall remain taxable according to the law of each Contracting State, due regard being had to the other provisions of this Convention." 11. It is contemplated under Article 11 of DTAA that the payment is a condition for taxing the interest only in the circumstances when the interest is arising in the contracting state and accrued to the resident of another contracting state and, therefore, the sa....
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....s exhaustive and not inclusive. The TPO has re-categorized the share application money to loan which is not permissible under the law. In support of his contention he has relied upon the following decisions:- (i) M/s Allcargo Global Logistics Ltd. Vs. ACIT (ITA no. 4909/Mum/2012 and 4910/Mum/2012) (ii) Parle Biscuits Pvt. Ltd V. DCIT ( I.T.A No. 9010/Mum/2010) (iii) Bharti Airtel Limited Vs. Adnl. CIT (I.T.A No. 5816/Del/2012) (iv) Besix Kier Dhabhol SA (ITA no. 776 of 2012) (Bom HC) (v) Besix Kier Dhabhol SA ( 134 TTJ 513) (TMum) 15. Thus the Ld. Authorized Representative has submitted that the purchase and sale as provided under the definition of international transaction is different from the subscription of shares of the AE. 16. On the other hand, the Ld. DR has relied upon the orders of authorities below and submitted that there is an abnormal delay in the allotment of shares and during the said period the amount paid by the assessee to the AE has to be considered as loan given without charging interest. The Ld. DR has submitted that in the normal course the application money is kept in escrow account and, therefore, the same cannot be used by the recip....
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.... interest free loan on allotment of shares under the CUP method, as has been claimed to have been done in this case, it was to be done on the basis as to what would have been interest payable to an unrelated share applicant if, despite having made the payment of share application money, the applicant is not allotted the shares. That aspect of the matter is determined by the relevant statute. This situation is not in pari materia with an interest free loan on commercial basis between the share applicant and the company to which capital contribution is being made. On these facts, it was unreasonable and inappropriate to treat the transaction as partly in the nature of interest free loan to the AE. Since the TPO has not brought on record anything to show that an unrelated share applicant was to be paid any interest for the period between making the share application payment and allotment of shares, the very foundation of impugned ALP adjustment is devoid of legally sustainable merits. 48. Let us also deal with two judicial precedents which have been heavily relied upon by the TPO, as also by the learned Departmental Representative, on which their case rests. None of these decisions....
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....factor for commercial expediency. However, as we have seen in the earlier discussions, such commercial expediency of granting interest free loans is wholly irrelevant because it is the impact of this interrelationship, on account of management, capital and control, which is sought to be neutralized by arm's length price adjustments. This was also not a case in which a capital contribution was deemed to be partly an interest free loan [i.e. for the period till the shares were actually allotted) and partly as capital contribution [i.e. when the subscribed shares were allotted by the subsidiary). Revenue, therefore, does not derive any advantage from these judicial precedents either. 49. In any event, it is not open to the revenue authorities to re-characterize the transaction unless it is found to be a sham or bogus transaction. While there are no specific powers vested in the TPO to re-characterize the transaction, even under the judge made law, such re-characterization can be done by the revenue authorities when the transactions are found to be substantially at variance with the stated form. In the present case, there cannot even a suggestion to hold that this is a bogus tra....
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....ctual period of delay in allotment and arm's length interest to be received by the assessee in case the transaction of share application money would have been with an unrelated party. 19. Ground no. 3 is regarding equity investment in overseas subsidiary treated as international transaction and full amount has been added to the income of the assessee. In the year 2007, the assessee acquired the entire capital of the company PMP Bakony from a third party in Hungary. The value of the capital contribution was based on the valuation report and accepted to be at arm's length price. Subsequently, the assessee infused further capital of Rs. 14,15,00,170/- in this subsidiary during the year under consideration. This additional investment was made at par and on that account claimed to be at arm's length. The TPO noted that book value of the shares as on 31.03.2008, the date nearest to the date of transaction, was negative and yet the assessee has paid par value to acquire additional capital. The TPO took the arm's length price of the shares at Nil and accordingly recommended the TP adjustment of the entire amount of Rs. 14,15,00,170/- 20. Before DRP, the assessee contended that this t....
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....red the rival submissions and relevant material on record. There is no dispute that the assessee has not produced any valuation or other material to show that the investment made in the subsidiary at par is at arm's length. The assessee has placed reliance on the valuation report of KPMG based of DCF method. We find that in case of investment in the 100% subsidiary of the assessee, the valuation has to be future prosective earning on the capital and should not be based on the present net worth of the subsidiary. Since the investment is for long term and not for earning the capital gain, therefore, we find merit in the contention of the assessee that the valuation should have been based on the discounted cash flow method (DCF). Since no such report was produced by the assessee before the TPO/Assessing Officer, therefore, in the facts and circumstances of the case and in the interest of justice, we remit this issue to the record of Assessing Officer/TPO to reconsider and decide the issue afresh after taking into account the valuation report based on DCF method. 25. The assessee has also raised additional grounds as under:- 1. On the facts and in the circumstances of the case an....
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....r pricing adjustment without properly appreciating the factual and legal matrix of the case as clearly brought out by the Assessing Officer in the Draft Assessment Order. (ii)The Learned DRP has erred on facts and in law in deleting the transfer pricing adjustment without properly appreciating the fact that the TPO had made the addition on account of interest chargeable on loan transaction with PMP Bakony ofRs.57,71,641/- as the assessee had not realized any amount of interest from additional capital investment made to its AE whereas assessee had passed tangible benefit on to the AE by infusion of an excess amount. (iii) The Learned DRP has erred on facts and in law in deleting the transfer pricing adjustment by holding that the transfer pricing provision in the Act does not envisage the concept of 'secondary transfer pricing adjustment' and a concept of'secondary adjustment' is alien to the Indian Transfer Pricing Law. 28. The only issue arises in the revenue's appeal is regarding secondary transfer pricing adjustment in respect of the capital infused by the assessee in its subsidiary. 29. We have heard the Ld. AR as well as Ld. DR and considered the re....