DCIT RG 8(1), MUMBAI vs. AFCONS INFRASTRUCTURE LTD, MUMBAI

assessee has challenged- Firstly, adjustment of Rs.1,73,28,778/- in respect of  extension of performance/ corporate guarantee to Afcons Construction Mideast LLC (Ground No.1.3) Secondly, Adjustment of Rs.55,59,523/- in respect of  receipts of interest on loan given to Afcons Construction Mideast LLC and Afcons Infrastructure International Ltd. Mauritius. Thirdly, the ld. AO has erred in not granting credit of tax at  Rs.13,419/- being additional income tax of distributed profits u/s.115JB. The last ground has not been argued, therefore, the same is dismissed as not pressed.

In so far as the first issue raised by the assessee is with regard to adjustment of Rs.1,73,58,778/- in respect of extension of corporate guarantee to Afcons Construction Mideast LLC. The assessee company is engaged in the business of executing large and complex civil engineering projects in the infrastructure sector for construction of roads, bridges, railways, jetties, transport terminals, tunnels, dams etc. in India and abroad. Assessee Company entered into contract with the Nad Al Sheba Race Course Development Project of the Road Transport Authority in Dubai (RTA) for construction of a bridge. However, in view of the legal requirements of the UAE and in order to carry out its business in that country, it formed a limited liability company in Dubai named as Afcons Construction Mideast LLC (Afcons Mideast). UAE regulations provide that it could not hold more than 49% in Afcons Mideast. Hence, 51% shareholding in the said company was held by a local sponsor Despite the shareholding structure, the assessee was wholly responsible to carry out almost the entire contract. It was agreed between the shareholders that the assessee would be entitled to 80% of the profits of Afcons Mideast. The share capital of Afcons Mideast as on 31.03.2009 stood at Rs.42,62,400/- only.

Since the share capital of Afcons Mideast was only Rs. 42,62,400/-, therefore, it was required to obtain credit facilities including performance guarantee from First Gulf Bank (FGB) in Dubai for execution of the said contract. During the relevant F.Y. 2008-09, assessee extended a guarantee of Rs.824 Crores (AED 580 million) to FGB for procuring 19 facilities by FGB to Afcons Mideast. The following 4 types of facilities were provided (and the amounts actually utilized) by FGB to Afcons Mideast during the year: Benefit Actually Benefit Benefit Benefit utilised (AED % p.a. AED p.a. INR p.a. in million) Letters of credit 24,730,000 0.5 123,650 1,756,818 Letters of 108,850,000 0.5 544,250 7,732,700 Guarantee Advance payment Letters of 108,850,000 0.5 544,250 7,732,700 Guarantee Performance Bond Labour Guarantee 1,500,000 0.5 7,500 106,560 TOTAL 243,930,000 17,328,778 6 ITA No.1135/Mum/2014& 1357/Mum/2014 M/s. Afcons Infrastructure Limited 7. The assessee did not charge any guarantee fee from Afcons Mideast for giving the guarantee to FGB as it was stated that effectively it was a guarantee given for its own performance of the contract (the performance guarantee) or a guarantee given for repayment of the advance which would also only arise in the case of non-performance of the contract.

The ld. TPO held that guarantee given by the assessee as an international transaction and held that the benefit which arose to Afcons Mideast was 0.50% as the guarantee fee charged by FGB from Afcons Mideast was at the rate of 1% which without such guarantee given by it would have been 1.5%. The ld. TPO concluded that it is in the nature of intra group services rendered by the assessee to its AE and there is always a cost of guarantee given by the assessee to its AE. Finally, he held that as per the standard rate of FGP, the rate would have been 1.50% p.a. However, since, assessee had extended a guarantee on behalf of the AE, the said AE was charged @1.00% p.a. by FGB. The benefit accrued to AE is 0.5% which ought to have been recovered by assessee from its AE. Accordingly, he made the adjustment of arm’s length guarantee fee rate at 0.50% which was calculated at Rs.1,73,28,778. The ld. DRP has upheld the adjustment made by the ld. AO.

Before us, ld. Sr. Counsel Shri J.D. Mistry after narrating the entire facts and background of the case submitted that one has to keep in mind that here in this case the contract work was carried out by the assessee i.e. Afcons Infrastructure Ltd. only.

In rejoinder, it has been clarified that in so far as submission of the ld. DR that arithmetically, the profit has been earned by the assessee by shifting of expenditure relating to sub- contract to its AE i.e. Afcons Mideast is completely incorrect and also it is neither in the case of the ld. TPO or ld. DRP at any stage of the proceedings. Nowhere, the ld. DR has pointed out which expenditure booked by the sub-contractor have been booked by Afcons Mideast in its books of accounts.

Before us ld. Counsel had also argued that such kind of performance guarantee is not an international transaction, however, at the time of hearing, we clearly stated that we are not inclined to agree with such a contention and accordingly, ld. Senior Counsel confined his arguments mostly on merits. Therefore, on this issue, we are not adjudicating the said plea.

We have heard rival submissions and perused the relevant finding given in the impugned order as well as material referred to before us. As noted above, assessee is in the business of construction of infrastructure projects and in order to secure the 14 1357/Mum/2014 M/s. Afcons Infrastructure Limited contract for construction of a bridge in Dubai with Road Transport Authority in Dubai, it had found limited liability Company in Dubai called as Afcons Mideast LLC. As per the UAE regulation assessee could not hold more than 49% in Afcons Mideast as 51% shareholding was to be held by local sponsorer. Despite the shareholding structure, the share capital of Afcons Mideast stood at Rs.42,62,400/- and it was agreed that the shareholders of the assessee company would be entitled to 80% of the profits of Afcons Mideast. Afcons Mideast was awarded contract amounting to Rs. 1,546.56 Crores and part of the work amounting to Rs.210.28 Crores was sub-contracted to the assessee company. The balance work has been performed by Afcons Midcast solely relying on the infrastructure in the form of the man-power, machines, technology, project management skills and organisational support provided by the assessee. In effect contract work performed by Afcons Midcast was done by assessee through its own support services. That is the reason, the assessee has earned profits at Rs.31.19 crores whereas Afcons Mideast has only earned Rs.30 lakhs. The entire profit earned by the assessee as a sub-contractor and for providing support services was Rs. 130.05 crores while Afcons Mideast earned only Rs. 10.86 crores from execution of the said project. Thus, 92.29% of the profits had accrued to the assessee as a sub-contractor and for the support services. Even for the balance 7.71% of the profits accruing to Afcons Mideast, then again 80% of such profits belonged to the assessee company as its share of profit. In substance, the assessee company has earned 99.10% of 15 1357/Mum/2014 M/s. Afcons Infrastructure Limited the profits. This factual background is very important to understand the impugned transaction of performance guarantee on which adjustment has been made by the ld. TPO, because while determining the arm’s length price where is the real benefit arisen or accrued is very crucial and FAR analysis of the transaction.

As noted above, for the performance of the entire contract work, guarantee was provided by FGB for provision of banking facilities to Afcons Mideast which in the F.Y. 2008-09 was of Rs. 824 Crores. During the year four types of facilities were provided as noted above which mostly consist of letters of credit, letters of guarantee and letters of advance payment, performance bond and letter. By way of security for providing these facilities FGB required the assessee to execute irrevocable and unconditional corporate guarantee and accordingly, performance guarantee was given by FGB in favour of Road Transport Authority, Dubai. It was only a guarantee that Afcons Mideast would not suspend or delay repayment of the advance of AED 108 million. The assessee had not charged any guarantee fee from Afcons Mideast on the ground that effectively guarantee has been given for its own performance of the contract or a guarantee given for repayment of advance which would also only arise in the case of a non-performance of the contract by the assessee. Thus, we agree with the contention of the ld. Senior Counsel that giving the performance of the corporate guarantee was to execute the work which in effect was carried out by the assessee itself for which the majority of the profit and the benefit went to the 16 1357/Mum/2014 M/s. Afcons Infrastructure Limited assessee. Even it is to be treated as international transaction, then also under the scope and meaning of international transaction as defined in Section 92B- “92B. (1) For the purposes of this section and sections 92, 92C, 92D and 92E, "international transaction" means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises.”

Ergo, it is to be seen whether such transaction is having a bearing on the profits, income, losses or assets or any kind of a mutual agreement or arrangement for the allocation or apportionment or contribution to any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided. Thus, the transaction or the arrangement should have the bearing of profit or income or any kind of benefit or facility. Here providing of performance guarantee or corporate guarantee did not gave benefit to the AE, albeit on the facts of the case the entire benefit for giving such 17 1357/Mum/2014 M/s. Afcons Infrastructure Limited guarantee is only to the assessee because the guarantee was given to carry out the work which was done de-facto by assessee. Even the work performed by the Afcons Mideast was totally done by the support service through infrastructure and man power and the organizational support of the assessee company only and that’s the reason why the entire reward and profit went to the assessee Once, the entire benefit and the profits belong to the assessee, and then it cannot be held that assessee has given any kind of benefit by providing corporate guarantee to Afcons Mideast. Here, in this case what has to be seen that the entire functions to carry out the work either in the form of sub-contract or executing the contract work by providing entire support services through its own infrastructure, man power, management, technological support, organizational support, etc. all has been done by the assessee. The function of the AE in the execution of work was only on paper and as a legal entity to comply with the domestic laws. In substance there is negligible function performed by the AE. Apart from that, even the assets deployed belonged to the assessee. The entire risk lied upon the assessee that is the risk assumed for executing the contract and carrying out the entire work solely belonged to the assessee. Ergo the rewards of the risks were also entirely reaped by the assessee in the form of 99% profit. Thus, even if one does FAR analysis of the performance guarantee given by the assessee to FGB for execution of the contract where entire risk and rewards and the benefit was of the assessee only, then where is the question of 18 ITA No.1135/Mum/2014& 1357/Mum/2014 M/s. Afcons Infrastructure Limited making any adjustment of ALP in the hands of the assessee that any benefit has been passed on to the AE.

Even if it is reckoned as international transaction, then also on FAR analysis and looking to fact that the reward or profit to the AE is almost negligible, i.e. the ultimate profit is not even 1%, the adjustment if at all would also be negligible on the facts of the present case. Thus, on the facts of the present case we hold that no transfer pricing adjustment can be made on account of corporate guarantee. Accordingly, the addition made by the ld.TPO / ld. AO is deleted.

Next issue relates to adjustment of Rs.55,59,523/- in respect of receipt of interest on loan given to Afcons Mideast and Afcons Infrastructure International Ltd.

The brief facts are that assessee had given advances amounting to Rs.14.66 Crores to Afcons Construction Mideast LLC and assessee had charged interest @12% per annum on daily balance of such advances and amount of interest received from M/s. Afcons Mideast amounting to Rs.2,16,19,153/-. Assessee has also given advance of Rs.1.40 Crores to Afcons Infrastructure International Ltd., Mauritius, from whom assessee had charged interest @12% per annum on daily advance of the said balance. The amount of interest received during the relevant financial year amounting to Rs.6,18,936/-. The ld. AO after collecting information u/s. 133(6) from M/s. CRISIL noted that yield from BBB grade corporate bond was 14.39% for five years 19 1357/Mum/2014 M/s. Afcons Infrastructure Limited period for F.Y.2007-08. As the case of the assessee according to him falls between the range of BB and D ratings and therefore, he held that unrated bonds will be varied by giving the credit period spread by minimum 20% over the equivalent rated bond of similar tenure which would be @20%. Thus, he held that arm’s length rate is 18.66% and worked out arm’s length price of Rs.3,36,17,782/- and after reducing the interest recovered @12% transfer pricing adjustment of Rs.1,19,98,629 was made. After the ld. DRP, the arm’s length rate of interest was determined at 15% p.a. 19. Before us, ld. Sr. Counsel submitted that transaction of receipt of interest on advances has to be benchmarked based on local market conditions of the borrower entity and therefore, the rate of interest of the Indian market is not a relevant factor. The rate of interest in respective markets of the AE should be considered. United Arab Emirates Interbank, i.e., EIBOR offered rate was approximately 1.50% as on 31/03/2009 and if EIBOR +2% is applied, the arm’s length rate of interest works out to approximately 3.50%. Since the assessee has charged 12% which is much more than the rate prevailing in the local market, hence no addition is warranted. 19. On the other hand, ld. DR strongly relied upon the order of the ld. AO. 20. It is an undisputed fact that loan has been provided to the AE at UAE and Mauritius. The assessee was provided EIBOR rate which was applicable in UAE was 1.50% and if 200 basis 20 1357/Mum/2014 M/s. Afcons Infrastructure Limited points is applied considering the RBI circular or External Commercial Borrowings, then it will come down to 3.50%. The one year LIBOR rate prevailing as on 31/03/2009 was 3.12% and he apply 200 basis points on the LIBOR rate, then also interest worked out to 4.12%. Thus, in any scenario, the interest @12% free loan given to AE is much more than the arm’s length rate of interest because arm’s length rate of interest has to be taken because arm’s length rate of interest has to be taken on the respective market rate of the AE and not by Indian market. Accordingly, the adjustment made by the ld.AO is deleted.

In Revenue’s appeal, the first issue is disallowance of interest u/s. 36(1)(iii) in respect of loans to Afcons Pauling Joint Venture. The ld. AO from the perusal of the balance sheet as on 31/03/2009 revealed that assessee had shown interest bearing secured loans at Rs.31923.68 lakhs and unsecured loans of Rs.37127.72 lakhs. On the interest bearing funds, assessee had paid interest of 8566.26 lakhs which resulted in average rate of 12.40%. The ld. AO noted that assessee has advanced loans to its joint ventures on which no interest has been charged for sums aggregating to Rs.771.76 lakhs. Accordingly, ld. AO made disallowance @12% which worked out to Rs.8.57 lakhs. The ld. DRP had given following directions to the ld. AO. “We have considered the facts of the case, the objections of the assessee and the evidences placed on record. The assessee has relied upon the decision of honourable Mumbai ITAT in its own case for the assessment year 1997-98, wherein it was directed to exclude the loans as on 1 April 1996 while computing the disallowance of interest. This direction was given on the fact 21 ITA No.1135/Mum/2014& 1357/Mum/2014 M/s. Afcons Infrastructure Limited that in the assessment years prior to Ay 97-98, there is no finding that any interest-bearing or funds were utilised for making such advances and no disallowance of interest was made in the earlier years. The assessee has also made a statement before us that against such finding of the Tribunal, the revenue has not preferred any further appeal before the High Court, In view of the above stated position, the AO is directed to restrict the disallowance of interest only to the extent as it relates to incremental advance party wise as compared to balance outstanding as on 31st of March 1996. As regards the interest on the balance amount, we uphold the action of the AO and the rate of interest 12% applied by him. The AO is directed to modify his order accordingly.”

It has been informed that the issue stands covered by the decision of the ITAT from A.Y.2001-02 to 2008-09. Since, the ld. DRP has followed the initial order of the Tribunal in A.Y.1997-98 which has been followed in subsequent years wherein it was held that interest disallowed should be in respect of incremental loans given from 31/03/1996. Once the position from the earlier years has been settled that the opening balance of the loan is to be excluded for making the loans, then we do not find any infirmity in the directions of the ld. DRP which is in accordance with the direction of the Tribunal in earlier year. Therefore, the ground raised by the Revenue is dismissed.

In so far as disallowance of depreciation of Rs.25,000/- and written down value of speed boat, it has been submitted that the issue is in favour of the assessee by ITAT in assessee’s own case for the A.Y. 2001-02, A.Yrs. 2002-03 to 2005-06 and A.Yrs 2006- 07 to 2008-09. As per the Tribunal order, it was held that:-

Accordingly, ground raised

In the result, appeal of the assessee is allowed and Revenue’s appeal is dismissed. Order pronounced on 9th November, 2023.