HAVELLS INDIA LTD.,DELHI vs. ACIT (LTU), CIRCLE-1, NEW DELHI

Per Dr. B. R. R. Kumar, Accountant Member:

“1.1 That the impugned order of CIT (A)-22, New Delhi is bad in law and wrong on the facts and in the circumstances of the case and legal position.

2.1 That on the facts and in the circumstances of the case and legal position, the learned CIT (A) has erred in confirming additions of Rs.1,86,00,000/- on account of the alleged arm’s length price of corporate guarantee provided by the appellant Company to the lenders on behalf of associate enterprises (AEs) on the basis of finding in the order passed by the Transfer Pricing Officer (‘TPO’) u/s 92CA(3) of the IT Act, 1961.

2.02 That on the facts and in the circumstances of the case and the legal position, the learned CIT(A) has erred in arriving at the arm’s length price of service provided by the appellant in the form of corporate guarantee to AEs; whereas:-

(i) Providing corporate guarantee is in the nature of shareholders’ activities and is not an ‘international transaction’ as investment in subsidiary Company is not an ‘international transaction’ as held in the case of Vodafone India Services Private Limited and Shell India Markets Private Limited.

(ii) The appellant has not incurred any cost for issuing corporate guarantee and such transaction has no bearing on the profits, income, losses or assets of the appellant and it cannot be considered as an ‘international transaction’ in terms of section 92B of the Act.

(iii) The corporate guarantee issued by the appellant was purely on the commercial consideration with anticipation of significant benefit in the form of profit income in the later years and to protect the interest of the appellant Company.

(iv) The providing bank guarantee and corporate guarantee are different and distinct matters and cannot be compared with.

3.01 That on the facts and in the circumstances of the case and the legal position, the learned CIT (A) has erred in confirming the disallowance off Rs.14,97,14,639/- in respect of provision made for sales incentive under “Shahenshah Scheme” and holding that the provision made by the appellant under the aforesaid scheme was not being made on a scientific or logical basis and therefore the provision, is not allowable as deduction.

3.02 That without prejudice of the above, on the facts and in the circumstances of the case and the legal position, the learned CIT (A) has erred in confirming the addition on account of provision made for sales incentive scheme for computing book profits u/s 115JB of the IT Act, 1961 since the same is an ascertained liability.

4.01 That on the facts and in the circumstances of the case and the legal position, the learned CIT (A) has erred in confirming the reduction of the deduction allowable u/s 80IC of the Act in respect of the units at Baddi and Haridwar, to the extent of Rs.2,93,984/, by excluding interest income earned by the said units, while computing the eligible profits. 5.01 That on the facts and in the circumstances of the case and the legal position, the learned CIT (A) has erred in not allowing the deduction of education cess and secondary and higher education cess of Rs.3,53,53,017/-.”

Adjustment u/s 92CA(3):

4. The relevant order of the TPO on the issue of corporate guarantees is as under:

[QUOTE] 2. As per the TP study furnished during the TP audit, the function of the assessee company is stated to be as under:

"Havells India is an electrical consumer product and power distribution equipment manufacturer. The company's product and services include industrial and domestic circuit protection devices, cables and wires, motors, fans, power capacitors, compact fluorescent lamps, luminaries fat domestic, commercial and Industrial applications, modular switches covering the entire gamut, of household and commercial and industrial electrical needs, The company operates in four segment:-

3. Benchmarking of Corporate Guarantee:

It is seen from the audited financial that the assessee company has given corporate guarantee to lenders of the beneficiaries which are AE of the assessee. On this guarantee no appropriate commission/fee has been charged by you for the above arrangement.

3.2 On the basis of details furnished and other material on record, I am of the considered view that the international transaction of providing corporate guarantee for the AE is an independent class of international transaction. In fact as per amendment made in the Section 92B w.e.f. 01.04.2002, a new Explanation has been inserted which gives inclusive definition of 'International Transaction’ and guarantee is included in the same.

3.3 In order to benchmark the international transaction of corporate guarantee CUP is the most appropriate method. The undersigned has therefore relied upon the data collected from the State Bank of India u/s 133(6) of the Income Tax Act, 1961 for the relevant period. The information received from the State Bank of India u/s 133(6).

No. Name of the Bank Corporate Guarantee Rate 1. SBI 1.3% I have examined the risk profile of the assessee company vis-à- vis the risk profile of the Bank. For a bank, providing the corporate guarantee is a normal business activity and they discount the losses arising out of such normal business activities in their rates of commission. However, for a company which is engaged in electrical equipment and power distribution products, providing of corporate guarantee is not a normal business activity. If the AE goes bankrupt or defaults in making the payment to the Bank, the assessee would be liable to pay the entire loan to bank and the assessee may not be in a position to recover that money from the AE. Such a situation warrants a higher price that the assessee should charge from the AE. In view of the above facts, I am of the considered view that the assessee has exposed itself to a big risk by providing the corporate guarantee for which the assessee has not charged any amount from the AE. The average fees charged by the SBI while issuing guarantee is 1.30%. Rate to be charged by the assessee from its AE is determined accordingly. Such fees shall be chargeable on guarantee given in the AY 2013-14 as well as outstanding guarantees of previous year.

3.4 In this regard, it may show caused why a commission of 1.30% based on the commission rate of SBI in performance guarantees exceeding Rs.10 Crores may not be charged on bank guarantees and taken as your income as an ALP on such extension of guarantee to AE after treating bank guarantee transaction as an international transaction. You are also requested to furnish credit rating of all the AEs with whom you have under taken aforesaid transactions.

3.5 The AE wise working of the corporate guarantee may also be submitted in following format:

S. No. In favour Purpose Period Currency Amount Charges of (Rs.) (1.30%) From To REPLY OF THE ASSESSEE AND COMMENTS OF TPO

5. Assessee replied to the show cause vide his submission dated 27.06.2017 and following issues has arisen on the objection of the assessee:

On the issue of charging corporate guarantee fee assessee submitted the followings: [Quote] a) In light of the above reasons, it can be concluded that the provision of guarantee by the Appellant (i.e. group's parent company) to consortium of banks for the loan /credit facility was in the nature of shareholder activity. b) That the amount of Corporate guarantee provided to wholly owned foreign subsidiary Companies present only equity contribution of the assessee Company for which no guarantee fee was charged. c) Furthermore, given that the long term credit worthiness of the overseas group companies are expected to Improve or at least remain same, the Appellant wishes to highlight that any debt obligations taken/ to be taken by such companies to repay the existing loan facility which are also guaranteed by Hit, represents MIL shareholder’s interest in such group companies for which no guarantee fee needs to be charged by NIL. d) That the Corporate guarantee provided to the wholly owned foreign subsidiary Companies to meet the financial requirement and to protect the interest in the business of such wholly owned subsidiaries Companies. Thus the guarantee provided are on account of the business exigency. e) That no expenses has beers Incurred by (he assessee Company for providing the Corporate guarantee to wholly owned foreign subsidiary Companies. Hence no expense should be adjusted. f) That as aforesaid, providing guarantee is not an international transaction since the same is at par with the providing equity to Associate Enterprises. Thus it can he concluded even though the Corporate guarantee given by the parent Company is a Corporate guarantee in ‘form' but in ‘substance’. The same is 'equity participation’ which does not warrant an arm's length guarantee fee. [Unquote|

6. Before proceeding to comment upon the submission of the assessee, it is necessary to discuss the concept of Guarantee.

What is a guarantee?

A legally binding agreement under which the guarantor agrees to pay any or the entire amount, due on a loan instrument in the event of non-payment by the borrower.

OECD Glossary of Statistical Terms "A collateral agreement, for performance of another's undertaking. An undertaking or promise that is collateral to primary or principal obligation and that binds guarantor to performance in event of non-performance, by the principal obligor."

Black's Law Dictionary The key factors which could affect guarantee fee pricing are:

 The credit quality of the borrower probability of default over a given period (the higher the likelihood of default, the more valuable the guarantee);  The Seniority and quality of collateral (or loss given default);  The lifetime of the guarantee;  The terms of the guarantee, relative to the terms of the underlying loan;  The prevailing interest rates (e.g. inter-bank rates, swap rates) and credit spreads above these rates (i.e. the ‘market price of risk’)  The credit quality of the guarantor, which generally needs to be viewed both in isolation and in terms of the ability of the guarantor to fulfill the guarantee obligation;  The ‘price of risk’ in financial markets and investor willingness to assume a given type of credit risk and  The uncertainty associated with the borrower’s and the guarantor’s credit quality.

Financial guarantees are usually provided in relation to loans by affiliates and can either be ‘explicit’ or ‘implicit’. Explicit guarantees are those where a direct assurance is given by an affiliate. For example, a parent company may guarantee loans taken by its subsidiary with third party banks, like the assessee has done. Implicit guarantees are those where being part of a multinational group makes it possible to secure a loan, which one might not have been able to obtain as an independent entity or secure more favourable terms. In these instances, the bank perceives that the parent would intervene in the case of any default.

It may be of relevance to mention the OECD guidelines on the issue which can be of persuasive value.

Interpretation provided under paragraph 7.13 of the OECD Transfer Pricing Guidelines on this issue:

...an associated enterprise should not be considered to receive an intra-group service when it obtains incidental benefits attributable solely to its being part of a larger concern, and not to any specific activity being performed….passive association should be distinguished from active promotion of the MNE group's attributes that positively enhances the profit-making potential of particular members of the group In the light of this guidance, it follows that an associated enterprise should not be considered as I receiving an intra- group service when it obtains incidental benefits attributable solely to its being part of a larger concern, and not to any specific activity being performed. In addition, no service could be said to be received where an associated enterprise by reason of its affiliation alone has a credit-rating higher than it would if it were unaffiliated, but an intra-group service would usually exist where the higher credit rating were due to a guarantee by another group member, or where the enterprise benefited from the group’s reputation deriving from global marketing and public relations campaigns.

It can be seen from the facts of the present case that the assessee company had provided the Guarantees to the AE for obtaining the credit facilities/acquisition of overseas subsidiary. This transaction has resulted into a direct benefit to the AE. Therefore, in the present case there is active promotion of the multinational group's attributes which positively enhance the profit- making potential of particular members of the group.

In a situation where a borrowing company could not borrow in its own right, given its difficult financial condition, would an independent party provide a guarantee without any consideration to support die borrowing of the company? The answer is NO in such a situation an independent party would not provide guarantee to any party without suitable compensation. Under similar circumstances, if a parent provides a guarantee to its subsidiary, should an arm's length guarantee fee be charged by it from the subsidiary? Of course the parent should charge an appropriate guarantee fee else the transaction is hot at arm's length,

8. Broadly, no Transfer Pricing regulation across the world prescribes or defines a method for benchmarking guarantee fees. Few draft guidelines (under discussion stage) have been issued by some countries deliberating upon different methods and the prudence of charging a guarantee fee. The ruling by the Tax Court of Canada in the case of GE Canada has deliberated upon the 'interest saving approach’, but still leaves many questions unanswered as the case relates to Investment Company which is functionally different from the assessee.

The ruling of tax court in any case is only persuasive in nature as held by Hon’ble ITAT Mumbai in the case of Serdia Pharmaceuticals (India) Pvt. Ltd. (2011-TII-02-ITAT-MUM-TP) wherein it has held, “the decision of Tax Court of Canada Is not a binding precedent, but it certainly deserves utmost respect and consideration not only because It comes from a very eminent forum of tax judiciary in the world, but also because of its very comprehensive and painstaking analysis of all the related issues and Its sheer technical excellence;”

The most common guarantees are financial guarantees. These provide credit enhancement to the guaranteed party, either (i) to access cheaper funding, or (ii) to access capital markets, Different methods would apply to each as the first case could happen without a guarantee in place, whereas in the second case, there could be no transaction in the absence of a guarantee. Financial guarantees are typically provided in relating to a particular funding transaction and the guaranteed amount would be the outstanding capital or the amount related to credit enhancement (i.e. the amount of additional capital required to obtain the targeted credit rating). For benchmarking obviously methods under the Indian Act will have to be followed.

Recent judicial precedent on guarantee fee payment by a Tax Court in Canada Facts of the Case On December 2009, the Tax Court of Canada (TCC) gave a ruling relating to the years 1996-2000 for General Electric Capital Canada Inc. (GE Canada) on a matter pertaining to financial guarantees. In this case, GE US had provided an explicit guarantee for the borrowings of GE Canada since 1988; however, it began charging a fee for the explicit guarantee only in 1995, equal to 1% of the principal amount of debt securities outstanding per annum. GE Canada claimed deduction for the guarantee fees that became payable to GE US for the tax years 1996 to 2000. The deductions claimed by GE Canada were disallowed by Canada's Revenue Agency (CRA). CRA argued that the guarantee fees should be zero due to the implicit guarantee inherent in the parent subsidiary relationship between the GE US and GE Canada.

TCC’s Judgment TCC differed from the CRA’s position that GE US controlled the capital structure of GE Canada and therefore could choose the amount of equity invested and control GE Canada's debt to equity ratio. TCC stated that this contradicts the well accepted principle that a corporation is a separate person whose existence provides limited liability protection to its shareholders such that the extent of a shareholder’s exposure is limited to the amount of capital the shareholder chooses to invest. TCC recognized the difference between implicit support which does not provide for a guaranteed recourse and an explicit guarantee which provides much stronger protection and legally enforceable recourse to the lender. TCC concluded that the yield curve approach (interest saving approach) was the appropriate methodology for ascertaining the economic value of the explicit guarantee. The approach would involve (i) estimating the standalone or status quo credit rating and noting the arrived credit rating for the shareholding relationship, and (ii) capturing the spread between the parent’s credit rating and the estimated standalone credit rating of GE Capital Canada (factoring the implicit support provided through the shareholding relationship). Factoring implicit support for estimation of standalone credit rating would mean that the implicit support is consistent with the arm’s length principle as per the ruling.

9. Determination of Arm’s Length Price for inter-company guarantees: What are the approaches followed across the world for benchmarking guarantee fees?

Broadly, no Transfer Pricing regulation across the world prescribes or defines a method for benchmarking guarantee fees. Few draft guidelines (under discussion Stage) have been issued by some countries deliberating upon different methods and the prudence of charging a guarantee fee. The ruling by the Tax Court of Canada in the case of GE Canada has deliberated upon the 'interest saving approach’, but stilt leaves many questions unanswered. Since no single and concrete approach has been finalized in any country or by the OECD guidelines, it is better to follow the methods which have been prescribed by the Indian Transfer Pricing legislation. The most common guarantees are financial guarantees. These provide credit enhancement to the guaranteed party, either (i) to access cheaper funding, or (ii) to access capital markets. Different methods would apply to each as the first case could happen without a guarantee in place, whereas in the second case, there could be no transaction in the absence of a guarantee. Financial guarantees are typically provided in relation to a particular funding transaction and the guaranteed amount would be the outstanding capital or the amount related to credit enhancement (i.e. the amount of additional capital required to obtain the targeted credit rating).

10. CUP Approach Under the CUP approach, the guarantee fee is quantified through a comparison of arm’s length guarantee fee rates charged by unrelated third parties providing similar guarantees under similar terms and conditions (i.e. third party comparable rates). This approach identifies what guarantee fee the borrower would have been required to pay if it were to have secured the guarantee through an unrelated third party, such as a bank or a finance company. Under this approach, two variables are estimated: (i) the assets at risk, and (ii) the guarantee fee rate. To estimate an appropriate guarantee fee rate, the borrower's credit Worthiness is evaluated by estimating an "implied" credit rating using credit rating guidelines published by a third party credit rating agency. An implied credit rating is a quantitatively derived estimate of an actual credit rating. The borrower's implied credit rating is used to identify comparable guarantee fees charged by third party lenders to borrowers with similar credit ratings. This approach is most appropriate in cases where the guarantee results in a measurable and material credit enhancement for the borrower and hence lowers the cost of its third party debt The application, of a CUP could either be:

11. Internal Guarantee CUP

 Take into account guaranteed and un-guaranteed third- party loans.  Ensure that the guarantee fee is equal to the spread between the two loans.

12. External Guarantee CUP:

 For example, the rates at which the financial Institutions are providing guarantee to its constituents.

The argument put forth by the assessee stipulates that by providing the guarantees, it was only serving its own interest. This is generally called the 'shareholder activity’ argument. Thus, as a shareholder, it was interested in the functioning of the subsidiaries which in turn benefitted from its own activities. However, this approach totally contradicts the arm's length principle which is based on the premise of interaction between independent enterprises. This approach requires the transactions between two parties to be examined as transactions taking place in a market-place with both parties acting on the basis- of cost-benefit analysis and maximization of profits. Further, the rights and duties of a shareholder do not envisage participation in the day- to-day business affairs of the company. The shareholder is not required to participate in the commercial dealings of the company. It is not that the 'shareholder activity’ argument is arising for the first time, in fact, in the Canadian tax ease referred above, this matter came up for discussion. This discussion is contained in paragraphs 240-246 of the referred order of the Tax Court of Canada. The views of the Court are mentioned below in brief:

 In theory, or in corporate law, directors manage, or supervise the, management of, the business arid affairs of a corporation, while officers run the daily operations within the framework of the policies and directions set by the elected board of directors. Yet, in practice, whore economic forces' come into play, officers of large corporations determine the corporate destiny; they nave the vision; they hold the reins of the corporation; and they often select the.ir own successors. (Para 241)

 Shareholders elect the board of directors. However, in case of the day-to-day operations of a business, the Canada Business Corporations Act (the "CBCA”) does not specifically allow for shareholders to appropriate powers of officers. (Paras 242-43)

 The Court referred to the decision in case of Duha Printers (Western) Ltd. Vs. Canada, where it was held that “…Directors generally owe a duty not to the shareholders but to the corporation and shareholders could not therefore, control the day-to-day business decisions made by the directors and their appointed officers. In other words, although the shareholders could elect the individuals who would make up the board, the board members, cone elected wielded virtually all the decision making power, subject to the ability of the shareholders to remove or fail to reelect unsatisfactory directors.” (Para 244, emphasis added by the Court)

 All in all, the fundamental distinction remains that shareholders can appropriate the powers to appoint the officers but not the powers of the officers to in fact manage the business. This is the result of a close reading of subsection 146(1) of the CBCA. (Para 245)

Thus, the Tax Court of Canada is of the view that by virtue of being a shareholder, the parent company cannot legally appropriate the money management and other commercial and business functions of the subsidiary.

In India also, the shareholders (i.e. 'members') have voting rights (Section 87 of the Companies Act, 1956) participate in the statutory (Section 165) and the annual general meetings (Section 166) and appoint (Sections 255 & 258) and remove the Directors (section 284). However, the business of the company is entrusted to the Board of Directors (Section 291) with applicable restrictions (Section 292 & 293). In fact, in the case of Rolta India Ltd. & Another Vs. Venire Industries Ltd. & Others (2000-(001)-CLJ -0161 -BOM), Hon’ble Bombay High Court had occasion to look into the powers of the Directors in relation to the shareholders in the conduct of the business of the company in case of pooling arrangements. The Hon'ble High Court held that "a pooling agreement, cannot be used to supersede the statutory rights given to the Board of directors to manage the company, the underlying reason being that the shareholders cannot achieve by pooling agreement that which is prohibited to them, if they are voting individually. Therefore, the power of shareholders to unite is not extended to contracts, whereby restrictions are placed on the powers of the Directors to manage the business of the Corporation. It is for this reason that a pooling agreement cannot be between the Directors regarding their powers as the Directors. There is a vast difference in principle between the case of a shareholder binding himself by such a contract and the Director of the company undertaking such an obligation by compromising his fiduciary status. The shareholder is dealing with his own property. He is entitled to consider his own interests, without regard to interests of other shareholders. However, Directors are fiduciaries of the company, the shareholders. It is their duty to do what they consider best in the interests of the company" (Para 22 of the order). Hon’ble Court also cited several international case laws which were of the same view. Thus, running of business in the interest of the company is the task of the management It needs to be noted that several civil and criminal actions are also provided in the Companies Act, 1956 against ‘officers' of a company for their acts of omission and commission associated with the running of the business of the company.

Further, commercial expediency is not important here and this view was upheld by ITAT, New Delhi In a recent decision in the case of Perot Systems TSI (India) Ltd. Vs DCIT, wherein it was discussed and held as under:

9. Before us, the Id. Counsel of the assessee contended that income means real income and not fictitious Income and since the assessee has not earned any Income, the same cannot be taxed. Reliance in this regard has been placed upon in the case of CIT Vs. KRMTT Thiagaraja Chetty & Co., reported in 24 ITR 525 (SC) & in the case of Morvi Industries Ltd. Vs. CIT reported In 82 ITR 835 (SC) for the proposition that liability to tax can arise only when there Is Income. No tax can be charged as notional income on accrual. Further reliance has been placed upon the ruling of Authority for Advance Rulings delivered in the case of Veneburg Group B.V. Vs. CIT 727 of 2006 for the proposition that in the absence of any income, transfer Pricing provisions being machinery provision shall not apply. It has further been argued that Transfer Pricing document maintained by the assessee clearly mention that these loans/advances are in the nature of quasi-equity and hence the transaction of granting interest free loan Is at arm's length. The loan agreements mentioned that these are interest free loans. Reliance in this regard is placed upon the decision of Delhi Tribunal in the case of Sony India Ltd. 114 ITD 440 Para 100 that under fiscal loans actual transaction as entered between the parties is to be considered. Authorities have no right to re- write the transaction unless it is held that it is sham or bogus or entered into by the parties to avoid and evade taxes." Further reference has been made la para 1.37 of 1995 of OECD guidelines for the proposition that it is legitimate to consider the economic substance of the transactions. The transactions has been said to be commercially expedient and loan granted to support the subsidiary and obtain returns in loan had been duly granted by the approval of the RBI. The Income Tax Act, 1961 and OECD guidelines support the contention that the effect of government control/ intervention should be considered while determining the arm's length price.

The real income theory is also not applicable in the context of Chapter-X of the IT Act, which contains special provisions relating to arm’s length price. Further, business expediency does not have any role to play here as while applying arm’s length principle, one has to see what the independent parties in comparable transactions would do i.e. if the same loan/guarantee transaction takes place between two independent entities; what they would expect in terms of compensation for the loan transaction/guarantee entered into between them. This view was upheld by ITAT, Mumbai in a recent decision in the case of VVF Ltd. Vs. DCIT (2010-TIOL- 55-ITAT-MUM), wherein it was discussed and held as under:

6. On a conceptual note, the purpose of making arm's length adjustments, in prices at which transactions have been entered into with associated enterprises, is to nullify the impact of interrelationship between the associated enterprises. Unless the method on the basis of which such hypothetical prices are computed is such that costs are to be taken into account, these hypothetical prices have nothing to do with the actual costs. CUP method seeks to ascertain arm's length price by taking into account prices at which similar transactions have been entered into by the assessee with unrelated parties (Internal CUP) or at which other unrelated parties have entered into similar transactions inter se (External CUP). None of these inputs have anything to do with the costs; they only refer to prevailing prices in similar unrelated transactions instead of adopting the prices at which the transactions have been actually entered in such cases, the hypothetical arm's length prices, at which these associated enterprises, but for their relationship, would have entered into the same transaction, are taken into account Whether the funds are advanced out of interest bearing funds or out of funds on which 14% interest is being paid, or whether such interest free advances are commercially expedient for the assessee or not, is wholly irrelevant in this context. The transaction in the present case is of lending money, In foreign currencies, co its foreign subsidiaries. The comparable transaction therefore is of foreign currency lending by unrelated parties.

Thus comparable uncontrolled transaction is relevant rather than commercial expediency for determining the arm’s length price.

The information received from State Bank of India u/s 133(6) of the I.T. Act was compiled and supplied to the assessee as annexure to the Show Cause Notice. The rate charged by State Bank of India represents the rates charged by the banking industry in India. Moreover in view of £he fact that there is stiff competition in the banking industry, there are no major differences in the rates charged by various financial Institutions. Rate charged by State Bank of India as applicable to the present case subject to the fact that adjustment has to be made for the high risk that the assessee has borne on providing the guarantee.

The Hon’ble DRP Mumbai in its order dated 04.09.2012 in the case of M/s Hindalco Industries Ltd. A.Y. 2008-09, on corporate guarantee has held that:

[QU0TE] “7.1 The contention of the assessee that income in the form of guarantee fee cannot be taxed in the hands of the assessee as it represents only a notional income, is without merit. It is true that section 92 is not a charging section, but this fact is not relevant. What is relevant is that by providing a corporate guarantee, the assessee has conferred a benefit on its AE and such benefit has the potential of affecting the income, profits or assets of the concerned parties. The provision of corporate guarantee is, therefore, clearly an international transaction u/s 92B. Moreover, the retrospective amendments made by the Finance Act 2012 in the section now place the issue beyond debate.

7.2 Once it is accepted that providing such a guarantee is an international transaction, the arm's length price of the transaction is required to be ascertained, because under section 92, the income arising from, an international transaction is required to be determined on the basis of the arm's length price, in which case no income can be said to arise from the transaction. But if it is shown that a non-zero arm's length price can be computed, the income from the transaction must be computed and taxed.

7.3 The assessee's contention that the guarantee was fair its own benefit bind not for the benefit of the AE, is again not relevant. A transfer pricing analysis seeks to determine the price that would be charged in an uncontrolled transaction between unrelated parties in comparable circumstances. Commercial expediency, business motives or business strategies are not included in the factors prescribed in the Rules for judging the comparability of a transaction. We, therefore, are in agreement with the TPO that the provision of corporate guarantee must he analyzed and an arm's length charge must be assigned to it and income of the assessee should be computed accordingly.

7.6 The AE is a distinct company and it cannot be said that it has no existence of its own apart from the relationship with the assessee. Obtaining the loan was crucial to the business of the AE and hence the guarantee provided by the assessee certainly benefits the AE when viewed in an arm’s length scenario. We are of the view that the assessee is incorrectly clouding its perspective by looking at the controlled situation in which it is place, without realizing that the TP analysis must be made in an uncontrolled situation.

7.9 We are not in agreement with the assessee that only 50% of the above differential of 139 bps should be taken as the guarantee fee. The assessee’s argument that no independent concern would agree to bear the entire guarantee fee does not hold goods in a normal situation involving the giving of corporate guarantee. It is only because the valuation of the guarantee is being made in a particular manner. In this case that the question of sharing an interest differential has arises. In a normal uncontrolled situation, the guarantee fee would be arrived at under mutual agreement after considering various factors. Further, the interest rate differentials are being considered. In the present case only to evaluate the economic risk assumed by the guarantee provider. There can be no issue of reducing such risk by 50% on extraneous concerns.

7.10 We are also of the considered view that the above amount would represent only the basic cost of the guarantee provided by the assessee. In accordance with the normal principles of transfer pricing, a reasonable mark-up has to be added to this cost considering the nature of benefit. Further, it is relevant to consider the foreign exchange risk and the foreign exchange fluctuation risk borne by the assessee in providing the corporate guarantee. In case the guarantee devolves upon the assessee at a future date, adverse movements in exchange rates can effect the assessee very significantly. This is particularly relevant since A V Minerals has apparently been repaying the loan and interest only with the help of capital infused by the assessee from time to time in the subsequent months. There are other risks also that should be kept in mind, such as sovereign risk and entity risk. The assessee would be put to considerable loss in the event of the business of the AE having to be wound up, which could even be due to a general financial crisis in its country of residence. Another factor to be considered in the present case is that AV Minerals does not have the capacity to meet the interest and principal repayments, of the loan on its own. The assessee has been advancing large sums to the AE, .which have been converted into equity after varying period of time. There is, therefore, also an element of interest that is being forgone by the assessee in the process of funding its AE.

16.1 Arm’s length price of providing the services in the form of bank guarantee is determined under CUP method and made a part of the order as given below:

Sl. No. In favour of Amount of Guarantee Guarantee fees @ 1.30% Provided (Amount in Crs.) 1. Havells Holding Ltd. 143.13 1.86 Crs. Total 1.86 Crs.

16.2 An adjustment u/s 92CA of Rs.1.86 Crores is to be made to the income of the assessee, being the arm’s length price of the services provided by the assessee in the shape of bank guarantee to AE. Thus, the above amount of Rs.1,86,00,000/- is treated as transfer pricing adjustment for the FY 2013-14.”

Shahenshah Scheme:

15. Ground No.3 is with respect to disallowance of Rs.2,47,68,964/- in respect of provision made for sales incentive under “Shahenshah Scheme

16. During the course of assessment proceedings, AO noticed that assessee had made provision in respect of “Shahenshah Scheme” and the assessee was asked to furnish the details of the same. Assessee inter alia submitted that it had made provision of Rs.5,67,26,847/- in respect of “Shahenshah Scheme” towards sales incentive payable to dealers and distributors and had paid Rs.2,61,14,170/- in respect to the said scheme and Rs.58,43,713/- was written back and credited to Excess Provisions of bad debts/sales incentive written back. The assessee also pointed to the relevant features to the “Shahenshah Scheme” and it was further submitted that the provision made for the scheme is not a contingent liability but rather a contractual liability which is legally enforceable by the dealers and distributors. The submissions made by the assessee were not found acceptable to AO. AO considering the fact that as against the provision of Rs. 5,67,26,847/-, the actual payment made by the assessee was Rs.2,61,14,170/- and Rs.58,43,713/- was written back, concluded that the provision made by the assessee was not based on any scientific method but was in the nature of contingent liability. He also noted that CIT(A) while deciding the issue in assessee’s own case for A.Y. 2008-09 had analyzed scheme and had confirmed the addition made by the AO. He therefore disallowed Rs.2,47,68,964/- [5,67,26,847 – 2,61,14,170 – (5843713/-)].

10. As a result, the appeal of the assessee on this ground is allowed and it is to be kept outside the purview of Section 115JB.

Deduction u/s 80IC:

“21. Ground No.4 is with respect to the denial of claim of deduction u/s 80IC on interest income.