VENA ENERGY PATAN POWER PRIVATE LIMITED,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX, CENTRAL CIRCLE- 2(2), BANGALORE

Against the draft assessment order, the assessee filed objections before the DRP, which confirmed the TP adjustments and also the disallowances listed in (i) & (ii) above. With regard to pre-operative expenses, the DRP reduced the amount of disallowance to Rs.9,45,270. In pursuance of the directions of the DRP, the AO passed the final assessment order. Aggrieved, the assessee is in appeal before the Tribunal.

The TPO rejected the comparables of the assessee stating that the filters applied by the assessee are not appropriate and rejected the CUP taken by the assessee that MAM. The TPO applied fresh filters to choose difference comparables to arrive at the median coupon rate of 9.32%. Therefore, the TPO made an adjustment for the difference in interest rate [14.7 – 9.32 = 5.38%] and computed the TP adjustment towards excess interest payment amounting to Rs.6,46,60,082.

The assessee raised objections before the DRP with regard to the filters applied by the TPO for choosing the comparables and also rejecting the internal CUP method and the regulatory rate. The DRP upheld the various filters applied by the TPO and the comparables thus arrived at by the TPO. With regard to the TPO rejecting the internal CUP and regulatory rate, the DRP held that the CUP method requires strict comparability in terms of products of services. In the instant case, the instrument involved is NCD, whereas the proposed comparable under CUP method is bank loan or loan from third party. The rate of interest charged in the case of debenture is decided by the IT(TP)A Nos.195 to 198/Bang/2021 Page 5 of 26 borrower and the amount is required to be paid at maturity. The debenture is an instrument tradeable in the open market and is a hybrid instrument which could be treated as a debt as well as equity. On the other hand, loan is issued by the bank and periodic payment of principal and interest is required to be made. Hence, the internal CUP method was rejected and the DRP held that arm’s length interest rate of NCD is required to be computed in the manner prescribed u/s. 92C of the Act. The assessee took an alternate plea before the DRP stating that according to section 194LD(2) of the Act the maximum allowable rate of interest for a rupee denominated bond of an Indian company cannot exceed SBI base rate on the date of issue plus 500 basis points which works out in assessee’s case to 14.85% and therefore no TP adjustment is warranted. The DRP rejected this contention stating Section 194LD(2) of the Act does not provide any guidelines for determination of ALP interest rate in the case of NCD. Aggrieved, the assessee is in appeal before the Tribunal.

Before us, the ld. AR made detailed written submissions which are as follows.

On the other hand, the ld. DR submitted that i. The DRP has held that Transfer pricing is not an exact science and the TPO and the Assessee have to make the TP analysis depending on the prevailing economic conditions and circumstances in each year. This is because the dynamics and profile of business keep on changing year on year. Therefore the TPO may not be in a position to directly apply the findings of the Hon'ble ITAT regarding comparables in earlier year to the current years. Further the DRP held that Rule 10B provides for making reasonably accurate adjustment to the uncontrolled comparable transaction to eliminate the material effects of differences on the price, cost or profits. The working capital requirements and impact depends on various factors such as business cycles, the nature of business activity with its IT(TP)A Nos.195 to 198/Bang/2021 Page 9 of 26

We heard the rival submissions and perused the materials on record. On perusal of the agreements relating to the issue of debentures we notice the following facts (i) As per clause 2.1 of the Debenture Subscription Agreement dated 01/05/2015, the debentures issued are unlisted, unrated, unsecured and redeemable non-convertible and having the nominal value in INR (Page 356 of paper book). (ii) The Debenture Trust Deed dated 01/05/2015 contains the definition of ‘Interest Rate’ for the purpose of the agreement as annual coupon rate of SBI Base Rate + 500 bps , ‘SBI Base Rate’ as the base rate as advised by State Bank of India on its website as on the Effective Date and ‘Redemption Date’ means the date on the 25th anniversary of the date of expiry of the availability period. (Page 381 to page 383 of paper book), (iii) As per clause 5.7 of the Debenture Trust Deed all the payment to the debenture holder is to be done in INR (page 390 of paper book).

The summary of inference from the above is that the assessee has issued unsecured non-convertible debentures in INR to its AE that are redeemable after 25 years carrying interest rate of 14.70%. The IT(TP)A Nos.195 to 198/Bang/2021 Page 11 of 26 assessee in the TP study has taken the comparables applying various filters including the transactions having duration equal to or greater than 15 years whereas we notice that this filter is not applied for the comparables selected by the TPO. One of contentions of the ld AR was that the longer the duration of the loan, the interest rate will be directly proportional to the same more so when the loan is unsecured. The TPO has did not consider this filter stating that the same is yielding few comparables (Page 12 of order u/s.92CA) and this reason is upheld by the DRP. In the given case the debentures are unsecured with a repayment period of 25 years and in our considered view duration of the debt / loan is a significant factor in the determination of interest rate given that the debentures are unsecured and the reason quoted by the TPO/DRP for not applying this filter is not right.

The TPO has rejected the internal CUP comparison of the assessee with the loans obtained from the financial institutions / banks for the reason that in the case of debentures interest rate is decided by the borrower whereas in the case of bank loans the interest rate is decided by the lender and that the repayment of debenture is on maturity and in the case of bank loan repayment is periodical. The TPO had stated few more similar reasons for concluding that the internal CUP is not MAM. One of the key criteria for determining the interest rate is the risk involved. When the loan is unsecured the risk is higher and there would be a higher rate of interest charged for the loan. Applying this logic the assessee has justified the interest charged at 14.70% with that of the third party borrowings where the interest is IT(TP)A Nos.195 to 198/Bang/2021 Page 12 of 26 charged between 11.05% to 12.50%. This contention of the assessee has merits as the assessee has taken loan in the form of non-convertible unsecured debentures which has a higher risk factor as it is unsecured. Even applying the contention of the of the TPO that debenture has repayment on maturity and loan has periodical repayment justifies higher rate of interest charged for debenture in the commercial sense.

We notice that the coordinate bench of the Tribunal in the case of M/s Praxair India Pvt. Ltd (supra) has considered the issue of interest rate Compulsory Convertible Debentures issued in INR and held that 8.6.2 The Hon’ble Delhi High Court in the case of CIT v Cotton Naturals (I) Pvt. Ltd. (supra) had held that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. The relevant finding of the Hon’ble High Court reads as follows:-

In assessee’s case the NCDs are issued in INR and the interest is also paid in INR and considering the ratio laid in M/s Praxair India Pvt. Ltd (supra), and the Master Directions issued by RBI, we are in agreement with the contention of the ld AR that the interest rate by the assessee is justified when benchmarked with the SBI Prime Lending Rate on the date of issue debenture. We therefore hold that the interest charged by the assessee on the unsecured non-convertible debentures issued to the AE is within arm’s length and TP adjustment stands deleted.

The AO has also held that the documentation provided by the assessee in the form of journal voucher, a copy of e-mail and copies of invoices raised, does not establish the purpose for which expenditure was incurred or its genuineness. Therefore, the AO made certain additions to the total income of the Company on the basis of the statement that was recorded. The DRP upheld the additions / disallowances made.

The key contention of the ld AR was with regard the sworn statement of Mr Subrahmanya since the basis on which the AO made additions is the statement recorded during the course of search u/s.132 of the Act. In this regard the ld. AR submitted that the assessee has been repeatedly asking for the statement recorder from 21/08/2018 and since there was no response received the assessee filed a letter of retraction of statement recorded on 17/09/2018. The assessee filed one more letter on 26/11/2019 and finally the copy of the Statement u/s 132 was provided to the assessee only on 29/11/2019. Hence, the ld AR submitted that the evidence in support of the expense claims could not be provided earlier when the Statement was retracted i.e. 17/09/2018 but was immediately furnished thereafter on 04/12/ 2019 as soon as the Statement copy was made available to the assessee.

In the above background, we now consider the issue on merits based on the grounds raised by the assessee.

During the year under consideration the assessee has paid a total salary cost Rs.2,92,64,181 VEPRPL as a reimbursement. Out of this a sum of Rs.2,45,52,196 was capitalized and the balance of Rs.47,11,985 was debited to the P&L account. In addition to the submissions made with regard to the retraction of statement made by Mr.Subramanya, the assessee on merits submitted that these salary payments are cost to cost reimbursements to the sister concerns who deploy the manpower to render services for the assessee. The AO did

With regard to the disallowance of salary cost debited to P&L account 30% of which is disallowed u/s.40(a)(ia) the Ld. AR submitted that for the very same nature of expense, i.e., salary cost reimbursement, the portion which has been charged to the P&L account by the assessee has been considered by the AO to be a genuine expense and a disallowance on the same has been made by the AO only for alleged non deduction of tax. However, when the very same expense has been charged to capital work-in-progress, the AO has questioned the genuineness of the expense. This clearly shows the adjustments made the AO are arbitrary in nature and without any basis.

With regard to the depreciation disallowance of salary cost capitalised the ld AR submitted that the assessee has not capitalized the said expenditure to the cost of plant and machinery and consequently has not claimed any depreciation on the same during the year, as the said expenditure has been capitalized as ‘capital work-in- progress. Therefore, the assessee has neither claimed any depreciation on the same nor claimed the said amount as an expenditure in the P&L account during the year (page 246 of PB-1 – Clause A.12.(ii) of Schedule BP of the ITR and page 249 of PB I for Depreciation schedule of ITR). It is therefore submitted that there ought not to be any disallowance made as no expense or charge has been claimed by the assessee.

The ld. AR also submitted that for the subject AY 2016-17, there ought to be no disallowance made (protective or otherwise) as no expense or charge has been made by the Company. Without prejudice, the AO while making protective disallowance has ignored that section 40(a)(ia) is not applicable on capital expenditure. The provisions of section 40(a)(ia) does not provide for disallowance of depreciation, since it is not an expenditure, but a statutory allowance. Reliance is on the jurisdictional Karnataka HC decision in the case of PCIT vs Tally Solutions (P.) Ltd. [2021] 123 taxmann.com 21 (Karnataka).

The ld. DR submitted that the DRP noted that from the perusal of the statement of Shri Subrahmanya Srinivas Sista it is clear that the IT(TP)A Nos.195 to 198/Bang/2021 Page 20 of 26 amount claimed as capitalized have actually not incurred by the assessee. Therefore, this amount is not liable for capitalization and depreciation claimed on the same is required to be disallowed. In view of the above, the Hon'ble DRP upheld the additions made by the AO.

Further the ld. DR submitted that the DRP noted that the services rendered are in the nature of technical/professional services, the payment made by assessee to VEPRPL attracts the provision of 194J. Since TDS is not deducted by the assessee, the AO has correctly applied the provisions of sec.40(a)(ia) and disallowed 30% thereof. From the perusal of the statement of Shri Subrahmanya Srinivas Sista it is clear that the amount claimed as capitalized have actually not incurred by the assessee. Therefore, the ld. DR submitted that this amount is not liable for capitalization and depreciation claimed on the same is required to be disallowed, as rightly held by the revenue authorities.

We have considered the rival submissions and perused the material on record. With regard to the protective and the substantive disallowance made by the AO, on perusal of financial statements of the assessee we notice that the impugned amounts have not been capitalized and is accounted a capital work in progress for the year under consideration. We therefore agree with the contention of ld AR that when there is no capitalization of the impugned payment and any depreciation claim towards the same, the disallowance of depreciation is not tenable. Since there is no charge of depreciation during the year.

Next we will consider the issue of disallowance of salary cost debited to the P&L account u/s.40(a)(ia). The ld AR submitted that employees were working under the direct supervision and control of the assessee and that the employees have been deployed to meet the business needs of the assessee. The ld AR brought to our attention the break-up of salary expense reimbursed to VEPRPL which is available at page 415 of the Vena KN PB. VEPRPL has cross-charged salary expense to the assessee on a cost-to-cost basis without any mark-up and the assessee has merely reimbursed the salary cost of the employees to VEPRPL. According to the ld AR The salary was paid by VEPRPL to the employees for administrative convenience only on which VEPRPL has deducted appropriate taxes under section 192, wherever applicable. On perusal of materials on record it is clear that the amount paid by the assessee to VEPRPL is only a reimbursement of the salary cost and not to carry out any work as defined in section 194C of the Act or provide any technical / consultancy services to the Assessee as defined under section 194J of the Act. Further there is no element of income in the salary cost reimbursed by the assessee to VEPRPL. We notice that the Karnataka High Court in the case of IT(TP)A Nos.195 to 198/Bang/2021 Page 22 of 26 Kalyani Steels Ltd [2018] 91 taxmann.com 359 (Karnataka) has held that there cannot be a TDS on the reimbursement since there was no ‘income’ element. The salary cost which is paid by VEPRPL to the employees has already been tax deducted and therefore the amount reimbursed by the assessee is only on a cost to cost basis cannot be subject to TDS under 194C / 194J. In view of the above discussion we hold that the salary cost paid by the assessee to VEPRPL cannot be disallowed u/s.40(a)(ia).

The ld. AR reiterated reiterated that the aforementioned statement recorded during search formed the basis upon which the expenses was disallowed by the AO. However, the subsequent withdrawal of the statement and the fact that the expenses can be substantiated on the basis of documentation conclusively proves that the AO has erred in making such disallowance. It is submitted that the Assessee has incurred the expenditure towards purchase of stamp paper and professional/ consultancy fees and had deducted taxes at source wherever applicable and that such expenditure was incurred for the IT(TP)A Nos.195 to 198/Bang/2021 Page 23 of 26 purposes of business supported by documentary evidence submitted during the course of assessment proceedings (Page 415 and 420 of Vena KN PB-1).

Further, notwithstanding and without prejudice to the above, the ld. AR submitted that the AO disallowed depreciation @ 7.69 %, without appreciating the fact that the assessee has not capitalized the said expenditure to the cost of plant and machinery and consequently has not claimed any depreciation on the same during the year, as the said expenditure has been capitalized as ‘capital work-in-progress. Therefore, the company has neither claimed any depreciation on the same nor claimed the said amount as an expenditure in the P&L account during the year. (page 246 of PB-1 – Clause A.12.(ii) of Schedule BP of the ITR and page 249 of PB I for Depreciation schedule of ITR). It is therefore submitted that no disallowance is warranted, as no expense or charge has been claimed by the assessee.

The ld. DR submitted that DRP noted that the genuineness of expenditure of Rs.1,22,92,200 is not proved in view of the statement of Mr.Subramanya Srinivas Sista, the depreciation claim (7.69 % of 1,22,92,200) is required to be disallowed and directed the AO accordingly and the same may be upheld.

We have considered the issue of disallowance of depreciation where the amount is not capitalized but is accounted as capital work in progress in para 25 of this order. Considering the fact that the pre- operative expenses are not capitalized and no depreciation is claimed

The common issue in appeals 196 to 198/BANG/2021 is the determination of ALP of the interest on the issue NCDs to the AEs. The details of interest charged by these assessee is tabulated below Name of Entity Date of Tenure Face Rate of Issue Coupo Adjustment issue (in value interest size (in n rate (Amt in INR) years) (in INR (Coupon INR as per lacs) rate) cr.) TP order Vena Energy 06 May 25 50.00 14.85% 500 9.32% 5,52,70,305 Fatanpur Power 2015 Private Limited Vena Energy MH 31 25 40.00 15.00% 260 10.24% 10,62,43,105 Wind Power December Private Limited 2014 Vena Energy 24 25 50.00 14.85% 500 9.32% 5,11,01,745 Patan Power December Private Limited 2013

Considering that the NCDs are issued to the same AE under the same terms as in the appeal and in view of our decision given in para 14 of this order we hold that no adjustment is warranted towards interest on NCDs issued by the assessee to the AE.

The issue of disallowance made towards salary cost debited to the P&L account u/s.40(a)(ia), protective and substantive disallowance depreciation on the salary cost accounted in capital work in progress and the disallowance of depreciation on the pre-operative expenses accounted in capital work in progress is common to appeal no 196 and IT(TP)A Nos.195 to 198/Bang/2021 Page 25 of 26 198/BANG/2021. The details of the disallowances made is given in the table below.

In view of our decision given para 25,26 and 31 of this order we delete the disallowances made towards salary cost and the depreciation.

In the result, the appeal is allowed in favour of the assessee