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Income Tax Appellate Tribunal, BENCH “K”, MUMBAI
Before: SHRI R.C. SHARMA & SHRI PAWAN SINGH
per the balance-sheet of the assessee as on 31.03.2009 no bank would
lend money to the assessee at PLR rate, as there is no financial strength in 12
ITA No. 649 & 1854 Mum 16, C.O. 33 Mum 16 M/s Vinca Developers Pvt. Ltd.
the balance sheet of the assessee and that none of the balance of the
comparable company as weak as that of assessee, despite that the
comparable company able to issue the debenture at higher interest rate.
Thus, the adjustment required to be made at PLR rate, looking at the
nature and business of financial strength of the assessee. The risk
adjustment at least 3% to 5% should be considered, keeping in mind (i)
industry in which assessee is engaged (ii) financial position of assessee
(iii) debenture is unsecured (iv) it is compulsorily convertible into equity,
etc. After factoring the risk adjustment of even 3%, the rate would be
14.55% (11.55% + 3%) therefore; the interest rate paid by assessee would
be at Arm’s Length. 9. On the contrary, the Ld. DR for the Revenue supported the order of
TPO/DRP. The Ld. DR for the Revenue further submits that the assessee
is AE of foreign entity/FMO. The FMO is lender and therefore, Clause-c
of sub-section (2) of section 92A, the FMO is AE of the assessee. The
decision relied by Ld. DR in Orchid Pharma Ltd. (supra) is not
applicable. The assessee is negotiating ever year. In the last Financial
Year related to the Assessment Year 2010-11 only a part of the
transaction of money was received by the assessee. All CCDs are listed
now-a-days and interest rate is based on the credit base, the ld. DR further
submits that this issue can be set-aside to the file of TPO/AO as the TPO
ITA No. 649 & 1854 Mum 16, C.O. 33 Mum 16 M/s Vinca Developers Pvt. Ltd.
has not given any comment on the study. On corporate issue the ld DR
for the revenue relied on the order of assessing officer. 10. We have considered the rival submissions of the parties and have gone
through the orders of the authorities below. The first foremost legal
objection of the assessee is that the assessee is not AE’s of FMO/foreign
entity. And /or the assessee is no estopped under the law, once the
assessee has furnished report under Rule 3CEB. It is not in dispute that
the assessee in its TP study has categorically submitted that the FMO is
not AE and that benchmarking of said transaction was done without
prejudice to the submission of assessee that assessee and FMO was not
AE. We find that this fact was asserted by assessee company before the
ld. TPO, which has been referred in para 4 of his order. The TPO has not
accepted the contention of the assessee. In our view there is no estoppels
against the law, even the assessee has submitted the TP study it cannot be
used against the assessee, as no tax can be levied without the authority of
law. The ld TPO concluded that CCD’s and loans are debts which is to
be repaid and therefore would be covered in clause (c) of Section 92A(2). 11. A careful reading of section 92A makes it clear that basic rule for treating
the enterprises as AE is set out in Section 92A(1). Section 92A(1) lays
down the basic rule that in order to treat an entity as associated
enterprise, one enterprise, in relation to another enterprise, participate,
directly or indirectly, or through one or more intermediaries, "in the 14
ITA No. 649 & 1854 Mum 16, C.O. 33 Mum 16 M/s Vinca Developers Pvt. Ltd.
management or control or capital of the other enterprise" or when "one or
more persons who participate, directly or indirectly, or through one or
more intermediaries, in its management or control or capital, are the same
persons who participate, directly or indirectly, or through one or more
intermediaries, in the management or control or capital of the other
enterprise". Further, careful reading of Section 92(A)(2) only prescribed
the illustrations of the cases in which such an enterprise participates in
management, capital or control of another enterprise. Which means that
Section 92A (1) decides is the principle on the basis of which one has to
examine whether or not two or more enterprise are associated enterprise
or not. The principle is, as we have noted above, that one of the
enterprise, in relation to other enterprise, participate, directly or
indirectly, in the management or control or capital of the other enterprise
and that persons who participate in such management, control or capital
of both the enterprises are common. As long as an enterprise participates
in any of the three aspects of the other enterprise, i.e. (a) management; (b)
capital; or (c) control. 12. Hon’ble Supreme Court in Narendra Kumar Vs UOI (AIR 1989 SC 2138)
while considering the meaning of Compulsory Convertible
debenture(‘CCD’) held that CCD does not postulates any repayment of
principal. Therefore, it does not constitute a ‘debenture’ in its classical
sense. The Hon’ble Apex Court also referred and relied the Guidelines for 15
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the ‘Protection of Debenture Holders’ issued on 14th January 1987, which
recognised the basic distinction between convertible and non convertible
debenture. On the basis of said guideline it was held that instrument
which is compulsorily convertible in to shares, is regarded as “equity”
and not as a ‘loan’ or ‘debt’. Therefore, we may conclude that the CCD
is not a loan and hence FMO would not fall within the definition of AE
as provided in section 92A(2)(c) of the Act.
The coordinate bench of Hyderabad Tribunal in Adama India (P) Ltd Vs
CIT [78taxmann.com 75 (Hyd)] held that CCD are not loan with the
following observation:
“8. We have considered the issue and examined the rival contentions. There is no dispute with reference to the fact that the CCDs were issued in Indian Rupees. Accordingly, following the principles laid down by the Co-ordinate Benches and the Hon'ble High Court as relied on by the assessee in the submissions, we have to hold that TPO has wrongly treated the issuance of CCDs as a loan, by treating it as an external commercial borrowing, ignoring the fact that loan is a debt, whereas CCD is hybrid instrument in nature basically categorised as equity in nature. It was accepted by the Hon'ble Supreme Court in the case of Sahara India Real Estate Corpn. Ltd. (supra) while assigning the jurisdiction to SEBI as an 'equity instrument'. Further, the policy of Govt. of India and also RBI effective from 01- 04-2010 also indicate that issuance of CCD is part of FDI being quasi-equity in nature and considering the same as a loan would be completely against regulations laid by DIPB, RBI and FEMA.” 14. The coordinate bench of Chennai Tribunal in Orchid Pharma Ltd. Vs
DCIT while considering the definition of AE as prescribed under section
92A(1) held as under; 16
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“14. As evident from the limited narration of facts in the said decision, the assessee-company (i.e. Page Industries Ltd; PIL in short) was "a licensee of the brand- name 'Jockey' for exclusive manufacture and marketing of goods under license agreement" but "the assessee-company owns entire manufacturing facility, capital investment of Rs.100 crores and 15000 employees" and "there is no participation of JII (i.e. Jockey International Inc., USA) in the capital and management of the assessee-company". On these facts, the coordinate bench has held that JII and PIL are not associated enterprises as there is no participation by JII in "management or capital of PIL(emphasis supplied by us)". We have our reservation, whatever be it's worth, on the conclusions arrived at in this case but that does not dilute our highest respect for an important principles of law laid down by the coordinate bench. The reasons for this approach are as follows. The expression 'control' appearing in Section 92A(1) is very crucial and the manner in which control is exercised could go well beyond capital and management, but the coordinate bench had no occasion to deal with the "control" aspect at all. As held in the case of Diagco India (P.) Ltd. v. Dy. CIT [2011] 47 SOT 252/13 taxmann.com 62 (Mum.), even when an enterprise exercise control over the other enterprises by way of controlling the supply of raw material or use of trade marks, this also constitutes 'participation in control' leading to the status of associated enterprises under section 92A(1). It appears that this aspect of the matter has not been brought to the notice of, or pleaded before, the bench. While the conclusion arrived at by the bench clearly overlooks the specific mention of the word "control" in both limbs of the basic rule under section 92A(1) (i) as also under section 92A(1)(ii), and to that extent we are unable to concur that in the absence of participation in capital or management, two enterprises cannot be 'associated enterprises' under section 92A, what is important to us is that the coordinate bench has, inter alia, also held that, "....in order to constitute relationship of an AE, the parameters laid down in both sub-sections (1) and (2) should be fulfilled" and justified this approach by observing that "if we were to hold that there is a relationship of AE, once the requirements of sub-sec.(2) are fulfilled, then the provisions of sub-sec.(1) renders otiose or superfluous" and that "it is well settled canon interpretation of statutes that while interpreting the taxing statute, 17
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construction shall not be adopted which renders particular provision otiose". The coordinate bench then further observed that "when interpreting a provision in a taxing statute, a construction, which would preserve the purpose of the provision, must be adopted". The legal position thus summed up by the coordinate bench is that in a situation in which the conditions, with respect to a set of enterprises, set out in section 92A(1) are clearly not fulfilled, even if the conditions under one of the clauses of section 92A(2) are fulfilled, such enterprises cannot be treated as associated enterprise under section 92A. To the limited extent of the principle so laid down by the coordinate bench, we are in considered agreement with the views of the coordinate bench, and it is this principle which is relevant for the purposes of our adjudication. It does directly affect the issue in appeal before us inasmuch as we are also dealing with a situation in which admittedly words of section 92A(2)(i) are clearly satisfied on the facts of this case, the scale of commercial relationship is so insignificant vis-à-vis total business operations of the assessee that there is admittedly no participation in control by one of the enterprise over the other enterprise so as to satisfy the mandate of Section 92A(1).
While dealing with this, we may also refer to some observations made by Dr Ramon Dwarkasing, an Associate Professor in Transfer Pricing at Maastricht University, the Netherlands, in his book "Associated Enterprises- A Concept Essential for Application of the Arm's Length Principle" [ ISBN: 978-90-81724- 0-1, published by Wolf Legal Publishers, the Netherlands @ page 6], as follows:
'....in various countries, the concept of associated enterprises may even cover relationships between independent enterprises, for instance, where a foreign buyer has a strong negotiating power. For example, an Indian software company has a customer in Netherlands which is responsible for more than 90% of turnover of Indian software developer. The Dutch customer is able to dictate the prices to Indian software developer. The Indian software company is, therefore, able to charge a price with 1% margin/mark up, which is very low compared to his Indian counterparts (which apply, for instance, 6% mark up).
ITA No. 649 & 1854 Mum 16, C.O. 33 Mum 16 M/s Vinca Developers Pvt. Ltd.
According to the Indian transfer pricing law, if the gods or articles manufactured or processed by one enterprises, are sold to other enterprise abroad or to person specified by such other enterprise, and the prices and other conditions relating thereto are influenced by such other enterprises, the two enterprises shall be deemed to be associated enterprises [See section 92A(2)(i) of the Indian Income Tax Act, 1961]
The Indian tax authorities consider the Indian software developer and its Dutch customer to be associated. They may adjust the prices and tax an unrealized profit, i.e. difference between real results and results based on prices derived from other software developers in India. The Netherlands does not consider the companies to be associated as it applies a narrow concept that does not include "de facto control" as a criterion for association. "Control" in the absence of company law based relationship or in the absence of any formal right to exercise control can be described as "de facto" control. Participation in capital and management can be characterized as "de jure" concepts; concepts covered by company law.' [Emphasis, by underlining, supplied by us]
While the above observations do seem to be at variance with the plain words of the statutory provision inasmuch as it refers to influence by way of "strong negotiating power" rather than an influence simplictor- as is the apparent scheme of the statutory provision, what is immediately discernible from the above extracts is that the 'de facto' control is the foundation of the wider approach to the concept of 'associated enterprises, and, of course, the impression that one of the ways in which use of expression 'influence', in concept of associated enterprises under the transfer pricing, can be rationalized is as dominant influence in the nature of de facto control. The definition of 'associated enterprise', as the above academic analysis shows, has two approaches- wider approach and narrow approach. A narrow approach to the concept of associated enterprises takes into account only "de jure" association i.e. though formal participation in the capital or participation in the management. A wider approach to the concept of 'associated enterprises' takes into account not only the de jure relationships but also de facto control, in the absence of participation in capital or participation in management, through other modes of control such as commercial relationships in which one has dominant influence over the other. This wider concept is clearly 19
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discernible from the principles underlying approach to the definition of 'associated enterprises' in the tax treaties and has also been adopted by the transfer pricing legislation in India in an unambiguous manner. There is no other justification in the Indian transfer pricing legislation, except the participation in capital of an enterprise, management of an enterprise or control of an enterprise, which can lead to the relationship between enterprise being treated as 'associated enterprises'. What essentially follows is that clause (i) of Section 92A(2) has, at its conceptual foundation, de facto control by one of the enterprise over the other enterprise, on account of commercial relationship of its buying the products, either on his own or through any nominated entities, from such other enterprise and in a situation in which it can influence the prices and other related conditions. The wordings of clause (i), however, do not reflect this position in an unambiguous manner inasmuch as it does not set out a threshold of activity, giving de facto control to the other enterprise engaged in such commercial activity, in percentage terms or otherwise- as is set out in clause (g) and (h) or, for that purpose, in all other operative clauses of Section 92A(2). If the words of this clause are to be interpreted literally, as the authorities below have read, even if there is one isolated transaction with an enterprise in such an enterprise can influence the prices, such an enterprise is to be treated as an associated enterprise- whether or not this commercial relationship amounts to control on the other enterprise. That will clearly be an incongruous result. However, as Section 92A(2)(i) is to be read along with Section 92(A)(1), in such a situation in which an enterprise does not participate in (a) capital, (b) management, or (c) control of other enterprise, and thus does not fulfil the basic rule under section 92A(1), even if the conditions of Section 92A(2)(i) are fulfilled, these enterprise cannot be treated as 'associated enterprise'. In the case before us, it is not even the case of the revenue that the assessee has any participation in management or capital of the other enterprise, nor there is anything to even remotely indicate, much less establish, that one of the enterprise, by way of this commercial relationship, participates in control over the other enterprise. Viewed thus, Northstar, even if it is assumed that it can influence prices and other conditions relating to sale, cannot be treated as associated enterprise of the assessee before us. It is also important to bear in mind the fact that given the context in which the expression "prices and other conditions relating thereto are influenced by such other 20
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enterprise" appears in Section 92A(2)(i), this influence has to be something more than influence in the ordinary course of business and in the process of negotiation, because, even in the course of ordinary every business and in the course of day to day negotiation, selling prices as also conditions of sale are invariably, in a way, influenced by the buyer. Therefore, even when a customer offers terms to someone with a 'take it or leave it' message, such an approach, by itself, cannot be termed as 'influence', for our purposes, unless the seller is in such a position and under such an influence that he has to simply accept the dictated terms. Any other view of the matter will result in all the enterprises dealing with each other as every party to a transaction has an influence over the price and conditions relating to the sale, and will lead to a situation in which all the enterprises dealing with each other on negotiated prices will have to be as associated enterprises. That again is a clearly absurd and unintended result, and it is only elementary that law is to be interpreted in such a manner as to make it workable rather than redundant. This principle is expressed in the latin maxim "ut res magis valeat quam pereat. Explaining this principle, Hon'ble Supreme Court has, in the case of CIT v. Hindustan Bulk Carriers [2003] 259 ITR 449/126 Taxman 321 (SC), has observed that "A construction which reduces the statute to a futility has to be avoided" and that "A statute or any enacting provision therein must be so construed as to make it effective and operative on the principle expressed in maxim utres magis valeat quam pereat i.e., a liberal construction should be put upon written instruments, so as to uphold them, if possible, and carry into effect the intention of the parties. [See Broom's Legal Maxims (10th Edition), p. 361, Craies on Statutes (7th Edition) p. 95 and Maxwell on Statutes (11th Edition) p. 221.]" It is, therefore, important that the expression 'influence' is given a sensible meaning so as to make the provisions of Section 92A(2)(i) workable rather than adopting a literal meaning which will lead to wholly incongruous results.
Viewed in this perspective, we must adopt a sensible meaning of expression 'influence' which advances the scheme of the transfer pricing provisions rather than making these provisions unworkable. That meaning had to be a dominant influence which leads to de facto control over the other enterprise rather than an influence simplictor. If we are to adopt literal meaning of influence, as has been
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adopted by the authorities below, all the transactions on negotiated prices will be hit by the provisions of Section 92A(2)(i). In the light of the discussions above, the expression 'influence', in the present context, must remain confined to dominant influence which amounts to de facto control. Acceptance of terms of the buyer on commercial considerations, as in this case, cannot be treated as influence of the buyer. It is a commercial decision whether to accept the terms of the buyer, with respect to the price or related conditions, or not. It becomes influence, for the purpose of Section 92A(2)(i), when the seller is placed in such a situation that he has no choice, because of buyer's dominant influence, but to accept it. It is thus clear that context in which a reference is made to the expression 'influence' in section 92A(2)(i) requires this expression to be read as a dominant influence in the sense of control by one enterprise over the other. Given the fact that the assessee's exports through the distribution part constitutes less than 5% of its entire exports, and less than 6% of its entire sales, Northstar is certainly not in a position to exercise any dominant influence, over the assessee. The assessee's decision to accept the terms set out by Northstar, even if that be so, may be justified on account of commercial expediencies or warranted by business exigencies or may simply be compulsion of this somewhat unique and complex business model, but it cannot, by any stretch of logic, be on account of dominant influence of Northstar as a customer. It may even be a sound business strategy to accept a rather passive and back seat role, if one can term it that way, in day to day decision making under this business model, but cannot be on account of dominant influence that Northstar exercises on buying of products from the assessee. The influence of Northstar, given the scale of business through Norrthstar as a distribution part, is too modest to make it a dominant influence in the nature of control. In this view of the matter, as also bearing in mind the earlier discussions on the issue, the assessee and Northstar can not be treated as 'associated enterprises' under section 92 A. We uphold the plea of the assessee.
Therefore, in view of above legal and factual discussion, we find force in
the submissions of the ld AR for the assessee that the CCD not a loan and
moreover, the Foreign entity namely “Netherlands Development Finance
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Company” called Nederlandse Financierings–Maatschappij Voor
Ontwikkelingslanden N.V. (“FMO”) would not fall within the definition
of AE as provided in section 92A(2)(c) of the Act. And therefore, no
reference for computation of ALP before the TPO was required. 16. The TPO has not brought on record any material on record to treat the
FMO as AE of assessee. The TPO without discussing the legal issues
raised by the assessee concluded that Article 9 of Netherlands India
Double Taxatition Avoidance Agreement (DTAA) is unfounded and the
transfer pricing provisions are to be governed by the domestic law of a
country. In our view the conclusion arrived by ld. TPO is unfounded,
when the FMO is not AE of the assessee. 17. Therefore, in view of our detailed discussion as referred above, we are of
the view that the foreign entity i.e. FMO is not AE of the assessee as
there in no participation, directly or indirectly, in the management or
control or in capital of the each other enterprise and in management,
control or capital are common and hence, no reference for computation of
ALP was warranted. Hence, the grounds No. 1 of the appeal of the
assessee is allowed. As we have allowed ground No.1 of the appeal and
held that FMO is not AE of assessee, therefore, discussion on merit raised
in ground No. 2 and 3 related with the adjustment of ALP has become
academic.
ITA No. 649 & 1854 Mum 16, C.O. 33 Mum 16 M/s Vinca Developers Pvt. Ltd.
Ground No.4 relates to disallowance of interest of Rs. 12,80,166/-. The
ld. AR of the assessee submitted that during the relevant financial year
related to the assessment year 2010-11, the assessee had advanced certain
money to Ackruti. The advance given to Ackruti consist of advance of
Rs. 10,61,00,000 /-and Rs. 1,79,60,000/-on account of Stamp duty,
therefore, a total sum of Rs. 12,40,60,000/- was advance given for
business purpose and interest should be allowed as expenditure. The ld.
AR further submits that assessee has own funds in the form of share
capital to the extent of Rs. 12,51,00,000/- and the same should be reduced
from working out the interest disallowance. The assessing officer did not
agree with the contention of the assessee and relying upon his own order
for assessment year 2010-11 proposed disallowance of Rs. 1,62,70,200/-.
Before DRP, the assessee contended that the CIT(A) in assessment year
2010-11 restricted the interest disallowance Rs. 12,80,166/-, after
granting credit of own funds to the assessee. Therefore, the DRP relying
on the order of ld. CIT(A) for assessment year 2010-11 restricted with
disallowance to Rs. 12,80,166/-. The ld AR further submits that in the
appeal before Tribunal in appeal for assessment year 2010-11, it was held
that disallowance would be restricted to the amount actually given by the
assessee and should exclude stamp duty charges for registration of
agreement. It is submitted that CIT (A) has already granted relief to the
assessee to the extent of own funds however, inadvertently the Tribunal 24
ITA No. 649 & 1854 Mum 16, C.O. 33 Mum 16 M/s Vinca Developers Pvt. Ltd.
in final direction has not mentioned that amount of own funds available
with the assessee should also be reduced for computing the disallowance.
On the contrary the ld. DR for the revenue supported the order of
assessing officer. The ld DR further submits this the Tribunal has given
categorical finding about the disallowance of interest for 3 months in
appeal for A 2010-11 on actual amount of advance as the amount was
advanced only on 31.12.2009. 19. We have considered the rival submission of the parties and have gone
through the orders of authorities below. We have also gone through the
order of coordinate bench in assessee’s own case for assessment year 2010-11 in ITA No. 5145/M/2014 dated 2nd March 2016 (in assessee’s appeal) and in ITA No. 6171/M/2014 dated 25th of May 2016 (in
revenue’s appeal). A careful perusal of the order passed by coordinate
bench of the Tribunal reveals that while framing assessment order under
section 143(3) for AY 2010-11, the assessing officer made the
disallowance of proportionate interest of Rs. 1,62,70,200/- @ 12%
attributable to the interest-free advances. On appeal before Commissioner
(Appeals) the disallowance was restricted to Rs. 12,80,166/-. Aggrieved
by the order of Commissioner (Appeals) both the party filed their cross
appeal before this Tribunal. It appears that the ld. representative for
assessee as well as Department representative has not brought the fact in
the notice of the Tribunal that both the parties have filed their cross 25
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appeal against the impugned order dated 25 July 2014. Therefore, both
the appeal were heard separately and decided by separate orders as
referred above. In assessee’s appeal ITA No. 5245/M/2014 the coordinate
bench directed to compute the interest disallowance only for three-month
as period involved in the assessment years 2010-11, was with effect from
31 December 2009. However, the appeal of revenue in ITA No.
6171/M/2014 in challenging of restricting the interest disallowance was
dismissed. Therefore, virtually the order of ld. Commissioner (Appeals)
for assessment year 2010-11 was partly confirmed. Therefore,
respectfully following the decision of coordinate bench in assessee’s
appeal in AY 2010-11, we direct the assessing officer to compute the
disallowance accordingly as directed in order dated 02.03.2016 in ITA
No/M/2016. Hence ground No. 4 of the appeal is partly allowed.
ITA No. 649/M/2016 by Revenue. 20. We have noted that the revenue has raised almost identical ground of
appeal as raised in appeal for assessment year 2010-11 in ITA No.
6171/Mumbai/2014. As we have already noted that appeal of the revenue
on identical ground of appeal was dismissed by Tribunal vide order dated 25th May 2016. Therefore, respectfully following the decision of
coordinate bench the appeal filed by revenue is dismissed. 21. In the result both the appeals filed by the assessee is partly allowed and
appeal by revenue is dismissed. 26
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Order pronounced in the open court on 30th day of May 2018.
Sd/- Sd/- (R.C. SHARMA) (PAWAN SINGH) ACCOUNTANT MEMBER JUDICIAL MEMBER Mumbai; Dated 30/05/2018 S.K.PS Copy of the Order forwarded to : 1. The Appellant 2. The Respondent. 3. The CIT(A), Mumbai. 4. CIT 5. DR, ITAT, Mumbai Guard file.�ािपत�ितC 6.
BY ORDER (Asstt.Registrar) ITAT, Mumbai