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Facts
The assessee and the Revenue filed cross-appeals challenging the CIT(A)'s order for AY 2010-11. The appeals involve issues related to the benchmarking of corporate guarantee commission, addition on account of interest on loans to AEs, and disallowance under Section 14A read with Rule 8D.
Held
The Tribunal observed that the issue of corporate guarantee commission needed to be determined on the basis of the interest-saving approach, and remanded the issue to the AO/TPO. Regarding the interest on loans to AEs, the Tribunal found that neither party had properly benchmarked the transaction and remanded the issue to the CIT(A) for fresh benchmarking. For the Section 14A disallowance, the Tribunal directed the AO to restrict the disallowance to investments yielding exempt income and verify the availability of interest-free funds.
Key Issues
Whether the corporate guarantee commission, interest on loans to AEs, and disallowance under Section 14A were correctly determined by the lower authorities.
Sections Cited
92B, 92C(3), 14A, Rule 8D
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Income Tax Appellate Tribunal, “K” BENCH, MUMBAI
Before: SHRI PRASHANT MAHARISHI, AM & MS. KAVITHA RAJAGOPAL, JM
O R D E R Per Kavitha Rajagopal, J M:
These are cross appeals filed by the assessee and the Revenue, challenging the order of the learned Commissioner of Income Tax (Appeals), National Faceless Appeal Centre (‘NFAC’ for short) passed u/s.250 of the Income Tax Act, 1961 (‘the Act'), pertaining to the Assessment Year (‘A.Y.’ for short) 2010-11.
2 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) 2. The assessee has challenged the present appeal on the following grounds:
GROUND I: TREATING GIVING OF CORPORATE GUARANTEE AS AN INTERNATIONAL TRANSACTION UNDER SECTION 92 OF THE ACT 1. On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in upholding the action of the Assessing Officer (AO") and Transfer Pricing Officer ("TPO") in benchmarking "corporate guarantee" given to a bank on behalf of the Appellant's subsidiary as an "international transaction" u/s 92B of the Act 2. The Appellant prays that Arm's length adjustment made by the TPO and confirmed by the AO be deleted. WITHOUT PREJUDICE TO GROUND I : GROUND II: ADDITION ON ACCOUNT OF ARM'S LENGTH ADJUSTMENT TO INCOME FROM GUARANTEE COMMISSION: 1 On the facts and in the circumstances of the case and in law, the Ld.CIT(A) erred in computing the arms length price u/s 92C(3) for the corporate guarantees provided by the Appellant and thereby making an addition of notional guarantee fee at the rate of 0.7% on the availed guarantee amount. 2 The Appellant therefore prays that the AO be directed to delete the Arm's length adjustment made in the form of income from guarantee commission GROUND NO. III ADDITION ON ACCOUNT OF ARM'S LENGTH ADJUSTMENT TO INCOME FROM INTEREST ON LOANS ADVANCED TO ASSOCIATED ENTERPRISE: 1. On the facts and in the circumstances of the case and in law, the learned CIT(A) erred in holding that the interest charged on the loans advance to group companies is not at Arm's Length Price and making addition of notional interest at the rate of 5% of the amount advanced to the AE 2. The Appellant prays that Arm's length adjustment made by the TPO and confirmed by the AO, be deleted or, be appropriately reduced. GROUND NO. IV: DISALLOWANCE U/S. 14A OF THE ACT R.W.RULE 8D OF 1962 (“THE RULES") AMOUNTING TO RS.1,00,31,857/- 1 On the facts and in the circumstances of the case and in law, the Ld. CIT(A) erred in upholding the disallowance made by the AO u/s 14A r.w. Rule 8D amounting to Rs.1,00,31,857/- 2. The Appellant prays that the Ld. AO be directed to delete the additional disallowance made u/s 14A amounting to Rs. 1,00,3 1,857/- and the disallowance should be restricted to the suo-moto disallowance made by the Appellant WITHOUT PREJUDICE TO GROUND IV GROUND NO. V 1. On the facts and in circumstances of the case and in law, the CIT(A) erred in considering the investment, on which no taxX-exempt income was received during the year, in computing the disallowance u/s. 14A of the Income Tax Act 3 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) 2. The Appellant, prays that the investment on which no tax-exempt income is received should be considered while computing the disallowance u/s. 14A r.w.r.8D of the Rules WITHOUT PREJUDICE TO GROUND IV&V 1. On the facts and in circumstances of the case and in law, the CIT(A) ought to have restricted the disallowance u/s. 14A of the Act to the extent of tax-exempt income generated during the year under consideration.
The Appellant, prays that the disallowance u/s. 14A of the Act ought to be restricted to tax-exempt income generated during the year under consideration.
The assessee was incorporated on 13.07.1961 which is engaged in the business of manufacturing of empty hard gelatin capsules of various sizes. The assessee had filed its return of income on 27.09.2010, declaring total income at Rs.98,96,82,091/-. The assessee’s case was selected for scrutiny and notice u/s. 143(2) and 142(1) of the Act were duly issued and served upon the assessee. The assessee has entered into the following international transaction, namely:
S. No. Transaction Amount (INR) 1 Export of empty hard getatin and cellulose capsules 53,16,08,191 2 Interest charged on Loan advanced to the AE 22,58,894 3 Reimbursement of expenses by ACPL to AEs 12,54,320 4 Reimbursement of expenses by AEs to ACPL 30,63,727 Total 53,81,85,132
Reference was made u/s. 92CA of the Act to the Transfer Pricing Officer ('TPO' for short) for determining the arm's length price ('ALP' for short) pertaining to the international transaction entered into by the assessee as per the audit report in Form No. 3CEB. The ld. TPO vide order dated 01.11.2013 passed u/s. 92CA(3) of the Act made an adjustment of Rs.1,07,98,788/- towards guarantee commission given on behalf of the Associated Enterprises (‘AE’ for short) aggregating to Rs.2,27,59,004/- and adjustment to Rs.1,19,60,216/- towards the interest on the loan advanced by the assessee to the AE.
4 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) 5. The ld. Assessing Officer ('A.O.' for short) vide order dated 24.03.2014 passed the assessment order u/s. 143(3) r.w.s 147C(1) of the Act thereby determining the total income at Rs.102,16,86,410/- by making an adjustment proposed by the ld. TPO along with the disallowance u/s. 14A of the Act to Rs.92,16,774/- and disallowance on account of bogus purchase amounting to Rs.28,444/-.
Aggrieved the assessee was in appeal before the ld. CIT(A) who vide order dated 30.03.2016 had partly allowed the appeal filed by the assessee.
Both the assessee as well as the Revenue are in appeal before us challenging the order of the ld. CIT(A).
Ground no. 1 of the assessee’s appeal pertains to the challenging of the order of the ld. CIT(A) in upholding the action of the ld. A.O./TPO in bench marking the corporate guarantee transaction given by the assessee on behalf of AE to a bank.
Ground no. 2 is without prejudice to ground no. 1 the assessee has challenged the arm’s length adjustment to income from guarantee commission. The facts of this ground are that the ld. A.O./TPO observed that the assessee has not reported the transaction of the corporate guarantee given by it on behalf of its subsidiary AE to a third party namely Zagrebacka Bank for an amount of Euro 4 million equivalent to Rs.26,79,60,000/- as on 31.03.2009 in Form No. 3CEB for which the assessee has not charged any guarantee commission from its AE. The assessee contended that it had given the corporate guarantee to Zagrebacka Bank for the loan availed by its 100% subsidiary Lukaps,
5 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) Europe even before the acquisition of Lukaps where the assessee has replaced the earlier guarantor. The assessee further stated that it was for the assessee’s own benefit and, therefore, no commission for the said guarantee was charged by the assessee to the AE. It was also contended that the assessee post acquisition of shares of Lukaps had the benefit of increased sales from Rs.187 million to Rs.445 million during Financial Year 2011-12 when compared to F.Y. 2007-08. As the profit earned by the assessee was much higher than the guarantee commission which ranges from 0.5% to 1.5% there was no reason for the assessee to charge guarantee commission to its AE. The assessee in its written submission has stated that the said transaction is out of the purview of intra group services as per 2010 TP Guidelines issued by the OECD. It is further submitted that the said transactions resulted in Nil expenses for the assessee and there was no taxable income. The assessee relied on the decision of Hon'ble Supreme Court in the case of SA Builders 288 ITR 1 (SC) where the Revenue cannot determine the arm's length price ('ALP' for short) when it cannot prove the nexus between the expenditure and the business. Further the assessee contended that amendment to clause (c) to Explanation (i) of section 92B is retrospective amendment which includes guarantee in the purview of international transaction where the said amendment will not be applicable to the year under consideration.
The lower authorities have failed to accept the contention of the assessee and held that the amendment to section 92B(2) brought about by Finance Act, 2012 was applicable retrospectively w.e.f. 01.04.2002 from A.Y. 2002-03. The ld. A.O./TPO held 4.03% to be the rate of guarantee commission after considering the interest rate for unsecured bonds
6 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) of AAA rate companies which is 8.25% and BBB rated companies @ 12.28% for a period of five years of unsecured bonds and made an adjustment of Rs.1,07,98,788/- from the total guarantee committee amounting of Rs.26,79,60,000/-.
The first appellate authority upheld the finding of the ld. A.O./TPO that the amendment to section 92B of the Act applies retrospectively from A.Ys. 2002 to 2003 and disagreed with the findings of the ld. TPO on the view that the ld. TPO has considered the rates of lending funds which is not the case of the assessee where it has given guarantee to two bank for its own subsidiary Lukaps. The ld. CIT(A) further held that the average rate of lending of unsecured bonds computed by the ld. TPO is not justifiable and made comparison with the Standard Chartered Bank Guarantee Commission which was 0.7% to be the reasonable rate for charging guarantee commission where the prevailing Libor rate was from 1.75 to 2% which would be the rate if Lucaps had borrowed from the European market have the assessee not given the corporate guarantee. The ld. CIT(A) held the said transaction to be an international transaction within the meaning of section 92B and directed the ld. A.O. to apply the rate of 0.7% instead of 4.03% on the guarantee commission.
The assessee has challenged the order of the ld. CIT(A) in upholding 0.7% guarantee commission and the Revenue, on the other hand, in its cross appeal has challenged the order of the ld. CIT(A) in restricting the said rate to 0.70%.
The learned Authorised Representative ('ld. AR' for short) for the assessee contended that this issue has been dealt with by the c-ordinate bench in the assessee’s
7 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) case for A.Ys. 2012-13 and 2013-14 where the Tribunal has remitted this issue back to the file of the ld. A.O./TPO for bench marking the said transaction. The ld. AR further stated that as the facts are identical as that of A.Ys. 2012-13 and 2013-14 and relied on the decision of the Tribunal.
The learned Departmental Representative ('ld.DR' for short) for the Revenue, on the other hand, had nothing to controvert the said fact.
15. On hearing both the sides, it is observed that this issue on corporate guarantee commission has been dealt with by the Tribunal in & 2384/Mum/2018 and others vide order dated 04.12.2023. The relevant extract of the said decision is cited hereunder for ease of ready reference:
We have heard the rival submissions and perused the materials available on record. It is evident that the issue of corporate guarantee commission by the assessee to its AEs was dealt with by the Tribunal in A.Y. 2008-09 in where the Tribunal has restricted the corporate guarantee commission @ 0.5% by relying on the decision of the Hon'ble Jurisdictional High Court in the case of CIT vs. Everest Kento Cylinders [2015] 378 ITR 57 (Bom). It is also pertinent to point out that the issue of the impugned transaction whether an international transaction falling within the meaning of section 92B of the Act has also been dealt with by the Tribunal holding the said transaction to be an international transaction. The ld. DR relied on the decision in the case of Glenmark Pharmaceuticals Ltd. (in ITA No. 5031/Mum/2012 vide order dated 13.11.2013) and stated that the ld. CIT(A) has failed to look into the credit rating of the AEs and has also failed to evaluate the risk factor involved by the assessee in providing the corporate guarantee on behalf of its AE. On considering the rival submissions it is observed that the corporate guarantee given by the assessee on behalf of its AE for availing loan facility is for the purpose of reducing the interest rate charged by the banks and while determining the ALP of the said transaction the same has to be considered on the perspective of the benefit received by the AE as per the interest saving approach by reason of the corporate guarantee given by the assessee and to compare the same as to what would be the interest rate charged by the bank for the loan availed by the AEs if the corporate guarantee is not given by the assessee for availing the said loan. It is observed that both the lower authorities have failed to look into this issue before determining the ALP of the said transaction. Reliance placed on the decision in the case of Hon'ble Jurisdictional High Court in the case of Everest Kento Cylinders (supra) cannot be the basis for holding the corporate guarantee commission to be 0.5% which was held to be an appropriate rate by the Hon'ble High Court in case of that assessee and for that particular year under consideration. It is evident that 0.5% cannot be a standard rate for charging corporate guarantee commission and the same has to be determined in each case and for each year based on the credit rating of AE, comparable loan transactions where guarantees
8 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) are issued and non guaranteed loans by working out interest saving and then sharing it between transacting parties. We, therefore, direct the ld. A.O./TPO to determine the ALP on corporate guarantee commission on the basis of the interest saving approach of the said transaction. The assessee is also directed to bench mark the said transaction where it has already been held to be an international transaction and on the basis of which the ld. A.O./TPO has to determine the ALP of the corporate guarantee commission as per the provisions of section 92CA of the Act which makes it compulsory to benchmark the international transactions every year. Exception may be if no significant difference between FAR or economic circumstances exists. We, therefore, remand this issue back to the ld. A.O. on the above observation. Hence, ground nos. I & II of the assessee’s appeal are allowed for statistical purpose.
As this issue has been squarely covered by the decision of the co-ordinate bench, we are of the considered opinion that there is no change in facts of this present appeal, this issue is to be remitted back to the file of the ld. A.O. with the direction to determine the arm's length price ('ALP' for short) on corporate guarantee commission on the basis of the interest saving approach of the international transactions by respectfully following the above said decision. Hence, ground nos. 1 & 2 of the assessee’s appeal and ground nos.
1(a) & 1(b) of the Revenue’s appeal are hereby allowed for statistical purpose.
Ground no. 3 pertains to the addition on account of arm’s length adjustment to income on interest from loans advance to AE amounting to Rs.1,19,60,216/-. The facts of this ground is that the assessee had given loan of Euro 6 lacs which is equivalent to Rs.3,89,47,332/- to its AE, ACG Holding BV Netherland which was given in the earlier financial year and had continued during the year under consideration along with another loan of Euro 20 lacs equivalent to Rs.13,75,18,000/- lent on 24.07.2009 which again continued during the impugned year for which the assessee had charged interest @ 2% which the ld. A.O./TPO observed that the assessee had reduced the interest rate from 5% to 2% for the earlier loan w.e.f. 01.04.2009 and 2% interest rate for the fresh loan advanced on 24.07.2009 as per the report in Form No. 3CEB.
9 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) 18. During the assessment proceeding, the assessee contended that the loan was granted out of the own funds through ODA – direct investments to its AE under automatic route that has been duly noted by the RBI for the purpose of financing the working capital requirements of Lukapsd.o.o which was the step down subsidiary company of the assessee as per FEMA Regulation. The assessee has not bench marked the said transaction for the reason that the transaction of lending money to its 100% subsidiary company would not come under the purview of arm's length price ('ALP' for short). The assessee further stated that 2% interest rate was more than the prevailing Libor rate of 1.28% where the additional charge of 0.72 basis point over average Libor rate converts into a markup of 56% over and Libor. The assessee reiterated that the loans advanced to AE be out of interest free reserves where the interest and the principal was receivable in Foreign Currency (Euros). It had also stated that the said loan was utilized to invest in Lukaps Croatia which was for the business expansion of the assessee and not merely to earn interest out of the said loan making the risk factor of repayment for the assessee is much lesser. The assessee without prejudice had compared the lending rate of Standard Chartered Bank to its subsidiary at Libor + 50 basis points and stated that on the above mentioned reasons, the said transaction was at arm’s length and warranted no adjustment. The assessee relied on the decision of the Tribunal in the case of Siva Industries & Holdings Ltd., Cotton Naturals (India) Pvt Ltd. and the Hon'ble Apex Court decision in the case of S A Builders (supra).
The ld. A.O./TPO rejected the assessee’s contention for the reason that have the assessee advanced fund to third party such huge amount, it would be entitled for interest
10 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) as return for such investment. The ld. TPO determined the arm’s length @ 10.68% by taking the rate of crisil bonds as comparable for the investment made by the assessee in the absence of data pertaining to the credit rating of AE. The ld. A.O/TPO relied on the decision of the co-ordinate bench in the case of Perot System TSI (India) Ltd. vs. DCIT [2010] TIOL ITAT (Del) which has held that even interest free loans given to AEs has to be charged at arm’s length interest and also relied on the decision of the Hon'ble Apex Court in the case of S A Builders (supra) as not applicable for Chapter X provisions dealing with the transfer pricing. The ld. A.O./TPO rejected the thin capital rule as having no relevance and also stated that mere RBI’s approval is not sufficient and the same has to be determined at arm’s length. The ld. A.O./TPO has held that the assessee has not charged the interest as per the prevailing rate as per the provision of section 92C(1) read with Rule 10B of the Rules.
The ld. CIT(A), on the other hand, has restricted the charging of interest @ 5% to be reasonable rate after duly considering the earlier years rate of interest charged by the assessee from its subsidiary. The ld. CIT(A) further held that the assessee had charged 2% rate of interest including foreign exchange currency which according to the ld. CIT(A) was if the investment in India was made then it would have fetched higher rate of interest, thereby restricting the rate of interest to 5%.
Both the assessee and the Revenue are in appeal challenging the order of the ld. CIT(A).
11 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) 22. From the above factual matrix, it is observed that neither the assessee nor the lower authorities have bench marked the transaction of the assessee lending money to its AE. The ld. A.O./TPO has considered 10.68% to be a reasonable estimation on the notional interest to be levied by the assessee on the basis of the crisil bonds and made an adjustment of Rs.1,19,60,216/- for the loan advanced by the assessee during the earlier financial year and during the year under consideration. The ld. TPO/A.O. has also without prejudice considered the safe Harbour Rules notified on 18.09.2013 for the loan transaction upto Rs.50 crores where the interest rate to be applied has to be the base rate of State Bank of India as on 30th June which is 12.28% + 150 basis point during the year under consideration and held that 10.68% to be at arm’s length rate would be reasonable.
The ld. CIT(A), on the other hand, has also not bench marked the said transaction and had merely restricted the rate of interest to be 5% keeping in view the earlier interest rate charged by the assessee and by stating that 5% would be a reasonable rate had the assessee advanced loan within India. The assessee, on the other hand, has also not bench marked the said transaction and had charged 2% notional interest on the loan advanced to its AE. It is evidenced that to determine the arm’s length price of any international transaction, there has to be a reasonable bench marking conducted by both the sides. Here the assessee and the Revenue in the present case has not carried out the same. In the absence of such bench marking, we are not justified in upholding either the interest rate considered by the assessee nor by the ld. A.O./TPO and the ld. CIT(A). For this purpose, we deem it fit to remand this issue back to the file of the ld. CIT(A) for the purpose of 12 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) bench marking the said transaction. Hence, ground no. 3 raised by the assessee and ground no. 2(a) & 2(b) of the Revenue are allowed for statistical purpose.
Ground nos. 4 & 5 pertains to the disallowance made by the ld. A.O. and upheld by the ld. CIT(A) u/s. 14A read with Rule 8D of the Rules amounting to Rs.1,00,31,857/- It is observed that the assessee has earned dividend income of Rs.1,54,53,187/- which was claimed as exempt u/s. 10(34) of the Act. The assessee had made suo moto disallowance of Rs.8,15,083/- being the salary of two employees of treasury division which was attributable to the earning of the tax free income and further during the assessment proceeding worked out Rs.24,41,004/- as disallowance computed under Rule 8D(2)(ii) of the Act. The ld. A.O. then worked out the disallowance under Rule 8D(2) at Rs.1,31,00,857/- and made an addition of Rs.92,16,774/- after reducing the suo moto disallowance made by the assessee.
The assessee was in appeal before the first appellate authority.
The ld. CIT(A) upheld the addition made by the ld. A.O. by rejecting the assessee’s contention.
The assessee is in appeal before us challenging the order of the ld. CIT(A).
It is observed that the assessee’s investment had increased from Rs.123,16,27,498/- as on 01.04.2009 to Rs.176,27,96,352/- as on 31.03.2010 and the borrowings has also increased from Rs.59,21,27,417/- to Rs.78,24,58,634/- for which interest of Rs.6,34,73,013/- was paid during the year under consideration. The assessee
13 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) has made a suo moto disallowance only towards the salary of two employees who are incharge of the treasury funds pertaining to the assessee’s investment. Both the lower authorities have rejected the assessee’s contention that its own funds were more than the borrowed funds for which disallowance ought not to have been made and also the contention that only the investments which has yielded exempt income has to be considered while determining the average value of investment.
The ld. AR for the assessee has relied on the decision of the Hon'ble Jurisdictional High Court in the case of CIT vs Reliance Utilities & Power Ltd [2009] 313 ITR 340 (Bom) for the proposition that when own funds are more than borrowed funds, no interest disallowance is warranted and the Special Bench decision of ITAT Delhi in the case of ACIT vs. Vireet Investment Pvt. Ltd. (in and CO NO.68/Del/2014 vide order dated 16.06.2017), wherein it was held that only those investments which has yielded income are to be considered for computing the average value of the investment.
From the above observation, it is evident that the assessee had interest free fund more than the borrowed fund during the year under consideration. As there are various judicial precedence on the proposition that when there are mixed funds, then the presumption would be that the assessee has made investment out of the own funds and not borrowed fund for the purpose of investment which has yielded exempt income. It is also pertinent to point out that the decision relied upon by the assessee in the case of Vireet Investment Pvt. Ltd. (supra) has held that while computing the average value of investments only those investments which has yielded income are to be considered and 14 & 4713/Mum/2016 (A.Y. 2010-11) ACG Associated Capsules Pvt. Ltd. (Formerly known as : Associated Capsules P. Ltd.) not the investments which has not earned exempt income during the year. Hence, we deem it fit to remand the issue back to the file of the ld. A.O. for restricting the disallowance to the extent of the investment which has yielded the exempt income during the year under consideration and also to verify that the assessee had sufficient interest free funds during the relevant year where the assessee has made investment which had yielded the exempt income. Hence, ground nos. 4 & 5 raised by the assessee are allowed for statistical purpose.
In the result, the appeal filed by the assessee and the Revenue are allowed for statistical purpose.
Order pronounced in the open court on 20.03.2024.