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Income Tax Appellate Tribunal, DELHI BENCH “I-2” NEW DELHI
Before: SHRI I.C. SUDHIR & SHRI PRASHANT MAHARISHI
ORDER
PER I.C. SUDHIR: JUDICIAL MEMBER These are six appeals filed by the assessee against the action of the learned DRP upholding the order passed by the AO under Section 153A read with section 144C of the Act for assessment years 2006-07 to 2010-11 and under section 143(3) for assessment year 2011-12 consequent to the direction issued by the learned Dispute Resolution Panel.
In the appeal filed for assessment years, 2006-07, 2007-08 and 2008-09, besides questioning the validity of assessment framed under section 153A of the Income-tax Act, 1961, the only issue is the addition of amount of the notional interest on foreign currency loan advanced by the assessee company to its wholly owned foreign subsidiaries. Whereas for assessment years 2009-10 to 2 2011-12, besides the above adjustment on account of the notional interest, the issue also is that of addition under Section 14A of the Income Tax Act.
The assessee company is engaged in manufacturing of flavoured chewing tobacco, kiwam, scented elaichi, etc. under the brand name ‘BABA’ and ‘TULSI’ and exported its 100% of production during the years under consideration.
The original assessments under section 143(3) were completed in respect of assessment years 2006-07, 2007-08 and 2008-09. Thereafter a search took place on 21st January, 2011.
The AO thereafter took up the assessment by issuing notice under section 153A. During the course of the assessment the AO referred the matter to the Transfer Pricing Officer. The learned TPO noted that the assessee company has extended loans to its subsidiary companies and held that the assessee ought to have charged interest in respect of such loans and accordingly the TPO recommend that interest as per the Prime Lending Rate of State Bank of India be added as income on account of adjustment of arm’s length price. Thereafter the AO passed the draft assessment order making additions as recommended by the TPO.
Aggrieved by the order of the TPO, the assessee filed objection before the Dispute Resolution Panel. It was contended by the assessee that since the money given as loan to its subsidiary companies was own money and hence no 3 adjustment is required to be made. It was further submitted that the rate of interest charged cannot be the Prime Lending Rate of State Bank of India. This money has been advanced in foreign currency and as such interest is to be charged as per the interest rate in foreign currency i.e. LIBOR.
The learned DRP did not agree with the contention of the assessee. However, it gave a part relief by holding that the interest rate be charged be only base rate and further adjusted by 150 basis point in terms of Safe Harbour Rules. On the issue of addition under Section 14A, the learned DRP confirmed the action of the AO.
Aggrieved by the order of the learned DRP and the final assessment order passed by the AO the assessee is in appeal before us.
It was contended by the learned AR that the AO was not justified in tinkering with the assessment for assessment years 2006-07 to 2008-09 as these assessments have not abated consequent to the search. The search has taken place on 21st January, 2011. No incriminating material was found during the course of the search as is evident from the assessment order. It was contended that in the absence of any incriminating material, the AO should not have made an addition. In support thereof the learned AR relied upon the order of the jurisdictional Delhi High Court in the case CIT (Central) – III versus Kabul Chawla [2016] 380 ITR 573 (Del)
On the issue of the merit, it was contended by the learned AR that the additions are untenable as the assessee has paid the advances to its subsidiary companies out of EEFC accounts. The EEFC account even otherwise does not earn any interest. The advances given to the subsidiary companies were in the nature of quasi capital and were for business consideration. The main purpose of giving advances to its subsidiary companies was to promote its export business and to have foothold in these foreign countries.
In the alternative, it was contended by the learned AR that the rate of interest cannot be that of the Indian Rupees. The money has been advanced in foreign currency and interest rate to be charged has to be the interest rate of such foreign currency. If the money has been advanced in US Dollar it has to be LIBOR. In respect of advances in Euro the interest rate has to be EUR (LIBOR) and in respect of advances given in Swiss Franc the interest rate has to be that of CHF (LIBOR). In support of its contention the learned AR relied upon the judgment of the Coordinate Bench of the ITAT in the case of Cotton Natural India Pvt. Ltd. vs. DCIT, Circle 3(1), New Delhi 142 ITD (Del) 662 which has also been confirmed by the jurisdictional Delhi High Court. The learned AR also relied upon the following judgments of the ITAT:-
(i) Siva Industries & Holdings Limited Vs ACIT (2011) 59 DTR 0182 (ii) Tata Autocomp Systems Limited Vs ACIT (2012) 73 DTR 0220 (iii) Four Soft Ltd. Vs DCIT (2014) 106 DTR 0137(Hyd)
5 (iv) Aurionpro Solutions Limited
It was further contended that the amount of loan outstanding to its subsidiary companies has been converted into share application money in the assessment year 2011-12. The said loan having become share application money, the TPO cannot change the characteristic of the transaction so as to treat the share application as loan money so as to charge interest thereon. In support thereof, the learned AR placed reliance on the judgment of the Coordinate Bench of the ITAT in the case of Bharti Airtel Limited vs ACIT, dated 11.03.2014. The learned AR also relied upon the following judgments:-
(i) Pan India Network Infravest Private Limited vs ACIT (ITA No. 7026 & 7025 /Mumbai/2013 dated 04.12.2015 (ii) CIT Vs EKL Appliances, and 1070/2011 (iii) Parle Buiscuits P Ltd Vs DCIT (ITA No. 9010/Mum/2010) dated 11.4.2014 ITAT Mumbai (iv) All cargo Logistics Ltd Vs ACIT (2014) 150 ITD 0651 dated. 10.6.2014
On the issue of disallowance under section 14A made by the AO in assessment year 2009-10 to 2011-12, it was submitted by the learned AR that the disallowance has been made by the AO without recording any satisfaction. The AO has straightaway invoked the provisions of Rule 8D. In support there of the learned AR has placed reliance on the judgment of the jurisdictional Delhi High Court in the case of CIT vs. Taikisha Engineering India Ltd., (2015) 370 ITR 0338 (Del).
6 14. It was further submitted that in any case the disallowance under Section 14A cannot exceed the dividend income earned by the assessee company.
The learned DR, on the other hand, supported the order passed by the TPO as modified by the learned DRP. It was contended that the order passed by the TPO as well as the learned DRP on the issue of adjustment of interest is a speaking order. It was further contended that once the search has been initiated all the assessments get reopened consequent to the issue of notice under section 153A and as such the AO is entitled to make adjustment to the income as permissible under the law.
On the issue of rate of interest it was contended that the rate of interest has to be that of Indian Rupees as assessee would have earned the interest in Indian Rupees had it not advanced the money to its foreign subsidiary.
As regards conversion of the loan into share application money in assessment year 2011-12 it was contended that there is no difference between the loan and the share application money and hence interest has to be charged for that year also.
On the issue of disallowance under section 14A it was contended that the AO has invoked the provisions of Rule 8D and mere not recording of satisfaction will not make such disallowance untenable in the eye of law.
7 19. We have considered the rival submissions and perused the order passed by the authorities below. The first issue is addition made by the AO in the assessment years which have not abated consequent to the search i.e. assessment years 2006-07, 2007-08 and 2008-09. As per the facts on record, the search took place on 21.1.2011. Assessments for all these three years have been completed under section 143(3) of the Act. No incriminating material was found during the course of the search. As is evident from the assessment order the addition has been made consequent to the reference made by the AO to TPO. The issue which arises for consideration is whether the AO could have made addition in these assessment years without there being any incriminating material and in absence of the abatement of assessment orders already framed. This issue is now squarely covered by the judgment of the jurisdictional Delhi High Court in the case of CIT (Central) – III vs. Kabul Chawla (Supra) wherein the Hon’ble High Court has been pleased to hold as under:-
“37. On a conspectus of Section 153A(1) of the Act, read with the provisos thereto, and in the light of the law explained in the aforementioned decisions, the legal position that emerges is as under: i. Once a search takes place under Section 132 of the Act, notice under Section 153 A(1) will have to be mandatorily issued to the person searched requiring him to file returns for six AYs immediately preceding the previous year relevant to the AY in which the search takes place. ii. Assessments and reassessments pending on the date of the search shall abate. The total income for such AYs will have to be computed by the AOs as a fresh exercise. iii. The AO will exercise normal assessment powers in respect of the six years previous to the relevant AY in which the search takes place. The AO has the power to assess and reassess the 'total income' of the aforementioned six years in separate assessment orders for each of the six years. In other words there will be only one assessment order in respect of each of the six AYs "in which both the disclosed and the undisclosed income would be brought to tax". iv. Although Section 153 A does not say that additions should be strictly made on the basis of evidence found in the course of the search, or other post-search material or information available with the AO which can be related to the evidence found, it does not mean that the assessment "can be arbitrary or made without any relevance or nexus with the seized material. Obviously an assessment has to be made under this Section only on the basis of seized material." v. In absence of any incriminating material, the completed assessment can be reiterated and the abated assessment or reassessment can be made. The word 'assess' in Section 153 A is relatable to abated proceedings (i.e. those pending on the date of search) and the word 'reassess' to completed assessment proceedings. vi. Insofar as pending assessments are concerned, the jurisdiction to make the original assessment and the assessment under Section 153A merges into one. Only one assessment shall be made separately for each AY on the basis of the findings of the search and any other material existing or brought on the record of the AO. vii. Completed assessments can be interfered with by the AO while making the assessment under Section 153 A only on the basis of some incriminating material unearthed during the course of search or requisition of documents or undisclosed income or property discovered in the course of search which were not produced or not already disclosed or made known in the course of original assessment. Conclusion 38. The present appeals concern AYs, 2002-03, 2005-06 and 2006- 07.On the date of the search the said assessments already stood completed. Since no incriminating material was unearthed during the search, no additions could have been made to the income already assessed.
The question framed by the Court is answered in favour of the Assessee and against the Revenue.”
The above view has been reiterated by the Hon’ble Delhi High Court in the case of CIT-7 vs. RRJ Securities Ltd. in [2016] 380 ITR 612 (Del) where the Hon’ble Court has been pleased to hold as under:-
“In respect of such assessments which have abated, the AO would have the jurisdiction to proceed and make an assessment. However, in respect of concluded assessments, the AO would assume jurisdiction toreassess provided that the assets/documents received by the AO representor indicate any undisclosed income or possibility of any income that may have remained undisclosed in the relevant assessment years. This Court in Commissioner of Income Tax (Central)-III v. Kabul Chawla: ITA707/2014, decided on 28th August, 2015 has held that completed assessments could only be interfered with by the AO on the basis of an incriminating material unearthed during the course of the search or requisition of the documents. In absence of any incriminating material, the AO does not have any jurisdiction to interfere in concluded assessments.
In the present case, as stated hereinabove, the addition has been made without there being any incriminating material and in absence of pendency of assessment. In the absence of any incriminating material, as held by the Hon’ble High Court, the addition cannot be made in an assessment under section 153A. Respectfully following the judgment of the jurisdictional Delhi High Court, we hold that the AO was not justified in making the addition and accordingly the addition made by the AO in the assessment years 2006-07, 2007-08 and 2008-09 are directed to be deleted. Consequently the appeals filed for these assessment years are allowed.
As regards assessment years 2009-10 and 2010-11 are concerned the learned DRP has confirmed the addition applying the base rate of State Bank of 10 India plus 150 basis points. It was the contention of the learned AR that no addition can be made as the advance made was out of the EEFC account which carries no interest. Further amount advanced was for promoting its business. On this issue we are not in agreement with the contention of the learned AR. The amount having been advanced to an Associated Enterprises, the same has to be evaluated by applying arm’s length price. Since it was a loan during the assessment years 2009-10 and 2010-11, the assessee company ought to have computed the arm’s length price in respect of such loan advanced to its subsidiary companies. However, as regards the interest rate we are in agreement with the contention of the learned AR that this cannot be the interest rate applicable to Indian Rupees. These advances having been made in the foreign currency, the rate of interest has to be with reference to the interest rate on loans and advances in respect of foreign currency. This issue is covered by the judgment of the jurisdictional Delhi High Court in the case of CIT vs. Cotton Naturals (P) P Ltd. (2015) 276 CTR 0445 (Del) wherein the Hon’ble High Court has been pleased to hold as under:-
“39. The question whether the interest rate prevailing in India should be applied, for the lender was an Indian company/assessee, or the lending rate prevalent in the United States should be applied, for the borrower was a resident and an assessee of the said country, in our considered opinion, must be answered by adopting and applying a commonsensical and pragmatic reasoning. We have no hesitation in holding that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. Interest rates should not be computed on the basis of interest payable on the currency or legal tender of the place or the country of residence of either party. Interest rates applicable to loans and deposits in the national currency of the borrower or the lender would vary and are dependent upon the fiscal policy of the Central bank, mandate of the Government and several other parameters. Interest rates payable on currency specific loans/ deposits are significantly universal and globally applicable. The currency in which the loan is to be re-paid normally determines the rate of return on the money lent, i.e. the rate of interest. Klaus Vogel on Double Taxation Conventions (Third Edition) under Article 11 in paragraph 115 states as under:- The existing differences in the levels of interest rates do not depend on any place but rather on the currency concerned. The rate of interest on a US $ loan is the same in New York as in Frankfurt-at least within the framework of free capital markets (subject to the arbitrage). In regard to the question as to whether the level of interest rates in the lender‘s State or that in the borrower‘s is decisive, therefore, primarily depends on the currency agreed upon (BFH BSt.B1. II 725 (1994), re. 1 § AStG). A differentiation between debt-claims or debts in national currency and those in foreign currency is normally no use, because, for instance, a US $ loan advanced by a US lender is to him a debt-claim in national currency whereas to a German borrower it is a foreign currency debt (the situation being different, however, when an agreement in a third currency is involved). Moreover, a difference in interest levels frequently reflects no more than different expectations in regard to rates of exchange, rates of inflation and other aspects. Hence, the choice of one particular currency can be just as reasonable as that of another, despite different levels of interest rates. An economic criterion for one party may be that it wants, if possible, to avoid exchange risks (for example, by matching the currency of the loan with that of the funds anticipated to be available for debt service), such as taking out a US $ loan if the proceeds in US $ are expected to become available (say from exports). If an exchange risk were to prove incapable of being avoided (say, by forward rate fixing), the appropriate course would be to attribute it to the economically more powerful party. But, exactly where there is no ‗special relationship‘, this will frequently not be possible in dealings with such party. Consequently, it will normally not be possible to review and adjust the interest rate to the extent that such rate depends on the currency involved. Moreover, it is questionable whether such an adjustment could be based on Art. 11 (6).For Art. 11(6), at least its wording, allows the authorities to ‗eliminate hypothetically‘ the special relationships only in regard to the level of interest rates and not in regard to other circumstances, such as the choice of currency. If such other circumstances were to be included in the review, there would be doubts as to where the line should be drawn, i.e., whether an examination should be allowed of the question of whether in the absence of a special relationship (i.e., financial power, strong position in the market, etc., of the foreign corporate group member) the borrowing company might not have completely refrained from making investment for which it borrowed the money.
13 The aforesaid methodology recommended by Klaus Vogel appeals to us and appears to be the reasonable and proper parameter to decide upon the question of applicability of interest rate. The loan in question was given in foreign currency i.e. US $ and was also to be repaid in the same currency i.e. US $. Interest rate applicable to loans granted and to be returned in Indian Rupees would not be the relevant comparable. Even in India, interest rates on FCNR accounts maintained in foreign currency are different and dependent upon the currency in question. They are not dependent upon the PLR rate, which is applicable to loans in Indian Rupee. The PLR rate, therefore, would not be applicable and should not be applied for determining the interest rate in the extant case. PLR rates are not applicable to loans to be re-paid in foreign currency. The interest rates vary and are thus dependent on the foreign currency in which the repayment is to be made. The same principle should apply.”
Accordingly the applicable rate of interest shall be the rate of interest in respect of such foreign currency in which the loans have been advance. As per the details available on record during the assessment years 2009-10 and 2010- 11 assessee has advanced to its subsidiary companies as detailed below:-
ASSESSMENT Baba Global Co. Baba Global Baba Global AG, YEAR (BD) Ltd Co. FZC Switzerland (Bangladesh) LTd(UAE) 2009-10 $44,944 CHF 7,56,957 CHF 40,00,000
2010-11 $57,944 CHF 98,447 CHF 50,00,000
2011-12 $77,944 - CHF 50,00,000 (Converted to share (Converted to Share applicable money) Application Money)
The interest rates applicable in respect of these currencies during these years, as submitted by the learned AR, were as under:-
Assessment year Currency wise LIBOR Rate USD ($) EURO(€) Swiss Franc(CHF) AY 2009-10 3.089% 4.822% 2.896% AY 2010-11 1.559% 1.604% 0.800% AY 2011-12 0.923% 1.327% 0.554% Taking into consideration of the above facts, the learned AO is directed to verify the above interest rate and recompute the adjustment on account of interest by applying the rate of interest of the relevant currency in the AY 2009-10 & 2010-11. Accordingly this ground of the assessee is partly allowed for AY 2009-10 & 2010-11.
As regards the addition on this account in assessment year 2011-12, the advance given to its subsidiary companies stand converted into share application money. Once the loan has been converted into share application money, for the issue of the share capital, then such amount cannot be considered as loan. The 15 TPO is not permitted under the law to re-characterize the transaction and accordingly we are of the view that no interest on such share application money can be charged. The above view is supported by the judgment of the Coordinate Bench of the ITAT in the case of Bharti Airtel Ltd. vs. ACIT, [2014] 161 TTJ 0283 (Del) wherein the ITAT has held as under:-
“47. We find that in the present case the TPO has not disputed that the impugned transactions were in the nature of payments for share application money, and thus, of capital contributions. The TPO has not made any adjustment with regard to the ALP of the capital contribution. He has, however, treated these transactions partly as of an interest free loan, for the period between the dates of payment till the date on which shares were actually allotted, and partly as capital contribution, i.e. after the subscribed shares were allotted by the subsidiaries in which capital contributions were made. No doubt, if these transactions are treated as in the nature of lending or borrowing, the transactions can be subjected to ALP adjustments, and the ALP so computed can be the basis of computing taxable business profits of the assessee, but the core issue before us is whether such a deeming fiction is envisaged under the scheme of the transfer pricing legislation or on the facts of this case. We donot find so. We donot find any provision in law enabling such deeming fiction.
In view of the above facts and the judgment of coordinate bench, the AO is directed to verify the date of conversion of loan to share application money and not to make any adjustment on account of interest post conversion of loan to share application money and accordingly this ground of the assessee is allowed for statistical purpose.
As regards the disallowance under section 14A in respect of the expenditure incurred for earning exempt income is concerned, we note that the assessee has earned the following income in the assessment years 2009-10 to 2011-12:-
Assessment Year Dividend Income AY 2009-10 Rs. 17,00,115 AY 2010-11 Rs.29,218 AY 2011-12 Rs. 4,39,358
Against this the AO has made disallowance as under:-
Assessment Year Amount of Disallowance 2009-10 1,38,903/- 2010-11 4,84,517/- 2011-12 17,99,732/-
The contention of the assessee is that in the absence of any satisfaction being recoded disallowance under section 14A cannot be sustained. The alternative contention of the learned AR has been that the addition in any case cannot exceed the exempt income. As regards first contention that no satisfaction has been recorded we note from the assessment order that the AO has considered the explanation of the assessee and after taking into
17 consideration the explanation he has invoked Rule 8D. Having done so, it cannot be said that the AO has not taken into consideration the explanation of the assessee.
However, as regards the second contention of the learned AR that the disallowance cannot exceed the exempt income, we are in agreement with this contention. This view is supported by the judgment of the Hon’ble jurisdictional Delhi High Court in the case of Joint Investments Pvt. Ltd. versus Commissioner of Income Tax [2015] 372 ITR 694 (Del). Accordingly we direct the AO to restrict the addition to the exempt income. Accordingly this ground is partly allowed in favour of the assessee.
In view of the above findings the assessee’s appeals for the A.Y. 2006-07 being A.Y. 2008-09 being ITA No. 1088/Del/2015 are allowed, Appeal for A.Y. 2009-10 being ITA No. 1089/Del/2015, A.Y. 2010-11 being ITA No. 1090/Del/2015 and A.Y. 2011-12 being ITA No. 1091/Del/2015 are partly allowed. Order pronounced in the open court on 05.05.2016 Sd/- Sd/- ( PRASHANT MAHARISHI ) ( I.C. SUDHIR ) ACCOUNTANT MEMBER JUDICIAL MEMBER Dated: 05/05/2016 Mohan Lal