UFO MOVIEZ INDIA LTD.,NEW DELHI vs. ACIT, NEW DELHI

By way of this appeal, the assessee appellant has challenged correctness of the order dated 1st November, 2012 passed by the Assessing Officer in the matter of assessment under section 143(3) r.w.s. 144C(4) of the Income Tax Act, 1961, for the assessment year 2008-09.

Although the assessee has raised as many as nine grounds of appeal, as learned representatives fairly agree, there are only three issues which we are required to adjudicate upon in this appeal- first, whether or not the Assessing Officer was justified in making an arm’s length price adjustment of Rs 74,20,785 in respect of interest charged by the assessee on loan advanced to its subsidiary abroad; second, whether or I.T.A. No.: 6321/Del/2012 Assessment year: 2008-09 Page 2 of 11 not the Assessing Officer was justified in making a disallowance of Rs 38,35,298 under section 14A of Act, and; finally, whether or not the Assessing Officer was justified in disallowance of Rs 3,98,750, as capital expenditure, in respect of purchase of FWP (fixed wireless phone) equipment. We will take up these three issues one by one.

So far as ALP adjustment of Rs 74,20,785 is concerned, the relevant material facts are like this. During the course of proceedings before the Transfer Pricing Officer, it was noted that the assessee had advanced a loan of US $ 1,08,50,000 to its subsidiary Edridge Limited, Cyprus, on an interest @ 7% p.a. The TPO was of the view that “the AE is not of such a financial health that it could have got the loan on its own”, that “one can reasonably conclude that this company (i.e. the AE) is at best a conduit” as the funds were used by the said to have been used for giving loans to the step down subsidiaries which, in turn, had purchased equipment with the money so received, that given the fact that it’s a one off transaction and that the assessee is not lending money in the regular course of business, “it can be stated that there is high level of risk borne by you (i.e. the assessee) in this transaction”, and since the assessee has not received any principal repayment so far, the belief that this transaction is a high risk transaction is further strengthened. In the backdrop of these observations, the Assessing Officer noted that the assessee is following the CUP method and assessee is the tested party, the arm’s length price of interest will be “the prevalent interest rate that could have been earned by the taxpayer by advancing a loan to an unrelated party in India with the same weak financial health as that of the taxpayer’s AE”. It was also noted that the assessee had given this loan without any security, and that since an unsecured loan like the one advanced by the taxpayer, which is without any guarantee or security, is equivalent to a corporate bond of BB to D category. Based on the average annualised yield information obtained from CRISIL, and an interpolation of this data on the basis of a series of assumptions, the TPO concluded that 17.26% p.a., compounded on monthly basis is a reasonable uncontrolled price for the loan advanced to the subsidiary. Aggrieved by the adjustment proposed on this basis, assessee approached the Dispute Resolution Panel. While the DRP did not approve the action of the TPO in benchmarking the interest on the basis of interest rate on rupee denominated loans, it did “not find fault with the findings of the TPPO that the credit rating of the loan given by the I.T.A. No.: 6321/Del/2012 Assessment year: 2008-09 Page 3 of 11 assessee to its subsidiary should be considered as BB” and proceeded to add that “generally, the Indian banks are charging interest rate of 2.5% to 5% above LIBOR/EURIBOR for foreign currency loans” and, therefore, the DRP was “of the view that interest rate of 4% above LIBOR would be reasonable for the loans of BB rating for a period of five years”. The TPO was, accordingly, directed to recompute the ALP of interest on loan advanced by the assessee by applying interest rate of 4% above LIBOR. On this basis, the TPO computed the interest at an arm’s length price of Rs 3,26,17,723 as against interest charged by the assessee at Rs 2,51,96,838, and, make an ALP adjustment of Rs 74,20,785. The assessee is aggrieved and is in appeal before us.

We have heard the rival contentions, perused the material on record and duly considered facts of the case in the light of the applicable legal position.

We have noted that there is no dispute that the LIBOR rate, so far as the relevant previous year was concerned, is to be taken at 4.53%, as the TPO himself has, pursuant to the directions of the DRP to adopt ALP at LIBOR+4%, taken the ALP at 8.53%. The order dated 19th March 2013, a copy of which was placed before us at pages 426 and 427 of the paper-book, clearly evidences this factual position. There is also no dispute that the assessee has advanced the loan to the subsidiary at 7% per annum. Clearly, therefore, as long as the comparable uncontrolled price of the US $ denominated lending is less than 247 points (i.e.700-453) above the LIBOR rate, the transaction entered into by the assessee with its subsidiary cannot be said to be at less than arm’s length price. The Transfer Pricing Study filed by the assessee, however, does not throw much light on this aspect of the matter beyond stating, in rather vague terms, that “a study revealed that around 100 basis points increase in the LIBOR rate is considered appropriate for lending to corporates”, and that “therefore, the adjusted interest percentage is to be taken the arm’s length interest rate i.e. 5.53%”. Such sweeping generalizations and vague justifications as inherent in the above comment in the TP study, in support of LIBOR+100 basis points as ALP, cannot meet any judicial approval.

While exploring such possibilities, it will be useful to take note of the fact that in the case of Bharti Airtel Limited Vs ACIT [(2014) 161 TTJ 283], and a coordinate bench had deleted a similar ALP adjustment on account of interest amounting to Rs 10,11,786 wherein the same approach of adopting 400 basis points above the LIBOR as ALP was adopted. While deleting this ALP adjustment, speaking through one of us, the Tribunal had, inter alia, observed as follows:

We see no substance in this adjustment either. The TPO has taken the lender as the tested party, and yet made adjustments for higher risks on account of assumed lack of security and increased risk of single party dealing. This approach overlooks the fact that the assessee has advanced monies to its subsidiaries which are under its management and control- a factor which substantially reduces the risk rather than increasing it. On these facts, it is difficult to understand, much less approve, any rationale for adjustment on account of higher risks. On this point also, we see no merits in the stand of the TPO.

When the matter was carried in further appeal, this time by the Commissioner, before Hon’ble Delhi High Court, Their Lordships were, vide judgment dated 25th February 2015- a copy of which was placed before us by the learned counsel, pleased to approve the reasoning adopted by the Tribunal. In doing so, Their Lordship observed as follows:

That was also a case in which the lender parent company was taken as the tested party, the loan was advanced to a subsidiary company without much to the credit of its financial credentials and the loan was treated as a high risk loan resulting in adopting the maximum LIBOR rate on which dollar loans were advanced. Yet, Hon’ble High Court specifically approved the Tribunal’s reasoning that the “assessee advanced monies to the subsidiaries which were under its management and control, which in fact substantially reduced the risk and in these circumstances there was no rationale of adjusting any amount of higher basis”. When such are the views of Their Lordships, it is futile to suggest that the loans advanced by the parents to subsidiary can indeed be taken as BB to D grade investments which refers to, as noted by the TPO himself at page 28 of the order, investments with serious risks of inadequate safety, investments of high risk, investments of substantial risk and investments of default. The approach adopted by the DRP cannot, therefore, meet our approval.

There are any number of decisions by the coordinate benches which show that the interest rates charged on foreign currency, say US dollars, loans are much lower than the 250 to 500 basis points above the LIBOR having been to be generally applicable rates. For instance, in the cases of Bharti Airtel (supra), which pertains to the assessment years 2007-08 and 2008-09, the comparable cases were taken as 150 basis points above LIBOR and in the range of 140-170 basis points above LIBOR. In contrast to this comparable case, the interest charged in the present case is 247 points above the LIBOR rate. In the case of Siva Industries & Holdings Ltd Vs ACIT [(2012) 145 TTJ 497 (Chennai)], dealing with the assessment year 2006-07 and while referring to LIBOR at 4.42, interest rate on advances to subsidiary at 6%, which was thus 158 points above the LIBOR rate, was held to be an arm’s length price. In view of these discussions, it cannot be said that the advance to subsidiary, at 247 basis points above the LIBOR, is not at an arm’s length price. In any event, once DRP itself states that the Indian banks are charging 250 basis above LIBOR on similar loans, even though this interest rate could reach upto 400 basis points in some cases, there cannot be any good reason for holding that loan advanced to a subsidiary at 247 basis points above the LIBOR rate is not at an arm’s length price. That apart, as noted earlier in this order, once Hon’b;le Delhi High Court, observes that the “assessee advanced monies to the subsidiaries which were under its management and control, which in fact substantially reduced the risk and in these circumstances there was no rationale of adjusting any amount of higher basis”, it cannot be open to the transfer pricing authorities to contend that this loan should be treated as a high risk loan on which high interest rate should be charged even within the range of interest rates charged by the Indian banks generally. In view of these discussions, as also bearing in mind entirety of the case, we uphold the grievance of the assessee and direct the Assessing Officer to delete this arm’s length price adjustment of Rs 74,20,785 in respect of interest charged on advances to the subsidiaries.

The next issue in this appeal, in ground no. 6, is with respect to disallowance of Rs 38,35,298 under section 14A.

So far this disallowance is concerned, the relevant material facts are as follows. During the relevant previous year, the assessee had received the e=tax exempt dividend of Rs 21,47,983. The uncontroverted stand of the assessee all along has been that no part of the investments in HDFC mutual fund units, which has resulted in the tax exempt dividend of Rs 38,35,298, was out of borrowed funds, and, as such, disallowance under section 14A was uncalled for. The Assessing Officer, however, rejected this submission on the ground that once a formula for computation for disallowance under section 14A has been set out in rule 8D, which is applicable in the assessment year- as held by Hon’ble Bombay High Court in the case of Godrej &Boyce Mfg Co Ltd Vs DCIT [( )328 ITR 81 (Bom)], the disallowance has to be made in accordance with the said rule, and disallowance for a part of interest in inherent in the said rule. When assessee raised the objection before the SDRP, the DRP held, even after noting that the investments were not made out of borrowed funds, that “….the Assessing Officer has not disallowed the entire interest” and that “he has only made pro-rata disallowance of interest in accordance with the formula set out in rule 8 D”. It is in this backdrop that the Assessing Officer proceeded with the disallowance of Rs 38,35,298. The assessee is aggrieved and is in appeal before us.

We have heard the rival contentions, perused the material on record and duly considered the facts of the case, in the light of the applicable legal position.