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Income Tax Appellate Tribunal, DELHI ‘I-1’ BENCH, NEW DELHI
By way of this appeal, the assessee appellant has challenged correctness of the order dated 27th December, 2013 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 2009-10.
Although the assessee has raised as many as eight grounds of appeal
, as learned representatives fairly agree, there are only two 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.1,50,41,205/- in respect of interest charged by the assessee on loan advanced to its subsidiary abroad and; second, whether I.T.A. No.: 1123/Del/2014 Assessment year: 2009
10. Page 2 of 10 or not the Assessing Officer was justified in making a disallowance of Rs 31,19,827/- under section 14A of Act.
Learned Representatives fairly agree that whatever we decide in the assessment year 2008-09 will apply, mutatis mutandis, for this assessment year as well. Vide our order of even date, we have upheld the similar grievance of the assessee for assessment Year 2008-09 by, inter alia, observing as follows:-
“3. 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 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 I.T.A. No.: 1123/Del/2014 Assessment year: 2009-10 Page 3 of 10 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.
6. What is important, however, is that even after this stated ALP of LIBOR + 100 basis points, there is still a cushion of further 147 basis points before the interest charged can be said to more than the arm’s length price, and it is an old matter. It is, therefore, worth exploring whether, even within the limitations of somewhat sketchy information available on the facts of this case, the matter can be decided one way or the other rather than sending it back to the TPO for fresh adjudication.
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: 62. As far as the first adjustment is concerned, while the TPO has adopted the rate as 4% over LIBOR rate, he has not set out the specific basis of this rate. He has mentioned about some information gathered from websites of financial institutions which, according to him, states that, "for the foreign currency denominated term loans, the maximum rate of interest is 4% over 6 months LIBOR", and then proceeded to adopt this maximum interest rate as a fair basis for his computing the arm's length price. On the other hand, the assessee has taken two specific comparables of USD borrowings, i.e. L&T and Seri Infrastructure, on the interest rate of LIBOR + 150 bps and 1.4% to I.T.A. No.: 1123/Del/2014 Assessment year: 2009-10 Page 4 of 10 1.7% band over LIBOR respectively. There is no material whatsoever, save and except for vague observations about weak financials of the subsidiaries - which are not supported by any specific facts and proceed on sweeping generalizations and assumptions, to reject the comparables taken by the assessee. When a Transfer Pricing Officer rejects comparables taken by the assessee, he has to set out specific, cogent and legally sustainable reasons for doing so. On this point, therefore, the stand of the Assessing Officer cannot be accepted. …………………. ………………….
That leaves us with third point of difference between the assessee and the TPO and that is with regard to adjustment of 177.60 points, as balancing figure, towards lack of security and lender not being in the business of borrowing and lending money. This adjustment is justified by the TPO on the following ground:
7.10 Adjustment between a banker and non-banker As the taxpayer is not in the business of lending and borrowing money, his risk is higher in advancing loan to a single customer than a bank, which spreads its risk among its various customers. Thus, the difference between banker and non-banker is to be kept in mind while arriving at the arm's length CUP rate based on bank rates. 7.11 Adjustment for security Usually, bankers extending loans in foreign currency also insist on sufficient security. In this case, no security is offered by the AE. Keeping in view the financial health of the subsidiary, it may not be in a position to offer security. Thus an adjustment is required to be made for not offering a security. This may be computed as the difference between the interest rates prevailing for the bonds of equivalent credit rating of the AE and sovereign government bonds in the country in which the AE is located. This can also be considered as the guarantee cost payable to the taxpayer for giving guarantee for equivalent amount of loan given to the AE i.e. the rate differential for the difference in interest spread between the credit rating of the taxpayer and the AE. Thus after the above analysis, the equivalent interest rate is the interest rate including the transaction cost for a foreign currency loan, if given to the AE for its credit standing / rating.
66. 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.
I.T.A. No.: 1123/Del/2014 Assessment year: 2009-10 Page 5 of 10 (Emphasis, by underlining, supplied by us now) 8. 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: 8. The ITAT has also taken note of the fact that two specific comparables of USD borrowings i.e. L&T and Seri Infrastructure, on the interest rate of Libor had been taken into consideration. There is no material whatsoever, save and except for vague observations about weak financials of the subsidiaries – which are not supported by any specific facts and proceed on sweeping generalizations and assumptions, to reject the comparables taken by the assessee. When a Transfer Pricing Officer rejects comparables taken by the assessee, he has to set out specific, cogent and legally sustainable reasons for doing so. On this point, therefore, the stand of the Assessing Officer cannot be accepted. 9……………… 10. The Tribunal further noticed 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.
11. This Court is of the opinion that the reasoning of the ITAT on each of the heads which went into the adjustment of ₹10,11786/- is reasonable and justified and does not call for any interference. (Emphasis, by underlining, supplied by us)
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.
I.T.A. No.: 1123/Del/2014 Assessment year: 2009-10 Page 6 of 10 10. Similarly, the DRP’s observation to the effect that “Generally, Indian banks are charging interest rate of 2.5% to 5% above the LIBOR/EURIBOR for foreign currency loans” is not only devoid of any basis but, as our day to day experience on the bench shows, ex facie incorrect.
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.
Ground nos. 1 to 5, which pertain to the ALP adjustment in respect of interest charged on interest to sib subsidiaries, are thus allowed in the terms indicated above.
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 I.T.A. No.: 1123/Del/2014 Assessment year: 2009-10 Page 7 of 10 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. 16 Learned counsel’s short submission is that since admittedly the investments are not out of the borrowed funds, no part of the interest expenses can be disallowed under section 14A. In support of this proposition, learned counsel of the assessee relies upon the decision of a coordinate bench of this Tribunal, in the case of ACIT Vs Champion Commercial Co Ltd [(2012) 139 ITD 108 (Kol)] which has held that there is an apparent incongruity in the formula under rule 8D which is to be read down to ensure that only common interest expenses are to be disallowed under rule 8D, and, accordingly, in a situation in which the investments in assets yielding tax exempt income are not out of borrowed funds, no part of the interest expenses can be disallowed. The view so taken by the coordinate bench has now been upheld by Hon’ble Delhi High Court, in the case of PCIT Vs Bharti Overseas Limited (judgment dated 17th December 2015). Summing up the views expressed by Their Lordships, www.itatonline.org has reported as follows: (iii) The object behind Section 14A (1) is to disallow only such expense which is relatable to tax exempt income and not expenditure in relation to any taxable income. This object behind Section 14A has to be kept in view while examining Rule 8D (2) (ii). In any event a rule can neither go beyond or restrict the scope of the statutory provision to which it relates. (iv) Rule 8D (2) states that the expenditure in relation to income which is exempt shall be the aggregate of (i) the expenditure attributable to tax exempt income, (ii) and where there is common expenditure which cannot be attributed to either tax exempt income or taxable income then a sum arrived at by applying the formula set out thereunder. What the formula does is basically to “allocate” some part of the common expenditure for disallowance by the proportion that average value of the investment from which the tax exempt income is earned bears to the average of the total assets. It acknowledges that funds are fungible and therefore it would otherwise be difficult to allocate the sum constituting borrowed funds used for making tax-free investments. Given that Rule 8 D (2) (ii) is concerned with only ‘common interest expenditure’ i.e. expenditure I.T.A. No.: 1123/Del/2014 Assessment year: 2009-10 Page 8 of 10 which cannot be attributable to earning either tax exempt income or taxable income, it is indeed incongruous that variable A in the formula will not also exclude interest relatable to taxable income. This is precisely what the ITAT has pointed out in Champion Commercial (supra). There the ITAT said that by not excluding expenditure directly relatable to taxable income, Rule 8D (2) (ii) ends up allocating “expenditure by way of interest, which is not directly attributable to any particular income or receipt, plus interest which is directly attributable to taxable income.” This is contrary to the intention behind Rule 8D (2) (ii) read with Section 14A of (1) and (2) of the Act. (v) The following illustration provided by the ITAT in Champion Commercial (supra) demonstrates the incongruity: “In the case of A & Co. Ltd., total interest expenditure is Rs.1,00,000, out of which interest expenditure in respect of acquiring shares from which tax free dividend earned is Rs.10,000. Out of the balance Rs. 90,000, the assessee has paid interest of Rs. 80,000 for factory building construction which clearly relates to the taxable income. The interest expenditure which is “not directly attributable to any particular receipt or income” is thus only Rs. 10,000. However, in terms of the formula in Rule 8D(2) (ii), allocation of interest which is not directly attributable to any particular income or receipt will be for Rs.90,000 because, as per formula the value of A (i.e. such interest expenses to be allocated between tax exempt and taxable income) will be “A = amount of expenditure by way of interest other than the amount of interest included in clause (i) [i.e. direct interest expenses for tax exempt income] incurred during the previous year”. Let us say the assets relating to taxable income and tax exempt income are in the ratio of 4:1. In such a case, the interest disallowable under Rule 8D(2) (ii) will be Rs.18,000 whereas entire common interest expenditure will only be Rs.10,000”. (vi) What the ITAT has done in the present case instead is to follow its earlier decision in Champion Commercial (supra) which in turn followed the decision of the Bombay High Court in Godrej & Boyce Mfg. Co. Ltd. (supra). The ITAT did not on its own read down rule 8D (2) (ii). Rather, it went by the stand taken by the Revenue before the Bombay High Court in Godrej & Boyce Mfg. Co. Ltd. (supra) in countering the challenge to the constitutional validity of Rule 8 D (2). The stand of the Revenue was that variable A in the formula in Rule 8D (2) (ii) would exclude both interest attributable tax exempt income as well as taxable income. The Bombay High Court took on board the said statement and negatived the challenge to the constitutional validity of the provision by holding as under:
I.T.A. No.: 1123/Del/2014 Assessment year: 2009-10 Page 9 of 10 “60. In the affidavit-in-reply that has been filed on behalf of the Revenue an explanation has been provided of the rationale underlying Rule 8D. In the written submissions which have been filed by the Addl. Solicitor General it has been stated, with reference to R.8D(2) (ii) that since funds are fungible, it would be difficult to allocate the actual quantum of borrowed funds that have been used for making tax-free investments. It is only the interest on borrowed funds that would be apportioned and the amount of expenditure by way of interest that will be taken (as ‘A’ in the formula) will exclude any expenditure by way of interest which is directly attributable to any particular income or receipt (for example- any aspect of the assessee’s business such as plant/machinery et.)….. The justification that has been offered in support of the rationale for R.8D cannot be regarded as being capricious, perverse or arbitrary. Applying the tests formulated by the Supreme Court it is not possible for this Court to hold that there is writ on the statute or on the subordinate legislation perversity, caprice or irrationality. There is certainly no ‘madness in the method”. (vii) Therefore the Court is unable to agree with the Revenue that in adopting the above interpretation the ITAT has on its own read down Rule 8D (2) (ii) of the Rules and therefore travelled beyond the scope of its jurisdiction and powers.
In view of the above discussions, and having noted the uncontroverted claim of the assessee that borrowed funds are not used in investments yielding the tax exempt in question, we are of the considered view that no part of the interest could be disallowed under rule 8D. The question of allocation of interest could arise only in a situation in which at least a part of borrowed funds are used in investments resulting in tax exempt income. That’s not the case here and none of the authorities even allege that. Accordingly, the disallowance under rule 8D remains restricted to 0.5% of the average value of investments resulting in tax exempt income. The Assessing Officer will, accordingly, recompute the disallowance under section 14A r.w.r. 8 D.
Ground no. 6 is thus allowed in principle but remitted to the file of the Assessing Officer for recomputation of disallowance.”
4. We see no reasons to take any other view of the matter than the view so taken by us in assessee’s own case for assessment year 2008-09. Respectfully following the same, we uphold both the grievances of the assessee and direct the Assessing Officer to grant relief in terms of our directions set out above.
I.T.A. No.: 1123/Del/2014 Assessment year: 2009-10 Page 10 of 10 5. So far as first grievance of the assessee is concerned, the disallowance of Rs.1,50,41,205/- shall stand deleted and so far as the second grievance, i.e. the disallowance under section 14A to the extent of Rs. 31,19,827/- is concerned, the matter is remitted to the file of Assessing Officer for recomputation of disallowance in the light of directions set out above which will also apply mutatis mutandis for the present assessment year as well.
In the result, the appeal is partly allowed in the terms indicated above. Pronounced in the open court today on 8th day of January 2016.