M/S INSTRUMENTARIUM CORPORATION LTD.,KOLKATA vs. DDIT (IT)-1(1), KOLKATA, KOLKATA

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IN THE INCOME TAX APPELLATE TRIBUNAL KOLKATA SPECIAL BENCH ‘A’, KOLKATA [Coram: Justice D D Sud (President), N V Vasudevan JM and Pramod Kumar AM] I.T.A. Nos.1548 and 1549/Kol/2009 Assessment years: 2003-04 and 2004-05 Instrumentarium Corporation Limited, Finland ………….Appellant PO Box 100, Fl 00031, GE Finland [PAN: AAADCG1535E] Vs. Assistant Director of Income Tax International Taxation I Kolkata ……..…Respondent Appearances by: N Venkatraman alongwith Avra Mazumdar, Prasun Kumar Maiti, Manish Sheth, Rahul Daga, and Nikita Chapparia, for the appellant Rahul Mitra, alongwith Nilesh Modi, Prashant Maheshwari, Mital Sangharajka for the intervenor Shell Global Solutions International BV [On the basis of ITA Nos. 2933/ Ahd/ 2011 and 2841/ Ahd/ 2012, for the assessment Years 2007-08 & 2008-09, in the cases of Shell Global Solutions International B.V. vs ADIT (International Taxation), Ahmedabad] Rashmi Ranjan Das, for respondent Date of concluding the hearing : April 19, 2016 Date of pronouncing the order : July 15, 2016 O R D E R Per Pramod Kumar, AM:

Question before the Special Bench:

This questions as referred to the special bench, vide order dated 6th April 1. 2010, were as follows:

(1) Whether, on the facts and in the circumstances of the case, no arm’s length rate of interest was required to be charged on the loan granted by

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the non-resident assessee-company to its wholly owned subsidiary Indian company M/s. Datex-Ohmeda (India) Pvt. Ltd. (Datex)? (2) Whether, in the given facts and circumstances of the case, CBDT Circular No.14 of 2001 [252 ITR (St.) 104] and Taxation Ruling TR 2007/1 issued by Australian Taxation Officer are relevant in the context of Transfer Pricing Regulations of India, in particular to the case of the assessee? (3) Whether, setting off of loss with future profits and not assessing the interest income in the hands of the assessee on arm’s length price will cause real loss to the Govt. exchequer?

However, when this finally came up for hearing on 19th April 2016, it was 2. noticed that some of these questions are not even raised in the grounds of appeal filed by the assessee and are in the nature of arguments on certain peripheral issues, in support of the core grievance, focussing on certain narrow facets of the issues requiring our adjudication. As all these aspects will have to be dealt with in the course of our adjudication anyway, it is not necessary to have specific questions on each of the arguments. It was in this background, and with a view to succinctly set out the controversy requiring our adjudication, that the need to modify the questions to be answered by the Special Bench was felt. Accordingly, with the consent of the parties, Hon’ble President was pleased to modify the questions for the consideration of special bench, and the question that this Special Bench thus finally adjudicated upon was as set out below:

Whether, on the facts and in the circumstances of the case, an arm’s length price (ALP) adjustment, of Rs 3,88,37,190 for the assessment year 2003-04 and Rs 5,18,95,560 for the assessment year 2004-05, was required to be made, in respect of interest free loan granted by the assessee, a non-resident company, to its wholly owned subsidiary in India?

The assessee and the transaction: 2. The background in which this question has come up for the consideration of this special bench is like this. The assessee before us, Instrumentarium Corporation Limited (ICL-Finland, in short), is a company incorporated in, and tax resident of,

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Finland. The assessee is engaged in the business of manufacturing and selling medical equipment, and it has a wholly owned subsidiary in India by the name of Datex Ohmeda India Pvt Ltd (Datex India, in short) which acts as ICL-Finland’s marketing arm for its products in India. On 26th August 2002, the assessee entered into an agreement, which was duly approved by the Reserve Bank of India, to advance an interest free loan of Rs 36 crores to Datex-India. It is this interest free advance by the assessee to its Indian subsidiary which is the subject matter of dispute before us. The precise point of dispute is that while the Assessing Officer is firm that by adopting an arm’s length interest on this loan, an arm’s length price (ALP) adjustment is required to be made to the income to be brought to tax in the hands of the assessee, i.e. ICL-Finland, the assessee is of the view that, for a variety of reasons- including primarily the issue of base erosion of Indian tax base, no such adjustment can be made.

AAR saga:

Adverting to question No. 3, as reframed, it will be necessary to bear in mind the scheme of sections 92, 92A, 92B. The assessing officer is enjoined to work out the arm’s length price as per sub-sections (1) and (2) of section 92 following the method outlined in section 92C. If he considers necessary or expedient so to do, he may with the previous approval of the Commissioner, refer the computation of arm’s length price in relation to the international transaction to the Transfer Pricing Officer under section 92CA. The Transfer Pricing Officer has to determine the arm’s length price after notice to the assessee. On the basis of such determination the assessing officer has to compute the total income of the assessee. It is only if the assessing officer

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comes to the conclusion that the interest of the revenue would be better served by not applying sub-sections (1) and (2) than by adhering to them, sub-section (3) would be attracted and the assessing officer will have to proceed with the assessment without giving effect to sub-sections (1) and (2). Without complying with the statutory requirements it will be too presumptuous to assume the said transaction is beneficial for the Revenue and then invoke sub- section(3) of section 92. 12. To consider the applicability of sub-section (3) of section 92, we have perused the loan agreement between the applicant and the Datex dated August 26, 2002. Clauses 5, 6 and 7 of the agreement are relevant for our purpose. 5. Repayment. The borrower shall repay the principal amount of the loan in a bullet payment of three years maturity calculated from the first day of loan period. On the maturity of the loan the borrower will pay back to the Lender equivalent amount in US dollars of 360,000,000 Rupees (Rupees Three Hundred and sixty million only) at the exchange rate prevalent on the date of repayment of the loan as full discharge of the loan. 6. Interest Rate The loan will be made available by the Lender to the Borrower free of any interest. 7. Overdue interest. If the payment is delayed default interest of 16% will be charged. Overdue interest is calculated for the period beginning from the maturity date and ending to date the Principal amount is received to the Lender’s bank account. The overdue interest shall be paid with the principal amount. Though clause 6 provides that the loan will be made available by the Lender to the Borrower free of any interest, clause7 stipulates that if the payment is delayed, default interest of 16%will be charged which has to be calculated for the period beginning from the maturity date and ending to date the principal amount is received to the lender’s bank account. The overdue interest has to be paid with the principal amount. Clause 5 requires that the borrower shall repay the principal amount of loan in a bullet payment of three years maturity calculated from the first day of loan period. It appears to us that clause 6 cannot be read in isolation; it has to be taken in conjunction with clauses 5 and 7 which stipulate about repayment of loan and for payment on overdue interest. Without knowing the exact position in regard to the repayment of loan or the applicability of overdue interest, it will be premature to assume that the rate of interest is 0% and proceed to pronounce ruling on that premise. 13. In this context, it is important to notice proviso (ii) to sub- section (2) of Section 245R of the Act, which gives no option to the Authority except to reject

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the application where the question raised in the application involves determination of fair market value of any property. There can be no dispute that determination of arm’s length price involves determination of fair market rate of interest. The sine qua non for applicability of sub-section (3) of Section 92 is the finding that the computation of income under sub-section (1) or determination of the allowance for any expense or interest under that sub-section read with the explanation or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under sub-section(2), has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in which the international transaction was entered into. Having regard to the aforementioned provision – proviso (ii) to sub-section (2) of Section 245R of the Act - it is a prohibited exercise for the Authority. Indeed the Authority is enjoined to reject the application if the question involves determination of fair market value of the property. It follows that the Authority cannot pronounce any ruling on the applicability of sub-section (3) of section 92 of the Act. 14. In the light of the above discussion, the applicant has no option but to comply with the provisions of the Act including the legislation relating to transfer pricing, namely, sections 92 to 92F of the Act with respect to the said transaction of loan. Whether or not the applicant would charge the interest, as per the principles of the arm’s length price, on the said loan advanced to Datex, having regard to its contractual obligation, is a matter for the applicant to consider but for the purposes of the Act the rate of interest will have to be taken as per the principles of arm’s length price. [Emphasis, by underlining, supplied by us now]

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Proceedings before the authorities below:

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application of arm’s length principle will result in a real loss for the Indian tax revenue, and not the other way round”. The Assessing Officer also briefly referred to, and relied upon, the Report of Expert Committee Group on Transfer Pricing Guidelines, 2002, and Section 482 of US Internal Revenue Code. On factual aspects regarding quantum of adjustment, the Assessing Officer noted that, as evident from the material on record in the case of Datex India, the assessee had an outstanding balance, as at the year end, of Rs 50,62,98,144 as against Rs 14,72,87,857 in the beginning of the year. This fact, according to the Assessing Officer, showed that “apart from the loan of Rs 36 crores under consideration, the assessee had granted loan to Datex India even in the earlier years”. It was also noted that, in the year before us, no provision was made by Datex India in respect of interest liability on loans granted by the assessee, whereas scrutiny of the past records show that the Datex India had made the provisions for “interest on parent company loan of US $ 3 million”. The Assessing Officer inferred that “this (change in accounting treatment for provision of interest) clearly indicates that Datex has stopped providing for interest on the loan from the assessee w.e.f. 2002-03, the earlier loan of USD 3 million was interest bearing”. The Assessing Officer also noted, as was stated in the transfer pricing report of Datex India, that “average PLR of the State Bank of India for 2002-03 was 10.87%”. Based on this analysis, and without the benefit of any assistance or cooperation from the assessee, the Assessing Officer finalized the arm’s length price adjustment to the income of the assessee as follows:

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the assessee to Datex during the year, but also on the opening balance of loan granted earlier i.e. 14,72,87,857/- as on 01.4.2002 on which Datex suddenly stopped making any provision for interest w.e.f. the last Asstt.Year. Interest was, therefore, chargeable on Rs. 36,00,00,000/- w.e.f. 01.09.02 to 31.3.2003 (in absence of the information about the specific date on which Datex received such loan, it is presumed that it was received on the last day of the month in which the agreement was entered in to i.e. 31.08.02) plus on 14,72,87,857/- for the entire F.Y.2002-03. In case any small adjustment in the figures by way of repayment etc. was made during the year, the same cannot be accounted for in absence of any co operation from the assessee. Interest income of the assessee is, therefore, computed as under: Loan Amount 36,00,00,000 14,72,87,857 Period 01.09.02 to 3 1.3.2003 = 7 Months 01.4.2002 to 31.3.2003 = 12 Months Interest @ 10.87% 2,28,27,000 1,60,10,190 Total 3,88,37,190

Assessee's income from interest on loan granted to Datex is, thus, determined at Rs.3,88,37,190/-, which will also be the total income of the assessee. (Rs.) Total Income - 3,88,37,190 Tax - 38,83,719 [The above interest income is chargeable to tax @10% as per Article 12.2 of the DTAA between India & Finland] 6. Aggrieved by the addition of Rs 3,88,37,190 made to the income of the assessee, assessee carried the matter in appeal before the CIT(A) but without any success. While rejecting the contentions of the assesse on merits, learned CIT(A), inter alia, observed as follows:

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charged as per the principles of arm's length price. Thereafter, it was on the A.O. of M/s. Datex to examine the applicability of arm's length price on such interest. However, the appellant has failed to do so. In fact, the A.O. of appellant company has taken the view in favour of the revenue by bringing to tax the interest not charged by the appellant against the provisions of the Act. 15. Under the new provisions, the primary onus is on the taxpayer to determine an arm's length price in accordance with the rules, and to substantiate the same with the prescribed documentation. Where such onus is discharged by the assessee and the data used for determining the arm's length price is reliable and correct, there can be no intervention by the A.O. However, in the present case, the appellant has failed to discharge the primary onus relating to international transaction. 16. In the Circular No.14 of 2001, the Board has clarified that the second proviso to Section 92C(4) of the Act refers to a case where the amount involved in the international transaction has already been remitted abroad after deducting the tax at source and subsequently, in the assessment of the resident payer, an adjustment is made to the transfer price involved and. thereby the expenditure represented by the amount so remitted is partly disallowed. Under the income Tax Act, a non-resident in receipt of income from which tax has been deducted at source has the option of filing a return of income in respect of the relevant income. In such case, a non-resident could claim a refund of a part of the tax deducted at source on the ground that an arm's length price has been adopted by the A.O. in the case of the resident and the same price should be considered in determining the taxable income of the non-resident. Thus, the appellant was having an option of getting the refund, had it been complied the provisions of the Act relating to the international transaction of said loan and had there been any adjustment to the transfer price adopted by the A.O. in the case of resident company. But the appellant has preferred to ignore the relevant provisions of the Act in this regard and suo-motu made a claim that by doing so it has taken decision in favour of the Govt. exchequer or the tax revenue of the country. On the contrary, by doing so it has acted against the tax revenue of the country. In continuation of above, it has further been clarified in the Circular that however, the adoption of the arm's length price in such cases would not alter the commercial reality that the entire amount claimed earlier would have actually been received by the entity located abroad. It has therefore been made clear in the second proviso that income of one associated enterprise shall not he recomputed merely by the reason of an adjustment made in the case of the other associated enterprise on determination of arm's length price by the Assessing Officer. Thus, in the case of appellant, even if, by applying the principles of arm's length price, the A.O. has computed the chargeable interest on loan, the Indian enterprise i.e. M/s. Datex would not be able to recomputed its income to enhance the claim of the loss. Hence, the A.O. has not acted against the spirits of the Board's Circular referred by the appellant.

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In view of above discussion, it is held that appellant has failed to comply with the provisions of the Act relating to an international transaction and hence the A.O. was justified in bringing to tax the interest income on loan granted to M/s. Datex by applying the principles of arm's length price. The action of the A.O. in this regard is upheld.

The case of the intervener

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assessment years, and as such, there was no erosion of tax base in these assessment years. It was in this backdrop that the Assessing Officer proceeded to make ALP adjustments of Rs Rs 8,53,03,582 for the assessment year 2007-08 and of Rs 29,43,61,998 for the assessment year 2008-09. The appeals filed by the intervener are now pending before The Tribunal. Since whatever this Special Bench decides on the relevance of base erosion principle in the transfer pricing will also have bearing on the appeals of the intervener, it is prayed that the intervener should also be allowed an opportunity of hearing by us.

Base Erosion theory- taxpayer’s perspective

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interest free loan to its Indian subsidiary, i.e. Datex-India, is not in dispute, and that the genuineness of the loan, its usage and return to the assessee is also not in dispute. It is also pointed out that if the computation of interest is imputed to the loan, the net result will be (a) a withholding tax of 10% on the interest payable, (b) a statutory reduction or deductibility of the said expenses e which will allow benefit of 36.75% tax to the assesse, and (c) a resultant base erosion of 26.75% to the Indian revenue. Learned counsel then invites our attention to the CBDT circular no. 14 of 2001 which, inter alia, states that “..the basic intention underlying the new transfer pricing regulations is to prevent shifting of profits by manipulating prices charged or paid in international transactions, thereby eroding the country’s tax base” and that “the new section 92 is, therefore, not intended to be applied in cases where adoption of arm’s length price, determined under the regulations, will result in a decrease in overall tax incidence in India in respect of parties involved in the international transactions”. A reference is then made to the CDBT circular no. 12 dated 23rd August 2001 which, inter alia, states that “the aforesaid provisions have been enacted with a view to provide statutory framework which can lead to computation of reasonable, fair and equitable profit and tax in India so that the profits chargeable to tax in India do not get diverted elsewhere by altering the prices charged and paid in intra- group transactions leading to erosion in our tax revenues”. Learned counsel then submits that these CBDT circulars have been referred to, with approval, by a five member bench of this Tribunal in the case of Aztec Software Technology Services Ltd Vs ACIT [(2009) 107 ITD SB 141 (Bang)]. Learned counsel also invited our attention to, and relied upon, the ruling no. 1 of 007 issued by the Australian Tax Office (ATO, in short) which holds that ALP adjustments are not required to be made in the cases of interest free loans granted by the non-resident company to the domestic company even if the domestic company is incurring losses. He submits that the same principle must follow in the present case as well, and, accordingly, no ALP adjustment is required to be made in respect of the loans given by the assessee to its Indian AE i.e. Datex India. Learned counsel submits that the bar on corresponding deduction adjustments in the hands of the AE, as set out in second proviso to Section 92C(4), comes into play only when arm’s length price is

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paid to the AE as is evident from the language of the proviso which refers to “arm’s length price paid to the associated enterprise”. The case of the assessee is that since no payment has been made by the Indian AE, i.e. Datex India, the bar on deduction does not come into play. For this reason also, according to the learned counsel, the ALP adjustments cannot made, and transfer pricing provisions cannot be invoked, on the facts of this case.

Submissions by the intervenor

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new Section 92 is, therefore, not intended to be applied in the cases where adoption of the arm’s length price determined under the regulation would result in a decrease in the overall tax incidence in India in respect of the parties involved in international transaction”. He submits that in the instant case, charging of higher service fees by the assessee to Indian AEs would have resulted in an erosion of tax base in India since the tax applicable on the additional income, by way of ALP adjustment, would be insufficient to offset the tax forgone by the Government on account of deduction available to Indian AEs of the assessee. He then refers to Hon’ble Supreme Court’s judgment in the case of K P Verghese Vs Income Tax Officer [(1981) 131 ITR 597 (SC)] in support of the proposition that a statute should be interpreted in a manner to achieve and advance the legislative intent. Learned counsel also referred to, and relied upon, the judicial precedents in support of the proposition that the circulars issued by the Central Board of Direct Taxes are binding upon all the field officers, and it is not open to the officers to take a stand different than the stand taken in such circulars. He then points out that the intervener assessee did make profits in the subsequent assessment years and started absorbing the losses incurred earlier. It cannot, therefore, be said that the assessee was all along incurring losses only and had no tax liability. He emphasizes that an effort to increase losses has always been viewed with the same degree of disdain and apathy, under the law, as an effort to decrease the profits. Learned counsel then referred to Hon’ble Supreme Court’s decision in the case of CIT Vs Gold Coin Health Food Pvt Ltd [(2008) 304 ITR 308 (SC)] in support of the proposition that when penalty can be levied for overstating the loss, and when Hon’ble Supreme Court has clarified that the expression ‘income’ always included ‘losses, i.e. negative profits, the same principle should apply in the context of losses suffered by the Indian AEs of the assessee inasmuch as notional computation of tax should be taken into account for computing the base erosion. A reference is then made to a ruling issued by the Australian Tax Office (ATO, in short), i.e. ruling no. 2007/1, which holds that no ALP adjustment needs to be made in the case of non- resident lender giving an interest free loan to the Australian domestic company, and this principle will apply even if the Australian domestic company was to incur a genuine tax loss since the tax loss eligible to being carried forward. He submits that

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the said ruling of the ATO, which is also the opinion of the Government of Australia- a country well experienced in the field of transfer pricing when compared to India, “squarely applies” to the case of the assessee. He hastens to add that even though this ruling does not bind the Tribunal, it should be treated as having persuasive effect and should be given due consideration. Learned counsel then makes an interesting reference to the decision of Hon’ble Supreme Court, in the case of DIT Vs Morgan Stanley & Co Ltd [(2007) 292 ITR 416 (SC)], and contends that, in the light of this decision, the transfer pricing provisions cannot be applied on the facts of this case as long as the additional income, which is sought to be brought to tax by way of ALP adjustments, is otherwise subject to tax in India. He submits that this decision was rendered in the context of attribution of profits to the PE but then it accepts, and in fact lays down, the broad principle that unless there are profits residing in the foreign enterprise in a jurisdiction outside India, there cannot be any occasion to bring them to tax in India. In case, according to the learned counsel, the profits sought to be taxed in India in the hands of the foreign enterprise are already residing in India in the hands of the AEs, it will be a meaningless formality and empty ritual inasmuch as these profits are already taxable in the hands of the AEs, and when examining the intra AE transactions, a holistic view is required to be taken. It is thus submitted that in the light of the Australian Tax Office Ruling (supra) as also Hon’ble Supreme Court’s judgment in the case of Morgan Stanley (supra) also, the transfer pricing provision cannot apply on the facts of this case.

Revenue’s stand on base erosion theory

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provisions of Section 92(3), he submits that it provides that the provisions of Section 92 “shall not apply in a case where the computation of income under sub- section (1) or the determination of the allowance for any expense or interest under, or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under sub-section (2), has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in which the international transaction was entered into” but then this limitation comes into play only when the income of the assessee, in whose hands income from international transactions is to be computed, stands reduced or the loss in his hands stands increased. Learned DR also submits that in the light of a five member bench decision of this Tribunal in the case of Aztech Software & Technology Limited Vs ACIT [(2007) 107 ITD SB 141 (Bang)], the application of transfer pricing, which must be applied no matter how inequitable the legal provisions are, in the present case cannot be questioned. He further points out just because ALP adjustments are made in the hands of the non-resident associated companies, these ALP adjustments will not entitle the Indian AEs to get any deductions in respect of the ALP adjustments. It is contended that learned counsel has misinterpreted the second proviso to suggest that corresponding deduction will be available in the hands of the AE on the ground that no arm’s length price has actually been paid by the Indian AE. It is stated that there is no provision in the statue enabling such a deduction on account of the ALP adjustment and in the hands of the affected AE. There is thus no loss, real or notional, to the Indian tax revenue by making ALP adjustments in the hands of the non-resident companies in respect of higher interest or fees that the non-resident companies, according to the TPO, should have charged from the Indian AEs. Learned Commissioner (DR) thus points out that this theory of erosion of Indian tax base is ill conceived. He also submits that, in any event, time value of money cannot be ignored and even if there was to be any impact of this ALP adjustment on the taxability in the hands of the Indian AE, it would have been only in a subsequent year and there is nothing on record to even remotely suggested that discounted net present value of this future loss is more than the tax revenue at present. He submits that a rupee in tax, say five years from now,

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cannot be treated as a rupee in tax today. It is submitted that the Indian AE is incurring losses as on now and as such tax advantage to the AE, even if any, is purely hypothetical at this stage. The loss to the revenue, for the purpose of Section 92(3), has to be a real loss and it cannot be a hypothetical loss which depends on the assessee not only making profits in the subsequent assessment years but making so much of profits as would set off all the losses incurred by the assessee. As for the Dispute Resolution Panel accepting the base erosion theory in the hands of the intervener, but declining to take it to the logical conclusion only on the ground that the assessee has suffered the losses in the relevant assessment year, learned Departmental Representative submits that at the relevant point of time the orders passed by the DRP were not appealable and that is the only reason that even when the revenue authorities did not agree with the interpretation given by the DRP, the matter could not have been carried further, but then in any event, the interpretation of law by the DRP does not bind this Tribunal. He points out that as the intervener himself accepts the views of the DRP do not bind the interpretation of law by this forum. It is, therefore, incorrect to say that the theory of taking a holistic view of taxability in the hands of all the AEs, as against the assessee alone, has been accepted by the revenue authorities. As for the CBDT circulars relied upon by the assessee, it is submitted that there is no dispute that these circulars are binding on the field authorities but then since there is no deduction available to the AEs in respect of ALP adjustments made in the hands of the assessee non-resident companies, there is no reduction in overall incidence of taxation as a result of the ALP adjustments being made in the hands of the non-resident companies earning income from their Indian AEs- which is sine qua non for the non application of transfer pricing provisions in such cases. Learned DR submits that as far as the circulars are concerned, these circulars at best deal with such situations in which there is overall reduction of tax incidence- which is certainly not the case before us. Coming to the Morgan Stanley decision (supra), leaned counsel points out that admittedly this decision is in the context of the profit attribution to the permanent establishment and it does not, therefore, have any bearing on the issue before us. He points out that the short issue before us is applicability of Section 92(3) which was not even the subject matter of consideration by Hon’ble Supreme Court. As for

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the loss to the revenue as a result of the impugned ALP adjustments, learned DR submits that it is for the revenue to decide what is best for the revenue, and just as much as the revenue is prevented from sitting in judgment over how should the assessee conduct his business, the assessee should not step into the shoes of the revenue authorities either. If the assessee thinks that as a result of the ALP adjustments being made in the hands of the assessee, the tax base of the Indian revenue is being eroded because taxability in the hands of the assessee’s AEs in India will be adversely affected, the assessee cannot be aggrieved of the same. The assessee stands to gain in such an eventuality, and no assessee in the world, and least of all these hard nosed business entities, can be aggrieved of being subjected to lower overall taxation. It is not their sense of fair play, but compulsions of their vested interests, which motivate such submissions. He submits that it is interesting to note that the assesse was earlier charging interest on loans given to the Indian companies but it was only when the losses suffered by the Indian AEs surfaced, and the Indian AEs did not gain any tax advantage from these interest payments, that the assessee stopped charging the interest on loans to the Indian AEs. By no stretch of logic, therefore, it could be said that not charging the interest was a bonafide business decision. As the developments suggest, according to the learned Departmental Representative, the decision of the foreign parent company not to charge interest on loans to the Indian AEs was triggered by the losses being incurred by the Indian AEs. Learned DR submits that in any event on the basis of assessee’s perceptions about some conceptual notions underlying these legal provisions, the clear mandate of law cannot be read down. What is being referred to as erosion of tax base of the Indian revenue is, according to the learned DR, based on some broad purpose and notions of the transfer pricing and with complete disregard to the facts of the present cases. Learned DR also invited our attention to the fact that the assessee has been completely indifferent to the notices served by the Assessing Officer and that no information was furnished by the assessee at the assessment stage. The assessee did not, despite specific requisition to that effect, even file the income tax return and has been completely non cooperative. The conduct of the assessee does not inspire any confidence. Learned counsel submitted that while, according to the learned counsel, stand of the assessee has been that there are no

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disputes about bonafides of interest free loan, the fact of the matter is that the assessee has not even given the basic details of dealings with the Indian AE and it was left to the Assessing Officer to compile information from the secondary sources and frame the assessment on that basis.

Rejoinder of the assessee on base erosion theory

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expression used in Section 92(3) is “has the effect of reducing the income chargeable to tax or reducing the loss”, that the expression “effect” and “impact” are synonymous, and, therefore, what needs to be examined is the consequence which should flow from the computation. He then submits that if the contentions of the revenue are to be upheld it will result in a situation that the foreign company will be taxed @ 10% on the same income in respect of which a tax shield at much higher rate, i.e. 36% in this case, is allowed for the corresponding deduction to Indian AE, and thus the assessee is legally permitted to erode the Indian tax base. He then submits that when the explicit intent of law in terms of section 92(3) is exactly to the opposite to such a scenario, a declaration of law or a judgment to the contrary should not be laid down or acceded to, and that either a rule of law or a judicial interpretation resulting in base erosion should not averted. Learned counsel then submits that the transfer pricing provisions deal with the transactions involving two or more parties, and what should be put to test is tax implications of a transaction as a whole rather than tax implications of the transaction in the hands of one of the assessee. Therefore, according to the learned counsel, section 92(3) cannot be given such a restrictive meaning so as to examine the impact of taxability only in the hands of the assesse rather than of all the AEs put together. As for the impact of Aztec decision (supra) by a five member bench of this Tribunal, learned counsel submitted that the Tribunal did not have any occasion to examine the impact of Section 92(3), and, therefore, this decision cannot have any bearing on the interpretation of Section 92(3). In the light of these submissions, learned counsel for the assessee once again urges us to hold that the transfer pricing provisions per se are not applicable on the facts of this case.

Our analysis of the base erosion argument

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to the arm’s length price. The case of the assessee, however, at best is that the assessee is covered by the exclusion clause set out in Section 92(3) which lays down the situation in which the provision of computation of income having regard to the arm’s length price, as set out in section 92(1), will not apply.

(3) The provisions of this section shall not apply in a case where the computation of income under sub-section (1)…………has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in which the international transaction was entered into

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the income chargeable to tax or increasing the loss” should be de facto read as reducing the tax liability on income or increasing the tax shield for the losses. In effect, thus, not only the actual tax impact but also the possible tax advantage, de hors the time value of money, should be taken into account. This interpretation, according to the assessee, will advance the intent of the legislature and objectives of the transfer pricing.

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not the case before us, and in such a situation, in any event, ALP adjustments would not have come into play at all. As regards learned counsel’s contention that if there is an enhancement to an income corresponding deduction cannot indeed be given to the related AE, but if an altogether new income is brought to tax in the hands of the assessee, as a result of ALP adjustment, corresponding deduction is required to be given to the Indian AE, we find no basis whatsoever for this contention. The scheme of transfer pricing legislation does not support the plea of the assessee. Learned counsel has not been able to point out any specific legal provision enabling such a corresponding deduction or demonstrate, or even remotely suggest, the line of demarcation as visualized by the learned counsel. As regards the reference to second proviso to Section 92C(4) made by the learned CIT(A), on incorrectness of which so much reliance has been placed by the learned counsel, the CIT(A) was indeed in error as it refers to re-computation of income in the hands of an AE, as a result of lower deduction being allowed, but then nothing really turns on that. The reasoning given by the CIT(A) was incorrect, the conclusion arrived at him by was not. He was right, even if serendipitously. The deduction for the ALP adjustment will not be available to the Indian AE because there is no provision enabling deduction for ALP adjustments. The second proviso to Section 92C(4) refers to a situation in which let us say an a resident assessee paid Rs 100 for interest to its AE abroad, and duly deducted tax from the same or the tax was deductible from the said payment, but the arm’s length price of the interest was ascertained at Rs 40. In such a situation, while deduction, as per arm’s length principle, is to be allowed only for Rs 40, the taxability in the hands of the AE shall continue to be for Rs 100. Clearly, therefore, reference to second proviso to Section 92C(4), as made by the learned CIT(A), was wholly unwarranted. However, learned counsel of the assessee is also equally in error when he contends that since the second proviso to Section 92C(4) does not come into play on the facts of this case, “there is nothing in the Act which prohibits Datex (i.e. Indian AE) to recompute its income and claim the loss to be set off against the profits of the future years”. In fact, nothing in the Income Tax Act enables such a claim of deduction. As for second proviso to Section 92C(4), it constitutes a bar against lowering income of the non-resident AE, as a result of lowering the deduction in the hands of the Indian AE, rather than as

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enabling a higher deduction in the hands of the Indian AE as a result of increasing non-resident AE’s income.

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broaden the tax base of Indian revenue. Of course, even this tax shield of accumulated losses is wholly academic inasmuch as the deduction has not been claimed, nor can it be claimed at this stage.

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https://www.ato.gov.au/law/view/document?DocID=TXR/TR9414/NAT/ATO/00001 The Commissioner has a discretion whether or not to apply section 136AD 114. In exercising the discretion in paragraph (d) of subsections 136AD(1), (2) and (3) the Commissioner must take into account all relevant facts and circumstances as they existed at the time the international agreement was made in forming a view as to whether the amount of consideration in an international agreement needs to be adjusted. It would also be relevant to consider subsequent events to the extent that they are relevant to testing purpose or assist in determining the true nature of any agreement by comparing the conduct of the parties and the stated terms of the agreement. The Commissioner must not consider irrelevant circumstances (paragraphs 390 - 391) . 115. In particular the Commissioner needs to be satisfied that the various preconditions in subsections 136AD(1), (2), or (3) are met as the case may be. Consideration also needs to be given to whether the exercise of the discretion, or a failure to exercise it, would be consistent with the policy underlying Division 13 (paragraph 392).

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New Legislation to curb tax avoidance by abuse of transfer pricing 55.1 The increasing participation of multi-national groups in economic activities in the country has given rise to new and complex issues emerging from transactions entered into between two or more enterprises belonging to the same multi-national group. The profits derived by such enterprises carrying on business in India can be controlled by the multi-national group, by manipulating the prices charged and paid in such intra-group transactions, thereby, leading to erosion of tax revenues. 55.2 Under the existing section 92 of the Income-tax Act, which was the only section dealing specifically with cross border transactions, an adjustment could be made to the profits of a resident arising from a business carried on between the resident and a non-resident, if it appeared to the Assessing Officer that owing to the close connection between them, the course of business was so arranged so as to produce less than expected profits to the resident. Rule 11 prescribed under the section provided a method of estimation of reasonable profits in such cases. However, this provision was of a general nature and limited in scope. It did not allow adjustment of income in the case of non-residents. It referred to a “close connection” which was undefined and vague. It provided for adjustment of profits rather than adjustment of prices, and the rule prescribed for estimating profits was not scientific. It also did not apply to individual transactions such as payment of royalty, etc., which are not part of a regular business carried on between a resident and a non-resident. There were also no detailed rules prescribing the documentation required to be maintained. 55.3 With a view to provide a detailed statutory framework which can lead to computation of reasonable, fair and equitable profits and tax in India, in the case of such multinational enterprises, the Act has substituted section 92 with a new section, and has introduced new sections 92A to 92F in the Income-tax Act, relating to computation of income from an international transaction having regard to the arm’s length price, meaning of associated enterprise, meaning of international transaction, computation of arm’s length price, maintenance of information and documents by persons entering into international transactions, furnishing of a report from an accountant by persons entering into international transactions and definitions of certain expressions occurring in the said sections. 55.4 The newly substituted section 92 provides that income arising from an international transaction between associated enterprises shall be computed having regard to the arm’s length price. Any expense or outgoing in an international transaction is also to be computed having regard to the arms length price. Thus in the case of a manufacturer, for example, the provisions will apply to exports made to the associated enterprise as also to imports from the same or any other associated enterprise. The provision is also applicable in a case where the international transaction comprises only an outgoing from the Indian assessee.

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55.5 The new section further provides that the cost or expenses allocated or apportioned between two or more associated enterprises under a mutual agreement or arrangement shall be at arm’s length price. Examples of such transactions could be where one associated enterprise carries out centralized functions which also benefit one or more other associated enterprises, or two or more associated enterprises agree to carry out a joint activity, such as research and development, for their mutual benefit. The new provision is intended to ensure that profits taxable in India are not understated (or losses are not overstated) by declaring lower receipts or higher outgoings than those which would have been declared by persons entering into similar transactions with unrelated parties in the same or similar circumstances. The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the country’s tax base. The new section 92 is, therefore, not intended to be applied in cases where the adoption of the arm’s length price determined under the regulations would result in a decrease in the overall tax incidence in India in respect of the parties involved in the international transaction. [Emphasis, by underlining, supplied by us]

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interpreted. That is not the case here. If intention of the law is not implemented by the plain words of the statute, and unless there is an ambiguity requiring some violence with the words, such an intention, no matter how noble it is, is of no relevance in the judicial interpretation. In such a situation, rejecting the relevance of intent of legislature in interpreting a statute, a division bench of this Tribunal, in the case of Tata Tea Ltd Vs JCIT [(2003) 87 ITD 351 (Kol)], has observed as follows:

The House of Lords itself, in a later judgment in the matter of Magor & St Mellons Rural District Council vs. Newport Corporation (1951) 2 All ER 839, did not approve the proposition advanced by Lord Denning. It is interesting to note the articulate expressions of Lord. Simonds, supporting the majority view and at p. 841 of 2 All ER (1951), unequivocally and categorically rejecting Lord Denning’s theory on the relevance of intent of legislature: "My Lords, the criticism which I venture to make of the judgment of learned Lord Justice (Denning L.J.) is not directed at the conclusion he has reached. It is after all a trite saying that on questions of construction different minds may come to different conclusions......... But it is on the approach of Lord Justice to which is a question of construction and nothing else. I think it desirable to make some comment, for, at a time when so large a proportion of the cases that are brought before the Courts depend on the construction of modern statutes, it would not be right for this House to pass unnoticed the propositions that the learned Lord Justice lays down for the guidance of himself and presumably others....... .......The part which is played in judicial interpretation of a statute by reference to the circumstances of its passing is too well known to need re- statement........ The duty of the Court is to interpret the words that the legislature has used. Those words may be ambiguous, but, even if they are, power and duty of the Court to venture outside them on a voyage of discovery are strictly limited; see, for instance, Assam Railways & Trading Company Ltd. vs. IRC (2) and particularly the observations of Lord Wright (1935) AC 458...... ...........What the legislature has not written, the Court must write, and fill in the gaps. This proposition, which restates in a new form the view expressed by the Lord Justice in the earlier case of Seaford Court Estates Ltd. vs. Asher (to which Lord Justice himself refers) cannot be supported. .......It appears to me to be naked usurpation of legislative function in the thin guise of interpretation and it is less justifiable when it is guesswork with what material the legislature would, if it had to discover the gap, have filled it in. If a gap is disclosed, the remedy lies in an amending Act......" Lord Denning’s aggressive definition of the power of the Courts, so far as question of casus omissus is concerned, was severally criticized by Lord Simonds and other law lords in the above case. Lord Morton observed that "these heroics are out of place"

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and pointed of Lord Tucker "Your Lordships would be acting in a legislative rather than judicial capacity of the view put forward by Denning L.J. were to prevail" (at p. 850). As observed in Cross : Statutory Interpretation (2nd Edition, at p. 45), the current tendency among English Judges would appear to incline away from the Denning approach. These views are also echoed by Hon’ble Supreme Court of India from time to time. In the case of State of Kerala vs. Mathai Verghese AIR 1987 SC 33, Hon’ble Supreme Court has taken a view that the Court cannot reframe the legislation for the very good reason that it has no power to legislate. In Jumma Masjid vs. Kodiamaniandra AIR 1962 SC 847, at p. 850 Hon’ble Supreme Court referred to, with approval, Lord Loreburn’s observation, "we are not entitled to read words into an Act of Parliament unless clear reasons for it is to be found within the four corners of the Act itself." [Vickers Sons and Maxim Ltd. vs. Evans (1910) AC 444 (HL) at p. 445]. Lord Simonds rejection of Denning’s approach was cited, with approval, by Hon’ble Supreme Court in the case of Punjab Land and Development Corporation vs. Presiding Officer, Labour Court (1990) 3 SCR 111, at pp. 153-4. We leave it at that.

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losses. Learned counsel has submitted, though in very general and uncommitted terms, that Indian AE of the assessee has subsequently merged in a profit making and all the losses brought forward must have been used in set off against the profits of the merged entity. These facts, even if true, could not have been known at the assessment stage, and, therefore, nothing really turns on these facts. What is known, only with the benefit of hindsight today, could not have been known at the time of assessment. That apart, this vague submission cannot have any bearing any bearing on our adjudication. It is only elementary that when a party leans upon, or refers to, a fact not borne out of records, he has to state that on an affidavit- as is the mandate of rule 10 of the Appellate Tribunal Rules 1963. We have taken note of the fact that the assessee before us has been completely non-cooperative and defiant in approach. The assessee did not file the tax return, the assessee did not submit the requisitioned information, and the assessee did not respond to any notice issued by the Assessing Officer. The conduct of the assessee leaves a lot to be desired. Yet, the assessee claims that the interest free loan granted by the assessee to its Indian AE was a bonafide business decision without any tax motive. When even basic facts about the assessee’s dealings with the Indian AE are not furnished by the assessee, and had to be collected by the Assessing Officer from the secondary sources, it is difficult to have faith in these wholly unsubstantiated claims of the assessee; there is no material before us to support these claims either.

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be taxed as long as entire profits are subjected to tax in India, and every payment by the Indian AE to the non-resident company will be outside the ambit of ALP adjustment because whatever is earned by the non-resident company from Indian AE will be tax neutral in the sense that whatever is added to the income of the non- resident will stand reduced from the income computation of the Indian AE but then such an approach is alien to Indian transfer pricing legislation. These macro observations, at some level, may come into conflict with the fundamentals of the present transfer pricing legislation but then this conflict, even if any, cannot allow us to ignore the specific provisions of the statute. The observations made by Their Lordships in the context of PE profit attribution, which is on the basis of a bilateral tax avoidance agreement, cannot be used to nullify or restrict the impact of transfer pricing provisions under the statute. These observations may at best show that the transfer pricing legislation is not based on, what could be construed as, sound first principles as appreciated by Hon’ble Supreme Court but then as long as this law is on the statute, we are bound by the same. Learned counsel’s reference to Article 141 of the Constitution of India, while making his point and emphasizing that the law laid down by Hon’ble Supreme Court in Morgan Stanley’s case (supra) binds this forum-as indeed all the courts in India, is perhaps wholly out of place inasmuch as the question before Hon’ble Supreme Court was altogether different.

…………… It is neither desirable nor permissible to pick out a word or a sentence from the judgment of this Court, divorced from the context of the question under consideration and treat it to be the complete 'law' declared by this Court. The judgment must be read as a whole and the observations from the judgment have to be considered in the light of the questions which were before this Court. A decision of this Court takes its colour from the questions involved in the case in which it is rendered and while applying the decision to a latter case, the Courts must carefully try to ascertain the true principle laid down by the decision of this Court and not to pick out words or sentences from the judgment, divorced from the context of the questions under consideration by this Court, to support their reasonings. In H.H. Maharajadhiraja Madhav Rao Jiwaji Rao Scindia Bahadur v. Union of India [1971] 3 SCR 9 this Court cautioned:

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"It is not proper to regard a word, a clause or a sentence occurring in a judgment of the Supreme Court, divorced from its context, as containing a full exposition of the law on a question when the question did not even fall to be answered in that judgment."

Other arguments

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expediency of a transaction. When in his wisdom the assessee has advanced an interest free loan, according to the learned counsel, the revenue authorities cannot disregard the commercial expediency of the interest free loan and instead impute interest thereon. In support of this proposition, he relies upon a decision of this Tribunal, in the case of Ericsson India Pvt Ltd Vs DCIT [(2012)17 ITR Trib 79 (Del)] which holds that it is taxpayer’s prerogative to avail the services from an AE and TPO cannot question the same. A reference is then made to decision of this Tribunal in the case of Abhishek Auto Industries Vs DCIT [(2011) 15 ITR Trib 168 (Del)], in support of the proposition that legally binding arrangements between the parties cannot be disregarded by the revenue authorities, without assigning cogent reasons. In substance, according to the learned counsel, a non interest bearing loan cannot be re-characterized as, even for transfer pricing purposes, an interest bearing loan. His contention is that an interest free loan being treated as an interest bearing loan amounts to re-characterization of a transaction- which is not permissible under the scheme of the law. Learned counsel refers to, and relies upon, judgments of Hon’ble Delhi High Court in the cases of CIT Vs Cotton Naturals India Pvt Ltd [(2015) 118 DTR 1 (Del)] and CIT Vs EKL Appliances Ltd [(2015) 345 ITR 241 (Del)] in this regard. His next argument is that taxation laws in India do not mandate the chagrining of interest on loan advanced to its associated enterprises. Furthermore, according to the learned counsel, where there is no income, there cannot be any tax. He then refers to judicial precedents in the cases of CIT Vs Shoorji Vallabhdas & Co [(1962) 46 ITR 144 (SC)], CIT Vs Arihant Avenues and Credit Ltd [(2013) 217 taxmann.com 105 (Guj)] and Shivnandan Buildcon Pvt Ltd Vs CIT [(2015) 60 taxmann.com (Del)] in support of the proposition that notional interest cannot be brought to tax. Learned counsel then takes us through Hon’ble Supreme Court’s judgment in the case of SA Builders Ltd Vs CIT [(2007) 288 ITR 1 (SC)] and points out that when assessee has deep interest in the other company, as a subsidiary, grant of interest free loan is fully justified on commercial considerations. By the same logic, according to the learned counsel, no ALP adjustments can be justified in respect of notional interest. Learned counsel then takes us through the definition of income under section 2(28A) of the Act, and contends that the statue does not obligate payment of interest. It is submitted that

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interest is defined as ‘interest payable in any manner’ and it is not really necessary that payment should be made at all. It is then submitted that section 92 (1) requires that income arising out of international transactions will be computed on the basis of arm’s length prices but when there is no income in the hands of the assesse, from such transactions, income cannot be invented on the basis of assigning arm’s length prices to the transactions. What is not an income cannot be brought to tax under the transfer pricing legislation. Reliance is placed on the judgment of Hon’ble Bombay High Court in the case of Vodafone India Services Limited Vs ACIT [(2015) 368 ITR 1 (Bom)] to support the contention that it is only when an income flows from the transaction that an ALP adjustment can be made, and an ALP adjustment can only modify, though not create, an income. It is submitted that transfer pricing provisions are only machinery provisions to adjust the quantification of income. He thus contends that while ALP adjustments permit increase in an income, in a case where no income is reported, ALP adjustments cannot be made at all. On the strength of these arguments, learned counsel urges us to hold that no ALP adjustments were warranted, even if permissible in law, on the facts and in the circumstances of this case.

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commercial expediency of the interest free loans which is being questioned by the revenue authorities. The assessee is indeed free to advance interest free loan to a subsidiary and even such a usage of funds by the assessee is to be considered to be commercially expedient use of funds, rather than diversion of funds, but then that aspect of the matter is relevant for grant of deduction in the hands of interest paid by the assessee. However, as for the impact of international transactions with the AEs, the law requires the income from such transactions being computed in accordance with the arm’s length price. The issues being raised by the assessee are wholly irrelevant in the context of transfer pricing. Learned DR further submits that assigning arm’s length interest to an interest free loan does not amount to re- characterizing a transaction. The transaction continues to be in the nature of a loan; its only an arm’s length consideration which has been assigned to this transaction. As regards reference to Section 2(28A) defining ‘interest’, it is submitted that the argument of the assessee is wholly irrelevant and nothing can be even made out of this argument. Learned DR then submits that there is no legal justification, or conceptual basis, for the plea that income can only be increased as a result of arm’s length price adjustment, though when income is at zero figure it must remain there. All that the Section 92 requires, according to the learned Departmental Representative, is that the income from international transactions is to be computed on the basis of arm’s length price, and, if the transactions at book value donot result in an income but transactions at ALP lead to an income, the income, as computed on the basis of ALP, is to be brought to tax. We are urged to reject the hyper technical, and rather creative but wholly divorced from the existing legal provisions, contentions of the assessee.

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business interests of the assessee as its marketing arm in India, and it was in business interest of the assessee, whether the Datex was an AE or not, to keep it alive and bail it out of financial distress. It is submitted that, while taking a call on submission of the assesse, we should bear in mind these business realities as well. In the light of these discussions, according to the learned counsel, it was indeed not a fit case for making an ALP adjustment even on merits. We are urged to hold so.

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computation of income and the provision of computation of income in the case of international transactions between the associated enterprises, what is held to be correct in the context of one set of legal provisions has no application in the context of the other set of legal provisions.

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questioning its need, and it was in this context that the Tribunal observed that legally binding joint venture arrangements cannot be disregarded by the revenue authorities. This observations, taken out of the context, cannot be interpreted to mean that an arm’s length price of an interest free loan cannot be adopted for ascertaining income from loan transaction.

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long as the transaction is an international transaction between the AEs, the computation of income has to be on the basis of arm’s length interest. Therefore, in our considered view, even when no income is reported in respect of an item in the nature of income, such as interest, but the substitution of transaction price by arm’s length price results in an income, it can very well be brought to tax under Section 92. This plea of the assessee is also, therefore, unsustainable in law.

Sd/xx Sd/xx Sd/xx N V Vasudevan Justice D D Sud Pramod Kumar (Judicial Member) (President) (Accountant Member) Dated: the 15th day of July, 2016. Copies to: (1) The appellant (2) The respondent (3) Commissioner (4) CIT(A) (5) Departmental Representative (6) Intervener (7) Guard file By order etc

Assistant Registrar Income Tax Appellate Tribunal Kolkata benches, Kolkata