STERLING OIL RESOURCES LTD,MUMBAI vs. ITO 9(3)(2), MUMBAI

These cross appeals call into question correctness of the directions dated 18th December 2013 issued by the Dispute Resolution Panel, in the matter of assessment under section 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961 for the assessment year 2009-10. As these appeals involve interconnected issues and challenge the same & 1970/Mum/2014 Assessment Year: 2009-10 Page 2 of 11 order passed by the DRP, we are disposing of both of these appeals by way of this common order.

Grievances raised by the parties, which are interconnected and which we will take up together for adjudication, are as follows: Grievance raised by the Assessing Officer: Whether on the facts and in the circumstances of the case and in law, the Hon’ble DRP was justified in deleting the interest charged on receivable without appreciating the fact that this transaction is clearly hit by the provision of section 92(2) of the I.T. Act 1961? Grievances raised by the assessee: Ground No. 1 The order of the Learned Assessing Officer (‘Ld. AO’)/Learned Transfer Pricing Officer (‘Ld. TPO') is bad in law as it has been passed without complying with the mandatory conditions of Section 92CA(3) read with Section 92C(3) of the Income-tax Act, 1961 ('the Act') for the reason that Ld. TPO did not serve upon the Appellant any written show cause notice as required and mandated in terms of proviso to Section 92C (3) read with Section 92CA(3) of the Act. Ground No. 2: The Ld. AO/Ld. TPO [following the directions of Dispute Resolution Panel-II ('DRP') under section 144C (5) of the Act] grossly erred, in law and in facts, in making an upward transfer pricing adjustment of Rs. 8,41,67,965/- in respect of Appellant's international transactional of share capital subscription into its associated enterprise ('AE') Sterling Global Oil Resources Pvt. Ltd. ('SGPL'). Ground No. 3: The Ld. AO/Ld. TPO [following the directions of Dispute Resolution Panel - II ('DRP') under section 144C (5) of the Act] grossly erred, in law and in facts, by re-characterizing a share subscription transaction as a transaction of advancing of loan and thereby, holding that the appellant's international transaction is not at arm's length. Ground No. 4: The Ld. AO/Ld. TPO [following the directions of Dispute Resolution Panel - II ('DRP') under section 144C (5) of the Act] grossly erred, in law and in facts, in adopting 12.25% interest rate being SBI PLR rate for Indian rupee loans as arm's length interest rate for benchmarking such deemed outbound foreign currency loan and not the LIBOR rate. & 1970/Mum/2014 Assessment Year: 2009-10 Page 3 of 11 Ground No. 5: The Ld. AO/Ld. TPO [following the directions of Dispute Resolution Panel - II ('DRP’) under section 144C (5) of the Act] grossly erred, in law and in facts, in considering interest free period of only 60 days relying on the MCA Notification dated December 14, 2011 as against the 180 days permissible under FEMA Regulations dealing with overseas investment. Ground No. 6 The Ld AO/Ld, TPO [following the directions of Dispute Resolution Panel - II ('DRP') under section 144C (5) of the Act] grossly erred, in law and in facts, in not allowing the benefit of arm's length range of +/- 5% provided in proviso to sec 92C(2) of the Act for computing the transfer pricing adjustment.”

Briefly stated, the relevant material facts, and developments leading to this dispute before us, are like this. The assessee company is an investment holding company which has invested in various companies through its wholly owned subsidiary Sterling Global Oil Resources Pvt Ltd (SGPL, in short) based in Mauritius. During the relevant previous year, the assessee has entered into international transactions with only one associated enterprise, i.e. SGPL, in respect of contribution to the share capital and in respect of reimbursement of expenses. When this matter came up in scrutiny before the Transfer Pricing Officer, he made ALP adjustment in respect of both the transactions. As far as payment of share capital subscription was concerned, the TPO required the assessee to show cause as to why an arm’s length price adjustment not be made, at the rate of SBI prime lending rate plus 3% premium, in respect of the amounts shown as share application money against which share are not issued. It was, inter alia, explained by the assessee that the assessee has issued shares at premium, and out of the funds so raised, invested the money in this subsidiary. It was submitted that it was obligation of the assessee company to provide capital to its subsidiary. It was pointed out that it was a capital account transaction which has no impact on income or expense of the assessee. It was also submitted that the fact that there is a delay in the allotment of shares does not mean that interest is to be charged for the period on the amount so paid for share subscription. It was also explained that this transaction, by no stretch of logic, could be treated as a loan on which interest needs to be charged. It was also submitted that, in any event and without prejudice to the above arguments, the interest, if at all applicable, will be on the basis of LIBOR and a minimum period of 180 days, & 1970/Mum/2014 Assessment Year: 2009-10 Page 4 of 11 permitted by the RBI for acquiring foreign security to receive share certificate, should be allowed as grace period. None of these submissions, however, impressed the Transfer Pricing Officer. As for the assessee’s contention that the transaction was not an international transaction, he was of the view that in the light of retrospective amendment to Section 92B, international transaction includes ‘capital financing, including any type of long term or short term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance payment or deferred payment or receivable or any other debt arising during the course of business’. He was also of the view that since, in this case, shares are allotted only in October 2010, and as the subsidiary has used these monies, received from the assessee as share application money, for advancing loans to step down subsidiary, “the transaction is that of a loan under the garb of share application money”. On this basis, TPO concluded that “the benchmarking will be done as a loan, where CUP will be used by taking rate of interest charged in independent transaction in the market or one undertaken by the assessee with a third party”. As regards the assessee’s contention that the remittance was made with due approval of the Reserve Bank of India, which has allowed the same as a share application money, the TPO was of the view that characterization of a transaction before the RBI does not decide its true character as required for the transfer pricing purposes. A reference was made to the decision of a coordinate bench, in the case of Perot Systems Vs DCIT [(2010) 5 ITR Trib 106 (Del)], and to Hon’ble Punjab & Haryana High Court decision in the case of Coca Cola Inc Vs CIT [(2009) 309 ITR 194 (P&H)]. A reference was also made to theory of substance over form. He held that “the transaction is in fact a loan and the term ‘share application money’ a fiction. The TPO thus concluded as follows:

The TPO also noted that the assessee had certain outstanding receivables, in respect of reimbursement of expenses, on which no interest was charged. It was noted that these amounts aggregated to Rs 3,42,37,697. The TPO made an arm’s length price adjustment, in respect of notional interest on these receivables, @ 15.5%.

It was in this backdrop, and aggrieved by the Assessing Officer proposing to make this arm’s length price adjustment in respect of interest on So far as the adjustment in respect of the interest on receivables was concerned, the DRP deleted the adjustment by noting that “the SGPL has not accepted these liabilities for various reasons, including the reason that some of the expenses pertained to period prior to incorporation of SGPL” and that “interest does not accrue when the receivable itself has gone bad”. The DRP concluded that “it is a peculiar fact situation where the assessee has made certain claims on subsidiaries which are not accepted” and “that being the case, there is no possibility of the revival of claim in future”. It was thus held that “the charging of interest is not warranted and the AO is directed not to charge the notional interest thereon”. As regards TPO’s treating the share application money as an unsecured loan, the DRP upheld the action of the assessee, in principle, by observing as follows:

Aggrieved by the stand so taken by the DRP, both the parties are in appeal before us. While the Assessing Officer is aggrieved of the DRP deleting ALP adjustment in respect of interest on receivables, the assessee is in appeal against the DRP confirming, inter alia, recharacterization of the amount given to the subsidiary as share application money.

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.

So far as the appeal of the Assessing Officer is concerned, we find that it is undisputed position that the amounts shown as recoverable from the subsidiary are no longer recoverable from the associated enterprises and that the assessee does not have any legal rights to recover the monies spent on behalf of the company prior to its incorporation. Such being the factual position, there is no basis of making any arm’s length price adjustment in respect of interest on receivables. In any case, the expenses so incurred by the assessee for the subsidiary under incorporation were in the nature of expenses on performing shareholder services and no interest can accrue in respect of the same. In view of these discussions, as also bearing in mind, we approve the stand of the DRP on this point and decline to interfere in the matter. As regards the appeal filed by the assessee against recharacterization of share application money as loan to the subsidiary, we find that there is no dispute that the shares were actually issued to the assessee in October 2010 and the entire payment so made by the assessee was on account of the share so allotted. The recharcterization has been done only on account of delay in allotment of shares. We have also noted that the RBI approval for the & 1970/Mum/2014 Assessment Year: 2009-10 Page 7 of 11 remittance of the amounts in question was also admittedly as for capital contribution, and, even at the time of making the payments in question, the subscription of the capital was duly approved as such by the Board of Directors. There is no difference in the form and substance, and yet the amount is treated as an interest bearing loan because there has been a delay in allotment of shares. As regards revenue’s reliance on Perot System’s case (supra), it is wholly misplaced inasmuch as it was a case of loan which was stated to be in the nature of quasi capital, whereas in the present case the payment was right from the initial stage towards subscription for shares. While on this issue, we may usefully refer to a co-ordinate bench decision in the case of Bharti Airtel Limited Vs ACIT [(2014) 63 SOT 113 (Del)] which has, inter alia, observed as follows:

Let us also deal with two judicial precedents which have been heavily relied upon by the TPO, as also by the learned Departmental Representative, on which their case rests. None of these decisions, however, deal with the core issue before us i.e. whether a capital contribution can be deemed to be partly an interest free loan, for the period till the shares were actually allotted, and partly as capital contribution, after the subscribed shares were issued by the subsidiary in which capital contribution was made. In the case of Perot Systems TSI India Ltd (supra), a coordinate bench of this Tribunal had an occasion to deal with the arm's length price adjustment with regard to interest free advances to the subsidiaries. That was a case in which the assessee, an Indian company, advanced interest-free loans to its 100% foreign subsidiaries. The subsidiaries used those funds to make investments in other step- down subsidiaries. On the question whether notional interest on the said loans could be assessed in the hands of the assessee under the transfer pricing provisions of Chapter X, the assessee argued that the said "loans" were in fact "quasi - equity" and made out of commercial expediency. It was also argued that notional income could not be assessed to tax. However, both of these arguments were rejected by a coordinate bench of this Tribunal. While doing so, the coordinate bench observed that there was no material on record to establish that the loans were in reality not loans but were quasi-capital and that there is also no reason why the loans were not contributed as capital if they were actually meant to be a capital contribution. It was observed that, "It is not the case that there was any technical problem that the loan could not have been contributed as capital originally, if it was meant to be a capital contribution". The argument of loan being in the nature of quasi capital was thus rejected on facts. It was not even a case of quasi capital, and, therefore, this case has no bearing on the question before us i.e. whether ALP adjustments can be made in respect of payments towards share application money in a situation in which the shares have been issued several months after the payments for share application money have been made. Similarly, in VVF's case (supra), the transaction was admittedly in the nature of interest free loan between AEs and the commercial expediency in advancing interest free loans was on account of ownership and control of subsidiary being in the hands of the assessee, which was recognized as a significant factor for commercial expediency. However, as we have seen in the earlier discussions, such commercial expediency of granting interest free loans is wholly irrelevant because it is the impact of this interrelationship, on account of management, capital and control, which is sought to be neutralized by arm's length price adjustments. This was also not a case in which a capital contribution was deemed to be partly an interest free loan & 1970/Mum/2014 Assessment Year: 2009-10 Page 9 of 11 (i.e. for the period till the shares were actually allotted) and partly as capital contribution (i.e. when the subscribed shares were allotted by the subsidiary). Revenue, therefore, does not derive any advantage from these judicial precedents either.

In any event, it is not open to the revenue authorities to recharacterize the transaction unless it is found to be a sham or bogus transaction. While there are no specific powers vested in the TPO to recharacterize the transaction, even under the judge made law, such rechracterization can be done by the revenue authorities when the transactions are found to be substantially at variance with the stated form. In the present case, there cannot even a suggestion to hold that this is a bogus transaction because admittedly the subscribed shares capital has indeed been allotted to the assessee. The transaction is thus accepted to be genuine in effect.

In view of these discussions, as also bearing in mind entirety of the case, we are of the considered view that the authorities below were in error in treating the payment of share application money, as partly in the nature of interest free loans to the AEs, and, accordingly, ALP adjustment based on that hypothesis was indeed devoid of legally sustainable merits. We delete the impugned adjustment of Rs.19,15,45,943. The assessee gets the relief accordingly. As we have decided this ground of appeal on the fundamental issue that the payment of share application money could not be partly treated as interest free loan to AE, we see no need to deal with other aspects of the matter.

In the result, the appeal of the Assessing Officer is dismissed and the appeal of the assessee is allowed. Pronounced in the open court today on 29th day of February, 2016.