ITA No 4249 / Del/2012, 4110/Del/2013 & 6337/Del/2013
A Y 2007-08 and 2008-09
Jindal Steel Limited Vs ACIT Cen Circle 4(1) , New Delhi
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INCOME TAX APPELLATE TRIBUNAL
DELHI BENCH I-I
NEW DELHI
BEFORE SMT DIVA SINGH, JUDICIAL MEMBER
AND
SHRI PRASHANT MAHARISHI, ACCOUNTANT MEMBER
ITA No. 4249/Del/2013
(Assessment Year: 2007-08)
ITA number 6337/Del/2012
(A.Y. 2008 – 09)
JSL Limited,
(Now known as Jindal Stainless Ltd, OP
Jindal Marg, Hissar
PAN: AABCJ1969M
Vs.
ACIT,
Central Circle-9,
New Delhi
(Appellant) (Respondent)
ITA No. 4110/Del/2013
(Assessment Year: 2007-08)
DCIT,
Central Circle-4(1),
New Delhi
Vs.
JSL Limited,
(Now known as Jindal Stainless
Ltd, OP Jindal Marg, Hissar
PAN: AABCJ1969M
(Appellant) (Respondent)
Assessee by : Shri Ajay Vohra, Sr. Adv
Shri Neeraj Jain, Adv
Shri Abhishek Agarwal, CA
Revenue by: Shri Kumar Parnav, Sr. DR
Date of Hearing 21/08/2018
Date of pronouncement 19/11/2018
O R D E R
PER PRASHANT MAHARISHI, A. M.
1. These are the three appeals pertaining to the same assessee, i.e. Jindal stainless Ltd, [ in
short Assessee‘ or JSL], two appeals filed by assessee for two AYs and one by
revenue for AY 2007-08 , involving the similar grounds for two assessment years i.e. AY
2007-08 and 2008-09,. At the request of the parties, those are argued together and disposed
of by this common order.
2. The assessee company is engaged in the business of manufacturing of premium stainless
steel i.e. such as hot rolled, cold rolled stainless steels slabs, plates, coils, blades, blank coils,
ferrochrome etc. It is a leading manufacturer of stainless steel in India and has substantial
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expertise, technical know-how, brand equity, and marketing network for manufacture of
stainless steel products.
3. In ITA number 4249/Del/2013 for A.Y. 2007 – 08, The assessee, has filed the appeal against
the order passed by the learned commissioner of income tax (appeals) – XX , New Delhi (the
learned CIT – A) dated 30/4/2013. The assessee has raised the following grounds of appeal:-
1. That the Commissioner of Income Tax (Appeals) erred on facts and in law in
sustaining the transfer pricing adjustment made by the TPO in respect of the
international transactions of (i) export of steel products aggregating to Rs.
2,47,83,673 (ii) interest on loan of Rs. 70,95,787 and (iii) commission on corporate
guarantee of Rs. Rs. 2,29,74,981 on the basis of the order passed under section
92CA(3) of the Act.
2. That the Commissioner of Income Tax (Appeals) erred on facts and in law in
sustaining adjustment of Rs. 2,47,83,673 in respect of the international transaction of
export of goods made by the TPO by comparing the price charged from export of
identical products to the associated enterprises and to unrelated third parties on the
same date or a nearby dates.
2.1 That the Commissioner of Income Tax (Appeals) erred on facts and in law in
rejecting the benchmarking of international transaction of export of goods undertaken
by the appellant in its transfer pricing study by comparing the monthly average price
realized in export to related parties with similar average of price of export to the
unrelated parties.
2.2 That the Commissioner of Income Tax (Appeals) erred on facts and in law in not
appreciating that prices of goods exported to associated enterprise and unrelated third
parties varies within a day itself on account of change in market price of nickel and
iron and accordingly, benchmarking undertaken on the basis of day to day
comparison does not provide accurate or reliable results.
2.3 That while benchmarking the transaction of export of goods applying CUP method,
the Commissioner of Income Tax (Appeals) erred on facts and in law in not allowing
comparability adjustment on account of bulk discount of 5% given on sales made to
associated enterprise allegedly holding that:
a. The invoice raised by the appellant does not speak about any discount.
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b. Sales made to associated enterprise are only 9% of the total sales and
accordingly, unrelated third parties should be getting the bulk discount.
2.4 That while benchmarking the transaction of export of goods applying CUP method,
the Commissioner of Income Tax (Appeals) erred on facts and in law in not allowing
comparability adjustment on account of basic custom duty allegedly holding that the
invoice raised to the associated enterprise and domestic customers does not include
custom duty.
2.5 That the Commissioner of Income Tax (Appeals) erred on facts and in law in not
appreciating that the price paid on international transaction of export of goods to
associated enterprise was within arm's length range of +1-5% of the price charged to
unrelated third parties, in terms of the proviso to section 92C(2) of the Act.
3. That the Commissioner of Income Tax (Appeals) erred on facts and in law in
sustaining addition of Rs. 70,95,787 on account of the alleged difference in the arm‘s
length price of international transactions of interest charged on loan given to the
associated enterprise, PT Jindal Indonesia by applying the interest rate of 14%, being
labor + 700 basis points, as against the rate of LIBOR +200 bps charged by the
appellant.
3.1 That the Commissioner of Income Tax (Appeals) erred on facts and in law in not
appreciating that the appellant has availed loan from financial institutions, viz., SBI,
at the rate of 3 months LIBOR + 170 basis points and from ICICI at 3 months LIBOR
+ 140 basis points and accordingly, since the rate of interest charged from the
associated enterprise at LIBOR+200 is higher, the international transaction of receipt
of interest shall be considered to be at arm's length price.
3.2 That the Commissioner of Income tax (Appeals) erred on facts and in law in
disregarding, the internal comparable uncontrolled transactions of the interest paid by
the associated enterprise in respect of loan of USD 10 million from Standard
Chartered Bank at the same rate of LIBOR+ 200 basis points.
3.3 That the Commissioner of Income-tax (Appeals) erred on facts and in law in rejecting
the internal CUP, allegedly holding that the associated enterprise at Indonesia is
differently placed and apart from being in a different geographical location, it is also
situated differently financially.
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3.4 That the Commissioner of Income Tax (Appeals) erred on facts and in law in
disregarding the fact that the loan was advanced by the appellant to its associated
enterprise in foreign denominated currency and accordingly, loan available in the
international market with interest rate computed considering Libor rates shall be
applied for benchmarking.
4. That the Commissioner of Income Tax (Appeals) erred on facts and in law in
sustaining addition of Rs. 2,29,74,981 allegedly on account of the difference in the
rate of the commission charged by the appellant for providing corporate guarantee to
consortium of Exim Bank and SBI on behalf of its Associated Enterprise.
4.1 That the Commissioner of Income-tax (Appeals) erred on facts and in law in
upholding the action of the ssessing officer in determining the arm‘s length price of
international transaction of provision of corporate guarantee at 3.5%, allegedly on the
basis of assumption that the corporate guarantee, issued by the appellant on behalf of
the associated enterprise at Indonesia, was beset with risk and, therefore, a mark-up of
200 basis point were to be charged as against corporate guarantee paid by the
appellant @ 1.5%.
4.2 That the Commissioner of Income Tax (Appeals) erred on facts and in law in
imputing the commission at the rate of 1.5% plus a markup of 200 basis points,
allegedly on the basis of data obtained from various banks u/s 133(6) of the Act.
4.3 That the Commissioner of Income Tax (Appeals) erred on facts and in law in not
appreciating that, the appellant has charged a commission of 1.5% from its associated
enterprise which is higher than the rate of guarantee charges of 0.95% charged by
State Bank of India in uncontrolled transactions.
4.4 Without prejudice, the Commissioner of Income Tax (Appeals) erred on facts and in
law in sustaining a markup of 200 bps on the average rate of commission charged by
various banks on account of adjustment for lending business risk and single customer
risk, without providing cogent reasons and on the basis of conjecture and surmises.
5. That the Commissioner of Income Tax (Appeals) erred on facts and in law in
sustaining disallowance of expenses alleging the same to be incurred for earning
exempt dividend income of Rs. 11,62,000, invoking provisions of section 14A of the
Act read with Rule 8D of the Income Tax Rules 1962.
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5.1 That the Commissioner of Income Tax (Appeals) erred on facts and in law in
upholding the finding of the assessing officer that the appellant was using common
infrastructure and personnel and the appellant has not maintained separate books of
accounts makes the nexus clear that the appellant was using the same for earning
exempt as well as taxable income, and accordingly, Rule 8D shall be applied to
determine the expense to be disallowed under section 14A.
5.2 That the Commissioner of Income Tax (Appeals) erred on facts and in law in not
appreciating that only expenses having direct nexus with earning of exempt income
could only be disallowed under section 14A of the Act.
5.3 That the Commissioner of Income Tax (Appeals) erred on facts and in law in
sustaining applicability of Rule 8D of the Income Tax Rules 1962 for computing
disallowance under section 14A of the Act, not appreciating that the said rule cannot
have retrospective operation.
4. For AY 2007-08, The learned Deputy Commissioner of Income Tax, Central Circle 4 (1),
New Delhi [ The ld AO ] is also aggrieved by the order of the learned Commissioner Of
Income Tax Appeals [ The Ld CIT- A] and therefore has raised the following substantive
grounds of appeal in ITA No. 4110/Del/2013:-
1. Whether in the facts and circumstances of the case, the Ld CIT(A) erred in deleting
the addition of Rs. 4,11,57,000/- on account of bad debts written off by ignoring the
findings of the A.O. that these debts were not bad in nature ?
2. Whether in the facts and circumstances of the case, the Ld. CIT (A) erred in deleting
the disallowance of Rs. 2,31,402/- made on account of excess claim of depreciation
on UPS @ 60% as UPS/Computer peripherals are not part of the Computer?
3. Whether in the facts and circumstances of the case, the Ld. CIT(A) erred in deleting
the addition of Rs. 21.74 crores by ignoring the findings of the A.O. which were
based on the decision of Tuticorin Alkalis Chemical & Fertilizers Ltd. Vs CIT 27
ITR 172 (SC)?.
5. ITA number 6337/Del/2012 is appeal of assessee for A.Y. 2008 – 09. The assessee has filed
appeal against the assessment order passed under section 143 (3) read with section 144C of
the Income Tax Act, 1961 [ The Act] dated 18/10/2012 passed by the learned Deputy
Commissioner of income tax, circle 4 (1), New Delhi,[ The Ld AO ] wherein the income of
the assessee is assessed at 8 70418750/– under the normal provisions and the book profit of
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3 744066585/– against the returned income of 6 96249090 and the book profit of 3
699258505/–. The assessee has raised the following grounds of appeal.
1. That the assessing officer erred on facts and in law in completing assessment under
section 144C/143(3) of the Income-tax Act, 1961 (the Act‘) at an income of Rs.
87,04,18,750 as against the income of Rs. 64,33,16,780 returned by the appellant.
2. That the assessing officer erred on facts and in law in making an adjustment of Rs.
18,20,95,679 to the arm‘s length price of the international transactions‘ on the basis
of the order passed under section 92CA(3) of the Act by the TPO.
3. That the assessing officer/ TPO erred on facts and in law in making an adjustment of
Rs. 12,78,29,707 on account of difference in arms length price of international
transaction of export of steel products to associated enterprises as follows:
(i) Making Transfer Pricing adjustment of Rs. 7,64,800 by comparing
international transaction of export of steel product with export to unrelated
party on 12.09.2007 and 25.01.2008,
(ii) Making Transfer Pricing adjustment of Rs. 12,35,70,462 by comparing the
prices of international transaction of export with prices in the domestic
transaction and
(iii) Making Transfer pricing adjustment of Rs. 34,94,445 by comparing prices of
international transaction of export with prices of export of steel product to
unrelated party after making adjustment for variation in composition of
Nickel.
3.1 That the assessing officer / TPO erred on facts and in law in not appreciating that the
prices of international transaction of export of steel product when compared with
prices of export' to unrelated party after appropriate adjustment being difference in
composition of Nickel, etc., no adjustment allegedly on account of difference in the
arm‘s length price, was warranted.
3.2 That the assessing officer/TPO erred on facts and in law in disregarding comparable
uncontrolled prices of similar steel product in the international market in the form of
Chinese market quotations as the most appropriate benchmark of the international
transaction of export of steel products.
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3.3 That the assessing officer/TPO erred on fats and in law in holding that comparable
data for the purposes of benchmarking should be actual transactions and hence,
market quotations cannot be used for applying CUP method.
3.4 That the assessing officer erred on facts and in law in benchmarking the international
transaction of export of goods to AEs with the prices of sales in domestic market
ignoring the differences in domestic market conditions, pricing policies, locational
economic difference, etc.
3.5 Without prejudice, the assessing officer/TPO erred on facts and in law in not allowing
adjustment on account of bulk discount of 5% given on sales made to AEs as per the
accepted practice in the market and ignoring the discount actually extended by the
appellant to its customers.
3.6 Without prejudice that the assessing officer/TPO erred on facts and in law in
comparing sales made by the appellant to associated eterprises with unrelated
enterprises (in domestic market) on the basis of date of contract/date of order
acceptance instead of monthly, which evens out daily fluctuation in the prices of
metals and hence, provides a better comparison.
3.7 That the assessing officer/TPO erred on facts and in law in comparing the export
made by appellant to its associated enterprise in Indonesia on 21.09.2007 at
USD 1,525 with sales made in Bangladesh on 12.09.2007 at USD 1,634 instead of
transactions of sales made by the appellant on 05.09.2007 to an unrelated party in
Indonesia at USD 1,504.
3.8 That the assessing officer/TPO erred on facts and in law in comparing the
export made by appellant to its related enterprise on 07.02.2008 at USD 1,750 with
sales made on 25.01.2008 at 1,904, instead of transactions of sale made by the
appellant on 22.02.2008 to an unrelated party in USD 1,834.
3.9 That the assessing officer/TPO erred on facts and in law in not appreciating that the
operating profit margin of the appellant on entity-wide basis at 9.85% being higher
than that of comparable companies at 7.71% and therefore, even applying TNMM, no
adjustment on account of arms length price of export of steel products is called for.
4. That the assessing officer / TPO erred on facts and in law in making an addition of
Rs. 64,03,612 on account of the alleged difference in interest charged on foreign
currency loan of USD 25,00,000 extended to the AE by applying the interest rate of
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13.25% being the PLR of SB1 against the rate of LIBOR+200 bps charged by the
appellant.
4.1 That the assessing officer/TPO erred on facts and in law in not appreciating that, the
rate of interest charged by the appellant is at arm‘s length applying CUP method on
the following grounds:
(i) The AE of appellant had also paid interest at the rate of LIBOR + 200 bps on
its borrowings.
(ii) The appellant has availed loan from financial institutions, viz., State Bank of
India, at the rate of 3 months LIBOR + 170 bps and from ICICI at 3 months
LIBOR +140 bps.
4.2 That the assessing officer/TPO erred on facts and in law in making an adjustment on
account of interest on foreign currency loan on the basis of interest rates charged by
Indian banks on foreign currency loan without providing details of interest charged by
such banks and heard, hence, violating the principle of natural justice.
4.3 That the assessing officer/TPO erred in law in not confronting the appellant with all
information obtained under section 133(6) of the Act prior to using such information
for determination of arm‘s length price.
4.4 That the assessing officer/TPO erred on facts and in law in further adding a markup
of 3.95% on account of the forward premium and ad-hoc markup of 3.43% on
account of adjustment for security and single customer risk, without providing any
cogent reasons and on the basis of his surmises and conjecture.
4.5 That the assessing officer/TPO erred on facts and in law in making an addition of Rs.
4,78,62,360, allegedly, on the ground that commission at a lower rate of 1.5% is
charged by the appellant for providing corporate guarantee to lenders of its associated
enterprise, PT Jindal Stainless.
5.1 That the assessing officer/ TPO erred on facts and in law in imputing the
commission at the rate of 2.68% plus a mark-up of 200 bps, allegedly on the basis of
data obtained from various banks u/s 133(6) of the Act.
5.2 That the assessing officer/ TPO erred on facts and in law in not appreciating that, the
appellant has himself paid commission at the rate of 0.75% on bank guarantee to
State Bank of India, which should be considered as CUP, as against the rate of 4.68%.
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6. That the assessing officer erred on facts and in law in disallowing expenses
amounting to Rs. 4,48,08,080 invoking section 14A of the Act read with rule 8D of
the Income-tax Rules, 1962 allegedly holding the same to be attributable to earning
the exempt dividend income.
6.1 That the assessing officer erred on facts and in law in not appreciating that only
expenditure incurred having direct relation to the earning of exempt income could be
disallowed in terms of sections 14A(1) and 14A(2) of the Act.
6.2 Without Prejudice, that the assessing officer erred on facts and in law in not recording
any finding/satisfaction for any expenditure being incurred by appellant in relation to
earning of exempt dividend income, in terms of sub-section (2) of section 14A of the
Act, before computing disallowance as per Rule 8D of the Rules.
7. That the assessing officer erred on facts and in law disallowing the depreciation
amounting to Rs. 1,98,212 on written down value of Rs. 13, 22,110 of cars sold to the
employees proceeds of which was credited to the block of such assets.
7.1 That the assessing officer erred on facts and in law in not appreciating that the block
of assets has not ceased to exist and hence, depreciation is to be allowed on the
written down value of the block after crediting the sales consideration of such cars to
the block.
8. That the Assessing Officer erred on facts and in law in levying interest under section
234B and Section 234C of the Act.
Facts for AY 2007-08
6. First, we take up the appeals for A.Y. 2007 – 08, the assessee company filed its return of
income [ROI] on 27/10/2007 declaring total income of 2610690840/- . This return was
revised on 20/3/2008 declaring that income of 2630499040/–. During the year, assessee has
entered into four international transactions with its associated enterprise as under:-
i. import of stainless steel scrap Rs. 129150028/-
ii. export of Cold rolled product 4 765543264/-
iii. corporate guarantee 1082750,000/-
iv. receipt of interest on loan to associated enterprises 7 989214
7. with respect to export of stainless steel to its associated enterprise of 4 765543264, it was
noted by the learned assessing officer that assessee has a wholly owned 100 % subsidiary in
Indonesia, namely PT Jindal stainless (Indonesia) Ltd [The Associated Enterprise or AE]
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and assessee has exported various hot rolled coils of the value of 4765543264/– to its
associated enterprise which has sold it further after processing into cold rolled coils. The
assessee has benchmarked this transaction using CUP [Comparable Uncontrolled Prices]
method. Assessee has supplied cold rolled stainless steel coils to its associated enterprise of
three grades, namely, J4 HRAP, J4 black, and J 1 Black. It was the contention of the assessee
that grades J4 HRAP and J1 black has unique cost structure, specially graded, and
manufactured by the assessee company only. The contention is that there are no comparable
prices available in the market. Therefore, assessee benchmark these international transactions
relating to export of J4 and J1 grades using CUP of sales made of the same grades to thirdparty
independent companies. The assessee to benchmark international transactions relating
to export of grade J4 stainless steel has aggregated transactions for the entire month and
computed the average rate of the same product sold to third parties. Similarly, the assessee
has computed average rate for the entire month of the goods sold o the assessee as well as
goods sold to the third parties and then made a comparison of month wise rates at which
sales have been made by the assessee to associated enterprise and 3rd parties.
8. The learned assessing officer examined the methodology adopted by the assessee and held
that on detailed comparison of the benchmarking of the international transactions on the date
of contract and the date of order of acceptance. There are certain comparable uncontrolled
prices available for sales made to associated enterprise and sales made to third party on the
same date. The analysis of the learned assessing officer revealed that there were differences
in the rate at which sales have been made to the associated enterprise and the sales made to
third party on the same date. Therefore, the assessing officer asked the assessee to explain the
benchmarking of grade J4 HRAP and J4 black under CUP.
9. The assessee explained that addition was made in the preceding A.Y. 2006 – 07 based on
comparison of the rates of the transactions with the associated enterprise and non-related
companies by taking the rates on daily bases. The assessee contended that the comparison of
rates on daily bases does not give proper results. The assessee also submitted the comparison
on daily bases in respect of various materials and stated that where as rates are higher on
certain dates and the rates are lower on other dates. The assessee also stated that the reasons
could be manifold including the variation in rates within the day itself. He further stated that
the rates might vary due to difference in raw material prices like nickel and due to market
conditions. Therefore, assessee contended that it is logical that comparisons should only be
made on a periodic basis. The assessee also submitted a chart to indicate that if the rates are
compared on a periodic basis they are well within 5%. It was further contended by the
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assessee that the difference between grade J1 and grade J4 is mainly on account of nickel
content. It was further stated that the rates of nickel have been very volatile in the year under
consideration. Assessee also submitted that the rate of nickel has varied from US dollar
14,800 per metric ton to US dollar 40,355 per metric ton. Therefore, the assessee contended
that only average rate should be adopted to even out the wide price fluctuations.
10. The learned, TPO considered the explanation of the assessee and stated that when the
assessee has itself used the third-party sales comparable uncontrolled prices and there are
variation in prices between sales made to associated enterprise and third-party of identical
product sold on the same date. Therefore, he held that explanation of the assessee does not
satisfy the difference in prices on the daily bases. The learned Transfer Pricing Officer also
noted that assessee has not furnished any evidence to prove that the quality of steel sold to
third party is different from that sold to associated enterprise. He also rejected the
explanation of the assessee with respect to the nickel content and wide fluctuation in the
price of the nickel. It was further stated by him that effect of 5% tolerance band is not
applicable in the CUP method when the prices are compiled on the daily bases from
transaction to transaction. Therefore, he held that the difference in price of same grade coils
sold to third party and associated enterprises is 24783673/– and therefore he proposed an
adjustment of the above sum on account of export of steel to the associated enterprise.
11. On the issue of interest on loans given to associated enterprise, the assessee has received
interest of 7989214 on loan given to its associated enterprise and assessee has charged
interest at the LIBOR +200 base points. The assessee has also benchmarked this interest
income using CUP method. The assessee contended that it is paying interest at the same rate
of interest to other lenders and therefore the transaction is at arm‘s length. The learned TPO
rejected the method of the assessee holding that interest received from associated enterprise
cannot be benchmarked with the interest that assessee is paying to other lenders. He further
held that the loan has been given by the assessee out of funds, which it has taken on loan
from various lenders. He also rejected the contention that loan given to associated enterprise
cannot be benchmarked with the rate that the assessee would have got by investing in fixed
deposits, current deposits and commercial papers. Therefore, assessee was directed to explain
the application of CUP interest rates. The assessee gave detailed explanation for the same
stating that assessee has paid average interest at the rate of 7.04% to its lenders and therefore
it has charged a higher rate of interest from its associated enterprise at about 7.5%
approximately. It was further stated that associated enterprise has also raised one loan of US
dollar 10 million from Standard Chartered Bank at LIBOR +200 basis point. It was further
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stated by the assessee that there is no justification of charging rate of interest higher than the
rate at which the borrower can obtain from the open market. Assessee contended that since
internal CUP is available, no other data could be used for benchmarking to arrive at arm‘s
length price of interest income. The learned assessing officer rejected the contention of the
assessee and concluded that basic interest rate for the credit rating of the associated enterprise
should be LIBOR +400 basis points and 300 basis points is the added transaction cost
thereof resulting into CUP rate of LIBOR +700 basis points. According to the learned TPO
as the currency in which the loan is extended is US dollar he considered 6 months US dollar
LIBOR and arrived at interest rate of 5.4% per annum and therefore he computed the CUP
interest rate of 12.4%. He further stated that AE has no security offered by the subsidiary
company and taxpayer is also not into lending and borrowing of the money, 14% rate of
interest would be just. Accordingly, on the total loan amount, he applied interest at the rate of
14% amounting to US$ 350,000 wherein the interest already charged is US dollar 185364.58
and computed the balance interest to be charged of 16463 US$ 5.42. He applied the
conversion rate of Rs. to dollar at the rate of 43.10 and proposed an adjustment of
7095787/-.
12. During the course of proceedings, the learned Transfer Pricing Officer noted that assessee
has given a bank guarantee of 10827.5 lakhs on behalf of its associated enterprise and it has
charged 149.21 lakhs for providing the corporate guarantee to its associated enterprise. The
assessee benchmarks the above transaction applying the CUP method. The learned TPO for
verification of the applicable rate sought information under section 133 (6) from State Bank
of India about the rate of commission charged for providing bank guarantee to corporate
during the same financial year. The State Bank vide letter dated 1/9/2010 informed that such
rates are 2.75% plus Rs. 100/-. Based on the above information, the learned TPO held that a
markup of 200 basis points on the rate charged by the National Bank would be appropriate in
the circumstances, and therefore adopted the rate of 3.5% on the bank guarantee and
determined the arm‘s-length price of 37896250/- and proposed an adjustmen of
2,29,74,981/–.
13. Consequently the learned TPO [ The TPO] passed in order under section 92CA (3) of the
act on 13/10/2010 proposing adjustment of 24783673/– on account of CUP data in export
segment and 7095787 on account of interest on loan given to associated enterprises and Rs.
22974981/– on account of bank guarantee totaling in all 54854441/–.
14. Incorporating the above adjustments on account of arm‘s-length price of the International
transaction the learned assessing officer passed an assessment order on 31/1/2011 whereby
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he made the following other corporate tax adjustment. He made the disallowance of
39214001 on account of earning of exempt income of Rs. 1162000/– under section 14 A of
the Income Tax Act. He further made the disallowance of bad debts of Rs. 41157000/-
holding that large part of the bad debt is related to the public sector undertaking which by no
stretch of imagination according to him can be construed as bad debt. According to him as
the assessee has not furnished any reason for writing of various other debtors such as their
precarious financial condition, which made them not able to pay the debt. He further made
disallowance of depreciation on UPS holding that they are not computers entitled to 60%
depreciation but normal rate of 15%. Thereby the disallowance of the excess depreciation
claimed of Rs. 231402/– was also made. In addition of Rs. 217439000/– was made on
account of the decapitalisation of interest. Accordingly the total income of the assessee was
assessed at Rs. 2983394884/–. The learned assessing officer also withdrawn the credit of tax
deduction at source amounting to 1458402/–. For some apparent mistakes in the assessment
order ,subsequently, the order under section 154 of the Income Tax Act was also passed on
17/12/ 2012 where the profit on sale of investment which was originally not reduced from the
total income was reduced of 135547000/–. Consequent to that total income originally
assessed under section 143 (3) vide order dated 31/1/2011 of Rs. 2983394884/– was reduced
by the above amount and assessed at 28 4784 7884/–.
15. Assessee aggrieved with the order of the learned assessing officer preferred an appeal before
the learned Commissioner of Income Tax (Appeals) –XX, New Delhi who disposed off the
appeal vide order dated 30/4/2013.
16. With respect to the corporate tax disallowance under section 14 A the learned CIT – A held
that the learned AO has correctly applied the provisions of section 14 A, however he directed
the learned AO to take the average value of the total asset as defined in rule 8D of the
Income Tax Rules, 1962 for the working out the disallowance of the expenditure. Regarding
the disallowance of bad debts of 41 1517 00/– he directed the learned AO to delete the
addition for the reason that it is the prerogative of the businessmen to decide the nature of the
debt and the since the amount has already been shown as income in the earlier years, and it
has been written off in the profit and loss account, there is no requirement of showing that the
debt has become bad during the year. With respect to the excess depreciation claimed on
uninterrupted power supply equipments he held that issue has been decided by the
jurisdiction High Court in CIT vs BSES Yamuna powers Ltd in favour of the assessee and
therefore he directed that assessee is entitled for the depreciation at the rate of 60% on these
equipments and deleted the disallowance. With respect to the disallowance of capitalization
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of interest of 21 7430 9000/– he relying upon the decision of the honourable Supreme
Court in the case of CIT versus Bokaro steel Ltd held that interest received on borrowed
funds exclusively for the purposes of setting up of the unit is not taxable as interest income
and therefore he directed the AO to delete the addition of 21 7430 9000/–.
17. On the issue of the transfer price adjustment with respect to the export of goods, he rejected
the monthly average price taken by the assessee under the transfer pricing study for the
reason that according to him the nearest date of the transaction if taken for comparison, the
variation in prices of the steel product by the appellant does not very as much within a short
span of time. He therefore upheld the order of the learned Transfer Pricing Officer in
adopting the transaction value of the independent parties on the nearest date and rejected the
approach of the assessee of taking the monthly average of prices for determination of the
arm‘s-length price. He also rejected the 5% claim of bulk discount to the associated
enterprise holding that as the appellant is selling more to the third parties rather than to the
related party therefore the third party should be getting the bulk discount. He also stated that
the customs duty adjustment is also not applicable in either the sale made to associated
enterprise or sales made to local customers. According to him the prices are compiled are
CIF prices and the learned TPO is right in not accepting such adjustments holding them
illogical and inconsistent with the business practices. Accordingly, he upheld the adjustment
proposed by the learned Transfer Pricing Officer to the International transaction on account
of sale of finished goods to associated enterprise. On the aspect of interest on loan given to
the associated enterprise, he also upheld the order of the learned TPO benchmarking the rate
of interest at LIBOR + 700 basis points and further addition on account of risk factor thereby
determining the interest rate at the rate of 14%. He held that entity at Indonesia is placed
differently apart from being in a different geography location; it is also situated different
financially. He also upheld the risk adjustment. Accordingly he upheld the interest
adjustment made by the learned TPO on loan given by the assessee of US dollars 25, 00,000
to Indonesian entity and interest income thereon. The 3rd adjustment is on account of the
issue of corporate guarantee given by the assessee to the associated enterprise. He upheld the
addition proposed by the learned TPO. Reason being that appellant itself has charged the
guarantee fee at the rate of 1.5% and the TPO has assumed that corporate guarantee on behalf
of entity at Indonesia is beset with risk and therefore 200 basis point were marked upon such
guarantee in addition to what the assessee has charged is justified. Therefore, he upheld the
3.5% guarantee charge proposed by the learned Transfer Pricing Officer.
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18. Therefore both the parties, assessee and assessing officer aggrieved with the order of the
learned Commissioner Of Income Tax Appeals has preferred appeal before us separately.
Facts for AY 2008-09
19. For A.Y. 2008 – 09 assessee filed its return of income on 29/9/2008 at 696249090/- which
was subsequently revised on 29/3/2010 at 643316780/– under the normal provisions and
3699258505/- under section 115JB of the act. The assessee has entered into certain
international transactions therefore the learned Assessing Officer made reference to the
learned TPO for determination of the arm&lsqo;s-length price of those international transactions
under section 92CA (3) of the act. During the year the assessee has entered into following
international transactions which were benchmarked by the assessee as well as the adjustment
proposed by the learned TPO as follows:-
serial
number
Nature of
transactions
Value of
transactions
(in Rs.)
Most
appropriate
method
adopted by
the assessee
Arm‘s-length
price
determined
by the
learned TPO
Adjustment
proposed
1
Export of
finished goods
4736804511 CUP 4864 634 218 127829707
2
Import of
stainless steel
scrap
16 4115 212 CUP No
adjustment
proposed
3
Commission
received on
corporate
guarantee
9701640 CUP 5 7564000 47862360
4
Commission paid
on sales
10 5693 173 CUP No
adjustment
proposed
5
Interest on
subordinate that
is
6892 462 CUP 17335147 10442685/-
6
Share application
money
20 000000 CUP No
adjustment
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proposed
7
Reimbursement
of expenses (net)
4844359 CUP No
adjustment
proposed
20. With respect to the export of stainless steel to associated enterprise the assessee has exported
several types of steel to its associated enterprise PT Jindal stainless (Indonesia) of 473.68
crores which was benchmarked by the assessee adopting the CUP method. With respect to
the various grades of steel exported by the assessee, the assessee exported two grades of
stainless steel, which was also exported to third parties. These grades are J4 plate and JSL
tube HRAP. Therefore, the third-party export rates were available only with respect to these
two grades. For determination of the arm‘s-length price of the export of these two grades,
assessee adopted the rates at which the sales are made to the third parties as CUP data.
However, for the purpose of the comparison, assessee has aggregated the transactions for the
entire month and computed average rate of the sales made to associated enterprises, similarly
computed average rate for the entire month of third-party sales, and compared these average
rates. With respect to the other grades of steel, for which no actual CUP data is available, the
assessee adopted Chinese market quotations downloaded from the Internet and used them for
benchmarking the transactions of export made to associated enterprises. Even the Chinese
quotations were available only in respect of two grades i.e. J4 HRAP and 304 HRAP. For the
other grades, the assessee adjusted even this quotation data on account of difference in the
nickel content and the conversion cost of black oil to pick the Nickled coil HRAP. With
respect to the nickel prices, the assessee adopted the rates, which are prevailing in the
London metal exchange.
21. On examination of the transfer pricing analysis done by the assessee, the learned TPO after
considering the replies of the assessee held that in export transaction of Rs. 4736804511/-
following adjustments are required to arrive at the arm‘s-length price:-
a. in case of the export data to associated enterprise compared with the rates of export to
the 3rd parties, the assessee has taken the monthly average of the prices of export to
associated enterprise and also computed the monthly average prices of export to 3rd
party, the learned TPO rejected the same and adopted the direct and most reliable data
being comparison of sales of goods to non associated enterprise on the same date or
nearest date. He adopted the same with respect to the grade of steel J4 plate. In that
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grade of steel four sale transactions were noted, nearest date of export to the thirdparty
export was found, difference between the two prices in US dollar was
determined and thereto exchange rate was applied. The learned TPO found that that
adjustment on that account is 764800/-.
b. With respect to the comparison of the export made by the assessee to the associated
enterprises with the Chinese market quotation, the learned TPO compared it with the
domestic sales rates by the assessee and allowed adjustments with respect to advance
license and duty entitlement passbook scheme benefits, basic customs duty, freight,
trimming cost and arrived at net rate in INR. Then he compared with net rate of sales
of the domestic parties with the export made to associated enterprises and determined
the adjustment of 123570462/–.
c. With respect to the exports where assessee compared it with the nickel adjusted price
data which is derived from export price in the past and adjusted for fall in nickel
prices to the date of the transaction, the learned transfer arising officer adopted actual
third-party export price base and then granted adjustment and derived at the
difference in arm‘s-length price of 3494445/–
22. With respect to the International transaction of interest received on loan given by the assessee
to its associated enterprise of 6892462/–, the learned TPO rejected the benchmarking of the
assessee that interest has been charged at the rate of monthly LIBOR + 200 basis points using
the CUP method stating that assessee is paying interest on the same rate of interest to other
lenders. The method adopted by the assessee was not disputed by the learned Transfer
Pricing Officer however; the manner in which the CUP method was used was rejected by
him. He stated that the interest received from associated enterprise cannot be benchmarked
with the interest that assessee is paying to other lenders. Further, the loan given to an
associated enterprise cannot be benchmarked with the rate that the assessee would have got if
invested in fixed deposits, current deposits, or commercial papers when assessee has already
borrowed loan from the banks. Therefore, he proceeded to determine the CUP rates. After
detailed analysis and dealing with the objection raised by the assessee and quotes called for
under section 133 (6) of the act, he held that that the basic interest rate for the credit rating of
the associated enterprise shall be 9.88% and transaction cost thereto should be added of 395
basis points resulting into the CUP rate of 13.83%. He further made a risk adjustment for
single customer to that rate as no securities offered by the subsidiary company. Further the
assessee is also not engaged in the business of lending and borrowing of the money and it is
a lending to a single customer, he held that interest should be chargeable at the rate of
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17.26% which is fair and reasonable. Therefore he held that interest has been charged by the
assessee resulting into the shortfall of interest charged, he proposed an adjustment of
10442685/–.
23. With respect to the corporate guarantee which the assessee has given of US dollar 30 million
to the lenders of Indonesian company and charged corporate guarantee commission of
9701640 computed at the rate of 1.5% on the amount of loan availed by the associated
enterprise, which is benchmarked by the assessee using CUP method, The learned Transfer
Pricing Officer accepted the CUP method but rejected the manner in which it is determined
by the assessee. He obtained he quotation from various banks under section 133 (6) of the
Income Tax Act and determine the arithmetic mean of all the quotation at 2.68%. The
assessee objected before him that the corporate guarantee is not an international transaction,
which was rejected by the learned Transfer Pricing Officer holding that assessee himself has
charged guarantee commission and earned the revenue and therefore now it cannot be said
that corporate guarantee is not an international transaction. He further held that as the
assessee has given guarantee without taking any margin from the associated enterprise or
without any security being offered by the associated enterprise. He therefore stated that it is
much more risky than the bank because banks issue guarantee only after taking margin from
the clients. He therefore presumed that there should have been a margin of 25% and the
assessee would have earned higher income on the amount of guarantee. However he took a
conservative estimate and proposed the markup of 200 basis point on account of the risk that
assessee is bearing and based on that he adopted the rate of 4.68% (2.68% is the arithmetic
mean of the various contentions obtained by the assessee from various banks +200 basis
point) on the value of the bank guarantee of US dollar 30 million computed the guarantee
commission that should have been received by the assessee amounting to US dollar 1.404
million and applied the conversion rate of 41/- per US dollar determined that assessee
should have shown a revenue of 57564000 and proposed an adjustment of Rs. 47862360/-.
24. Further on aspect of the corporate tax adjustment the learned AO disallowed Rs. 44808080/–
on account of disallowance under section 14 A of the Income Tax Act read with rule 8D of
the income tax rules 1962. He further disallowed depreciation on the computer peripherals
holding that they are not entitled to the depreciation at the rate of 60% but that at the rate of
normal depreciation rate applicable to a plant and machinery. Therefore the adjustment on
account of excess depreciation claimed by the assessee was disallowed to the extent of
192197/–. The learned assessing officer further disallowed a sum of 125330/– being the
depreciation on cars under section 32 of the act. Certain other adjustments were also made.
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Consequently the draft assessment order under section 144C (1) of the Income Tax Act 1961
was passed by the learned assessing officer and forwarded to the assessee on 28/12/2011.
25. Assessee aggrieved with the above order preferred objection before the Dispute Resolution
Panel – 1, New Delhi who passed the direction under section 144C (5) of the Income Tax
Act 1961 on 3/9/2012. The learned Dispute Resolution Panel with respect to the objection on
account of international transaction on export of goods of 1 27829707 on account of export
of steel products to the associated Enterprises upheld the adjustment proposed by the learned
TPO . Before the learned Dispute Resolution Panel, the assessee also raised an objection that
that the learned TPO has compared the third-party sales made in Indonesia with Bangladesh
and the learned TPO has not appreciated that the operating profit margin of the assessee is
any way higher than the comparables. The learned DRP also rejected the objection of the
assessee holding that benchmarking analysis has to be undertaken on a transaction-totransaction
basis with respect to the comparison of sales made in Bangladesh. The learned
Dispute Resolution Panel held that it has been adopted by the learned TPO due to closer
comparability of dates, which is also appropriate. On the 2nd aspect of the adjustment on the
interest received from the associated enterprise on loan granted by the assessee which has
been benchmarked by the learned TPO adopting the rate of 17.26%, the learned Dispute
Resolution Panel directed the learned TPO to adopt the interest at the PLR of the RBI in the
financial year 2007 – 08. Otherwise, the computation made by the learned Transfer Pricing
Officer was upheld. The learned TPO obtained during the course of transfer pricing
assessment the information under section 133 (6) of the act from the various bank which was
objected by the assessee before the learned Dispute Resolution Panel. The learned Dispute
Resolution Panel rejected the same as the information obtained by the assessee was
confronted to the assessee and assessee was given complete opportunity of rebutting that
information. With respect to the corporate guarantee computed at 4.68% by the learned
Transfer Pricing Officer it upheld the same.
26. With respect to the corporate tax issues the learned Dispute Resolution Panel upheld the
disallowance under section 14 A of the Income Tax Act disallowing a sum of Rs.
44808080/–. The learned Dispute Resolution Panel further noted that assessee has earned the
dividend income of Rs. 237000 and has offered the disallowance of 1 lakh on account of
expenditure incurred. With respect to the depreciation restricted by the learned assessing
officer at the rate of 15% on the computer peripherals, which were claimed by the assessee at
the rate of 60%, the learned Dispute Resolution Panel accepted the argument of the assessee
and directed the learned assessing officer to allow depreciation at the rate of 60% on
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computer peripherals relying on the decision of the jurisdictional High Court of BSES
Yamuna powers Ltd. With respect to the disallowance of depreciation of 1 25330 with
respect to the purchase of 3 ready built flats purchased by the assessee where the learned
assessing officer disallowed this the appreciation is holding that 5% of the total cost of Rs.
25066109/– is related to the land the learned Dispute Resolution Panel directed the learned
AO to delete the disallowance of depreciation of 1 25330/–. With respect to the
depreciation disallowed on cars sold to the employees, the learned Dispute Resolution Panel
agreed with the opinion of the learned assessing officer and rejected the argument of the
assessee. The learned Dispute Resolution Panel was of the opinion that assessee has devised
a scheme to claim more depreciation than what is justifiably entitled to where purchase cost
of 3 527637/– and written down value is Rs. 2206227 which has been sold at a ridiculously
low price of Rs. hundred each totaling to 700 since the sale of cars to its employees is
made under the colorable device, the assessee cannot be allowed to take undue benefit in the
claim of depreciation in respect of written down value of these cars. With respect to the
unrealized exchange fluctuation gain credited to the profit and loss account the learned
Dispute Resolution Panel directed the assessing officer not to make the adjustment on
account of exchange fluctuation as it is covered by the decision of honourable Supreme Court
in case of oil and natural Gas Corporation Ltd 322 ITR 180 where the honourable Supreme
Court has observed that it is permissible to adjust the actual cost of imported assets acquired
in foreign currency on account of fluctuation in the rate of foreign exchange at each balance
sheet date pending actual payment of the liability. With respect to the disallowance of the
credit of tax deduction at source claimed by the assessee of Rs. 3326422/– the learned
Dispute Resolution Panel rejected the contention o the assessee where it was submitted that
the disallowance of credit of tax deduction at source claimed by the assessee is not
sustainable because the assessee has not claimed the credit of the aforementioned tax in
earlier years when they were actually deducted. The learned Dispute Resolution Panel stated
that since the income in question in relation to which the tax deduction at source has been
made is not assessable for the A.Y. under consideration, the learned assessing officer is
justified in denying the credit of Rs. 3326422/–. The learned Dispute Resolution Panel also
rejected the alternative argument of the assessee to allow the credit in earlier years by
direction to the assessing officer where the respective income has been assessed, the learned
Dispute Resolution Panel held that no such direction can be given by the Dispute Resolution
Panel as jurisdiction of the Dispute Resolution Panel is restricted to the variation made by the
assessing officer in the A.Y. under consideration. With respect to the adjustment to the book
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profit made by the learned assessing officer on account of transfer pricing adjustment,
depreciation disallowance on computer peripherals, depreciation on cars and depreciation on
buildings, the learned Dispute Resolution Panel directed the learned assessing officer to not
to make such adjustment as it is not warranted according to the provisions of section 115 JB
of the Income Tax Act.
27. Consequent to the direction of the learned Dispute Resolution Panel the learned Assessing
Officer passed an assessment order under section 143 (3) read with section 144C of the
Income Tax Act, 1961 on 18/10/2012 and determined the total income of the assessee at 8
70418751.
28. The assessee aggrieved with the order of the learned Assessing Officer passed under section
143 (3) read with section 144C of the act has preferred an appeal before us.
29. Therefore, now it is apparent that following issues are under dispute in these two appeals
filed by the assessee and one appeal filed by the revenue for two assessment years.
i. Transfer pricing adjustment made by the learned assessing officer with respect to
the arm‘s-length price of export of goods made by the assessee to its associated
enterprise of stainless steel [ Ground no 3 for AY 2008-09 and Ground No 2 for
AY 2007-08 in appeal of assessee]
ii. Transfer pricing adjustment made by the learned TPO with respect to the
computation of interest received by the assessee on loan given by the assessee to
its associated enterprise[ Ground no 4 for AY 2008-09 and Ground no 3 for Ay
2007-08 in appeal of assessee]
iii. Transfer pricing adjustment made by the learned TPO with respect to the
International transaction of the corporate guarantee given by the assessee to its
associated enterprise. [ Ground no 4 for AY 2007-08 and Ground no 5 for AY
2008-09 in appeal of the assessee]
iv. Disallowance under section 14 A of the Income Tax Act [ Ground no 5 for AY
2007-08 and Ground no 6 for Ay 2008-09 in appeal of assessee]
v. Disallowance of depreciation on written down value of cars sold to the employees
[ Ground no 7 for Ay 2008-09 in appeal of assessee]
vi. Disallowance of depreciation on computer peripherals considering them as
computers [ Ground no 2 in appeal of AO for Ay 2007-08]
vii. Disallowance of bad debts written off [ Ground no 1 of appeal of AO for AY
2007-08]
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viii. Disallowance of interest decapitalisation [ Ground no 3 of appeal of AO for Ay
2007-08]
30. In appeals of the assessee, Ground number 1 for assessment year 2007 – 08 and ground
number 1 and 2 for assessment year 2008 – 09 are challenging the various
additions/adjustment made by the learned assessing officer/Transfer Pricing Officer which
are also independently challenged by the separate grounds, are general in nature and
therefore same are dismissed.
31. Similarly ground number 4 to 6 of the appeal of the learned assessing officer for assessment
year 2007 – 08 are also general in nature and therefore same are also dismissed.
32. Ground number 8 of the appeal of the assessee for assessment year 2008 – 09 is against
charge of interest under section 234B and 234C of the act which is consequential in nature,
no arguments advanced on it, therefore same is also dismissed.
33. Now we deal with the first issue of Transfer pricing adjustment made by the learned
assessing officer with respect to the arm‘s-length price of export of stainless steel made by
the assessee to its associated enterprise. This is challenged by assessee for assessment year
2007 – 08 by ground number 2 and its grounds for assessment year 2007 -08 and ground
number 3 and its of grounds for assessment year 2008-0 9. We have already explained the
facts above for both the years. For AY 2007-08, assessee has exported various grades of
Stainless Steel products to the associated enterprise, viz., PT Jindal Stainless, Indonesia,
aggregating to Rs. 476,55,43,264. For benchmarking the aforesaid transaction, the appellant
has applied CUP method as the most appropriate method. For application of CUP method the
prices of international transactions of export of the various grades of stainless steel products
was compared with prices of export of the same grades of stainless steel products to
unrelated party on the same or the nearest possible date. Wherever such comparison was not
available, market quotation published in International Weekly Stainless Steel Review was
considered as the benchmark for applying CUP method, as under:
Product Quantity
Exported
Average
Rate
Value
INR
Rate as
per
Arm‘s
length
Value as per
Arm‘s length
HR SS Coils Grade
J4/J8
56442.295 60.840 3,433,951.939 60.094 3,391,843.276
HR SS Coils Grade
304
4228.855 129.645 548,249.906 133.338 563,867,068
HR SS Coils Grade 6530.400 107.694 703,284,898 105.361 688,049,474
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J1
Grade JSJ Tube 733.000 56,244 40,494,111 54,672 40,074,576
Grade J4 HRAP 543,110 70,492 38,284,910 71,263 35,703,648
Store Items 1,277,500 1,277,500
68477.860 4,765,543,264 4,723,815,542
During the course of assessment proceedings, the TPO required the appellant to provide
comparison of price of goods sold to its associated enterprise vis-à-vis sale made to unrelated
third parties on daily basis. Accordingly, the appellant vide reply dated 30.09.2010 submitted
comparison of price on daily basis (nearest available date of sale to unrelated third parties)
for Grade J4 HRAP, J4 Black Coil and J1 (JSL AUS) coils. The ld TPO, rejected the
contention of the assessee that (i) the price of goods is volatile even on daily basis, (ii) the
appellant has charged higher price in most cases and (ii) the price charged by the appellant is
within the range of +/- 5% of the price charged from unrelated third parties and without
allowing comparability adjustment on account of (i) discounts and (ii) basic custom duty,
made transfer pricing adjustment of Rs. 2,47,83,673 in respect of the transactions shown at
pages 3-6 of the transfer pricing order, wherein allegedly, the price charged by the appellant
from its associated enterprise was lower tha the price charged from unrelated parties.
34. For AY 2008-09 appellant has exported various grades of stainless steel products to the
associated enterprise, viz., PT Jindal Stainless, Indonesia, aggregated to Rs.4,73,68,04,611,
as under:
Products Quantity exported Average rate Value INR
MT Rs. Rs.
HR SS Coils Grade 204CU
HRAP
331.115 74,263 2,45,89,627
HR SS Coils Grade 204CU
Black
1,512.335 74,542 11,27,32,964
HR SS Coils Grade 304 HRAP 444.740 1,51,735 6,74,82,617
HR SS Coils Grade 304 Black 2,646.335 1,51,695 40,14,36,716
HR SS Coils Grade 430 Black 436.020 46,999 2,04,92,346
HR SS Coils Grade J4 HRAP 2,202.630 66,605 14,67,07,249
HR SS Plate Grade J4 382.805 68,362 2,61,69,462
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HR SS Coils Grade J4 Black 45,205.790 62,446 2,82,29,29,453
HR SS Coils Grade JSL AUS
HRAP
803.585 1,16,381 9,35,21,792
HR SS Coils Grade JSL AUS
Black
5,581.245 1,11,765 62,37,87,101
HR SS Coils JSL Tube HRAP 734.765 56,902 4,18,09,522
HR SS Coils JSL Tube Black 6,612.860 52,515 34,72,75,662
Store Items 78,70,000
Total 66,894.225 4,73,68,04,511
The appellant has also made export of following grades of Stainless Steel products to
unrelated parties during the same period:
Products
Quantity
exported
Average
rate
Value INR
MT Rs. Rs.
HR SS Coils Grade 304 HRAP 444.740 1,51,735 6,74,82,617
HR SS Coils Grade J4 HRAP 2,202.630 66,605 14,67,07,249
HR SS Plate Grade J4 382.805 68,362 2,61,69,462
HR SS Coils JSL Tube HRAP 734.765 56,902 4,18,09,522
The remaining grades of Stainless Steel products were not exported to unrelated parties
during the same month in all transactions. Wherever such comparable uncontrolled
transactions of export to unrelated parties in the same month was not available, comparison
was made with reference to prices of export during the same month by unrelated party
manufacturers of Stainless Steel products in China, viz., LISCO and BAO Steel. For the
purpose of comparison of prices of international transactions of export of Stainless Steel
products to the associated enterprise, viz., Pt Jindal Stainless, Indonesia, the following
adjustments were made:
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(i) Comparison of prices of international transactions of export has been made with
reference to the date of order accepted with the price of export to unrelated parties
on the nearest possible uncontrolled transactions of export during the same month.
(ii) Comparison in prices has been made for export on CIF basis and in US Dollars.
(iii) Adjustment has been made to the prices of export to unrelated parties on account
of payment of export commission.
(iv) While comparing unrelated party prices in China, comparability adjustment is
made on account of levy of VAT @ 17%.
Comparable uncontrolled transactions of sale of stainless steel products by uncontrolled
enterprises in China were available only for J4 HRAP and 304 HRAP grades of coils.
Accordingly, for comparing such uncontrolled prices with other grades of stainless steel
products, adjustment was made because of difference in Nickel content and conversion cost
of Black Coil (HR) to Pickled Coils HRAP Annealed, as follows:
Grades
Adjustment for Nickel
contents
HRAP
Adjustment for
conversion from Black
to HRAP
204 CU HRAP coil 0.50%
204 CU HRAP coil
(second)
0.50%
204 CU Black coil 0.50% USD 60
304 Black coil - USD 60
JSL AUS HRAP coil 3%
JSL AUS Black Coil 3% USD 60
JSL Tube Black coil 0.70% USD 60
Adjustment because of difference in Nickel content has been made with reference to prices
prevailing in London Metal Exchange (LME) on the respective dates. Accordingly, prices of
international transactions of export of various grades of Stainless Steel products were
compared with prices of comparable uncontrolled transactions of export to unrelated parties
by JSL or uncontrolled transactions of export by uncontrolled enterprises in China. The
prices of international transactions of export of the various grades of Stainless Steel products
to associated enterprise was found to be comparable / higher than the prices charged by JSL
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from export of similar products to unrelated parties or by uncontrolled enterprise in China.
Such international transactions of export of finished goods were, therefore, considered at
arm‘s length applying CUP method. Alternatively, the appellant vide reply dated 29.09.2011
had also undertook benchmarking analysis applying Transactional Net Margin Method
(TNMM) with operating profit to operating income (OP/OI) as PLI. After considering
various selection criteria, one comparable company viz. Salem Steel Plant of Steel Authority
of India was identified as functionally comparable to the operations of JSL. The results of the
Transfer Pricing analysis applying TNMM are summarized herein below:
Company Name Financial year Sales OP/OI (%)
Steel Authority of India (Salem Steel
Plant)
200803 1397.13 7.71%
Jindal Stainless Ltd. 200803 5707.06 9.85%
Since the operating profit ratio (OP/OI %) of JSL @ 9.85% is higher than the operating profit
margin (OP/OI %) of 7.71% of Salem Steel Plant of Steel Authority of India, the comparable
enterprise, the international transactions entered into by JSL were considered as having been
entered at arm‘s length price, applying TNMM on an entity-vide basis.
The TPO, however, during the assessment proceedings has disregarded the benchmarking
analysis undertaken by the appellant for comparing the export of goods made to associated
enterprises with Chinese market quotations on the following grounds, as under:
i. Price charged in Chinese market quotations are not comparable to price charged
by the appellant due to different in geography, product, quality etc.
ii. As per rule 10B(1)(a), only actually transacted data can be used as comparable
price.
iii. The quality of goods manufactured by the appellant are different from goods sold
by Chinese manufacturers and therefore, cannot be compared applying CUP.
Accordingly, during the course of assessment proceedings, the TPO required the appellant to
compare export of goods to related parties with domestic sales and any other comparable
prices. In reply to the requirements of the TPO, the appellant vide reply dated 29.09.2011
submitted the comparison of prices of export of steel products to related parties with
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domestic sales and also with export sales made to unrelated parties after adjusting for nickel
content in the exported goods. The TPO while comparing export of goods made to related
parties with domestic sales, rejected the adjustment claimed by the appellant on account of
bulk discount of 5% to associated enterprises for purchases made in huge quantum by them
holding that the appellant has not been able to produce any analysis or documentary evidence
for providing 5% discount on bulk purchases. Further, the TPO while comparing export of
goods made to related parties with export of goods to unrelated parties has also made
following observations in two cases, as under:br />(i) For benchmarking of international transactions of export of J-4 HR Plate SS to
associated enterprise in Indonesia on 21-09-2007, the appellant considered price of
export of same grade of steel made to unrelated party in Indonesia on 05-09-2007.
The TPO however, has compared the price of export of J-4 HR Plate SS to
unrelated party in Bangladesh on 12-09-2007 as comparable uncontrolled price.
(ii) With respect to the international transaction of J-4 HR Plate SS made on 07-02-
2008, the appellant had considered comparable uncontrolled transactions of export
of similar product undertaken on 22-02-2008 as the benchmark. The TPO,
however, considered the price of export of similar product made on 28-01-2008 to
unrelated party as comparable uncontrolled price.
Accordingly, the TPO has made following adjustments in the arm‘s length price of various
grades of steel products exported to AE as under:
Category
International Transaction CUP
Variance determined
by TPO
I J4 Plate Exports made to
third party
7,64,800
Total 7,64,800
II Other grades Adjusted
domestic prices
(excluding
adjustment of
bulk discount)
5,07,141
304 Black coil 43,96,216
430 Black Coil 15,288
J4 Black Coil 9,71,47,635
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JSLAUS HRAP Coil 19,663
JSLAUS Black Coil 1,52,37,778
JSL Tube Black Coil 49,14,453
204 CU HRAP Coil (Second) 5,62,211
J4 HRAP Coil (Second) 6,70,884
JSLAUS HRAP Coil
(Second)
99,194
Total (INR) 12,35,70,462
III 304 HRAP Coil Nickel price
adjusted export
Prices
31,818
304 Black Coil 2,850
JSL Tube Black coil 50,562
Total (INR) 34,94,445
Total 12,78,29,707
35. The ld CIT (A) and Ld DRP for respective years confirmed the adjustments proposed by the
ld TPO and Therefore assessee is agitated and appealed before us.
36. The ld AR submitted a written note which also covers his oral arguments made before us
as under :-
The adjustment made by the TPO in the arm‘s length price of the international
transaction of export of goods is unjustifiable and bad in law, for the following reasons
as under:
1. Rejection of Chinese market quotations as CUP data:
The TPO rejected the use of Chinese market quotations for the purpose of
benchmarking the international transaction of export of steel products to associated
enterprises, holding that as per rule 10B(1)(a) of the Income Tax Rules, 1962, the data
to be used is transacted data and thus use of quotations as done by the appellant is not
as per intent of law. In this regard, it is respectfully submitted that:
Clause (a) of Rule 10B(1) of the Income-tax Rules (the Rules) provides for
application of CUP method as follows:
10B.Determination of arm‘s length price under section 92C.
(1) For the purposes of sub-section (2) of section 92C, the arm's length price
in relation to an international transaction shall be determined by any of the
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following methods, being the most appropriate method, in the following
manner, namely:-
(a) comparable uncontrolled price method, by which,
(i) the price charged or paid for property transferred or services provided in
a comparable uncontrolled transaction, or a number of such transactions, is
identified;
(ii) such price is adjusted to account for differences, if any, between the
international transaction and the comparable uncontrolled transactions or
between the enterprises entering into such transactions, which could
materially affect the price in the open market;
(iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm's
length price in respect of the property transferred or services provided in the
international transaction;(emphasis supplied)
For the purpose of application of CUP method, prices charged in an international
transaction are required to be compared with the prices charged for comparable
uncontrolled transactions. For the purpose of the aforesaid comparison of prices of
international transactions applying CUP method, Rule 10B(1) of the Rules provides for
making adjustment to account for differences, if any, between the international
transactions and the comparable uncontrolled transactions, which could merely effect
the price in the open market.
Further, Rule 10D of the Income-tax Rules provides for information and documents
which are required to be kept and maintained by the appellant in terms of the
requirements of section 92D of the Income-tax Act in order to support the prices of
international transactions as at arm‘s length. Sub-rule (1) of Rule 10D, inter alia,
requires the appellant to keep and maintain as part of the documentation description of
methods considered for determining the arm‘s length price in respect of each of the
international transactions. Sub rule (3) of Rule 10D further produces that the
information specified in sub-rule (1) shall be supported by authentic documents which
may include, inter alia, price publication including stock exchange and commodity
market quotation. The relevant portion of sub-rule (3) of rule 10D reads as follows:
10D. Information and documents to be kept and maintained under section 92D.
(1) …………………………
(2) …………………………
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(3) The information specified in sub-rule (1) shall be supported by authentic
documents, which may include the following:
(a) official publications, reports, studies, and data bases from the Government of
the country of residence of the associated enterprise, or of any other country;
(b) reports of market research studies carried out and technical publications
brought out by institutions of national or international repute;
(c) price publications including stock exchange and commodity market
quotations;
The appellant for the purpose of applying CUP method compared the prices of
international transactions of export of the various grades of stainless steel products with
prices of export of the same grades of stainless steel products to unrelated party on the
same or the nearest possible date. Wherever such comparison was not available, market
quotation of Chinese manufactures, i.e., BAO Steel and LISCO, was considered as the
benchmark for applying CUP method. It is further respectfully submitted that stainless
steel is a metal compound and is required to be made as per the specified composition /
specifications. There would not be any difference in stainless steel products of a
particular grade manufactured by different manufacturers. Further, market price
quotation of Chinese manufacturers represents the price at which similar stainless steel
products are available in the international market. Such market price quotation of the
Chinese manufacturers, i.e., BAO Steel and LISCO, of stainless steel products, it is
respectfully submitted, are available in public domain and represents prices at which
actual transactions have taken place in the international market and, therefore, in our
respectful submission, represent comparable uncontrolled transactions.
Further, it is respectfully submitted that CUP method evaluates wether the amount
charged in a controlled transaction is at arm's length with reference to the amount
charged in a comparable uncontrolled transaction. The CUP seeks to provide a direct
estimate of the price the parties would have agreed to, had they resorted directly to an
open market alternative to the controlled transaction. The results derived from applying
CUP method generally will be the most direct and reliable measure of an arm's length
result for the controlled transaction. The OECD guidelines also provide in paragraph
2.7 that-
…….Where it is possible to locate comparable uncontrolled transactions, the
CUP method is the most direct and reliable way to apply the arm‘s length
principle. Consequently, in such cases the CUP Method is preferable over all
other methods.
In paragraph 2.13, the OECD guidelines further illustrate application of CUP method in
case where an enterprise sells some products to an associated enterprise and also to an
independent enterprise, as follows:
2.13 As another example, assume a taxpayer sells 1,000 tons of a product
for $80 per ton to an associated enterprise in its MNE group, and at the same
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time sells 500 tons of the same product for $100 per ton to an independent
enterprise. This case requires an evaluation of whether the different volumes
should result in an adjustment of the transfer price. The relevant market
should be researched by analyzing transactions in similar products to
determine typical volume discounts.
Attention in this regard is invited to the relevant portion of the order of Special Bench
of Tribunal in the case of Aztec Software and Technology Ltd. v. ACIT: 107 ITD 141,
where the Tribunal while discussing the applicability of various methods of
determining arm‘s length price, provided under the Act, duly considered that the public
data available at exchanges, quotation media etc., on the basis of which actual
transaction take place in the market, even amongst unrelated parties can be used/ relied
upon, while applying CUP method.
The relevant observations of the Tribunal are as under:
119. .……..XX……….. XX……… XX………
However, where CUP method is to be applied on the basis of public data, it is
provided in Regulation 1.482-3(b)(5) that following requirements must be
met:
- The data is widely and routinely used in ordinary course of business in the
industry to negotiate prices for uncontrolled sales.
- The data is used to set prices in the controlled transaction in the same way
that it is used by uncontrolled taxpayers in the industry; and
- The amount charged in the controlled transaction is adjusted to reflect
product and service variations.
The US regulations further warn that data from public exchanges, quotation
media should not be used in extraordinary situations such as war period,
economic depression, natural calamities period. We are of the considered
view that above principles are of universal application and there is no good
reason why they should not be applied in transfer pricing determination in
India.
………XX…..XX……XX…... (emphasis supplied)
Reliance is also placed on the decision of the Hon‘ble Pune Bench of the Tribunal in
the case of ACIT vs. MSS India (P) Ltd.: 123 TTJ 657, wherein, the appellant had
determined the arm‘s length price of the international transactions with associated
enterprise applying CUP/ Cost Plus method. In that case, the appellant had in respect of
the international transaction of import of raw materials, applied CUP method by
comparing the prices of import on the basis of London Metal Exchange Price plus
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certain markup. The markup of 2 to 6% towards cost of significant services in
procuring raw material and freight, insurance etc., incurred by the associated
enterprise. The TPO, however, rejecting the application of CUP/ Cost Plus method by
the appellant, made adjustment-applying TNMM. The Hon‘ble Tribunal, while holding
that the TPO was not justified in rejecting the CUP/ Cost Plus method, which was
transactional based method, and instead making adjustment applying TNMM even if
the appellant has suffered loss in those transactions with its associated enterprise,
observed as under.
However, whenever necessary inputs for applying one of these methods are
available and there is no dispute about comparability of those inputs, there is
no good reason to resort to transactional profit methods. It would thus follow
that in a situation in which the appellant has followed one of the standard
methods of determining ALP, such a method cannot be discarded in preference
over transactional profit methods unless the revenue authorities are able to
demonstrate the fallacies in application of standard methods. In any event, any
preference of one method over the other method must be justified by the
Transfer Pricing Officer on the basis of cogent material and sound reasoning.
Let us, in the light of this factual position, revert to the facts of this case.
xxx xxx xxx xxx xxx
The external CUP, by way of London Metal Exchange prices, is the basis of
determination of transaction prices and all that the Transfer Pricing Officer is
to see is whether the variation in such prices vis-a-vis the prices at which the
appellant has entered into transactions with the AE is reasonably explained. As
a matter of fact, Rule 10B(1)(a)(ii) categorically provides that price charged for
the property transferred in comparable uncontrolled transaction, which London
Metal Exchange price inherently is, to be 'adjusted on account of differences, if
any, between the international transaction and the comparable uncontrolled
transactions or between the enterprises entering into such transactions, which
could materially affect the price in the open market". What is translates into, on
the facts of the present case, is that the adjustment on account of services
rendered by the AE and the insurance and freight costs are required to be made
to the LME prices. An adjustment of 2% to 6%, for such factors, cannot be said
to be unjustified……..
xxx xxx xxx xxx xxx
The test in selecting the most appropriate method of ALP determination does
not have complexity of the method‘ as one of the factors. All that is to be
taken into account for the said purpose is the nature and class of international
transaction, the class or classes of associated enterprises entering into
transactions and their FAR, the availability, coverage and reliability of data
necessary for application of the method, the degree of comparability existing
between the international transaction and the uncontrolled transaction and
between the enterprises entering into such transactions, the extent to which
reliable and accurate adjustments can be made to account for differences, if
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any, between the international transaction and the comparable uncontrolled
transaction or between the enterprises entering into such transactions; and the
nature, extent and reliability of assumptions required to be made for
application of the method.
In the afresaid decision of Hon‘ble Pune Bench of the Tribunal, application of CUP
method has been upheld by treating the prices of metal quoted in London Metal
Exchange treating as the comparable uncontrolled price.
Reliance in this regard is placed on the decision of the Hon‘ble Gujarat High Court in
the case of CIT vs. Adani Wilmar Ltd (ITA No 240/2014) wherein the Hon‘ble High
Court upheld the use of quotations as a valid CUP. The relevant finding of the Hon‘ble
High Court are as under:
7. In terms of clause (c) of subsection (3) of Rule 10D of the Rules,
these price publications as long as the same were authentic and
reliable, would be relevant materials. In this background, mere base of the
organization would be of no
consequence. Further, though the price quotationsof the MPOB would be entit
led to its due and fullweightage and respect, would not necessarily mean that
the other quotations would lose their significance, unless, of course,
it is pointed out that such quotations lack basis.
Following the decision of Hon‘ble Gujarat High Court in the case of Adani Wilmar
(supra), Hon‘ble Pune Bench of Tribunal in the case of Cargil foods India Limited vs.
DCIT [ITA No. 1460/Pn/2010], too, accepted the price of commodities listed on
Chicago Board of Trade (CBOT) and Oil world as appropriate comparable uncontrolled
transaction:
18. Ostensibly, the rules pertaining to the transfer pricing assessment refer to
information, being price publications including stock exchange and commodity market
quotations. It is a common knowledge that for the products, which are listed on the
stock and commodity exchanges, the transactions of buying and selling are carried out
by parties based on the prices prevailing/quoted on the respective stock or commodity
exchanges. Therefore, such published data available from stock or commodity
exchanges is available to set prices in the uncontrolled and controlled transactions both.
At this stage, we may also refer to the judgment of Hon‘ble High Court of Gujarat in
Tax Appeal No.240 of 2014 in the case of CIT Vs. Adani Wilmar Limited, dated
07.04.2014 which was relied upon by the appellant before us. In the case before the
Hon‘ble High Court of Gujarat, the TPO adopted CUP method to benchmark an
international transaction. The appellant presented two sets of prices claiming them to
be comparable to his transactions with the associated enterprises. One set of prices
relied upon by the appellant was supplied by the Malaysian Palm Oil Board and the
second set of prices was the quotations published by Oil World, an independent
organization. The TPO took into account the rates mentioned by Malaysian Palm Oil
Board and disregarded the rates published by Oil World. According to the TPO, the
Malaysia Palm Oil Board was a statutory body of Malaysia whereas the quotations
published by Oil World did not have any statutory authority. The aforesaid objection of
the TPO was negated by the CIT(A) as well as the Tribunal, and such stand of the TPO
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also did not find favour with the Hon‘ble High Court of Gujarat. Following discussion
in the order of the Hon‘ble High Court of Gujarat is relevant in this regard:-
7. ……………………………………………..
19. It is evident that the Hon‘ble High Court of Gujarat held that the price publications
are also relevant material for the purposes of carrying out the comparability analysis in
the course of application of CUP method; so however, such price publications ought to
be authentic and reliable. It is also noteworthy that the Hon‘ble High Court of Gujarat
was considering an objection of the Transfer Pricing Officer, which is similar to that
being raised before us, which is to the effect that the price publication of Oil World
only reflect quotations and not actual transactions. The said argument did not find
favour with the Hon‘ble High Court of Gujarat and it noted that the reliability and
authenticity of the material stood established. In fact, the decision of the Pune Bench of
the Tribunal in the case of ACIT Vs. MSS India (P) Ltd. (supra) relied upon by the
Ld.CIT-DR does not help the Revenue on this aspect, and in any case the said decision
is not an authority for the proposition that price contained in the Broker Note, based on
a commodity exchange, is not a valid CUP data. Based on the aforesaid judgment of the
Hon‘ble High Court of Gujarat, in our view, the rejection by the TPO of the price
publication of Oil World and the prices quoted by MMSPL, which are based on the
rates quoted on CBOT, Chicago, is not justified.
The aforesaid decision of the Hon‘ble Pune Tribunal was upheld by the jurisdictional
High Court in ITA No. 157/2016, wherein, Hon‘ble Delhi High Court has held:
4. However, as noted by the ITAT, Rule 10 D (3) (c) of the Income Tax Rules, 1962
envisages that the TPO should take into consideration price publications including
stock exchange and commodity market quotations. Therefore, such published data
available from stock or commodity exchanges could form the basis of the prices in both
uncontrolled and controlled transactions.
5. Having heard learned counsel for the parties, the Court is not persuaded to hold that
the above reasoning by the ITAT is perverse and suffers from any legal infirmity. No
substantial question of law arises for determination.
Reliance in this regard is also placed on the recent decision of Mumbai Bench of
Tribunal in the case of Reliance Industries Limited vs. ACIT (ITA No.
3082/Mum/2006), wherein the Hon‘ble Tribunal for the purpose of benchmarking
international transaction applying CUP method has directed the assessing officer to
consider data available in public domain in the form of publication of shipping
Intelligence weekly and Drewry Monthly, as under:
12.10 Both the parties agreed before us that the "CUP" method should be followed. As
there is no comparable transactions, in view of the fact that "Reichem Isha", is a Unique
Vessel, with no comparable ship available, as suggested by both the parties, we set
aside the issue to the file of the Assessing Officer for the limited purpose of recomputing
the arm‘s length price by taking the date available in the public domain in
the form of publication of Shipping Intelligence Weekly and Drewry Monthly as a
"comparable price", and thereafter to make various adjustments towards weight, capital
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cost, risk, etc., and then arrive at the arm‘s length price. The appellant has furnished its
calculation. The Assessing Officer shall examine this calculation of arm‘s length price
given by the appellant wherein various adjustments are claimed on account of variation
and arrive at the arm‘s length price. Needless to say, opportunity of being heard should
be given to the appellant.
Reliance in this regard is also placed on recent decision of Delhi Bench of Tribunal in
the case of Tilda Riceland Pvt. Ltd. vs. ACIT (ITA No. 6279/Del/2012), wherein the
facts of the case were found to be identical to the facts of the case of appellant.
Relying upon the decision of the Hon‘ble High Court, the Hon‘ble Delhi Tribunal in the
case of Noble Resources and Trading India Pvt Ltd vs DCIT (TA No 3132/Del/2013)
upheld the use of quotations as a valid CUP. The Hon‘ble Tribunal held as under:
14…... However, ld AR has relied on the decision of Hon'ble Gujarat
High Court in case of CIT Vs. Adani Wilmar Ltd. wherein the Hon'ble
High Court has held that the price publication as long as same are
authentic and reliable would be relevant material for the purpose of Rule
10D(3)(c). The Hon'ble High Court considered the quotations of
Malaysian Palm Oil Board prices and quotation by One Oil World for
comparability analysis Before us the ld DR has stated that that these data
are not authentic. However, we do not find a whisper in the order of ld.
Transfer Pricing Officer that the internal and external comparable data
have been examined at all with respect to their authenticity. They have
been simply rejected relying on Rule 10D(3) of the Income Tax Rules. On
the issue before the Hon'ble Gujarat High Court in case of CIT Vs. Adani
Wilmar Ltd. was not on unacceptability of quotations but TPO only
objected with respect to the geographical location of the transactions and
the quotations. Therefore, even before the Hon‘ble Gujarat High court the
quotations were accepted as external CUPs. The Hon‘ble Gujarat High
Court has held as under:
XXX
15. We would also draw support for use of Quoted Prices, if they are
authentic for comparability analysis in CUP method from OECD BEPS
Action Plan also. For this we refer to the release of new guidance on cross
border commodity transactions by OECD on its Base Erosion and Profit
Shifting (BEPS) plan actions 8 and 10, 2015 Final Reports, wherein there
is an addition to Chapter II of the Transfer Pricing Guidelines relating to
commodity transactions [Extracted from OECD publication Aligning
Transfer pricing Outcomes with value creation OECD 2015] as under…..
XXX
Therefore respectfully following the decision of Honble Gujarat High
Court and drawing support from OECD BEPS Action Plan , we are of the
view that even the „quoted prices which is authentic may be acceptable
as per Rule 10D(3) of the Income Tax Rules for comparability analysis
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It is also submitted that the appellant is selling its steel products in global market and
the Chinese manufactures, with whom the comparison has been made by the appellant
sells its products globally. Since, the market for both appellant and Chinese
manufacturers are same, the market quotation provided by the Chinese manufacturers
provides better comparable uncontrolled transactions. Reliance in this regard is placed
on the decision of M/s Clear Plus India Pvt Ltd vs. DCIT (ITA No.3944/D/2010),
wherein the Hon‘ble Tribunal held that:
7. We have examined the ratio of these cases in the context of the facts of
the case. At the cost of repetition, it may be mentioned that goods were sold
by the Chinese manufacturers in the USA market. The appellant has also
sold the goods in U.S.A. market. Therefore, market conditions in the
territory of sale are the same. In view thereof, we are in agreement with the
learned counsel that the buyer in the USA market will be more concerned
with quality and price rather than economic conditions prevailing in China
and India…..
………In the case of Serdia Pharmaceuticals India (P) Limited, it has been
held that CUP method is a preferred method and it leads to more reliable
results visa- vis the results obtained by applying transaction profit method.
In the case of SNF (Australia) Pty. Limited, it has been held that the focus is
on the market in which products are acquired. The ratio of this case is
applicable mutatis-mutandis to the facts of the case as the focus is on the
market in which products are sold.
In view of the aforesaid, it is respectfully submitted that the appellant has appropriately
considered market quotations of the Chinese manufacturers as a benchmark for
applying CUP method in respect of international transactions of export of stainless steel
products.
It is further submitted that the TPO has sought to make comparison of price charged by
the appellant in sales made to associated enterprise with domestic sales made to
unrelated third parties.
In this regard it is submitted that the price charged for sale of such products in
domestic market, on the other hand, is subject to the demand and supply situation,
Government policy and duty structure, etc. in domestic market. More specifically, the
following factors may influence the prices of stainless steel in the domestic market:
i) The prices being offered by the competitors in the market.
ii) The duties and taxes on imports in to the country and the resultant
delivered cost to the customer.
iii) International demand-supply situation.
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iv) Domestic capacity and domestic prices of local manufacturers in respective
countries.
Additionally it is submitted that prices of export of finished goods in one country
cannot be benchmarked with reference to prices prevailing in another country by
applying CUP method, on account of, inter alia, (i) variation on account of the strength
of the currency, (ii) geographical differences from country to country owing to
economic scenario/ purchasing power, level of competition, (iii) market condition, (iv)
time of export and (v) size of the order, etc.
In fact, in the year under consideration, the price charged by Chinese manufacturers in
the open market were lower than the price charged by the appellant from its associated
enterprises, due to huge production of steel in their country. Despite slowdown in the
steel industry, China has produced 36% more steel than the preceding year which is
much higher than the growth in production reported by entire Asia region at 6.3% (refer
page 35 of the paper book). Therefore, considering the economic scenario prevalent in
the international market, the price charged by the appellant in sales made to associated
enterprise cannot be compared with domestic sales and the right comparable ought to
be the price at which goods were available to the associated enterprise in the open
market, i.e. price charged by Chinese Manufacturers.
It is respectfully submitted that comparison of prices of international transactions of
export of various grades of stainless steel products with the prices in domestic market
would not satisfy the test of comparability, in as much as, the two transactions have
been undertaken in different economic and geographical scenario. Such comparison, it
is submitted with entire emphasize, does not satisfy the cardinal principle of
comparability under the Transfer Pricing regulations and would lead to fallacious and
misleading results.
It would be appreciated that in the case of the appellant, the tests for application of CUP
method, as the most appropriate method, as provided in sub-rule (2) of Rule 10C of the
Rules are satisfied only be comparing the price charged by the appellant in export of
stainless steel products made to associated enterprise with that of transactions of sale of
stainless steel products in the international market, i.e. quotation issued by Chinese
manufacturers in international market.
2. Rejection of adjustment on account of bulk discount of 5%
It is respectfully submitted that the results derived from applying CUP method
generally will be th most direct and reliable measure of an arm's length result for the
controlled transaction, if an uncontrolled transaction has no differences as compared to
the controlled transaction that would affect the price, or if for which appropriate
comparability adjustments can be made. It is submitted for the purpose of applying
CUP method, minor differences in contractual terms or economic conditions can
materially affect the amount charged in an uncontrolled transaction. CUP method
becomes less reliable substitute for arm's length dealings if not all significant
characteristics of the uncontrolled transactions are comparable. Therefore, it would be
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appreciated that, if significant differences, CUP method will not produce a reliable
measure of an arm's length result.
It would be noted that in order to apply the CUP method, the comparable uncontrolled
transaction have to satisfy the strict comparability criteria. Hon‘ble ITAT in the case of
UCB India (P) Ltd. vs. ACIT [2009] 30 SOT 95 [MUM] examining the test of
comparability on application of CUP method held as under:
80. ………………………….circumstances and conditions have to be
evaluated………………. For pricing of a product is a very subjective exercise and is
true value, as received by the receiver, can differ from that received by others in the
market place. Thus, CUP method requires a high degree of comparability along the
following dimensions:
(i) Quality of the product or service;
(ii) Contractual terms (example, scope and terms of warranties provided, sale or
purchase volumes, credit terms, transportation terms, etc)
(iii) Level of market i.e. wholesale, retail, etc.
(iv) Geographical market in which the transaction takes place.
(v) Date of transaction
(vi) Intangible property associated with the sale
(vii) Foreign currency receipt
(viii) Alternatives realistically available with the buyer and the seller.
81. In OECD Transfer Pricing guidelines at II-3 paragraphs 2.8 and 2.9 it is states as
follows:
"2.8 It may be difficult to find a transaction between independent enterprises that is
similar enough to a controlled transacting such that no differences have a material
effect on price. For example, a minor difference in the property transferred in the
controlled and uncontrolled transactions could materially affect the price even though
the nature of the business activities undertaken may be sufficiently similar to generate
the same overall profit margin. When this is the case, some adjustments will be
appropriate. As discussed below in paragraph 2.9, the extent and reliability of such
adjustments will affect the relative reliability of the analysis under the CUP method.
2.9 In considering whether controlled and uncontrolled transactions are comparable,
regard should be had to the effect on price of broader business functions other than just
product comparability (i.e. factors relevant to determining comparability under chapter
1). Where differences exist between the enterprises undertaking those transactions, it
may be difficult to determine reasonably accurate adjustments to eliminate the effect on
price. The difficulties that arise in attempting to make reasonably accurate adjustments
should not routinely preclude the possible application of the CUP method. Practical
considerations dictate a more flexible approach to enable the CUP method to be used
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and to be supplemented as necessary by other appropriate methods, all of which should
be evaluated according to their relative accuracy. Every effort should be made to adjust
the data so that it may be used appropriately in a CUP method. As for any method, the
relative reliability of the CUP method is affected by the degree of accuracy with which
adjustments can be made to achieve comparability."
Reliance is placed in this regards on the following decisions where in it is held that
application of CUP method requires strict comparability and comparability adjustment
is required to be made for the differences if any:
- UCB India Pvt. Ltd. vs ACIT (2009) 30 SOT 95(Mum)
- ACIT vs. MSS India Pvt.Ltd.:123 TTJ 653 (Pune)
- Gharda Chemicals vs DCIT (2009) 35 SOT 406 (Mum)
- Intervet India Pvt .Ltd.ACIT :130 TTJ 301(Mum)
- ACIT vs Dufon Laboratories: (2010) 39 SOT 59 (Mum)
Further, the cardinal principle of the transfer pricing regulations is to compare like with
like and to eliminate differences, if any, by suitable adjustment. Rule 10B(3) also
provides for appropriate comparability adjustments to made in the PLI of the tested
party and comparable companies while computing the arm‘s length price. Rule 10B(3)
of the rules provides that:
An uncontrolled transaction shall be comparable to an international transaction if—
(i) none of the differences, if any, between the transactions being compared, or
between the enterprises entering into such transactions are likely to materially affect the
price or cost charged or paid in, or the profit arising from, such transactions in the open
market; or
(ii) reasonably accurate adjustments can be made to eliminate the material effects of
such differences.
The said regulations clearly provide for adjustments in margins of the enterprise
entering into international transactions for any differences between such international
transactions and the transaction of the comparables or between the enterprise entering
into international transactions and comparable companies.
Reliance is also placed on the following decisions, wherein undertaking economic
adjustment for improved comparability of the entities being compared for
benchmarking experience has been emphasized.
- Sony Ericsson Mobile Communications India Pvt. Ltd. vs CIT III (374 ITR 118)
- Transwitch India Pvt Ltd vs DCIT (ITA No 6083/Del/2010) - Hon‘ble Delhi High
Court, in the appeal preferred by the revenue, vide order dated 17.07.2013 upheld the
adjustment claimed by the appellant on account of capacity utilization.
- Mentor Graphics (Noida) : Private Limited : 109 ITD 101 (Del),
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- Sony India (P) Limited : 106 ITD 175 (Del).
- Skoda Auto India (P) Ltd. vs. ACIT : 122 TTJ 699 (Pune)
- Schefenacker Motherson Ltd. vs. ITO (in ITA Nos. 4459 & 4469/Del/07),
- Honeywell Automation India Pvt. Ltd. vs. DCIT (ITA No. 4/PN/08),
- Egain Communication Pvt. Ltd. vs. ITO : 118 ITD 243 (Pune)
- Brintons Carpets Asia Pvt. Ltd. vs. ACIT (ITA No. 1296/PN/10)
- CRM Services India P. Ltd. vs. DCIT (ITA No. 4068/Del/2009) - The aforesaid
decisions of the Tribunal have been affirmed by the Hon‘ble High Court in ITA No.
618/2012 and 619/2012
- Genisys Integrating Systems (India) Pvt Ltd vs DCIT (ITA No 1231/Bang/2010)
- Radhashir Jewellery Co. Pvt. Ltd. vs. ACIT (ITA No. 7066/Mum/2013)
- Calsonic Kansel otherson Products Ltd vs. DCIT (ITA No. 667/Del/2015)
- ACIT vs. Fiat India Pvt Ltd (ITA no 1848/Mum/2009)
- E.I. Dupont India Pvt Ltd vs. DCIT (ITA No 5336/D/2010)
- DCIT vs. Panasonic AVC Networks India Co. Ltd. (ITA No. 4620/Del/2011)
- HCL Technologies BPO Services Ltd. vs. ACIT in ITA No. 3547/Del/2010
In the case of the appellant, while undertaking the benchmarking analysis applying
CUP, in order to make comparison of like to like, comparability adjustments of bulk
discount are required to be made.
It is a common market practice that the bulk purchasers are generally given some
discount. In the case of the appellant, the A.Es have been given sale-price discount of
5% due to the high quantity of purchases. The fact that the quantity discount were given
to associated enterprises can also be corroborated from the fact that during the year, the
total sale made to related party per invoice was much higher than the sales made to
unrelated third parties:
Grade Sales made
to associated enterprise
Sales made
to unrelated third parties
No. of
Invoices
Quantity
(MT)
Sales
quantity
per
invoice
No. of
Invoices
Quantity
(MT)
Sales
quantity
per
invoice
204 CU Black
Coil
22
1,512.335
69
3
30.350 10
204CU HRAP
Coil
10
331.115
33
11
106.221 10
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304 Black Coil
23
2,646.335
115
432
6,367.050 15
304 HRAP Coil 4
444.740
111
401
3,666.023 9
430 Black Coil 8
436.020
55
2
1.240 1
J4 Black Coil
296
45,205.790
153
174
2,243.400 13
J4 HRAP Coil
32
2,202.630
69
69
605.482 9
J4 Plate
14
382.805
27
104
858.935 8
JSL AUS Black
Coil
46
5,581.245
121
23
330.510 14
JSL AUS HRAP
Coil
18
803.585
45
53
441.518 8
JSL Tube Black
Coil
68
6,612.860
97
285
5,233.315 18
JSL Tube HRAP
Coil
5
734.765
147
368
2,414.421 7
In fact in the case of J4 Black coil, it would be noted that the appellant has sold
45205.790 MT to the associated enterprise, whereas, the total quantity of J4 Black Coil
sold to unrelated third parties is merely 2234.400 MT, constituting only 4.7% of the
total sales. Accordingly, in a situation where the manufacturing facility of the appellant
established for J4 Black Coil is substantially dependent on the purchase orders received
from associated enterprise, it is natural commerce that the price ought to be
comparatively discounted from the price charged in sales made to unrelated third
parties.
Accordingly, while undertaking the benchmarking analysis with unrelated third parties,
applying CUP, in order to make comparison of like to like, the appellant has made
adjustment of bulk discount of 5% given on export sales made to related party
customers.
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Reliance in this regard is also placed on the decision of Ahmadabad bench of the
Tribunal in the case of Atul Limited vs. ACIT (ITA No. 3118/Ahd/2010), wherein, the
Hon‘ble Tribunal, in the similar situation, has allowed adjustment of bulk discount in
CUP prices, as under:
regarding the adjustment on the basis of quantity discount‘ as claimed by the
appellant, there were few products, the sales of which to the AE were higher. It was a
common market practice for bulk purchasers to be given some discount.
The Hon‘ble Mumbai Bench of Tribunal in the case of Clariant Chemicals (India) Ltd.
vs. JCIT (ITA No. 2393/Mum/2011), too, allowed comparability adjustment on account
of trade discount, holding as under:
6. We have heard both the parties on this issue and their contentions have carefully
been considered. We have also carefully gone through the case law and documents
relied upon by both the parties. The main contention of the appellant in this regard is
grant of 20% discount on volume difference.. This contention of the appellant is
supported by the arguments that in immediate preceding assessment year TPO had
accepted such volume discount and reference in this regard has been made to the order
of TPO rendered in respect of assessment year 2002-03, the relevant portion of which
has been reproduced in the above part of this order. The relevant portion of impugned
TPO‘s order has also been reproduced in the above part of this order. So as it relates to
chemical HOSTAPERM the turnover for this year to the related parties is 29,400 Kgs.
@ 302.38 per Kg as against similar sales made to AE‘s in A.Y 2002-03 to the tune of
23,500 Kgs. at the average the price of Rs.310.83 per Kg. The uncontrolled party sales
for the year under consideration for the same chemical is 700 kgs. as against the similar
sales to unrelated parties of 125Kgs. Therefore, it cannot be said that there is any
material difference in the facts of the two years i.e. A.Y 2002-03 and 2003-04. When
the facts are same the question will be that whether on the same facts Department can
take a different stand for the year under consideration which is against the rule of
consistency. When there is no difference in the facts of preceding year where the case
of appellant has been accepted by the TPO expressly, then in our considered view TPO
cannot take a different stand during the year under consideration as the appellant will
be entitled to get benefit of the stand taken by the revenue in immediate preceding year.
There is insignificant difference in the rates of the commodity and the volume of
transactions. The difference, if any, favours the appellant as the volume of related party
transaction is much more this year as it has gone upto 29,400 kgs against last years
sales of 23,500 kgs.
The TPO, while comparing the international transaction of exports of goods with
domestic sales has disregarded the claim of quantity discount holding it to be a
contagious issue.
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It is pertinent to note that the fact that average sales made to associated enterprises per
invoice is invariably higher than the average sales made to unrelated third parties, is in
itself an evidence to corroborate that the associated enterprises were offered discounted
price on account of bulk purchases, for which comparability adjustment ought to be
made in the price of goods sold to unrelated third parties.
It shall also be noted that had the appellant charged a price higher than the international
market price to the associated enterprise, it would have purchased similar goods from
other unrelated third parties and consequently, the appellant would had to incur higher
cost on account of unsold stock/ utilization of production capacity, resulting into lower
profitability.
In fact, in the year under consideration, the price charged by Chinese manufacturers in
the open market were lower than the price charged by the appellant from its associated
enterprises, due to huge production of steel in their country. Despite slowdown in the
steel industry, China has produced 36% more steel than the preceding year which was
much higher than the growth in production reported by entire Asia region at 6.3% (refer
page 35 of the paper book). Therefore, it could be concluded that the associated
enterprises has only accommodated the appellant by purchasing its goods at a price
higher than the market price, in order to protect it from anticipated capital loss due to
unsold stock/ unutilized capacity.
Accordingly, in view of the aforesaid provision of the Act and various decisions given
by the Hon‘ble Tribunal regarding comparability adjustment on account of difference in
geographies, market conditions, terms and conditions of sales, etc., it is respectfully
submitted that while comparing the international transaction of export of goods with
domestic sales, the price ought to be determined by making adjustment on account of
bulk discount of 5% given the assess to its associated enterprises.
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It would be appreciated that prices of international transactions of export to associated
enterprise, after considering adjustment on account of bulk discount of 5%, is higher/
within the range of +/-5% than the comparable uncontrolled prices in all grades of
stainless steel products. In view of the aforesaid, too, the international transactions of
export of stainless steel products is to be regarded as having been undertaken as at
arm‘s length applying CUP method.
3. Comparison on the basis of date of order acceptance cannot be applied in the
present case:
In the present case, it is submitted that the goods exported by the appellant, namely, hot
rolled and cold rolled stainless steel coils contains metal components such as nickel and
iron and the prices of the goods sold by the appellant is determined considering the
prices prevailing in London Metal Exchange (LME) on the respective dates of such
metal components. In view of the aforesaid, the price of goods sold on one specific date
cannot be compared with the prices of goods sold on any preceding or subsequent date.
Accordingly, in view of the volatility in the prices of metal components on day to day
basis and consequential change in the final products sold by the appellant, it is
submitted that the benchmarking of price ought to be made on the basis of average
price charged in uncontrolled transactions for the same period, for each of the grade of
stainless steel products.
It shall further be appreciated that the export of goods made by the appellant to its
associated enterprise on several dates are one class of transaction, i.e. export of goods,
the same can be benchmarked together applying CUP method. Rule 10A(d) provides
that closely linked transaction can be considered together. Further, para 3.9 of the
revised OECD guidelines on transfer pricing states that:
"3.9 Ideally, in order to arrive at the most precise approximation of fair market value,
the arm's length principle should be applied on a transaction by- transaction basis.
However, there are often situations where separate transactions are so closely linked or
continuous that they cannot be evaluated adequately on a separate basis. Examples may
include
1. Some long-term contracts for the supply of commodities or services,
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2. rights to use intangible property, and
3. pricing a range of closely linked products (e.g. in a product line) when it is
impractical to determine pricing for each individual product or transaction.
Another example would be the licensing of manufacturing know-how and the supply of
vital components to an associated manufacturer; it may be more reasonable to assess
the arm's length terms for the two items together rather than individually. Such
transactions should be evaluated together using the most appropriate arm's length
method or methods. A further example would be the routing of a transaction through
another associated enterprise; it may be more appropriate to consider the transaction of
which the routing is a part in its entirety, rather than consider the individual transactions
on a separate basis.
Hon‘ble Delhi High Court in the case of Sony Ericsson Mobile Communications India
Pvt Ltd. vs. CIT (374 ITR 118), on the issue of set off of transaction in the case of
segregation of bundled transaction, held as under:
136. This leads us to the question of set off when bundled transactions are
segregated. Conceptually, this is justified and equitable, as tax is payable on
the total income after transfer pricing computation in respect of international
transactions (See Section 92(4) of the Act).
137. The question of aggregation and disaggregation of transactions when the
TNM Method or even in other methods is sought to be applied, must have
reference to the strength and weaknesses of the TNM Method or the
applicable method. Aggregation of transactions is desirable and not merely
permissible, if the nature of transaction(s) taken as a whole is so inter-related
that it will be more reliable means of determining the arms length
consideration for the controlled transactions. There are often situations where
separate transactions are intertwined and linked or are continuous that they
cannot be evaluated adequately on separate basis. Secondly, the controlled
transaction should ordinarily be based on the transaction actually undertaken
by the AEs as has been struck by them. We should not be considered as
advocating a broad-brush approach but, a detailed scrutinized ascertainment
and determination whether or not the aggregation or segregation of
transactions would be appropriate and proper while applying the particular
Method, is necessary.
139. The majority judgment in the case of L.G. Electronics India Pvt. Ltd.
(supra) opines that the Act, i.e. Chapter X of the Act, prohibits and does not
permit set off or adjustment. Reference stands made to sub-section (3) to
Section 92 of the Act. We would like to reproduce the said Section and
understand the object and purpose behind the said provision.
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(3) The provisions of this section shall not apply in a case where the
computation of income under sub-section (1) or sub-section (2A) or the
determination of the allowance for any expense or interest under sub-section
(1) or sub-section (2A), or the determination of any cost or expense allocated
or apportioned, or, as the case may be, contributed under sub-section (2) or
sub-section (2A), 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 or specified domestic transaction was entered into.
140. Sub-section (3), we do not think incorporates a bar or prohibits set offs or
adjustments. It states that Section 92, which refers to computation of income
from international transaction with reference to arms length price under subsection
(2) or (2A), would not have the effect of reducing income chargeable
to tax or increase the loss, as the as may be, computed by the appellant on the
basis of entries in the books of account. Income chargeable to tax or loss as
computed in the books is with reference to the previous year. The effect of
sub-section is that the profit or loss declared, i.e. computed by the appellant
on the basis of entries in the books of account shall not b enhanced or
reduced because of transfer pricing adjustments under sub-section (2) or (2A)
to Section 92. It states the obvious and apparent. In case the assessed has
declared better and more favourable results as per the entries in the books of
account, then the income chargeable to tax or loss shall not be decreased or
increased by reason of Transfer Pricing computation. Thus, transfer pricing
adjustments do not enure to the benefit or advantage the assessed, thereby
reducing the income declared or enhancing the declared loss. Pertinently, the
Sub-Section makes reference to the income chargeable to tax or increase in
the loss on the basis of the entries in the books of account. The concept of set
off or adjustments was/is well recognized and accepted internationally and by
the tax experts/ commentators. In case the legislative intent behind sub-section
(3) to Section 92 was to deny set off, the same would have been spoken about
and asserted different and categorical words. Legislative intent to the contrary
should not be assumed.
142. The Legislature, therefore, if it wanted to provide and stipulate that set
off would not be available or should be denied, would have appropriately
expressed their intention in specific and express words. The intention on the
other hand of the Legislature is not what is propounded by the Revenue.
Consistent, the stand of the Revenue, it is apparent is divergent from the
internationally accepted practice relating to Transfer Pricing determinations.
The Legislature when it wanted to deviate, has adopted such recourse as with
the year data and use of inter-quartile range. We do not read any repugnancy
on this aspect in Section 92(3) of the Act. Thus, where the Act, i.e. the Income
Tax Act, 1961 or the Rules do not devise or enact a contrary provision, we
should not discard or ignore, without adequate justification, the OECD
Transfer Pricing Guidelines or the U.N. Transfer Pricing Manual. Otherwise
we deny ourselves benefit and advantage of the study and the dexterous and
deliberated elucidations made in the extant OECD Transfer Pricing Guidelines
or the U.N. Transfer Pricing Manual, as if they are redundant and superfluous.
The Act, i.e. the Income Tax Act, 1961 and the Rules are supreme, but the
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OECD Transfer Pricing Guidelines or the U.N. Transfer Pricing Manual can
be supplement and constitute a valuable and convenient commentary on the
subject. They are not binding but surely their rational and articulacy requires
cogitation, if not acceptance, when warranted.
144. Question of set off would only arise in case two transactions are separate
and arms length price should be computed separately. It would not arise for
consideration in cases where there are closely linked or continuous
international transactions. Yet, there may be a third category of cases, where
the appellant perceives and files his report in form 92E treating the
international transaction as one or as continuous or an interconnected package,
but the Revenue perceives and believes that the transaction is not one, but
should be segregated for the purpose of computation of arms length price.
For the present reasoning, we will assume and accept that the position of the
Revenue is correct and the aggregation‘ made by the appellant is wrong. In
such cases, it would be grossly unfair and inequitable not to apportion or
segregate the transactions as declared in a reasonable and logical manner. It
would be conspicuously wrong and incorrect to treat the segregated
transactional value as NIL‘ when in fact, the two AEs had treated the
international transactions as a package or a single one and contribution is
attributed to the aggregate package. It is noticeable that sub-section (3) to
Section 92 does not make reference to the computation of the form 92E but
makes reference to the books of account and computation on the basis of the
entries in the books of account. It stipulates that the computation made under
sub-section (2) or (2A) shall not have effect of reducing the income or
increasing the losses as declared on the basis of the said entries. Income or
loss is the net figure which is computed after taking into account the business
activities undertaken by the assessed AE which will have reference to the
declared bundled/packaged international transaction.
Reliance is also placed in this regard on the decision of the Hon‘ble Pune Bench of the
Tribunal in the case of Demag Cranes & Components (India) Pvt. Ltd. vs. DCIT (ITA
No. 1683/Pn/2011), wherein, the Hon‘ble Tribunal while upholding the principal of
aggregation held as under:
30. We have carefully considered the rival submissions. Section 92B of
the Act provides the meaning of expression international transaction as a
transaction between two or more associated enterprises. Rule 10A(d) of the
Rules explains the meaning of the expression transaction for the purposes
of computation of ALP as to include a number of closely linked
transactions. Rule 10B of the Rules prescribes the manner in which the
ALP in relation to an international transaction is to be determined by
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following any of the methods prescribed. Shorn of other details, it would
suffice to observe that on a combined reading of Rule 10A(d) and 10B of
the Rules, a number of transactions can be aggregated and construed as a
single transaction‘ for the purposes of determining the ALP, provided of
course that such transactions are closely linked‘. Ostensibly the rationale
of aggregating closely linked‘ transactions to facilitate determination of
ALP envisaged a situation where it would be inappropriate to analyse the
transactions individually. The proposition that a number of individual
transactions can be aggregated and construed as a composite transaction in
order to compute ALP also finds an echo in the OECD guidelines under
Chapter III........................
XX XX
31. In this background, considering the legislative intent manifested by way
of Rule 10A(d) read with Rule 10B of the Rules, it clearly emerges that in
appropriate circumstances where closely linked transactions exist, the same
should be treated as one composite transaction and a common transfer
pricing analysis be performed for such transactions by adopting the most
appropriate method. In other words, in a given case where a number of
closely linked transactions are sought to be aggregated for the purposes of
bench marking with comparable uncontrolled transactions, such an
approach can be said to be well established in the transfer pricing
regulation having regard to Rule 10A(d) of the Rules. Though it is not
feasible to define the parameters in a water tight compartment as to what
transactions can be considered as closely linked‘, since the same would
depend on facts and circumstances of each case. So however, as per an
example noted by the Institute of Chartered Accountants of India (in short
the ICAI‘) in its Guidance Notes on transfer pricing in para 13.7, it is
stated that two or more transactions can be said to be closely linked‘, if
they emanate from a common source, being an order or contract or an
agreement or an arrangement, and the nature, characteristic and terms of
such transactions substantially flow from the said common source.
Your Hnour‘s attention is invited to recent decision of the Hon‘ble Pune Bench of the
Tribunal in the case of Cummins India Ltd vs Addl CIT (ITA No 1616/PN/2011),
wherein, interpreting Rule 10A(d) of the Rules, it was held as under:
26. In view of the ratio laid down by Pune Bench of the Tribunal in Demag
Cranes & Components (India) Pvt. Ltd. Vs. DCIT (supra), it is held that where
number of transactions are closely linked transactions, then the same can be
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aggregated and construed as a single transaction for the purpose of determining
the arm's length price. In case, there is close link exists between the different
transactions, the same should be treated as composite transaction and
appropriate method should be applied to work out the transfer pricing analysis.
Where two or more transactions emanate from common source being an order
or contract or an agreement or an arrangement, then such transactions could be
said to be closely linked as the nature, characteristic and terms of such
transaction substantially flow from the said common source.
Reliance is also placed in this regard on the decision of the Canadian
International Trade Tribunal in the case of Skechers USA Canada Inc (Appeal
No AP -2012-073) wherein the Tribunal held that in cases where the Research
and Development activity is necessary for creation of successful models of
goods, costs relatable to such R&D activity when separately allocated by the
manufacture of goods to the distributor of goods, is required to be taken into
consideration while determining the arm‘s length price of sale of goods by the
manufacturer to the distributor. The relevant findings of the Tribunal are as
under:
82. Not only does the Tribunal consider the R&D payments to be necessary
for the creation of the footwear, it also considers that a sufficient link can be
established between the R&D payments and the goods in issue by examining
the way in which the owed amounts are determined. To paraphrase previous
Tribunal jurisprudence on the scope of in respect of the evidence shows that
the R&D payments are not general payments unaffected by the imported
goods.
XXX
88. For these reasons, the Tribunal finds that the evidence establishes that the
R&D payments in their entirety are in respect of the goods in issue.
XXX
108. Given the Tribunal‘s conclusion that the full amount of the R&D
payments must be included in the price paid or payable, there is agreement
between the parties that the conditions for applying the transaction value of
the goods method of section 48 are met. Indeed, the CBSA argued that some
of the conditions for applying that method could not be met only in the case
that the R&D payments were not included in the price paid or payable in their
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entirety. Skechers Canada‘s position throughout was that the transaction value
of the goods method could and must be applied, all conditions being met.
Various benches of Tribunal in the following cases also upheld the benchmarking of
closely linked transaction on aggregate basis:
(i) McCann Erickson India Pvt Ltd vs Addl CIT (ITA No 5871/Del/2011)
(ii) Atul Ltd vs ACIT (ITA No 3118/Ahd/2010)
(iii) Toyota Kirloskar Motor (P) Ltd. vs. ACIT (ITA No. 1315/Bang/2011)
(iv) Panasonic India Pvt Ltd vs Income Tax Officer (ITA No.1417/Del/2008)
(v) Hindustan Unilever Ltd. vs. ACIT (ITA No.7868/Mum/2010)
(vi) Amphenol Interconnect India Pvt. Ltd. vs. DCIT (ITA No.1486/PN/2010)
(vii) Lumax Industries Ltd. vs. ACIT (ITA No. 4456/Del/2012)
(viii) DCIT vs. CLSA India Limited – (ITA No. 2362/Mum/2011)
(ix) Cadbury India Limited vs. ACIT – (ITA No. 7408/Mum/2010)
(x) Thyssen Krupp Industries India Pvt Ltd vs ACIT (ITA No 7032/Mum/2011)
(xi) DCIT vs. SAS Research and Development (India) P. Ltd. (ITA No.
810/Pn/2013)
In an identical situation of export of hot rolled coils to the associated enterprise, the
Hon‘ble Mumbai Bench of Tribunal in the case of ACIT vs. Essar Steel Limited (ITA
No. 3727/Mum/2011) upheld the benchmarking analysis undertaken by the appellant,
wherein, the appellant has compared the average price of eight transactions of export of
goods made to associated enterprise, applying CUP method, holding as under:
10. We have considered rival contentions and gone through the orders of the
authorities below. A clear finding has been recorded by the CIT(A) to the effect
that appellant has already considered all the 8 transactions with its AE in
totality by aggregating the same whereas the TPO picked up two transactions
where the price charge was less than the average market price. Rule 10(A)(a)
defines a transaction to include a number of closely linked transaction. In case
they are closely linked then they can be aggregated for determining the ALP.
We found that appellant has exported hot rolled coils to its AE between 30-6-
2005 to 10-3-2006, the price has been determined from the website whose data
is not subject to challenge. The product remains the same and the source from
which the average price has been taken remains the same. Accordingly, it is a fit
case for aggregation. We found that if the average price is adopted for all the 8
transactions, then the average comes exactly to 420.71 which is what the price
charged by the appellant to its AE. Furthermore, the detailed finding recorded
by the CIT (A) at para 3.4 to 3.8 has not been controverted by learned DR by
bringing any cogent material on record. Accordingly, we do not find any reason
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to interfere in the order of CIT(A) for deleting the addition in respect of
adjustment made of Rs.5,82,41,193.
In view of the above, it would be appreciated that the benchmarking ought to be
undertaken on the basis of average price charged by the appellant from sales made to
associated enterprise vis-à-vis average price charged from sales made to unrelated third
parties in the same period, for each grade of stainless steel products.
Without prejudice, it is submitted that even after considering the average sales price in
domestic sales made to unrelated third parties and without allowing adjustment on
account of bulk discount, i.e. after considering the average of daily price considered by
the TPO for the purpose of applying CUP method, the adjustment made by the TPO
works out to Rs. 99,04,929 as against original adjustment of Rs. 12,78,29,707 made by
the TPO. The detailed working of the average prices is enclosed as Annexure 4.
4. Alternative benchmarking by comparing the export price with adjustment on
account of nickel content:
It is respectfully submitted that the appellant has appropriately considered market
quotations of the Chinese manufacturers as a benchmark for applying CUP method in
respect of international transactions of export of stainless steel products. Even
otherwise, in respect of international transactions of export of stainless steel products,
wherever the appellant had earlier relied upon Chinese market quotation rates of similar
manufacturers of stainless steel products, viz., BAO Steel and LISCO, the prices of
such exports have also been compared with the prices of export of similar grade of
stainless steel products made to unrelated paties, after making adjustment of Nickel
content, as under:
(i) J-4 Black Coil: The appellant has also compared the prices of international
transactions of export of J-4 Black Coil grade of stainless steel products with prices of
export of the same grade of stainless steel products to unrelated party in earlier months
after adjustment on account of variation in nickel prices on the basis of day-to-day
variation in prices of nickel as per price quoted in London Metal Exchange (LME). It
may be noted that variation in stainless steel prices had happened primarily on account
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of variation in nickel prices in open market. In any case, the aforesaid comparison made
by the appellant on the conservative basis, since the prices of stainless steel products
were higher in earlier month and have gradually declined in the later month during the
relevant financial year. The aforesaid comparison would clearly establish that the prices
of international transactions of export of J-4 Black Coil grade of stainless steel product
are at arm‘s length applying CUP method.
(ii) 304 Black Coil: In respect of international transactions of export of 304 Black
Coil made in the month of April, 2007 (OA date 28-02-2007) was compared with prices
of export of similar grade of stainless steel products, viz., 304 HRAP Coil with the
minor adjustment on account of difference in conversion of black stainless steel coil to
annealed and pickled (AP) coil by USD 60 per metric ton. For international transactions
undertaken in the subsequent month, comparison has been made with reference to the
comparable uncontrolled prices arrived at, as aforesaid, after making adjustment on
account of variation in prices of nickel on day to day variation in prices of nickel as per
price quoted in London Metal Exchange (LME). It may be noted that variation in
stainless steel prices had happened primarily on account of variation in nickel prices in
open market. In any case, the aforesaid comparison made by the appellant on the
conservative basis, since the prices of stainless steel products were higher in earlier
month and have gradually declined in the later month during the relevant financial year.
The aforesaid comparison would clearly establish that the prices of international
transactions of export of 304 Black Coil grade of stainless steel product are at arm‘s
length applying CUP method.
(iii) JSL AUS HRAP Coil: CUP method was applied in respect of international
transactions of export of JSL AUS HRAP Coil grades of stainless steel products with
reference to the unrelated party price of market quotation of the above manufacturers of
stainless steel products in China. The appellant has also compared the prices of such
international transactions of export of JSL AUS HRAP Coil grades of stainless steel
products with the prices of export of highest rate of J-4 Stainless Steel coil with
appropriate adjustment of difference in composition on account of nickel content.
(iv) JSL AUS Black Coil: CUP method was applied in respect of international
transactions of export of JSL AUS Black Coil grades of stainless steel products with
reference to the unrelated party price of market quotation of the above manufacturers of
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stainless steel products in China. The appellant has also compared the prices of such
international transactions of export of JSL AUS Black Coil grades of stainless steel
products with the prices of export of highest rate of J-4 Stainless Steel coil with
appropriate adjustment of difference in composition on account of nickel content.
(v) JSL Tube Black Coil: CUP method was applied in respect of international
transactions of export of JSL Tube Black Coil grades of stainless steel products with
reference to the unrelated party price of market quotation of the above manufacturers of
stainless steel products in China. The appellant has also compared the prices of such
international transactions of export of JSL Tube Black Coil grades of stainless steel
products with the prices of export of highest rate of J-4 Stainless Steel coil with
appropriate adjustment of difference in composition on account of nickel content.
(vi) 204CU HRAP Coil: CUP method was applied in respect of international
transactions of export of 204CU HRAP Coil grades of stainless steel products with
reference to the unrelated party price of market quotation of the above manufacturers of
stainless steel products in China. The appellant has also compared the prices of such
international transactions of export of 204CU HRAP Coil grades of stainless steel
products with the prices of export of highest rate of J-4 Stainless Steel coil with
appropriate adjustment of difference in composition on account of nickel content.
(vii) 204CU Black Coil: CUP method was applied in respect of international
transactions of export of 204CU Black Coil grades of stainless steel products with
reference to the unrelated party price of market quotation of the above manufacturers of
stainless steel products in China. The appellant has also compared the prices of such
international transactions of export of 204CU Black Coil grades of stainless steel
products with the prices of export of highest rate of J-4 Stainless Steel coil with
appropriate adjustment of difference in composition on account of nickel content.
The workings of the aforesaid comparison of international transactions of export of
various grades of stainless steel products (for which the appellant has earlier applied
CUP method with reference to the price of market quotations of stainless steel
manufacturers in China) with prices of export to unrelated party made on a rational and
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scientific basis, was filed before the TPO vide reply dated 29.09.2012 (enclosed at
pages 271-323 of the paper book).
Under this analysis also, it would be appreciated that prices of international transactions
of export to associated enterprise is higher than the comparable uncontrolled prices in
all grades of stainless steel products. In view of the aforesaid, too, the international
transactions of export of stainless steel products is to be regarded as having been
undertaken as at arm‘s length applying CUP method.
5. Alternative benchmarking applying TNMM as the most appropriate method
It would be appreciated that economic scenario, geographical market comparability,
contractual term influencing comparability are important factors which are required to
be compared while applying CUP method. In case of difference, necessary
comparability adjustments are required to be made to eliminate differences between
controlled and uncontrolled transactions. Accordingly, under the circumstances, a profit
based method, i.e. TNMM can only be applied for the purpose of benchmarking
analysis.
The Transfer Pricing Regulations in India provide no priority of methods. Rather, the
selection of the pricing method to be used to test the arm's length character of a
controlled transaction must be made under the 'Most Appropriate Rule', which under
the facts and circumstances of the transaction under review, provides the most reliable
measure of an arm's length result.
Rule 10C of the Rules inter-alia, provides for the factors which are to be considered in
selecting the most appropriate method. The major considerations in this regard have
been specified to be (i) availability, coverage, and reliability of data necessary for
application of the method; (ii) the degree of comparability existing between the
international transaction and the uncontrolled transaction and extent to which reliable
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and accurate adjustment can be made on account of differences, if any, and the
assumptions required to be made for application of a method.
It is submitted that since CUP cannot be applied in the case of the appellant due to
reasons submitted infra, it is respectfully submitted that the international transactions
undertaken by the appellant ought to be benchmarked applying TNMM.
The TNMM examines the net profit margin relative to an appropriate base (e.g. cost,
sales, assets) that a taxpayer realizes from a controlled transaction (or transactions that
are appropriate to aggregate under the transfer pricing principles). TNMM determines
an arm‘s length price for the transfer of tangible property by reference to an objective
measure of profitability of an uncontrolled party, or comparable, that engages in similar
transactions or operates under similar circumstances. The method compares the
profitability of either the controlled party buyer or seller to the profitability of the
comparable.
Reliance is placed on the decision of the Mumbai Bench of the Tribunal in the case of
ACIT vs. Tara Ultimo Pvt. Ltd. (ITA No. 5098/Mum/2010), wherein the Hon‘ble
Tribunal held that, when ALP cannot be reasonably determined by CUP or any other
direct method (i.e., cost plus method and resale price method) in respect of even one of
these areas, the application of TNMM or other indirect method (i.e. profit split method)
is inevitable and it cannot be rejected.
Reliance is also placed on the following decisions wherein it has been held that when
CUP cannot be applied due to non-availability of data, TNMM can be applied for the
purpose of benchmarking analysis:
- Toyota Kirloskar Auto Parts vs ACIT (ITA No 1642/Bang/2012)
- ACIT vs Super Diamonds (6399/Mum/2007
- AWB India Pvt Ltd vs DCIT (ITA No 6480/Del/2012)
- M/s Garware Polyster Ltd vs. DCIT (ITA 6169/Mum/2011
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In the present case, the appellant had also undertaken benchmarking analysis applying
Transactional Net Margin Method (TNMM) with operating profit to operating
income (OP/OI) as the PLI. After considering various selection criteria, one
comparable company vis. Salem Steel Plant of Steel Authority of India was identified
as functionally comparable to the operations of JSL (refer reply dated 29.09.2007
placed at pages 271-323 of the paper book for complete search process). The results of
the Transfer Pricing analysis applying TNMM are summarized herein below:
Company Name Finance
year
Sales OP/OI(%)
Salem Steel Plant 200803 1397.13 7.71%
Jindal Stainless Ltd. 200803 5707.06 9.85%
Since the operating profit ratio (OP/OI %) of JSL @ 9.85% is higher than the operating
profit margin (OP/OI %) of 7.71% of Salem Steel Plant of Steel Authority of India, the
comparable enterprise, the international transactions entered into by JSL were
considered as having been entered at arm‘s length price, applying TNMM on an entitywide
basis.
6. Without prejudice, arm‘s length price of export of goods is within safe harbor
range of +/-5% of transacted value
It is respectfully submitted that, in most of the cases, the difference in the arm‘s length
price of goods exported by the appellant to its associated enterprise fall within the range
of +/-5% of the transacted price, as provided under second proviso to Section 92C(2) of
the Act.
Reliance in this regard is made to the decision of Mumbai Bench of Tribunal in the case
of DDIT vs. Development Bank of Singapore, reported at 155 TTJ 265, wherein the
Hon‘ble Tribunal held that the benefit of range of +/-5% is available not only to a
situation where more than one price is determined as ALP by the most appropriate
method but also where only one price is determined as ALP, as under:
8. We have heard the rival submissions and perused the relevant material on record.
Section 92C deals with computation of arm's length price (ALP). Sub-section (1) of this
provision provides that the ALP in relation to an international transaction shall be
determined by any of the prescribed methods, being the most appropriate method
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having regard to the nature of transaction or class of transaction or class of associated
persons etc. Five specific methods starting with (a) comparable
uncontrolled price method, are set out in this provision with the sixth residual method
under clause (f) as : "such other method as may be prescribed by the Board". Subsection
(2) provides that the most appropriate method referred to in sub-section (1) shall
be applied for determination of arm's length price in the manner as may be prescribed,
which has been prescribed in rule 10B(1). Proviso to section 92C(2), which is the core
of controversy, at the relevant time provided as under :-
"Provided that where more than one price is determined by the most appropriate
method, the arm's length price shall be taken to be the arithmetical mean of such prices,
or, at the option of the assessee, a price which may vary from the arithmetical mean by
an amount not exceeding five per cent of such arithmetical mean."
9. On going through sub-section (2) in juxtaposition to the above extracted proviso, it
transpires that the most appropriate method referred in sub-section (1) [any one of the
six methods] shall be applied for the determination of ALP. The manner of computation
of ALP under the CUP method has been prescribed under rule 10B(1)(a) as under : -
"(a) comparable uncontrolled price method, by which,—
(i) the price charged or paid for property transferred or services
provided in a comparable uncontrolled transaction, or a
number of such transactions, is identified ;
(ii) such price is adjusted to account for differences, if any,
between the international transaction and the comparable
uncontrolled transactions or between the enterprises entering
into such transactions, which could materially affect
the price in the open market ;
(iii) the adjusted price arrived at under sub-clause (ii) is taken to
be an arm's length price in respect of the
property transferred or services provided in the international
transaction ;"
10. From the above rule, it is palpable that the price charged or paid in a comparable
uncontrolled transaction, or a number of such transactions, as adjusted to account for
differences, is taken as ALP of the international transaction. What emerges from the
interpretation of the first part of the proviso is that where more than one price is
determined by the most appropriate method, the arm's length price shall be taken to be
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the arithmetical mean of such prices. Thus under the CUP method, if there are more
than one comparable uncontrolled price, then the ALP shall be taken to be thearithmetical mean of such prices. Second part of the proviso grants an option to the
assessee by providing that the ALP may be a price varying from the arithmetical mean
by an amount not exceeding five per cent of such arithmetical mean. It means that if the
difference between the arithmetical mean of such prices and the price actually charged
or paid does not exceed 5%, then the price so charged or paid may be taken as ALP, not
calling for any adjustment. In order to be eligible for exercising option of having ALP
as a price varying by +-5% of the price worked out as per rule 10B, it is necessary that
there should be more than one price determined by the most appropriate method as per
rule 10B which should be then averaged. To put it simply, if there is more than
one price determined by the most appropriate method, the ALP shall be considered by
taking the cushion of plus minus five percent of the arithmetical mean of such prices. If,
however, there is only one price determined by the most appropriate method, then this
option of plus minus 5% is not available for determination of the ALP.
11. At this juncture, we consider it expedient to note that the above quoted proviso to
section 92C(2) has been substituted by the Finance (No.2) Act, 2009 w.e.f. 1.10.2009
with two provisos. The first proviso states that : 'Provided that where more than
one price is determined by the most appropriate method, the arm's length price shall be
taken to be the arithmetical mean of such prices'. As per the second proviso if the
variation between the arm's length price so determined and price at which the
international transaction has actually been undertaken does not exceed the specified
percentage of the latter, the price at which the international transaction has actually
been undertaken shall be deemed to be the arm's length price. Main sub-section (2)
provides that the most appropriate method as per sub-section (1) shall be applied for the
determination of ALP. As per the first proviso where more than one price is determined
by the most appropriate method, the arm's length price shall be taken to be the
arithmetical mean of such prices. Per contra, if there is only one price which is
determined by the most appropriate method, then as per the main sub-section (2)
without the aid of proviso, that price shall constitute the ALP. The
second proviso comes into play to deem the actual transacted price as the ALP. It
provides that where the variation between the ALP 'so determined' does not exceed the
specified percentage, the price at which the international transaction has actually been
undertaken 'shall be deemed to be the arm's length price'. The words 'so determined' as
employed in the second proviso assume significance. As these have been used in the
second proviso distinct from the subject matter of the first proviso, naturally these will
apply to the ALP determined under sub-section (2) consisting of the main provision and
also the first proviso. Resultantly, the option of 'deemed' ALP shall extend not only to a
situation where more than one price is determined as ALP by the most appropriate
method but also where only one price is determined as ALP. The net result is that the
option to the assessee shall be available in both the situations, covered under main subsection
(2) and also the first proviso.
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Accordingly, since the transaction of export of goods undertaken by the assessee with
its associated enterprise is within the range of +/-5% of the arm‘s length price, in
certain cases, in terms of second proviso to section 92C(2), such transactions
undertaken by the appellant ought to be considered to be at arm‘s length price.
7. Without prejudice, errors in selection of comparable price
Further, the TPO in his order noted certain errors in the comparison made by the
appellant from prices of international transactions of export of stainless steel products
to associated enterprise and price of export to unrelated party. It is respectfully
submitted in this regard as follows:
(i) For benchmarking of international transactions of export of J-4 HR Plate SS to
associated enterprise in Indonesia on 21-09-2007, the appellant has considered price of
export of same grade of steel made to unrelated party in Indonesia on 05-09-2007. The
TPO however, has compared the price of export of J-4 HR Plate SS to unrelated party
in Bangladesh on 12-09-2007 as comparable uncontrolled price or applying CUP
method instead of comparable uncontrolled price of export to the unrelated party in the
same country, i.e., Indonesia on 05-09-2007.
Accordingly, since the price charged by appellant on sales made to AE at USD 1525
PMT is higher than the price charged from sales made to unrelated third party in
Indonesia at USD 1504 PMT, the adjustment of Rs. 83,528 made by the TPO will be
deleted.
(ii) With respect to the international transaction of J-4 HR Plate SS made on 07-
02-2008, the appellant had considered comparable uncontrolled transactions of export
of similar product undertaken on 22-02-2008 as the benchmark. The TPO, however,
considered the price of export of similar product made on 28-01-2008 to unrelated party
as comparable uncontrolled price.
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Accordingly, the price charged by appellant on sales made to AE at USD 1750 PMT is
within the range of +/-5% of the price charged from sales made to unrelated third party
in Indonesia at USD 1834 PMT, the adjustment of Rs. 5,23,160 made by the TPO will
be deleted.
Even otherwise, after considering the average of uncontrolled price at USD 1869 PMT
[(1834+1904)/2], the adjustment will reduce to Rs. 10,216.
It would be appreciated that the aforesaid errors noted in the comparison of price for
applying CUP method in respect of international transaction of export of stainless steel
product are not sustainable and, therefore, liable to be deleted.
37. The Ld DR vehemently supported the orders of the learned Commissioner Of Income Tax
(Appeals), the learned Dispute Resolution Panel and the learned TPO for respective years.
He submitted that
a. There are three categories of benchmarking done for the transaction of export of
goods as classified by the learned TPO. He submitted that the learned Transfer
Pricing Officer has compared export to associated enterprises with the export to
unrelated party of the similar products, export of associated enterprises with price in
domestic transaction, and export to associated enterprises with export to unrelated
parties after adjusting for variation in composition of nickel. He vehemently stated
that the appellant has benchmarked the transaction of export of goods by applying
the monthly average price realized in export to related parties with similar average
price of export to the unrelated parties as well as quotation downloaded of some
Chinese markets from Internet. Thereafter he discussed the salient features,
applicability and examples of situation where CUP method can be applied referring
to the relevant portion of OECD Transfer Pricing Guidelines 2010. Therefore, he
stated that for establishing the compatibility under the CUP method, the difference
between the two transactions should not affect the price in the open market and it
should not be possible to make reasonable accurate adjustment to eliminate effects of
such differences. He therefore submitted that for benchmarkin the transaction of
export to associated enterprise with export to unrelated party as far as possible if the
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comparable transactions are to be compared between the associated property and the
Non associate enterprise, the transaction date, the product, quality, and quantity needs
to be same. If exact replication is not possible, then it is preferred that in almost
replication is achieved. Therefore, he stated that this implies that if the same or
similar products are not transacted on the same date, then, the nearest date on which
the similar products are transacted should be the date for comparison. He submitted
that in the transfer pricing study, the assessee has used monthly average rates.
However, it is clear from the transfer pricing study that similar transactions have
happened either on the same day or in the same week with similar products with both
the associated enterprises and non-associated enterprises. He therefore submitted that
hence the approach of the assessee is flawed since it is not judicious to utilize average
monthly price while applying CUP method, as the prices through the wall month are
likely to fluctuate much more (which is also evident from the case in hand).
Therefore, it stated that this might call for suitable adjustments, which are not
possible to be quantified accurately. This difficulty can easily be overcome if the
same day transactions or nearby the transaction are used instead. This is precisely
what is done by the learned Transfer Pricing Officer in the present instance and hence
is the correct method for applying the CUP.
b. He further stated that for the benchmarking of the transactions were no actual CUP
was present since the product developed by the assessee is of high grade and
renowned, for benchmarking purposes, the assessee has used the Chinese market
quotations. The approach adopted by the assessee is not correct, as the product
manufactured by the company is indigenous and driven by Indian market forces, and
as already pointed out; the grade of the material is also very superior. Thus to apply
the CUP method the first requirement is that the quality of the product needs to be
matched. If the approach of the assessee had to be followed, then the basic
requirement of the CUP method fails as the quality of the product whose quotation it
has used is not comparable to that of the products manufactured by the assessee.
Further, the prices shown from the Chinese market cannot be checked for its
authenticity and reliability also. Furthermore the rule 10 B (1) (a) of the income tax
rules dictate that the price charged or paid should be used instead of some quoted
rates as used by the assessee. In comparison to the assessee‘s approach, the approach
adopted by the learned Transfer Pricing Officer is more suitable as per the
requirement of CUP method. For this purpose, the Transfer Pricing Officer adopted
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price for the same quality products sold in the Indian market by the assessee. Further
in order to remove any effect of difference in the transactions of the products sold to
the associated enterprise with nonassociated enterprises, the learned TPO allowed for
material adjustments, which is as per the provisions of rule 10 B (1) (a) of the income
tax rules. He therefore submitted that the Transfer Pricing Officer allowed adjustment
to the amount of products sold on the same date or nearby date in the domestic
market.
c. He contended that the contention of the assessee that the learned Transfer Pricing
Officer has added in not using the Chinese quotation is the most appropriate
benchmark for the international transaction of export of steel products; he submitted
that the issue that needs to be addressed is whether a contention is an acceptable
document for the application of CUP method. He stated that quotation precedes an
actual transaction and is not a transaction per se. According to him, quotation is
merely intent to enter into transaction but it is certainly not a transaction. Those being
the case, the amount quoted in a quotation can be by no stretch of imagination takes
the same of price charged or actually paid under any circumstances. He further stated
that for the benchmarking of the transactions were no actual CUP was present since
the product developed by the assessee is of high grade and renowned, for
benchmarking purposes, the assessee has used the Chinese market quotations. The
approach adopted by the assessee is not correct as the product manufactured by the
company is in the genius and driven by Indian market forces, plus as already pointed
out, the grade of the material is very superior. Thus, to apply up method the first
requirement is that the quality of the product needs to be matched. If the approach of
the assessee had to be followed, then the basic requirement of CUP method fails as
the quality of the product whose quotation it has used is not comparable to that of the
products manufactured by the assessee. Further, the prices shown from the Chinese
market cannot be checked for its authenticity and reliability also. He stated that in
comparison to the assessee‘s approach, the approach adopted by the learned Transfer
Pricing Officer is more suitable as per the requirement of CUP method. For this
purpose, the learned Transfer Pricing Officer adopted price for the same quality
products sold in the Indian market by the assessee. Further, in order to remove any
effect of differences in the transaction of the products sold to the associated
enterprises versus known associated enterprises, the learned TPO allowed for
material adjustments which are as per the rule 10 B (1) (A). He therefore stated that
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the learned Transfer Pricing Officer allowed adjustment to the amount of products
sold on the same date or nearby date in the domestic market. He further submitted
that the Chinese quotation adopted by the assessee is neither authentic, and reliable
nor related to a comparable product. Therefore, it cannot be used as comparable
prices. He further stated that it is also not known that whether the transaction has
happened at that price or not. He further stated that the quotations used by the
assessee are not a stock exchange quotation at least and are not authentic.
d. With related to the 3rd category of the transactions that is comparison of export to
associated enterprises with export to unrelated parties after adjusting for variation in
composition of nickel, the learned TPO use the domestic data and adjusted it to the
nickel adjusted price that are similar to the adjustment done by the assessee on
Chinese market quotation price. Therefore he stated that the rates used from the
assessee‘s own domestic sale hold more ground as they are in line with the definition
of the CUP as per rule 10 B (1) (a) of the income tax rules 1962.
e. He further submitted that the assessee has raised the contention that the prices of the
goods exported to associated enterprises and on related party are compiled for the
purposes of benchmarking and no adjustment on the ground of difference in compose
it of nickel is provided. He submitted that the contention of the assessee is without
any basis as on the contrary the learned Transfer Pricing Officer has the divided the
transaction into three categories and for the third he has provided appropriate
adjustment to nickel prices similar to the adjustment done by the assessee. He further
referred to the order of the learned Dispute Resolution Panel in assessee‘s own case
for assessment year 2008 – 09 where the adjustment in the price of fabricated
stainless steel is not dependent on the fluctuating price of the nickel alone. It also
depends on various other constituent components of stainless steel. Additionally the
learned Transfer Pricing Officer has pointed out that demand and supply gap,
seasonal variation; global economic situations also play a vital role. He therefore
submitted that any alternate analyses using only one variable would not give the
desired results. He therefore supported the order of the learned Transfer Pricing
Officer on this count.
f. With respect to the contention of the assessee that the learned Transfer Pricing
Officer has erred in benchmarking the transaction of export of goods to associated
enterprises with the price of goods sold in domestic market ignoring the difference in
domestic marketing conditions, pricing policies, locational economic differences et
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cetera. He therefore submitted that it is important to underline the basic principles of
transfer pricing, which is that a controlled transaction should be compared to an
uncontrolled transaction. For this purpose in the present scenario, the assessee is an
Indian entity selling products to its associated enterprise in domestic parties. The part
where it says the product to the domestic parties is the uncontrolled transaction. Any
independent entity would want to replicate the margin on in the uncontrolled
transactions. The same process was done by the learned Transfer Pricing Officer also.
On the contrary, the assessee has used some random, unverifiable, and
unsubstantiated Chinese market quotation rates that are not even the actual
transaction rates. Further the assessee applied some adjustment to these Chinese
market quotation rates and the same with some exceptions, was also replicated by the
learned Transfer Pricing Officer. The learned Transfer Pricing Officer has already
allowed the adjustment on the ground of advance license and duty entitlement
passbook scheme benefits, basic customs duty, freight, trimming cost et cetera. He
therefore stated that the approach of the learned Transfer Pricing Officer is the most
reasonable approach and should be upheld.
g. He further referred to the claim of the assessee that it has given a bulk discount at the
rate of 5% per metric ton to its associated enterprises. He stated that the invoices
provided by the assessee do not show any such discount offered, this claim of the
assessee further weakens its own case, as the main exercise conducted in the transfer
pricing is to determine whether any profit has been shifted outside India in terms of
any undue favour. This bulk discount, as per the assessee, is being forwarded to the
associated enterprise only and not to the unrelated parties. The sunroof ever made
towards the associated enterprise resulted in tax base erosion in India. That question
that needed to be answered here that if we consider an independent third party instead
of the associated enterprises of the assessee, would the same assessee give above the
discount to an entity, which is giving it merely 10 – 15% of its business. The answer
will be simple no. Thus, when the assessee is easily able to sell a much higher amount
of its total sales to an Indian domestic market without any bulk discount, why would
it give a bulk discount to an entity with which it has only 10 to 15% of the
businesses? He further stated that it is pertinent to mention here as stated by the
learned CIT appeal that out of the total sales only 10 – 15% of the sale is towards the
associated enterprises. Therefore in uncontrolled conditions the transactions involving
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85 – 90 percentage of the transaction would include the bulk discount and not in the
other way around.
h. He further referred to the contention of the assessee that the learned Transfer Pricing
Officer has erred in comparing the sales based on the date of contract/date of order
acceptance instead of monthly, which evens out a daily fluctuation in the price of
metals as per the assessee. He submitted that the contention of the assessee is entirely
unsustainable as it fails to satisfy the basic requirement of CUP method as laid down
in the act, rules as well as the international guidelines such as you and TP manual and
OECD guidelines et cetera. He submitted that in the present scenario, as far as
possible, if the comparable transactions are to be compared between the associated
enterprise and the known associated enterprises, the transaction date, the products, the
quality, and quantity needs to be the same. If exact replication is not possible, then it
is preferred that in almost replication is achieved. This implies that if same or similar
products are not transacted on the same date, then, the nearest date on which the
similar products are transacted should be the date for comparison. He submitted that
in the transfer pricing study report, the assessee has used monthly average rates.
However, it is clear from the transfer pricing study that similar transactions have
happened at around the same day or in the same week with similar products with both
associated enterprise and known associated enterprises. Hence, the approach of the
assessee is flawed since it is not judicious to utilize average monthly price while
applying CUP method, as the prices through the wall month are likely to fluctuate
much more. This may call for suitable adjustment, which are not possible to be
quantified accurately. This difficulty can easily be overcome if the same day
transaction on the nearby the transactions are used instead. This is precisely what has
been done by the learned Transfer Pricing Officer in the present instance and hence
the correct method is applied by the learned Transfer Pricing Officer applying the
CUP method.
i. He further stated that the contention of the assessee is that the learned TPO has erred
by comparing sales to associated enterprise on 21/9/2007 to sales made to third-party
in Bangladesh on 12/9/2007 instead of transactions made it to third party based in
Indonesia on 5/9/2007 and further by comparing sales to an associated enterprise on
7/2/2008 with the sales made to third party on 25/1/2008 instead of sales made to
third-party on 22/2/2008, he submitted that under the CUP method it is most improper
8 and beneficial to use that from a nearby date and therefore there is no error in the
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approach of the learned TPO . He further submitted that of the assessee has not
shown any reason that whether the comparison is not proper except the difference of
jurisdiction. He stated that the assessee has also not sure that because of the
difference in jurisdiction what impact it has made on the price. He therefore stated
that the contention of the assessee is unsubstantiated.
j. With respect to the contention of the assessee that the learned TPO has added in not
applying the transactional net margin method (TNMM) where assessee has a margin
of 9.85% where the comparable companies have a margin of 7.71%, he submitted that
in essence, what is being argued by the taxpayer is that cases where profit higher than
those of the comparable is are demonstrated at net level, when international
transaction is benchmarked using TNMM method, in such cases the ALP should be
determined by aggregating the international transactions, where they pertain to
purchase, sale, transactions of royalty, warranty charges, intragroup services and
AMP expenses. He submitted that the taxpayer is argued that since the ratio of
operating margin to operating revenue of the taxpayer is above that of the two
comparable companies, the same should be treated to have benchmarked all other
international transaction also at arm‘s length. He submitted that that the net margin of
an entity is in operation of various factors. The task of the Transfer Pricing Officer is
not so much to determine the profit of the entity but to determine the arm‘s-length
price of international transactions. In the taxpayer‘s case, the higher operating profit
margin that the taxpayer is demonstrating is due to a higher unit price as the product
manufactured by the assessee is of a superior grade and a renowned brand that it is
able to charge from customers. He therefore stated that that the argument of the
assessee is inconsistent with the CUP method. He otherwise stated that in the
previous years, also the assessee has itself adopted the CUP method and now it is
arguing for acceptance of TNMM method only because adjustment has been made by
the learned Transfer Pricing Officer as assessee is not selling goods to its associated
enterprise at arm‘s-length price.
38. In view of the above facts, he vehemently submitted that the adjustment proposed by the
learned Transfer Pricing Officer, confirmed by the learned Commissioner Appeals for
assessment year 2007 – 08, and approved by the learned Dispute Resolution Panel for
assessment year 2008 – 09 deserves to be upheld.
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39. We have carefully considered the rival contentions. There are seven different types of
arguments of the assessee against the transfer pricing adjustment made by the learned
Transfer Pricing Officer. We deal each of them.
40. The 1st grievances is the rejection of the Chinese market quotation adopted by the assessee
applying CUP method for comparability analysis of the export made to the foreign
associated Enterprises. The claim of the assessee is that according to rule 10 B of The
Income Tax Rules , prices are required to be adjusted to account for the differences if any
between the international transaction and the comparable uncontrolled transactions, which
could materially affect the pricing in open market. His further reliance is on rule 10 B of the
income tax rules wherein it is stated that price publications including stock exchange and, to
market quotations stating that the international transaction is further required to be supported
by authentic document of such a nature. The assessee has also stated that whenever the
comparison is not available to the assessee, market quotation of the Chinese manufacturers
was considered for applying CUP method. Before us, the claim is that the market price
quotation of the Chinese manufacturers represents the price at which similar stainless steel
products are available in the international market. The claim of the assessee is that market
price quotations are also available in public domain and represents the price at which actual
transactions have taken place in the international market. Hence, it is a comparable
uncontrolled transaction. Various judicial precedents and OECD guidelines were quoted by
the assessee. The objection of the learned Transfer Pricing Officer is that that the data to be
used is transacted data and the quotations are not the transacted data. The identical issue
arose in case of a decision by the honourable Gujarat High Court in case of CIT versus Adani
Wilmar Ltd [tax appeal number 240 2014 dated 7/4/2014] where the issue was whether the
quotation of Malaysian oil price from oil word which is an independent agency of Germany
engaged in providing forecasting services for the purpose of deciding the arm‘s-length price
of valuation palm oil is right. The honourable High Court while dealing with the issue noted
that firstly the learned assessing officer did not object before the lower authorities that oil
word is a forecasting agency and such rates were not based on actual transactions. Thereafter
the honourable High Court held that the price publications as long as they are authentic and
reliable would be relevant materials. Merely the basis of organization would be of no
consequence. Such quotations also would be entitled to its due and full weightage unless it
lacks basis. The issue before the honourable High Court was the consideration of the
quotations of the oil world that was not based in Malaysia but it was an independent
organization established in 1958 in Germany, which provided the independent forecasting
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services for oilseeds, oils and providing primary information and professional analysis. It
also compiled information of various countries in the oil sector. It publishes the daily
monthly and yearly journals in oil sector compiling information of various countries and has
a broad base database. In the quotation adopted by the assessee from oil word was for
Malaysia and not for Germany. Therefore, it was held that it is an authentic independent
trade quotation. Further honourable Delhi High Court has on occasion to consider in CIT
versus Cargill food India Ltd in [ITA number 157/2016 dated 19/2/2016] where the basis of
a broker quote adopted in CUP method was accepted as it was based on the prices prevailing
in the market. The honourable High Court held that published data are available from stock
or commodity exchanges could form the basis of the price in both controlled and
uncontrolled transactions. In that particular case the price quote given by the broker was
based on the prices prevalent in the commodity exchanges and other market including
Chicago Board of trade. Further in the case of the ACIT versus MSS India private limited
(2009) 32 SOT 132 (Pune) the rates adopted were based on rates prevailing at London metal
exchange with respect to the raw material mainly consisting of copper and lead. Therefore, it
is apparent that if the quotations are authentic and reliable then only they can be used as
comparable in CUP method. In this background, we examine the quotations taken by the
assessee as comparable prices. In the transfer pricing study report the assessee has stated that
where similar grades of stainless steel products was not exported to an unrelated party,
comparison was made with reference to comparable uncontrolled prices being market
quotations available in public domain of sale of such products by a manufacturer of stainless
steel products in China i.e. . BAO steel and LISCO. In fact, it is an established fact that these
are the companies, which are one of the largest manufacturers of the steel, however the
assessee neither established product comparability with the product sold by the assessee. As
assessee itself is selling number of different quality of steel it was not known that how the
products of those of Chinese companies are comparable with the assessee. At page number 8
of the order of the learned Transfer Pricing Officer this was the one of main reason for
rejecting the Chinese quotations. For the CUP method to be reliably applied to commodity
transactions, the economically relevant characteristics of the controlled transactions and the
uncontrolled transactions or the uncontrolled arrangements represented by the quoted price
need to be comparable. For the products manufactured by the assessee the economically
relevant characteristics include among others, the physical features and the quality of the
steel, the contractual terms of the controlled transactions, such as volumes traded of the
arrangements, the timing and terms of delivery, transportation, insurance and foreign
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currency terms are very important. Further relevant factor in determining the appropriateness
of using the quoted price for a specific commodity is the extent to which the quoted price is
widely and routinely used in the ordinary course of business in the industry to negotiate
prices for uncontrolled transactions comparable to the controlled transactions. Further, the
prices mentioned in the quotation are also not substantiated by any authentic and reliable
material. If such quotations are accepted, which are devoid of any comparability analysis
with the product and how they are authentic and reliable is not proved, then the whole
purpose of finding the uncontrolled comparable prices would be defeated. In all the decisions
which are pushed forward before us were speaking about authentic and reliable price quote.
In almost all the decisions, the prices are backed by some exchanges or some reputable
agencies, which are in the business of providing price-based data. No such evidences were
led by the assessee in case of these Chinese quotations, which are downloaded from the
Internet without any Comparability analysis, cannot be accepted. Before the learned Transfer
Pricing Officer the assessee also did not substantiate that how the Chinese market quotations
support the rule 10 B and D of the income tax rules. Further according to the OECD
Transfer Pricing Guidelines For Multinational Enterprises And Tax Administration (July
2017) in Para number 2.18 has stated that the term quoted price refers to the price of the
commodity in the relevant period obtained in an international or domestic commodity
exchange market. The quoted price also include prices obtained from recognized and
transparent price reporting or statistical agencies or from governmental price setting agencies
where such indexes are used as a reference by unrelated parties to determine prices in
transactions between them. Therefore, we fully agree with the order of the learned Transfer
Pricing Officer and the learned Dispute Resolution Panel in holding that the Chinese market
quotations downloaded from Internet by the assessee of BAO steel and LIiSCO cannot be
used for comparability analysis in CUP method.
41. The second grievance of the assessee is the rejection of bulk discount of 5% relevant for
adjustment made in J 4 black coil exported to its associated enterprise. The main claim of the
assessee is that assessee has made total sales of 43898 metric ton to its associated enterprise
against 309 MT sold to an unrelated 3rd parties. Therefore, the price charged by the assessee
to its associated enterprise should be adjusted for quantity discount of 5% for the reason of
the large volume purchased from the assessee. For the claim assessee has relied on the
decision of the coordinate bench in case of ATUL Ltd versus ACIT [ITA number
3118/HD/2010] and the decision of the Mumbai bench of tribunal in case of Clariant
chemicals India Ltd versus JCIT [ITA number 2393/IBM/2011]. Therefore, it is stated that if
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the above discount were factored into the prices then the transactions with the associated
enterprise would be in the range of +- 5%. The learned TPO has rejected the discount as has
been stated by the learned the TPO that onus is on the assessee to substantiate it claim for
quantity discount. The assessee has not been able to submit any analysis or produce any
documentary evidences that the assessee is giving 5% discount on bulk purchases since this
claim is not substantiated by any evidence, hence rejected. We have carefully considered
the decision of the coordinate bench in case of ATUL limited versus ACIT wherein para
number 5.19.2 the coordinate bench has held that
as far as the merit of this adjustment is concerned we are of the view that it is a
common market practice that the bulk purchases are generally given some discount. If
the associated enterprise have been given sale price discount due to the high quantity
of purchases then the assessee is required to place on record the commercial policy of
the assessee company, whether based upon some agreement or resolution. The
assessee is also expected to demonstrate with supporting evidence the basis of
applying 2% adjustment and in some cases it was found to be 5% adjustment. In
natural question has also come up that whether such discount in sale price had also
been granted by the assessee to non-associated enterprise on bulk purchases.
However, we are of the view that the TPO was not justified in rejecting that claim
which is otherwise prevalent in the market and can be said to be a common market
practice. However, before claiming this adjustment the assessee must be fair in not
claiming this adjustment on such sale transactions to associated enterprise, which are
apparently lower than the sales to non-associated enterprise. Rather bulk purchases by
the AES are only required to be taken into account for this adjustment
Further, we have also perused the decision of the Mumbai ITAT in case of Clariant
chemicals Ltd (supra) in that particular decision the 20% volume discount was given to the
assessee only because of the reason that in the earlier years the same was given by the
learned Transfer Pricing Officer. In the OECD transfer pricing guidelines for MNE and tax
administration (July 2017) in para number 2.26 and example is given where the quantitative
discount can be allowed. It is stated that in that assume a taxpayer sales 1000 tons of a
product for $ 80 per tonne to an associated enterprise in its MNE group, and at the same ties
time sales 500 tons of the same product $ 400 per tonne to an independent enterprise. This
case requires an evaluation of whether the different volumes should result in an adjustment of
the transfer price. The relevant market should be researched by analyzing transaction in
similar products to determine typical volume discounts. No such market research or any other
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market policy of the assessee was produced before us or authorities below, therefore, the
facts of the case before us are not such. Even otherwise, the assessee has not shown that there
was any pricing policy with the associated enterprise of giving a bulk discount. It was also
not shown that what is the bulk quantity purchased on which discount is eligible. In all the
circumstances, the claim of the assessee is merely an ad hoc claim without any supporting
evidences. No documents was also placed before the lower authorities or beforeus that
giving the volume discount is a market trend or commercial practice in steel business when
assessee is a premium steel manufacturer of the country. In view of this we do not find any
infirmity in the order of the lower authorities in rejecting 5% bulk discount to the assessee.
Therefore, this contention is rejected.
42. The third contention of the assessee that prices based on the date of order acceptance cannot
be applied in the present case. The claim of the assessee is that the products sold by the
assessee contains metal components such as nickel , the prices of the goods sold by the
appellant is determined considering the prices prevailing in London metal exchange on the
respective dates. It was further stated that there were huge price variation in the price of
nickel in a particular year where it has fluctuated 33 times the base price. It was therefore
stated that the price of the product sold on one specific date cannot be compared with the
price of goods sold on any preceding or subsequent date and therefore it was stated that
monthly average prices should be taken. For this proposition para number 3.9 of the revised
OECD guidelines on transfer pricing was also relied upon along with the decision of the
honourable Delhi High Court in case of Sony Ericsson Mobile Communications India private
limited versus CIT 374 ITR 118. The assessee has also relied upon several other decisions,
which are already reproduced by us earlier. The learned AR vehemently relied upon the
decision of the coordinate bench in case of ACIT versus Essar Steel Limited in ITA number
3727/ MUM/ 2011 where the assessee has compared the average price of eight transactions
of export of goods made to associated enterprise applying CUP method was upheld. We have
carefully considered the argument of the learned authorised representative and the decision
of the coordinate bench in CIT versus Essar Steels Ltd (Supra). The facts in that particular
cases were that the appellant had considered all the transaction with its associated enterprise
in totality by aggregating the same. The Transfer Pricing Officer picked up only two
transactions where the price charged was less than the average market price and also beyond
5% permissible band width to make the addition ignoring other transactions where the
average price charged was more. On careful consideration of the above decision, it is
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apparent that if the transactions are the interlinked transactions then the ALP should be
considered of export of goods on aggregate basis. It can be established in many ways that
transactions are interlinked, one of the illustrative way is supply of goods billed separately
but the purchase order is common and the rates are also predetermined with adjustments on
account of material prices. Before us, no such data is available or any other information by
which we can say that the transactions of export to associated enterprise are interlinked
transactions. It is also clear that merely because they are the export of the same goods over a
period to the Associated Enterprises, they do not become interlinked. There has to be a
binding element behind all the transactions to make them one and connected. Such data was
also not available before the learned Transfer Pricing Officer or learned Dispute Resolution
Panel. If this fact is established by the assessee then the issue is squarely covered in favour of
the assessee on this point by the decision of the coordinate bench. Therefore, respectfully
following the decision of the coordinate bench, we also direct the AO to compute the ALP
considering the transactions of export to associated enterprise on aggregate basis after
assessee establishes before him that all these export transactions of the associated enterprise
are interlinked. To this extent, this issue is sent back to the file of the learned AO/TPO with a
direction to the assessee to substantiate the argument that the transactions of export of goods
to associated enterprise are interlinked.
43. The fourth contention of the assessee before us is that it has made an analysis based upon the
nickel price adjusted export data. According to this the comparison of the prices of
international transactions of export of those grade of stainless steel product has been
compared with the prices of export of the same grade of stainless steel products to unrelated
party in the earlier months was determined. There from the adjustment on account of
variation in the nickel prices on day-to-day basis as per the prices quoted in London metal
exchange was made. After this analysis, the assessee stated that the variation in steel prices
has happened primarily because of variation of nickel prices in open market. Further,
undisputedly this analysis has been done by the assessee on conservative basis. Learned
Transfer Pricing Officer stated that this does not meet the intent of rule 10 B (1) (a) of the IT
rules 1962 and it is a simplistic view of the price change happening over a period. He also
stated that the price of stainless steel product is not only dependent upon the in nickel prices,
it has other material also such as steel, chromium et cetera. The learned Transfer Pricing
Officer in the end, stated that there are also some dates and some transactions for which
neither the third-party export data is available nor the domestic sale data is available, and in
such cases there is no option but to adopt this data and use it as a fill gap Type of
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arrangement where no other option is available. We fully appreciate the contention of the
assessee that if nickel prices are adjusted between the export of similar products on two
different dates to AE and non-AE for comparability analysis provided there is no other
recourse available and further there is no similar fluctuation in the price of other material
component. The learned Transfer Pricing Officer has also agreed that in the rare cases where
the export data is not available to the third party on the date of export made to the associated
Enterprises and further the domestic sales of the similar product on that date is also absent,
there is no option available but to accept such adjustments. Cautiously, we also say that, if
the assessee is embarking upon benchmarking the transaction in such a rare situation then the
onus is on the assessee to establish the nickel content in the stainless steel product, the
relevant prices of the nickel from London metal exchange, any further variation in the other
materials prices over that period are also required to be adjusted in the similar fashion, if
material. Neither before the learned Transfer Pricing Officer, before the learned Dispute
Resolution Panel , or before us this data is made available. Even the composition of the each
product with respect to the nickel content, steel content, chromium content et cetera has not
been established. Therefore, we do not have any alternative to give such kind of adjustment
to the assessee at this stage. Therefore we set aside this issue to the file of the learned
assessing officer with a direction to the assessee to substantiate its claim accordingly with
respect to the nickel content in the product, nickel price variations over the period, variation
in other commodity prices et cetera. The AO may examine the detail and then decide the
issue afresh with respect to the alternative claim of the assessee.
44. Alternatively the assessee has also stated that if the CUP method cannot be applied in the
case of the appellant due to the reasons stated above, the alternative claim of the assessee is
that international transactions undertaken by the assessee to be benchmarked applying the
Transaction Net Margin Method. For assessment year 2007 – 08 The assessee has also
submitted that comparable namely Salem Steel Plant and assessee has operating profit
ratio of at the rate of 9.85% which is higher than the operating profit margin of 7.71% of the
comparable. Undisputedly both the assesses as well as the learned Transfer Pricing Officer
are on the same page that most appropriate method applicable in this case is CUP. It is also
not the case of the assessee that the appropriate data is not available, as such statement has
never been made before the lower authorities or before us. In such circumstances,
considering the altogether different method at this stage is inappropriate. Further even
assuming while denying, the assessee has stated that there is only one comparable. Therefore,
undisputedly the data availability in both the methods is scarce. Further, the decisions relied
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on Mumbai bench of the tribunal in case of ACIT vs Tara ultimate private limited in ITA
number 5098/UM/2010, the finding was that where arm‘s-length price cannot be reasonably
determined by CUP method or any other direct method in respect of even one of the areas,
the application of TNMM or other direct method is inevitable and it cannot be rejected. Here
the assessee has given multiple data to justify the benchmarking methodology with respect to
sale of export of steel material to its Associated Enterprises; therefore, such are not the facts
before us as are decided by the coordinate bench. Further the other decisions relied upon are
also related to the non-availability of the data. Therefore, unless the assessee says that there
are no data available for benchmarking under the CUP method, the TNMM should be the
alternative method could not be accepted. Therefore, this argument of the learned authorised
representative is rejected.
45. The sixth argument of the assessee is with respect to, without prejudice, that the difference
in the arm‘s-length price of goods exported by the appellant to its associated enterprise fall
within the range of 5% of the transacted price as provided under the second proviso to
section 92C (2) of the act. The assessee has relied on the decision of the coordinate bench in
the case of DDIT vs Development Bank Of Singapore [155 TTJ 265] wherein the tribunal
held that the benefit of range of 5% is available not only to a situation where more than one
price is determined as arm‘s-length price by the most appropriate method but also where only
one price is determined as arm‘s-length price. The identical issue has been considered by the
coordinate bench in appellant‘s own case for assessment year 2006 – 07 in ITA number 4111
and 4248/del/2013 wherein para number 23 – 30 this issue has been considered. In para
number 30 the coordinate bench has held that:-
30. The fine from the submissions that the details are not coming out clearly which
requires a revisit to the file of the TPO for proper appreciation of the facts. We
therefore in the interest of justice, deem it proper to restore the ground raised by the
assessee relating to TP adjustment to the file of the TPO for fresh adjudication of the
issue in the light of the submission details filed by the assessee in the paper book….
Therefore, respectfully following the decision of the coordinate bench in the assessee‘s own
case, we set aside this argument of the assessee to the file of the learned assessing
officer/Transfer Pricing Officer, with a direction that if there are more than one prices the
learned Transfer Pricing Officer is directed to consider the ± 5 percent as in the case for
assessment year 2006 – 07. Accordingly, this argument of the assessee is accepted.
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46. The seventh argument of the assessee is with respect to certain errors in the comparison made
by the Transfer Pricing Officer in his order. The errors pointed out by the assessee with
respect to assessment year 2008 – 09 deserve consideration by the learned Transfer Pricing
Officer. The assessee is directed to show the error to the learned TPO/assessing officer and
the learned AO and TPO are directed to verify the error and if found correct it may be
rectified. Therefore, this argument of the assessee is accepted.
47. The Eighth argument of the assessee is that there should be an adjustment of basic customs
duty when the price of the product of export is compared with the domestic market prices.
The contention of the assessee is that domestic market price would be higher at least to the
extent of the customs duty imposed on import by the government. Therefore, according to
assessee the prices determined in the domestic market for the comparability by the learned
Transfer Pricing Officer would be required to be adjusted to the extent of the rate of the
customs duty imposed by the government of India for comparing the price in the
international market. Accordingly, the assessee stated that for the purpose of the comparison
of the price of international transaction of export of various grades of stainless steel products
with the price of domestic market an adjustment for basic rate of customs duty to the extent
of 5% of the basic price is required to be made. The main claim of the assessee is with
respect to the export of J1 black coil for assessment year 2008-09. On careful analysis of
page number 168 of the order of the learned Transfer Pricing Officer in category II of the
benchmarking, the basic customs duty has been considered by the learned Transfer Pricing
Officer therefore this argument has already been addressed by the learned Transfer Pricing
Officer by granting appropriate adjustment. It is also clear on reading page number 10 of the
order of the Transfer Pricing Officer at para number five. Therefore, now this grievance of
the assessee is resolved.
48. Accordingly ground number two for assessment year 2007 -08 and ground number three for
assessment year 2008 -09 are decided accordingly. These grounds of the appeal of the
assessee are partly allowed.
49. The second issue is transfer-pricing adjustment made by the learned Transfer Pricing Officer
with respect to the computation of interest received by the assessee on loan given by the
assessee to its associated enterprise. For AY 2007-08, it is noted that during the financial
year 2005-06, the appellant has granted loan amounting to USD 25,00,000 to PT Jindal
Stainless, Indonesia. Interest is charged on the loan at the rate of three moths LIBOR plus
200 basis point. During the relevant financial year, JSL received interest amounting to USD
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1,85,364.58 on loan granted to PT Jindal Stainless, Indonesia. In case of JSL, comparable
transaction is available where JSL has availed loan from financial institutions, viz., State
Bank of India, at the rate of 3 months LIBOR + 170 basis point and from ICICI at 3 months
LIBOR + 140 basis point. JSL had provided the loan to PT Jindal Stainless, Indonesia at
igher rate, i.e., 3 months LIBOR + 200 basis points. In addition, the associated enterprise,
viz., PT Jindal Stainless, Indonesia has obtained external commercial borrowings from
unrelated parties for meeting its working capital requirements at LIBOR + 200 basis point.
Considering that, the international transaction of receipt of interest by JSL at LIBOR + 200
basis points was higher or comparable to comparable uncontrolled prices for similar
uncontrolled transactions, the international transaction of interest received is considered as
being at arm‘s length applying Comparable Uncontrolled Price method. The TPO, however,
in the impugned order has disregarded the benchmarking analysis undertaken by the
appellant for determining the arm‘s length price of interest on loan applying CUP method.
He instead imputed a rate of interest of 14% on the basis of interest charged at LIBOR + 4%
by Indian Banks on foreign currency loans from bb‘ rated companies plus a markup of 3%
as transaction cost and 1.6% on account of security risk. For AY 2008-09 the appellant has
charged interest at the rate of LIBOR plus 200 basis point on loan amounting to USD
25,00,000 issued to PT Jindal Stainless, Indonesia. In case of JSL, comparable transaction is
available where JSL has availed loan from financial institutions, viz., State Bank of India, at
the rate of 3 months LIBOR + 170 basis point. Considering that, the international transaction
of receipt of interest by JSL at LIBOR + 200 basis points was higher or comparable to
comparable uncontrolled prices for similar uncontrolled transactions, the international
transaction of interest received is considered as being at arm‘s length applying Comparable
Uncontrolled Price method. The TPO, however, has disregarded the benchmarking analysis
undertaken by the appellant for determining the arm‘s length price of interest on loan
applying CUP method and instead imputed a rate of interest of 17.26% on the basis of
information sought under section 133(6) of the Act. The TPO further added a markup of
3.95% because of forward premium and ad-hoc markup of 3.43% on account of adjustment
for security and single customer risk, on the rate of interest charged by various banks in
India, without providing any cogent reasons and on the basis of his surmises and conjecture.
Accordingly, the TPO made an addition of Rs. 1,04,42,685 in the arm‘s length price of
interest of loan.
50. The Ld AR submitted as under :-
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1. Benchmarking of international transaction undertaken for receipt of interest using internal
CUP:
In the Transfer pricing document the transaction of loan advanced to the associated
enterprise is benchmarked applying CUP method wherein the loan availed by the
appellant from State Bank of India, at the rate of 3 months LIBOR + 170 basis point and
from ICICI at 3 months LIBOR + 140 basis point, as the appropriate internal
uncontrolled transaction. It was also submitted that the associated enterprise, viz., PT
Jindal Stainless, Indonesia has obtained external commercial borrowings from unrelated
parties for meeting its working capital requirements at LIBOR + 200 basis point.
Clause (a) of Rule 10B(1) of the Income-tax Rules (the Rules) provides for application
of CUP method. In terms of the provisions of the said clause, Comparable Uncontrolled
Price ("CUP") Method compares the price charged for property or services transferred in
a controlled transaction to the price charged for property or services transferred in a
comparable uncontrolled transaction in comparable circumstances, as under:
10(1) (a) comparable uncontrolled price method, by which,—
(i) the price charged or paid for property transferred or services provided in a
comparable uncontrolled transaction, or a number of such transactions, is identified;
(ii) such price is adjusted to account for differences, if any, between the international
transaction and the comparable uncontrolled transactions or between the enterprises
entering into such transactions, which could materially affect the price in the open
market;
(iii)the adjusted price arrived at under sub-clause (ii) is taken to be an arm's length price
in respect of the property transferred or services provided in the international
transaction;
In practice, there are two types of comparable uncontrolled transactions. The first, known
as an "Internal Comparable", is a transaction between one of the parties to the controlled
transaction and an unrelated third party. The second, known as an "External
Comparable", is a transaction between two unrelated third parties.
Generally, specific details regarding internal comparables are more readily available to
the parties engaged in the controlled transaction than details regarding external
comparables. In light of above, External CUP should be used with utmost caution, and if
internal CUP is available, it is preferred over external CUP.
In fact, internal comparables available in case of an appellant are to be preferred for the
purpose of benchmarking of international transactions even in the case where any of the
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prescribed method is applied, instead of relying on external comparables, as provided in
Paragraph 3.26 of the OECD Guidelines, 2009.
It is respectfully submitted that the OECD Guidelines on Transfer Pricing recognizes the
fact that internal comparables, if available, are to be adopted in the first instance, as the
preferred benchmark. Only where such internal comparables are not available, resort can
be had to external comparables, which may even otherwise be difficult to obtain and
information in respect of which may be incomplete and difficult to interpret.
The revised OECD Transfer Pricing Guidelines issued on 22 July 2010, too,
recommended the use of internal comparable data for benchmarking analysis.
Further, it is a settled law that internal comparables available in case of a taxpayer ought
to be preferred over external comparables for the purpose of benchmarking of
international transactions. Reliance in this regard is placed on the recent decision of
Hon‘ble Delhi High Court in the case of Sony Ericsson Mobile Communications India
Pvt. Ltd. vs. CIT (374 ITR 118) wherein the Hon‘ble court held that preference shall be
given to internal comparables while applying TNMM over external TNMM. The
observations of Hon‘ble Court are as under:
The TNM Method is a preferred transfer pricing arms length principle for its
proficiency, convenience and reliability. Ideally, in TNM Method preference should be
given to internal or in-house comparables. In absence of internal comparables, the
taxpayer can and would need to rely upon external comparables, i.e. comparable
transactions by independent enterprises.
Reference is also made to the decision of Hon‘ble Delhi High Court in the case of ACIT
vs. Birlasoft Limited in ITA No. 44/2015, Wherein, while dismissing the appeal of the
revenue filed against the decision of Hon‘ble Tribunal for application of internal TNMM,
Hon‘ble High Court held the court sees no reason to interfere firstly because the ITAT‘s
order has become final. Furthermore, the ITAT‘s reasoning is in accord with Rule
10B(1)(e)(ii) of the Income Tax Rules.
Further, the Benches of the Tribunal has consistently held that while undertaking
benchmarking analyss, internal comparable uncontrolled transactions is to be preferred
over the external comparable uncontrolled transactions. Reference, in this regard, is made
to the following decisions:
(i) Inslico Ltd vs. DCIT (ITA No. 4880/Del/2013)
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(ii) M/s e4e Business Solutions India Pvt. Ltd. vs. DCIT (ITA No. 324/Bang/2015)
(iii) M/s. Agila Specialties Pvt. Ltd. vs. DCIT (ITA No. 214/Bang/2015)
(iv) Valtech India Systems P. Ltd. vs. DCIT (ITA No. 22/Bang/2014)
(v) UCB India (P) Ltd. v ACIT 30 SOT 95
(vi) Easton Fluid Power Limited vs. ACIT (ITA No. 1623/PN/2011)
(vii) Cybertech Systems & Software Ltd. vs. ACIT (ITA No. 7307/Mum/2012)
(viii) Gharda Chemicals Limited Vs DCIT, 130 TTJ 556
(ix) Destination of the World vs. DCIT [ITA No 5534/Del/2010]
(x) Interra Information Technologies India (P) Ltd. Vs. DCIT (ITA No.
5568&5680/Del/2011)
(xi) Honeywell Electrical Devices & Systems India Pvt. Ltd. vs. ACIT (ITA No.
2152/Mds/2011)
(xii) Lummus Technology Heat Transfer BV vs. DCIT (ITA No. 6227/Del/2012)
Reliance in this regard is also placed on the decision of Chennai Bench of Tribunal in the
case of VVF LTD Vs DCIT [ITA No. 673/Mum/06], wherein, in a similar case involving
transaction of loan advanced to the associated enterprise, the Hon‘ble Tribunal held as
under:
We have noted that as was also noted by the Transfer Pricing Officer himself at
page 3 of his order the appellant has borrowed foreign currency loans in US Dollars
and for the purposes of investing in subsidiaries abroad, from ICICI Bank at the rate
of LIBOR + 3% The appellant has also filed a letter from Bank of India stating that
"during March 2002, we had been charging spreads of 150 bps to 300 bps over
LIBOR in respect of foreign currency loans based on financial position and credit
rating of the borrower". As for the LIBOR rate, as per the information provided by
appellant, it ranged from 1.85000 (2 weeks) to 3.00250 (1 year). On the given facts,
in our considered view, it would be appropriate to accept internal CUP, i.e. the rate at
which the appellant has resorted to foreign exchange borrowings from the ICICI, as
arms length price under CUP method. The fact, as painstaking brought on record by
the authorities below that this loan from ICICI bank was not used for the purposes of
remittance to subsidiaries as interest free loans has no bearing for the purposes of
computing ALP of interest free loan. The financial position and credit rating of the
subsidiaries will be broadly the same as the holding company, and, therefore, the
precise rate at which the ICICI Bank has advanced the foreign currency loans to the
appellant company can be adopted at arm‘s length price of interest free loans
advanced by the appellant company to its foreign subsidiaries.
The Hon‘ble Tribunal in the case of Bharti Airtel Ltd. (ITA No. 5636/Del/2011), too,
following the principles laid down in the case of VVF Ltd. (supra), upheld the contention
of the appellant that internal benchmark available in the form of interest paid on
borrowings in same or similar currency, ought to be taken into consideration for
undertaking benchmarking of international transactions of loan extended to the AE in
foreign currency.
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Reliance is also placed in this regard on the decision of the Hon‘ble Pune Bench of the
Tribunal in the case of Varroc Engineering Pvt Ltd vs ACIT (ITA No 2482/PN/2012),
wherein, the Hon‘ble Tribunal held as under:
In the totality of the facts and circumstances where the appellant has the internal
CUP of operating at international rates available and since the said loan raised by the
appellant at international rates was advanced to its associated enterprises, we find no
merit in the order of the TPO in applying the domestic loan rates i.e. BPLR rates for
benchmarking transaction of charging of interest on the loans advanced to the
associated enterprises by the appellant.
In view of the aforesaid, it is respectfully submitted that since the appellant has charged
interest on the loan @ monthly LIBOR plus 200 basis point from JSL Indonesia, being
higher than the internal CUP where JSL has availed loan from financial institutions, viz.,
State Bank of India, at the rate of 3 months LIBOR + 170 basis point and from ICICI at 3
months LIBOR + 140 basis point. JSL had also provided the loan to PT Jindal Stainless,
Indonesia at higher rate, i.e., 3 months LIBOR + 200 basis points, the international
transaction of interest received is considered as being at arm‘s length applying
Comparable Uncontrolled Price method.
2. Without prejudice, Interest rate applicable to appellant is available for AA category
companies
It is submitted that Credit Analysis and Research Limited, a third party credit rating
agency in India, vide report dated 23.02.2008 has rated the appellant as AA [Care Double
AA] category company. The credit rating of the parent company shall also apply
commercial practice to its wholly owned subsidiary.
Reliance in this regard is also placed on the recent decision of Chennai Bench of Tribunal
in the case of V.V.F. LTD Vs DCIT [ITA No. 673/Mum/06], wherein, the Hon‘ble
Tribunal held that:
The financial position and credit rating of the subsidiaries will be broadly the
same as the holding company, and, therefore, the precise rate at which the ICICI
Bank has advanced the foreign currency loans to the appellant company can be
adopted at arm‘s length price of interest free loans advanced by the appellant
company to its foreign subsidiaries.
In view of the aforesaid, the arm‘s length rate of interest to be charged from the
associated enterprise should be equivalent to the rate of interest chargeable on category
AA companies and therefore, without prejudice, the adjustment made by the TPO ought
to be restricted to the rate of interest charged on category AA company.
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3. Ad-hoc adjustment of transaction cost, security and single customer risk upon interest
rate:
The TPO, on the arm‘s length rate of interest determined at Libor + 4%, has allegedly
added transaction cost of 3% considering the premium charged by banks on forward
contract of 3-months tenure. It is submitted that the TPO himself has considered the
highest rate of interest charged by banks on foreign currency loans, and therefore, a
separate mark-up of transaction cost is unwarranted. Further, there is no justification in
considering premium on forward contracts as transaction cost when the banks provides
for specific processing charges on loans.
Further, with regard to risk adjustments, it is submitted that the TPO has grossly
misunderstood the underlying facts of the case with regard to risk. A bank, it is
submitted, cannot have control over the operations of the borrower and accordingly
always carry credit risk. However, in the case of the appellant, the associated enterprise,
is its wholly owned subsidiary company and accordingly, question of any margin
money/security does not arise.
Reference in this regard is also made to the recent decision of Delhi Bench of the
Tribunal in the case of Bharti Airtel Limited vs. ACIT (ITA No. 5816/Del/2012),
wherein, the Hon‘ble Tribunal upheld the foresaid proposition of the appellant, as under:
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 appellant 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.
In view of the aforesaid, it is respectfully submitted that the addition made by the TPO on
account of interest charged on foreign currency loan extended to the associated enterprise
is bad in law and liable to be deleted
51. The ld DR vehemently supported the order of the lower authorities. He submitted that
assessee is contended that the loan provided to the associated enterprise should not be
benchmarked at 13.25% as against the rate of LIBOR + 200 basis points charged by the
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assessee, as assessee itself has obtained loan from banking institutions at the rate of 3 months
LIBOR + 170 bps and 140 bps, he submitted that the purpose of benchmarking the interest
on loan, the credit rating in the necessary to reduce the interest rates. He submitted that the
assessee has failed to submit the credit rating of the associated enterprise is the Transfer
Pricing Officer was left with no other option but to consider the rating at a minimal. He
submitted that assessee has provided the internal CUP data in form of loans, which were
acquired by the assessee itself from banking institutions in India. Here the internal CUP
applied by the assessee does not hold good as the geographical conditions, economic
conditions, market forces of the countries involved are different. Therefore, the assessee has
wrongly applied the internal CUP, which is not appropriate. He further submitted that the risk
factor being adjusted by comparing the bonds as per any rating agency was the only option
left before the learned Transfer Pricing Officer to benchmark the international transactions of
receipt of interest on loan. The learned Transfer Pricing Officer has followed the
international best practices in determining arm‘s-length interest in situation like this by
taking financial, credit, business, and structural risk into account. Therefore, the interest rate
applied by the learned Transfer Pricing Officer is justified.
52. He further submitted that though assessee has contended that internal CUP of interest paid by
the associated enterprise at the LIBOR + 200 bps should be used, he submitted that it is the
Indian associated enterprise which needs to be taken as the tested party since the loan is
extended by a to its associated enterprises. Further from a, shall point of view, as pointed out
by the TPO in his order dated 24th/10/ 2011 that if the associated enterprise was able to
acquire a loan at a cheaper rate than what enticed the associated enterprise to obtain a loan
from other entities at a higher rate. The logic behind it is that the associated enterprise had
exhausted its borrowing limit with the local banks and then it had to take a loan from Indian
associated enterprise. He further stated that the contention of the assessee that loan was
advanced by the assessee to the associated enterprise in foreign denominated currency
therefore should be benchmarked accordingly using LIBOR rates prevalent in the
international market is also devoid of any merit. He stated that the company that lent in
foreign currency has to bad and additional transaction cost, which for the year under
consideration works out to the tune of 3%. Further the learned TPO has examined in detail
how he has applied LIBOR + appropriate basis points after accounting for transaction cost,
adjustment between the bank and non-bank and adjustment of security. He further submitted
that the argument of the assessee that the learned TPO has used information acquired under
section 133 (6) without confronting the same to the assessee, he submitted that assessee has
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been confronted with the result of this exercise so there is no secrecy hence the tenets of
natural justice have been followed and no further opportunity in the view of Dispute
Resolution Panel is required to be provided to the assessee. He therefore submitted that this
argument of the assessee requires to be rejected at the threshold. He further submitted that
even at this stage the assessee could not show that how assessee is aggrieved by the action of
the learned TPO in obtaining information under that section when the assessee has not
provided adequate information to the learned TPO for benchmarking the interest income. He
submitted that it is not the case of the assessee that it has provided the complete information
on the learned TPO has rejected it and obtain information under section 133 (6) of the act
and assessee has not been confronted. He further submitted that the contention of the
assessee that the learned TPO has erroneously charged markup of 3.95% on account of the
forward premium and ad hoc markup of 3.43% on account of adjustment for security and
single customer risk without giving any cogent reason. He submitted that while deciding the
markup the learned TPO has considered the transaction cost which the assessee has to bear
on account of the associated enterprise as explained in detail on page number 32 of the
transfer pricing order dated 24/10/2011. He further stated that further adjustments were made
by the learned TPO because of adjustment between a banker and non-bank and further men
adjustment on account of security and single customer risk. These risk factors do affect
compatibility and hence the TPO has followed the international best practices in determining
arm‘s-length interest in situation like this by taking into account suitable adjustments for all
the risks. He therefore submitted that the interest rate applied by the Transfer Pricing Officer
is justified.
53. We have carefully considered the rival contentions and perused the orders of the lower
authorities. We also considered the various decisions cited by both the parties before us on
the issue.
54. The first contention of the assessee is that benchmarking of international transaction based on
interest rates for receipt of interest using internal CUP by the assessee should be accepted.
The assessee has adopted the internal CUP of the interest rates on which the assessee has
borrowed the money. These are two different transactions the assessee is trying to benchmark
the transaction of receipt of interest with the transaction of payment of interest. Therefore,
according to us this is not a proper internal comparable, hence, this argument of the assessee
is rejected.
55. Second contention is that benchmarking should be done based on the borrowing rates on
Thailand Company as internal CUP. Here the tested party is the assessee therefore the
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transaction is required to be benchmarked what an independent person in India would have
charged on the interest on loanto the foreign AE. Therefore, internal CUP with respect to
the borrowing made by the Thailand Company is also correctly rejected by the learned
Transfer Pricing Officer.
56. For assessment year 2007 – 08 the learned commissioner of income tax appeal has upheld the
action of the learned Transfer Pricing Officer in benchmarking the rate of interest at Libor
+700 basis points and addition on account of the risk factor as a result of that the interest to
be charged is determined at the rate of 14%.. Coming to the order of the learned Dispute
Resolution Panel for assessment year 2008 – 09, wherein they have directed the learned
Transfer Pricing Officer to consider the rate of interest at the prime lending rate of the
reserve Bank of India as prevalent in the financial year 2007 – 08. Therefore, there is a
dichotomy in the approach of the revenue in taking in the first year based LIBOR +700 basis
points and in the second year to consider the prime lending rate of the reserve Bank of India.
Therefore, both the benchmarking for both the years by the LD TPO confirmed by LD CIT
A and Ld DRP deserves to be rejected.
57. Further the Honorable Delhi High court in case of CIT V Cotton Naturals ITA 233 of 2014
dated 27/3/2015 [2015] 55 taxmann.com 523 (Delhi) [2015-TII-09-HC-DEL-TP ] and held
as under :-
15. The case of the appellant-Revenue finds lucid exposition in the following table quoted
by the Transfer Pricing Officer, pointing out the difference between lending and borrowing:
"The difference between lending and borrowing when dealing at arm's length is given in
the below table (Assuming X is in India and Y is outside India).
Sl.
No.
Aspect Lending money
b X to Y
Borrowing
Money b X
from Y
1 Primary
Consideration
The primary
consideration
for X is to
maximize its
return in terms
of interest
keeping in view
the risk
involved.
The primary
consideration
for X is to
minimize its
rate of interest
keeping in
view the risk
involved.
2 Interest Rate Interest rate Interest rate
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depends on the
tenure, credit
rating of Y, and
security
offered.
depends on the
tenure, credit
rating of X,
and security
offered.
3 Benchmarking X would see
what the
maximum
return he gets
in India and
spread required
for taking the
risk of losing
money
(depends on the
credit rating of
Y) as well as
security being
offered by Y.
Independent
party would not
lend outside
India if it can
get higher
return in India.
Thus the
benchmarking
would be based
on the interest
rate receivable
in India for
giving loans to
parties with
similar credit
rating as that of
Y (like
corporate
bonds) and also
the level of
security offered
by Y.
X would see
what the
minimum
interest rate it
can borrow
from Y as
interest rates
in India are
higher when
compared to
the interest
rates charged
in ECB loans.
Thus the bench
marking is
based on
LIBOR + some
basis points
depending on
the credit
rating of X.
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Indian companies go for External Commercial Borrowings as the interest rates on ECB
loans are generally cheaper than the prevailing interest rates in the domestic market. Thus
as can be seen from above, while borrowing money by X (in India) from Y (outside India),
the interest rates are benchmarked with LIBOR and the interest rate above LIBOR is
decided by the stand alone credit rating of X. On the contrary, no company in India would
like to investment in the form of loan outside India and that also without security as the
interest returns in India would be higher than those prevailing in developed markets. Thus
while lending money by X (in India) to Y (outside India), the interest rates would be bench
marked against those prevailing in India for investing in corporate bonds (which are
without security)."
16. We would first like to deal with the aforesaid table and the reasoning given in the case
of Logic Micro Systems Ltd. (supra) before we advert to other facets of the issue.
17. In our opinion, the reasoning recorded therein suffers from a basic and fundamental
fallacy. Transfer pricing determination is not primarily undertaken to re-write the character
and nature of the transaction, though this is permissible under two exceptions. Chapter X
and Transfer Pricing rules do not permit the Revenue authorities to step into the shoes of
the assessee and decide whether or not a transaction should have been entered. It is for the
assessed to take commercial decisions and decide how to conduct and carry on its business.
Actual business transactions that are legitimate cannot be restructured. It is not uncommon
for manufacturers cum exporters to enter into distribution and marketing agreements with
third parties or incorporate subsidiaries in different countries for undertaking marketing and
distribution of the products. The Delhi High Court in Commissioner of Income Tax versus
EKL Appliances Limited, (2012) 345 ITR 241 (Delhi) = 2012-TII-01-HC-DEL-TP referred
to the Paragraphs 1.36 to 1.38 of the Transfer Pricing Guidelines for Multinational
Enterprises and Tax Administrations, 2010 published by the Organization for Economic
Cooperation and Development (OECD, for short) and held as under:-
"17. The significance of the aforesaid guidelines lies in the fact that they recognise
that barring exceptional cases, the tax administration should not disregard the actual
transaction or substitute other transactions for them and the examination of a
controlled transaction should ordinarily be based on the transaction as it has been
actually undertaken and structured by the associated enterprises. It is of further
significance that the guidelines discourage re-structuring of legitimate business
transactions. The reason for characterisation of such re-structuring as an arbitrary
exercise, as given in the guidelines, is that it has the potential to create double
taxation if the other tax administration does not share the same view as to how the
transaction should be structured.
18. Two exceptions have been allowed to the aforesaid principle and they are (i)
where the economic substance of a transaction differs from its form and (ii) where the
form and substance of the transaction are the same but arrangements made in
relation to the transaction, viewed in their totality, differ from those which would
have been adopted by independent enterprises behaving in a commercially rational
manner."
18. This judgment was referred to by us in ITA No. 16/2014, Sony Ericsson Mobile
Communications India Private Limited (Now known as Sony India Limited) versus
Commissioner of Income Tax-III and other connected cases decided on 16th March,
2015 = 2015-TII-06-HC-DEL-TP and it was held as under:-
"147. Tax authorities examine a related and associated parties transaction as
actually undertaken and structured by the parties. Normally, tax authorities cannot
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disregard the actual transaction or substitute the same for nother transaction as per
their perception. Restructuring of legitimate business transaction would be an
arbitrary exercise. This legal position stands affirmed in EKL Appliances Ltd.
(supra). The decision accepts two exceptions to the said rule. The first being where
the economic substance of the transaction differs from its form. In such cases, the tax
authorities may disregard the parties' characterisation of the transaction and recharacterise
the same in accordance with its substance. The Tribunal has not invoked
the said exception, but the second exception, i.e. when the form and substance of the
transaction are the same, but the arrangements made in relation to the transaction,
when viewed in their totality, differ from those which would have been adopted by the
independent enterprise behaving in a commercially rational manner. The second
exception also mandates that actual structure should practically impede the tax
authorities from determining an appropriate transfer price. The majority judgment
does not record the second condition and holds that in their considered opinion, the
second exception governs the instant situation as per which, the form and substance
of the transaction were the same but the arrangements made in relation to a
transaction, when viewed in their totality, differ from those which would have been
adopted by an independent enterprise behaving in a commercially rational manner.
The aforesaid observations were recorded in the light of the fact in the case of L.G.
Electronics (supra). Commenting on the factual matrix of L.G. Electronics case
(supra) would be beyond our domain; however, we do not find any factual finding to
this effect by the TPO or the Tribunal in any of the present cases. However, in L.G.
Electronics decision (supra), it is observed that if the AMP expenses and when such
expenses are beyond the bright line, the transaction viewed in their totality would
differ from one which would have been adopted by an independent enterprise
behaving in a commercially rational manner. No reason or ground for holding or the
ratio, is indicated or stated. There is no material or justification to hold that no
independent party would incur the AMP expenses beyond the bright line AMP
expenses. Free market conditions would indicate and suggest that an independent
third party would be willing to incur heavy and substantial AMP expenses, if he
presumes this is beneficial, and he is adequately compensated. The compensation or
the rate of return would depend upon whether it is a case of long-term or short-term
association and market conditions, turnover and ironically international or
worldwide brand value of the intangibles by the third party."
19. It would also be appropriate at this stage to reproduce the following portion from the
UN Model Double Taxation Convention Between Developed and Developing Countries,
wherein reference was made to the OECD Model Convention Commentary on Paragraph 6
of Article 11, in the following words:
"22. This paragraph reproduces Article 11, paragraph 6, of the OECD Model
Convention, the Commentary on which reads as follows:
32. The purpose of this paragraph is to restrict the operation of the provisions
concerning the taxation of interest in cases where, by reason of a special
relationship between the payer and the beneficial owner or between both of them
and some other person, the amount of the interest paid exceeds the amount which
would have been agreed upon by the payer and the beneficial owner had they
stipulated at arm's length. It provides that in such a case the provisions of the
Article apply only to that last-mentioned amount and that the excess part of the
interest shall remain taxable according to the laws of the two Contracting States,
due regard being had to the other provisions of the Convention.
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33. It is clear from the text that for this clause to apply the interest held excessive
must be due to a special relationship between the payer and the beneficial owner
or between both of them and some other person. There may be cited as examples
cases where interest is paid to an individual or legal person who directly or
indirectly controls the payer, or who is directly or indirectly controlled by him or
is subordinate to a group having common interest with him. These examples,
moreover, are similar or analogous to the cases contemplated by Article 9.
34. On the other hand, the concept of special relationship also covers
relationship by blood or marriage and, in general, any community of interests as
distinct from the legal relationship giving rise to the payment of the interest.
35. With regard to the taxation treatment to be applied to the excess part of the
interest, the exact nature of such excess will need to be ascertained according to
the circumstances of each case, in order to determine the category of income in
which it should be classified for the purposes of applying the provisions of the
tax laws of the States concerned and the provisions of the Convention. This
paragraph permits only the adjustment of the rate at which interest is charged
and not the reclassification of the loan in such a way as to give it the character
of a contribution to equity capital. For such an adjustment to be possible under
paragraph 6 of Article 11 it would be necessary to as a minimum to remove the
limiting phrase"having regard to the debt-claim for which it is paid". If greater
clarity of intent is felt appropriate, a phrase such as"for whatever reason" might
be added after"exceeds". Either of these alternative versions would apply where
some or all of an interest payment is excessive because the amount of the loan or
the terms relating to it (including the rate of interest) are not what would have
been agreed upon in the absence of the special relationship. Nevertheless, this
paragraph can affect not only the recipient but also the payer of excessive
interest and if the law of the State of source permits, the excess amount can be
disallowed as a deduction, due regard being had to other applicable provisions
of the Convention. If two Contracting States should have difficulty in determining
the other provisions of the Convention applicable, as cases require, to the excess
part of the interest, there would be nothing to prevent them from introducing
additional clarifications in the last sentence of paragraph 6, as long as they do
not alter its general purport.
36. Should the principles and rules of their respective laws oblige the two
Contracting States to apply different Articles of the Convention for the purpose
of taxing the excess, it will be necessary to resort to the mutual agreement
procedure provided by the Convention in order to resolve the difficulty.
23. When this issue was last considered, some members of the former Group of
Experts pointed out that there are many artificial devices entered into by persons
to take advantage of the provisions of Article 11 through, inter alia, creation or
assignment of debt claims in respect of which interest is charged. While
substance over form rules, abuse of rights principle or any similar doctrine
could be used to counter such arrangements, Contracting States which may want
to specifically address the issue may include a clause on the following lines in
their bilateral tax treaties during negotiations, namely:
The provisions of this Article shall not apply if it was the main purpose or one of
the main purposes of any person concerned with the creation or assignment of
the debt claim in respect of which the interest is paid to take advantage of this
Article by means of that creation or assignment."
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20. Reverting to the reasoning given, we record that the respondent-assessee had
incorporated a subsidiary in United States for undertaking distribution and marketing
activities for the products manufactured by them. It is obvious that this was done with the
intention to expand and promote exports in the said country and was a legitimate business
decision. The transaction of lending of money by the respondent-assessee to the subsidiary
should not be seen in isolation, but also for the purpose of maximising returns, propelling
growth and expanding market presence. The reasoning ignores the said objective facet.
Transfer pricing rules treat the domestic AE and the foreign AE as two separate entities and
profit centres, and the test applied is whether the compensation paid for the products and
services is at arm's length, but it does not ignore that the two entities have a business and a
commercial relationship. The terms and conditions of the commercial business relationship
as agreed and undertaken are not to be rewritten or obliterated. Transfer pricing is a
mechanism to undo an attempt to shift profits and correct any under or over payment in a
controlled transaction by ascertaining the fair market price. This is done by computing the
arm's length price. The purpose is to ascertain whether the transfer price is the same price
which would have been agreed and paid for by unrelated enterprises transacting with each
other, if the price is determined by market forces. The first step in this exercise is to
ascertain the international transaction, which in the present case is payment of interest on
the money lent. The next step is to ascertain the functions performed under the international
transaction by the respective AEs. Thereafter, the comparables have to be selected by
undertaking a comparability analysis. The comparability analysis should ensure that the
functions performed by the comparables match with the functions being performed by the
AE to whom payment is made for the services rendered. These aspects have been
elucidated in detail in Sony India Ltd. (supra) by referring to the OECD Guidelines as well
as United Nations Practical Manual of Transfer Pricing for Developing Countries.
21. Appropriate in this regard would be reference also to Rules 10B and 10C of the Income
Tax Rules, 1962. Rule 10B (2) reads:-
"10B. xxx
(2) For the purposes of sub-rule (1), the comparability of an international transaction or a
specified domestic transaction with an uncontrolled transaction shall be judged with
reference to the following, namely:-
(a) the specific characteristics of the property transferred or services provided in either
transaction;
(b) the functions performed, taking into account assets employed or to be employed and the
risks assumed, by the respective parties to the transactions;
(c) the contractual terms (whether or not such terms are formal or in writing) of the
transactions which lay down explicitly or implicitly how the responsibilities, risks and
benefits are to be divided between the respective parties to the transactions;
(d) conditions prevailing in the markets in which the respective parties to the transactions
operate, including the geographical location and size of the markets, the laws and
Government orders in force, costs of labour and capital in the markets, overall economic
development and level of competition and whether the markets are wholesale or retail."
Equally important is sub-rule (3) to Rule 10B, which reads:-
"10B. (3) An uncontrolled transaction shall be comparable to an international transaction
or a specified domestic transaction ifITA
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(i) none of the differences, if any, between the transactions being compared, or between the
enterprises entering into such transactions are likely to materially affect the price or cost
charged or paid in, or the profit arising from, such transactions in the open market; or
(ii) reasonably accurate adjustments can be made to eliminate the material effects of such
differences."
Similarly, Rule 10C (1) reads:-
"10C. (1) For the purposes of sub-section (1) of section 92C, the most appropriate method
shall be the method which is best suited to the facts and circumstances of each particular
international transaction or specified domestic transaction, and which provides the most
reliable measure of an arm's length price in relation to the international transaction or the
specified domestic transaction, as the case may be.
(2) In selecting the most appropriate method as specified in sub-rule (1), the following
factors shall be taken into account, namely:-
(a) the nature and class of the international transaction or the specified domestic
transaction;
(b) the class or classes of associated enterprises entering into the transaction and the
functions performed by them taking into account assets employed or to be employed and
risks assumed by such enterprises;
(c) the availability, coverage and reliability of data necessary for application of the
method;
(d) the degree of comparability existing between the international transaction or the
specified domestic transaction and the uncontrolled transaction and between the
enterprises entering into such transactions;
(e) the extent to which reliable and accurate adjustments can be made to account for
differences, if any, between the international transaction or the specified domestic
transaction and the comparable uncontrolled transaction or between the enterprises
entering into such transactions;
(f) the nature, extent and reliability of assumptions required to be made in application of a
method."
22. The aforesaid Rules indicate factors that ought to be taken into account for selection of
the comparables, which necessarily include the contractual terms of the transaction and
how the risks, benefits and responsibilities are to be divided. The conditions prevailing in
the market in which the respective parties to the transactions operate, including the
geographical location and the size of the markets, the laws and Government orders in force,
costs of labour and capital in the markets, overall economic development and level of
competition, are all material and relevant aspects. If we keep the aforesaid aspects in mind,
it would be delusive not to accept and agree that as per the prevalent practice, subsidiary
AEs are often incorporated to carry on distribution and marking function. This is not an
unusual but common. Once this is accepted, then we cannot accept the reasoning given by
the TPO that the transfer pricing adjustment could restructure the transaction to reflect
maximum return that a party could have earned and this would be the yardstick or the
benchmark for determining the interest payable by the subsidiary AE. This is not what
Chapter X of the Act and Rules mandate and stipulate. The aforesaid provisions neither
curtail the commercial freedom, nor do they bar or prohibit a legitimate transaction. They
permit transfer pricing adjustment so as to bring to tax what would have been paid for the
transaction in the same or similar comparable circumstances by an independent third party.
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23. This ratio and rationale, when applied to the facts of the present case, would mean that
the transfer pricing determination would decide what an independent distributor and
marketer, on the same contractual terms and having the same relationship, would have
earned/paid as interest on the loan in question. What an independent party would have paid
under the same or identical circumstances would be the arm's length price or rate of
interest. What the assessed would have earned in case he would have entered into or gone
ahead with a different transaction, say with a party in India, is not the criteria. What is
permitted and made subject matter of the arm's length determination is the question of rate
of interest and not re-classification or substitution of the transaction. The position would
have been different, if the two exceptions carved out in the case of EKL Appliances (supra)
were applicable.
24. This is clear and lucid when we examine the methodology prescribed in Rule 10B (1)
(a), which prescribes the manner of computing arm's length price under CUP method. Rule
10B (1) (a) reads:-
"10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in
relation to an international transaction 55a[or a specified domestic transaction] shall be
determined by any of the following methods, being the most appropriate method, in the
following manner, namely:-
(a) comparable uncontrolled price method, by which,-
(i) the price charged or paid for property transferred or services provided in a comparable
uncontrolled transaction, or a number of such transactions, is identified;
(ii) such price is adjusted to account for differences, if any, between the international
transaction or the specified domestic transaction and the comparable uncontrolled
transactions or between the enterprises entering into such transactions, which could
materially affect the price in the open market;
(iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm's length price
in respect of the property transferred or services provided in the international transaction
or the specified domestic transaction
xxx "
25. The comparison, therefore, has to be with comparables and not with what options or
choices which were available to the assessed for earning income or maximizing returns.
Importantly, the TPO, DRP and the Assessing Officer have all accepted that the respondent
assessee had adopted and applied CUP Method for computing arm's length interest payable
by the subsidiary AE. To this extent, there is no lis or dispute.
26. The TPO has noticed the contractual terms and referred to the following facets: The
advance given by the parent company i.e. the assessed to M/s JPC Equestrian Inc. was to
meet the working capital requirements of the subsidiary AE. He noted that when
independent enterprises transact with each other, their business relations are determined by
the market forces operating, i.e. what is the amount of interest that would have been earned
had such an advance been given to an unrelated party placed in a similar position as that of
the subsidiary AE. The TPO had asked for the audited financial accounts of the subsidiary.
Credit rating would be relevant. He accepted that there was a sense of commercial
expediency and related benefits in the loan transaction but the assessed had not been able to
demonstrate that the interest charged satisfied the arm's length standard. He observed that
business prudence or necessity of advancing loan to the subsidiary was not relevant for
computing arm's length price (i.e. rate of interest in this case) in unrelated party
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transactions. This aspect, he held, would not take precedence over the arm's length nature
of interest.
27. Several aspects enunciated above, reflect the correct legal position. We, however,
express our inability to accept that commercial expediency and related benefits have no
connection or relationship with the rate of interest. In terms of Clause (c) and (d) to Rule
10B (2), contractual relations or terms, and other material facts should be recognized.
Having said so, we do accept the force of the alternative argument advanced that this fact
could be of marginal significance and effect. It would be for the assessed to show and
prove that a transaction separately benchmarked, included consideration for the lower
interest rate being paid.
28. We do not agree with the finding recorded in paragraph 5 of the TPO's order that the
comparable test to be applied is to ascertain what interest would have been earned by the
assessed by advancing a loan to an unrelated party in India with a similar financial health
as the taxpayer's subsidiary. The aforesaid reasoning is unacceptable and illogical as the
loan to the subsidiary AE in the instant case is not granted in India and is not to be repaid in
Indian Rupee. It is not a comparable transaction. The finding of the TPO that for this
reason the interest rate should be computed at 14% per annum i.e. the average yield on
unrated bonds for Financial Years (FY, for short) 2006-07, has to be rejected.
29. The TPO has referred to the decision of the Tribunal in the case of Perot Systems TSI
(India) Limited versus DCIT and VVF Limited versus DCIT, 2010-TIOL-55-ITATMUM
wherein LIBOR plus 1.64% i.e. 4.03% and LIBOR plus 3% respectively, were
accepted as the arm's length rate of interest. But these decisions, he held, were unacceptable
for the reasons set out in paragraph 6.1 of the TPO's order (the table has been quoted
above). We have rejected the reasoning given in the table.
30. However, the TPO was right in rejecting computation of arm's length interest on the
basis of Reserve Bank of India Master Circular dated 1st July, 2006 and 2nd July, 2007,
fixing a ceiling on the interest rate on export credit at LIBOR plus 100 basis points etc. The
reasoning given is correct and befitting. These were special schemes floated by the Reserve
Bank of India for encouraging and facilitating exports with the said object and purpose.
Export credit interest was available only for limited number of days and for specific
purposes. The rates fixed did not reflect comparable market rates.
31. On the question of adjustment, the TPO referred to the FCNR loan advanced by the
Power Finance Corporation to the Indian company i.e. Jindal Thermal Power Company
Ltd. of US$ 44.50 million. Interest charged in the said case was US LIBOR plus 350 basis
points for a company which had been given BB+ credit rating. However, full facts like the
nature of transaction; risk factors etc. are not elucidated. He has also referred to the Bank of
Baroda website that the rate of interest on FCNR loan were between 350-650 basis points
over LIBOR for the FY 2006-07. TPO held that in view of the financial health of the
subsidiary AE, interest rate could be taken as the average of six months LIBOR plus 400
basis points. On the question of transaction cost, it was stated that it was mandatory for the
bank to insist that the borrower must book forward contracts to hedge their position. The
TPO referred to the premium payable for undertaking the said hedging transactions and
added a cost of 3% per annum as premium, which should have been paid. At the same time,
the TPO acknowledged that the taxpayer was not in the business of lending or borrowing
money and observed that the taxpayer's risk was higher in advancing loan to a single
customer, vis a bank which spreads its risk among various customers. Banks spread their
risk when loans are/were advanced to various consumers, but this does not happen when a
loan is given to a single customer.
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32. On the question of adjustment made on account of the transaction cost, we do not
appreciate the reasoning given by the TPO and find it difficult to accept. The transaction or
hedging cost is borne and paid by the borrower. These are undertaken when they take loans
in US Dollars or other foreign currencies because the borrower wants to cover any loss on
account of the depreciation of the Indian Rupee vis- a- vis the foreign currency. The
assessee in the present case is not the borrower, but the lender. Transaction cost is not,
therefore, applicable in the case in question, as the loan had to be repaid in US Dollars.
Mark up towards the transaction cost is exorbitant and even comparison with banks is
unsound and unintelligible. Risk factor adjustment is also stretched, for it ignores the close
relationship between the two AEs and the funds were the shareholder funds, and not
borrowed money.
33. The DRP accepted the addition of 700 basis points on account of credit rating and
transaction costs, but the suggested third adjustment of 1.776 basis points was not accepted
as loan was given out of the shareholder funds, which flowed from one set of shareholders
to another set of shareholders. The security aspect it was held was embedded by default in
the transaction. Thus, there was no requirement to make further addition on account of
security.
34. In the present case, the loan was granted in the year 2002-2003 and not during the
period relevant to the assessment year in question. The agreements in respect of loan was
entered into on 13th April, 2002, 7th May, 2003 and then on 8th September, 2003. The
agreements fixed the rate of interest at 4% per annum on the principal sum. The said rate
has been accepted in the earlier assessment years and, as noticed above, even in the
subsequent assessment year 2008-09.
35. The LIBOR rate plus markup or the interest rate prevailing in the United States at that
time, i.e. 2003 have not been examined and are not the basis on which the TPO made the
adjustment and compute the interest rate for the transaction under consideration. It claimed
that the LIBOR rates in the year 2002 varied between 1.447 % to 3.006 % and in the year
2003 between 1.201% to 1.487%. Rates in the year 2004 were again marginal, with the
highest at 3.100% and the lowest at 1.340%. The LIBOR rate of 5.224% quoted in the
TPO's order, it is pointed out, was the rate received on the investment made during the
assessment year in question by the assessed. Thus, it was argued that the present case is of
a long-term loan granted to the AE and the rate of interest charged was much higher than
the then prevailing LIBOR interest rate. There is no finding of the TPO, the DRP or the
Assessing Officer questioning the long-term transaction as such.
36. Under sub-rule (4) to Rule 10B, the data used for comparability of the uncontrolled
transaction should be the data relating to the financial year in which the international
transaction has been entered into. The proviso permits consideration of data, not more than
two years prior to the financial year, if such data reveals facts which would have influenced
determination of transfer price in relation to the transaction being compared. The
transaction in question was entered into in the year 2002-03 when the loans were granted to
the AE. This was the financial year of the international transaction. Payment of interest is
also an international transaction but would have reference to the year in which the loan was
granted in case of a long term loan. However, in such situations, question may arise
whether the case would fall under the second exception mentioned in the case of E.K.L.
Appliances (supra), when an AE has the right to recall and ask for repayment of loan.
These aspects have not been considered and applied by the TPO, DRP and the Assessing
Officer. Neither has this ground been argued before us on behalf the Revenue. We,
therefore, would not proceed to examine the said aspect and leave the question open.
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Similarly, we have not expressed any opinion on the issue or question of"thin
capitalization" which does not arise for consideration in the present case.
37. We observe that whatever the Revenue argues and submits in the case of outbound
loans or for that matter what we have observed would be equally applicable to inbound
loans given to Indian subsidiaries of foreign AEs. The parameters cannot be different for
outbound and inbound loans. A similar reasoning applies to both inbound and outbound
loans. Revenue has erroneously argued that different parameters would apply for inbound
and outbound loans, which is not acceptable .
38. The DRP referred to the PLR rates fixed in India. It is evident that the PLR rates were
not the basis for fixing the arm's length price. Both TPO and the DRP have referred to the
PLR rates only by way of analogy so as to state the prevailing interest rates in India, but
while applying CUP method for comparability, they had applied LIBOR rates prevailing
and had applied a mark-up of 700 points on account of low credit rating of the subsidiary
AE and the cost of transaction.
39. The question whether the interest rate prevailing in India should be applied, for the
lender was an Indian company/assessee, or the lending rate prevalent in the United States
should be applied, for the borrower was a resident and an assessee of the said country, in
our considered opinion, must be answered by adopting and applying a commonsensical and
pragmatic reasoning. We have no hesitation in holding that the interest rate should be the
market determined interest rate applicable to the currency concerned in which the loan has
to be repaid. Interest rates should not be computed on the basis of interest payable on the
currency or legal tender of the place or the country of residence of either party. Interest
rates applicable to loans and deposits in the national currency of the borrower or the lender
would vary and are dependent upon the fiscal policy of the Central bank, mandate of the
Government and several other parameters. Interest rates payable on currency specific loans/
deposits are significantly universal and globally applicable. The currency in which the loan
is to be re-paid normally determines the rate of return on the money lent, i.e. the rate of
interest. Klaus Vogel on Double Taxation Conventions (Third Edition) under Article 11 in
paragraph 115 states as under:-
"The existing differences in the levels of interest rates do not depend on any place but
rather on the currency concerned. The rate of interest on a US $ loan is the same in New
York as in Frankfurt-at least within the framework of free capital markets (subject to the
arbitrage). In regard to the question as to whether the level of interest rates in the lender's
State or that in the borrower's is decisive, therefore, primarily depends on the currency
agreed upon (BFH BSt.B1. II 725 (1994), re. 1 § AStG). A differentiation between debtclaims
or debts in national currency and those in foreign currency is normally no use,
because, for instance, a US $ loan advanced by a US lender is to him a debt-claim in
national currency whereas to a German borrower it is a foreign currency debt (the
situation being different, however, when an agreement in a third currency is involved).
Moreover, a difference in interest levels frequently reflects no more than different
expectations in regard to rates of exchange, rates of inflation and other aspects. Hence, the
choice of one particular currency can be just as reasonable as that of another, despite
different levels of interest rates. An economic criterion for one party may be that it wants, if
possible, to avoid exchange risks (for example, by matching the currency of the loan with
that of the funds anticipated to be available for debt service), such as taking out a US $
loan if the proceeds in US $ are expected to become available (say from exports). If an
exchange risk were to prove incapable of being avoided (say, by forward rate fixing), the
appropriate course would be to attribute it to the economically more powerful party. But,
exactly where there is no special relationship', this will frequently not be possible in
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dealings with such party. Consequently, it will normally not be possible to review and
adjust the interest rate to the extent that such rate depends on the currency involved.
Moreover, it is questionable whether such an adjustment could be based on Art. 11 (6). For
Art. 11(6), at least its wording, allows the authorities to eliminate hypothetically' the
special relationships only in regard to the level of interest rates and not in regard to other
circumstances, such as the choice of currency. If such other circumstances were to be
included in the review, there would be doubts as to where the line should be drawn, i.e.,
whether an examination should be allowed of the question of whether in the absence of a
special relationship (i.e., financial power, strong position in the market, etc., of the foreign
corporate group member) the borrowing company might not have completely refrained
from making investment for which it borrowed the money."
40. The aforesaid methodology recommended by Klaus Vogel appeals to us and appears to
be the reasonable and proper parameter to decide upon the question of applicability of
interest rate. The loan in question was given in foreign currency i.e. US $ and was also to
be repaid in the same currency i.e. US $. Interest rate applicable to loans granted and to be
returned in Indian Rupees would not be the relevant comparable. Even in India, interest
rates on FCNR accounts maintained in foreign currency are different and dependent upon
the currency in question. They are not dependent upon the PLR rate, which is applicable to
loans in Indian Rupee. The PLR rate, therefore, would not be applicable and should not be
applied for determining the interest rate in the extant case. PLR rates are not applicable to
loans to be re-paid in foreign currency. The interest rates vary and are thus dependent on
the foreign currency in which the repayment is to be made. The same principle should
apply.

41. Counsel for the Revenue had made reference to Chapter 10 of the U.N. Transfer Pricing
Manual, relevant portion of which reads:-
"10.4.10. Financial Transactions
10.4.10.1. Intercompany loans and guarantees are becoming common international
transactions between related parties due to the management of cross-border funding within
group entities of an MNE group. Transfer pricing of inter-company loans and guarantees
are increasingly being considered some of the most complex transfer pricing issues in
India. The Indian transfer pricing administration has followed a quite sophisticated
methodology for pricing inter-company loans which revolves around:
- Examination of the loan agreement;
- A comparison of terms and conditions of loan agreements;
- The determination of credit ratings of lender and borrower;
- The identification of comparable third party loan agreements: and
- Suitable adjustments to enhance comparability.
10.4.10.2. The Indian transfer pricing administration has come across cases of outbound
loan transactions where the Indian parent has advanced to its associated entities (AE) in a
foreign jurisdiction either interest free loans or loans at LIBOR (London Interbank Offered
Rate) or EURIBOR (Euro Interbank Offered Rate). The main issue before the transfer
pricing administration is benchmarking of these loan transactions to arrive at the ALP of
the rates of interest applicable on these loans. The Indian transfer pricing administration
has determined that since the loans are advanced from India and Indian currency has been
subsequently converted into the currency of the geographic location of the AE, the Prime
Lending Rate (PLR) of the Indian banks should be applied as the external CUP and not the
LIBOR or EURIBOR rate.
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10.4.10.3. A further issue in financial transactions is credit guarantee fees. With the
increase in outbound investments, the Indian transfer pricing administration has come
across cases of corporate guarantees extended by Indian parents to its associated entities
abroad, where the Indian parent as guarantor agrees to pay the entire amount due on a
loan instrument on default by the borrower. The guarantee helps an associated entity of the
Indian parent to secure a loan from the bank. The Indian transfer pricing administration
generally determines the ALP of such guarantee under the Comparable Uncontrolled Price
Method. In most cases, interest rates quotes and guarantee rate quotes available from
banking companies are taken as the benchmark rate to arrive at the ALP. The Indian tax
administration also uses the interest rate prevalent in the rupee bond markets in India for
bonds of different credit ratings. The difference in the credit ratings between the parent in
India and the foreign subsidiary is taken into account and the rate of interest specific to a
credit rating of Indian bonds is also considered for determination of the arm's length price
of such guarantees.
10.4.10.4. However, the Indian transfer pricing administration is facing a challenge due to
non-availability of specialized databases and of comparable transfer prices for cases of
complex inter-company loans as well as mergers and acquisitions that involve complex
inter- company loan instruments as well as an implicit element of guarantee from the
parent company in securing debt."
42. The first paragraph quoted above, rightly stipulates that inter- company loans would
require examination of the loan agreement, comparison of the terms and conditions of loan
agreements, the determination of credit rating of the lender and the borrower, identification
of comparable third party loan agreements and suitable adjustments should be made. In
addition to the aforesaid factors, the comparability analysis should also take into account
the business relationship and the functions performed by the subsidiary AE for the parent
company. In the present case, we are not concerned with paragraph 10.4.10.3 of the United
Nations Transfer Pricing Manual. However, we are unable to agree with the position set out
and asserted in paragraph 10.4.10.2 of th Manual. The reasoning given therein is contrary
to the accepted international tax jurisprudence and the rules adopted and applied. There is
no justification or a cogent reason for applying PLR for outbound loan transactions where
the Indian parent has advanced loan to an AE abroad. Chapter 10 of the United Nations
Practical Manual on Transfer Pricing relates to country practices. The said Chapter sets out
an individual country's view point and its experiences for the information of the readers.
The said Chapter does not reflect the view of the Manual. Paragraph 10.1 of the United
Nations Practical Manual on Transfer Pricing for Developing Countries reads:-
"10.1. Preamble by the Subcommittee on Transfer Pricing: Practical Aspects
10.1.1. In the first nine chapters of this Manual, the Subcommittee has sought to provide
practical guidance on the application of transfer pricing rules based on Article 9(1) of the
UN Model Tax Convention and the arm's length principle embodied in that Article. With
regard to chapters one through nine, the Subcommittee has discussed and debated the
merits of the guidance that is provided and, while there may be some disagreement on
certain points, for the most part the Subcommittee is in agreement that the guidance in
those chapters reflects the application of the arm's length principle as embodied in the UN
Model Tax Convention.
10.1.2. The Subcommittee recognizes that individual countries, particularly developing and
emerging economies, struggle at times with the details of applying these treaty-based
principles in a wide variety of practical situations. It therefore seemed appropriate to allow
representatives of individual countries an opportunity to set out their individual country
viewpoints and experiences for the information of readers. Those individual country views
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are contained in this chapter. It should be emphasized that it does not reflect a consistent
or consensus view of the Subcommittee."
43. Normally there would be a difference between the lending rate and borrowing rate in
each country. Some authors and writers suggest that the average or mid-point between the
two should be taken. However, others like Klaus Vogel, have suggested that economic
purpose and substance of the debt-claim or debt for which granting of credit calls for the
lending rate would be determinative. Thus, in case of a capital investment, the borrowing
rate will apply, whereas in case of credit allowed to a customer on sale of goods, the
lending rate would apply. We do not deem it necessary to enter into this controversy and
express our view as regards the same.
44. We are also not expressing any view on adjustment for lack of security as this issue
does not arise for consideration in terms of the observations of the DRP.
58. In the above decision, the honourable High Court has held that PLR rates are not applicable
to loans to be repaid in foreign currency and the interest rates are dependent on the foreign
currency in which the repayment is to be made. It is also not dependent on the residence of
either party. Therefore, the interest rate should be applied based on the currency in which the
repayment is to be made. Therefore, in the present case the LIBOR should be the basis and
not the prime lending rate. The assessee has benchmark the interest by applying LIBOR +200
basis points applying the CUP method. The learned Transfer Pricing Officer has adopted the
LIBOR+ 400 the information available in public domain on various websites of Indian banks
and various free public reports where the lending rates are ranging from libor+ 350 basis
points to 650 points for FY 2006 – 07. The assessee has granted loan to its subsidiary
company. Therefore, economic purpose and substance of the debt claim or debt for which
granting of credit calls for the lending rate would be determinative. The commercial
expediency and related benefits of close connections with the above transaction, of course,
would have a marginal significance and effect. The lending rates shown by the bankers as
adopted by the learned Transfer Pricing Officer will not have any factoring of that
consideration. Furthermore, the credit rating would also be an issue when the banks are
lending to a foreign party. The learned assessing officer has also stated that adjustment for
securities also required to be made and the bankers extending loan in foreign currency would
be insisting on sufficient security which looking at the financial health of the subsidiary is
not possible and therefore interest rates are required to be imputed which will take care of
this aspect also. In the present case, the borrower is the subsidiary of the lender company and
therefore we do not find it necessary to include the same in the interest cost. Therefore, the
interest rate adopted by the learned Transfer Pricing Officer is further required to be reduced
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by this factor. In view of these facts, we do not find any reason that interest charged by the
assessee at LIBOR +200 is not at arm‘s-length.
59. Now we come to the other issue where there should be an adjustment of the transaction cost
and adjustment for security. The learned Transfer Pricing Officer has made addition of 300
basis points on account of transaction cost. Learned Transfer Pricing Officer has made an
adjustment at the rate of 3% on account of transaction cost, security, and single customer risk
on interest rate. Contesting this adjustment the learned authorised representative has relied
upon the decision of the coordinate bench in case of Bharti Airtel Limited V ACIT
[5816/Del/2012] wherein it has been held that that when the Transfer Pricing Officer has
taken the lender as the tested party and yet made adjustment for higher risk on account of
assumed lack of security and increased risk of single party dealing is not based on any
rational for adjustment on account of higher risk. Apparently, in this case the assessee,
lender is a tested party and further the loan is advanced to 100% wholly owned subsidiary in
Indonesia the facts of the case are clearly covered by the decision of coordinate bench. The
honourable Delhi High Court in CIT vs Cotton Naturals (supra) has already held that the
transaction cost of hedging cost is borne and paid by the borrower therefore transaction cost
is not applicable in case in question the loan had to be repaid in the foreign currency.Even
otherwise according to us the markup towards the transaction cost is exorbitant and
comparison with the bank is also untenable. In view of this, we do not see any rational in the
impugned in further cost and risk premium on the rate directed by the learned Dispute
Resolution Panel . Accordingly we direct the learned Transfer Pricing Officer to not to
charge any risk premium following the decision of the coordinate bench. In view of this, the
transaction cost imputed of 300 basis points cannot be sustained.
60. In view of our above discussion, we find that the learned Transfer Pricing Officer should
have considered for both the years the LIBOR +200 basis points in both the financial year
financial year for the benchmarking for the interest income of the assessee.
61. In view of this ground number 3 of the appeal for assessment year 2007 – 08 and ground
number 4 of appeal of the assessee for assessment year 2008 – 09 is partly allowed.
62. The third issue was with respct to the transfer pricing adjustment made by the learned
Transfer Pricing Officer with respect to the International transaction of the corporate
guarantee given by the assessee to its associated enterprise. For AY 2007-08, the appellant
had issued corporate guarantee for a sum of USD 30 million to the lenders of its associated
enterprise, PT Jindal Stainless, Indonesia. The appellant has received commission of Rs.
1,49,21,269 computed @ 1.5% on the amount of loan availed by the associated enterprise
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which is covered by the corporate guarantee. In the transfer-pricing document, the transaction
of receipt of guarantee charges was benchmarked considering charges for issuing guarantee
charged by State Bank of India from the appellant. Since, the rate of commission charged
from the associated enterprise for issue of corporate guarantee at 1.5% was higher than the
rate of guarantee charged by State Bank of India at 0.75%, the international transactions of
commission received on issue of corporate guarantee was, therefore, considered as being at
arm‘s length applying CUP method. The TPO , however, in the impugned order held the
transaction of providing bank guarantee as an independent class of international transaction
and accordingly benchmarked the same applying the rate charged by State Bank of India at
the rate of 1.5% plus a mark-up 200 bps on account of security risk. The adjustment made by
the TPO of Rs. 2,29,74,981, in relation to issue of corporate guarantee. For AY 2008-09,
appellant has received commission of Rs. 97,01,640 computed @ 1.5% on the amount of
loan availed by the associated enterprise which is covered by the corporate guarantee. The
rate of commission charged from the associated enterprise for issue of corporate guarantee is
comparable / higher than the rate of guarantee charges of 0.75% charged by State Bank of
India in uncontrolled transactions. The international transactions of commission received on
issue of corporate guarantee is, therefore, considered as being at arm‘s length applying CUP
method. The TPO, however, disregarded the internal CUP provided by the appellant and
instead imputed a rate of commission of 2.68% plus 200 bps on the basis of information
sought from various banks under section 133(6). Accordingly, the TPO has made an
adjustment of Rs. 4,78,62,360 in the arm‘s length price of commission on corporate
guarantee.
63. The ld AR submitted as under :-
1. Issue of guarantee was pursuant to an obligation of the appellant and not at behest of
the associated enterprises
Section 92(1) of the Act provides for computation of income‘ arising from an
international transaction‘ having regard to the arm‘s length price. The essential
elements that should exist for application of provisions of section 92 of the Act are
income‘ and international transactions‘.
Sub-section (2) of section 92 of the Act, further provides that, where in an international
transaction, two or more associated enterprises enter into a mutual agreement or
arrangement for allocation or apportionment or contribution to any cost or expenses
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incurred or to be incurred in connection with the benefit, service or facility provided or
to be provided by one or more enterprises, the cost or expense allocated or apportioned
or contributed by such enterprise shall be determined having regard to the arm‘s length
price of such benefit, service or facility as the case may be.
The term International transaction is defined in section 92B of the Act to mean a
transaction between two or more 'associated enterprises', either of whom is a nonresident.
Section 92B of the Act reads as under:
92B. (1) For the purposes of this section and sections 92, 92C, 92D and 92E,
"international transaction" means a transaction between two or more associated
enterprises, either or both of whom are non-residents, in the nature of purchase, sale or
lease of tangible or intangible property, or provision of services, or lending or borrowing
money, or any other transaction having a bearing on the profits, income, losses or assets
of such enterprises, and shall include a mutual agreement or arrangement between two
or more associated enterprises for the allocation or apportionment of, or any contribution
to, any cost or expense incurred or to be incurred in connection with a benefit, service or
facility provided or to be provided to any one or more of such enterprises.
xxx xxx xxx
Explanation.—For the removal of doubts, it is hereby clarified that—
(i) the expression "international transaction" shall include—
(a) ………….
(b) …………..
xxx xxx xxx
(c) 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, payments
or deferred payment or receivable or any other debt arising during the course of
business;
(d) ………….
(e) …………..
Definition of international transaction‘ as provided in section 92B (1) of the Act has
two limbs, viz., (a) any transaction‘ having bearing of profits, income, losses or assets
of the enterprise; and (b) a mutual agreement or arrangement between two or more
associated enterprises for allocation or apportionment of any contribution, any cost or
expense incurred in connection with benefit, service or facility provided to any of such
associated enterprise.
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A corporate guarantee, even though, pursuant to a mutual agreement or arrangement
between the two associated enterprises, there is no cost or expense incurred in
connection with a benefit or facility on this account, which is to be allocated or
apportioned in terms of the second limb of section 92B(1) of the Act.
Therefore, the issue for consideration is whether the corporate guarantee in the present
case would constitute a transaction‘, having bearing on profits, income, losses or assets
of such enterprises, so as to be regarded as an international transaction‘ in terms of the
first limb of sub-section (1) of section 92B of the Act.
It is further respectfully submitted that for the purpose of determining whether any
guarantee fee was liable to be charged or not in a case where the underlying guarantee is
furnished by a parent entity, it needs to be seen whether the guarantee results in a benefit
constituting a service to the AE or it is being provided only by the guarantor as a
shareholder.
Reference in this regard is made to the OECD Transfer Pricing Guidelines, wherein, the
shareholder activity is defined as under:
Shareholder activity
An activity which is performed by a member of an MNE group (usually the parent
company or a regional holding company) solely because of its ownership interest in one
or more other group members, i.e. in its capacity as shareholder.
Further, para 7.10 of the OECD Transfer Pricing Guidelines further provide the
following examples of shareholder activity:
7.10 The following examples (which were described in the 1984 Report) will
constitute shareholder activities, under the standard setforth in paragraph 7.6:
a) Costs of activities relating to the juridical structure of the parent company itself, such
as meetings of shareholders of the parent, issuing of shares in the parent company and
costs of the supervisory board;
b) Costs relating to reporting requirements of the parent company including the
consolidation of reports;
c) Costs of raising funds for the acquisition of its participations.
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It is respectfully submitted that shareholder activity is an activity, which is performed by
an entity solely because of its ownership interest in other company i.e. in the capacity of
shareholder.
In the present case, the appellant is engaged in manufacture and sales of stainless steel
coils of various grades. The associated enterprise of the appellant acts as a distributor of
products been manufactured by the appellant in India. It is further submitted that with
the sales made to the associated enterprise, the appellant is able to maximize its
utilization of installed capacity.
In view thereof, it would be appreciated that the corporate guarantee has been given
pursuant to an obligation of the appellant as the shareholder. In the present case, the
appellant itself was to benefit from supply of stainless steel coils as it will create a larger
market for the appellant and the production of additional stainless steel will lower down
the fixed cost of production.
The apex Court has in the landmark judgment of Morgan Stanley and Co. Inc. : 292 ITR
416 recognized the concept of stewardship or shareholder services by drawing a
distinction between services that benefit the service recipient and those which benefit the
service provider itself. In the said case, the Court held that services rendered by the
assessee to its India subsidiary in the nature of quality control, monitoring to ensure
client confidentiality and supervision aimed in protecting the group interest as a whole,
could not be considered as services‘ within the meaning of Article 5(2)(1) of the India-
US Tax Treaty. The relevant extract in this regard is re-produced below:
In such a case it cannot be said that MSCo has been rendering the services to MSAS. In
our view MSCo is merely protecting its own interests in the competitive world by
ensuring the quality and confidentiality of MSAS services. We do not agree with the
ruling of the AAR that the stewardship activity would fall under Article 5(2)(1).
It is respectfully submitted that issuance of corporate guarantee being a shareholder
activity does not amount to a service to the associated enterprise and therefore has no
bearing on the income of the assessee.
It has also been the settled position that the commercial expediency is to be taken into
consideration for determining the taxability or otherwise of a transaction.Reference in
this regard is also made to the decision of Hon‘ble Delhi High Court in the case of CIT
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vs. Cotton Naturals (I) Pvt. Ltd. in ITA No. 233/2014, Where the Delhi High Court held
as under:
17. In our opinion, the reasoning recorded therein suffers from a basic and fundamental
fallacy. Transfer pricing determination is not primarily undertaken to re-write the
character and nature of the transaction, though this is permissible under two exceptions.
Chapter X and Transfer Pricing rules do not permit the Revenue authorities to step into
the shoes of the assessee and decide whether or not a transaction should have been
entered. It is for the assessed to take commercial decisions and decide how to conduct
and carry on its business. Actual business transactions that are legitimate cannot be
restructured.
xxx xxx xxx
22. The aforesaid Rules indicate factors that ought to be taken into account for selection
of the comparables, which necessarily include the contractual terms of the transaction
and how the risks, benefits and responsibilities are to be divided. The conditions
prevailing in the market in which the respective parties to the transactions operate,
including the geographical location and the size of the markets, the laws and
Government orders in force, costs of labour and capital in the markets, overall economic
development and level of competition, are all material and relevant aspects. If we keep
the aforesaid aspects in mind, it would be delusive not to accept and agree that as per the
prevalent practice, subsidiary AEs are often incorporated to carry on distribution and
marking function. This is not an unusual but common. Once this is accepted, then we
cannot accept the reasoning given by the TPO that the transfer pricing adjustment could
restructure the transaction to reflect maximum return that a party could have earned and
this would be the yardstick or the benchmark for determining the interest payable by the
subsidiary AE. This is not what Chapter X of the Act and Rules mandate and stipulate.
The aforesaid provisions neither curtail the commercial freedom, nor do they bar or
prohibit a legitimate transaction. They permit transfer pricing adjustment so as to bring
to tax what would have been paid for the transaction in the same or similar comparable
circumstances by an independent third party.
xxx xxx xxx
26. The TPO has noticed the contractual terms and referred to the following facets: The
advance given by the parent company i.e. the assessed to M/s JPC Equestrian Inc. was to
meet the working capital requirements of the subsidiary AE. He noted that when
independent enterprises transact with each other, their business relations are determined
by the market forces operating, i.e. what is the amount of interest that would have been
earned had such an advance been given to an unrelated party placed in a similar position
as that of the subsidiary AE. The TPO had asked for the audited financial accounts of
the subsidiary. Credit rating would be relevant. He accepted that there was a sense of
commercial expediency and related benefits in the loan transaction but the assessed had
not been able to demonstrate that the interest charged satisfied the arms length standard.
He observed that business prudence or necessity of advancing loan to the subsidiary was
not relevant for computing arms length price (i.e. rate of interest in this case) in
unrelated party transactions. This aspect, he held, would not take precedence over the
arms length nature of interest.
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27. Several aspects enunciated above, reflect the correct legal position. We, however,
express our inability to accept that commercial expediency and related benefits have no
connection or relationship with the rate of interest. In terms of Clause (c) and (d) to Rule
10B (2), contractual relations or terms, and other material facts should be recognized.
Having said so, we do accept the force of the alternative argument advanced that this
fact could be of marginal significance and effect. It would be for the assessed to show
and prove that a transaction separately benchmarked, included consideration for the
lower interest rate being paid.
Reliance is placed in this regard on the decision of the Supreme Court in the case of S.A.
Builders Ltd. vs. CIT : 288 ITR 1, wherein it is held that where it is obvious that the
holding company has deep interest in its sbsidiary and the subsidiary has used the funds
borrowed for its business, the loan can ordinarily be considered as given to subsidiary as
a measure of commercial expediency and accordingly the interest expense on the funds
lent should be allowed as a deductible expense to the company. The relevant findings of
the Supreme Court read as under:
20. In Madhav Prasad Jatia v. CIT AIR 1979 SC 1291, this Court held that the
expression "for the purpose of business" occurring under the provision is wider in scope
than the expression "for the purpose of earning income, profits or gains", and this has
been the consistent view of this Court.
21. In our opinion, the High Court in the impugned judgment, as well as the Tribunal
and the Income-tax authorities have approached the matter from an erroneous angle. In
the present case, the assessee borrowed the fund from the bank and lent some of it to its
sister concern (a subsidiary) on interest free loan. The test, in our opinion, in such a case
is really whether this was done as a measure of commercial expediency.
22. In our opinion, the decisions relating to section 37 of the Act will also be applicable
to section 36(1)(iii) because in section 37 also the expression used is "for the purpose of
business". It has been consistently held in decisions relating to section 37 that the
expression "for the purpose of business" includes expenditure voluntarily incurred for
commercial expediency, and it is immaterial if a third party also benefits thereby.
23. Thus in Atherton v. British Insulated &Helsby Cables Ltd. [1925] 10 TC 155, it was
held by the House of Lords that in order to claim a deduction, it is enough to show that
the money is expended, not of necessity and with a view to direct and immediate benefit,
but voluntarily and on grounds of commercial expediency and in order to indirectly to
facilitate the carrying on the business. The above test in Atherton's case, (supra) has
been approved by this Court in several decisions e.g.Eastern Investments
Ltd. v. CIT [1951] 20 ITR 1, CIT v. ChandulalKeshavlal& Co. [1960] 38 ITR 601 etc.
24. In our opinion, the High Court as well as the Tribunal and other income-tax
authorities should have approached the question of allowability of interest on the
borrowed funds from the above angle. In other words, the High Court and other
authorities should have enquired as to whether the interest free loan was given to the
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sister company (which is a subsidiary of the assessee) as a measure of commercial
expediency, and if it was, it should have been allowed.
25. The expression "commercial expediency" is an expression of wide import and
includes such expenditure as a prudent businessman incurs for the purpose of business.
The expenditure may not have been incurred under any legal obligation, but yet it is
allowable as a business expenditure, if it was incurred on grounds of commercial
expediency.
26. No doubt as held in Madhav Prasad Jatia's case (supra), if the borrowed amount was
donated for some sentimental or personal reasons and not on the ground of commercial
expediency, the interest thereon could not have been allowed under section 36(1)(iii) of
the Act. In Madhav Prasad Jatia's case (supra), the borrowed amount was donated to a
college with a view to commemorate the memory of the assessee's deceased husband
after whom the college was to be named. It was held by this Court that the interest on
the borrowed fund in such a case could not be allowed, as it could not be said that it was
for commercial expediency.
27. Thus, the ratio of Madhav Prasad Jatia's case (supra) is that the borrowed fund
advanced to a third party should be for commercial expediency if it is sought to be
allowed under section 36(1)(iii) of the Act.
28. In the present case, neither the High Court nor the Tribunal nor other authorities
have examined whether the amount advanced to the sister concern was by way of
commercial expediency.
29. It has been repeatedly held by this Court that the expression "for the purpose of
business" is wider in scope than the expression "for the purpose of earning
profits" videCIT v. Malayalam Plantations Ltd. [1964] 53 ITR 140 , CIT v. Birla Cotton
Spg. &Wvg. Mills Ltd. [1971] 82 ITR 166 etc.
30. The High Court and the other authorities should have examined the purpose for
which the assessee advanced the money to its sister concern, and what the sister concern
did with this money, in order to decide whether it was for commercial expediency, but
that has not been done.
Also, in the case of CIT vs United Breweries Ltd 204 Taxmann 244 (Karnataka) the
Hon‘ble Karnataka High Court held that corporate guarantee fee paid by a company to
its managing director for standing as a guarantor is not lawfully allowable under section
37 of the Act. The relevant extract is as under:
17. In this background, if we look into the facts of this case, though the Chairman has
stood as a guarantor in his personal capacity, the Banks have lent money not on the
personal guarantee but on the assets of the Company which are offered as a security to
the Bank. This personal guarantee is adopted as a means to pay remuneration to the
Managing Director for which he was otherwise not entitled to. It is to overcome the
directions issued by the RBI. It is to overcome the statutory provision contained in
Section 309 of the Companies Act. This payment is characterized as a guarantee
commission and the amount is paid. It is not a lawful payment in the facts of the case
and therefore, the Assessing Authority was fully justified in disallowing the said
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expenditure under Section 37 of the Act. The said expenditure incurred is not for the
purpose of earning profits of the business. Merely because the banks insisted on such
guarantee and the Managing Director agreed to stand as a guarantor on payment of such
commission, the commission is actually paid. That would not constitute a lawful
expenditure so as to claim deduction under Section 37 of the Act.
The Chennai bench of the Tribunal in the case of Mascon Global Ltd. vs. ACIT (ITA
No. 2205/Mds/2010) has appreciated the concept of shareholder services holding that no
interest payment on advances extended to a subsidiary was required where the advances
made were to undertake an acquisition and hence arose out of commercial expediency.
The Hon‘ble Ahmadabad Bench of the Tribunal in the case of Micro Ink Ltd vs Addl
CIT (ITA No 2873/Ahd/10), too, while relying on the OCED guidelines held that
activity which is solely undertaken because of the ownership interest in the subsidiary
would not justify a charge from the subsidiary and that shareholder activity, in issuance
of corporate guarantees, is to be taken out of the ambit of Intra group services. The
Hon‘ble Tribunal further held that the occasion of benchmarking the transaction of
issuance of corporate guarantee would arise only when the transaction falls within the
definition of the term international transaction and that the transaction of corporate
guarantee would fall in the definition of international transaction only when costs are
incurred for the same or recoveries, as a matter of abundant caution, for this non
chargeable activity. The relevant findings of the Hon‘ble Tribunal read as under:
43 …………..In view of the above discussions, OECD Guideines, as a matter of fact,
strengthen the claim of the assessee that the corporate guarantees issued by the assessee
were in the nature of quasi capital or shareholder activity and, for this reason alone, the
issuance of these guarantees should be excluded from the scope of services and thus
from the scope of international transactions‘ under section 92B.Of course, once a
transaction is held to be covered by the definition of international transaction, whether in
the nature of the shareholder activity or quasi capital or not, ALP determination must
depend on what an independent enterprise would have charged for such a transaction. In
this light of these discussions, we hold that the issuance of corporate guarantees in
question was not in the nature of provision for services‘ and these corporate guarantees
were required to be treated as shareholder participation in the subsidiaries.
XXX
44…………..That is, in our considered view, purely fallacious logic. In our considered
view, under Section 92 B, corporate guarantees can be covered only under the residuary
head i.e. any other transaction having a bearing on the profits, income, losses or assets
of such enterprise. It is for this reason that Section 92 B, in a way, expands the scope of
international transaction in the sense that even when guarantees are issued as a
shareholder activity but costs are incurred for the same or, as a measure of abundant
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caution, recoveries are made for this non chargeable activity, these guarantees will fall in
the residuary clause of definition of international transactions under section 92B.
Further, the Ahmedabad Bench of Tribunal in the case of Micro Inks Limited vs. ACIT
(ITA No. 2873/Ahd/2010) for subsequent year, i.e. assessment year 2006-07,
extensively dealt with the issue of shareholder‘s activity with respect to transaction of
issue of corporate guarantee and held as under:
33. On a conceptual note, thus, there is a valid school of thought that the corporate
guarantees can indeed be a mode of ownership contribution, particularly when, as is
often the case, where such a guarantee is given it compensates for the inadequacies in
the financial position of the borrower; specifically, the fact that the subsidiary does not
have enough shareholders‘ funds. There can be number of reasons, including
regulatory issues and market conditions in the related jurisdictions, in which such a
contribution, by way of a guarantee, would justify to be a more appropriate and
preferred mode of contribution vis-a-vis equity contribution. It is significant, in this
context that the case of the assessee has all along been, as noted in the assessment order
itself that said guarantees were in the form of corporate guarantees / quasi capital and
not in the nature of any services. In other words, these guarantees were specifically
stated to be in the nature of shareholder activities. The assessee‘s claim of the
guarantees being in the nature of quasi capital, and thus being in the nature of a
shareholder‘s activity, is not rejected either. The concept of issuance of corporate
guarantees as a shareholder activity is not alien to the transfer pricing literature in
general. On the contrary, it is recognized in international transfer pricing literature as
also in the official documentation and legislation of several transfer pricing
jurisdictions. The OECD Transfer Pricing Guidelines for Multinational Enterprises and
Tax Administrations‘ itself recognizes the distinction between a shareholder activity and
a provision for services, when, contrasting the shareholder activity with broader term
stewardship activity and thus highlighting narrow scope of shareholder activity, it
states that Stewardship activities covered a range of activities by a shareholder that
may include provision for services to other group members, for example services that
would be provided by a coordinating centre. It proceeded to add, in the immediately
following sentence at page 207 of 2010 Guidelines, that These latter type of nonshareholder
activities could include detailed planning services for particular operations,
management or technical advice (trouble shooting) or in some cases assistance in day to
day management. The shareholder activities are thus seen as conceptually distinct from
the provision of services. The issuance of corporate guarantee, as long as it is in the
nature of shareholder activity, cannot, therefore, amount to a provision for services.
XXXX
43. It is thus clear that even if we accept the contention of the learned Departmental
Representative that issuance of a corporate guarantee amounts to a provision for
service‘, such a service needs to be re-characterized to bring it in tune with commercial
reality as arrangements made in relation to the transaction, viewed in their totality,
differ from those which would have been adopted by independent enterprises behaving
in a commercially rational manner. No bank would be willing to issue a clean
guarantee, i.e. without underlying asset, to assessee‘s subsidiaries when the banks are
not willing to extend those subsidiaries loans on the same terms as without a guarantee.
Such a guarantee transaction can only be, and is, motivated by the shareholder, or
ownership considerations. No doubt, under the OECD Guidance on the issue, an explicit
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support, such as corporate guarantee, is to be benchmarked and, for that purpose, it is in
the service category but that occasion comes only when it is covered by the scope of
international transaction‘ under the transfer pricing legislation of respective
jurisdiction. The expression provision for services‘ in its normal or legal connotations,
as we have seen earlier, does not cover issuance of corporate guarantees, even though
once a corporate guarantee is covered by the definition of international transaction‘, it is
benchmarked in the service segment. In view of the above discussions, OECD
Guidelines, as a matter of fact, strengthen the claim of the assessee that the corporate
guarantees issued by the assessee were in the nature of quasi capital or shareholder
activity and, for this reason alone, the issuance of these guarantees should be excluded
from the scope of services and thus from the scope of international transactions‘ under
section 92B. Of course, once a transaction is held to be covered by the definition of
international transaction, whether in the nature of the shareholder activity or quasi
capital or not, ALP determination must depend on what an independent enterprise
would have charged for such a transaction. In this light of these discussions, we hold
that the issuance of corporate guarantees in question was not in the nature of provision
for services‘ and these corporate guarantees were required to be treated as shareholder
participation in the subsidiaries.
The Kolkata Bench of Tribunal in the case of Tega Industries Limited vs. DCIT in ITA
No. 1912/Kol/2012, held that corporate guarantee furnished by assessee to bank for
extending loan to subsidiary company in the Bahamas (SPV), for the purpose of
acquiring 2 South African entities is a shareholder function not warranting any
commission on issue of such corporate guarantee.
Reliance in this regard is also placed on th decision of Delhi Bench of the Tribunal in
the case of Bharti Airtel Limited vs. ACIT (ITA No. 5816/Del/2012), wherein, the
Hon‘ble Tribunal held that the guarantees having no impact on income, profits, losses or
assets of the assessee cannot be construed as an international transaction. The relevant
portion of judgment has been reproduced below for your consideration:-
22. We have heard the rival contentions, perused the material on record and duly
considered factual matrix of the case in the light of the applicable legal position.
24. In the light of the above discussions, we consider it appropriate to begin by
dealing with the fundamental question as to whether issuance of corporate
guarantees, which do not involve any costs to the assessee, can indeed be subjected
to the arm‘s length price adjustment. We find that Section 92(1) provides that, any
income arising from an international transaction shall be computed having regard to
the arm‘s length price. In order to attract the arm‘s length price adjustment,
therefore, a transaction has to be an international transaction‘. Section 92 B, which
defines international transaction‘ for the purpose of transfer pricing legislation, is
as set out below:
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25. An analysis of this definition of international transaction‘ under Section 92 B,
as it stood at the relevant point of time, and its break up in plain words, shows the
following:
1. An international transaction can be between two or more AEs, at least one of
which should be a non-resident.
2. An international transaction can be a transaction of the following types:
a. in the nature of purchase, sale or lease of tangible or intangible property,
b. in the nature of provision of services,
c. in the nature of lending or borrowing money, or
d. in the nature of any other transaction having a bearing on the profits, income,
losses or assets of such enterprises
3. An international transaction shall include a mutual agreement or arrangement
between two or more associated enterprises for the allocation or apportionment of,
or any contribution to, any cost or expense incurred or to be incurred in connection
with a benefit, service or facility provided or to be provided to any one or more of
such enterprises.
4. Section 92B (2), covering a deeming fiction, provides that even a transaction with
non AE in a situation in which such a transaction is defacto controlled by prior
agreement with AE or by the terms agreed with the AE.
26. Let us now deal with the Explanation, inserted with retrospective effect from 1st
April 2002 i.e. right from the time of the inception of transfer pricing legislation in
India, which was brought on the statute vide Finance Act, 2012.
27. This Explanation states that it is merely clarificatory in nature in as much as it is
for the removal of doubts‘, and, therefore, one has to proceed on the basis that it
does not alter the basic character of definition of international transaction‘ under
Section 92 B. Clearly, therefore, this Explanation is to be read in conjunction with
the main provisions, and in harmony with the scheme of the provisions, under
Section 92 B. Under this Explanation, five categories of transactions have been
clarified to have been included in the definition of international transactions‘.
28. The first two categories of transactions, which are stated to be included in the
scope of expression international transactions‘ by the virtue of clause (a) and (b) of
Explanation to Section 92 B, are transactions with regard to purchase, sale, transfer,
lease or use of tangible and intangible properties. These transactions were anyway
covered by 2 (a) above which covered transactions in the nature of purchase, sale
or lease of tangible or intangible property‘. The only additional expression in the
clarification is use‘ as also illustrative and inclusive descriptions of tangible and
intangible assets. Similarly, clause (d) deals with the provision of services,
including provision of market research, market development, marketing
management, administration, technical service, repairs, design, consultation,
agency, scientific research, legal or accounting service which are anyway covered
by 2(b) and 3 above in provision for services and mutual agreement or
arrangement between two or more associated enterprises for the allocation or
apportionment of, or any contribution to, any cost or expense incurred or to be
incurred in connection with a benefit, service or facility provided or to be provided
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to anyone or more of such enterprises. That leaves us with two clauses in the
Explanation to Section 92 B which are not covered by any of the three categories
discussed above or by other specific segments covered by Section 92 B, namely
borrowing or lending money.
29. The remaining two items in the Explanation to Section 92 B are set out in clause
(c) and (e) thereto, dealing with (a) capital financing and (b) business restructuring
or reorganization. These items can only be covered in the residual clause of
definition in international transactions, as in Section 92 B(1), which covers any
other transaction having a bearing on profits, incomes, losses, or assets of such
enterprises.
30. It is, therefore, essential that in order to be covered by clause (c) and (e) of
Explanation to Section 92 B, the transactions should be such as to have bearing on
profits, incomes, losses or assets of such enterprise. In other words, in a situation in
which a transaction has no bearing on profits, incomes, losses or assets of such
enterprise, the transaction will be outside the ambit of expression international
transaction‘. This aspect of the matter is further highlighted in clause (e) of the
Explanation dealing with restructuring and reorganization, wherein it is
acknowledged that such an impact could be immediate or in future as evident from
the words irrespective of the fact that it ( i.e. restructuring or reorganization) has
bearing on the profit, income, losses or assets of such enterprise at the time of
transaction or on a future date. What is implicit in this statutory provision is that
while impact on profit, income, losses or assets is sine qua non, the mere fact that
impact is not immediate, but on a future date, would not take the transaction outside
the ambit of international transaction‘. It is also important to bear in mind that, as it
appears on a plain reading of the provision, this exclusion clause is not for
contingent impact on profit, income, losses or assets but on future impact on
profit, income, losses or assets of the enterprise. The important distinction between
these two categories is that while latter is a certainty, and only its crystallization
may take place on a future date, there is no such certainty in the former case…
31. In this light now, let us revert to the provisions of clause (c) of Explanation to
Section 92 B which provides that the expression international transaction‘ shall
include 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, payments or deferred payment or receivable or any other debt arising
during the course of buiness. In view of the discussions above, the scope of these
transactions, as could be covered under Explanation to Section 92 B read with
Section 92B(1), is restricted to such capital financing transactions, including inter
alia any guarantee, deferred payment or receivable or any other debt during the
course of business, as will have a bearing on the profits, income , losses or assets
or such enterprise. This pre-condition about impact on profits, income, losses
orassets of such enterprises is a pre-condition embedded in Section 92B(1) and the
only relaxation from this condition precedent is set out in clause (e) of the
Explanation which provides that the bearing on profits, income, losses or assets
could be immediate or on a future date. The contents of the Explanation fortifies,
rather than mitigates, the significance of expression having a bearing on profits,
income, losses or assets‘ appearing in Section 92 B(1).
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32. There can be number of situations in which an item may fall within the
description set out in clause (c) of Explanation to Section 92 B, and yet it may not
constitute an international transaction as the condition precedent with regard to the
bearing on profit, income, losses or assets ‘ set out in Section92B(1) may not be
fulfilled. For example, an enterprise may extend guarantees for performance of
financial obligations by its associated enterprises. These guarantees do not cost
anything to the enterprise issuing the guarantees and yet they provide certain
comfort levels to the parties doing dealings with the associated enterprise. These
guarantees thus do not have any impact on income, profits, losses or assets of the
assessee. There can be a hypothetical situation in which a guarantee default takes
place and, therefore, the enterprise may have to pay the guarantee amounts but such
a situation, even if that be so, is only a hypothetical situation, which are, as
discussed above, excluded. One may have also have a situation in which there is a
receivable or any other debt during the course of business and yet these receivables
may not have any bearing on its profits, income, losses or assets, for example, when
these receivables are out of cost free funds and these debit balances donot cost
anything to the person allowing such use of funds. The situations can be endless, but
the common thread is that when an assessee extends an assistance to the associated
enterprise, which does not cost anything to the assessee and particularly for which
the assessee could not have realized money by giving it to someone else during the
course of its normal business, such an assistance or accommodation does not have
any bearing on its profits, income, losses or assets, and, therefore, it is outside the
ambit of international transaction under section 92B (1) of the Act.
33. In any event, the onus is on the revenue authorities to demonstrate that the
transaction is of such a nature as to have bearing on profits, income, losses or
assets of the enterprise, and there was not even an effort to discharge this onus.
Such an impact on profits, income, losses or assets has to be on real basis, even if in
present or in future, and not on contingent or hypothetical basis, and there has to be
some material on record to indicate, even if not to establish it to hilt, that an intra
AE international transaction has some impact on profits, income, losses or assets.
Clearly, these conditions are not satisfied on the facts of this case.
34. There is one more aspect of the matter. The Explanation to Section 92 B has
been brought on the statute by the Finance Act 2012. If one is to proceed on the
basis that the provisions of Explanation to Section 92 B enlarge the scope of Section
92B itself, even as it is modestly described as clarificatory‘ in nature, it is an issue
to be examined whether an enhancement of scope of this ant avoidance provision
can be implemented with retrospective effect. Undoubtedly, the scope of a charging
provision can be enlarged with retrospective effect, but an anti-avoidance measure,
that the transfer pricing legislation inherently is, not primarily a source of revenue
as it mainly seeks compliant behavior from the assessee vis-à-vis certain norms, and
these norms cannot be given effect from a date earlier than the date norms are being
introduced. However, as we have decided the issue in favour of the assessee on
merits and even after taking into account the amendments brought about by Finance
Act 2012, we need not deal with this aspect of the matter in greater detail.
36. For the reasons set out above, and as we have held that the issuance of corporate
guarantees in question did not constitute international transaction‘ within meanings
thereof under section 92B, we uphold the grievance of the assessee and direct the
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Assessing Officer to delete the impugned ALP adjustment of Rs 33,10,161. The
assessee gets the relief accordingly
The Ahmedabad Bench of Tribunal in the case of Micro Inks (supra), reiterated their
decision in the case of Bharti Airtel and after extensively dealing with the laws and
precedents of other countries, vi-a-vis Indian Laws, and held as under:
44. As for the words provision for services appearing in Section 92 B, and
connotations thereof, our humble understanding is that this expression, in its natural
connotations, is restricted to services rendered and it does not extend to the benefits of
activities per se. Whether we look at the examples given in the OECD material or even
in Explanation to Section 92 B, the thrust is on the services like market research, market
development, marketing management, administration, technical service, repairs, design,
consultation, agency, and scientific research, legal or accounting service or coordination
services. As a matter of fact, even in the Explanation to Section 92 B- which we will
deal with a little later, guarantees have been grouped in item c‘ dealing with capital
financing, rather than in item d‘ which specifically deals with provision for services‘.
When the legislature itself does not group guarantees‘ in the provision for services‘
and includes it in the capital financing‘, it is reasonable to proceed on the basis that
issuance of guarantees is not to be treated as within the scope of normal connotations of
expression provision for services‘. Of course, the global best practices seem to be that
guarantees are sometimes included in services‘ but that is because of the extended
definition of international transaction‘ in most of the tax jurisdictions. Such a wide
definition of services, which can be subject to arm‘s length price adjustment, apart,
Transfer Pricing and Intra Group Financing – by Bakker &Levvy (ibid) notes that
the IRS has issued a non binding Field Service Advice (FSA 1995 WL 1918236, 1
May 1995) stating that, in certain circumstances (emphasis, by underling, supplied by
us), a guarantee may be treated as a service. If the natural connotations of a service‘
were to cover issuance of guarantee in general, there could not have been an occasion to
give such hedged advice. This will be stretching the things too far to suggest that just
because when guarantees are included in the international transactions, these guarantees
are inclued in service segment in contradistinction with other heads under which
international transactions are grouped, the guarantees should be treated as services, and,
for that reason, included in the definition of international transactions. That is, in our
considered view, purely fallacious logic. In our considered view, under Section 92 B,
corporate guarantees can be covered only under the residuary head i.e. any other
transaction having a bearing on the profits, income, losses or assets of such enterprise.
It is for this reason that Section 92 B, in a way, expands the scope of international
transaction in the sense that even when guarantees are issued as a shareholder activity
but costs are incurred for the same or, as a measure of abundant caution, recoveries are
made for this non chargeable activity, these guarantees will fall in the residuary clause
of definition of international transactions under section 92B. As for the learned
Departmental Representative‘s argument that whether the service has caused any extra
cost to the assessee should not be the deciding factor to determine whether it is an
international and then gives an example of brand royalty to make his point. What, in the
process, he overlooks is that is that Section 92B(1) specifically covers sale or lease of
tangible or intangible property. The expression bearing on the profits, income, losses
or assets of such enterprises is relevant only for residuary clause i.e. any other services
not specifically covered by Section 92 B. It was also contended that, while rendering
Bharti Airtel decision, the Delhi Tribunal did go overboard in deciding something
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which was not even raised before us. In the written submission, it was stated that
Hon‘ble Delhi ITAT was not requested by the contesting parties to decide the issue as
to whether the provision of guarantee was a service or not. That‘s not factually correct.
We are unable to see any merits in learned Departmental Representative‘s contention,
particularly as decision categorically noted that not only before the Tribunal, but this
issue was also raised before the DRP- as evident from the text of DRP decision. We
now take up the issue with respect to specific mention of the words in Explanation to
Section 92B which states that For the removal of doubts, it is hereby clarified that (i)
the expression "international transaction" shall include…….. (c) 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, payments or deferred
payment or receivable or any other debt arising during the course of business. There is
no dispute that this Explanation states that it is merely clarificatory in nature inasmuch
as it is for the removal of doubts‘, and, therefore, one has to proceed on the basis that it
does not alter the basic character of definition of international transaction‘ under
Section 92 B. Accordingly, this Explanation is to be read in conjunction with the main
provisions, and in harmony with the scheme of the provisions, under Section 92 B.
Under this Explanation, five categories of transactions have been clarified to have been
included in the definition of international transactions‘. The first two categories of
transactions, which are stated to be included in the scope of expression international
transactions‘ by the virtue of clause (a) and (b) of Explanation to Section 92 B, are
transactions with regard to purchase, sale, transfer, lease or use of tangible and
intangible properties. These transactions were anyway covered by transactions in the
nature of purchase, sale or lease of tangible or intangible property‘. The only additional
expression in the clarification is use‘ as also illustrative and inclusive descriptions of
tangible and intangible assets. Similarly, clause (d) deals with the provision of
services, including provision of market research, market development, marketing
management, administration, technical service, repairs, design, consultation, agency,
scientific research, legal or accounting service which are anyway covered in provision
for services and mutual agreement or arrangement between two or more associated
enterprises for the allocation or apportionment of, or any contribution to, any cost or
expense incurred or to be incurred in connection with a benefit, service or facility
provided or to be provided to any one or more of such enterprises . That leaves us with
two clauses in the Explanation to Sect ion 92 B which are not covered by any of the
three categories discussed above or by other specific segments covered by Section 92 B,
namely borrowing or lending money. The remaining two items in the Explanation to
Section 92 B are set out in clause (c) and (e) thereto, dealing with (a) capital financing
and (b) business restructuring or reorganization. These items can only be covered in the
residual clause of definition in international transactions, as in Section 92B (1), which
covers any other transaction having a bearing on profits, incomes, losses, or assets of
such enterprises. It is, therefore, essential that in order to be covered by clause (c) and
(e) of Explanation to Section 92 B, the transactions should be such as to have beating on
profits, incomes, losses or assets of such enterprise. In other words, in a situation in
which a transaction has no bearing on profits, incomes, losses or assets of such
enterprise, the transaction will be outside the ambit of expression international
transaction‘. This aspect of the matter is further highlighted in clause (e) of the
Explanation dealing with restructuring and reorganization, wherein it is acknowledged
that such an impact could be immediate or in future as evident from the words
irrespective of the fact that it (i.e. restructuring or reorganization) has bearing on the
profit, income, losses or assets of such enterprise at the time of transaction or on a future
date. What is implicit in this statutory provision is that while impact on profit,
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income, losses or assets is sine qua non , the mere fact that impact is not immediate,
but on a future date, would not take the transaction outside the ambit of international
transaction‘. It is also important to bear in mind that, as it appears on a plain reading of
the provision, this exclusion clause is not for contingent impact on profit, income,
losses or assets but on future impact on profit, income, losses or assets of the
enterprise. The important distinction between these two categories is that while latter is
a certainty, and only its crystallization may take place on a future date, there is no such
certainty in the former case. In the case before us, it is an undisputed position that
corporate guarantees issued by the assessee to the various banks and crystallization of
liability under these guarantees, though a possibility, is not a certainty. In view of the
discussions above, the scope of the capital financing transactions, as could be covered
under Explanation to Section 92 B read with Section 92B(1), is restricted to such capital
financing transactions, including inter alia any guarantee, deferred payment or
receivable or any other debt during the course of business, as will have a bearing on
the profits income, losses or assets or such enterprise. This pre-condition about impact
on profits, income, losses or assets of such enterprises is a pre-condition embedded in
Section 92B(1) and the only relaxation from this condition precedent is set out in clause
(e) of the Explanation which provides that the bearing on profits, income, losses or
assets could be immediate or on a future date. These guarantees do not have any impact
on income, profits, losses or assets of the assessee. There can be a hypothetical situation
in which a guarantee default takes place and, therefore, the enterprise may have to pay
the guarantee amounts but such a situation, even if that be so, is only a hypothetical
situation, which are, as discussed above, excluded. When an assessee extends an
assistance to the associated enterprise, which does not cost anything to the assessee and
particularly for which the assessee could not have realized money by giving it to
someone else during the course of its normal business, such an assistance or
accommodation does not have any bearing on its profits, income, losses or assets, and,
therefore, it is outside the ambit of international transaction under section 92B (1) of the
Act.
The decision of the Tribunal in the case of Bharti (supra) was followed by the Chennai
Bench of Tribunal in the case of Redington (India) Limited vs. JCIT (ITA
No.513/Mds/2014). The aforesaid decision in the case of Micro Inks (supra) was
followed by the Hon‘ble Ahmedabad bench of Tribunal in the case of Suzlon Energy
Limited vs. ACIT (ITA No. 1369/Ahm/2013).
In the following cases too, relying on the decision of Bharti Airtel (supra), Hon‘ble
Tribunal held that since no material has been brought by the revenue to show that the
corporate guarantee issued by the assessee has bearing on profits, income, losses or
assets, no transfer pricing adjustment could be made with respect to corporate
guarantee:
- Videocon Industries Limited vs. ACIT (ITA No. 6145/mum/2012)
- Advanta India Limited vs. ACIT (ITA No. 1643/Ban/12)
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Reliance is also placed on the recent decision of the Hon‘ble Rajkot bench of the
Tribunal in the case of Jyoti CNC Automation Pvt. Ltd., wherein, while dealing with the
entire legal position in this regard, the Hon‘ble Tribunal held the corporate guarantee to
be in the nature of shareholders‘ activity and, therefore, not give rise to any international
transaction. The findings of the Hon‘ble Tribunal in this regard are as under:
36. We have noticed that the 'OECD Transfer Pricing Guidelines for Multinational
Enterprises and Tax Administrations' specifically recognizes that an activity in the
nature of shareholder activity, which is solely because of ownership interest in one or
more of the group members, i.e. in the capacity as shareholder "would not justify a
charge to the recipient companies". It is thus clear that a shareholder activity, in issuance
of corporate guarantees, is taken out of ambit of the group services. Clearly, therefore, as
long as a guarantee is on account of, what can be termed as 'shareholder's activities',
even on the first principles, it is outside the ambit of transfer pricing adjustment in
respect of arm's length price. It is essential to appreciate, at this stage, the distinction in a
service and a benefit. One may be benefited even when no services are rendered, and,
therefore, in many a situation it's a 'benefit test' which is crucial for transfer pricing
legislation, such as in US Regulations 1.482-9(1)(3)(i) which defines 'benefit', form a
US Transfer Pricing perspective, as "an activity is considered to be provided a benefit to
the recipient if the activity directly results in a reasonably identifiable increment of
economic or commercial value that enhances the recipient's commercial position, or that
may be reasonably anticipated to do so". The expression "activity", in turn is defined, as
"including the performance of functions; the assumption of risks; the use by a rendered
of tangible or intangible property or other resources capabilities or knowledge (including
knowledge of and ability to take advantage of a particularly advantageous situation or
circumstances); and making available to the recipient any property or other resources of
the rendered" [Regulation 1.482-9(1)(2)]. The issuance of guarantees is not within the
ambit of transfer pricing in United States because it is a service but because it is covered
by the specific definition discussed above. As a matter of fact, David S Miller, in a paper
titled 'Federal Income Tax Consequences of Guarantees; A Comprehensive Framework
for Analysis' published in the 'The American Lawyer Vol. 48, No. 1 (Fall 1994), pp.
103-165 (http://www.jstor.org/stable/20771688), has stated that a guarantee is not a
service. The following observations, at pages 114, are important:
The position that guarantees are services has been discredited by the courts with good
reason38. Guarantee fees do not represent payments for services any more than
payments with respect to other financial instruments constitute payment for services39.
A guarantor does not arrange financing for the debtor, but merely executes a financial
instrument in its favour. 38 See. e.g., Centel Communications Co. v. Commissioner, 92
T.C. 612, 632 (1989), aff d, 920 F2d 1335 (7th Cir. 1990); Bank of Am. v. United
States, 680 F.2d 142, 150 (Cl. Ct. 1982). The Service's current position on the
characterization of guarantee fees as payment for services under section 482 is
inconsistent with its treatment of guarantee fees under other provisions. See P.L.R.
9410008 (Dec. 13, 1993). 39 But cf Federal Nat'l Mortgage Ass'n v. Commissioner, 100
T.C. 541, 579 (1993) (Fannie Mae provided services by buying mortgages).
37. We are in agreement with these views. There can thus be activities which benefit the
group entities but these activities need not necessarily be 'provision for services'. The
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fact that the OECD considers such activities in the services segment does not alter the
character of the activities. While the group entity is thus indeed benefited by the
shareholder activities, these activities do not necessarily constitute services. …..
XXX
39. The issuance of financial guarantee in favour of an entity, which does not have
adequate strength of its own to meet such obligations, will rarely be done. The very
comparison, between the consideration for which banks issue financial guarantees on
behalf of its clients with the consideration for which the corporates issue guarantees for
their subsidiaries, is ill-conceived because while banks seek to be compensated, even for
the secured guarantees, for the financial risk of liquidating the underlying securities
andmeeting the financial commitments under the guarantee, the guarantees issued by the
corporates for their subsidiaries are rarely, if at all, backed by any underlying security
and the risk is entirely entrepreneurial in the sense that it seeks to maximize profitability
through and by the subsidiaries. It is inherently impossible to decide arm's length price
of a transaction which cannot take place in arm's length situation. The motivation or
trigger for issuance of such guarantees is not the kind for consideration for which a
banker, for example, issue the guarantees, but it is maximization of gains for the
recipient entit and thus the MNE group as a whole. In general, thus, theconsideration
for issuance of corporate guarantees are of a different character altogether.
XXX
41. As evident from the OECD observation to the effect "In contrast, if for example a
parent company raises funds on behalf of another group member which uses them to
acquire a new company, the parent company would generally be regarded as providing a
service to the group member", it is also to be clear that when the corporate guarantees
are issued for the purpose ofsubsidiaries raising funds for acquisitions by such
subsidiaries, these guarantees will be deemed to be services to the subsidiaries, and, as a
corollary thereto, when corporate guarantees are issued for the subsidiaries to raise funds
for their own needs, the corporate guarantees are to be treated as shareholder activity.
The use of borrowed funds for own use is a reasonable presumption as it is a matter of
course rather than exception. There has to be something on record to indicate or suggest
that the funds raised by the subsidiary, with the help of the guarantee given by the
assessee, are not for its own business purposes. As a plain look at the details of corporate
guarantees would show, these guarantees were issued to various banks in respect of the
credit facilities availed by the subsidiaries from these banks. The guarantees were prima
facie in the nature of shareholder activity as it was to provide, or compensate for lack of,
core strength for raising the finances from banks. No material, indicating to the contrary,
is brought on record in this case. Going by the OECD Guidance also, it is not really
possible to hold that the corporate guarantees issued by the assessee were in the nature
of 'provision for service' and not a shareholder activity which are mutually exclusive in
nature. In the light of these discussions, we are of the considered view, and are fully
supported by the OECD Guidance in this, that the issuance of corporate guarantees, in
the nature of quasi-capital or shareholder activity- as is the uncontroverted position on
the facts of this case, does not amount to a service in which respect of which arm's
length adjustment can be done.
XXX
48. In the present case, we have held that the issuance of corporate guarantees were in
the nature of shareholder activities as was the uncontroverted claim of the assessee, and,
as such, could not be included in the 'provision for services' under the definition of
'international transaction' under section 92B of the Act. We have also held, taking note
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of the insertion of Explanation to Section 92B of the Act, that the issuance of corporate
guarantees is covered by the residuary clause of the definition under section 92B of the
Act but since such issuance of corporate guarantees, on the facts of the present case, did
not have "bearing on profits, income, losses or assets", it did not constitute an
international transaction, under section 92B, in respect of which an arm's length price
adjustment can be made. In this view of the matter, and for both these independent
reasons, we have to delete the impugned ALP adjustment…..
.
49. The second issue is this. We must deal with the question whether in this case the
matter should have been referred to a larger bench. The parties before us were opposed
to the matter being sent for consideration by the special bench, and at least oneof the
reasons for which the grievance of the assessee is upheld, i.e. guarantees being in the
nature of shareholder activity and excludible from the scope of services for that reason
alone, is anarea which had come up for consideration for the first time. In effect,
therefore, there was no conflict on this issue of and the other issues, given decision on
the said issue, were wholly academic. It cannot be open to refer the academic questions
to the special bench.
13. We are in considered agreement with the views so expressed by the coordinate
bench. Respectfully following the views so expressed by the coordinate bench, we
uphold the relief granted by the CIT(A) and decline to interfere in the matter.
10. Respectfully following the views so expressed by us in assessee‘s own case for the
assessment year 2009-10, which is deemed to be attached to and forming part of this
order as well, we dismiss the grievances of the Assessing Officer as also the assessee.
The order of the CIT(A) thus stands confirmed.
Recently, Mumbai Bench of Hon‘ble Tribunal in the case of The Bombay Dyeing &
Mfg. Co. Limited vs. DCIT in ITA No. 1716/Mum/2017 dated 27.10.2017, reiterating
the principle of Shareholder‘s fu`nction and relying on the decision of Hon‘ble Supreme
Court's in case of S.A. Builders Ltd. v. CIT (2007) 288 ITR 1 (SC). The Hon‘ble
Tribunal while deleting the transfer pricing adjustment made by the TPO on account of
issue of corporate guarantee, upheld the contention of the assessee that reiterates the
proposition of the assessee that when the guarantee has been given by the assessee
results in a direct or indirect benefit to the assessee itself, then there arises no need to
charge any commission on the same. The relevant findings of the Tribunal read as
under:
18. Further, we are in agreement with the argument of the assessee that even if
providing corporate guarantee falls within the definition of "international transaction", in
our view, providing such corporate guarantee by a parent company to its wholly owned
subsidiary without charging any commission/fees would still be regarded as being at
arm's length price, if such corporate guarantee was provided by the parent company for
the overall benefit of the business of the group and therefore, ultimately benefiting the
parent company itself. Having regard to the direct or indirect commercial interest of the
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Company, corporate guarantee is given with a view to safeguard and to further business
interest.Hence, relying on the Hon'ble Supreme Court's decision in case of S.A. Builders
Ltd. v. CIT (2007) 288 ITR 1 (SC), wherein it has been held that once it is established
that there was nexus between the expenditure and the purpose of the business (which
need not necessarily be the business of the assessee itself), the Revenue cannot
justifiably claim to put itself in the arm-chair of the businessman or in the position of the
board of directors and assume the role to decide how much is reasonable expenditure
and having regard to the circumstances of the case.
19. Further we have also gone through the decision of the Mumbai Tribunal in the case
of ACIT v. Nimbus Communications Ltd. [2013] 145 ITD 582 (Mum-Trib.), wherein it
was held as under:
"For the guarantee given to the bank against the financial assistance given to its AEs, no
commission was charged by the assessee company on the ground that the said AEs were
not benefited by the guarantee so given and it was the assessee who benefited as a result
of commercial benefits secured for future. In support of this stand of the assessee, the
assessee has contended that business strategy should be taken into consideration while
making any TP adjustments in respect of such transactions and has relied on the OECD
Transfer Pricing Guidelines issued in 2010. As stated in para 1.59 of the said guidelines,
the business strategies should also be examined in determining comparability fo
transfer pricing purposes and certain illustrations of such business strategies are also
given therein. As stated in para 1.60 of the said guidelines which has been relied upon
by the assessee, business strategies also could include market penetration schemes and
taxpayer seeking to penetrate a market or to increase its market share might temporarily
charge a price for its product that is lower than the price charged for otherwise
comparable products in the same market. As explained further, a taxpayer seeking to
enter a new market or expand (or defend) its market share might temporarily incur
higher costs and hence achieve lower profit levels than other taxpayers operating in the
same market. The relevant facts of the present case do not indicate that there was any
such business strategy adopted by the assessee in not charging commission in respect of
guarantees issued for its AEs. As a matter of fact, there is nothing to suggest that any
such business strategy was adopted by the assessee with specific intention or motive and
the case has been sought to be made out merely on the basis of commercial expediency
by claiming that the assessee was benefited as a result of giving the guarantees in the
form of commercial benefits secured for future."
20. Thus, the above decision of the Mumbai Tribunal reiterates the proposition of the
assessee that when the guarantee has been given by the assessee results in a direct or
indirect benefit to the assessee itself, then there arises no need to charge any commission
on the same. Thus, following the decisions of the co-ordinates benches of the Tribunal
(supra), we, in the present case are of the view that the above transaction does not fall
within the purview of international transaction as defined under section 92B of the Act
and hence, the orders of the lower authorities are reversed. This issue of assessee‘s
appeal is allowed.
In view of the aforesaid, it would be appreciated that the guarantee provided by the
appellant to its associated enterprise was for its own benefit as a shareholder and
therefore, any compensation for the said arrangement is not warranted.
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It is further submitted that the Revenue is known to have consistently taken a position
that no compensation is required to be paid to the parent /AE for intra group services
which are in the nature of shareholder activity.
The present case, however, it is submitted, stands on a better footings, where the
corporate guarantee, it would be appreciated, has been given pursuant to an obligation
of the appellant as the shareholder to facilitate funding of the associated enterprises, in
order to gain benefit from the sale of stainless steel coils without incurring any cost of
borrowing to fund the associated enterprises.
However, since the appellant has already charged commission on the guarantee issued
on behalf of the aforesaid enterprise, no additional compensation is warranted and the
transfer pricing adjustment made by the TPO ought to be deleted.
Re: Benchmarking undertaken by the assessee shall be considered:
It is respectfully submitted, in this regard that during the relevant financial year the
appellant has charged a commission of 1.5% from its associated enterprise, PT Jindal
Indonesia on the amount of guarantee. Further, since the rate of commission charged
from the associated enterprise for issue of corporate guarantee is higher than the rate of
guarantee charges of 0.75% charged by State Bank of India in uncontrolled transactions,
the international transactions of commission received on issue of corporate guarantee is,
therefore, considered as being at arm‘s length applying CUP method.
The TPO, in the impugned order has disregarded the internal CUP relied upon by the
appellant for benchmarking the aforesaid transaction of commission on corporate
guarantee and considered data sought under section 133(6).
Reliance in this regard is placed on the decision of Mumbai Bench of Tribunal in the
case of Everest Kanto Cylinder ltd. vs. DCIT (ITA No. 542/Mum/2012), wherein the
Hon‘ble Tribunal while rejecting the blanket rate of commission on corporate guarantee
at 3% applied by the TPO, upheld the internal rate of commission paid by the assessee to
its banks at the rate of 0.6%.
Further, Hon‘ble Bombay High Court in ITA No. 1165 of 2013, dismissing the appeal
filed by the revenue against the order of the Tribunal, held that:
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In the matter of guarantee commission, the adjustment made by the TPO were based on
instances restricted to the commercial banks providing guarantees and did not
contemplate the issue of a Corporate Guarantee. No doubt these are contracts of
guarantee, however, when they are Commercial banks that issue bank guarantees which
are treated as the blood of commerce being easily encashable in the event of default, and
if the bank guarantee had to be obtained from Commercial Banks, the higher
commission could have been justified. In the present case, it is assessee company that is
issuing Corporate Guarantee to the effect that if the subsidiary AE does not repay loan
availed of it from ICICI, then in such event, the assessee would make good the amount
and repay the loan. The considerations which applied for issuance of a Corporate
guarantee are distinct and separate from that of bank guarantee and accordingly we are
of the view that commission charged cannot be called in question, in the manner TPO
has done. In our view the comparison is not as between like transactions but the
comparisons are between guarantees issued by the commercial banks as against a
Corporate Guarantee issued by holding company for the benefit of its AE, a subsidiary
company. In view of the above discussion we are of the view that the appeal does not
raise any substantial question of law and it is dismissed.
Similar conclusion has been arrived at in the case of:
- Asian Paints Limited v. CIT(ITA408/Mum/2010)
- Reliance Industries Limited vs. ACIT(ITA No. 4475/Mum/2007)
- Asst. CIT v. M/s. Nimbus Communication Ltd.
- Glenmark Pharmaceuticals Ltd. vs. ACIT (ITA No. 5031 & 5488/Mum/2012
It is further submitted that the bank charges guarantee fees on case to case basis.
Generally, banks gives discount on the rate of guarantee fees depending upon the credit
rating of the customer, the past experience, the future outlook of the customers and
various other factors. It is respectfully submitted that, in case of credit rating and
reputation, the subsidiary company holds the same as of the holding company.
Reliance in this is placed on the recent decision of Chennai Bench of Tribunal in the
case of VVF LTD Vs DCIT [ITA No. 673/Mum/06], where in the Hon‘ble Tribunal,
while holding that the rate of interest on loan taken by the appellant from an Indian Bank
serves as an internal comparable to the rate of interest of loan extended by the appellant
to the associated enterprise for the application of CUP method, has held that the
financial position and credit rating of the subsidiaries will be broadly the same as the
holding company.
In view of the above, it is reiterated that, since the State Bank of India has charged only
0.75% p.a. rate of bank guarantee fees from the appellant, it would have charged the
same from the subsidiary of appellant also. Hence, it is respectfully submitted that, since
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the appellant has charged higher than the rate of commission charged by the State Bank
of India, no adjustment can be made on this account.
Re: Ad-hoc adjustment of risk upon rate of commission on corporate guarantee:
The TPO in the impugned order has allegedly added an ad-hoc markup of 200 bps on the
rate of commission of 1.5% charged by various banks as per information sought under
section 133(6).
In this regard, at the outset it is respectfully submitted that the TPO has already
considered the highest rate of commission charged by State Bank of India on corporate
guarantee. It is common understanding that the rate of commission increases depending
on the increase in level of risk involved in the providing such guarantee. Accordingly, if
the highest rate of commission has been considered, the risk has already been factored in
such rates. Further, no cogent basis and reason is provided in the impugned order for
charging a markup of 200 bps on account of security and single customer risk. Since the
TPO has considered the highest rate of commission charged by the banks without taking
into account the credit worthiness and market reputation of the appellant, a markup on
account of risk adjustment is unwarranted and liable to be reduced from the arm‘s length
rate of interest so determined.
64. The ld DR vehemently relied upon the order of the learned Transfer Pricing Officer, the
learned Dispute Resolution Panel , and the learned commissioner of income tax appeals. He
submitted that the claim of the assessee that giving a corporate guarantee to its associated
enterprise is not an international transaction is devoid of any merit as the assessee itself is
considered it is an international transaction and charged price from its associated enterprise.
He therefore submitted that all the decisions relied upon by the assessee in that aspect that
corporate guarantees are not international transactions is devoid of any merit. He further
referred to those decisions relied upon by the assessee and stated that in those decision there
was no charge claimed by the assessee from its associated enterprise and therefore it was
held that these corporate guarantees are not an international transaction or are shareholder
activities. He submitted that in the present case when the assessee itself is classified
throughout that it is an international transaction now there is merely an argument without
substantiating further, that how it is not an international transaction is devoid of any merit.
He further stated that the commission has been imputed by the learned TPO at the rate of
2.68% +200 basis points after obtaining the data under section 133 (6) from various banks.
No prejudice is caused to the assessee by obtaining this information as it has also been
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confronted to the assessee in proper opportunity has been given. Even before the tribunal the
assessee did not show that how assessee is aggrieved with that. He further stated that assessee
has challenged that the commission charged by the State Bank of India to the assessee is at
0.75% while the learned TPO has applied the rate of 4.68%, the assessee is failing to
appreciate the fact that before computing the rate of corporate guarantee the 1st thing to
consider is the credit rating of the company to whom corporate guarantee has been extended.
Clearly, the assessee was able to receive corporate guarantee at such low rate because of its
good credit rating, while the associated enterprise does not enjoy the benefit of such good
credit rating, thus, the stand taken by the learned Transfer Pricing Officer is as per the
methods of transfer pricing. He therefore submitted that the learned TPO called for the
information from different banks under section 133 (6) of the Income Tax Act, 1961 and
applied a suitable markup of 200 basis points considering the risk profile of the associated
enterprise. He therefore submitted that no fault is found in the approach of the learned
Transfer Pricing Officer. He therefore submitted that the addition made by the learned TPO,
confirmed by the learned CIT appeal and approved by the learned Dispute Resolution Panel
is deserves to be upheld.
65. We have carefully considered the rival contention. Briefly stated the facts of the case is that
assessee has issued a corporate guarantee for a sum of US dollars 30 million to the lenders of
its associated enterprise PT Jindal stainless, Indonesia. For assessment year 2007 – 08 the
assessee received the commission of 1 4921269 computer that the rate of 1.5% on the
amount of loan availed by the associated enterprise and further for assessment year 2008 – 09
at the same rate the assessee received the sum of 9 701640/–. The learned Transfer Pricing
Officer computed the ALP @ of 3.5% for assessment year 2007 – 08 making an adjustment
of 200 basis points on account of adjustment for risk and 4.68% for assessment year 08-09
considering the margin of 25%, proposing a markup of 200 basis point and made the
respective adjustment. For AY 2007 – 08 the learned commissioner of income tax appeals
and for assessment year 2008 – 09 the learned Dispute Resolution Panel upheld the
adjustment made by the learned Transfer Pricing Officer.
66. The first contention of the assessee is that corporate guarantee is not an international
transaction as it is not at behest of the AE but it is an obligation of the assessee. For this, it
has relied upon several decisions. We have carefully perused all the decisions and find that in
none of the decisions cited assessee has charged on its own the guarantee commission. In the
present case, the assessee itself has charged 1.5% guarantee commission. It has shown this
transaction as an international transaction, benchmarked it applying CUP method. Further, no
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evidence has been laid down before us that it is part of the shareholders activity and not an
independent international transaction. No evidence is placed before us that it is not at the
behest of the AE but an obligation of the assessee. In view of this we reject this contention of
the assessee that corporate guarantee issued by the assessee is not an international
transaction.
67. The second contention raised before us is that benchmarking by the assessee should be
accepted. The assessee has charged guarantee commission from AE @ 1.5 %. The ld TPO
has bench marked it after obtaining the quotation from various banks, which are 2.68 %. He
further added 2 % as mark up because of security and margin adjustments. The assessee
substantiated the Alp stating that ING Vasya bank has given a quote of 1.5 % further
similar is stated to be the quote of Indusind bank. The TPO has also taken the quotes of
Axis Bank, Canara Bank, PNB, and ICICI bank, bank of Baroda, HDFC bank, and SBI. He
arrived at Arithmetic mean of 2.68 %. In the present case the ld TPO has benchmarked the
transaction by obtaining the quote from bankers and Hon Bombay High court in case of
[2015-TII-16-HC-MUM-TP] THE COMMISSIONER OF INCOME TAX, MUMBAI Vs
M/s EVEREST KENTO CYLINDERS LTD as relied by the ld AR has held as under :-
In the matter of guarantee commission, the adjustment made by the TPO were based
on instances restricted to the commercial banks provding guarantees and did not
contemplate the issue of a Corporate Guarantee. No doubt, these are contracts of
guarantee, however, when they are Commercial banks that issue bank guarantees,
which are treated as the blood of commerce being easily encashable in the event of
default, and if the bank guarantee had to be obtained from Commercial Banks, the
higher commission could have been justified. In the present case, it is assessee
company that is issuing Corporate Guarantee to the effect that if the subsidiary AE
does not repay loan availed of it from ICICI, then in such event, the assessee would
make good the amount and repay the loan. The considerations which applied for
issuance of a corporate guarantee are distinct and separate from that of bank
guarantee and accordingly we are of the view that commission charged cannot be
called in question, in the manner TPO has done. In our view the comparison is not as
between like transactions but the comparisons are between guarantees issued by the
commercial banks as against a Corporate Guarantee issued by holding company for
the benefit of its AE, a subsidiary company.
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68. Even otherwise the commission charged by the assessee also in conformity with the rates
quoted by Indusind bank and ING vasya bank. Further, the reasons given by us with respect
to Risk adjustments and margins while deciding the issue of Interest receipt relying on the
decision of Bharti Airtel decision (Supra) are equally applicable for this transaction too. In
view of this Ground No 5 for Ay 2008-09 and Ground No 4 for Ay 2007-08 are partly
allowed.
69. The fourth issue was with respect to Disallowance under section 14 A of the Income Tax
Act. For AY 2007-08, during the year under consideration, the appellant earned dividend
income of Rs. 11,62,000. The assessing officer, however, applied Rule 8D of the Rules,
holding that the appropriate cost of composite funds needed to be allocated towards
investments made for earning exempt income. Accordingly, the assessing officer disallowed
Rs. 3,92,14,001 under section 14A of the Act, applying Rule 8D of the Rules on notional
basis. For AY 2008-09 the appellant had earned dividend income of Rs. 2,37,000 in respect
of investment made in shares and mutual funds, which was exempt under section 10(34) of
the Act. It was submitted before the assessing officer that the appellant had not incurred any
expense for earning aforesaid dividend income and no portion of expenses were disallowable
under section 14A of the Act. However, the appellant suo-moto disallowed a sum of Rs.
1,00,000 on estimate basis. The assessing officer, however, made disallowance of expenses
to the tune of Rs. 4,48,08,080 under section 14A of the Act by applying Rule 8D of the Rules
on the ground that provisions of that Rule are procedural in nature and have retrospective
operation.
70. The ld AR submitted as under :-
The disallowance made by the assessing officer is bad in law and is not sustainable for
the following reasons submitted as under:
At the outset it is submitted that issue of retrospective applicability of Rule 8D is now
been settled by the Hon‘ble Supreme Court in CIT vs. Essar Teleholdings Limited,
reported at 30 CTR (SC) 561, wherein, the Hon‘ble Supreme Court has held:
There is no indication in Rule 8D to the effect that Rule 8D intended to apply
retrospectively.
48. Applying the principles of statutory interpretation for interpreting retrospectivity of
a fiscal statute and looking into the nature and purpose of sub-section (2) and subsection
(3) of Section 14A as well as purpose and intent of Rule 8D coupled with the
explanatory notes in the Finance Bill, 2006 and the departmental understanding as
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reflected by Circular dated 28.12.2006, we are of the considered opinion that Rule 8D
was intended to operate prospectively.
It is submitted that the Mumbai High Court in the case of Godrej & Boyce Mfg. Co.
Ltd. v. CIT: 328 ITR 81 (which is now been affirmed by the Hon‘ble Supreme Court in
Civic Appeal No.7020 of 2011) and Hon‘ble Delhi High Court in the case of Maxopp
Investment Ltd. : 347 ITR 272, too held that Rule 8D is not retrospective and applies
from assessment year 2008-09 only. In view of the above Rule 8D has wrongly been
applied by the assessing officer.
Even otherwise, the disallowance made by the assessing officer is not sustainable for
the following reasons submitted as under:
The provisions of section 14A of the Act provide that no deduction shall be allowed in
respect of expenditure incurred by the appellant in relation to income that does not form
part of the total income. The said section reads as under:
Expenditure incurred in relation to income not includible in total income.
14A. (1) For the purposes of computing the total income under this Chapter, no
deduction shall be allowed in respect of expenditure incurred by the appellant in
relation to income which does not form part of the total income under this Act.
(2) The Assessing Officer shall determine the amount of expenditure incurred in
relation to such income which does not form part of the total income under this Act in
accordance with such method as may be prescribed, if the AssessingOfficer, having
regard to the accounts of the appellant, is not satisfied with the correctness of the claim
of the appellant in respect of such expenditure in relation to income which does not
form part of the total income under this Act.
(3) The provisions of sub-section (2) shall also apply in relation to a case where an
appellant claims that no expenditure has been incurred by him in relation to income
which does not form part of the total income under this Act
Provided that nothing contained in this section shall empower the Assessing Officer
either to reassess under section 147 or pass an order enhancing the assessment or
reducing a refund already made or otherwise increasing the liability of the appellant
under section 154, for any assessment year beginning on or before the 1st day of April,
2001.
In terms of sub-section (1) of section 14A of the Act, any expenditure incurred in
relation to exempt income is not allowable deduction. Sub-section (2) of the section
empowers/ enables the assessing officer (AO‘) to determine such expenditure where
the AO is not satisfied with the claim of appellant or the quantum of such expenditure.
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The provisions of section 14A clearly postulate disallowance of expenditure only in a
case where it is proved that the expenses incurred have a real relationship with the
income which does not form part of the total income. In the absence of such nexus
being established, it is not open to the assessing officer, it is respectfully submitted, to
disallow any part of the expenditure on proportionate basis.
Reference in this regard is drawn to the decision of Hon‘ble Supreme Court in the case
of CIT vs Walfort Share & Stock Brokers: 326 ITR 1 (SC),wherein it has been held by
the apex Court that there must be a proximate relationship of expenditure with exempt
income, for the purposes of making disallowance of same under section 14A of the Act.
In that case, the subject matter before the Supreme Court was allowabilty of loss
incurred on sale of mutual funds, pursuant to decline in their value on declaration/
receipt of dividend, being exempt from tax, on such mutual funds. One of the
contentions that were raised by the Department before the Supreme Court was that the
aforesaid loss had accrued to the appellant on account of earning of exempt dividend
declared on such mutual fund and therefore, the same needs to be disallowed under
section 14A of the Act. The relevant portions of the decision of Supreme Court,
wherein the contentions of the Department have been dealt are as under:
According to the Department, the differential amount between the purchase and sale
price of the units constituted "expenditure incurred" by the appellant for earning taxfree
income, hence, liable to be disallowed under Section 14A. As a result of the
dividend pay-out, according to the Department, the NAV of the mutual fund, which
was Rs. 17.23 per unit on the record date, fell to Rs. 13.23 on 27.3.2000 (the next
trading date) and, thus, Rs. 4/- per unit, according to the Department, constituted
"expenditure incurred" in terms of Section 14A of the Act. In its return, the appellant,
thus, claimed the dividend received as exempt under Section 10(33) and also claimed
set-off for the loss against its taxable income, thereby seeking to reduce its tax liability
and gain tax advantage.
The Supreme Court negated the contentions of the Department and held that there
needs to be a proximate nexus of an expenditure with exempt income before a
disallowance of same can be made under section 14A of the Act. The relevant
observations of the Court are as follows:
Expenditure is a pay-out. It relates to disbursement. A pay-back is not expenditure in
the scheme of Section 14A. For attracting Section 14A, there has to be a proximate
cause for disallowance, which is its relationship with the tax exempt income. Pay-back
or return of investment is not such proximate cause, hence, Section 14A is not
applicable in the present case. Thus, in the absence of such proximate cause for
disallowance, Section 14A cannot be invoked. In our view, return of investment cannot
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be construed to mean "expenditure" and if it is construed to mean "expenditure" in the
sense of physical spending still the expenditure was not such as could be claimed as an
"allowance" against the profits of the relevant accounting year under Sections 30 to 37
of the Act and, therefore, Section 14A cannot be invoked. Hence, the two asset theory
is not applicable in this case as there is no expenditure incurred in terms of Section
14A.
The aforesaid decision has also been followed by the Bombay High Court in the case of
Godrej & Boyce Mfg. Co. Ltd. v. CIT: 328 ITR 81 which is now been affirmed by the
Hon‘ble Supreme Court in Civic Appeal No.7020 of 2011
The aforesaid decisions, it is respectfully submitted, fortifies the interpretation of the
provisions of section 14A of the Act that only direct expenses, having proximate nexus,
with earning of exempt income can be disallowed under section 14A of the Act.
Reliance is also placed on the decision of Delhi High Court in the case of Maxopp
Investment Ltd:347 ITR 272 (Del) wherein after considering the aforesaid decision of
Supreme Court, the High Court has analyzed the scope of provisions of section 14A
and the powers vested with the assessing officer before invoking the same. The High
Court held, that the expression expenditure incurred refers to actual expenditure and
not to some imagined expenditure. It was held, that the provisions of sub-section (2)/
(3) of section 14A read with Rule 8D of the Rules can be applied from assessment year
2008-09 and onwards, only if the assessing officer first rejects the claim of the
appellant of having not incurred any expenditure in relation to earning of exempt
income, with cogent reasons. In other words, the onus is on the assessing officer to
establish nexus of expenses with exempt income, before rejecting the claim of appellant
and computing disallowance under section 14A as per Rule 8D of the Rules. The
relevant observations of the High Court are as under:
………..
Thus, we will have to consider the argument of the asssessees in respect of the
expression "expenditure incurred" in the context of the expenditure being in connection
with or pertaining to income which does not form part of the total income under the
said Act.
27. A reference was made to the decision of the Punjab and Haryana High Court in the
case of CIT-II v. Hero Cycles Ltd [ITA No. 331/2009: decided on 4/11/2009] wherein
it was observed that:-
"Disallowance under Section 14A requires finding of incurring expenditure where it is
found that for earning exempted income no expenditure has been incurred,
disallowance under Section 14A cannot stand."
28. It was contended that unless and until there was actual expenditure for earning the
exempted income, there could not be any disallowance under section 14A. While we
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agree that the expression "expenditure incurred" refers to actual expenditure and not to
some imagined expenditure we would like to make it clear that the 'actual' expenditure
that is in contemplation under section 14A(1) of the said Act is the 'actual' expenditure
in relation to or in connection with or pertaining to exempt income. The corollary to
this is that if no expenditure is incurred in relation to the exempt income, no
disallowance can be made under section 14A of the said Act. (emphasis supplied)
Attention is also invited to the decision of Punjab & Haryana High Court in the case of
CIT vs Hero Cycles: 323 ITR 518,wherein, too, High Court held that disallowance
under section 14A can be made only if assessing officer establishes proximate nexus of
expenditure with exempt income.
In that case, the appellant had earned exempt dividend income during the relevant year.
The assessing officer made disallowance of expenses under section 14A of the Act on
the basis of presumption. On appeal before the CIT (A) and ITAT, the appellant
conclusively established that non-interest bearing funds were utilized for making
investment in shares reaping exempt dividend income and no portion of interest
expenditure incurred during the year was related to exempt dividend income. The
Tribunal deleted the disallowance made by the assessing officer on the ground that facts
clearly show that no expenditure was incurred to earn dividend income and
disallowance under section 14A cannot be made on the basis of mere presumption.
On further appeal before the High Court, it was contended by the Revenue that
disallowance under section 14A could be made on the basis of presumption as some
expenditure, directly or indirectly, is always incurred, which needs to be disallowed
under that section. For the aforesaid proposition, the Revenue relied upon provisions of
Rule 8D of the Rules.
However, the High Court negated the contentions of the Revenue and held that
disallowance under section 14A requires clear finding of incurring of expenditure and
the disallowance cannot be made on the basis of presumption. The relevant
observations of the High Court are as under:
……..
Learned counsel for the appellant relies upon Section 14A(2) and Rule 8D (1) (b) to
submit that even where the appellant claimed that no expenditure had been incured, the
correctness of such claim could be gone into by the Assessing Officer and in the present
case, the claim of the appellant that no expenditure was incurred was found to be not
acceptable by the Assessing Officer and thus disallowance was justified. We are unable
to accept the submission.
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4. In view of finding reproduced above, it is clear that the expenditure on interest was
set off against the income from interest and the investment in the share and funds were
out of the dividend proceeds. In view of this finding of fact, disallowance under Section
14A was not sustainable. Whether, in a given situation, any expenditure was incurred
which was to be disallowed, is a question of fact. The contention of the revenue that
directly or indirectly some expenditure is always incurred which must be disallowed
under Section 14A and the impact of expenditure so incurred cannot be allowed to be
set off against the business income which may nullify the mandate of Section 14A,
cannot be accepted. Disallowance under Section 14A requires finding of incurring of
expenditure where it is found that for earning exempted income no expenditure has
been incurred, disallowance under Section 14A cannot stand. In the present case
finding on this aspect, against the revenue, is not shown to be perverse. Consequently,
disallowance is not permissible.
Reliance in this regard is further placed on the decision of the Delhi Bench of Tribunal
in the case of SIL Investment Ltd vs ACIT: ITA No. 2431/Del/2010, wherein the
Tribunal held that the assessing officer cannot make disallowance under section 14A,
without bringing any evidence on record to establish that any expenditure had been
incurred by the appellant for earning exempt income. The relevant extract of the
Tribunal‘s decision is as under:
………..In the present case, the AO did not bring any evidence on record to establish
that any expenditure had been incurred by the appellant company for earning the
exempt income. In the absence of such evidence, it was wrong on the part of the AO to
proceed to compute disallowance of the expenses u/s 14A of the Act by merely
applying Rule 8D(2)(iii) of the Rules (emphasis supplied)
Recently, the Delhi Bench of the Tribunal in the case of NIIT GIS Ltd vs Assistant CIT
in ITA No .2087/Del/2013, held that the assessing officer has to record cogent reasons
for rejecting the claim of the appellant with respect to incurrence/ non-incurrence of
expenditure for earning exempt income, before invoking the provisions of the said
section. Relevant extract of the decision is reproduced hereunder:
9. Having gone through the orders of the authorities below and the decisions relied
upon, we find that the assessing officer has not recorded his dissatisfaction as to how
the disallowance of Rs.2,52,252 suo moto made by the appellant under sec 14A on the
basis of given working by the appellant was not correct. As per sub-section (2) of sec.
14A of the Act, the assessing officer can determine the amount of expenditure having
relation with exempt income in accordance with the method provided in Rule 8D of the
Rules, if the assessing officer is not satisfied with the correctness of claim suo moto
made by the appellant . The assessing officer has dealt with the issue in para Nos. 3,
3.1 to 3.8 of the assessment order but he has not recorded his dissatisfaction in specific
wording as to how the working of disallowance under section 14A of the Act at
Rs.2,55,252 suo moto made by the appellant is erroneous and thus cannot be accepted.
The satisfaction of the assessing officer is not an empty/ idle formality and has to be
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based on objective satisfaction of the assessing officer. The assessing officer needs to
point out the mistake/ incorrectness in the claim of the appellant and only thereafter can
the assessing officer proceed to complete disallowances as per Rule 8D of the I.T.
Rules. On the other hand, we find that the appellant considering the time span by the
employee in relation to the investment activity has attributed 10% of the salary and
other overheads relating to said employee as having relation with making investment
/earning exempt dividend income has computed the amount of Rs.2,40,000 as
disallowable under section 14A of the Act, and in the manner as explained above in the
submissions of the Learned AR. In addition to above the appellant has further allocated
10% of administrative expenses per head amounting to RS.15,252 to cover further
indirect cost in relation to various services that the financial controller may have used
while performing investment decision. In absence of dissatisfaction recorded by the
assessing officer on the working of the above disallowance made under section 14A of
the Act and offered by the appellant, we are of the view that the assessing officer was
not justified in making the disallowance of Rs.30,29,248 (Rs.32,84,500 –
Rs.2,55,252).In this regard, we also find strength from the decision of the Hon‘ble
jurisdictional High Court of Delhi in the case of Max Opp Investment Ltd v. CIT
(supra) wherein the Hon‘ble High Court has been pleased to hold that sub-section (2) of
section 14A deals with cases where the appellant specifies a positive amount of
expenditure in relation to income which does not form part of the total income under
the Act and sub-section (3) applies to cases where the appellant asserts that no
expenditure had been incurred in relation to exempt income. In both cases, the
Assessing Officer, if satisfied with the correctness of the claim of the appellant in
respect of such expenditure or no expenditure, as the same may be, cannot embark upon
a determination of amount of expenditure in accordance with any prescribed method as
mentioned in sub-section (2) of sec. 14A of the Act. It is only if the assessing officer is
not satisfied with the correctness of the claim of the appellant, in both case, that the
assessing officer gets jurisdiction to determine the amount of expenditure incurred in
relation to such income which does not form part of the total income under the Act in
accordance with the prescribed method. The prescribed method is the method stipulated
in Rule 8D of the Rules. While rejecting the claim of the appellant with regard to the
expenditure or no expenditure, as the case may be, in relation to the exempt income, the
assessing officer would have to indicate cogent reasons for the same. It is, therefore,
clear that determination of the amount of expenditure in relation to exempt income
under Rule 8D would only come into play when the assessing officer rejects the claim
of the appellant in this regard, held the Hon‘ble High Court. We thus respectfully
following the above ratios laid down by the Hon‘ble jurisdictional High Court, set aside
the orders of the authorities below with direction to the assessing officer to delete the
addition of Rs. 13,29,248. The grounds involving the issue are accordingly allowed.
(emphasis supplied)
To the same effect are the following decisions:
CIT v. Metalman Auto P. Ltd.: 336 ITR 434 (P&H)
CIT v. Reliance Industries Ltd. : 339 ITR 632 (Bom)
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Chemical &Mettallurgical Design Co. Ld : ITA No. 803/2008 (Delhi HC)
CIT v. Torrent Power Ltd.: 363 ITR 474 (Guj)
CIT Vs Ms. Sushma Kapoor : 319 ITR 299 (Delhi)
CIT v. Adarsh Kumar Goel: [2011] 199 Taxman 149 (Punj. &Har.)(Mag.)
Wimco Seedlings Limited vs. DCIT : 107 ITD 267 (Del.)(TM)
Minda Investments Ltd. v. DCIT: 138 TTJ 240 (Del.)
Maruti Udyog Limited V. DCIT: 92 ITD 119 (Del.)
ACIT v. Eicher Limited: 101 TTJ 369 (Del.)
DLF Ltd. vs. CIT: 27 SOT 22 (Del)
Punjab National Bank V. DCIT: 103 TTJ 908 (Del.)
Vidyut Investment Ltd: [2006] 10 SOT 284 (Del.)
Impulse (India) Pvt. Ltd.: (2008) 22 SOT 368 (Del.)
D.J. Mehta v. ITO: 290 ITR 238 (Mum.)(AT)
Jindal Photo Ltd vs. DCIT: ITA No. 814 (Del) 2011
CIT v. K. Raheja Corporation Ltd.: ITA No. 1260/2009 (Bom.)
Hence, only expenditure which has direct nexus with the earning of exempt income,
ought to be disallowedunder section 14A of the Act.
That apart and without prejudice to the above, even otherwise, no expenditure debited
to the profit & loss account including interest expenditure has proximate, leave alone
remote nexus with investments in shares/ mutual funds, as demonstrated as under:
On perusal of the balance sheet of the appellant for the relevant previous year ending
31st March, 2007, it would be noted that the appellant held investments aggregating to
Rs. 18855.93 lacs as on 31.3.2007 vis-à-vis investment of Rs. 31021.77 lacs held as at
the beginning of the previous year.
Accordingly, the appellant had not made fresh deployment of funds during the previous
year and fresh investment made in the year are from redemption of old investments. In
view of the same, the question of nexus of any portion of the borrowed funds, being
outstanding at the beginning of the year, and interest paid thereon, with the fresh
investments made during the year does not arise.
Further, it is submitted that the appellant company has accumulated sufficient reserves
to the tune of Rs. 137412.76 lacs as on March, 2007, increasing from reserves of Rs.
98309.97 lacs from the preceding year. Therefore, all investment have been made out
of the accumulated profit and no borrowed fund have been utilized for investment in
shares.
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In view of the above, considering that the appellant had mixed pool of funds, wherein
the interest free funds were sufficient for making investment in shares/ mutual funds,
no part of the borrowed funds shall be deemed to have been utilized for making such
investments and therefore, question of nexus of interest expenditure incurred on such
opening balance of borrowed funds with the investment in shares does not arise.
Reliance in this regard is placed on the following decisions, wherein, it has been held
that where appellant had sufficient funds/ deposits for advancing interest free loans or
making investment in shares, etc., and there is nothing on record to show that borrowed
funds have been directly utilized for such purpose, a presumption in favour of the
appellant can be drawn with respect to utilization of interest free and borrowed funds:
Indian Explosives Ltd. vs CIT: 147 ITR 392 (Cal.)
Woolcombers of India Ltd. v. CIT: 134 ITR 219 (Cal.) - approved by Supreme Court in
the case of East India Pharmaceutical Works Ltd. v. CIT: 224 ITR 627
CIT v. Reliance Utilities and Power Ltd.: 313 ITR 340 (Bom.)
CIT vs. M/s. Ashok Commercial Enterprises: ITA No. No.2985 of 2009 (Bom)
While following the ratio emanating from the aforesaid decisions, it has been held that
interest expenditure cannot be disallowed under section 14A of the Act, where the
appellant had sufficient surplus funds and there was no finding by the assessing officer
of any direct nexus of borrowed funds with investments.
The Gujarat HC in the case of CIT vs UTI Bank Ltd: 215 Taxman 8, held that where
there are sufficient interest free funds to meet tax free investments, they are presumed
to be made from interest free funds and not loaned funds and no disallowance can be
made under section 14A of the Act. Relevant extract of the judgment is reproduced as
under:
3. The issue pertains to disallowance under Section 14A of the Act made by the
Assessing Officer which was partially deleted by the CIT(A). Such order of CIT(A)
gave rise to cross appeals at the hands of the appellant as well as the revenue. Tribunal
confirmed the view of the CIT(A) making following observations:
"33. We have heard the rival contentions and perused the material on record, The
undisputed facts are that during the year the appellant has earned interest of Rs. 17.45
crore on tax free bond and debentures as against which the appellant had suomotu
disallowed Rs. 5.53 crore being the interest expenses u/s. 14A as against which the AO
has worked out the disallowance of Rs. 32.76 crore. After giving the credit of
disallowance of Rs. 5.53 crore made by the Appellant, the AO disallowed Rs. 27.23
crore u/s. 14A. As on 31st March, 2003, the interest free funds available with the
appellant was to the tune of Rs. 3404 crore (comprising of share capital of Rs. 230
crore Reserves of Rs. 689 crores and interest free demand deposits and Rs. 2485 crores)
as against which the tax free investments were to the tune of Rs. 589 crore. Thus the
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interest free funds were far in excess of the investments. CIT(A) has given a finding
that the facts in AY 2003-04 are identical to the facts of the case in AY 2002-03 and
accordingly he has followed the decision of CIT(A) for AY 2002-03. These facts have
not been controverted by the Ld. D.R. nor have they brought on record any facts to the
contrary. Hon'ble Bombay High Court in case of CIT v. Reliance Utilities & Power
Ltd. (supra) has held that if there are interest free funds available to an appellant
sufficient to meet its investments and at the same time the appellant has raised a loan it
can be presumed that the investments were from interest free funds available. In the
present case, since the appellant has suo moto disallowed Rs. 5.53 crore u/s. 14A,
respectfully following the decision of Bombay High Court, we are of the view that in
the facts of the present case, no further disallowance over and above than what has been
disallowed by the Appellant is called for.…………."
4. In our opinion the Tribunal has committed no error. Basically the entire disallowance
has been made on the basis of facts emerging on record. The Tribunal also relied on the
decision of the Bombay High Court in case of CIT v. Reliance Utilities & Power
Ltd. [2009] 313 ITR 340/178 Taxman 135. Additionally, we find that the Assessing
Officer had, without giving a finding as to how much administrative expenditure have
been incurred to earn the exempt income, had made disallowance. In the earlier years
also, similar position obtained. That being the fact, no question of law arises.
(emphasis supplied)
To the same effect are the following decisions:
Lubi Submersibles Ltd.: ITA No.868 of 2010 (Guj.)
CIT v. K. Raheja Corporation Pvt. Ltd: ITA No.1260 of 2009 (Bom.)
CIT v. Gujarat Power Corporation Ltd.: 352 ITR 583 (Guj)
Gujarat State Fertilizers and Chemicals Ltd : Tax Appeal No. 82 of 2013 (Guj
HC)
CIT v. Torrent Power Ltd.: 363 ITR 474 (Guj)
CIT vs. Suzlon Energy Ltd.: 215 Taxman 272 (Guj)
M/s Agrovet Ltd. v. ACIT: ITA No. 1629/Mum/09 (Mum.)
Dy.CIT v. EimcoElecon (ndia) Ltd.: 142 ITD 52 (Ahd)
Dy.CIT v. Jammu & Kashmir Bank Ltd.: 142 ITD 553 (Asr.)
Hero Honda Finlease Ltd vs. ACIT: ITA No. 3726/Del/2012 (Del)
ACIT vs. Champion Commercial Co Ltd: 152 TTJ 241 (Kol)
TML Drive Lines Ltd vs. ACIT : ITA No. 6064/Mum/2010 (Mum)
Kulgam Holdings Pvt. Ltd. vs. ACIT : ITA No. 1259/Ahd/2006 (Ahd)
Max India Limited vs. DCIT: ITA No. 103/2006 (Amr)
It is submitted that the aforesaid interest expenditure being presumed to have not been
incurred for investment in shares/mutual funds cannot even be disallowed under section
14A by applying sub-rule 2(ii) of Rule 8D for the following reasons:
In accordance with provisions of Sub-Rule (2)(ii) of Rule 8D of the Rules, interest
expenditure, which is not directly attributable to any particular income or receipt, can
be disallowed by applying formula prescribed therein, viz., ratio of average value of
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investment to average value of total assets. As a necessary corollary, interest
expenditure which is directly related to other business activity, other than resulting in
earning of exempt income, cannot be disallowed under the aforesaid sub-rule.
Your Honour‘s attention, in this regard, is invited to the provisions of rule 8D of the
Rules, which reads as under:
Rule 8D. Method for determining amount of expenditure in relation to income not
includible in total income.
(1) Where the Assessing Officer, having regard to the accounts of the appellant of a
previous year, is not satisfied with –
(a) the correctness of the claim of expenditure made by the appellant; or
(b) the claim made by the appellant that no expenditure has been incurred
in relation to income which does not form part of the total income under the Act for
such previous year, he shall determine the amount of expenditure in relation to such
income in accordance with the provisions of sub-rule (2).
(2) The expenditure in relation to income which does not form part of the total income
shall be the aggregate of following amounts, namely :—
(i) the amount of expenditure directly relating to income which does not form part of
total income;
(ii) in a case where the appellant has incurred expenditure by way of interest during the
previous year which is not directly attributable to any particular income or receipt, an
amount computed in accordance with the following formula, namely :—
A x B/C
Where A = amount of expenditure by way of interest other than the amount of interest
included in clause (i) incurred during the previous year;
B = the average of value of investment, income from which does not or shall not form
part of the total income, as appearing in the balance sheet of the appellant, on the first
day and the last day of the previous year;
C = the average of total assets as appearing in the balance sheet of the appellant, on the
first day and the last day of the previous year;
(iii) an amount equal to one-half per cent of the average of the value of investment,
income from which does not or shall not form part of the total income, as appearing in
the balance sheet of the appellant, on the first day and the last day of the previous year.
3. For the purposes of this rule, the 'total assets' shall mean, total assets as appearing in
the balance sheet excluding the increase on account of revaluation of assets but
including the decrease on account of revaluation of assets.
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In terms of sub-rule 2(ii) of Rule 8D, interest expenditure incurred by the appellant,
which is not directly attributable to any particular income or receipt, can be disallowed
proportionally as per prescribed method.
The provisions of the aforesaid sub-rule, in our respectful submission, are attracted,
where borrowed funds are not directly attributable to any particular activity, i.e.,
taxable or non-taxable.
However, where borrowed funds have direct relation with particular activity/ income/
expenditure, the interest expenditure incurred thereon, is not liable for apportionment in
that Rule.
Reliance in this regard is placed on the decision of Kolkata Bench of Tribunal in the
case of ACIT vs Champion Commercial Co Ltd: ITA No. 644/ Kol./2012, wherein, the
Tribunal held that, while computing disallowance under Rule 8D(2)(ii), only common
interest expenditure is to be considered, i.e., after excluding interest directly relatable to
any particular income/ expenditure, including amount considered for disallowance
under Rule 8D(2)(i) of the Rules. The relevant extract of Tribunal‘s observations in this
regard is reproduced hereunder for your Honour‘s reference:
Viewed thus, the correct application of the formula set out in rule 8D(2)(ii) is that, as
has been noted by Hon‘ble Bombay High Court in the case of Godrej and Boyce
(supra), 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 appellant's business
such as plant/machinery etc.). Accordingly, even by revenue‘s own admission, interest
expenses directly attributable to tax exempt income as also directly attributable to
taxable income, are required to be excluded from computation of common interest
expenses to be allocated under rule 8D(2)(ii).
…………………………………………………………………………
In our considered view, therefore, the right course of action will be that while we
uphold the action of the CIT(A) in principle, assuming that it was based on principle
discussed earlier in this order that quantum of allocated common interest expenses were
reduced, we remit the matter to the file of the Assessing Officer for adjudication de
novo in the light of the legal position discussed above. We make it clear that common
interest expenses which are to be allocated in terms of the formula under rule 8D(2)(ii)
will only be such interest expenses as are neither directly attributable to borrowings
specifically used for tax exempt incomes or receipts, nor are directly attributable to
borrowings specifically used for taxable incomes or receipts.
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The Hon‘ble Delhi High Court in the case of Pr. Commissioner of Income-tax Delhi-2
vs Bharat Overseas Pvt Ltd in ITA 802/2015 vide order dated 17.12.2015, held that
disallowance under section 14A read with Rule 8D(2)(ii) cannot be made in absence of
common interest expenditure and while computing disallowance, not only interest
directly attributable to tax exempt income, but also interest directly relatable to taxable
income has to be excluded from variable A of Formula prescribed under Rule 8D(2)(ii).
Relevant extracts of the judgment are reproduced as under:
16. 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 nor restrict the scope f the statutory
provision to which it relates.
17. 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 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.
In view of the above, it is only the common interest expenditure, incurred on borrowed
funds, not directly attributable to any particular activity (taxable or non-taxable), which
can only be considered for apportionment under Rule 8D(2)(ii).
In the case of the appellant, since such borrowed funds have nexus with regular
business activities of the appellant, in light of the discussion above, the same will not be
considered for disallowance in the above Rule.
Without prejudice, it is submitted that the Hon‘ble ITAT in appellant‘s own case for the
assessment year 2005-06 (ITA No. 2518/Del/2013) and 2006-07 (ITA No.
4111/Del/2013), has sustained disallowance of Rs. 25,000 against ad-hoc disallowance
of Rs. 50,000 made by the assessing officer, in reference to section 14A of the Act.
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71. The Ld DR supported the orders of the lower authorities. He submitted that for AY 2007-08,
assessee has not disallowed any sum and for AY 2008-09 assessee has disallowed only Rs. 1
lakhs. For both the actions of the assessee, there is no basis.
72. We have carefully considered the rival contention and perused the orders of the lower
authorities. For assessment year 2007 – 08 the learned assessing officer has applied rule 8D
for making disallowance under section 14 A of the Income Tax Act of 3 9214001 where
the assessee has earned the exempt income of rupees 1162000/–. Now it is a settled judicial
precedent that for assessment year 2007 – 08 the rule 8D the does not apply. The assessee has
contested that in assessment year 2006 – 07 the assessing officer has made an addition of
50,000 under section 14 A on the ground that assessee has earned a sum of Rs. 482.26 crores
as dividend on investment of 25209.08 lakhs and no disallowance has been offered by the
assessee. For that year vide para no. 9 of the order of the coordinate bench following
assessee‘s own case has restricted the disallowance to the extent of 25,000 under section 14
A of the Income Tax Act. During the year the dividend income on the by the assessee is Rs.
1162000 /- which is far less compared to the earlier year and there is no finding by the
learned AO that assessee has spent sums for earning dividend income. Therefore in the
interest of justice and following the binding precedent we restrict the disallowance under
section 14 A of the Income Tax Act on estimate basis at 25,000 for this year too.
Accordingly, ground number five of the appeal of the assessee for assessment year 2007 – 08
is partly allowed.
73. For assessment year 2008 – 09, admittedly the provisions of rule 8D are applicable. Assessee
has also disallowed a sum of 1 lakh on its own. The assessee is also on dividend income of
Rs. 237000/– during the year. The learned AO made disallowance applying the provisions of
rule 8D of 44808080/–. However on reading para number four of the order of the learned
assessing officer straightway jumped to the issue of show cause notice to the assessee as to
why disallowance under section 14 A read with rule 8 D should not be made. Therefore it is
apparent that there is no satisfaction recorded by the assessing officer with respect to the
correctness of the claim of the assessee of disallowing 1 lakh under section 14 A of the
Income Tax Act with regard to the books of accounts of the assessee. Now the judicial
precedent is settled that before invoking the provisions of rule 8D the learned assessing
officer has to record the satisfaction about the correctness of the claim of the assessee and
without recording, that satisfaction the disallowance cannot be made. The learned
departmental representative also could not show the satisfaction of the learned assessing
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officer. Even otherwise it is also a settled law that the disallowance under section 14 A of the
Income Tax Act cannot exceed the exempt income which is only Rs. 237000/-for this year.
In absence of any satisfaction recorded by the assessing officer the disallowance made cannot
be sustained. Hence, we direct the learned assessing officer to delete the disallowance of 4
4808080/- under section 14 A of the act. Accordingly, ground number six of the appeal of the
assessee for assessment year 2008 – 09 is allowed.
74. The next issue is the disallowance of depreciation on cars sold to employees. This issue is
only relevant for AY 2008-09. Brief facts shows that the appellant has sold 7 cars to its
employees @ Rs. 100 each amounting to a total sales consideration of Rs. 700/-. Details of
cars sold and WDV is as under:
Detail of Cars sold during the F.Y.2007-0-088
Sr.
No.
Particulars Year of Cap. Vehicle No. Original Cost
(Rs.)
1 Lancer 2001-02 DL9CC-8287 826,901
2 Esteem LX 2002-03 HR20H-4527 487,520
3 Santro LP 2002-03 DL9CH-0327 336,557
4 Santro LP 2002-03 DL9CH-0350 336,557
5 Esteem 2002-03 DL8CJ-0300 513,135
6 Esteem 2002-03 DL9CC-9938 510,563
7 Maruti Esteem 2003-04 HR20J-3912 516,404
Total 3,527,637
The difference in WDV and actual sale consideration comes to Rs. 13,21,410. The assessing
officer, denied depreciation amounting to Rs.1,25,330 in the relevant previous year on the
WDV value of cars sold.
75. The LD AR submitted that the action of the assessing officer is inconsistent with the scheme
of depreciation provided under section 32(1) of the Act. Under the scheme of the Act,
depreciation is allowed on the written down value of the block of assets less the sale
consideration of the assets sold during the year. Under the scheme of the Act, depreciation is
allowed on the written down value of the block of assets less the sale consideration of the
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assets sold during the year. Reliance in this regard is placed on the decision of High Court of
Delhi in the case of CIT vs Oswal Agro Mills Ltd. and Oswal Chemicals and Fertilizers Ltd.
341 ITR 467, wherein it was held that depreciation is to be allowed on the asset, forming part
of the 'block of assets' even if it is not used, i.e. the depreciation is to be allowed with respect
to the block of assets and not the individual assets. The action of the assessing officer
therefore is inconsistent with the scheme of depreciation provided under section 32(1) of the
Act.
76. Learned departmental representative relied upon the orders of the lower authorities.
77. We have carefully considered the rival contention and perused the orders of the lower
authorities. During the year the assessee has sold seven card to its employees at the rate of
rupees hundred each amounting to a total sale consideration of 700. Such cars were
transferred in the name of the employees and 700 was credited to the block of the return
down value of the asset. We fully agree with the contention of the learned authorised
representative that there is still the block of the appreciable asset in existence therefore the
depreciation cannot be disallowed if the sale consideration of the assets is less than the
written down value of that block. Even otherwise after the concept of the block of assets
introduced in the Income Tax Act, the identity, for the limited purpose of the claim of the
depreciation, of an individual asset is obliterated. In view of this we do not find any
justification for making disallowance of 1 98212/– of depreciation on account of sale of
cars to the employees. Accordingly, ground number seven of the appeal of the assessee for
assessment year 2008 – 09 is allowed.
78. The Next issue is relevant for AY 2007-08 regarding disallowance of Bad Debts of Rs. Rs.
4,11,57,000/-. This issue is challenged by revenue vide ground number 1 of appeal of the
learned AO for assessment year 2007 – 08. The Facts shows that the assessee during the
relevant previous year, in its books of accounts, claimed deduction of Rs. 411.57 lacs
pertaining to irrecoverable bad debts. Out of the total bad debts of Rs. 411.57 lacs, bad debts
amounting to Rs. 403.2 lacs were related to sales made to India Govt. Mint, a public sector
enterprise, against supply of cold rolled stainless steel coils. The details of bad debts are
summarized at pages 343-366 of the paper book. The assessee, during the course of
assessment, vide reply dated 03.12.2010 submitted before the assessing officer that the bad
debts were arise out of the sale of cold rolled stainless steel coils made to India Govt. Mint in
the financial year 2004-05. The customer, arbitrarily and without providing any computation,
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deducted the balance outstanding to the assessee. The details are at pages 345-346 of the
paper book accordingly, during the year under consideration, the assessee has written off Rs.
411.57 lacs as irrecoverable bad debts in the books of accounts. The various correspondence
entered into with the customer is enclosed as pages 345-366 of the paper book. The assessing
officer, however while completing the assessment made disallowance of deduction of bad
debts amounting to Rs. 411.57 Lacs, alleging that (i) large part of bad debt is related to
Public sector undertaking, which by no stretch of imagination can be construed as bad debt
and (ii) the deduction claimed by the assessee does not qualify the condition as enunciated in
the provision of 36(2) of the Act.
79. Both the parties agreed before us that this issue is covered in favor of the assessee by the
decision of Hon‘ble ITAT in the assessee‘s own case for the assessment year 2006-07 in ITA
No. 4111/Del/2013, wherein, following the decision of Hon‘ble Supreme Court in the case of
T.R.F. Ltd. vs. CIT (323 ITR 397), Hon‘ble ITAT, deleted the disallowance of bad debts
claimed in that year.
80. We have also considered the rival contentions and in view of the issue already covered in
favour of the assessee, by the decision in the case of the assessee itself for assessment year
2006 – 07, wherein following the decision of the honourable Supreme Court, the coordinate
bench has deleted the disallowance, we respectfully following the decision of the coordinate
bench confirm the order of the learned CIT Appeal in deleting the disallowance of Rs .
41157000/– on account of bad debts. Accordingly, ground number 1 of the appeal of the
revenue for assessment year 2007 – 08 is dismissed.
81. The Next issue is with respect to excess disallowance of depreciation on computer
peripherals. This issue is raised by the revenue for assessment year 2007 – 08 vide ground
number two of the appeal of the learned assessing officer. Both the parties agreed that this
issue is squarely covered in favour of the assessee by the decision of Hon‘ble Delhi High
Court in the case of CIT vs. BSES Yamuna Powers Limited (ITA No. 1267/Delhi/2010 dated
31.08.2010) .
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82. We have also carefully considered the rival contention and find that on into the power supply
equipments and computer peripherals are held to be the part of the computers and are eligible
for depreciation at the rate of 60%. The issue is squarely covered by the decision of the
honourable jurisdictional High Court in favour of the assessee. The learned departmental
representative could not point out any other decision, which binds us. Therefore, respectfully
following the decision of the honourable High Court‘s the disallowance deleted by the
learned commissioner appeals of 231402/– on account of excess claim of depreciation is
confirmed. Accordingly, ground number 2 of the appeal of the learned AO for 2007 – 08 is
dismissed.
83. The Next issue is with respect to Disallowance of Rs. 21.74 crores on account of
capitalization of interest. This ground is raised by the learned assessing officer for assessment
year 2007 – 08 vide ground number three of the appeal.
84. Both the parties submitted that The issue is covered by the decision of Hon‘ble Delhi Bench
of Tribunal in the assessee‘s own case for the assessment year 2005-06 (ITA No.
2518/Del/2013) and 2006-07 (ITA No. 4111/Del/2013), wherein, the Hon‘ble Tribunal
upheld the alternative contention of the assessee and allowed deduction of interest expense
incurred on earning interest on short term deposits under section 57 (iii) of the Act. further,
the assessing officer, vide order dated 17.12.2012 passed under section 154 of the Act
(enclosed at pages 48-51 of the appeal memo), rectified the amount of disallowance to Rs.
818.92 lacs after excluding profit on sale of investment of Rs. 1355.47, which has already
been offered to tax by the assessee.
85. In view of the order of the learned assessing officer as well as the order of the coordinate
bench in assessee‘s own case for earlier years, we confirm the finding of the learned CIT A
in deleting the addition of 21.74 crores on account of interest capitalization. Consequently,
ground number 3 of the appeal of the revenue for assessment year 2007 – 08 is dismissed.
86. Therefore ITA number 4110/Del/2013 filed by the learned deputy Commissioner of income
tax, New Delhi for assessment year 2007 – 8 is dismissed. Appeals of the assessee for AY
2007-08 and 2008-09 are also party allowed.
87. Order pronounced in the open court on 19 /11/2018.
-Sd/- -Sd/-
(DIVA SINGH) (PRASHANT MAHARISHI)
JUDICIAL MEMBER ACCOUNTANT MEMBER
ITA No 4249 / Del/2012, 4110/Del/2013 & 6337/Del/2013
A Y 2007-08 and 2008-09
Jindal Steel Limited Vs ACIT Cen Circle 4(1) , New Delhi
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Dated: 19 /11/2018
A K Keot
Copy forwarded to
1. Applicant
2. Respondent
3. CIT
4. CIT (A)
5. DR:ITAT
ASSISTANT REGISTRAR
ITAT, New Delhi