TMI Blog2014 (10) TMI 469X X X X Extracts X X X X X X X X Extracts X X X X ..... lding to step down subsidiary - CUP method can be applied and the LIBOR or other bank rate linked rate is generally taken as a rate for comparable uncontrolled transaction - there is a difference in the nature of transaction and there is also a difference in the nature of the enterprises, including their inter se commercial relationship, entering into this transaction - The differences are so fundamental that these differences, to use the phraseology employed in Rule 10 B (1)(a)(ii), "could materially affect the price in the open market" - the application of LIBOR plus rate or, for that purpose, any bank rate will be inappropriate to this case. Price of interest free advances - What would be the price at which such interest free advances could be given in comparable uncontrolled transactions – Held that:- If the investments are in the nature of equity, then, they cannot be treated as loans and advances - for coming to a definite conclusion in this regard necessary details need to be examined from the books of account and other related documents. Since this aspect has not been properly examined either by the TPO or by the DRP, the matter is to be remitted back to the AO/TPO for f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sment year 2008-09. 2. Assessee has raised as many as 29 main grounds and one additional ground. At the outset, learned AR expressed his intention not to contest ground Nos. 15, 16 17. Hence, these grounds are dismissed as not pressed. Ground No. 29 being general in nature need not be adjudicated. Out of the remaining ground Nos. 1 to 8 are in respect of addition made on account of Transfer Pricing Adjustment by computing the Arms Length Price of the interest to be charged on the advances made to overseas subsidiaries. 3. Briefly the facts, as emanate from record are, assessee is a global provider of customized information technology (IT) solutions and engineering services to a number of clients in USA. Assessee generally provides services in knowledge solutions, IT and software solutions, technology, engineering services etc. Assessee, directly or indirectly, owns a number of subsidiary companies overseas. The financial results of the company as per its annual report for the accounting period 2007-08 are as under: Operating revenue ₹ 1112,79,06,165 Operating Cost ₹ 996,71,63,318 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... any interest on such advances made to subsidiaries. TPO being of the view that loans to the subsidiaries should carry interest at arm's length proceeded to determine the same. TPO opined that as assessee is the tested party, the prevalent interest that could have been earned by the assessee had the loan been advanced to an unrelated party in India with the same weak financial health as that of AE, should be considered as arm's length interest under CUP method. Further, TPO noted that the loans advanced to the subsidiaries are also not secured. 5. TPO observed that while advancing loans financial institutions generally consider four risk factors, such as, financial risk, credit risk, business risk and structural risk. He noted that while Government Bonds are subjected to only interest rate risk, but, corporate bonds issued by the companies in India are subjected to credit risk in addition to interest rate risk. As per the credit rating of the most reputed loan credit rating agency CRISIL, the ratings scale vary between 'AAA' to 'D'. Government bonds are considered to be in 'Zero' risk category i.e. above 'AAA' rating whereas 'D' gr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f internal accruals and no borrowed funds were utilized. It was submitted that subsidiaries have also converted the investment made in equities to shares and issued share certificates by allotting shares. It was, therefore, submitted that since the investments are in the nature of share application money, it cannot be treated as loans and advances. Alternatively, it was also submitted by the assessee that even if the investments are treated as loans and advances, the risk basis rate adopted by the TPO would have no applicability, arm's length interest has to be considered by applying LIBOR +% point basis. 7. The DRP after considering the submissions of the assessee and the facts and materials on record as well as the report submitted by the AO noted that in 3CEB report filed along with the return of income, the auditors have stated that out of ₹ 35,43,69,090/- to the subsidiaries, an amount of ₹ 2,14,36,960/- was only classified as investment in equity in Prithvi Solutions Inc., USA and Prithvi Quatar, UAE and rest of the amounts (Rs. 30,49,93,000) were mentioned as loans given, That apart, an amount of ₹ 2,79,39,130/- was shown as advances given for legal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of interest at LIBOR+2% instead of domestic interest rate. As a consequence of the order passed by the DRP, AO finalized the assessment vide order dated 23/11/2012 by determining the arm's length rate of interest at ₹ 1,67,08,838/- and made the addition of the said amount to the income of the assessee. 8. Reiterating the submissions made before the DRP, the learned AR submitted before us that though initially the amount advanced to the subsidiaries, was treated as loan, but, subsequently, the subsidiary has allotted shares to the assessee, which the subsidiary could not inform assessee due to oversight. For that reason alone, the amount advanced was wrongly mentioned as loan in the auditors report in form No. 3CEB. However, that does not alter or change the nature and character of the investment made by the assessee in the subsidiaries. It was submitted that when there is no dispute to the fact that the subsidiary has allotted shares to the tune of ₹ 30,00,60,000/-, the amount advanced cannot be considered as a loan. In this context, the learned AR placed strong reliance on the decision of ITAT, Hyderabad Bench in case of M/s Vijai Electricals Ltd. Vs. ACIT (IT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e DRP and other statutory authorities. As can be seen from the facts on record, admittedly, assessee has not complied to the notice issued by the TPO calling for various informations and evidences, which led to the rejection of the TP study and ultimate determination of arm's length interest by applying the rate of 17.2%. However, as can be seen from the order of the DRP, in course of proceeding before the DRP, assessee has not only furnished details with regard to investments made in the subsidiaries but has taken a specific stand that the investments are towards equity. It is also a fact on record that before the DRP assessee has produced share allotment certificates towards allotment of shares to the tune of ₹ 30,60,50,000/-. Similarly, assessee claims to have submitted revised auditor's report before the departmental authorities. However, the revised audit report has not been referred to either by the DRP or by the TPO/AO. Further, assessee's claim that the investments are towards equity to a great extent is borne out from the fact that shares have actually been allotted to the assessee. If that is the case investments made by the assessee cannot be treated as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... fore, the assessee could not also have, without the permission of the Reserve Bank of India, entered into loan agreements with a provision of conversion of such loans equity either. It is only elementary legal position that what could not have been done directly could not have done indirectly also. There is thus not much of a merit in the stand of the revenue authorities that in the absence of a specific mention about conversion of loan into equity, it cannot be presumed that the interest free loans could not have been in the nature of quasi capital. As to the position that the relationship between the assessee and Micro USA was not of a lender and borrower simplicitor - a relationship which is essence of a loan transaction, it will be clear from the following observations in the annual financial statement of Micro USA : As of March 31, 2002, the company had generated an accumulated deficit of US $ 27.48 million and had a net working capital surplus of US $ 3.31 million. Net cash used in operating activities for the year ended March 31, 2002 was US $ 39.49 million. Until the management is able to achieve its plan for profitable future operations, the company continues to be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee step process which requires that (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 arms length price in respect of the property transferred or services provided in the international transaction; (Emphasis by underlining supplied by us) 18. Therefore, even when we take LIBOR plus rate as the base rate for an advance in step 1 of the above computation process, such base rate will have to adjusted inter alia for the differences .. (a) between the international transaction and the comparable uncontrolled transaction, and (b) between the enterprises entering into such transactions, which could materially affect the price in the open market . On both of these counts, adjustments will have to be necessarily made in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ate to this case. 19. The next logical question, therefore, is as to what would be the price at which such interest free advances could be given in comparable uncontrolled transactions. In other words, in case the assessee and the Micro USA were not associated enterprises in legal sense of that expression, at what rate the assessee would have granted advances pending approval for capital subscription in a company which is playing such a vital role in its business plans. It is so for the reason, as we begun by pointing out, the whole purpose of the arm's length price adjustment is to nullify the impact of management, capital and control interrelationship between the associated parties. In our humble understanding, on the pure commercial factors and notwithstanding the management, capital and control relationship between the parties, such non interest bearing advances were equally justified even if the assessee and Micro USA were independent enterprises. Of course, we are alive to the fact that but for the management, capital and control interrelationship, Micro USA could not have played such a strategically significant role in assessee's business but then right now we are ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... period of loan but not exceeding the period of 12 months. The calculation for more than 12 months by AO has to be disapproved. This ground of the assessee is considered to be allowed for statistical purposes. 13. The next issue as raised in Ground Nos. 9, 10 11 relates to disallowance of an amount of ₹ 25,16,90,008/- for not deducting tax at source. 14. Briefly the facts relating to the issue are during the assessment proceeding, the AO noticed that the auditors in their report in Form 3CD have qualified under Sl. No. 17(f) that an amount of ₹ 25,16,90,008/- is inadmissible u/s 40(a). However, in the computation of income, assessee has not added back the same to the profit as per P L A/c. The AO noticed that under the provisions of section 40(a) of the Act, any interest, royalty, fees for provisional technical services payable to a contractor for carrying out any work on which tax is deductible at source under Chapter XVII-B and such tax has not been deducted or after deduction has not been paid in to Government account within the prescribed time, then, such amount shall not be deducted while computing income under the head 'profit and gains of business or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ax at source. In view of the conflicting claim of the assessee and the department it needs to be established on record whether the assessee has in fact incurred the expenditure of ₹ 25,16,90,008/- by verifying the books of account and other related document. In this view of the matter, we are inclined to remit this issue back to the file of the AO for examining afresh and taking a decision after looking into the books of account and other evidences, which may be produced by the assessee. The assessee must be given a reasonable opportunity of being heard in the matter. These grounds are allowed for statistical purposes. 19. The next issue as raised in ground No. 12 to 14 is in respect of disallowance of ₹ 66,77,993/- sustained by the DRP out of the total disallowance of ₹ 5,03,24,607/- made by the AO. 20. Briefly the facts are during the assessment proceeding while examining assessee's compliance to TDS provisions on the expenditure debited to profit loss account, the AO noticed that, the assessee has not deducted tax at source as per the provisions of section 200 of the Act, on payments made to various persons under the head 'advertising and sales& ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... licable. 23. The learned DR on the other hand supported the orders of the DRP on this issue. 24. After considering the submissions of the parties, we are of the view that in respect of payment made to M/s Kedia Silk House, the matter needs to be examined afresh by the AO. If the amount paid to M/s Kedia Silk towards logo expenses is on principal to principal basis then section 194C would not be applicable. However, for coming to such conclusion, the contract order between the assessee and the party concerned needs to be examined. Accordingly, we remit the matter back to the file of the AO for deciding the issue afresh after extending an opportunity of being heard to the assessee. So far as payment of rent for Dubai Office is concerned, the AO has not disputed the fact that it was incurred outside India. However, alleging that it was paid through Standard Chartered Bank of India, AO has commented that such payment attracts section 194I. DRP has also confirmed such view. In our view, the finding of the DRP and AO is not acceptable. When the payment has been made to a party outside India and who is not a resident, the provisions of section 194-I will not be applicable unless suc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s of period of time when these amounts were taken into account in computing income with supporting evidence, the efforts made to recover the advances, etc. As alleged by the AO, since the assessee failed to furnish the informations called for he disallowed the deduction claimed and added back to the income returned by observing that mere writing off advances as irrecoverable is not sufficient to claim deduction as the assessee has to substantiate it with necessary proof. The assessee objected to such disallowance before the DRP. The DRP was also sustained the disallowance by upholding the view of the AO. 30. The learned AR submitted before us that the advances made to the parties have actually become irrecoverable, hence, were written off in the books of account. It was submitted that all the details with regard to the project wise advances made were furnished before the AO as well as DRP. The learned AR submitted that when the department is not questioning the fact that the advances were for the purpose of business, the deduction claimed by the assessee cannot be disallowed. In support of such contention, the learned AR relied upon a decision in case of Padmalaya Telefilms ITA ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d the orders of the revenue authorities as well as other material on record. The learned AR has contended before us that the expenditure incurred was towards cash payments relating to travel and conveyance during the year which was sanctioned and authorized by the Managing Director. It was submitted that since the expenditure are of small amounts, it is not always possible to keep supporting evidence in the form of bills and vouchers. Having considered the submissions of the parties, we are of the view that the AO as well as DRP were not justified in disallowing the entire amount of ₹ 62.60 lakhs incurred towards travelling and conveyance expenditure. It cannot be denied that assessee must have incurred some expenditure on account of travelling and conveyance. Further, considering the turnover of assessee at about ₹ 1112 crores, the expenditure claimed is not that unreasonable. However, considering the fact that the entire expenditure was incurred in cash and the assessee may have inflated the expenditure to some extent, we disallow 10% out of the amount of ₹ 62.60 lakhs claimed towards travelling and conveyance expenditure. This ground is partly allowed. 36. T ..... X X X X Extracts X X X X X X X X Extracts X X X X
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