2025 (5) TMI 184 - AT - Income Tax

Disallowance made u/s. 14A r.w.r.8D - Mandation to record satisfaction - CIT(A) has arrived at the conclusion that assessing officer has failed to record dissatisfaction with respect to the correctness of the claim of expenditure made by the assessee after considering the various decisions of the courts - HELD THAT - ITAT Mumbai in the case of Trent Limited 2024 (12) TMI 1565 - ITAT MUMBAI wherein after following the decision of Maxopp Investment Ltd. others 2018 (3) TMI 805 - SUPREME COURT it is held that disallowance u/s 14A cannot be made where no satisfaction has been recorded by the assessing officer. No reason to interfere in the decision of ld. CIT(A). Disallowance of notional interest expenditure u/s 36(1)(iii) - CIT(A) has deleted such disallowance of interest expenditure after following the decisions of the ITAT on this recurring issue - HELD THAT - It is undisputed fact that assessee has not debited any interest expenditure in the P L A/c and shown the whole amount as advances towards acquisition of land in the balance sheet. We find that this is recurring issue which has been decided in favour of the assessee by the ITAT Mumbai in assessee s own case for A.Y. 2014- 15 and earlier years. It is also undisputed fact that the interest free funds available with the assessee were more than the advances given to the aforesaid party. Looking to this fact the ITAT in its decision in the case of the assessee for A.Y. 2014-15 2024 (4) TMI 88 - ITAT MUMBAI after considering the decision of Reliance Utilities Power Ltd 2009 (1) TMI 4 - BOMBAY HIGH COURT has deleted the addition on the ground that if the interest free funds of the assessee are in the excess of the loan advance then it can be presumed that the funds invested by the said entities are not out of the borrowed fund. TP Adjustment - financial guarantee resulting in adjustment - HELD THAT - We find that ld. CIT(A) has restricted the rate of corporate guarantee to 0.5% or actual cost incurred by the assessee 10% mark up after following the decision of Everest Kento Cylinders Ltd 2015 (5) TMI 395 - BOMBAY HIGH COURT However the ITAT in assessee s own case for the A.Y. 2014-15 2024 (4) TMI 88 - ITAT MUMBAI wherein considered view that the matter should be remanded back to the file of the Id. TPO for the purpose of applying any of the prescribed methods for determining the ALP of the international transactions only to the extent of the finance guarantee given by the assessee on behalf of its AEs. As the performance guarantee has already expired in 2013 there would not be any necessity to determine the ALP and hence we confirm the deletion made by the Id. CIT(A) on this ground. Therefore following the decision of the ITAT this issue remanded to the file of the TPO for determining the ALP as directed in the said order. Accordingly both the grounds of appeal of the Revenue and Assessee are allowed for statistical purpose. Adjustment of performance guarantee - TPO applied CUP method using information called from various banks u/s 133(6) of the Act since there was no internal CUP available - HELD THAT - Revenue has not brought any material on record to controvert the fact that in case an associate enterprise failed to execute a contract then by invoking the performance guarantee issued by the assessee the assessee would be executing the contract on its own by using its own fund without any requirement of paying any fees. Therefore we inclined with the submission of the assessee that no adjustment is required in respect of performance guarantee as discussed. Therefore ground of appeal of the assessee is allowed and grounds of appeal of Revenue are dismissed. Letter of comfort towards credit facilities sanctioned by bank to its subsidiary AE - HELD THAT - Nowhere the TPO and the ld. CIT(A) establish that letter of comfort create any contractual financial obligation on the assessee company for only providing letter of comfort for keeping the investment in its holding company. Therefore following the findings of the ITAT in the decisions as referred supra the addition is deleted. Adjustment of book profit u/s 115JB in relation to expenditure relatable to earning exempt income u/s 14A r.w. Rule 8D - HELD THAT - The assessee while computing difference book profit in terms of section 115JB of the Act had suo moto made adjustment u/s 115JB(2) of the Act of an amount of Rs. 40, 32, 630/- towards administrative cost and interest cost for collection of dividends. The assessing officer while computing the book profit in the assessment order had made further adjustment of an amount (disallowance computed by the assessing officer under Rule 8D of the I.T. Rule). We find that Special Benches of ITAT in the case of Vireet Investment (P) Ltd. 2017 (6) TMI 1124 - ITAT DELHI held that disallowance made under Rule 8D cannot be added while computing book profit u/s 115JB of the Act. Therefore we consider merit in the decision of ld. CIT(A) in restricting the addition u/s 115JB to the extent of suo moto disallowance made by the assessee. Accordingly the appeal of the Revenue is dismissed and cross objection of the assessee is dismissed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in these appeals pertain to the following issues:

(a) Whether the Commissioner of Income Tax (Appeals) was correct in restricting the disallowance under section 14A of the Income Tax Act to Rs. 10,00,000/- despite the Assessing Officer's higher disallowance computed under Rule 8D, and whether the disallowance can be made without recording dissatisfaction as mandated by law and CBDT Circular No. 5/2014.

(b) Whether disallowance under Rule 8D can be adopted while computing book profit under section 115JB, especially in light of the Special Bench decision in Vireet Investments, and whether expenses incurred for earning exempt income should be disallowed in book profit computation.

(c) Whether the disallowance of notional interest expenditure under section 36(1)(iii) on advances for non-business purposes is justified, particularly when interest-free funds were available and advances were made for acquisition of land in the ordinary course of business.

(d) Whether the Transfer Pricing Officer (TPO) and Commissioner of Income Tax (Appeals) correctly determined the arm's length price (ALP) for corporate guarantee fees charged by the assessee to associated enterprises, including the appropriateness of applying a fixed rate of 0.5% based on precedent cases like Everest Kanto, and whether transfer pricing adjustments were properly made considering facts and Rule 108 of the Income Tax Rules.

(e) Whether the issuance of financial guarantees, performance guarantees, and letters of comfort (LOC) constitute international transactions under section 92B of the Income Tax Act, and whether fees or adjustments for such guarantees are warranted.

(f) Whether the letter of comfort issued by the assessee creates any contractual financial obligation and whether it should attract transfer pricing adjustments.

(g) Whether the Assessing Officer and appellate authorities correctly applied the law and judicial precedents in determining disallowances and transfer pricing adjustments, including treatment of shareholder or stewardship activities versus commercial transactions.

2. ISSUE-WISE DETAILED ANALYSIS

(a) Disallowance under Section 14A and Rule 8D

Legal Framework and Precedents: Section 14A disallows expenditure incurred to earn exempt income. Rule 8D prescribes the method for computing such disallowance when the Assessing Officer is dissatisfied with the assessee's claim. CBDT Circular No. 5/2014 clarifies that disallowance can be made even if no exempt income is earned in the relevant year. Supreme Court decisions (Maxopp Investment Ltd. vs CIT and Godrej Boyce Manufacturing Co. Ltd. vs DCIT) require Assessing Officer to record satisfaction before invoking section 14A.

Court's Interpretation and Reasoning: The Assessing Officer computed disallowance under Rule 8D at Rs. 7.37 crores without recording any specific dissatisfaction regarding the assessee's claim. The CIT(A) restricted disallowance to Rs. 10 lakhs, relying on the assessee's suo-moto disallowance and prior ITAT and Bombay High Court decisions affirming the need for recorded dissatisfaction. The Tribunal upheld CIT(A)'s order, emphasizing the absence of recorded dissatisfaction and reliance on authoritative precedents.

Application of Law to Facts: Since the Assessing Officer did not record dissatisfaction, mechanical application of Rule 8D was impermissible. The assessee's suo-moto disallowance was considered appropriate.

Treatment of Competing Arguments: Revenue argued for higher disallowance without recorded dissatisfaction; the Tribunal rejected this as contrary to settled law.

Conclusion: Disallowance under section 14A restricted to Rs. 10 lakhs; Revenue's appeal dismissed on this ground.

(b) Disallowance under Section 14A in Computation of Book Profit under Section 115JB

Legal Framework and Precedents: Section 115JB mandates computation of book profit for Minimum Alternate Tax (MAT). The Special Bench decision in Vireet Investments held that disallowance under Rule 8D cannot be added back while computing book profit.

Court's Interpretation and Reasoning: The Assessing Officer made an additional disallowance of Rs. 7.37 crores under section 14A for book profit computation. CIT(A) restricted this to the amount disallowed suo-moto by the assessee. The Tribunal upheld CIT(A)'s view, following the Special Bench ruling.

Application of Law to Facts: Only the actual expenditure debited to profit and loss account should be considered for adjustment under section 115JB, not the disallowance computed under Rule 8D.

Conclusion: Additional disallowance under section 14A for book profit computation disallowed; Revenue's appeal dismissed.

(c) Disallowance of Notional Interest Expenditure under Section 36(1)(iii)

Legal Framework and Precedents: Section 36(1)(iii) disallows interest expenditure on funds borrowed for non-business purposes. The principle of consistency applies to recurring issues.

Court's Interpretation and Reasoning: The Assessing Officer disallowed Rs. 19.81 crores as notional interest on advances made for acquisition of land. CIT(A) deleted the disallowance, relying on earlier ITAT decisions in assessee's own case for prior years and the fact that advances were shown as work-in-progress (current assets), not debited as interest expense.

Application of Law to Facts: The assessee had sufficient interest-free funds and the advances were part of regular business activities. The notional interest disallowance was therefore unwarranted.

Treatment of Competing Arguments: Revenue contended advances were for non-business purposes; Tribunal rejected on facts and prior consistent decisions.

Conclusion: Disallowance of notional interest deleted; Revenue's appeal dismissed.

(d) Transfer Pricing Adjustment on Corporate Guarantee Fees

Legal Framework and Precedents: Section 92C and Rule 108 prescribe methods for determining ALP in international transactions. The Bombay High Court's decision in CIT vs Everest Kanto Cylinders Ltd. restricts guarantee fees to 0.5% or actual cost plus markup. Transfer pricing is highly fact-specific, requiring consideration of all relevant factors.

Court's Interpretation and Reasoning: The TPO applied CUP method based on bank data, arriving at an average guarantee fee of about 1.66%. CIT(A) reduced this to 0.5% following Everest Kanto. The assessee contended that transfer pricing study must be case-specific and that the Everest Kanto rate should not be mechanically applied. The Tribunal referred to its own prior decision for the assessee's earlier year, which remanded the matter to the TPO for application of prescribed methods under Rule 108.

Application of Law to Facts: Since internal CUP was unavailable, external CUP was applied but without full appreciation of facts. The Tribunal held that ALP determination should be remanded for fresh examination applying prescribed methods and considering all factors.

Treatment of Competing Arguments: Revenue supported TPO's external CUP method; assessee argued for fact-specific analysis and reliance on judicial precedents excluding mechanical application of Everest Kanto rate.

Conclusion: Transfer pricing adjustment on corporate guarantee fees remanded to TPO for fresh determination of ALP applying Rule 108 methods.

(e) International Transaction Status and Transfer Pricing on Financial Guarantee, Performance Guarantee, and Letter of Comfort

Legal Framework and Precedents: Section 92B defines international transactions. Safe Harbour Rules and Rule 10TA(c) distinguish between explicit corporate guarantees and letters of comfort. Judicial precedents hold that letters of comfort and performance guarantees may not constitute international transactions if they do not create financial obligations.

Court's Interpretation and Reasoning: The TPO treated financial guarantees as international transactions and made adjustments. CIT(A) reduced guarantee fees following Everest Kanto. The assessee contended that issuance of LOC, performance guarantee, and financial guarantee are shareholder or stewardship activities without financial cost or risk, hence outside the scope of international transactions.

For performance guarantees, the Tribunal relied on decisions (KEC International Ltd., Afcons Infrastructure Ltd.) establishing that where the assessee bears the risk and rewards, no adjustment is warranted for performance guarantees issued to AEs. For letters of comfort, the Tribunal noted that they do not create contractual financial obligations and thus are not international transactions, supported by Safe Harbour Rules and multiple ITAT decisions.

Application of Law to Facts: The guarantees and LOC issued by the assessee did not involve cost or risk warranting transfer pricing adjustments. The performance guarantee risk was borne by the assessee, and the LOC was a mere assurance without indemnity obligation.

Treatment of Competing Arguments: Revenue argued for adjustments based on guarantee fees; Tribunal rejected these, emphasizing the nature of transactions and relevant precedents.

Conclusion: No transfer pricing adjustments warranted for performance guarantees and letters of comfort; adjustments deleted and appeals of Revenue dismissed on these grounds.

3. SIGNIFICANT HOLDINGS

"Subsection (2) of section 14A provides that assessing officer shall determine the expenditure incurred in relation to the exempt income in accordance with Rule 8D if the assessing officer, having regard to the accounts of the assessee, is not satisfied that the correctness of claim of assessee in respect of such expenditure in relation to exempt income. Such dissatisfaction should be recorded by the assessing officer after examining the accounts of the assessee."

"The Hon'ble Supreme Court in Maxopp Investment Ltd. vs CIT held that the assessing officer was not empowered to invoke the provisions contained u/s 14A r.w. Rule 8D in a mechanical manner without recording satisfaction that claim of the assessee is not correct."

"The Special Bench of the ITAT in Vireet Investments held that disallowance made under Rule 8D cannot be added while computing book profit u/s 115JB of the Act."

"Advances given towards acquisition of land are in the course of regular business activities and thereby, there would not be any notional disallowance of interest expenditure."

"Corporate guarantee issued in favour of the AE is an international transaction. However, the arm's length price for guarantee fee should be determined based on prescribed methods under Rule 108 and not by mechanical adoption of rates decided in other cases."

"Performance guarantee issued by the assessee on behalf of its AE does not attract transfer pricing adjustment where the assessee bears the risk and rewards of the contract and no commission is charged."

"Letter of comfort does not create any contractual financial obligation on the assessee and is not an international transaction within the meaning of section 92B."

Final determinations include dismissal of Revenue's appeals on disallowance under section 14A and notional interest under section 36(1)(iii), remand of transfer pricing adjustment on corporate guarantee fees for fresh determination, and deletion of adjustments relating to performance guarantees and letters of comfort.