2024 (5) TMI 1558 - AT - Income Tax

TP Adjustment - issuance of Letters of Comfort (LOC) to associated enterprises (AEs) - HELD THAT - The issue is squarely covered by the order of co-ordinate bench in assessee s own case for A.Y. 2008-09 2024 (2) TMI 921 - ITAT MUMBAI Further the LOC is continuing from earlier years. The coordinate benches of earlier years are decided in favour of assessee. In earlier years the same addition are fully deleted. We cannot circumvent the orders of coordinate bench. DRP directed @1.5% adopt on ALP. During the hearing the DR was unable to submit any contrary judgement against the order of ITAT. The addition is directed to be deleted. Accordingly the ground of the assessee succeeds. Interest charged on delayed receivable from AEs - AR placed that the interest is charged on outstanding receivable from AEs - assessee itself charged the interest on outstanding @6% to 10% without allowing any credit period - TPO determined interest @13.10%. But the DRP held prime lending rate to be charged - HELD THAT - The issue is squarely covered by the order of ITAT in assessee s own case in 2024 (2) TMI 921 - ITAT MUMBAI (supra). The average LIBOR rate for the year under consideration submitted by the ld. AR is less than the interest charged by the assessee. Therefore we cannot circumvent the order of coordinate bench and no further adjustment is required in this regard. Accordingly the TP adjustment is deleted. Non-recovery of interest in respect of loan to AEs - AR claimed that the own funds were utilized for interest free loans to the subsidiary - HELD THAT - We notice that the assessee had granted loan to TATA West Asia FZE (wholly owned subsidiary of the assessee) during the financial year 2008-09 that no new loan has been granted during the year under consideration. AE incurred a bad debt due to which its Net Assets fell below 75% of its share capital and hence money was advanced by the appellant to comply with JAFZA rules as quasi equity. Therefore such loan / advances shall not attract any interest. From the above it is clear that the loan was given for the purpose of business and therefore in our view no interest should be disallowed keeping in view the decision of S.A.Builders Ltd 2006 (12) TMI 82 - SUPREME COURT There is also merit in the submissions of the assessee that even otherwise the loan was granted from interest free funds i.e. receipts from the maturity of mutual funds. Considering these facts non-recovery of interest from interest free loan the addition of interest amount is quashed. Disallowance of exemption claimed by the assessee u/s 14A - HELD THAT - From the calculation of capital the investment was made from assessee s own funds. DR in argument asked to implement Finance Bill 2021 in relation to amendment under section 14A. But in contrary the Ld.AR relied on the judgement of Ira Infrastructure India Ltd 2022 (7) TMI 1093 - DELHI HIGH COURT Accordingly this particular amendment is not effective for the impugned appeal. Related to Section 14A we respectfully follow the order of South Indian Bank Ltd 2021 (9) TMI 566 - SUPREME COURT In our considered view the addition should be restricted to @.5% only those investments which have yielding income amount to Rs.2255.02 lakhs. DR has not circumvented the offer made by the assessee. Accordingly the entire addition U/s 14Ais directed to restrict amount to Rs. 11.28 lakhs. Disallowance of professional fees paid to Deloitte Touche Tohmatsu for market research and survey - HELD THAT - Assessee company is active in the global export market for leather footwear and manufacturer of leather footwear to major global brands like Hush Puppies Zara Marks and Spencer etc. with annual footwear exports of over Rs. 150 crores. So the expenses to DHS for exploring local market is well acceptable before the bench. We respectfully follow the order of Alembic Chemical Works Co. Ltd 1989 (3) TMI 5 - SUPREME COURT and we follow the order of Asian Paints 2024 (3) TMI 542 - ITAT MUMBAI DR was unable to place any contrary judgment against the submission of the AR. We set aside the appeal order in this ground. Professional charges paid - HELD THAT - The issue is already decided against the assessee and matter is pending before the Hon ble jurisdictional High Court. Accordingly we follow the order of our co-ordinate bench 2024 (2) TMI 921 - ITAT MUMBAI (supra) and the ground of the assessee is dismissed.

Summary

1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered by the Tribunal in this appeal include:

(a) Whether the transfer pricing adjustments made by the Assessing Officer (AO) and Dispute Resolution Panel (DRP) regarding issuance of Letters of Comfort (LOC) to associated enterprises (AEs) are valid, particularly whether issuance of LOC constitutes an international transaction and whether a commission should be charged on LOCs.

(b) Whether the interest charged on delayed remittance of export sales proceeds from AEs at a rate higher than that charged by the assessee is justified, and the appropriate arm's length interest rate applicable.

(c) Whether notional interest on interest-free shareholder loans granted to AEs is chargeable, and if so, at what rate and on what basis.

(d) Whether the disallowance of interest expenditure on borrowed capital under section 14A and related provisions is justified, including the application of Rule 8D and the nexus between borrowed funds and investments yielding exempt income.

(e) Whether the disallowance of professional fees paid to Deloitte Touche Tohmatsu for market research and survey is sustainable, specifically whether such expenditure is revenue or capital in nature and incurred wholly and exclusively for business purposes.

(f) Whether the disallowance of professional fees paid to Vaishnavi Corporate Communications Pvt Ltd for media and public relations services is justified.

(g) Whether interest charged under sections 234D and 244A of the Income Tax Act is correctly levied.

(h) Whether penalty under section 271(1)(c) is rightly imposed given the disclosure of facts in the return and transfer pricing report.

2. ISSUE-WISE DETAILED ANALYSIS

(a) Transfer Pricing Adjustment on Letters of Comfort (LOC)

Legal framework and precedents: The issue revolves around the definition of "international transaction" under section 92B of the Income-tax Act, 1961, and the applicability of transfer pricing provisions. The Tribunal relied on earlier coordinate bench decisions and judicial pronouncements including the Hon'ble Karnataka High Court ruling in United Breweries (Holding) Ltd. vs. Karnataka State Industrial Investment and Development Corporation, which distinguished LOCs from guarantees, holding LOCs as unilateral assurances without binding contractual obligations.

Court's interpretation and reasoning: The Tribunal noted that LOCs do not constitute enforceable contracts or guarantees and do not impose any legal obligation on the issuer towards the bank in case of default by the AE. The Tribunal referred to OECD Guidelines (July 2011), highlighting that incidental benefits from passive association do not amount to intra-group services requiring remuneration.

Key evidence and findings: The assessee issued LOCs aggregating Rs. 735.94 crores, without incurring any cost or employing assets. Prior years' decisions in the assessee's own case for AY 2005-06, 2006-07, 2007-08, and 2008-09 had held issuance of LOCs not to be international transactions and disallowed transfer pricing adjustments.

Application of law to facts: Following these precedents, and absent any new adverse material, the Tribunal held that the issuance of LOCs does not constitute international transactions and no commission or adjustment under transfer pricing provisions is warranted.

Treatment of competing arguments: The Revenue contended that commission should be charged as the assessee did not receive any commission from AEs for LOC issuance. The Tribunal rejected this, emphasizing the legal distinction between LOCs and guarantees and the binding nature of contracts.

Conclusion: The Tribunal deleted the addition relating to LOCs, allowing grounds 1.1 to 1.12.

(b) Interest on Delayed Remittance of Export Sales Proceeds

Legal framework and precedents: The arm's length principle under section 92C and the first proviso to section 92C(2) require benchmarking of interest rates. The Tribunal referred to its own earlier decision for AY 2008-09 and the Delhi High Court decision in CIT vs. Cotton Naturals India Pvt. Ltd., which held that interest rates should be based on the currency in which credit is extended (e.g., LIBOR for foreign currency) rather than domestic prime lending rates.

Court's interpretation and reasoning: The Tribunal observed that the assessee charged interest @6% to 10% on delayed payments, which was higher than the average LIBOR rate of 4.74% for the year. The DRP's direction to apply the bank prime lending rate (PLR) of India was considered inappropriate for foreign currency transactions.

Key evidence and findings: The assessee's own interest charged exceeded the LIBOR benchmark. The Revenue failed to produce contrary evidence.

Application of law to facts: The Tribunal held that the arm's length price for interest on delayed receivables should be based on the currency of the loan and that the assessee's charging of interest was at arm's length.

Treatment of competing arguments: The Revenue argued for higher interest based on domestic PLR; the Tribunal rejected this given the foreign currency context and prior coordinate bench rulings.

Conclusion: The Tribunal deleted the transfer pricing adjustment on this ground, allowing grounds 1.13 and 1.18.

(c) Notional Interest on Interest-Free Shareholder Loan to AEs

Legal framework and precedents: The principle established by the Hon'ble Supreme Court in S.A. Builders Ltd. vs. CIT (288 ITR 1) was relied upon, which allows interest deduction if there is a nexus between the borrowed funds and advances made to sister concerns for commercial expediency.

Court's interpretation and reasoning: The assessee granted interest-free loans to its wholly owned subsidiary located in Jebel Ali Free Zone (JAFZA), where regulatory rules require maintaining net assets at 75% of share capital. The loan was quasi-equity, granted to comply with JAFZA regulations and to protect the investment.

Key evidence and findings: Board resolution evidencing the purpose of the loan, audited financials showing own funds exceeding loan amount, and regulatory provisions were considered.

Application of law to facts: The Tribunal held that since the loan was made from own funds and for business purposes, no interest disallowance should be made. The non-recovery of interest on such quasi-equity loans was justified.

Treatment of competing arguments: The Revenue argued for disallowance of notional interest; the Tribunal found no material to support this and relied on the Supreme Court precedent.

Conclusion: The addition of Rs. 26,84,253/- as notional interest was quashed, allowing ground no. 2.

(d) Disallowance of Interest Expenditure under Section 14A and Related Provisions

Legal framework and precedents: Section 14A disallows expenditure incurred in relation to exempt income. Rule 8D prescribes the manner of computing disallowance. The Tribunal referred to the Supreme Court decision in South Indian Bank Ltd. vs. CIT (438 ITR 1) and Delhi High Court's judgment in PCIT vs. Ira Infrastructure India Ltd. (2022) 141 taxmann.com 289.

Court's interpretation and reasoning: The Tribunal noted that the assessee's investments were made from own funds, which exceeded the total investments. The interest expenditure related to export credit and business operations, not to investments yielding exempt income. The Tribunal accepted the assessee's computation restricting disallowance to 0.5% of investments yielding exempt income.

Key evidence and findings: The assessee's detailed computation, audit reports, and prior years' decisions were considered.

Application of law to facts: The Tribunal held that the disallowance under section 14A should be restricted to Rs. 11.28 lakhs and that the amendments to section 14A by Finance Act, 2021, were not applicable to the assessment year in question.

Treatment of competing arguments: The Revenue urged application of the amended provisions and higher disallowance; the Tribunal rejected this based on precedents and facts.

Conclusion: The disallowance under section 14A was restricted, allowing ground no. 3.

(e) Disallowance of Professional Fees Paid to Deloitte Touche Tohmatsu

Legal framework and precedents: Expenditure wholly and exclusively incurred for business purposes is allowable under the Act. The Tribunal relied on the Hon'ble Supreme Court decision in Alembic Chemical Works Co. Ltd vs. CIT (177 ITR 377) and coordinate bench decision in Asian Paints vs. ACIT (160 taxmann.com 356).

Court's interpretation and reasoning: The expenditure related to market opportunity assessment for the leather footwear business in India, aimed at extension and better conduct of existing business. The Tribunal held that such expenditure is revenue in nature and has a direct nexus to business income.

Key evidence and findings: The scope of work, nature of business, and prior judicial principles on capital vs. revenue expenditure were examined.

Application of law to facts: The Tribunal concluded that the expenditure was incurred wholly and exclusively for business and was revenue in nature.

Treatment of competing arguments: The Revenue contended the expenditure was capital and not related to existing business; the Tribunal rejected this.

Conclusion: The disallowance was set aside, allowing ground no. 4.

(f) Disallowance of Professional Fees Paid to Vaishnavi Corporate Communications Pvt Ltd

Legal framework and precedents: The Tribunal relied on its own earlier decision in the assessee's case for AY 2008-09 (ITA No. 537/Mum/2013) and principles relating to substantiation of professional services.

Court's interpretation and reasoning: The assessee failed to provide cogent evidence of services rendered by Vaishnavi Corporate Communications Pvt Ltd. The Tribunal found no basis to allow the expenditure.

Key evidence and findings: Lack of agreement or documentation demonstrating professional services.

Application of law to facts: The Tribunal upheld the disallowance.

Treatment of competing arguments: The assessee accepted the dismissal of the ground.

Conclusion: Ground no. 5 was dismissed.

(g) Interest Charged under Sections 234D and 244A

The assessee challenged the levy of interest under these sections. The Tribunal noted the grounds but no detailed adjudication was recorded in the text provided. The grounds were raised but not specifically decided in the excerpt.

(h) Penalty under Section 271(1)(c)

The assessee contended that penalty was wrongly imposed as all facts and details were disclosed in the return and transfer pricing report under section 92E. The Tribunal noted the ground but no detailed decision was recorded in the provided text.

3. SIGNIFICANT HOLDINGS

"The issuance of Letter of Comfort by the assessee did not incur any cost. The issuance of Letter of Comfort has no bearing on the profit, income or loss as the assessee did not incur any cost or expenditure for issuing such Letter of Comfort and it does not constitute international transaction under section 92B of the Act."

"Letter of Comfort merely indicates the appellant's assurance that respondent would comply with the term of financial transaction without guaranteeing performance in the event of default."

"An associated enterprise should not be considered to receive an intra-group service when it obtains incidental benefits attributable solely to its being part of a larger concern, and not to any specific activity being performed."

"The arm's length price of the credit extended by the assessee to its associated enterprises outside India is the rate of interest prevailing outside India. PLR primarily relates to the lending transactions in Indian Rupees and cannot be applied to transactions of lending in foreign currency such as US Dollars."

"Once it is established that there was nexus between the expenditure and the purpose of 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 having regard to the circumstances of the case."

"The financial outlay under the agreement was for the better conduct and improvement of the existing business and should, therefore, be held to be a revenue expenditure."

"The disallowance under section 14A should be restricted to the expenditure relating only to investments yielding exempt income and computed in accordance with Rule 8D."

Final determinations:

(i) Transfer pricing adjustments on issuance of LOCs are not sustainable; no commission or adjustment is warranted.

(ii) Interest on delayed export proceeds should be benchmarked to foreign currency rates (e.g., LIBOR), and the assessee's charged interest was at arm's length.

(iii) No notional interest disallowance on interest-free shareholder loans given for business and regulatory compliance purposes.

(iv) Disallowance under section 14A is to be limited to expenditure attributable to exempt income investments, and the assessee's computation restricting disallowance to Rs. 11.28 lakhs is accepted.

(v) Professional fees paid for market research related to business expansion are allowable as revenue expenditure.

(vi) Professional fees paid without substantiation of services rendered are disallowed.

(vii) Grounds relating to interest under sections 234D, 244A, and penalty under section 271(1)(c) were raised but not specifically adjudicated in the text provided.