TMI Blog2014 (11) TMI 845X X X X Extracts X X X X X X X X Extracts X X X X ..... submitted that when no interest was charged by the assessee as per the agreement on moratorium for one year, then no notional interest can be added under transfer pricing adjustment - The transaction of loan given to the AE is an international transaction and subjected to ALP as per the transfer pricing provisions of Income Tax Act - The assessee has raised an alternative plea that even in case the transfer pricing provisions are applicable in respect of the non charging of interest on loan given to AE, it is not taxable in India as per the provisions of Article 11 of Indo-Mauritius DTAA because the said interest was not paid to the assessee - the provisions of Article 11 are applicable in the case of interest arising in the contracting state and paid to the resident of another contracting state. It is contemplated under Article 11 of DTAA that the payment is a condition for taxing the interest only in the circumstances when the interest is arising in the contracting state and accrued to the resident of another contracting state and, it is subjected to tax in the other state when it is paid - the provisions of Article 11 defers the taxability of the interest arising but not rec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ation or other material to show that the investment made in the subsidiary at par is at arms length - The assessee has placed reliance on the valuation report of KPMG based of DCF method - in case of investment in the 100% subsidiary of the assessee, the valuation has to be future prospective earning on the capital and should not be based on the present net worth of the subsidiary - Since the investment is for long term and not for earning the capital gain, the valuation should have been based on the discounted cash flow method (DCF) - Since no such report was produced by the assessee before the TPO/AO thus, the matter is to be remitted back to the AO for reconsideration Decided in favour of assessee. Secondary transfer pricing adjustment - Capital infused by the assessee in its subsidiary Held that:- The adjustment on account of notional interest on the additional capital infused by the assessee in the subsidiary is over and above, the adjustment of the entire capital investment amount - it is not an alternative but it is an adjustment of over and above of the entire amount of capital investment DRP was rightly of the view that the transfer pricing adjustment on accoun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... On the facts and in the circumstances of the case and in law, the Ld. DRP and the Ld. AO (following the directions of the DRP) erred in treating the investments in equity shares of the foreign subsidiary as an international transaction u/s 92B(1) and re-characterizing the share application money as a loan and thereby computing interest and making addition of notional interest income on the loan ofRs.l,24,69,9201-. GROUND III: TREATING EQUITY INVESTMENT IN OVERSEAS SUBSIDIARY AS AN INTERNATIONAL TRANSACTION AND ADDING TO THE TOTAL INCOME ₹ 14,15,00,170/- 1. On the facts and in the circumstances of the case and in law, the Ld. DRP and the Ld. AO (following the directions of the DRP) erred in treating the incremental investments in equity shares of the foreign subsidiary as an 'international transaction' u/s. 92B(I) of the Act and adding the entire investment made in previous year to the total income of the Appellant. 2. Ground no. 1 is regarding addition under transfer pricing adjustment on account of interest on loans given to the Subsidiaries/Associate Enterprise. The assessee is engaged in the business of manufacturing and marketing auto components to origin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ring the period under consideration on account of moratorium agreed upon with the AE and further in terms of Article 11 of DTAA with Mauritius, interest paid alone could be subjected to tax. The DRP did not accept the contention of the assessee and held that Article 11 is relevant for taxation of an in come and has no relevance for transfer pricing perspective, which follows the arm s length principle. The DRP has accepted the reasons given by the TPO for adopting the bank lending rate +3% markup on account of risk in giving the loan to AE without any security. Further it was observed by the DRP that the LIBOR rate can be considered for the funds raised overseas and not for the amounts lent by the assessee out of its funds in India. As regards the Moratorium agreed upon by the assessee with its AE in respect of payment of interest on loan, the DRP has held it is not relevant for the issue of arm s length price instead the issue is whether in a comparable transaction with an unrelated party similar concession would have been given. Therefore, the DRP observed that in the absence of any justification or comparable uncontrolled transaction to establish to have foregone the interest ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... referred Article 11 of the Indo Mauritius DTAA and submitted that the Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. The interest in question was not paid by the AE to the assessee, therefore, the same is not taxable in India as per the provisions of Article 11 of Indo-Mauritius DTAA. In support of his contention he has relied upon the decision of this Tribunal in the case of Johnson Johnson Vs. Assistant Director of Income-tax (International Taxation) (32 taxmann.com 102) (third Member decision) wherein, the Tribunal after considering the decision of Hon ble Jurisdictional High Court in the case of Director of Income-tax (International Taxation) Vs. Siemens Aktiongesellschaft dated 22-10-2012 in Income tax appeal no. 124/2010. 7. On the other hand, the Ld. DR has submitted that in the case of Aurionpro Solutions Ltd. vs. ACIT (supra), the Tribunal after considering the other decisions of Tribunal on this issue has held that the transaction of advancing loan to AE falls under the ambit of international transactions as per the terms of section 92B. Further the assessee is a tested party for the pur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the assessee is expected to have been earned from the transaction of advancing loans to the AEs. 8.9 Thus, on principle, we do agree with the DRP on the point of the tested party for determining the Arm's Length interest rate that would have been earned by the assessee by advancing loans to the unrelated third party. 8.10 The Transfer Pricing Regulation are based on the deeming principle by taking into account a hypothecal situation that instead of having transaction with AE had the assessee transacted with unrelated party what would have been the financial/commercial result of that transaction. Thus, the effect of transaction on the income of the assessee is to be seen and considered and not effect on the cost or income of the AE. Therefore, the tested party is always the taxpayer and not the AE. None of the factors under the Transfer Pricing Regulations require to consider whether the AEs would have incurred or earned more or less; but it is always considered whether the assessee had earned more or less by doing a similar transaction with an unrelated parties. 8.11 Even under Rule 10B of the IT Rules, the factors prescribed for inclusion or exclusion of comparabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... /commercial as well as geographical condition in which the assessee is doing business are relevant to be considered for the purpose of determining the arm s length price. However, the Tribunal has followed the earlier decision of the co-ordinate bench to maintain the rule of consistency and accordingly directed the TPO/Assessing Officer to determined the arm s length price by considering the LIBOR + 2% on the loan given to the AE. Accordingly, to maintain the consistency on the point, we direct the Assessing Officer/TPO to determine the arm s length interest by considering the LIBOR + 2% on the transaction of loan given to the AE. 9.1 As regards the non charging of interest by the assessee from its Mauritius bassed AE, we do not agree with the contention of the assessee that because of the assessee agreed for a moratorium of payment of interest, the assessee did not charge the interest for the year under consideration and, therefore, no adjustment can be made under arm s length price. It is pertinent to note that when the transaction betweeen the assessee and its AE falls under the ambit of International transaction as per the provisions of section 92B, then the arm s length pri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ation in this context. The fact that the loan has the RBI's approval does not put a seal of approval on the true character of the transaction from the perspective of transfer pricing regulation as the substance of the transaction has to be judged as to whether the transaction is at arms length or not. The Delhi Bench of ITAT in the case of Perot Systems TSI (India) Ltd. v. DCIT (supra) had considered identical argument and held as follows: 9. Before us, the ld. Counsel of the assessee contended that income means real income and not fictitious income and since the assessee has not earned any income, the same cannot be taxed. Reliance in this regard has been placed upon in the case of CIT v. KRMTT Thiagaraja Chetty Co. reported in 24 ITR 525 (SC) in the case of Morvi Industries Ltd. v. CIT reported in 82 ITR 835 (SC) for the proposition that liability to tax can arise only when there is income. No tax can be charged as notional income on accrual. Further reliance has been placed upon the ruling of Authority for Advance Rulings delivered in the case of Veneburg Group B.V. v. CIT 727 of 2006 for the proposition that in the absence of any income, Transfer Pricing provisions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d. CIT(A) the agreements show that these are loan amount given by the assessee to Associated Enterprises (AEs). This in fact is an admitted position. There is no case that any special feature in the contract make the transaction as capital in nature. It is also an admitted proposition that the assessee has extended the loan to its AE's who are 100% subsidiaries. The Assessee's case is that it has actually not earned any interest and it was commercially expedient to extend these interest free loans. Now it is noted that this is not a case of ordinary business transaction. The question relates to scrutiny of international transaction to determine whether or not the same it as arm's length. The principle of transfer pricing aims at determining the pricing in the situations of cross-border international transactions, where two enterprises which are subject to the same centre or direction or control (associated enterprise) maintain commercially or financially relation with other. In such a situation, the possibility exist that by way of intervention from the centre or otherwise, business conditions must be accepted by the acting units which differs from those which in the sa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Interest arising in a Contracting State and paid to a resident of the other Contracting State may be taxed in that other State. 2. However, subject to the provisions of paragraphs 3 and 4 of this Article, such interest may also be taxed in the Contracting State in which it arises and according to the laws of that State. 3. Interest arising in a Contracting State shall be exempt from tax in that State provided it is derived and beneficially owned by: a. the Government or a local authority of the other Contracting State; b. any agency or entity created or organised by the Government of the other Contracting State; or c. any bank carrying on a bonafide banking business which is a resident of the other Contracting State. 4. Interest arising in a Contracting State shall be exempt from tax in that Contracting State to the extent approved by the Government of that State if it is derived and beneficially owned by any person (other than a person referred to in paragraph 3) who is a resident of the other Contracting State provided that the transaction giving rise to the debt-claim has been approved in this regard by the Government of the first-mentioned Contracting State. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... only in the circumstances when the interest is arising in the contracting state and accrued to the resident of another contracting state and, therefore, the same is subjected to tax in the other state when it is paid. In other words, the provisions of Article 11 defers the taxability of the interest arising but not received and, therefore, it is taxed only when it is received. Article 11 does not exempt the interest arising in a contracting state and accrued to a resident of other contracting state but it makes the same taxable on the event of payment. In the case in hand, when the assessee has not even admitted the interest arised and accrued to the assessee on the loan given to the AE for the assessment year under consideration, therefore, the provisions of Article 11 of Indo-Mauritius treaty cannot be pressed into service. 12. Ground No. 2 is regarding adjustment on account of interest on the share application money in overseas subsidiary. The assessee remitted the share application money on various dates total amounting to ₹ 16,20,24,380/- for the equity shares of its subsidiary PMP Mauritius. Since there was a delay and the shares were allotted after a period of almos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rging interest. The Ld. DR has submitted that in the normal course the application money is kept in escrow account and, therefore, the same cannot be used by the recipient company before the allotment of shares. Thus for the period the money remained with the AE, the assessee has foregone the interest on the said amount which would have been earned in the similar transaction with a third party. 17 We have considered the rival submissions and relevant material on record. At the outset, we note that an identical issue has been considered by Delhi Benches of this Tribunal in the case of Bharti Airtel Limited Vs. Addl. CIT in ITA no. 5816/Del/2012, and held vide its decision dated 11.3.2014 in para 47 to 50 as under:- 47. We find that in the present case the TPO has not disputed that the impugned transactions were in the nature of payments for share application money, and thus, of capital contributions. The TPO has not made any adjustment with regard to the ALP of the capital contribution. He has, however, treated these transactions partly as of an interest free loan, for the period between the dates of payment till the date on which shares were actually allotted, and partly as c ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... icial precedents which have been heavily relied upon by the TPO, as also by the learned Departmental Representative, on which their case rests. None of these decisions, however, deal with the core issue before us i.e. whether a capital contribution can be deemed to be partly an interest free loan, for the period till the shares were actually allotted, and partly as capital contribution, after the subscribed shares were issued by the subsidiary in which capital contribution was made. In the case of Perot Systems TSI India Ltd Vs. DCIT (supra), a coordinate bench of this Tribunal had an occasion to deal with the arm's length price adjustment with regard to interest free advances to the subsidiaries. That was a case in which the assessee, an Indian company, advanced interest-free loans to its 100% foreign subsidiaries. The subsidiaries used those funds to make investments in other step- down subsidiaries. On the question whether notional interest on the said loans could be assessed in the hands of the assessee under the transfer pricing provisions of Chapter X, the assessee argued that the said loans were in fact quasi - equity and made out of commercial expediency. It was als ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the transactions are found to be substantially at variance with the stated form. In the present case, there cannot even a suggestion to hold that this is a bogus transaction because admittedly the subscribed shares capital has indeed been allotted to the assessee. The transaction is thus accepted to be genuine in effect. 50. In view of these discussions, as also bearing in mind entirety of the case, we are of the considered view that the authorities below were in error in treating the payment of share application money, as partly in the nature of interest free loans to the AEs, and, accordingly, ALP adjustment based on that hypothesis was indeed devoid of legally sustainable merits. We delete the impugned adjustment of ₹ 19,15,45,943. The assessee gets the relief accordingly. As we have decided this ground of appeal on the fundamental issue that the payment of share application money could not be partly treated as interest free loan to AE, we see no need to deal with other aspects of the matter. 18. The other decisions of the Tribunal relied upon by the assessee are also on the similar lines as the decision in the case of Bharati Airtel Ltd was followed. Further the r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ength price of the shares at Nil and accordingly recommended the TP adjustment of the entire amount of ₹ 14,15,00,170/- 20. Before DRP, the assessee contended that this transaction would not come within the ambit of the definition of the term international transaction and had been reported only by way of abundant disclosure. The assessee had invested at par value even though the discounted cash flow valuation as per the KPMG report had recommended a much higher value. The DRP did not accept the contention of the assessee and confirmed the adjustment made by TPO/Assessing Officer in this respect. 21. Before us, the Ld. Authorized Representative of the assessee has submitted that when the assessee has made investment by infusing the capital in the subsidiary then the entire amount of investment cannot be treated as income of the assessee by applying the transfer pricing provisions. The TPO applied the net worth method for determination of arm s length price whereas the assessee is the only share holder of the subsidiary and the infusion of further capital will have no effect on the value of the shares held by the assessee rather, this infusion of capital will increase t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... into account the valuation report based on DCF method. 25. The assessee has also raised additional grounds as under:- 1. On the facts and in the circumstances of the case and in law, the Learned Assessing Officer erred in violating the principle of natural justice inasmuch as no opportunity of hearing was given to the appellant before making a reference to the Transfer Pricing Officer u/s. 92CA(1) of the Income tax Act, 1961 ( the Act ). 2. The Appellant prays that the order of the Transfer Pricing Officer ( the TPO ) passed u/s. 92CA of the Act be treated as null and void and consequently all additions/ adjustments made in the said order in violation of principle of natural justice be struck down as bad in law and deleted. 26. We have heard the Ld. AR as well as Ld. DR and considered the relevant material on record. The assessee has raised the objection in the additional ground that the Assessing Officer has not given the opportunity of hearing before referring the issue of international transaction to the transfer pricing officer for determination of arm s length price. As per the provisions of section 92 CA, it is not mandated that before referring the international ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... secondary transfer pricing adjustment in respect of the capital infused by the assessee in its subsidiary. 29. We have heard the Ld. AR as well as Ld. DR and considered the relevant material on record. The Ld. DR has relied upon the order of the TPO and submitted that this adjustment is only alternative to the adjustment of amount of capital infused in the subsidiary. 30. On the other hand, the Ld. Authorized Representative of the assessee has submitted that the TPO has made the double adjustment in respect of the same transaction. The TPO after making adjustment of entire capital infused in the subsidiary has also made a further adjustment of interest chargeable on the said amount. 31. Having considered the rival submissions and careful perusal of the record, we note that the adjustment on account of notional interest on the additional capital infused by the assessee in the subsidiary is over and above, the adjustment of the entire capital investment amount. Therefore, it is not an alternative but it is an adjustment of over and above of the entire amount of capital investment. The DRP has considered this issue in para 5 as under:- 5 Objection 4 is against the TP adj ..... X X X X Extracts X X X X X X X X Extracts X X X X
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