TMI Blog2016 (5) TMI 719X X X X Extracts X X X X X X X X Extracts X X X X ..... e not available then it cannot be held that such a tenor adjustment for taking into time period cannot be made under CUP, if it has been made quite accurately taking into account the material factors relating to time of the transaction affecting the price. We though agree that, a high degree of comparability is required under CUP, but in absence of such a comparable data, a minor adjustment can be made to eliminate the material effect of time difference for arriving at a comparable uncontrolled price. Now before us, the assessee had filed two comparable transactions for the year 2009, that is, for the same financial year in the case of Shriram Transport Financial Company Ltd. and Tata Capital Ltd., wherein, for credit rating of AA Enterprises the coupon rate of interest per annum was between 11% to 12% for a tenor of 60 months. The yield on redemption is also around 11.25% to 12%. If for a credit rating company AA or AA(+) the interest rate is ranging between 11% to 12%, then in the case of the assessee which is admittedly BBB(-) credit rating company, 11.30% interest paid by the assessee to its AE is much within the arm’s length rate. This data/ document from public domain now mad ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... oresaid appeal has been filed by the assessee against impugned Final Assessment Order dated 27th November, 2014 passed under section 143(3) r.w.s. 144C(13) by Deputy Commissioner of Income-tax, Circle -3(2)(1), Mumbai in pursuance of direction given by Dispute Resolution Panel I, Mumbai (DRP) under section 144C(5), vide order dated 16.10.2014. In the various grounds of appeal, the assessee has mainly challenged following issues: (i) Ground No.I -Transfer Pricing Adjustment of ₹ 48,53,19,133/- in respect of interest expenses incurred on account of Compulsory Convertible Debentures (CCDs) issued by the assessee to its AE; (ii) Ground No.II Disallowance under section 14A for sum of ₹ 2,15,71,424/- after invoking Rule 8D; (iii) Ground No.III -Addition of ₹ 33,73,86,850/- on account of interest accrued in respect of Non- Performing Assets ( NPAs ); (iv) Ground No.IV -Levy of interest under section 234A. (v) Ground No.V -Levy of interest under section 234B and 234D of the Act. 2. The brief facts qua the first issue of Transfer Pricing Adjustment are that, the assessee, that is, India Debt Management Pvt. Ltd. (IDM) is a company incorporat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... om databases of Thomson Reuters DealScan, and Bloomberg Databases. Since the assessee had issued CCDs in terms of INR (Indian Rupees) and interest was also payable in terms of INR as India being the borrowing region, therefore, no comparables were thrown in the search for Indian region as INR denomination for loans/bonds. The search accordingly, was expanded to include other geographical regions or currencies. After identifying various comparables transactions, various qualitative adjustments were made to factor-in the differences in the risk profiles of the comparables viz., currency of the loan; borrower s region; and tenor (i.e., time factor). After carrying out such adjustments, 14 transactions were identified whereby the Arm s length interest rate of 14.50% was arrived at by the assessee, as against average interest rate of 11.3% paid by the assessee. Alternative, the assessee also carried out corroborative search process using Bombay Stock Exchange (BSE) data on INR denominated debt issuances. After various qualitative analysis and keep into consideration the credit rating of the borrower and the time of issuance, two comparable transactions were identified and after carryin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to 14% in most of the debenture from 01.08.2009. In response to the show cause notice, to explain the reasons for such an increase in interest charge from earlier year at 7% to 14%, the assessee submitted that the portfolio of IDM deteriorated substantially during financial year 2009-10 and there was huge increase in NPA which is evident from the fact that from INR 1603.44 millions in the earlier years, the NPA during the financial year 2009-10 had increased to INR 5248.9 million. Such a sharp increase in NPAs would have substantially increased the IDM s default risk, thereby necessitating increase in interest rate offered on its borrowings with its AEs. After analyzing the method and the manner in which the assessee had carried out its benchmarking of the interest rate, first of all, the Ld. TPO rejected the entire methodology adopted by the assessee mainly on the ground that, assessee had not pointed out anywhere in its TP Study report, whether it has taken assessee as a tested party or AE as a tested party . If the assessee is taken as a tested party , then it could have used the rate at which external commercial borrowings are available in India and if the AE is taken a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 09- 10. He then took the data of USD Corporate Bond rates and held that, the ALP rate of interest would be at 5.68%. The data has been reproduced by him at pages 12 13 and his final conclusion is as under:- The average LIBOR rate during the year was less than 1% therefore companies with credit rating BBB- have borrowed at a rate of LIBOR plus 308 basis points (1% plus 308 basis points), which comes to 4.08%. Even by taking the rating of the AE 3 notches lower than BBB- i.e. BB- the arm length rate would be LIBOR+4.68% if the AE had given loan to a company with credit rating of B-. It would have earned interest @1% plus 4.68% that is 5.68%. The rate charged by the AE from the assessee @ 14% is not at arm s length Finally, he benchmarked the transactions after adopting Arm s length interest rate of 5.68% as per working given at page 13 para 11 and thereby made a huge adjustment of ₹ 48,53,19,133/-. 5. Before the DRP, assessee after explaining the entire process as to how the benchmarking of the transaction of interest payment has been done vis-a-vis, the external comparables taken from Thomson Reuters DealScan, and Bloomberg Database and also from the website o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... PO for benchmarking of the international transaction of interest payment. It also proceeded with the premise that there should be first, identification of the tested party and based on such tested party s geographical locations, economic conditions and comparability factors benchmarking can be done. Here in this case, DRP observed that it is not clear, whether the assessee is the tested party or the AE. To arrive at this conclusion that selection of the tested party is a condition precedent for carrying out transfer pricing analysis of the ALP; the DRP referred to the OECD guidelines as well as UN Practice Manual guidelines on transfer pricing and has even incorporated relevant paragraphs of such guidelines at pages 21 to 23 of the order. Thereafter, the DRP observed that the TPSR of the assessee is very sketchy to prove that international transactions are at arm s length and even FAR analysis has not been carried out. Further, the assessee was charging interest from its investments @ 9.75% whereas, the revised interest rates claim for its AE are 14%. It further noted that there are no comparables available in the Indian domain which has identical or similar facts as that of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5.68% and thereby the quantum of adjustment made by the TPO as per the discussion appearing from pages 25 to 29 of the impugned order. 8. Before us on behalf of the assessee, Ld. Senior Counsel, Shri J.D. Mistry submitted that, the assessee is involved in a very high risk business whereby it identifies the midcap companies for making the investment which are financially distress companies and because of such business profile it has been rated as BBB (-) as a credit rating. As a primary source of funding for its operations, the assessee issues compulsory convertible debentures in INR and given the circumstance where funding from outside is difficult such debentures have been taken up by the associated enterprises. Considering the various debentures series issued, the effective rate of interest paid (in INR) by the assessee to its AE during the year 2010-11 was 11.30%. The main issue here is, whether in such a highly risky investment where the assessee being BBB (-) rating company, can in India anybody will give loan or subscribe to debenture for less than 11%. He submitted that, it would not be possible at least in the Indian scenario. Though, here the assessee has tried to bench ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... o be applicable at all, because such a data have no nexus whatsoever to India especially when transaction of payment of interest by an Indian borrower is on the basis of INR denominated debt. What needs to be considered is the INR lending data to a borrower in India having same or similar credit rating. In support of his contention, he strongly relied upon the decision of Hon ble Delhi High Court in the case of CIT vs Cotton Naturals India (P) Ltd, reported in [2015] 55 Taxman.com wherein, the Hon ble High Court held that arm s length interest rate should be computed based on market determinant interest rate applicable to a currency in which loan has to be repaid. Thus, USD Corporate Bond rate and LIBOR rates on ECBs cannot be applied herein this case, because currency here is in INR. 9. He further submitted that, if assessee s benchmarking with the external data from Thomson Reuters DealScan, and Bloomberg Databases are not accepted then assessee s benchmarking by analyzing the BSE listed companies should be accepted. The assessee has identified two comparables based on B+ and BB rating in its TP Study report which gives the average rate of interest of more than 15% and henc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the relevant facts, the assessee as its business strategy acquires and makes investments in midsized enterprises which are financially distress companies but otherwise have potential or viable business proposition. Such an investment merits the assessee company a highly risk undertaking enterprise and because of such a risky operations of investments it has been rated as BBB (-) . The funding of these investments is primarily through intra-group financing wherein, it raises money through debt in the form of series of compulsory convertible debentures (CCDs) which in turn uses these funds to carry out investment activities. These CCDs are raised in terms of Indian Rupee (INR) and even the interest paid on such debt is also in terms of INR only. Since these debts have been taken up by the AE, therefore, the payment of interest on these debts amounting to ₹ 99,06,92,142/- is the subject matter of Transfer Pricing. During the year, the payment of rate of interest has been varied from 9.75% to 14% due to reset clause and the average rate of interest paid on most of the debentures from 01.08.2009 was around 11.30%. Such a reset of interest rate was mainly on account of increase of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er, the said rate has not been applied finally for benchmarking the assessee s transaction. The whole premise on which the assessee s analysis has been rejected both by the TPO as well as by the DRP is that, the assessee has not identified the tested party for benchmarking the international transaction. Without identifying the tested party, the whole transfer pricing analysis conducted by the assessee is erroneous as per the TP provisions. As per the TPO, if the assessee is being treated as a tested party, then it should have used the rate at which ECBs as available in India and if AE is taken as tested party then geographical data where AEs is located should have been used for benchmarking the interest. The DRP has quoted certain paragraphs of United Nations Practical Manual on Transfer Pricing as given in Chapter V and also OECDs Transfer Pricing Guidelines in Chapter III. The relevant portions have been incorporated at page 21 to 22 of the DRP s order. 12. In wake of this background, the first and foremost issue for our adjudication is whether, while applying the CUP Method, it is necessary to identify the tested party . Although Indian TP regulation does not laid down any ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the tax administration and vice versa in order for the latter to be able to verify the selection and application of the transfer pricing method . Similarly in OECD guidelines also the concept of tested party has been stressed under CPM, RPM and TNMM, which is evident from para 3.18, reproduced hereunder:- When applying a cost plus, resale price or transactional net margin method is described in Chapter II, it is necessary to choose the party to the transaction for which a financial indicator (mark-up on costs, gross margin, or net profit indicator) is tested. The choice of the tested party should be consistent with the functional analysis of the transaction. As a general rule, the tested party is one to which a transfer pricing method can be applied in the most reliable manner and for which the most reliable comparables can be found, i.e. it will most often be the one that has the less complex functional analysis From the above, it can be clearly inferred that identification of the tested party is far more imperative while applying CPM, RPM or TNMM and not while applying CUP. Here one important aspect which is to be bear in mind while deciding the concept of tes ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent issuances is more reliable and ideal base for benchmarking similar transactions undertaken by the companies or entities with similar ratings. 14. The TPO and DRP in our opinion have committed a fallacy, firstly, by considering the AE as a tested party and secondly, relying upon USD Corporate Bond Rates to benchmark the ALP of the interest rate because the interest rates for bonds or loan has to be seen from the point of view of borrowers creditworthiness and not the lender s creditworthiness. Thus, the entire approach of the TPO/DRP in applying USD Corporate bond rates to benchmark the interest transaction in a blanket manner is not correct. As pointed out by Ld. Senior counsel, now, Hon ble Delhi High Court in the case of Cotton Naturals P Ltd. (supra) have held that, arm s length interest rate should be computed based on market determined interest rate applicable to currency in which loan has to be repaid. The relevant observation of the Hon ble High Court in this regard reads as under:- 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 St ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... respectfully following the aforesaid ratio, we reject the TPO s application of USD Corporate Bonds Rate as well as the LIBOR rate for benchmarking the interest transaction in this case. 15. The last leg of the controversy is, whether the benchmarking analysis done by the assessee is correct or not and whether the average rate of interest of 11.30% paid by the assessee to its AE is at ALP or not. So far as the assessee s benchmarking analysis as done in TP Study report based on external data using Thomson Reuters DealScan, and Bloomberg Database, we find that such an approach is not correct, firstly , there are no INR denominated debt issuance available on such databases and; secondly, in absence of such a data the assessee has to carry out huge adjustments on account of country risk, currency risk and tenor risk. With all these factors of adjustments, it would be difficult to arrive at an appropriate arm s length range of price; therefore, in our opinion such an approach of the assessee for benchmarking the arm s length interest rate may not be correct. However, as regards the search undertaken for comparable debt issuances in BSE data, we find that the assessee has shortli ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d by the assessee during the year. Since assessee had not made any suo motto disallowance of expenditure under section 14A, the AO held that in view of the decision of Hon ble Bombay High Court in the case of Godrej Boyce Manufacturing Co. Ltd., reported in 328 ITR 81, disallowance has to be made under Rule 8D r.w.s. 14A and accordingly, he computed the disallowance in the following manner:- Disallowance under Rule 8D(2)(i) Rs. Nil Disallowance under Rule 8D(2)(ii) Rs.2,04,97,799/- Disallowance under Rule 8D(2)(iii) ₹ 10,73,625/- Total disallowance Rs.2,15,71,424/- 18. Before the DRP, the assessee s case was that, firstly , since assessee had not earned any exempt income, therefore, no disallowance should be made u/s 14A and; secondly , the investment in shares has been made as part of the regular business activity since it is primarily engaged in making investment in distress companies where there is remote or no chance of earning any dividend income. However, the DRP after detailed discussion u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... S Differences Remarks 1 Kitply Industries Limited Nil 41,20,200 41,20,000 4,12,00,000 2 Brandhouse Retails Limited Nil 86,73,470 86,73,470 8,67,34,700 3 Sanghi Industries Limited 1,95,52,535 3,37,88,771 1,42,36,176 14,23,61,760 4 Ganesh Benzoplast Limited 1,83,04,565 2,50,13,604 67,09,039 6,70,90,390 Total 3,37,38,685 33,73,86,850 In response to the show cause notice, the assessee s reply was in the following manner: Sr No Name of borrower TDS claimed in ROI by 26AS TDS reflected in form 26AS Differences Remarks 1 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tated as under: Interest income is accounted on an accrual basis. Income on the NPAs is accounted for on a realization basis in accordance with the Non-Banking Financial (Non-Deposit Accepting or Holding) Companies Prudential Norms (Reserve Bank) Directions, 2007 issued by the Reserve Bank of India Accordingly, the interest in relation to the three portfolios (out of four) which were classified as NPA has been recognized on realization basis. The assessee has classified the loans and advances as NPA in accordance with the RBI directions. The relevant extract of which has been incorporated in the DRPs order from pages 41 to 43. The DRP after considering the entire submissions, however, rejected the assessee s submission and upheld the action of the AO after observing and holding as under:- 7.3 We have considered the above submissions of the assessee and the facts of the case. It is seen that the interest income from i) Kitply Industries Ltd has not been declared by the assessee in the return of income simply because the assessee had not received such interest. Since the assessee is following mercantile system of accounting, actual receipt of interest income is of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f 2012 judgment and order dated 11th June, 2014 (Bombay High Court); and b) CIT vs. Vasisth Chay Vyapar Ltd ., reported in [2011] 330 ITR 440 (Delhi High Court). On the other hand, the Ld.CIT DR strongly relied upon the order of the DRP as well as the AO. 26. After considering the relevant finding given in impugned orders and submissions made by the parties, it is seen that AO has taxed the amount of interest on the ground that assessee should have shown the interest income on accrual basis as per the mercantile system of accounting and not on receipt basis as done by the assessee. The assessee s contention has been that this income specifically from the three parties has been offered in the succeeding year on the basis of year of receipt which is in consonance with the guidelines issued by the RBI Prudential Norms which is binding on the assessee being a NBFC. It is admitted facts that, the interest in relation to the three parties were classified as NPA which has been recognized by the assessee on realization basis. The RBI norms, as applicable to the NBFCs in this regard read as under: - With effect from March 31, 2003, 'non-performing asset' (referred to in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... it Loss Account of the assessee. After detailed discussion, the Hon ble High Court concluded in the following manner:- 91. We do not find that the Tribunal has either misdirected itself in law or its order can be termed as perverse warranting interference in our appellate jurisdiction. We find that the view taken by the Tribunal accords with the Reserve Bank of India guidelines and which are not in any way in conflict with the Income Tax Act, 1961, the Hon ble Supreme Court has held in the case of UCO Bank that the interest income would have been brought to the Profit and Loss Account provided it was actually realized, that in case of Nationalized Bank it treated something which is doubtful, and therefore, kept it in a suspense account, was held to be a permissible exercise. In respect of the loans which are advanced, recovery of some of them if considered doubtful, then, even the interest on the loans advanced may not be realized. That is how the amount is not brought to the profit and loss account because they are not likely to be realized by the bank or a NBFC as well. It is permissible therefore to disclose or to show them as income in assessment year in which either the ..... X X X X Extracts X X X X X X X X Extracts X X X X
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