TATA AUTOCOMP SYSTEMS LTD, MUMBAI V. ASST CIT CIR 2(3), MUMBAI

ITA 7354/MUM/2011

• Counselvise Citation: 735419914 RSA 2011
• Duration Of Justice: 5 month(s) 28 day(s)
• Appeal Type: Income Tax Appeal
• Pronouncement Date: 30-04-2012
• Appeal Filed By: Assessee
• Order Result: Partly Allowed
• Bench Allotted: E
• Assessment Year: 2007-2008
• Appeal Filed On: 02-11-2011
• Result in Favour of: Partly Allowed
• Court: TRIBUNAL
• Department Lawyers: AJEET KUMAR JAIN
• Assessee Lawyers: R MURALIDHAR
• Keywords: Related party transaction; Depreciation; Transfer pricing; International transaction; Wholly owned subsidiary; Avoidance of tax; Notional interest; Commercial expediency; Unabsorbed depreciation
• Section: 92C; 143(3); 10B; 92

Judgement Text

IN THE INCOME TAX APPELLATE TRIBUNAL, MUMBAI BENCH E, MUMBAI BEFORE SHRI P.M.JAGTAP (A.M) & SHRI N.V.VASUDEVAN( J.M) ITA NO. 7354/MUM/11(A.Y. 2007-08) TATA AUTOCOMP SYSTEMS LIMITED, BOMBAY HOUSE, HOMI MODI STREET, FORT, MUMBAI 400 001. PAN: AAACT 1848E) (APPELLANT) VS. THE ACIT, CIR. 2(3), MUMBAI. (RESPONDENT) APPELLANT BY : SHRI R.MURALIDHAR RESPONDENT BY : SHRI AJEET KUMAR JAIN DATE OF HEARING : 16/04/2012 DATE OF PRONOUNCEMENT : 3 0/04/2012 ORDER PER N.V.VASUDEVAN, J.M THIS IS AN APPEAL BY THE ASSESSEE AGAINST THE ORDE R DATED 19/9/2011 OF THE ACIT 2(3), MUMBAI (HEREAFTER REFERRED TO AS THE AO) PASSED UNDER SECTION 143(3) R.W.S. 144C OF THE INCOME TAX ACT, 1 961 (THE ACT). 2. IN GROUND NOS. 1 TO 4 THE ASSESSEE HAS CHALLENG ED THE ORDER OF THE AO WHEREBY THE AO MADE AN ADDITION OF RS. 1.76 CRORES CONSEQUENT TO A TRANSFER PRICING ADJUSTMENT TO INTERNATIONAL TRANSACTION OF INTEREST FREE LOAN GIVEN BY THE ASSESSEE TO ONE ITS ASSOCIATE ENTERPRISE(AE). 3. THE ASSESSEE IS A COMPANY. IT IS ENGAGED IN THE BUSINESS OF MANUFACTURE OF INDOOR PLASTIC, RENDERING ENGINEERIN G SERVICES, SUPPLY CHAIN MANAGEMENT SERVICES AND ADMINISTRATIVE SUPPORT FOR JOINT VENTURE COMPANIES. THE ASSESSEE ENTERED INTO INTERNATIONAL TRANSACTIONS WITH ITS AE AND IN TERMS OF SECTION 92 OF THE ACT SUPPORTED THE PRICE PAID IN RESPECT OF ITA NO. 7354/MUM/11(A.Y. 2007-08) 2 THE INTERNATIONAL TRANSACTION BY FILING THE NECESSA RY FORM 3CEB. THERE IS NO DISPUTE REGARDING THE PRICE CHARGED BY THE ASSESSEE IN RESPECT OF INTERNATIONAL TRANSACTIONS SET OUT IN FORM 3CEB FIL ED BY THE ASSESSEE. THE TPO NOTICED THAT THE ASSESSEE HAD ALSO MADE ADVANCE S OF EURO 26,25,000/- TO ITS WHOLLY OWNED SUBSIDIARY A GERMAN COMPANY BY NAME TACO KUNSTSOFFTECHNIK GMBH (HEREINAFTER REFERRED TO AS T KT). HOWEVER, NO INTEREST WAS CHARGED ON THE ABOVE LOAN AND NO SEPAR ATE TP ANALYSIS HAS BEEN DONE IN RESPECT OF THIS TRANSACTION NOR WAS TH IS INTERNATIONAL TRANSACTION REFERRED TO IN FORM 3CEB. THE TPO CALL ED UPON THE ASSESSEE VIDE SHOW CAUSE, DATED 22.10.2010, TO SHOW CAUSE AS TO WHY THE INTEREST SHOULD NOT BE CHARGED ON THIS TRANSACTION AT THE RA TE OF 10.25%. 4. THE ASSESSEE SUBMITTED THAT THE INTEREST FREE L OAN WAS GRANTED TO TKT ON ACCOUNT OF BUSINESS REASONS AND COMMERCIAL EXPEDIEN CY. THE ASSESSEE SUBMITTED BEFORE TPO THAT THE BUSINESS STRUCTURE AN D THE COMMERCIAL RATIONALE THAT LED TO THE DECISION OF THE ASSESSEE TO GIVE INTEREST FREE LOAN TO ITS TPO CAN BE UNDERSTOOD FROM THE MANNER IN WHICH IT CONDUCTS ITS BUSINESS IN GERMANY. THE ASSESSEE EXPLAINED THAT FO RD WAS AN ESTEEMED CUSTOMER BOTH IN INDIA AND ABROAD. THE ASSESSEE HAD AN OPPORTUNITY OF CONDUCTING BUSINESS WITH FORD IN EUROPE. THIS PRESE NTED THE ASSESSEE WITH A STRATEGIC BUSINESS OPPORTUNITY AS THE SAME WOULD BE ADVANTAGEOUS TO THE ASSESSEE BY WAY OF: -STRENGTHENING RELATIONSHIP WITH FORD AS A CUSTOMER , WHICH WILL HELP IN GETTING MORE BUSINESS OPPORTUNITIES IN INDIA; AN D - PROVIDING THE ASSESSEE THE OPPORTUNITY TO WORK IN STRINGENT EUROPEAN QUALITY NORMS, WHICH WOULD HELP IN ACQUIRING TECHNI CAL SKILLS, WHICH WOULD BE USED FOR BOTH DOMESTIC AND EXPORT BUSINESS OF THE ASSESSEE. ITA NO. 7354/MUM/11(A.Y. 2007-08) 3 ACCORDINGLY, THE ASSESSEE DECIDED TO GRAB THIS BUSI NESS OPPORTUNITY OF SUPPLYING INTERIOR PARTS TO FORD EUROPE. SUPPLYING OF INTERIOR PARTS TO FORD EUROPE ENTAILED THE SUPPLY OF LARGE PARTS AS WELL A S SMALL PARTS. BASED ON THE BUSINESS ANALYSIS CONDUCTED, IT WAS CONCLUDED T HAT IT WOULD NOT BE FEASIBLE TO MANUFACTURE BOTH BIG PARTS AND CHILD PA RTS AND EXPORT THE SAME TO FORD EUROPE, SINCE THE COST OF FREIGHT AND INSUR ANCE WOULD BE HUGE. INSTEAD, IT WAS FOUND FEASIBLE TO MANUFACTURE THE B IG PARTS IN GERMANY ITSELF AND SUPPLY THE CHILD PARTS FROM INDIA, ASSEMBLE THE BIG PARTS AND CHILD PARTS IN GERMANY AND SUPPLY THE SAME TO FORD EUROPE. THU S, IN ORDER TO ACHIEVE COST EFFICIENCY, ENSURE SMOOTH BUSINESS OPERATIONS AND PROMPT AND SATISFYING CUSTOMER SERVICE, THE ASSESSEE DECIDED T O CONDUCT THE BUSINESS WITH FORD EUROPE BY ESTABLISHING A PRESENCE IN GERM ANY. 5. ACCORDINGLY, TKT WAS ESTABLISHED IN GERMANY UND ER THE FOLLOWING BUSINESS ARRANGEMENT:- - THE ASSESSEE TO MANUFACTURE CHILD PARTS AND EXPO RT THE SAME TO TKT; AND - TKT TO MANUFACTURE BIG PARTS, ASSEMBLE THE SAME W ITH CHILD PARTS IMPORTED FROM THE ASSESSEE AND SELL THE SAME TO FOR D EUROPE. AS MENTIONED THE ABOVE BUSINESS ARRANGEMENT WAS AIM ED TO ENSURE SMOOTH FUNCTIONING OF THE ASSESSEES BUSINESS, PROVIDING B ETTER CUSTOMER SERVICE CONSIDERING THE GEOGRAPHICAL PROXIMITY OF TKT TO FO RD EUROPE, SAVINGS IN COSTS, ETC. 6. THE ASSESSEE HIGHLIGHTED THE FACT THAT EXISTENC E OF TKT WAS ESSENTIAL FOR THE ASSESSEES ACHIEVEMENT OF BUSINESS OBJECTIVES R ELATED TO FORD, IT WAS VERY MUCH IN THE ASSESSEES INTEREST THAT TKT WAS ADEQUA TELY FUNDED AND OPERATIONAL. ACCORDINGLY IT WAS A DECISION MADE PU RELY ON COMMERCIAL GROUNDS TO FUND TKT THROUGH INTEREST-FREE DEBT FOR FOLLOWING REASONS: ITA NO. 7354/MUM/11(A.Y. 2007-08) 4 - NEED OF FUNDS TO HELP TKT MANAGE ITS WORKING CAPI TAL REQUIREMENTS FOR MANUFACTURE OF BIG PARTS; - START-UP STAGE OF BOTH ASSESSEE AND TKT IN RESPEC T IF BUSINESS WITH FORD EUROPE; - ESTIMATION OF LOSS IN THE ENTIRE VALUE CHAIN DURI NG THE INITIAL YEARS, CONSIDERING THE 1ARNING CURVE, OPERATIONAL INEFFICI ENCIES, STRINGENT EUROPEAN QUALITY NORMS, ETC; - INTEREST COST WOULD HAVE RESULTED IN INCREASING T HE LOSSES OF TKT, AND WOULD HAVE STRAINED THE AVAILABILITY OF CASH FOR DA Y TO DAY OPERATIONS; AND - THE EXISTENCE AND SURVIVAL OF TKT BEING OF STR ATEGIC IMPORTANCE TO THE ASSESSEE, FROM THE PERSPECTIVE OF ITS FORD BUSI NESS. BASED ON THE ABOVE, THE ASSESSEE CONTENDED THAT THE LOAN WAS GRANTED TO TK PURELY ON THE BASIS OF COMMERCIAL EXPEDIENCY AND FO R THE PURPOSES OF THE ASSESSEES BUSINESS WITH FORD EUROPE AND THUS NO NO TIONAL INTEREST SHOULD BE CHARGED THEREON. 7. BASED ON JUDICIAL DECISIONS THE ASSESSEE CONTEN DED THAT LENDING OF INTEREST FREE FUNDS TO SUBSIDIARY IS A NORMAL AND ACCEPTABLE BUSINESS PRACTICE AND THUS, THE EXISTENCE OF SUCH INTEREST F REE LOANS DOES NOT MEAN THAT THE TRANSACTION IS NON ARMS LENGTH, IF GENUINE BUSINESS REASONS EXIST, THEN NON-CHARGING OF INTEREST IS JUSTIFIABLE. 8. WITHOUT PREJUDICE TO THE ABOVE SUBMISSION, THE ASSESSEE CONTENDED THAT EVEN IF INTEREST IS TO BE CHARGED ON THE INTEREST F REE LOAN PROVIDED BY THE ASSESSEE TO TKT, THE SAME SHOULD BE RESTRICTED TO 4 .15% WHICH IS THE RATE SPECIFIED IN THE BENCHMARKING EXERCISE CONDUCTED BY THE ASSESSEE FOR ASCERTAINING THE ARMS LENGTH INTEREST RATE. THE A SSESSEE ALSO SUBMITTED ITA NO. 7354/MUM/11(A.Y. 2007-08) 5 THAT IT HAD AT NO TIME ANY INTENTION TO EVADE TAX A ND SHIFT PROFITS OUT OF INDIA. THIS WAS EVIDENCED BY THE FACT THAT TKT SUBS EQUENTLY FILED FOR LIQUIDATION ON ACCOUNT OF INSOLVENCY. THIS IS A CLE AR INDICATION OF THE FACT THAT TKT WAS IN ECONOMIC DISTRESS AND WAS IN NEED O F FUNDS, WHICH HAS SUBSEQUENTLY LED TO ITS APPLICATION FOR INSOLVENCY. THE ASSESSEE ALSO FILED A COPY-OF THE APPLICATION FOR REQUESTING INSOLVENCY P ROCEEDINGS MADE BY TKT TO GERMAN COURT. THE ASSESSEE ALSO SUBMITTED A COPY O F BAIT SANCTION LETTER TO TKT BY HYPO VEREINS BANK DATED AUGUST 10, 2006 WHIC H STIPULATES AN INTEREST RATE OF EURIBOR PLUS 80 BASIS POINTS, I. E. EURIBOR PLUS 0.8% P.A.. BASED ON THE ABOVE, THE ASSESSEE CONTENDED THAT THE EXTENSION OF INTEREST-FREE LOAN WAS A PART OF DECISION FROM CORP ORATE FUNCTION OF THE ASSESSEE AND INTEREST WAS NOT CHARGED CONSIDERING T HE COMMERCIAL EXPEDIENCY AND THE BUSINESS REASONS AND EXTREME ECO NOMIC DISTRESS FACED BY TKT. THE ASSESSEE ALSO CONTENDED THAT IT WOULD H AVE ENTERED INTO SIMILAR BUSINESS ARRANGEMENT WITH A THIRD PARTY, IF TKT WOU LD NOT HAVE BEEN IN PICTURE. 9. WE HAVE ALREADY SEEN THAT THE TPO PROPOSED TO A DOPT 10.5% AS THE INTEREST RATE FOR DETERMINING ALP OF THE INTERNATIO NAL TRANSACTION. THE TPO PROPOSED TO APPLY THE COMPARATIVE UNCONTROLLED PRIC E (CUP) METHOD AS THE MOST APPROPRIATE METHOD AND IN THIS REGARD APPLIED THE LENDING RATE APPLICABLE IN INDIA BY BANKS. AS REGARDS THE RATE OF INTEREST PROPOSED TO BE APPLIED BY THE TPO, THE ASSESSEE SUBMITTED THAT THE GEOGRAPHY THAT NEEDS, TO BE CONSIDERED FOR ADOPTING A COMPARABLE RATE IS THE GEOGRAPHY IN WHICH THE LOAN HAS BEEN CONSUMED AND ON THE GEOGRAPHY FR OM WHICH THE LOAN HAS BEEN GRANTED. IN THIS CONNECTION, THE ASSESSEE CONT ENDED THAT THE COMPARABLE UNCONTROLLED PRICE (CUP) METHOD PROPOS ED TO BE ADOPTED BY THE AO/TPO AS THE MOST APPROPRIATE METHOD REQUIRES FULFILLMENT OF STRINGENT REQUIREMENTS. ACCORDINGLY, FOR THE PURPOSE, OF UNDE RTAKING COMPARABILITY ANALYSIS FOR ARRIVING AT ARMS LENGTH INTEREST RATE , IT IS PERTINENT TO TAKE INTO ITA NO. 7354/MUM/11(A.Y. 2007-08) 6 CONSIDERATION THE INTEREST RATES PREVAILING IN THE GEOGRAPHY IN WHICH THE LOAN HAS BEEN CONSUMED I.E. IN GERMANY, AS DIFFERENCES I N GEOGRAPHIC MARKETS WOULD ALSO INFLUENCE THE RELIABILITY OF THE COMPARI SON UNDER THIS METHOD. IT WAS CONTENDED THAT IT WOULD BE IMPORTANT TO LOOK AT OPTIONS AVAILABLE TO TKT FOR RAISING FUNDS IN GERMANY AND NOT IN INDIA. 10. THE TPO REJECTED THE ARGUMENT OF THE ASSESSEE T HAT THE INTEREST FREE LOAN WAS GIVEN TO THE AE OWING TO COMMERCIAL CONSIDERATI ONS AND THEREFORE NO ADJUSTMENT/ADDITION SHOULD BE MADE. THE TPO GAVE T HE FOLLOWING REASONS FOR DOING SO: A. LENDING OR BORROWING IS NOT ONE OF THE MAIN BUSI NESSES OF THE ASSESSEE. B. TWO INDEPENDENT ENTERPRISES IN THE SIMILAR CIRCU MSTANCES AS THAT OF THE ASSESSEE AND ITS SUBSIDIARY WOULD HAVE CHARGED INTEREST AS COMPENSATION FOR THE FINANCIAL FACILITY PROVIDED BY ONE PARTY TO ANOTHER KEEPING IN VIEW THE FINANCIALS OF THE SUBSIDIARY AN D NO SECURITY BEING OFFERED. BUT FOR THE RELATIONSHIP BETWEEN THE ASSES SEE AND ITS SUBSIDIARY, THE ASSESSEE WOULD HAVE EARNED INTEREST ON THE LOAN EXTENDED BY IT. C. THE BUSINESS PRUDENCE OR NECESSITY OF ADVANCING LOANS TO SUBSIDIARY IS NOT RELEVANT FOR COMPUTING ARMS LENG TH PRICE IN UNRELATED PARTY TRANSACTIONS. 11. THE TPO THEREAFTER PROCEEDED TO DETERMINE THE ARMS LENGTH INTEREST. HE HELD THAT THE TAXPAYER HAS MADE LOANS TO ITS AES WI THOUT CHARGING ANY INTEREST. SIMILAR UNCONTROLLED TRANSACTION WOULD HA VE PROVIDED FOR INTEREST. IN VIEW OF THIS FACT HE HELD THAT THE INTERNATIONAL TRANSACTION REPRESENTING LOAN WITHOUT CHARGING INTEREST IS NOT AT ARMS LENG TH PRICE WITHIN THE MEANING OF SECTION 92C (3) (A) (B) AND (C) OF THE I NCOME TAX ACT READ WITH ITA NO. 7354/MUM/11(A.Y. 2007-08) 7 RULE 10B (1) (A) OF THE INCOME TAX RULES. HE HELD THAT THE MOST APPROPRIATE METHOD FOR DETERMINING ARMS LENGTH INTEREST WOULD BE BY FOLLOWING CUP METHOD WHEREIN THE INTEREST RATE IS DETERMINED, UN DER THE CIRCUMSTANCES, IN WHICH THE ASSESSEE AND ITS SUBSIDIARY IS OPERATING I.E. WHAT IS THE INTEREST THAT WOULD HAVE BEEN EARNED IF SUCH LOANS GIVEN TO UNRELATED PARTIES IN SIMILAR SITUATION AS THAT OF SUBSIDIARY. HE FURTHER HELD THAT SINCE THE TESTED PARTY IS THE ASSESSEE, THE PREVALENT INTEREST THAT COULD HAVE EARNED BY THE ASSESSEE BY ADVANCING A LOAN TO AN UNRELATED PARTY IN INDIA, HAVE TO BE DETERMINED. HE ALSO HELD THAT RULE OF RELEVANCY SUG GESTS THAT ALP RATE OF INTEREST SHOULD BE DECIDED ON THE BASIS OF TAKING TPS TRANSACTIONS OF THE LENDER INTO CONSIDERATION AND NOT THAT OF BORROWER OR THE GEOGRAPHY IN WHICH BORROWER IS SITUATED. CONSEQUENTLY THE TPO HELD THA T IT WILL BE MORE RELEVANT TO SEE THAT HOW THE ASSESSEE WOULD HAVE BEHAVED IN UNCONTROLLED TRANSACTION. HE HELD THAT IN AN UNCONTROLLED TRANS ACTION LIKE THIS BETWEEN UNRELATED PARTIES, INTEREST WOULD HAVE BEEN CHARGED TAKING INTO ACCOUNT CREDIT WORTHINESS OF THE AES, MARGINS, SECURITY OR ANY OTHER CONSIDERATION RELEVANT FOR DECIDING THE FINANCIAL SOLVENCY OF THE BORROWER. 12. THE ASSESSEE HAD SUBMITTED THAT IF AT ALL ANY ALP HAS TO BE DETERMINED THEN THE LIBOR RATES SHOULD ALONE BE ADOPTED. ON T HE ABOVE SUBMISSION, THE TPO HELD THAT LIBOR IS A RATE OF REFERENCE FOR INTER BANK TRANSACTIONS, IS PRIMARILY FOR POUND STERLING TRANSACTIONS, THOUGH I T IS USED AS A RATE OF REFERENCE BY A FEW OTHER CURRENCIES (NOT INCLUDING INR) ALSO. IT IS ALSO GENERALLY THE NORM THAT LIBOR IS FOR MATURITIES RAN GING FROM OVERNIGHT TO ONE YEAR. IT IS APPLICABLE, EVIDENTLY, FOR CONTRIBU TIONS IN THE CURRENCY CONCERNED AND NOT FOR THE COST OF PRODUCING ONE CUR RENCY BY BORROWING IN ANOTHER CURRENCY AND ACCESSING THE REQUIRED CURRENC Y VIA THE FOREIGN EXCHANGE MARKETS. THE TPO THEREFORE HELD THAT LIBO R IS NOT THE RATE OF CONSIDERATION FOR LOANS WHERE A CURRENCY IS TO BE B OUGHT - WHETHER BOUGHT IN ITA NO. 7354/MUM/11(A.Y. 2007-08) 8 THE MARKET OR TRANSACTED THROUGH A BANK - I.E. IS N OT APPLICABLE WHERE THE CURRENCY OF THE ORIGIN COUNTRY OF LOAN IS NOT THE C URRENCY IN WHICH THE LOAN IS FINALLY EXTENDED. IN THE INDIAN SCENARIO, THEREFORE , SUCH A LOAN, FOR EXTENSION OF WHICH DOLLARS! POUND STERLING/EURO ETC. NEED TO BE PURCHASED, CANNOT BE GOVERNED BY THAT RATE. 13. THE ASSESSEE HAD RELIED ON THE HONBLE CHENN AI BENCH OF ITAT RULING IN THE CASE OF M/S. SIVA INDUSTRIES AND HOLDING LTD . VS. ACIT (INFRA) AND OF THE MUMBAI TRIBUNAL IN THE CASE OF DCIT VS. TECH MA HINDRA LTD. (INFRA) WHEREIN IT WAS HELD THAT LIBOR RATE WOULD BE THE BE ST BENCHMARK TO DETERMINE ALP WHEN INTEREST FREE LOANS ARE GIVEN IN FOREIGN CURRENCY TO AE ABROAD. THE TPO HOWEVER REJECTED THE STAND OF THE ASSESSEE BY HOLDING THAT THE ABOVE ASPECTS OF LIBOR (SET OUT IN THE EARLIER PARA) WERE NOT BEFORE THE HONOURABLE ITAT WHEN THE DECISIONS WERE TAKEN. IT I S ALSO SEEN THAT ASSESSEE HAS NOT DEMONSTRATED THAT A LOAN ON SIMILAR TERMS I NCLUDING SECURITY, PURPOSE AND TERM OF LOAN ETC., AS GIVEN BY THE ASSE SSEE TO THE ASSOCIATED ENTERPRISE, WAS INDEED AVAILABLE TO THE ASSOCIATE E NTERPRISE IN ITS COUNTRY OF RESIDENCE. THIS BEING THE CASE, THE TPO HELD THAT THE INTEREST RATE CHARGED BY A GERMAN HANK TO TKT CANNOT BE CONSIDERED AS CUP . IN THIS BACKGROUND, NEITHER THE FOREIGN BENCHMARKING DONE BY THE ASSESS EE NOR THE EXAMPLE OF INTEREST RATE CHARGED BY THE GERMAN BANK, ACCEPTABL E PROPOSITIONS FOR BENCHMARKING THE TRANSACTIONS IN TERMS OF ARMS LEN GTH PRICE. THE TPO HELD THAT THE INTEREST RATE THAT ASSESSEE WOULD HAVE EAR NED HAD IT INVESTED THE LOAN AMOUNT IN A BANK DEPOSIT IS ALSO NOT AN ACCEPT ABLE COMPARISON. BANK DEPOSITS ARE SECURE AND THE PURPOSE IS DIFFERENT, W HEREAS THE LOAN GIVEN BY THE ASSESSEE TO ITS ASSOCIATE ENTERPRISE IS RIOT SE CURED AND IS A WORKING CAPITAL LOAN OR FOR THAT AES USE. IN THE FACTS A ND CIRCUMSTANCES OF THE CASE AND OF ASSESSEE ITSELF HAVING BORROWED A SECURED LO AN AT 9.75%, THE BENCHMARKING AT 10.25% WAS ADOPTED BY THE TPO. THE DRP UPHELD THE ORDER OF TPO BUT ARRIVED AT 12% RATE OF INTEREST AN D DIRECTED THE AO TO ITA NO. 7354/MUM/11(A.Y. 2007-08) 9 RECALCULATE THE ADJUSTMENT ADOPTING RATE OF INTERES T AT 12% PER ANNUM INSTEAD OF THE CALCULATION AT 10.25% IN THE TPOS O RDER. 14. WE HAVE HEARD THE RIVAL SUBMISSIONS. THE LEAR NED DR REITERATED THE STAND OF THE REVENUE AUTHORITIES. THE LEARNED COUN SEL FOR THE ASSESSEE SUBMITTED THAT THE LD. AO/DRP HAVE NOT APPRECIATED THE FACT THAT THE DECISION TO NOT CHARGE INTEREST, WAS BASED ON COMME RCIAL EXPEDIENCY. IT WAS SUBMITTED THAT THE AE WAS SUFFERING FROM A FINANCIA L CRISIS SO SEVERE THAT ITS VERY EXISTENCE WAS THREATENED( THE AE HAS SUBSEQUEN TLY BEEN LIQUIDATED). IT WAS ARGUED THAT IF THE APPELLANT HAD CHARGED INTERE ST, THE SAME WOULD HAVE TO BE WRITTEN OFF UPON THE AES LIQUIDATION. THE LO AN GRANTED TO THE AE WAS IN THE NATURE OF QUASI EQUITY AND THUS, NOTIONAL INTEREST SHOULD NOT BE COMPUTED. IT WAS SUBMITTED THAT THE SELECTION OF TH E CUP METHOD IS NOT IN ACCORDANCE WITH THE INDIAN TRANSFER PRICING REGULAT IONS AS THE LD. A.O/DRP HAS FAILED TO CONDUCT THE ANALYTICAL PROCESS ENSHRI NED IN THE INDIAN TRANSFER PRICING REGULATION (ITPR) FOR THE SELECTION OF THE MOST APPROPRIATE METHOD. THE APPLICATION OF THE CUP METHOD BY THE LD. AO/DRP IS NOT IN ACCORDANCE WITH THE ITPR ON THE FOLLOWING COUNTS: - THE LD. AO/DRP HAS NOT CONDUCTED ANY BENCHMARK AN D FAILED TO IDENTITY ANY COMPARABLE UNCONTROLLED TRANSACTION FO R IDENTIFYING THE ARMS LENGTH INTEREST RATE. - THE ADDITIONAL 2.25% INTEREST CHARGED IS WITHOUT ANY BASIS. - THE LD. AO/DRP HAS FAILED TO IDENTIFY AN INTERNAT IONAL TRANSACTION WHEREIN THE RAT AT WHICH AN UNRELATED PARTY WOULD L END MONEY TO ANOTHER UNRELATED ENTITY UNDER SIMILAR BUSINESS CIR CUMSTANCES. - THE INTEREST RATE CHARGED BY A DOMESTIC BANK CANN OT BE CONSIDERED TO BE COMPARABLE RATE AS THE APPELLANT IS NOT IN THE BUSINESS OF GRANTING LOANS. BY WAY OF ALTERNATIVE ARGUMENT AND WITHOUT PREJUDIC E IT WAS SUBMITTED THAT IN A SITUATION WHERE AN INTERNATIONAL LOAN WAS GRAN TED TO AN AE, EURIBOR ITA NO. 7354/MUM/11(A.Y. 2007-08) 10 BASED INTEREST RATE WOULD HAVE BEEN THE MOST APPROP RIATE COMPARABLE UNCONTROLLED RATE. THE FOLLOWING JUDICIAL RULING S UPPORTING THE ASSESSEES CONTENTIONS WERE CITED. VVF LTD. VS. DCIT (ITA NO .673/MUM/06) MUMBAI TRIBUNAL; M/S. SIVA INDUSTRIES & HOLDING LTD. VS. A CIT (ITA NO.2148/MDS/2010)(CHENNAI TRIBUNAL); DCIT VS. TECH MAHINDRA LTD. (ITA NO. 1176/MUM/2010)(MUMBAI TRIBUNAL); M/S. FOUR SOFT LIMITED VS. DCIT (ITA NO.1495/HYD/2010). IT WAS SUBMITTED THAT THIR D PARTY INTERNATIONAL TRANSACTIONS OF THE ASSESSEE/ THE COST INCURRED BY THE ASSESSEE (IN THE PRESENT CASE, THE RATE AT WHICH LOAN HAS BEEN TAKEN BY THE ASSESSEE FROM A DOMESTIC BANK) ARE NOT RELEVANT FOR DETERMINING THE ARMS LENGTH RATE OF INTEREST. IN THIS REGARD RELIANCE IS PLACED ON THE FOLLOWING RULINGS VVF LTD. VS. DCIT (ITA NO.673/MUM/06) MUMBAI TRIBUNAL; M/ S. AITHENT TECHNOLOGIES PVT. LTD. ITA NO.3647/DEL/2007. ACC ORDINGLY, IT WAS SUBMITTED THAT EVEN IF AN ARMS LENGTH INTEREST COM PUTATION IS AT ALL WARRANTED, THE FOLLOWING OPTIONS ( IN ORDER OF PRIO RITY) NEED TO BE CONSIDERED FOR COMPUTING THE SAME: A) THE DETAILED FOREIGN BENCHMARK CONDUCTED BY THE AS SESSEE FOR IDENTIFYING THE ARMS LENGTH INTEREST RATE WHICH WO RKS OUT TO RS. 4.15%. INTEREST RATE CHARGED BY A GERMAN BANK TO T KT. THE INTEREST RATE THAT THE ASSESSEE WOULD HAVE EARNED HAD IT INV ESTED THE LOAN AMOUNT IN A BANK DEPOSIT. B) INTEREST RATE CHARGED BY A GERMAN BANK TO THE AE 4.34% 15. ON THE ISSUE WHETHER THE TRANSACTION IN QUESTI ON VIZ., INTEREST FREE LOAN BY THE ASSESSEE TO ITS SISTER CONCERN CAN BE SUBJEC T MATTER OF TEST OF ARMS LENGTH PRICE (ALP) U/S.92 OF THE ACT, WE ARE OF THE VIEW THAT THE ORDER OF THE REVENUE AUTHORITIES HAVE TO BE UPHELD. IT WAS ARGU ED ON BEHALF OF THE ASSESSEE THAT UNDER THE NORMAL PROVISIONS OF THE AC T (CHAPTER IV), HAD THE ASSESSEE GIVEN INTEREST FREE LOAN OUT OF ITS INTERE ST FREE FUNDS TO A RESIDENT OR TO A NON-RESIDENT WHO IS NOT AN ASSOCIATED ENTERPRI SE, THEN THE REVENUE ITA NO. 7354/MUM/11(A.Y. 2007-08) 11 COULD NOT HAVE BROUGHT TO TAX NOTIONAL INTEREST INC OME ATTRIBUTABLE TO SUCH INTEREST FREE LOAN GIVEN BY THE ASSESSEE. THE POSI TION CANNOT BE DIFFERENT WHEN INTEREST FREE FUNDS ARE GIVEN TO AE WHICH IS A NON-RESIDENT. WE ARE UNABLE TO AGREE WITH SUCH ARGUMENT. CHAPTER X OF THE ACT DEALING WITH SPECIAL PROVISIONS RELATING TO AVOIDANCE OF TAX WAS INTRODUCED W.E.F. AY 02- 03 BY THE FINANCE ACT, 2001. PRIOR TO SUCH INTRODU CTION SEC.92 OF THE ACT WAS THE ONLY SECTION DEALING WITH TRANSFER PRICING. THOSE PROVISIONS AND RULES MADE THEREUNDER DID NOT GIVE SUFFICIENT POWER S TO THE REVENUE AUTHORITIES TO FIND OUT WHETHER THE FOREIGN COMPANI ES/NON-RESIDENTS OPERATING IN INDIA OR EARNING INCOME IN INDIA WERE BEING TAXED ON THEIR INDIAN INCOME ON AN ARMS LENGTH BASIS. THE LEGISL ATIVE INTENT BEHIND THE INTRODUCTION OF DETAILED TRANSFER PRICING PROVISION S IS BROUGHT OUT IN PARA 55.6 OF CBDT CIRCULAR NO. 14 / 2001 ON PROVISIONS R ELATING TO FINANCE ACT, 2001, WHICH INTERALIA STATES: THE BASIC INTENTION UNDERLYING THE NEW TRANSFER PR ICING REGULATIONS IS TO PREVENT SHIFTING OUT OF PROFITS BY MANIPULATING PRICES CHARGED OR PAID IN INTERNATIONAL TRANSACTIONS, THEREBY ERODING THE COUNTRYS TAX BASE. SEC.92 OF THE ACT LAYS DOWN THAT ANY INCOME ARISING FROM AN INTERNATIONAL TRANSACTION SHALL BE COMPUTED HAVING REGARD TO THE ARMS LENGTH PRICE. THE CHARGE TO TAX UNDER THE ACT IS ON THE TOTAL INCOME COMPUTED IN ACCORDANCE WITH THE PROVISIONS OF THE ACT. SEC.28 OF THE ACT LAYS DOWN THE CATEGORIES OF INCOME THAT ARE ASSESSED AS INCOME FROM BUSINESS OR PROFESSION. SEC.29 LAYS DOWN THE MANNER OF COMPUTATION OF INCOME FROM BUSINESS OR PROFESSION. THESE ARE GENERAL PROVISIONS FOR COMPU TATION OF INCOME FROM BUSINESS APPLICABLE TO ALL CLASS OF ASSESSEES. PRO VISIONS OF SEC.92 IN PARTICULAR AND CHAPTER X IN GENERAL ARE SPECIAL PRO VISIONS DEALING WITH COMPUTATION OF INCOME IN AN INTERNATIONAL TRANSACTI ON. THOSE PROVISIONS WILL PREVAIL OVER THE GENERAL PROVISIONS. GENERALIA SPE CIALIBUS NON DEROGANT (GENERAL PROVISIONS MUST YIELD TO THE SPECIFIC PROV ISIONS). GENERALLY ITA NO. 7354/MUM/11(A.Y. 2007-08) 12 SPEAKING, THE SECTIONS IN THE ACT DO NOT OVERLAP ON E ANOTHER AND EACH SECTION DEALS WITH THE MATTER SPECIFIED THEREIN AND GOES NO FURTHER. IF A CASE APPEARS TO BE GOVERNED BY EITHER OF TWO PROVISIONS, IT IS CLEARLY THE RIGHT OF THE ASSESSEE TO CLAIM THAT HE SHOULD BE ASSESSED UN DER THE ONE, WHICH LEAVES HIM WITH A LIGHTER BURDEN. WHEN THERE IS A CONFLICT BETWEEN A GENERAL PROVISION AND SPECIAL PROVISION, THE LATTER SHALL P REVAIL. 16. INTEREST FREE LOAN EXTENDED TO THE ASSOCIATED CONCERNS AS AT ARM'S LENGTH LENDING OR BORROWING MONEY BETWEEN TWO ASSOCIATED E NTERPRISES COMES WITHIN THE AMBIT OF INTERNATIONAL TRANSACTION AND W HETHER THE SAME IS AT ARMS LENGTH PRICE HAS TO BE CONSIDERED. THE QUESTIO N OF RATE OF INTEREST ON THE BORROWING LOAN IS AN INTEGRAL PART OF ARMS LENG TH PRICE REDETERMINATION 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 TRANS ACTION 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 LEN GTH OR NOT. THE DELHI BENCH OF ITAT IN THE CASE OF PEROT SYSTEMS TSI (IND IA) LTD. VS. DCIT (SUPRA) HAD CONSIDERED IDENTICAL ARGUMENT AND HELD AS FOLL OWS: 9. BEFORE US, THE ID. COUNSEL OF THE ASSESSEE CONT ENDED THAT INCOME MEANS REAL INCOME AND NOT FICTITIOUS INCOME AND SIN CE 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 VS. KRMTT THIAGARAJA CHETTY & CO. REPORTED IN 24 ITR 525 (SC) & IN THE C ASE OF MORVI INDUSTRIES LTD. VS. 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 RELI ANCE HAS BEEN PLACED UPON THE RULING OF AUTHORITY FOR ADVANCE RUL INGS DELIVERED IN THE CASE OF VENEBURG GROUP B.V. VS. CIT 727 OF 2006 FOR THE PROPOSITION THAT IN THE ABSENCE OF ANY INCOME, TRAN SFER PRICING PROVISIONS BEING MACHINERY PROVISION SHALL NOT APPL Y. IT HAS FURTHER BEEN ARGUED THAT TRANSFER PRICING DOCUMENT MAINTAIN ED BY THE ASSESSEE CLEARLY MENTIONED THAT THESE LOANS/ADVANCE S ARE IN THE NATURE OF QUASI-EQUITY AND HENCE THE TRANSACTION OF GRANTING INTEREST FREE LOAN IS AT ARM'S LENGTH. THE LOAN AGREEMENTS M ENTIONED THAT THESE ARE INTEREST FREE LOANS. RELIANCE IN THIS REGARD IS PLACED UPON THE ITA NO. 7354/MUM/11(A.Y. 2007-08) 13 DECISION OF DELHI TRIBUNAL IN THE CASE OF SONY INDI A LTD. 114 ITD 448 PARA 100 THAT 'UNDER FISCAL LOANS ACTUAL TRANSACTIO N AS ENTERED BETWEEN THE PARTIES IS TO BE CONSIDERED. AUTHORITIE S HAVE NO RIGHT TO RE- WRITE THE TRANSACTION UNLESS IT IS HELD THAT IT SHA M OR BOGUS OR ENTERED INTO BY THE PARTIES TO AVOID AND EVADE TAXES.' FURT HER REFERENCE HAS BEEN MADE TO PARA 1.37 OF 1995 OF OECD GUIDELINES F OR THE PROPOSITION THAT IT IS LEGITIMATE TO CONSIDER THAT ECONOMIC SUBSTANCE OF THE TRANSACTIONS. THE TRANSACTIONS HAS BEEN SAID TO BE COMMERCIALLY EXPEDIENT AND LOAN GRANTED TO SUPPORT THE SUBSIDIAR Y AND OBTAIN RETURNS IN FUTURE. THE ASSESSEE HAD FULL CONTROL OV ER ITS SUBSIDIARY WHICH REDUCE THE CREDIT RISK. THE LOAN HAD BEEN DUL Y GRANTED BY THE APPROVAL OF THE RBI. THE INCOME TAX ACT, 1961 AND O ECD GUIDELINES SUPPORT THE CONTENTION THAT THE EFFECT OF GOVERNMEN T CONTROL/ INTERVENTION SHOULD BE CONSIDERED WHILE DETERMINING THE ARM'S LENGTH PRICE. UNDER THE THIN CAPITALIZATION RULES, NO DEDU CTION WAS ALLOWABLE TO THE HUNGARY ENTITY FOR PAYMENT OF INTEREST THERE FORE, THERE EXISTED IMPOSSIBILITY OF PERFORMANCE WITH REGARD TO PAYMENT OF HUNGARY ENTITY. ECONOMIC CIRCUMSTANCES OF THE SUBSIDIARIES DID NOT WARRANT THE CHARGING OF INTEREST FROM SUBSIDIARIES. THE ID. COU NSEL FOR THE ASSESSEE FURTHER RELIED UPON THE APEX COURT DECISION IN THE CASE OF M/S S.A. BUILDERS LTD. VS. CIT(APPEALS) AND OTHERS 288ITR 1 (SC). 9.1 THE ID. DR FOR THE REVENUE ON THE OTHER HAND RE LIED UPON THE ORDERS OF THE ID. CIT(A), HE CLAIMED THAT THE ID. C IT(A)'S ORDER WAS A SPEAKING ORDER AND IT HAS REBUTTED ALL THE ARGUMENT S OF THE ASSESSEE. 10. WE HAVE CAREFULLY CONSIDERED THE SUBMISSIONS AN D PERUSED THE RECORDS. THE PRIMARY CONTENTION BEFORE US, AS SUBMI TTED BY THE ID. COUNSEL OF THE ASSESSEE IS THAT IT WAS COMMERCIALLY EXPEDIENT FOR ASSESSEE TO ADVANCE INTEREST FREE LOANS TO THE AES AND THAT SINCE NO INTEREST HAS ACTUALLY BEEN CHARGED, THERE IS NO REA L INCOME EXIGIBLE TO TAX. AS OBSERVED BY THE ID. CIT(A) THE AGREEMENTS S HOW THAT THESE ARE LOAN AMOUNT GIVEN BY THE ASSESSEE TO ASSOCIATED ENT ERPRISES (AES). THIS IN FACT IS AN ADMITTED POSITION. THERE IS NO C ASE THAT ANY SPECIAL FEATURE IN THE CONTRACT MAKE THE TRANSACTION AS CAP ITAL 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 COM MERCIALLY 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 SUBJE CT TO THE SAME CENTRE OR DIRECTION OR CONTROL (ASSOCIATED ENTERPRI SE) MAINTAIN ITA NO. 7354/MUM/11(A.Y. 2007-08) 14 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 SAME CIRCUMST ANCES WOULD HAVE AGREED UPON BETWEEN UN-RELATED PARTIES. THE AIM IS TO EXAMINE WHETHER THERE IS ANOMALY IN THE TRANSACTION WHICH A RISE OUT OF SPECIAL RELATIONSHIP BETWEEN THE CREDITOR AND THE DEBTOR. H ENCE THE CONTENTION OF HAVING ACTUALLY NOT EARNED ANY INCOME CANNOT COM E TO THE RESCUE OF THE ASSESSEE IN THIS SCENARIO. THE CASE LAWS FROM T HE APEX COURT CITED BY THE ID. COUNSEL OF THE ASSESSEE ARE IN THE CONTE XT OF THE PROPOSITION THAT ONLY THE REAL INCOME HAS TO BE TAXED AND INTER EST FREE ADVANCES CAN BE GIVEN BY COMPANIES (DOMESTIC) TO THEIR SUBSI DIARIES ON THE GROUND OF COMMERCIAL EXPEDIENCY. BUT THESE DECISION S ARE NOT IN THE CONTEXT OF CHAPTER-X OF THE IT ACT WHICH RELATES TO SPECIAL PROVISION RELATING TO COMPUTATION OF INCOME FROM INTERNATIONA L HAVING REGARD TO ARM'S LENGTH PRICE. OTHER CASE LAWS CITED BY THE AS SESSEE ARE NOT GERMANE TO THE FACTS OF THIS CASE. HENCE IN OUR CON SIDERED OPINION THEY DO NOT HELP THE CASE OF THE ASSESSEE. 17. THE AFORESAID DECISION OF THE TRIBUNAL IS AN A NSWER TO THE ARGUMENT OF THE ASSESSEE BEFORE US THAT THE IMPUGNED ADDITION C OULD NOT HAVE BEEN MADE BY THE AO AT ALL. RESPECTFULLY FOLLOWING THE SAID DECISION, WE HOLD THAT THE AO WAS WELL WITHIN HIS POWERS IN MAKING THE IMP UGNED ADDITION. THE JUSTIFICATION FOR THE QUANTUM OF NOTIONAL INCOME CO NSIDERED AS TAXABLE IN THE HANDS OF THE ASSESSEE IS A MATTER WHICH WE WILL EXA MINE IN THE SUBSEQUENT PARAGRAPHS. 18. ON THE ISSUE AS TO WHAT IS QUANTUM OF ADDITION THAT HAS TO BE MADE, WE WILL PROCEED TO EXAMINE THE ISSUE ON THE BASIS THAT CUP IS THE MOST APPROPRIATE METHOD FOR DETERMINING ALP IN THE PRESE NT CASE. IT HAS BEEN THE ARGUMENT ON BEHALF OF THE ASSESSEE THAT THE TPO HAS ADOPTED THE INTEREST RATE CHARGED BY A DOMESTIC BANK AS COMPARABLE RATE IGNORING THE FACT THAT THE ASSESSEE IS NOT IN THE BUSINESS OF GRANTING LOA NS. IT HAS FURTHER BEEN SUBMITTED THAT IN A SITUATION WHERE AN INTERNATIONA L LOAN WAS GRANTED TO AN AE, A EURIBOR BASED INTEREST RATE WOULD HAVE BEEN T HE MOST APPROPRIATE COMPARABLE UNCONTROLLED RATE. THE WORKING OF THE EU RIBOR RATE AT 4.15% ITA NO. 7354/MUM/11(A.Y. 2007-08) 15 HAS ALREADY BEEN SET OUT IN THE EARLIER PART OF THI S ORDER AND IS NOT BEING REPEATED. THE CONTENTION OF THE ASSESSEE IN THIS R EGARD FINDS SUPPORT FROM THE FOLLOWING RULINGS OF THE TRIBUNAL VVF LTD. VS. DCIT (SUPRA), M/S.SIVA INDUSTRIES & HOLDINGS LTD. VS. ACIT (SUPRA), DCIT V S. TECH MAHINDRA LTD. (SUPRA) AND M/S.FOUR SOFT LTD. VS. DCIT (SUPRA). THE MUMBAI TRIBUNAL IN THE CASE OF TECH MAHINDRA (SUPRA) HELD THAT THE ARM S LENGTH PRICE IN CASE OF INTEREST ON EXTENDED CREDIT PERIOD GRANTED TO AN AS SOCIATED ENTERPRISE SHALL BE DETERMINED ON THE BASIS OF USD LIBOR AND NOT ON ANY OTHER CURRENCY DENOMINATED LOAN RATE. THE MUMBAI BENCH OF THE IN COME-TAX APPELLATE TRIBUNAL (THE TRIBUNAL) IN CASE OF TECH MAHINDRA LI MITED (THE TAXPAYER) FOR ASSESSMENT YEAR (AY) 2004-05, HELD THAT THE ARMS L ENGTH PRICE IN CASE OF INTEREST ON EXTENDED CREDIT PERIOD ALLOWED TO AN AS SOCIATED ENTERPRISE (AE) BASED IN USA SHALL BE DETERMINED ON THE BASIS OF US D LONDON INTER BANK OFFER RATE (LIBOR) INSTEAD OF APPLYING THE RATE OF INTEREST PERTAINING TO EURO DENOMINATED LOAN CHARGED TO AE BASED IN GERMAN Y SINCE THE AE WAS BASED IN USA. THE FACTS OF THE CASE WERE THAT THE ASSESSEE IN THAT CASE WAS A A JOINT VENTURE BETWEEN MAHINDRA & MAHINDRA LIMI TED (INDIAN COMPANY) AND BRITISH TELECOMMUNICATIONS (UK COMPANY), WAS EN GAGED IN RENDERING OF SOFTWARE SERVICES RELATING TO TELECOMMUNICATION, IN TERNET TECHNOLOGY AND ENGINEERING ETC. DURING THE PREVIOUS YEAR , THE TA XPAYER HAD EXTENDED CREDIT BEYOND THE STIPULATED CREDIT PERIOD TO ITS AE BASED IN USA WITHOUT CHARGING ANY INTEREST ON SUCH EXTENDED CREDIT PERIOD. DURIN G THE ASSESSMENT PROCEEDINGS, THE TRANSFER PRICING OFFICER (TPO) RE JECTED TAXPAYERS ARGUMENTS AND DETERMINED THE ARMS LENGTH INTEREST FOR SUCH EXTENDED CREDIT PERIOD TO US AE AT THE RATE OF 10 PERCENT PER ANNUM . THE TPO DETERMINED THIS RATE BASED ON THE RATE OF INTEREST CHARGED BY THE TAXPAYER ON EURO DENOMINATED LOAN GRANTED TO ITS GERMAN AE. THE RE SULTANT TRANSFER PRICING ADJUSTMENT AMOUNTED TO INR 1.87 CRORES. THE ASS ESSING OFFICER (AO) ADOPTED THE ADJUSTMENTS MADE BY THE TPO. AGGRIEVED BY THE DECISION OF THE AO, THE TAXPAYER FILED OBJECTIONS BEFORE THE COMMIS SIONER OF INCOME TAX ITA NO. 7354/MUM/11(A.Y. 2007-08) 16 (APPEALS) [CIT(A)]. THE CIT(A) CONFIRMED THE TRANSF ER PRICING ADJUSTMENT, HOWEVER, RESTRICTED THE SAME TO 2 PERCENT BASED ON THE USD LIBOR RATE PLUS 80 BASIS POINT MARK-UP. AGGRIEVED BY THE ORDER OF T HE CIT(A), THAT AO FILED AN APPEAL BEFORE THE TRIBUNAL. THE TRIBUNAL HAD TH AT THE TPO MADE AN ERROR IN SELECTING THE TRANSACTION OF CHARGING OF INTERES T TO GERMAN AE ON LOAN GRANTED AT THE RATE OF 10 PERCENT PER ANNUM AS INTE RNAL COMPARABLE. FOLLOWING THE POSITION SETTLED IN CASE SKODA AUTO I NDIA AND RULE 10B(1)(A) OF THE INCOME-TAX RULES, 1962, TO BE AN INTERNAL COMPA RABLE UNDER THE COMPARABLE UNCONTROLLED PRICE (CUP) METHOD, THE TRA NSACTION NEEDS TO OCCUR BETWEEN THE TAXPAYER AND AN INDEPENDENT PARTY . EVEN ASSUMING THAT THE ADJUSTMENT FOR EXTENDED CREDIT WAS NECESSA RY, USD LIBOR IS MORE APPROPRIATE BASIS THAN THE RATE OF INTEREST ON EURO DENOMINATED LOAN CONSIDERING THE FACT THAT THE AE IS BASED IN USA AN D COMMERCIAL PRINCIPLES AND PRACTICES RELATED TO USD DENOMINATED EXTENDED C REDIT. THE TRIBUNAL HAS ALSO MADE A CRUCIAL POINT THAT THE ARMS LENGTH INTEREST RATE SHOULD BE TAKEN FROM THE COUNTRY OF THE BORROWER/DEBTOR, I.E. THE RATE OF INTEREST TO BE USED FOR BENCHMARKING SHALL BE THE RATE OF INTEREST IN RESPECT OF THE CURRENCY IN WHICH THE UNDERLYING TRANSACTION HAS TA KEN PLACE IN CONSIDERATION OF ECONOMIC AND COMMERCIAL FACTORS AR OUND THE SPECIFIC CURRENCY DENOMINATED INTEREST RATE. THE AFORESAID RULING WAS FOLLOWED BY THE CHENNAI BENCH OF ITAT IN THE CASE OF M/S.SIVA I NDUSTRIES & HOLDINGS LTD. (SUPRA), WHEREIN THE TRIBUNAL HELD AS FOLLOWS: WE HAVE CONSIDERED THE RIVAL SUBMISSIONS. A PERUSA L OF THE ORDER OF THE TPO CLEARLY SHOWS THAT THE ASSESSEE HAD RAISED THE FUNDS BY WAY OF ISSUANCE OF 0% OPTIONAL CONVERTIBLE PREFERENTIAL SHARES. THUS IT IS NOTICED THAT THE FUNDS RAISED BY THE ASSESSEE COMPA NY FOR GIVING THE LOAN TO INDIA TELECOM HOLDINGS LTD., MAURITIUS, WHI CH IS ITS ASSOCIATED ENTERPRISES AND WHICH IS THE SUBSIDIARY COMPANY, IS OUT OF THE FUNDS OF THE ASSESSEE COMPANY. IT IS NOT BORROWED FUNDS. THE ASSESSEE HAS GIVEN THE LOAN TO THE ASSOCIATED ENTERPRISES IN US DOLLARS. THE ASSESSEE IS ALSO RECEIVING INTEREST FROM THE ASSOCI ATED ENTERPRISES IN INDIAN RUPEES. ONCE THE TRANSACTION BETWEEN THE ASS ESSEE AND THE ASSOCIATED ENTERPRISES IS IN FOREIGN CURRENCY AND T HE TRANSACTION IS AN INTERNATIONAL TRANSACTION, THEN THE TRANSACTION WOU LD HAVE TO BE ITA NO. 7354/MUM/11(A.Y. 2007-08) 17 LOOKED UPON BY APPLYING THE COMMERCIAL PRINCIPLES I N REGARD TO INTERNATIONAL TRANSACTION. IF THIS IS SO, THEN THE DOMESTIC PRIME LENDING RATE WOULD HAVE NO APPLICABILITY AND THE INTERNATIO NAL RATE FIXED BEING LIBOR WOULD COME INTO PLAY. IN THE CIRCUMSTANCES, W E ARE OF THE VIEW THAT IT LIBOR RATE WHICH HAS TO BE CONSIDERED WHILE DETERMINING THE ARMS LENGTH INTEREST RATE IN RESPECT OF THE TRANSA CTION BETWEEN THE ASSESSEE AND THE ASSOCIATED ENTERPRISES. AS IT IS N OTICED THAT THE AVERAGE OF THE LIBOR RATE FOR 1.4.2005 TO 3 1.3.200 6 IS 4.42% AND THE ASSESSEE HAS CHARGED INTEREST AT 6% WHICH IS HIGHER THAN THE LIBOR RATE, WE ARE OF THE VIEW THAT NO ADDITION ON THIS C OUNT IS LIABLE TO BE MADE IN THE HANDS OF THE ASSESSEE. IN THE CIRCUMSTA NCES, THE ADDITION AS MADE BY THE ASSESSING OFFICER ON THIS COUNT IS D ELETED. 19. IN THE PRESENT CASE THE AE IS A GERMAN COMPANY . EUROBIOR RATES ARE BASED ON THE AVERAGE INTEREST RATES AT WHICH A PANE L OF MORE THAN 50 EUROPEAN BANKS BORROW FUNDS FROM ONE ANOTHER. THER E ARE DIFFERENT MATURITIES, RANGING FROM ONE WEEK TO ONE YEAR. THE SE RATES ARE CONSIDERED TO BE THE MOST IMPORTANT RATE IN THE EUROPEAN MONEY MA RKET. THE INTEREST RATES DO PROVIDE THE BASIS FOR THE PRICE AND INTERE ST RATES OF ALL KINDS OF FINANCIAL PRODUCTS LIKE INTEREST RATE SWAPS, INTERE ST RATE FUTURES, SAVING ACCOUNT AND MORTGAGES. WE FIND THAT THE RBI IN RES PECT OF EXPORT CREDIT TO EXPORTERS AT INTERNATIONALLY COMPETITIVE RATES UNDE R THE SCHEME OF PRE- SHIPMENT CREDIT IN FOREIGN CURRENCY (PCFC) AND REDI SCOUNTING OF EXPORT BILLS ABROAD (EBR), HAS PERMITTED BANKS TO FIX THE RATES OF INTEREST WITH REFERENCE TO RULING LIBOR, EURO LIBOR OR EURIBOR, WHEREVER AP PLICABLE AND THERETO APPROPRIATE PERCENTAGE RANGING FROM 1% TO 2%. THE REFERENCE TO THE SAID CIRCULAR IS AT PAGE -80 OF THE ASSESSEES PAPER BOO K. IN OUR VIEW THE CLAIM OF THE ASSESSEE TO ADOPT EURIBOR RATE AS STATED BEFORE THE TPO IS REASONABLE AND DESERVES TO BE ACCEPTED. FOLLOWING THE RULING OF THE TRIBUNAL IN THE AFORESAID CASES, WE ARE OF THE VIEW THAT THE CLAIM MADE BY THE ASSESSEE IN THIS REGARD HAS TO BE ACCEPTED. THE AO IS DIRECTED TO WORK OUT THE TP ADJUSTMENT ACCORDINGLY. GR.NO.1 TO 4 ARE THUS PARTL Y ALLOWED. ITA NO. 7354/MUM/11(A.Y. 2007-08) 18 21. IN GR.NO.5 THE ASSESSEE HAS PRAYED FOR ALLOWIN G CLAIM OF SET OFF OF UNABSORBED DEPRECIATION OF RS.6.68 CRORES AGAINST B USINESS INCOME. BOTH THE PARTIES BEFORE US AGREED THAT THIS ISSUE CAN BE REMANDED TO THE AO FOR FRESH CONSIDERATION WITH A DIRECTION TO ALLOW THE C LAIM IN ACCORDANCE WITH LAW. WE ORDER ACCORDINGLY. 22. IN THE RESULT, THE APPEAL OF THE ASSESSEE PART LY ALLOWED. ORDER PRONOUNCED IN THE OPEN COURT ON THE 30 TH DAY OF APRIL 2012 SD/- SD/- (P.M.JAGTAP ) (N.V.VASUDEVAN) ACCOUNTANT MEMBER JUDICIAL MEMBER MUMBAI, DATED 30 TH APRIL 2012 COPY TO: 1. THE APPELLANT 2. THE RESPONDENT 3. THE CIT CITY CONCERNED 4. THE CIT(A)- CONCERNED 5. THE D.RE BENCH. (TRUE COPY) BY ORDER ASST. REGISTRAR, I TAT, MUMBAI BENCHES MUMBAI. VM.