ITAT MUMBAI BENCH 'K'

IT Appeal No. 254 (Mum.) of 2013
[ASSESSMENT YEAR 2008-09]

D. MANMOHAN, VICE-PRESIDENT
AND P.M. JAGTAP, ACCOUNTANT MEMBER

Sunil M. Lala and Harsh R. Shah for the Appellant.
Mrs. Sasmita Mishra and A.K. Jain for the Respondent.

ORDER

D. Manmohan, Vice-President - This is an appeal filed at the instance of the assessee-company and it pertains to A.Y. 2008-09. Pursuant to directions of Dispute Resolution Panel the Assessing Officer passed an order under section 143(3) read with section 144C(13) of the Act wherein, several additions/disallowances were made which were challenged before us by raising seven grounds in grounds of appeal annexed to Form No. 36B.

2. At the time of hearing learned counsel, appearing on behalf of the assessee, submitted that Ground No. 1 is general in nature and hence need not be adjudicated upon and with reference to Ground No. 4 assessee-company is not interested in pursuing the matter due to smallness of the tax effect. We accordingly dismiss ground No. 1 & 4.

3. Vide ground No. 2 the assessee contends that the Assessing Officer as well as DRP erred in not allowing the claim of deduction under section 10A of the Act in respect of Unit No. II and Unit No. III. The case of the assessee was that Units No. II & III were set up in Software Technology Park. The units were validly formed during the Financial year 2000-01 & 2001-02 respectively with substantial new plant and machinery, new business contracts, new employees and new lines of business and hence, profit derived from the said units are to be considered under section 10A of the Act since they are new independent units. It was also submitted that the manner of registration with the STP authorities i.e. "expansion" of existing units is not relevant in this context since the only aspect that has to be seen is that whether the units are operating as independent units or not.

4. Pursuant to the opinion expressed by the DRP, the Assessing Officer observed that similar claim was rejected in assessee's own case for A.Y. 2005-06 and, the facts and issues being same for this assessment year, he preferred to follow his orders passed for earlier assessment years and accordingly held that Unit Nos. II & III do not fulfill the conditions stipulated under section 10A(2) of the Act for the reason that they are merely expansion of already existing business.

5. Learned counsel adverted our attention to page No. 10 of the assessment order to highlight that the Assessing Officer merely followed the orders passed by him in assessee's own case for earlier years whereas the said issue was considered by the ITAT "L" Bench, Mumbai in respect of A.Y. 2005-06 (ITA No.4089 & 4062/Mum/2011 dated 31.01.2012) wherein the Bench considered the factual matrix of the case in coming to the conclusion that the facts were not properly looked into by the tax authorities and the matter requires to be reconsidered afresh by taking into consideration the decision of the Co-ordinate Bench of the Tribunal in the case of Patni Computer Systems Limited. In this regard he adverted our attention to page No.9 of the paper book as well as page No. 18 of the paper book wherein the matter was set aside to the file of the Assessing Officer. On the other hand learned Departmental Representative relied upon the order passed by the Assessing Officer.

6. Having regard to the rival submissions we are in agreement with the plea of the assessee that the facts and circumstances of the instant case are mutatis mutandis identical to those of the immediately preceding year. By respectfully following the aforecited judgements, we set aside the assessment order on this point and direct the Assessing Officer to redecide this issue in consonance with the observations made by the Tribunal in the Appellate order for A.Y. 2005-06.

7. Vide ground No. 3 the assessee contends that the AO is not justified in reallocating certain common head office expenses amongst various units. It may be noticed that the AO disallowed the claim under section 10A of the Act in respect of Units No. 2 & 3 and also reallocated the expenses between different units, without prejudice to the disallowance. In the opinion of the AO the expenses have to be reallocated on the basis of percentage of turnover of the units.

8. The matter was referred to DRP. The assessee contended that the expenditures were allocated amongst all the units on a reasonable basis which is consistent with the ratio of allocation made in the earlier years and hence the AO was not justified in reallocating these expenses on the basis of turnover of the units. Without prejudice to the above contention the case of the assessee was that the assessee having already allocated certain expenses for each unit, in the event of reallocating the expenses the AO should have first added back the expenses already allocated by the assessee and then proceeded to arrive at the expenses of each unit by taking the turnover, as otherwise it would amount to double allocation. The DRP observed that the allocation of expenditure as per assessee's statement has no basis since it was not adequately supported with evidence. The DRP, therefore, observed that the method adopted by the AO is fair and reasonable in the absence of any scientific basis followed by the assessee. However, the DRP noticed that there is some merit in the contention of the assessee with regard to the alternative contention i.e., if the expenses are to be reallocated then the AO should have first added back the expenditure that was already allocated by the assessee and then reallocate them based on the turnover criteria. The AO was asked to verify this issue at the time of passing an order under section 143(3) r.w.s. 144C of the Act. While passing the order, pursuant to the view taken by the DRP, the AO observed that the assessee has not been able to furnish the basis of allocation of expenses unitwise and hence the assessee's allocation of the expenditure deserves to be rejected. He also observed that taking the turnover as the basis for allocation of expenditure is the most suitable method in the instant case since the P & L Account submitted by the assessee is consolidated for all the units. In his opinion once the expenditure is consolidated, merely because the assessee reallocated the expenditure, it would not amount to allocating the expenditure twice. In his opinion the disallowance of common expenses at the time of reallocation with regard to Units 2 & 3 should be as under: -

9. Aggrieved, the assessee preferred an appeal before us. The learned counsel for the assessee in the grounds of appeal submitted that reallocation of expenditure on the basis of turnover is not in accordance with law and, at any rate, the AO should have first added back the expenditure that was already allocated by the assessee. At the time of hearing the appeal the learned counsel for the assessee did not seriously press the main issue. In other words, he admitted that the turnover was correctly taken into consideration for allocation of expenditure against each unit. However, he focussed his submissions on the limited issue of what should be the net profit of Units 2 & 3 when reallocation of expenditure is made as per the method followed by the AO. In this regard he adverted our attention to pages 60 & 61 of the paper book to submit that the assessee had already allocated the common expenses of Rs. 2,27,66,000/- and Rs. 90,87,000/- respectively against Units 2 & 3 and only upon adding the same the reallocation procedures should have been started by the AO.

10. On the other hand, the learned D.R. relied upon the order passed by the AO.

11. We have carefully considered the rival submissions and perused the record. At the outset it may be noticed that ground No. 3 of the appeal raised before us contains 3a & 3b; ground No. 3a is not pressed. Even ground No. 3b is without prejudice to the claim of deduction under section 10A of the Act i.e., the reallocation of expenditure should be done only after adding back the common expenses as originally allocated by the assessee. It appears that the AO has not properly appreciated the issue. Since ground No. 2 is already set aside, we deem it fair and reasonable to set aside this issue also with a direction to the AO to reconsider the matter in accordance with law. Needless to observe that the assessee shall be given an opportunity of being heard and if the assessee has already allocated the expenditure the same has to be added back to the profits of the units and then only the reallocation process should begin. In this regard the assessee shall be given an opportunity of being heard. With these observations ground No. 3 is disposed of.

12. Vide ground No. 5 & 6 the assessee contends that the adjustments recommended by the TPO and DRP with regard to the interest receipts shown on loan given to AE is not in accordance with law. As per Form 3CEB report the assessee lent a sum of US$28,31,775 to C Cubed NV Netherlands (Antilles). The assessee's wholly owned subsidiary Pacific Horizon Limited, Mauritius holds 100% shareholding in C Cubed (Antilles) and hence the loan was stated to have been advanced to the Associate Enterprises (AE). The assessee company charged interest @ 6% p.a. The Transfer Pricing Officer was of the opinion that the arm's length price has to be determined on the said loan transaction by following CUP method wherein the interest rate has to be determined by taking into consideration the circumstances under which the tax payer and its subsidiary are borrowing i.e., what is the interest that would have been earned if such loans were given to unrelated parties in similar situation as that of subsidiaries. In this regard he observed that the financial institutions generally weigh four elements in determining whether or not to issue loans i.e.,

By taking into consideration the nature of lending the TPO was of the prima facie view that it is an unsecured loan which falls in the credit rating range AAA to BBB and also observed that yield from BB rate corporate bond was 14.39% for 5 year period and as per the Fixed Income Money Market and Derivatives Association of India (FIMMDA) the unrated bonds will be valued by marking up the credit spread by a minimum of 20% over the equivalent rated bond of similar tenure. In his opinion the overall scenario reflects that the loan has to be graded as "BB". As per the information obtained from CRISIL the annual average yield for "BB" rated bond for 5 year or more term is 17.26%. When the assessee was asked as to why transfer pricing adjustments should not be made in the light of the above observations it was replied on behalf of the assessee company that the Indian companies go for external commercial borrowings as the interest rate on ECB loans are generally cheaper than the prevailing interest rate in the domestic market. The interest rates are benchmarked with LIBOR (London Interbank Offer Rate) and the benchmarking for lending would be different from borrowings. It was explained in detail that even as per the CUP method if it is benchmarked against LIBOR the interest rate declared by the assessee is higher and hence no adjustment is required.

13. Not being satisfied with the case made out by the assessee the matter was referred to DRP which in turn observed that benchmarking the loan against LIBOR was correctly rejected by the TPO. The Committee was of the view that LIBOR is not the rate of consideration for loans where a currency is to be bought i.e. it is not applicable where the currency of the origin country of loan is not the currency in which the loan is finally extended. In the Indian scenario, the loan given in dollars cannot be governed by that rate since the conversion is fraught with exchange risk at the time of repayment and the cost of conversion and the applicable rates at the time of extension also, against which the assessee needs to guard itself. Even for argument sake if LIBOR is sought to be considered as a rate of reference for loans originating out of India, in the opinion of the DRP, LIBOR would have to be adjusted for currency risk, country risk and forex market fluctuations even before it can be considered as a rate of reference. At the same time the DRP noticed that the rating given by the TPO is also not clear and further it noticed that the assessee's own domestic cost of borrowings or the rate at which income had been foregone by the assessee to extend the loan would be the right basis in the facts and circumstances of the case. However, the assessee also needs to protect itself against various risks. Therefore it suggested that a markup of 3% would take into consideration the risk factors and accordingly directed the TPO to verify and adopt assessee's domestic cost of borrowings, etc. plus 3% markup for making adjustments in this regard. In the final order passed under section 143(3) r.w.s. 144C(13) of the Act the AO observed that the assessee's own domestic cost of borrowings or the rate at which income has been foregone by the assessee to extend loan would be the right basis in the circumstances of the case but would have put the assessee in a no-profit no-loss situation. He also observed that a markup of 3% on assessee's domestic cost of borrowing should also be taken into consideration to meet the ends of justice. Aggrieved assessee is in appeal before the Tribunal.

14. The learned counsel for the assessee submitted that the loan was given to the AE in the immediately preceding year where same interest rate was charged by the assessee and the TPO has not made any adjustment with regard to interest rate in the said year. In this regard he adverted out attention to the TPO's order, at pages 156,157 and 178 of the paper book, to highlight that though the issue was considered but finally no adjustment was made with regard to the interest charged by the assessee from the AE. He also adverted our attention to pages 133 and 125 of the paper book to submit that the loan was given in the preceding year and due to exchange rate difference the loan amount reflected in the Balance Sheet got reduced from Rs. 12.34 crores for the year ending 31.03.2007 to Rs. 11.33 crores for the year ending 31.03.2008. He also challenged the markup of 4+3%, which was to cover other risks and submitted that it was only with regard to the loan given in India Rupees to Indian companies whereas in the instant case the loan was given in US dollars and hence the LIBOR rate is more appropriate for benchmarking. In fact the DRP has applied the Indian rate and they have not accepted the LIBOR rate because of the alleged complications involved in working. The learned counsel for the assessee submitted that as compared to LIBOR rate the assessee charged higher rate of interest and at any rate the issue stands squarely covered by the decision of the ITAT "B" Bench Delhi in the case of Cotton Naturals (I) P. Ltd. v. Dy. CIT [2013] 32 taxmann.com 219 (Delhi) (Trib) wherein, on identical circumstances, the Bench observed that the interest rate charged by the assessee for the loan transactions with AE was at arm's length hence no transfer pricing adjustment was called for. In this regard the Bench followed the decision of the ITAT Bangalore Bench in the case of Philips Software Centre (P.) Ltd. v. Asstt. CIT [2008] 26 SOT 226. In the light of the aforecited decision, and following other decisions, the learned counsel strongly submitted that the issue stands squarely covered in favour of the assessee and hence no adjustment is required in the instant case:-

15. On the other hand, the learned D.R. submitted that even in earlier years there were borrowings which are reflected from pages 126 of the paper book wherein payment of interest of Rs. 35.10 lakhs was reported for the year ending 31.03.2007. This in turn shows that even in earlier year there were borrowings but they might have been repaid before the end of the year. He also referred to page 135 of the paper book to highlight that the assessee availed cash credit facility in earlier years which shows that the assessee borrowed money in the year in which the amount was loaned to AE and hence the AO was justified in making the adjustment in this year. He adverted out attention to the decision of the Hon'ble Apex Court in the case of Distributors (Baroda) (P.) Ltd. v. Union of India [1985] 155 ITR 120/22 Taxman 49 to submit that in the event of noticing any mistake, in a later year where the facts are properly bought out, the correctness of the view taken by the TPO/DRP/AO can be considered afresh in the backdrop of the facts and circumstances instead of merely banking upon the view taken in the immediately preceding year. He further submitted that in the case of Cotton Naturals (I) (P.) Ltd. (supra) the assessee paid less interest on borrowing and hence he could not have charged more. Under this circumstance the Appellate Tribunal adopted the internal CUP. He adverted our attention to page 36 of the order of the ITAT "B" Bench Delhi in the case of Cotton Naturals (I) (P.) Ltd. (supra) to highlight that the loan from City Bank was availed for less than 4% whereas the assessee provided loan to its AE by charging interest at 4% p.a. Therefore the case law relied upon by the assessee was not applied to the circumstances of the case. He further submitted that the decision in the case of Philips Software Centre (P.) Ltd., referred to by the Delhi Bench, was stayed by the Hon'ble Karnataka high Court and hence the view taken by the Delhi Bench, based on the decision of the Bangalore Bench, is not applicable and need not be followed. He thus strongly supported the order passed by the AO.

16. Joining the issue the learned counsel for the assessee submitted that the decision of the ITAT, Delhi Bench was not solely based upon the internal rate of interest for borrowings but it was largely based upon the fact that LIBOR has been accepted as a preferred rate for benchmarking to arrive at the arm's length price in the case of loan given in US dollars. In the instant case also the loan was given in US dollars and hence the transaction has to be considered by applying the commercial principles in regard to international transactions and under such a situation domestic rate would have no applicability. With regard to the decision of the Hon'ble Karnataka High Court staying operation of the order passed in the case of Philips Software Centre (P) Ltd. (supra), the learned counsel for the assessee submitted that if an order is stayed it is only vis-à-vis that case and the other orders are not affected. At any rate, sans the decision of the ITAT Bangalore Bench, the matter was considered at length by the Delhi Bench in order to arrive at a conclusion that with regard to loans given in US dollars the LIBOR rate should be taken as benchmark. He thus submitted that it is not a fit case for making transfer pricing adjustments.

17. We have carefully considered the rival submissions and perused the record. The case of the assessee was that LIBOR as on 31.03.2008 was 2.49% against which the assessee has charged interest @ 6% p.a. In other words, interest charged by the assessee is much higher than the corresponding arm's length LIBOR even from an Indian transfer pricing perspective. It is not in dispute that the loan has been denominated in US dollars. Though the learned D.R., for the first time, raised a contention that the assessee might have taken loan in the earlier year to advance the same to its AE in the earlier year, in fact neither the TPO nor the DRP has considered the aspect from that angle and the assessee consistently prayed before the tax authorities that the assessee has not incurred any interest cost on funds given to the AE as the source of fund is surplus available with the assessee. In the absence of any material to prove to the contrary, merely because some interest has been paid in the immediately preceding year, it cannot be assumed that the assessee borrowed funds in the immediately preceding year was the source for the purpose of advancing loans to its AE. Having regard to the overall circumstances of the case we are of the view that the issue stands squarely covered by the decision of the ITAT Delhi Bench in the case of Cotton Naturals (I) P. Ltd. wherein the Bench observed that the CUP method is the most appropriate method in order to ascertain arm's length price of the international transaction i.e., where the lending of money was in foreign currency to its AE the domestic prime lending rate would have no applicability and the interbank rate fixed should be taken as benchmark rate for international transactions. We, therefore, hold that LIBOR rate has to be adopted in the instant case since the interest charged by the assessee from its AE is higher than the LIBOR rate in the year under consideration no transfer pricing adjustment in that regard is warranted. We therefore set aside the order of the AO in this regard and allow the grounds urged by the assessee.

18. With regard to ground No. 7 the learned counsel for the assessee submitted that though charging of interest under section 234B is mandatory but it is consequential in nature depending upon the additions/adjustments upheld. The AO is directed to compute the interest chargeable under section 234B of the Act.

19. In the result, appeal filed by the assessee is partly allowed.