Technical update KOLKATA ITAT (SB) RULES IN FAVOUR OF THE REVENUE BY DIRECTING MANDATORY ALP DETERMINATION FOR INBOUND INTEREST FREE LOAN

Transcription

1 Technical update KOLKATA ITAT (SB) RULES IN FAVOUR OF THE REVENUE BY DIRECTING MANDATORY ALP DETERMINATION FOR INBOUND INTEREST FREE LOAN Contributed by : CA Virav Dedhia a member of the association he can be reached at ca.viravdedhia@gmail.com The exercise of arm s length price ( ALP ) determination for an inbound interest free loan has always been a challenge. The taxpayers have been raising various contentions to defend such NIL interest such as business and commercial expediency, transaction being in the nature of shareholder activity, and absence of any base erosion in such a scenario where the non-resident counterpart was also liable to pay tax on such interest income. However, the Indian revenue authorities have vehemently pressed for an adjustment to the income of the non-resident taxpayer as the Indian Transfer Pricing ( TP ) Regulations mandate ALP determination of every international transaction and the limitation of Section 92(3) comes into play when the income of the assessee in whose hands the ALP is to be determined stands reduced or loss increases. The recent verdict by the Income tax Tribunal in case of Instrumentarium Corporation Limited, Finland vs. Assistant Director of Income Tax, International Taxation, I, Kolkatafor the assessment year (AY) and AY , provide some useful insights into the various issues involved. The facts relating to the case, the assessee s contentions and the ruling of the SB of ITAT are as follows: Facts of the case Instrumentarium Corporation Limited ( ICL Finland or assessee ), a tax resident of Finland, was engaged in the business of manufacturing and selling of medical equipment. It had a wholly owned subsidiary in India by the name of Datex Ohmeda India Pvt. Ltd. ( Datex India ) which acted as the marketing arm of ICL Finland in India. During financial year ( FY ) , the ICL Finland had advanced an interest free loan in USD equivalent to INR 36 crores to Datex India for its general business purposes. During the course of assessment, the Assessing Officer ( AO ) had objected to such loan being interest free. Accordingly, the AO proposed an adjustment to ICL Finland s income by adopting average prime lending rate ( PLR ) of the State Bank of India ( SBI ) as the arm s length interest rate. ICL Finland then approached the Authority for Advance Ruling ( AAR ). AAR rejected the application of ICL Finland by observing that the question of determining arm s length price was beyond its scope as it involves the determination of fair market value ofproperty.hence the issue was left open for adjudication in the normal assessment proceeding of the assessee. Aggrieved by the order of AO, assessee appealed before CIT(A) but without any success. The taxpayer being aggrieved with the order of the CIT(A), an appeal is filed with the Tribunal. Furthermore, Shell Global Solutions International BV ( Shell Global or intervener ) also approached the SB as an intervener in the said matter. SB ruling and observations Section 92(3) Section 92(3) states (3) The provisions of this A plain reading of the above extract of and concept section shall not apply in a case where the the Act indicates that what is to be of base erosion computation of income under sub-section considered is the impact on profits or (1) has the effect of reducing the income losses for the year in consideration itself chargeable to tax or increasing the loss, as the as it is to be computed on the basis of 30 You will never find time for anything. If you want time you must make it.

2 VOL. 20 NO. 2 / AUGUST 2016 case may be, computed on the basis of entries entries made in the books of accounts made in the books of account in respect of the in respect of previous year in which previous year in which the international the international transaction was transaction was entered into. entered into. Thus, there is thus no scope at all for taking into account the Adoption of ALP shall not be resorted to where impact on taxes for the adjustment has effect of reducing overall subsequent years. income or increasing loss in India in respect of parties involved in the transaction. The SB of ITAT rejected the base erosion theory propounded by the During the year under consideration, the assessee on the following assessee s income was liable to 10% on grounds: gross basis, while Datex India was liable to There is no base erosion by the pay withhold 36.75%. Accordingly, had ALP adjustments in the hands of Datex India paid any interest to the assessee, income of the non-resident company it would have resulted in erosion of Indian tax in respect of transactions with the base by 26.75% since assessee would have paid Indian AEs 10%, while Datex India would have If adjustment is not made it will obtained a tax shield of 36.75% against such lead to tax base erosion of by payment. Since the non-charging of any 10% of ALP interest is ultimately benefitting the Indian The Indian TP provisions do not revenue in preventing base erosion at the permit the Indian AE to avail a macro level, therefore, TP provisions should corresponding deduction in respect of not be applied in such a scenario. any adjustment made to the income of assessee for arm s length purposes. The assessee submitted that the transfer Accordingly, any increase in the income pricing provisions deal with the transactions of the assessee on account of such TP involving two or more parties, and what adjustment cannot lead to any base should be put to test is tax implications of erosion for India and would help the a transaction as a whole rather than tax Indian tax revenue to tax assessee s implications of the transaction in the hands enhanced 10%. of one of the assessee. Section 92(3) cannot be given such a The Hon ble Supreme Court in the case restrictive meaning so as to examine the of Morgan Stanley was analysing the impact of taxability only in the hands of the scope and impact of the tax treaty assesse rather than of all the AEs put together. provisions and made certain observations of macro observations in Further, the assessee also presented its this context. These observations made rejoinder of the base erosion theory wherein it were in the context of PE profit contended that the Indian AE had a statutory attribution, which is on the basis of a right to carry forward the loss for a period of bilateral tax avoidance agreement, 8 years and set off the same against the profits cannot be used to nullify or restrict the within the stipulated time frame. impact of transfer pricing provisions under the statute. Additionally, the assessee also placed reliance on Morgan Stanley & Co. Ltd. [(2007) 292 ITR 416 (SC)] wherein it is held that, the profits sought to be taxed in India in the hands of the foreign enterprise are already residing in India in the hands of the AEs. We must use time as a tool, not as a couch. 31

3 Implications The assessee submitted that the bar on Nothing in the Act enables the assessee of Section corresponding deduction adjustments in the to claim such a deduction. Moreover, 92C(4) hands of the AE, as set out in second proviso the second proviso to Section 92C(4), to Section 92C(4), comes into play only when constitutes a bar against lowering arm s length price ispaid to the AE. income of the non-resident AE, as a result of lowering the deduction in the In the instant case, since no payment has been hands of the Indian AE, rather than made by the Indian AE, i.e. Datex India, the asenabling a higher deduction in the bar on deduction does not come into play and hands of the Indian AE as a result of hence the transfer pricing provisions cannot increasing non-resident AE s income. be invoked. Australian ATO had observed that ALP adjustments are The Australian TP provisions provide a Tax Office not required to be made in the cases of discretionary power to the tax ( ATO ) ruling interest free loans granted by a non-resident authorities to apply the arm s length company to a resident company even if principle while computing income, the resident company is incurring losses. whereas the Indian TP provisions Accordingly, same principle should also be provide for mandatory determination of applied to the case of the assessee. ALP of an international transaction. Further, under the Australian Income tax assessment provisions, consequential adjustments are permissible in certain conditions. No such adjustments are permissible under the Indian Income Tax Act, Thus the SB held that the relevant legal rovisions are not in pari materia. Shareholder The interest free loan was advanced by the The SB rejected the assessee s plea activity assessee to its Indian AE only because of its of loan being in the nature of ownership interest in the AE and to bail it out shareholder activity on the ground of financial distress, and therefore, the same that such argument was taken up for constituted a shareholder activity. the first time and there were no evidences to demonstrate the same.such facts cannot be inferred or assumed; there has to be some material on record to demonstrate the existence of these facts. Commercial The assessee hadadvanced an interest free loan, The commercial expediency of a loan to expediency the revenue authorities cannot disregard the subsidiary is irrelevant in ascertaining and Re-chara commercial expediency of the interest free loan arm s length interest on such a loan. cterization and impute interest thereon. Further a There is no bar on advancing an of loan non interest bearing loan cannot be interest free loans, however, as per re-characterized as an interest bearing loan. Section 92 the income from such transactions is to be computed on the basis of arm s length price. There is no re-characterization of the transaction, as it continues to be a loan transaction and the substitution of zero interest by arm s length interest does not alter the basic character of transaction. 32 Those that make the best use of their time have none to spare.

4 VOL. 20 NO. 2 / AUGUST 2016 Real loss vs. Datex India was incurring business losses. It is uncertain to determine whether hypothetical Under the provision of the Act, such AEs were the Indian AEs would actually earn loss entitled to carry forward losses for a period of profits to set-off such carry-forwarded 8 years and set off the same against its losses in future. The benefit of loss is future profits within the said time frame. not real, only contingent and these facts could not have been known at the The assessee, in support of this claim, pointed time of assessment and they were also out that the assessee s AE, i.e. Datex India, unsubstantiated before the SB. had merged with Wipro GE Healthcare Ltd in the year much before the statutory period of eight years and hence the losses were real losses. Declaration Unless any income from an international The transactions under consideration of an income transaction is reported by the assesse, the were international transactions and ALP adjustment to the same cannot be made. therefore, the income from such transactions was required to be computed having regard to the ALP CBDT As per circular no. 14 of 2001 the basic CBDT as per Section 119(1) may circulars intention of the new provisions was to issue such orders, instructions and prevent shifting of profits outside India directions to other income-tax due to manipulation of prices of authorities as it may deem fit for the international transactions. The new proper administration of this Act. section 92 as introduced by Finance Act, There are certain situations, as 2001 was not intended to be applied in cases envisaged in Section 119(2), in which where adoption of ALP results in a decrease in the CBDT circulars can relax the overall tax incidence in India in respect rigour of law, however, CBDT cannot of parties to the transaction. relax the provisions of Section 92 under Section 119(2). Summary of the Ruling The SB was in agreement with the view of the division bench of this Tribunal in case of Tata Tea Ltd Vs. JCIT [(2003) 87 ITD 351 (Kol)] and stated that even if the intent of the legislature was that transfer pricing provisions are not to be invoked in cases where there is lowering of the overall profits of all the associated enterprises connected with the transactions as the words of the statutory provision did not translate this intent into the law, it cannot be open to the SB to hold that transfer pricing provisions are not to be invoked. While rejecting the plea that erosion of tax base or base erosion is a sine qua non for triggering of Indian TP Regulations, the SB of the ITAT made the following observations: Section 92 of the Indian Income Tax Act, 1961 ( the Act ) mandates determination of income arising from an international transaction having regard to arm s length principle; Provisions of section 92(3) of the Act are applicable in the hands of the taxpayer in whose hands the income from such international transaction is computed; The swiftness of time is infinite, as is still more evident when we look back on the past. 33

5 Central Board of Direct Taxes s ( CBDT ) understanding of the intent of the legislature contained in its circular which is not in the nature of an order, direction, or instruction issued u/s 119(1) of the Act can neither bind the filed authorities, nor can it reduce the rigors of section 92 of the Act; Declaration of some income from an international transaction by the taxpayer is not a pre-requisite for determination of ALP of such international transaction; and Assignment of interest to an interest free loan does not tantamount to re-characterisation of such loan transaction. Our view: The prevalent view in regards to the inbound loans was that the arm s length analysis is not required to be carried out however, this judgement challenges this view by negating the base erosion theory albeit on the facts of this case.there will definitely be more developments in future on this issue and one needs to follow the same, however, this will definitely create litigation at enforcement level. NEW MEMBERS ENROLLED CA CHHEDA DHRUVIN JASMIN Bagada Mulund Check Naka Mobile : cdhruvin@gmail.com CA VORA ANANT DEEPAK Varandi Moti Sion Koliwada, Mumbai Mobile : voraanant@gmail.com CA SHAH JILL JAYESH Pragpur Dadar West Mumbai Mobile : jillshaha93@yahoo.com CA GADA MANSI CHANDRAKANT Patri Matunga West, Mumbai Mobile : gada.mansi@gmail.com CA DHAROD ALPESH TANSUKH Vanki Andheri East Mumbai Mobile : alpesh.dharod1984@yahoo.co.in CA VORA NEEL MUKESH Pragpur Sewri West, Mumbai Mobile : neelmvora@gmail.com CA SONI HARSH LALIT Banbhadai Mulund East, Mumbai Mobile : harshsoni.hs@gmail.com CA CHHEDA PRIYANKA SURJI Gagodar Andheri West, Mumbai Mobile : priyankachh23@yahoo.in CA CHHEDA SURJI DAMJI Gagodar Andheri West, Mumbai Mobile : sdchheda@yahoo.in CA MARU JINAL PANKHIL Lakhapur Mulund West, Mumbai Mobile : jinalshah16@gmail.com CS DEDHIA KINJAL SACHIN Nanikhakhar Borivali West, Mumbai Mobile : cskinjaldedhia@gmail.com CA SAVLA DHAVAL KHUSHAL Wadala Malad West, Mumbai Mobile : dhavalsavla11@gmail.com 34 Time, which changes people, does not alter the image we have of them.