Bhw Home Finance Ltd., Gurgaon vs Assessee

First Blue Home Finance Ltd., Vs. Asstt. Commissioner of 201, Vipul Agora, MG Road, Income Tax, Circle-10(1), New Sahara Mall, Gurgaon New Delhi (PAN: AABCB6216H) (Appellant) (Respondent)

Appellant by : Sh. H.P. Agarwal, CA Respondent by : Sh. Gaurav Dudeja, Sr. DR

Date of hearing: 04.06.2015 Date of pronouncement: 05.06.2015

ORDER

PER R.S. SYAL, A.M.:

This appeal by the assessee is directed against the order passed by the

CIT(A) on 28.10.2011 in relation to the assessment year 2007-08.

2. The only issue raised in this appeal is against the sustenance of addition

on account of transfer pricing adjustment on account of interest on the deemed

loan, determined as a result of the issue of shares at value lower than their fair

value estimated by the Transfer Pricing Officer (TPO).

3. Succinctly, the assessee is a 100% Indian subsidiary of BHW Holding AG

(BHW Germany). It is engaged in the business of providing loans to retail

customers for the construction or purchase of residential properties in India.

Two international transactions were reported by the assessee in Form No. 3CEB. 2 ITA No. 5460/Del/2011

AY: 2007-08

The first transaction is of "Issue of share capital" with the transacted value of

Rs. 128,11,95,000/-. We are not concerned with the other international

transaction of "Provision of services", which has been accepted by the

authorities at arm's length price (ALP). On a reference made by the Assessing

Officer (AO) to the TPO, the latter observed that the assessee demonstrated the

international transaction of `Issue of share capital' at ALP by following the

Comparable Uncontrolled Price (CUP) method as the most appropriate method.

The TPO observed that the book value of each share of the assessee company at

the beginning of the year stood at Rs. 13.70. The assessee was found to have

issued shares to its AEs at the rate of Rs. 10 per share. Since the book value of

the shares was higher than the issued price, the TPO held it as a transaction of

`transfer of assets of the company' to its AEs in the guise of issue of share

capital. It was opined that such under-charging of the price of shares was in the

nature of a deemed loan given by the assessee to its AEs without any

consideration. He held that the assessee ought to have been compensated for

such deemed loan with suitable interest. After entertaining objections from the

assessee, the TPO determined the arm's length value of shares issued by the

assessee company at Rs. 13.70 per share. Applying this benchmark as arm's

length price of the share capital, the TPO treated the differential amount of

Rs.47,40,42,150/- as deemed loan given by the assessee to its AEs. It was

thereafter held that the assessee ought to have charged interest on such loan of 3 ITA No. 5460/Del/2011 AY: 2007-08

Rs. 47.40 crore from its AEs. By applying the benchmark interest rate of 14%

on such deemed loan, the TPO worked out the arm's length value of interest

received at Rs. 6,63,65,901/-. Since no interest was charged by the assessee on

such deemed loan, the TPO proposed transfer pricing adjustment of equal

amount at Rs. 6.63 crore. The Assessing Officer made this addition, which came

to be affirmed in the first appeal. The assessee is aggrieved against the

sustenance of this addition.

4. We have heard the rival submissions and perused the relevant material on

record. The short question is whether any addition towards transfer pricing

adjustment on account of interest on deemed loan can be made under the

circumstances as are obtaining in the instant case. Section 92(1) of Income-tax

Act, 1961 (hereinafter also called as "the Act") provides that : "Any income

arising from an international transaction shall be computed having regard to the

arm's length price". A bare perusal of this provision divulges that, firstly, there

should be an international transaction and secondly, such international

transaction should result into income chargeable to tax. When both these

conditions are satisfied then the income so arising from an international

transaction is computed having regard to its ALP. The reported international

transaction is of the issue of 12,81,19,500 number of equity shares by the

assessee to its AEs at the rate of Rs. 10 per share. This transaction of issue of

shares was rightly considered by the assessee as an international transaction. 4 ITA No. 5460/Del/2011

AY: 2007-08

There can be no doubt about such transaction being characterized as anything

other than an international transaction. Section 92B gives meaning to

`International transaction'. Sub-section (1) provides that : `For the purposes of

this section and sections 92, 92C, 92D and 92E, "international transaction"

means a transaction between two or more associated enterprises, either or both

of whom are non-residents, in the nature of purchase, sale or ....... or any other

transaction having a bearing on the profits, income, losses or assets of such

enterprises........'. It is apparent from the definition of `international transaction'

that it encompasses a transaction between two associated enterprises which,

inter alia, has a bearing on assets of such enterprises. As the issue of shares by

a company has direct bearing, inter alia, on its assets in terms of receipt of

consideration, such transaction cannot be held to be a non-international

transaction. The legislature has clarified this position beyond any doubt by

inserting clause (c) to the Explanation at the end of section 92B through the

Finance Act, 2012, w.r.e.f. 1.4.2002, providing that the international transaction

shall include : `(c) capital financing, including any type of long-term or short-

term borrowing, lending or guarantee, purchase or sale of marketable securities

or any type of advance, payments or deferred payment or receivable or any other

debt arising during the course of business;'. This shows that the issue of share

capital is an international transaction. Once there is an international transaction,

the mandate of section 92C is triggered, which talks of computation of arm's 5 ITA No. 5460/Del/2011 AY: 2007-08

length price of an international transaction. Sub-section (1) of section 92C

provides that : `The arm's length price in relation to an international transaction

..... shall be determined by any of the following methods, being the most

appropriate method, having regard to the nature of transaction or class of

transaction or class of associated persons or functions performed by such

persons or such other relevant factors as the Board may prescribe.......'. Then

five specific methods have been provided and lastly, there is a general method

as per clause (f), being, `such other method as may be prescribed by the Board.'

Second condition for invoking the provisions of Chapter-X of the Act is that

some income should arise from an international transaction. It is only when

some income chargeable to tax arises from an international transaction, that the

income so arising is substituted with the income determined on the basis of the

ALP of the transaction. Thus, it is apparent that if an international transaction

with its determined ALP does not lead to the generation of any income

chargeable to tax, then the provisions of section 92(1) are not magnetized. The

Hon'ble Bombay High Court in Vodafone India Services Pvt. Ltd. Vs. Additional

Commissioner of Income Tax, (2014) 368 ITR 1 (Bom.) has held that Chapter-X

of the Act does not contain any charging provision but is a machinery provision

to arrive at ALP of a transaction between two or more Associated Enterprises. It

has further been held that this Chapter does not change the character of the 6 ITA No. 5460/Del/2011 AY: 2007-08

receipt but only permits re-quantification of income uninfluenced by the

relationship between the Associated Enterprises.

5. In such circumstances the moot question is whether the transaction of issue

of share capital leads to generation of any income chargeable to tax in the hands

of a company issuing shares, warranting the substitution of such income with

income determined on the basis of its ALP. An income is chargeable to tax, if it

is either of a revenue character or of a capital nature having been specifically

included in the ambit of income under the Act. The definition of income does

not specifically include any capital receipt arising on issue of share capital

within its purview. Thus it follows that the issue of shares at par or premium is a

transaction on capital account, which does not affect the computation of total

income of a company. Here it is important to mention that the Finance Act, 2012

w.e.f. 01.04.2013 has inserted clause (viib) to section 56(2) of the Act, the

relevant part of which provides as under:

`(viib) where a company, not being a company in which the public are substantially interested, receives, in any previous year, from any person being a resident, any consideration for issue of shares that exceeds the face value of such shares, the aggregate consideration received for such shares as exceeds the fair market value of the shares:..........'.

6. The above provision makes it explicit that where a company, not being a

one in which public are substantially interested, receives consideration for issue

of shares exceeding the fair market value of the shares, then the consideration

received for such shares as exceeds the fair market value of the shares is 7 ITA No. 5460/Del/2011 AY: 2007-08

considered as income under the head "Income from other sources". To put it

simply, if a share with the face value of Rs.10 is issued for Rs.50 and the fair

market value of such share is Rs.15, then the excess premium received

amounting to Rs.35 (Rs.50 minus Rs. 15) shall be treated as the income of the

company chargeable under this provision. It is further relevant to note that this

provision is attracted only when the share capital is issued to any person being a

resident. Au contraire, if the shareholder is a non-resident then the mandate of

this provision does not apply. The position which ergo follows is that prior to

the insertion w.e.f. 01.04.2013 there was no provision under the Act providing

for charging excess share premium to tax. In our considered opinion, this

provision has no application on the instant assessee for two reasons. First, we

are dealing with the assessment year 2007-08 and it is obvious that section

56(2)(viib) has been inserted w.e.f. 1.4.2013 and further there is nothing to

indicate that it has a retrospective operation. Second, the assessee company

issued shares to its non-resident AEs and section 56(2)(viib) applies only when a

shareholder is resident. Moreover, this provision activates only when a company

issues shares at a price above the fair market value and not vice versa. On the

other hand, we are confronted with a converse situation, in which the assessee

company, as per the opinion of the authorities below, has issued shares at a price

less than the fair market value. Once neither the amount of face value of the

shares issued nor the expected share premium leads to the accrual of income 8 ITA No. 5460/Del/2011 AY: 2007-08

chargeable to tax in the hands of the issuing company, there can be no question

of substituting the transacted value of the international transaction with its ALP.

7. The Hon'ble Bombay High Court in Vodafone India Services Pvt. Ltd.

(supra) had an occasion to consider a case in which the Indian company issued

shares to its non-resident holding company at a premium which was held by the

TPO to be inadequate. A higher amount of premium, in the opinion of the TPO,

was chargeable by the Indian enterprise. Since lower amount was charged, it

was held that the differential amount of share premium not charged by the

Indian enterprise was a deemed loan to the foreign company and as such, the

addition on account of transfer pricing adjustment was made on this score.

Repelling such a point of view, the Hon'ble High Court held that the provisions

of Chapter X are not applicable to the international transaction of issue of equity

shares by the resident company to its non-resident holding company at certain

value, since neither the capital receipt by the resident company on issue of

equity shares to its non-resident holding company nor shortfall between the fair

market price of the equity shares and the issue price of equity shares can be

considered as income within the meaning of the expression as defined under the

Act. Respectfully following the precedent, we hold that there can be no question

of treating the alleged uncharged share premium by the assessee company

leading to an addition on account of transfer pricing adjustment. The TPO has

rightly not made any addition on account of the lesser share premium charged by 9 ITA No. 5460/Del/2011 AY: 2007-08

the assessee, which amount was worked out by him at Rs.47.40 crore. Rather,

this amount has been treated as a deemed loan on which addition towards

transfer pricing adjustment of interest has been made amounting to Rs.6.63

crore. Now the question is about the legality or otherwise of such addition.

8. The Hon'ble Bombay High Court in Vodafone (supra), having held that no

addition on account of transfer pricing adjustment is contemplated in respect of

less share premium received by the assessee from its AE, proceeded further to

examine the effect of the transactions on capital accounts on the total income.

The relevant observations have made in para 31 of the judgment, which are as

under:

`31 Similarly, the reliance by the revenue upon the definition of

International Taxation in the sub clause (c) and (e) of Explanation (i) to

Section 92B of the Act to conclude that Income has to be given a broader

meaning to include notional income, as otherwise Chapter X of the Act

would be rendered otiose is farfetched. The issue of shares at a premium

does not exhaust the universe of applicability of Chapter X of the Act.

There are transactions which would otherwise qualify to be covered by

the definition of International Transaction. The transaction on capital

account or on account of restructuring would become taxable to the

extent it impacts income i.e. under reporting of interest or over reporting

of interest paid or claiming of depreciation etc. It is that income which is 10 ITA No. 5460/Del/2011 AY: 2007-08

to be adjusted to the ALP price. It is not a tax on the capital receipts. This

aspect appears to have been completely lost sight of in the impugned

order.'

9. On going through the above extracted observations of the Hon'ble

Bombay High Court, the overall ratio of the entire judgment can be culled out

that though the international transaction on capital account itself would not lead

to generation of any income because of the transfer pricing adjustment, but the

international transaction on capital account, which impacts income, such as,

under reporting of interest or over reporting of interest paid or claiming of

depreciation etc. is required to be adjusted to the ALP price, which is not a tax

on the capital receipts. The effect of this judgment on a holistic basis is that

though the international transaction on capital account per se cannot call for any

addition on account of transfer pricing adjustment because of the absence of any

provision under the Act charging income from such transactions, but the

transactions flowing out of such original transaction on capital account, having

impact on the profitability of the assessee, would be required to pass the

mandate of Chapter-X of the Act. In other words, if such offshoot transactions

of the original transaction on capital account, such as, interest or depreciation

are not at arm's length price, then it is mandatory to determine their ALP and

make addition, if any, on account of transfer pricing adjustment. It can be

understood with the help of a simple example. Suppose an Indian company 11 ITA No. 5460/Del/2011 AY: 2007-08

purchases some asset from its AE at a consideration of Rs.300 (the arm's length

price of which is Rs.100), on which it claims depreciation of Rs.30 at the rate of

10% on such purchase consideration. Now the TPO can rightly determine the

ALP of the international transaction of purchase of asset at Rs.100. Since the

transaction of purchase of asset is on capital account, there can be no addition of

Rs.200 (Rs.300 minus Rs.100), being the difference between the ALP and

transacted value. However this international transaction of purchase of asset on

capital account having impact on the income of the assessee by means of

transaction of claim of depreciation is to be adjusted to the ALP price.

Consequently, the TPO will be within his jurisdiction to determine the ALP of

the transaction of claim of depreciation by reducing it to Rs.10 on the basis of

the ALP of the international transaction on capital account, for which no

addition of Rs.200 is maintainable. Similar is the position as regards the under

reporting of interest on an international transaction on a capital account.

10. The Hon'ble Bombay High Court in Shell India Markets Pvt. Ltd. Vs.

ACIT and Others, (2014) 369 ITR 516 (Bom.) has dealt with a case in which

equity shares were allotted by an Indian enterprise to its non-resident AEs at

face value. The TPO enhanced the value of shares from the face value of Rs.10

to Rs.183.44 per share and computed the ALP of this transaction accordingly.

Apart from making the resultant addition on account of such transaction on

capital account, he also held that interest on the deemed loan due to short receipt 12 ITA No. 5460/Del/2011 AY: 2007-08

of the consideration resulting in transfer pricing adjustment, was also to be

made. Such interest was also benchmarked and addition was made. The

Hon'ble High Court, following the judgment in Vodafone India Services Pvt.

Ltd. (supra) held that there can be no addition by applying the provision under

Chapter-X on account of less share premium received and also the consequential

interest on the resultant deemed loan. The learned DR has not drawn our

attention towards any contrary judgment not mandating the determination of

ALP of interest on deemed loan consequent upon issue of shares by an Indian

company to its non-resident AE at lower price than its fair market value.

Respectfully following the precedent, we hold that the addition of Rs. 6.63 crore

on account of interest on the deemed loan due to under-receipt of share

premium, upheld by the learned CIT(A), cannot be sustained. Accordingly, the

addition is deleted and the ground is allowed.

11. In the result, the appeal is allowed.

The decision is pronounced in the open court on 5 th June, 2015.

Sd/- Sd/- (C.M. GARG) (R.S. SYAL) JUDICIAL MEMBER ACCOUNTANT MEMBER Dated: 5th June, 2015. RK/- Copy forwarded to: 1. Appellant 2. Respondent 3. CIT 4. CIT(A) 5. DR Asst. Registrar, ITAT, New Delhi