Shrenuj & Co. Ltd, Mumbai vs Assessee

IN THE INCOME TAX APPELLATE TRIBUNAL "K" BENCH, MUMBAI BEFORE SHRI I.P. BANSAL, JUDICIAL MEMBER AND SHRI R.C. SHARMA, ACCOUNTANT MEMBER

आयकर अपील सं./I.T.A. No. 8189 /Mum/2010 ( नधा रण वष / Assessment Year : 2006-2007 आयकर अपील सं./I.T.A. No. 7948 /Mum/2011 ( नधा रण वष / Assessment Year : 2007-2008

M/s Shrenuj & Co. Ltd., बनाम/ Addl. Commissioner of 405, Dharam Palace, Income Tax - Range Vs. 100/103, N.S. Patkar 5(3), Marg, Aayakar Bhavan, Mumbai - 400 007. M.K. Marg, 5 t h floor, Mumbai- 400 020. थायी ले खा सं . /PAN : AAACS0690P (अपीलाथ /Appellant) .. ( यथ / Respondent)

Appellant by Shri F.V. Irani & Shri Apurva Sheth Respondent by : Shri N.K. Chand

ु वाई क तार ख / Date of Hearing सन : 04-03-2015 घोषणा क तार ख /Date of Pronouncement : 17-04-2015 [

आदे श / O R D E R PER R.C. SHARMA, A.M. :

These two appeals filed by the assessee are directed against the orders passed by the ld. DRP Panel II, Mumbai dated 17-9-2010 & 12-09-2011for the assessment years 2006-07 and 2007-08, in the matter of order passed by A.O. u/s 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961.

2. Common grounds have been taken by the assessee in both these years, therefore, these were heard together and disposed of by this consolidated order.

2 ITA 8189/M/2010 & 7948/M/11

3. The following grounds have been by the assessee in A.Y. 2006-07:-

"The Additional Commissioner of Income Tax - Range 5(3), Mumbai erred in making as assessment u/s 143(3) r.w.s. 144C(13) and erred in:-

1.1 in making an adjustment u/s 92CA towards interest of Rs.

45,01,303 that ought to have been charged to overseas subsidiaries.

1.2 in not appreciating that the loans given to the overseas subsidiaries are in the nature of quasi equity .

1.3 in not considering the external Comparable Uncontrolled Price benchmarks provided by the appellant.

1.4 without prejudice, the rate of interest used by the A 0 is excessive and needs to be substantially reduced.

2.1 in disallowance of interest assumed to be expended on expansion of the business by investment in property at Bharat Diamond Bourse which was a business asset.

2.2 in not appreciating that no funds had been specifically borrowed for the purpose of making this investment and that hence nothing was disallowable on this account.

2.3 in not appreciating that the appellant had adequate non interest bearing funds available with it and that hence no disallowance of interest was called for.

3.1 in disallowing interest paid to the extent that sums of money were advanced to subsidiary on an interest free basis.

3.2 in not appreciating that the assessee has shown commercial expediency for the said loans.

3.3 in assuming that interest free advance given to subsidiary was given only from the borrowed funds of the company as a whole and in disallowing proportionate interest expense;

4. Rival contentions have been heard and record perused. Facts in brief are that the assessee company is engaged in the business of manufacture of cut and polished diamonds and jewellery and in sale thereof including exports. During the scrutiny assessment, the A.O. referred the matter to the 3 ITA 8189/M/2010 & 7948/M/11

TPO wherein transfer pricing adjustment was sought on account of interest free loans given to the following wholly owned foreign subsidiaries:-

1. Shrenuj Mauritius Pvt. Ltd. Rs. 18,90,000/-

2. Astral USA Inc. Rs. 2,36,34,025/-

3. Shrenuj DMCC Rs. 4,94,97,675/-

The A.O. found that the assessee has also given interest bearing loan of Rs. 5,31,95,406/- @ 6% to Daily Jewellery Ltd., a foreign subsidiary, in which the assessee company held 51% of the shareholding. Since no interest was charged, the T.P.O./A.O. applied 6% interest on the basis of advance given to M/s Daily Jewellery Ltd., a foreign subsidiary, and worked out interest in respect of advance given to wholly owned foreign subsidiaries amounting to Rs. 45,01,303/-. Similar addition was made by A.O./TPO in the A.Y. 2007-08. By the impugned order, the DRP confirmed the action of the TPO/A.O and aggrieved by this, the assessee is in further appeal before us.

5. It was contended by the ld. A.R. that the assessee has charged interest in respect of all loans given to Associated Enterprises that are not 100% owned by it. In respect of subsidiaries, wherein the assessee owns 100% of the share capital (Wholly Owned Subsidiaries - "WOS"'), no interest is charged for the same. As per the ld. A.R. the assessee has provided external comparables of reputed companies such as Infosys Technologies Limited, Wockhardt Limited wherein interest free loans have been provided to their 100% subsidiaries. Further, within the industry itself, Suashish Diamonds Limited has given loans to its subsidiaries that are interest-free. As per the ld. A.R. in situations where financing is provided by the 100% holding company, the question of reasonable interest does not arise because the entire profits anyways belongs to the holding company only. In view of the above it was contended by the ld. A.R. that interest-free loans given to its 100% subsidiaries of the assessee company are at Arms Length Price.

4 ITA 8189/M/2010 & 7948/M/11

6. It was further argued by the ld. A.R. that this is a case where no interest has been charged on the loans given, transfer pricing provisions applicable only when something has been charged to determine whether the income is under reported. Since there is no charge at all in this case, the transaction is on capital account and cannot be subject matter of Transfer Pricing and for this purpose relied on Bombay HC - Vodafone 386 ITR 1. As per the ld. A.R. the need to charge interest would arise only in a situation where there is a cost to the assessee - for e.g. if a guarantee is given on the back of a guarantee taken by the assessee, the latter has a cost and that has to be in turn at least recovered. In the present case, there is no specific finding that loans are taken for onward lending.

7. The ld. A.R. also invited our attention to the fact that as against aggregate loans to the 3 parties of Rs. 7.50 crores, interest free funds in the form of reserve and surplus at beginning of the year was Rs. 103.16 crores warranting no addition/disallowance on account of interest. For this purpose, reliance was placed on the decision of Hon'ble Bombay High Court in the case of Reliance Utilities Ltd. 313 ITR 340. Since there is no cost to the assessee of the funds lent and hence the need to charge an ALP for these loans does not arise. It was also argued by the ld. A.R. that the loans given to wholly owned subsidiary cannot be anything but quasi equity for the reason that they are wholly owned and their entire fund requirement in any case has to be provided for by the Holding company. It is not that funds needs to be provided only when there are losses. Whatever fund is needed for their startup, for their growth fund requirements has to go from the holding company and hence this is always quasi equity. If a payment, designated as a loan, is to a WOS, its nature is that of quasi equity and hence the substance must be seen and not the form or nomenclature. For this purpose reliance was placed on Delhi ITAT judgment in Bharati Airtel in ITA No. 5816/Del/2012 and on Ahm ITAT judgment in Micro Inks Ltd. (157 TTJ 289.) 5 ITA 8189/M/2010 & 7948/M/11

8. It was further submitted that if in addition to the giving of a loan there are commercial transactions between the holding company and the WOS then the loan is not a loan simpliciter and the need to charge interest is not there. In case of Shrenuj DMCC, there are sales of diamonds to them during the year of a magnitude of 4681 carats totaling to Rs. 9.60 crores and hence the ALP for this loan would be nil for this purpose. For this purpose reliance was placed on Ahm ITAT judgment in Micro Inks Ltd. 157 TTJ 289. As per the ld. A.R. using interest charged to Daily Jewellery as an internal CUP is incorrect since this is not an uncontrolled price. Hence 6% cannot be used as an ALP.

9. Without prejudice to above contentions, it was vehemently argued by the ld. A.R. that since loans are given to overseas subsidiaries, the appropriate benchmark is LIBOR and not any domestic rate of interest (also because the interest free funds are anyway higher than loan given). Reliance placed on Varro Engineering P Ltd. in ITA No. 2482/PN/2012 - Pune, ITAT. It was also emphasized by the ld. A.R. that no bps to be added to LIBOR - Bps is an adjustment for risk. Just as LIBOR is an interbank rate, here is a loan between parent and a WOS - and it's almost like the same entity because complete risk of WOS is borne by the holding Co - hence there can be no further risk adjustment or risk premium. He submitted that even if bps is to be added, it should be minimal because the loans are to an entity in USA, UAE and Mauritius and not to lesser known countries which may have huge political or economic risk.

10. The ld. A.R. relied on the decision of Hon'ble jurisdictional High Court in the case of CIT vs. Tata Autocomp Systems Ltd., (IT Appeal No. 1320 of 2012 dated 3-2-2015) wherein it was held that quantum of addition on account of interest is to be made in case of interest free loans given to wholly owned subsidiary as per the rate of interest to be determined on Euribor rate of interest i.e. rates prevailing in Europe.

6 ITA 8189/M/2010 & 7948/M/11

11. On the other hand, it was argued by the ld. D.R. that giving loans to the Associated Enterprises comes under the definition of international transactions, therefore, non-charging of interest requires adjustment for arriving at ALP in respect of such advances. The ld. D.R. relied on the decision of Tata Autocomp Systems Ltd. vs. ACIT, [2012] 21 Taxmann.com 6 (Mumbai) wherein it was held that transaction of granting interest-free loan by assessee to its AE comes within ambit of international transaction and, thus, such a transaction can be subject-matter of test of arm's length price u/s 92. As per the ld. D.R., while determining arm's length price in international transaction of advancing interest free loans to A.E., fact of advancing out of interest free funds does not matter. The ld. D.R. further contended that the ld. A.O. has correctly applied the rate of interest of other AE while computing the ALP in respect of loan given to the subsidiaries.

12. We have considered the rival submissions and found that the assessee has given advance to 100% wholly owned foreign subsidiaries on which no interest has been charged. Since the advance was given to its AE without charging interest, the transaction comes under the purview of international transaction requiring adjustment on account of arm's length price u/s 92. It does not matter even if advance is given out of interest free funds available with the assessee. The issue with regard to determining arm's length adjustment in respect of loan given to its wholly owned subsidiaries is covered by the decision of Hon'ble jurisdictional High Court in the case of CIT vs. Tata Autocomp Systems Ltd., (IT Appeal No. 1320 of 2012 dated 3-2-2015) wherein it was held that the rate of interest was to be determined by applying the Euribor rate of interest i.e. rates prevailing in Europe. Similarly the decision of Tribunal in the case of VVF Ltd. vs. DCIT (ITA No. 673/Mum/06 and in the case of DCIT vs. Tech Mahindra Ltd. (46 SOT 141) also supports this issue. Respectfully following the decision of Hon'ble jurisdictional High Court in the case of CIT vs. Tata Autocomp Systems Ltd., (IT Appeal No. 1320 of 2012 7 ITA 8189/M/2010 & 7948/M/11

dated 3-2-2015) vis-à-vis the decision of Tribunal as cited above, we direct the A.O. to make arm's length adjustment by applying the LIBOR rate of interest. From the record we found that part of loan was subsequently converted into equity.To the extent of loan converted into equity, no transfer pricing adjustment is required with effect to the date of such conversion, in view of decision of Hon'ble jurisdictional High Court in the case of Vodafone, 386 ITR

1. We direct accordingly.

13. The next grievance of the assessee in the A.Y. 2006-07 and 2007-08 relates to Disallowance of interest on amounts spent on acquiring premises at Bharat Diamond Bourse - BDB. We find that the assessee had been allotted an office space at Bharat Diamond Bourse which was under construction and various installments were being paid for the same. The same was in the nature of advance towards acquisition of an office space in a Bourse which will house various diamond manufacturing and trading companies in Mumbai. For this purpose, the assessee had made advances to M/s Bharat Diamond Bourse amounting Rs.5,77,27,OOO/- out of its owned funds i.e. assessee has not borrowed money specifically for the said project and aggregate amount of advances was shown under Capital work-in-progress. While disallowing the interest, the A.O. wrongly observed that the assessee has capitalized interest in its books and was claiming this capitalized interest as a revenue for tax purposes. We find that there is no capitalisation of interest as mentioned by the A O and the assessee has not identified any interest as specifically pertaining to the acquisition of the said asset for accounting purposes and which is being claimed as a deductible for tax purposes. We find that the said Bourse is not being constructed specifically for the assessee and the assessee is only required to pay installments towards cost as and when called for. The process of setting up the Bourse has been going on for a long period of time. The assessee has not borrowed any money specifically for the payment of these installments and hence since there is no 8 ITA 8189/M/2010 & 7948/M/11

capital borrowed for the said acquisition the question of applying the proviso to Section 36(1)(iii) does not arise.

14. From the record we also found that the assessee had huge amount of interest free funds at its disposal as well and that it is normally rational that owned funds in the form of accumulated undistributed profits are utilized for acquisition of capital assets - particularly an asset which has been under construction for more than a decade. The total non-interest bearing funds available with the assessee as of 31st March 2006 are Rs. 141.56 crores and after excluding the current year's profit, the same are Rs. 123.19 crores. The expenditure on capital assets till the year end is only Rs. 5.77 crores. Hence it would be rational to state that the same has been funded from owned funds. Accordingly we do not find any justification for the disallowance of interest expense as made by lower authorities. Above issue is also covered in favour of the assessee by the decision of the Tribunal in assessee's own case in ITA No. 1782/M/06, ITA No. 1672/M/07, ITA No. 6195/M/07 and ITA No. 669/M/08 for assessment years 2002-03 to 2005-06 dated 24-09-2014. The relevant observation of the Tribunal is as under:-

"On going through the arguments, we find that AR pointed out that the claim was genuine from the point of view that the assessee had itself capitalized the amount of interest of Rs. 11,54,000/-. In that view of the matter we hold that the order of CIT(A) does not reflect any infirmity. We, therefore, sustain the order of the CIT(A) consequentially rejecting the ground taken by the department. (This observation shall be used for deciding ground No. 7 raised by the assessee, wherein, it shall result into allowance of the ground)."

15. As the facts and circumstances of the issue during the year under consideration are same, we respectfully following the order of the Tribunal in assessee's own case direct the A.O. to delete the disallowance made by him in both the years under consideration. These grounds are accordingly allowed in both the years.

9 ITA 8189/M/2010 & 7948/M/11

16. In both the years under consideration the assessee also aggrieved for the disallowance of interest on account of interest free advance given to its subsidiaries.

17. Rival contentions have been considered and record perused. Facts in brief are that the assessee has given an interest free advance to its wholly owned subsidiary named Aditi Diaimpex Trading and Manufacturing Co. Ltd. The assessee had adequate interest free funds at its disposal represented by accumulated profits over the years and no amount was borrowed specifically for the purpose of giving the said loans. From the record we found that Aditi Diaimpex is 100% owned subsidiary of the assessee and is engaged in the same business as the assessee viz. manufacturing of jewellery for exports. Assessee also has trade transactions with it - it purchases jewellery from them to fill orders on hand if such jewellery is not available as a part of its stock. Unused materials are also sold/purchased from the subsidiary. Hence keeping in mind the nature of ownership, the nature of the subsidiary business and the existence of transactions between the assessee and the subsidiary, the loan was given only out of commercial expediency and not otherwise.

18. We have verified the Balance Sheet of the assessee which shows the magnitude of interest free funds available to the assessee. Since the assessee had sufficient interest free funds at its disposal, it is to be assumed that since the assessee is a rational businessman, these loans have been given from the interest free funds available, [2003] 260 ITR 637. The total noninterest bearing funds available with the assessee as of 31st March 2006 are Rs. 141.56 crores and after excluding the current year's profit, the same are Rs. 123.19 crores. The aggregate loans given to the subsidiary is merely Rs. 6.42 crores. In view of decision of Hon'ble jurisdictional High Court in the case of 10 ITA 8189/M/2010 & 7948/M/11

Reliance Utilities, 313 ITR 340, there is no justification for the disallowance of interest so made by lower authorities.

19. We find that this issue is also covered by the order of the Tribunal in assessee's own case for A.Y. 2005-06 wherein at page 16 the Tribunal confirmed the deletion by placing reliance on the decision of Hon'ble jurisdictional High Court in the case of CIT vs. Reliance Utilities and Power Ltd. reported in 313 ITR 340 (Bom). Since during the year under consideration also there is no dispute to the fact that the assessee was having sufficient interest free funds, we do not find and merit in the disallowance made by the A.O. in respect of advances given to its subsidiaries. This ground is also accordingly allowed.

20. In both the years under consideration the assessee is aggrieved for the disallowance arising out of purchases from subsidiary company.

21. Facts in brief are that the assessee in order to meet some of its pending orders, had purchased some ready jewellery from its subsidiary Aditi Diaimpex Trading & Manufacturing Co. Ltd. and the same was exported at the same price at which it was purchased. The goods were sold almost immediately on purchase. However, the A.O. apportioned the overheads and made disallowance out of purchases. We find that assessee has discharged its onus u/s 40A(2)(b) by showing the circumstances in which the purchases have been made and in explaining why the entire sale proceeds had to be in turn passed over to the subsidiary company. It is the assessee who had orders to fill and needed the goods and the subsidiary merely provided these goods to the assessee instead of exporting them directly. However, nothing was brought on record by the A.O. to show that the price paid by the assessee was excessive as compared to the prevailing market price of similar goods available in the market, for making any disallowance u/s 40A(2) of the Act. The onus is on the Revenue to prove that assessee has paid to its sister 11 ITA 8189/M/2010 & 7948/M/11

concern more than the price prevailing in the open market for similar goods. Accordingly we do not find any merit in the action of lower authorities, therefore, we delete the disallowance so made by the A.O. Furthermore, similar issue has been decided in favour of the assessee by the Tribunal in assessee's own case in the assessment years 2002-03 to 2005-07 vide order dated 24-09-2014. As the facts and circumstances of the case during the year under consideration are same, respectfully following the decision of Tribunal in assessee's own case, we allow this ground raised by the assessee.

22. The assessee also aggrieved for the disallowance arising out of sales to subsidiary company in both the years under consideration.

23. Facts in brief are that the assessee has sold certain materials aggregating to Rs. 353.17 lakhs to Aditi Diaimpex Trading and Manufacturing Limited, a Wholly Owned subsidiary. These represent unused raw materials and the assessee has made no profit on sale of these diamonds to its subsidiary. Applying the provisions of section 40A(2), the A.O. made addition in respect of sales made to its subsidiary companies equivalent to 2% of the sales price. From the record we found that the said materials were sold at cost and no profit was made on the same. It was also submitted that even if the assessee follows a FIFO system of valuation, cost of these diamonds would also be worked on a FIFO basis. There was no evidence to show that the sale has actually been done at a higher amount. The assessee is following FIFO method of valuing its stock. Therefore, identifying particular item of rough diamond is not possible. Moreover it is seen that these types of transactions have been entered into earlier years also. The AO has held that since there is no evidence to prove that the sales are made at prevalent market prices, 2% of the sales are disallowed.

24. We find that this issue is also covered by the decision of the Tribunal in assessee's own case for assessment years 2002-03 to 2005-06 vide order 12 ITA 8189/M/2010 & 7948/M/11

dated 24-9-2014. As the facts and circumstances of the case during the year under consideration are same, respectfully following the order of Tribunal we do not find any merit in the action of the lower authorities for the disallowance made arising out of the sales to subsidiary company.

25. In the result, appeals of the assessee are allowed in part.

Order pronounced in the open court on 17th April, 2015.

आदे श क घोषणा खल ु े #यायालय म% &दनांकः 17-04-2015 को क गई ।

Sd/- sd/- (I.P. BANSAL) (R.C. SHARMA) JUDICIAL MEMBER ACCOUNTANT MEMBER मुंबई Mumbai; &दनांक Dated 17-04-2015

व.=न.स./ RK , Sr. PS

आदे श क! " त$ल%प अ&े%षत/Copy of the Order forwarded to :

1. अपीलाथ / The Appellant

2. यथ / The Respondent.

3. आयकर आयु>त(अपील) / The CIT(A) -concerned,, Mumbai

4. आयकर आय> ु त / CIT --concerned Mumbai

5. Aवभागीय =त=नCध, आयकर अपील य अCधकरण, मुंबई / DR, ITAT, Mumbai K Bench

6. गाडG फाईल / Guard file.

ु ार/ BY ORDER, आदे शानस

स याAपत =त //True Copy// उप/सहायक पंजीकार (Dy./Asstt. Registrar) आयकर अपील य अ धकरण, मुंबई / ITAT, Mumbai