ransfer Pricing: Closely linked international transactions can be aggregated to determine the ALP
(i) On a combined reading of Rule 10A(d) and 10B of the Rules, a number of transactions can be aggregated and construed as a single 'transaction' for the purposes of determining the ALP, provided of course that such transactions are 'closely linked'. Ostensibly the rationale of aggregating 'closely linked' transactions to facilitate determination of ALP envisaged a situation where it would be inappropriate to analyse the transactions individually. The proposition that a number of individual transactions can be aggregated and construed as a composite transaction in order to compute ALP also finds an echo in the OECD guidelines. As per an example noted by the Institute of Chartered Accountants of India ('ICAI') in its Guidance Notes on transfer pricing in para 13.7, it is stated that two or more transactions can be said to be 'closely linked', if they emanate from a common source, being an order or contract or an agreement or an arrangement, and the nature, characteristic and terms of such transactions substantially flow from the said common source;
(ii) On facts, the international transactions of import of spare parts, export of spare parts, IT support services, access to customized parts catalogue and amount received for warranty consideration are inter-related transactions, which were the sourcing activities of the assessee company and have to be aggregated in order to benchmark the international transactions. The assessee had benchmarked the arm's length price of all the transactions by comparing results of the comparable companies which were found to be at arm's length price (Demag Cranes & Components (India) Pvt. Ltd. Vs. DCIT followed).
Transfer Pricing: ALP of interest on funds advanced to AEs has to computed on LIBOR and not as per domestic Prime Lending Rate (PLR)
While benchmarking the international transactions what has to be seen is the comparison between related transactions i.e. where the assessee has advanced money to its associated enterprises and charged interest then the said transaction is to be compared with a transaction as to what rate the assessee would have charged, if it had extended the loan to the third party in foreign country. Once there is a transaction between the assessee and its associated enterprises in foreign currency, then the transaction would have to be looked upon by applying the commercial principles with regard to the international transactions. In that case, the international rates fixed being LIBOR+ rates would have an application and the domestic prime lending rates would not be applicable. The assessee has further explained that it had raised the loan from Citi Bank on international rates for the purpose of investment in the share application money of its associated enterprises, which in turn was partly converted from capital into loan. Where the assessee had a comparable of borrowing loan on international rates and advancing to its associated enterprises, then the said comparable was to be applied for benchmarking the transaction of advancing the loan on interest to its associated enterprises. The assessee had charged interest rate of 4.75% on the loan advanced to the associated enterprises. The assessee on the other hand, claims that it had borrowed the money on LIBOR+ rates i.e. international rates, which were Japanese based LIBOR+ rates which were lower than the US based LIBOR+ rates. The plea of the assessee before us was that it had advanced the loan to its associated enterprises on LIBOR+ rates i.e. 4.75%. Where the assessee has the internal CUP of operating at international rates available and since the said loan raised by the assessee at international rates was advanced to its associated enterprises, we find no merit in the order of the TPO in applying the domestic loan rates i.e. BPLR rates for benchmarking transaction of charging of interest on the loans advanced to the associated enterprises by the assessee. Where the assessee had made the borrowings on LIBOR+ rates and advanced the same at LIBOR+ rates, then the said transaction is at arm's length price and there is no merit in any adjustment to be made on this account (Siva Industries & Holdings Limited vs. ACIT (2012) 26 taxmann.com 96, DCIT vs. Tech Mahindra Ltd. (2011) 12 taxmann.com 132 (Mum) & Hinduja Global Solutions Ltd. vs. ACIT (2013) 35 taxmann.com 348 (Mumbai – Trib) followed).
Distinction between 'diversion of income by over-riding title' and 'application of income' explained. Contribution of 1% of net profit to the Cooperative Education Fund maintained by National Cooperative Union is an application of income
(i) Diversion of income has multi-facets. Diversion arises where income is applied in a particular manner under statutory or contractual obligation or under the provisions of a document under which the company is constituted viz., memorandum of article of association or a firm has come into existence. In these circumstances, the principle that has emerged is that if a person has alienated or assigned the source of his income so that it is no longer remains his income, he cannot be taxed upon the income arising after the assignment of the source. In such event, it is not income of the assessee at all. On the contrary, if the source is not assigned to, or transferred but passes through the assessee to an ultimate purpose, the case of application of income in a particular manner. Even though he may enter into a legal obligation to apply it in a particular way, still it remains the income of the assessee. Sec. 61 to s. 62 provides an exception to legislative rule where notwithstanding assignment of source of income, the income is deemed to be the income of the person who has assigned such source by creating a legal fiction.
(ii) Another shade of such controversy is where the income is not applied but diverted by an overriding title from the assessee, which he would otherwise have received. Such diverted income cannot be considered the income of the assessee at all. Reference may be made to Raja Bejoy Singh Dudhuria vs. CIT (1933) 1 ITR 135 (PC);
(iii) On facts, the liability to pay the amount is after quantification of profits by the society under the Societies Act. It is only after the net profit reaches the co-operative society that the question of its disposal in terms of the provisions arise of the Act of 1965 and not earlier thereto, net profit is to be apportioned by transferring part of it as may be prescribed by Rules to the reserve fund or to other funds. Part of the profits has to be carried to the co-operative deduction fund constituted under the Rules and the balance is available for utilisation for payment of dividends to the members, bonus to the members and contribution to such other special funds as may be specified in the Rules as per Sec.63(2). As already stated earlier, assessee is not charging the amount of 1% on the profits of the year, in the year of accrual but is claiming the amount paid during the year on the profits of earlier year. This certainly indicates that the amounts have been received by assessee and utilized by assessee, then only amount was remitted to the said National Union under the Act. This indicates, there is no diversion at source but is only appropriation of profits as per principles laid down. It is also an admitted fact that there is no charge in the year in which assessee incurs losses. It is only when there are profits the amount has to be paid. This also distinguishes the issue that it is only an appropriation of profits earned but not diversion of income. If it is to be considered as diversion at source by overriding title, whether assessee incurs profits or loss, the said amount has to be paid. This is not the case here. The amount at 1% is payable only when assessee has profits in any year. This supports the view that this is not a diversion at source but an appropriation of amounts.
(iv) Thus, respectfully following the principles laid down in CIT vs. Jodhpur Cooperative Marketing Society 275 ITR 372 (Raj), we are of the opinion that the amount contributed by assessee to the National Cooperative Union, New Delhi is appropriation from the net profits. There is a right to receive the income independent of accrual and receipt of income by the assessee before third party could lay claim to any part of it. Since income reached assessee before it reached to a third party, there is no diversion. As already stated, there is no payment in the year of losses. Therefore, payment under section 63(1)(b) is only an appropriation of profit. Moreover, this amount paid during the year is also not out of the profits of this year but profits of earlier year. Therefore, on that count also amount cannot be allowed as deduction during the year.
Companies Act provisions need greater clarity
The new Companies Act, 2013 (Act) came into force in September, 2013 but its first full year of implementation was year 2014.
Not surprisingly, the Act drew flak from all stakeholders due to its poor pre-enforcement planning, the needless hurry for its piecemeal enforcement and extremely messy and complicated implementation.
The circulars and notifications all through 2014 did try to bring the situation under control but still that wasn't enough.
The Act and the corresponding rules are still filled with many ambiguous and irrational provisions needing immediate attention and correction. Some of them are discussed in this column.
Life for listed companies can be made much simpler by aligning the Act and the SEBI regulations. Interestingly, some provisions of the Act and the corresponding rules do clarify that in cases of contradiction or conflict between the Act and the SEBI regulations, the latter will prevail. But this clarity has to be ensured throughout the Act, wherever there is any possibility of a conflict with the SEBI regulations.
It is unclear if a foreign holding company of an Indian company is a 'related party' of that Indian company? The definition of related party makes this ambiguous because it uses the expression "any company" which is a holding company. It is a settled principle that unless otherwise provided in the Act, the expression "company" means only an Indian company (and not a foreign company).Therefore, there is a doubt that using the expression "any company" in the definition of related party was intended to exclude foreign holding companies. It doesn't seem that can be the intent. Therefore, clarity is a must.
Another faulty definition is that of a 'holding company'. Here again, in order to define a holding company, the expression "a company" has been used which raises a doubt that foreign holding companies are not treated as holding companies under the Act. Such exclusion could have a far reaching effect and perhaps this was never intended and, therefore, there is an urgent need to address this.
Yet another area of concern is the meaning of "foreign company" read with the corresponding rule which defines "electronic mode". The combined reading of the two leads to a widespread confusion. "Electronic mode" includes carrying out electronically any business to business or business to consumer transactions, web marketing, advisory and transactional services whether by e-mail, mobile devices, social media, voice or data transmission or otherwise, a wide range of activities may amount to a foreign company having a place of business in India. It is common these days for foreign companies to electronically do business in India. This definition may to lead to an unintended consequence of making every foreign company having any electronic transaction with its Indian customers or clients as having established a place of business in India. It will be strange if this was the intent of the legislature. The ambiguous rule needs to be rectified otherwise it will discourage foreign companies from doing business electronically in India.
The nature of an unlisted company whose securities (other than equity shares) are listed is doubtful. In its current avatar, the Act treats such companies as listed companies although only certain securities are listed. The MCA seems to have understood this concern but it hasn't still issued the much needed clarification.
One of the most debatable issues which remains unresolved since its enactment in September, 2013 is the meaning of expression "ordinary course of business" used in Section 185 dealing with loans to directors and person connected to directors and Section 188 dealing with related party transactions. There are divergent views on this issue. One view is that it means in the 'usual course of business' while the other view is that it means the 'principal business' of the company. Both views have convincing arguments.
Therefore, it is extremely important for MCA to quickly clarify this very long pending doubt.
Another area which needs clarity is the tussle between Sections 186 (dealing with loans and investments) and Section 185. The ambiguous language used in Section 185 gives an impression that Section 186 could override 185 although that does not seem to be the intention of the Act. It is better that this gets clarified.
MCA should be credited for taking timely actions in 2014 to ease the implementation of the Act but it shouldn't stop and keep the momentum of reform in 2015 by further rectifying the faulty provisions of Act and provide India Inc with a simpler and an easy to implement company law. Adherence to law is directly proportional to its ease of implementation.
Source : Business Today dated January 7, 2015
Regards,
Bobby Mehndiratta
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