Case Law Details

Case Name : M/s. Topsgrup Electronic Systems Ltd. Vs ITO (ITAT Chennai)
Appeal Number : ITA No.-2115/MUM/2015, 19/02/2016
Date of Judgement/Order : 2009-10
Related Assessment Year :
Courts : All ITAT (1731) ITAT Chennai (69)

Brief of the case:

  • The ITAT bench of Mumbai in the above cited case held that investment in share capital of a subsidiary being an international transaction on capital account  does not result in income as defined under section 2(24) of the Act, the Transfer Pricing provisions a would not be applicable to such transaction.
  • Further, in the absence of thin capitalization rules, re-characterization of debt capital into equity or vice versa not allowed.

Facts of the case:

  • The assessee company, a wholly owned subsidiary of the Tops Securities Ltd. (TSL) is engaged in the business of providing security services. For AY 2009-10 the assessee filed its return of income on 23.09.2009 declaring total income of Rs.3,65,280/-.AO referred the case to Transfer Pricing Officer (TPO) for determining the arm length price (ALP) of the reported international transactions entered into by the assessee with its Associated Enterprises.
  • In order to expand assessee’s group business of security on a global scale, the holding co. (TSL) proposed to invest in Shield Guarding Company Ltd., U.K. (‘Shield’), a private company engaged in the business of providing security services through assessee. Assessee’s holding co. raised Rs.140 crores and invested/subscribed to 12,46,010 shares of the assessee of face value of Rs.10/- plus premium of Rs.990/-; resulting in investment of Rs.124,60,14,673/-).
  • The money of Rs.124,60,14,673/- received by the assessee from ‘TSL’ was invested by acquiring 7200 shares @ Euro 2,663.38 per share in Tops BV Netherlands, which then became a wholly owned subsidiary of the assessee , which was to be an intermediate holding company to acquire ‘Shield’.
  • Assessee disclosed the investment made in shares of ‘Tops BV’ under notes to the Form 3CEB but did not benchmark to ALP as in its opinion subscription to equity capital did not have any bearing on profitability, TP regulations were not applicable.
  • According to the TPO, the premium was nothing but a loan given by the assessee to its AE (vis. Tops BV) in the garb of share premium. The TPO then proceeded to compute the book value per share on the basis of Schedule III of the Wealth Tax Act, 1957 and accordingly made an addition of Rs.124,17,50,258/- . The TPO made a further adjustment/ addition of Rs.18,62,62,539/- being notional interest computed @15% on the aforesaid sum of Rs.124,17,50,258/-.
  • As such, the TPO passed an order under section 92CA of the Act proposing an addition of Rs.142,80,14,163/- to mark the international transactions at ALP. The AO completed the assessment for A.Y. 2009-10 under section 143(3) read with section  144C of the Act incorporating the TPO’s proposed addition.
  • Assessee’s appeal was rejected by CIT(A) appeal too who is in appeal before tribunal.

Contention of the Assessee:

  • It was submitted by the assessee that investment for acquisition of shares of ‘Tops BV’ was not benchmarked as the subscription to equity capital did not have any bearing on profitability, TP regulations were not applicable.
  • Further, re-characterization of this transaction as a loan was not permissible, as this was not in accordance with the provisions of the Act.

Contention of the Revenue:

  • It was submitted that the term ‘income’ includes potential income also. It was contended that potential income could arise by the investment made by the assessee in the share capital of Tops BV, Netherlands.
  • It was also submitted that the assessee invested in the shares of its subsidiary Tops BV, Netherlands at a value which was abnormally high with respect to the book value of the subsidiary company determined as per Schedule III of the Wealth Tax Act, 1957.This was a manipulation and not bonafide. Infact, it was a bundled transaction actually consisting of two parts -investment in share capital (including premium) and a loan.
  • In this context, the learned D.R. submitting that the re-characterization of investment was possible, placed reliance on the decision of the Hon’ble Delhi High Court in the case of CIT vs. EKL Appliances Ltd. (2012) and Article 9 of the OECD guidelines.

Held by ITAT Mumbai:

  • As per Sec 92(1) of the Act , any income arising from and international transaction shall be computed having regard to the arms length price. Therefore, it is quite clear that income must arise from international transaction so as to benchmark it to ALP. In the absence of such income, benchmarking of an international and computing ALP thereof would not be in order.
  • Thus, an international transaction on capital account and does not result in income as defined under section 2(24) of the Act, the Transfer Pricing provisions as contained in Chapter X of the Act would not be applicable to such transaction.
  • The tribunal also examined the plea of departmental representative that there is a scope for effect on potential income arising from subsequent sale of these shares. In this regard , tribunal  observed that the concept of potential income has been dealt with by the Hon’ble Bombay High Court in the case of Vodafone India Services Pvt. Ltd. (368 ITR 1)  wherein the court held that the potential income, if any, should arise from the  international transaction which is before the Transfer Pricing Officer for consideration and not out of a hypothetical international transaction which may or may not take place in future.
  • Therefore, the international transaction entered into by assessee cannot be brought within the ambit of Indian Transfer Pricing provisions merely on the presumption that it may impact profits arising out of a subsequent transaction which may or may not be an international transaction.
  • Another question for consideration is whether Transfer Pricing adjustments can be made by re-characterizing the equity into loan and thus, adding notional interest to the total income of assessee.
  • In this regard, even assuming that such a re-characterization of the investment in equity share capital as a loan is permissible, the addition of that part of the equity capital re-characterized as loan would not be possible, as the said loan cannot, by any stretch of imagination, be considered income of the assessee.
  • In order to answer the issue of sustainability of addition of notional interest as a result of re-characterization it is required to be examined that whether re-characterization of investment in equity share capital into loan is permissible under the Act. Tribunal placed reliance on the judgement of Hon’ble Bombay HC in the case of Besix Kier Dabhol SA wherein it was held that in the absence of thin capitalization rules, debt capital could not be re-characterized as equity capital and vice-versa.
  • Further, the assessee’s balance sheet reflects the investment made as investment in equity shares which is also correspondingly reflected in the balance sheet of the investee company, Top BV Netherlands. The details of investment in equity shares were informed and submitted to the Reserve Bank of India.
  • The only ground taken by the Transfer Pricing Officer for re-characterization of the loan was that the value at which the investment was made was far in excess of the book value as determined under Schedule III of the Wealth Tax Act. But shares are not covered under the definition of assets, there is no sense in applying the erstwhile Wealth Tax Valuation Rules to determine the Arm’s Length Price of equity shares.
  • In the result, the assessee’s appeal for assessment year 2009-10 is allowed as indicated above.

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