Quasi-Equity Loans to Overseas Subsidiaries Escape Notional Interest TP Adjustment: ITAT Chennai

SAS Hotels & Enterprises Ltd. Vs DCIT (ITAT Chennai)

Summary: The Chennai Bench of the Income Tax Appellate Tribunal considered the appeal of SAS Hotels & Enterprises Ltd. for Assessment Year 2020-21 against the final assessment order dated 24 July 2024. Three issues arose: a transfer-pricing adjustment of ₹12,98,74,694 on notional interest on interest-free advances to foreign associated enterprises; an adjustment relating to corporate guarantees provided to overseas subsidiaries; and additions aggregating ₹13,85,368 under Section 41(1) for liabilities written off by creditors. The assessee maintained that its overseas advances were promoter contributions in the nature of quasi-equity for an international resort project, rather than ordinary commercial loans. The Transfer Pricing Officer had benchmarked the loans using six-month LIBOR plus 350 basis points, while the Dispute Resolution Panel sustained the interest adjustment and applied a 1% benchmark to corporate guarantees.

Examining the ownership and financing structure, the Tribunal noted that the assessee owned Swetharanaya Holdings Pte Ltd., Singapore, and SAS Holdings FZE, Dubai, which together held an indirect 79.36% interest in Residency Resorts Male Pvt. Ltd. The resort project was structured with promoter funding and bank financing, and the advances were made in furtherance of the assessee’s hospitality business. A substantial portion of the Swetharanaya advance and the entire SAS advance were converted into 1% redeemable preference shares on 4 April 2021; the remaining Swetharanaya balance was subsequently repaid. The Tribunal also noted that no fresh advance was made to SAS during the relevant year, and the movement in the outstanding balance was attributable to foreign exchange fluctuation. It considered the domestic borrowings to be earmarked for domestic projects and working capital, rather than funding the overseas advances.

Referring to the lender’s perspective discussed in paragraph 10.53 of the OECD guidelines on intra-group loans and to Pr. CIT v. Inductis India Pvt. Ltd., the Tribunal held that the advances were in substance quasi-capital or ownership investments undertaken to expand the assessee’s business overseas. Business expansion considerations therefore took precedence over notional interest considerations in the circumstances of the case. The Tribunal also noted that comparable adjustments had not been made in earlier years. It consequently deleted the transfer-pricing adjustment on notional interest. On corporate guarantees, the Tribunal followed Indian Public School Pvt. Ltd. and the Bombay High Court ruling in CIT v. Everest Kento Cylinders Ltd., directing the Assessing Officer to restrict the arm’s-length guarantee commission adjustment to 0.5%, rather than the 1% sustained by the DRP.

Regarding Section 41(1), the Tribunal upheld the addition of ₹3,15,060 relating to Akar Granites, whose books reflected a write-off of the outstanding amount. In respect of the remaining ₹10,70,308 attributed to Velayutham Rajendran, the assessee asserted that no corresponding liability was outstanding in its own books. The Tribunal directed the Assessing Officer to verify that factual contention and decide the issue afresh. The interest-adjustment grounds were allowed, the corporate-guarantee grounds were partly allowed, and the Section 41(1) grounds were partly allowed for statistical purposes. Accordingly, the appeal was partly allowed by the order pronounced on 5 November 2024.

Cases Discussed

• Pr. CIT v. Inductis India Pvt. Ltd. — 157 taxmann.com 87 (Delhi High Court); cited on interest adjustment for a debt-free entity.
• Indian Public School Pvt. Ltd. — IT(TP) No. 34/Chny/2018, order dated 15.06.2022 (ITAT Chennai); followed on corporate guarantee ALP.
• CIT v. Everest Kento Cylinders Ltd. — 58 taxmann.com 254 (Bombay High Court); followed on 0.5% corporate guarantee commission.

FULL TEXT OF THE ORDER OF ITAT CHENNAI

1.1 Aforesaid appeal by assessee for Assessment Year (AY) 2020-21 arises out of final assessment order dated 24-07-2024 passed by Ld. Assessing Officer, (AO) u/s 143(3) r.w.s.144C(13) of the Act pursuant to the directions of Ld. Dispute Resolution Panel-2, Bengaluru (DRP) u/s 144C(5) dated 28-06-2024. Since the assessee carried out certain international transactions with its Associated Enterprises (AE), the same were referred to Ld. DCIT (TPO)-3(1), Chennai (TPO) for determination of Arm’s Length Price (ALP). The Ld. TPO passed an order u/s 92CA (3) on 11-07-2023 proposing certain Transfer Pricing (TP) adjustment. Incorporating the same, a draft assessment order was passed on 30-09- 2023 which was subjected to assessee’s objections before Ld. DRP. Pursuant to the directions of Ld. DRP, Ld. TPO passed another order on 28-06-2024. Finally, the directions of Ld. DRP as well as the computations made by Ld. TPO were incorporated in final assessment order dated 24-07-2024 which is in further appeal before us.

1.2 The grounds raised by the assessee read as under:-

1. For that the Order of the Learned Assessing Officer (‘Learned AO’) u/s. 143(3) r.w.s.144C(13) of the Income Tax Act, 1961 is opposed to law/facts and circumstances of the case. 2 Issue No.1: Upward adjustment of Rs.12,98,74,694/- towards notional interest receivable.

2.1. For that the Learned TPO/ Learned AO/ Hon’ble DRP erred in upholding the upward adjustment of Rs.12,98,74,694/- towards notional interest receivable on loans extended to its Associated Enterprises without considering the facts and circumstances of the case

2.2. For that the Learned TPO/ Learned AO/ Hon’ble DRP overlooked the fact that the appellant is a debt-free company and loans extended by the appellant were financed from net-owned funds which were intended as quasi-equity to expand operations, specifically for establishing an international resort.

2.3. For that the Learned TPO/ Learned AO/ Hon’ble DRP erred in concluding that the appellant did not receive any shares against the loan, which is essentially quasi-capital and the preference shares were indeed issued in the year 2021 for the amount lent. 3 lssue No.2: Upward adjustment of Rs.3,12,34,368/- in respect of corporate Guarantee Fee

3.1. For that the Learned TPO/ Learned AO/ Hon’ble DRP erred in upholding the upward adjustment of Rs.3,12,34,368/- in the guise of guarantee fees with respect to the corporate guarantee extended by the applicant to its AE.

3.2. For that the Learned TPO/ Learned AO/ Hon’ble DRP erred in considering the average rate of bank guarantee rates for benchmarking the corporate guarantee fee at 1%.

3.3. For that the Learned TPO/ Learned AO/ Hon’ble DRP erred in not considering the fact that corporate guarantee provided to its AE has been given in the capacity as parent company and with the purpose of furthering its own business interest.

3.4. Without prejudice to above points, we submit that the guarantee fees charged by the bank for us is about 0.25%. If at all our contentions as in 3.1 to 3.3 are not accepted, considering the fact that Corporate Guarantee is in our business interest and addition may be considered at 0.50% as our guarantee is definitely not on par with guarantee issued by a Schedule bank.

4. Issue No.3 Debts written off by creditors treated as deemed income u/s. 41(1) of the Act amounting to Rs.13,85,368/- 4.1 For that the Ld. AO/ Hon’ble DRP erred in upholding an addition of Rs.3,15,060/- u/s.41(1) of the Act as deemed income from M/s. Akar Granites.

4.2. For that the Learned AO/Hon’ble DRP erred in upholding the addition without acknowledging that the appellant had ongoing disputes regarding the quality of materials.

4.3. For that the Learned AO/ Hon’ble DRP erred in upholding an addition of Rs.10,70,308/- u/s 41(1) of the Act as deemed income from Mr. Velayudham Rajendran.

4.4. For that the Learned AO/Hon’ble DRP erroneously upheld the addition u/s 41 (1) of the Act without considering that Mr. Velayudham Rajendran unilaterally wrote off the amount while disputing it before the MSME Facilitation Council, creating ambiguity on cessation of liability, as per section 41(1) of the Act.

As is evident, three issues fall for our consideration – (i) Transfer Pricing (TP) Adjustment on outstanding loans; (ii) ALP of Corporate Guarantee;

(iii) Addition on account of remission of trading liability u/s 41(1). 1.3 The Ld. AR advanced arguments and referred to OECD guidelines to support the case of the assessee on TP adjustments. The Ld. CIT-DR also advanced argument supporting the orders of lower authorities. Having heard rival submissions and upon perusal of case records, our adjudication would be as under. 1.4 The assessee being resident corporate assessee is stated to be engaged in hospitality business and the assessee runs hotels and restaurants. With a view to establish international resort, the assessee set up a wholly owned subsidiary entity under the name and style of Swetharanaya Holdings Pvt. Ltd. (SHPL) in Singapore. Proceedings before lower authorities 2.1 It transpired that the assessee advanced loan of Rs.753.85 Lacs to SHPL. Another loan of Rs.215.69 Crores was outstanding against another subsidiary entity by the name SAS Holding FZE (SAS). Both the loans were interest-free loans and accordingly, Ld. TPO proceeded to compute ALP interest on the same. 2.2 The assessee submitted that no additional loan was advanced to SAS during this year and the change in loan amount was nothing but foreign exchange appreciation during the year. The other loan to SHPL was stated to be in the nature of quasi-capital. The financial institutions had stipulated that the promoters should not derive dividends or interest prior to settling the loan and interest commitments. 2.3 The Ld. TPO rejected the said submissions and held that the assessee was not a debt-free company to advance loans to subsidiary free of cost. The assessee borrowed working capital loans and therefore, these transactions were required to be benchmarked separately. The Ld. TPO applied 6 Months LIBOR+350 bps and arrived at ALP rate of 5.818%. Applying the same to year-end outstanding, Ld. TPO proposed upwards adjustment of Rs.1298.74 Lacs. 2.4 The assessee advanced corporate guarantee to three foreign subsidiaries which was benchmarked by Ld. TPO at 2.55% which resulted into another adjustment of Rs.796.47 Lacs. Both the adjustments were incorporated in draft assessment order dated 30-09- 2023. 2.5 The Ld. AO made addition u/s 41(1) for Rs.3.15 Lacs against M/s Akar Granites and also made similar adjustment of Rs.10.70 Lacs against Shri Velayutham Rajendran. Both these parties claimed write-off of the debt in their books though the assessee stated that there was quality issue with M/s Akar Granites. The assessee also stated that there was no transaction with another entity. However, Ld. AO invoked the provisions of Sec. 41(1) and added both the amounts to the income of the assessee. 2.6 The Ld. DRP confirmed TP adjustment of interest on the ground that the assessee had not been issued any shares in lieu of the loans given to its AEs. Had the assessee advances loans to unrelated parties, the assessee would have earned interest on the same. Therefore, the TP adjustment was confirmed. The ALP of corporate guarantee was pegged at 1% considering the ratio of various judicial decisions. The addition made u/s 41(1) was also confirmed against which the assessee is in further appeal before.

Our findings and Adjudication

3. From the submissions of Ld. AR as well as case records, it emerges that the assessee has two wholly owned subsidiary entities viz. Swetharanaya Holdings Pte Ltd., Singapore (SHPL) and SAS Holdings FZE, Dubai (SAS). SHPL has held 50.18% share in another entity by the name Residency Resorts Male Pvt. Ltd. (RRMPL) whereas SAS held 29.18% shareholding of RRMPL. Thus, the assessee has indirectly held 79.36% shareholding of RRMPL who is engaged in hospitality line only which is quite similar to assessee’s line of business. From assessee’s reply to Ld. TPO on 06-07-2022, it could be seen that with a view to establish international resort, the assessee has set-up wholly owned subsidiary i.e., SHPL at Singapore who negotiated with the banks / financial institutions for financial assistance to implement the project. It was agreed that the 40% of investments would be made by owner whereas remaining 60% investment would be made by Banks as loans. It was also agreed that entire promoters’ contribution would be invested by the assessee company in a structured manner partly as equity capital / convertible preferences shares / loans in the nature of quasi equity as per the requirements of the bank. It was thus stated that the loans were advanced to meet the requirements of the banks and the same was in the nature of quasi- capital which would not require any TP adjustment.

4. It also emerges that the assessee has advanced loans to SHPL from time to time which could be summarized as under: –

Similarly, the loans advanced by the assessee to SAS could be summarized as under: –

It could also be seen that SHPL and SAS has made investments in RRMPL which is in furtherance of assessee’s line of business. From the above tabulation, it could be seen that loan granted by the assessee to SHPL has substantially been converted into preference shares on 04-04- 2021 and the remaining loan has fully been repaid in AY 2023-24. Similarly, the assessee has not granted any fresh loan to SAS in this year. The loan figure has undergone change only due to foreign currency fluctuation at year-end. Further, the loan granted to SAS has fully been converted into preference shares on 04-04-2021. Therefore, the aforesaid transactions are not a transaction of loan simplicitor but a transaction in furtherance of assessee’s line of business. By making these transactions, the assessee has advanced its business interest. It is also discernible that the loans have been converted into preference share capital on 04-04-2021 which point was raised by Ld. DRP. In these facts, it could be said that the loan was nothing but quasi-capital / owners’ capital in nature and the same was ownership investment by the assessee. From assessee’s reply dated 06-07-2022 to Ld. TPO, it could also be seen that no TP adjustments have been made for above transactions in earlier years and the same has been accepted by revenue. Another fact brought on record by Ld. AR is that the working capital loans as obtained by the assessee are specific domestic loans and the same were not used to advance the loans to these subsidiaries. To support the same, the extract from financial statements has also been placed on record. Upon perusal of the same, it could be seen that Long- term as well as short-term borrowings are specific loans to meet domestic project requirements as well as to meet working capital requirements. The same would dispel the allegation of lower authorities that the assessee was not a debt-free entity. It is another fact that the assessee has not advanced any fresh loans to SAS in this year and no such adjustments have been made in earlier years. The rule of consistency favors the case of the assessee.

5. Proceedings further, as per para 10.53 of OECD guidelines on Intra-group loans, one of the factors to be considered while determining ALP interest would be the lender’s perspective in the decision of whether to make a loan, how much to lend and on what terms, will involve evaluation of various factors relating to the borrower, wider economic factors affecting both the borrower and the lender and other options realistically available to the lender for the use of funds. As noted earlier, the loan transaction was in the nature of quasi-equity in furtherance of assessee’s line of business and the ultimate objective of the said transaction was to expand assessee’s line of business in overseas market. Therefore, the loan transaction cannot be equated with granting of loan simplicitor but the same has to be viewed as an opportunity for the assessee to make its business more profitable. In such a case, furtherance of business interest would take precedence over interest considerations.

6. The Ld. AR has relied on the decision of Hon’ble High Court of Delhi in the case of Pr. CIT vs. Inductis India Pvt. Ltd. (157 Taxmann.com 87). In this decision, the Hon’ble Court has held that where the assessee was a debt-free company, question of receiving any interest on receivable would not arise and therefore, the adjustment made on account of interest on outstanding receivables was liable to be deleted. This case law duly supports the case of the assessee.

7. Therefore, upon due consideration of material facts and circumstances, we would hold that the impugned TP adjustment on account of interest is not sustainable. We order so. The corresponding grounds stand allowed.

8. We find that the issue of ALP of corporate guarantee is covered by the decision of this Tribunal in the case of M/s Indian Public School Pvt. Ltd. {IT(TP) No.34/Chny/2018 dated 15-06-2022}. The bench, following the decision of Hon’ble Bombay High Court in the case of Everest Kento Cylinders Ltd. (58 Taxmann.com 254), restricted the TP adjustment to 0.5%. Respectfully following the binding decision of Hon’ble High Court of Bombay, we direct Ld. AO to restrict the ALP adjustment of corporate guarantee to the extent of 0.5%. The corresponding grounds stand partly allowed.

9. So far as the addition u/s 41(1) is concerned, we find that the M/s Akar Granites has written-off the outstanding amount against the assessee. Considering the same, the addition made by Ld. AO, to that extent, confirmed. However, with respect to the other party, it has been submitted that there is no such outstanding in the books of the assessee. Therefore, we direct Ld. AO to verify the same and re-decide this issue. The corresponding grounds stand partly allowed for statistical purposes.

10. The appeal stand partly allowed in terms of our above order.

Order pronounced on 5th November, 2024