TP: Temporary price differentials occurring due to fluctuation in treatment charges should be ignored

Brief about the case

In the case of Hindalco Industries Ltd. -Vs- The Addl. Commissioner of Income tax, there were several grounds on which the appeal was made, both by the revenue as well as the assessee. The major ground being of transfer pricing has been discussed here under. Other grounds have been discussed in the facts mentioned herein.

The Assessee-company purchased cooper concentrates from its AE as well as non-AEs – Assessing Officer noticed that purchase price was higher in case of AE vis-a-vis non-AEs – Accordingly, he worked out differential price for purchases effected and added same to total income of assessee – It was found that there was no difference between AE and non-AE with regard to methodology adopted for determining price of copper concentrates but difference occurred as non-AEs had synchronized reduction of treatment charges with Japanese rates on calendar year basis whereas AE followed financial year basis for reduction of treatment charges. Held, temporary price differentials occurring due to fluctuation in treatment charges should be ignored and thus, addition made should be deleted.

The assessee had given corporate guarantee to its AEs and charged guarantee fee at 0.25 per cent per annum. The Assessing Officer noticed that a US bank had charged a fee of 1.5 per cent to 2 per cent to the guarantee given by it. Accordingly, he adopted the rate of 1.75 per cent and computed the guarantee commission/fee, which resulted in an addition of Rs. 9.70 crores. The Commissioner (Appeals) also confirmed the same. On appeal to the Mumbai ITAT , it relied on the case of CIT v. Everest Kanto Cylinder Ltd. [2015] 232 Taxman 307/58 taxmann.com 254 which was considered by the Bombay High Court. Accordingly, order of Commissioner (Appeals) on this issue was modified and the Assessing Officer is directed to compute the addition by adopting the rate of 0.50 per cent.

Facts of the case:

• The assessee is engaged in the business of manufacture and sale of aluminium metal, copper metal, precious metals, certain chemicals including DAP/NPK and is also engaged in the generation of power, extraction of alumina, reduction of alumina into aluminium by electrolytic process, manufacture of Aluminium semi-fabricated products, Aluminium Foils etc.
• The assessee appealed on a list of grounds as discussed below.

Issue 1: Disallowance made u/s 14A / 36(1)(iii) of the Act.

• The AO noticed that the assessee has made investment in shares, Tax free bonds, GOI stock and Mutual Funds (Dividend Scheme). The AO noticed that the assessee has also borrowed funds for the purpose of business and paid interest thereon. Hence, the AO took the view that the assessee has used the interest bearing borrowed funds for making the above investments. Accordingly he worked out the interest attributable to said investments at Rs.27.93 crores and added the same to the total income of the assessee. The ld. CIT(A) enhanced the interest disallowance by 0.22 crores and accordingly held that the interest to the extent of Rs.28.15 crores is disallowable.
• Thereafter the ITAT perused the Balance sheet of the assessee and observed that it had held own funds of Rs.6857.9 and Rs.7666.5 crores respectively as on 31.3.2004 and 31.3.2005, as against investments of Rs.3377.2 and Rs.3702.1 crores respectively on those dates. Hence, the ITAT relying on the decision rendered by Hon’ble Bombay High Court in the case of HDFC Bank (supra) held that the interest disallowance made by the tax authorities is not called for and directed the AO to delete the same.

Issue 2: Disallowance of foreign travelling expenses

Disallowance of foreign travelling expenses of Rs.2,12,010/- on the ground that the assessee incurred these expenses for the wife of Chairman, whole time Director and Executives on foreign tours. The CIT (A) confirmed the disallowance. The ITAT had earlier decided the same issue for the assessee and so following the same decision the disallowance was confirmed by ITAT (Mumbai)

Issue 3 : Assessment of rental income and service charges income

• The third issue relates to the assessment of rental income under the head income of house property and service charges income under the head Income from other sources, as against the claim of the assessee that both the receipts should be assessed as business income of the assessee. Identical issue was considered by the Tribunal in the assessee’s own case in ITA No.5468/Mum/2001 wherein the CIT(A) confirmed the assessment of rental income as income from house property and recovery of service charges as income from other sources after allowing deduction of expenses under respective heads of income. Consistent with the view taken by the co-ordinate bench of Tribunal in the earlier years, ITAT confirmed the order of ld CIT(A).

Issue 4:

• next issue relates to the disallowance of Rs.7,19,01,340/- paid to IFFCO as per the arbitration proceedings. The ICGL had entered into a MOU with the Indian Farmers Fertilizer Co-operative (IFFCO) in the previous year 1998-99, whereby IGCL agreed to supply certain chemicals to IFFCO. In the subsequent years, dispute arose between the ICGL and IFFCO about lifting and supply of chemicals. The disputes were referred to an Arbitrator. Pending receipt of arbitrator’s ward in the matters, the assessee made a provision of Rs.7,19,01,340/- in year ending 31.3.2003 relevant to the AY 2003-04. The claim of the assessee was disallowed both by the AO and ld.CIT(A) in that year. The Mumbai ITAT considered an identical issue in the case of Navijan Roller Flour and Pulse Mills Ltd Vs. Dy. CIT (supra) wherein the Hon’ble Gujrat High court said that merely because the award was challenged in appeal by the assessee cannot be a ground for holding that the liability had not been incurred. Accordingly by following the Hon’ble Gujarat High Court, the Mumbai ITAT directed the AO to allow deduction of the arbitration award.

Issue 5: Addition u/s 92CA

• Further, the subsequent issue relates to the addition of Rs.6,03,07,020/- made u/s 92CA of the Act in respect of purchases made from the Associated Enterprises (AE) of the assessee.
• The assessee has entered into a long-term contract with its AE for procuring the copper concentrates. The period of contract was for the life time of the mine. It is an admitted fact that no other comparables is having this feature and hence, on this ground alone, the comparables adopted by the Assessing Officer/TPO is liable to be rejected. Further, there is no difference between AE and non-AE with regard to the methodology adopted for determining the prices of copper concentrates, viz., ascertain the price quoted for copper metal in LME, ascertain the TC/RC charges fixed by Japanese smelters annually on calendar year basis, reduce the TC/RC charges from the price of copper and adjust the price so arrived at for freight differentials.
• The difference in prices has occurred only due to the fact that the non-AEs have synchronized the reduction of TC/RC charges with Japanese rates, i.e., they have changed TC/RC charges on calendar year basis. However, AE has followed financial year basis for effecting such kind of change, i.e., the AE has given effect to the modified TC/RC charges from 1st April of every year, even though the modified rates were announced in the month of January itself. The effect of this practice is that the non-AEs shall adopt new rate of TC/RC charges for January to March every year, while the AE shall adopt old rates for that period. The natural effect of this practice is that there is bound to be price difference between the AE and non-AEs in these three months, mainly on account of TC/RC charges.·        As submitted by assessee that it had to pay higher purchase price during the year under consideration for the purchases effected in the months of February and March, due to adoption of lower TC/RC charges applicable to immediately preceding calendar year. However, as can be seen from the details given in book, the difference in the rates of TC/RC charges adopted between AE and non-AE was 98 per cent during the year under consideration and it has come down to 12 per cent in the succeeding year, i.e., for calendar year 2006. However, from calendar year 2007 onwards, the TC/RC charges have fallen down resulting in payment of lower purchase price to AEs in the months of Jan. to March. For example, the TC/RC charges determined in 2007 was US $ 66, but the assessee was deducting US $ 104.5 (the rate applicable for calendar year 2006) in the months of January, 2007 to March, 2007 as per the practice followed by it. In the subsequent years also, the TC/RC charges has fallen down, but the AE was deducting TC/RC charges at higher rate resulting in payment of lower purchase price to AE. Thus, the pattern followed by the assessee and its AE shows that the same has been consistently followed and the difference in purchase prices was mainly on account of following a particular pattern. The same would show the bona fides of the assessee and also the AE. Hence, there is merit in the contention of the assessee that the temporary price differentials due to following a particular pattern should be ignored. Besides the above, as noticed earlier, the comparison should be between two cases having similar features. However, in the instant case, the assessee has entered into a long-term contract for the life time of the mines and hence the price paid to its AE should be compared with a case having similar features. Accordingly, the contract entered with AE cannot be compared with other cases having only annual contracts ‘No holiday contract’ is a variant of long-term contract. The assessee has entered no holiday contract with two parties, but they were for lifting fixed quantity of materials, i.e., they were not life time contracts. Hence, they cannot also be compared. Even otherwise, there is no difference in the methodology adopted by AE and non-AE for determining the price. The difference had occurred due to following ‘financial year basis’ for AE, where as the non-AEs had followed calendar year basis. Since the assessee was following a particular pattern for its AEs year after year, the temporary price difference occurring due to fluctuations in TC/RC charges should be ignored. These submissions brings out the exact reason for the price difference and, the said reasons are reasonable and need to be factored in, i.e., adjustments should be permitted, in which case it would result that the payments made to AE was at ALP. Further, it is not the case that the assessee was paying higher purchase price to its AE year after year in the months of Jan. to March. In subsequent years, the assessee has gained by paying lower purchase prices. In view of the foregoing, the assessee should be considered as having paid the purchase price to its AE at ALP only and, hence, there is no necessity to make adjustments. Accordingly, the order of Commissioner (Appeals) on this issue is set aside and the Assessing Officer is directed to delete the addition.

Issue 6: Addition of Corporate guarantee fee

• The next issue relates to addition made u/s 92CA made on account of corporate guarantee fee, which has resulted in an addition of Rs.9,70,40,250/-In the additional ground no.3, the assessee is challenging the addition on the ground that the Explanation (i)(c) to sec. 92B was inserted by Finance Act, 2012 and hence the same should not be made applicable to the year under consideration.
• The assessee has referred to the decision rendered by the co-ordinate Bench in the case of Manugraph India Ltd [IT Appeal No. 4761 (Mum.) of 2013], wherein the co-ordinate Bench has determined a rate of 0.50 per cent for guarantee given.
• The rate of 0.50 per cent is consistently followed in many of the cases by the Tribunal. Even in the case of CIT Everest Kanto Cylinder Ltd. [2015] 232 Taxman 307/58 taxmann.com 254, which was considered by the Bombay High Court, the Tribunal had determined the rate at 0.50 per cent and the same has not been disturbed by the Bombay High Court. Accordingly, order of Commissioner (Appeals) on this issue was modified and the Assessing Officer is directed to compute the addition by adopting the rate of 0.50 per cent.
• In the result, the appeal filed by the assessee is partly allowed and the appeal of the revenue is dismissed.

Contention of the Revenue

• Where assessee had entered into a long-term contract with its AE for procuring copper concentrates for life time of mines, price paid to its AE should be compared with the prices paid to non-AE.
• Rate of 0.50 per cent charged by assessee for giving corporate guarantee to its AE was appropriate .The ld D.R submitted that the assessee has not given any bench mark and hence the TPO/AO was constrained to adopt the rate charged by the banks. Accordingly he submitted that this matter may be restored back to the file of the AO for fresh consideration.

Contention of the Assessee

The assessee contended that:

1. Disallowance made u/s 14A of the Act is unjustified as he had invested the funds out of his owned funds and not borrowed funds.
2. Assessment of rental income of house property and service charges must be as business income.
3. The award given by the arbitrators has crystallized during the year under consideration since the award has been given during the year under consideration, and thereby eligible for deduction.
4. the Ld A.R placed reliance on the decision dated 08-05-2015 rendered by Hon‟ble jurisdictional Bombay High Court in the case of CIT Vs. M/s Everest Kento Cylinders Ltd (ITA No.1165 of 2013), wherein the High Court has held that the consideration which applied for issuance of Corporate guarantee are distinct and separate from that of bank guarantee. Accordingly he contended that the tax authorities are not justified in adopting the rate quoted by a bank for giving bank guarantee to the case of the assessee.

Held by ITAT (Mumbai)

• Held that temporary price differentials occurring due to fluctuation in treatment charges should be ignored and thus, addition made should be deleted.
• Held that rate of 0.50 per cent charged by assessee for giving corporate guarantee to its AE was appropriate.