Facts of the Case

Sterling Oil Resources Pvt. Ltd. ("the taxpayer") is an investment holding Company, which has invested in various Companies through its mauritius based wholly owned subsidiary viz. Sterling Global Oil Resources Pvt Ltd ("SGPL").

During the year under consideration, the Transfer Pricing Officer ("TPO") noticed that the taxpayer has entered into international transactions in the nature of "Contribution to the share capital" and "Reimbursement of expenses" with its Associated Enterprise ("AE") i.e. SGPL

In the course of the Transfer Pricing ("TP") assessment proceedings, the TPO re-characterized the transaction of "Contribution to the Share Capital", as a "Transaction of Loan", stating that there was a delay in allotment of shares against the share application money received from the taxpayer and also the subsidiary used the received money for advancing loan to step down subsidiary. Accordingly, the TPO used Comparable Uncontrolled Price ("CUP") by taking rate of interest as SBI prime lending rate plus 3% premium & proposed an arm's length adjustment.

Further, TPO also made adjustment towards outstanding receivables in respect of reimbursement of expenses on which no interest was charged and proposed a notional interest on these receivables @ 15.5%.

Furthermore, Dispute Resolution Panel ("DRP") confirmed the TP adjustment on account of share application money, whereas in respect of outstanding receivables, deleted the respective TP adjustment on the ground that there is no possibility of revival of the said expenses in future as the subsidiaries are not accepting the said claim

Aggrieved by the same, both parties filed an appeal before the Income Tax Appellant Tribunal ("the ITAT"/ "the Tribunal").

ITAT'S Ruling

Contribution to the Share Capital

The ITAT rejected the re-characterization done by TPO/DRP & deleted the TP adjustment on the basis of following observations:

Payment made by the taxpayer was on account of the shares issued to the taxpayer in October 2010 and the same was re-characterised by the tax authorities as loan only on account of delay in allotment of shares.

RBI provided approval on the remittance of the amount by taxpayer to its AE stating it to be capital contribution and subscription of the capital has also been duly approved by the Board of directors.

ITAT relied on the decision in the case of Bharti Airtel Limited Vs ACIT [TS-76-ITAT-2014(DEL)-TP], "wherein it was held that payment of share application money cannot be treated as interest free loan to AE"

The TPO and DRP have overlooked the fact that the taxpayer was only shareholder of the subsidiary company & thus the fruits of this investment belong to the taxpayer only. On giving this money to the subsidiary and on use of this money by the subsidiary, the taxpayer, in its capacity as sole owner of the subsidiary, is beneficiary of all the gains of the subsidiary company.

Lastly, ITAT referred to the Delhi HC decision in CIT Vs EKL Appliances Limited [TS-206-HC-2012(DEL)-TP] and stated that none of conditions specified therein for re-characterization of transactions had been satisfied in the present case and the time of allotment of shares did not make a difference to the position of the shareholder, as the subsidiary was wholly owned by a single shareholder.

Outstanding Receivables in respect of Reimbursement of Expenses

ITAT upheld the decision of DRP in relation to outstanding receivables in respect of reimbursement of expenses stating that the taxpayer has no legal right to recover the money spent on behalf of its subsidiary prior to its incorporation and the amounts shown are no longer recoverable from the AE.

Also, expenses incurred by the taxpayer for its AE under incorporation is in nature of expenses on performing shareholder services. Thus, no interest can accrue on the same.

Aggrieved by above ITAT ruling, the revenue has challenged the decision in the High Court.

High Court's Ruling

High Court ("HC") stated that as per the facts on records the taxpayer has entered into transaction of purchase and sale of shares with its subsidiary and nothing brought on record by the revenue suggest that the transaction was sham.

Further, HC relied on the co-ordinate bench decision in the case of Aegis Ltd, wherein HC confirmed ITAT decision of rejecting TPO's re-characterization of investment in preference shares into loan and charging of notional interest. Accordingly, HC in the present case upholds the ITAT order.

Nangia's Take

The principles drawn in the current judgement are in line with the rulings pronounced on the same issue by coordinate benches. The instant case reiterates the fact that the TPO cannot re-characterise a transaction unless the same was found to be a sham or bogus transaction. Also, the TPO cannot determine the ALP of the transactions on its own whims and fancies. Accordingly, in the present case, following the same principles that the form and substance of the transaction are the same, the taxpayer behaved in a commercially rational manner and in the absence of a reasonable and permissible time period for allotment of shares, the TPO cannot proceed to re-characterize the payment of share application money made to overseas subsidiaries as loans. Thus, the very foundation of the transfer pricing adjustment made by the TPO was held to be devoid of legally sustainable merits and was accordingly deleted. The aforesaid rulings is a welcome move for enhancing the confidence of the taxpayer and assisting in reducing the incessant litigations on such issues.

August, 2019

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