THE issues before the Bench are - Whether when the assessee had paid a huge premium on its investment in the share capital of its subsidiaries, the Revenue is justified to treat the amount of share premium as a disguised loan and Whether when the assessee had claimed section 10A exemption, and not excluded communication expenses incurred in foreign exchange in providing the technical services outside India, the Revenue is justified to reduce these charges from the export turnover and not the total turnover. The primary question is remanded to the AO.
Facts of the case
The assessee company was engaged in the business of information technology enabled services and provided online advertisement solutions to advertisers and publishers. It offered products and services that enabled marketers to advertise and sell their products through online marketing channels. Services provided by the assessee facilitated the online management of website advertisement inventory by publishers. The assessee had filed its return showing income.
The assessee, while claiming the exemption under section 10A, had not excluded communication and internet charges attributable to the delivery of computer software and expenses incurred in foreign exchange in providing the technical services outside India.
The assessee had made investments in its subsidiaries consisting of share capital and share premium in addition to having given funds to its subsidiaries. The assessee had thus paid Rs. 8 crore as value for purchase of shares and Rs. 131 crore as share premium. The shares of the subsidiaries were valued on the basis of discounted cash flow method and net asset value method.
The TPO held that the share premium paid by the assessee was actually a disguised loan as the "taxpayer could not explain the economic rationale behind the payment of huge amounts of share premium in the subsidiaries in question with reference to recognized methods of share price valuation." The TPO thus held that it was not an arm’s length transaction.
The AO, while calculating the deduction under section 10A, disallowed the communication, internet, travelling and other expenditure from export turnover. However, the AO reduced the bandwidth charges, leased line charges, internet charges etc only from the export turnover and not the total turnover. Regarding share premium, the AO observed that there was absolutely no justification with regard to payment of share premium and it is a deemed loan given without interest. The AO also confirmed the addition on account of the transfer pricing adjustment towards interest on funds given to subsidiaries and also interest on loans given to subsidiaries.
In appeal, the CIT(A) held that the communication charges, internet charges and travelling expenditure should be reduced both from export turnover as well as from total turnover for the purpose of calculation of exemption under section 10A. Regarding the interest on funds given to subsidiaries, the CIT(A) deleted the addition on the ground that there was no evidence to show that this amount was actually a loan given by the assessee.
Regarding share premium, the CIT(A) considered that the share price calculations were not accurate and in fact there was absolutely no reason to give such a huge share premium. Clearly, the assessee has resorted to huge over projections of the future earnings in order to show an inflated share price relating to the subsidiaries. This has resulted in an absolutely wrong transfer of funds from the assessee to the subsidiaries. This needed to be considered for taxation in the hands of the subsidiaries. However, as the amounts had been drawn from the reserves of the assessee and there was no debit in the profit and loss account, there is no element of income in the hands of the assessee. Further, there was no evidence to show that the share premium was actually a loan given by the assessee. The TPO had not even analysed the accounts of the subsidiaries, nor had he calculated at any stage, the share value of the subsidiaries in question. Even in the future no interest payments had been received nor was there any accounting treatment which showed that this amount was actually a debt. Therefore, the CIT(A) concluded that the share premium was not a debt and deleting the addition, allowed the assessee’s claim.
However, regarding the addition with regard to the interest on loan given to subsidiaries, the CIT(A) confirmed this addition by holding that the assessee could not substantiate its claim by showing evidence regarding the lower level of risk in its loans. Therefore, there was no reason to interfere in the arm’s length interest calculations at which AO had calculated the notional interest.
In the cross appeals before the Tribunal, the Revenue submitted that the AO had excluded telecom expenses, and other elements from the export turnover, as the assessee had not done so.
Regarding share premium, the Revenue submitted that the funds given to subsidiaries without any interest was not proper, but, at least interest could have been charged at the rate of 14 per cent per annum. The fund had been given to the subsidiaries in the guise of share premium, which was nothing but interest free loan.
The assessee submitted that the CIT(A) has analysed the Discounted Cash Flow method, based on the comparison of projected Earnings, before Interest and Tax as per the valuation report with the actual EBIT. The valuation report carried out by the valuer represented the revenues and the cash flows which would be additionally generated by the group as a whole through these subsidiaries located at USA, UK, and Hong Kong. The profit earned through these subsidiaries was, based on the Function, Assets and Risk Analysis, and allocated between the assessee and its subsidiaries in the manner provided in the transfer pricing report. Also, the margin of profit at the subsidiaries level was much lower than the margin without profits retained at the assessee level.
Having heard the parties on the cross appeals, the Tribunal held that,
++ regarding the revenue appeal on telecom charges, the Special Bench had held that "for the purpose of applying the formula under section 10A(4), the freight, telecom charges or insurance attributable to the delivery of articles or things or computer software outside India or the expenses, if any, incurred in foreign exchange in providing the technical services outside India are to be excluded both from the export turnover and from the total turnover, which are the numerator and denominator respectively in the formula.". Therefore, we do not find any infirmity in the order of the CIT(A), which is hereby confirmed on this issue. Accordingly, the ground raised by the revenue is dismissed;
++ regarding the revenue appeal against issue of share premium, the assessee has to prove the amounts advanced was actually towards premium and to substantiate that the shares of the subsidiaries actually command such premium in the open market in term of fair market value worked out as per the guidelines issued by the Controller of Capital Issues in the case of unquoted shares. The prescribed methods for determination of fair market value are either by net asset value (NAV) or by profit earning capacity value (PECV) methods. The taxpayer failed to furnish the valuation of the subsidiary companies in which shares were acquired as per these two methods. Unless the price paid as premium is justified in an arm’s length situation, the same will be treated as NIL under CUP method as no independent party would like to pay such huge amounts in the form of premium without any basis. Therefore, the monies parked with its subsidiaries in the form of share premium have to be treated as loan transactions. When asked to justify the funds given to its AEs in the form of share premium, there was no compliance from the taxpayer. Being so, the TPO/AO computed notional interest on that and disallowed the same. However, the CIT(A) considered certain datas furnished by the assessee and allowed the claim of the assessee. In our opinion, it is appropriate to remit the issue back to the file of the AO for deciding the issue afresh. The assessee is directed to place all the necessary evidences before the AO, what was placed before the CIT(A), for considering the same by the AO while adjudicating the issue;
++ regarding the assessee’s appeal against notional interest on loans to subsidiaries, the issue was squarely covered by the decision of the coordinate bench. This bench had held that the mostly used and recognised benchmark rate for international loan is LIBOR based. However, the actual LIBOR was 4.42 per cent as against the 5.78 per cent approved by the DRP whereby the issue was remitted to the file of the AO;
++ as the issue under consideration is identical to the case decided by the coordinate bench, we remit the issue back to the file of the AO to consider the same in line with the material placed by the assessee before the CIT(A) and decide the issue in the light of the decision of the coordinate bench. The assessee is directed to place all the material evidence before the AO in support of its claim. This ground is allowed for statistical purposes.
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