The Mumbai Bench of the Income Tax Appellate Tribunal (ITAT) has held that a Transfer Pricing Officer’s jurisdiction is confined to determining the arm’s length price of an international transaction and does not extend to deciding the assessment year in which an otherwise undisputed income is taxable.

The bench of Beena Pillai (Judicial Member) and Arun Khodpia (Accountant Member) deleted a ₹3.23 crore transfer pricing adjustment concerning compensation for marketing external commercial borrowings (ECB) and trade loans. It observed that a dispute over the year of income recognition cannot be converted into a transfer pricing adjustment merely because the underlying transaction is international.

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The appellant/assessee is a non-resident banking company operating in India through its branches, challenged additions and disallowances arising from the assessment of its Indian banking operations.

The assessment covered broken period interest on securities, expenditure relating to exempt dividend income, overseas employee training expenses, bad debts, valuation of outstanding forward exchange contracts, interest paid to overseas branches and payments under voluntary retirement schemes.

The Transfer Pricing Officer separately proposed adjustments totalling approximately ₹16.23 crore concerning various international transactions. After the Commissioner of Income Tax (Appeals) granted partial relief, both the bank and the Revenue approached the tribunal.

One of the principal disputes concerned compensation for support provided by the Indian branch in marketing ECB and trade loans.

The bank explained that the compensation was computed and invoiced in December 2002 and offered to tax in Assessment Year 2003–04. The TPO nevertheless made an adjustment of ₹3,23,36,826 for Assessment Year 2002–03 by applying the methodology followed in the subsequent year.

The Commissioner (Appeals) sustained the addition but directed that the corresponding amount be excluded from the following year to prevent double taxation.

The tribunal found that the controversy concerned the timing of income recognition rather than its arm’s length character. It noted that the TPO had not demonstrated that the compensation attributable to the services was inconsistent with an arm’s length price.

The bench explained that whether income accrued in a particular year must be examined under the provisions governing accrual and computation of income. Section 92CA does not authorise the TPO to determine that question through transfer pricing proceedings.

Accordingly, the tribunal deleted the adjustment. It also held that the Commissioner (Appeals)’ corresponding direction to exclude the income in the subsequent year consequently did not survive.

The tribunal also deleted a ₹3,06,11,597 adjustment sustained by the Commissioner (Appeals) for correspondent banking activities involving overseas branches.

These activities included facilitating remittances, letters of credit, guarantees, cheque collections and related banking functions. The TPO had allocated costs to these activities and applied a 20.82% mark-up, which the Commissioner (Appeals) reduced to 15%.

The bench held that the activities had to be understood in the context of an integrated international banking network. The Indian branch performed functions connected with its Indian customers, while overseas branches carried out corresponding local functions.

Merely identifying work performed in connection with overseas branches did not establish an independently chargeable service. The Revenue had to establish the existence and nature of a separate transaction and explain why independent remuneration was warranted.

On the facts before it, the tribunal found that the basis for imposing a separate cost-plus charge had not been established.

In another significant finding, the tribunal deleted the ₹1,62,47,228 adjustment sustained for derivative transactions entered into by overseas branches with Indian customers referred by the Indian branch.

The TPO had attributed 60% of the day-one Initial Net Present Value to the Indian branch under the Profit Split Method. The Commissioner (Appeals) reduced the attribution to 20%.

The tribunal held that neither percentage was supported by the exercise required under Rule 10B(1)(d). The rule requires determination of the combined net profit and an evaluation of the parties’ relative contributions based on their functions, assets, risks and relevant economic circumstances.

The overseas branches entered into the derivative contracts directly and assumed the substantive market, interest-rate, commodity, credit, operational, legal and regulatory risks.

The bench concluded that customer referrals alone could not justify allocating a substantial share of overseas profits to the Indian branch without a proper analysis of its actual contribution.

The tribunal deleted a further ₹53,82,059 adjustment relating to supervisory responsibilities exercised by Indian branch employees over branches in Bangladesh, Sri Lanka and Nepal.

It found that the employees principally worked for the Indian business and performed overseas oversight through routine communication, including email and telephone.

There was no evidence of dedicated personnel deployed for an independent overseas service or specifically incurred expenditure establishing such a service.

The tribunal held that allocating salary and overhead costs by reference to overseas revenue did not, by itself, establish a separate international transaction. The actual functions, time devoted, resources employed and benefits derived required examination.

On the facts of the case, the overseas functions were incidental to the employees’ overall responsibilities and did not warrant an independent cost-plus remuneration.

The bench deleted the transfer pricing adjustment for data centre support services, for which the bank charged cost plus 10%.

It noted that MYM Technologies Ltd., a comparable relied upon by the bank, had a margin of 5.31%, and no cogent reason had been shown for excluding it. The bank’s 10% margin was therefore accepted as being at arm’s length on the material available.

For overnight and short-term foreign currency placements with overseas associated enterprises, the tribunal directed the Assessing Officer/TPO to consider closely linked transactions on an aggregated basis.

It rejected selective benchmarking that counted interest shortfalls while disregarding excess interest recovered on corresponding transactions. Set-off was permitted subject to verification of the bank’s computation.

The tribunal upheld the deduction of ₹89,38,56,853 towards broken period interest on securities, including securities remaining unsold at year-end.

Following the binding decisions discussed in the order, it held that where securities constitute stock-in-trade, broken period interest belongs to the revenue account and cannot be treated as capital expenditure.

The Revenue’s challenge was dismissed. The bank’s alternative cross-objection seeking deduction when the securities were eventually sold became infructuous.

Section 14A, Training Expenses And Bad Debts

The bench upheld deletion of a ₹10,82,500 interest disallowance under Section 14A relating to dividend income from an investment in National Securities Depository Ltd.

The availability of sufficient interest-free funds remained uncontroverted, and the Assessing Officer had not established a direct nexus between interest-bearing borrowings and the investment.

The tribunal also upheld deduction of ₹1,12,56,290 spent on overseas training of employees working in India. It held that the expenditure did not fall within the relevant categories of head office expenditure under Section 44C merely because the training took place abroad.

On bad debts, the tribunal upheld the use of the opening credit balance in the provision for bad and doubtful debts account, rather than the closing balance, for the adjustment under the proviso to Section 36(1)(vii).

The tribunal deleted ₹48,79,384 representing notional profit on unmatured forward exchange contracts.

It held that a year-end valuation surplus, without settlement or crystallisation of a right to receive income, could not by itself be treated as real income merely because an accounting entry had been passed.

It also deleted a ₹27,73,955 disallowance under Section 40(a)(i) for interest paid to overseas branches.

For Assessment Year 2002–03, the bench followed the applicable Special Bench ruling that such payments did not produce taxable income in the hands of the head office or overseas branch. Consequently, the alleged failure to deduct tax under Section 195 could not sustain the disallowance.

The bank also obtained relief concerning recurring pension and Mediclaim payments under its voluntary retirement arrangements.

The tribunal held that, under the wording of Section 35DDA applicable to the relevant year, recurring payments after retirement could not mechanically be subjected to the amortisation treatment applicable to lump-sum voluntary retirement compensation.

It directed allowance of actual recurring payments after limited verification that the corresponding provisions had been disallowed earlier and that no double deduction would result.

The tribunal rejected the bank’s argument that the transfer pricing order was invalid merely because it had been passed by an Additional Commissioner. It noted that the statutory definition of “Joint Commissioner” includes an Additional Commissioner.

It also rejected the general challenge to applying transfer pricing provisions to dealings between the Indian permanent establishment and its head office or overseas branches.

For venture capital advisory services, the tribunal accepted the 2.5% portfolio-based remuneration for the relevant transactions. A separate adjustment concerning Citicorp International Finance Corporation was left undisturbed because the bank did not press for further relief for that year.

Ultimately, the tribunal partly allowed the bank’s appeal, dismissed the Revenue’s appeal and dismissed the bank’s cross-objection as infructuous.

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