Corporate Guarantees to AE: ITAT Mumbai Holds They Fall Under Section 92B; ALP Commission Limited to 0.20%

1. Background of the Case

The Mumbai Bench of the Income Tax Appellate Tribunal decided the appeal in DCIT Vs KEC International Ltd. (ITAT Mumbai) for Assessment Year 2011-12. The appeal arose from an assessment framed under Section 143(3) read with Section 144C(3) of the Income Tax Act 1961.

KEC International Ltd. is engaged in:

  • Design, fabrication, galvanizing and testing of transmission lines and telecom towers
  • Fabrication of various types of masts
  • Erection of transmission lines and telecom towers
  • Supply and erection of sub-station structures
  • Overhead equipment for railway electrification
  • Managing telecom infrastructure sites

For AY 2011-12, the assessee:

  • Filed its original return on 30.11.2011 declaring total income under normal provisions at Rs. 139,34,07,542/- after set-off of brought-forward losses of Rs. 52,91,33,759/-
  • Declared book profit under Section 115JB at Rs. 230,87,92,525/-
  • Subsequently filed a revised return on 30.03.2013 declaring total income under normal provisions at Rs. 113,00,88,168/- while retaining the same book profit under Section 115JB

The Revenue raised multiple grounds involving:

  • Depreciation on revalued assets of the transmission business
  • Disallowance of mark-to-market (MTM) foreign exchange loss
  • Transfer pricing (TP) adjustments on:
    • Performance guarantees to associated enterprises (AEs)
    • Bank/corporate guarantees given in favour of Chadian Company for Water and Electricity (CCWE)
    • Corporate guarantees issued to ICICI Bank on behalf of KEC US LLC and KEC Transmission LLC, USA

The Tribunal decided each cluster of issues largely by following its own earlier rulings in the assessee’s prior years.

2. Depreciation on Revalued Assets of Transmission Business

2.1 AO’s Disallowance

Pursuant to a composite scheme of arrangement sanctioned by the Bombay High Court on 27.09.2006, KEC International Ltd. acquired all movable and immovable assets and liabilities of the power transmission business of KEC Infrastructure. After the acquisition, the assessee revalued these assets and began claiming depreciation on the enhanced revalued amounts rather than on the pre-existing book value.

The Assessing Officer (AO):

  • Treated the scheme as a demerger within the meaning of Section 2(19AA)
  • Held that depreciation should be computed only on the written down value (WDV) of the block of assets, ignoring the revaluation increment
  • Following the approach taken in assessments for AYs 2007-08 to 2009-10, disallowed excess depreciation of Rs. 18,12,94,916/- and added it to the assessee’s total income

2.2 Relief by CIT(A)

On appeal, the Commissioner of Income Tax (Appeals) [CIT(A)]:

  • Relied on the order of the Bombay High Court in the assessee’s own case for AY 2006-07
  • Also followed the Tribunal’s decisions in the assessee’s favour for AYs 2007-08 to 2009-10
  • Allowed the assessee’s claim and deleted the disallowance

2.3 ITAT’s Findings

Before the Tribunal:

  • The Departmental Representative (DR) supported the AO’s reasoning
  • The assessee’s counsel placed reliance on the ITAT’s order for AY 2010-11 in ITA No. 5611/Mum/2015

The Tribunal noted that:

  • In AY 2010-11, at paras 12 and 12.2, the Coordinate Bench had already upheld the assessee’s position and rejected the Revenue’s challenge on an identical issue
  • Facts and legal matrix remained the same for AY 2011-12

Accordingly, the ITAT followed its earlier decision and dismissed Ground Nos. 1, 2 and 3 of the Revenue’s appeal.

3. Disallowance of Mark-to-Market Foreign Exchange Loss

3.1 AO’s Treatment

For the relevant year, the assessee debited Rs. 1094.81 lakhs in its Profit & Loss account on account of foreign exchange gain/loss. The AO identified unrealised MTM forex loss of Rs. 5,33,16,399/- and held:

  • Such loss was neither accrued nor actually incurred
  • It did not satisfy the tests for allowance of an expenditure/loss under Part D of Chapter IV of the Income Tax Act 1961 (profits and gains of business or profession)
  • No specific provision permitted deduction of unrealized MTM forex loss

Consequently, the AO:

  • Added back Rs. 5,33,16,399/- to the assessee’s income under the normal provisions
  • Also increased book profit under Section 115JB by Rs. 5,33,16,399/- by invoking clause (c) to Explanation 1 of Section 115JB(2)

3.2 CIT(A) and ITAT’s View

The CIT(A):

  • Followed the ITAT’s decision in the assessee’s own case for AY 2009-10
  • Allowed the assessee’s claim and deleted the addition under both normal provisions and MAT

Before the ITAT, the DR relied on the AO’s reasoning, while the assessee’s counsel referred to the Tribunal’s order in AY 2010-11, where identical disallowance had been rejected.

The ITAT:

  • Referred to paras 12.1 and 12.5 of the AY 2010-11 order, where the Tribunal had followed its own earlier decisions in favour of the assessee
  • Held that the facts for AY 2011-12 are indistinguishable

Therefore, Ground Nos. 4 and 5 raised by the Revenue were dismissed.

4. Performance Guarantees to Associated Enterprises

4.1 Facts and TPO’s Adjustment

During AY 2011-12, the assessee issued certain performance guarantees in favour of third parties on behalf of its AEs. These guarantees were:

  • Not reported as international transactions in Form 3CEB
  • However, details were furnished in the TP documentation in response to notice under Section 92CA(2)

The assessee did not benchmark these guarantees. The Transfer Pricing Officer (TPO):

  1. Sought information from various banks under Section 133(6)
  2. Based on bank responses, determined an arm’s length rate of 1.04% per annum for performance guarantees
  3. Computed TP adjustment for performance guarantee at Rs. 2,05,58,246/- by applying 1.04% on the guarantee amount for the relevant period

Subsequently, the assessee filed a rectification application before the TPO pointing out that: