ITAT Mumbai Deletes Interest Disallowance on Overseas Loan Where TPO Accepted Arm’s Length Interest
Background and Context
The Mumbai Bench of the Income Tax Appellate Tribunal, in the case of ACIT Vs Reliance Coal Resoures Pvt. Ltd., examined whether interest expenditure could be disallowed under Section 36(1)(iii) where:
- The assessee borrowed funds from its Indian holding company at 15% interest, and
- On-lent those funds in foreign currency to its overseas subsidiary in Netherlands at 5% interest,
- And the Transfer Pricing Officer (
TPO) had already accepted the 5% rate as being at arm’s length.
The appeal by the Revenue related to Assessment Year (AY) 2020–21 and arose from the order of the National Faceless Appeal Centre (NFAC), Delhi, which had deleted a disallowance of interest expenditure amounting to Rs. 47,76,75,486/-.
The Tribunal was required to decide if, in these circumstances, the Assessing Officer (AO) was justified in invoking Section 36(1)(iii) to disallow part of the interest payment on the ground that:
- The assessee was paying interest at a higher rate (15%) on its borrowings,
- But charging a lower rate (5%) on loans advanced to its foreign subsidiary,
- Allegedly resulting in loss and lack of commercial expediency.
Procedural History
Delay in Filing Revenue’s Appeal
- The Department’s appeal to the Tribunal was filed with a delay of 22 days.
- After considering submissions of the Departmental Representative (
DR), the Tribunal accepted that there was reasonable cause for the delay. - The delay was condoned, and the appeal was admitted for adjudication on merits.
Scope of Dispute
Although four grounds were formally raised, they all pertained to a single core issue:
Whether the NFAC was correct in deleting the disallowance of interest expenditure of Rs. 47,76,75,486/- made by the AO under
Section 36(1)(iii).
Facts of the Case
Business Profile of the Assessee
- The assessee is a resident company engaged in trading, production, and mining of coal in India and overseas.
- It is a wholly owned subsidiary of Reliance Power Ltd., a listed company.
- For AY 2020–21, the assessee filed its return of income on 11.02.2021, declaring a loss of Rs. 30,65,50,828/-.
- The case was selected for scrutiny assessment.
International Transactions and Reference to TPO
During the scrutiny proceedings, the AO noticed international transactions between:
- The assessee and its overseas subsidiary in Netherlands – Reliance Power, Netherlands B.V.
A reference was made to the TPO under Section 92CA to determine the Arm’s Length Price (ALP) of these international transactions, including the loan granted by the assessee to its foreign subsidiary.
Loan Structure and Interest Rates
The AO recorded the following facts:
- There was an opening balance of advances to the Netherlands subsidiary of Rs. 401,21,80,441/- as on 01.04.2019.
- During the relevant year, the assessee further advanced Rs. 5,15,81,780/- to this subsidiary.
- The assessee charged 5% interest on this foreign currency loan.
- At the same time, the assessee had borrowed funds from its holding company, Reliance Power Ltd., at an interest rate of 15% per annum (for the year under consideration and earlier years).
The AO concluded that:
- While the assessee paid 15% interest on its Indian currency borrowings,
- It charged only 5% interest on the foreign currency loan advanced to its Netherlands subsidiary.
- According to the AO, this mismatch led to a substantial loss and was commercially unjustified.
Assessment Proceedings and Disallowance by AO
AO’s Show Cause and Assessee’s Explanation
The AO issued a show cause notice asking why interest expenditure should not be disallowed under Section 36(1)(iii) on the ground that:
- The assessee had allegedly understated interest income by charging only 5% on the foreign loan while incurring 15% on borrowings.
In response, the assessee explained:
- The loan to the Netherlands subsidiary was a foreign currency loan.
- The prevailing bank lending rate in Netherlands was around 4%, linked to international benchmarks such as LIBOR.
- Charging 5% interest thus exceeded the typical market rate in the borrower’s country and reflected an arm’s length rate.
The assessee also clarified that:
- Its role was to facilitate overseas coal procurement for the group,
- And the lending to the Netherlands subsidiary was part of this commercial arrangement.