Section 43A- Change in rate of exchange of currency- Implications

The section 43A provides as under:-

1.       Notwithstanding anything contained in other provision of the Act- Overriding all other provision of Income Act

2.       Assessee acquired asset in any previous year from country outside India

3.       For the purpose his business or profession

4.       On account of change in rate of exchange, there is increase or decrease in liability of assessee in Indian Currency, as compared to liability existing at the time of acquisition of asset, at the time of making payment towards:-

a)      Whole or part of the cost of asset

b)      Repayment of the whole or part of  the moneys borrowed in foreign currency for acquiring the asset along with interest if any

5.       The increase or decrease in liability in Indian currency shall be added or deducted from:-

a)      Actual Cost of asset as defined u/s 43(1)

b)      Cost of acquisition of a capital asset (not being a capital asset referred to in section 50)

c)       Ohers

Implications

1.       Interest payable on money borrowed in Foreign Currency

Ø  Suppose assessee borrow US$ 1,0,000 for purchase of asset outside India on1/4/2011. The money is repayable in US$ 20,000 half yearly along with interest @ 3%. The Interest payable is US$ 4500 over tenure of loan (US$ 1500 on 30/9/11 and US$ 1200 on 31/3/2012).

Ø  The rate of exchange on 1/4/2011 is Rs. 45. Further assets was put to use on 1/10/2011

Ø  Suppose rate of exchange on 30/9/2011 and 31/3/2012 is Rs. 50 & 52 respectively

Ø  Treatment of Interest in First year will be as under:-

a)      Interest for period 1/4/2011 – 30/9/2011

·         Original Liability based on rate of exchange as at 1/4/2011 = US$ 1500 * 45 = Rs. 67,5000 – Will be not be allowed as revenue expenditure u/s proviso to section 36(1)(iii), may be capitalised

·         Additional Liability – US$ 1500 *5 (50-45) = 7,500 - Will be capitalised to cost of an asset u/s 43A.

b)      Interest for period 1/10/2011 – 31/3/2012 and for subsequent period (after asset is put to use)

·         Original Liability based on rate of exchange as at 1/4/2011 = US$ 1200 * 45 = Rs. 54,000 – Will be charged to Revenue by virtue of explanation 8 to section 43(1)

·         Additional Liability – US$ 1200 *7 (52-45) = 8,400 - Will be capitalised to cost of an asset u/s 43A, since it override any other provision of Act, including explanation 8 to section 43(1).

2.       Interest payable on deferred payment to Seller.

Ø  Section 43A provides for specific treatment of increase or decrease in interest liability on account exchange fluctuation (additional interest), when money is specifically borrowed for acquisition of asset

Ø  Since no money is borrowed, additional interest will not be regulated by section 43A and will be governed by other provisions of Act- Section 37, explanation  8 to section 43(1)

3.       Additional Depreciation u/s 32(1)(iia)

Ø  Section 32(1)(iia) provides for additional depreciation @ 20% on actual cost of prescribed plant & machinery

Ø  As per section 43A on account of  exchange rate fluctuations , actual cost of asset will be increased or decreased every year in which foreign liability is paid

Ø  Does it means, assessee will keep on adjusting additional depreciation every year in which such increase or decrease is added or reduced from actual cost of asset?

4.       Disposal of Asset acquired from outside India, but Block of asset exist

Ø  Assessee acquires an asset outside India on 1/10/2011, which is falling under block of assets having 15% rate of depreciation

Ø   On 1/4/2012, assessee sold such an asset, but said block still exist.

Ø  Subsequently on account of exchange rate fluctuation, assessee paid additional sum to vendor as compared to amount recorded at the time of acquisition of asset

Ø  Since asset does not exist, will the additional amount be added to block of asset or will be charged to revenue or will be dead cost to assessee?

Ø  However if there is any amalgamation or demerger, whereby asset is transferred to amalgamated or resulting company, actual cost in the hands of amalgamated or resulting company will also considered sum paid on account of exchange rate fluctuation by amalgamating or demerged company by virtue of explanation 7 and 7A of section 43(1).

5.       Cessation of Block, but asset exists.

Ø  Assessee acquires an asset outside India on 1/10/2011, which is falling under block of assets having 15% rate of depreciation

Ø  On 1/4/2012, assessee sold other asset of bloc, as a result value of block reduced to ZERO

Ø  Subsequently on account of exchange rate fluctuation, assessee paid additional sum to vendor as compared to amount recorded at the time of acquisition of asset

Ø  Since block does not exist, will the additional amount be will be charged to revenue or will be dead cost to assessee?

Transfer Pricing Case law- Tellabs India (P) Ltd

Tellabs India (P) Ltd. vs ACIT

IT (TP)A Nos. 1037 & 1038/Bang/2008

A/Y 2003-04 & 2004-05

Bangalore Tribunal

Facts:-

1.       The Assessee was incorporated in India on 30.12.1998 as a wholly owned subsidiary of Tellabs International Inc., USA (Tellabs US). Tellabs group designs, manufactures and markets extensive line of telecom equipments and products. The Assessee was initially set up as sales and marketing office of Tellabs US and its group companies which are engaged in the business of manufacture and sale of telecommunication equipment. The Assessee also renders services in connection with installation and commissioning of telecommunication equipment, on behalf of Tellabs group of companies worldwide for their customers in India.

2.       Tellab Denmark, AE of assessee, entered into contract with Power Grid Corporation of India Ltd (PGCIL) for the supply, installation and commissioning of the telecommunication equipments. The work was to be performed both outside India (manufacture and supply of telecom equipments from Denmark- offshore) and in India (customs clearance in India and  installation of the equipments - onshore).

3.       After the award of contract to Tellabs Denmark, a corporate restructuring exercise took place in 2002, wherein the entire business activities of the assessee’s group were restructured. . Tellabs Denmark therefore sought permission of PGCIL to assign a portion of the Onshore contract to the Assessee. PGCIL agreed to the proposal subject to the condition that Tellabs Denmark will continue to be liable for due performance of all the 4 contracts.

4.       Tellabs Denmark assigned on shore contract on the same terms and conditions to which it has agreed with PGCIL in original contract. Thus in place of Tellabs Denmark , assessee has  become  party to on-shore contract  with PGCIL.

5.       In its TP report, submit with respect to other transactions of  marketing, sales and customer support services to Tellabs International Inc, USA, assessee does not report anything about performance of contract under assignment.

6.       AO/TPO held that transaction between Assessee and PGCIL is international transaction u/s 92B(2), ignoring the fact that assessee and PGCIL both are residents. Section 92B(2) provides as under:-

“A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be a transaction entered into between two associated enterprises, if there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise”

7.       AO/TPO applied TNMM and PBT/Cost as PLI, as adapted by assessee for its other international transaction, to deemed international transaction and arrive at ALP on the basis of expenses incurred by assessee in performance of on shore contract. In other words AO/TPO assumed that assessee is providing custom clearance and installation service under on shore contract on behalf of Tellabs Denmark and it needs to be compensated accordingly. However post assignment, assessee was executing the contract in its own capacity and not as an agent of Tellabs Denmark.

Held:

1.       The transaction between assessee and PGCIL is not deemed international transaction u/s 92B(2) on following ground:-

PGCIL is a Government of India entity, performing a governmental functions in a restricted sector. Its policies are directly controlled by the Central Government. It can neither be accused of entering into tainted agreements or exercising undue influence for the purpose of avoiding taxes. PGCIL is neither part of a prior agreement as stipulated in the first limb of section 92B(2) nor has in substance determined the terms of the transaction with the appellant as stipulated in the second limb of section 92B(2). It has followed all the prescribed norms for calling international bids for awarding contracts, and thus cannot be accused of acting as an intermediary between Tellabs Denmark and the appellant for such purpose.

2.       Assignment of on shore contract by Tellabs Denmark to assessee is international transaction and directed the AO determine the ALP of said international transaction.

Critical Comments:-

1.       Deemed International transaction.

Section 92B(1) provide that for transaction to be international transaction either or both of the parties should be non-resident.

Section 92B(2) provides that transaction between enterprise and any third person will be deem as international transaction, if the terms of such transaction is regulated by Associated enterprise. This sub-section is silent about the residential status of parties to the transaction.

In the instant case Assessee and PGCIL are both residents and even then TPO deemed the transaction between them as international transaction

Tribunal, on the basis that PGCIL is government entity and it has no ulterior motive to evade tax, has held that terms of agreement between Assessee and PGCIL is not regulated by Tellabs Denmark and hence it is not deemed international transaction.

Tribunal does not decided the crucial question, if both the parties to the transaction are resident, can it be deemed international transaction u/s 92B(2)

2.       Arm’s Length price on assignment of contract

a)      The nature of international transaction appears to fall with the criterion of transfer on Intangibles. OECD has come up with  Discussion Draft on Transfer Pricing aspect of Intangible , wherein rights under contract is treated as intangible and transfer thereof between associated price requires determination of ALP.

b)      Since the transfer of such type of contract is rare in practice, it will be difficult to find the comparable for such type of international transaction. The comparable will be determined assuming what independent enterprise would arrive at on assignment of such contract. On this basis, the assignor will receive compensation for assigning the contract and assignee will make payment.

c)       If assignee is required under comparable conditions to make payment for getting assignment of contract, it will constitute expenditure on the part of assignee, assessee in this case. Such expenditure will reduce the taxable income of assessee.

If above comparability is adopted, there will not be any need to determine ALP on assignment of such contract in view of provisions of section 92(3), which provides that section 92 does not apply in the case, where determination of ALP has the effect of reduction of taxable income of assessee