The Hindu Business Line : On-lending sans interest

Bulk of the petitions before the Company Law Board (CLB) under Section 398 of the Companies Act, 1956 revolve around diversion of funds by those in the saddle. Quite often the allegation becomes an open and shut case, given the brazenness of those calling the shots by forming a separate company that enures for their benefit alone ousting the rival group in the company from its spoils.

Before the income-tax authorities however the matter does not find instant resolution with the department examining transactions within the group to find out whether they were at arm’s length. Thus if the parent company borrows and diverts either the entire or a part of the borrowings to its subsidiary sans interest, the tax authorities’ instinctive reaction is to smell something fishy in the deal and disallow the proportionate part of the interest in the assessment of the parent company.

Impasse broken

This approach has won the approbation of the Bombay High Court in Phaltan Sugar Works Ltd vs CWT (1994 208 ITR 989) which upheld the view that the term ‘for the purpose of business’ cannot be extended and stretched to cover the business of the subsidiary. The Delhi High Court however thought otherwise in CIT vs Dalmia Cement (B) Ltd (2002 254 ITR 377) by taking a liberal view that the tax authorities cannot sit on judgment over what a businessman does — in other words they cannot think, as it were, for the board of directors. The impasse has been broken by the Supreme Court in SA Builders Ltd vs CIT (2007 288 ITR) with the matter being resolved in favour of the liberal school.

Commercial expediency is at the core of any business. Thus a parent with a stronger balance sheet and credibility can easily get a loan on favourable terms which may not be possible for a subsidiary yet to find its feet. Therefore, there is obviously nothing wrong if it borrows money and diverts the same to its subsidiary, especially if the terms of the loan do not bar such diversion. Fine. But how can the parent assume the resultant expenditure — read interest — as well which non-charging of interest on such on-lending amounts to, given the fact that in India the group is not an assessable unit.

Group assessment

Had the group been an assessable unit, it makes very little difference who bears the expenditure — the parent or its subsidiary. But when the parent and its subsidiary are separate assessable entities there is a real danger of tax evasion through such deals assuming that the parent is enjoying huge profits and the subsidiary is reeling under losses. Tax evasion or not, the tax law has erected a Chinese wall between the parent and its subsidiary and this must be respected so long as the wall stands.

We have put in place a transfer pricing mechanism to find out the arm’s length price in deals between residents and non-residents. Alas, if only we had a similar mechanism at one place comprehensively — at present there are references to this at couple of places in the income-tax law — to regulate the dealings amongst desi group members as well. Whether that happens or not, the tax administration must bring to the apex court’s attention the fact that the l iberal viewpoint expounded would have been warranted had there been the system of group assessment in this country.

The apex court has implicitly fostered the idea of group assessment. It is now for the Government to take the call — change the law to usher in group assessment if it is in agreement with the Supreme Court; else, approach the court for a review.

(The author is a Delhi-based chartered accountant.)

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