Employee benefit expenses and coupon interest on Indian currency NCDs are fully allowable.

ORDER

Manjunatha G., Accountant Member.- This appeal filed by the Revenue is directed against the order of the Commissioner of Income Tax (Appeals)-10, Hyderabad, dated 19.08.2025, and pertains to assessment year 2021-22.

2. The Revenue has raised the following grounds of appeal:

1. Grounds of appeal in respect of disallowance of Employee Benefit Expenses:

1.1 On the facts and in the circumstances of the case and in law, the Learned CIT(A) erred in deleting the disallowance of Rs.8,04,95,000/-made towards Employee Benefit Expenses without appreciating that the assessee failed to substantiate the genuineness and business expediency of the expenditure as required under section 37(1) of the Income-tax Act, 1961.

1.2 The CIT(A) erred both in law and on facts The CIT(A) erred both in law and on facts by adjudicating the issue based on submissions made by the appellant during appellate proceedings with additional evidences about the employee benefit expenses which were not produced before the AO and was not remanded under Rule 46A of Income Tax Rules, 1962 for verification, thereby violating the mandatory provisions of Rule 46A.

1.3 The CIT(A) erred in misapplying judicial precedents that may restrict examination of reasonableness but do not bar verification of genuineness and ignoring that the onus lies on the appellant to substantiate the claims u/s.37 by sufficient evidences.

1.4 The CIT(A) further erred in ignoring the abnormal increase in such expenses despite a decline in business revenue, thereby overlooking possible inflation of expenses. The order of the CIT(A) is therefore perverse and unsustainable both on facts and in law.”

2. Grounds of appeal in respect of Transfer Pricing Adjustment

2.1 Whether on the facts and circumstances of the case and in law, the CIT(A) is justified in rejecting the benchmarking analysis carried out by the TPO.

2.2 Whether on the facts and circumstances of the case and in law, the CIT(A) is justified in directing to apply Prime Lending Rate (PLR) as arms length rate of interest without appreciating the fact that PLR has been replaced with Marginal Cost of Funds based Lending Rate (MCLR) and later with External Benchmark-based Lending Rates (EBLR) and thus, for the year under consideration application of EBLR is more appropriate.

3. Brief facts of the case are that the assessee company is engaged in the business of generation of electricity through wind resources and the company is currently operating 15MW wind powerplant in the state of Karnataka. The assessee company filed its return of income for AY 202122 on 10.03.2022 declaring current year loss of Rs.4,79,98,746/- and total income at Rs.NIL. The case was selected for scrutiny and during the course of assessement proceedings, a reference u/s.92CA(1) of the Income Tax Act, 1961 was made to the Transfer Pricing Officer (TPO) for determination of Arm’s Length Price in relation to the international transaction entered into with its Associated Enterprise (AE). The Ld. TPO has passed order u/s.92CA(3) of the Act on 20.09.2023 and made ALP adjustment of Rs.13,02,752/- in respect of interest payment on NonConvertible Debentures (NCDs) to its AE, Greenko Dutch B.V. The Ld.TPO has computed interest by applying 8.61% rate of interest as against coupon interest 11% paid by the assessee and determined ALP interest payment on NCDs at Rs.44,11,198/- as against amount reported in Form 3CEB for Rs.57,13,950/- and difference of Rs.13,02,752/- has been treated as excess payment and proposed adjustment.

4. The AO has passed draft assessement order u/s.144 of the Act on 24.11.2023 and proposed TP adjustment as suggested by the TPO in respect of interest payment made on NCDs of Rs.13,02,752/-. Further, the TPO has also made addition in respect of disallowance of ’employee benefits expenses’ of Rs.8,04,95,000/- in respect of increase in the ’employee benefits expenses’ to Rs.1176.70 lakhs from Rs.371.75 lakhs as compared to last year on the ground that the assessee has failed to substantiate huge increase in ’employee benefits expenses’, even though, there was a reduction in ‘revenue from operations’ from Rs.30,43,44,953/- to Rs.23,60,96,779/-. Since the assessee didn’t produce any satisfactory explanation regarding increase in ’employee benefits expenses, when compared to decrease in total ‘revenue from operations, the AO disallowed a sum of Rs. Rs.8,04,95,000/- being difference between ’employee benefits expenses’ of the current financial year and ’employee benefits expenses’ of the previous financial year.

5. The assessee vide its reply dated 27.12.2023 informed the AO that the company preferred to file an appeal before the Ld.CIT(A) instead of filing objections before the Dispute Resolution Panel (DRP). Accordingly, the AO passed the final assessement order u/s.143(3) r.w.s.144C(3) r.w.s.144B of the Act on 28.12.2023 and determined total income at Rs.3,37,99,006/- by making addition towards TP adjustment of Rs.13,02,752/- and disallowing ’employee benefits expenses’ of Rs.8,04,95,000/-.

6. Being aggrieved by the assessment order, the assessee preferred an appeal before the Ld.CIT(A). Before the Ld.CIT(A), the assessee challenged the additions made by the AO towards disallowance of ’employee benefits expenses’ of Rs.8,04,95,000/- and submitted that the AO was completely erred in disallowing ’employee benefits expenses’ only on the basis of increase in the said expenses and decrease in ‘revenue from operations’, even though, there is no direct link between increase in ’employee benefits expenses’ and decrease in ‘revenue from operations’. The assessee had also challenged the additions made by the AO towards TP adjustment of Rs.13,02,752/- on the ground that the Ld.TPO has erred in making adjustment by recomputing the interest payment on NCDs by applying External Benchmark-based Lending Rates (EBLR) as against Prime Lending Rate (PLR) considered by the assessee.

7. The Ld.CIT(A) after considering the relevant submissions and also certain judicial precedents including the decision of the Hon’ble Supreme Court in the case of CIT v. Walchand & Co. (Pvt.) Ltd. [1967] 65 ITR 381 (SC) and decision of the Hon’ble Bombay High Court in the case of Extrusion Process Pvt. Ltd. v. CIT 119 ITR 287 (Bombay), deleted the additions made by the AO towards disallowance of ’employee benefits expenses’ by holding that the AO was not justified in arbitrary disallowance of ’employee benefits expenses’ only on the basis of increase in expenses and reduction in ‘revenue from operations’, even though, there is no direct nexus between increase in expenses and decrease in ‘revenue from operations’. The Ld.CIT(A) further observed that the reasonableness of the remuneration to be considered from the point of view of businessman and it was not open to the AO to decide what is the reasonable amount of remuneration to an employee. Further, if an assessee justifies payment of remuneration to a person with relevant details then which is not open for the AO to question reasonableness, unless the AO makes out a case that the expenditure incurred by the assessee is unreasonable or excessive. In the present case, the assessee has furnished relevant details of remuneration paid to Key Managerial Personnel (KMPs) who are actively involved into day to day affairs which resulted in substantial revenue in subsequent financial year and therefore, the remuneration paid to KMPs from the point of view of the businessman can’t be questioned, once it is proved that the said expenditure was incurred wholly and exclusively for the purpose of the assessee. Therefore, the ld CIT(A) deleted the addition made by the AO towards disallowance of ’employee benefits expenses’ of Rs.8,04,95,000/-.

8. In so far as TP adjustment of Rs.13,02,752/- made by the AO on the basis of TP adjustment suggested by the TPO in respect of interest payment on NCDs, the Ld.CIT(A) by following the decision of the ITAT Hyderabad Special Bench in the case of Hyderabad Infratech (P.) Ltd. v. DCIT  (Hyderabad – Trib.) (SB) deleted the addition made by the AO by holding that, if NCDs denominated in Indian currency, then for the purpose of benchmarking interest payment on NCDs, PLR is appropriate, instead of EBLR rate considered by the TPO. Therefore, directed the AO/TPO to delete addition towards TP adjustment of Rs.13,02,752/-.

9. Aggrieved, the Revenue is in appeal before the Tribunal.

10. The first issue that came up for our consideration from Ground Nos.1 to 1.4 of the Revenue’s appeal is deletion of addition made by the AO towards disallowance ’employee benefits expenses’ of Rs.8,04,95,000/-.

11. The Ld.CIT-DR, Shri Pavan Kumar Beerla submitted that the Ld.CIT(A) erred in deleting the disallowance without appreciating the fact that the assessee failed to substantiate the genuineness and business expediency of the expenditure as required u/s.37(1) of the Act. The CIT-DR further referring the assessment order submitted that the AO has brought out the clear facts that there was a steep increase in ’employee benefits expenses’ from Rs.371.75 lakhs to Rs.1176.70 lakhs, whereas the ‘revenue from operations’ was decreased from Rs.30,43,44,953/- to Rs.23,60,96,779/-. Although, there is a decrease in ‘revenue from operations and huge increase in ’employee benefits expenses, the assessee has not substantiated expenditure by filing relevant evidence. Although the assessee claims to have deducted TDS on ’employee benefits expenses’ and claimed that the employee benefit expenses has been paid to KMPs for rendering services which resulted in enhanced Revenue for the company in the subsequent years, but fact remains that the assessee has not filed any details except stating that there is no link between ‘revenue from operations’ and ’employee benefits expenses’. The Ld.CIT(A) without appreciating the relevant facts and also admitting certain additional evidence filed by the assessee, has deleted the addition without providing an opportunity to the AO to verify the additional evidences filed by the assessee contrary to Rule 46A of the Income Tax Rules, 1962. Therefore, he submitted that the addition made by the AO should be upheld or in the alternative matter may be remanded back to the file of the AO for further verification.

12. The Ld.Counsel for the assessee, Shri S.K. Gupta, Advocate, on the other hand, supporting the order of the CIT(A), submitted that the AO has not disallowed the expenditure u/s.37(1) of the Act, because provisions of Section 37(1) of the Act has to be invoked for disallowance of capital expenditure or personal expenses. Further, any expenditure can be disallowed u/s.37(1) of the Act, if such expenditure is personal in nature or capital in nature only. Therefore, the arguments of the Ld.CIT-DR, invoking Section 37(1) of the Act is incorrect. The Ld.Counsel for the assessee further submitted that the assessee has paid remuneration to KMPs which resulted in substantial increase in ’employee benefits expenses’ when compared to previous financial year. The assessee has deducted TDS on the said payment and the employee has paid higher rate of 38% tax on their income including remuneration received from company whereas tax rates for the assessee company is at 25% which is below the tax paid by individual employees and therefore, the allegation of the AO is that it is a colorable device to reduce the profit is incorrect. Further, the assessee also filed relevant acknowledgment of minutes of board meeting to prove the payment of KMPs for rendering services and also considering the importance of the services to the company. The Ld.CIT(A) after considering the relevant facts has rightly deleted the addition made by the AO. Therefore, he submitted that the order of the Ld.CIT(A) should be upheld and ground taken by the Revenue should be rejected.

13. We have heard both the parties, perused the materials available on record and had gone through orders of the authorities below. We also carefully considered the reasons given by the AO to disallow ’employee benefits expenses’ of Rs.8,04,95,000/-. Admittedly, the AO disallowed ’employee benefits expenses’ on the ground that there is a steep increase in the expenses whereas there was a reduction in ‘revenue from operations’ and the assessee couldn’t explain the rationale behind enhanced ’employee benefits expenses’ and when compared earlier financial year. The AO was compared the expenditure incurred by the assessee for the year under consideration when compared to earlier financial year with corresponding ‘revenue from operations’ for the year under consideration and corresponding ‘revenue from operations’ and observed that the ’employee benefits expenses’ has been increased from Rs.371.75 lakhs to Rs.1176.70 lakhs whereas ‘revenue from operations’ decreased from Rs.30,43,44,953/- to Rs.23,60,96,779/- and the same has not been explained or substantiated by the assessee. Except this, there is no observation from the AO with regard to genuineness of expenditure incurred by the assessee and corresponding supporting evidences filed in respect of expenditure including Form 16 for deducting TDS on the said payment, etc. The Ld.CIT(A) deleted the additions made by the AO by holding that there is no nexus between expenditure and ‘revenue from operations’ and further the reasonableness of the expenses has to be considered from the point of view of businessman and it was not open to the AO to subjective satisfaction with regard to expenditure which should have been incurred. The Ld.CIT(A) further observed that the assessee company has justified payment of higher benefits to KMPs for rendering services to the company and also considering the importance of the services and the Ld.CIT(A) also noted that the company has benefited from the services rendered by the KMPs which resulted in substantial increase in ‘revenue from operations’ in the subsequent years. Therefore, observed that the AO was erred in arbitrary disallowance of expenditure only on the basis of increase in expenditure and decrease in ‘revenue from operations’.

14. The Revenue has challenged the reasons given by the ld CIT(A) to delete the addition made by the AO towards disallowance of ’employee benefits expenses’. The first and foremost objection of the Revenue is that genuineness of expenditure and business expediency of the expenditure as required u/s.37(1) of the Act has not been proved by the assessee. Admittedly, the AO does not disputed the genuineness of expenditure incurred by the assessee and further, the AO was not on the point of expenditure incurred by the assessee u/s.37(1) of the Act. Further, Section 37(1) of the Act is applicable in a case where any expenditure incurred by the assessee is personal in nature or capital in nature and not being laid down or expanded wholly and exclusively business or profession of the assessee. In the present case, it was not the case of the AO that the expenditure incurred by the assessee was not for the purpose of business of the assessee and further it is personal expenditure in nature and capital expenditure in nature. Therefore, in our considered view, the ground taken by the Revenue u/s.37(1) of the Act fails.

15. Further, the AO had also not doubted the genuineness of expenditure which is evident from the observation of the AO. The AO has disallowed ’employee benefits expenses’ only on the basis of increase in ’employee benefits expenses’ and decrease in ‘revenue from operations’. The AO compared the ‘revenue from operations’ against expenditure incurred under the head ’employee benefits expenses’ and observed that there is decrease in ‘revenue from operations’, and increase in ’employee benefits expenses’ and the same was not substantiated by the assessee. We find that right from the stage of assessement to appellate proceedings, the assessee claimed that it has paid remuneration to KMPs for rendering services and also considered the importance of their services to the company. The assessee has also filed relevant details including Form 16 for deducting TDS on the said remuneration and also filed corresponding minutes of the board meeting which approved higher remuneration payment to the KMPs. From the details filed by the assessee, it is observed that the assessee paid remuneration to KMPs considering the importance of the services to the assessee company and therefore, in our considered view reasonableness of any expenditure has to be considered from the point of view of the businessman and it was not open to the AO to adopt subjective standard with regard to appropriate remuneration which should have been paid to the employees. Further, in our considered view, the Rule that increased remuneration can only be justified if there is a corresponding profit/Revenue is also not correct as held Hon’ble Supreme Court in case of Walchand & Co. (Pvt.) Ltd. (supra). A similar view taken by the Hon’ble Bombay High Court in the case of Extrusion Process Pvt. Ltd., where it has been held reasonableness of any expenditure has to be considered from the point of view of the businessman and it was not open to the AO to adopt subjective standard with regard to appropriate remuneration which should have been paid to the employees. In our considered view, it is for an assessee, a businessman who happens to be well versed in coming to a conclusion as to what remuneration/salary is to be paid to any employee and therefore, reasons given by the AO to disallow ’employee benefits expenses’ only on the basis of increase in expenses and decrease in ‘revenue from operations’ is totally devoid of merits and can’t be accepted. Further, it is not a case of the Revenue that the assessee has not justified payment of higher remuneration to KMPs. The assessee has filed relevant details including Form 16. The KMPs have paid higher rate of tax of 38% on total income whereas the same income would have suffered tax in the assessee’s company @ 25% and therefore, it is not a case of tax avoidance planning as claimed by the AO, because it is a revenue neutral and no loss of the Revenue to the department. Further, the assessee also proved that it is a case that by paying higher remuneration to KMPs, the company has earned more revenue from the services of the above KMPs which was resulted in substantial increase in ‘revenue from operations’ in the subsequent financial year. Therefore, from the above, it is clear that the assessee has justified payment to higher remuneration to employees which resulted in increase in ’employee benefits expenses’ for the year under consideration when compared to earlier financial year. Since there is no nexus between ‘revenue from operations’ and ’employee benefits expenses’, in our considered view, the AO ought not to have disallowed the difference amount as unreasonable or excessive. The Ld.CIT(A) after considering relevant facts has rightly deleted the addition made by the AO. Further, although, the Revenue has taken a ground under Rule 46A and violation of principles of natural justice, but in our considered view going by the evidences considered by the Ld.CIT(A) including Form 16 and minutes of board meeting, the above two documents can’t be considered as additional evidences so as to apply Rule 46A, because right from the assessement stage the assessee claims to have filed Form 16A and further in so far as minutes of the board meeting, it is only an additional documents which describe the payment of remuneration to employees and therefore, in our considered view, ground taken by the Revenue in light of Rule 46 is also devoid of merits and can’t be accepted.

16. In this view of the matter and considering the facts and circumstances of the case, we are of the considered view that the AO was not justified any arbitrary disallowance of ’employee benefits expenses’. The Ld.CIT(A) after considering the relevant facts has rightly deleted the addition made by the AO and thus, we are inclined to uphold the findings of the Ld.CIT(A) and reject the ground taken by the Revenue.

17. The next issue that came up for our consideration from Ground No.2 of the Revenue’s appeal is deletion of TP adjustment of Rs.13,02,752/- made by the AO in respect of interest payment on NCDs.

18. The CIT-DR submitted that the Ld.CIT(A) was not justified in directing to apply PLR as ALP rate without appreciating the fact that the PLR has been replaced with marginal cost of funds lending rate and later with corresponding benefit based lending rate and thus, application of EBLR is more appropriate.

19. The Ld.Counsel for the assessee submitted that the issue is now stands covered in favour of the assessee by the decision of ITAT Special Bench in the case of Hyderabad Infratech (P.) Ltd. (supra) wherein it has been held that if NCDs are denominated in Indian currency, for the purpose of benchmarking interest payment, PLR of Indian bank is appropriate rate but not EBLR considered by the AO. The Ld.CIT(A) after considering the relevant facts has rightly deleted the addition made by the AO and therefore, the order should be upheld.

20. We have heard both the parties, and perused the materials available on record. This issue is no longer res-integra. The Co-ordinate Bench of this ITAT Hyderabad in the case of Hyderabad Infratech (P.) Ltd., had considered an identical issue and after considering the relevant facts on this issue held that, if NCDs/ECDs/other debentures which are denominated in Indian currency to be bench marked by applying PLR rate instead of EBLR. In the present case, the assessee has borrowed NCDs at a coupon rate of interest 11% which is much below the PLR for the year under consideration, whereas the TPO has adopted EBLR rate @ 8.6% and proposed adjustment of Rs.13,02,752/-. Since PLR is the appropriate rate for benchmarking interest payment on NCDs, in our considered view, the coupon rate of interest @11% paid by the assessee on NCDs is at ALP and therefore, the TP adjustment proposed by the TPO can’t be upheld. Ld. CIT(A) after considering relevant facts has rightly deleted the addition made by the AO. Thus, we are inclined to uphold the findings of the Ld.CIT(A) and reject the ground taken by the Revenue.

21. In the result, appeal filed by the Revenue is dismissed.