As the funds were mixed, it is not possible to ascertain whether the investment in tax free bonds is out of the assessee’s own funds. The source of investment in the tax free bonds was not identified. The AO did not establish any nexus between the borrowed funds and the investments in the tax free bonds. The cash flow of the assessee was not seen. Therefore, the apportionment on a pro rata basis was improper in the absence of anything brought by the AO to rebut the assessee’s stand that the investment in the tax free bonds had been made out of the funds of own funds (Minda Investments, Hero Cycles 323 ITR 518 (P&H) and Winsome Textile Industries 319 ITR 204 (P&H) followed)

Rule 8D r.w.s. 14A(2) can be invoked only if the AO “having regard to the accounts of the assessee, is not satisfied with the correctness of the claim of the assessee in respect of expenditure incurred” in relation to tax-free income. However, the assessment order did not evince any such satisfaction of the AO regarding the correctness of the claim of the assessee. As such, Rule 8D was not appropriately applied by the AO. The AO merely made an ad hoc disallowance. The onus was on the AO to establish that expenditure was incurred to earn tax-free income. This onus has not been discharged. S. 14A requires a clear finding of incurring of expenditure and no disallowance can be made on the basis of presumptions (CIT vs. Hero Cycles 323 ITR 518 (P&H). The burden is on the AO to establish nexus of expenses incurred with the earning of exempt income, before making any disallowance u/s14A (ACIT vs. Eicher Ltd 101 TTJ (Del) 369). Before making any disallowance u/s14A, the onus to establish the nexus of the same with the exempt income, is on the revenue (Maruti Udyog vs. DCIT 92 ITD 119 (Del)). There is be no presumption that the assessee must have incurred expenditure to earn tax free income (Wimco Seedlings vs. DCIT 107 ITD 267 (Del.)(TM))

A transfer pricing adjustment can be made u/s 92 in respect of an “international transaction”. A continuing debit balance is not an “international transaction” per se but is a “result” of the international transaction. A continuing debit balance reflects that the payment, even though due, has not been made by the debtor. It is not necessary that a payment is to be made as soon as it becomes due. Many factors, including terms of payment and normal business practices, influence the fact of payment in respect of a commercial transaction. Unlike a loan or borrowing, it is not an independent transaction which can be viewed on standalone basis. What has to be examined is whether the commercial transaction is at arms length. The payment terms are an integral part of any commercial transaction and the transaction value takes into account the terms of payment such as permissible credit period as well. Even the residuary clause in the definition of ‘international transaction’ i.e. “any other transaction having a bearing on the profits, incomes, losses or assets of such enterprises” does not apply to a continuing debit balance as there is nothing on record to show that as a result of not realizing the debts from the AE there has been an impact on profits, incomes, losses or assets of the assessee

In Circular 204 dated 24.7.1976, the CBDT has accepted that u/s 23(1)(a) the “sum for which the property might reasonably be expected to let from year to year” is the municipal valuation of the property. The same view that the Municipal valuation is the annual value u/s 23(1)(a) has been taken in CIT vs. Prabhabati Bansali 141 ITR 419 (Cal) & M.V. Sonavala vs. CIT 177 ITR 246 (Bom)

There is no presumption in law that the AO is supposed to discharge an impossible burden to assess the tax liability by direct evidence only and to establish the evasion beyond doubt as in criminal proceedings. He can assessee on consideration of material available on record, surrounding circumstances, human conduct, preponderance of probabilities and nature of incriminating information/ evidence available on record

On merits, the CUP method is the ‘most appropriate method’ to determine the arm’s length price in the cases of generic drug manufacturers so long as comparables are available. As the API imported by the assessee was a generic drug and not patent protected, the CUP method could be used. The argument that the APIs are “unique” on the ground that they are better, of proven effectiveness and manufactured using WHO – GMP practices is not acceptable because while the high quality standards does confer a certain degree of comfort, it does not affect the comparability of the API with the same API manufactured by competitors. (Principles laid down in Glaxo Smith Kline Inc Vs Her Majesty (2008 TCC 324) approved on this point by the Canadian Court of Appeal in 2010 FCA 201, followed – Noted that it was not the argument that the higher prices of API were warranted on account of commercial compulsions arising out of licensing agreement)