Executive Summary
The Mumbai bench of the Income Tax Appellate Tribunal (“the Tribunal”) recently pronounced its ruling in case of Tata Autocomp Systems Limited (“the taxpayer”), wherein the Tribunal held that the transaction of granting interest free loan by the taxpayer to its associated enterprise (“AE”) falls within the ambit of transfer pricing regulations. Further, domestic interest rates cannot be used as comparable to determine arm’s length interest rate for foreign currency loans.
Facts
The taxpayer is a company engaged in the business of manufacture of indoor plastic, rendering engineering services, supply chain management services and administrative support for joint venture companies. During the assessment year (“AY”) 2007-08, the taxpayer extended an interest free loan of Euro 26,25,000/- to its wholly owned German subsidiary. This transaction was not reported in the form no. 3CEB nor had any separate TP analysis been done in respect to such transaction.
During the course of assessment proceedings, the Transfer Pricing Officer (“TPO”) issued a show cause notice as to why interest should not be charged on this transaction at the rate of 10.25%.
Contentions of the taxpayer
The taxpayer’s contentions are summarised below:
The interest free loan was granted to AE on account of commercial expediency and for the purpose of taxpayer’s business with Ford Europe;
The existence of such interest free loans does not mean that the transaction is not at arm’s length, if genuine business reasons exist, then non-charging of interest is justifiable;
There was no intention to evade tax and shift profits out of India. The subsidiary was suffering from severe financial crisis and it would not have been possible to recover the interest which would then have to be written-off;
Interest free loan to AE should be accepted without adjustment for notional interest as tax authorities could not have brought to tax notional interest income if the interest free loan was given to third parties;
On a without prejudice basis, it was contended that for comparability the interest rate prevailing in Germany should be considered. Thus, it would be important to look at the options available to the AE for raising funds in Germany and not in India;
In a situation where an international loan was granted to an AE, a EURIBOR based interest rate would have been the most appropriate comparable uncontrolled rate. The working of the EURIBOR rate stands at 4.15%;
Reliance was place of the ITAT ruling in the case of M/s Siva Industries and Holding Limited v. ACIT (ITA No. 2148/Mds/2010) and DCIT v. Tech Mahindra Limited (ITA No. 1176/Mum/2010).
Contentions of the TPO
The TPO rejected the arguments of the taxpayer and applied the interest rate charged by a domestic bank i.e. 10.25% to determine the arm’s length price. The TPO contentions are summarised below:
Lending or borrowing is not one of the main businesses of the taxpayer;
Two independent enterprises in the similar circumstances would have charged interest as compensation for the financial facility provided by one party to another;
The business prudence or necessity of advancing loans to subsidiary is not relevant for computing arm's length price in unrelated party transactions;
Arm’s length rate of interest should be decided after taking the lender into consideration and not the borrower or the geography in which borrower is situated;
LIBOR cannot be used when the currency of the lender country is not the currency in which the loan is finally executed;
Interest charged by a German Bank to AE cannot be considered as Comparable uncontrolled price.
Aggrieved by the standpoint of the TPO, the taxpayer filed objections before the Dispute Resolution Panel (“DRP”). The DRP upheld the order of the TPO and enhanced the arm’s length rate to 12% instead of 10.25%. The taxpayer being aggrieved by the DRP’s direction filed an appeal before the Tribunal.
Ruling of the Tribunal
The Tribunal dismissed the taxpayer’s proposition that only real income should be taxed and noted that these arguments could not be accepted in the context of Chapter X - Special Provisions relating to Avoidance of Tax, of the Act. In this regard, reliance was placed on the decision of Perot System TSI (India) Limited;
The Tribunal observed that RBI's approval was not sufficient from an Indian transfer pricing perspective as the character and substance of the transaction needs to be judged in order to determine whether the transaction has been done at arm’s length;
The Tribunal dismissed the taxpayer’s contention that the loans granted were commercially expedient and economic circumstances did not warrant the charging of interest;
In determining the arm’s length interest rate, the Tribunal placed reliance on the Mumbai Tribunal decision in the case of Tech Mahindra Limited wherein it was held, inter alia, that the arm's length interest rate should be taken from the country of the borrower/ debtor, i.e. the rate of interest to be used for benchmarking shall be the rate of interest in respect of the currency in which the underlying transaction has taken place in consideration of economic and commercial factors around the specific currency denominated interest rate;
The Tribunal also placed reliance on the decision of the Chennai Tribunal in the case of Siva Industries & Holdings Limited wherein it was held that when the international transaction entered between AE is in foreign currency, than the domestic prime lending rate would have no applicability and the international rate fixed being LIBOR has to be considered;
Based on the aforesaid cases, the Tribunal upheld that the claim of the taxpayer to adopt EURIBOR rate is reasonable and deserves to be accepted.
Conclusion
The ruling upholds that the international transaction of grant of interest free loan is subject to arm’s length test irrespective of commercial expediency. Further, the rate of interest in respect of the currency in which the underlying transaction has taken place should be considered to determine the arm’s length interest rate.
Source: Tata Autocom Systems Ltd vs. Assistant Commissioner of Income Tax (ITA No.7354/MUM/2011) AY 2007-08, Mumbai Bench of the Tribunal dated 30 April 2012
The Mumbai bench of the Income Tax Appellate Tribunal (“the Tribunal”) recently pronounced its ruling in case of Tata Autocomp Systems Limited (“the taxpayer”), wherein the Tribunal held that the transaction of granting interest free loan by the taxpayer to its associated enterprise (“AE”) falls within the ambit of transfer pricing regulations. Further, domestic interest rates cannot be used as comparable to determine arm’s length interest rate for foreign currency loans.
Facts
The taxpayer is a company engaged in the business of manufacture of indoor plastic, rendering engineering services, supply chain management services and administrative support for joint venture companies. During the assessment year (“AY”) 2007-08, the taxpayer extended an interest free loan of Euro 26,25,000/- to its wholly owned German subsidiary. This transaction was not reported in the form no. 3CEB nor had any separate TP analysis been done in respect to such transaction.
During the course of assessment proceedings, the Transfer Pricing Officer (“TPO”) issued a show cause notice as to why interest should not be charged on this transaction at the rate of 10.25%.
Contentions of the taxpayer
The taxpayer’s contentions are summarised below:
The interest free loan was granted to AE on account of commercial expediency and for the purpose of taxpayer’s business with Ford Europe;
The existence of such interest free loans does not mean that the transaction is not at arm’s length, if genuine business reasons exist, then non-charging of interest is justifiable;
There was no intention to evade tax and shift profits out of India. The subsidiary was suffering from severe financial crisis and it would not have been possible to recover the interest which would then have to be written-off;
Interest free loan to AE should be accepted without adjustment for notional interest as tax authorities could not have brought to tax notional interest income if the interest free loan was given to third parties;
On a without prejudice basis, it was contended that for comparability the interest rate prevailing in Germany should be considered. Thus, it would be important to look at the options available to the AE for raising funds in Germany and not in India;
In a situation where an international loan was granted to an AE, a EURIBOR based interest rate would have been the most appropriate comparable uncontrolled rate. The working of the EURIBOR rate stands at 4.15%;
Reliance was place of the ITAT ruling in the case of M/s Siva Industries and Holding Limited v. ACIT (ITA No. 2148/Mds/2010) and DCIT v. Tech Mahindra Limited (ITA No. 1176/Mum/2010).
Contentions of the TPO
The TPO rejected the arguments of the taxpayer and applied the interest rate charged by a domestic bank i.e. 10.25% to determine the arm’s length price. The TPO contentions are summarised below:
Lending or borrowing is not one of the main businesses of the taxpayer;
Two independent enterprises in the similar circumstances would have charged interest as compensation for the financial facility provided by one party to another;
The business prudence or necessity of advancing loans to subsidiary is not relevant for computing arm's length price in unrelated party transactions;
Arm’s length rate of interest should be decided after taking the lender into consideration and not the borrower or the geography in which borrower is situated;
LIBOR cannot be used when the currency of the lender country is not the currency in which the loan is finally executed;
Interest charged by a German Bank to AE cannot be considered as Comparable uncontrolled price.
Aggrieved by the standpoint of the TPO, the taxpayer filed objections before the Dispute Resolution Panel (“DRP”). The DRP upheld the order of the TPO and enhanced the arm’s length rate to 12% instead of 10.25%. The taxpayer being aggrieved by the DRP’s direction filed an appeal before the Tribunal.
Ruling of the Tribunal
The Tribunal dismissed the taxpayer’s proposition that only real income should be taxed and noted that these arguments could not be accepted in the context of Chapter X - Special Provisions relating to Avoidance of Tax, of the Act. In this regard, reliance was placed on the decision of Perot System TSI (India) Limited;
The Tribunal observed that RBI's approval was not sufficient from an Indian transfer pricing perspective as the character and substance of the transaction needs to be judged in order to determine whether the transaction has been done at arm’s length;
The Tribunal dismissed the taxpayer’s contention that the loans granted were commercially expedient and economic circumstances did not warrant the charging of interest;
In determining the arm’s length interest rate, the Tribunal placed reliance on the Mumbai Tribunal decision in the case of Tech Mahindra Limited wherein it was held, inter alia, that the arm's length interest rate should be taken from the country of the borrower/ debtor, i.e. the rate of interest to be used for benchmarking shall be the rate of interest in respect of the currency in which the underlying transaction has taken place in consideration of economic and commercial factors around the specific currency denominated interest rate;
The Tribunal also placed reliance on the decision of the Chennai Tribunal in the case of Siva Industries & Holdings Limited wherein it was held that when the international transaction entered between AE is in foreign currency, than the domestic prime lending rate would have no applicability and the international rate fixed being LIBOR has to be considered;
Based on the aforesaid cases, the Tribunal upheld that the claim of the taxpayer to adopt EURIBOR rate is reasonable and deserves to be accepted.
Conclusion
The ruling upholds that the international transaction of grant of interest free loan is subject to arm’s length test irrespective of commercial expediency. Further, the rate of interest in respect of the currency in which the underlying transaction has taken place should be considered to determine the arm’s length interest rate.
Source: Tata Autocom Systems Ltd vs. Assistant Commissioner of Income Tax (ITA No.7354/MUM/2011) AY 2007-08, Mumbai Bench of the Tribunal dated 30 April 2012
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