Interest free loan is subject to arm’s length test irrespective of commercial expediency

ITA NO. 7354/MUM/11(A.Y. 2007-08)

Tata Autocomp Systems Limited Vs. ACIT

The assessee is a company. It is engaged in the business of manufacture of indoor plastic, rendering engineering services, supply chain management services and administrative support for joint venture companies. The assessee entered into international transactions with its AE and in terms of section 92 of the Act supported the price paid in respect of  the international transaction by filing the necessary Form 3CEB. There is no dispute regarding the price charged by the assessee in respect of international transactions set out in form 3CEB filed by the assessee. The TPO noticed that the Assessee had also made advances of Euro 26,25,000/- to its wholly owned subsidiary a German Company by name TACO Kunstsofftechnik GMBH (hereinafter referred to as TKT). However, no interest was charged on the above loan and no separate TP analysis has been done in respect of this transaction nor was this international transaction referred to in Form 3CEB. The TPO called upon the assessee vide show cause, dated 22.10.2010, to show cause as to why the interest should not be charged on this transaction at the rate of 10.25%.4. The Assessee submitted that the interest free loan was granted to TKT on account of business reasons and commercial expediency.

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.