A guaranty to a lender that a loan will be repaid, guaranteed by a company other than the one who took the loan. Typically,
a larger company (often a parent
company, or another related
company) will make the guarantee on behalf of a smaller company who may not be
well known or have developed a relationship with the lender.
Thus from the above definition we come to know
that to obtain a bank loan, the Financial institution or bank needs Corporate
guarantee either of holding company or main operating associate company or
promoters or directors of the company. Hence, this comes under the related
party transactions both under domestic or international transactions.
Practically while providing corporate guarantee,
the guarantor need not require to pay anything to anyone and hence no financial
transactions recorded in the books. However as per disclosures required under
Indian Accounting Standard, the amount of guarantee provided will be disclosed
under notes of accounts.
Till 2009, Transfer Pricing authorities in India
had never disputed the corporate guarantee, however later they found that related
parties are getting benefited due to corporate guarantee and hence they feel
the necessity of benchmarking it and compare the same with bank guarantee
charges. Further in the last finance
act, the same has been included in the Income tax act also and hence
benchmarking of Corporate guarantee now become compulsory under transfer
pricing.
What the courts have
to say
A. Indian Court Rulings
Indian courts have, on the basis of different
line of arguments & facts & circumstances of the case largely held in
favour of the revenue (income tax officer) & treated Corporate Guarantee as
International transaction & subjected to Indian Transfer Pricing law. There
are some Indian rulings which have held that Corporate Guarantees are not
covered within the definition of International transaction (before
amendment as well as post amendment).
i) Ruling in favour of assessee before
amendment
(a) M/s Foursoft Ltd. vs. DCIT (Hyd ITAT) – 62 DTR 308:
One of the first
rulings from an Indian judiciary on the issue of applicability of transfer
pricing provisions on providing of corporate guarantee by a parent to its
subsidiary company, in this ruling, the Hyderabad bench of the Income-tax
Appellate Tribunal (‘ITAT’) has adjudicated on the transfer pricing issues
arising on loans and guarantees given by parent company. The ruling is briefly
explained below:
Facts:
·
The taxpayer, M/s
Foursoft Ltd had provided corporate guarantee to a third party in relation to
the moneys borrowed by its overseas Associated Enterprise (‘AE’). However, it
did not charge any fee/commission for providing such corporate guarantee.
·
The contention raised
by the Transfer Pricing Officer (TPO) was that by providing the corporate
guarantee, the taxpayer, has assumed an obligation and if the AE were not to
honour its obligations, the taxpayer being the guarantor would be liable to
fulfill the obligations of its AE and pay the amount to the third parties.
·
Given the same, the
TPO considered provision of guarantee as a service and determined a commission
of 3.75% as the arm’s length price under the Comparable Uncontrolled Price
(‘CUP’) method on the basis of the commission charged by a Bank as a benchmark.
Ruling of the ITAT:
·
Not
covered by definition
The ITAT concurred
with the arguments of the taxpayer and held that the definition of
international transaction did not specifically cover transaction for providing
corporate guarantee and hence, in absence of any charging provision enabling
application of TP regulations to the said transaction, the same would be
outside the purview of transfer pricing.
·
Incidental
to the main business of tax payer
Further, ITAT also
accepted that the provision of corporate guarantee by the taxpayer to its AE is
incidental to the business of the taxpayer and hence, cannot be compared to the
transaction of providing guarantee by banks is in their regular course of
business.
ii) Ruling in favour of assessee post amendment
(a) Bharti Airtel Limited vs. ACIT (ITAT Delhi) (March
2014)
Facts:
The assessee issued a
corporate guarantee to Deutsche Bank on behalf of its associated enterprise,
Bharti Airtel (Lanka), whereby it guaranteed repayment for working capital
facility. The assessee claimed that since it had not incurred any cost on account
of issue of such guarantee, and the guarantee was issued as a part of the
shareholder activity, no transfer pricing adjustment could be made. However,
the TPO held that as the AE had benefited, the ALP had to be computed on CUP
method at a commission income of 2.68% plus a mark-up of 200 bp. This was
upheld by the DRP by relying on the retrospective amendment to s. 92B which
specifically included guarantees in the definition of “international
transaction”.
Ruling of the ITAT:
·
Transaction
not having bearing on profits, incomes , losses or assets
A transaction between
two enterprises constitutes an “international transaction” u/s 92B only if it
has a bearing on profits, incomes, losses, or assets of such enterprises”. Even
the transactions referred to in the Explanation to s. 92 B, which was inserted
with retrospective effect (which includes giving of guarantees under clauses
(c)), should also be such as to have a bearing on profits, incomes, losses or
assets of such enterprise;
·
Impact
on real basis and not on contingent or hypothetical basis
The onus is on the
revenue to demonstrate that the transaction has a bearing on profits, income,
losses or assets of the enterprise. The said impact has to be on real basis,
even if in present or in future, and not on contingent or hypothetical basis.
There has to be some material on record to indicate, even if not to establish
it to hilt, that an intra AE international transaction has some impact on
profits, income, losses or assets;
·
No
additional cost
When an assessee
extends assistance to the AE, which does not cost anything to the assessee and
particularly for which the assessee could not have realized money by giving it
to someone else during the course of its normal business, such an assistance or
accommodation does not have any bearing on its profits, income, losses or
assets, and, therefore, it is outside the ambit of international transaction
u/s 92B (1).
iii) Ruling against assessee before amendment
(a)M/s Nimbus Communications Ltd Vs. ACIT (34 taxmann.com 298) (Mumbai ITAT) & (b)Hindalco
Industries (India) Ltd have on similar facts
held that corporate guarantee transaction is an international transaction by
relying on OECD transfer pricing guidelines 2010.
iv) Ruling against assessee post amendment
(a) M/s Everest Kanto Cylinder Ltd. vs DCIT (ITA No. 542/Mum/2012) (Mumbai Tribunal) &
(b)Technocraft Industries (India) Ltd. vs. ACIT, Mumbai (Mumbai ITAT) (January 2014) have on similar facts held that post
amendment there remains no scope for debate on whether providing of corporate
guarantee is an international transaction under the Indian transfer pricing
regulations and have made following observations:
·
Amended
definition
In view of the amended
definition of International Transaction, transfer pricing regulations are
specifically applicable to a guarantee transaction.
·
Benchmarking
as per appropriate methods
Further, as the
transaction is specifically included as an international transaction, then the
methods prescribed under the statute also become applicable for benchmarking
the said transaction. Hence, the existing methods specified under the statute
could be very well utilised to benchmark the transaction of corporate
guarantee.
·
Cost
or benefit always involved in Corporate Guarantee Transaction
While providing a
corporate guarantee, there is always a case of an element of benefit or cost
involved. Hence, the taxpayer’s argument that no costs were incurred would not
hold good. Otherwise, also the taxpayer had itself charged a guarantee
commission of 0.5% from its AE. Therefore, it cannot be said to be a case where
the taxpayer has contested charging of guarantee commission from its AE.
B. Foreign Court Ruling
GE Capital Canada (Federal Court of Canada):
Perhaps the most
contentious ruling on the issue of corporate guarantee fees, this ruling was
widely followed across the world by taxpayers and revenue authorities alike.
The ruling is briefly discussed below:
Facts:
·
The taxpayer, General
Electric Capital Canada Inc (‘GE Canada’) had paid guarantee fee at the rate
of1% p.a. on the value of corporate guarantee given by its parent company,
General Electric Capital Corporation (‘GE US’) which amounted to over $135
million over a period of five years from 1996 to 2000.
·
Payment of such
guarantee fees by GE Canada to GE US was picked up for transfer pricing
scrutiny by the Canadian Revenue authorities. After a detailed transfer pricing
scrutiny, the Canadian Revenue authorities determined that GE Canada did not obtain
any economic benefit from the guarantee and hence, such fees were held to be
not at arm’s length and thus, not allowed.
Key arguments by Revenue Authorities
·
The key arguments
raised by the Revenue Authorities is that providing of a corporate guarantee
only provided an implicit benefit to the GE Canada and providing of an explicit
guarantee provided no value to GE Canada.
Key Observations of the Federal Court:
·
Implicit
guarantee surely benefits the borrower
Guarantee fees paid to
AE(parent co) by WOS for explicit guarantee furnished by parent co to WOS’s
lenders cant be disallowed on the grounds that no arm’s length person
benefiting from implicit guarantee would pay for explicit guarantee. The
argument that credit rating of a WOS would be equalized with credit rating of
its parent by reason of affiliation in the absence of a guarantee arrangement
and WOS would be able to borrow at same terms as parent cannot be accepted.
• Adoption of Yield Approach
Yield approach should
be adopted for computing the value of benefit provided by the explicit
guarantee and to compute ALP for the guarantee fees paid. This involves
comparison, based on recognized credit rating criteria, the credit rating
associated with implicit support and the credit rating associated with explicit
support.
4. What the OECD has to say
As per OECD transfer pricing guidelines 2010
there is a specific chapter on intra group services“Chapter – VII Special
Considerations for Intra-Group Services which discusses about the issues that may arise in determining
for transfer pricing purposes whether
services have been
provided by one member of an MNE group to other members of that group and, if
so, in establishing arm’s length pricing for those intra-group services. Para
7.13 of the guidelines talks about the benefits of associating with a group and
reads as follows:
“An associated enterprise should not be
considered to receive an intra-group service when it obtains incidental
benefits attributable solely to its being part of a larger concern, and not to
any specific activity being performed. For example, no service would be
received where an associated enterprise by reason of its affiliation alone has
a credit-rating higher than it would if it were unaffiliated, but an intra-group service would usually exist
where the higher credit rating were due to a guarantee by another group member, or where the enterprise benefitted
from the group’s reputation deriving from global marketing and public relations
campaigns. In this respect, passive association should be
distinguished from active promotion of the MNE group’s attributes that
positively enhances the profit-making potential of particular members of the
group. Each
case must be determined according to its own facts and circumstances.
5. Conclusion
The transactions
relating to providing of corporate guarantee are difficult to characterize for
Transfer Pricing purpose for they many times involve an analysis of mixed
elements of the time value of money and shareholder activity. Guarantee
transactions may further raise the question of whether the facility actually
confers a specific benefit on the recipient or there is only an implicit
benefit. Accordingly, the issue of whether a charge should be imposed for
provision of guarantee is primarily a question of fact.
The important
principles emanating from the above rulings are the acceptance of the fact that
guarantee does result in an implicit support to the recipient entity, yield
approach based on the differential credit ratings and therefore interest
savings could be an appropriate way of determining the appropriate fees for
guarantee and in case an internal comparable transaction is available to
benchmark the payment of guarantee fee then such transaction should be given
preference over undertaking a search for identifying an external comparable.
Given the same,
taxpayers would be well advised to undertake a review of the facts and
circumstances of their specific case to determine the need of charge of
guarantee fee and based on such analysis determine the most appropriate method
to benchmark the arm’s length nature of such fees which could be done by
utilizing the yield approach and/or such other comparative benchmarks which may
be available depending upon the facts of their individual case. However, given
the general inadequate guidance available in India, the taxpayers in India
should also keep an eye on the evolving international practices.
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