Navneet Singal
Transfer Pricing: Rate
for benchmarking in respect of the loan given to AE’s
outside India – Whether it should be LIBOR or interest rate prevailing in
India?
Whenever we look for a
Transfer Pricing comparable in respect of the loan giving to AE’s outside India,
it was always an issue that which party should be taken as Tested Party and
what rate should be taken as benchmarking rate. Whether it should be
LIBOR or interest rate prevailing in India?
In the Judgment of Aurionpro Solutions
Ltd. vs. ACIT, Range – 4(3), Mumbai, ITA No. 7872 (Mum.) of 2011, ITAT Mumbai has
held that for purpose of determination of Arm’s Length Price, tested
party is always assessee and not its Associate Enterprise (AE), LIBOR is
acceptable for benchmarking loans given by Indian company to its foreign AEs,
instead of interest rates prevailing in India. However, it has been mentioned
by the ITAT that in its view, the safest comparable, which can be
taken as Arm’s Length interest rate in such a case would be the interest on
FD with the bank for a term equivalent to the term for which the loans were
given to the AEs.
It mentioned further
that though in principle the view of DRP i.e. that only inbound loans
taken by Indian entities from outside India were to be benchmarked with LIBOR
and interest rate prevailing in India on corporate bond should be
taken for benchmarking the loan transaction is acceptable, however, since
the issue of LIBOR has been considered and decided by the Tribunal in various
cases as relied upon by the assessee, therefore, to maintain the rule of
consistency, the decision of the coordinate Benches of this Tribunal is
followed and LIBOR is accepted for benchmarking interest on interest free loans
to AEs.
Facts of the Case:
1. The assessee has given loans to its
Associated Enterprises (AEs) in USA, Singapore and Bahrain. It is engaged in
the business of software development and web designing services.
2. The assessee
claimed that there was no relationship of lender and borrower as the advances
were given to 100% subsidiaries and since the assessee got business from the
AEs, the transaction were on commercial consideration and there was no motive
to evade tax.
3. The assessee benchmarked the transactions
at cost plus zero mark-up, using cost plus method, as no cost was claimed to be
incurred by the assessee.
4. The TPO did not accept the contentions of
the assessee and benchmarked the loans at dollar denominated LIBOR plus mark-up
of 3 per cent.
5. DRP held that only
inbound loans taken by Indian entities from outside India were to be
benchmarked with LIBOR. It took interest rate prevailing in India on corporate
bond for benchmarking the loan transaction, holding that the taxpayer was the
tested party and prevalent interest rate that could have been earned by the
taxpayer by advancing loan to an unrelated party in India with same financial
health as that of the tax assessee’ s AE was to be considered.
The ITAT Mumbai held
that
1. The first contention of the assessee was
that the advance was given to the AEs towards working capital and the assessee
was getting good business from the AEs; therefore, having commercial
consideration, no adjustment of transfer price was justified. This contention
of the assessee cannot be accepted because, though it may be an objective
behind the Transfer Pricing Regulation that the profits taxable in India are
not shifted out of India by manipulating the price charged between the AEs;
however, as per the Transfer Pricing Regulations, there is no such condition of
existence or non-existence of commercial consideration between the assessee and
the AEs.
2. Further, in the
case in hand, the advance does not represent the credit period extended to the
AEs in respect of the business transaction; but it is a transaction of
advancing loans to the AEs, which falls under the ambit of international
transactions as per the terms of section 92B whereby the ‘international
transaction’ means a transaction between two or more associated enterprises, inter
alia lending or borrowing money, or any other transaction having a
bearing on the profits, income, losses or assets of such enterprises.
3. Having treated the transaction as
international transaction, the only question which remains to be considered and
adjudicated is Arm’s Length rate of interest. So far as the question of most
appropriate method for determining the ALP is concerned, the same is also
settled by the various decisions as relied upon by the assessee wherein it has
been held that in case of benchmarking of interest on the loans to the AEs, CUP
is the most appropriate method for determining the ALP. Even, the assessee has
not challenged the method adopted by the authorities below for determination of
the ALP in the case of the assessee.
4. The question arises
whether LIBOR or prevailing market rate in India could be considered
for determining the Arm’s Length interest rate in respect of the loans advanced
by the assessee to the AEs. The TPO had adopted LIBOR plus 3 per cent as ALP
for the rate of interest on the loan transaction in this case; whereas the DRP
took the bond rate prevailing in Indian market and treated the AE as below BBB
rating bond and, accordingly, determined the rate at 14 per cent as ALP. Under
the Transfer Pricing Regulations, an international transaction has to be
compared with an uncontrolled transaction between unrelated parties which means
that an international transaction is tested with the transaction, if the
assessee could have entered into a similar transaction with unrelated third
party and thereby the income the assessee would have earned from a similar
transaction with an uncontrolled party. Thus, the same income is expected or
deemed to have been earned from the transaction with the AEs. The underlining
principle of determining the ALP is based on the transaction between the
unrelated parties. Therefore, tested party for the purpose of determination of
ALP is the assessee and not the AEs.
5. In the case in
hand, the assessee advanced loans to the AEs without charging any interest;
therefore, the transaction has to be tested with a situation, had the assessee
invested or advanced or deposited the said amount with an unrelated third party
and thereby the income, which would have been earned by the assessee is
expected to have been earned from the transaction of advancing loans to the
AEs. Thus, the effect of transaction on the income of the assessee is
to be seen and considered and not effect on the cost or income of the AE.
Therefore, the tested party is always the taxpayer and not the AE. None of the
factors under the Transfer Pricing Regulations require to consider whether the
AEs would have incurred or earned more or less; but it is always considered
whether the assessee had earned more or less by doing a similar transaction
with an unrelated parties.
6. The factors prescribed
for inclusion or exclusion of comparable to determine the ALP are also based on
the comparison of the assessee with the chosen entities and the AE has no role
in the exercise of selecting the comparable. Thus, in our
view, the interest that would have been earned by the assessee by advancing or
placing the said amount with unrelated parties would be the Arm’s Length
interest in relation to the interest free loans/advances to the AE. The safest
comparable, which can be taken as Arm’s Length interest rate in such a case
would be the interest on FD with the bank for a term equivalent to the term for
which the loans were given to the AEs.
7. That in case of FD with the Bank, the
investment is safe as it is free from risk of credit and interest. On the other
hand, if the loan/advance is given to the unrelated party, then always there is
some risk of credit and interest involved in such transaction. There is one
more reason for taking the FD as an appropriate and good comparable because the
lending rate by financial institutions/bank varies depending upon the credit
rating of the borrower and further on the guarantee and security provided to
secure the loans.
8. The view of DRP on
this issue is acceptable in principle, however, since the issue of LIBOR has
been considered and decided by the Tribunal in various cases as relied upon by
the assessee (supra); therefore, to maintain the rule of consistency,
the decision of the coordinate Benches of this Tribunal is followed and LIBOR
is accepted for benchmarking interest on interest free loans to AEs. Since the
LIBOR is a rate applicable in the transactions between the banks and further
the loans advanced by the bank to clients are secured by security and
guarantee; therefore, a loan which has been advanced without any security or
guarantee as in the case of the assessee has to be benchmarked by taking the
Arm’s Length interest rate as LIBOR plus. Though the TPO took ALP as LIBOR + 3
per cent; however, the appropriate rate would be LIBOR plus 2 per cent. The
Assessing Officer /TPO is directed to determine the Arm’s Length interest by
considering the LIBOR plus 2 per cent on the monthly closing balance of
advances during the financial year relevant to the Assessment year under
consideration.
9. In the result, the appeal of the assessee
is partly allowed.
Recently in the case
of PMP Auto Components P. Ltd v. DCIT (ITA No. 1484/Mum/2014 & ITA No.
1506/Mum/2014), the Tribunal has directed the AO/TPO to consider LIBOR plus 2 %
relying on the Tribunal ruling in Aurionpro Solutions Ltd.
(Author may be
contacted at Navneet.Singal@gmrgroup.in)
