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COMMISSIONER OF INCOME TAX-I …Appellant
Through Mr. Rohit Madan, Sr. Standing Counsel
Through Mr. Ved Jain with Mr. Pranjal Srivastava, Advocates.
HON'BLE MR. JUSTICE V. KAMESWAR RAO SANJIV KHANNA, J.
The question raised in the present appeal by the Revenue under Section 260A of the Income Tax Act, 1961 (Act, for short) relates to determination of arm‘s length rate of interest, paid to the assessed, i.e. Cotton Naturals (I) Pvt. Ltd., by their subsidiary M/s
JPC Equestrian, a company registered in the United States of
America. The appeal emanates from the order of the Income Tax
Appellate Tribunal (Tribunal, for short), dated 30th October, 2013, and pertains to the assessment year 2007- 08.
JUDGMENT
2. On the basis of the contentions raised by the parties, the following substantial question of law needs to be answered and decided: 2015:DHC:2970-DB
1. Whether the Income-Tax Appellate Tribunal was right in following their earlier order for the assessment year 2008-09, dated 8th February, 2013 in ITA NO. 5855/Del./2012 and in holding that the interest @ 4% p.a. charged by the respondent assessee from its subsidiary i.e. the Associated Enterprise was arm‘s length rate of interest and the adjustment made in the Assessment Order determining the arms‘ length rate of interest at 12.20% was unwarranted?
3. With the consent of the counsel, we had heard them on the aforesaid substantial question.
4. The respondent assessee, an Indian company was engaged during the relevant period, in the business of manufacture and exports of rider apparels like riding breeches, jodhpurs, socks, riding jackets, horse blankets, fly sheets, riding boots, shirts, saddle pads and riding helmets. The Headquarter of the assessed was located in Delhi, India with presence in 10 countries through designated channel partners and distributors. However, for the purpose of marketing and promoting their exports to USA, the respondent assessee had incorporated the aforesaid subsidiary, which was wholly owned by them and their two shareholders.
5. As per 3CEB report and Transfer Price documents, the following international transactions between the respondent assessee and the Associated Enterprise i.e. M/s JPC Equestrian (hereinafter referred to as an AE), were disclosed: Equestrian Apparel sold to JPC Equestrian Inc. Rs.24,438,153/- Loan provided to JPC Equestrian Inc 10,50,000 $ Interest Received Rs.20,52,101/-
6. The respondent assessee had selected the Comparable Uncontrolled Price method (CUP method, for short) to benchmark sale of equestrian apparels and the interest received on the loan. The respondent assessee had declared that the interest received at the rate of 4% was comparable with the export packing credit rate obtained from independent banks in India.
7. The Transfer Pricing Officer (TPO, for short) in his report enumerated several reasons, which we are not highlighting at this stage to avoid repetition, to hold that the arm‘s length interest rate should be taken as 14% p.a. He computed arm‘s length interest on the loan at Rs.71, 82, 354/-, in the place of interest received of Rs.20,52,101/-. The aforesaid upward revision was made as per the following table/ chart:- ―CUP Rate is thus arrived at as under: Basic interest rate for the credit LIBOR+400 basis points rating of the AE Add: Transaction Cost 300 basis points CUP Rate LIBOR + 700 basis points Add: Adjustment for security Not computed Final CUP Rate > LIBOR + 700 basis points As the currency in which the loan is extended to the AE is GBP, 6-month GBP LIBOR (sic) is considered. These rates are given as per Annexure - A. The average 6-month GBP LIBOR (sic) is arrived at 5.224% p.a. Thus the CUP rate is arrived at as under. CUP Rate > LIBOR + 700 basis points > 5.224%+7% > 12.224% Keeping in view that no security is offered by the subsidiary and also that the taxpayer is not into lending and borrowing money, a reasonable interest rate of 14% p.a. can be considered.‖
8. The respondent assessee filed objections before the Dispute Resolution Panel (DRP, for short) against adoption of 14% rate of interest as suggested by the TPO. DRP while substantially rejecting the contentions, granted partial relief in the form of reduction of rate of interest to 12.20%, recording that the loan was given on fixed rate of interest out of shareholder funds. Funds had flown from one shareholder to another, and the reality being that both set of shareholders were the same, the security aspect was embedded by default in the transaction. The DRP also noted that the Prime Lending Rate (PLR, for short) fixed by the Reserve Bank of India, ranged from 10.25% to 10.75% in April, 2006 to 12.25% to 12.50% in March, 2007. In view of the above stated, the upward revision of interest rate i.e. the arm‘s length interest was computed as Rs.62, 58, 908/-, in place of Rs.20,52,101/-. On the basis of the directions issued by the DRP, an assessment order was passed, making an addition of Rs.42, 06, 807/- by way of transfer pricing adjustment.
9. The respondent assessee succeeded before the Tribunal who preferred to follow their earlier order dated 8th February, 2013 in ITA No. 5855/Del/2012 relating to the subsequent assessment year 2008-
09. The reasoning in this order dated 8th February, 2013 has been reproduced in the impugned order and for the sake of convenience we would also like to quote the same:
rider apparel. Assessee entered into international transaction as under:- Equestrian Apparel sold to JPC Equestrian Inc 48191540/- Loan provided to JPC Equestrian Inc 10,50,000 $
12. As per the TP document, CUP method has been chosen to benchmark the sale of apparel as well as interest received on loan. The TPO accepted the assessee's submission qua sale of apparel that the same was at arms length. As regards interest the assessee mentioned that it has received interest at a rate of 4% which was comparable with the export packing credit rate obtained from independent banks in India. The TPO was not in agreement with the above contention of the assessee. He observed that it is to be seen that what the assessee would have earned by giving loans in the Indian market. He noted that lending or borrowing is not one of the main businesses of the taxpayer. He opined that what is to be considered is the prevalent interest that could have been earned by advancing a loan to an unrelated party in India with the same financial health as that of the tax payer's subsidiary. The TPO further observed that the taxpayer has not submitted the financial of the subsidiary, hence the.financial healthy of the subsidiary cannot be judged. The TPO further noted that while deciding the interest rate that may be charged on receivables from AE's, Libor rate for calculating interest is not proper. He opined that instead of US rate, Indian rate is to be adopted. He observed that an independent person in India would expect the maximum return on its investment, and if the lending rate is higher in Indian currency then he would not lend in foreign currency where the lending rate is not so attractive. The TPO further noted that it should not be forgotten that, had the AE of the assessee company would have got loan from any bank or financial institution in the place of residency at Libor rate, then why it did not avail of loan at such a rate. Assessing Officer observed that, no company in India would like to invest in the form of loan outside India and that also without security as the interest returns in India would be higher than those prevailing in developed markets. Finally, Assessing Officer held that interest rate at 17.26% would be fair and reasonable.
13. Before the DRP assessee inter-alia contended that comparison has to be made with respect of advance or loan in USA and not based on Indian conditions. The comparison could also be with rate of interest being paid by the multinational companies or banks in respect of money borrowed from India. However, the DRP agreed with TPO 's point of view. But, it held that further addition on account of security is not needed. It opined that Arm's length interest rate may be taken as the PLR of RBI for the financial year 2007-08. In accordance with the above decision, the TPO adopted 13.25% as the rate of arms length interest rate.
14. We note that CUP method is the most appropriate method in order to ascertain arms length price of the international transaction as that of the assessee. We agree with the assessee's contention that where the transaction was of lending money in foreign currency to its foreign subsidiaries the comparable transactions, therefore, was of foreign currency Tended by unrelated parties. The financial position and credit rating of the subsidiaries will be broadly the same as the holding company. In such a situation,domestic prime lending rate would have no applicability and the international Rate Mixed being LIBOR should be taken as the benchmark rate for international transactions.
15. The above view is duly supported by following case laws relied upon by the assessee's counsel. In Siva Industries and Holding Ltd. vs. ACIT Supra it was held by ITAT that the assessee had given the loan to the associate enterprise in U.S. dollars, and in such a situation when the transaction was in foreign currency, and the transaction was an international transactions, then the transaction would have to be looked upon by applying the commercial principles in regard to international transactions. In such a situation domestic prime lending would have no applicability and the international rate fixed being LIBOR rate would have to be adopted.
16. Similar view as above was expressed by the ITAT in the case of M/s Four Soft Ltd., Hyderabad vs. DCIT Supra, Dy. C.I.T vs. Tech. Mahindra Supra, Tata Autocomp Systems vs. ACIT Supra.
17. We further note that assessee has arrangement, for loan with Citi Bank, for less than 4%. However, for loan provided to its AE's it has charged 4% p.a. interest. Hence, adjustment suggested by the TPO is not warranted.
18. We further note that assessee's profits are exempt u/s. 10B. Hence, there is no case that assessee would benefit by shifting profits outside India. This view is supported by Bangalore Tribunal decision in this case Philips Software Centre P Ltd. vs. ACIT Supra and Mumbai Tribunal in the case of I.T.O. vs. Zydus Altana Health Care P Ltd. Supra.
19. We further note that in this case the loan agreement was for fixed rate of interest. The LIBOR has been accepted in decision referred above as the most suitable bench mark for judging Arms' length price in case for foreign currency loan. Hence, adjustment as made by the TPO is not warranted.
20. In the background of the aforesaid discussions and precedents, we hold that the rate of interest charged by the assessee for the loans transactions with the AE was Arms Length Price. Hence, no transfer pricing adjustment is called for."
10. The aforesaid quotation refers to several decisions of the Tribunal starting from Siva Industries & Holdings Ltd. vs. ACIT, which is a decision by the Chennai Bench of the Tribunal in ITA NO. 2148/Mds/2010. In the instant case it has been held: ―11. We have considered the rival submissions. A perusal of the order of the TPO clearly shows that the assessee had raised the funds by way of issuance of 0% optional convertible preferential shares. Thus it is noticed that the funds raised by the assessee company for giving the loan to India Telecom Holdings Ltd., Mauritius, which is its Associated Enterprises and which is the subsidiary company, is out of the funds of the assessee company. It is not borrowed funds. The assessee has given the loan to the Associated Enterprises in US dollars. The assessee is also receiving interest from the Associated Enterprises in Indian rupees. Once the transaction between the assessee and the Associated Enterprises is in foreign currency and the transaction is an international transaction, then the transaction would have to be looked upon by applying the commercial principles in regard to international transaction. If this is so, then the domestic prime lending rate would have no applicability and the international rate fixed being LIBOR would come into play. In the circumstances, we are of the view that it LIBOR rate which has to be considered while determining the arm‘s length interest rate in respect of the transaction between the assessee and the Associated Enterprises. As it is noticed that the average of the LIBOR rate for 1.4./2005 to 31.3.2006 is 4.42% and the assessee has charged interest at 6% which is higher than the LIBOR rate, we are of the view that no addition on this count is liable to be made in the hands of the assessee. In the circumstances, the addition as made by the Assessing Officer on this count is deleted.‖
11. The aforesaid view has been subsequently followed by different Benches of the Tribunal for almost identical reasons in DCIT vs. Tech Mahindra Ltd. – ITA no. 1176/Mum./2010, dated 30th June, 2011; M/s Four Soft Ltd. Hyderabad vs.
DCIT- ITA NO. 1495/Hyd/2010, dated 9th September, 2011; Tata Autocomp Systems Ltd. vs. ACIT – ITA No. 7354/Mum/2011, dated 30th April, 2012; M/s Aurobindo Pharma Ltd. vs. ACIT – ITA No. 1866/Hyd/2012 dt. 29th November, 2013; Siva Ventures Ltd. vs.
ACIT - ITA NO. 2161/Mds/2011, dated 27th June, 2013; Apollo Tyres Ltd. vs.
ACIT - ITA No. 616/Coch/2011 dated 20th December, 2013; Hinduja Global Solutions Ltd. vs. Addl. CIT – ITA No. 254/Mum/2013, dated 5th June, 2013; M/s PMP Auto components P. Ltd. vs. DCIT – ITA NO. 1484/Mum/2014 dated 22nd August, 2014; and VIP Industries Ltd. vs. Addl. CIT – ITA No. 526/Mum/2014 and its cross appeal titled Dy. CIT vs. VIP Industries Ltd., ITA No. 881/Mum./2014 dated 10th December, 2014.
12. In some of the cases, the Tribunal has applied a mark up on the London Interbank Offered Rate (LIBOR for short) and Euro Interbank Offered Rate (EURIBOR, for short). LIBOR is calculated and published by Thomson Reuters, on behalf of British Bankers‘ Association. The rate is calculated on inter-bank offers for lending rates from banks in a reasonable market place. The highest 25% and lowest 25% of the values offered are eliminated, and the rate is determined on the remaining 50%. EURIBOR is also calculated and published each day and 15% of the lowest and the highest interest rates quoted by the panel of European banks are eliminated and the remaining 70% form the basis of calculation.
13. The reasoning given in the decision relied upon by the Revenue for applying PLR, namely Logic Micro Systems Ltd. vs. ACIT, ITA No. 423/Bang/2009, dated 7th October, 2010 records as under: ―22. Another important direction given by the Commissioner of Income-tax(A) is to adopt LIBOR/US- FED rate for calculating the interest. This proposition has been made by the Commissioner of Income-tax(A) on the premise that the ALP factor of interest is to be computed with reference to the benefit that would have been earned by the AE in USA. On the other hand, in calculating the cost factors of the assessee in India, it is more appropriate to consider the potential loss suffered by the assessee in India by not bringing the receivables within the normal period. In fact, the said potential loss of the assessee in India is the ALP factor which contributes to the additional income attributable to the assessee. Therefore, instead of the US rate, the TPO is justified in adopting the Indian rate.
23. While adopting the Indian rate, it is not proper to rely on PLR of the State Bank of India. This is because if the funds were brought in time and those funds were properly deployed, the assessee company may earn an income at the maximum rate applicable to deposits and not at the rate applicable to loans. Therefore, we vacate the direction of the TPO to adopt the PLR rate of 10.25%. Instead we find it appropriate to adopt a reasonable rate that would be available to the assessee on short-term deposits.
24. We have held that the period chargeable to interest has to be recomputed and a reasonable deposit rate has to be applied for calculating the interest. Taking into consideration all aspects of the case like interest-free period and piece-meal remittance of the receivables, we fix the ALP interest rate at 5% and direct the Assessing Officer to compute the additional income at the rate of 5% on Rs.5,52,24,261/- as against 10.25% adopted by the Assessing Officer.‖ (emphasis supplied)
14. In another decision, Nimbus Communications Ltd. vs.
ACIT ITA No. 6597/Mum/2009, it stands observed that LIBOR is relevant in only cases of lending, borrowing of fund and not in cases of commercial overdues. The said decision would however not be relevant to the extant case as Nimbus Communications Ltd.(supra) is a case of debt balance not paid in a commercial transaction. We do not have to answer the said question/ aspect.
15. The case of the appellant-Revenue finds lucid exposition in the following table quoted by the Transfer Pricing Officer, pointing out the difference between lending and borrowing: ―The difference between lending and borrowing when dealing at arm‘s length is given in the below table (Assuming X is in India and Y is outside India).
┌────────────────────────────────────────────────────────────────────────────────────────────┐ │ Sl. No. Aspect Lending money Borrowing │ │ b X to Y Money b X │ │ from Y │ ├────────────────────────────────────────────────────────────────────────────────────────────┤ │ 1 Primary The primary The primary │ │ Consideration consideration consideration │ │ for X is to for X is to │ │ maximize its minimize its │ │ return in terms rate of interest │ │ of interest keeping in view │ │ keeping in view the risk │ │ the risk involved. │ │ involved. │ │ 2 Interest Rate Interest rate Interest rate │ │ depends on the depends on the │ │ tenure, credit tenure, credit │ │ rating of Y, and rating of X, and │ │ ITA No. 233/2014 Page 10 of 34 │ │ 2015:DHC:2970-DB │ │ security offered. security offered. │ │ 3 Benchmarking X would see X would see │ │ what the what the │ │ maximum return minimum │ │ he gets in India interest rate it │ │ and spread can borrow │ │ required for from Y as │ │ taking the risk interest rates in │ │ of losing money India are higher │ │ (depends on the when compared │ │ credit rating of to the interest │ │ Y) as well as rates charged in │ │ security being ECB loans. │ │ offered by Y. Thus the bench │ │ Independent marking is │ │ party would not based on │ │ lend outside LIBOR + some │ │ India if it can basis points │ │ get higher return depending on │ │ in India. Thus the credit rating │ │ the of X. │ │ benchmarking │ │ would be based │ │ on the interest │ │ rate receivable │ │ in India for │ │ giving loans to │ │ parties with │ │ similar credit │ │ rating as that of │ │ Y (like │ │ corporate │ │ bonds) and also │ │ the level of │ │ security offered │ │ by Y. │ └────────────────────────────────────────────────────────────────────────────────────────────┘
6.[1] of the TPO‘s order (the table has been quoted above). We have rejected the reasoning given in the table.
30. However, the TPO was right in rejecting computation of arm‘s length interest on the basis of Reserve Bank of India Master Circular dated 1st July, 2006 and 2nd July, 2007, fixing a ceiling on the interest rate on export credit at LIBOR plus 100 basis points etc. The reasoning given is correct and befitting. These were special schemes floated by the Reserve Bank of India for encouraging and facilitating exports with the said object and purpose. Export credit interest was available only for limited number of days and for specific purposes. The rates fixed did not reflect comparable market rates.
31. On the question of adjustment, the TPO referred to the FCNR loan advanced by the Power Finance Corporation to the Indian company i.e. Jindal Thermal Power Company Ltd. of US$ 44.50 million. Interest charged in the said case was US LIBOR plus 350 basis points for a company which had been given BB+ credit rating. However, full facts like the nature of transaction; risk factors etc. are not elucidated. He has also referred to the Bank of Baroda website that the rate of interest on FCNR loan were between 350-650 basis points over LIBOR for the FY 2006-07. TPO held that in view of the financial health of the subsidiary AE, interest rate could be taken as the average of six months LIBOR plus 400 basis points. On the question of transaction cost, it was stated that it was mandatory for the bank to insist that the borrower must book forward contracts to hedge their position. The TPO referred to the premium payable for undertaking the said hedging transactions and added a cost of 3% per annum as premium, which should have been paid. At the same time, the TPO acknowledged that the taxpayer was not in the business of lending or borrowing money and observed that the taxpayer‘s risk was higher in advancing loan to a single customer, vis a bank which spreads its risk among various customers. Banks spread their risk when loans are/were advanced to various consumers, but this does not happen when a loan is given to a single customer.
32. On the question of adjustment made on account of the transaction cost, we do not appreciate the reasoning given by the TPO and find it difficult to accept. The transaction or hedging cost is borne and paid by the borrower. These are undertaken when they take loans in US Dollars or other foreign currencies because the borrower wants to cover any loss on account of the depreciation of the Indian Rupee vis- a- vis the foreign currency. The assessee in the present case is not the borrower, but the lender. Transaction cost is not, therefore, applicable in the case in question, as the loan had to be repaid in US Dollars. Mark up towards the transaction cost is exorbitant and even comparison with banks is unsound and unintelligible. Risk factor adjustment is also stretched, for it ignores the close relationship between the two AEs and the funds were the shareholder funds, and not borrowed money.
33. The DRP accepted the addition of 700 basis points on account of credit rating and transaction costs, but the suggested third adjustment of 1.776 basis points was not accepted as loan was given out of the shareholder funds, which flowed from one set of shareholders to another set of shareholders. The security aspect it was held was embedded by default in the transaction. Thus, there was no requirement to make further addition on account of security.
34. In the present case, the loan was granted in the year 2002-2003 and not during the period relevant to the assessment year in question. The agreements in respect of loan was entered into on 13th April, 2002, 7th May, 2003 and then on 8th September, 2003. The agreements fixed the rate of interest at 4% per annum on the principal sum. The said rate has been accepted in the earlier assessment years and, as noticed above, even in the subsequent assessment year 2008-
09.
35. The LIBOR rate plus markup or the interest rate prevailing in the United States at that time, i.e. 2003 have not been examined and are not the basis on which the TPO made the adjustment and compute the interest rate for the transaction under consideration. It claimed that the LIBOR rates in the year 2002 varied between 1.447 % to 3.006 % and in the year 2003 between 1.201% to 1.487%. Rates in the year 2004 were again marginal, with the highest at 3.100% and the lowest at 1.340%. The LIBOR rate of 5.224% quoted in the TPO‘s order, it is pointed out, was the rate received on the investment made during the assessment year in question by the assessed. Thus, it was argued that the present case is of a long-term loan granted to the AE and the rate of interest charged was much higher than the then prevailing LIBOR interest rate. There is no finding of the TPO, the DRP or the Assessing Officer questioning the long-term transaction as such.
36. Under sub-rule (4) to Rule 10B, the data used for comparability of the uncontrolled transaction should be the data relating to the financial year in which the international transaction has been entered into. The proviso permits consideration of data, not more than two years prior to the financial year, if such data reveals facts which would have influenced determination of transfer price in relation to the transaction being compared. The transaction in question was entered into in the year 2002-03 when the loans were granted to the AE. This was the financial year of the international transaction. Payment of interest is also an international transaction but would have reference to the year in which the loan was granted in case of a long term loan. However, in such situations, question may arise whether the case would fall under the second exception mentioned in the case of E.K.L. Appliances (supra), when an AE has the right to recall and ask for repayment of loan. These aspects have not been considered and applied by the TPO, DRP and the Assessing Officer. Neither has this ground been argued before us on behalf the Revenue. We, therefore, would not proceed to examine the said aspect and leave the question open. Similarly, we have not expressed any opinion on the issue or question of ―thin capitalization‖ which does not arise for consideration in the present case.
37. We observe that whatever the Revenue argues and submits in the case of outbound loans or for that matter what we have observed would be equally applicable to inbound loans given to Indian subsidiaries of foreign AEs. The parameters cannot be different for outbound and inbound loans. A similar reasoning applies to both inbound and outbound loans. Revenue has erroneously argued that different parameters would apply for inbound and outbound loans, which is not acceptable.
38. The DRP referred to the PLR rates fixed in India. It is evident that the PLR rates were not the basis for fixing the arm‘s length price. Both TPO and the DRP have referred to the PLR rates only by way of analogy so as to state the prevailing interest rates in India, but while applying CUP method for comparability, they had applied LIBOR rates prevailing and had applied a mark-up of 700 points on account of low credit rating of the subsidiary AE and the cost of transaction.
39. The question whether the interest rate prevailing in India should be applied, for the lender was an Indian company/assessee, or the lending rate prevalent in the United States should be applied, for the borrower was a resident and an assessee of the said country, in our considered opinion, must be answered by adopting and applying a commonsensical and pragmatic reasoning. We have no hesitation in holding that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. Interest rates should not be computed on the basis of interest payable on the currency or legal tender of the place or the country of residence of either party. Interest rates applicable to loans and deposits in the national currency of the borrower or the lender would vary and are dependent upon the fiscal policy of the Central bank, mandate of the Government and several other parameters. Interest rates payable on currency specific loans/ deposits are significantly universal and globally applicable. The currency in which the loan is to be re-paid normally determines the rate of return on the money lent, i.e. the rate of interest. Klaus Vogel on Double Taxation Conventions (Third Edition) under Article 11 in paragraph 115 states as under:- ―The existing differences in the levels of interest rates do not depend on any place but rather on the currency concerned. The rate of interest on a US $ loan is the same in New York as in Frankfurt-at least within the framework of free capital markets (subject to the arbitrage). In regard to the question as to whether the level of interest rates in the lender‘s State or that in the borrower‘s is decisive, therefore, primarily depends on the currency agreed upon (BFH BSt.B[1]. II 725 (1994), re. 1 § AStG). A differentiation between debt-claims or debts in national currency and those in foreign currency is normally no use, because, for instance, a US $ loan advanced by a US lender is to him a debt-claim in national currency whereas to a German borrower it is a foreign currency debt (the situation being different, however, when an agreement in a third currency is involved). Moreover, a difference in interest levels frequently reflects no more than different expectations in regard to rates of exchange, rates of inflation and other aspects. Hence, the choice of one particular currency can be just as reasonable as that of another, despite different levels of interest rates. An economic criterion for one party may be that it wants, if possible, to avoid exchange risks (for example, by matching the currency of the loan with that of the funds anticipated to be available for debt service), such as taking out a US $ loan if the proceeds in US $ are expected to become available (say from exports). If an exchange risk were to prove incapable of being avoided (say, by forward rate fixing), the appropriate course would be to attribute it to the economically more powerful party. But, exactly where there is no ‗special relationship‘, this will frequently not be possible in dealings with such party. Consequently, it will normally not be possible to review and adjust the interest rate to the extent that such rate depends on the currency involved. Moreover, it is questionable whether such an adjustment could be based on Art. 11 (6). For Art. 11(6), at least its wording, allows the authorities to ‗eliminate hypothetically‘ the special relationships only in regard to the level of interest rates and not in regard to other circumstances, such as the choice of currency. If such other circumstances were to be included in the review, there would be doubts as to where the line should be drawn, i.e., whether an examination should be allowed of the question of whether in the absence of a special relationship (i.e., financial power, strong position in the market, etc., of the foreign corporate group member) the borrowing company might not have completely refrained from making investment for which it borrowed the money.‖
40. The aforesaid methodology recommended by Klaus Vogel appeals to us and appears to be the reasonable and proper parameter to decide upon the question of applicability of interest rate. The loan in question was given in foreign currency i.e. US $ and was also to be repaid in the same currency i.e. US $. Interest rate applicable to loans granted and to be returned in Indian Rupees would not be the relevant comparable. Even in India, interest rates on FCNR accounts maintained in foreign currency are different and dependent upon the currency in question. They are not dependent upon the PLR rate, which is applicable to loans in Indian Rupee. The PLR rate, therefore, would not be applicable and should not be applied for determining the interest rate in the extant case. PLR rates are not applicable to loans to be re-paid in foreign currency. The interest rates vary and are thus dependent on the foreign currency in which the repayment is to be made. The same principle should apply.
41. Counsel for the Revenue had made reference to Chapter 10 of the U.N. Transfer Pricing Manual, relevant portion of which reads:- ―10.4.10. Financial Transactions 10.4.10.1. Intercompany loans and guarantees are becoming common international transactions between related parties due to the management of cross-border funding within group entities of an MNE group. Transfer pricing of inter-company loans and guarantees are increasingly being considered some of the most complex transfer pricing issues in India. The Indian transfer pricing administration has followed a quite sophisticated methodology for pricing inter-company loans which revolves around: Examination of the loan agreement; A comparison of terms and conditions of loan agreements; The determination of credit ratings of lender and borrower; The identification of comparable third party loan agreements: and Suitable adjustments to enhance comparability. 10.4.10.2. The Indian transfer pricing administration has come across cases of outbound loan transactions where the Indian parent has advanced to its associated entities (AE) in a foreign jurisdiction either interest free loans or loans at LIBOR (London Interbank Offered Rate) or EURIBOR (Euro Interbank Offered Rate). The main issue before the transfer pricing administration is benchmarking of these loan transactions to arrive at the ALP of the rates of interest applicable on these loans. The Indian transfer pricing administration has determined that since the loans are advanced from India and Indian currency has been subsequently converted into the currency of the geographic location of the AE, the Prime Lending Rate (PLR) of the Indian banks should be applied as the external CUP and not the LIBOR or EURIBOR rate. 10.4.10.3. A further issue in financial transactions is credit guarantee fees. With the increase in outbound investments, the Indian transfer pricing administration has come across cases of corporate guarantees extended by Indian parents to its associated entities abroad, where the Indian parent as guarantor agrees to pay the entire amount due on a loan instrument on default by the borrower. The guarantee helps an associated entity of the Indian parent to secure a loan from the bank. The Indian transfer pricing administration generally determines the ALP of such guarantee under the Comparable Uncontrolled Price Method. In most cases, interest rates quotes and guarantee rate quotes available from banking companies are taken as the benchmark rate to arrive at the ALP. The Indian tax administration also uses the interest rate prevalent in the rupee bond markets in India for bonds of different credit ratings. The difference in the credit ratings between the parent in India and the foreign subsidiary is taken into account and the rate of interest specific to a credit rating of Indian bonds is also considered for determination of the arm‘s length price of such guarantees. 10.4.10.4. However, the Indian transfer pricing administration is facing a challenge due to non-availability of specialized databases and of comparable transfer prices for cases of complex intercompany loans as well as mergers and acquisitions that involve complex inter- company loan instruments as well as an implicit element of guarantee from the parent company in securing debt.‖
42. The first paragraph quoted above, rightly stipulates that intercompany loans would require examination of the loan agreement, comparison of the terms and conditions of loan agreements, the determination of credit rating of the lender and the borrower, identification of comparable third party loan agreements and suitable adjustments should be made. In addition to the aforesaid factors, the comparability analysis should also take into account the business relationship and the functions performed by the subsidiary AE for the parent company. In the present case, we are not concerned with paragraph 10.4.10.[3] of the United Nations Transfer Pricing Manual. However, we are unable to agree with the position set out and asserted in paragraph 10.4.10.[2] of the Manual. The reasoning given therein is contrary to the accepted international tax jurisprudence and the rules adopted and applied. There is no justification or a cogent reason for applying PLR for outbound loan transactions where the Indian parent has advanced loan to an AE abroad. Chapter 10 of the United Nations Practical Manual on Transfer Pricing relates to country practices. The said Chapter sets out an individual country‘s view point and its experiences for the information of the readers. The said Chapter does not reflect the view of the Manual. Paragraph 10.[1] of the United Nations Practical Manual on Transfer Pricing for Developing Countries reads:- ―10.1. Preamble by the Subcommittee on Transfer Pricing: Practical Aspects 10.1.1. In the first nine chapters of this Manual, the Subcommittee has sought to provide practical guidance on the application of transfer pricing rules based on Article 9(1) of the UN Model Tax Convention and the arm‘s length principle embodied in that Article. With regard to chapters one through nine, the Subcommittee has discussed and debated the merits of the guidance that is provided and, while there may be some disagreement on certain points, for the most part the Subcommittee is in agreement that the guidance in those chapters reflects the application of the arm‘s length principle as embodied in the UN Model Tax Convention. 10.1.2. The Subcommittee recognizes that individual countries, particularly developing and emerging economies, struggle at times with the details of applying these treaty-based principles in a wide variety of practical situations. It therefore seemed appropriate to allow representatives of individual countries an opportunity to set out their individual country viewpoints and experiences for the information of readers. Those individual country views are contained in this chapter. It should be emphasized that it does not reflect a consistent or consensus view of the Subcommittee.‖
43. Normally there would be a difference between the lending rate and borrowing rate in each country. Some authors and writers suggest that the average or mid-point between the two should be taken. However, others like Klaus Vogel, have suggested that economic purpose and substance of the debt-claim or debt for which granting of credit calls for the lending rate would be determinative. Thus, in case of a capital investment, the borrowing rate will apply, whereas in case of credit allowed to a customer on sale of goods, the lending rate would apply. We do not deem it necessary to enter into this controversy and express our view as regards the same.
44. We are also not expressing any view on adjustment for lack of security as this issue does not arise for consideration in terms of the observations of the DRP.
45. In the light of the aforesaid discussion, the substantial question of law mentioned above has to be answered against the appellant i.e. the Revenue and in favour of the respondent-assessee. The appeal is accordingly disposed of. There will be no order as to costs.
(SANJIV KHANNA) JUDGE (V. KAMESWAR RAO) JUDGE March 27th, 2015 kkb