Transfer Pricing – ALP of Interest-Free Loan – ITAT Delhi Explains Law

M/s Aithent Technologies Pvt Ltd. V/s. ITO (ITAT Delhi)- Indisputably, the aforesaid international transaction of interest free loan to the AE is an independent transaction ,requiring determination of ALP. The assessee in their transfer pricing study inferred that no external comparable uncontrolled price was available for bench marking this transaction and thus, it applied Transactional Net Margin Method (TNMM) method and concluded that transaction was at arms length.

However, the TPO noticed on an analysis of the financial transactions of the assessee that the amount of USD 7 million was claimed to have been received from the Singapore based venture capital fund in the F.Y. 2000-01 through the ITG Investment as share application money. A major part of this share application money amounting to Rs. 32.61 crore remained invested in the form of FDRs as in the beginning of the financial year. At the end of the year, a major part of the FDR stood withdrawn which apparently was used to fund the interest free loan to the subsidiary. Accordingly, the TPO while rejecting the assessee’s method considered a risk free return from the subsidiary, a notional interest of 10% on this loan as ALP amounting to ~31,51,259/-.Consequently, this amount was added to the income and the ld. CIT(A) upheld the findings of the AO. Before us, the ld. DR relied upon a decision of a co-ordinate Bench in Perot Systems TSI(India) Ltd. Vs. DCIT,,2010-TIOL-15-Del, where in the assessee granted interest-free loans to two of its wholly owned subsidiaries in Canada and Dubai. In its Transfer pricing study, the assessee adopted CUP method and justified the interest free loan on the basis that it had sufficient interest free funds. The TPO rejected the claim and computed notional interest at the rate of 14percent, based on certain domestic borrowings of the assessee.. On appeal, the Tribunal observed that the cost incurred by the assessee was not a relevant consideration under the CUP method and held that it was irrelevant whether the loans were advanced out of own funds or out of borrowed funds and whether the interest free loan were commercially expedient for the assessee or not. However, the Tribunal held that since the transaction was of lending in foreign currencies to its foreign subsidiaries, the comparable transaction should be foreign currency lending between unrelated parties. Since, the assessee had a foreign currency loan from a bank, it held that the rate of lending by the bank would be an appropriate comparable, irrespective of whether such funds were actually used for lending monies to the subsidiaries. On this basis, the Tribunal directed the TPO to recompute the ALP considering the rate at which the assessee had borrowed in foreign currency from the bank. In the light of aforesaid view taken by a co-ordinate Bench and considering the facts and circumstances of the case, we are of the opinion that the asseseee, in the instant case, was required to comply with the provisions of the Act containing the legislation relating to transfer pricing, namely, sections 92 to 92F of the Act , with respect to the said transaction of interest free loan to its subsidiary. In the instant case, neither the AO/TPO nor the ld. CIT(A) recorded any findings on the most appropriate method to be followed in such a transaction. In line with the reasoning in the aforesaid decision in Perot Systems TSI(India) Ltd. (supra), we are of the opinion that CUP method is the most appropriate method in order to ascertain arms length price of the aforesaid international transaction by taking into account prices at which similar transactions with other unrelated parties. For that purpose assessment of the credit quality of the borrower and estimation of a credit rating, evaluation of the terms of the loan e.g period of loan, the amount, the currency, interest rate basis , and any additional input such as convertibility and finally estimation of arm’s length terms for the loan based upon the key comparability factors and internal and/or external comparable transactions are relevant. None of these inputs have anything to do with the costs; they only refer to prevailing prices in similar unrelated transactions instead of adopting the prices at which the transactions have been actually entered in such cases, the hypothetical arms length prices, at which these associated enterprises, but for their relationship, would have entered into the same transaction, are taken into account. Whether the funds are advanced out of interest bearing funds or interest free advances or are commercially expedient for the assessee or not, is wholly irrelevant in this context. The transaction in the present case is of lending money, in foreign currency, to its foreign subsidiary. The comparable transaction therefore should be of foreign currency lending by unrelated parties. The ld. AR relied on decision of Chennai Bench in M/s Shiva Industries & Holdings Ltd.(supra) and suggested to adopt LIBOR rates. However, we find that though Chennai Bench referred to LIBOR rates of 4.42%, since the assessee charged interest @6% , no further addition was made.

Since in the instant case, neither the assessee nor the TPO/AO and the ld. CIT(A) have examined the applicability of CUP method as the most appropriate method in order to determine ALP of the international transaction of interest free foreign currency loan to its subsidiary by the assessee, we consider it fair and appropriate to vacate the findings of the ld. CIT(A) and restore the matter to the file of the AO for fresh adjudication with the directions to recompute the ALP of the aforesaid international transaction in the light of our aforesaid observations, following CUP method, keeping in view various judicial pronouncements, including those referred to above and of course, after allowing sufficient opportunity to the assessee. Since onus is on the assessee to establish ALP of the international transaction ,the assessee shall also provide all necessary relevant inputs for establishing ALP of the transaction in accordance with CUP method.

O R D E R

A.N.Pahuja:- This appeal filed by the assessee on 14^th August, 2007 against an order dated 23^rd May, 2007 of ld. CIT(A)-VI, New Delhi, raises the following grounds: –

“1. “The order passed by the Ld. Assessing Officer and the Ld. Transfer Pricing Officer is bad in law and on the facts and circumstances of the case.

2. The ld. Assessing Officer/ld. Transfer Pricing Officer has erred in law and on the facts and circumstances of the case in:

a) holding that the transaction between the appellant and its associated enterprise has not been carried out at arm’s length price. The said conclusion has been arrived at, ignoring the principle of commercial expediency.

b)  Charging notional interest on the loan given by the appellant to its wholly owned subsidiary in USA (i.e. Aithent Inc).

3. The following contentions of ld. A O/ld. TPO, amongst others, are bad in law and on the facts and circumstances of the case:

a) Extending interest free loans to associate enterprise was an entirely separate transaction which was not in conjunction with the main activity of software development and hence merited a separate analysis.

b) The loan was not given from the funds received from ITG Investments (a company which has invested money in the appellant company).