Why this article-:
1. This article is based on a judicial pronouncement ITAT – KOLKATA SPECIAL BENCH ‘A’, KOLKATA vide its order dated July 15, 2016 in the case of Instrumentarium Corporation Limited, Finland v ADIT -International Taxation I Kolkata.
2. The bench has concluded that, in view of section 92C of the Income Tax Act 1961 related parties cannot have interest free loan transaction.
3. Apparently, the author is not in agreement with this conclusion. It is not necessary that all moratoriums or free services between associated enterprises must be compensated in terms of charging of fees / remuneration. It is always possible that there are other means of remunerating / compensating the moratoriums or free services.
4. The bench is of the opinion that “there is no concept like FREE LUNCH.”
5. But the bench has recorded a fact of non co-operation by the assessee and lack of relevant facts of the case. The AO had to pass an order u/s 144 r.w.s 147.
6. Being a special bench, it will be binding on all tribunals across India and will have significant ramifications.
Narrow Compass of article:
The author has restricted himself to the question of bench-marking interest free loan transaction between related parties. The author has not considered the concept of
(a) Correctness or otherwise of Advance ruling obtained by the assessee
(b) Base erosion theory in itself
(c) Relevance of Board’s CBDT circular no. 12 dated 23rd August 2001 explaining Section 92
(d) Applicability of transfer pricing provisions
(e) Relevance of the Australian Income Tax Assessment Act 1936
(f) General discussion on principles of interpretation of law
Facts of the case:
1. The assessee, Instrumentarium Corporation Limited (ICL-Finland, in short), is a company incorporated in, and tax resident of Finland.
2. The assessee is engaged in the business of manufacturing and selling medical equipment, and it has a wholly owned subsidiary in India by the name of DatexOhmeda India Pvt Ltd (Datex India, in short) which acts as ICL-Finland’s marketing arm for its products in India.
3. On 26th August 2002, the assessee entered into an agreement, which was duly approved by the Reserve Bank of India, to advance an interest free loan of Rs 36 crores to Datex-India.
4. It is this interest free advance by the assessee to its Indian subsidiary which is the subject matter of dispute before us.
5. Earlier, the interest was all along charged by the assessee on its loans to Datex. The assessee has stopped charging interest in the assessment year 2003-04 because the Indian subsidiary was running into losses.
The critical question before special bench:
Whether, on the facts and in the circumstances of the case, no arm’s length rate of interest was required to be charged on the loan granted by the non-resident assessee-company to its wholly owned subsidiary Indian company M/s. Datex-Ohmeda (India) Pvt. Ltd. (Datex)?
Requirement of transfer pricing and more importantly “arm’s length price”
CHAPTER X
SPECIAL PROVISIONS RELATING TO AVOIDANCE OF TAX
Computation of income from international transaction having regard to arm’s length price.
92. (1) Any incomearising from an international transaction shall be computed having regard to the arm’s length price.
Explanation.—For the removal of doubts, it is hereby clarified that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm’s length price.
Definitions of certain terms relevant to computation of arm’s length price, etc.
92F. In sections 92, 92A, 92B, 92C, 92D and 92E, unless the context otherwise requires,—
(i) ….;
(ii) “arm’s length price” means a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions;
Observation of the Bench:
The bench has addressed following contentions of the assessee but none can impress the bench. Refer para from 34 to 39 of the order.
Commercial expediency
1. Any person has right to conduct his business in a manner as he deems it fit. An AO has no Jurisdiction to challenge the commercial expediency of any activity provided it is within 4 corners of law.[1]
2. commercial expediency, [specific requirements over-ride over general requirements.]
Real Income theory
It was contended that charging interest in case of interest free loan is a notional income. The Act provides for charging tax on real income only. [2]& [3]
Re-characterisation of transaction
Charging of Interest will amount to change in character of transaction and an AO is not authorised to do it. [4] [5].
Binding nature of agreement
The case relied upon states that a binding nature of agreement as approved by RBI can not be dis-regarded. [6]
Shareholders service
It is a service done to protect the capital. It also enunciates “benefit test” which suggest that this kind of a shareholder service is not required to be a treated as a service for the purpose of arm’s length price adjustment. – [7]
Conclusion of the Bench:
The assessee has to charge interest on loan as per TP regime.
Fall out of the judgement:
Apparently, there can be an interest free loan transaction between related domestic related parties but not with associated enterprises as per section 92C.
Author’s Personal opinion
Before the author states anything on this issue, it is interesting to consider the factor of non-discrimination. Incidentally the bench member who has authored the judgement has himself authored an elucidate the concept of non-discrimination in the case of Daimler Chrysler India (P.) Ltd. V DCIT-Cir 8, [2009] 29 SOT 202 (Pune)/[2009] 120 TTJ 803 (Pune) dated January 21, 2009.
Reproducing the non-discrimination clause from DTAA with USA
ARTICLE 26
NON-DISCRIMINATION
1. Nationals of a Contracting State shall not be subjected in the other Contracting State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation and connected requirements to which nationals that other State in the same circumstances are or may be subjected. This provision shall apply to persons who are not residents of one or both of the Contracting States.
2. Except where the provisions of paragraph 3 of article 7 (Business Profits) apply, the taxation on a permanent establishment which an enterprise of a Contracting State has in the other Contracting State shall not be less favorably levied in that other State than the taxation levied on enterprises of that other State carrying on the same activities. This provision shall not be construed as obliging a Contracting State to grant to residents of the other Contracting State any personal allowances, reliefs and reductions for taxation purposes on account of civil status or family responsibilities which it grants to its own residents.
3. Except where the provisions of paragraph 1 of article 9 (Associated Enterprises), paragraph 7 of article 11 (Interest), or paragraph 8 of article 12 (Royalties and Fees for Included Services) apply, interest, royalties, and other disbursements paid by a resident of a Contracting State to a resident of the other Contracting State shall, for the purposes of determining the taxable profits of the first-mentioned resident, be deductible under the same conditions as if they had been paid to a resident of the first-mentioned State.
4. Enterprises of a Contracting State, the capital of which is wholly or partly owned or controlled, directly or indirectly, by one or more residents of the other Contracting State, shall not be subjected in the first-mentioned State to any taxation or any requirement connected therewith which is other or more burdensome than the taxation connected requirements to which other similar enterprises of the first-mentioned State are or may be subjected.
5. Nothing in this article shall be construed as preventing either Contracting State from imposing the taxes described in Article 14 (Permanent Establishment Tax) or the limitations described in paragraph 3 of Article 7 (Business profits).
The bench has distinguished the case in hand vis-à-vis judgements dealing with domestic laws for the reason that they are not para materia [same subject].
There is no problem in the requirement of transfer pricing and more importantly “arm’s length price” which is unrelated persons and uncontrolled conditions.
The crucial factor of “compassionate relationship”, benefit test should also be there in the transaction with which the AE transaction is being compared. Otherwise this will not be a comparison of apple to apple.
Consider following scenarios where Loan is granted at Bankers lower rate
(a) small business persons
(b) salaried persons
(c) lower amount of loan
(d) micro-finance
(e) priority sector loans – like agricultural loans
Finance by Government where it is major owner by way of subsidy or Long term loan / interest free loan when
(a) Priority sector
(b) Gestation period is longer [mining / coal]
(c) Defence sector
One can get the information about the bail out loans given by US Government to companies at https://www.propublica.org/special/government-bailouts
Expectation
While following this decision, the factual matrix regarding non co-operation by the assessee as recorded by the bench be born in mind.
Citations referred
