Interest free loans extended as quasi capital to 100% subsidiary cannot have nil ALP

Brief of the case:

In this case ITAT examined that whether Arm’s Length Price (ALP) adjustments will also be warranted in case of interest free loans extended as quasi capital and what are the connotations of expression ‘quasi capital’ in the context of the transfer pricing legislation. After considering the facts and circumstances of the matter ITAT decided the issue against the assessee and confirmed the view taken by AO & CIT (A) by observing that the assessee has not offered any assistance on the quantum of ALP adjustment in respect of loan transaction, and that in the subsequent assessment years, the assessee himself has accepted ALP adjustment by adopting the LIBOR + 2% interest rate.

Facts of the case:

• The assessee is engaged in the business of manufacturing of textile cotton fabrics.
• During the year under consideration assessee established a wholly owned subsidiary, by the name of Soma Textiles FZE in UAE. The assessee had invested Rs 21,71,723 in share capital of Soma Textiles FZE and the assessee had also advanced Rs 16,75,88,215 to this company.
• The Assessing Officer took a view that these transactions are covered by the scope of ‘international transactions’, as per section 92CA(3) of the Act and accordingly referred to TPO for ascertaining the arm’s length price (ALP) of these transactions.
• Before TPO, the basic contention of the assessee has been that the entire amount of Rs 16.75 crore advanced to the Soma Textiles FZE was out of the foreign exchange proceeds of assessee’s Global Depository Receipts (GDRs) issue and that it was in nature of “contribution towards quasi capital of the said company”. The commercial expediency of this interest free loan was also pointed out.
• Being dissatisfy from the arguments of assessee AO held that commercial expediency of the transaction was not relevant inasmuch and it is necessary to determine the price at which such transactions would have been entered into by the parties if these parties were independent enterprises to ascertain the ALP.
• TPO relied upon the decision of Perot Systems 130 TTJ 685 (Del) and proceeded to treat LIBOR plus 2% as ALP of the loan and make an adjustment.

Contention of the revenue:

As regards the claim for the advance being in the nature of quasi capital, the TPO relied upon a coordinate bench’s decision in the case of Perot Systems TSI Vs DCIT [(2010) 130 TTJ 685 (Del) where it was held that “the argument that the loans were in reality not loans but quasi capital cannot be accepted because the agreements show them to be loans and there is no special feature in the contract to treat them otherwise”.

Contention of the assessee:

• So far as Perot System’s case (supra) is concerned, the argument of loan being in quasi capital was rejected on facts, though the core legal issue, i.e. whether ALP adjustments will also be warranted in case of interest free loans extended as quasi capital, was left open.
• Whenever it can be said that the loan transaction is in the nature of quasi capital, its arm’s length price should be ‘nil’ rate of interest.
• The grant of loan was intended to be a long term investment in the subsidiary which has a crucial role to play in its business plans.
• The arm’s length price of this quasi capital investment by the assessee in Soma Textiles FZE should be treated at ‘nil’.

Held by CIT (A):

• The company has not shown amount given as capital but it has been shown as loan to the company.
• The appellant has also not given any evidence to show that the amount was not loan but the intention was to treat the same as capital contribution.
• The rate of LIBOR+ 2% was very reasonable by any standard and that it would be the minimum rate at which the AE could have borrowed in UAE in an arm’s length transaction.
  

Held by ITAT:

• The relevance of ‘quasi capital’, so far as ALP determination under the transfer pricing regulation is concerned, is from the point of view of comparability of a borrowing transaction between the associated enterprises.
• Nobody would advance loan, in arm’s length situation, at a nil rate of interest.
• When the loan is given out of the GDR funds held abroad, the arm’s length price of the loan is to be ascertained.
• ITAT confirmed the order of the lower authorities by observing that the assessee has not offered any assistance on the quantum of ALP adjustment in respect of this loan transaction, and that in the subsequent assessment years, the assessee himself has accepted ALP adjustment by adopting the LIBOR + 2% interest rate.