“Explore the intricacies of Transfer Pricing on Intra-Group Guarantees in India. This detailed discussion covers the meaning, determination of Arm’s Length Price, popular methods, and ongoing debates. Stay informed to navigate Transfer Pricing regulations effectively.”
There is always a debate between Indian Tax Authorities and Taxpayers regarding the application of Transfer Pricing Regulations (TPR) on ‘Contract of Guarantee’. Below is the detailed discussion on the issue.
Meaning
A contract of Guarantee is a contract to perform the promise or discharge the liability of a third person (“Principle Debtor”) by another person (“Surety”) in case of default.
In the current business scenario where the MNEs are having subsidiaries working across the globe, it has been a common practice to provide a Guarantee by a Parent Entity for its Subsidiaries in different tax Jurisdictions.
The transaction may take place with or without consideration i.e., Guarantee Commission. In both the context where the subsidiary is deriving any benefit from such Guarantee (for e.g., lower rate of Interest charged by the lender), the TPR would apply and such Guarantee should be determined at Arm’s Length Price (“ALP”).
Determination of Arm’s Length Price
The most appropriate method (“MAM”) to determine the ALP of the Intra-Group Guarantee is Comparable Uncontrolled Price (“CUP”) Method. However, for the application of CUP method, it is found difficult to make adjustments with regard to credit rating, swap fees, commitment fees, etc.
Further, in a recent judgment, Hon’ble Mumbai Tribunal held that the other method like Yield method or Interest saving method, and cost to the guarantor can also be used to determine the ALP of the international transaction.
The most popular method to determine the ALP in India is Yield Method wherein the interest savings are attributed to the entities on the basis of the creditworthiness of both the parties involved in the transaction i.e., the difference of the interest that would have been payable by the borrower on a stand-alone basis and interest payable with the guarantee would be attributed to both the parties.
In order to determine the explicit guarantee commission using this method, public databases are used.
Issues relating to Intra-Group Guarantee
In India, there has always been a debate as if the Intra-Group Guarantee is an international transaction or not.
After the insertion of explanation (i) to section 92B vide Finance Act, 2012, it was settled that the explicit Intra-Group Guarantee would be an international transaction which was further upheld by several rulings.
Indian-Tax Authorities also compare the Intra-Group Guarantees with Corporate Guarantees. However, various courts have held that corporate guarantees cannot be compared with Intra-Group Guarantees paying regard to the functions and risk involved in both types of Guarantees.
Conclusion
In India, it has been a practice of Taxpayers that the free-of-cost Guarantees are not shown as “International Transaction” in the view that no consideration is involved.
This may lead to Transfer Pricing Assessment and Tax Authorities may determine the ALP of the transaction more than that should have been. The issue won’t be settled unless it would be settled by Court.
Thus, Taxpayers shall always determine ALP of Guarantee or proactively enter into Advance Pricing Agreements to avoid costly Litigations.
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