The assessee is a company. It is engaged in the business of manufacture of indoor plastic, rendering engineering services, supply chain management services and administrative support for joint venture companies. The assessee entered into international transactions with its AE and in terms of section 92 of the Act supported the price paid in respect of the international transaction by filing the necessary Form 3CEB.
There is no dispute regarding the price charged by the assessee in respect of international transactions set out in form 3CEB filed by the assessee. The TPO noticed that the Assessee had also made advances of Euro 26,25,000/- to its wholly owned subsidiary a German Company by name TACO Kunstsofftechnik GMBH (hereinafter referred to as TKT). However, no interest was charged on the above loan and no separate TP analysis has been done in respect of this transaction nor was this international transaction referred to in Form 3CEB. The TPO called upon the assessee vide show cause, dated 22.10.2010, to show cause as to why the interest should not be charged on this transaction at the rate of 10.25%.4. The Assessee submitted that the interest free loan was granted to TKT on account of business reasons and commercial expediency.
The Tribunal dismissed the taxpayer’s proposition that only real income should be taxed and noted that these arguments could not be accepted in the context of Chapter X – Special Provisions relating to Avoidance of Tax, of the Act. In this regard, reliance was placed on the decision of Perot System TSI (India) Limited. The Tribunal observed that RBI’s approval was not sufficient from an Indian transfer pricing perspective as the character and substance of the transaction needs to be judged in order to determine whether the transaction has been done at arm’s length. The Tribunal dismissed the taxpayer’s contention that the loans granted were commercially expedient and economic circumstances did not warrant the charging of interest.
In determining the arm’s length interest rate, the Tribunal placed reliance on the Mumbai Tribunal decision in the case of Tech Mahindra Limited wherein it was held, inter alia, that the arm’s length interest rate should be taken from the country of the borrower/ debtor, i.e. the rate of interest to be used for benchmarking shall be the rate of interest in respect of the currency in which the underlying transaction has taken place in consideration of economic and commercial factors around the specific currency denominated interest rate.
The Tribunal also placed reliance on the decision of the Chennai Tribunal in the case of Siva Industries & Holdings Limited wherein it was held that when the international transaction entered between AE is in foreign currency, than the domestic prime lending rate would have no applicability and the international rate fixed being LIBOR has to be considered;
Based on the aforesaid cases, the Tribunal upheld that the claim of the taxpayer to adopt EURIBOR rate is reasonable and deserves to be accepted.
INCOME TAX APPELLATE TRIBUNAL, MUMBAI
ITA NO. 7354/MUM/11(A.Y. 2007-08)
Tata Autocomp Systems Limited Vs. ACIT
Date of pronouncement : 30/04/2012
PER N.V.VASUDEVAN, J.M
This is an appeal by the assessee against the order dated 19/9/2011 of the ACIT 2(3), Mumbai (hereafter referred to as the AO) passed under section 143(3) r.w.s. 144C of the Income Tax Act, 1961 (the Act).
2. In ground Nos. 1 to 4 the assessee has challenged the order of the AO whereby the AO made an addition of Rs. 1.76 crores consequent to a transfer pricing adjustment to international transaction of interest free loan given by the assessee to one its Associate Enterprise(AE).
3. The assessee is a company. It is engaged in the business of manufacture of indoor plastic, rendering engineering services, supply chain management services and administrative support for joint venture companies. The assessee entered into international transactions with its AE and in terms of section 92 of the Act supported the price paid in respect of the international transaction by filing the necessary Form 3CEB. There is no dispute regarding the price charged by the assessee in respect of international transactions set out in form 3CEB filed by the assessee. The TPO noticed that the Assessee had also made advances of Euro 26,25,000/- to its wholly owned subsidiary a German Company by name TACO Kunstsofftechnik GMBH (hereinafter referred to as TKT). However, no interest was charged on the above loan and no separate TP analysis has been done in respect of this transaction nor was this international transaction referred to in Form 3CEB. The TPO called upon the assessee vide show cause, dated 22.10.2010, to show cause as to why the interest should not be charged on this transaction at the rate of 10.25%.
4. The Assessee submitted that the interest free loan was granted to TKT on account of business reasons and commercial expediency. The Assessee submitted before TPO that the business structure and the commercial rationale that led to the decision of the assessee to give interest free loan to its TPO can be understood from the manner in which it conducts its business in Germany. The assessee explained that Ford was an esteemed customer both in India and abroad. The assessee had an opportunity of conducting business with Ford in Europe. This presented the assessee with a strategic business opportunity as the same would be advantageous to the assessee by way of:
-strengthening relationship with Ford as a customer, which will help in getting more business opportunities in India; and
– providing the assessee the opportunity to work in stringent European quality norms, which would help in acquiring technical skills, which would be used for both domestic and export business of the assessee.
Accordingly, the assessee decided to grab this business opportunity of supplying interior parts to Ford Europe. Supplying of interior parts to Ford Europe entailed the supply of large parts as well as small parts. Based on the business analysis conducted, it was concluded that it would not be feasible to manufacture both big parts and child parts and export the same to Ford Europe, since the cost of freight and insurance would be huge. Instead, it was found feasible to manufacture the big parts in Germany itself and supply the child parts from India, assemble the big parts and child parts in Germany and supply the same to Ford Europe. Thus, in order to achieve cost efficiency, ensure smooth business operations and prompt and satisfying customer service, the assessee decided to conduct the business with Ford Europe by establishing a presence in Germany.
5. Accordingly, TKT was established in Germany under the following business arrangement:-
– The assessee to manufacture child parts and export the same to TKT; and
– TKT to manufacture big parts, assemble the same with child parts imported from the assessee and sell the same to Ford Europe.
As mentioned the above business arrangement was aimed to ensure smooth functioning of the assessee’s business, providing better customer service considering the geographical proximity of TKT to Ford Europe, savings in costs, etc.
6. The Assessee highlighted the fact that existence of TKT was essential for the assessee’s achievement of business objectives related to Ford, it was very much in the assessee’s interest that TKT was adequately funded and operational. Accordingly it was a decision made purely on commercial grounds to fund TKT through interest-free debt for following reasons:
– Need of funds to help TKT manage its working capital requirements for manufacture of big parts;
– Start-up stage of both Assessee and TKT in respect if business with Ford Europe;
– Estimation of loss in the entire value chain during the initial years, considering the 1arning curve, operational inefficiencies, stringent European quality norms, etc;
– Interest cost would have resulted in increasing the losses of TKT, and would have strained the availability of cash for day to day operations; and
– The existence and survival of TKT being of strategic importance to the Assessee, from the perspective of its Ford business.
Based on the above, the assessee contended that the loan was granted to TK purely on the basis of commercial expediency and for the purposes of the assessee’s business with Ford Europe and thus no notional interest should be charged thereon.
7. Based on judicial decisions the assessee contended that lending of interest free funds to subsidiary is a normal and acceptable business practice and thus, the existence of such interest free loans does not mean that the transaction is non arms length, if genuine business reasons exist, then non-charging of interest is justifiable.
8. Without prejudice to the above submission, the Assessee contended that even if interest is to be charged on the interest free loan provided by the Assessee to TKT, the same should be restricted to 4.15% which is the rate specified in the benchmarking exercise conducted by the assessee for ascertaining the arm’s length interest rate. The Assessee also submitted that it had at no time any intention to evade tax and shift profits out of India. This was evidenced by the fact that TKT subsequently filed for liquidation on account of insolvency. This is a clear indication of the fact that TKT was in economic distress and was in need of funds, which has subsequently led to its application for insolvency. The assessee also filed a copy-of the application for requesting insolvency proceedings made by TKT to German Court. The assessee also submitted a copy of bait sanction letter to TKT by Hypo Vereins bank dated August 10, 2006 which stipulates an interest rate of “EURIBOR plus 80 basis points”, i.e. “EURIBOR plus 0.8% p.a.”. Based on the above, the assessee contended that the extension of interest-free loan was a part of decision from corporate function of the Assessee and interest was not charged considering the commercial expediency and the business reasons and extreme economic distress faced by TKT. The assessee also contended that it would have entered into similar business arrangement with a third party, if TKT would not have been in picture.
9. We have already seen that the TPO proposed to adopt 10.5% as the interest rate for determining ALP of the international transaction. The TPO proposed to apply the Comparative Uncontrolled Price (CUP) method as the most appropriate method and in this regard applied the lending rate applicable in India by Banks. As regards the rate of interest proposed to be applied by the TPO, the assessee submitted that the geography that needs, to be considered for adopting a comparable rate is the geography in which the loan has been consumed and on the geography from which the loan has been granted. In this connection, the assessee contended that the Comparable Uncontrolled Price (“CUP”) method proposed to be adopted by the AO/TPO as the most appropriate method requires fulfillment of stringent requirements. Accordingly, for the purpose, of undertaking comparability analysis for arriving at arm’s length interest rate, it is pertinent to take into consideration the interest rates prevailing in the geography in which the loan has been consumed i.e. in Germany, as differences in geographic markets would also influence the reliability of the comparison under this method. It was contended that it would be important to look at options available to TKT for raising funds in Germany and not in India.
10. The TPO rejected the argument of the Assessee that the interest free loan was given to the AE owing to commercial considerations and therefore no adjustment/addition should be made. The TPO gave the following reasons for doing so:
A. Lending or borrowing is not one of the main businesses of the Assessee.
B. Two independent enterprises in the similar circumstances as that of the assessee and its subsidiary would have charged interest as compensation for the financial facility provided by one party to another keeping in view the financials of the subsidiary and no security being offered. But for the relationship between the assessee and its subsidiary, the assessee would have earned interest on the loan extended by it.
C. The business prudence or necessity of advancing loans to subsidiary is not relevant for computing arm’s length price in unrelated party transactions.
11. The TPO thereafter proceeded to determine the arm’s length interest. He held that the taxpayer has made loans to its AEs without charging any interest. Similar uncontrolled transaction would have provided for interest. In view of this fact he held that the international transaction representing loan without charging interest is not at arm’s length price within the meaning of section 92C (3) (a) (b) and (c) of the Income Tax Act read with Rule 10B (1) (a) of the income Tax Rules. He held that the most appropriate method for determining arm’s length interest would be by following CUP method wherein the interest rate is determined, under the circumstances, in which the assessee and its subsidiary is operating i.e. what is the interest that would have been earned if such loans given to unrelated parties in similar situation as that of subsidiary. He further held that since the tested party is the assessee, the prevalent interest that could have earned by the assessee by advancing a loan to an unrelated party in India, have to be determined. He also held that rule of relevancy suggests that ALP rate of interest should be decided on the basis of taking TP’s transactions of the lender into consideration and not that of borrower or the geography in which borrower is situated. Consequently the TPO held that it will be more relevant to see that how the assessee would have behaved in uncontrolled transaction. He held that in an uncontrolled transaction like this between unrelated parties, interest would have been charged taking into account credit worthiness of the AES, margins, security or any other consideration relevant for deciding the financial solvency of the borrower.
12. The Assessee had submitted that if at all any ALP has to be determined then the LIBOR rates should alone be adopted. On the above submission, the TPO held that LIBOR is a rate of reference for inter bank transactions, is primarily for Pound Sterling transactions, though it is used as a rate of reference by a few other currencies (not including INR) also. It is also generally the norm that LIBOR is for maturities ranging from overnight to one year. It is applicable, evidently, for contributions in the currency concerned and not for the cost of producing one currency by borrowing in another currency and accessing the required currency via the foreign exchange markets. The TPO therefore held that LIBOR is not the rate of consideration for loans where a currency is to be bought – whether bought in the market or transacted through a bank – i.e. is not applicable where the currency of the origin country of loan is not the currency in which the loan is finally extended. In the Indian scenario, therefore, such a loan, for extension of which dollars! pound sterling/euro etc. need to be purchased, cannot be governed by that rate.
13. The Assessee had relied on the Hon’ble Chennai Bench of ITAT ruling in the case of M/s. Siva Industries and Holding Ltd. Vs. ACIT (Infra) and of the Mumbai Tribunal in the case of DCIT vs. Tech Mahindra Ltd. (Infra) wherein it was held that LIBOR rate would be the best benchmark to determine ALP when interest free loans are given in foreign currency to AE abroad. The TPO however rejected the stand of the Assessee by holding that the above aspects of LIBOR (set out in the earlier para) were not before the honourable ITAT when the decisions were taken. It is also seen that assessee has not demonstrated that a loan on similar terms including security, purpose and term of Loan etc., as given by the assessee to the associated enterprise, was indeed available to the associate enterprise in its country of residence. This being the case, the TPO held that the interest rate charged by a German hank to TKT cannot be considered as CUP. In this background, neither the foreign benchmarking done by the assessee nor the example of interest rate charged by the German bank, acceptable propositions for benchmarking the transactions in terms of arm’s length price. The TPO held that the interest rate that assessee would have earned had it invested the loan amount in a bank deposit is also not an acceptable comparison. Bank deposits are secure and the purpose is different, whereas the loan given by the assessee to its associate enterprise is riot secured and is a working capital loan or for that AE’s use. In the facts and circumstances of the case and of assessee itself having borrowed a secured loan at 9.75%, the benchmarking at 10.25% was adopted by the TPO. The DRP upheld the order of TPO but arrived at 12% rate of interest and directed the AO to recalculate the adjustment adopting rate of interest at 12% per annum instead of the calculation at 10.25% in the TPO’s order.
14. We have heard the rival submissions. The learned DR reiterated the stand of the revenue authorities. The learned counsel for the Assessee submitted that the Ld. AO/DRP have not appreciated the fact that the decision to not charge interest, was based on commercial expediency. It was submitted that the AE was suffering from a financial crisis so severe that its very existence was threatened( the AE has subsequently been liquidated). It was argued that if the Appellant had charged interest, the same would have to be written off upon the AEs liquidation. The loan granted to the AE was in the nature of “quasi equity” and thus, notional interest should not be computed. It was submitted that the selection of the CUP method is not in accordance with the Indian Transfer Pricing Regulations as the Ld. A.O/DRP has failed to conduct the analytical process enshrined in the Indian Transfer Pricing Regulation (ITPR) for the selection of the most appropriate method. The application of the CUP method by the ld. AO/DRP is not in accordance with the ITPR on the following counts:
– The ld. AO/DRP has not conducted any benchmark and failed to identity any comparable uncontrolled transaction for identifying the arm’s length interest rate.
– The additional 2.25% interest charged is without any basis.
– The ld. AO/DRP has failed to identify an international transaction wherein the rat at which an unrelated party would lend money to another unrelated entity under similar business circumstances.
– The interest rate charged by a domestic bank cannot be considered to be comparable rate as the appellant is not in the business of granting loans.
By way of alternative argument and without prejudice it was submitted that in a situation where an international loan was granted to an AE, EURIBOR based interest rate would have been the most appropriate comparable uncontrolled rate. The following judicial ruling supporting the assessee’s contentions were cited. VVF Ltd. vs. DCIT (ITA No.673/Mum/06) – Mumbai Tribunal; M/s. Siva Industries & Holding Ltd. vs. ACIT (ITA No.2148/Mds/2010)(Chennai Tribunal); DCIT vs. Tech Mahindra Ltd. (ITA No. 1 176/Mum/2010)(Mumbai Tribunal); M/s. Four Soft Limited vs. DCIT (ITA No. 1495/Hyd/20 10). It was submitted that third party international transactions of the assessee/ the cost incurred by the assessee (in the present case, the rate at which loan has been taken by the assessee from a domestic bank) are not relevant for determining the arm’s length rate of interest. In this regard reliance is placed on the following rulings VVF Ltd. vs. DCIT (ITA No.673/Mum/06) – Mumbai Tribunal; M/s. Aithent Technologies Pvt. Ltd. – ITA No.3647/Del/2007. Accordingly, it was submitted that even if an arm’s length interest computation is at all warranted, the following options (in order of priority) need to be considered for computing the same:
a) The detailed foreign benchmark conducted by the assessee for identifying the arm’s length interest rate which works out to Rs. 4.15%. Interest rate charged by a German bank to TKT. The interest rate that the assessee would have earned had it invested the loan amount in a bank deposit.
b) Interest rate charged by a German bank to the AE – 4.34%
15. On the issue whether the transaction in question viz., interest free loan by the Assessee to its sister concern can be subject matter of test of Arm’s Length Price (ALP) u/s.92 of the Act, we are of the view that the order of the revenue authorities have to be upheld. It was argued on behalf of the Assessee that under the normal provisions of the Act (Chapter IV), had the Assessee given interest free loan out of its interest free funds to a resident or to a non-resident who is not an associated enterprise, then the revenue could not have brought to tax notional interest income attributable to such interest free loan given by the Assessee. The position cannot be different when interest free funds are given to AE which is a non-resident. We are unable to agree with such argument. Chapter X of the Act dealing with Special Provisions relating to Avoidance of Tax was introduced w.e.f. AY 02- 03 by the Finance Act, 2001. Prior to such introduction Sec.92 of the Act was the only section dealing with Transfer pricing. Those provisions and Rules made thereunder did not give sufficient powers to the Revenue authorities to find out whether the foreign companies/non-residents operating in India or earning income in India were being taxed on their Indian income on an arm’s length basis. The legislative intent behind the introduction of detailed transfer pricing provisions is brought out in para 55.6 of CBDT Circular No. 14 / 2001 on provisions relating to Finance Act, 2001, which interalia states:
“The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the Country’s tax base.”
Sec.92 of the Act lays down that any income arising from an international transaction shall be computed having regard to the arm’s length price. The charge to tax under the Act is on the total income computed in accordance with the provisions of the Act. Sec.28 of the Act lays down the categories of income that are assessed as income from business or profession. Sec.29 lays down the manner of computation of income from business or profession. These are general provisions for computation of income from business applicable to all class of assessees. Provisions of Sec.92 in particular and Chapter X in general are special provisions dealing with computation of income in an international transaction. Those provisions will prevail over the general provisions. Generalia Specialibus Non Derogant (general provisions must yield to the specific provisions). Generally speaking, the sections in the Act do not overlap one another and each section deals with the matter specified therein and goes no further. If a case appears to be governed by either of two provisions, it is clearly the right of the Assessee to claim that he should be assessed under the one, which leaves him with a lighter burden. When there is a conflict between a general provision and special provision, the latter shall prevail.
16. Interest free loan extended to the associated concerns as at arm’s length lending or borrowing money between two associated enterprises comes within the ambit of international transaction and whether the same is at arms length price has to be considered. The question of rate of interest on the borrowing loan is an integral part of arms length price redetermination in this context. The fact that the loan has the RBI’s approval does not put a seal of approval on the true character of the transaction from the perspective of transfer pricing regulation as the substance of the transaction has to be judged as to whether the transaction is at arms length or not. The Delhi Bench of ITAT in the case of Perot Systems TSI (India) Ltd. Vs. DCIT (supra) had considered identical argument and held as follows:
“9. Before us, the Id. Counsel of the assessee contended that income means real income and not fictitious income and since the assessee has not earned any income, the same cannot be taxed. Reliance in this regard has been placed upon in the case of CIT Vs. KRMTT Thiagaraja Chetty & Co. reported in 24 ITR 525 (SC) & in the case of Morvi Industries Ltd. Vs. CIT reported in 82 ITR 835 (SC) for the proposition that liability to tax can arise only when there is income. No tax can be charged as notional income on accrual. Further reliance has been placed upon the ruling of Authority for Advance Rulings delivered in the case of Veneburg Group B.V. Vs. CIT 727 of 2006 for the proposition that in the absence of any income, Transfer Pricing provisions being machinery provision shall not apply. It has further been argued that Transfer Pricing document maintained by the assessee clearly mentioned that these loans/advances are in the nature of quasi-equity and hence the transaction of granting interest free loan is at arm’s length. The loan agreements mentioned that these are interest free loans. Reliance in this regard is placed upon the decision of Delhi Tribunal in the case of Sony India Ltd. 114 ITD 448 Para 100 that “under fiscal loans actual transaction as entered between the parties is to be considered. Authorities have no right to re¬write the transaction unless it is held that it sham or bogus or entered into by the parties to avoid and evade taxes.” Further reference has been made to para 1.37 of 1995of OECD guidelines for the proposition that it is legitimate to consider that economic substance of the transactions. The transactions has been said to be commercially expedient and loan granted to support the subsidiary and obtain returns in future. The assessee had full control over its subsidiary which reduce the credit risk. The loan had been duly granted by the approval of the RBI. The Income Tax Act, 1961 and OECD guidelines support the contention that the effect of government control/ intervention should be considered while determining the arm’s length price. Under the thin capitalization rules, no deduction was allowable to the Hungary entity for payment of interest therefore, there existed impossibility of performance with regard to payment of Hungary entity. Economic circumstances of the subsidiaries did not warrant the charging of interest from subsidiaries. The Id. Counsel for the assessee further relied upon the Apex Court decision in the case of M/s S.A. Builders Ltd. Vs. CIT(Appeals) and others 288ITR 1 (SC).
9.1 The Id. DR for the revenue on the other hand relied upon the orders of the Id. CIT(A), he claimed that the Id. CIT(A)’s order was a speaking order and it has rebutted all the arguments of the assessee.
10. We have carefully considered the submissions and perused the records. The primary contention before us, as submitted by the Id. Counsel of the assessee is that it was commercially expedient for assessee to advance interest free loans to the AEs and that since no interest has actually been charged, there is no real income exigible to tax. As observed by the Id. CIT(A) the agreements show that these are loan amount given by the assessee to Associated Enterprises (AEs). This in fact is an admitted position. There is no case that any special feature in the contract make the transaction as capital in nature. It is also an admitted proposition that the assessee has extended the loan to its AE’s who are 100% subsidiaries. The Assessee’s case is that it has actually not earned any interest and it was commercially expedient to extend these interest free loans. Now it is noted that this is not a case of ordinary business transaction. The question relates to scrutiny of international transaction to determine whether or not the same it as arm’s length. The principle of transfer pricing aims at determining the pricing in the situations of cross border international transactions, where two enterprises which are subject to the same centre or direction or control (associated enterprise) maintain commercially or financially relation with other. In such a situation, the possibility exist that by way of intervention from the centre or otherwise, business conditions must be accepted by the acting units which differs from those which in the same circumstances would have agreed upon between un-related parties. The aim is to examine whether there is anomaly in the transaction which arise out of special relationship between the creditor and the debtor. Hence the contention of having actually not earned any income cannot come to the rescue of the assessee in this scenario. The case laws from the Apex Court cited by the Id. Counsel of the assessee are in the context of the proposition that only the real income has to be taxed and interest free advances can be given by companies (domestic) to their subsidiaries on the ground of commercial expediency. But these decisions are not in the context of Chapter-X of the IT Act which relates to special provision relating to computation of income from international having regard to arm’s length price. Other case laws cited by the assessee are not germane to the facts of this case. Hence in our considered opinion they do not help the case of the assessee.”
17. The aforesaid decision of the Tribunal is an answer to the argument of the Assessee before us that the impugned addition could not have been made by the AO at all. Respectfully following the said decision, we hold that the AO was well within his powers in making the impugned addition. The justification for the quantum of notional income considered as taxable in the hands of the Assessee is a matter which we will examine in the subsequent paragraphs.
18. On the issue as to what is quantum of addition that has to be made, we will proceed to examine the issue on the basis that CUP is the most appropriate method for determining ALP in the present case. It has been the argument on behalf of the Assessee that the TPO has adopted the interest rate charged by a domestic bank as comparable rate ignoring the fact that the Assessee is not in the business of granting loans. It has further been submitted that in a situation where an international loan was granted to an AE, a EURIBOR based interest rate would have been the most appropriate comparable uncontrolled rate. The working of the EURIBOR rate at 4.15% has already been set out in the earlier part of this order and is not being repeated. The contention of the Assessee in this regard finds support from the following rulings of the Tribunal VVF Ltd. VS. DCIT (supra), M/S.Siva Industries & Holdings Ltd. Vs. ACIT (Supra), DCIT Vs. Tech Mahindra Ltd. (supra) and M/S.Four Soft Ltd. VS. DCIT (supra). The Mumbai Tribunal in the case of Tech Mahindra (supra) held that the arm’s length price in case of interest on extended credit period granted to an Associated Enterprise shall be determined on the basis of USD LIBOR and not on any other currency denominated loan rate. The Mumbai Bench of the Income-tax Appellate Tribunal (the Tribunal) in case of Tech Mahindra Limited (the taxpayer) for Assessment Year (AY) 2004-05, held that the arm’s length price in case of interest on extended credit period allowed to an Associated Enterprise (AE) based in USA shall be determined on the basis of USD London Inter Bank Offer Rate (LIBOR) instead of applying the rate of interest pertaining to EURO denominated loan charged to AE based in Germany since the AE was based in USA. The facts of the case were that the Assessee in that case was a a joint venture between Mahindra & Mahindra Limited (Indian company) and British Telecommunications (UK Company), was engaged in rendering of software services relating to telecommunication, internet technology and engineering etc. During the previous year, the taxpayer had extended credit beyond the stipulated credit period to its AE based in USA without charging any interest on such extended credit period. During the assessment proceedings, the Transfer Pricing Officer (TPO) rejected taxpayer’s arguments and determined the arm’s length interest for such extended credit period to US AE at the rate of 10 percent per annum. The TPO determined this rate based on the rate of interest charged by the taxpayer on Euro denominated loan granted to its German AE. The resultant transfer pricing adjustment amounted to INR 1.87 crores. The Assessing Officer (AO) adopted the adjustments made by the TPO. Aggrieved by the decision of the AO, the taxpayer filed objections before the Commissioner of Income Tax (Appeals) [CIT(A)]. The CIT(A) confirmed the transfer pricing adjustment, however, restricted the same to 2 percent based on the USD LIBOR rate plus 80 basis point mark-up. Aggrieved by the order of the CIT(A), that AO filed an appeal before the Tribunal. The Tribunal had that the TPO made an error in selecting the transaction of charging of interest to German AE on loan granted at the rate of 10 percent per annum as internal comparable. Following the position settled in case Skoda Auto India and Rule 10B(1)(a) of the Income-tax Rules, 1962, to be an internal comparable under the Comparable Uncontrolled Price (CUP) method, the transaction needs to occur between the taxpayer and an independent party. Even assuming that the adjustment for extended credit was necessary, USD LIBOR is more appropriate basis than the rate of interest on Euro denominated loan considering the fact that the AE is based in USA and commercial principles and practices related to USD denominated extended credit. The Tribunal has also made a crucial point that the arm’s length interest rate should be taken from the country of the borrower/debtor, i.e. the rate of interest to be used for benchmarking shall be the rate of interest in respect of the currency in which the underlying transaction has taken place in consideration of economic and commercial factors around the specific currency denominated interest rate. The aforesaid ruling was followed by the Chennai Bench of ITAT in the case of M/S.Siva Industries & Holdings Ltd. (supra), wherein the Tribunal held as follows:
“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 3 1.3.2006 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.”
19. In the present case the AE is a German company. Eurobior rates are based on the average interest rates at which a panel of more than 50 European banks borrow funds from one another. There are different maturities, ranging from one week to one year. These rates are considered to be the most important rate in the European money market. The interest rates do provide the basis for the price and interest rates of all kinds of financial products like interest rate swaps, interest rate futures, saving account and mortgages. We find that the RBI in respect of export credit to exporters at internationally competitive rates under the scheme of pre-shipment credit in foreign currency (PCFC) and Rediscounting of Export Bills abroad (EBR), has permitted banks to fix the rates of interest with reference to ruling LIBOR, EURO LIBOR or EURIBOR, wherever applicable and thereto appropriate percentage ranging from 1% to 2%. The reference to the said circular is at page -80 of the Assessee’s paper book. In our view the claim of the Assessee to adopt EURIBOR rate as stated before the TPO is reasonable and deserves to be accepted. Following the ruling of the tribunal in the aforesaid cases, we are of the view that the claim made by the Assessee in this regard has to be accepted. The AO is directed to work out the TP adjustment accordingly. Gr.No. 1 to 4 are thus partly allowed.
21. In Gr.No.5 the Assessee has prayed for allowing claim of set off of unabsorbed depreciation of Rs.6.68 Crores against business income. Both the parties before us agreed that this issue can be remanded to the AO for fresh consideration with a direction to allow the claim in accordance with law. We order accordingly.
22. In the result, the appeal of the Assessee partly allowed. Order pronounced in the open court on the 30th day of April 2012.
· The Tribunal dismissed the taxpayer’s proposition that only real income should be taxed and noted that these arguments could not be accepted in the context of Chapter X – Special Provisions relating to Avoidance of Tax, of the Act. In this regard, reliance was placed on the decision of Perot System TSI (India) Limited;
· The Tribunal observed that RBI’s approval was not sufficient from an Indian transfer pricing perspective as the character and substance of the transaction needs to be judged in order to determine whether the transaction has been done at arm’s length;
· The Tribunal dismissed the taxpayer’s contention that the loans granted were commercially expedient and economic circumstances did not warrant the charging of interest;
· In determining the arm’s length interest rate, the Tribunal placed reliance on the Mumbai Tribunal decision in the case of Tech Mahindra Limited wherein it was held, inter alia, that the arm’s length interest rate should be taken from the country of the borrower/ debtor, i.e. the rate of interest to be used for benchmarking shall be the rate of interest in respect of the currency in which the underlying transaction has taken place in consideration of economic and commercial factors around the specific currency denominated interest rate;
· The Tribunal also placed reliance on the decision of the Chennai Tribunal in the case of Siva Industries & Holdings Limited wherein it was held that when the international transaction entered between AE is in foreign currency, than the domestic prime lending rate would have no applicability and the international rate fixed being LIBOR has to be considered;
· Based on the aforesaid cases, the Tribunal upheld that the claim of the taxpayer to adopt EURIBOR rate is reasonable and deserves to be accepted.