The Mumbai Tribunal disallowed the claim of the taxpayer in providing interest free loans to its overseas subsidiary. The Tribunal rejected the argument of the tax payer that the loan was extended on account of commercial expediency and out of its own fund (i.e. interest free).
Facts of the case
VVF Limited was a company incorporated in India and owned equally by Mr. Rustom Joshi, Mr Faraz Joshi and M/s Interred Products Limited, Bahamas. The Company had two wholly owned subsidiaries (associated enterprises or AEs) namely, VVF Inc, Canada and VVF FZE, Dubai. The taxpayer advanced certain interest free loans to its AEs and determined the arm’s length price (ALP) of the interest free funds at Nil.
During the course of assessment proceedings for assessment year (AY) 2002- 03, the Transfer Pricing Officer (TPO) held that the international transaction undertaken by the taxpayer, in relation to the interest free loan, was not at arm’s length and made upward adjustment by adopting 14 percent per annum as arm’s length interest. The Commissioner of Income-tax (Appeals) [CIT (A)] upheld the order passed by the TPO.
Taxpayer’s Contentions:
- Loan was granted to AEs out of the interest free funds and since the taxpayer had sufficient interest free funds it was justified in not charging interest on the loans given to the AEs.
- The loan was given to AEs on account of commercial expediencies and Revenue cannot levy tax on notional interest – as per settled law, only real interest income can be taxed and fictitious income cannot be attributed to the transactions for levy of tax by the Revenue. Reliance was placed on the judgement of Honourable Supreme Court in the case of S A Builders Ltd Vs CIT (288 ITR 1) (2006-TIOL- 179-SC-IT).
- On a without prejudice basis, the taxpayer submitted that the TPO in subsequent assessment years had computed the arm’s length price of the international transaction of interest free loan at 4.5 percent per annum and hence the TPO should have at best determined the ALP at 4.5 percent.
- The taxpayer submitted a letter from Bank of India indicating the rate at which foreign currency loans are granted by Bank of India as external CUP. The letter stated that Bank of India charged a spread of 150 to 300 basis points over LIBOR for foreign currency loans based on the credit rating and the financial position of the borrower.
Tax department’s Contentions:Since the incremental cost of borrowing to the taxpayer was 14 percent per annum (i.e. the rate that taxpayer paid to Citibank in cash credit account and the funds were lent out of this account to the subsidiary), the arm’s length interest rate at which the funds should have been given must be no less than 14 percent.
Tribunal’s Rulings
