Case Law Details
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
- The Tribunal observed that the purpose of making arm’s length adjustments, in prices at which transactions have been entered into with AEs, is to nullify the impact of interrelationship between the AEs. Accordingly, the taxpayer should have charged interest on the loans advanced to the subsidiaries.
- In determining the ALP using the CUP method, it is irrelevant whether the funds are advanced out of interest bearing funds or out of funds on which 14 percent interest is being paid.
- The transaction in the present case is of lending money, in foreign currencies, to its foreign subsidiaries. The comparable transaction therefore is of foreign currency lending by unrelated parties and hence the transaction should be bench marked on this basis.
- ICICI Bank had advanced a foreign currency loan to the taxpayer at LIBOR plus 3 percent. This constitutes an internal CUP and can be adopted as the ALP of the loans advanced by the taxpayer to its subsidiaries. The Tribunal in applying the internal CUP also observed that the financial position and credit rating of the subsidiaries will be broadly the same as the holding company i.e. the taxpayer.
- The external CUP, provided by the taxpayer by way of letter from Bank of India, was relatively vague as it did not mention the exact rate at which the loan is granted by Bank of India to its customers and hence internal CUP is more reliable than the external CUP in the present case.
- The Tribunal directed the AO to recompute the ALP using internal CUP.
- The taxpayer had also raised a ground against the dis allowance of deduction under Section 80HHC. In this connection, the Tribunal directed the AO to recompute the deduction as per the amended Section 80HHC.
Our Comments
In a recent decision of the Delhi Tribunal in the case of Perot Systems TSI (India) Private Limited v. DCIT [2010-TIOL-51-ITAT], it was held that interest-free loans advanced by the Indian taxpayers to foreign subsidiaries shall attract Transfer Pricing additions and held that RBI approval per-se does not endorse arm’s length compliance for loan transactions.
The above has been reinforced in the subject decision where it has been held that the tax payer should have charged interest to its overseas subsidiary and such interest transaction should be bench marked with other foreign currency lending transactions undertaken by unrelated parties. The Tribunal has highlighted that nil cost of funds to the taxpayer and commercial expediency are not relevant factors for extending interest free loan from a transfer pricing perspective.
Source:- VVF Limited Vs. Deputy Commissioner of Income Tax [2010-TIOL-55-ITAT-MUM]
