INTRODUCTION:
Transfer Pricing Regulations is an internationally accepted method to check that multinational enterprises entering into transactions with associated enterprises do not evade taxes by undervaluing the transaction. The purpose and ambit of Transfer Pricing Regulations is to ensure that international transactions between associated enterprises are computed having regard to the arm’s length price. Further, OECD Guidelines serve as a benchmark and a reference point to structure the domestic Transfer Pricing Regulations accordingly. India incorporated the Transfer Pricing Regulations under Chapter X (Section 92-92F) vide Finance Act, 2002.
The pertinent and the basic issue with which there have considerable divergent views are the transactions to which Transfer Pricing Regulations are to be applied. The Chapter of Transfer Pricing becomes operative and applicable only when the criteria under Section 92B of international transaction are fulfilled. One such area of debate has been the transactions of intra group financing in terms of corporate guarantee. The debate hinges around the fact as to whether transactions involving corporate guarantee should be under the ambit of international transaction or not. The judicial trend and the legislative intention seem to be divergent concerning the issue. This article shall explore the legal position with regard to Transfer Pricing Regulations with respect to corporate guarantee against the judicial backdrop and international practice.
LEGAL POSITION:
Section 92 of 92F[1] deal with the Transfer Pricing provisions. It was imperative to have concrete provisions for determination of arm’s length price and bring it at par with international standards. Section 92B defines the parameters of what constitutes an international transaction:
- International transaction is between two or more associated enterprises either or both of whom are non-residents which includes:
- Purchase, sale or lease of tangible or intangible property or provision of services.
- Lending or borrowing of money.
- Any transaction having a bearing on the profits, losses, assets and income of the enterprises.
- Mutual arrangement or agreement for the allocation or apportionment of any contribution, benefit or facility.
- Deemed international transaction if there exists a prior agreement in relation to the transaction between the enterprises.
Although the ambit of international transaction was wide enough, yet due to judicial interpretation, certain classes of transactions were being left out of the transfer pricing net. To tackle the same, Finance Act of 2014 added Explanation to Section 92B[2] which were clarificatory in nature to add the following categories of transactions within the ambit of international transactions:
- Purchase, sale, transfer or lease of tangible property includes building, transportation vehicle, machinery, equipment plant, tools, furniture or any other product, article or thing.
- Purchase, sale, transfer or lease of intangible property includes the transfer of ownership or the provision of use of copyrights, trademarks, licenses, franchises, industrial property right, brand or any other business or commercial right of similar nature.
- Capital financing, including any type of short-term or long-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance or any other debt during the course of business.
- Provision of services, including provision of market research, market development, administration, legal or accounting service.
- A transaction of business restructuring or reorganization, entered into by an enterprise with an associated enterprise, irrespective of the fact that it has bearing on the profit, income, assets and losses of such enterprise at the time of transaction.
It can be seen that corporate guarantee was included within the ambit of international transaction vide the Finance Act. One plausible reason to do so might have been to negate the judgment rendered in the case of M/s Four Soft Ltd v DCIT[3] where the Hyderabad Bench of ITAT held that “We find that the TP legislation provides for computation of income from international transaction as per Section 92B of the Act. The corporate guarantee provided by the assessee company does not fall within the definition of international transaction. The TP legislation does not stipulate any guidelines in respect to guarantee transactions. In the absence of any charging provision, the lower authorities are not correct in bringing aforesaid transaction in the TP study.”
Exactly four months after the judgment, Finance Act 2014 was brought in with retrospective effect and corporate guarantee as a mode of international transaction was specifically included. The Hyderabad Bench of ITAT in the case of the same assessee for a different assessment year after the amendment held that, “Having considered the submissions of the parties, we are unable to accept the contention of the learned AR that corporate guarantee of the nature provided by the assessee will not come within the meaning of international transaction in terms with section 92B of the Act. A reading the clause from the Explanation would make it clear that the corporate guarantee provided by the assessee comes within the scope and ambit of ‘international transaction’ as per the aforesaid clause. Therefore, the contention of the learned AR that the issue is covered in favour of the assessee by virtue of the order passed in assessee’s own case for AY 2006-07 no longer holds good since the order passed by the coordinate bench is prior to the amendment made to provision of section 92B of the Act.”[4]
Following the retrospective amendment, the same rationale as mentioned above had been followed in some other cases where corporate guarantee transactions were made subject to Transfer Pricing Regulations and Arm’s Length Price.[5]
From the above decisions and the legislative provisions, the issue of corporate guarantee and transfer pricing seemed settled until divergent view taken by ITAT Delhi emerged in the case of Bharti Airtel Limited v ADIT[6].
The Hon’ble ITAT Delhi held that “after the amendment in Section 92 B, by amending Explanation to Section 92 B, a corporate guarantee issued for the benefit of the AEs, which does not involve any costs to the assessee, does not have any bearing on profits, income, losses or assets of the enterprise and, therefore, it is outside the ambit of ‘international transaction’ to which ALP adjustment can be made.”
The Tribunal came to the conclusion after analyzing the provisions contained under Chapter X of Income Tax, OECD Guidelines on Transfer Pricing and the factual scenario. The thrust of the reasoning in the case was that any corporate guarantee advanced by Indian company to its associated enterprise resident outside India must entail some costs to the enterprise. If it does not entail any cost, then there would not be any impact on the profits and losses of the enterprise and hence, the same would not be an international transaction. The Tribunal held that the Explanation derives its existence from the main section and in the main section the wording used is ‘any other transaction having a bearing on the profits, income, losses or assets of such enterprises’; unless corporate guarantee impacts either of the above, the provisions of Transfer Pricing Regulations becomes redundant from the departmental perspective.
Following the same rationale, the Mumbai Bench of ITAT in the case of Siro Clinpharm Private Limited v DCIT[7] held that corporate guarantee issued without any incidental cost to Associated Enterprise shall be outside the purview of international transaction and hence Transfer Pricing Regulations.
Reference was also made to the Explanatory Memorandum of Finance Act of 2014 wherein the element of ‘bearing on profits, losses, income and assets’ was exclusively referred for Explanation (e) and not Explanation (c) which covers corporate guarantee. In other words, the reasoning of the Tribunal was that had the intention been to cover every corporate guarantee, then the criteria of having some impact on assets or profits and loss would have been treated at par like Explanation (e) and a specific mention would have been made. Interpreting the legal position as such, the Tribunal reasoned that corporate guarantee which does not entail any cost shall not be treated as international transaction.
ANALYSIS:
These judgments have again revived a situation wherein there seems to be no clarity regarding the treatment of such transactions. Carefully analyzing the same, one can say that the judgments of Delhi and Mumbai Tribunal are not in conflict with the judgments rendered after the retrospective amendment in the sense the Tribunal specifically states, that only those corporate guarantee which does not have any associated cost shall not be treated as an international transaction.
However, another view can be that any corporate guarantee transaction will come with an associated cost as an enterprise will never give such guarantee to an unrelated enterprise without any security for the guarantee so provided. Thus, certain cost is always inherent in the transaction. Certain benefit or facility is always present in such transactions which are a two way thing. Further, the author is of the view that Section 92B was amended to cover such cases of loopholes and it would be imprudent to ascertain that the Legislature wanted to envisage the ‘impact on bearing on profits, losses, assets and income’ only for Explanation (e) and not for Explanation (c), more so when the Finance Act of 2014 was implemented within four months of passing of the judgment in the case M/s Four Soft Ltd v DCIT[8].
It can be concluded that even though the judgments might seem to be contradictory, ultimately the law as of now is that a factual analysis is to be done to see the impact of corporate guarantee on a case to case basis. The retrospective amendment does not help much to the tax authorities in light of these decisions. The only way Explanation (c) to Section 92B can be made subject to Transfer Pricing Regulations is to show and bring on record that certain associated costs are inherent with the advance of the guarantee by the Indian taxpayer to its associated enterprise.
OECD & US POSITION:
The arguments put forth in these cases also encompassed around the fact that the taxpayer stated it to be a shareholding activity with no immediate benefit to the enterprises. In this regard, it is imperative to understand the OECD Guidelines and international position. OECD Guidelines[9] define shareholder activity and also evolved the test of ‘willingness to pay’ wherein it is stated that “under the arm’s length principle, the question of whether an intra-group service has been rendered when an activity is performed for one or more group members by another group member should depend on whether the activity provides a respective group member with economic or commercial value to enhance its commercial position. This can be determined by considering whether an independent enterprise in comparable circumstances would have been willing to pay for the activity if performed for it by an independent enterprise or would have performed the activity in-house for itself. If the activity is not one for which the independent enterprise would have been willing to pay or perform for itself, the activity ordinarily should not be considered as an intra-group service under the arm’s length principle.” The OECD Guidelines, 1995, also provided that activities which provide indirect and incidental benefits or are duplicative in nature are generally categorized as non-chargeable services.
The United States of America through judicial precedents in the case of Columbian Rope Co v Commissioner[10],Young and Rubican v United States[11] and Tax Advisory Memorandum issued in 1987 evolved the test of ‘proximate and direct benefit’ to ascertain the impact of intra group financing. The thrust of the test is to see what benefit if at all is entailed to the parent company and whether the service recipient would pay for it in a transaction with an unrelated party. If the service recipient does not pay for it, then the same is not an intra group service and hence outside the ambit arm’s length pricing. With time, the US Tax Administration has further evolved the jurisprudence and has come out with list of transactions and the benefits that might occur and also its nature on the enterprises involved.
It seems to be a good test to ascertain the correctness of the transactions as a proper analysis of benefit and cost associated with the advance of guarantee is made. Considering that US is one of the largest economy, such a transparent way of approaching the Transfer Pricing Regulations seems beneficial to the economy.
CONCLUSION:
As has been put forth, any kind of advance does entail some operative cost and the only way which seems plausible now is to bring in another amendment to rectify Explanation (c). However, considering the fact that the government has chosen not to do so yet, the law is what the decision in Bharti Airtel case is. It is believed that at certain stage, comprehensive tests such as ‘proximate and direct benefit test’ or the like might also be adopted to the Indian scenario in Transfer Pricing domain.
[1] Substituted by Finance Act 2002, wef 1.4.2002
[2] With retrospective effect from 1.4.2002.
[3] ITA No 1495/Hyd/2010.
[4] ITA No 1903/Hyd/2011.
[5] Mahindra & Mahindra v DCIT, ITA No 8597/Mum/2010, Infotech Enterprises v ACIT, [2014] 41 Taxmann 364(Hyb).
[6] ITA 5816/Del/2012.
[7] ITA 2618/Mum/2014.
[8] ITA No 1495/Hyd/2010.
[9] Paragraph 7.6 of OECD Guidelines on Transfer Pricing, 2010.
[10] 42 TC 800 (1964)
[11] 410 F.2d 1233 (1969).
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