The assessee, an Indian company, advanced interest-free loans to its 100% foreign subsidiaries. The subsidiaries used those funds to make investments in other step-down subsidiaries. On the question whether notional interest on the said loans could be assessed in the hands of the assessee under the transfer pricing provisions of Chapter X, the assessee argued that the said “loans” were in fact “quasi-equity” and made out of commercial expediency.
It was also argued that notional income could not be assessed to tax. HELD rejecting both arguments:
(i) The argument that the loans were in reality not loans but were quasi-capital cannot be accepted because the agreements show them to be loans and there is no special feature in the contract to treat them otherwise. There is also no reason why the loans were not contributed as capital if they were actually meant to be a capital contribution;
(ii) The argument that the loans were given on interest-free terms out of commercial expediency is not acceptable because this was not a case of an ordinary business transaction but was an international transaction between associated enterprises. One had to see whether the transaction was at arms length under the transfer pricing provisions;
(iii) The argument that notional interest income cannot be assessed is not acceptable in the context of transfer pricing. S 92(1) provides that any income arising from an international transaction has to be computed having regard to the arm’s length price. S. 92B (1) defines an “international transaction” to mean “a transaction between two or more associated enterprises … in the nature of … lending or borrowing money …” In considering the “arms length” price of a loan, the rate of interest has to be considered and income on account of interest can be attributed;
(iv) The result of the transaction was that the income of the assessee in India would reduce while that of the assessee in Bermuda, a tax haven, would increase. This was a classic case of violation of transfer pricing norms where profits were shifted to tax havens to bring down the aggregate tax incidence of a multi national group;
(v) The Proviso to s. 92C (2) which allows a variation of 5% from the arms length price applies only when “more than one price is determined” and an arithmetic mean is adopted. The TPO had adopted the LIBOR rate of 2.39 and added the arithmetic mean of ‘average basis point’ charged by other companies which came to 1.64 and worked out the arms length price at LIBOR + 1.64%. As only one LIBOR rate has been applied which has been adjusted for some basis points, it cannot be said that “more one price” has been used so as to attract the Proviso.
Note: In In Re Dana Corporation (AAR) it was held that transfer pricing provisions, not being in the nature of a charging provision but being mere computation provisions, could not apply when there was no income.