Transactions having contingent impact on profit/ losses are not international transactions

Brief of the case:

• The ITAT bench of Mumbai in the above cited case law held that any contingent impact on profit/loss would not take the transaction to fall within the purview of international transaction. In the present case , giving of corporate guarantee on behalf of loans given to overseas subsidiaries there can be a hypothetical situation in which a guarantee default takes place making  the enterprise liable to  pay  the guarantee amounts but such a situation, even if that be so, is only a hypothetical situation
• Therefore, such transactions cannot be treated as having bearing on profit/losses and consequently cannot be included in the definition of international transaction.
  

Facts of the case:

• The assessee is a clinical research organization rendering clinical research services to its clients mainly conducting clinical trials in the pharmaceutical, biotechnology and medical devices related sectors. In the course of scrutiny assessment proceedings the Transfer Pricing Officer noted that while the assessee has given a guarantee, on behalf of its associated enterprises Sir Clinpharm Germany GMBH, Germany to ABN Amro Bank for Rs 19.44 crores, and on behalf of Sir Clinpahrm Singapore Pvt. Ltd, Singapore, to DBS Bank for Rs 16.20 crores.
• Assessee did not charge any fee or commission to subsidiaries (associated enterprises) for issuance of these guarantees in their favour and so far as the bank charges by levied by the lending banks the assessee was duly reimbursed the same by the associated enterprises concerned.
• It was in this backdrop that the Transfer Pricing Officer required the assessee to show cause as to why an arm’s length price adjustment @ 3% not be made for the guarantee issued by the assessee in favour of its associated enterprises. Transfer Pricing Officer(TPO) concluded that thus, in all respects, the guarantee provided by the assessee to the lenders of its associated enterprises is a ‘service’ provided by the assessee to its AE, and, hence, assessee should have charged fees at an arm’s length price.
• He noted that as per information gathered from the State Bank of India, the bank is charging a guarantee fees of 1.75% on guarantees above Rs 10 crore. Considering the cost , functional and geographical differences the TPO adopted 3% as an arm’s length price for issuance of the guarantee issued by the assessee. On this basis an ALP adjustment of Rs 1,13,40,000 was  proposed appropriate by the Transfer Pricing Officer.
• The CIT(A) also upheld the order of AO holding that whether or not it is the business of the assessee , the facts remains that the it has given corporate guarantee for the loan to be availed by the AEs which has benefited the AE and has effect on income, profit or assets of the assessee  and AE. Such activity on the part of the appellant being an international transaction has to be judged from the perspective of transfer pricing regulations and consequent income of this international transaction has to be determined having regard to arm’s length price.
• Aggrieved assessee is in appeal before tribunal.

Contention of the Assessee:

• It was submitted that it is not in the business of providing guarantees and the guarantee provided by it was solely for its own benefit since it intended to expand its business operations overseas. In this regard, it is stated that whether or not it is the business of the assessee, the facts remains that the assessee has given corporate guarantee for the loan to be availed by the AE which has benefited the Associated Enterprise( AE) and has effect on income, profit or assets of the appellant and AE.
• Such activity on the part of the assessee being an international transaction has to be judged from the perspective of transfer pricing regulations and consequent income of this international transaction has to be determined having regard to arm’s length price.
  

Contention of the Revenue:

• It was submitted that corporate guarantees, as issued by the assessee to the bank- on behalf of its AEs, are specifically covered by the definition of ‘international transaction’ under section 92B read with Explanation c to Section 92B(1).
• Since no independent party, behaving in a commercially rational manner, would have stood surety for another enterprises, without charging a fees, the arm’s length price of the corporate guarantee ought to have been charged by the assessee. It was also noted that this transaction would have bearing on the profits, income, losses or assets of the assessee.
• Thus in all respects, the guarantee provided by the assessee to the lenders of its associated enterprises is a ‘service’ provided by the assessee to its AE, and, hence, assessee should have charged fees at an arm’s length price” and that “the assessee would not have taken this risk in case of any third party without a consideration”. Therefore, the corporate guarantee fee even if not charged required to be benchmarked with Arm Length Price(ALP).
  

Held by ITAT Mumbai:

• The whole dispute revolves around the inclusion or not of corporate guarantee under explanations to Sec 92B which defines international transaction. Explanation to Section 92B which states that “For the removal of doubts, it is hereby clarified that the expression “international transaction” shall include inter alia capital financing, including any type of long -term or short -term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business.”
• There is no dispute that this Explanation states that it is merely clarificatory in nature as it contains words ‘for the removal of doubts’, and, therefore, one has to proceed such that it does not alter the basic character of definition of ‘international transaction’ under Section 92B. Accordingly, this Explanation is to be read in conjunction with the main provisions, and in harmony with the scheme of the provisions, under Section 92B.
• In a situation in which a transaction has no bearing on profits, incomes, losses or assets of such enterprise, the transaction will be outside the ambit of expression ‘international transaction’. However, the mere fact that impact is not immediate, but on a future date, would not take the transaction outside the ambit of ‘international transaction’.
• But at the same time it is important to note that this exclusion clause is not for “contingent” impact on profit, income, losses or assets but on “future” impact on profit, income, losses or assets of the enterprise i.e. any contingent impact on profit/loss would not take the transaction within the purview of international transaction.
• The important distinction between these two categories i.e. contingent and future is that while latter is a certainty, and only its crystallization may take place on a future date, there is no such certainty in the former case. In the present case , it is an undisputed position that corporate guarantees issued by the assessee to the various banks and crystallization of liability under these guarantees, though a possibility, is not a certainty.
• In view of the above discussion, corporate guarantees do not have any impact on income, profits, losses or assets of the assessee there can be a hypothetical situation in which a guarantee default takes place and making the  enterprise liable to pay the guarantee amounts but such a situation, even if that be so, is only a hypothetical situation, which are, as discussed above, excluded.
• When an assessee extends an assistance to the associated enterprise, which does not cost anything to the assessee and particularly for which the assessee could not have realized money by giving it to someone else during the course of its normal business, such an assistance or accommodation does not have any bearing on its profits, income, losses or assets, and, therefore, it is outside the ambit of international transaction under section 92B (1) of the Act.
• In result the appeal of assessee was allowed by ordering the deletion of addition of the corporate guarantee fee.