The New Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has clarified that the Arm’s length interest rates must be determined with reference to the currency in which the loan was extended. For foreign currency loans, the relevant LIBOR rate plus an appropriate spread is the correct benchmark, not domestic rates like PLR. Where the rate charged by the assessee exceeds the arm’s length rate, no TP adjustment is warranted.
The ITAT also held that corporate guarantees extended by a holding company to its step-down subsidiaries fall within the definition of international transactions under Section 92B of the Income Tax Act as they constitute indirect long-term financing. However, the notional commission must be reasonable and the TPO’s rate of notional commission plus 200 basis points markup is excessive. The disallowance is thus restricted to 0.50% per annum on outstanding guarantee amounts, following Everest Kanto Cylinder Ltd. vs ACIT [ITA No. 7073/Mum/2012].
The Tribunal also clarified that where AEs have suffered losses in their transactions with the assessee, there is no case of profit shifting. Since the TPO’s adjustment on the whole revenue amount is “apparently absurd”, the ITAT held that the adjustment must be restricted to the revenue retained by the AEs, and the FAR analysis must be considered.
As far as Interest on Loans to HCL Bermuda Limited is concerned, the Division Bench comprising Raj Kumar Chauhan (Judicial Member) and S. Rifaur Rahman (Accountant Member) observed that the loan was admittedly extended in GBP and the issue of currency-specific benchmarking was already settled by various courts. It adopted the same rate as directed by the DRP in the assessee’s own case for AY 2011-12 i.e., 6-month LIBOR plus 400 basis points, and held that the applicable arm’s length rate would be 7.72% (3.72% LIBOR + 400 bps). Since the assessee had charged 9.50%, which was higher than the arm’s length rate, the interest charged was held to be at arm’s length price.
As far as Corporate Guarantees to Associated Enterprises are concerned, the Tribunal held that extending corporate guarantees falls within the definition of international transactions under Section 92B, as it constitutes indirect long-term financing extended by the assessee to its step-down subsidiaries. The Tribunal drew an analogy with bank guarantees, i.e., while banks charge a premium because they take the risk of default, a holding company gives corporate guarantees for the comfort of third parties, and the risk remains on the transaction until concluded.
The Tribunal noted that in certain cases the holding company charges premiums to its subsidiaries, but the issue arises when the holding company chooses not to charge any fee. The Tribunal held that the deeming provision applies and the transaction needs to be benchmarked. However, the TPO’s rate of notional commission plus 200 basis points markup was held to be improper. Following Everest Kanto Cylinder Ltd. vs ACIT [ITA No. 7073/Mum/2012], the Tribunal directed the AO to sustain disallowance only to the extent of 0.50% of the total outstanding guarantee at the end of each year under consideration.
Briefly, the assessee extended loans denominated in GBP to its associated enterprise, HCL Bermuda Limited, at an interest rate of 9.50% per annum. For benchmarking, the assessee relied on internal CUP, the interest earned on fixed deposits with Indian banks at 8.18%, and contended that since 9.50% exceeded 8.18%, the transaction was at arm’s length. The Transfer Pricing Officer (TPO) rejected this benchmarking and instead adopted SBI’s Prime Lending Rate of 12.77% plus a markup of 333 basis points on account of security and single customer risk, arriving at an arm’s length rate of approximately 16%, resulting in a TP adjustment of Rs. 14.17 crores for AY 2009-10 and Rs. 21.52 crores for AY 2010-11.
The assessee had also extended various corporate guarantees on behalf of its step-down subsidiaries for purposes of financial support, performance guarantees, and acquisition/merger activities. The TPO treated these as international transactions under Section 92B and imputed notional guarantee commission at rates ranging from 1.75% to 2% per annum, adopting notional rates obtained from banks under Section 133(6) and adding 200 basis points markup, resulting in adjustments of Rs. 47.13 crores for AY 2009-10 and Rs. 20.16 crores for AY 2010-11.
