TMI Blog2015 (3) TMI 1031X X X X Extracts X X X X X X X X Extracts X X X X ..... determines the rate of return on the money lent, i.e. the rate of interest. The methodology recommended by Klaus Vogel Klaus Vogel on Double Taxation Conventions (Third Edition) under Article 11 appears to be the reasonable and proper parameter to decide upon the question of applicability of interest rate. The loan in question was given in foreign currency i.e. US $ and was also to be repaid in the same currency i.e. US $. Interest rate applicable to loans granted and to be returned in Indian Rupees would not be the relevant comparable. Even in India, interest rates on FCNR accounts maintained in foreign currency are different and dependent upon the currency in question. They are not dependent upon the PLR rate, which is applicable to loans in Indian Rupee. The PLR rate, therefore, would not be applicable and should not be applied for determining the interest rate in the extant case. PLR rates are not applicable to loans to be re-paid in foreign currency. The interest rates vary and are thus dependent on the foreign currency in which the repayment is to be made. The same principle should apply. Income-Tax Appellate Tribunal was right in in holding that the interest @ 4% p.a. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ents, the following international transactions between the respondent assessee and the Associated Enterprise i.e. M/s JPC Equestrian (hereinafter referred to as an AE), were disclosed: Equestrian Apparel sold to Equestrian Inc. JPC Rs.24,438,153/- Loan provided to JPC Equestrian Inc 10,50,000 $ Interest Received Rs.20,52,101/- 6. The respondent assessee had selected the Comparable Uncontrolled Price method (CUP method, for short) to benchmark sale of equestrian apparels and the interest received on the loan. The respondent assessee had declared that the interest received at the rate of 4% was comparable with the export packing credit rate obtained from independent banks in India. 7. The Transfer Pricing Officer (TPO, for short) in his report enumerated several reasons, which we are not highlighting at this stage to avoid repetition, to hold that the arm s length interest rate should be taken as 14% p.a. He computed arm s length interest on the loan at ₹ 71, 82, 354/-, in the place of interest received of ₹ 20,52,101/-. The aforesaid upward r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... /Del/2012 relating to the subsequent assessment year 200809. The reasoning in this order dated 8th February, 2013 has been reproduced in the impugned order and for the sake of convenience we would also like to quote the same: 11. We have carefully considered the submissions and perused the records, we find that the assessee company in this case is a leading manufacturer of rider apparel. Assessee entered into international transaction as under:- Equestrian Apparel sold to JPC Equestrian Inc 48191540/- Loan provided to JPC Equestrian Inc 10,50,000 $ 12. As per the TP document, CUP method has been chosen to benchmark the sale of apparel as well as interest received on loan. The TPO accepted the assessee's submission qua sale of apparel that the same was at arms length. As regards interest the assessee mentioned that it has received interest at a rate of 4% which was comparable with the export packing credit rate obtained from independent banks in India. The TPO was not in agreement with the above contention of the assessee. He observed that it is to be seen that wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 39;s contention that where the transaction was of lending money in foreign currency to its foreign subsidiaries the comparable transactions, therefore, was of foreign currency Tended by unrelated parties. The financial position and credit rating of the subsidiaries will be broadly the same as the holding company. In such a situation,- domestic prime lending rate would have no applicability and the international Rate Mixed being LIBOR should be taken as the benchmark rate for international transactions. 15. The above view is duly supported by following case laws relied upon by the assessee's counsel. In Siva Industries and Holding Ltd. vs. ACIT Supra it was held by ITAT that the assessee had given the loan to the associate enterprise in U.S. dollars, and in such a situation when the transaction was in foreign currency, and the transaction was an international transactions, then the transaction would have to be looked upon by applying the commercial principles in regard to international transactions. In such a situation domestic prime lending would have no applicability and the international rate fixed being LIBOR rate would have to be adopted. 16. Similar view as above was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he commercial principles in regard to international transaction. If this is so, then the domestic prime lending rate would have no applicability and the international rate fixed being LIBOR would come into play. In the circumstances, we are of the view that it LIBOR rate which has to be considered while determining the arm s length interest rate in respect of the transaction between the assessee and the Associated Enterprises. As it is noticed that the average of the LIBOR rate for 1.4./2005 to 31.3.2006 is 4.42% and the assessee has charged interest at 6% which is higher than the LIBOR rate, we are of the view that no addition on this count is liable to be made in the hands of the assessee. In the circumstances, the addition as made by the Assessing Officer on this count is deleted. 11. The aforesaid view has been subsequently followed by different Benches of the Tribunal for almost identical reasons in DCIT vs. Tech Mahindra Ltd. ITA no. 1176/Mum./2010, dated 30th June, 2011; M/s Four Soft Ltd. Hyderabad vs. DCIT- ITA No. 1495/Hyd/2010, dated 9th September, 2011; Tata Autocomp Systems Ltd. vs. ACIT ITA No. 7354/Mum/2011, dated 30th April, 2012; M/s Aurobindo Pharma Ltd ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ught in time and those funds were properly deployed, the assessee company may earn an income at the maximum rate applicable to deposits and not at the rate applicable to loans. Therefore, we vacate the direction of the TPO to adopt the PLR rate of 10.25%. Instead we find it appropriate to adopt a reasonable rate that would be available to the assessee on short-term deposits. 24. We have held that the period chargeable to interest has to be recomputed and a reasonable deposit rate has to be applied for calculating the interest. Taking into consideration all aspects of the case like interest-free period and piece-meal remittance of the receivables, we fix the ALP interest rate at 5% and direct the Assessing Officer to compute the additional income at the rate of 5% on ₹ 5,52,24,261/- as against 10.25% adopted by the Assessing Officer. (emphasis supplied) 14. In another decision, Nimbus Communications Ltd. vs. ACIT ITA No. 6597/Mum/2009, it stands observed that LIBOR is relevant in only cases of lending, borrowing of fund and not in cases of commercial overdues. The said decision would however not be relevant to the extant case as Nimbus Communications Ltd.(supra) is a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ndia would like to investment in the form of loan outside India and that also without security as the interest returns in India would be higher than those prevailing in developed markets. Thus while lending money by X (in India) to Y (outside India), the interest rates would be bench marked against those prevailing in India for investing in corporate bonds (which are without security). 16. We would first like to deal with the aforesaid table and the reasoning given in the case of Logic Micro Systems Ltd. (supra) before we advert to other facets of the issue. 17. In our opinion, the reasoning recorded therein suffers from a basic and fundamental fallacy. Transfer pricing determination is not primarily undertaken to re-write the character and nature of the transaction, though this is permissible under two exceptions. Chapter X and Transfer Pricing rules do not permit the Revenue authorities to step into the shoes of the assessee and decide whether or not a transaction should have been entered. It is for the assessed to take commercial decisions and decide how to conduct and carry on its business. Actual business transactions that are legitimate cannot be restructured. It is no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... an arbitrary exercise. This legal position stands affirmed in EKL Appliances Ltd. (supra). The decision accepts two exceptions to the said rule. The first being where the economic substance of the transaction differs from its form. In such cases, the tax authorities may disregard the parties characterisation of the transaction and re-characterise the same in accordance with its substance. The Tribunal has not invoked the said exception, but the second exception, i.e. when the form and substance of the transaction are the same, but the arrangements made in relation to the transaction, when viewed in their totality, differ from those which would have been adopted by the independent enterprise behaving in a commercially rational manner. The second exception also mandates that actual structure should practically impede the tax authorities from determining an appropriate transfer price. The majority judgment does not record the second condition and holds that in their considered opinion, the second exception governs the instant situation as per which, the form and substance of the transaction were the same but the arrangements made in relation to a transaction, when viewed in their to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rest shall remain taxable according to the laws of the two Contracting States, due regard being had to the other provisions of the Convention. 33. It is clear from the text that for this clause to apply the interest held excessive must be due to a special relationship between the payer and the beneficial owner or between both of them and some other person. There may be cited as examples cases where interest is paid to an individual or legal person who directly or indirectly controls the payer, or who is directly or indirectly controlled by him or is subordinate to a group having common interest with him. These examples, moreover, are similar or analogous to the cases contemplated by Article 9. 34. On the other hand, the concept of special relationship also covers relationship by blood or marriage and, in general, any community of interests as distinct from the legal relationship giving rise to the payment of the interest. 35. With regard to the taxation treatment to be applied to the excess part of the interest, the exact nature of such excess will need to be ascertained according to the circumstances of each case, in order to determine the category of income in which it s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ollowing lines in their bilateral tax treaties during negotiations, namely: The provisions of this Article shall not apply if it was the main purpose or one of the main purposes of any person concerned with the creation or assignment of the debt claim in respect of which the interest is paid to take advantage of this Article by means of that creation or assignment. 20. Reverting to the reasoning given, we record that the respondent-assessee had incorporated a subsidiary in United States for undertaking distribution and marketing activities for the products manufactured by them. It is obvious that this was done with the intention to expand and promote exports in the said country and was a legitimate business decision. The transaction of lending of money by the respondent-assessee to the subsidiary, should not be seen in isolation, but also for the purpose of maximising returns, propelling growth and expanding market presence. The reasoning ignores the said objective facet. Transfer pricing rules treat the domestic AE and the foreign AE as two separate entities and profit centres, and the test applied is whether the compensation paid for the products and services is at arm s l ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. Equally important is sub-rule (3) to Rule 10B, which reads:- 10B. (3) An uncontrolled transaction shall be comparable to an international transaction or a specified domestic transaction if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. Similarly, Rule 10C (1) reads:- 10C. (1) For the purposes of sub-section (1) of section 92C, the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction or specified domestic transaction, and which provides the most reliable measure of an arm's length price in relation to the in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ot what Chapter X of the Act and Rules mandate and stipulate. The aforesaid provisions neither curtail the commercial freedom, nor do they bar or prohibit a legitimate transaction. They permit transfer pricing adjustment so as to bring to tax what would have been paid for the transaction in the same or similar comparable circumstances by an independent third party. 23. This ratio and rationale, when applied to the facts of the present case, would mean that the transfer pricing determination would decide what an independent distributor and marketer, on the same contractual terms and having the same relationship, would have earned/paid as interest on the loan in question. What an independent party would have paid under the same or identical circumstances would be the arm s length price or rate of interest. What the assessed would have earned in case he would have entered into or gone ahead with a different transaction, say with a party in India, is not the criteria. What is permitted and made subject matter of the arm s length determination is the question of rate of interest and not reclassification or substitution of the transaction. The position would have been different, if th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iary. Credit rating would be relevant. He accepted that there was a sense of commercial expediency and related benefits in the loan transaction but the assessed had not been able to demonstrate that the interest charged satisfied the arm s length standard. He observed that business prudence or necessity of advancing loan to the subsidiary was not relevant for computing arm s length price (i.e. rate of interest in this case) in unrelated party transactions. This aspect, he held, would not take precedence over the arm s length nature of interest. 27. Several aspects enunciated above, reflect the correct legal position. We, however, express our inability to accept that commercial expediency and related benefits have no connection or relationship with the rate of interest. In terms of Clause (c) and (d) to Rule 10B (2), contractual relations or terms, and other material facts should be recognized. Having said so, we do accept the force of the alternative argument advanced that this fact could be of marginal significance and effect. It would be for the assessed to show and prove that a transaction separately benchmarked, included consideration for the lower interest rate being paid. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... f the financial health of the subsidiary AE, interest rate could be taken as the average of six months LIBOR plus 400 basis points. On the question of transaction cost, it was stated that it was mandatory for the bank to insist that the borrower must book forward contracts to hedge their position. The TPO referred to the premium payable for undertaking the said hedging transactions and added a cost of 3% per annum as premium, which should have been paid. At the same time, the TPO acknowledged that the taxpayer was not in the business of lending or borrowing money and observed that the taxpayer s risk was higher in advancing loan to a single customer, vis a bank which spreads its risk among various customers. Banks spread their risk when loans are/were advanced to various consumers, but this does not happen when a loan is given to a single customer. 32. On the question of adjustment made on account of the transaction cost, we do not appreciate the reasoning given by the TPO and find it difficult to accept. The transaction or hedging cost is borne and paid by the borrower. These are undertaken when they take loans in US Dollars or other foreign currencies because the borrower want ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing Officer questioning the long-term transaction as such. 36. Under sub-rule (4) to Rule 10B, the data used for comparability of the uncontrolled transaction should be the data relating to the financial year in which the international transaction has been entered into. The proviso permits consideration of data, not more than two years prior to the financial year, if such data reveals facts which would have influenced determination of transfer price in relation to the transaction being compared. The transaction in question was entered into in the year 2002-03 when the loans were granted to the AE. This was the financial year of the international transaction. Payment of interest is also an international transaction but would have reference to the year in which the loan was granted in case of a long term loan. However, in such situations, question may arise whether the case would fall under the second exception mentioned in the case of E.K.L. Appliances (supra), when an AE has the right to recall and ask for repayment of loan. These aspects have not been considered and applied by the TPO, DRP and the Assessing Officer. Neither has this ground been argued before us on behalf the Re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of interest. Klaus Vogel on Double Taxation Conventions (Third Edition) under Article 11 in paragraph 115 states as under:- The existing differences in the levels of interest rates do not depend on any place but rather on the currency concerned. The rate of interest on a US $ loan is the same in New York as in Frankfurt-at least within the framework of free capital markets (subject to the arbitrage). In regard to the question as to whether the level of interest rates in the lender s State or that in the borrower s is decisive, therefore, primarily depends on the currency agreed upon (BFH BSt.B1. II 725 (1994), re. 1 AStG). A differentiation between debt-claims or debts in national currency and those in foreign currency is normally no use, because, for instance, a US $ loan advanced by a US lender is to him a debt-claim in national currency whereas to a German borrower it is a foreign currency debt (the situation being different, however, when an agreement in a third currency is involved). Moreover, a difference in interest levels frequently reflects no more than different expectations in regard to rates of exchange, rates of inflation and other aspects. Hence, the choice of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ied for determining the interest rate in the extant case. PLR rates are not applicable to loans to be re-paid in foreign currency. The interest rates vary and are thus dependent on the foreign currency in which the repayment is to be made. The same principle should apply. 41. Counsel for the Revenue had made reference to Chapter 10 of the U.N. Transfer Pricing Manual, relevant portion of which reads:- 10.4.10. Financial Transactions 10.4.10.1. Intercompany loans and guarantees are becoming common international transactions between related parties due to the management of cross-border funding within group entities of an MNE group. Transfer pricing of inter-company loans and guarantees are increasingly being considered some of the most complex transfer pricing issues in India. The Indian transfer pricing administration has followed a quite sophisticated methodology for pricing inter-company loans which revolves around: Examination of the loan agreement; A comparison of terms and conditions of loan agreements; The determination of credit ratings of lender and borrower; The identification of comparable third party loan agreements: and Suitable adjustments to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent company in securing debt. 42. The first paragraph quoted above, rightly stipulates that inter- company loans would require examination of the loan agreement, comparison of the terms and conditions of loan agreements, the determination of credit rating of the lender and the borrower, identification of comparable third party loan agreements and suitable adjustments should be made. In addition to the aforesaid factors, the comparability analysis should also take into account the business relationship and the functions performed by the subsidiary AE for the parent company. In the present case, we are not concerned with paragraph 10.4.10.3 of the United Nations Transfer Pricing Manual. However, we are unable to agree with the position set out and asserted in paragraph 10.4.10.2 of the Manual. The reasoning given therein is contrary to the accepted international tax jurisprudence and the rules adopted and applied. There is no justification or a cogent reason for applying PLR for outbound loan transactions where the Indian parent has advanced loan to an AE abroad. Chapter 10 of the United Nations Practical Manual on Transfer Pricing relates to country practices. The said Chapte ..... X X X X Extracts X X X X X X X X Extracts X X X X
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