In a recent transfer pricing ruling the Mumbai Tribunal disallowed the claim of the taxpayer to provide interest-free loans to its overseas subsidiaries.
The tribunal rejected the arguments of the taxpayer that the loan was extended out of interest-free funds available with the taxpayer and was extended for commercial expediency.
The taxpayer, VVF Limited, an Indian company, had advanced interest-free loans to its subsidiaries. In determining the arm’s-length price of the interest the taxpayer used the comparable uncontrolled price method and contended that since it had advanced the loans out of interest-free funds it was justified in not charging interest on the loans given to the subsidiaries.
The taxpayer further contended that the loans were given to its subsidiaries on account of commercial expediencies and the Revenue cannot levy tax on notional interest – as the law states, only real interest income can be taxed and fictitious income cannot be attributed to the transactions for levy of tax by the Revenue.
The transfer pricing officer however, made an upward adjustment by adopting 14% a year as arm’s-length interest on the basis that the cost of incremental borrowing to the taxpayer was 14%.
The tribunal upheld the position of the Revenue that the taxpayer should have charged interest on the funds advanced to the subsidiaries. In deciding this, the Tribunal observed that the cost of funds, out of which the loans were given, and the commercial expediencies due to which no interest was charged to the subsidiaries were completely irrelevant.
This observation of the tribunal further reinforces the decision of the Delhi Tribunal in the case of Perot Systems TSI (India) Private Limited which held that interest should be charged on loans advanced by an Indian taxpayer to its subsidiaries.
It would be interesting to note that even in this case the Delhi Tribunal indicated that the taxpayer’s argument regarding commercial expediency had no bearing on determination of the arm’s-length price under the Indian transfer pricing regulations.
In the VVF Limited case the tribunal determined the arm’s-length interest rate on the basis of the interest charged by ICICI Bank on a foreign currency loan advanced to the taxpayer, in other words, VVF Limited itself.
In doing so the Tribunal observed that the financial position and credit rating of the subsidiaries will be broadly the same as the holding company (the taxpayer). The basis for this observation was not explained in the judgment.
Furthermore, the judgment does not specifically discuss other comparability factors for a loan transaction, such as quantum of loan, term of loan, debt market in which the loans were advanced and so on.
The tribunal’s ruling emphasises that interest rate on a cross border loan transaction between associated companies should be computed on an arm’s length basis. Furthermore, the cost of funds and commercial expediency are not relevant factors when determining the arm’s-length price.
Hasnain Shroff (hshroff@kpmg.com) and Poonam Mehta Ghelani (pghelani@kpmg.com)
