In absence of any impact on profits, income, losses or assets of an enterprise, no addition can be made on issuance of corporate guarantee (Delhi ITAT) - Bharti Airtel Ltd

Adjustment on account of corporate guarantee given by assessee on behalf of its AE – Held, no addition on account of issuance of corporate guarantee can be made in absence of any impact on profits, income, losses or assets of an enterprise

Adjustment on account of notional interest on share application money advanced to AE pending allotment of shares for a long time - Held that, no interest would have been received by a third party in a similar situation - Revenue authorities have no power to recharacterise a transaction unless it is found to be a sham or bogus transaction

Adjustment on account of interest charged on foreign currency loans – Held that, TPO needs to set out specific, cogent and legally sustainable reasons while rejecting comparables selected by the assessee - Interest rate on rupee loans cannot at all be compared with interest rates on foreign currency loans – Internal CUP to be considered while evaluating arm’s length price

 

DELHI TRIBUNAL RULING [Bharti Airtel Ltd vs ACIT (ITA No. 5816/ Del/ 2012)]

 

Adjustment on account of corporate guarantee given on behalf of subsidiary

Background/ Facts 

  • The assessee has, during the relevant previous year, issued a corporate guarantee to Deutsche Bank, New Delhi Branch.  This corporate guarantee is issued on behalf of its associated enterprise (AE), Bharti Airtel (Lanka) Pvt. Ltd., and it guarantees repayment for working capital facility.  The assessee’s contention was that since the assessee had not incurred any costs or expenses on account of issue of such guarantee, and the guarantee was issued as a part of the shareholder activity, the same was issued for NIL consideration.
  • However, the assessee made a suo-moto adjustment @ 0.65% of the guarantee amount in its transfer pricing (TP) study/ return of income, based on market quotes obtained by it
  • The Transfer Pricing Officer (TPO) made an adjustment stating that the assessee benefitted the AE by increasing its credit rating.  He determined the ALP @ 4.68% under the CUP[1] method on the basis of data obtained from various banks u/s 133(6) of the Income-tax Act, 1961 (Act).  The TPO also placed reliance in respect of the adjustment on the decision of the Tax Court of Canada in the case of GE Capital Canada Inc vs The Queen[2].

 

Key observations and decision of the Tribunal

  • The Tribunal analysed the meaning of the term “International Transaction” as per Section 92B of the Income Tax Act, 1961 (Act) and the Explanation thereto.  It observed that the Explanation to Section 92B, being clarificatory in nature, is to be read in harmony with the scheme of provisions u/s 92B.  Out of the 5 clauses i.e. clause (a) to (e) mentioned in the Explanation to Section 92B, clauses (a), (b) and (d) find a direct mention in Section 92B(1).  Thus, clauses (c) and (e) dealing with capital financing and business restructuring or reorganization can only be covered in the residual clause of Section 92B(1) i.e. ‘any other transaction having a bearing on profits, income, losses or assets of such enterprises’ 
  • This pre-condition about impact on profits, income, losses or assets is embedded in Section 92B(1) and the only relaxation from this condition precedent is set out in clause (e) of the Explanation to Section 92B, which provides that the bearing on profits income, losses or assets could be immediate or on a future date.  Thus, contingent impact situations are excluded 
  • It also held that the onus is on Revenue authorities to demonstrate that the transaction is of such a nature as to have ‘bearing on profits, income, losses or assets’ on a real basis (even if in future), and not on a contingent or hypothetical basis.  Such onus was not discharged in the instant case
  • As regards existing judicial precedents in India in relation to guarantee fee adjustment, the Tribunal observed that in none of the cases the scope of international transaction u/s 92B(1) came for examination.  Thus, such cases cannot be relied upon.  Further, the adjustment in GE Canada’s case (supra) was done in light of Canada’s domestic law provisions which significantly vary with the Indian transfer pricing legislation
  • Thus, the Tribunal held that even after insertion of Explanation to Section 92B, a corporate guarantee given for benefit of the AE, which does not involve any costs to the assessee, does not have a bearing on profits, income, losses or assets and therefore it is outside the ambit of ‘international transaction’ to which any ALP adjustment can be made

 

Adjustment on account of notional interest on share application money advanced to AE

Background/ Facts 

  • During the year, payments were made by the assessee towards share application money to its overseas AEs.  Being in the nature of share application money payments, the same were not benchmarked by the assessee
  • The TPO did not question the character of the payment.  He, however, noted that the shares were allotted against the same after a considerable length of time after the money was advanced.  He treated the aforesaid amounts advanced by the assessee to its AEs as interest free loans since the same were not converted into equity for a long time, and made an adjustment on account of interest @ 17.26% relying upon information obtained from banks u/s 133(6) of the Act

 

Key observations and decision of the Tribunal

  • The Tribunal held that there is no dispute that the impugned transactions were in the nature of payments for share application money, and thus, in the nature of capital contribution
  • It observed that the TPO has not brought any material on record to show that an unrelated share applicant was to be paid any interest for the period between making the share application payment and allotment of shares
  • The judicial precedents in the case of Perot Systems[3] and VVF Ltd[4] dealt with interest free loans/ advances given to AEs and not capital contribution as in the instant case
  • It is not open for the Revenue authorities to recharacterise a transaction unless it is found to be a sham or bogus transaction.  The Tribunal held that in the instant case, there cannot even be a suggestion to hold the transaction as a bogus one since shares have indeed been allotted to the assessee.  Thus, the adjustment was deleted

 

Adjustment on account of interest on foreign currency loans

Background/ Facts 

  • The assessee advanced loans in foreign currency to its AEs @ 7.33%.  Such loans were benchmarked under the CUP method (external CUP) whereby assessee worked out the ALP at 6.82%
  • The TPO made an adjustment @ 17.26% on the basis that the correct ALP to be applied, given that the assessee is the tested party, should be the rate prevalent in India that could be earned if the loans were given to an unrelated party with the same weak financial health as the assessee’s AEs

This rate of 17.26% was arrived at based on information obtained from domestic banks u/s 133(6) of the Act, and included adjustments made by the TPO on account of single transaction risk, hedging costs on account of RBI norms, as well as lack of security offered by AEs

 

Key observations and Decision of the Tribunal

  • The Tribunal observed that the TPO needs to set out specific, cogent and legally sustainable reasons while rejecting comparables selected by the assessee.  In the instant case, TPO has not done so and further, there also does not exist any specific basis to arrive at the ALP determined by him
  • It also observed that interest rate on rupee loans cannot at all be compared with interest rates on strong currencies like GBP, USD and CAD.  Even if the interest that the assessee would have earned is to be considered, one needs to consider such interest on foreign currency loans and not rupee denominated loans as done by the TPO
  • The hedging costs referred to by the TPO are relevant to a domestic borrower borrowing in foreign currency and not in the instant case i.e. borrowing by an overseas subsidiary.  The risk factor referred to by the TPO is also not relevant as the assessee is dealing with its subsidiaries which are under its management and control – this factor in fact reduces risk rather than increases it
  • As held in VVF Ltd (supra), the rates of interest applicable to the assessee’s borrowings in similar foreign currencies (which are lower in the instant case) constitute an acceptable internal CUP as, in absence of anything else to the contrary, it is reasonable to assume that the credit rating of the parent and its subsidiary (which is under its management and control) will be the same
  • Thus, the adjustment on account of interest rate difference was deleted by the Tribunal

 

Our Comments:

Of the various judicial rulings pertaining to adjustments on account of corporate guarantees, this is the first ruling that deals with the aspect whether furnishing of corporate guarantee constitutes an international transaction or not.  On similar lines, it would be worthwhile to examine applicability of TP in a situation where even though there exists an international transaction, no income accrues or arises to an assessee. 

Further, while dealing with the adjustment made on account of notional interest on share application money advanced to AE, the ruling has reiterated the position that the Revenue authorities have no power to recharacterise a transaction unless it is found to be a sham or bogus transaction.  Also, in cases of foreign currency loans given to AEs, the ruling has aptly highlighted the importance of qualitative factors while determining the ALP and reiterated the legal position that the TPO needs to set out specific, cogent and legally sustainable reasons before rejecting comparables selected by the assessee.

 

[1] Comparable Uncontrolled Price

[2]  2009-TCC-563

[3]  2010-TII-3-ITAT-DEL-TP

[4] 2010-TIOL-55-ITAT-MUM-TP

12 Mar 2014
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