Newsflash

Transfer Pricing: Notional interest on interest free loan to be

charged and arms length interest rate to be taken from the country of borrower: Mumbai Tribunal

CASE REFERENCE Assessees Name Before Date & Reference no. Assessment year SYNOPSIS In the present case, the Honourable Mumbai Tribunal dealt with the two key issues, firstly, chargeability of notional interest on interest free advances given by M/s Tata Autocomp Systems Ltd (the assessee) to its subsidiary and secondly, the quantum of notional interest to be charged. With respect to the first issue, the Tribunal affirmed the addition of the notional interest following the decision of Delhi Tribunal in the case of Perot Systems TSI (India) Ltd. v. DCIT wherein it had categorically rejected the argument of the assessee that interest free advances can be given to their subsidiaries on the ground of commercial expediency. As regards the second issue, the Tribunal relied on decision of Mumbai Tribunal in the case of DCIT v.Tech Mahindra1 wherein it was pointed out that the arm's length interest rate should be taken from the country of the borrower. EURIBOR rate, being the most important rate in the European money market should be considered for the determination of Arms length price (ALP) as the subsidiary company was geographically located in Germany. FACTS OF THE CASE The assessee, an Indian company, was engaged in the business of manufacture of indoor plastic, rendering engineering services, supply chain management services and administrative support for joint venture companies. It had a wholly owned subsidiary company (Associated Enterprise AE) in Germany. The AE was engaged in business of manufacturing and assembling parts for FORD. During the course of assessment, the Transfer Pricing Officer (TPO) noticed that assessee had given advances amounting to EURO 2.62 Million to its AE, however, no interest was charged on the aforesaid advances . Thus, the TPO issued a show cause notice to explain as to why the interest at the rate of 10.25% should not be charged on the advances. The assessee contended as follows: M/s Tata Autocomp Systems Ltd Vs ACIT ITAT Mumbai Bench E 30 April 2012[IT Appeal No. 7354 of 2011] 2007-08

The loan was granted purely on the basis of commercial expediency and thus no notional interest should be charged thereon. If at all interest is to be charged, the same should be restricted to 4.15% which is the rate specified in the benchmarking exercise
conducted by the assessee for ascertaining the arms length interest rate.

LIBOR rate being the best benchmark alone should be adopted for computing the arms length interest2. As regards the rate of interest proposed to be applied by the TPO, the assessee submitted that the geography that needs to be
considered for adopting a comparable rate is the geography in which the loan has been consumed and not the geography from which the loan has been granted.

Alternatively, EURIBOR based interest rate should be adopted for computing the arms length interest3.
I 1. 2. 3. TA No. 1176/Mum/2010 Reliance was placed on the decision of Chennai Tribunal in the case of M/s. Siva Industries &Holding Ltd.v. ACIT (ITA No. 2148/Mds/2010) and of Mumbai Tribunal in the case of DCIT v. Tech Mahindra Ltd. (ITA No. 1176/Mum/2010) Reliance was placed on the decision in the case of VVF Ltd. v. DCIT (ITA No.673/Mum/06) - Mumbai Tribunal; M/s. Siva Industries & Holding Ltd. v. ACIT (ITA No. 2148/Mds/2010) (Chennai Tribunal); DCIT v. Tech Mahindra Ltd. (ITA No. 1176/Mum/2010) (Mumbai Tribunal); M/s. Four Soft Limited v. DCIT (ITA No. 1495/Hyd/2010).

The TPO rejected the above arguments of the assessee and held as follows:

The international transaction representing loan without charging interest is not at ALP within the meaning of section 92C(3)(a)(b) and (c)
of the Income Tax Act read with Rule 10B(1)(a) of the income Tax Rules.

The most appropriate method for determining arm's length interest would be Comparative Uncontrolled Price (CUP) method.
Since the tested party is the assessee, the prevalent interest that could have been earned by the assessee by advancing a loan to an unrelated party in India, have to be determined. the lender into consideration and not that of borrower or the geography in which borrower is situated.

The rule of relevancy suggests that ALP rate of interest should be decided on the basis of taking Transfer Pricing (TP) transactions of LIBOR is a rate of reference for inter bank transactions, is primarily for Pound Sterling transactions, though it is used as a rate of

reference by a few other currencies (not including INR) also. It is applicable, evidently, for contributions in the currency concerned and not for the cost of producing one currency by borrowing in another currency and accessing the required currency via the foreign exchange markets. Theses aspects of LIBOR were not put before the above referred Honourable Tribunals and hence the reliance can not be placed on such decisions. similar terms including security, purpose and term of loan etc., as given by the assessee to the AE, was indeed available to the AE in its country of residence. be 10.25%.

The interest rate charged by a German bank to AE cannot be considered as CUP as the assessee has not demonstrated that a loan on

As per the present fact of the case, assessee itself had borrowed a secured loan at 9.75% and, therefore, the benchmarking rate should
The assessee approached the Dispute Resolution Panel (DRP), which further increased the benchmark rate to 12%. Being aggrieved, the assessee appealed before the Tribunal . ISSUE BEFORE THE TRIBUNAL

Whether AO/DRP was justified in charging notional interest on interest free advances made to AE even though such advance was given
on the basis of commercial expediency? Whether AO/DRP was justified in determination of quantum of above interest at INR.17.6 Million consequent to a transfer pricing adjustment?

DECISION OF THE HONOURABLE MUMBAI TRIBUNAL The Tribunal upheld the order of the AO as far as chargeability of notional interest was concerned .On the issue of quantum of notional income, the Tribunal held that EURIBOR rate as claimed by the assessee should be adopted for computation of the arms length interest. The following formed the basis for the same:

Commercial Expediency not a basis for interest free advances to AE The Tribunal referred to the decision of the Delhi Tribunal in the case of Perot Systems TSI (India) Ltd. v. DCIT wherein Delhi Tribunal
had upheld the chargeability of notional interest by emphatically rejecting the argument of the assessee that interest free advances can be given to their subsidiaries on the ground of commercial expediency. of notional interest in the present case.

The Tribunal respectfully following the above decision of the Delhi Tribunal held that the AO was well within his power to make addition Quantum of Notional Interest The Tribunal proceeded to decide on the issue as to what would be the quantum of addition on the basis that CUP was the most
appropriate method for determining ALP in the present case.

The Tribunal referred to the decision of the Mumbai Tribunal in the case of DCIT v.Tech Mahindra wherein it was pointed out that the

arm's length interest rate should be taken from the country of the borrower/debtor, i.e. the rate of interest to be used for benchmarking shall be the rate of interest in respect of the currency in which the underlying transaction has taken place in consideration of economic and commercial factors around the specific currency denominated interest rate. The said decision was followed by the Chennai Tribunal in the case of M/s. Siva Industries & Holdings Ltd.

 The Tribunal noted that in the present case the AE is a German company. EURIBOR rates are based on the average interest rates
at which a panel of more than 50 European banks borrows funds from one another. There are different maturities, ranging from one week to one year. These rates are considered to be the most important rates in the European money market. The interest rates do provide the basis for the price and interest rates of all kinds of financial products like interest rate swaps, interest rate futures, saving account and mortgages. pre-shipment credit in foreign currency (PCFC) and Rediscounting of Export Bills abroad (EBR), has permitted banks to fix the rates of interest with reference to ruling LIBOR, EURO LIBOR or EURIBOR, wherever applicable and thereto appropriate percentage ranging from 1% to 2%.

It was further noted that the RBI, in respect of export credit to exporters at internationally competitive rates under the scheme of

Thus, the Tribunal accepted the claim of the assessee to adopt EURIBOR rate being reasonable.

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9 May 2012
RSM Astute Consulting, 2012