2015 (3) TMI 1031 - HC - Income Tax

Determination of arms length rate of interest - ITAT holding that the interest @ 4% p.a. charged by the respondent assessee from its subsidiary i.e. the Associated Enterprise was arm s length rate of interest and the adjustment made in the Assessment Order determining the arms length rate of interest at 12.20% was unwarranted - Held that - We have no hesitation in holding that the interest rate should be the market determined interest rate applicable to the currency concerned in which the loan has to be repaid. Interest rates should not be computed on the basis of interest payable on the currency or legal tender of the place or the country of residence of either party. Interest rates applicable to loans and deposits in the national currency of the borrower or the lender would vary and are dependent upon the fiscal policy of the Central bank, mandate of the Government and several other parameters. Interest rates payable on currency specific loans/ deposits are significantly universal and globally applicable. The currency in which the loan is to be re-paid normally 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. charged by the respondent assessee from its subsidiary i.e. the Associated Enterprise was arm s length rate of interest and the adjustment made in the Assessment Order determining the arms length rate of interest at 12.20% was unwarranted - Decided in favour of assessee

Issues Involved:
1. Determination of arm's length rate of interest for loans provided by an Indian company to its foreign subsidiary.
2. Applicability of Comparable Uncontrolled Price (CUP) method.
3. Consideration of LIBOR vs. Indian PLR for benchmarking interest rates.
4. Validity of adjustments made by the Transfer Pricing Officer (TPO) and Dispute Resolution Panel (DRP).

Detailed Analysis:

1. Determination of Arm's Length Rate of Interest:
The primary issue was whether the interest rate of 4% per annum charged by the respondent assessee from its subsidiary was at arm's length, or if the adjustment to 12.20% by the TPO was justified. The respondent assessee, Cotton Naturals (I) Pvt. Ltd., had provided a loan to its subsidiary in the USA, JPC Equestrian Inc., and charged interest at 4% per annum. The TPO suggested that the arm's length rate should be 14%, which was later revised to 12.20% by the DRP.

2. Applicability of Comparable Uncontrolled Price (CUP) Method:
The respondent assessee used the CUP method to benchmark the interest rate, comparing it with the export packing credit rate from independent banks in India. The TPO, however, did not agree with this comparison and instead used a higher rate based on Indian market conditions and the credit rating of the subsidiary.

3. Consideration of LIBOR vs. Indian PLR:
The court discussed whether the interest rate should be based on the LIBOR (London Interbank Offered Rate) or the Indian PLR (Prime Lending Rate). The TPO and DRP had used Indian PLR to determine the interest rate, arguing that the loan should be benchmarked against what could be earned in India. However, the court emphasized that the interest rate should be the market-determined rate applicable to the currency in which the loan is to be repaid, which in this case was USD. The court referenced multiple decisions supporting the use of LIBOR for international transactions.

4. Validity of Adjustments by TPO and DRP:
The TPO had made several adjustments, including adding basis points for credit rating and transaction costs, and suggested a final rate of 14%. The DRP reduced this to 12.20% but did not accept the need for further adjustments for security. The court found these adjustments flawed, particularly the transaction cost adjustment, which was not applicable as the loan was to be repaid in USD, and the risk factor adjustment, which ignored the close relationship between the AEs and the fact that the funds were shareholder funds, not borrowed money.

Court's Conclusion:
The court concluded that the interest rate should be determined based on the LIBOR rate applicable to the currency of the loan, not the Indian PLR. The court rejected the TPO's reasoning for using the Indian interest rates and emphasized that the arm's length price must reflect what an independent party would have paid under similar circumstances. The court upheld the Tribunal's decision that the 4% interest rate charged by the respondent assessee was at arm's length and no further transfer pricing adjustment was warranted.

Final Judgment:
The substantial question of law was answered in favor of the respondent assessee, and the appeal by the Revenue was dismissed. The court emphasized that the interest rate should be based on the currency in which the loan is to be repaid, supporting the use of LIBOR over Indian PLR for this international transaction.

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