2016 (9) TMI 1456 - AT - Income Tax

Inter-corporate loan for determination of interest rate for loans provided to other associated enterprises - Held that - With respect to credit spread, TPO mentioned that the same needs to be based upon the creditworthiness of the borrower, citing detailed explanation about credit rating, the agencies determining the same and Standard & Poor s Corporate Rating Criteria as provided by them in a booklet issued in 2006 (S&P Criteria). TPO erred in applying the same in a biased manner and came to a conclusion that the rating of Tega US and Australia would not be more then B . TPO has only placed reliance on four out of seven ratios as prescribed by the S&P Criteria to arrive at the credit rating for AEs even after acknowledging the fact that S&P prescribes all seven ratios. ld. TPO has identified a single loan transaction as comparable from Loan Connector having B rating commanding a spread of 3% for the risks associated with its rating therefore, we find that the methodology adopted by the TPO may be wrong. However, the assessee has submitted before us some additional evidence pertaining to credit rating. As we noticed in the additional evidences that the assessee has computed credit rating of Tega Australia at BBB and Tega US at AA by applying scientific and logical method, as explained above, and submitted before us additional evidences, accordingly, we are of the view that this issue requires fresh examination at the end of the TPO/AO, therefore we restore this issue to the file of the TPO/AO with the direction to ascertain, the arm s length price of the loan. Appeal filed by the assessee on this ground is allowed for statistical purposes. Corporate guarantee provided by the assessee for loans taken from ICICI bank, U.K. - Held that - As the assessee s expectation from provision of loan and guarantee are not that of a lender or guarantor i.e. to earn a market rate of interest or guarantee fee, rather, the expectation was of a shareholder to protect its investment interest, help it to achieve acquisition of Tega Beruc for furtherance of its own business and get return in terms of appreciation in value and dividends. It can be verified from the fact that no third party would have agreed to grant loans, on an independent basis, to the tune of ₹ 5 crores to Tega Bahamas given its skewed debt-equity ratio reflected in the balance sheet, as equity funding is mere ₹ 23 Lakhs, therefore in the present case the guarantee is a shareholder activity hence no TP adjustment on account of corporate guarantee should be required. Accordingly, we direct the ld. DRP AO to delete the addition. In the result, the appeal of the assessee is allowed.

Issues Involved:
1. Inter-Corporate Loan
2. Corporate Guarantee

Issue-wise Detailed Analysis:

1. Inter-Corporate Loan:

The facts of the case reveal that Tega Industries Ltd. (the assessee) set up Tega Investment Ltd., Bahamas (Tega Bahamas) as a special purpose vehicle (SPV) to acquire two South African companies. To facilitate this acquisition, the assessee provided a shareholder loan to Tega Bahamas and a corporate guarantee to ICICI Bank UK. The TPO proposed an upward adjustment for the corporate guarantee and interest-free loan provided by the assessee.

The assessee argued that the shareholder loan and guarantee were provided as a substitute for equity funding and thus should not warrant any charges. However, the TPO computed an additional charge for interest-free loans at ?2,883,461, based on a higher risk spread.

The assessee conducted a Transfer Pricing Study (TP-Study Report) and selected the Comparable Uncontrolled Price (CUP) method as the most appropriate method to determine the arm's length rate of interest. The study identified 20 comparable borrowings with an average rate of LIBOR plus 87 basis points. The assessee offered LIBOR plus 100 bps as interest income to tax.

The TPO, however, disregarded the assessee's contention and computed the arm's length price of the loan advanced to Tega Bahamas at 13.75%, resulting in an upward adjustment. The DRP confirmed the TPO's order but directed that interest should be charged for the actual period the loan was outstanding.

The Tribunal found merit in the assessee's submissions, noting that the loan was quasi-equity and should be benchmarked using the CUP method. The Tribunal also observed that the TPO's methodology was flawed and required fresh examination. The issue was restored to the TPO/AO for re-assessment of the arm's length price of the loan.

2. Corporate Guarantee:

The assessee provided a corporate guarantee to ICICI Bank UK for a loan taken by Tega Bahamas. The TPO made a transfer pricing adjustment for the corporate guarantee at 2.5%, resulting in an additional charge of ?9,00,979. The TPO argued that the corporate guarantee provided by the assessee was a service and had a bearing on the profits or losses of the entities involved.

The assessee contended that the corporate guarantee was a shareholder activity and should not be subject to transfer pricing adjustments. The assessee cited various guidelines and judicial precedents to support its claim that the guarantee was quasi-equity in nature and merited no consideration.

The DRP confirmed the TPO's adjustment, stating that the guarantee provided a benefit to the AE and should be charged at arm's length. The DRP rejected the assessee's argument that the guarantee was a shareholder service.

The Tribunal agreed with the assessee's submissions, noting that the guarantee was provided to protect the assessee's investment and facilitate the acquisition of the South African companies. The Tribunal observed that no third party would have granted the loan to Tega Bahamas given its skewed debt-equity ratio. The Tribunal concluded that the guarantee was a shareholder activity and directed the DRP/AO to delete the addition.

Conclusion:

The appeal of the assessee was partly allowed for statistical purposes. The Tribunal directed the TPO/AO to re-assess the arm's length price of the loan and delete the addition for the corporate guarantee.

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