2024 (12) TMI 820 - AT - Income Tax

TP Adjustment - corporate guarantee - transaction with EXIM Bank - international transaction or not? - HELD THAT - Certainly once the international transaction arising out of the guarantee given for the benefit of AE goes, then what is left is a transaction between the assessee and the EXIM Bank only, which are unrelated parties. The vital constituent of an international transaction is that the same should be between associated enterprises. Section 92B(2) of the Act outlines the circumstances under which a transaction between two persons would be deemed to be between the associated enterprises. What is important is to be examined now is if for the purpose of section 92B(2) of the Act, the assessee s transaction with EXIM Bank is an independent transaction or a prior agreement between the assessee and its AE, makes the assessee s transaction with EXIM Bank a deemed international transaction. Once the surety has paid the guaranteed debt, they are subrogated to the rights of the creditor against the principal debtor. This means that the surety can exercise all the rights that the creditor had against the principal debtor, such as the right to recover the amount paid from the principal debtor, and any security held by the creditor for the debt. The surety can also take legal action against the principal debtor to recover the amount paid as a guarantee. However, subrogation is the assumption of another party's legal right to collect debts or damages, but that does create a new debt in the books of guarantor. Thus, we are of the considered view that ld. tax authorities below have fallen in error in proceeding with a proposition that the guarantee once invoked by the EXIM Bank became a debt towards the EXIM Bank on account of AE so as to treat the same as loan to AE and to charge an arm s length interest on the same. Consequently, the grounds of the assessee are sustained. Assessee appeal allowed.

Summary

Issues:
1. Whether the invocation of a corporate guarantee by the EXIM Bank constitutes an international transaction for transfer pricing analysis under section 92A of the Income Tax Act, 1961.
2. Whether the liability arising from the invoked corporate guarantee should be treated as a loan to the associated enterprise (AE) and subjected to arm's length interest rate determination.
3. Whether the principles of subrogation under Sections 140 and 141 of the Indian Contract Act, 1872 apply to the guarantor's rights and liabilities after the invocation of a corporate guarantee.

Analysis:
1. The appeal involved a dispute regarding the invocation of corporate guarantees provided by the assessee to its associated enterprises (AEs) and whether it constitutes an international transaction subject to transfer pricing analysis. The assessee argued that the guarantee invocation with the EXIM Bank was a transaction with an unrelated entity and not covered under section 92A. The tribunal considered the nature of the transaction and concluded that once the international transaction arising from the guarantee ceased, the subsequent dealings were between unrelated parties, thus not falling under the ambit of associated enterprises.

2. The tax authorities contended that the invoked corporate guarantee should be treated as a loan to the AE, attracting arm's length interest determination. However, the tribunal examined the guarantee deeds and noted that the liability of the assessee was contingent on the discharge of debt by the AE to the EXIM Bank. As no payment or recovery had been made, the tribunal held that there was no crystallized liability for the assessee, and no reduction in income or increase in loss should be attributed to the invoked guarantee.

3. The tribunal delved into the principles of subrogation under Sections 140 and 141 of the Indian Contract Act, 1872, which govern the rights of a guarantor upon payment of the guaranteed debt. It clarified that while the guarantor gains the rights of the creditor against the principal debtor, it does not create a new debt for the guarantor. The tribunal emphasized that the tax authorities erred in treating the invoked guarantee as a debt towards the EXIM Bank and applying arm's length interest, ultimately ruling in favor of the assessee and quashing the enhancement.

In conclusion, the tribunal's decision revolved around the interpretation of international transactions, the treatment of invoked guarantees as loans, and the application of subrogation principles in determining the tax implications of corporate guarantees. The judgment provided clarity on the tax treatment of such transactions and upheld the assessee's position in this case.