Transfer Pricing - Interest Free Loan to Foreign AE- Commercial Factors to be considered for ALP

The Ahmedabad Tribunal Judgment in Micro Ink Ltd (ITA No. 1668/AHD/2006, AY- 2002-03) is hallmark judgment establishing the fact that international transaction is not be evaluated in isolation from Transfer Pricing perspective but entire commercial considerations involved in transaction and Associated enterprises has to be considered.

Tribunal held that in international transaction involving loan to foreign subsidiary, the said transaction should be benchmarked against prevailing LIBOR rate but the commercial business expediency between associated enterprise is also need to be considered rather than blindly applying LIBOR plus rate to loan transaction.

Facts:-

1.       The assessee is engaged in the business of manufacturing and sale of printing inks and other intermediate and allied products. The assessee claims that it was ranked first in India and it was ranked sixteenth in the world, and that the assessee, thus, is a major global player in the field of printing inks and allied activities.

2.       Having achieved a leading position in the Indian market and established a presence abroad as an exporter, the assessee explored the possibilities of physical operations in its foreign markets and to strengthen its position globally.

3.       Assessee, through its wholly owned subsidiary, Micro Inks GmbH, Austria (Micro GmbH Austria), set up a company by the name of Micro Inks Corporation Inc. (Micro USA, in short),incorporated in Delaware, USA, said step down subsidiary referred to as MIC.

4.       During the FY 2001-02 assessee advanced interest free amount to MIC, which it claims to quasi-capital. The assessee advanced money to MIC from EEFC account and per RBI regulation, loan from EEFC could be given up to $ 50 Mn, without any RBI clearance. For Investment is equity RBI permission is required. Assessee has applied for RBI permission for equity investment w.e.f April 1, 2013 and pending that permission, it has classified the amount as loan/quasi capital

5.       Assessee 92% of total exports and 50% of entire sales was to MIC.

6.       MIC was is losses at that point of time.

7.       TPO/CIT(A) determine the ALP of Loan transaction by benchmarking the same with LIBOR plus rate and made addition.

Held

1.       For benchmarking loan transaction, through CUP method and using LIBOR plus rate, one essential condition is that adjustment should be made for difference between international transaction and uncontrolled comparable transaction or between the enterprises undertaking the transactions.

2.       LIBOR plus rate cannot be applied in the instant case on account of following factors:-

a)      In typical LIBOR plus rate transaction, motive for giving advance is to earn interest only.

b)      LIBOR plus rate cannot be adopted for following two reasons:-

i)      Transaction is not a simplictor financing transaction between the assessee and Micro USA, as it is a transaction of investing in a step down subsidiary as quasi capital pending formal capital subscription with the approval of Reserve Bank of India.

ii)      It is not a case of granting advance to a business concern without significant and decisive commercial considerations, as the monies are given for strengthening assessee’s marketing apparatus in US and to keep alive its biggest exports customer.

3.       Further held that the comparable uncontrolled price for interest on such a transaction in which advances are made pending capital subscription in a company which plays strategically significant commercial role in assessee’s business , in our considered view, would be nil.