India: Extending Corporate Guarantee By Indian Entity Its Overseas Subsidiary Is A ‘Shareholder Activity'; Restores The Matter In Respect Of Intercompany Loan

Facts of the case

Tega India ("the taxpayer") had set up Tega Investment Ltd., Bahamas, an associated enterprise ("AE") ("TIL") as a special purpose vehicle for undertaking acquisition of Beruc equipment Pty Limited and Bentod Manufacturing Limited.  In order to acquire the aforementioned companies, the taxpayer provided a interest free shareholder loan to TIL and a corporate guarantee to ICICI Bank UK to fund the taxpayer's AE (i.e. TIL).  The Transfer Pricing Officer ("TPO"), during the assessment proceedings, proposed upward adjustment by levying interest on interest free loan advanced by taxpayer to its AE and determining a charge @2.5% towards the for providing corporate guarantee. 

Aggrieved, the taxpayer challenged the orders of the TPO before the Dispute Resolution Panel ("DRP").  The DRP upheld the orders of the TPO.  Subsequently, the taxpayer challenged the actions of DRP before Income Tax Appellant Tribunal ("ITAT"/ "the Tribunal").                                                                                                                                             

The Tribunal's Ruling

1 On interest free inter-Corporate loan

The taxpayer's contentions: The taxpayer contended that it had benchmarked the captioned transaction using Comparable Uncontrolled Prices ("CUP") method and determined the interest rate of LIBOR plus 100 bps as the arm's length rate ("ALP").  The taxpayer suo-moto offered to tax such notional income on interest free loan to TIL and to its other AEs.  However, the TPO, by downgrading the credit rating of the Australian and US AEs of the taxpayer, arrived at 300 bps as credit spread to make TP adjustment.  The taxpayer argued that the loan was provided as a substitute to equity funding to TIL for furthering its own intent of acquiring the two South African entities and hence, it should be classified as loan performing shareholder function, thus, warranting no charge.  The Taxpayer reiterated the fact that it never had an expectation to earn interest income from its subsidiary but to benefit itself.  The taxpayer further stated that the funds were provided as a means to mitigate its own risks vis-à-vis infusion of additional funds in the form of equity and hence they were quasi- equity in nature. 

The Tribunal's Findings: The ITAT agreed that the loan was advanced by the taxpayer to its subsidiary company on account of commercial expediency i.e. in order to expand its business globally.  Also, since TIL had a low capital, therefore, without injecting funds, it was not possible for it to run the business for benefit of the taxpayer.  The Tribunal also found merit in taxpayer's submissions and pointed out that the loan granted was indeed a kind of quasi-equity.  The ITAT further stated that the mechanism adopted by TPO to determine the credit rating of the taxpayer and its AEs is erroneous and held that the captioned issue required fresh examination.  Accordingly, the matter was restored to TPO in order to determine the ALP of the loan.

2 On Corporate Guarantee

The taxpayer's contentions: The taxpayer ingeminated that his expectations from the corporate guarantee provided were never to earn a guarantee fee but to benefit itself.  This was evident from the skewed debt-equity ratio of TIL since no other independent entity would have lent any funds to it.  Thus, it was clear that the intent of the taxpayer was that of the investor and not that of a lender.

The Tribunal's Findings: The Tribunal was completely in agreement with the taxpayer's contentions and stated that the taxpayer opted for providing a guarantee tête-à-tête blocking its own funds to facilitate furtherance of its own business and get return in terms of appreciation in value and dividends.  The ITAT also supported the taxpayer relying on judicial precedents wherein it was held that corporate guarantee by an Indian entity to its overseas subsidiary is a shareholder's activity and hence, no TP adjustment is required.  Based thereon, the ITAT ordered to delete TP addition on account of subject transaction.  

Nangia's take

ITAT ruling confirms that providing corporate guarantee in respect of a loan extended to an AE cannot be covered under the ambit of TP provisions without placing emphasis upon the aim of the guarantor.  If the intent of the taxpayer is furtherance of his own business objective, it will be wise to classify it as a shareholder activity. 

Source: Tega Industries Ltd. Vs DCIT [TS-780-ITAT-2016(Kol)-TP]

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