Libor – a good benchmark for transfer pricing

Ozg Transfer Pricing Consultant

Ozg Center | London | New Delhi | New York | Mumbai

Back Office Phone # 0091-9811415861-72-84-92-94

Email: transfer.pricing@ozg.co.in

www.TransferPricingConsultant.com

 

Interest rates in India are quite high compared to the rates prevailing outside of the country
It is a common feature now that Indian companies establish subsidiaries in foreign countries. It is also common that sometimes the subsidiary company is not in a position to obtain adequate finances overseas. In case raising funds abroad is not possible, funds are provided from India by way of advance or loan to the foreign subsidiary. Such loans normally are interest bearing. The issue for consideration is the rate that should be charged by the parent company which will be considered appropriate for determining arm’s length price. The issue is important, particularly because the interest rates in India are quite high compared to the rates prevailing outside of the country. The problem gets multiplied because transfer pricing laws of both the countries have to be complied with. If the parent company receives interest from the foreign subsidiary at a higher rate, revenue authorities where subsidiary is located, may raise objections against payment of such higher rate. On the other hand, if the rate of interest is low (in line with Libor rate), Indian tax authorities demand that normal interest rates prevailing in India should apply. In either case, the taxpayer is left in lurch.

In a recent case decided by ITAT, Delhi [ITA No. 5855/D/2012] on February 8, 2013, (Cotton Naturals (I) Pvt Ltd) the Indian company, provided loan for working capital to its foreign subsidiary in the US, namely, JPC Equestrian Inc because, being a new entrant in the US market, the US subsidiary did not have adequate credit rating. The Indian parent company charged interest at the rate of four per cent from its foreign subsidiary. The loans were shown as outstanding at the end of the financial year. In the transfer pricing documentation, the Indian company applied Comparable Uncontrolled Price Method (CUP) and compared the rate of export packing credit obtained from independent banks in India with the rate of interest charged by it from the subsidiary.

Transfer Pricing Officer (TPO) did not accept the rate of four per cent for the following reasons:

  • It is to be seen what the assessee would have earned by giving loans in the Indian market;
     
  • Lending or borrowing money is not one of the main business of the taxpayer and therefore what is to be considered is the prevalent market interest that could have been earned by advancing loan to an unrelated party in India with the same financial health as that of the taxpayer’s subsidiary.
     
  • Libor rate for calculating interest is not proper and instead of the US rate, the Indian rate is to be adopted;
     
  • Any independent person in India would expect the maximum return on its investment. If the lending rate is higher in Indian currency, then he would not lend in foreign currency where the lending rate is not so attractive;
     
  • Had the AE of the taxpayer got the loan from any bank in USA the rate of interest would be low;
     
  • No company in India would like to invest in the form of loan outside India and that also without security as the interest returns in India would be higher than those prevailing in developed markets.
TPO, therefore, adopted 17.26 per cent as arms’ length interest rate.

The Dispute resolution panel (DRP) upheld the view of TPO. It further held that the loan was given on fixed rate of interest out of shareholders’ funds and hence the arm’s length interest rate could be taken as the PLR of RBI for the relevant financial year.

The Hon’ble ITAT held that where the transaction was of lending money in foreign currency to its foreign subsidiary, the comparable transaction was of foreign currency lent by unrelated parties. Importantly, the tribunal held that the financial position and credit rating of the subsidiaries will be broadly the same as the holding company. In such a situation, the domestic prime lending rate would have no applicability and the international rate, being Libor, should be taken as the benchmark rate for international transactions.

The above judgment is in consonance with the other judgments of courts on this issue and provides useful guidance on these types of transactions.

Business Standard / March 25, 2013

Ozg Transfer Pricing Consultant

Ozg Center | London | New Delhi | New York | Mumbai

Back Office Phone # 0091-9811415861-72-84-92-94

Email: transfer.pricing@ozg.co.in

www.TransferPricingConsultant.com

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