Cotton Naturals (I) Pvt. Ltd. v DCIT (I.T.A. No. 5855/Del/2012 dtd 8/2/2013) Delhi ITAT

Background:

The assessee is a company engaged in the business of manufacturing & export of Ready made Garments. The assessee had entered into international transactions with with its associated enterprise (‘AE’) during the year 2007-08. It had provided loan amounting to USD 10,50,000 to its AE at the rate of 4%. As per Form 3CEB, CUP method was chosen to bench mark the interest received on loan. The assessee has contended that since it has received interest at a rate of 4% which is comparable with the export packing credit rate obtained from independent Banks in India, the interest is at arm’s length price.

The TPO by making comparison with uncomparables like government bonds and the amount advanced by the Indian banks in foreign currency to entities in India and by making arbitrary additions of transaction cost, security and risk etc. to such rate determined the arm’s length rate of interest at 17.26% per annum and proposed an addition of RS.68,02,619.  The assessee carried the matter to DRP. The DRP ignored all the contentions and held that loan is in Indian currency hence LIBOR is not the relevant rate and ordered that PLR (Prime Lending Rate of RBI for FY 2007-08 be applied. AO accordingly applied the PLR of 13.25%..

Tax Authority’s arguments:

• Lending or borrowing is not one of the main businesses of the taxpayer.
• Two independent enterprise in the similar circumstances as that of the tax payer and its subsidiary would have charged arm’s length interest as compensation for the financial facility provided by one party to another keeping in view the financials of the subsidiary and no security being offered.
• The business prudence or necessity of advancing loans to subsidiary is not relevant for computing arm’s length price in unrelated party transactions.
• Libor rate for calculating interest is not proper, as for calculating the cost factor of the assessee in India, the potential loss suffered by him is to be considered. Instead of US rate, Indian rate is to be adopted.
• 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.
• Accordingly, benchmarking was proposed considering the following:
  – The prevailing rate of interest for foreign currency loans extended by Banks in India for companies with similar credit rating as that of the AE on stand alone basis.

  – The additional transaction costs for the tax payers to get similar loan by a Bank in India.

  – Adjustments needs to be made for the tax payer for credit risk/ single customer risk as it is not into lending and borrowing money. Banks spread their risk various customers whereas the same is not possible for the tax payer in its loan transactions. Thus the taxpayer has higher risk than the banker in lending money to its related party.
  – Adjustment needs to be made for no security offered by the related party.

• DRP opined that the Arm’s length interest rate may be taken as the PLR of RBI for the financial year 2007-08. The TPO is directed accordingly.

Assessee’s contentions:

• The comparison has to be made with respect of advance or loan in USA and not based on Indian conditions. The comparison could also be with rate of interest being paid by the multinational companies or banks in respect of money borrowed from India.
• Reliance was placed on following judicial precedents:
  – Siva Industries & Holdings Ltd. v. Asstt. C.I.T. [2011] 11 taxmann.com 404 (Chennai – ITAT)
  – M/s Four Soft Ltd, Hyderabad v. DCIT (ITA No.1495/HYD/2010) (Hyd – ITAT)
  – Dy. ClT v. Tech Mahindra Ltd. [2011] 46 SOT 141 (URO)/12 taxmann.com 132 (Mum.)
  – Tata Autocomp Systems Ltd. v. Asst. C.I.T. [2012] 21 taxmann.com 6 (Mumbai – Trib.)
• The loan is in US $ advanced to an entity even interest is to be computed in US$. Thus the application of PLR of RBI which is a bench mark for interest rate in rupee and that too in India is not correct.
• Assessee has availed loan at much lower rate from Citi Bank
• The LIBOR rate during the March 08 was 2.7088% and which being less than the interest charged by assessee no adjustment is required in ALP.
• The Agreement is for fixed rate of interest and when the agreement was entered into with AE, the LIBOR, which is the accepted by the Hon’ble Tribunal in all cases as the most suitable benchmark for judging ALM in case of foreign currency loans, was well below the rate fixed by the taxpayer in this case.

HELD:

• CUP method is the most appropriate method in order to ascertain arm’s length price of the aforesaid international transaction.
• Where the transaction was of lending money, in foreign currencies, to its foreign subsidiaries, the comparable transaction, therefore, was of foreign currency lended by unrelated parties.
• Domestic prime lending rate would have no applicability and the international rate fixed being LIBOR should be taken as the benchmark rate for international transactions.