An interest free debt funding of an overseas company, compared to a loan simpliciter, cannot be subjected to ALP adjustment on the basis of CUP method

Bennett Coleman & Co Ltd. vs. Deputy Commissioner of Income Tax; ITAT, ITA No. 298//Mum/2014; Mumbai;30.08.2021

The Ld. ITAT considered the issue of whether an interest-free debt funding of an overseas company in the nature of a special purpose vehicle (SPV), with a corresponding obligation to use it for the purpose of acquisition of a target company abroad, can be compared with a loan simpliciter, and be, subjected to an arm’s length price adjustment, on the basis of Comparable Uncontrolled Price (CUP) method accordingly.

The issue in dispute was an ALP adjustment of Rs 44.26 crores on account of notional interest on a loan stated to be of this nature by the assessee company to its fully owned foreign subsidiary, which is used as an SPV for overseas acquisitions.

FACTS:

• The assesses M/s. TIML India is a company having investment in companies engaged in private FM radio broadcastings. It also has investment in film entertainment business and event management and experiential marketing business through investment in its subsidiary. During the period under consideration, the assessee made maiden entry in the international media business through participation in an auction m March, 2008 for its radio business in the UK. The proposed acquisition of Virgin Radio was for and by TIML India. Therefore, the assessee claimed that the potential sales of Virgin Radio was strictly between SMG Plc and TIML India, though the same got executed through SPV created for effecting the acquisition. The assessee contended that since a direct acquisition by TIML India would have imposed additional legal obligation in the UK on TIML -India, It was decided to effect the acquisition through SPV which are 100% equity financed from the international resources of TIML India / BCCL.
• The Ld. TPO has given the fund flow chart of the assessee in his order which demonstrates that the assessee has given interest free loan to its AEs. In response to the show cause given by the TPO the assessee reiterated his submissions to the effect that TIML made investment in Virgin Radio via TIGL and TIML Golden for expanding its presence in the UK radio market. It further submitted that FEMA, 1999 permits an Indian company to make an investment in its overseas WOS through a mix of equity loan and provision of guarantee. The loan provided by the parent is merely an arrangement enabling the subsidiary to avail funding through debt rather than shareholders equity and therefore the same partakes the character of quasi equity. The assessee claimed that the debt equity ratio of the wholly owned subsidiary and adequacy of capitalization is determined by the parent. Since the subsidiary capital structure is factually and economically controlled by the parent, any action taken by the parent to supplement or strengthen the creditworthiness are integral part of equity support which parent provides to the subsidiary.
• Ld. DRP observed that there seems to be no dispute regarding the treatment of fund in this case of the TPO and the assessee. The only point of dispute is that the Ld. TPO has obtained that though the assessee’s stated intention was to invest in the equity, the actual mode adopted by it is that of loan. Once it is accepted by the assessee that it has given loan to the AE, the only possible treatment for the transaction has to be to treat it as a loan to the AE. The Ld. TPO has also pointed out that the assessee itself has referred this transaction as loan in its annual report. In the opinion of the ld. TPO, any independent entity would have charged interest on such transactions.
• LD DRP held: Though Assessee has accepted that the fund was in nature of loan, Its contention is that significantly the fund is equity in nature. In our considered opinion, there is no need to look beyond the proximate nature of funding and the purported nature of the same while doing the transfer pricing study. It is not material whether the asssessee could have contributed to the AE in any farm other than the loan. It is stated position that the assessee advanced the loan to the AE for which it did not charge any interest. As long as the fund stood as loan in the AE’s books and the assessee’s books, the law not only permitted but required the TPO to undertake transfer pricing adjustment in respect of the transaction treating the same as loan. The ld. TPO has further differentiated the risk reward matrix of loan and equity transaction at para 6.5.2 to conclude the transaction as the loan transaction. Under the circumstances, we are of the considered opinion that the Ld. TPO and AO have correctly treated the transactions as loan and conducted the TP study based on this finding. However, the DRP accepted the assessee’s contention that so far as it has pointed out that though TIML India provided funds in two tranches to its AE, the Ld. TPO erred in considering the period of loan for the second tranche of GBP 375,000 from 27/6/08 instead of 19/9/08. It was held that the Ld. TPO / AO will cause necessary corrections in this regard besides carrying out the directions in respect of percentage of 12.25% to be applied for working out the interest component.
• Accordingly, the ALP adjustment was recomputed by the Assessing Officer at Rs 44,26,61,264 and added to the income of the assessee. So aggrieved, the assessee had file dthe present appeal before this ITAT, Mumbai.

ASSESSEE’S CONTENTIONS:

• Transfer pricing adjustment on the funds provided to TIML Global Limited (hereinafter referred as ‘AE’):
  The Ld. AO based on directions of Ld. DRP has erred in computing the arm’s length interest with respect to the alleged international transaction of provision of loan to the AE resulting in an addition of Rs. 44,26,61,264 to the total income of the Assessee.
• Transaction akin to stewardship activity:
  The Ld. AO based on directions of Ld. DRP has erred in not appreciating the fact that the alleged loan transaction was given for the purpose of acquiring a controlling stake in company outside India, which was in the same business of the Assessee and hence the transaction was akin to stewardship activity which does not require any benchmarking analysis.
  The Ld. AO based on directions of Ld. DRP has erred in not appreciating the impugned loan transaction was entered into purely out of commercial expediency and hence the intent of giving loan to the AE should be taken into consideration.
• Funds to AE are quasi-equity:
  The Ld. AO based on directions of Ld. DRP has erred in not accepting the fact the funds provided by the Assessee to its AE are quasi-equity in nature and hence the question of charging any interest on the same does not arise.
• Funds provided to the AE do not bear any cost:
  The Ld. AO based on directions of Ld. DRP has erred in not considering the fact that Assessee has remitted funds to its AE out of the funds received from its holding company, which have been provided to the Assessee free of cost for the purposes of acquisition.
• Arm’s length interest rate:
  The Ld. AO based on directions of Ld. DRP has erred in law and in facts in considering the SBI Prime Lending Rate (PLR) of 12.25% p.a. as the arm’s length interest rate for imputation of notional interest on the alleged loan transaction.
  Without prejudice to the above, The Ld. AO based on directions of Ld. DRP has erred erred in not appreciating the fact that certain adjustments would be required to the SBI PLR rate considered for arriving at the arm’s length interest rate, considering the fact that the impugned loan transaction involved minimal risk in respect of repayment, complete transparency of the transaction and control over the AE’s activities.
  Without prejudice to the above, The Ld. AO based on directions of Ld. DRP has erred erred in not considering the LIBOR rates as the arm’s length interest rate for benchmarking of the alleged loan transaction as the said loan was given in foreign currency.

OBSERVATIONS BY HON’BLE ITAT, MUMBAI:

• The entire ALP ascertainment exercise is to determine if a hypothetical or real but same or materially similar transaction was to take place between two independent enterprises in uncontrolled conditions, whether such a hypothetical transaction would have been any different vis-à-vis the subject transaction entered into two associated enterprises, and, if so, to quantify the impact of such variations.
• The destination is thus arm’s length price as defined in section 92F(ii), and the means to reach that destination are set out in the methods of determining arm’s length price under section 92C(1), and the path chosen by the Assessing Officer, which is in challenge before us, is CUP method which is defined under rule 10B(1)(a) of the Income Tax Rules, 1962. It is in this light we have to address the issue before us.
• There are three fundamental questions that arise in this context:

i. Whether there can be such a funding transaction between the parties which are not associated enterprises, or, to put it differently, whether there can be valid comparables, under the CUP method, for such a transaction of SPV funding?

Ans: Once we have held that transactions between the owner of SPV and the SPV belong to a genus different from the transactions between lenders and borrowers, such transactions between an SPV and the entity creating such an SPV, as long as it is for a specific transaction structured by the owner entity- as in this case, is inherently incapable of taking place between independent enterprise. The moment this kind of funding is done, the relationship between the entity funding the SPV and the SPV will be rendered as of ‘associated enterprise’ within the meanings of Section 92A(1) as also 92A(2).

ii. Whether if such a transaction is hypothetically possible, what could be the rate of interest in such financing is done in an uncontrolled situation;

Ans: Even if one proceeds on the basis that one can assume or hypothesize a transaction similar to SPV funding in a non-AE relationship situation and fiduciary in nature- and such a hypothesis may also have some merits, it is important to bear in mind the fact that interest is compensation for the time value of money in the sense that when lender puts the money at the disposal of the borrower for a certain period, the interest that the borrower pays the lender is compensation for placing the money at the disposal of the borrower for borrower’s use during this period. In a situation, when the borrower has no discretion of using the funds gainfully, the commercial interest rates do not come into play at all.

iii. If interest is not the arm’s length consideration for such funding, what could constitute an arm’s length price of such financing.

Ans. in an arm’s length situation, the risks and rewards for the risks go hand in hand, and when someone assumes particular risks, the rewards for that risk cannot be assigned to someone else. This hypothesis appeals to us and, in our humble understanding, perhaps it truly reflects the arm’s length compensation for the role played by the owner of the SPV in providing all the requisite wherewithal to the SPV to achieve its objectives. Therefore, when the CUP method is to be adopted for ascertaining arm’s length price of providing wherewithal to the SPV, for achieving its objectives and purpose, the arm’s length consideration thereof could at best be the corresponding gain to the SPV concerned- whether directly or indirectly.

Held: In view of the aforesaid, the Ld. Bench held that the arm’ length price, under the CUP method and on the facts of this case, of funding of the SPVs by the assessee company, or providing them with the wherewithal to achieve objectives of the SPVs- which were determined by the commercial exigencies of the assessee company, is ‘nil’. We, therefore, delete the impugned ALP adjustment of Rs 44,26,61,264.