Section 92 of the Act – Tribunal upholds interest imputed on interest free loan; TP provisions, being anti-abuse provisions can tax notional income.
Facts
The Taxpayer, a company incorporated in Finland, was engaged in the business of manufacturing and selling medical equipment. A wholly owned Indian subsidiary (ICo) of Taxpayer, acted as its marketing arm in India. In 2002, the Taxpayer entered into an agreement to grant interest free loan to ICo which was duly approved by RBI. Transfer pricing Officer (TPO) sought to impute interest on such loan.
For the relevant year, ICo had incurred losses. Had Taxpayer granted loan charging ALP, losses of ICo would have increased while Taxpayer would have suffered source taxation on interest @10 %.
The Taxpayer argued that there is no erosion of tax base in India on giving an interest free loan to its wholly owned Indian subsidiary and hence, transfer pricing provisions cannot be invoked. Further it was contended that for evaluating section 92(3) one must consider the tax implications of a transaction as a whole rather than tax implications in the hands of the Taxpayer alone and hence charging of higher service fees by the Taxpayer to ICo would have resulted in an erosion of tax base in India as it would increase losses of ICo. Additionally, where the Taxpayer has advanced interest free loan, the Assessing Officer (AO) cannot disregard the commercial expediency of the interest free loan and impute interest thereon.
Held
For the following reasons, Tribunal held that TPO was correct in imputing interest on the interest free loan given by the Taxpayer
Section 92(1) requires that any income from international transaction has to be computed at ALP. It is not in dispute that grant of interest free loan by the Taxpayer to its India AE was an international transaction. However, section 92(3) provides that, if on computation of ALP u/s 92(1), either the income of the Taxpayer is decreased or losses are increased, section 92(1) will not be pressed into service.
Moreover, section 92(3) refers to the Taxpayer in respect of whom computation of income is being done under section 92(1). Thus Taxpayer’s contention that while evaluating the impact of section 92(3), overall impact on profits and losses of not only the taxpayer but also the impact on its AEs should be considered, cannot be accepted.
It was further contended by Taxpayer that u/s. 92(3) one needs to not only consider the actual tax impact but also possible tax advantage de hors the time value of money. These contentions of the taxpayer cannot be accepted. The impact has to be seen only in respect of the previous year in which the international transaction was entered into and not for the subsequent years. Besides, mere possibility of a tax shield which may be available to AE as a result of accumulated losses, if any, can only affect the income of the subsequent years, which as stated above is not relevant for section 92(3).
If the transaction structure is to be accepted without ALP adjustment, while India will lose the taxability of interest in the hands of the Taxpayer @10%, it will have nothing to lose in the respect of taxability of the ICo because admittedly ICo was incurring losses.
In the present case, as a result of TP adjustment, there is neither any lowering of profit of AE nor increase in losses of AE, even while income of the Taxpayer is increased. Thus there is no base erosion by the ALP adjustments in the hands of Taxpayer. The base erosion could have, if at all, taken place at best in a situation in which ICo was actually allowed a deduction.
Further, there is no provision enabling corresponding deduction for ALP adjustments in the hands of ICo merely because TP adjustment is made in the hands of Taxpayer
Under the Indian TP provisions, the use of ALP is mandatory for computation of income arising from international transactions between the AEs. The only exception is that these provisions are not to be applied only in the event where section 92(3) is satisfied.
If the intent of legislature was that TP provisions are not to be invoked in the cases where there is lowering of the overall profits of all the AEs connected with the transactions, the words of the statutory provision would have been so provided so. In absence of the same, it is incorrect to say that, TP provisions are not to be invoked when, there is no erosion of Indian tax base.
Commercial expediency of a loan to subsidiary is wholly irrelevant in ascertaining ALP of such a loan. Once a transaction is treated as international transaction between AEs, section 92 mandates that income from such transaction be computed as per ALP. Transfer pricing provisions, being anti-abuse provisions with the sanction of the statute, come into play in specific situation of certain transactions with the associated enterprise and the same can tax notional income too.
While notional interest income cannot indeed be brought to tax in general, the arm’s length principle requires that income be computed, in certain situations, on the basis of certain parameters which inherently lead to notional taxation. When the legal provisions are not pari materia, (i.e the provision of normal computation of income and the provision of computation of income in the case of international transactions between the AEs), what is held to be correct in the context of one set of legal provisions has no application in the context of the other set of legal provisions.
