By Geeta Jani | Dhishat B. Mehta | Bhaumik Goda
Chartered Accountants
Bennett Coleman & Co. Ltd. vs. DCIT [(2021) 129 taxmann.com 398 (Mum-Trib)] [ITA No.: 298/Mum/2014] A.Y.: 2009-10 Date of order: 30th August, 2021
Section 92C of the Act and CUP method – Arm’s length price of interest-free debt funding of an overseas Special Purpose Vehicle (SPV), with a corresponding obligation on the SPV to use it for the purpose of acquisition of a target company abroad, under CUP method is Nil
FACTS
The assessee (an Indian resident entity – TIML) was, inter alia, engaged in the radio broadcasting business and wanted to acquire shares of a UK operating company (Virgin Radio, referred as Target Company below) to expand its radio business and thereby provide horizontal synergy. Acquisition of the target company was pursuant to a bid process and in the final bid proposal submitted for acquisition of the target company, TIML stated as under:
i) An SPV will be formed specifically for the purpose of acquiring the target company and such SPV will be wholly owned by TIML;
ii) The transaction will be financed wholly from internal resources of the group.
As part of implementation of a successful bid acquisition, TIML acquired two UK entities from third parties, viz., TIML Global and TIML Golden (UK SPV). These UK entities were typical £1 companies without substance and were used by TIML as SPVs for acquiring shares of the target company.
Further, as mentioned in the bid proposal, the financing of the acquisition was implemented through internal resources of the group. The taxpayer (TIML) was financed by its own Indian parent and these funds were used by TIML to grant interest-free loan to its UK SPV to acquire the target company.
The structure below depicts the underlying subsidiaries of the taxpayer and the mode in which the target company got acquired by TIML’s subsidiary:
As regards benchmarking of the loan, the assessee contended that the acquisition of the target company was to expand its own radio business and hence the activity of issuing interest-free loan to its subsidiary was in the nature of stewardship and the loan was in the nature of quasi capital. Accordingly, it had not charged any interest. The TPO held that benchmarking of this loan transaction was required to be done on the footing as if an independent entity would have charged interest on such a transaction. The TPO adopted the CUP method and imputed interest at 13% treating the transaction as an unsecured loan.
DRP confirmed the addition of imputed interest but reduced interest rate to 12.25%. Being aggrieved, the assessee appealed before the ITAT.
HELD
Nature of transaction
• The transaction was not a loan simpliciter to the UK SPV but an advance with a corresponding obligation that the funds were to be used in the manner specified by the lender TIML.
• The entire amount of funds remitted to the UK SPV was to be, and in fact was, spent on the acquisition of the target company and this specific end-use of funds was an integral part of the entire transaction.
• Accordingly, the transaction of remittance to the UK SPV cannot be considered on a standalone basis but in conjunction with the restricted use of these funds.
Benchmarking of loan under CUP
• The transaction between TIML and its UK SPV should be compared with such transactions where remittance is made to an independent enterprise with the corresponding obligation to use the funds remitted for acquiring a target company already selected by, and on the terms already finalised by, the entity remitting the funds.
• Funding transactions between the owner of the SPV and the SPV belong to a genus different from transactions between lenders and borrowers.
• The moment funding is done by the owner to the SPV, it will render parties as associated enterprises. Since the comparable transaction will be between AEs, such transaction cannot be used in CUP.
• Even if it is assumed that such transaction is hypothetically possible, since borrower has no discretion to use the funds, the concept of commercial interest rates does not apply.
• If there must be an arm’s length consideration under the CUP method, other than interest for such funding, it must be net effective gains – direct and indirect – attributable to the risks assumed by the sponsor of the SPV. In other words, in an arm’s length situation when an SPV is created and such SPV is a mere conduit, the net gains of that project or purpose must go to the person(s) sponsoring the SPV. In this regard, support was drawn from Rule 8(1) of the Nigerian Income Tax (Transfer Pricing) Regulations, 2018, which states that ‘A capital-rich, low-function company that does not control the financial risks associated with its funding activities, for tax purposes, shall not be allocated the profits associated with those risks and will be entitled to no more than a risk-free return. The profits or losses associated with the financial risks would be allocated to the entity (or entities) that manage those risks and have the capacity to bear them.’
• However, in the present case this aspect of whether net gains of the UK SPV can be attributed to TIML was considered as academic because the financial statement of the UK SPV reflected a loss figure.
ITAT gave a caveat in its ruling by stating that it has adjudicated on the limited issue of arm’s length price adjustment of interest-free loan to the SPV under the CUP method and not under any other method. Also, that ruling cannot be an authority for the proposition that ALP adjustment cannot be made under any other TP method in respect of interest-free debt funding to the overseas SPV.
