Transfer pricing- Section 92C-A. Y. 2007-08- Arm’s length interest rate for loan advanced to foreign subsidiary by Indian company should be computed based on market determined interest rate applicable to currency in which loan has to be repaid

The assessee, an Indian company, was one of the leading manufacturers of rider apparel. It had incorporated a subsidiary company in United States for undertaking distribution and marketing activities for the products manufactured by it and advanced loan to its subsidiary and received interest at the rate of 4%. It applied CUP method and claimed rate of 4% to be comparable with the export packing credit rate obtained from independent banks in India. The TPO opined that what was to be considered was the prevalent interest that could have been earned by advancing a loan to an unrelated party in India with the same financial health as that of the tax payer’s subsidiary. The TPO further noted that while deciding the interest rate that may be charged on receivables from AE’s, Libor rate for calculating interest was not proper and instead of US rate, Indian rate was to be adopted. Finally, the TPO held that interest rate at 14% would be fair and reasonable. DRP granted partial relief in the form of reduction in rate of interest to 12.20%, recording that the loan was given on fixed rate of interest out of shareholder funds and the Prime Lending Rate (PLR, for short) fixed by the Reserve Bank of India, ranged from 10.25% to 10.75% in April, 2006 to 12.25% to 12.50% in March, 2007. The Tribunal agreed with assessee in view of earlier year’s decision of Tribunal.

On appeal by the Revenue, the Delhi High Court upheld the decision of the Tribunal and held as under:

“Arm’s length interest rate for loan advanced to foreign subsidiary by Indian company should be computed based on market determined interest rate applicable to currency in which loan has to be repaid. Interest rates should not be computed on basis of interest payable on currency or legal tender of place or country of residence of either party. There is no justification or a cogent reason for applying PLR for outbound loan transactions where Indian parent has advanced loan to an AE abroad. Parameters cannot be different for outbound and inbound loans and a similar reasoning applies to both inbound and outbound loans.”