Corporate guarantee need not be intra-group service
Partner and National Leader - Transfer Pricing
The issue of commission for provision of corporate guarantees has been one of the most contentious issues in the battleground of transfer pricing litigation. There are conflicting views on whether corporate guarantees can inherently be treated as international transactions, or whether their treatment would depend on the purpose of the corporate guarantee.
The Delhi Income Tax Appellate Tribunal (ITAT) in its recent ruling in the case of Bharti Airtel Limited has provided some much-needed guidance on this issue. In the case, the taxpayer had provided a corporate guarantee and also charged a guarantee commission from its subsidiary. However, the income tax department enhanced the rate of guarantee commission, thus making an adjustment.
The Tribunal has addressed the fundamental issue of whether the provision of a corporate guarantee can, in fact, be considered to be an "international transaction" under the Indian transfer-pricing regulations. The Tribunal, after examining all provisions of the law as well as all judicial precedence, is of the view that only transactions that have an impact on a taxpayer's profits, or income, or losses, or assets, would constitute an "international transaction" under the Indian law. Further, the Tribunal has also held that such an impact may be at the time of the transaction, or at a future date, but needs to be a definite impact. A "contingent" impact that may or may not materialize would not be considered to be an "international transaction" under the Indian law. In the instant case, the corporate guarantee provided by the Bharti Airtel to its subsidiary created only a possibility that Bharti Airtel may in future need to pay on behalf of its subsidiary. There was no tangible cost borne by the company that had any demonstrable impact on its income, profit, losses, or assets. Thus, in the absence of a definite impact in the instant case, the Tribunal held that the provision of a corporate guarantee would not constitute an international transaction under the Indian law.
Apart from the issue of commission for corporate guarantee, the Tribunal has also deleted transfer pricing additions made by the department in respect of interest on loan and interest on share application money advanced to subsidiaries. On the first issue, the Tribunal has rejected the arm's length price of LIBOR plus 877.60 basis points determined by the department on the grounds that the price was based on an analysis that was ad-hoc and subjective. The Tribunal has reinforced the view expressed in various other rulings that the analysis done to determine an appropriate benchmark price has to be objective and based on sound numerical reasoning and computation.
On the second issue of share capital, the Tribunal has rejected the department's approach of treating advance share capital money as an interest free loan simply on the grounds that the issue of share has been delayed. In this instance as well, the Tribunal has re-enforced the general principle laid down by many other courts that the department cannot change the character of a transaction unless it is proved to be a sham. In this issue too, since the Department was not able to substantiate its claim that in a third-party scenario an interest would have been charged, its contentions were rejected.
On the issue of corporate guarantee, the Tribunal has drawn a very subtle, but significant difference between an impact that is definite and tangible versus an impact that is contingent and intangible and thus may or may not materialize at some point of time.
Here, it needs to be pointed out that the Tribunal's view that in the absence of a tangible impact, the provision of corporate guarantee would not constitute a transaction is contrary to the general accepted transfer pricing principle that explicit corporate guarantees constitute intra-group services. However, the Tribunal has also clearly stated that despite international literature and foreign case laws, its decision has been made within the framework of Indian regulations as they stand today. Intra-group loan transactions are a challenge at the best of times given the multiple factors that affect their pricing. In many cases such transactions are undertaken purely due to a related party relationship with a view on the long term benefits that a multinational group as a whole may enjoy. In such a fuzzy scenario, the Tribunal has attempted to provide clear and explicit guidance on how various financial transactions should be treated.
Without doubt, its most important judgment is on the issue of under what circumstances would corporate guarantees constitute international transaction under the Indian transfer pricing regulations. If the interpretation taken by the Delhi Tribunal gets confirmed by higher courts, it will prove to be one of the most significant pieces of guidance that would have been given in the otherwise ever dynamic arena of Indian transfer pricing, which has proved to be a challenge for both, taxpayers and tax authorities.
Views expressed are personal