The Mumbai Bench of the Income-tax Appellate Tribunal held that: (1) the selection of a “tested party” is to be made with reference to the entity that has undertaken the transaction; and (2) the rate of interest on related-party debt instruments or other borrowings must be market-determined and at arm’s length and must be reported in the currency in which the loan was made / repaid.
The case is: India Debt Management Pvt. Ltd. v. DCIT [IT(TP)A No. 7518/Mum/2014]
The taxpayer—a non-banking finance company registered in India and a subsidiary of a Mauritius entity holding 75% of the taxpayer’s equity share capital—engaged in the business of identifying investment opportunities in financially distressed companies.
The investments were funded through intra-group financing, and the related-party debt instruments (debentures) issued before June 2007 had a fixed rate of interest of 7%, whereas those issued after June 2007 had a rate of interest that was reset annually, and ranged between 9.75% and 14%. The average interest rate was determined to be 11.30%.
The taxpayer, in its transfer pricing study, adopted the Comparable Uncontrolled Price (CUP) method. Because there was no internal CUP information available, the taxpayer relied on external market data. Also, there were no comparables of instruments in the Indian currency (INR), so the taxpayer expanded its search to include other regions and currencies and concluded that based on this information, the average rate of interest of 11.30% was at arm’s length.
The Transfer Pricing Officer, however, rejected the entire methodology adopted by the taxpayer, in part, because the transfer pricing study did not clearly note whether the taxpayer or the related party was the “tested party.” The Dispute Resolution Panel reiterated this finding on benchmarking the interest rate.
The taxpayer sought judicial review by the tribunal. The tribunal found that simply because the taxpayer had not identified the “tested party,” this did not support the conclusion reached by the Transfer Pricing Officer. Also, the tribunal found that the approach taking by the tax authorities in applying the U.S. dollar corporate bond rates to benchmark the taxpayer’s interest transactions was not correct. Rather, the arm’s length interest rate was to be based on the currency (INR) in which the debt instruments were issued and on the currency in which interest is being paid—and not on any foreign currency lending rate. The 11.30% interest paid to the related party was found to be within the arm’s length rate.
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