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Corp Guarantee To Subsidiary Not Subject To TP

Published on Tue, Dec 01,2015 | 16:38, Updated at Tue, Dec 01 at 16:38Source : 


By: Rakesh Nangia, Managing Partner & Amit Agarwal, Partner, Nangia & Co

India is becoming the native of new engenders of India owned multinational companies that are increasingly having their presence felt in into numerous jurisdictions around the world. The growth in India outbound investment has a consequential increase in financing transactions between Indian parents and their subsidiaries outside India. Traditionally overseas subsidiaries of Indian companies have always been dependent on equity/debt funding from their Indian parents, which is typically made at ‘Nil’ or very lower rate of interest given the limited financial capability of the subsidiary in form of a bank to bank counter guarantee, or in form of a corporate guarantee.  This note touch bases the implications of transfer pricing provisions and the consequent tax adjustments made on the Corporate Guarantees in the light of recent Income - Tax Appellate Tribunal (“the Tribunal”/ “the ITAT”) rulings.  For a better understanding of the issue, a corporate guarantee is defined as “A contractual agreement where one party (the guarantor) provides payment to a second party (the beneficiary) should the contracting party default on its obligations. Through the provision of the guarantee, the obligations of the contracting party assume the credit rating of the guarantor, often a highly rated bank or insurer.”

Corporate Guarantee – Covered or not?
In this context, it is worthwhile to note that the issue with respect to the transactions pertaining to the corporate guarantee is an international transactions [as defined under provisions of Section 92B of the Income-tax Act (“the Act”)] or not, the same needs to be dwelled into the broader perspective and thus, should be a matter subject to adjudication by the Special Bench of the Tribunal.  While deliberating on the argument of referring the transactions of corporate guarantee to the Special Bench, the Tribunal has ruled out various adjudications, for and against the concerned issue, and held that the facts were very different from case to case basis referred and thus, the Tribunal held that in case of Bharti Airtel[1], the corporate guarantee transaction was in the nature of “Shareholder’s Activity” and does not need adjudication by the Special Bench.  Accordingly, the corporate guarantee was outside the ambit of ‘provision of services’ under definition of ‘international transaction’ under section 92B of the Act.  Further, in relation to the same it is relevant to note that there could be transactions other than corporate guarantee which benefit the ‘entities of a multinational group ’ but do not tantamount as ‘provision of services’ as there could be many transactions, which are not receipt of services from the perspective of the shareholders and hence, the transaction of issuance of corporate guarantee cannot be termed as an international transaction.  Additionally, the Tribunal in the case of Bharti Airtel (supra) also observed that a corporate guarantee only had a contingent bearing on profits or assets and accordingly, held that the transaction of corporate guarantee, in the absence of any bearing on profits, income, losses or assets of the enterprises, is not covered under the primary definition of ‘international transaction’ and hence, would not fall within the ambit of Transfer Pricing provisions despite the Explanation introduced in Section 92B of the Act by Finance Act of 2012 whereby the definition of ‘international transaction’ has been widened.

Discussing the Recent ITAT Ruling on Corporate Guarantee in case of Micro Ink Limited[2]
Micro Ink Limited (“the taxpayer”) is a leading ink manufacturer in India.  The taxpayer has a wholly owned subsidiary of Micro Inks GmbH (an in Austria based entity).  During the course of assessment proceedings, the taxpayer contended that the corporate guarantee issued to its subsidiary was a part of the “shareholders activity” and did not incur any additional cost for the same and hence, the same is not subject to any transfer pricing adjustment.  However, the Revenue contended that the purpose of Transfer Pricing is to determine the profits of the taxpayer as if the transaction was entered into with a third party and in this context, it was irrelevant that the taxpayer did not incur any additional cost for the same. Further, the Revenue also relied on several rulings of the Indian Tribunal and the decision of Tax Court of Canada supported its view.  Further, it contended that with the retrospective amendment of section 92B of the Act, it is clear that corporate guarantee falls within the meaning of ‘international transaction’. Accordingly, the transfer pricing officer made an upward adjustment of INR 22.36mn as a notional charge for corporate guarantee issued by the taxpayer on behalf of its overseas subsidiary.

During the course of appellate proceedings before ITAT, the Tribunal noted that the crux of the matter lies in the definition of international transaction under Section 92B of the Act read with the Explanation.  While doing so, the Tribunal extensively referred to the observations of the Tribunal in the case of Bharti Airtel (supra), wherein the Tribunal held that a transaction would not merely fall under the ambit of Section 92B, even if it was included in the Explanation of the Section 92B of the Act, when it does not fit under the primary definition under section 92B of the Act. The principal observations of the ITAT are provided as under:
  •    Corporate guarantee only had a contingent bearing on profits or assets of an enterprise and thus, held that the corporate guarantee, in the absence of any bearing on profits, income, losses or assets of an enterprises, is not covered under the primary definition of ‘international transaction’ and consequently, it would not fall within the ambit of Transfer Pricing, despite the Explanation introduced by Finance Act of 2012.  
  • While referring to the decision of Canada Court in case of GE Capital held that the same did not even deal with the fundamental question as to whether issuance of ‘corporate guarantee’ is an international transaction at all.  Further the provisions of the Indian Income-tax Act, 1961 and the Canadian Income Tax Act, 1985 are so radically different and hence, the case of GE Capital cannot be considered.
  • ITAT while referring to the “benefit test” noted that though there could be activities which benefit entities of a multinational group but are not necessarily ‘provision of services’. Accordingly the ITAT states that there is no express reference to ‘benefit test’ in the main definition of ‘international transaction’ under the Act;
  • While relying on another ITAT ruling in case of Everest Kanto Cylinders Limited[3], the ITAT held that the Revenue cannot seek to widen the net of transfer pricing legislation by taking refuge of the best practices recognized by OECD work.  Further, states that even if issuance of corporate guarantee is accepted as ‘provision of services’, such services need to re-characterize to bring to the tune with commercial reality as “no independent enterprise would issue a corporate guarantee without an underlying security” as has been done by the taxpayer in the instant case.
  • In the instant case, the corporate guarantee issued to its subsidiary was a part of the “shareholders activity” and did not incur any additional cost for the same and hence. the Transfer Pricing adjustment should not be attracted on this transaction.

The aforesaid ruling along with earlier ruling in the case of Bharti Airtel provide that it is high time that there is clarity to the industry with respect to the transaction of corporate guarantee specially in the current scenario wherein the Indian companies are expanding their businesses overseas and more and more corporate guarantee transactions would be evident.  Moreover, the overseas entities which are cash strapped will require financial assistance from their Indian parent companies for raising funds and continuing their businesses.  The present decision does provide a sigh of relief whereby issuance of such corporate guarantees would be kept out of the net of transfer pricing provisions.  However, it is high time that the Government comes out with some substantial clarity or notification which would solidify this issue and will bring much clarity with respect to the provisions of the corporate guarantee.

Attached here is the ITAT ruling:
Attachments : TS-568-ITAT-2015(Ahd)-TP-micro_ink.pdf

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