Soma Textile & Industries Limited vs. ACIT (ITAT Ahmedabad)

The assessee established a wholly owned subsidiary, by the name of Soma Textiles FZE, in the United Arab Emirates (UAE), and invested Rs 21,71,723 in share capital of Soma Textiles FZE and also advanced Rs 16,75,88,215 to this company. The AO and TPO held that these transactions are covered by the scope of ‘international transactions’, as defined under section 92CA(3 ) of the Act. The basic contention of the assessee that the entire amount of Rs 16.75 crore advanced to the Soma Textiles FZE was out of the foreign exchange proceeds of assessee’s Global Depository Receipts (GDRs) issue and that it was in nature of “contribution towards quasi capital of the said company” was rejected. It was held that commercial expediency of the transaction was not relevant inasmuch as what is to be examined, while ascertaining the arm’s length price, is the price at which such transactions would have been entered into by the parties if these parties were independent enterprises. As regards the claim for the advance being in the nature of quasi capital, the TPO relied upon the decision in the case of Perot Systems TSI Vs DCIT [(2010) 130 TTJ 685 (Del)] where it was held that “the argument that the loans were in reality not loans but quasi capital cannot be accepted because the agreements show them to be loans and there is no special feature in the contract to treat them otherwise”. The TPO proceeded to treat LIBOR plus 2% as arm’s length price of this loan and made an adjustment in respect of the same. This was upheld by the CIT(A). On appeal by the assessee to the Tribunal HELD:

(i) The relevance of ‘quasi capital’, so far as ALP determination under the transfer pricing regulation is concerned, is from the point of view of comparability of a borrowing transaction between the associated enterprises.It is only elementary that when it comes to comparing the borrowing transaction between the associated enterprises, under the Comparable Uncontrolled Price (i.e. CUP) method, what is to be compared is a materially similar transaction, and the adjustments are to be made for the significant variations between the actual transaction with the AE and the transaction it is being compared with. Under Rule 10B(1)(a), as a first step, the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified, and then such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market. Usually loan transactions are benchmarked on the basis of interest rate applicable on the loan transactions simplictor which, under the transfer pricing regulations, cannot be compared with a transaction which is something materially different than a loan simplictor, for example, a non-refundable loan which is to be converted into equity. It is in this context that the loans, which are in the nature of quasi capital, are treated differently than the normal loan transactions.

(ii) The expression ‘quasi capital’ is relevant from the point of view of highlighting that a quasi-capital loan or advance is not a routine loan transaction simplictor. The substantive reward for such a loan transaction is not interest but opportunity to own capital. As a corollary to this position, in the cases of quasi capital loans or advances, the comparison of the quasi capital loans is not with the commercial borrowings but with the loans or advances which are given in the same or similar situations. In all the decisions of the coordinate benches (Perot Systems TSI Vs DCIT [(2010) 130 TTJ 685 (Del)]., Micro Inks Ltd Vs ACIT [(2013) 157 TTJ 289 (Ahd)], Four Soft Pvt Ltd Vs DCIT [ (2014) 149 ITD 732 (Hyd)], Prithvi Information Solutions Pvt Ltd Vs ACIT [(2014) 34 ITR (Tri) 429 (Hyd)], wherein references have been made to the advances being in the nature of ‘quasi capital’, these cases referred to the situations in which (a) advances were made as capital could not subscribed to due to regulatory issues and the advancing of loans was only for the period till the same could be converted into equity, and (b) advances were made for subscribing to the capital but the issuance of shares was delayed, even if not inordinately. Clearly, the advances in such circumstances were materially different than the loan transactions simplicitor and that is what was decisive so far as determination of the arm’s length price of such transactions was concerned. The reward for time value of money in these cases was opportunity to subscribe to the capital, unlike in a normal loan transaction where reward is interest, which is measured as a percentage of the money loaned or advanced.

(iii) The assessee’s contention that whenever it can be said that the loan transaction is in the nature of quasi capital, and the grant of loan was intended to be a long term investment in the subsidiary which has a crucial role to play in its business plans, its arm’s length price should be ‘nil’ rate of interest is not acceptable. On a conceptual note, several types of debts, particularly long term unsecured debts, and revenue participation investments could be termed as ‘quasi capital’. So far as arm’s length price of such transactions are concerned, this cannot be ‘nil’ because, under the comparable uncontrolled price method, such other transactions between the independent enterprises cannot be at ‘nil’ consideration either. Nobody would advance loan, in arm’s length situation, at a nil rate of interest. The comparable uncontrolled price of quasi capital loan, unless it is only for a transitory period and the de facto reward for this value of money is the opportunity for capital investment or such other benefit, cannot be nil. As for the intent of the assessee to treat this loan as investment, nothing turns on it either. Whether assessee wanted to treat this loan as an investment or not does not matter so far as determination of arm’s length price of this loan is concerned; what really matters is whether such a loan transaction would have taken place, in an arm’s length situation, without any interest being charged in respect of the same. As for the contention regarding crucial role being played by, or visualized for, this AE, there is no material on record to demonstrate the same or to justify that even in an arm’s length situation, a zero interest rate loan would have been justified to such an entity. A lot of emphasis has also been placed on the fact that the loan was out of the GDR funds, and, for this reason, the interest free loan was justified. We are unable to see any logic in this explanation either. Even when the loan is given out of the GDR funds held abroad, the arm’s length price of the loan is to be ascertained. The source of funds is immaterial in the present context. We have also noted that the assessee has not offered any assistance on the quantum of ALP adjustment in respect of this loan transaction, and that in the subsequent assessment years, the assessee himself has accepted ALP adjustment by adopting the LIBOR + 2% interest rate. In this view of the matter, no interference is warranted on the quantum of the ALP adjustment either.