Kohinoor Foods Ltd vs. ACIT (ITAT Delhi)

Transfer pricing implications of interest-free loans, corporate guarantee & export turnover adjustments explained

The Tribunal had to consider the law on transfer pricing adjustments for the following three issues:

(i) Interest free loans to AEs: We have no issue of the TPO applying the CUP method. But the problem arises when in the name of applying CUP method; a wholly inapplicable comparable model applied which leads to distorted results. A significant sector of multi-national corporate set up involves creation of subsidiaries and associate enterprises for advancement of their overseas business. They help them in terms of finance by offering soft loans and subsidiary loans; they are primary focused to spread the business of the principal unit. It would have been very reasonable, judicious and appropriate on the part of the TPO to have looked into such type of transactions and applying it as uncontrolled transactions. Re-course straightaway to CRISIL, which deals in hardcore institutional finance transactions that too with clear commercial object of earning out of loans bereft on other considerations, is wholly inapplicable. While the real income theory has no application to a fictional working as provided by section 92 but this being part of the Income-tax Act, the valid consideration for properly assessing a transaction cannot be given a go by. Every fiction has limits to its application. In view thereof, the rate of 13.49% applied solely relying upon a third party opinion by applying on uncontrolled set of transaction is factually not correct and cannot be accepted. The correct comparable which can be applied is of LIBOR rate which is internationally recognized. It is the most appropriate comparable for the relevant periods and being reasonable and scientific uncontrolled comparable to be applied to the assessee’s loan transactions;

(ii) Adjustment for corporate guarantee: The TPO’s action, in first going to SBI and then further enhancing it for mark-up, is based on surmises and conjectures. His adjustment has no basis or corroboration whatsoever from any authentic source. In Reliance Industries Ltd and Nimbus Communications Ltd., the ITAT Mumbai has adopted the rate of such inter group guarantees at 0.38% and 0.5% respectively. The assessee itself has charged guarantee fee of 1% from one AE. Accordingly, the guarantee commission adjustment under TP at the rate of 1% is fair and reasonable;

(iii) Export Turnover Adjustments: The main controversy on the export turnover adjustment pertains to the method to be adopted for adjustment. The TPO, having earlier adopted the TNMM method, should not have reviewed his own report in the first place without giving cogent reasons. The business model, agreement, relationship of parties remaining the same, there is no justification in switching to CUP method. The reasons given by the TPO for applying CUP method are totally vague and bereft of any cogent reasons. There is a perceptible difference in the risk between the sales made to related parties as the surety of repayments is within the control of the assessee and in case of sales to unrelated parties, the recovery of repayment of goods bears potentially high risk. In our view, the TNMM method as adopted earlier by TPO is the most appropriate method which deserves to be first applied.