Transfer Pricing
This query is : Resolved
23 October 2009
As per Section 372A (8)(c) of Companies act, holding companies can lend to wholly owned subsidiaries with out any restrictions contained in Section 372A. When an Indian Holding company lends to its wholly owned foreign susbsidiary without charging any interest, transfer pricing regulations under IT Act would be applicable. In such case, what interest rate could be be considered as Arms Length Price for such transaction ?
Normally this test has to be done considering this question --- would the borrower be eligible to avail similar credit lines from an unrelated lender on identical terms and conditions ? The answer to this question would be NO, in respect of case of holding company loan to subsidiary.
In such case what could be the benchmark rate to be treated as ALP. Can one take an argument that considering Comparable Uncontrolled Price (CUP) Method , the interest rate charged by any other holding company to its wholly owned subsidiary as the benchmark ALP. Considering the fact that there could be many holding companies lending to foreign subsidiaries at ZERO interest rate, can such ZERO rate be considered as benchmark ALP for lending between holding and subsidiary company ?
Any answers from colleagues in CA fraternity ?
Normally this test has to be done considering this question --- would the borrower be eligible to avail similar credit lines from an unrelated lender on identical terms and conditions ? The answer to this question would be NO, in respect of case of holding company loan to subsidiary.
In such case what could be the benchmark rate to be treated as ALP. Can one take an argument that considering Comparable Uncontrolled Price (CUP) Method , the interest rate charged by any other holding company to its wholly owned subsidiary as the benchmark ALP. Considering the fact that there could be many holding companies lending to foreign subsidiaries at ZERO interest rate, can such ZERO rate be considered as benchmark ALP for lending between holding and subsidiary company ?
Any answers from colleagues in CA fraternity ?
23 October 2009
Another angle of these type of transactions is if a holding company is paying interest on finance obtained by him from Bank or other lending institutions and then giving loan to it's subsidiaries at concessional rate then Income Tax authorities can disallow the proportionate Interest paid by the holding company.
The logic is it's claiming the interest as expenditure but not using for business purpose.
Moreover in my opinion as far TP is concerned the lending rate should not be lower than the PLR ( prime lending rate) to satisfy the arms length pricing as nobody will lend to a third person at a rate below market rate or even below than what its paying to it's own lender.
I would request learned experts to help on this.
The logic is it's claiming the interest as expenditure but not using for business purpose.
Moreover in my opinion as far TP is concerned the lending rate should not be lower than the PLR ( prime lending rate) to satisfy the arms length pricing as nobody will lend to a third person at a rate below market rate or even below than what its paying to it's own lender.
I would request learned experts to help on this.
26 October 2009
Thanks Sanjay.
U/s 372A reference is to Bank rate.
As far as loans to foreign susbsidiaries their bench mark rate could be the possible rate for borowing in those countries. Can the Overall ceiling on ECB (300 to 500 basis points above 6 month USD LIBOR) be used a benchmark ALP ?
U/s 372A reference is to Bank rate.
As far as loans to foreign susbsidiaries their bench mark rate could be the possible rate for borowing in those countries. Can the Overall ceiling on ECB (300 to 500 basis points above 6 month USD LIBOR) be used a benchmark ALP ?
02 August 2025
You're raising an important and complex issue at the **intersection of transfer pricing** and **cross-border inter-company lending**, particularly where **interest-free loans** are extended by an **Indian holding company to its foreign wholly owned subsidiary**.
Let’s address this step-by-step based on Indian tax and TP principles:
---
### ✅ **Key Facts to Consider**
* Indian holding company lends to a **foreign subsidiary**.
* Loan is **interest-free**.
* **Transfer Pricing (TP) under the Income Tax Act** is applicable since this is an **international transaction between associated enterprises**.
* You are seeking the **appropriate Arm’s Length Price (ALP)** interest rate.
---
### 📌 **Legal Framework**
1. **Section 92(1)** of the Income Tax Act:
> Any income arising from an international transaction shall be computed having regard to the arm’s length price.
2. **Rule 10D and Rule 10B** of Income Tax Rules:
> Documentation must support the selected method and ALP determined.
3. **CBDT Circular No. 15/2014**:
* Recognizes **interest-free loans to foreign subsidiaries** as **international transactions**.
* Arm’s length interest must be **imputed**, even if no interest is actually charged.
---
### ❗ Key Transfer Pricing Concepts:
* **The “Substance over Form” principle** applies.
* **Even if the holding company doesn’t charge interest**, TP law **requires imputing** interest income if an independent third party would not give a loan on such terms.
---
### 🔍 **What Should Be the ALP Benchmark Rate?**
You’ve asked several intelligent sub-questions. Let's tackle them directly:
---
### ❓ **1. Can Zero Interest Be Considered ALP?**
**NO**, generally **not accepted** by tax authorities.
* Indian courts (e.g., *CIT vs. Cotton Naturals (I) Pvt. Ltd.* \[Delhi HC, 2015]) and CBDT are clear:
> You must **impute interest income** based on **arm’s length principle**, even if the loan is interest-free.
* **Zero interest** is **not an acceptable benchmark** unless **unrelated parties** in similar circumstances lend at zero — very rare.
---
### ❓ **2. Can CUP Method Be Used?**
**Yes.** CUP (Comparable Uncontrolled Price) is the **most appropriate method** for inter-company loans.
* It compares the interest rate charged in comparable uncontrolled transactions (e.g., similar loans between unrelated parties under similar conditions).
---
### ❓ **3. What is a Good Benchmark Rate?**
For **foreign currency loans**, courts and CBDT have accepted:
| ✅ Benchmark | Description |
| ---------------------------------------- | ------------------------------------------------------------------------------------ |
| **6-month LIBOR + 300–500 basis points** | Previously accepted benchmark (prior to LIBOR phase-out). |
| **SOFR + Spread** | LIBOR's successor; spread adjusted based on borrower risk, tenure. |
| **Country-specific borrowing rate** | Interest rate the subsidiary would get locally from a bank or financial institution. |
| **PLR or MCLR** | Used for INR loans within India. Not suitable for foreign currency loans. |
> ✅ **ECB guidelines** by RBI allow spreads of **300–500 bps over LIBOR/SOFR** — a good practical starting point for ALP determination.
---
### 🧾 **Example:**
Let’s say an Indian holding company lends **USD 1 million** to a wholly owned subsidiary in Singapore, interest-free.
To determine ALP:
* Check 6-month USD SOFR (say 1.5%).
* Add 300–400 basis points (3–4%).
* ➤ ALP interest = 4.5% to 5.5% p.a.
That interest must be imputed as **notional income** in the hands of the Indian lender (holding company).
---
### ⚠️ Additional Point:
If the Indian holding company borrowed funds (say from a bank) and is **claiming interest deduction**, but then lent to its subsidiary **interest-free**, the **AO may disallow the deduction** (Section 36(1)(iii)) to the extent the funds are diverted.
---
### ✅ **Conclusion & Recommendations:**
* Interest-free loans to foreign subsidiaries **must be benchmarked** for transfer pricing.
* Use **CUP method**, preferably based on **international market rates** like LIBOR/SOFR + appropriate spread.
* **Zero interest** is unlikely to be accepted as ALP unless **strong comparable data** is available (very rare).
* Documentation should explain:
* Borrower’s creditworthiness
* Currency of loan
* Tenure
* Country risk
* Comparable loans (ECB data, Bloomberg, Reuters, etc.)
---
Would you like a template for benchmarking inter-company loans or a sample TP adjustment calculation?
Let’s address this step-by-step based on Indian tax and TP principles:
---
### ✅ **Key Facts to Consider**
* Indian holding company lends to a **foreign subsidiary**.
* Loan is **interest-free**.
* **Transfer Pricing (TP) under the Income Tax Act** is applicable since this is an **international transaction between associated enterprises**.
* You are seeking the **appropriate Arm’s Length Price (ALP)** interest rate.
---
### 📌 **Legal Framework**
1. **Section 92(1)** of the Income Tax Act:
> Any income arising from an international transaction shall be computed having regard to the arm’s length price.
2. **Rule 10D and Rule 10B** of Income Tax Rules:
> Documentation must support the selected method and ALP determined.
3. **CBDT Circular No. 15/2014**:
* Recognizes **interest-free loans to foreign subsidiaries** as **international transactions**.
* Arm’s length interest must be **imputed**, even if no interest is actually charged.
---
### ❗ Key Transfer Pricing Concepts:
* **The “Substance over Form” principle** applies.
* **Even if the holding company doesn’t charge interest**, TP law **requires imputing** interest income if an independent third party would not give a loan on such terms.
---
### 🔍 **What Should Be the ALP Benchmark Rate?**
You’ve asked several intelligent sub-questions. Let's tackle them directly:
---
### ❓ **1. Can Zero Interest Be Considered ALP?**
**NO**, generally **not accepted** by tax authorities.
* Indian courts (e.g., *CIT vs. Cotton Naturals (I) Pvt. Ltd.* \[Delhi HC, 2015]) and CBDT are clear:
> You must **impute interest income** based on **arm’s length principle**, even if the loan is interest-free.
* **Zero interest** is **not an acceptable benchmark** unless **unrelated parties** in similar circumstances lend at zero — very rare.
---
### ❓ **2. Can CUP Method Be Used?**
**Yes.** CUP (Comparable Uncontrolled Price) is the **most appropriate method** for inter-company loans.
* It compares the interest rate charged in comparable uncontrolled transactions (e.g., similar loans between unrelated parties under similar conditions).
---
### ❓ **3. What is a Good Benchmark Rate?**
For **foreign currency loans**, courts and CBDT have accepted:
| ✅ Benchmark | Description |
| ---------------------------------------- | ------------------------------------------------------------------------------------ |
| **6-month LIBOR + 300–500 basis points** | Previously accepted benchmark (prior to LIBOR phase-out). |
| **SOFR + Spread** | LIBOR's successor; spread adjusted based on borrower risk, tenure. |
| **Country-specific borrowing rate** | Interest rate the subsidiary would get locally from a bank or financial institution. |
| **PLR or MCLR** | Used for INR loans within India. Not suitable for foreign currency loans. |
> ✅ **ECB guidelines** by RBI allow spreads of **300–500 bps over LIBOR/SOFR** — a good practical starting point for ALP determination.
---
### 🧾 **Example:**
Let’s say an Indian holding company lends **USD 1 million** to a wholly owned subsidiary in Singapore, interest-free.
To determine ALP:
* Check 6-month USD SOFR (say 1.5%).
* Add 300–400 basis points (3–4%).
* ➤ ALP interest = 4.5% to 5.5% p.a.
That interest must be imputed as **notional income** in the hands of the Indian lender (holding company).
---
### ⚠️ Additional Point:
If the Indian holding company borrowed funds (say from a bank) and is **claiming interest deduction**, but then lent to its subsidiary **interest-free**, the **AO may disallow the deduction** (Section 36(1)(iii)) to the extent the funds are diverted.
---
### ✅ **Conclusion & Recommendations:**
* Interest-free loans to foreign subsidiaries **must be benchmarked** for transfer pricing.
* Use **CUP method**, preferably based on **international market rates** like LIBOR/SOFR + appropriate spread.
* **Zero interest** is unlikely to be accepted as ALP unless **strong comparable data** is available (very rare).
* Documentation should explain:
* Borrower’s creditworthiness
* Currency of loan
* Tenure
* Country risk
* Comparable loans (ECB data, Bloomberg, Reuters, etc.)
---
Would you like a template for benchmarking inter-company loans or a sample TP adjustment calculation?
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