In Transfer pricing proceedings, corporate guarantee given by assessee to its foreign AE is almost always disputed by the department as an international transaction and adjustment determined on the basis of average bank guarantee rates. However, in number of judgements by tribunal and HC, the stand of the department is overruled and relief granted to the assessee.
A. Corporate Guarantee is not an International Transaction
Some of the arguments that can be cited favouring contention of assessee that Corporate Guarantee is not an international transaction are:
That explanation to section 92B read with section 92B(1), is restricted to such capital financing transactions, including inter alia any guarantee, deferred payment or receivable or any other debt during the course of business, as will have 'a bearing on the profits, income, losses or assets or such enterprise'. This pre-condition about impact on profits, income, losses or assets of such enterprises is a pre-condition embedded in section 92B(1)
The guarantees do not have any impact on income, profits, losses or assets of the assessee. when an assessee extends an assistance to the associated enterprise, which does not cost anything to the assessee and particularly for which the assessee could not have realized money by giving it to someone else during the course of its normal business, such an assistance or accommodation does not have any bearing on its profits, income, losses or assets, and, therefore, it is outside the ambit of international transaction under section 92B(1).
In any event, the onus is on the revenue authorities to demonstrate that the transaction is of such a nature as to have 'bearing on profits, income, losses or assets' of the enterprise, and there was not even an effort to discharge this onus. Such an impact on profits, income, losses or assets has to be on real basis, even if in present or in future, and not on contingent or hypothetical basis, and there has to be some material on record to indicate, even if not to establish it to hilt, that an intra AE international transaction has some impact on profits, income, losses or assets.
That corporate guarantee Issuance of corporate guarantee by assessee on behalf of its subsidiary company is in nature of quasi capital or shareholder activity and not in nature of 'provision for services' and, therefore, said transaction is to be excluded from scope of 'international transaction' under section 92B.
That the AEs were not benefited by the guarantee so given and it was the assessee who benefited as a result of commercial benefits secured for future and that that business strategy should be taken into consideration while making any TP adjustments in respect of such transactions and has relied on the OECD Transfer Pricing Guidelines issued in 2010.
That if corporate guarantee is given to Bank in India on behalf of foreign subsidiary, it is not a transaction between assessee and its foreign subsidiary but a transaction between assessee and Bank in India both of which are residents of India and, therefore, corporate guarantee in question cannot be regarded as an international transaction.
Since the corporate guarantee is given keeping in view paramount business interest of the parent company it has to be allowed as business expenditure.
There may be lot of other arguments based on particular facts and circumstances of the case
Few of the relevant decisions where Corporate guarantee is considered as outside the ambit of international transaction include:
Guarantee Commission not being an International transaction, provisions of Chapter X of Act will not be applicable. (Marico Ltd. Vs. ACIT [TS-411-ITAT-2016(Mum)-TP] [2016] 70 taxmann.com 214 (Mumbai - Trib.))
No adjustment for corporate guarantee on the basis of intended transaction when actual transaction never happened for want of approval from RBI for pledge of shares. Pr. CIT vs. Adani Enterprises Limted (TS-621-HC-2016 (Guj.))
Corporate bank guarantee given to AEs which does not involve any cost and which has no bearing on profits, income, losses or assets of AE will be outside purview of international transaction. (Videocon Industries Ltd. v. Addl. CIT [2015] 55 taxmann.com 263 (Mumbai - Trib.))
Where TPO made addition to assessee’s ALP in respect of commission on corporate guarantee given on behalf of subsidiaries located abroad, in view of fact that guarantee so provided did not have any bearing on profits, income, loss or assets of assessee, impugned addition was to be set aside. (Redington (India) Ltd. v. Jt. CIT [2014] 49 taxmann.com 146 (Chennai - Trib.))
Issuance of corporate guarantee by assessee on behalf of its subsidiary company is in nature of quasi capital or shareholder activity and not in nature of 'provision for services' and, therefore, said transaction is to be excluded from scope of 'international transaction' under section 92B. Even otherwise, since issuance of corporate guarantee does not have "bearing on profits, income, losses or assets", it does not constitute an international transaction, under section 92B, in respect of which an arm's length price adjustment can be made. (Micro Ink Ltd. [2015] 63 taxmann.com 353 (Ahmedabad - Trib.))
Since corporate guarantee issued for benefit of AE does not involve any costs to assessee and it does not have any bearing on profits, income, losses or assets of enterprise, it has to be kept outside ambit of 'international transaction' to which ALP adjustment can be made. (Bharti Airtel Ltd [2014] 63 SOT 113/43 taxmann.com 150)
Letter of comfort is nothing but a guarantee given by assessee-company to its AE to avail loan from financial institutions and since it does not involve any cost to assessee, it is outside ambit of international transaction. (TVS Logistics Services Ltd. [2016] 72 taxmann.com 89 (Chennai - Trib.))
Issuance of a corporate guarantee may have an influence on profits, incomes, losses and assets of an entity, in whose favour guarantee is issued, but it has no impact on these factors as long as it is issued without a consideration and as long as guarantee is not invoked by beneficiary. The issuance of corporate guarantee by assessee on behalf of its subsidiary company is in nature of quasi capital or shareholder activity and not in nature of 'provision for services' and, therefore, said transaction is to be excluded from scope of 'international transaction' under section 92B and also otherwise, since issuance of corporate guarantee does not have bearing on profits, income, losses or assets, it does not constitute an international transaction, under section 92B, in respect of which an arm's length price adjustment can be made. (Manugraph India Ltd. [2016] 69 taxmann.com 400 (Mumbai - Trib.))
B. Corporate Guarantee is an international transaction
Some of the arguments that can be raised in favour of Department/TPO for treating CG as an international transaction include:
That the guarantee in the form of support agreement, as given to the bank, provided a benevolent advantage to the AE in obtaining credit facilities from the bank. That the assessee may not have incurred any apparent cost but there was an inherent cost in this and that the overall risk exposure of the assessee company becomes high by the quantum of guarantee.
Transaction of providing corporate guarantee involves service rendered to AE and, therefore, provisions of transfer pricing can be invoked in respect of such a transaction Since independent enterprise would have charged a fee for this service, ALP of such transaction was to be determined
By providing corporate guarantee, subsidiary's creditworthiness increases and hence postulates provision of services by holding company. Where higher credit rating of AE is due to a guarantee by another group member, such association positively enhances the profit making potential of that AE. There was a clear benefit accrued to the AEs by the guarantee provided by the assessee and when such benefit was passed on by the assessee to the said AEs, guarantee commission should have been charged at arm's length price.
There may be lot of other arguments based on particular facts and circumstances of the case.
Some of decisions where Corporate guarantee is treated as international transaction and transfer pricing adjustments upheld
In this case, for the guarantee given to the bank against the financial assistance given to its AEs, no commission was charged by the assessee-company on the ground that the said AEs were not benefited by the guarantee so given and it was the assessee who benefited as a result of commercial benefits secured for future. ITAT held that since there was a clear benefit accrued to AE by guarantee provided by assessee as it improved credit worthiness and hence lower interest rate, guarantee commission should had been charged at arm's length price. (Nimbus Communications Ltd [2013] 34 taxmann.com 298 (Mumbai - Trib.))
Assessee contended that corporate guarantee was part of business strategy for market penetration and hence no benefit to AE which was rightly rejected by tribunal. The assessee failed to provide good arguments as in Bharti Airtel case that no costs were incurred or arguments in case of Micro Ink Limited that issuance of corporate guarantee by assessee on behalf of its subsidiary company was in nature of quasi capital or shareholder activity.
Provision of guarantee always involve risk and there is a service provided to AE in increasing is creditworthiness in obtaining loans in market, be from Financial institutions or from others. There may not be immediate charge on Profit & Loss account but inherent risk cannot be ruled out in providing guarantees. Transaction of providing corporate guarantee involves service rendered to AE and, therefore, provisions of transfer pricing can be invoked in respect of such a transaction (Prolifics Corporation Ltd. v. Dy. CIT [2015] 55 taxmann.com 226 (Hyderabad - Trib.)
ITAT held that the assessee did incur costs on issuance of the guarantee to its subsidiary and, for that reason, the issuance of guarantee indeed had a bearing on the profits and income of such enterprise. And hence the issuance of guarantees, on the facts and in the circumstances of this case, constituted an 'international transaction' (Advanta India Ltd. [2015] 64 taxmann.com 251 (Bangalore - Trib.))
: The judgement reflects that mere glitch in transaction viz. incurring of costs simply turned the tide against the assessee. Assessee should have raised other arguments as mentioned in section above. Also, assessee giving guarantee should be careful not to incur any costs on the same to keep it out of ambit of international transaction.
Corporate guarantees issued by assessee to Indian bank for benefit of its US subsidiary is an international transaction within meaning of section 92B. Though immediate transaction was between assessee and CITI Bank of India, benefit of guarantee was for US Subsidiary and, hence, assessee had rendered a service to its US subsidiary for which it must charge fees at an arm's length. (Infotech Enterprises Ltd. v. Addl. CIT [2014] 41 taxmann.com 364 (Hyderabad -Trib.))
Assessee should have raised arguments of ‘no costs’ or ‘shareholder service’ or other arguments as mentioned above
The tribunal held that the corporate guarantee provided by the assessee comes within the scope and ambit of 'international transaction' by virtue of Explanation I (c) to section 92B of the Act as inserted with retrospective effect. (Four Soft Ltd. v. Dy. CIT[2014] 44 taxmann.com 479/149 ITD 732 (Hyderabad-Trib.))
Assessee should have raised arguments of ‘no costs’ or ‘shareholder service’ or other arguments as mentioned above
Transaction of providing corporate guarantee involves service rendered to AE and, therefore, provisions of transfer pricing can be invoked in respect of such a transaction following decision of Four Soft Ltd.(supra). (Mylan Laboratories Ltd. [2015] 63 taxmann.com 179 (Hyderabad - Trib.))
It is better to contest the case in High court and obtain relief.
Tribunal rejected the argument of assessee that it is the responsibility of the parent company to provide guarantee to its subsidiaries / AEs, therefore, in principle, no commission is chargeable and held that CG is an international transaction. (Reliance Industries Ltd.v. Addl. CIT [IT Appeal No. 4475 (Mum.) of 2011, dated 13-9-2013] )
C. Transfer Pricing Adjustments for Corporate Guarantee Fees
There are conceptual differences in Bank Guarantee and Corporate Guarantee. Hence, TPO's are not justified in mechanically picking up the BG rates as the external/internal CUPs, as the case may be. Comparing the bank guarantee commission transactions with that of the corporate bank guarantee transactions is prima facie incorrect so long as the FAR analysis is applied successfully and the CUP are appropriately adjusted in accordance with the Rule 10B of the IT Rules, 1962. Therefore, applying the 'quote' available on the website of the banks without making adjustments, duly necessary, makes ALP studies erroneous
In most of the cases, the TPOs are frequently using the BG rates, that to, the naked quotes for bench marking the CG Rates without making requisite downward adjustments to the said BG Rates by factoring the obvious differences. The Tribunal is consistently disapproving this trend as evident from the plethora of cited decisions as mentioned below.
Some of the decisions which have decided the ALP rates for Corporate guarantee adjustments:
TPO argued that assessee should have charged a higher mark up of 400 Bps above HDFC rate to cover the additional risk of bankruptcy or defaults by AEs and accordingly made adjustments. ITAT held that ‘there is no difference between the bank or a corporate entity as far as GC is concerned. Both have to consider the functions performed, assets employed and risks assumed. In case of default by the borrower, the corporate guarantor is exposed to the same risk of a bank. In case of an AE the risk would not be as high as in case of an outsider.’ (Marico Ltd. Vs. ACIT [TS-411-ITAT-2016(Mum)-TP]
Where assessee had given corporate guarantee to its AE without charging any commission, adjustment to be made at 0.5 per cent (Nimbus Communication Ltd. v. Addl. CIT [2014] 42 taxmann.com 139 (Mum. - Trib.))
ITAT held that the Bank Guarantee Commission Prices cannot be used as External CUPs to benchmark the Corporate Guarantee Commission Prices. (Glenmark Pharmaceuticals v. Addl. CIT [2014] 62 SOT 79/43 taxmann.com 191 (URO))
Tribunal accepted the rate of 0.38% being average rate on which the assessee has paid guarantee commission to third party and held that the charging of a guarantee commission depends upon transactions to transaction and mutual understanding between the parties. (Reliance Industries Ltd.v. Addl. CIT [IT Appeal No. 4475 (Mum.) of 2011, dated 13-9-2013] )
ITAT directed the TPO to adopt 0.53 per cent as the guarantee commission rate instead of 2 per cent adopted by him. (Mylan Laboratories Ltd. [2015] 63 taxmann.com 179 (Hyderabad - Trib.))
ITAT held that TPO was not justified in determining ALP for bank guarantee at rate of 3 percent of amount of guarantee applying external comparables of banks without bringing into record that under which terms and conditions other banks were charging guarantee commission at rate of 3 per cent. Charging of 0.5 per cent guarantee commission from AE being quite near to 0.6 per cent, which assessee had paid to ICICI Bank for credit arrangement, rate of 0.5 per cent can be said to be at arm's length (Everest Kanto Cylinder Ltd. v. Dy. CIT [2013] 34 taxmann.com (Mum. - Trib.))
HC held that considerations which apply for issuance of a corporate guarantee are distinct and separate from that of bank guarantee and, therefore, no transfer pricing adjustment can be made in respect of guarantee commission by making comparison between guarantees issued by commercial banks as against a corporate guarantee issued by holding company for benefit of its AE, a subsidiary company. (Everest Kento Cylinders Ltd. ([2015] 58 taxmann.com 254 (Bombay HC))
Rate of 0.5 per cent guarantee fee/commission would be at arm’s length where rates of guarantee commission charged by various banks were found to be in range of 0.15 per cent to 3 per cent. (Godrej Household products Ltd. v. Addl. CIT [2014] 41 taxmann.com 386 (Mum.- Trib.)
ITAT held that arm's length rate of guarantee commission fee cannot be determined based on probable rate being charged by commercial banks. Rate of 0.50 per cent would be proper for purpose of determining arm's length rate of guarantee commission fee (Thomas Cook (India) Ltd. ([2016] 69 taxmann.com 443 (Mumbai - Trib.))
The corporate guarantee is not in the nature of bank guarantee, the rate applicable to bank guarantee provided by the bank cannot be applied to corporate guarantee which is provided by a group company and rate of 3.75%, which is applicable to bank guarantee issued by the bank cannot be applied. (Four Soft Ltd. v. Dy. CIT[2014] 44 taxmann.com 479/149 ITD 732)
ITAT held that it would be appropriate to charge corporate guarantee fee at 0.50 per cent (Rain Commodities Ltd. [2016] 65 taxmann.com 240 (Hyderabad - Trib.))
ITAT held that TPO should adopt 0.5 per cent as arm's length guarantee commission charges in respect of corporate guarantee given by assessee for its foreign AE. (Aditya Birla Minacs Worldwide Ltd. [2015] 56 taxmann.com 317 (Mumbai - Trib.))
Rate of 0.50 per cent charged by assessee for giving corporate guarantee to its AE was appropriate. (Hindalco Industries Ltd. [2015] 62 taxmann.com 181 (Mumbai - Trib.))
Thus, as can be seen from above, 0.5% is generally accepted as ALP for giving CG to AE. And also, bank guarantee commission cannot be used as comparable in determining corporate guarantee commission rates.
D. Conclusion
Transactions of giving corporate guarantee to AE for purpose of funding are highly popular in corporate world but is also a highly litigated issue during TP proceedings. Assessee should be cautious at the time of execution of the transaction and in also presenting the arguments before department/tribunal. By a mere glitch in transaction or arguments the corporate guarantee can be held as international transactions and subject to TP adjustments by income tax department
The author can also be reached at ca.guptarohit@gmail.com
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