Indian corporates have now started investing in foreign countries in multifarious ways. In many cases foreign subsidiaries are established by Indian companies. Sometimes the subsidiary company is not in a position to obtain finance overseas. Therefore, in order to fulfill the financial needs of the subsidiary, the parent company often provides financial support by way of a corporate guarantee to facilitate raising of funds by the foreign company abroad.
The issue for debate is, whether the Indian company should charge any commission on the corporate guarantee provided by it. If yes, what should be the rate of commission in order to comply with the arm’s length standard under transfer pricing regulations in India.
Prior to Finance Act, 2012, there were speculations as to whether providing financial guarantee would fall within the definition of “international transaction” or not. Finance Act, 2012 which has become infamous because of its desperate attempt to bring retrospective amendments to prove legislature’s primacy over judiciary, has also overhauled the definition of “international transaction” with retrospective effect. Section 92B now specifically covers provision of corporate guarantee within the ambit of international transaction.
As for the rate of corporate guarantee, the issue has recently been decided by Mumbai bench of ITAT in the case of Everest Kanto Cylinders Limited [ITA No. 542/Mum/2012]. In that case the Indian parent company provided corporate guarantee against a loan obtained by its associated enterprise (AE) from ICICI bank (Bahrain branch). The parent company charged 0.5 per cent commission. Transfer Pricing Officer rejected the 0.5 per cent rate of the taxpayer and applied a rate of 3 per cent based on information gathered by him on bank guarantee rates charged by various banks under various circumstances.
The Hon’ble Tribunal rejected the taxpayer’s contention that guarantee commission is not an international transaction and also that there could not be any method for evaluating the ALP for the guarantee commission.
The ITAT referred to the amendment brought in by the Finance Act, 2012. Payment of guarantee fee was held to be included in the expression 'international transaction' in view of the Explanation i(c) of Section 92B. Once the guarantee fee falls within the meaning of 'international transaction', then the methodology provided in the rules also becomes applicable.
The Tribunal however did not approve the rate of 3 per cent applied by the TPO on corporate guarantee which was based on external comparable. It was held that TPO has not brought anything on record that under which terms and conditions and circumstances, the banks have been charging guarantee commission at the rate of three per cent. The rate of guarantee commission depends upon transaction to transaction and mutual understanding between the parties. The universal application of the rate of three per cent for guarantee commission cannot be upheld in every case.
The rate of commission is largely dependent on the terms and conditions on which loan has been given, risk undertaken, relationship between the bank and client, economic and business interest etc.
On the facts of the instant case, the tribunal held that the independent transaction of the assessee under which it has paid 0.6 per cent guarantee commission to ICICI Bank for its credit arrangement could be a very good parameter and a comparable for taking it as internal CUP and comparing the same with the transaction with the AE. The charging of 0.5 per cent guarantee commission from the AE is quite near to 0.6 per cent. Therefore, charging of guarantee commission at the rate of 0.5 per cent from its AE can be said to be at arm’s length.
Therefore, the logical conclusion is that the provision of financial guarantee certainly falls within the definition of “international transaction”. As far as the rate of commission is concerned, the comparable rates of the banks may be used, but only after taking into consideration all the facts and circumstances. Internal comparable, if available, may be a good indicator.
External rates or the rates available on the banks’ website should be used only after carefully analysing the circumstances under which particular rates have been applied.
The Hon’ble Tribunal in an earlier decision in respect of guarantee commission had rightly observed that “there is no need for making any adjustment on the basis of the ‘naked quote’ available in the website of the bank where the rates vary from 0.15 per cent to 3 per cent”.