The Delhi High Court in the case of:  CIT v. Cotton Naturals India Pvt. Ltd. [ITA No. 233/2014 (AY 2007-08) (Delhi High Court) concerning the benchmarking of the rate of interest on an inter-company loan made to a foreign related party—held that a transfer pricing determination is not to be undertaken principally to re-characterize the character and nature of business transactions, and that actual business transactions that are legitimate cannot be restructured.  .

Summary of the case:

The taxpayer was engaged in the business of manufacturing and exporting rider apparel. The taxpayer selected the Comparable Uncontrolled Price (CUP) method to benchmark the interest received on an inter-company loan advanced to a foreign related party.

In its transfer pricing documentation, the taxpayer declared that interest receivable (at a rate of 4%) was comparable to the export packing credit rate obtained from independent banks in India.

However, the Transfer Pricing Officer, observing that lending or borrowing was not one of the taxpayer’s main businesses and further noting that London Interbank Offered Rate was not a proper reference for calculating the corresponding interest on a loan, determined that the interest rate on outbound loans to a foreign related party would be benchmarked against interest rates in India for investing in corporate bonds or other investment avenues. The Transfer Pricing Officer determined the arm’s length interest rate to be 14%.

The Dispute Resolution Panel granted partial relief to the taxpayer reducing the interest rate to 12.20%. The tribunal, however, held that interest at a rate of 4% was at arm’s length and that no transfer pricing adjustment was needed.

Decision of the court:

The HC ruled in favor of the Taxpayer that the arm’s length interest rate should be determined using LIBOR as a benchmark and not Indian prime lending rate. As the Taxpayer was already within the arm’s length range, adjustments to the interest income were not called for.