Recently, Income Tax Appellate Tribunal by a ruling rejected and deleted transfer pricing adjustments proposed with respect to a taxpayer’s interest-free advances made to its related party (a U.S. subsidiary) on a finding that the taxpayer had valid business and commercial reasons for these advances.

Summary of the case:

The taxpayer manufactures and sells printing inks and other allied products and established a U.S. subsidiary to conduct manufacturing activities with ingredients supplied by the taxpayer. He also reported its sale of goods and packing material samples to the U.S. subsidiary as international transactions. The guarantees and advances were also disclosed by the taxpayer.

The taxpayer’s stated in determining the arm’s length price of the advances was not agreed by the Transfer Pricing Officer.  The Officer therefore proposed adjustments to reflect that these funds were in the nature of interest-bearing advances and were subject to an interest rate of 11% per annum.

According to the taxpayer funding the U.S. subsidiary through equity capital would have required the prior approval of the Reserve Bank of India, whereas no such approval was required for the advances. Once the taxpayer received approval from the Reserve Bank of India, it immediately converted the advances to equity capital.

However, the taxpayer argued that the advances were similar to shareholder’s funds, and that because the U.S. subsidiary was a new entrant in the U.S. market and faced stiff competition, it was necessary for the taxpayer to increase its capital support in order to provide an appropriate capital base for the U.S. subsidiary.

Finally, the tribunal generally agreed with the taxpayer and decided that there would be no interest on the advances provided to the related party based on the commercial and business considerations presented.