Recently, the Income-tax Appellate Tribunal upheld an interest adjustment on a loan that the taxpayer advanced to a related entity In the case of: Soma Textile & Industries Ltd. v. ACIT. Here the tribunal found that the comparable uncontrolled price of a “quasi capital loan” cannot be nil unless the loan was only made for a transitory period of time. In fact, the reward for the value of money advanced was an opportunity for capital investment or some other similar benefit.
Summary of the case:
The taxpayer was involved in the manufacture of textile cotton fabrics, and had a wholly owned subsidiary in the UAE. The taxpayer had both invested funds and advanced funds to the UAE subsidiary. The taxpayer contended that the funds advanced or loaned to the UAE subsidiary were “in the nature of a contribution towards quasi capital” because of reasons of commercial expediency for the interest-free loan.
However, the Transfer Pricing Officer determined that commercial expediency was not an appropriate test in arriving at the arm’s length price, but that the standard was what would be the price of such transactions if entered into by independent, unrelated parties. The Transfer Pricing Officer then applied an interest rate of LIBOR plus 2% as the arm’s length price, and made a transfer pricing adjustment which was supported by the Commissioner of Income-tax Appeals.
Finally, the Ahmedabad tribunal agreed, and set clear limits about the concept of “quasi capital” with respect to funds advanced between related entities.
