(2015) 276 CTR 445 (Del)
Meaning of international transaction; determination of arm's length price
The currency in which the loan is denominated and repayable. The interest rate applicable to that currency in the borrower's market governs, and the lender's domestic rates are irrelevant.
Which currency determines the arm's length interest rate on a loan to an overseas associated enterprise — the lender's home currency or the currency in which the loan is denominated and repayable?
The assessee advanced a loan in foreign currency to its wholly owned subsidiary abroad, charging interest at a rate reflecting conditions in the currency and market concerned. The Transfer Pricing Officer substituted a rate derived from Indian lending conditions, reasoning that the funds originated in India and that the appropriate comparison was with what the assessee could have obtained by lending domestically. A substantial adjustment followed.
The Tribunal held in favour of the assessee on the choice of benchmark. The Revenue appealed to the Delhi High Court, which delivered a detailed judgment on the principles governing the pricing of cross-border intra-group loans.
For the assessee
Interest compensates the lender for the use of money in a particular currency over a period, and different currencies carry different rates because they carry different inflation and monetary conditions. A loan denominated and repayable in foreign currency must be compared with foreign currency lending; the rupee rate reflects an entirely different economic environment.
For the Revenue
The lender is an Indian enterprise that has deployed Indian funds abroad. The arm's length exercise should measure what those funds would have earned had they been lent in India, and the domestic rate supplies that measure.
The Court held that the currency in which the loan is to be repaid is the determining factor in fixing the applicable interest rate. It reasoned that interest rates are not universal but are specific to currencies, reflecting the inflation, monetary policy and credit conditions attaching to each. A loan advanced and repayable in a foreign currency therefore has to be benchmarked against the rates at which comparable foreign currency loans are made in the relevant market, and the domestic prime lending rate has no application. The Court rejected the opportunity cost approach, holding that the transfer pricing exercise asks what price the transaction itself would have commanded between independent parties, not what the taxpayer might have earned from an alternative deployment of its funds. It went on to identify the factors relevant to comparability in such lending — the currency, the tenor, the credit rating of the borrower, the security offered and the prevailing conditions in the borrower's market — and held that an appropriate benchmark rate in that currency, suitably adjusted for risk, is the correct starting point.
Read with Tata Autocomp, this settles the approach to outbound intra-group lending under Sections 163 and 165 of the IT Act 2025. The detailed comparability factors it identifies are used in practice to construct the benchmark, and the analysis extends to guarantee fees and other cross-border financing. The specific reference rates have moved on with the replacement of LIBOR, but the currency principle is unaffected.