(2015) 374 ITR 516 (Bom)
Meaning of international transaction; determination of arm's length price
The rate prevailing where the loan is received and used. Benchmarking a foreign currency loan against Indian rupee lending rates is inappropriate, because the two are not comparable.
When an Indian company lends in foreign currency to its overseas associated enterprise, should the arm's length interest rate be the Indian lending rate or the rate prevailing in the country where the loan is received?
The Indian company advanced a loan in foreign currency to its wholly owned subsidiary in Germany, charging interest at a rate that reflected European market conditions. The Transfer Pricing Officer rejected that rate and substituted the Indian prime lending rate, which was substantially higher, on the footing that the funds had been provided by an Indian enterprise and that the opportunity cost to be measured was what the Indian company could have earned by lending in India. An adjustment was made for the difference.
The Tribunal held that the comparable rate was the one prevailing in the country where the loan was received, following the approach taken in other cases involving foreign currency advances to overseas subsidiaries. The Revenue appealed to the Bombay High Court.
For the assessee
The comparison required is with what an independent lender would have charged the borrower for a loan of the same currency, tenor and risk in the market where the borrower operates. A loan denominated in euros and used in Germany bears European rates. The Indian prime lending rate reflects rupee lending in Indian conditions and has no bearing on the pricing of a euro loan abroad.
For the Revenue
The lender is an Indian enterprise which has parted with funds it could otherwise have deployed in India. The appropriate measure of what the transaction should have yielded is the return available domestically, and the domestic prime lending rate supplies that measure.
The Court upheld the Tribunal. It held that the arm's length enquiry asks what independent parties would have agreed for a comparable transaction, and comparability must be judged by reference to the currency in which the loan is denominated, the market in which it is placed, the tenor and the credit risk. A loan advanced and repayable in foreign currency, made available to a borrower operating abroad, is comparable to other foreign currency lending in that market, and its price is set by the interest rates prevailing there. The Indian prime lending rate reflects an entirely different set of conditions — rupee funding, Indian inflation and Indian credit conditions — and provides no proper comparison. The Court rejected the opportunity cost argument, observing that the transfer pricing provisions ask what price the transaction would have commanded between independent parties, not what alternative return the taxpayer might have earned by doing something else with its money. The adjustment founded on the domestic rate was accordingly deleted.
The settled position on outbound intra-group lending, applying under Sections 163 and 165 of the IT Act 2025. It governs the choice of benchmark for foreign currency loans to overseas subsidiaries and is routinely applied to guarantee fees and other cross-border financing arrangements. The reference rate itself has moved on with the retirement of LIBOR in favour of successor rates, but the principle — benchmark in the currency and market of the loan — is unaffected.