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Cotton Naturals (I) Pvt. Ltd. v. Dcit, Circle 3(1)

Income Tax Appellate Tribunal

Feb 8, 2013

Judgment

Subsequent
References

CaseIQ

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Concise Analytical Summary of the Tribunal Order

Factual and Procedural Background

The appeal arises from an assessment order passed by the Assessing Officer (AO) dated 19.10.2012 under section 143(3) read with section 144C of the Income-tax Act, relating to assessment year 2008-09. The assessee (a manufacturer and exporter of rider apparel) reported international transactions with associated enterprises (AEs) for the year 2006-07, including sales of equestrian apparel to JPC Equestrian Inc. (Rs. 48,191,540) and loans to that AE totalling US$ 10,50,000, on which the assessee reported interest received of Rs. 2,052,072 (charged at 4% p.a.). The matter was referred to the Transfer Pricing Officer (TPO) who, after analysis, determined an arm's length interest rate of 17.26% p.a. and computed an adjustment of Rs. 68,02,619 under section 92CA. The assessee filed objections before the Dispute Resolution Panel (DRP). The DRP, while accepting some TPO/Assessing Officer contentions (notably on the need for transaction cost loading and treating loan as without further security adjustment), directed the AO to adopt the Prime Lending Rate (PLR) of the RBI for FY 2007-08 as the ALP benchmark; following that direction the AO/TPO recomputed ALP at 13.25% giving an adjustment of Rs. 47,45,416. The assessee appealed to the Tribunal (the present order), challenging the AO/TPO/DRP determinations principally on whether LIBOR/international benchmarks, rather than Indian PLR, should be used to determine arm's length interest for USD-denominated inter-group loans.

Legal Issues Presented

Whether the interest rate of 4% charged by the assessee on USD-denominated loans to its US subsidiary is at arm's length, or whether an upward transfer pricing adjustment is warranted.
Whether the benchmarking for a foreign-currency loan advanced by an Indian parent to its foreign subsidiary should use international reference rates (primarily LIBOR) or domestic Indian benchmarks (such as RBI's PLR / bond yields).
Whether adjustments made by the TPO (for transaction cost, security, and single-customer risk) to arrive at a much higher interest rate were justified.
Whether the AO/DRP/TPO correctly treated the loan and the relevant comparables for purposes of the Comparable Uncontrolled Price (CUP) method and transfer pricing analysis.

Arguments of the Parties

Assessee's Arguments

CUP method was correctly chosen and is the most appropriate method for both sale of apparel and interest on loans.
The loan to the US subsidiary was denominated in US dollars and therefore comparables and benchmarking should be in respect of foreign-currency loans (i.e., LIBOR-based international benchmarks), not domestic Indian rates such as RBI PLR.
The assessee had access to external borrowings (e.g., from Citibank) at rates lower than 4%, and the loans to AEs were at fixed rates (agreements dated 2002–2003 fixing interest at 4%), with LIBOR in those years being substantially lower than 4%; therefore no upward adjustment is warranted.
The TPO's determination (17.26%) relied on comparisons with domestic instruments (bond yields/Indian currency benchmarks) and made arbitrary additions (transaction cost, security, single-customer risk), applying internal and external uncomparables; that approach was incorrect.
The DRP's adoption of RBI PLR (leading to 13.25%) was improper because the transaction was in USD and commercial principles for international transactions point to LIBOR as the relevant benchmark.
The loan agreements were bona fide, fixed-rate commercial contracts entered into in 2002–03; there was no suggestion of sham or tax-avoidance, and judicial authorities require giving effect to valid commercial contracts in the absence of fraud/bad faith.
The assessee also emphasised that most of its profits were exempt under section 10B and its AE was not in a tax haven, negating an intent or incentive to shift profits abroad to avoid Indian tax.

Departmental (TPO / DRP) Arguments

TPO/AO: When the tested party is the Indian taxpayer, comparable rates should be selected from the Indian domain to reflect what the assessee would have earned by giving loans in the Indian market; LIBOR (a US/foreign benchmark) is not appropriate for computing the cost factor of an assessee in India.
TPO/AO: Independent lenders in India would expect higher returns for unsecured foreign currency lending to a single customer; hence adjustments for transaction cost, security absence, and single-customer risk are necessary — leading to a high arm's length rate (17.26% in primary analysis).
DRP: While accepting some TPO observations (no security, assessee not being in lending business, need to account for transaction cost), DRP held that no further addition for security was required and directed the AO to adopt RBI PLR for FY 2007-08 as the arm's length interest rate (which the AO fixed at 13.25%).

Table of Precedents Cited

Precedent	Rule or Principle Cited For	Application by the Court
Siva Industries & Holdings Ltd. v. Asstt. CIT [2011] 11 taxmann.com 404 (Chennai - ITAT)	Where loans are in foreign currency to an associated enterprise, LIBOR (international benchmark) is the appropriate rate for determining arm's length interest rather than domestic PLR.	The Tribunal accepted Siva Industries as supporting the proposition that foreign-currency inter-company loans should be benchmarked by international commercial principles (LIBOR), and applied that reasoning in favour of the assessee.
M/s Four Soft Ltd. v. DCIT (ITA No.1495/Hyd/2010)	LIBOR-based benchmarks are appropriate comparables for foreign currency loans; DRP's direction to use LIBOR plus mark-up was upheld.	The Tribunal relied on Four Soft to support using LIBOR for foreign-currency loans and noted that the DRP's approach in that case was affirmed; this precedent reinforced the Tribunal's acceptance of LIBOR-based comparables here.
Dy. CIT v. Tech Mahindra Ltd. [2011] 46 SOT 141 (URO)/12 taxmann.com 132 (Mumbai)	Arm's length interest rate should correspond to the currency and country of the borrower/debtor (i.e., USD LIBOR for a US AE) and internal comparables must meet Rule 10B criteria (external vs internal comparables).	The Tribunal invoked Tech Mahindra to underline that currency-specific commercial principles govern benchmarking (use USD LIBOR for US AE) and that internal comparables must be truly comparable; this supported rejection of applying domestic (rupee) benchmarks.
Tata Autocomp Systems Ltd. v. Asstt. CIT [2012] 21 taxmann.com 6 (Mumbai - Trib.)	Foreign-currency inter-company lending falls within international transactions and ALP determination must consider appropriate international benchmarks (CUP method suitable in such contexts).	The Tribunal cited Tata Autocomp for the proposition that CUP is appropriate and that benchmarking should reflect the currency-specific market (e.g., EURIBOR for euro transactions), reinforcing the assessee's position for currency-relevant benchmarks.
Perot Systems TSI (India) Ltd. v. Dy. CIT [2010] 37 SOT 358 / 130 TTJ 685 / 5 ITR (Trib.) 106 (Delhi)	Lending/borrowing between associated enterprises constitutes an international transaction; failure to charge arm's length interest can result in profit shifting and transfer pricing adjustments.	The decision was discussed by the assessee (and noted by the Tribunal) to distinguish facts: unlike Perot, here assessee's profits are largely exempt under section 10B and AEs are not in a tax haven, reducing concerns about tax-motivated profit shifting.
Philips Software Centre (P.) Ltd. v. Asstt. CIT [2008] 26 SOT 226 (Bangalore)	Transfer pricing provisions are not to be applied where application of ALP would reduce overall tax incidence in India; if there is no manipulation to shift profits outside India, TP provisions may not be invoked harshly.	The Tribunal relied on Philips to support the assessee's submission that, given exemption under section 10B and absence of AEs in tax havens, there was no evidence of profit shifting to warrant aggressive TP adjustments.
ITO v. Zydus Altana Healthcare (P.) Ltd. [2011] 44 SOT 132 (Mumbai)	Where assessee's profits are exempt under section 10B and overseas entities are appropriately taxed, aggressive TP adjustments may not be justified solely to increase taxable income in India.	The Tribunal cited Zydus Altana to reinforce that exemption under section 10B and substantive taxation of AEs abroad weigh against finding manipulative profit shifting; this supported the assessee's stance.
Union of India v. D.N. Revri & Co., AIR 1976 SC 2257 (Supreme Court)	Commercial contracts between parties should be interpreted with a commonsense approach and given effect, not invalidated by strict technical construction, absent bad faith.	The assessee relied on this Supreme Court authority; the Tribunal referenced it to underscore that genuine commercial loan agreements (fixed-rate contracts) should be respected unless there is evidence of sham or fraud.
Dharamvir Dhir v. CIT [1961] 42 ITR 7 (Supreme Court)	Contracts must be examined on their tenor and commercial substance; genuineness of documents not challenged requires construing them as they stand.	The Tribunal cited Dharamvir Dhir to support the proposition that the fixed-rate loan agreements must be given effect where genuineness is not disputed.
CIT v. Motors & General Stores (P.) Ltd. [1967] 66 ITR 692 (Supreme Court)	In absence of bad faith or fraud, taxing statutes are applied according to the legal rights and document language; do not displace the legal effect of a transaction without reason.	The Tribunal used this precedent to bolster the assessee's argument that the loan contract terms should govern taxation absent evidence of sham.
CIT v. B.M. Kharwat [1969] 72 ITR 603 (Supreme Court)	The legal effect of a transaction cannot be displaced merely by probing substance where legal relations are correctly recorded; authorities must determine true legal relations from documents/conduct.	The Tribunal relied on this case to underline that recorded legal relations in a bona fide contract are to be respected in tax/TP analysis unless evidence indicates otherwise.
Vodafone International Holdings B.V. v. UOI [2012] 17 taxmann.com 202 (Supreme Court)	Onus is on Revenue to establish abuse or tax-avoidance before invoking judicial anti-avoidance principles; substance-over-form or piercing the veil is available only after establishing that the structure is sham or abusive.	The Tribunal cited Vodafone to stress that the Revenue must prove abuse or tax-avoidance before disregarding the legal form; absence of such proof here supported giving effect to the loan agreements and rejecting aggressive TP adjustments.
Reference to Skoda Auto India and Rule 10B(1)(a) of the Income-tax Rules, 1962	Rule 10B and related authorities concern selection of internal comparables under CUP; internal comparables must be transactions with independent parties.	Used in the Tech Mahindra discussion (as cited) to stress that internal comparables must be truly comparable and that currency/country-specific benchmarks are relevant; assisted the Tribunal in rejecting unsuitable internal comparables relied upon by Revenue.

Court's Reasoning and Analysis

The Tribunal undertook a stepwise analysis, confined to the materials and authorities cited in the record:

Methodological choice: The Tribunal accepted that the CUP method was the appropriate and most suitable method to determine arm's length price for the assessee's international transactions (sales and loan interest), consistent with the assessee's TP documentation and submissions.
Currency of the transaction controls benchmarking: The Tribunal agreed with the assessee's central submission that because the loan transaction was denominated in US dollars and advanced to a US subsidiary, comparables and benchmarking should reflect foreign-currency lending practices (i.e., international benchmarks such as LIBOR) rather than domestic rupee benchmarks. The Tribunal found support for this principle in several precedents (Siva Industries, Four Soft, Tech Mahindra, Tata Autocomp).
Assessment of TPO/AO approach: The Tribunal reviewed the TPO/AO's rationale for applying Indian domain rates and upward adjustments (17.26%). The TPO/AO had emphasized that the tested party was the Indian assessee and that Indian market expectations, transaction cost, absence of security, and single-customer risk justified a higher rate. The DRP however modified by directing application of RBI PLR (13.25%).
Precedent analysis: The Tribunal analysed the cited authorities and concluded those decisions support the proposition that foreign-currency intra-group loans should be benchmarked using internationally-recognised reference rates (LIBOR/EURIBOR as appropriate to the currency), and that currency/country of the borrower/debtor is material in selecting the benchmark. The Tribunal relied on case law (explicitly Siva Industries, Four Soft, Tech Mahindra, Tata Autocomp) for this principle.
Commercial reality and contractual terms: The Tribunal noted that the loan agreements were fixed-rate commercial contracts entered into in 2002–03 (fixing 4% interest), at a time when LIBOR was substantially lower than 4%. The Tribunal emphasised that these contracts were not shown to be sham or entered into for tax-avoidance — and that jurisprudence requires giving effect to bona fide commercial contracts unless revenue establishes abuse or sham (citing Supreme Court authorities including Union of India v. D.N. Revri & Co., Dharamvir Dhir, Motors & General Stores, B.M. Kharwat, and Vodafone).
Absence of profit-shifting motive: The Tribunal observed that the assessee's substantial profits were exempt under section 10B and the AE was in the United States (not a tax haven). Given these facts and authorities (Philips Software Centre, Zydus Altana), the Tribunal found no persuasive evidence of tax-motivated profit shifting that would warrant aggressive TP adjustments.
Available external comparables and market evidence: The assessee pointed to external borrowing arrangements (e.g., with Citibank) at rates less than 4% and historical LIBOR averages (for the years when the loans were contracted) that were below 4%. The Tribunal found these points supportive of the assessee's contention that the 4% rate was commercially reasonable and consistent with international benchmarks at the relevant times.
Conclusion from application of law to facts: On the combined footing — suitability of CUP, currency-specific benchmarking (LIBOR), bona fide fixed-rate contracts, lack of evidence of abuse, and available commercial comparables — the Tribunal concluded that the rate charged by the assessee (4%) constituted the arm's length price for the loan transactions in issue, and that no transfer pricing adjustment was warranted.

Holding and Implications

Holding: The Tribunal allowed the assessee's appeal and held that the rate of interest charged by the assessee on the USD-denominated loans to its US associated enterprise was the arm's length price; accordingly, no transfer pricing adjustment was called for in respect of the interest charged.

Implications and Consequences:

Direct effect: The AO/TPO/DRP's upward adjustment (which culminated in an addition by applying 13.25% per the DRP and an assessed adjustment of Rs. 47,45,416) was reversed in so far as it related to the interest charged on the USD-denominated loans; the assessee's position on the interest rate (4%) was accepted.
Benchmarks and methodology: The Tribunal reaffirmed that for foreign-currency intra-group loans the appropriate benchmarking must reflect international commercial practice and the currency of the transaction (LIBOR or relevant international reference), rather than applying domestic rupee benchmarks mechanically.
No finding of abuse/sham: Because the Tribunal found no evidence of sham or tax-avoidance purpose and the assessee's contracts were bona fide, it declined to disregard the contractual fixed-rate arrangements.
Precedential posture: The Tribunal applied and relied on existing authorities to reach its conclusion. The order does not purport to lay down a novel binding precedent beyond applying the cited jurisprudence to the facts of the case; the decision resolves the specific assessment-year dispute between the parties on these facts.

Result: Assessee's appeal is allowed.

Signed: Varsha (on behalf of the Bench). Order recorded and reasons provided in the Tribunal's judgment as summarised above.

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ORDER

Shamim Yahya, Accountant Member - This appeal by the Assessee is directed against the order of the Assessing Officer dated 19.10.2012 passed u/s. 143(3) read with section 144C of the I.T. Act.

2. The grounds raised read as under:-

1. On the facts and circumstances of the case, the order passed by the learned Assessing Officer under Section 143(3) read with Section 144C of the Act is bad both in the eye of law and on facts.

2. On the facts and circumstances of the case, the Assessing Officer has erred, both on facts and in law in assessing the income of the appellant Rs. 67,46,180/- as against income of Rs. 20,75,768/- declared by the assessee.

3. On the facts and circumstances of the case, the learned AO has erred both on facts and in law in making an addition of Rs. 47,45,416/- as difference in arm's length price determined by Transfer Pricing Officer (TPO) in pursuance of DRP's order & the appellant.

4. On the facts and circumstances of the case, the Hon'ble DRP has erred both on facts and in law In determining reasonable interest rate at 13.25% as against 4% determined and levied by the assessee in respect of loan advanced by it in US Dollar to its subsidiary company in U.S.A.

5. On the facts and circumstances of the case, the Hon'ble DRP has erred both on facts and in law in ignoring the contention of the appellant that the comparison made by the Transfer Pricing Officer for determining the rate of interest on a transaction of a loan availed by an Indian entity is unjustified.

6. On the facts and circumstances of the case, the Hon'ble DRP has erred both on facts and in law in ignoring the contention of the appellant that for the purpose of determining the rate of interest the currency in which the loan has been advanced has to be taken into consideration and the rate of interest cannot be based on the PLR rate of Reserve Bank of India in respect of Indian Rupees.

7. On the facts and circumstances of the case, the Hon'ble DRP has erred both on facts and in law in ignoring the contention of the appellant that the interest rate in respect of international transaction in foreign currency has to be in accordance with LIBOR.

8. On the facts and circumstances of the case, the Hon'ble DRP has erred both on facts and in law in the contention of the appellant that the adjustment on account of transaction cost by the TPO is per se on wrong assumption of facts.

9. On the facts and circumstances of the case, the Hon'ble DRP has erred both on facts and in law in ignoring the contention that this loan having been advanced at a fixed rate way back in the year 2002 and 2003, the interest rate cannot be varied or changed in the year under consideration.

10(i) That the above said addition has been made ignoring the detailed transfer pricing study made by the appellant for determining the arm's length price.

( ii) On the facts and circumstances of the case, the learned AO has erred both on facts and in law in making the above-said addition without qualifying comparable instance for rate of interest on the comparable transaction.

11. On the facts and circumstances of the case, the learned AO has erred both on facts and in law in ignoring the contention of the assessee that the variation of 5%, plus-minus arm's length interest determined will not be applicable in the case of the assessee ignoring the specific provisions of the Act.

12. On the facts and circumstances of the case Hon'ble DRP has erred hath on facts and in law in ignoring the contention of the appellant that the loan being advanced by parent company to the subsidiary company there was no need to make adjustment on account of security.

13. That the appellant craves leave to add, amend or alter any of the grounds of appeal.

3. The assessee in this case is a leading manufacturer of rider apparel. As per the 3CEB Report and TP document, the following are the details of the international transactions entered into by the taxpayer with its associated enterprises during the year 2006-07:-

Equestrian Apparel sold to JPC Equestrian Inc	Rs. 48191540/-
Loan provided to JPC Equestrian Inc	10,50,000 $
Interest received	Rs. 20,52,072/-

3.1 As per the TP document, CUP method has been chosen to bench mark the sale of apparel as well as interest received on loan. The assessee has contended that since the sale of apparel to uncontrolled enterprises are at a lower ate, the same are at Arm's Length. In the case of interest, the assessee has mentioned that it has received interest at a rate of 4% which is comparable with the export packing credit rate obtained from independent Banks in India.

3.2 The Transfer Pricing Officer noticed from the balance sheet of the tax payer for the A.Y. 2008-09 that certain amounts given as loans by the taxpayer to its associated enterprises were outstanding as on 31.3.2007. The amount of loan which has also been reported in Form 3CEB is $ 10,50,000. The TPO further observed that in a situation where Indian company has been chosen as the tested party, the comparable rates for benchmarking the interest have to be selected from the Indian domain. He observed that it is to be seen that what the assessee would have earned by giving loans in the Indian market. It cannot be compared with the rate of interest that the AE would have paid to some third party. The TPO held that the assessee cannot be compared to the Barclays Bank. That one has to see what the independent parties in comparable transactions would do i.e. if the same loan transactions takes place between two independent entities, what they would expect in terms of compensation for the loan transaction entered into between them. The Assessing Officer issued notices and obtained details from the tax payer. Assessing Officer observed that the tax payer has not submitted the financials of the subsidiary in the U.S. TPO summarized his views as under:-

"The above arguments of the Department can be summarized as under:-

(a) The tax payer has extended loan to its associated enterprise at 4%.

(b) Lending or borrowing is not one of the main businesses of the taxpayer.

(c) Two independent enterprise in the similar circumstances as that of the tax payer and its subsidiary would have charged arm's length interest as compensation for the financial facility provided by one party to another keeping in view the financials of the subsidiary and no security being offered.

(d) But for the relationship between the tax payer and its subsidiary, the tax payer would have earned interest on the loan extended by it in terms that an independent enterprise would have earned.

(e) The business prudence or necessity of advancing loans to subsidiary is not relevant for computing arm's length price in unrelated party transactions."

3.3 Transfer Pricing Officer further observed that tax payers has made loan to its AEs at @ 4% interest. That similar uncontrolled transaction would have provided for interest which is at arm's length. That the circumstances in which the tax payer and its subsidiary is operating i.e. what is the interest that would have been earned if such loans were given to unrelated parties in similar situation as that of subsidiary. TPO further observed that since the tested party is tax payer, the prevalent interest that could have earned by the tax payer by advancing a loan to an unrelated party in India with the same financial health as that of the tax payer's subsidiary is to be considered. However, the TPO noted that the tax payer has not submitted the financials of the subsidiary, the financial health of the subsidiary cannot be judged.

3.4 Assessing Officer further observed that it has been held that while deciding the interest that may be charged on receivables from AE's, Libor rate for calculating interest is not proper, as for calculating the cost factor of the assessee in India, the potential loss suffered by him is to be considered. Instead of US rate, Indian rate is to be adopted. Assessing Officer further observed that an independent person in India would expect the maximum return on its investment and if the lending rate is higher in Indian currency then he would not lend in foreign currency where the lending rate is not so attractive. Had the AE of the assessee been the tested party, then the labor rate would have been of any significance. That it should also not be forgotten that, had the AE of the assessee company would have got loan from any bank or FI in its state of residency at Libor rate, then why it did not avail of loan at such a rate. In view of the above, Assessing Officer proposed interest rate of 17.26% per annum (average yield on unrated bonds for the F.Y. 2007-08) to be adopted as the uncontrolled interest rate to arrive at the interest charged at arm's length.

3.5 TPO further observed that Indian companies go for External Commercial Borrowings as the interest rates on ECB loans are generally cheaper than the prevailing interest rates in the domestic market. That thus as can be seen that while borrowing money by X (in India) from Y (outside India), the interest rates are benchmarked with LIBOR and the interest rate above Libor is decided by the stand alone credit rating of X. That on the contrary, no company in India would like to invest in the form of loan outside India and that also without security as the interest returns in India would be higher than those prevailing in developed markets. Thus, while lending money by X (in India) and Y (Outside India), the interest rates would be benchmarked against those prevailing in India for investing in corporate bonds (which are without security). Thus the benchmarking rate for lending would be different from that of borrowing.

3.6 Assessing Officer further observed that if loan given to foreign entity is to be benchmarked with LIBOR or FCNR loan rates, then following is the manner in which the arm's length price would be arrived at:

(i) The prevailing rate of interest for foreign currency loans extended by Banks in India for companies with similar credit rating as that of the AE on stand alone basis.

(ii) The additional transaction costs for the tax payers to get similar loan by a Bank in India.

(iii) Adjustments needs to be made for the tax payer for credit risk/ single customer risk as it is not into lending and borrowing money. Banks spread their risk various customers whereas the same is not possible for the tax payer in its loan transactions. Thus the taxpayer has higher risk than the banker in lending money to its related party.

(iv) Adjustment needs to be made for no security offered by the related party. Banks generally ask for security even for foreign currency loans. But in the loan transaction between the taxpayer and the AE, there is no security provided by the AE to the tax payer.

3.7 After discussing the above facets the Assessing Officer concluded as under:-

"CUP rate is thus arrived at as under:-

	Basic interest rate for the credit rating of the AE	9.88%
	Add: Transaction cost	395 basis points
	CUP rate	13.83%
	Add: Adjustment for security	Not computed
	Final CUP rate >	13.83 + Adjustment for security + risk adjustment for single customer.

Keeping in view that no security is offered b y the subsidiary and also that the tax payer is not into lending and borrowing money, if the adjustments for risk of single customer, for security/ collateral, credit rating of AE of the assessee is also made, then the interest rate would reach almost the same rate of interest at 17.26%, which has been arrived at, in the 'primary' analysis done above, by relying upon the Bond Yield data supplied by the CRISIL.

The assessee has also not challenged / objected to the credit rating of the AE taken by the TPO at highest of the range (BB to D). Therefore, even going by the alternative calculation, the rate of interest arrived at 17.26% is fair and reasonable.

6. Computation of Arm's Length Price :

Based on the above, the arms length price of the international transactions entered into by the tax payer (providing financial facility in the form of working capital loan to its associated enterprises) is computed as under:-

6.1 Computation of Arms Length Price :

	The amount on which interest of Rs. 2052072 at 4% has been received	INR 5,13,01,800/-
	Arms Length Interest Rate	17.26% p.a.
	Arms length price @ 17.26% p.a. on the amount of Rs. 5,13,01,800/-	Rs. 88,54,691/-

6.2 Price received vis-a-vis the Arms Length Price :

The price charged by the tax payer at Rs. NIL in the form of interest to its Associated Enterprises is compared to the Arms Length Price or interest as under:-

	Arms length interest	- Rs. 88,54,691/-
	Interest received	- Rs. 20,52,072/-
	Shortfall being adjustment u/s 92CA	- Rs. 68,02,619/-

The above amount of Rs. 68,02,619/- is treated as an adjustment u/s. 92CA."

4. Against the above order the Assessee filed objections before the DRP.

5. The assessee inter-alia submitted that the comparison has to be made with respect of advance or loan in USA and not based on Indian conditions. The comparison could also be with rate of interest being paid by the multinational companies or banks in respect of money borrowed from India. After considering the various objections of the assessee the DRP concluded as under:-

"7.2 We have examined the issue and we agree with the TPO that no security was offered by the subsidiary and the main business of the assessee was not lending and borrowing money. We find that the AE being new did not have adequate credit rating in USA so the Indian parent company gave the loan; hence a transaction cost needs to be loaded. This factor would have to be taken into account for computing arms's length price. Further, loan was given on fixed rate of interest out of share holders. In reality both sets of shareholders are same and security aspect is therefore, embedded by default in this transaction. In the circumstances, there is no requirement for further addition on account of security. However, we are of the opinion that the Arm's length interest rate may be taken as the PLR of RBI for the financial year 2007-08. The TPO is directed accordingly.

9. Directions under section 144(c) of the I.T. Act.

The DRP after considering all arguments of the assessee and submissions of TPO/Assessing Officer as well as evidences on record has passed the above order.

In view of discussion on each of the grounds of objection, the Assessing Officer is directed to complete the assessment according to the direction of the DRP as above. The objections of the assessee are disposed off as above."

6. In pursuant to the directions from the DRP, TPO recomputed the ALP on interest as under:-

The amount on which interest of Rs. 2052072 at 4% has been received.	Rs. 5,13,01,800/-
Arm's length interest rate as directed by DRP	13.25%
Arm's length price of the above interest	67,97,488

The total adjustment as per the DRP directions is as below:-

Arms length interest @ 13.25%	Rs. 67,97,488/-
Interest received	Rs. 20,52,072/-
Shortfall being adjustment u/s. 92CA	Rs. 47,45,416/-

7. Against the above order the assessee is in appeal before us.

8. We have heard the rival contentions in light of the material produced and precedent relied upon.

9. The assessee's submissions are as under:-

"1. The assessee is a company engaged in the business of manufacturing & export of Ready made Garments. During the asstt. year 2008-09 following were the transactions with its associated enterprises -

	Equestrian Apparel sold to JPC Equestrian Inc. USA	Rs. 4,81,91,540/-
	Loan provided to JPC Equestrian Inc. USA	$10,50,000
	Interest received	Rs. 20,52,101 /-

2. The CUP method was chosen to bench mark the sale of apparel as well as interest received on loans.

3. The case was referred to the Transfer Pricing Officer. The Ld. TPO vide its order dated 28.10.2011, determined the arm's length price. In its order, the Ld. TPO accepted the arm's length price determined by the assessee in respect of the sale of apparel to the Associated Enterprises. However, in respect of interest on the loan advanced by the assessee to its Associated Enterprise @ 4% per annum was considered to be not at arm's length. The Ld. TPO by making comparison with uncomparables like government bonds and the amount advanced by the Indian banks in foreign currency to entities in India and by making arbitrary additions of transaction cost, security and risk etc. to such rate determined the arm's length rate of interest at 17.26% per annum and proposed an addition of Rs. 68,02,619/-.

4. The assessee carried the matter to DRP and made detailed submissions (PB Pg 278-293). The DRP ignoring all the contentions surprisingly held that loan is in Indian currency hence LIBOR is not the relevant rate and ordered that PLR (Prime Lending Rate of RBI for FY 2007-08 be applied. AO accordingly applied the PLR of 13.25% and made addition of Rs 47,45,416 which is subject matter of appeal. This is the only point of dispute.

5.0 Arm's Length Rate of Interest in case of amount advanced in foreign currency

5.1 The points on this issue which emerge from the decisions of Hon'ble Tribunal in various cases discussed hereinafter are :-

CUP method is the most appropriate method in order to ascertain arm's length price of the aforesaid international transaction. (In this case also, the method adopted is CUP method)

Where the transaction was of lending money, in foreign currencies, to its foreign subsidiaries, the comparable transaction, therefore, was of foreign currency lended by unrelated parties.

The financial position and credit rating of the subsidiaries will be broadly the same as the holding company.

If that was so, then the domestic prime lending rate would have no applicability and the international rate fixed being LIBOR would come into playas it is the mostly used and recognised benchmark rate for international loan.

5.2 In the case of Siva Industries & Holdings Ltd. v. Asstt. CIT [2011] 11 taxmann.com 404 (Chennai - ITAT), the assessee had granted a loan of Rs. 50 crores to its subsidiary in Mauritius for the purpose of making investments and had charged interest at the rate of 6 per cent per annum. The issue was referred to the TPO. Before the TPO it was submitted that the average of 12 months US $ denominated LIBOR rate for the period 1-4-2005 to 31-3-2006 was 4.42 per cent and consequently no addition on account of the arm's length interest rate was liable to be made. The Assessing Officer had taken a view that the US$ denominated LIBOR rate could not be considered as the loan was given from India and the prime lending rate in India was to be considered. Consequently, the Assessing Officer had determined the rate at 11.75 per cent and the difference to the extent of Rs. 45,23,817.53 was added to the assessee's income. The assessee submitted that the prime lending rate was a domestic rate and the transaction done by the assessee was an international transaction for which the LIBOR rate was to be applied. It further submitted that the RBI had also given directions wherein it was specifically mentioned that the LIBOR rate was to be applied. Therefore, it prayed for the deletion of addition to the total income as made by the AO. The Tribunal held that the assessee had given the loan to the associated enterprises in US dollars, and assessee was also receiving interest from the associated enterprises. Once the transaction between the assessee and the associated enterprises was in foreign currency and the transaction was an international transaction, then the transaction would have to be looked upon by applying the commercial principles in regard to international transaction. If that was so, then the domestic prime lending would have no applicability and the international rate fixed being LIBOR would come into play. In the circumstances, the view that LIBOR rate had to be considered while determining the arm's length interest rate in respect of the transaction between the assessee and the associated enterprises was to be upheld. As it was noticed that the average of the LIBOR rate for 1-4-2005 to 31-3-2006 is 4.42 per cent and the assessee had charged interest at 6 per cent which was higher than the LIBOR rate, no addition on this count was liable to be made in the hands of the assessee. In the circumstances, the addition made by the Assessing Officer on this count was deleted.

5.3 In the case of M/s Four Soft Ltd, Hyderabad v. DCIT (ITA No. 1495/Hyd/2010), Hon'ble Tribunal held as below:

"We have considered the rival submissions and perused the materials available on record. We do not find any merit in the arguments of the learned departmental representative as we find that the ALP is to be determined for the international transaction, that is, on international loan and not for the domestic loan. Hence, the comparable, in respect of foreign currency loan in the international market, is to be LIBOR based which is internationally recognised and adopted. In our considered view, the DRP rightly directed the assessing officer to adopt the LIBOR plus for the purpose of TP adjustment. Our view is fortified by the decision of the Madras Bench in the case of Siva Industries ( supra). We do not find any merit in the arguments of the learned counsel for the assessee that the DRP should have adopted the EURIBOR for the purpose of the TP adjustments, as we find that the mostly used and recognised benchmark rate for international loan is LIBOR based. Hence, the DRP rightly directed the assessing officer to adopt the LIBOR rates. We confirm the directions of the DRP. However, by considering the contentions of the learned counsel for the assessee that the actual LIBOR was 4.42% as against the 5.78% approved by the DRP, we find it proper to restore this issue to the file of the assessing officer, to verify the correctness of the claim made by the assessee company. In view of this matter, we remit this matter to the file of the assessing officer to verify the actual average LIBOR prevailed in the financial year relevant to the assessment year under consideration and adopt the interest rate 4.42% if the claim of the assessee is found correct. The ground raised by the assessee on this issue is partly allowed for statistical purpose."

5.4 The Mumbai Bench in case of Dy. CIT v. Tech Mahindra Ltd. [2011] 46 SOT 141 (URO)/12 taxmann.com 132 (Mum.) for Assessment Year (AY) 2004-05, held that the arm's length price in case of interest on extended credit period allowed to an Associated Enterprise (AE) based in USA shall be determined on the basis of USD London Inter Bank Offer Rate (LIBOR) instead of applying the rate of interest pertaining to EURO denominated loan charged to AE based in Germany since the AE was based in USA. The facts of the case were that the Assessee in that case was a joint venture between Mahindra & Mahindra Limited (Indian company) and British Telecommunications (UK Company), was engaged in rendering of software services relating to telecommunication, internet technology and engineering etc. During the previous year, the taxpayer had extended credit beyond the stipulated credit period to its AE based in USA without charging any interest on such extended credit period. During the assessment proceedings, the TPO rejected taxpayer's arguments and determined the arm's length interest for such extended credit period to US AE at the rate of 10 percent per annum. The TPO determined this rate based on the rate of interest charged by the taxpayer on Euro denominated loan granted to its German AE. The resultant transfer pricing adjustment amounted to INR 1.87 crores. The AO adopted the adjustments made by the TPO. Aggrieved by the decision of the AO, the taxpayer filed objections before the Commissioner of Income Tax (Appeals) [CIT(A)]. The CIT(A) confirmed the transfer pricing adjustment, however, restricted the same to 2 percent based on the USD LIBOR rate plus 80 basis point mark-up. Aggrieved by the order of the CIT(A), that AO filed an appeal before the Tribunal. The Tribunal held that the TPO made an error in selecting the transaction of charging of interest to German AE on loan granted at the rate of 10 percent per annum as internal comparable. Following the position settled in case Skoda Auto India and Rule 10B(1(a) of the Income-tax Rules, 1962, to be,. an internal comparable under the Comparable Uncontrolled Price (CUP) method, the transaction needs to occur between the taxpayer and an independent party. Even assuming that the adjustment for extended credit was necessary, USD LIBOR is more appropriate basis than the rate of interest on Euro denominated loan considering the fact that the AE is based in USA and commercial principles and practices related to USD denominated extended credit. The Tribunal has also made a crucial point that the arm's length interest rate should be taken from the country of the borrower/debtor, i.e. the rate of interest to be used for benchmarking shall be the rate of interest in respect of the currency in which the underlying transaction has taken place in consideration of economic and commercial factors around the specific currency denominated interest rate.

5.5 Mumbai Tribunal in the case of Tata Autocomp Systems Ltd. v. Asst. CIT[2012] 21 taxmann.com 6 (Mumbai - Trib.) also held that lending or borrowing money between two associated enterprises comes within the ambit of international transaction and whether the same is at arm's length price has to be considered. The question of rate of interest on the borrowings is an integral part of arm's length price determination in this context. The fact that the loan has the RBI's approval does not put a seal of approval on the true character of the transaction from the perspective of transfer pricing regulation as the substance of the transaction has to be judged as to whether the transaction is at arm's length or not. Further, CUP is the most appropriate method for determining ALP in the present case. In this case the Tribunal held as below:

"In the present case the AE is a German company. Eurobior rates are based on the average interest rates at which a panel of more than 50 European banks borrow funds from one another. There are different maturities, ranging from one week to one year. These rates are considered to be the most important rate in the European money market. The interest rates do provide the basis for the price and interest rates of all kinds of financial products like interest rate swaps, interest rate futures, saving account and mortgages. We find that the RBI in respect of export credit to exporters at internationally competitive rates under the scheme of pre-shipment credit in foreign currency (PCFC) and Rediscounting of Export Bills abroad (EBR), has permitted banks to fix the rates of interest with reference to ruling LIBOR, EURO LIBOR or EURIBOR, wherever applicable and thereto appropriate percentage ranging from 1% to 2%. The reference to the said circular is at page -80 of the Assessee's paper book. In our view the claim of the Assessee to adopt EURIBOR rate as stated before the TPO is reasonable and deserves to be accepted. Following the ruling of the tribunal in the aforesaid cases, we are of the view that the claim made by the Assessee in this regard has to be accepted. The AO is directed to work out the TP adjustment accordingly.

6.0 DRP makes a wrong (reverse) comparison of a loan availed by Indian entity in India

6.1 The DRP has misdirected itself by observing that is Indian Currency. As is evident from the agreements (PB Page 162-167) the loan is in US $ advanced to an entity even interest is to be computed in US$. Thus the application of PLR of RBI which is a bench mark for interest rate in rupee and that too in India is not correct. The DRP instead of making the comparison with the comparables, made a comparison with the loan advanced in India by an entity in foreign currency ignoring that the comparison is to be made not of a loan in India but of loan in the US. The comparison was to be made with respect to interest rate prevalent in the US.

7. Assessee has availed loan at much lower rate from Citi Bank

7.1 In the present case, Cotton Natural (I) Pvt Ltd. has arrangements for loan with Citi Bank for less than 4% However, for the loan provided to its AEs, it has charged 4% p.a. interest (Page No. 162-167 of the Paper Book). Another company also had taken loan from Citi Bank at 4% (Page No. 179 onwards of the Paper Book shows interest rate of 3.37%. Hence both internal and external rate of interest is available. Applying the ratio, no adjustment was called for.

7.2 Labor Rate in March, 8 - 2.7088%

The LIBOR rate during the March 08 was 2.7088% and which being less than the interest charged by assessee no adjustment is required in ALP.

8.0 The loan agreement with AE is entered into 2002 and 2003 with fixed rate of interest.

8.1 The assessee has entered into following loan transactions with its associated enterprises -

AE	Loan amount	Date	Rate of interest (fixed)	LIBOR Annual average Rate (relevant month ending)
JPC Eques trian Inc. (USA)	$1,50,000	13.04.2002	4%	2.613%
JPC Eques trian Inc. (USA)	$50,000	7.09.2003	4%	1.286%
JPC Eques trian Inc. (USA)	$50,000	7.9.2003	4%	1.286%

8.2 The CUP method was chosen to bench mark interest received on loans. As per the transfer pricing study and the audit, the international transaction entered into by the assessee both in respect of sale of apparels as well as interest of loan advanced to its subsidiary was found to be at arm's length.

8.3 The Agreement is for fixed rate of interest and when the agreement was entered into with AE, the L1BOR, which is the accepted by the Hon'ble Tribunal in all cases as the most suitable benchmark for judging ALM in case of foreign currency loans, was well below the rate fixed by the taxpayer in this case. The L1BOR for two years are given below:

1 Year USOR

Month	2002	2003
Jan	2.420%	1.477%
Feb	2.496%	1.368%
Mar	3.006%	1.340%
Apr	2.613%	1.362%
May	2.634%	1.221%
Jun	2.251%	1.201%
Jul	2.070%	1.279%
Aug	1.943%	1.471%
Sep	1.813%	1.286%
Oct	1.664%	1.455%
Nov	1.705%	1.487%
Dec	1.447%	1.458%

8.4 At that time the rate of interest was declining. Hence it was in the best interest to go for fixed rate of interest. At that time, rate of interest was much less than 4% in USA for which comparable was also provided. In the present case, Cotton Natural (I) Pvt Ltd. has also arrangements for loan with Citi Bank for less than 4%. However, for the loan provided to its AEs, it has charged 4% p.a. interest. Another 'group company also had taken loan from Citi Bank at less than 4%. It is not the case of revenue that the agreement is Sham or Tax Avoidance agreement.

9.0 Loan Agreement is valid and can't be ignored.

9.1 Business is done through agreements and contracts. What is paid or what is received by the assessee is dependent on the terms of agreements. The question may arise as to whether the Assessing Officer has power to disregard the agreement and disallow any payment even if the same is as per the terms of agreement. The Supreme Court in Union of India v. D.N. Revri & Co. AIR 1976 SC 2257 have observed that a contract being a commercial document between the parties must be interpreted in such a manner as to give efficacy to the same rather than to invalidate it, and that it would not be right while interpreting a contract entered into between the two parties to apply the strict rules of construction which are ordinarily applicable to a conveyance and other formal documents. The meaning of such a contract must be gathered by adopting a commonsense approach and it must not be allowed to be thwarted by a narrow, pedantic and legalistic interpretation.

9.2 In the case of Dharamvir Dhir v. CIT [1961] 42 ITR 7 (SC) the assessee entered into a coal raising contract and because of insufficient funds, he entered into an agreement with a trust to procure finance, and agreed to pay, in addition to interest, portion of the profits. The lender could withdraw its money at any time, and was not responsible for losses. The assessee showed the payment not in his 'profit and loss account', but in his 'profit and loss appropriation account'. The question was whether the payment was an expenditure of the assessee or whether the method of accounting showed that the assessee was only parting with the share of profits. The genuineness of the document had not been challenged. The Supreme Court held that the case had to be decided on the tenor of the document as it stood and in view of the circumstances of the case. Hence, the assessee was not parting with share of profits, but the payment made by it to the trust was an expenditure laid out wholly and exclusively for the purposes of business.

9.3 In CIT v. Motors & General Stores (P.) Ltd. [1967] 66 ITR 692 it was held by the Supreme Court that in the absence of any suggestion of bad faith or fraud, the true principle was that the taxing statute had to be applied in accordance with the legal rights of the parties to the transaction. When the transaction is embodied in a document, the liability to tax depends upon the meaning and content of the language used in accordance with the ordinary rules of construction.

9.4 In ClT v. B.M. Kharwat [1969] 72 ITR 603 the Supreme Court again reiterated that the legal effect of a transaction cannot be displaced by probing into the substance of the transaction. It was further held that the taxing authorities were bound to determine the true legal relation resulting from a transaction, where the legal relation was recorded in a formal document or it had to be gathered from evidence and the conduct of the parties to the transaction.

9.5 Very recently in a landmark decision, Hon'ble Supreme Court in the case of Vodafone International Holdings B.V. v. UOI [2012] 17 taxmann.com 202 (SC) held that when, it comes to taxation of a Holding Structure, at the threshold, the burden is on the Revenue to allege and establish abuse, in the sense of tax avoidance in the creation and/or use of such structure(s). In the application of a judicial anti-avoidance rule, the Revenue may invoke the "substance over form" principle or "piercing the corporate veil" test only after it is able to establish on the basis of the facts and circumstances surrounding the transaction that the impugned transaction is a sham or tax avoidant. To give an example, if a structure is used for circular trading or round tripping or to pay bribes then such transactions, though having a legal form, should be discarded by applying the test of fiscal nullity. Similarly, in a case where the Revenue finds that in a Holding Structure an entity which has no commercial/business substance has been interposed only to avoid tax then in such cases applying the test of fiscal nullity it would be open to the Revenue to discard such inter-positioning of that entity. However, this has to be done at the threshold. In this connection, one may reiterate the "look at" principle enunciated in W.T. Ramsay Ltd. case ( supra) in which it was held that the Revenue or the Court must look at a document or a transaction in a context to which it properly belongs to. It is the task of the Revenue/Court to ascertain the legal nature of the transaction and while doing so it has to look at the entire transaction as a whole and not to adopt a dissecting approach. The Revenue cannot start with the question as to whether the impugned transaction is a tax deferment/saving device but that it should apply the "look at" test to ascertain its true legal nature…..Applying the above tests, it can be said that every strategic foreign direct investment coming to India, as an investment destination, should be seen in a holistic manner. While doing so, the Revenue/Courts should keep in mind the following factors: the concept of participation in investment, the duration of time during which the Holding Structure exists; the period of business operations in India; the generation of taxable revenues in India; the timing of the exit; the continuity of business on such exit. In short, the onus will be on the Revenue to identify the scheme and its dominant purpose. The corporate business purpose of a transaction is evidence of the fact that the impugned transaction is not undertaken as a colourable or artificial device. The stronger the evidence of a device, the stronger the corporate business purpose must exist to overcome the evidence of a device.

10.0 Assessee's profits are exempt under section 10B

10.1 In the case of Perot Systems TSI (India) Ltd. v. Dy. CIT [2010] 37 SOT 358/130 TTJ 685/5 ITR (Trib.) 106 (Delhi), on which the Ld. TPO put reliance, Hon'ble Delhi Tribunal held that lending or borrowing money between two associated enterprises comes within the ambit of international transaction and whether same is at ALP, has to be considered. It was held that not charging of interest on loan by assessee from AEs resulted in higher income in hands of AEs and income of assessee in India was reduced by corresponding amount. Hence, it made loan transaction in question violative of TP provisions as mentioned under section 92B and the contention of having actually not earned any income could not come to the rescue of assessee.

10.2 In this case one of the arguments of the TPO was that one of the AEs was situated in a tax heaven and not charging of the interest by the assessee from the AEs, would result in higher income in the hands of the AEs, and the income of the assessee in India would reduce by the corresponding amount. Thus, this would bring down the overall tax incidence of the group by shifting profit from the Indian jurisdiction to Bermuda which was a tax heaven country with zero rate of tax on corporate profit.

Hence, as per Hon'ble Tribunal, it was a classic case of the violation of transfer pricing norms where profits were shifted to tax heavens or low tax regimes to bring down the aggregate tax incidence of a multinational group.

10.3 This is not the position in present case. While the substantial income of assessee is tax exempt u/s 10B, the AE is also not situated in tax heaven. There was no incentive to shift Indian income to AE.

10.4 Hon'ble Bangalore Tribunal in the case of Philips Software Centre (P.) Ltd. v. Asstt. CIT, Circle 12(2) [2008] 26 SOT 226 (Bang.) held that the basic intention behind introducing transfer pricing provisions in the Act is to prevent shifting of profits outside India and where an assessee is entitled to claim benefit under section 10A. transfer pricing provisions ought not to be applied. Hence, unless TPO/AO has established that assessee has manipulated prices to shift profits outside India, as per CBDT Circular No. 14/2001, transfer pricing provisions ought not to be applied to such a case.

The assessee is not contesting that transfer pricing provisions are not applicable but only arguing that it has no intention to avoid taxes.

10.5 Hon'ble Mumbai Tribunal very recently in the case of ITO v. Zydus Altana Healthcare (P.) Ltd. [2011] 44 SOT 132 (Mum.), observed that the assessee's submission that its profits were 'exempt under section 10B carried lot of substance because the assessee was in no way benefited by charging 5 per cent mark-up as against 17.14 per cent fixed by the TPO because in any view of the matter, the profits were exempt. The assessee had also pointed out that the profits by the AEs had been subjected to tax in the respective overseas jurisdiction and, therefore, there was no necessity for the assessee to transfer the profits to any overseas jurisdiction. This aspect should not have been lost sight of while examining the issue. In view of above, there was no infirmity in the order of the Commissioner (Appeals) and, accordingly, the same was to be upheld.

10.6 In the present case also, the assessee's substantial profits are exempt under section 10B and AEs are not situated in tax heavens but in US where the tax rates are at par with India or may be more than that.

10.7 As per the CBDT Circular (Circular No. 12/2001, DATED 23-8-2001), the intention underlying the provision is to prevent avoidance of tax by shifting taxable income to a jurisdiction outside India by an associate enterprise controlling the prices charged in intra-group transactions. The CBDT circular explains the objective of this provision in following manner:

"The new provision is intended to ensure that profits taxable in India are not understated (or losses are not overstated) by declaring lower receipts or higher outgoings than those which would have been declared by persons entering into similar transactions with unrelated parties in the same or similar circumstances. The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charged or paid in international transactions, thereby eroding the country's tax base. The new section 92 is, therefore, not intended to be applied in cases where the adoption of the ALP determined under the regulations would result in a decrease in the overall tax incidence in India in respect of the parties involved in the international transaction.

10.8 Hence, erosion of Indian tax base is one of the prime objectives behind insertion of new TP Provisions. In the present case, as discussed above, there is no erosion of tax base in India."

10. Ld. Departmental Representative relied upon the order of TPO and the DRP.

11. We have carefully considered the submissions and perused the records, we find that the assessee company in this case is a leading manufacturer of rider apparel. Assessee entered into international transaction as under:-

Equestrian Apparel sold to JPC Equestrian Inc	Rs. 48191540/-
Loan provided to JPC Equestrian Inc	10,50,000 $

12. As per the TP document, CUP method has been chosen to bench mark the sale of apparel as well as interest received on loan. The TPO accepted the assessee's submission qua sale of apparel that the same was at arms length. As regards interest the assessee mentioned that it has received interest at a rate of 4% which was comparable with the export packing credit rate obtained from independent banks in India. The TPO was not in agreement with the above contention of the assessee. He observed that it is to be seen that what the assessee would have earned by giving loans in the Indian market. He noted that lending or borrowing is not one of the main business of the taxpayer. He opined that what is to be considered is the prevalent interest that could have been earned by advancing a loan to an unrelated party in India with the same financial health as that of the tax payer's subsidiary. The TPO further observed that the taxpayer has not submitted the financial of the subsidiary, hence the financial healthy of the subsidiary cannot be judged. The TPO further noted that while deciding the interest rate that may be charged on receivables from AE's, Libor rate for calculating interest is not proper. He opined that instead of US rate, Indian rate is to be adopted. He observed that an independent person in India would expect the maximum return on its investment, and if the lending rate is higher in Indian currency then he would not lend in foreign currency where the lending rate is not so attractive. The TPO further noted that it should not be forgotten that, had the AE of the assessee company would have got loan from any bank or financial institution in the place of residency at Libor rate, then why it did not avail of loan at such a rate. Assessing Officer observed that, no company in India would like to invest in the form of loan outside India and that also without security as the interest returns in India would be higher than those prevailing in developed markets. Finally, Assessing Officer held that interest rate at 17.26% would be fair and reasonable.

13. Before the DRP assessee inter-alia contended that comparison has to be made with respect of advance or loan in USA and not based on Indian conditions. The comparison could also be with rate of interest being paid by the multinational companies or banks in respect of money borrowed from India. However, the DRP agreed with TPO's point of view. But, it held that further addition on account of security is not needed. It opined that Arm's length interest rate may be taken as the PLR of RBI for the financial year 2007-08. In accordance with the above decision, the TPO adopted 13.25% as the rate of arms length interest rate.

14. We note that CUP method is the most appropriate method in order to ascertain arms length price of the international transaction as that of the assessee. We agree with the assessee's contention that where the transaction was of lending money in foreign currency to its foreign subsidiaries the comparable transactions, therefore, was of foreign currency lended by unrelated parties. The financial position and credit rating of the subsidiaries will be broadly the same as the holding company. In such a situation, domestic prime lending rate would have no applicability and the international rate fixed being LIBOR should be taken as the benchmark rate for international transactions.

15. The above view is duly supported by following case laws relied upon by the assessee's counsel. In Siva Industries & Holdings Ltd. v. Asstt. CIT [2011] 11 Taxmann.com 404 (Chennai) it was held by ITAT that the assessee had given the loan to the associate enterprise in U.S. dollars, and in such a situation when the transaction was in foreign currency, and the transaction was an international transactions, then the transaction would have to be looked upon by applying the commercial principles in regard to international transactions. In such a situation domestic prime lending would have no applicability and the international rate fixed being LIBOR rate would have to be adopted.

16. Similar view as above was expressed by the ITAT in the case of Four Soft Ltd. v. Dy. CIT [IT Appeal No. 1495 (Hyd.) of 2010], Dy. CIT v. Tech. Mahindra Ltd. [2011 46 SOT 141 (URO)/12 Taxmann.com 132 (Mum.) ], Tata Autocomp Systems Ltd. v. Asstt. CIT [2012] 21 Taxmann.com 6 (Mum.) .

17. We further note that assessee has arrangement, for loan with Citi Bank, for less than 4%. However, for loan provided to its AE's it has charged 4% p.a. interest. Hence, adjustment suggested by the TPO is not warranted.

18. We further note that assessee's profits are exempt u/s. 10B. Hence, there is no case that assessee would benefit by shifting profits outside India. This view is supported by Bangalore Tribunal decision in this case Philips Software Centre (P.) Ltd. v. Asstt. CIT [2008] 26 SOT 226 and Mumbai Tribunal in the case of ITO v. Zydus Altana HealthCare (P.) Ltd. [2011] 44 SOT 132 .

19. We further note that in this case the loan agreement was for fixed rate of interest. The LIBOR has been accepted in decision referred above as the most suitable bench mark for judging Arms' length price in case for foreign currency loan. Hence, adjustment as made by the TPO is not warranted.

20. In the background of the aforesaid discussions and precedents, we hold that the rate of interest charged by the assessee for the loans transactions with the AE was Arms Length Price. Hence, no transfer pricing adjustment is called for.

21. In the result, the Assessee's appeal is allowed.

Varsha