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Facts
JE Energy Ventures Private Limited, a holding company, provided corporate guarantees for two loans from EXIM Bank totaling USD 95 million to its step-down foreign subsidiaries, JEBV and JEHBV. The TPO proposed an Arm's Length Price (ALP) adjustment of INR 12,32,98,585 for these corporate guarantees, considering them international transactions and applying the Hull-White model. The Dispute Resolution Panel (DRP) upheld this adjustment. The subsidiaries defaulted on the loans in May 2016, leading to EXIM Bank initiating recovery proceedings against the assessee as the primary guarantor.
Held
The Tribunal held that since the subsidiaries defaulted on the loans in May 2016 and recovery proceedings were initiated against the assessee, the corporate guarantee ceased to exist as an international transaction at the beginning of the assessment year under consideration. Therefore, the TPO was incorrect in initiating benchmarking proceedings for this assessment year, and the proposed addition was directed to be deleted.
Key Issues
1. Whether the provision of corporate guarantee constitutes an international transaction under Section 92B of the Income Tax Act, 1961. 2. The appropriateness of the Hull-White model for benchmarking corporate guarantees, especially after the borrower's default. 3. Whether a corporate guarantee, once invoked due to default, can still be considered an existing international transaction for the current assessment year. 4. Whether the amount payable by the appellant on invocation of corporate guarantee is an allowable expenditure under Section 37(1).
Sections Cited
143(3), 144C(13), 144B, 92B, 270A, 234A, 234B, 234C, 234D, 37(1), 92CC(4), Chapter X
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Income Tax Appellate Tribunal, DELHI BENCH ‘I’: NEW DELHI
Assessee by Shri K.M. Gupta, Adv. & Ms. Shruti Khimta, AR Department by Shri Rajesh Kumar, CIT-DR Date of Hearing 11/06/2024 Date of Pronouncement 05/07/2024 ORDER PER S.RIFAUR RAHMAN, AM: 1. . This appeal has been filed by the Assessee against the final assessment order dated 27/01/2022 passed U/s 143(3) r.w.s.144C (13) r.w.s 144B of the Income Tax Act, 1961 (hereinafter called ‘the Act’) subsequent to the direction of the Ld. Dispute Resolution Panel (DRP) vide direction dated 08/12/2021 for Assessment Year 2017-18.
J E Energy Ventures Private Limited vs. DCIT
The assessee has raised the following grounds of appeal:-
“1. That on the facts and circumstances of the case and in law; 1.1 The Learned Assessing Officer ('Ld. AO') / Learned Transfer Pricing Officer ('Ld. TPO') have erred in assessing the income of the Appellant at INR 3.99.52,039/- as against the returned loss declared by the Appellant at INR 8,34,02,439/-. 1.2 The Ld. AO/ Ld. TPO have erred in enhancing the income of the Appellant by INR 12,32,98,585/- by: 1.2.1 incorrectly considering the provision of corporate guarantee as an international transaction u/s 92B of the Income-tax Act 1961 ('the Act'); 1.2.2 incorrectly holding that the international transaction of provision of corporate guarantee to its Associated Enterprises ('AEs') do not satisfy the arm's length principle envisaged under the Act; 1.2.3 ignoring the fact that no service subsists after default of loan by the borrower thus warranting no payment of corporate guarantee fees. 1.2.4 ignoring the fact that the Hull-White model has no legal recognition under the Income Tax Act, 1961. 1.2.5 ignoring the fact that critical variables required for application of Hull-White model were not available/ applied incorrectly and therefore, TPO's benchmarking of the international transaction of provision of corporate guarantee is erroneous. 1.2.6 incorrectly holding that the Appellant has undertaken risk on behalf of its AEs and there is an inherent cost in providing corporate guarantees for which the Appellant should have charged a consideration; 1.2.7 disregarding the fact that the provision of corporate guarantee to the AEs was in the nature of shareholder activity; 1.2.8 disregarding the fact that in absence of the corporate guarantee provided, the Appellant being the holding company would have provided the funds to the subsidiary by increasing the share capital, and thus, the guarantee provided should be treated as quasi-equity in nature for which arm's length compensation is not required;
1.2.9 imputing the corporate guarantee commission of 2.01% based on adhoc model without any veracity.
J E Energy Ventures Private Limited vs. DCIT 1.2.10 the Ld. TPO has grossly erred by not selecting the most appropriate method for benchmarking the subject international transaction; and 1.3 That the Ld. AO erred in initiating penalty proceedings under section 270A of the Act. 1.4 That on the facts and circumstances of the case, and in law the Ld. AO has grossly erred by proposing to compute interest under sections 234A, 234B, 234C and 234D of the Act mechanically and without recording any satisfactory reasons for the same. The above grounds are without prejudice to each other. The Appellant craves leave to alter, amend or withdraw all or any of the Grounds of Objections contained herein or add any further grounds as may be considered necessary either before or during the hearing of the objections.”
The brief facts relating to the appeal under consideration are, the assessee had filed its return of income declaring total loss of Rs.834,02,439/- and case was selected for complete scrutiny under CASS. Accordingly, the notices u/s 143(3) and 142(1) were issued and served on the assessee. The assessee is engaged in the business of providing support and other services of Air Charter, leasing, trading, lending finance business and investments. The issue under consideration is, the assessee is holding company of two step down foreign companies wherein the assessee holds majority share holdings and the step down foreign subsidiaries has availed loans from EXIM bank and assessee being holding company provided primary guarantee for the obligations for its foreign subsidiary companies. When the matter was selected for this purpose and referred to Transfer Pricing Officer (TPO), he proposed for ALP adjustment for corporate guarantee fees adopting
J E Energy Ventures Private Limited vs. DCIT Hull-White method for bench marking the transaction. Aggrieved, the assessee preferred an appeal before Dispute Resolution Panel (DRP) and after considering the submissions of the assessee, they sustained the ALP adjustment proposed by the TPO. Aggrieved with the above order, the assessee is in appeal before us.
4. At the time of hearing, the Ld. AR of the assessee has submitted brief facts of the case and his submissions are as under:- 1.1 Jubilant Energy Ventures Private Limited ('JEPL'/the 'Company'/ the 'Appellant') is a strategic 'venture business' segment of Jubilant Bhartia Group. JEPL, through its alliances with international companies, provides business, marketing and technical support related to oil and gas services, power and infrastructure services and aviation related services (sales/maintenance of aircrafts and helicopters).
1.2 The Appellant provided corporate guarantee for two loan arrangements between its AEs and EXIM Bank. The Appellant is the ultimate holding company having 100% shares of Jubilant Energy Holding BV ('JEHBV'). JEHBV holds 84.02% shares of Jubilant Energy NV ('JENV') which indirectly holds 100% share in Indian subsidiaries. The detailed holding structure is placed at page 62 of Paperbook. The details of the loan arrangement are as follows:
J E Energy Ventures Private Limited vs. DCIT
Parties/AE’s Amount of Loan Date of Loan Date of Loan (USD Million) availed/Period Default by AEs/NPA declared by bank Loan 1 Jubilant Energy USD 50 million 1st August, 2011 May 2016 BV (‘JEBV’) and EXIM Bank Loan 2 Holding BV USD 45 million 9th January May 2016 (‘JEHBV’) and 2014 EXIM Bank Loan 1 In August 2011, JEBV has entered into a loan arrangement with EXIM Bank for USD 50 million loan facility. The above loan was provided by EXIM Bank to the borrower for the purpose of part- financing the borrower's exploration, development and production expenses incurred/ to be incurred in various oil and gas assets of the borrower or its subsidiary companies in India overseas. In relation to this, the under-mentioned guarantee/ counter guarantee was provided by the group companies on behalf of JBV [RE: Page 151 of Paper book] Liability of JEPL in terms of its guarantees shall not exceed the amount realized from: i. All investments of JEPL in its subsidiary JEHBV; and ii. The assets and investments held by its subsidiary JEHBV or through its step down subsidiaries. Loan 2
J E Energy Ventures Private Limited vs. DCIT In January 2014, Jubilant Energy Holdings BV ('JEHBV') entered into a loan arrangement with EXIM Bank for USD 45 million loan facility bearing interest rate of 6 month Libor plus 650 basis points. The above loan was provided by EXIM Bank to JEHBV for the purpose of investments in/ on-lending to subsidiaries of JEHBV for exploration, development and related production activities incurred/ to be incurred in various oil and gas assets. In relation to this loan, corporate guarantee was provided by JEPL in favour of EXIM bank guaranteeing in its corporate capacity the due repayment of the dollar loan and payment of interest thereon and all costs, charges, expenses and other monies payable by JEHBV to EXIM bank under the loan agreement. [RE: Page 143 of Paper book] The liability of JEPL in terms of its guarantees shall not exceed the amount realized from: [RE: Page 145 of Paperbook] -All investments of JEPL in its subsidiary JEHBV; and -The assets and investments held by its subsidiary JEHBV or through its step down subsidiaries. 1.3 Besides the above, other securities were also provided in relation to the above loan facility availed by JEBV and JEHBV and the details of the same are mentioned on [page 143-146 of the paper book]. 1.4 In relation to the international transaction of provision of corporate guarantee, the bank had asked for guarantee by the parent company i.e. JEPL but the obligation of the parent is J E Energy Ventures Private Limited vs. DCIT restricted upto its investment in its subsidiary being the borrower and the assets and investments held by the borrower and its step down subsidiaries. The Appellant by treating its transaction qua providing service of corporate guarantee as its shareholder activity, found the same at Arm's Length Price (ALP) [RE: Page 78-79 of S. No. Particulars Method selected Amount in INR by Appellant 1 Provision of Other Method NIL corporate guarantee 1.5 Since, the invocation of guarantee did not result in any additional obligation of the Assessee nor it provide any economic and commercial benefit to the lender as well as the borrower, therefore the provision of corporate guarantee was held to be at arm's length [RE: Page 79 of the paper book] 1.6 It is also pertinent to mention that during the year JEBV and JEHBV were not able to meet its obligations for payment of interest and principal of the outstanding amount of loan and the same were classified as nonperforming assets by the EXIM bank with effect from 17 May 2016. [Re: Page 249 and 254 of Paper book] 2. Transfer Pricing Audit Proceedings 2.1 Provision of Corporate Guarantee (International Transaction) The Learned Transfer Pricing Officer ('Ld. TPO') disregarded the approach of the Appellant and held as follows: -Held provision of corporate guarantee as an 'international transaction' u/s 92(B) of the Act (RE: page 60 of Appeal Set)
J E Energy Ventures Private Limited vs. DCIT
-Dismissed the interest saved approach for benchmarking the international transaction of provision of corporate guarantee applied by the Assessee on the ground that it has many shortcomings (RE: page 61 of Appeal Set) -In order to benchmark its international transaction qua providing corporate guarantee applied Hull White model and arrived at an arms length guarantee fees @ 2.01%. (RE: page 63,65 of Appeal Set) -Consequently, proposed to enhance the income of the Appellant by Rs. 12,32,98,585 on account of ALP with regard to the international transaction of provision of corporate guarantee. (RE: page 65 of Appeal Set) 3. DRP Proceedings The Hon'ble DRP upheld the approach of the Ld. TPO, and held that the provision of corporate guarantee is an international transaction. The Hon'ble DRP also upheld the use of Hull and White model used by the Ld. TPO for benchmarking the international transaction of provision of corporate guarantee. (RE: page 20,21 of Appeal Set) Following the order of the Ld. DRP, the Assessing Officer made an adjustment on account of corporate guarantee fees amounting to Rs. 12,32,98,585/- to the total income of the Assessee (RE: page 8- 9 of Appeal Set) 4. Appellant's Contentions (Adjustment on account of Corporate Guarantee)
J E Energy Ventures Private Limited vs. DCIT 4.1 No service of corporate guarantee is subsisting after default by the borrower thus warranting no payment of corporate guarantee fees and thus, provision of guarantee is not covered under the definition of 'international transaction' 4.2 During the year JEBV and JEHBV were not able to meet its obligations for payment of interest and principal of the outstanding amount of loan and the same were classified as nonperforming assets by the EXIM bank with effect from 17 May 2016 [Re: Page 249 and 254 of Paperbook) This disclosure is made in the financial statements of the Appellant as well as the transfer pricing report 4.3 As soon as the borrowers ie. JEBV and JEHBV default in their payment obligations to the bank, the provision of service of corporate guarantee ceases to exist and the repayment obligation of loan and interest thereon by the Appellant becomes crystalised. Thus, the service of guarantee towards the loan facility availed by JEBV and JEHBV does not exist anymore. As a result, the Appellant cannot avail any guarantee fees from the borrowers ie. JEBV and JEHBV 4.4 Assuming that the provision of corporate guarantee, falls within the purview of international transaction under section 92B of the Act (though not admitted), it is pertinent to mention that in order to constitute an international transaction, the requirement of the law is that it must be in existence or in effect an actual transaction undertaken by the AE, However, in the present case
J E Energy Ventures Private Limited vs. DCIT services have not been provided on account of the event of invoking of guarantee by the banker. Therefore, there is no transaction per se which is in existence, much less an international transaction.
4.5 Reliance in this regard can be placed on the special bench ruling in the case of New Delhi Television Ltd. Vs ACIT, Circle 13(1), New Delhi (ITA 3865/Del/2014) [RE: Page 1-3 of Case Law Compendium] wherein it has been held that where only an obligation has been incurred which is short of guarantee, the same cannot be termed as an international transaction. The converse of the same being that once guarantee has been invoked then the existence of the transaction of corporate guarantee ceased to exist. 4.6 In light of the above, the action of the Ld. TPO that the provision of corporate guarantee constitutes an international transaction is liable to be dismissed. 4.7 No economic or commercial benefit to the lender as well as the borrower 4.8 For the above mentioned loan agreements entered into by JEBV and JEHBV with EXIM bank, the Appellant has provided the primary corporate guarantee. The primary guarantee provided by JEPL to JEBV and JEHBV is in the nature of downstream guarantee where the guarantee is provided by the parent company for the obligations of its subsidiary. In order to evaluate whether any valuable service has been provided by JEPL by providing this corporate guarantee, the obligation of JEPL arising from the corporate guarantee must be analysed.
J E Energy Ventures Private Limited vs. DCIT 4.9 The guarantor company i.e. JEPL can be said to have provided valuable service to the borrower only in case the lender has got access to additional assets which can be utilised in case of default by the borrower and where such guarantee is not in essence a shareholder activity. Since the guarantor's liability in case of default by the borrower i.e. JEBV/JEHBV is restricted to primarily the assets of the borrower company only, there is no benefit received by the lender and JEEBV/JEHBV as a result of this guarantee. 4.10 JEPL being the equity shareholder would have the last right on the assets owned by the borrower company and would receive the residual amount in consideration of its investment in JEBV/JEHBV after paying all other debts of the borrower including the loan availed from the bank. Therefore, no additional risk is borne by JEPL as a result of providing this corporate guarantee which warrants any guarantee fee.
4.11 It should be evaluated that whether the provision of guarantee has resulted in any economic or commercial benefit for the borrower or whether the company providing guarantee would have to face any exposure because of guarantee provided for loan obtained by the borrower.
4.12 In the instant case, the bank has asked for guarantee by the parent company but the obligation of the parent is restricted upto the assets owned by JEHBV (which derive its value from the J E Energy Ventures Private Limited vs. DCIT borrower) and its step down subsidiaries. Thus, it is a typical example of belt and brace policy where the bank has tried to cover a bundle of duplicative securities by this arrangement but in essence has got access to the assets ultimately owned and controlled by the borrower company and has not got access to any additional assets over and above the assets owned by the borrower. 4.13 Accordingly, no guarantee fee is payable by JEBV/JEHBV to its parent company because the guarantee provided by JEPL does not provide any economic or commercial benefit to the lender as well as the borrower.
4.14 Guarantees given by the Appellant is a shareholder activity 4.15 Any support to the subsidiaries, is in the business interest of the shareholder (i.e. the Appellant) and treated as part of its own core business. 4.16 It is noteworthy that the Appellant could have alternatively infused funds by way of equity capital in the subsidiaries. However, the same would have resulted in additional blockage of funds for the Appellant itself. Thus, instead of infusing equity for this purpose, it was decided to support the subsidiary by furnishing guarantee to enable the subsidiary to raise its own funds and infusing equity capital in the eventuality of default by the subsidiary in the repayment of the loan. 4.17 On proper consideration of all the facts and circumstances, as provided above, the guarantee risk relates exclusively to the further
J E Energy Ventures Private Limited vs. DCIT infusion of funds by the Promoters as an investor (equity). Thus, as the said guarantee transaction substitute for the investment of the equity, which was to be infused by the parent entity, it represents shareholder service. 4.18 In the present case, the Assessee took a conscious decision of financing its subsidiary by way of debt financing rather than equity contribution. In such a scenario due to the inability of the subsidiaries to borrow funds on a standalone basis, the Assessee was required to give corporate guarantees as a shareholder. This does not result in any service being rendered to the subsidiaries and accordingly no charge is warranted. 4.19 Incorrect Application of Hull White model and undue reliance on BEPS action plan 4, 8-10 by the TΡΟ 4.20 TPO has used the Hull-White model for Credit Default Swap ('CDS') for valuation of guarantee provided. A Credit Default Swap is a derivate instrument which a lender can avail from any other party to secure its lending. It cannot be used in case of corporate guarantee analysis between a parent and its subsidiary. 4.21 Further it is submitted that the TPO, while benchmarking the provision of corporate guarantee applied the Hull White model for determining the risk associated with financial assets especially CDS. As evident from point C.1.2.4 of BEPS action plan 4, 8-10, CDS means the following: C.1.2.4. Credit default swaps
J E Energy Ventures Private Limited vs. DCIT
10.101. Credit default swaps reflect the credit risk linked to an underlying financial asset. In the absence of information regarding the underlying asset that could be used as a comparable transaction, taxpayers and tax administrations may use the spreads of credit default swaps to calculate the risk premium associated to intra-group loans. 10.102. As financial instruments traded in the market, credit default swaps may be subject to a high degree of volatility. This volatility may affect the reliability of credit default swaps as proxies to measure the credit risk associated to a particular investment in isolation, since the credit default spreads may reflect not only the risk of default but also other non-related factors such as the liquidity of the credit default swaps contracts or the volume of contracts negotiated. Those circumstances could lead to situations where, for instance, the same instrument may have different credit default swaps spreads. 4.22 From the above, it can be said that the above method/instruments is with regard to the treasury function of the AE which is mentioned in Section C of the Transfer Pricing Guidance on Financial Transactions and not applicable to the facts of the present case whereas there is a specific chapter of financial guarantees i.e. Chapter D, wherein the expected loss method is mentioned. However, it does not recognize CDS but recommends Capital Asset Pricing Model. [RE: Page 329 of Paper book]
J E Energy Ventures Private Limited vs. DCIT 4.23 In order to determine the arm's length price of guarantees, the BEPS plan gives guidance on 5 methods namely: 1 CUP method 2 Yield approach 3 Cost approach 4 Valuation of expected loss approach 5 Capital support method 4.24 The Ld. TPO has applied the cost approach which requires the identification of the default event which is central to the comparability analysis between the control transaction and the potentially comparable credit default swap. 4.25 In the present case, since the borrowers to whom the corporate guarantee has been provided have already defaulted in payment of interest and principal, therefore this method cannot be applied by the TPO as the probability of default is not applicable and cannot be applied in the present case. Since the default of loan guaranteed has already occurred in the present case and this variable is not in existence therefore, the entire exercise of determination of arm's length price of corporate guarantee fees cannot be applied for the year under consideration. 4.26 Additionally, the TPO, while determining the arm's length price of corporate guarantee fees by using the Hull White model is incorrect. It is also pertinent to add that the TPO used the following variables:
J E Energy Ventures Private Limited vs. DCIT
(a) Risk Free Rate: The AE JENV is based in Amsterdam, Netherands. So, Risk free rate in Netherlands in the period 0.31% is taken. (b) Probability of default (PD): PD is usually found by feeding the financial of the borrower into risk calc and getting a credit rating. The taxpayer provided the PD as 2.46% with default rate mapping of Ba3. (c) Recovery rate: Recovery rate depends on the fixed assets and investments or the borrower. If the borrower defaults, the guarantor can recover a portion of the liability from the borrower by selling the fixed assets. It is calculated as a percentage of fixed assets and investments over debt. The same is calculated at 19.39% 4.27 It is also submitted that the TPO never provided the data relating to risk free rate to the Assessee. Also in the present case the variable of probability of default cannot be taken at 2.46% since the borrowers have already defaulted in payment and therefore the entire exercise is vitiated because incorrect variables have been applied while calculating corporate guarantee fees. The Hull white model takes into account the probability of default, which in the present case ceased to exist as the borrowers have already made a default in payment to the EXIM bank in May 2016. 4.28 The Assessee also submits that neither the Hull White Model nor the BEPS guideines have any statutory recognition in the Indian Tax regime. Therefore, the same cannot be blindly relied
J E Energy Ventures Private Limited vs. DCIT upon by the TPO as vital parameters essential for application of Hull White model are missing in the present case. 4.29 Interest Saving Approach to be followed to determine the quantum of guarantee fees payable by the borrower. 4.30 Without prejudice to our contentions that the corporate guarantee provided by the Appellant does not warrant an arm's length compensation, in case this Hon'ble Tribunal determines the arm's length compensation, interest saving approach needs to be applied. The difference between market interest rate payable by JEBV/JEHBV on a standalone basis (had it not received the corporate guarantee from JEPL) and the interest rate it pays to the bank after being guaranteed by JEPL, provides an indicative range of the benefit derived by JEBV/JEHBV on account of interest saved due to the higher credit quality of the guarantor i.e. JEPL. In case the borrower, does not derive any benefit in terms of saving of interest in those circumstances no guarantee fees is warranted by the Appellant.
4.31 As evident from Para 4.28 (supra) the interest savings approach is not only an accepted method recognised by various courts in India and abroad and also recognised in OECD BEPS action plan 4, 8-10 as the "yield approach". The relevant extract of the same is as follows: D.2.2. Yield approach 10.174. This approach quantifies the benefit that the guaranteed party receives from the guarantee in terms of lower interest rates.
J E Energy Ventures Private Limited vs. DCIT The method calculates the spread between the interest rate that would have been payable by the borrower without the guarantee and the interest rate payable with the guarantee. The first step is to determine the interest rate that would have been payable by the borrower on its own merits, taking into account the impact of implicit support as a result of its group membership. See Section C.1.2. 10.175. The next step would be to determine, by a similar process (unless directly observable in the case of a loan from a third party), the interest rate payable with the benefit of the explicit guarantee. The interest spread can be used in quantifying the benefit gained by the borrower as a result of the guarantee. In determining the extent of the benefit provided by the guarantee, it is important to distinguish the impact of an explicit guarantee from the effects of any implicit support as a result of group membership. See Example 2 at paragraph 1.167. The benefit to be priced is not the difference between the cost to the unguaranteed borrower on a stand-alone basis and the cost with the explicit guarantee but the difference between the cost to the borrower after taking into account the benefit of any implicit support and the cost with the benefit of the explicit guarantee. 10.176. The benefit of implicit support will be the difference between the borrowing terms attainable by the borrowing entity based on its credit rating as a member of the MNE group and those attainable on the basis of the stand-alone credit rating it would have had if it were an entirely unaffiliated enterprise. If the borrower has its own
J E Energy Ventures Private Limited vs. DCIT independent credit rating from an unrelated credit rating agency, this will usually reflect its membership of the MNE group and so ordinarily no adjustment would be needed to this credit rating to reflect implicit support. 10.177. The result of this analysis sets a maximum fee for the guarantee (the maximum amount that the recipient of the guarantee will be willing to pay), namely, the difference between the interest rate with the guarantee and the interest rate without the guarantee but with the benefit of implicit support (and taking into account any costs). The borrower would have no incentive to enter into the guarantee arrangement if, in total, it pays the same to the bank in interest and to the guarantor in fees as it would have paid to the bank in interest without the guarantee. Therefore this maximum fee does not of itself necessarily reflect the outcome of a bargain made at arm's length but represents the maximum that the borrower would be prepared to pay." 4. 32 In the present case, the interest rate paid by JEHBV/JEBV to bank is Libor plus 650 and 550 basis points respectively. The difference between the interest rate and the comparable arithmetic mean of interest rate reflects the value attributable to the guarantee. Since the arithmetic mean of interest rate of comparable agreements of Libor plus 400 basis points is less than the interest rate paid by JEBV/JEHBV, no guarantee fee is payable to JEPL on the guaranteed loan amount as no interest was actually saved. This indicates that the international transaction of provision
J E Energy Ventures Private Limited vs. DCIT of corporate guarantee was in accordance with the arm's length standard required under the Indian Regulations. 4.33 The interest savings approach is a viable means of benchmarking the international transaction of corporate guarantee and has been upheld in the case of Deputy Commissioner of Income-tax v. Dhunseri Ventures Ltd. [2022] 144 taxmann.com 110 (Kolkata Trib.) wherein the Hon'ble Kolkata bench of the ITAT upheld the use of interest savings approach for benchmarking the international transaction of provision of corporate guarantee. [RE: Page 31,32 of Case Law Compendium] 4.34 Further, in the case of DCIT, CC 7(3) Mumbai vs. M/s Macrotech Developers Ltd. (2384/Mum/2022), the Hon'ble ITAT used the interest saving approach to benchmark the international transaction of provision of corporate guarantee [RE: Page 22,23 of Case Law Compendium] 4.35 In the case of Canada vs. General Electric Capital, November 2010, Federal Court, Case No 2010 FCA 344 the tax court agreed with the tax administration that implicit support should be taken into account and applied a "yield approach, comparing the interest rate the Canadian company would have paid with and without the guarantee. 4.36 In view of the above, it is prayed that the interest saving approach must be followed in the matter as the judicial mandate is in favour of applying the interest saved approach and the TPO's action of benchmarking the transaction of provision of corporate
J E Energy Ventures Private Limited vs. DCIT guarantee using the cost approach/ Hull and White Model instead of the interest saving approach is liable to be rejected. 4.37 Amount payable by the Appellant on invocation of corporate guarantee is otherwise an allowable expenditure u/s 37(1). 4.38 It is also pertinent to add that once the corporate guarantee has been invoked by the bank, the Appellant is now liable to pay the amount of debt and interest thereon to the EXIM bank. Since, the same is irrecoverable; it is to be written off and can be claimed as a legitimate business loss u/s 37(1). Reliance in this regard can be placed on the decision of Chennai bench of the ITAT in the case of Refex Industries Ltd. Vs DCIT, Corporate Circle 5(3)/5(4), Chennai (ITA 2938 &2939/ CHNY/2017) [RE: Page 90,91 of Case Law Compendium] wherein it has been held that corporate guarantee once invoked can be claimed as a revenue expenditure u/s 37(1) of the Income Tax Act, 1961. Further, reliance can be placed on the decision of Madras High Court in the matter of CIT vs Amalgamation Pvt. Ltd. (108 ITR 895) and later affirmed by the Hon'ble Supreme Court wherein it has been held that any Loss arising from guarantee liability was allowable as a business loss.
On the other hand, the Ld. DR submitted that in this case the assessee company has provided the Corporate Guarantee (CG) for the two loan arrangements between its AEs of USD 50 Millions and J E Energy Ventures Private Limited vs. DCIT 45 Millions and EXIM bank. The assessee company has stated that providing of CG's is the shareholder activity and as such no service has been rendered to the AE's. The assessee company also made the contentions that provision of CG's is not covered under the definition of international transactions. Further assessee company by treating the CG's as the shareholder activity, has benchmarked is by applying "Other Method" and the "Interest saving approach" and came to the conclusion that 'Nil' addition/adjustment are warranted on account of giving CG. Issue involved in the case:- 1. Whether providing of the corporate quarantee is a separate international transaction: At the outset, it is humbly submitted that the issue of corporate guarantee is no more res integra after the amendment brought in the IT Act in explanation 1c of Section 92 B of the IT Act from 1/4/2012 with retrospective effect from 01/04/2002. Reliance is placed on the decisions of Hon'ble. Madras High Court in the case of PCIT 5, Chennai Vs Redington (India) Ltd. (2020) 122, Taxmann.com 136 Madras, a copy of which is enclosed. The Hon'ble High Court (in para 67 to 75), not only held the provisions as constitutionally valid but also held that its retrospective validity from 1/4/2002, thus the validity of provisions from 1/4/2002 is no more in question. Also this issue of providing of CG's as separate international transaction or not has also been decided by other High Court's/Various Tribunal's across the country and it is J E Energy Ventures Private Limited vs. DCIT the settled issue and for the take of brevity, the individual cases are not discussed.
2. Concept of giving/ issuing CG as shareholder services The assessee has stated that the issue of notional income and share holders activity is not considered in this judgement. The assessee is wrong because of the fact that the Hon'ble High Court in the case of Redington has relied on the decision of the Hon'ble. Hyderabad Tribunal in the case of Prolifics Corporations Ltd. In 55 taxmann.com. 226 (2016), (para 75 of High Court order), while upholding CG Commission. As brought before the bench, the Hon'ble. Hyderabad Tribunal in the case of Prolifics Corporations Ltd. In 55 taxmann.com. 226 (2016) has duly considered the issue of giving/issuing CG as shareholder activity in Para 3.1/3.2 of its order and for the sake of brevity, the same is not being reproduced. Also after considering this aspect, the Hon'ble. Tribunal has upheld CG Commission in para 6/7/8 of its order. Thus, if a Hon'ble high Court has approved the decision of Hon'ble. Hyderabad Tribunal in the case of Prolifics Corporations Ltd., than it is clearly implied that even the facts about giving CG as shareholders services also stands approved by Hon'ble Madras High court in the case of Redington. Also this aspect of giving /issuing CG as shareholders activity has now been approved in umpteen number of cases including Hon'ble Special Bench in the case of Instrumentarium Corporation Ltd. Vs. ADIT in 71 taxmann.com 193 (Kolkata Tribunal) (Special Bench).
J E Energy Ventures Private Limited vs. DCIT
3. Issues raised by assessee with regard to CG's are fully covered in its case by Hon'ble ITAT decision for A.Y 2013-14 published in 108 Taxmann.com 418 As stated above also, the assessee has raised the issue of CG as shareholder services, not a separate international transaction and tried to justify the interest saving approach for making nil adjustments. It is seen that all these issues have been dealt in detail by Hon'ble coordinate bench in assessee's own case for A.Y 2013-14 in IT appeal no. 7602 of 2017. In this case, the fact are identical and the assessee has provided CG to its AE's for claiming loans from Banks and in fact the loan no. 2 in that year is the same loan as in instant year. Also in that year, the assessee has shown the CG's commissions of Rs. 2.7 Crores. Further in that year also, the assessee has applied the "Other Method" and "Interest saving approach" for benchmarking the CG's commission. The Hon'ble tribunal after discussing the issue in detail and also relying on several case laws rejected the assessee's contentions, assessee's approach of benchmarking by applying interest saving approach and held that because of the risk taken by the assessee company for proving CG on behalf of AE's the assessee has to suitably compensated and after rejecting assessee's approach, remitted back the matter to TPO for doing the fresh benchmarking analysis. Being pertinent, the relevant extract of the Hon'ble ITAT order is reproduced below-
J E Energy Ventures Private Limited vs. DCIT
So, following the decision rendered by the coordinate Bench of the Tribunal, we are of the considered view that in order to benchmark the international transactions qua corporate guarantee appropriate comparable data needs to be adopted and benchmarking made in this case on the basis of bank quotes is not sustainable, hence, the TP adjustment made by the TPO/DRP is not sustainable in the eyes of law. We are also not agreed with contentions raised by the Id. AR for the taxpayer that providing corporate guarantee in case of its loan to its AE is not an international transaction and this issue has been rightly decided by the JTPO/DRP by treating the provision of corporate guarantee as international transaction 25. However, at the same time, we are not inclined to agree with the contentions raised by the taxpayer that since no benefit has been passed on to its AE, there is no need to compensate the taxpayer because in a business transaction there is no concept of free lunch Because without providing corporate guarantee by the taxpayer no loan would have been given to the AE that the taxpayer has taken the risk on behalf of its AE which would not have been taken by any third party without consideration and that keeping in view the high risk involved in giving loan by any lender to the AE, the cost needs to be charged from the AE and as such, the commission received by the taxpayer for providing corporate guarantee has to be at arm's length. However, the amount received by the taxpayer on account of commission charged for providing corporate guarantee to its AE
J E Energy Ventures Private Limited vs. DCIT needs to be at arm's length price in view of the ratio of the order passed by the coordinate Bench of the Tribunal in Glenmark Pharmaceuticals Ltd. (supra) as discussed in Para 21 of this order So the TPO is directed to benchmark the intemational transaction providing corporate guarantee to its AE by providing an opportunity of being heard to the taxpayer. So, grounds no.2 to 2.8 & 3 are determined in favour of the taxpayer for statistical purposes. So from the perusal of the above order of the ITAT in the case of assessee only, the following facts are culled out i) The Tribunal on identical facts, as that of the present year also (even the assessee's counsel has admitted in the hearing) rejected the assessee's contentions, of treating CG's as shareholder services, and CG as a separate international transaction. ii) Even though the assessee has shown the CG commission of Rs. 2.70 Crores, still the tribunal found, it not proper and insufficient and remitted the matter to TPO for the fresh benchmarking after rejecting assessee's use of Other Methods and Interest saving approach. The revenue is on the stronger footing for the current year because the assessee has even not followed its earlier practice of showing CG's commission on similar loans to AE's (Last time shown 2.70 Crores) and totally disregarded the Hon'ble ITAT order in its own case.
J E Energy Ventures Private Limited vs. DCIT
Other Contentions raised by the assessee's During the course of hearing, the assessee has raised the contention as the AE's have defaulted in the loan payments and EXIM Bank has already initiated the proceeding for the recovery of loans, accordingly no CG commission is to be received by the assessee's company. Before addressing the assessee's contentions it is first imperative to go through the facts of the case. A) The commission for providing any guarantee, whether by any corporate, bank or any financial institution is provided in advance or at max, at the time when the said transaction takes place and the corporate / banks takes up the liability for that transaction Thus, the liability for getting commission for issuing CG's crystallises at the time of issuance of the CG to the bank on behalf of AE's ie on the first day of financial year ie 01-04-2016 like all other years as reflected by the assessee in its account for example, as mention in the ITAT order for AY 2013-14 and in fact, on this basis only, the Hon'ble ITAT decided the assessee's case of receiving CG's commission for A.Y 2013-14 (cited supra) B) The assessee has also taken the ground that as AE's have defaulted in repaying loans during the year, accordingly on commission is required to be charged for issuing CG's as the banks have already issued the recovery notice to the assessee's company. From the perusal of recovery letter issued by the banks (Page no. 248 to 256 of paper book for both the loans) and also the assessee's
J E Energy Ventures Private Limited vs. DCIT written synopsis, It is seen that the assessee's AE's have defaulted in repaying the loans only in May, 2016 which means that on first day of the year, when the CG was given to the bank, there was no default and accordingly the assessee company was legally required to charge the CG commission (legal position as explained above and decision in assessee's own case by ITAT). In other words when, on the first day of financial year, the assessee has taken the liability and risk associated with issuance of CG on behalf of AE's accordingly, the asseessee was required to be compensated for the risk assumed on that day itself and the assessee's argument has no force and merits that no CG commission was to be charged as loan was defaulted during the year. In fact going by the assessee's contentions, the banks would not have given the loans / recovered that entire amount on the first day of the year if CG was not given by the assessee's company. Analogy is drawn to the bank guarantees / insurance policies issued by banks / insurance companies. If the bank guarantee commission / insurance policy premium is not deposited with the bank / insurance companies on the very first days of this issuance /renewal, then the banks / insurance companies are not liable to discharge the liability stipulated in the policy / guarantee document. C) The other argument that as the AE's have already defaulted in repaying loans during the years and even the assessee's was aware of the defaults and assessee's itself is required pay the amount and J E Energy Ventures Private Limited vs. DCIT therefore no CG commission is to be charged for the defaulted amount is clearly preposterous and absurd because of the following facts. i) TP provision are to strictly applied- in this connection, it is submitted that TP provisions clearly provides for determining ALP in the case of related parties and as these are anti tax avoidance provisions which hits at tax base of the country and accordingly are required to be strictly applied as held by several courts including the Pune Tribunal in the case of M/s. AGS Customer Services India P. Ltd., & C.O. No.22/PUN/2022. Being pertinent the relevant extract of the Hon'ble Tribunals order is given below:- 5. We have given our thoughtful consideration to the forgoing rival pleadings and find forced in the Revenue's stand since an advance pricing agreement "APA" is applicable only for the specified time span not exceeding five consecutive previous years u/s 92CC(4) rw sub section (9A) of the Act. We make it clear that Chapter X in the Act is in the nature of a SPECIAL PROVISION RELATING TO AVOIDANCE OF TAX in an anti avoidance measure introduced by the legislature. Hon'ble apex court's recent landmark decisions PCIT V/s Wipro Ltd. (2022) 140 taxmann.com 223, Commissioner V/s Dilip Kumar & Co 2018 (9) SCC 1(SC) FB & CIT V/s GM Knitting Industries (P) Ltd (2015) 376 ITR 456 (SC) have settled the law that the relevant provisions in the Act ought to be put to stricter interpretation only.
J E Energy Ventures Private Limited vs. DCIT Thus if the TP provisions / legislature provides for statutory charging of CG commission for the CG provided on behalf of the AE's, then in line with the provision as content in the Act, the same has to be charged without any exceptions. ii) CG Commission is required to be charged because of the risk undertaken for any anticipated default by the AE's / other person. Usually at the time of issuance of CG only the remote probability of default is there and that is why the CG commission rate are very less/negligible. If the assessee's contentions are accepted then the CG commission should be far more higher because when assessee's company was aware of impending defaults by AE's then it becomes the case of deliberately and intentionally putting its investment / Assets at risk for the sake of AE's and if that is the case then the assessee's company should have received far higher CG commission than the normal standards. As the TPO was aware for the higher risk involved in the case of assessee's company in giving CG's to AE's, whose credit rating were of non investment categorised as speculative and were B-,minus (page 6 to 8 of TPO order) and providing any guarantee to such companies clearly carries a risk of high defaults Accordingly after analysing the case in detail, the TPO has rightly rejected the interest saving approach and adopted the Hull and white model for benchmarking the international transaction related to CG. This model has been recommended by OECD and is a good method for calculation of probability of default in high risk transaction like
J E Energy Ventures Private Limited vs. DCIT giving of CG by the holding company to the AE's. In fact OECD guidelines were referred and relied upon by several courts including jurisdictional High Court in various Case like- Cotton naturals (1) Pvt. Ltd., Sony Ericson Mobile (1) Pvt. Ltd., ITA No. 16/2014, etc. Moreover it is also submitted that details and the facts and figures for computation of default risk for application of Hull and White model in the instant case was provided by assessee's company only. iii) The assessee has also taken the ground that amount payable by an assessee on invocation of CG's is allowable expenditure U/s 37(1), First of all, as this amount is payable because of capital loan taken by the AE's, accordingly the payment made to bank by assessee is to be treated as capital expenditure. However without prejudice to the above contentions, if assessee's arguments for revenue expenditures are accepted for the moment, then it becomes more the case for the bringing CG's commission as the income of assessee because if expenditure against claim raised by the bank is treated as revenue expenditure, then corresponding income is treated as revenue income. iv) The Assessee has raised a point that as it has been saddled with huge liability accordingly, no income should be imputed to it on account of CG given. In this connection, reliance is placed on the decision of the Hon'ble apex court in the case of Popat Bahiru Govardhane and others vs Special Land Acquisition officer and J E Energy Ventures Private Limited vs. DCIT another [2013] 10 SCC 765. For the ready reference, the relevant extract is reproduced below: "The statutory provision may cause hardship or inconvenience to a particular party but the Court has no choice but to enforce it giving full effect to the same. The legal maxim "dura lex sed lex" which means "the law is hard but it is the law", stands attracted in such a situation. It has consistently been held that, "inconvenience is not a decisive factor to be considered while interpreting a statute. "A result flowing from a statutory provision is never an evil. A Court has no power to ignore that provision to relieve what it considers a distress resulting from its operation." (See The Martin Burn Ltd. v. The Corporation of Calcutta, AIR 1966 SC 529 and Rohitas Kumar & Ors. v. Om Prakash Sharma & Ors., AIR 2013 SC 30) In view of the above, we are of the candid view that none of the submissions advanced on behalf of the appellants is tenable." Lastly it is humbly prayed that in accordance with Transfer Pricing / IT Act provisions and various decision of Hon'ble High Courts, if no CG commission is shown / received by the assessee's company, then by any stretch of imagination, the assessee company cannot be saddled with huge liability arising because of default by the AE's in repayments of loans. Thus, in view of above arguments, the assessee appeal may kindly be dismissed and the order of TPO / AO /DRP may kindly be upheld.
Considered the rival submissions and material placed on record. We observed from the record that the assessee has provided primary guarantee to its step down foreign subsidiaries against the loan taken by them and obligations towards servicing of the loan to EXIM Bank for first loan of USD 50 Million in the Financial Year 2011-12 and for second loan of USD 45 Million in the Financial Year 2013-14. It is fact on record that the assessee always classified
J E Energy Ventures Private Limited vs. DCIT the above guarantee as share holder activities, not provided any economic/commercial benefit to the lender as well as borrower and denied that this falls under the definition/category of corporate guarantee in the past. We observed that similar issue was considered by the coordinate bench in the AY 2013-14, in that AY, the assessee had received fee for providing corporate guarantee of Rs. 2.7 crores and with the similar facts on record, on appeal, the coordinate bench held that the services provided by the assessee to their step down subsidiary falls within the definition of Corporate Guarantee and remitted the issue back to the file of AO/TPO to bench mark the same as an international transaction. From the decision of coordinate bench, it is clear that the submissions of the assessee for performing shareholder services do not fall under corporate guarantee were rejected. Therefore, before us also, the assessee submitted the similar arguments and we are inclined to reject the same.
The issue has to be analyzed based on the facts of each year, coming to the real issue in this year under consideration are, the assessee has given corporate guarantee to its step down subsidiaries while availing the loan by them in the past. In order to bench mark the transaction, it has to be evaluated every year and it cannot be held that once the guarantee is given in the past, it continued to have impact on every assessment year subsequently. In this case, the assessee has given guarantee towards the loan and primary obligation of servicing the loan to the bank when they
J E Energy Ventures Private Limited vs. DCIT granted loan to the step down subsidiaries. No doubt the assessee also collected fees for providing the guarantee in the past, as per records, the assessee has collected Rs. 2.7 crores in the AY 2013- 14. It was adjudicated in AY 2013-14 that this transaction falls within definition of the international transaction. However, the facts are different in this AY considering the fact that the step down subsidiaries had not serviced the obligation towards the loan taken by them and the same were classified as non-performing assets (NPA) by EXIM bank. The same was intimated to the assessee on May 2016 and initiated the recovery proceedings from the assessee being the primary guarantor. The assessee being the holding company, it is aware of the situation prior to the intimation received from the bank ie., in the previous year itself. Once the situation is apparent and recovery proceedings are commenced, the guarantee seized to exist at the beginning of the year itself. It is not something happens over night. The banks classify the loan as NPA after providing several opportunities and discussions. This process must have commenced prior to the intimation of default by the bank in the month of May 2016. That being so, the corporate guarantee provided by the assessee seizes to exist in the beginning of the year itself. Therefore, in our considered view, in the beginning of the year, there was no existence of any guarantee to the EXIM bank and it is also relevant to notice that the assessee has not recovered any fees for guarantee, as in the past, during the year under consideration and the EXIM bank has initiated the recovery
J E Energy Ventures Private Limited vs. DCIT proceedings from the assessee. The liability of the assessee towards the guarantee are restricted to the extent of its investments in the subsidiaries and to the extent of recovery of the assets held by the subsidiaries. Therefore, the liabilities of the assessee was converted from guarantor to the actual liabilities to the extent of default by the step down subsidiaries, absolutely nothing left for the assessee itself to recover from its subsidiaries till the bank recovers their dues. Similar submissions were made by the Ld DR and are not in agreement of the views. Further, no doubt, as per the submissions of the Ld DR, the statutory provisions may cause hardship or inconvenience but court has no choice but to enfore it, irrespective of the situation, the transaction has to be bench marked. After considering the facts on record, what is relevance is whether the guarantee existed at the commencement of the impugned AY, in this case, in our opinion, the assessee was aware as well as the intimation received from the bank in the month of May itself, therefore, there was no guarantee existed as soon as the intimation of classification of NPA. It is crystallized/non-existence of the guarantor in the beginning of the year itself, therefore, we cannot presume that the corporate guarantee existed, hence, there is no possibility that the assessee has continued the guarantee, in our view for this AY, there is no international transaction. Therefore, the TPO was wrong in initiating proceedings to bench mark corporate guarantee as there is no international transaction at the first place.
J E Energy Ventures Private Limited vs. DCIT
Coming to the issue of method adopted by the TPO is proper or not, since we held that there is no international transaction existed relating to corporate guarantee in this assessment year, it is irrelevant at this stage to adjudicate on the issue of proper method adopted by the TPO or not. Accordingly, we direct the AO/TPO to delete the addition proposed in this AY. Accordingly, the ground no 1.2.3 raised by the assessee is allowed and all other grounds relating to the issue of corporate guarantee are dismissed.
Coming to the issue of initiating penalty proceedings, it is premature ground raised by the assessee at this stage, hence it is dismissed as such.
The next issue of proposing penal interest u/s 234A, 234B, 234C and 234D, these are also consequential in nature, hence the ground no 1.4 raised by the assessee is not adjudicated at this stage and remitted to the file of assessee.
In the result, the appeal filed by the assessee is partly allowed. Order pronounced on 5th July, 2024.