MULTINATIONALS, by definition, operate in different jurisdictions and much of the time through establishing subsidiaries in such jurisdictions. Generally speaking, the parent company of a multinational group will enjoy a better credit rating than most of its subsidiaries, particularly the ones that are formed abroad. The subsidiary will often need loan from banks and others to finance its working capital and other needs. Often times, the parent company gives a guarantee to the lender for financing the needs of the subsidiary, thereby assuming the risk of default from the lender.

According to Black's Law dictionary, a guarantee is 'a promise to answer for the payment of some duty, in the case of the failure of another who is liable in the first instance.' The guarantee improves the subsidiary's accessibility to loans and also enables the subsidiary to borrow at a rate that will be cheaper than the rate it would have been asked to pay had it been a stand alone company. A guarantee is thus a part of inter company financial transaction and confers a benefit to the subsidiary. In the transfer-pricing context, it is therefore necessary to make appropriate adjustment when such explicit guarantee is given by the parent company.

In the case of Four Soft Ltd [2011-TII-92-HYD-TP], the assessee had provided a corporate guarantee to its subsidiary in the Netherlands. The TPO held that the guarantee was an obligation and in case of the failure of the debtor, the liability will be on the principal and applying the CUP method based on the commission charged by banks, he made an adjustment. When the matter reached the Tribunal, it held that the corporate guarantee provided by the company did not fall within the definition of international transaction as per Section 92B of the Act. "The TP legislation does not stipulate any guidelines in respect to guarantee transactions. In the absence of any charging provision, the authorities were not correct in bringing transaction in the TP study." The Tribunal held that corporate guarantee being incidental to the business of the assessee the same could not be compared to a bank guarantee transaction of a Bank or financial institution. The Tribunal, however, did not explain why corporate guarantee would not fall within section 92B.

In 2012, there were significant amendments in the Transfer Pricing provisions and section 92B was amended adding various explanations to clarify the intent of the legislature. Explanation.-(i) © specifically included the word 'guarantee'. Recently, the Delhi Tribunal has considered the amendments in the case of Bharti Airtel [2014-TII-60-ITAT-DEL-TP] and has come to the conclusion that even after the amendment, corporate guarantee may be out of the ambit of ' international transaction' as defined in section 92B and hence out of the pale of TP adjustments.

In this case, there were a number of important issues relating to transfer pricing but for the purpose of this article, we restrict the discussion only to the aspect of corporate guarantee. Bharti Airtel had issued a corporate guarantee to Deutsche Bank on behalf of its Sri Lankan subsidiary. Bharti contended that it had not incurred any cost for the issue of the guarantee and the same was for NIL consideration. Nevertheless, based on market quote, it took 0.65% of the amount as commission in its TP study and offered the same as adjustment.

The TPO observed that by issuing the corporate guarantee, the assessee has benefited its AE by increasing its credit rating. Applying CUP method, he determined arm's length price of the guarantee commission @ 2.68% plus a mark-up of 200 basis points on the basis of data obtained from various banks u/s 133(6) of the Act.

On appeal before the Tribunal, Bharti argued that arm's length price adjustment can be made only when a transaction has a cost attached thereto; that by extending corporate guarantee to its AE, the assessee neither incurred any cost nor suffered any impact on its profits within the meaning of section 92B so as to attract the scope of international transaction. Further, providing such corporate guarantee to a subsidiary company was a part of the shareholder's activity and this did not constitute an international transaction warranting transfer-pricing adjustments. There were arguments about the quantum as well but considering the outcome of the case, the same is not discussed here.

The Tribunal analyzed section 92B and the amendments made by Finance Act, 2012. The relevant provisions are as follows:

"92 B - Meaning of international transaction

(1) For the purposes of this section and sections 92, 92C, 92D and 92E, "international transaction'' means a transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises."

The Tribunal broke it down into the following components:

• (a) purchase, sale or lease of tangible or intangible property

• (b) provision of services

• (c) lending or borrowing money

• (d) other transaction having a bearing on the profits, income, losses or assets of such enterprises

According to the Tribunal, the phrase 'having a bearing on profits, income, losses or assets of such enterprises' qualifies 'any other transaction'.

The Tribunal then examined the Explanation inserted by the Finance Act, 2012 and grouped the various clauses in the explanation to see whether they represent the first 3 groups or fall in the last group.

"Explanation 1 -For the removal of doubts, it is hereby clarified that-

(i) the expression "international transaction" shall include-

(a) the purchase, sale, transfer, lease or use of tangible property including building, transportation vehicle, machinery, equipment, tools, plant, furniture, commodity or any other article, product or thing;

(b) the purchase, sale, transfer, lease or use of intangible property, including the transfer of ownership or the provision of use of rights regarding land use, copyrights, patents, trademarks, licences, franchises, customer list, marketing channel, brand, commercial secret, know-how ,industrial property right, exterior design or practical and new design or any other business or commercial rights of similar nature;

(c) capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business;

(d) provision of services, including provision of market research, market development, marketing management, administration, technical service, repairs, design, consultation, agency, scientific research, legal or accounting service;

(e) a transaction of business restructuring or re-organisation, entered into by an enterprise with an associated enterprise, irrespective of the fact that it has bearing on the profit, income, losses or assets of such enterprises at the time of the transaction or at any future date."

According to the Tribunal, items (a)&(b) of the newly inserted explanation correspond to the first group of its analysis; item (d) corresponds to the second group. It held that none of the explanations covers the third group of lending or borrowing money. According to the Tribunal, the other two clauses of the Explanation- (c) and (e), relating to capital financing and business restructuring must therefore be covered by 'any other transaction' which in turn must have a bearing on the profits, income etc. before the same can be called an 'international transaction'.

Following this logic, the Tribunal, examined the present transaction of guarantee and came to the conclusion that it did not have any effect on the profit, income, assets etc. of Bharti and hence was beyond the scope of section 92B.

In this connection, the Tribunal observed:

"… [T]he scope of these transactions, as could be covered under Explanation to Section 92 B read with Section 92B (1), is restricted to such capital financing transactions, including inter alia any guarantee, deferred payment or receivable or any other debt during the course of business, as will have "a bearing on the profits, income, losses or assets or such enterprise". This pre-condition about impact on profits, income, losses or assets of such enterprises is a pre-condition embedded in Section 92B(1) and the only relaxation from this condition precedent is set out in clause (e) of the Explanation which provides that the bearing on profits, income, losses or assets could be immediate or on a future date. The contents of the Explanation fortify, rather than mitigate, the significance of expression 'having a bearing on profits, income, losses or assets' appearing in Section 92 B (1) ."

Analysis:

Applying the Tribunal's own logic, if the transaction in question relates to either purchase or sale, provision of service or lending or borrowing, then the transaction need not be one having any bearing on the profits etc. of the company. Therefore, it is first necessary to ascertain what is the nature of a corporate guarantee.

OECD Transfer Pricing guidelines (2010) in chapter VII relating to Intra group services in Para.7.13 mentions as follows:

"Similarly, an associated enterprise should not be considered to receive an intra-group service when it obtains incidental benefits attributable solely to its being part of a larger concern, and not to any specific activity being performed. For example, no service would be received where an associated enterprise by reason of its affiliation alone has a credit-rating higher than it would if it were unaffiliated, but an intra- group service would usually exist where the higher credit rating were due to a guarantee by another group member, or where the enterprise benefited from the group's reputation deriving from global marketing and public relations campaigns…"

Determining the ALP of a guarantee may be a complex task but the short point here is that a guarantee is considered to be a service. And if it is a service, then, in terms of section 92B, it can be subjected to TP adjustment, according to the logic adopted by the Tribunal. One might then possibly say that provision of services has been included in explanation 1(d) whereas 'guarantee' is included in explanation 1© and hence a guarantee should be considered only as part of capital financing and not of service. It is not clear whether such an interpretation would be correct since there is no indication that such a division was intended by the amendment. As we have seen, contrary to international practice, the Tribunal in Four Soft held that guarantee was not an international transaction without explaining why. The government introduced a clarificatory amendment and included guarantee as one of the items that should always be considered as international transaction even when such an amendment was perhaps unnecessary.

Besides, even if it is assumed that guarantee will only form part of capital financing, capital financing involves lending and borrowing. In fact, the items in this group are related to lending or borrowing and it is not clear why the Tribunal held that 'lending and borrowing ' is not represented by any of the explanations.' Guarantees are also connected with lending or borrowing and are parts of inter company financial transactions. In fact, section 372A of the Companies Act regulate Inter corporate loan, investment, guarantee and securities.

Further, even if it is assumed that a guarantee stands on its own and must therefore have a bearing on profit etc. of the enterprise to be called an international transaction, even then, one has to see whether the finding of the Tribunal in this regard is correct. To arrive at its conclusion, the Tribunal held as follows:

"There can be number of situations in which an item may fall within the description set out in clause (c) of Explanation to Section 92 B, and yet it may not constitute an international transaction as the condition precedent with regard to the 'bearing on profit, income, losses or assets' set out in Section 92B(1) may not be fulfilled. For example, an enterprise may extend guarantees for performance of financial obligations by its associated enterprises. These guarantees do not cost anything to the enterprise issuing the guarantees and yet they provide certain comfort levels to the parties doing dealings with the associated enterprise. These guarantees thus do not have any impact on income, profits, losses or assets of the assessee. There can be a hypothetical situation in which a guarantee default takes place and, therefore, the enterprise may have to pay the guarantee amounts but such a situation, even if that be so, is only a hypothetical situation, which are, as discussed above, excluded. One may have also have a situation in which there is a receivable or any other debt during the course of business and yet these receivables may not have any bearing on its profits, income, losses or assets, for example, when these receivables are out of cost free funds and these debit balances do not cost anything to the person allowing such use of funds. The situations can be endless, but the common thread is that when an assessee extends an assistance to the associated enterprise, which does not cost anything to the assessee and particularly for which the assessee could not have realized money by giving it to someone else during the course of its normal business, such an assistance or accommodation does not have any bearing on its profits, income, losses or assets, and, therefore, it is outside the ambit of international transaction under section 92B (1) of the Act."

In other words, according to the Tribunal, there must be a cost to the parent before it can be said that the transaction had any effect on its profits/assets etc. This seems to be a fundamentally flawed assumption in the context of transfer pricing. Assuming that a parent advances loan from its internal accruals to a subsidiary and does not charge anything to the subsidiary on the ground that it did not cost anything, surely a transfer pricing adjustment will have to be made. In the context of guarantee, the relevant question to ask is not whether it cost anything to the parent in issuing the guarantee. The relevant question to ask is whether the subsidiary would have got a guarantee from an unrelated party without incurring any expenditure. The answer is obviously no. In that case, it would have to be determined what an unrelated party would have charged the subsidiary for giving such a guarantee. In case, the amounts charged in the related party transaction were to be less, the difference would represent the required adjustment. This is not to say that determination of the arm's length price in the case of a guarantee is an easy task. In fact, it may be a difficult task. But that does not mean that TP adjustment cannot be made in the case of a corporate guarantee given by an Indian parent unless it is shown that the parent has incurred any cost for the same.

The Tribunal mentions that when it was put to the Departmental Representative that there could be a view that issuance of guarantees could be outside the ambit of scope of 'international transaction' itself, he submitted that there are large number of decisions in India and abroad, notably in Canada, dealing with the determination of arm's length price of guarantees. His argument seemed to be that even such a view is to be upheld, entire transfer pricing jurisprudence will be turned upside down.

The Tribunal then held that there was no legally sustainable merits in this argument and as for the decisions dealing with quantum of ALP adjustments in the guarantee charges, in none of these cases the scope of 'international transactions' under section 92B(1) has come up for examination.

From the order of the Tribunal, it is not known which Indian cases were actually brought to the notice of the Tribunal. A search from our database shows that in quite a few cases, assessees took the same argument that guarantee is not covered under international transaction and more importantly that it cost nothing to the parent company. In this context, in Everest Kanto [2012-TII-145-ITAT-MUM-TP], the Tribunal held as follows:

"…[S]o far as the Senior Counsel's contention that guarantee commission is not an international transaction and there could not be any method for evaluating the ALP for the guarantee commission, we do not find any merit in the said contention in view of the amendment brought by the Finance Act, 2012 with retrospective effect from 1-4-2002 by way of Explanation added in Section 92B. Payment of guarantee fee is included in the expression 'international transaction' in view of the Explanation i(c) of Section 92B …We also do not agree with the contention of the counsel that there could not be any cost or charge of guarantee fee by providing corporate guarantee to its subsidiary because there is an always element of benefit or cost while providing such kind of guarantee to AE"

The Tribunal in the case of Nimbus Communications Ltd [2013-TII-132-ITAT-MUM-TP] reiterated the same view. In the case of Reliance Industries Ltd - 2013-TII-185-ITAT-MUM-TP, the Tribunal held:

"… [W]e agree with TPO that there is a benefit to assessee's AE by providing of guarantee by the assessee for the loan taken from bank by Trevira GmbH." The Tribunal pointed out that the assessee has undertaken a risk on behalf of its AE, which in any case, a third party would not have undertaken or would have charged a consideration for it. Of course, in this case the Tribunal also rejected a different argument that guarantee was not an international transaction since the transaction was between the company and a bank that was not an AE.

It is therefore not entirely correct to say that the same issue was not considered in any other judgements in India. The Tribunal also refused to consider the Canadian case [GE Capital Canada Inc. Vs. The Queen] on the ground that the Canadian domestic law was different. In the Canadian case, the situation was actually the reverse. There, the US parent had charged the Canadian subsidiary @ 1% on account of a guarantee given. The Canadian Revenue disallowed the claim of payment by the subsidiary of such guarantee fee on the ground that the subsidiary even otherwise would have got the same credit rating as the parent and hence it did not benefit from the payment. This was negatived by the Tax Court, which after examining dozens of experts held that the subsidiary's rating would have been lower. The Appeals' Court subsequently upheld the decision of the Tax Court. The GE case is an extremely complex case that shows the difficulties in valuing the guarantees. But, there was never any doubt that guarantee given by a parent should be charged to the subsidiary. To that extent the decision was relevant.

It is possible that in the facts of this particular case, no adjustment was necessary particularly since the Tribunal at one place says that no borrowings were actually resorted to by the subsidiary from Deutsche Bank. But to lay down a broad proposition that whenever there is no cost to the parent company in issuing a guarantee to its subsidiary, there should be no transfer pricing adjustment, does not seem to be correct.