Chennai ITAT: Domestic PLR is not a comparable interest rate for loan given in foreign currency

Judgment dated May 20, 2011 of Hon'ble Income-tax Appellate Tribunal (‘ITAT’) in case of Siva Industries & Holdings Ltd. vs. Assistant Commissioner of Income-tax [IT Appeal No.2148 (MDS) of 2010] provides bit of guidance on justification of arm’s length rate of interest (‘ALP’) for a loan given by an Indian Company to its Foreign Subsidiary.

Facts of the Case

The tax payer, Siva Industries, has granted a loan to its subsidiary company in Mauritius for the purpose of making investment and had charged 6% interest p.a. the tax payer took average of 12 month’s US $ denominated LIBOR rate for the said period for the purpose of computing the ALP.

The tax authorities contended that the said rate cannot be taken for computing ALP since the loan was given from India and hence Prime Lending Rate (PLR) in India at that time should be considered and accordingly determined 11.75% p.a as the rate for computing the ALP and made the addition consequently.

Observation of the ITAT

The ITAT observed that as the loan provided to subsidiary company in Mauritius was out of its own funds and in foreign currency, the transaction would have to be looked upon by applying commercial principles in regard to international transaction. If that was so, then the domestic PLR would have no applicability. Further, the Hon’ble ITAT has also observed that as the rate charged by the taxpayer is more than mean LIBOR for a year, the LIBOR charged by the taxpayer from its subsidiary company in Mauritius is at arm’s length.

Our Comments

We feel though this judgment would provide relief to the taxpayers but it should give worry to the tax authorities. From a technical perspective it is correct to say that domestic PLR should not be considered comparable interest rate for the foreign currency loan however it may not be correct to say that LIBOR can be considered as comparable interest rate.

We understand that LIBOR is an interest rate at which banks can borrow funds, in marketable size, from other banks in the London interbank market. The LIBOR is fixed on a daily basis by the British Bankers' Association. The LIBOR is derived from a filtered average of the world's most creditworthy banks' interbank deposit rates for larger loans with maturities between overnight and one full year.

The LIBOR is the world's most widely used benchmark for short-term interest rates. It's important because it is the rate at which the world's most preferred borrowers are able to borrow money. It is also the rate upon which rates for less preferred borrowers are based. For example, a multinational corporation with a very good credit rating may be able to borrow money for one year at LIBOR plus four or five points. 

(Source: http://www.investopedia.com/terms/l/libor.asp)

We feel the correct approach would be to consider LIBOR as a base rate and then adjustment should be carried out based on the credit worthiness of the borrower and other commercial factors like time period, security, purpose etc.

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