In common parlance, corporate guarantee transaction entails providing guarantee to a third-party for the benefit of the borrowing company. Typically, a fee is charged for such guarantee as a factor of risk is involved. Such guarantee transaction assumes significance where the guarantor is providing guarantee to the lender on behalf of borrower who is a related party to the guarantor, in which case arms length principle has to be satisfied.
Telecom major Bharti India had issued a corporate guarantee to an Indian bank on behalf of its subsidiary, Bharti Lanka, for repayment of working capital. The tax department made an adjustment on account of the corporate guarantee, citing it as an intra-group service resulting in Bharti Lankas enhanced credit rating. Bharti challenged this, arguing that a corporate guarantee was not exigible to tax as there was no transaction. Bharti based its argument on the real income theory which advocates that where there is no income, there is no cause for tax adjustment, citing that it is one of the fundamental principles of anti-avoidance taxation laws.
It further argued that since the provision of such guarantee did not result in imposition of any real obligation, the proposal of benchmarking such guarantee to meet the arms length principle was flawed. It was iterated that the onus was on the revenue authorities to demonstrate that a transaction has a bearing on the profits/ income/ losses or assets to bring it in the realm of transfer pricing (TP) adjustment. The Tribunal ruled in favor of the taxpayer concluding that capital financing falls under the residual category of expanded definition of international transaction which tests the bearing on profits, income, losses or assets of an enterprise.
Revenues primary argument was that guarantee is covered within the ambit of TP regulations as explained in the retrospectively inserted explanation to Section 92B. The explanation was introduced in the Finance Act 2012, to enlarge the scope of international transaction to include corporate guarantee within its ambit. In 2012, India witnessed record retrospective amendments to tax laws, causing mayhem in the minds of taxpayers, even as such expansion in definition militates against the real income theory.
Though the Tribunal briefly touched upon the issue of such retrospective amendment and its implication, it being mindful of its power, dropped from venturing into it. Taxability of guarantee was under dispute in many cases including the famous Hindalco Novelis acquisition wherein the Bombay High Court refused to entertain a writ of Birla group challenging taxation of corporate guarantee. Pronouncement of landmark judgments like that of the Hyderabad Bench of Tribunal in the case of Four Soft and the coordinate bench of Mumbai Tribunal in the case of Mahindra & Mahindra did subsequently come as a sign of relief. The benches held that guarantees do not fall within the definition of international transaction. The relief was short-lived since, in 2012, corporate guarantee was specifically inserted within the ambit of TP provisions, albeit retrospectively.
One essential aspect that the Tribunal in the Bharti case examined was if transfer pricing, being an anti-avoidance statute, should be subject to retrospective amendment. Under the laws of Indian transfer pricing, the onus of compliance through maintaining TP documentation is on the taxpayer. Any retrospective amendment that imposes a charging burden or additional compliance on the taxpayer coupled with penal consequences is inherently defective. This is because the taxpayer cannot be penalised for a compliance that is impossible to perform due to it being a past event.
Leaving the retrospective amendment issue aside and talking of the prospective law and its effects, the possible tests to analyze taxability of guarantee should first be identified. OECD guidelines do not provide a straight approach to treat all guarantee transactions as intra-group services. On the contrary, OECD advocates the presence of taxpayers active association with its associated enterprise through specific performance to improve its credit rating. This active association concept is envisaged in the TP rules of countries like the US, Australia and Malaysia. Active association can be proven by analysing the global marketing policies and any specific public relation campaigns entered into by taxpayer in order to establish the credibility of its associated enterprise. It is also necessary to examine the benefit test from a recipients perspective. India should consider picking a leaf from global regulations.
In summary, this judgment is relevant because it is one of the foremost cases that discuss the taxability of corporate guarantee after an expansive definition of international transaction was introduced. The real essence of the analysis covered in the judgment lies in the nuggets of logical arguments placed by Bharti. Since OECD guidelines are also suggestive of following a case-to-case approach while dealing with corporate guarantee, this judgment reinforces the importance of analyzing the factual matrix by taxpayers, while analysing their case within the four corners of the TP statute.
With inputs from Parul Mittal, associate, BMR Legal
The author is managing partner, BMR Legal. Views are personal