In a recent, first-of-its-kind ruling, in the case of Credit Lyonnais India branch, the Income Tax Appellate Tribunal in Mumbai held that the role played by the Indian bank branch in relation to credit analysis of Indian borrowers is core to the overseas co-branch for taking decisions on granting loans to the Indian borrowers. Accordingly, an attribution was considered necessary and the tribunal attributed 20% of the fee received by the overseas co-branch from the borrower, to the Indian branch for the credit analysis function. Since the Indian branch did not contribute to the loan amount, the tribunal did not attribute any interest income to it. During the course of the proceedings, the tax payer, relying on the India-France tax treaty, had argued that no profit should be attributed to it on account of its mere facilitation role that helped signing of the loan agreement. However, the tribunal held that the credit analysis carried out by the Indian bank branch of the bank was core to taking decisions on granting the loan, and a part of the fee income earned by the overseas co-branch should be attributed to the Indian branch. Having said this, the tribunal did not discuss the relative importance of other functions involved in the lending transactions, and the impact of such functions on the attribution of profits. The tribunal also did not provide any guidance with respect to suggested comparability analysis for such inter-company arrangements, which is essential from an arm's length price setting perspective.
While current industry practice for such attribution varies across banks, typically a portion of income from the relevant lending transactions is attributed to the Indian branch for its role. Of course, one will need to factor the specific fact patterns, and the role played by the Indian branches while attributing appropriate arm's length compensation to them. Such role may be limited to pure liaising/monitoring or include active relationship management and credit decisions. In this regard, the Organisation for Economic Co-operation and Development (OECD), in its report on Attribution of Profits to Permanent Establishments, provides relevant guidance on attributing arm's length profits to bank branches by considering the key people functions performed in creating financial assets and their ongoing management.
As discussed, this is one of the first rulings on the subject, and provides a level of guidance. Hence, it will be important to watch for further direction emerging through future rulings that involve adjudication of diverse transfer pricing policies on the subject, particularly with respect to treatment of key functions and the resultant level of attribution to Indian bank branches.
For bank taxpayers in todays times, it is important to develop robust intra-group transfer pricing policies to implement transactions between Indian branches and overseas booking locations from an arms length standpoint. Towards this objective, they should also consider conducting a thorough comparability analysis to support the income that needs to be attributed to their Indian bank branches, with the objective of mitigating the possibility of attribution on an arbitrary basis. Importantly, integrating technical guidance such as the OECD with a practical factual analysis to set policies in each case is critical.
As a final point, while taxpayers deal with their transfer pricing in this important area, they must plan to review their policies on a regular basis to ensure that they align with evolving market practices/business dynamics. Further, changing business structures such as subsidiary models (versus branch structures) will have a bearing where, for example, aspects such as the approach to allocate a return to capital deployed may play a role in the arm's length pricing framework.
Dhaivat Anjaria & Archit Kotwal
Anjaria is partner and Kotwal is senior manager at PricewaterhouseCoopers India. Views are personal