Though corporate guarantee as a term was coined by the investor community, lately it’s been much talked about in legal circles. More so, after the Delhi Tribunal judgment in case of Bharti Airtel which has turned the tables in favour of the taxpayer.
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 arm’s 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 Lanka’s 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 arm’s 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.
Revenue’s 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.