LIBOR benchmarking, usance interest and foreign tax relief shape transfer pricing and deduction treatment in cross-border transactions.

Usance interest paid to non-resident suppliers on imported purchases was treated as part of the purchase transaction, so it did not constitute interest for section 195 and no disallowance under section 40(a)(ia) followed. For foreign currency loans to an associated enterprise, LIBOR-based pricing was accepted as the proper arm's length benchmark, not domestic lending rates. ERP-related outgo was split: the software purchase component was capital, while licences, implementation, maintenance and support were revenue expenditure. Treaty relief for foreign tax paid in Brazil was allowed on the tax liability relating to income accrued and offered to tax, not merely on amounts remitted during the year.

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Issues: (i) Whether usance interest paid to non-resident suppliers on imported purchases attracted tax deduction at source and disallowance under section 40(a)(ia); (ii) whether LIBOR plus basis was the proper benchmark for determining arm's length interest on a foreign currency loan to an associated enterprise; (iii) whether expenditure on ERP software, licences and maintenance was capital or revenue in nature; and (iv) whether relief under section 90 for foreign tax paid in Brazil was confined only to the amount actually remitted during the year or extended to the tax liability on the income accrued and offered to tax.

Issue (i): Whether usance interest paid to non-resident suppliers on imported purchases attracted tax deduction at source and disallowance under section 40(a)(ia).

Analysis: The payment was treated as part of the purchase transaction and, following the decision rendered in the assessee's own earlier years, it was held that such usance interest did not assume the character of interest within section 2(28A) so as to attract section 195. Once no obligation to deduct tax at source arose, the consequential disallowance under section 40(a)(ia) could not be sustained.

Conclusion: The issue was decided in favour of the assessee and against the Revenue.

Issue (ii): Whether LIBOR plus basis was the proper benchmark for determining arm's length interest on a foreign currency loan to an associated enterprise.

Analysis: For an international transaction in foreign currency, the comparable market rate had to be tested on international parameters and not on domestic lending rates. The accepted approach in earlier Tribunal decisions was that LIBOR-based pricing reflected the relevant commercial benchmark for cross-border lending and the domestic prime lending or corporate bond rates were not determinative.

Conclusion: The issue was decided in favour of the assessee and against the Revenue.

Issue (iii): Whether expenditure on ERP software, licences and maintenance was capital or revenue in nature.

Analysis: The invoices showed that the major part of the outgo related to licences, implementation, maintenance and support, which only enabled use of the software and did not result in acquisition of a capital asset. Only the actual software purchase component was capital in nature, while the balance was allowable as revenue expenditure.

Conclusion: The issue was decided partly in favour of the assessee.

Issue (iv): Whether relief under section 90 for foreign tax paid in Brazil was confined only to the amount actually remitted during the year or extended to the tax liability on the income accrued and offered to tax.

Analysis: The assessee had offered the entire interest income on accrual basis and the treaty relief was meant to eliminate double taxation on the income so taxed. The expression "tax paid" was read in the context of the Income-tax Act and the accounting method followed by the assessee, so that the liability incurred on the accrued income could not be denied merely because only part of the tax was remitted in the relevant year. Since the tax on the full income was ultimately discharged, full relief was held to be admissible.

Conclusion: The issue was decided in favour of the assessee.

Final Conclusion: The Revenue's appeal failed, the assessee obtained substantial relief on the foreign tax credit issue, and the software expenditure was only partly capitalised.

Ratio Decidendi: In an international transaction denominated in foreign currency, LIBOR is the appropriate benchmark for arm's length interest; usance interest on import purchases does not necessarily attract TDS disallowance where it forms part of the purchase price; and treaty relief for foreign tax must be aligned with accrual and actual tax liability on the income assessed.

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