Transfer pricing for interest-free AE loans: LIBOR-based benchmarking accepted, but loan period must match actual duration.

Interest-free loans advanced to associated enterprises were treated as international transactions for transfer pricing purposes, and their arm's length price was benchmarked by reference to the LIBOR of the country where the funds were used, with an additional 2% markup accepted on the facts. The Tribunal also held that a uniform 12 months' average LIBOR was inappropriate where the loans were repaid within shorter periods and the loan tenures were not uniform; the relevant loan periods needed verification before the correct LIBOR period could be applied. The appeal thus succeeded partly on the benchmark rate, while the LIBOR period issue was remitted for fresh consideration.

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Issues: (i) Whether notional interest on interest-free loans advanced to associated enterprises was required to be benchmarked under transfer pricing provisions and, if so, at what rate; (ii) whether 12 months' average LIBOR could be applied for benchmarking loans that were repaid within a shorter period.

Issue (i): Whether notional interest on interest-free loans advanced to associated enterprises was required to be benchmarked under transfer pricing provisions and, if so, at what rate.

Analysis: The loans to the associated enterprises were treated as international transactions. The arm's length price of such loans had to be determined with reference to the LIBOR applicable to the country where the loan was consumed. For the benchmark rate, the Tribunal followed the view that an additional mark-up over LIBOR was justified.

Conclusion: The transaction was required to be benchmarked at the LIBOR of the respective country plus 2%, and this issue was decided partly in favour of the assessee.

Issue (ii): Whether 12 months' average LIBOR could be applied for benchmarking loans that were repaid within a shorter period.

Analysis: The loan periods were not uniform and none of the loans continued beyond one year. Applying a uniform 12 months' average LIBOR was held to be inappropriate on the facts. The matter required verification of the relevant loan periods and reconsideration of the appropriate LIBOR period after giving the assessee an opportunity.

Conclusion: The issue was restored for fresh consideration and allowed for statistical purposes.

Final Conclusion: The appeal was partly succeeded on the benchmark rate for notional interest, while the question of the appropriate LIBOR period was sent back for verification and fresh decision.

Ratio Decidendi: Interest-free loans to associated enterprises are benchmarkable as international transactions at the LIBOR of the country where the funds are used, with an appropriate markup, and the benchmarking period must correspond to the actual loan duration.

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