Effective interest rate must consider time value of money before benchmarking international transactions per Goodyear precedent

ITAT Bangalore allowed the assessee's appeal for statistical purposes in a transfer pricing case involving interest on Non-convertible Debentures issued to an Associated Enterprise. The TPO had made adjustments by applying coupon rates of 15% and 14.25% without considering the effective interest rate that factored in moratorium periods of 60 months, 58 months 11 days, and 24 months for different tranches. Following the Goodyear South Asia Tyres precedent, ITAT held that effective interest rates must be computed considering time value of money before benchmarking international transactions. The matter was remitted back to TPO for fresh analysis of the transfer pricing study.

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Issues Involved:
1. Transfer pricing adjustment on account of interest paid on Non-convertible Debentures (NCDs) issued to Associated Enterprise (AE).
2. Consideration of moratorium period in determining the effective rate of interest for arm's length price (ALP).

Summary:

Issue 1: Transfer Pricing Adjustment on Interest Paid on NCDs
The appeal concerns the transfer pricing adjustment made by the TPO on the interest paid by the assessee on NCDs issued to its AE. The assessee, engaged in real estate development, issued NCDs in three tranches with accrued interest rates of 15% p.a. for the first two tranches and 14.25% p.a. for the third tranche. The total interest accrued amounted to INR 23,03,62,501. The assessee used the Comparable Uncontrolled Price (CUP) method to benchmark these transactions, concluding that the interest rates were within the arm's length price. However, the TPO did not accept the effective rate of interest considered by the assessee and made a TP adjustment of INR 4,97,51,100 by applying the coupon rate of 15% as interest on Tranche I & II of NCDs. The DRP upheld this adjustment, rejecting the assessee's objections.

Issue 2: Consideration of Moratorium Period in Determining Effective Rate of Interest
The primary contention was whether the moratorium period should be factored in while determining the effective rate of interest for ALP. The assessee argued that the effective rate of interest, considering the moratorium period, was lower than the agreed coupon rate due to savings in cash outflow and the time value of money. The Pune Bench of the Tribunal in Goodyear South Asia Tyres P. Ltd. held that it is appropriate to compute the effective rate of interest considering the moratorium period before benchmarking such international transactions. The Tribunal noted that the lower authorities did not consider the detailed working provided by the assessee for arriving at the effective rate of interest and rejected it based on the interest accrued in the Profit & Loss account and the pre-payment clause in the agreement. The Tribunal found this approach incorrect, emphasizing the need to consider the time value of money and the factual position that no interest was paid to the AE till date.

Conclusion:
The Tribunal remitted the issue back to the TPO to re-analyze the transfer pricing study done by the assessee afresh, directing the TPO to consider the ratio laid down in the Goodyear South Asia Tyres P. Ltd. case and the comparables chosen by the assessee. The assessee's appeal was allowed for statistical purposes, and the rest of the grounds raised by the assessee regarding the TP adjustment were left open.

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