Transfer pricing on foreign currency loans: LIBOR, not domestic lending rates, is the proper benchmark for arm's length interest.

An interest-free advance to an associated enterprise may still attract arm's length interest under transfer pricing principles, and an Article 11 treaty argument was treated as inapplicable because the dispute concerned a section 92 adjustment rather than taxation of actually paid interest. For benchmarking a foreign currency loan repayable in the same currency, the comparable rate should reflect that currency's market rate, so LIBOR was preferred over SBI Prime Lending Rate. The transfer pricing addition was therefore sustained in principle, while recomputation was directed using LIBOR, giving the assessee only partial relief.

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Issues: (i) Whether the additional ground challenging transfer pricing adjustment on the basis of Article 11 of the India-Finland Double Taxation Avoidance Agreement could be admitted and succeed on merits; (ii) Whether, for benchmarking an interest-free foreign currency loan, the proper comparable rate was SBI Prime Lending Rate or LIBOR.

Issue (i): Whether the additional ground challenging transfer pricing adjustment on the basis of Article 11 of the India-Finland Double Taxation Avoidance Agreement could be admitted and succeed on merits.

Analysis: The challenge under Article 11 was treated as a new limb of the already considered transfer pricing issue. The earlier Special Bench had already held that arm's length interest could be imputed on the interest-free loan, and that finding bound the Division Bench. Article 11, which addresses taxation of interest on a payment basis, was held inapplicable because the dispute concerned a transfer pricing adjustment under Article 9 and section 92, not the taxation of actually paid interest. The ground was therefore not fit for admission and, in any event, failed on merits.

Conclusion: The additional ground was not admitted and was rejected on merits, against the assessee.

Issue (ii): Whether, for benchmarking an interest-free foreign currency loan, the proper comparable rate was SBI Prime Lending Rate or LIBOR.

Analysis: The loan was denominated in US dollars and repayable in the same currency. The proper benchmark was therefore the market rate applicable to the currency of repayment, not the domestic rupee lending rate. Applying the currency-specific approach, the rate had to reflect the foreign currency loan character of the transaction, making LIBOR the appropriate comparable rather than SBI Prime Lending Rate.

Conclusion: LIBOR was held to be the correct benchmark, in favour of the assessee.

Final Conclusion: The transfer pricing addition was upheld in principle, but the matter was sent back for recomputation of the arm's length adjustment by applying LIBOR, resulting in only partial relief to the assessee.

Ratio Decidendi: An interest-free advance to an associated enterprise can attract arm's length interest under section 92, but where the loan is in foreign currency and repayable in that currency, the comparable interest rate must be determined by reference to that currency and not the domestic lending rate.

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