Transfer pricing, tax treaty exemption, and head office expenditure rules clarified in inter-bank indemnity and refund interest dispute

In transfer pricing, back-to-back inter-bank indemnity services were treated as support services, and where no reliable third-party comparable for identical services existed, TNMM was accepted as the most appropriate method rather than CUP. Interest on income-tax refund was treated as interest paid by the Government and held exempt under Article 11(3) of the India-Canada DTAA. For head office expenditure, section 44C was applied as the governing ceiling for non-resident claims, and the absence of a separate branch-book entry was held not decisive where the claim remained within the statutory limit.

---

---

Issues: (i) Whether the transfer pricing adjustment on administrative support services in relation to inter bank indemnities was sustainable by applying the comparable uncontrolled price method instead of the transactional net margin method; (ii) whether interest on income-tax refund was taxable in India or exempt under Article 11(3) of the India-Canada DTAA; (iii) whether deduction under section 44C of the Income-tax Act, 1961 was allowable on the assessee's claim for head office expenditure.

Issue (i): Whether the transfer pricing adjustment on administrative support services in relation to inter bank indemnities was sustainable by applying the comparable uncontrolled price method instead of the transactional net margin method.

Analysis: The issue was held to be identical to an earlier year where the assessee's transaction of issuing guarantees against back-to-back inter-bank indemnities was treated as a support-service activity. The available material showed that the assessee was protected by counter-guarantees from overseas branches, that no reliable third-party comparable for identical services was available, and that comparable margins under the transactional net margin method were available. In those circumstances, the comparable uncontrolled price method could not be applied and the transactional net margin method was accepted as the most appropriate method.

Conclusion: The transfer pricing adjustment was deleted and the issue was decided in favour of the assessee.

Issue (ii): Whether interest on income-tax refund was taxable in India or exempt under Article 11(3) of the India-Canada DTAA.

Analysis: Article 11 of the treaty provides that interest arising in a contracting state and paid to a resident of the other contracting state is exempt from tax in the first-mentioned state if the payer is the Government of that state. Interest on income-tax refund is interest arising from a statutory refund payable by the Government, and the treaty language was treated as covering such payment. The contrary reliance on a different treaty was found inapposite because the relevant exemption clause in the India-Canada DTAA was materially distinct.

Conclusion: The interest on income-tax refund was held to be exempt under Article 11(3) and the issue was decided in favour of the assessee.

Issue (iii): Whether deduction under section 44C of the Income-tax Act, 1961 was allowable on the assessee's claim for head office expenditure.

Analysis: The statutory ceiling in section 44C governs allowability of head office expenditure attributable to the Indian business of a non-resident. The existence or absence of a book entry in the Indian branch accounts was held not to be decisive. Since the assessee's claim was within the statutory ceiling and supported by the material on record, the disallowance made by the Assessing Officer was not sustainable.

Conclusion: The deduction under section 44C was upheld and the issue was decided in favour of the assessee.

Final Conclusion: The assessee succeeded on the substantive transfer pricing and treaty issues, while the Revenue succeeded only on the withdrawn comparator ground, resulting in a mixed outcome across the connected appeals.

Ratio Decidendi: Where no reliable third-party comparable for identical inter-bank indemnity services exists and the assessee is fully protected by counter-guarantees, the transactional net margin method may be the most appropriate method; interest on an income-tax refund paid by the Government falls within the treaty exemption where the applicable DTAA so provides; and head office expenditure attributable to Indian business is deductible within the statutory ceiling irrespective of whether it is separately reflected in the branch books.

---