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The Mumbai Tribunal upheld guarantee commission charged on loans and letter
of credit facility at 0.53 percent and 1.47 percent respectively as arms length
11 December 2013

Background

Facts of the case

Recently, the Mumbai Bench of the Income-tax Appellate


Tribunal (the Tribunal), in the case of Glenmark
1
Pharmaceuticals Limited (the taxpayer), explained the
difference between corporate guarantee and bank
guarantee, and held that bank guarantee rates available in
the public domain cannot be mechanically applied in
determining the arms length price. If proposed to be
used, the bank guarantee rates should be adjusted for
various differences, such as (i) risk profiles of the
respondents for the guarantee, (ii) financial position of the
loan applicants, (iii) term of the guarantee, (iv) security
involved, (v) quantum of guarantee, (vii) period of
guarantee, (viii) past history of the customers, etc. in
accordance with Rule 10B of the Income-tax Rules, 1962
(the Rules).

The taxpayer is engaged in the business of


manufacturing
and
marketing
of
pharmaceutical products and related Research
and Development activities.

During the year under consideration, the


taxpayer had charged guarantee commission
of 0.53 percent and 1.47 percent in respect of
guarantee provided in connection with bank
loans and LC facilities availed by its Associated
Enterprises (AEs); Glenmark Holding SA,
Switzerland and Glenmark Generics SA,
Argentina respectively. In the Transfer Pricing
study (TP study) undertaken by the taxpayer,
the guarantee commission charged of 0.53
percent for loan guaranteed and 1.47 percent
for LC facility was determined to be at arms
length applying the Comparable Uncontrolled
Price (CUP) method.

The Tribunal analysed co-ordinate bench rulings in case


of Asian Paints, Reliance Industries, Everest Kanto, etc.,
and upheld guarantee commission rates charged on loans
and letter of credit facility at 0.53 percent and 1.47 percent
respectively as arms length.
_________________
1

Glenmark Pharmaceuticals Limited v. ACIT (ITA No. 5031/M/2012)


Taxsutra.com
2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International
Cooperative (KPMG International), a Swiss entity. All rights reserved.

- EXIM Bank of USA (3 percent per


annum):

The Transfer Pricing Officer (TPO) rejected the TP


study stating that the taxpayer failed to discharge its
primary onus of benchmarking the transaction and
determined arms length guarantee commission at
three percent of the guaranteed amount based on
guarantee commission rates charged by various
banks, i.e. Allahabad Bank (3 percent per annum);
Dutch State, FMO (2.5 percent per annum); HSBC Ltd
(0.15 percent to 3 percent per annum); and EXIM
Bank of USA (3 percent per annum) resulting in an
adjustment of INR 115.1 million.
The taxpayer filed an appeal before the Commissioner
of Income-tax (Appeals) [CIT(A)] against the above
adjustment and submitted that following points should
be considered while determining arms length price of
the taxpayers guarantee commission: (a) Interest
saving, (b) Adjustments towards negotiations, (c) risk
undertaken by the taxpayer while providing guarantee
to the AEs, etc. The CIT(A) however, upheld the
adjustment made by the TPO and determined the
guarantee commission at 3 percent as arms length.

- Allahabad Bank (3 percent per annum):

- FMO (Netherland Financier) (2.5 percent per


annum):

Essential facts relating to this comparable are


not available in the public domain.

- HSBC (0.15 percent to 3 percent per annum):

The taxpayers contentions were in line with


those for Allahabad Bank.

Guarantee commission rate cannot be


equal to LIBOR rate which is nearly 3
percent.

The taxpayer contended that guarantee


commission rates charged by its financier, Bank
of India, to its customers may also be indicative
of the arms length guarantee commission.
However, the same would need to be adjusted
for factors, such as interest rates, risk factors,
guarantee amounts, nature of transactions, past
history of customers, etc.

Bank guarantees are not comparable to the


corporate guarantee provided by the taxpayer.

The Tribunal in various cases has upheld


corporate guarantee commission prices/ rates in
the range of 0.25 percent to 0.6 percent as arms
length.

The DR relied on the order of TPO, and the


Tribunal decision in case of M/s Technimont ICB
Pvt. Ltd. (ITA No. 6394/Mum/ 2012) stating that
bank guarantee commission rate of 3 percent
was upheld in this case.

The rates apply to guarantee upto INR 100 million


vis--vis INR 4500 million guaranteed by the
taxpayer.

Details of negotiations were not available in


the public domain

This is a case of bank guarantee offered to the


customers and not a corporate guarantee
The rates are applicable to rupee loans and not
foreign currency loans

The taxpayer highlighted that the above rates


were rejected by the Tribunal in various rulings,
i.e. M/s Asian Paints Ltd. (ITA No.
1937/Mum/2010) and M/s Everest Kanto Cylinder
Ltd. (ITA No. 542/Mum/2012) and M/s Reliance
Industries Limited (ITA No. 4475/ Mum/2011).

Aggrieved by the order of CIT(A), the taxpayer filed an


appeal before the Tribunal.

The taxpayer distinguished each of the comparables


selected by the TPO on, inter alia, the following
grounds:

The said transaction is not the case of


corporate guarantee

Proceedings before the Tribunal

Tribunals ruling

There are conceptual differences between a bank


guarantee and a corporate guarantee.
In
corporate guarantee, guarantee of payment is
made by a corporation on behalf of another
business entity. The guarantee is provided in
consideration of a vendor providing credit to a
business, on whose behalf the guarantee is
made. Corporate guarantee operates not for
business considerations, but to provide
safeguards for the financial health of the AEs.
Bank guarantee is a surety bond in finance, a
promise by one party to assume responsibility for
the debt obligation of a borrower if the borrower

2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International
Cooperative (KPMG International), a Swiss entity. All rights reserved.

defaults. Commercial considerations are paramount in


fixing charges in case of a bank guarantee. Hence, a
bank guarantee comparable may not clear the
Functions, Assets and Risks (FAR) analysis test in
case of a corporate guarantee.

Bank guarantee rates cannot be applied mechanically.


These need to be adjusted for various factors, such as
(i) risk profiles of the respondents for the guarantee,
(ii) financial position of the loan applicants,(iii) terms of
the guarantee, (iv) securities involved,(v) quantum of
guarantee,(vi) amount involved, (vii) period of
guarantee, (viii) past history of the customers, etc.

The ruling of Technimont ICB Ltd. is an aberration and


the facts are distinguishable vis--vis taxpayers case.
The Tribunal has analysed various rulings like Asian
Paints Ltd, Everest Kanto Cylinder Ltd, and Reliance
Industries Ltd on guarantee commission and
concluded that the guarantee commission rates of
0.53 percent and 1.47 percent on loans and LC facility
are at arms length.

Our comments
In recent assessments, the TPOs have determined the
arms length guarantee commission either by applying
guarantee commission rates charged by banks or by
applying the interest savings method using Indian interest
rates. The above ruling exhibits significant precedent value
in the first case as the Tribunal has evaluated and clearly
distinguished a corporate guarantee vis--vis a bank
guarantee. Further, it also emphasises the need to make
adjustments for various factors affecting the guarantee
rates as highlighted above. Hence, in the absence of any
specific guidance under the Indian TP Regulations, this
ruling assumes notable importance and should prove to be
useful from a taxpayers perspective. However, from a
taxpayers perspective it would be important to ensure that
there is robust documentation in relation to the guarantee
transaction and that the same is appropriately
benchmarked based on a complete understanding of the
facts surrounding the transaction.
Separately, it is relevant to note that recently the CBDT has
issued Safe Harbour Rules wherein, a safe harbor
guarantee commission of 2 percent (where the amount
guaranteed does not exceed INR 1000 million) and 1.75
percent (where the amount guaranteed exceeds INR 1000
million) has been prescribed. In light of this, a guarantee
commission of 0.53 percent and 1.47 percent accepted by
the Tribunal is a positive development.

2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International
Cooperative (KPMG International), a Swiss entity. All rights reserved.

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Cooperative (KPMG International), a Swiss entity. All rights reserved.
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2013 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International
Cooperative (KPMG International), a Swiss entity. All rights reserved.