The taxpayer demonstrated that funding the U.S. subsidiary through equity capital would have required prior approval of the Reserve Bank of India, whereas no such approval was required for the advances. Once the taxpayer received approval from the Reserve Bank of India, it immediately converted the advances to equity capital.
The taxpayer manufactures and sells printing inks and other allied products. In exploring opportunities in foreign markets, the taxpayer established a U.S. subsidiary to conduct manufacturing activities with ingredients supplied by the taxpayer.
The taxpayer made guarantees and advances (in the form of “quasi capital”) to the U.S. subsidiary without charge. The guarantees and advances were made to assist the subsidiary in borrowing funds from banks and financial institutions.
The taxpayer reported, as international transactions, its sale of goods and packing material samples to the U.S. subsidiary. The taxpayer also disclosed the guarantees and advances.
The Transfer Pricing Officer did not agree with the taxpayer’s approach in determining the arm’s length price of the advances, and proposed adjustments to reflect that these funds were in the nature of interest-bearing advances and therefore were subject to an interest rate of 11% per annum.
The taxpayer countered that the advances were akin to shareholder’s funds, and that because the U.S. subsidiary was a new entrant in the U.S. market and faced stiff competition, it was necessary for the taxpayer to increase its capital support in order to provide an appropriate capital base for the U.S. subsidiary.
The taxpayer explained that it had intended to fund the subsidiary through equity capital (pending approval of the Reserve Bank of India), and that such approval was not required in order to provide an advance to a foreign subsidiary. Once the taxpayer received such approval, the taxpayer had immediately converted the advances into equity capital.
The tribunal generally agreed with the taxpayer that there would be no interest on the advances provided to the related party based on the commercial and business considerations presented.
Read an August 2013 report [PDF 180 KB] prepared by the KPMG member firm in India: Ahmedabad Tribunal held that no transfer pricing adjustment should be made on interest-free advances to associated enterprises owing to commercial considerations
Contact a tax professional with KPMG's Global Transfer Pricing Services.