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The Mumbai Tribunal upheld attribution of 20 percent of fees and other charges after excluding interest charged by foreign branches, as appropriate compensation for the Indian branch

30 October 2013

Background Recently, the Mumbai Bench of the Income-tax Appellate

Tribunal (the Tribunal) in the case of Credit Lyonnais1 (the

taxpayer) held that services provided by the taxpayer

were crucial services and inevitable for the decision

making of providing loan by the foreign branches. Such

services cannot be said to be a mere facilitation for

conclusion of the loan agreement or signing thereof, as

specified in Para 4 of the Protocol of the India-France tax

treaty. The Tribunal upheld the order of the Commissioner

of Income-tax (Appeals) [CIT(A)] for attribution of 20

percent of fees charged by foreign branches on account of

agent fee, commitment fee and arrangement fees but

observed that such addition should only be in respect of

the fees excluding the interest charged by the foreign

branches, as the taxpayer had not contributed to the loan

amount.

________________ 1 Credit Lyonnais v. ADIT (ITA No.1935/Mum/2007)

Facts of the case

The taxpayer has facilitated foreign currency loan to its clients from overseas branches but did not show any income on the said transaction. Services with regard to structured finance and syndicate business were rendered by the syndication desk in Hong Kong.

All negotiations, discussions with potential clients were done by the syndication desks in Hong Kong. The role of the taxpayer was to provide financial analysis of the borrower, general market conditions in India and regulatory environment. The arrangement fees were received by the lead arrangers or co-lead arrangers.

In case of the existing clients of the taxpayer, the financial analysis is readily available with the taxpayer branch for local facilities, which is forwarded to the syndicate desk team. All other activities and facilities like loan document, legal opinion, signature, execution of loan document were done by the syndication desk and legal team in Hong Kong.

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The Transfer Pricing Officer (TPO) did not accept the contention of the taxpayer and computed the arm’s length charges being 25 percent of the total amount comprising interest and fee received by the offshore branches.

The CIT(A) observed that the TPO has made the adjustment on the basis of estimation without any supporting evidence. Accordingly, the CIT(A) reduced the adjustment from 25 percent to 20 percent of the interest and fee amount.

Issues before the Tribunal

Whether profit can be attributed to a Permanent Establishment (PE) by reason of facilitation of conclusion of loan agreement or mere signing thereof?

Whether attribution of 25 percent of interest and other fees received by the foreign branches is correct?

Taxpayer’s contentions

Foreign exchange loan (ECB) has been given by the Headquarter/foreign branches of the taxpayer. The services of the taxpayer was limited only to provide financial analysis of borrower, general market conditions in India and regulatory environment for which the taxpayer had not received any service charges, commission or fee.

As per para 4 of the protocol of the tax treaty, no profit can be attributed to a PE by reason of facilitation of conclusion of foreign trade or loan agreements or the mere signing thereof.

The term used in the protocol being ‘facilitation’ means to ‘render easier the performance’. The role of the taxpayer to provide certain information is only to facilitate the loan agreement and, therefore, no profit can be attributed to the taxpayer on account of such limited services.

During the year under consideration, the foreign currency loan was given to the existing clients of the taxpayer for which the financial analysis was readily available and therefore, there is no new party for which the taxpayer would have provided any specific services.

The transactions were completed outside India as all documents were signed outside India and therefore, the fee received by the foreign branches on this account was not attributable to the taxpayer.

Alternatively, it was contended by the taxpayer that the adjustment of 20 percent in respect of interest and other fees received by the foreign branches is highly arbitrary. The interest cannot be attributed to the taxpayer when the loan is provided by the foreign branch and, therefore, even if a profit is attributed to the taxpayer, the same should be limited to the various fees or service charges received by foreign branches and that too in a reasonable proportion i.e. 10 percent.

Another alternative submission by the taxpayer was that, if at all interest was also attributed to the taxpayer then the attribution to the taxpayer should not be more than 2 to 5 percent of the total income (including interest and fees) received by the foreign branches.

Tax department’s contention

Paragraph 4 of the Protocol to the tax treaty, is not applicable in the case of the taxpayer. The role of the taxpayer was to facilitate the loan transaction by providing the financial analysis of the borrowers, general market condition and regulatory environment in India. It was not in the nature of facilitating the loan agreement or signing of loan agreement, but these activities are directly related to the loan transaction itself.

Tribunal’s ruling

The taxpayer provided the services regarding client’s creditability analysis, its capacity so as to consider the capacity to repay the loan and risk involved in the loan transaction. Therefore, the role of the taxpayer in providing such a crucial service is inevitable for taking the decision of providing loan. The plain reading of paragraph 4 of the protocol of the tax treaty, makes it clear that if the role of the PE is only to facilitate the conclusion of foreign trade or loan agreement or mere signing thereof, then no profit shall be attributed to PE in terms of Article 7(2) of the tax treaty.

Since, the taxpayer’s role in providing the services is the core-basis of taking the decision of granting loan, therefore, the nature of services provided by the taxpayer does not fall under the terms facilitation of conclusion of loan agreement or signing thereof as stipulated under paragraph 4 of the Protocol.

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When the loan is provided by the syndicate and the

taxpayer has not contributed to the loan amount then as regards the interest charged on loan, the same cannot be attributed to the taxpayer. However, in the facts and circumstances of the case, only the fee and other charged received by the foreign branches should be taken into consideration for making adjustment under transfer pricing provisions, as the taxpayer has provided the services of the financial analysis of the borrowers, market conditions and the regulatory environment in India.

Since none of the parties to appeal have come out with the suitable comparables, the Tribunal held that the estimation made by the CIT(A) at the rate of 20 percent was just and proper, however, the same would be only in respect of the fee and charges excluding the interest received by the foreign branches

Our comments

This is an important decision of the Mumbai Tribunal

affirming that since the Indian branch has not contributed to

the loan amount, interest received by the foreign branch

cannot be taken into account for attribution of income to the

Indian branch. Therefore, in the facts and circumstances of

the case only the fee and other charges received by the

foreign branches can be taken into consideration for

determining the fee or commission in respect of support

services in the nature of credibility analysis rendered by

Indian branch of overseas Bank for foreign currency deals

between Indian customers and foreign branches.

© 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.

The information contained herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we

endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue

to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.

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Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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