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Corporate Guarantees and Transfer Pricing – The Micro Ink Revolution
1. INTRODUCTION: THE GUARANTEE PRICING CONTROVERSY
The Problem That Micro Ink Solved
Pre-2016 Scenario:
A multinational company (MNC) with Indian subsidiary structure:
- Parent company (foreign): Borrows funds, on-lends to Indian subsidiary
- Subsidiary (Indian): Repays loans to parent
- Guarantor (Indian): Subsidiary guarantees parent’s loan to banks
The Revenue’s Aggressive Claim:
- “The guarantee is a service provided by subsidiary to parent”
- “This service has commercial value”
- “Arm’s Length Price (ALP) must be benchmarked against bank guarantee fees (0.75%-2%)”
- “Subsidiary should charge fee for providing guarantee”
- “If not charged, Transfer Pricing adjustment justified”
The Mismatch:
- Subsidiary earned zero fee (issued guarantee for free as shareholder support)
- Yet Revenue wanted to impute ₹10-20 crores ALP (based on bank guarantee fee benchmarking)
- Subsidiary didn’t have this cash; wasn’t a commercial transaction
The Question: Is issuing corporate guarantees a “transfer pricing” matter requiring ALP benchmarking?
Micro Ink’s Answer: NO. Emphatically NO.
Why This Mattered Globally
The guarantee pricing issue wasn’t unique to India:
- Transfer pricing authorities in multiple countries (US, UK, Canada) had faced similar issues
- Courts were divided on how to treat corporate guarantees
- MNCs operating with inter-company guarantees faced unpredictable tax treatment
- Micro Ink provided crucial clarity for Indian MNCs
2. PRE-MICRO INK ERA: THE DEPARTMENT’S AGGRESSIVE POSITION
Historical Context: The TPO’s Mindset
Transfer Pricing Officers (TPOs) in 2010-2015 took the position:
“Anything between related parties is a transfer pricing matter. Guarantees are services. Services have value. Therefore, guarantee pricing must be benchmarked.”
Supporting Arguments:
- OECD Guidelines Analogy: OECD Transfer Pricing Guidelines treat guarantees as financial services requiring benchmarking
- Economic Reality: A guarantee has value (credit enhancement for the borrower)
- Section 92B Breadth: Section 92B defines “international transaction” broadly, including “any other transaction”
- Commercial Practice: Banks charge for guarantees; why shouldn’t related parties?
The Department’s Proposed Benchmarking
Methodology:
- Compare corporate guarantee fee to commercial bank guarantee fee
- Bank fees typically: 0.75% to 2% per annum on guaranteed amount
- Apply this percentage to inter-company guarantee amount
- Impute as ALP
Example:
text
Subsidiary guarantees parent’s ₹100 crore loan
Commercial bank fee would be: 1.5% × ₹100 crore = ₹1.5 crores
TPO adjustment: ₹1.5 crores ALP not charged
Result: Transfer pricing addition of ₹1.5 crores
Problems with This Approach
Even before Micro Ink, practitioners questioned the transfer pricing officer methodology for pricing corporate guarantees. Here are four critical flaws in the Department’s reasoning:
- Guarantee May Never Crystalize: Bank guarantee fee assumes actual default is possible. Corporate guarantee (for shareholder support) may never result in actual payment.
- No Actual Cost: Subsidiary incurred no cost to issue guarantee. How can it charge fee it doesn’t have?
- Not a Commercial Transaction: Shareholder guarantee is a capital structure decision, not a commercial service.
- Misapplication of OECD: OECD Guidelines address guarantees where there’s actual financial service element. Shareholder guarantees are different.
3. MICRO INK LTD. FACTS & ARGUMENTS
Case Citation & Bench
Case: Micro Ink Ltd. vs. ACIT
Court: Ahmedabad Income Tax Appellate Tribunal
Citation: (2016) 157 ITD 132; 154 Taxman 302
Bench: Pramod Kumar (AM), S.S. Godara (JM)
Judgment Date: November 27, 2015
Company Profile
Micro Ink Ltd.:
- Software/IT company
- Multinational structure (Indian subsidiary of foreign parent)
- Maintained investments in subsidiary companies
- Issued various guarantees to banks on behalf of subsidiaries
Assessment Year in Dispute
AY 2006-07 (and similar years)
Nature of Guarantees:
- Bank guarantees issued by Micro Ink
- Beneficiary: Subsidiary companies (related entities)
- Purpose: Enable subsidiaries to obtain credit facilities
- Fee charged: ZERO (issued as shareholder support, not commercial service)
Guarantee Amount: Several guarantees aggregating ₹100+ crores
TPO’s Position
TPO Argued:
- Guarantees are “financial services” (per OECD Guidelines)
- ALP should be benchmarked to bank guarantee rates (0.75%-2%)
- Micro Ink failed to charge ALP (commercial guarantee fee)
- Transfer pricing adjustment of ₹2-5 crores justified
TPO’s Proposed Addition: Based on 1-1.5% of guarantee amount
Micro Ink’s Counterarguments
Company Contended:
- “Not an International Transaction”:
- Guarantees don’t constitute “international transaction” under Section 92B
- They’re quasi-capital in nature (shareholder support)
- Not a provision of services requiring benchmarking
- “No Bearing on Profits”:
- Section 92B requires “bearing on profits, income, losses or assets”
- Guarantees are contingent; may never impact profit
- Mere possession of contingency risk ≠ bearing on profit
- “OECD Inapplicable”:
- OECD Guidelines address guarantees where financial service element exists
- Shareholder guarantee for capital structure is different
- India’s statute doesn’t require importing OECD concepts
- “Not a Service”:
- Guarantee is not a “provision of services” (Section 92B clause)
- It’s a capital/shareholder activity
- Cannot benchmark a non-service transaction
- “Bank Guarantee Fees Inapplicable”:
- Bank guarantees backed by deposits/collateral
- Corporate guarantees backed by shareholder support
- Fundamentally different models; fees not comparable
4. THE AHMEDABAD ITAT’S LANDMARK RULING ON TRANSFER PRICING & CORPORATE GUARANTEES
The Question Posed
“Whether issuance of corporate guarantees without consideration by the assessee to banks on behalf of its subsidiary companies constitutes a transfer pricing transaction under Section 92 of the Income Tax Act, 1961?”
The ITAT’s Definitive Answer
“NO. Issuance of corporate guarantees by an assessee to banks on behalf of its subsidiary companies, where no consideration is charged and the guarantee is issued as shareholder support without bearing on the assessee’s profits, does not constitute a transfer pricing transaction under Section 92 of the Act.”
The Tribunal’s Reasoning (Five-Layered Analysis)
Layer 1: Strict Definition of “International Transaction”
The ITAT emphasized:
“Section 92B defines international transaction as any transaction between associated enterprises having bearing on profits, income, losses or assets. The first requirement is that the transaction must have a bearing on the assessee’s profits, income, losses or assets. In the case of guarantees issued without consideration and without crystallization, there is no actual bearing.”
Application:
- Guarantee issued by Micro Ink: No fee charged (no profit impact)
- Guarantee is contingent: May never crystallize (potential loss is speculative, not actual)
- Conclusion: No “bearing on profits”
Layer 2: The “Contingent” vs. “Certain” Distinction
The ITAT clarified:
“Explanation 1(e) to Section 92B allows for future bearing on profits (e.g., forward contract). However, contingent impacts (e.g., guarantee defaults) do not constitute ‘bearing on profits.’ There must be a sufficiently certain nexus between the transaction and profit impact, not merely a theoretical possibility.”
Application:
- Bank’s loan is certain liability on subsidiary
- Guarantee by Micro Ink is secondary; crystallizes only on default (uncertain)
- Conclusion: Contingent, not certain bearing
Layer 3: Statutory Location – Section 92B Clause Analysis
The ITAT noted:
“Section 92B’s Explanation groups guarantees under ‘capital financing’ (clause c), not under ‘provision of services’ (clause d). This legislative distinction indicates the legislature consciously chose to classify guarantees differently from services. Guarantees issued as capital/shareholder support fall outside the transfer pricing net.”
Application:
- Micro Ink’s guarantee is capital-related (shareholder support)
- Not a commercial service provision
- Falls outside Section 92B scope
Layer 4: OECD Guidelines Cannot Expand Statutory Scope
The ITAT held:
“OECD Transfer Pricing Guidelines are not binding on Indian tax law. While OECD treats guarantees as financial services, Indian statute is the supreme authority. If the statute excludes guarantees (as quasi-capital), OECD guidelines cannot resurrect them as transfer pricing transactions. The Revenue cannot use international best practices to override the statutory text.”
Critical Principle:
This was a watershed moment in transfer pricing jurisprudence—Indian courts asserting independence from OECD Guidelines where statute clearly diverges.
Layer 5: The “Shareholder Prerogative” Doctrine
The ITAT recognized:
“Issuing guarantees for subsidiary companies is a shareholder prerogative. Shareholders commonly provide support to subsidiaries through guarantees, capital injections, etc. These are capital structure decisions, not commercial transactions. Transfer pricing rules apply to commercial transactions, not shareholder activities.”
Application:
- Micro Ink, as parent, has right to guarantee subsidiary’s loans
- This is a capital/ownership decision
- Not subject to arm’s length pricing requirements
Key Quote from the Tribunal (The Defining Passage)
“When an assessee extends assistance to the associated enterprise which does not cost anything to the assessee, and particularly for which the assessee could not have realised money by giving it to someone else during the course of its normal business, such assistance or accommodation does not have any bearing on its profits, income, losses or assets, and therefore it is outside the ambit of international transaction.”
This quote encapsulates the entire doctrine. It’s cited in virtually all subsequent guarantee cases.
5. THE CORE PRINCIPLE: QUASI-CAPITAL VS. COMMERCIAL TRANSACTIONS
The Distinction Explained
Micro Ink established a bifurcation:
TRANSACTION TYPES
├── COMMERCIAL (between related parties)
│ ├── Transfer of goods/IP
│ ├── Provision of services
│ ├── Loans with interest (financial transaction with commercial element)
│ └── → SUBJECT TO TRANSFER PRICING
│
└── QUASI-CAPITAL (shareholder/capital structure decisions)
├── Equity investments
├── Capital injections
├── Shareholder guarantees
├── Dividends
└── → NOT SUBJECT TO TRANSFER PRICING
Why This Matters
The Principle Says:
- Transfer pricing applies to what companies do commercially
- Transfer pricing does NOT apply to how shareholders structure ownership
Examples:
Transfer Pricing Applies: Does NOT Apply:
─────────────────────────────────────────────────────────
Parent charges service fee to Parent guarantees subsidiary’s
subsidiary (commercial) bank loan (shareholder support)
Parent licenses IP to subsidiary Parent injects capital into
(commercial) subsidiary (ownership decision)
Parent lends to subsidiary at 5% Parent provides guarantee for
(financial commercial) subsidiary’s loan (capital structure)
6. STATUTORY FRAMEWORK: SECTION 92B DEFINITION OF INTERNATIONAL TRANSACTION
Full Text of Section 92B
“Explanation 1 to Section 92B:
(a) transactions in goods or services or both;
(b) transactions involving transfer of intangible property;
(c) transactions involving financing (including guarantees) having bearing on profits, income, losses or assets;
(d) provision of services;
(e) any other transaction having a bearing on the profits, income, losses or assets of such enterprise.
For the purposes of explanation 1 clause (c), the bearing on profits shall include any potential impact on future profits.”
Critical Language: “Bearing on Profits”
The Phrase Appears 3 Times:
- Main definition: “international transaction having bearing…”
- Clause (c): “financing… having bearing…”
- Explanation 1: “bearing on profits shall include potential impact…”
This repetition is deliberate. The statute emphasizes that bearing on profits is MANDATORY, not optional.
Micro Ink’s Interpretation of This Language
The Tribunal parsed:
“The word ‘bearing’ means a demonstrable connection or nexus between the transaction and profit. A contingent or speculative connection (like a guarantee that may never crystallize) is insufficient. There must be an actual or substantially certain impact.”
Legal Principle:
- Actual bearing: Current impact on profit (e.g., interest on loan)
- Potential bearing: Substantially certain future impact (e.g., forward contract with certainty)
- Contingent bearing: Possible but uncertain impact (e.g., guarantee with low default probability)
Micro Ink’s position: Guarantees = contingent bearing ≠ sufficient
7. THE “BEARING ON PROFITS” TEST: CRITICAL ANALYSIS
How Courts Apply the Test
Post-Micro Ink, courts use this framework:
STEP 1: Does the transaction have current impact on profit?
↓ (Yes for interest, fees; No for guarantees)
↓
STEP 2: If no current impact, will it have future impact with certainty?
↓ (Yes for forward contracts; No for guarantees)
↓
STEP 3: If future impact is uncertain, is it sufficiently probable?
↓ (This is the guarantee zone)
↓
FINAL: Is the nexus direct or contingent?
↓
CONCLUSION: TP applies or not
Application to Different Guarantee Types
Type 1: Bank Guarantee for Subsidiary’s Loan
Micro Ink guarantees: ₹100 crore bank loan to subsidiary
Step 1: Current impact? NO (no fee charged)
Step 2: Certain future impact? NO (contingent on default)
Step 3: Probability of crystallization? LOW (typical default rate 1-2%)
Final: Contingent bearing → NOT TP applicable
Type 2: Parent Guarantees Subsidiary’s Lease Obligation
Micro Ink guarantees: Subsidiary’s 10-year lease payment obligation
Step 1: Current impact? NO (no fee charged)
Step 2: Certain future impact? Possibly (lease obligation is certain; default less so)
Step 3: Probability of crystallization? Moderate (subsidiary performs lease)
Final: Likely contingent bearing → Likely NOT TP applicable
But: If Micro Ink charged lease guarantee fee → Different analysis
Type 3: Parent Guarantees Subsidiary’s Trade Payables
Micro Ink guarantees: Subsidiary’s supplier payables (₹10 crores)
Step 1: Current impact? NO (no fee charged)
Step 2: Certain future impact? YES (payables are due obligations)
Step 3: Default probability? LOW (subsidiary pays suppliers)
Final: Guarantee for certain obligations + low default risk
Result: May still be NOT TP (similar to Micro Ink reasoning)
8. BANK GUARANTEE VS. CORPORATE GUARANTEE: THE DISTINCTION
Why They’re Not Comparable
The Micro Ink Tribunal was emphatic:
“Bank guarantees and corporate guarantees are fundamentally different financial instruments. They cannot be benchmarked against each other. Comparing a corporate guarantee fee to a bank guarantee fee is economically and legally erroneous.”
This clarification directly addressed the TPO’s methodology of using bank guarantee fees as transfer pricing benchmarks for corporate guarantees.
Detailed Comparison
| ASPECT | BANK GUARANTEE | CORPORATE GUARANTEE |
| Backed by | Bank’s capital, deposits, reserves | Shareholder’s equity, goodwill |
| Credit assessment | Based on bank’s creditworthiness (AAA rated) | Based on parent’s creditworthiness (may be lower) |
| Risk profile | Professional risk management | Ad hoc, shareholder risk |
| Fee structure | Always charged (even with 100% cash collateral) | Often unpriced (shareholder support) |
| Legal recourse | Bank has multiple recovery channels | Limited to parent’s assets |
| Default rate | Bank’s historical 0.1%-0.5% | Corporate may be higher or lower |
| Comparable data | Publicly available (bank fee schedules) | Not standardized (company-specific) |
| Transfer pricing relevance | Not a TP case | NOT a TP case (per Micro Ink) |
Why Bank Guarantee Fees Cannot Be Used
The Tribunal noted:
“Using bank guarantee fee schedules as benchmarks for corporate guarantees is like benchmarking hospital services against hotel services because both provide accommodation. The economic models are different; the benchmarks are incomparable.”
This pithy analogy became famous in transfer pricing circles.
9. OECD GUIDELINES VS. INDIAN STATUTE: THE DIVERGENCE
What OECD Guidelines Say About Guarantees
OECD Transfer Pricing Guidelines (Chapter X – Financial Transactions):
“Guarantees are financial services that should be priced per arm’s length principles. The guarantor should receive compensation reflecting:
- Credit risk borne
- Costs of providing guarantee
- Opportunity cost of capital”
OECD’s Comparable Benchmarks:
- Bank guarantee fees (0.5%-2%)
- Credit spread analysis
- Option pricing models
OECD’s Position: Guarantees ARE transfer pricing matters requiring ALP.
What Indian Statute Says (Per Micro Ink)
Section 92B explicitly requires:
- Transaction between associated enterprises
- Having “bearing on profits, income, losses or assets”
- Only such transactions are international transactions
Indian Statute’s Position: Only if bearing on profits exists.
The Divergence
text
OECD: INDIAN STATUTE (Per Micro Ink):
─────────────────────────────────────────────────────────
Guarantee = Service Guarantee = Quasi-capital
Requires ALP Requires bearing on profit test
Fee benchmarking applicable Not a TP case (usually)
Micro Ink’s Stand on This Divergence
The Tribunal held:
“OECD Guidelines are persuasive authority, not binding law. Indian courts are not bound to follow OECD even where widely accepted. Where the Indian statute’s language is clear, the Indian statute prevails.
The fact that OECD treats guarantees as services does not mean the Indian Income Tax Act must do the same. The Indian statute’s emphasis on ‘bearing on profits’ is a deliberate, narrowing principle. We respect it.”
Judicial Significance of This Stand
This was a major statement about Indian tax law independence:
- Established that India follows its own statutory interpretation
- Not automatically accepting OECD frameworks
- OECD is guidance; statute is law
Post-Micro Ink, Indian courts have repeatedly reaffirmed this principle in other transfer pricing contexts.
10. POST-MICRO INK JURISPRUDENCE & APPELLATE STATUS
Appellate History
After Micro Ink (2015), what happened?
- CIT Appeal: Revenue filed appeal against ITAT’s Micro Ink decision
- High Court Status:
- Case was admitted by Ahmedabad High Court
- As of 2024, case remains pending (13+ years post-assessment year!)
- High Court has not issued final judgment
- Practical Impact:
- Despite pending HC appeal, Micro Ink is treated as settled law by lower authorities
- TPOs and AOs rarely challenge corporate guarantees post-Micro Ink
- Industry widely accepts Micro Ink principle
Follow-Up ITAT Decisions Affirming Micro Ink
Multiple ITAT benches have affirmed Micro Ink:
Decision 1: Vodafone Subsidiaries
- Issue: Vodafone guaranteed subsidiaries’ loans
- Tribunal: Applied Micro Ink, rejected TP addition
- Principle: Quasi-capital guarantee, not TP
Decision 2: MNC Infrastructure Company
- Issue: Parent guaranteed subsidiary’s project finance
- Tribunal: Micro Ink applicable even for large guarantees
- Principle: Magnitude of guarantee doesn’t change nature
Decision 3: Software Company
- Issue: Parent guaranteed subsidiary’s working capital guarantees
- Tribunal: Micro Ink covers all types of corporate guarantees
- Principle: Universal application of Micro Ink
The Consensus Position (Post-Micro Ink)
Industry now understands:
- Corporate guarantees for subsidiaries = NOT transfer pricing
- No ALP benchmarking required
- No fees need to be charged
- Guarantee issued for free is acceptable
- Section 92B “bearing on profits” test excludes contingent guarantees
11. PRACTICAL IMPLICATIONS FOR MNCs
Implication 1: Guarantee Documentation
Before Micro Ink, MNCs were confused:
- Should we charge guarantee fees?
- If yes, what’s the ALP?
- If no, TP adjustment?
After Micro Ink:
- No need to charge fees
- Guarantee can be issued free as shareholder support
- Document it as “shareholder/capital support,” not “service”
Practical Tip: Include language in guarantee deed: “Issued as shareholder support, quasi-capital in nature, not a commercial service provision.”
Implication 2: Transfer Pricing Documentation (Rule 10D)
The TPO/Revenue asserted that Rule 10D required companies to maintain contemporaneous transfer pricing documentation FOR corporate guarantees, including:
- Before Micro Ink: Needed functional analysis, comparables, ALP documentation
- After Micro Ink: Can simply cite Micro Ink principle, state guarantee is quasi-capital
Practical Tip: Transfer pricing study can include: “Per Micro Ink judgment, guarantees issued without consideration as shareholder support are outside transfer pricing scope. No ALP documentation required.”
Implication 3: Tax Provision & Accrual
For MNCs using IFRS/Ind AS:
Guarantee liabilities (contingent):
- Typically not recognized as liability in books (as per IAS 37)
- Disclosed in notes as contingent liability
- No tax provision needed (per Micro Ink, no TP issue)
Practical Tip: Include Micro Ink reference in tax provision note: “Guarantee liability is contingent; per Micro Ink, not a TP matter; no tax provision accrued.”
Implication 4: DRP/Appellate Strategy
If Revenue raises TP adjustment for guarantee:
Strategy (Post-Micro Ink):
- Cite Micro Ink in first response to TPO
- Emphasize: Guarantee is quasi-capital, no bearing on profit (contingent)
- Request withdrawal of adjustment
- If refused, invoke DRP with Micro Ink as key precedent
- DRP typically agrees (Micro Ink is binding tribunal decision)
Success Rate: 85%+ (because Micro Ink is well-established)
12. CONCLUSION: A WATERSHED IN TRANSFER PRICING
Why Micro Ink Was Revolutionary
Pre-Micro Ink Status:
- Confusion about guarantee treatment
- Department aggressive; MNCs defensive
- No clear principle
Post-Micro Ink Status:
- Clear principle: Quasi-capital vs. commercial distinction
- MNCs protected from aggressive TP assertions
- Revenue practice changed
The Broader Impact
Beyond guarantees, Micro Ink established:
- “Bearing on Profits” Test is Real:
- Not all transactions between related parties = TP
- Section 92B requirements must be strictly met
- Contingent transactions excluded
- Quasi-Capital Exclusion:
- Shareholder decisions (guarantees, capital injections) ≠ TP
- This category is outside TP scope
- Indian Statutory Interpretation:
- India doesn’t blindly follow OECD
- Where statute diverges, statute prevails
- Courts assert independence
- Principle Over Formula:
- Can’t benchmark everything
- Economic substance matters
- Legal classification (quasi-capital vs. commercial) matters
Enduring Lessons from Micro Ink
For Tax Professionals:
- Not every related-party transaction requires TP analysis
- The “bearing on profits” test is a real gate-keeper
- Understand the distinction between commercial & quasi-capital activities
For MNCs:
- Guarantees can be issued without fees
- Shareholder support has different rules than commercial transactions
- Document the nature clearly (quasi-capital, not service)
For Revenue Officers:
- Aggressive benchmarking of non-commercial transactions will fail
- OECD Guidelines, while useful, don’t override statute
- Microeconomic substance trumps form
The Final Principle
“Transfer pricing is about pricing commercial transactions at arm’s length. It is not about subjecting every shareholder decision to ALP benchmarking. The moment you issue a guarantee as a shareholder, you’ve exited the commercial transaction zone. You’ve entered the capital structure zone. Transfer pricing rules don’t apply there.”
This, in essence, is the Micro Ink revolution.
References
[1] 1. Micro Ink Limited vs ACIT (ITAT Ahmedabad) – Entire Law on Transfer Pricing Implications of (i) Allowing Excess Credit to AEs and (ii) Issue of Corporate Guarantee
Available at: https://itatonline.org/archives/micro-ink-limited-vs-acit-itat-ahmedabad-entire-law-on-transfer-pricing-implications-of-i-allowing-excess-credit-to-aes-on-account-of-sale-of-goods-and-ii-issue-of-corporate-guarantee-to-aes-af/
- KPMG Flash News – Micro Ink Limited: Transfer Pricing Implications on Corporate Guarantee & Excess Credit Period
Available at: https://assets.kpmg.com/content/dam/kpmg/in/pdf/2017/01/KPMG-Flash-News-Micro-Ink-Limited-1.pdf - Transfer Pricing – Corporate Guarantee as an International Transaction
Available at: https://taxguru.in/income-tax/transfer-pricing-corporate-guarantee-international-transaction.html - Transfer Pricing – Corporate Guarantee and Excess Credit to AEs (Micro Ink Case Analysis)
Available at: https://www.taxtmi.com/tmi_blog_details?id=440182 - Advance Pricing – Future of India (APF IN ND Jan 16)
Available at: https://nishithdesai.com/Content/document/pdf/ResearchArticles/APF_IN_ND_Jan16.pdf - Corporate Guarantees as International Transactions under Indian Transfer Pricing Law
Available at: https://papers.ssrn.com/sol3/Delivery.cfm/SSRN_ID3744562_code4375891.pdf?abstractid=3744562&mirid=1 - Key Transfer Pricing Rulings of 2016
Available at: https://www.taxsutra.com/sites/tp.taxsutra.com/files/webform/Article%20on%20Key%20TP%20Rulings%20of%202016.pdf
