Innodis granted loans to five wholly-owned subsidiaries between 2002 and 2004. The loans were unsecured, interest-free and had a grace period of one year. The subsidiaries to which the loans were granted were either start-up companies with no assets or companies in financial difficulties.
The tax authorities (MRA) had carried out an assessment of the tax liability of Innodis Ltd for the assessment years 2002 – 2003 and 2003 – 2004. In the course of the assessment, a number of items were added to the taxable income, including income from interest-free loans to subsidiaries and overseas passage allowances to eligible employees, which had been earmarked but not paid.
The tax authorities took the view that the grant of the interest-free loans was not on arm’s length terms as required by section 75 of the Income Tax Act 1995 (ITA) and was clearly preferential treatment of the subsidiaries. An assumed interest rate of 13% was applied to the loans, based on the market rate for loans made to Innodis for other purposes around the same time.
Innodis Ltd appealed the decision of the tax authorities to the Assessment Review Committee, where all issues raised in the appeal were settled by agreement between the parties, except those relating to the items of interest-free loans to subsidiaries and overseas passage allowances to employees.
Innodis Ltd then appealed to the Supreme Court.
Judgment of the Supreme Court.
The Court dismissed Innodis’ appeal and upheld the decision of the Assessment Review Committee. According to the Court, providing interest-free loans to a wholly owned subsidiary were not at arm’s length. Accordingly, the tax authorities were entitled to impute a deemed interest and to tax the income at the level of the parent company.
Excerpt
“With regard to the complaint of the appellant that the ARC wrongly accepted the application of “deemed interest” to assess the liability to tax as such notion has no legal basis, we note that the ARC clearly explained the expression “deemed interest” and its application. In that respect, the ARC observed that “deemed interest” is an expression commonly used in practice by the tax authorities and accountants to denote interest which a party should have claimed from another party if there had been no relationship between them. It also explained that the use of the expression of “deemed interest” was relevant since in the present case, in effect, the Appellant has been assessed on interest income, which it should have derived if it had been at arm’s length with its subsidiaries regarding the loans. It further observed that it is not correct to say that the assessment has no legal basis because it has always been the case for the MRA that this assessment is based on section 75 Income Tax Act 1995 and the term “deemed interest” was used in the heading to designate the nature of the amount assessed under section 75.
We find no fault in the above reasoning of the ARC. As a matter of fact, we agree that, as found by the ARC, the assessment itself had a legal basis by virtue section 75, which empowers the Director General to do so if he is of the opinion that the transaction in question was not at “arm’s length.” Once this is done, it was necessary for the Director General to designate by an appropriate term the income that would have been derived if the transactions had been at “arm’s length.” Since the transactions targeted were loans, which in practice generate interests as income, there can be no wrong in designating the income that the applicant ought to have derived from them as “deemed interest”. Furthermore, as observed by the ARC, the concept of “deemed interest” is neither one invented by it or the respondent nor blatantly inappropriate since it is an expression used by the tax authorities and accountants to denote interest which a party should have claimed from another party if there had been no relationship between them.
With regard to the application of the provisions under Part Vll of the Income Tax Act, particularly those under section 90, we note that in brushing aside the contentions of the appellant in that respect, the ARC made the following observations, with which we agree. Part VII concerns anti-avoidance provisions and section 90 relates to transactions designed to avoid liability to Income Tax. The MRA had decided to base its case on section 75 or the Income Tax Act as it was entitled to and to the extent that section 75 imposes on domestic companies an obligation to deal with subsidiaries at arm’s length, it is irrelevant whether section 90 could also have been applicable. It is therefore correct to say, as the ARC observed, that even if section 90 would have been applicable, it does not mean that the Director General was bound to apply section 90 or that section 75 was wrongly relied upon.
Therefore, there is no substance in the appellant’s contention that the ARC was wrong to have discarded and failed to properly address its mind to the application of section 90 of the Income Tax Act 1995 and the arm’s length principle which is enunciated therein.
For all the above reasons, the present appeal cannot succeed. We accordingly dismiss it with costs.”
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