MIRA v CDLHT Oceanic Maldives Pvt Ltd | MIRA v Sanctuary Sand Maldives Pvt Ltd

/in , /by

On 24 September 2023, the High Court handed down the judgement in a case which provided clarity on two issues: 1) the deductibility of interest on a loan transaction between related parties, 2) requirement to perform a comparability analysis in determining whether a transaction is at arm’s length.

Background

  1. Due to the similarity between the subject matter of the appeals, the High Court reviewed the appeals submitted against CDLHT Oceanic Maldives Pvt Ltd (“CDLHT”) and Sanctuary Sands Maldives Pvt Ltd (“Sanctuary Sands”) by the Maldives Inland Revenue Authority (“MIRA”) in conjunction, in accordance with the principle set out by the Supreme Court in Ahmed Shiyaz & Anor v Furana Holdings Pvt Ltd1 in conducting such cases.
  2. The appeals submitted by MIRA against CDLHT and Sanctuary Sands concerned disputes between MIRA, CDLHT and Sanctuary Sands regarding the deductibility of interest applicable on a loan obtained by CDLHT and Sanctuary Sands from related parties.
  3. Upon conducting audits of CDLHT and Sanctuary Sands, MIRA had determined that the interest on loans obtained by CDLHT and Sanctuary Sands could not be deducted under Section 10(a) and Section 11(a)(5) of the BPT Act in computing the taxable profit of CDLHT and Sanctuary Sands.
  4. MIRA maintained that the loan transactions entered into by CDLHT and Sanctuary Sands would not have been entered into by unrelated parties as the funding arrangement does not represent general norms of issuing loans, and hence the interest on those loans is not deductible in computing their taxable profits pursuant to Section 29(g) of the BPT Act. In coming to the aforementioned conclusion, MIRA gave reference to the gearing ratios, nonexistence of a clear repayment schedule and security in the loan transactions.
  5. Additionally, MIRA concluded that the terms of the loan transactions entered into by CDLHT and Sanctuary Sands contained more characteristics of equity rather than a loan arrangement.
  6. CDLHT and Sanctuary Sands contested the MIRA’s decision to disallow the interest on loans obtained by them were in violation of Sections 10(a) and 11(a)(5) of the BPT Act on the grounds that the loans were obtained to settle the consideration pertaining to the respective resorts that were purchased for the purpose of generating income. Further, CDLHT and Sanctuary Sands asserted that in disallowing interest on the loans, MIRA had not conducted a comparability analysis while applying Section 29(g) of the BPT Act and thus, had failed to prove that the transactions in question were not bona fide loans and/or would not have been entered into between unrelated parties.
  7. The Tax Appeal Tribunal (“TAT”) decided that the loans in question obtained by CDLHT and Sanctuary Sands are in relation to bona fide transactions and the parties had the right to deduct their interest on loans obtained from persons other than approved financial institutions subject to a 6% cap on interest in accordance with Sections 10(a) and 11(a)(5) of the BPT Act. Moreover, the TAT held that a comparability analysis must be performed to determine whether the transaction was within arm’s length terms prior to MIRA disallowing the deduction under Section 29(g) of the BPT Act.
  8. TAT also opined that under the contract law of the Maldives, taxpayers have the freedom to contract and there are no generally accepted guidelines for loans lent by persons other than approved financial institutions of the Maldives. Hence, the TAT held that the conclusion of the MIRA that the loans do not represent general norms of issuing loans was without basis.
  9. Thereby, it was unanimously held by the TAT that CDLHT and Sanctuary Sands should be allowed to deduct the interest on loans in question in accordance with Sections 10(a) and 11(a)(5) of the BPT Act.

Issue

The issues before the High Court in the cases were as follows.

  1. Are the transactions in question bona fide loans?
  2. Should Sections 11 and 29(g) of the BPT Act be read together as a whole? What is the applicable treatment to the interest on loans in transactions such as those presented in the cases?

High Court’s Decision

(a) Issue of whether the transactions were bona fide loans

  • One of the key arguments by MIRA was that the transactions involved in the cases were equity contributions rather than bona fide loans. In that regard, MIRA gave reference to the case of Minor International (Labuan) Limited v MIRA 2 (“Minor International case”) decided by the TAT in which the TAT had applied the debt-equity test laid down by the United States Tax Court in the case of Dixie Dairies Corporation v Commissioner of Internal Revenue3 (“Dixie Dairies case”).
  • The High Court asserted that the Minor International case had been appealed to the High Court and the High Court had decided on the appeal by holding that while the 13 factors in the debt-equity test laid down in the Dixie Dairies case could be considered in establishing whether a transaction involves a debt or equity, all 13 factors need not be present or applied in every transaction. Accordingly, the Court held that although all factors within the debt-equity test established in the Dixie Diaries case that would determine whether a transaction is a debt or equity were not present in the transactions of the cases at hand, the aforementioned reason was not sufficient to determine that the transactions were not bona fide loans. This is, as the Dixie Dairies case itself had determined that each factor is not equally significant and that no single factor is determinative, AND due to the myriad factual circumstances under which debt-equity questions can arise, all of the factors are not relevant to each case.
  • The 13 factors prescribed in the Dixie Diaries case are:
    1. Names given to the certificates evidencing the indebtedness
    2. Presence or absence of a fixed maturity date
    3. Source of payments
    4. Right to enforce payments
    5. Participation in management as a result of the advances
    6. Status of the advances in relation to regular corporate creditors
    7. Intent of the parties
    8. Identity of interest between creditor and stockholder
    9. “Thinness” of capital structure in relation to debt
    10. Ability of corporation to obtain credit from outside sources
    11. Use to which advances were put
    12. Failure of debtor to repay
    13. Risk involved in making advances
  • The High Court further highlighted that it was determined in the Minor International case that among the 13 factors prescribed in the Dixie Dairies case, more consideration should be given to the following factors in determining the transaction as a debt or equity.

 

      • Names given to the certificates evidencing the indebtedness
      • Presence or absence of a fixed maturity date
      • Source of repayments (i.e. does the repayments depend on corporate earnings?)
      • Right to enforce payments
      • Intent of the parties
      • Thinness of capital structure in relation to debt
  • The High Court then applied the above factors to the case and concluded that the loans under question can be considered bona fide as it satisfies the following factors.
      • Names given to the certificates evidencing the indebtedness: The title of the agreements clearly indicates they are loan transactions
      • Presence or absence of a fixed maturity date: The loan amount, interest rate and maturity date is clearly mentioned in the agreements
  • Right to enforce payments: actions to be taken in the event of default are prescribed in the agreements
  • The Court went on to state that as there are no existing laws in the Maldives which specify the factors that must be present in loan transactions with parties other than banks for the transaction to be considered as a bona fide loan, and as MIRA had not questioned the validity of the transactions themselves, it can be safely concluded that the loan transactions in the cases are bona fide.

(b) Sections 11 and 29(g) of the BPT Act and the applicable treatment

  • The second appeal point by MIRA mainly contested that Sections 11(a)(5) (the provision which allows a deduction of interest payable to persons other than approved financial institutions up to an interest limit of 6%) and 29(g) (the provision which states that where the transaction in question would not have been entered into between persons who are not associated with each other, such transactions should be disregarded in computing the taxable profits) should be read as a whole. This means that even though Section 11(a)(5) allows a deduction of up to 6% on loans from persons other than approved financial institutions, Section 29(g) must still be applied to see if the transaction would not have been entered into between persons who are not associated with each other. The MIRA argued that not referring to the anti-avoidance rule in Section 29(g) of the BPT Act in concluding whether interest on the loan can be deducted under Section 11(a)(5) would render the former Section of the BPT Act useless.
  • MIRA also argued that performing a comparability analysis is not a requirement under the law for MIRA to disregard a transaction under Section 29(g) of the BPT Act.
  • The High Court pointed out that when reading Section 11(a)(5) of the BPT Act as a standalone Section, it is clear that it provides that interest from persons other than approved financial institutions can be deducted subject to a 6% cap. It does not require the MIRA to consider whether or not the parties in question are related. Section 29(g) of the BPT Act serves as an anti-avoidance rule to prevent taxpayers from taking undue or unlawful advantage of the allowances accounted for in the tax regime. Subsequently, the High Court held that the Sections should be read together in a cohesive manner in order to uphold the actual objectives of the BPT Act.
  • That being said, the High Court further held that in determining whether Section 29(g) could be applied or not, the MIRA still bears the burden of proving whether the transactions in question would not have been carried out between unrelated parties. Until MIRA discharges that burden, a benefit available to the taxpayer under the Act could not be hindered or unallowed.
  • The Court further elaborated that in order to determine whether a transaction could not have occurred between unrelated parties, it is important to establish whether the transaction was conducted within arm’s length terms as described in Section 29(e) of the BPT Act. In order to establish whether a transaction was conducted within arm’s length terms, the following steps must be taken.

 

      • Conducting a comparability analysis to determine whether the transaction was a controlled transaction or a bona fide transaction.
      • Identify the most appropriate transfer pricing method.
      • Determine whether the transaction was within the arm’s length terms.
  • As it was evident from the facts of the cases at hand that the MIRA had not conducted comparability analysis and had not proven that the transactions were not within arm’s length terms, the Court held that MIRA had not successfully proven that the interest of loan transactions should be disallowed with reference to Section 29(g).

Commentary

It has been a common practice of MIRA to disallow intra-group financing arrangements during BPT audits without clarifying the basis of that decision or establishing a clear test for determining the funding arrangement as equity contributions, merely because the transaction was entered between related parties. This has caused uncertainty to taxpayers who elected to go for debt financing when making their investment decisions. For many investments which flow into the Maldives, the deductibility of intra-group loan interest at a reasonable rate is crucial to maintain the profitability of that investment (i.e. to maintain a positive Net Present Value). The High Court’s decision in this case brings more certainty to the taxpayers on the deductibility of interest from intra-group financing arrangements as it provides clarity on the deductibility of interest in related party loan transactions, emphasizing the importance of correctly delineating intra-group funding as either debt or equity transactions, performing proper comparability analysis, and the harmonious reading of relevant sections of the BPT Act. The High Court provided further guidance on the significant factors to consider when determining funding as either a debt or equity and the necessary steps to follow when conducting a comparability analysis to determine the arm’s length nature of the transaction.

References

  1. Supreme Court Case Number 2018/SC-A/31 (24 November 2020)
  2. TAT-CA-B/2019/002
  3. 74 T.C. 476 (U.S.T.C. 1980)