Bank _ Letter of Credit, Bank Guarantees

 This is a common set of questions from a tax department, particularly when dealing with cross-border transactions and new entities. They are trying to understand the nature of the charges and payments for tax purposes (e.g., whether it's a fee, interest, or something else) and how it flows through the entities to ensure proper tax treatment in India.

General Context:

Your new India entity needs a credit facility (bank line) with Citibank India to issue Bank Guarantees (BGs) to its customers. BGs are non-fund-based facilities, meaning the bank doesn't directly lend money but provides a guarantee of payment if your India entity defaults on its obligation to the customer. This is crucial for local regulations and customer requirements in India.

Tax Department Questions & Explanations:

1. How is the bank compensated for providing the bank guarantee/standby letter of credit? Is it based on a fee, or based on the payment of interest? I can see in the “Fee” section that there is an “N/A” but also an indication that “At every continuation of the Facility (continuations as effected by the Bank at its sole discretion), an amount, as indicated by the Bank at the time of each continuation will be payable by the Borrower for the Facility” which would seem to suggest that there is some amount paid by Solar to the bank for the guarantee/letter of credit. If this amount is not identified as a “Fee”, then how is this amount identified?

(1) Tax Concern: The tax department wants to correctly classify the payment for the BG.

   * "Fee": If it's a fee (commission), it's typically subject to Goods and Services Tax (GST) in India and might be deductible for income tax purposes as a business expense.

   * "Interest": If it's considered interest, it has different tax implications (e.g., withholding tax if paid to a non-resident, specific rules for deductibility). Generally, bank guarantee charges are treated as fees/commissions, not interest, because the bank isn't lending money to the company but guaranteeing a third-party payment. Interest would only arise if the bank had to pay out on the guarantee, at which point the company would owe the bank that amount plus interest.

 * Likely Explanation: The "N/A" in the "Fee" section for the initial setup might be confusing. The "amount as indicated by the Bank at the time of each continuation" is almost certainly a "Bank Guarantee Commission" or "Guarantee Fee." Banks in India charge a commission (a percentage of the guaranteed amount, often quarterly or annually) for providing BGs. It's a service charge.

 * What to clarify: You need to confirm with Citibank India the exact nomenclature they use for this recurring charge. It should be explicitly stated as a "Bank Guarantee Commission," "Guarantee Fee," or a similar service charge. This is a standard practice for non-fund-based facilities. The document might have a generic "Fee" section that's N/A for this specific type of fee, but then detail the specific "Guarantee Commission" elsewhere.

2. Is interest due on the bank guarantee/standby letter of credit only if the bank has to make payment for us? If interest is due in other cases, please help me to understand how it is calculated.

 * Tax Concern: Again, distinguishing between a fee for the guarantee service and actual interest on a debt. This impacts taxability and deductibility.

 * Likely Explanation: Yes, typically, interest on a bank guarantee (BG) in India is only charged if the bank has to make a payment to the beneficiary (the customer of your India entity) because your India entity defaulted. This is called "invocation" of the BG. Once the bank pays, your India entity effectively owes that money to the bank, and the bank will then charge interest on that outstanding amount until it's repaid by your India entity.

 * What to clarify: Confirm with Citibank India that interest is only applicable upon invocation of the BG and what the interest rate and calculation method (e.g., daily compounding) would be in such a scenario. This is crucial for understanding the potential financial liability and its tax treatment.

3. It appears based on the attached email that there were some fees for ABC for India entity in the past. What does this amount represent? Is it a fee, or some amount of interest due?

 * Tax Concern: The term "ABC" is ambiguous in this context. The tax department wants to understand the nature of previous payments to properly classify them.

 * Likely Explanation: As discussed in our previous chat, "ABC" in the general Indian context usually refers to "Academic Bank of Credits," which is clearly unrelated. In a banking context, "ABC" could be an internal bank code, a shorthand for another type of charge, or even a typo. Without further context, it's difficult to pinpoint.

   * It could be an Application Fee for the credit facility itself.

   * It might be a Processing Fee for the initial setup.

   * It might refer to "Arrangement Fees" or "Agency Fees" if there was a syndication or complex structuring involved in the past.

   * It's highly unlikely to be interest, given the context of "fees."

 * What to clarify: This is critical. You must ask Citibank India (or whoever sent the attached email) to clarify what "ABC" refers to in the context of past charges for your India entity. Get a clear definition and purpose of that charge.

4. For the amounts at hand under the current agreement, are we expecting the bank to charge our India entity directly (and not route through our EAME entity)? This would be the tax preference and we want to confirm. We would expect the BG/ABC would be issued in the name of our India entity and should be charged to our India entity directly.

 * Tax Concern: This is a crucial point for transfer pricing and tax residency.

   * Tax Preference: Charging the India entity directly is the correct and preferred tax treatment for India. Since the bank guarantee is being issued for the India entity and to its customers in India, the service is rendered to the India entity, and the costs should naturally be borne by it. Routing it through an EAME (Europe, Africa, Middle East) entity would create complex intercompany charges, potentially triggering withholding tax issues on payments to the EAME entity, transfer pricing adjustments, and debates about whether the service was truly rendered to the EAME entity or merely facilitated through it.

   * Indian Regulations: Indian tax authorities would expect the local entity benefiting from the service to be directly charged.

 * Likely Explanation: Your expectation is correct and aligns with standard international tax practices (arm's length principle) and Indian tax regulations. The BG/SBLC should be issued in the name of your India entity, and all associated charges (fees/commissions) should be debited directly from your India entity's account with Citibank India.

 * What to confirm: Get explicit confirmation from Citibank India that all charges related to this facility (BG commissions, any potential invocation interest) will be directly charged to and debited from the bank account of your new India entity. This confirmation is vital for your tax team.

5. How, in practice, does the bank let us know that amounts are due today? Do they issue an invoice to us? If not, how do we become aware of the amount due to the bank?

 * Tax Concern: This relates to documentation, timing of expense recognition, and GST compliance (if invoices are required for input tax credit).

 * Likely Explanation: Banks in India generally don't issue a separate "invoice" in the traditional sense for recurring fees like bank guarantee commissions. Instead:

   * Debit Advice/Statement: They will typically auto-debit the amount from the India entity's current account with Citibank India on the due date. The debit will be reflected in the bank statement, often with a clear narration like "BG Commission" or "Guarantee Fee."

   * Email/System Notification: For larger corporate clients, banks often send a pre-debit notification via email or through their online banking portal a few days before the due date. This allows the company to ensure sufficient funds are available.

   * Facility Letter/Agreement: The initial facility letter or agreement will usually specify the frequency (e.g., quarterly, annually) and method of charging these fees.

 * What to confirm: Ask Citibank India their exact operational procedure:

   * Will they auto-debit the fees?

   * Will they send a pre-debit notification (and to which email/contact)?

   * Will the transaction narrative on the bank statement be sufficiently clear?

   * Will they provide a "debit advice" or a "charge statement" upon request, which acts as a form of an invoice for internal accounting and potentially for GST input credit purposes (though the bank statement debit itself is usually sufficient for income tax purposes).

In Summary for the Sign-Off:

Before you provide a sign-off on the document for the new India entity, ensure you have clear, written answers (preferably from Citibank India directly) addressing each of these points. This will prevent future tax headaches and ensure compliance in India. Your tax team's questions are highly relevant and demonstrate good due diligence.