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January 12, 2011 Transfer
Pricing: No obligation to charge interest on overdue payments In a recent ruling by the Mumbai Income Tax
Appellate Tribunal (“Tribunal”) held that overdue payments from an associated
enterprise cannot be treated as an international transaction for the purposes
of transfer pricing, and hence no interest need be charged on the same. Background The taxpayer was an Indian company, engaged
in the business of marketing of airtime, available on television programs,
cricket and other sports events. It was also into the business of production
of television serials. Its associated enterprise was a Singaporean company,
which had to make certain payments to the taxpayer which were overdue and for
which no interest was charged by the tax payer. As a practice, the tax payer
neither charged any interest on the debit balances with independent parties
nor paid any interest to international creditors. For the purpose of
ascertainment of the arm’s length price, the said transaction was referred to
the Transfer Pricing Officer (“TPO”) and the TPO observed that charging of
interest on outstanding balances, after 30 day period would be the expected
arm's length transaction given that the tax payer and the Singaporean company
were associate enterprises for the transfer pricing purposes. Based on this, the TPO made an adjustment
of INR 12,51,175 and the notional interest was
quantified based on the adoption of interest at 2.19% LIBOR on the overdue
amount beyond 30 days. This was subsequently confirmed by the Commissioner of
Income Tax (Appeals) (“CIT (A)”). The assessee appealed against the order of
the CIT (A) before the Tribunal. Therefore, the issue before the Tribunal
was whether an ALP adjustment in respect of interest not charged by the
assessee on the debit balances, overdue for a period beyond 30 days to an
associated enterprises was justified or not. Decision of the Tribunal At the
outset, the Tribunal reiterated the principle that any income arising from an
international transaction has to be computed in accordance with the arm’s
length price (“ALP”) and that this exercise includes the allowance for any
expense or interest arising from an international transaction as well. The
key element as per the Tribunal was that an ALP adjustment could be made only
in respect of an “international transaction” as defined under the Income Tax
Act, 1961 (“ITA”). The Tribunal opined that a continuing debit balance was
not an “international transaction” but a result of an international
transaction. Further, a ‘continuing debit balance’ reflects that the payment,
even though due, has not been made by the debtor and also it is not necessary
that a payment is to be made as soon as it becomes due. It was
highlighted by the Tribunal that the factors like ‘terms of payments’ and
‘accepted business practices’ play a role in influencing payments in respect
of commercial transactions Unlike a
loan or borrowing, it is not an independent transaction which can be viewed
on standalone basis. What can be examined on the touchstone of arm’s length
principles is the commercial transaction itself, as a result of which the
debit balance has come into existence, and the terms and conditions,
including terms of payment, on which the said commercial transaction has been
entered into. The
Tribunal examined the residuary clause of the definition of “international
transaction” under Section 92B of the ITA Act, i.e., whether the debit
balance would have a bearing on the profits, incomes, losses or assets of the
tax payer. In this regard, it was held that the debit balance would not
constitute an international transaction, as there was nothing on record to
reflect that as a result of not realizing the debts from associated
enterprises, there can be any impact on the profits, incomes, losses or
assets of the tax payer and therefore, the overdue accounts receivable
balance from associated enterprise cannot be termed as an international
transaction per se, but can be said to be a "result" of an
international transaction and so there is no need to benchmark the
transaction at ALP. The
Tribunal pointed that even if continuing debit were treated as “international
transaction”, the right course of applying the CUP method in the case of non
charging of interest on overdue balances, would have been by comparing this
not charging of interest with other cases in which the assessee has charged
interest on overdues with independent enterprises
(internal CUP) or with the cases in which other enterprises have charged
interest, in respect of overdues in respect of
similar business transactions, with independent enterprises (external CUP).
No such exercise has been carried out in this case. Based upon
the above reasoning, the Tribunal held that the ALP adjustments cannot be
made and held that the impugned addition of INR 12, 51,175 was unsustainable
in law. Analysis This is an interesting
judgement, with respect to an area, where there is a paucity of Indian
judicial precedents. Even though, the conclusion
drawn by the Tribunal seems apt, it is quite unclear as to why the continuing
debit balances between the associated enterprises cannot be termed as an
international transaction as the interest component would normally have a
bearing on the profits and income of the tax payer. The Tribunal is correct in
suggesting that if the instant transaction was an international transaction
then the internal CUP method would be used for the non-charging of the
interest on such payment overdues. The Tribunal
itself emphasised that the business practices play a pivotal role in any
commercial transaction however, with respect to the application of external
CUP method, the Tribunal has not examined the
industry comparables with regard to the continuing debit balances.
Nonetheless, it is advisable for companies to maintain both internal as well
as external comparables to avoid any future dispute relating to transfer
pricing. Although, the amount involved
is not large, given the significance of the issue, it is likely that the Tax
Department would go in appeal against the order of the Tribunal as this
judgement would have an impact on the terms of payments between the
associated enterprises and set a strong benchmark for future transfer pricing
cases involving overdue payments. Many taxpayers would be keenly following
the progress of this case. Watch this space for further
developments in this matter. - Ankita Srivastava & Abhay Sharma |
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