Prescribed methods to be followed for ALP determination and interest on outstanding trade balances not the same as interest on loan
Court : Mumbai Bench of the Income Tax Appellate Tribunal
Citation : Nimbus Communications Ltd v. ACIT [2010–TI1-21-ITAT-MUM-T9
Overview :- In a recent ruling in the case of Nimbus Communications Ltd v. ACIT [2010–TI1-21-ITAT-MUM-T9, the Mumbai Bench of the Income Tax Appellate Tribunal ("the Tribunal"), while deciding the case in favour of the assessee, ruled that for determination the of arms' length price ("ALP"), any one of the methods as prescribed in section 92C(1) of the Income Tax Act, 1961 ("the Act") must be followed. The Tribunal also ruled that levying interest on outstanding trade balances is different from interest charged on loans and cannot be compared.
Facts :-The assessee is engaged in the business of marketing airtime on television. During the course of transfer pricing ("TP") assessment proceedings, the Transfer Pricing Officer ("TPO") proposed an adjustment for an interest charge from associated enterprises ("AEs") on long outstanding balances.
The Assessing Officer ("AO") passed an order, incorporating the TP order, against which the assessee filed an appeal before the Commissioner of Income-Tax (Appeals) ("CIT(A)"). The CIT(A) only gave partial relief, aggrieved by which the assessee appealed before the Tribunal.
Appeal Proceedings before the Tribunal
Key contentions of the assessee were as follows:
• For other international or domestic trade transactions, the assessee has not charged any interest on outstanding balances, and not paid any interest either. Only where a loan was advanced, interest was charged.
• The interest cost was implicit in the billing to AEs.
• For the purpose of making the adjustment, the TPO had not followed any of the prescribed methods, nor had it specified any data on which it has relied upon. By not doing so, the TPO had not followed the provisions of section 92C(1) of the Act which mandate use of any of the prescribed methods to determine ALP. Therefore, the TPO made an addition on an adhoc basis.
Key contentions of the Revenue were as follows:
• The assessee had charged interest on loan advanced to AEs and the rate of interest which had been applied for the purpose of the loan was rightly considered by the TPO while computing the transfer pricing adjustment of the assessee.
• The assessee had granted a credit facility to the AEs for over 180 days, without charging interest. This affected the ALP.
The Tribunal held as follows:
• Referring to section 92C(1) of the Act, the Tribunal held that the TPO had not followed the mandate provided in the Act. Therefore, the adjustment made by the TPO cannot be sustained.
• Charging interest on a loan granted is different from charging interest on outstanding bills for services rendered. The two are not comparable.
Accordingly, the addition made by the TPO / AO was bad in law as well as on merits.
By highlighting the necessity to use any one of the methods specified in the Act for determining the ALP in relation to international transactions, the Tribunal has only reiterated what has been specified in the Act. Applying the same rationale as has been applied in this case, for transactions which are deemed and given a value by the TPO without specifying any method, for example, transactions relating to intangibles, services, etc., the action taken by the TPO could be argued as being bad in law. It may be noted, that similar pronouncement has been made in earlier rulings including Mumbai Tribunal's decisions in the case of CA Computer Associates Pvt. Ltd. v. DCIT [2010-TIOL-68-ITAT-MUM] and DCIT v. M/s. Starlite [2010-TII-28-ITAT-MUM-TP].
Further, in this ruling, the Tribunal has not explained why it believes that interest on loan granted is not comparable to interest on outstanding bills for trade transactions. Nevertheless, this decision would receive a positive reaction from the business community since the Tribunal has ruled in favour of the typical trade practice followed by the assessee. In effect, the Tribunal has recognised that charging of interest is not a general trade practice. Whether or not to charge interest, and to what extent, would depend upon several commercial factors including relative bargaining power of the parties involved in the transaction, volumes, credit history and credit worthiness of the buyer, length of relationship between the parties involved in the transaction, type of industry in which the parties operate, etc.
In fact, the working capital adjustment made by many taxpayers in their transfer pricing analysis takes into account the differential between a taxpayer and its comparables on account of different levels of outstanding trade balances. Also, in a recent ruling in case of ADIT v. Boston Scientific International BV India Branch [2010-T11-16-ITAT-MUM-TP] relating to interest on outstanding trade balances, the Mumbai Tribunal held that if two trade transactions are inter-related then the payable on account of one cannot be examined independent of the receipt on account of the other.