Case Law Details
Court: Bangalore bench of the Income Tax Appellate Tribunal
Citation: Logix Micro Systems Ltd. Vs. ACIT
Brief: The Bangalore tribunal has confirmed the inclusion of imputing interest on inter- company receivables as part of the transfer pricing assessment scrutiny and held that the arm’s length principle is equally applicable to interest on receivables under the India transfer pricing regulations.
Facts of the case
• M/s Logix Micro Systems Ltd (the taxpayer) is engaged in the provision of software development and consultancy services to its Associated Enterprise (AE) in USA. During AY 2004- 05 (FY 2003- 04) the taxpayer reported international transactions in the category of purchase of capital equipment, purchase of computer software, provision for software development and consultancy services.
• During assessment scrutiny the Transfer Pricing Officer (TPO) accepted the transfer pricing methodology of the taxpayer and held the referred international transactions to be at arm’s length. However, as the taxpayer had receivables due from its AE’s and the same were outstanding for more than six months. The TPO contended that the taxpayer has parked the above amount at the disposal of the AE and therefore depriving the taxpayer of the funds which otherwise would have been available with it and adversely affecting the profitability of the taxpayer.
• The TPO concluded the case by applying the Prime Lending Rate (PLR) at 10.25% on the receivables as an adjustment u/s 92CA of the Income-tax Act, 1961 (the Act).
Aggrieved by the adjustment that taxpayer filed an appeal with Commissioner of Income tax (Appeals) [CIT(A)].
Decision of CIT (A)
• The CIT (A) upheld the decision of the TPO with regard to the interest income attributable to the receivables outstanding as on the last day of the previous year.
• The CIT (A) further stated that PLR cannot be used as a Comparable Uncontrolled Price (CUP) method and directed the AO to calculate the interest on the outstanding receivables by adopting the London Inter- bank offered rate (LIBOR)/US Federal Fund Rate.
Aggrieved by the order of the CIT (A) both the parties preferred an appeal before the Income Tax Appellate Tribunal (ITAT).
Taxpayer’s Contention
• The reference by the AO to the TPO does not cover the aspect of delay in collecting the receivables and the adjustment directed by the TPO on the question of interest chargeable to outstanding receivables is without jurisdiction and bad in law.
Observation and Ruling of the ITAT
The tribunal observed and ruled that:
• Reference made by the AO to the TPO on matters of ALP is not made in piece-meal. The AO is not expected to classify the areas of international transactions into different segments and refer only certain segments to the TPO. The ITAT further ruled that the outstanding receivables were generated on account of international transaction and therefore, they are not separate from the international transactions;
• By not remitting back the funds into India within the normal period, the taxpayer is losing an opportunity to pay off its working capital loans, if any and/ or is also loosing an interest income had the funds been deployed in a considerable investment destination in India;
• The ITAT upheld the decision of the CIT(A) to allow a reasonable period as the collection period of the receivables and to compute the interest only for the period greater than the reasonable time limit;
• The ITAT observed that the funds parked with the AE do not partake the nature of a loan transaction. Therefore, the directions of the CIT(A) applicable to formal loans will not be applicable;
• The potential loss (income that would have been earned had the funds been deployed in an investment destination in India/payment of working capital loan by the taxpayer) to the taxpayer is the ALP factor which can contribute to the additional income taxpayer and therefore LIBOR/ US-Fed rate cannot be used to calculate the interest;
• The ITAT after taking into consideration all aspects of the case fixed the ALP interest rate at 5% (this rate after other adjustments for piece-meal remittance and interest-free period was based on the short term deposit rates prevailing in India in the relevant financial year) and directed the AO to compute that additional income accordingly.
Our Comments:- Revenue authorities in India are seeking to impute interest on receivables not realized within a reasonable time period. The question of whether the rate of interest should be as per local regulation in India or as per the rate prevalent in the borrower’s jurisdiction seems to have become a controversial topic. However, recent rulings have provided marginal relief as both LIBOR/ Short term deposit rate are lower than the PLR.
