No adjustment if impact of outstanding receivable considered in Working Capital

M/s. Barco Electronic Systems (P.) Ltd. Vs. DCIT (ITAT Delhi)

Facts of the Case

♣ Barco Electronic Systems Pvt. Ltd. ( taxpayer) is engaged in business of manufacturing of projectors and parts, trading in visual display products and provision of software development services.

♣ During the year under consideration, the taxpayer entered into various international transactions with its AEs namely, import of raw material, export of goods, import of goods, purchase of fixed assets and rendering of services. Consequently, the case was referred to the TPO by AO.

♣ During assessment proceedings, the TPO observed that the according to the inter-company agreement between the taxpayer and its AE, the taxpayer agreed to earn a cost plus markup of 25% on total cost whereas in actual the taxpayer earned a markup of 23.3% on total cost which is higher than the comparables margin but not as per the inter-company agreement with the AEs.

♣ Accordingly, the TPO computed the Arm’s Length Price (“ALP”) with the higher markup as stated in the agreement i.e. 25% on total cost and accordingly proposed an upward adjustment.

♣ Further, the TPO also propose an upward adjustment on outstanding receivables from AEs by charging interest on the same by adopting average prime lending rate of SBI as a benchmark for the interest instead of LIBOR basis as adopted by the taxpayer.

♣ Aggrieved by the same, the taxpayer filed an appeal before Commissioner of Income Tax (Appeal) [“CIT(A)”] wherein CIT(A) deleted the adjustment towards the mark-up on supply of services but held outstanding receivables as a separate international transaction and confirmed the bench marking for interest by taking SBI PLR and confirmed an upward adjustment

♣ Aggrieved,the taxpayer filed an appeal before Delhi Income Tax Appellant Tribunal (“ITAT”/ “the Tribunal”).

ITAT’s Ruling

ITAT made the following observations:

♣ ITAT noted that the taxpayer was a debt free company, neither paying any interest on funds utilized in business nor charging interest on overdue debts from the third parties and the credit period allowed by taxpayer was lesser than that allowed by the comparable companies.

♣ ITAT also notes that the taxpayer had margin of 23.3% on Software Development segment as compared to the margin of 11.42% of the comparable companies and the working capital adjustment margin already factored into account the delay in receivables.

♣ ITAT further relied on the decision of the “Hon’ble Delhi High Court in the case of CIT v. EKL Appliances Ltd wherein it was held that since the impact of the delayed receivables had already been factored in the working capital adjusted margin of the taxpayer, no separate adjustment on the outstanding receivables was required”.

Accordingly, the Hon’ble Tribunal directed the AO to delete the adjustment made on account of the outstanding receivables.

FULL TEXT OF THE ITAT JUDGEMENT

This appeal by the assessee is directed against order dated 25/01/2016 passed by the Ld. Commissioner of Income-tax (Appeals)-42, New Delhi [in short ‘the Ld. CIT(A)’] for assessment year 2010-11 raising following grounds:

1. That the learned Commissioner of Income Tax (Appeals) has erred both in law and on facts in upholding addition of Rs. 12,74,485/- by bench marking the receivables on transactions of sales/services of the appellant company by adopting the prime lending rate of SB1 plus markup of 300 basis points.

1.1 That the learned Commissioner of Income Tax (Appeals) has failed to appreciate that after having determined the ALP in a sale/service transaction, it cannot be assumed that separate adjustment is required in respect of interest therefrom, since outstanding net receivables emanate from the service sales transaction itself.

1.2 That furthermore the learned Commissioner of Income Tax (Appeals) has also failed to appreciate that since appellant is also not charging any interest on overdue debts from third parties, therefore notional interest on outstanding receivables with AE is neither factually and nor legally sustainable, particularly when appellant is a debt free company and is not paying interest on funds utilized in business activities or on credit from suppliers.

1.3 That the learned Commissioner of Income Tax (Appeals) has also failed to appreciate that while determining the margin appellant had not made any adjustment for working capital and since appellant had earned higher margin of 23.33% as compare to the margin of 11.42% of comparable companies, no further adjustment was warranted.

2. That in any case and without prejudice the learned Commissioner of Income Tax (Appeals) has also erred both in law and on facts in not applying the LIBOR rate for computation of interest in view of the judgment of jurisdictional High Court in the case of CIT vs. Cotton Naturals (I) (P) Ltd. reported in 276 CTR 445.

It is therefore prayed that, adjustment and addition so upheld by the learned Commissioner of Income Tax (Appeals) be deleted and appeal of the appellant company be allowed.

2. Briefly stated facts of the case are that the assessee is A 100% subsidiary of “Barco NV Belgium” and was engaged in the business of manufacturing of projectors and parts in trading in visual display products as well as provision of software development services to its Associated Enterprises (AEs). For the year under consideration, the assessee filed return of income on 06/10/2010 declaring total income of Rs.4,66,13,010/-. The case was selected for scrutiny and notice under section 143(2) of the Income-tax Act, 1961 (in short ‘the Act’) was issued and complied with. The Assessing Officer observed International transaction carried out by the assessee and referred the matter of determination of arm’s-length price of the International transaction to the Ld. Transfer Pricing Officer (in short “TPO”. The Ld. TPO noted following international transactions carried out by the assessee and method used for determining the arm’s-length price by the assessee as under:

2.1 The Ld. TPO observed, the transfer pricing approach of the assessee of the two segments of manufacturing and software development as under:

2.2 The Ld. TPO observed that according to the agreement for computer software and IT enabled services dated 15/03/2008 with its associated Enterprises, the assessee agreed to supply services to its associated Enterprises for a cost plus markup of 25% of the total actual cost whereas the assessee has earned a markup of 23.3% on cost, though which was higher than the comparables but it was not as per the agreement with the Associated Enterprises. The Ld. TPO after rejecting the submission of the assessee, computed the arm’s-length price of the transaction with 25% markup on the cost and accordingly calculated the adjustment of Rs.18,64,202/-.

2.3 Further, the Ld. TPO asked the assessee to furnish the details regarding receivables with regard to the outstanding dues from its Associated Enterprises. The learning TPO rejected the plea of the assessee to adopt the interest rate on LIBOR basis and adopted average prime lending rate of SBI of 11.80% with an additional 300 basis points (to take into account other factors/reasons) as the right benchmark for the interest. The learning TPO accordingly proposed adjustment of Rs.41,44,702/-

2.4 After incorporating, that adjustment proposed by the Ld. TPO in his order dated 20/01/2014, the Assessing Officer passed a draft assessment order on 17/02/2014. As no objections were filed before the Ld. Dispute Resolution Panel, within the stipulated period, the Assessing Officer passed final assessment order on 18/03/2014 computing the total income as under:

2.5 Aggrieved with the additions, the assessee filed appeal before the Ld. CIT(A), who after considering the submission of the assessee deleted the transfer pricing adjustment of Rs. 18, 64, 202/-on account of lower markup on cost as compared to the agreement.

2.6 On the issue of transfer pricing adjustment of receivables, the Ld. CIT(A) held the outstanding receivables as separate International transaction and confirmed the action of the Assessing Officer for applying SBI prime lending rate of 11.80%, however directed the Assessing Officer/TPO to reduce the interest on payables and further directed to restrict the calculation of the interest for the period of the outstanding dues falling within the current year and not beyond that. As per the directions of the Ld. CIT(A), the adjustment was computed at Rs.12,74,485/- by the Assessing Officer.

2.7 Aggrieved with the finding of the Ld. CIT(A) on the issue of the bench marking of the receivables, the assessee is in appeal before the Tribunal raising the grounds is reproduced above.

3. Before us the Ld. counsel of the assessee made detailed arguments and filed written submissions, which are reproduced as under:

“3 Contention of Appellant Company in detail:

3.1 Receivables are not an international transaction per-se

• ‘Receivable’ mentioned under Explanation to Sec. 92B of the Act does not mean ‘accounts receivable’ therefore outstanding balance cannot be treated as an independent transaction.
• ‘Receivable’ under clause (c) of explanation to section 92B of the Act apply to loan funds only therefore charging of interest is applicable only in the case of lending or borrowing of funds and not in the case of commercial over-dues.
• ‘Receivable’ does not mean that de hors the context every ‘receivables’ appearing in the accounts which have dealing with AE would automatically be characterized as international transaction.
• Further allowing the credit period to the AE is not an independent international transaction but it is depending and consequential on the sales made to the AE.
• Reliance is placed on following judicial pronouncements:

– 403 ITR 45 (Del) PCIT vs. B.C. Management Services (P) Ltd.

– 34 taxmann.com 298 (Mum) ACIT Vs. Nimbus Communications Ltd.

– 94 Taxmann.com (Visakhapatnam) GVK Power & Infrastructure Ltd vs. ACIT

– 68 SOT 259 (Mum) Goldstar Jewellery Ltd vs. JCIT

– 65 Taxmann.com 187 (Bang) Avnet India (P) Ltd vs. Dy CIT

3.2 No separate adjustment in respect of interest is required once ALP of the sale/service transaction has been determined;

• Overdue debts are necessary outcome of any form of business of normal buy and sale transaction of goods and services.
• Early or late realization of sale/ service proceeds is incidental to the transaction of sale/ service, and not a separate transaction in itself.
• Where credit period allowed is more than the normal period, the financial effect of the said credit allowed to the AE has to be taken and considered as part of the sales made to the AE and not as an independent international transaction.
• Reliance is placed on following judicial pronouncements:

– ITA No 379/2016 (Del) Pr CIT vs. Bechtel India (P) Ltd [SLP of deptt dismissed by Hon’ble Supreme Court in CC No(s) 4956/2017]

– ITA No 765/2016 (Del) Pr CIT vs. Kusum Healthcare (P) Ltd.

– 68 SOT 259 (Mum) Goldstar Jewellery Ltd vs. JCIT

– 80 taxmann.com 12 (Bang) ACIT vs. Millipore (India) Ltd

– 97 taxmann.com 668 (Bang) Adcock Ingram Ltd vs. Dy CIT

3.3 No interest has been charged on overdue debts from third party, appellant is a debt free company and not paving any interest on funds utilized in business:

• Overdue debts in respect of AEs and independent third parties are of similar transaction. The appellant is also not paying any interest on the supplier credit that it is availing from domestic as well as from AEs.
• Appellant is a debt free company and is not paying interest on any funds utilized by it in its business activities.
• Reliance is placed on the following judicial pronouncements:

– 87 Taxmann.com 42 (Del) Kadimi Tool Manufacturing Co (P) Ltd vs. Deputy Commissioner of Income Tax

– 99 taxmann.com 167 (Del) Inductis (India) (P) Ltd vs. ITO – ITA No 87/D/2017 Teradata India (P) Ltd vs. ACIT – ITA No. 7653/MUM/2011 in Evonik Degussa India (P) Ltd – ITA No. 3120/Ahd/2010 MASTER Ltd. vs. Addl. CIT

– ITA No. 1053 of 2012 (Bom) CIT vs. Indo American Jewellery Ltd.

– ITA No. 6597/Mum/09 Nimbus Communications Ltd vs. Asstt. Commissioner of Income Tax.

3.4 No adjustment for working capital has been made since appellant earned margin of 23.33% compared to margin of 11.42% of comparable companies;

• That working capital adjusted margins of appellant have already factored in to account for the impact of delay in receivables therefore separate adjustment on this account was not warranted.
• Appellant has earned higher margins as compare to the comparable companies and also has lower credit period as compare to the comparable companies

• Appellant has already factored the impact of delayed receivables in the working capital and thereby any further adjustment only on the basis of the outstanding receivables would re-characterized the transaction. Reliance is placed on the judgment by Hon’ble Delhi High Court in the case of CIT vs. EKL Appliances Ltd reported in 345 ITR 241.
• Reliance is also placed on following judicial pronouncements:

– 91 taxmann.com 443 (Del) Motherson Sumi Infotech & Designs Ltd vs Dy CIT

–

– ITA No 765/2016 (Del) Pr CIT vs. Kusum Healthcare (P) Ltd.

3.5 In alternate- LIBOR rate be applied in for computation of interest against SBI PLR rate applied by AO.

• Since AE is not based in India for bench marking, SBI PLR rate in not a valid comparable. Rates should be as per the prevalent borrowing rates in the other countries, which is LIBOR.
• Indian interest rates for the purpose of bench marking of lending or borrowing does not constitute an appropriate comparable within the meaning of Rule 10B(a)(i) of the Rule. Reliance is placed on the decision by Hon’ble Delhi High Court in case of CIT v. Cotton Naturals India (P) Ltd. v. reported in 276 CTR 445.

4. On the other hand, the Ld. DR supported the order of the CIT(A).

5. We have heard the rival submission and perused the relevant material on record. We have noted that the assessee is not charging interest on overdue debts from the third parties and also the assessee is a debt free company and not paying any interest on funds utilized is business. We have also noted that the assessee company has a margin of 23.3% on Software Development segment as compared to the margin of 11.42% of the comparable companies. The working capital adjusted margin of the assessee have already factored into account the delay in the receivables and therefore no separate adjustment on this account is required to be made. The credit period of the comparable companies has been found to be 147 days as against the credit period allowed by the assessee of the 30 days. In view of the decision of the Hon’ble Delhi High Court in the case of CIT Vs EKL Appliances Ltd (supra), we are of the opinion that impact of the delayed receivables has already been factored in the working capital adjustment and, therefore, any further adjustment on the outstanding receivables is not required separately in the instant case. Accordingly, we direct the Assessing Officer to delete the adjustment made on account of the outstanding receivables. As we have already deleted the addition in question, we are not adjudicating the other arguments of the assessee, as same are rendered only academic. The grounds of the assessee are accordingly allowed.

6. In the result, the appeal of the assessee is allowed.

Order is pronounced in the open court on 28^th June, 2019.

Conclusion

This judgement will provide respite to the taxpayers facing extensive litigation on the issue of imputation of notional interest on outstanding receivables.