Continuing debit balance is not an “international transaction”

The Mumbai bench of the Income Tax Appellate Tribunal (“ITAT”) recently pronounced its ruling in the case of M/s Nimbus Communications Limited vs. ACIT Circle 11(1), Mumbai for Assessment Year 2004-05, ITA No. 6597/Mum/09, on transfer pricing issues arising from amount overdue to the Taxpayer from its associate enterprise (“AE”). The tribunal held in favour of the Taxpayer observing that if a commercial transaction was at arms? length, no transfer pricing addition for non-charging of interest on overdue debt was warranted.

Facts

The Taxpayer did not charge any interest on overdue payments from its AE and it justified the same on the ground that it does not charge any interest on debit balances with independent parties, nor does it pay any interest to the international creditors. The TPO rejected this plea and held that interest @ 2.19 % LIBOR on outstanding balances after a period of time of 30 days should be the arm?s length price. Being aggrieved by the said transfer pricing order, the taxpayer carried the matter in appeal before Commissioner of Income Tax (Appeals) (“CIT(A)”) who upheld the decision of TPO.

Ruling of the Tribunal

On appeal, the Tribunal reversed the order of the CIT(A). The salient reasons stated by the Tribunal in its order are as below:

• A continuing debit balance is not an “international transaction” u/s 92B per se but is a “result” of the international transaction. Arm?s length price adjustments can only be made in respect of an “international transaction”. A continuing debit balance reflects that the payment, even though due, has not been made by the debtor. It is not necessary that a payment is to be made as soon as it becomes due. Many factors, including terms of payment and normal business practices, influence the fact of payment in respect of a commercial transaction;

•  Unlike a loan or borrowing, continuing debit balance is not an independent transaction which can be viewed on standalone basis. What has to be examined on the touchstone principles of arms length is whether the commercial transaction and terms and conditions including terms of payment is at arm?s length due to which overdue amount has come into existence;

• Even the residuary clause in the definition of „international transaction? i.e. “any other transaction having a bearing on the profits, incomes, losses or assets of such enterprises” does not apply to a continuing debit balance as there is nothing on record to show that as a result of not realizing the debts from the AE, there has been an impact on profits, incomes, losses or assets of the taxpayer;

• When an Arms Length Price is made in respect excessive credit period allowed under the CUP method, the comparable has to be dues recoverable from a debtor and not a borrower. The adoption of interest @ 2.19%  LIBOR on balances which exceed 30 days is not justified because LIBOR is relevant only in the case of lending or borrowing of funds and not to commercial over-dues;

• Assuming the continuing debit balances can be treated as an ‘international transaction’, the TPO ought to have applied the CUP method by considering whether the taxpayer had charged interest on over dues from independent enterprises (internal CUP) or whether other enterprises had charged interest in respect of over dues in respect of similar business transactions from independent enterprises (external CUP).No such exercise has been carried out by TPO in this case.

Conclusion:-This ruling of the Tribunal lays down an extremely useful precedent in respect of arm’s length requirement of charging interest on commercial over-dues as against borrowed funds.