CA Manish Soni
Context: The amendment made by Finance Act 2012 (‘FA 2012’) by way of explanation to Sec. 92B w.r.e.f. 1 April 2002 included many transactions in the definition of international transaction for Transfer Pricing (‘TP’) purpose. In this case, the ITAT ruled that extended credit period allowed to the Associated Enterprises (‘AE’) amounted to short term funding without interest and thus attracted TP adjustment on account of notional interest from such short term funding. TPO made adjustment considering interest rate @18.816% but DRP reduced it to 7%.
In this case, the average collection period from different debtors of assessee was as under:
|Particulars||Non AE||AE||Delay in AE|
|Manufacturing of Jewellery||125 days||351 days||226 days|
|Diamond Trading||209 days||332 days||123 days|
Contentions of assessee
ñ Continuing debit balance or amount outstanding from the AE on account of delayed realization does not amount to an international transaction. Export is the only international transaction.
ñ Mercantile system of accounting followed thus immediate payment from debtor is not mandatory.
ñ As per company’s policy, no interest is charged from debtors (either AE or Non-AE) on late payment.
ñ In the case of Nimbus Communications Ltd., Mumbai ITAT held in favour of assessee even though payment was received late from AE based in US due to bad economic conditions in US market.
ñ Interest income is associated only with the lending or borrowing of money and not in case of sale. [CIT Vs. Indo American Jewellery Ltd.(2014)]
ñ Only 18% sales to AE and rest 82% to Non AE, therefore no such benefit to AE.
ñ In any case, Arm’s length interest should not exceed cost of capital of assessee.
Contentions of department
ñ Finance Act 2012 included capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business [expl. (i)(c)]
ñ Assessee took loan from financial institution on which it paid interest whereas no interest is charged from AE/Non AE for late payment.
ñ Deferred payment/receivable is covered by amendment made by FA 2012. Also confirmed in Logix Micro Systems Ltd Vs. ACIT.
ñ After retrospective amendment by FA 2012, case law of Nimbus Communications Ltd. and Indo American Jewellery Ltd. are irrelevant.
ñ As per agreement with AE, credit period is allowed only for 150 days. Inspite of that, TPO allowed 180 days as credit period for adjustment.
The ITAT, while upholding the view of the department, held as under:
ñ Extended credit period is covered by the amendment and thus it is an international transaction.
ñ Credit period allowed also depends upon price charged by assessee from buyer.
ñ Granting extended credit period is not an independent transaction but closely linked with international transaction being sale to AE. It cannot be treated as a transaction stand alone without considering main transaction of sale.
ñ Rule 10A(d) allows the aggregate and clubbing of closely linked transaction. The same is also supported by OECD guidelines.
ñ Lending rates should not be used for determining ALP as this is not a transaction of loan or advance to the AE but it is only an excess period allowed. Thus, arm’s length interest should be the average cost of total fund available to the assessee.
Author’s view: After insertion of explanation by FA 2012, any type of advance, payments or deferred payment or receivable is covered by ‘International Transaction’. All assessees dealing with AE should be attentive w.r.t credit period allowed as per agreement and actual credit period.