Recovery of expenses beyond normal period was in the nature of deemed loan in the hands of AEs and require TP adjustment

Brief of the case

In the case of Tecnimont ICB House  vs. DCIT, ITAT has held that Recovery of expenses beyond the normal period was in the nature of deemed loan in the hands of AEs and require transfer pricing adjustment.

Facts of the case

1. cnimont ICB Private Limited (hereinafter referred to as ‘TICB is engaged in the business of execution of turnkey project services particularly in the field of petrochemicals, oil and gas, fertilizers and instrumentation and electrical erection. It is also engaged in activities like EPC lump sum turnkey contracts, engineering design services, supervision services, translation services and feasibility studies. It also renders onshore/ offshore design and engineering services and field construction supervision services.

2. During AY 2009-10, TICB has entered into the following international transactions with its associated enterprises (‘AEs’) The TPO accepted all the transactions to be at arm’s length price (ÁLP’). However, the learned TPO made an adjustment of Rs.10,36,49,646/- by charging notional interest for delayed recovery of export receivables and delayed recovery of expenses from AE’s till the date of transfer pricing order (i.e. 25th January, 2013).

3. The assessment was completed by the AO under Section 143(3) read with Section 144C (13) of the Act. An order dated 24 December 2013 was issued assessing the assessee at total income of Rs.67,96,55,391, thereby confirming the transfer pricing adjustment of Rs.10,36,49,646 on account of notional interest for delayed recovery of export receivables and delayed recovery of expenses from AEs by applying interest rate of 12.25% (i.e. SBI PLR).

4. Assessee is aggrieved by this addition of notional interest. Assessee preferred an appeal before Tribunal.

Issue

Whether Assessing Officer is correct in making adjustment on account of notional interest for delayed recovery of export receivables and delayed recovery of expenses from AE’s till the date of transfer pricing order of Rs 10,36,49,646/-

Assessee ‘s Contention

1. That delay in recovery of outstanding receivables from debtors does not fall within the purview of “international transaction” under the provisions of section 92B of the Act read with Rule 80IB of the Income-tax Rules as prevailing at that point of time and therefore the transfer pricing regulations do not apply to the same.

2. That while transacting with group entities/ third parties, it is a common practice to extend certain credit period. Assessee provides services to AEs and hence inter-company balances (debit! credit receivables) are unavoidable. AO/TPO failed to appreciate that AEs were facing financial difficulties in the relevant assessment year, which has resulted in delay in payment to assessee. Such circumstances happen in business cycle and therefore interest cannot be charged for such delays.

That since the margin earned from its AE transactions is higher as compared to similarly placed comparable companies, the element of interest for delayed payment is subsumed in the higher mark-up charged. In view of the same, adjustment on account of notional interest on outstanding balances of AEs is not warranted. Even if one assumes that deemed interest income on account receivables is already included as a part of the total profit of the assessee as per the audited financials for AY 2009-10 and the same is reduced from such total profit so as to exclude such notional interest income from the total income, the margin earned by the assessee even after reducing such amount is still much higher than the margin earned by the comparable companies.

That transaction between TICB and Tecnimont SpA India Project Office (‘TIPO’) (PE of foreign AE in India) is a transaction between two resident entities and therefore such transaction does not come under the purview of Indian transfer pricing regulations since there was no possibility of shifting of profits outside India or erosion of country’s tax base.

Revenue Contention

That in respect of export to associate enterprise the amount was recovered after a period of 60 days, therefore, the TPO was justified in directing to charge interest at SBI PLR rate of 12.25% as the benchmarked rate for delay in recovery of export receivable beyond the normal credit period of 60 days.

ITAT decision / observations

1. We found that the AE was having advances with the assessee, therefore, while computing interest on realized amount beyond 60 days, the AO should reduce the proportionate advance relating to the transaction under consideration. We also found that the TPO has directed for charging of interest even beyond the end of the financial year i.e. 31.3.2009. Accordingly, we direct the AO to charge interest only uptil the end of the financial year insofar as Section 92(1) of the Act specifically provides to tax not income arising from any international transaction which is to be computed with regard to the arms length price for the year under consideration. Accordingly, we restore the matter back to the file of AO to recompute the interest in terms of the above direction.

2. It was also brought to our notice that while fixing the sale price the assessee has already considered the delay, if any, in recovery of the price. Accordingly, while recomputing the interest, the AO should also take into account the price fixed by the assessee with respect to the transaction entered with non-AE vis-à-vis AE and if he finds that price so charged has already taken care of the delayed period of payment, the same should be taken into account while computing the interest chargeable.

3. We also found that operating margin earned by the assessee on provision of EPC services (17.03% OP/ OC) from its AEs transactions is higher than the margin earned on its non-AE transactions. Since the transactions are intrinsically linked and the assessee under the TNMM fits within the arm’s length, the assessee should be given due credit for the same while computing chargeable interest for delayed payment.

4. The addition on account of interest should be computed only till the end of financial year (i.e. till 31 march 2009 and not till the date of passing of transfer pricing order (i.e. 28 January 2013). It is trite law that income tax has to be computed with reference to previous year and as per Section 5 of the Act explains the scope of total income to be considered earned by any person during the previous year. In the present case, the TPO has made addition of notional interest till the date of passing of order (i.e. 28 January 2013) which is incorrect and against the basic principle of taxation as laid down by Income Tax Act. Hence, interest adjustment on delayed accounts receivables, if any, should be computed only upto 31 March 2009.

5. We also found that during the year under consideration, the assessee has received advances from AE’s for the purpose of export, therefore computation of interest, if any, on delayed recovery of export receivables should be after reducing the advances received from AE’s for the purpose of export.

6. As per our considered view the notional interest has to be worked out for so called amount receivable from AE, by applying LIBOR interest rate for the purpose of computation of transfer pricing adjustment, if any.

7. In respect of the expenditure incurred on behalf of the AEs and which was reimbursed by the AE, the AO also levied interest thereon. We found that the recovery of expenses was beyond the normal period of 60 days. Recovery of expenses beyond the normal period was in the nature of deemed loan in the hands of AEs and require transfer pricing adjustment. Accordingly, we do not find any infirmity in the transfer pricing adjustment made. However, we direct the AO to charge interest by applying LIBOR rate.