2024 (12) TMI 1633 - AT - Income Tax

Transfer pricing appeal: deletion of interest adjustment on trade receivables under Section 92 due to lack of analysis

ITAT CHENNAI allowed the appeal and deleted the transfer pricing adjustment imputing interest on outstanding trade receivables. The bench relied on HC ... TP Adjustment - outstanding receivables from associated enterprises - international transaction or not? - HELD THAT:- The Hon’ble Delhi High Court in the case of Kusum Healthcare Pvt. Ltd [2017 (4) TMI 1254 - DELHI HIGH COURT] had categorically held that inclusion in the Explanation to Section 92B of the Act by the Finance Act, 2012 in regard to expression ‘receivables’ does not mean that de hors the context every item of ‘receivables’ appearing in the accounts of an entity, which may have dealings with foreign AEs would automatically be characterized as an international transaction. Hon’ble High Court held that when the assessee having already factored in the impact of receivables on the working capital and thereby on its profitability viz-a-vis with that of its comparables, any further adjustment, only on the basis of outstanding receivables would have distorted the picture. Hence, it was held that it is not permissible. In this instant case before us also, the TPO has not carried out basic exercise or any analysis on the facts of the case or the factors mentioned by the Hon’ble Delhi High Court. TPO has not carried out any exercise of statistics and the pattern which would indicate that the receivables from supplies will benefit the AEs in some way. Most importantly, we find that the assessee is a debt free company. In other words, outstanding receivables will not impact the profitability of the company because the assessee is having largely its own funds and there is no debt secured by assessee on which interest is to be paid by the assessee. Hence, the delayed receivables will not impact in any way. From the order of Bechtel India Pvt. Ltd[2017 (5) TMI 965 - ITAT DELHI] ITAT had deviated from its earlier order for AY 2012-13 and followed the judgment of Hon’ble Delhi High Court and Hon’ble Supreme Court concerning AY 2010-11. The Delhi Bench of the Tribunal in Bechtel India Pvt. Ltd., for the assessment year 2013-14 had categorically held that there need not be any transfer pricing adjustment for imputing interest cost for the outstanding trade receivables from AEs when the assessee in the said case is a debt free company. Therefore, the DRP’s reliance on the order of Delhi Bench of the Tribunal in Bechtel India Pvt. Ltd., concerning assessment year 2012-13 (which according to us has not laid down a correct proposition of law) is legally not tenable. In light of the above, we delete the transfer pricing adjustment imputing interest income on the outstanding trade receivables. Appeal filed by the assessee allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether outstanding receivables from associated enterprises constitute a separate international transaction warranting imputation of interest under the Transfer Pricing provisions. 2. Whether imputation of interest on overdue receivables is permissible where the tested party is a debt-free (zero-debt) entity. 3. Whether a notional credit period of 30 days applied by the Transfer Pricing Officer (TPO) is appropriate where intercompany agreements provide a longer agreed credit period (e.g., 180 days) and comparables/precedents support longer credit periods. 4. Whether working capital adjustment (WCA) subsumes any claim for imputed interest on delayed receivables, obviating a separate transfer pricing adjustment. ISSUE-WISE DETAILED ANALYSIS Issue 1: Characterisation of outstanding receivables as a separate international transaction Legal framework: Explanation to section 92B (Finance Act, 2012) includes 'receivable or any other debt arising during the course of business' within the expression 'international transaction,' enabling TP scrutiny of receivables. Precedent treatment: The decision in Kusum Healthcare (Delhi HC/ITAT) cautions that not every receivable automatically becomes an international transaction; factual investigation and study of patterns/working capital impact are required. Subsequent decisions (e.g., certain ITAT benches) have treated receivables as standalone international transactions after considering the 2012 Explanation, while other benches and higher courts have declined imputation where facts demonstrate otherwise. Interpretation and reasoning: The Tribunal held that mere inclusion of receivables in the Explanation does not mandate automatic re-characterisation; the TPO must examine whether receivables reflect an arrangement intended to benefit the AE and whether the impact on working capital/profitability has been analyzed statistically over time. In the present matter, the TPO did not perform the requisite factual enquiry or statistical/pattern analysis and proceeded to treat outstanding receivables as a separate international transaction based solely on an arbitrary methodology. Ratio vs. Obiter: Ratio-an item of receivable cannot be treated as a separate international transaction without fact-specific enquiry; the TPO must investigate pattern, working capital impact, and whether the arrangement benefits the AE. Obiter-Reference to the 2012 Explanation as permitting inclusion of receivables in the concept of international transactions, without automatic application. Conclusion: The TPO's treatment of outstanding receivables as a separate international transaction was impermissible on the facts because the mandatory factual/statistical enquiry was not carried out; thus the adjustment could not be sustained on that basis (cross-reference to Issues 2 and 4 where relevant). Issue 2: Imputation of interest on receivables when the tested party is a debt-free entity Legal framework: Transfer Pricing adjustments for imputed interest on overdue receivables rely on treating delayed receivables as akin to financing from the tested party to the AE; benchmarking is then required (e.g., LIBOR/BPLR-based rates applied by some tribunals/TPOs). Precedent treatment: The Supreme Court and High Court have upheld that where the tested party is a debt-free entity and the tribunal/HC have found as a fact that no borrowing/interest burden exists, imputing interest on receivables is not justified (Bechtel-related judgments). Co-ordinate Tribunal orders have deleted imputed interest for zero-debt entities (e.g., Integra/other ITAT decisions relying on Kusum/Bechtel). Conversely, some Tribunal orders (in certain years) upheld imputation relying on the 2012 Explanation and CUP/benchmarking. Interpretation and reasoning: The Court noted that a zero-debt status means outstanding receivables do not impact profitability via interest costs; absent evidence that the tested party financed operations through borrowings or incurred interest expense, presuming accommodation to AE by way of receivables is unsound. Where the tested party funds operations from internal resources, delayed collections do not translate into a notional financing cost to the entity and do not justify TP adjustment. Ratio vs. Obiter: Ratio-No imputation of interest on outstanding receivables where the tested party is a debt-free entity and there is no evidence of financing costs being incurred. Obiter-Discussion of conflicting Tribunal orders and the temporal interplay of decisions applying the 2012 Explanation. Conclusion: Imputation of interest of Rs. 3,14,15,287/- was deleted because the assessee was a zero-debt company and the Revenue failed to demonstrate that delayed receivables caused financing costs or profit distortion warranting TP adjustment (cross-reference to Issue 1 and decision history in Bechtel-related line of authority). Issue 3: Appropriateness of applying a 30-day credit period by the TPO Legal framework: Benchmarking of overdue receivables requires determination of an appropriate credit period based on intercompany agreements, industry practice, and comparables; arbitrary adoption of a normative period risks erroneous adjustments. Precedent treatment: Judicial precedents have upheld credit periods of 90-180 days where supported by intercompany agreements and comparables; Kusum and other authorities emphasize fact-specific analysis rather than application of an ad hoc 30-day norm. Interpretation and reasoning: The TPO applied a blanket 30-day credit period without considering the contractual agreed credit period of 180 days, the actual collection pattern, or the credit terms of comparables. The Tribunal observed that in absence of such fact-based analysis, the 30-day norm is arbitrary and unreliable for computing overdue days and interest. Ratio vs. Obiter: Ratio-Credit period for TP benchmarking must be grounded in intercompany agreements, industry/comparable practice, and factual collection patterns; arbitrary adoption of 30 days is impermissible. Obiter-Reference to precedents supporting longer credit periods where the record justifies them. Conclusion: The 30-day credit period adopted by the TPO was arbitrary; reliance on contractual credit terms and comparables should have been given primacy (cross-reference to Issues 1 and 4 regarding the need for WCA and broader analysis). Issue 4: Whether Working Capital Adjustment (WCA) subsumes delayed receivables and obviates separate interest imputation Legal framework: TNMM analyses commonly incorporate working capital adjustments to account for differences in credit terms, inventory, and payables impacting profitability; where WCA is properly performed, additional adjustments for receivables may duplicate effects and distort ALP determination. Precedent treatment: Kusum Healthcare and various ITAT orders have held that if the working capital effect of receivables has been duly factored into the WCA and comparables' margins, no separate imputation for interest on receivables is warranted. Some tribunals, however, have distinguished and required separate benchmarking where receivables are demonstrably outside the scope of WCA. Interpretation and reasoning: The Tribunal found that the TPO accepted TNMM for principal transactions but did not examine whether receivables were subsumed in the WCA. The assessee contended that NCP margins and WCA already factored the effect of extended credit; the TPO failed to perform the WCA or reconcile margins to justify an additional notional interest adjustment. Ratio vs. Obiter: Ratio-Where WCA has been applied and the impact of receivables on profitability is reflected in the adjusted margins of comparables, a separate imputation of interest on receivables is not permissible. Obiter-Situations where receivables fall outside WCA and require separate benchmarking. Conclusion: Because the TPO did not demonstrate that the receivables' effect was not subsumed in the TNMM/WCA and did not undertake the necessary analysis, a separate adjustment for imputed interest could not be sustained (cross-reference to Issues 1-3). Overall Conclusion The transfer pricing adjustment imputing interest on outstanding trade receivables was deleted: (a) the TPO failed to undertake the requisite fact-specific/statistical enquiry required before treating receivables as a separate international transaction; (b) the assessee was a debt-free entity, negating justification for imputing financing costs; (c) the arbitrary 30-day credit norm was inappropriate in light of contractual credit terms and precedents; and (d) the TPO did not show that working capital effects were not already captured by TNMM/WCA. Consequently, the adjustment of Rs. 3,14,15,287/- was disallowed and other sub-grounds were not adjudicated as moot in view of deletion of the TP adjustment.