2019 (5) TMI 2040 - AT - Income Tax

Interest on outstanding receivables deemed international transaction requiring ALP; apply industry-average credit period and LIBOR+200bps instead of unilateral 30-day credit fixation

Open Text Technologies India Private Limited Versus DCIT, Circle-16 (2), Hyderabad

ITAT HYDERABAD partially allowed the appeal. It held interest on outstanding receivables constitutes an international transaction requiring ALP ... TP Adjustment - interest on outstanding receivables - international transaction or not? - HELD THAT:- As we find that the assessee has not charged interest on outstanding receivables. We have gone through the intercompany agreement and we do not find any such clause mentioning that only 30 days of credit period is allowed for making payments as recorded by the TPO his order. Therefore, in our opinion, fixing the credit period of 30 days is without any basis. We have gone through the details of outstanding receivables and we find that in certain cases, the period has exceeded to 600 days. In most of the cases, the period was below 100 days. As in the case of Mckinsey Knowledge Centre India (P.) Ltd. [2018 (8) TMI 592 - DELHI HIGH COURT] has considered the issue at length and has held that the Explanation to section 92B by Finance Act, 2012 is applicable retrospectively and therefore, the assessee can be visited with the Transfer Pricing adjustment. Thus, interest on outstanding receivables is an international transaction for the relevant assessment year and needs determination of ALP of the same. Assessee’s objection that the working capital adjustment - We find that there is no working given by the TPO in the TP order nor has it been annexed to the TP order. We do not know whether the interest on outstanding receivables factored in the computation of working capital adjustment. Therefore, we are unable to give a finding as to whether the interest on outstanding receivables was a factor considered in the working capital adjustment given by the TPO. Assessee being a debt free company and there being no interest expenditure - We find that the assessee has relied upon the decision of Bechtel India Pvt. Ltd. [2016 (9) TMI 196 - DELHI HIGH COURT] confirming the ITAT order and the Hon’ble Supreme Court dismissing the SLP of the Revenue vide [2017 (7) TMI 1058 - SC ORDER] But we find that the Hon’ble Supreme Court in the latest order [2017 (7) TMI 1058 - SC ORDER] has dismissed the SLP filed by the appellant against the decision of the Hon’ble Delhi High Court in the case of MC Kinsey Knowledge Centre India (P.) Ltd. [2016 (9) TMI 196 - DELHI HIGH COURT] wherein as already reproduced in the above paras has held the issue in favour of the revenue. As per the law of precedents, the latest decision on an issue is to be followed. Therefore, the said contention of the assessee is also rejected. LIBOR plus’ rate should be considered as an interest on outstanding receivables - We have held that where the export turnover was brought in foreign exchange then international transaction should be considered in LIBOR + 200 points rate and after expiry of credit period. Therefore, we agree with Assessee that since the payments are to be made in foreign exchange, the interest should be charged at LIBOR plus (+) 200 basis points. AO / TPO are directed to work-out the industry average of the credit period for outstanding receivables and apply the above rate of LIBOR + 200 basis points after expiry of such credit period from the date of invoice. Assessee’s appeal is partly allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether non-charging/under-charging of interest on outstanding receivables arising from provision of services to Associated Enterprises constitutes an 'international transaction' requiring determination of arm's length price under section 92B/92CA framework. 2. Whether the effect of outstanding receivables is subsumed within the Working Capital Adjustment (WCA) under the TNMM such that separate imputation of interest is impermissible or redundant. 3. Appropriate benchmark/interest rate and credit period to be applied for imputing interest on overdue foreign-currency receivables (SBI PLR v. LIBOR + basis points), and the temporal scope for computing interest. 4. Whether outstanding payables to Associated Enterprises must be netted off against outstanding receivables before computing imputed interest. 5. Whether the assessee's status as a 'debt-free' entity (no actual interest expense) precludes imputation of interest on overdue receivables for transfer-pricing purposes. ISSUE-WISE DETAILED ANALYSIS Issue 1: Characterisation of unpaid/underpaid interest on receivables as an 'international transaction' Legal framework: Explanation to the definition of 'international transaction' (amendment by Finance Act, 2012) includes 'capital financing' and expressly covers 'any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business,' thereby bringing overdue trading debts within transfer-pricing ambit. Precedent treatment: Followed and applied decisions holding that overdue receivables/debt arising in course of business are international transactions requiring ALP determination (reliance on leading High Court and tribunal pronouncements treating non-charging of interest as benchmarkable international transaction). Interpretation and reasoning: The Court reads the retrospective Explanation as encompassing trading debts and consequential unpaid interest; thus delay in realization of trading debt is not merely incidental but a separable facet requiring ALP determination. The legislative language is treated as determinative that any debt arising in course of business is includable and subject to benchmarking. Ratio vs. Obiter: Ratio - interest on overdue receivables constitutes an international transaction and is assessable for ALP determination. This forms a binding part of the decision on the facts. Conclusion: Interest on outstanding receivables is an international transaction for the relevant year and requires transfer-pricing adjustment where interest is uncharged or undercharged. Issue 2: Whether WCA under TNMM exhausts the effect of overdue receivables so as to preclude separate interest imputation Legal framework: TNMM with Working Capital Adjustment attempts to normalize differences in working capital requirements between tested party and comparables; WCA may, in principle, reflect effect of receivables on margins. Precedent treatment: No conclusive precedent established on record proving that WCA, as computed, subsumed interest imputation; tribunal noted absence of working details evidencing such inclusion. Interpretation and reasoning: The Tribunal examines the record and finds the TPO's TP order does not include workings to demonstrate that interest on receivables was factored into WCA. Without documented computation showing interest inclusion, one cannot presume WCA covered the interest impact. Therefore, a factual determination is required on whether WCA already accounted for overdue interest. Ratio vs. Obiter: Ratio - where no working shows inclusion of interest within WCA, separate imputation may not be foreclosed; factual proof is required. This finding is outcome-determinative as to whether adjustment is duplicative. Conclusion: Absent explanatory workings from the TPO, the Tribunal cannot accept the contention that WCA already accounted for interest; therefore separate benchmarking of interest remains open unless the revenue shows it was included in WCA. Issue 3: Appropriate benchmark rate and credit period for imputing interest on foreign-currency receivables Legal framework: ALP of capital financing/overdue receivables is to be determined by reference to comparable market rates for the currency and risk profile of the instrument; for foreign-currency exposures, LIBOR-linked benchmarks are commonly applied with appropriate spread. Precedent treatment: The Tribunal refers to its own practice and earlier decisions applying LIBOR + basis points for export/foreign-currency receivables; it distinguishes the DRP/AO approach of imposing domestic bank PLR. Interpretation and reasoning: Since the receivables are payable in foreign currency, international market lending rates (LIBOR plus margin) are more appropriate than a domestic bank's PLR. The Tribunal, while rejecting an arbitrary 30-day credit period imposed by the TPO, directs application of LIBOR + 200 bps after expiry of an industry-average credit period to be worked out by AO/TPO, ensuring procedural fairness (opportunity to be heard). The Tribunal also relies on precedential practice to adopt LIBOR + 200 bps in similar fact patterns. Ratio vs. Obiter: Ratio - where receivables are in foreign currency, LIBOR + appropriate spread (here directed as +200 bps) is the correct benchmark post expiry of a factually established credit period; arbitrary imposition of domestic PLR and a 30-day credit period without contractual or evidentiary basis is impermissible. This determination forms a core remedial holding. Conclusion: Interest on outstanding foreign-currency receivables should be benchmarked at LIBOR + 200 basis points after expiry of an industry-average credit period (to be computed by AO/TPO with opportunity to the taxpayer). The AO/TPO's fixation of 30 days and use of SBI PLR is replaced by this approach. Issue 4: Netting of outstanding payables against receivables before imputing interest Legal framework: ALP determination for a given international transaction requires consideration of its commercial character; mutual balances with the same AE can, in principle, be netted if legally and commercially appropriate. Precedent treatment: The tribunal notes the assessee's contention that payables should be netted but finds no explicit legal bar; however, the record does not contain a detailed analysis by revenue reconciling payables and receivables for netting purpose. Interpretation and reasoning: The Tribunal identifies the arguable merit in netting reciprocal balances but does not make a definitive direction given absence of detailed computations and analysis by AO/TPO. The matter is factual - whether balances are with same AE, standing arrangements permit netting, and whether netting alters ALP computation materially. Ratio vs. Obiter: Obiter with procedural effect - netting is a relevant consideration and should be examined by AO/TPO; the Tribunal does not decide netting's applicability on the present record. Conclusion: The AO/TPO is to consider and, where justified on facts and documentation, net outstanding payables against receivables before computing imputed interest; no blanket disallowance of netting is directed. Issue 5: Whether absence of actual interest expense (debt-free status) precludes imputation of interest for TP benchmarking Legal framework: Transfer pricing determines ALP of transactions irrespective of actual accounting treatment; absence of an expense in tested party's books does not by itself negate existence of an international transaction requiring benchmarking. Precedent treatment: The Tribunal follows more recent authoritative precedent which holds that being an 'interest-free' or debt-free entity does not preclude benchmarking of overdue receivables as an international transaction requiring interest imputation. Earlier conflicting authority relied upon by taxpayer (favourable to non-imputation) is displaced by later superior decisions. Interpretation and reasoning: The Tribunal applies the law of precedents - later binding decisions that adjudicate the same statutory amendment and issue are to be followed. The mere fact that the tested party incurred no interest expense is not determinative; the legislature's inclusion of debts within international transactions mandates consideration of imputed interest irrespective of actual bookkeeping. Ratio vs. Obiter: Ratio - debt-free status does not preclude imputation of arm's length interest on overdue receivables; this is a binding aspect of the Tribunal's decision. Conclusion: The assessee's argument based on absence of interest expense is rejected; imputation remains permissible and required where ALP analysis so dictates, following later authoritative precedent. Overall Disposition The appeal is partly allowed: the Tribunal confirms that overdue receivables constitute an international transaction and are subject to ALP determination; it rejects arbitrary fixation of a 30-day credit period and the application of domestic PLR, directing AO/TPO to apply LIBOR + 200 bps after expiry of an industry-average credit period (to be worked out with fair hearing). The Tribunal requires AO/TPO to demonstrate whether WCA already included interest and to consider netting of reciprocal balances where factually justified.