2024 (7) TMI 1338 - HC - Income Tax

Transfer Pricing Officer cannot recharacterize receivables as loans or disallow management fees on commercial expediency grounds

The Delhi HC ruled against the revenue in a transfer pricing case involving two key issues. First, regarding outstanding receivables from associated ... TP Adjustment - interest on receivables - payment of invoices raised to its AEs had not been received on time - it chose to treat those outstanding receivables as being liable to be recharacterized as unsecured loans - HELD THAT:- Issue stands conclusively answered against the appellants by a Coordinate Bench of this Court in terms of the judgment rendered in Principal Commissioner of Income-tax v. Kusum Health Care Pvt. [2017 (4) TMI 1254 - DELHI HIGH COURT]held that entire focus of the Assessing Officer was on just one assessment year and the figure of receivables in relation to that assessment year can hardly reflect a pattern that would justify a Transfer Pricing Officer concluding that the figure of receivables beyond 180 days constitutes an international transaction by itself. With the assessee having already factored in the impact of the receivables on the working capital and thereby on its pricing/profitability vis-a-vis that of its comparables, any further adjustment only on the basis of the outstanding receivables would have distorted the picture and re-characterised the transaction. This was clearly impermissible in law as explained by this court in CIT v. EKL Appliances Ltd [2012 (4) TMI 346 - DELHI HIGH COURT] TP Adjustment - payment of management fee - whether payment made for Intra Group Services[IGS] was for commercial expediency? - assessee had not undertaken any benchmarking exercise in respect of IGS - HELD THAT:- We find that the TPO has essentially doubted those payments on the anvil of commercial expediency. In our considered opinion, this issue has been correctly answered by the Tribunal and which drew sustenance for its conclusions bearing in mind the decision rendered by this Court in Commissioner of Income-tax v. EKL Appliances Ltd [2012 (4) TMI 346 - DELHI HIGH COURT] as held So long as the expenditure or payment has been demonstrated to have been incurred or laid out for the purposes of business, it is no concern of the Transfer Pricing Officer to disallow the same on any extraneous reasoning. As provided in the OECD guidelines, he is expected to examine the international transaction as he actually finds the same and then make suitable adjustment but a wholesale disallowance of the expenditure, particularly on the grounds which have been given by the Transfer Pricing Officer is not contemplated or authorised. As this Court had held in EKL Appliances, it is clearly impermissible for the TPO to disregard the actual transaction unless it comes to the conclusion that an unrelated party would not have undertaken the same in usual course of business. More importantly it is wholly impermissible for the TPO to doubt commercial soundness of the expenditure that may be incurred. It would also not be permissible for the TPO to engage in the restructuring of a transaction, unless the economic substance of a transaction differed from its form and if the form and substance of the transaction were the same but the arrangements relating to the transaction when viewed in totality differed from that which would have been adopted by independent enterprises acting in a commercially rational manner.This position has been duly affirmed by the decision rendered by this Court in Sony Ericsson Mobile Communication India P. Ltd. [2015 (3) TMI 580 - DELHI HIGH COURT] as held here is no material or justification to hold that no independent party would incur the AMP expenses beyond the bright line AMP expenses. Free market conditions would indicate and suggest that an independent third party would be willing to incur heavy and substantial AMP expenses, if he presumes this is beneficial, and he is adequately compensated. The compensation or the rate of return would depend upon whether it is a case of long-term or short-term association and market conditions, turnover and ironically international or worldwide brand value of the intangibles by the third party. Decided against revenue. Issues Involved:1. Justification of deletion of addition made by the TPO for Intra Group Services (IGS).2. Consideration of factors beyond non-substantiation of commercial expediency by the Assessee.3. Deletion of entire interest on receivables.Detailed Analysis:1. Justification of Deletion of Addition Made by the TPO for Intra Group Services (IGS):The Tribunal deleted the addition made by the TPO, holding that the payment made for Intra Group Services was for commercial expediency. The TP Report and the Tribunal's findings indicated that the Transactional Net Margin Method (TNMM) was adopted for Arm's Length Analysis. The Tribunal followed its decision for A.Y. 2008-09, emphasizing that the tax administration should not disregard the actual transaction unless an unrelated party would not have undertaken the same. The Tribunal referred to the judgment in Commissioner of Income-tax v. EKL Appliances Ltd., which held that the TPO cannot disallow expenditure based on the assessee's financial health or perceived commercial soundness. The Tribunal found that the TPO's rejection of the assessee's evidence was not justified, and the cost allocation for services provided was logical and supported by evidence.2. Consideration of Factors Beyond Non-Substantiation of Commercial Expediency by the Assessee:The Tribunal noted that the TPO had rejected the assessee's claim on several grounds, including lack of evidence of services provided, cost allocation, and the basis of charges. However, the Tribunal found that the TPO's conclusions were not supported by adequate evidence. The Tribunal emphasized that the TPO should not engage in restructuring the transaction unless the economic substance differed from its form. The Tribunal reiterated that the TPO's role is to examine the transaction as it is and not to re-characterize it based on perceived commercial rationality.3. Deletion of Entire Interest on Receivables:The Tribunal addressed the issue of interest on receivables, noting that the TPO had treated outstanding receivables as unsecured loans and suggested an interest rate of 14.88%, which was reduced to 13.88% by the CIT(A). The Tribunal referred to its decision for A.Y. 2008-09, where it held that applying the prime lending rate of RBI was not appropriate. The Tribunal found that the interest received by the assessee was at arm's length and no TP adjustment was called for. The Tribunal also referred to the judgment in Principal Commissioner of Income-tax v. Kusum Health Care Pvt. Ltd., which held that receivables do not automatically constitute an international transaction and must be examined in the context of the assessee's working capital and pricing/profitability.Conclusion:The Tribunal's decision to delete the additions made by the TPO was based on a thorough examination of the TP Report, evidence provided by the assessee, and relevant judicial precedents. The Tribunal emphasized that the TPO should not disregard actual transactions or re-characterize them based on perceived commercial rationality. The Tribunal's findings were consistent with the principles laid down in Commissioner of Income-tax v. EKL Appliances Ltd. and Principal Commissioner of Income-tax v. Kusum Health Care Pvt. Ltd. The appeals were dismissed, affirming the Tribunal's decision.