2025 (9) TMI 1189 - AT - Income Tax

Notional interest imputation on intercompany receivables set aside as commercial transaction, margins and working-capital adjustments suffice

ITAT allowed the appeal and set aside the TPO's notional interest adjustment on outstanding inter-company receivables. The tribunal found receivables must ... TP Adjustment - notional interest on receivables outstanding from the AEs - TPO disregarded inter-company pricing arrangement like loan or borrowings, outstanding receivables are not an independent transactions which can be violated on standalone basis and needs to be examined with the commercial transaction, as a result of which the debit balance has come into existence - HELD THAT:- The net margin of appellant after excluding the interest on outstanding receivables works out to 52.82%, whereas the arithmetic mean of the margin earned by the comparable companies is 9.58%. As per ratio in the case of GKN Driveline (India) Ltd. [2024 (10) TMI 308 - ITAT DELHI] it well settled that where assessee’s margin was higher than comparable margin, no transfer pricing adjustment could be made on account of interest on outstanding receivables. It is well settled principles of law that where there is uniformity in not charging interest both from Assessee neither charges from associated enterprises and non-associated enterprises, no transfer pricing adjust can be made. Assessee is a debt free company. Assessee company neither borrowing any funds for carrying its business nor has incurred any interest expenses. A Co-ordinate Bench in Bechtel India (P) Ltd. [2015 (12) TMI 1560 - ITAT DELHI] upheld by Hon’ble High Court [2016 (9) TMI 196 - DELHI HIGH COURT] has held that the question of charging interest does not arise when assessee is a debt free company. CIT(A) in assessee’s own case for assessment year 2015-16 deleted adjustment made by Ld. TPO where interest on outstanding receivables computed after allowing set off of receivable payable. Working capital adjustment taken into account, the impact of outstanding receivables on profitability and, therefore, no further imputation of interest is warranted. Working capital adjustment margin of independent comparable would reflect the allowance and any further adjustment on account of outstanding receivables is not permissible. Reliance is placed on the decision of PCIT Vs. Kusum Health Care (P) Ltd. [2017 (4) TMI 1254 - DELHI HIGH COURT] TPO has used an interest rate of 4.45690% for computing interest on outstanding receivable on the basis of 6 months LIBOR rate as on March 2013 and 400 basis points (300 basis plus additional 100 points on account of currency risk) were added to the 6 month LIBOR rate. Ld. TPO relied on RBI Circular where ECB LIBOR rates has been specified for loan having maturity of three years. However, in the present case, the outstanding receivables have been realized in average period of 93 days. Therefore, further addition on in arbitrarily adding a mark-up of 100 basis points to LIBOR based rate used to impute interest on receivables outstanding in foreign currency by relying on the RBI master circular being unjustified is set aside. Ground of appeal are allowed. ISSUES PRESENTED AND CONSIDERED 1. Whether year-end outstanding receivables from Associated Enterprises constitute an 'international transaction' under Section 92B and its Explanation(1)(c) so as to permit imputation of notional interest under Chapters X and Sections 92C/92CA. 2. Whether imputation of notional interest on outstanding receivables is permissible where (a) the tested party is a debt-free entity that neither borrows nor pays/charges interest in its ordinary course of business; (b) the underlying inter-company commercial transactions and pricing arrangements have been accepted for transfer-pricing benchmarking; and (c) a working capital adjustment has been made in the comparability analysis. 3. Whether set-off between outstanding receivables and outstanding payables with Associated Enterprises must be allowed when computing any notional interest adjustment. 4. Whether the rate/method adopted by the Transfer Pricing Officer to impute interest - specifically use of a 6-month LIBOR plus a spread (300 bps) and an additional 100 bps - was legally justified given the maturity profile of the receivables. 5. Whether the assessing authority erred in not crediting claimed tax deducted at source (TDS) and foreign tax credit (FTC) to the assessee, and whether that issue required remand for fresh adjudication. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Characterisation of year-end outstanding receivables as an 'international transaction' Legal framework: Chapter X (Sections 92B, 92C, 92CA) permits transfer-pricing adjustments where international transactions between Associated Enterprises are not at arm's length; Explanation(1)(c) to Section 92B addresses characterization of certain amounts. Precedent treatment: Authorities and tribunals have considered whether year-end receivables, by themselves, constitute discrete international transactions or are part of the underlying commercial transactions; precedents emphasize aggregation of closely connected transactions and the context of inter-company arrangements. Interpretation and reasoning: The Tribunal accepted that outstanding receivables arise from the commercial transaction and inter-company pricing arrangement; they are not independent standalone transactions to be separately benchmarked where the underlying transaction and its price are otherwise accepted. The Tribunal relied on the principle of aggregation of inextricably connected transactions and examined whether a separate imputation was warranted after benchmarking of underlying transactions. Ratio vs. Obiter: Ratio - year-end receivables do not automatically give rise to an independent international transaction warranting separate notional interest if the underlying international transaction and its pricing have been tested and accepted; Obiter - contextual remarks on when receivables may be treated separately in other factual matrices. Conclusions: The TPO/AO/DRP erred in treating outstanding receivables as a separate international transaction in the facts of this case; this ground of appeal (challenge to characterization) is allowed. Issue 2 - Permissibility of imputing notional interest where the tested party is debt-free, does not charge/pay interest, and comparables include working capital adjustment Legal framework: Transfer pricing adjustments must conform to arm's length principles; working capital adjustments and aggregation principles form part of customary TP methodology. Section 92(3) (non-application if income reduces post application) is referenced for net effect considerations. Precedent treatment: Decisions cited support that (a) no notional interest is chargeable where the tested party is debt-free and has no interest costs; (b) uniform absence of charging/ paying interest to third parties supports rejection of imputed interest; and (c) working capital adjustments in comparables already capture effects of receivable timing so further imputation would be double counting. Interpretation and reasoning: The Tribunal examined the tested party's high net margin (post-exclusion of interest on receivables) relative to comparables (tested party ~52.82% vs comparables ~9.58% pre-WCA; post-WCA comparables ~4.43%). Given (i) substantially higher profitability even after hypothetical exclusion, (ii) the assessee's debt-free status and absence of interest bearing operations, and (iii) working capital adjustments in benchmarking that reflect receivable timing, the Tribunal found that separate imputation of notional interest was unwarranted and would amount to double adjustment. Ratio vs. Obiter: Ratio - where an assessee is debt-free, does not incur/charge interest in ordinary business, and the working capital adjusted comparables have been applied, imputing notional interest on receivables is not warranted; Obiter - observations on the interplay of business model and TP adjustments in other fact patterns. Conclusions: TP adjustment by imputing notional interest on receivables was inappropriate on the facts - appeals on grounds 2-17 (and 2-16 in the companion appeal) allowed on this basis. Issue 3 - Requirement to allow set-off of outstanding payables against receivables Legal framework: Transfer pricing computations assessing net inter-group exposures may permit consolidation/set-off to reflect net economic position; Section 92(3) contemplates the net effect of transfer pricing adjustments. Precedent treatment: Tribunals have allowed computation of interest on net inter-group position where appropriate; prior orders in the assessee's own case and other precedents demonstrate allowance of set-off. Interpretation and reasoning: The Tribunal noted TPO computed interest only where receivables existed without consistently providing set-off where payables existed, leading to selective application. The record showed net interest position was minimal (post set-off net payable INR 4,64,538 in one year), undermining basis for notional income imputation. Ratio vs. Obiter: Ratio - computation of notional interest must consider net inter-group receivable/payable position where relevant; selective withholding of set-off amounts is unsustainable; Obiter - particulars of netting depend on contractual and accounting arrangements of the parties. Conclusions: Set-off between receivables and payables ought to be recognized; selective non-allowance by TPO was an error supporting reversal of the adjustment. Issue 4 - Appropriateness of the interest rate (LIBOR + spreads) adopted for imputing notional interest Legal framework: Arm's length interest rate should reflect comparable market rates for the relevant maturity and risk; use of external benchmarks (e.g., LIBOR and RBI circulars on ECB/trade credit ceilings) must be factually and legally applicable. Precedent treatment: Authorities rely on RBI master circulars for guidance on spreads for ECBs/trade credits, but applicability depends on classification (ECB vs short-term receivables) and maturity profile. Interpretation and reasoning: The Tribunal found the TPO used a 6-month LIBOR plus 400 bps (300 + 100) based on an RBI circular applicable to loans with multi-year maturity, whereas the assessee's receivables averaged ~93 days. The additional 100 bps mark-up was held to be arbitrary where the risk spread contemplated by the RBI circular already addresses currency/credit risk; application of long-term ECB spreads to short-term receivables was unjustified. Ratio vs. Obiter: Ratio - benchmark spreads and reference rates must be applied consistent with the tenure and economic nature of the instrument; applying long-term ECB spreads to short-term receivables without justification is improper; Obiter - acceptable alternative approaches depend on demonstrated comparables for short-term trade credits. Conclusions: The mark-up of 100 bps and reliance on multi-year ECB spreads for short-term receivables was unjustified; that aspect of the TPO's rate methodology was set aside (to the extent it influenced the impugned adjustments), supporting relief to the assessee. Issue 5 - TDS/FTC credit and remand for fresh adjudication Legal framework: Credit for tax deducted at source and foreign tax credit must be given in computing taxable income where supported by Form 26AS and foreign tax documents; assessing officer must record reasons if credit is denied. Precedent treatment: Principles require that TDS reflected in statutory records (Form 26AS) be credited unless cogent reasons exist; foreign tax credit requires documentary support and adherence to sections 90/90A as applicable. Interpretation and reasoning: The Tribunal observed mismatch between claimed TDS/FTC and amount allowed by AO; documents were placed on record. In the absence of a satisfactory finding by the AO and given procedural fairness, the Tribunal considered it expedient to remit the issue to the AO for fresh decision after affording the assessee opportunity of hearing. Ratio vs. Obiter: Ratio - where TDS/FTC claims are supported on record and the AO has not recorded satisfactory reasons for denial, remand for fresh adjudication is appropriate; Obiter - specifics of allowance will depend on AO's fresh findings consistent with law. Conclusions: Ground regarding TDS/FTC credit is allowed for statistical purposes by setting aside the AO's order and remitting the matter for fresh adjudication with opportunity to the assessee. OVERALL CONCLUSION The Tribunal allowed the appeals in part by: (a) disallowing the TPO/AO/DRP's separate imputation of notional interest on year-end receivables on the facts (aggregation, high tested margins, debt-free status, working capital adjustment and need for set-off); (b) holding the additional mark-up applied to LIBOR unjustified for short-term receivables; and (c) remanding the TDS/FTC credit issue to the AO for fresh decision after hearing. Grounds consequential to these determinations were allowed accordingly.