2012 (2) TMI 366 - AT - Income Tax

Transfer pricing adjustment to ALP Revenue contended that distinct operating profit margin to cost in the preceding year qua the AEs and non-AEs should not be applied to the ratio of operating profit to cost in the current year on a combined basis Held that - Nature of international transactions in the year under consideration with its AE s are similar to the preceding year and Operating profit margin for the current year compares favorably with that finally determined for the preceding year therefore, CIT(A) order of deleting addition is upheld. Addition on account of non-charging of interest on trade debtors from the AEs Held that - Section 92B transpires that the transactions of sale and lending ... money have been distinctly set out. It is evident that interest income is associated only with the lending or borrowing of money and not with sale. When the international transaction is that of sale , the interest aspect is embedded in it. Early or late realization of sale proceeds is only incidental to the transaction of sale, but not a separate transaction in itself. No adjustment is warranted. Further, relevant consideration is the taxation of the enterprises of the group that are chargeable to tax in India. If the concept of over all higher or lower rate/amount of tax in the other countries in which AEs are situated is taken into consideration, then Chapter-X of the Income-tax Act would become meaningless.

Summary

Issues Involved:
1. Deletion of addition on account of adjustment made to arm's length price (ALP) in respect of international transaction with Associated Enterprises (AEs).
2. Deletion of addition due to adjustment of interest receivable on outstanding amount from the AEs.

Detailed Analysis:

1. Deletion of Addition on Account of Adjustment Made to ALP:

The primary issue was the deletion of an addition of Rs. 49,99,680 made by the Transfer Pricing Officer (TPO) to the arm's length price (ALP) concerning international transactions with Associated Enterprises (AEs). The assessee had used the Transactional Net Margin Method (TNMM) to determine the ALP, showing an operating profit margin to sales rate of 5.47% and to cost at 5.78%. The TPO, after adjustments, determined a margin of 6.93% and proposed an adjustment of Rs. 49,99,680. The Commissioner of Income-tax (Appeals) [CIT(A)] deleted this addition, noting that exports to AEs were minimal (3.59% of total sales), the TPO had not identified specific defects in the assessee's Functional, Asset, and Risk (FAR) analysis, and one of the AEs was in the USA where the tax rate was higher than in India.

Upon review, it was observed that the facts for the assessment year 2005-06 were similar to those for the preceding year (2004-05), where the Tribunal had deleted a similar addition. The combined operating profit to cost ratio for the current year (5.78%) was higher than the preceding year (3.70%). The Tribunal found no merit in the Departmental Representative's contention that different profit margins for AEs and non-AEs in the preceding year should affect the current year's combined ratio. The Tribunal upheld the CIT(A)'s decision, emphasizing that the current year's profit margin was higher than the preceding year's, and the TPO had not demonstrated that the profit margin on transactions with AEs was lower than the combined margin. Thus, the addition of Rs. 49,99,680 was rightly deleted, and these grounds were not allowed.

2. Deletion of Addition Due to Adjustment of Interest Receivable:

The second issue concerned the deletion of an addition of Rs. 87,66,461 proposed by the TPO for interest receivable on outstanding amounts from AEs. The TPO noted an outstanding balance of Rs. 8,76,64,611 from AEs and observed that the assessee allowed a credit period of 180 days. The TPO proposed an interest rate of 10% on delayed payments, resulting in the addition. The CIT(A) deleted this addition.

The Tribunal reviewed the relevant material and noted that the total debtors included non-AE debtors, and the assessee allowed a 180-day credit period to both AEs and non-AEs. The Tribunal emphasized that Section 92 of the Income-tax Act covers both income and expenses from international transactions, and interest is included as an expense, not income. Section 92B defines 'international transaction' and distinguishes between 'sale' and 'lending money,' associating interest income only with lending or borrowing money. The Tribunal concluded that interest income cannot be treated as a separate international transaction when it is part of a sale transaction. The arm's length price (ALP) determined for the sale transaction inherently covers all elements, including credit period, and no separate adjustment for interest is warranted.

Additionally, the Tribunal noted that the assessee did not charge interest from non-AE debtors for delayed realization, indicating uniform treatment. Even if non-charging of interest from AEs could be construed as an international transaction, no adjustment could be made under the Comparable Uncontrolled Price (CUP) method since the assessee did not charge interest from non-AEs either. The Tribunal did not agree with the CIT(A)'s reasoning that no adjustment was needed because the AE was taxed at a higher rate. The Tribunal emphasized that transfer pricing provisions aim to ensure India gets its due tax share, irrespective of the tax rates in other countries.

In conclusion, the Tribunal held that no addition on account of interest adjustment was maintainable, and this ground was not allowed. The appeal was dismissed.