2015 (2) TMI 58 - AT - Income Tax

Adjustment of notional interest on account of extended credit period allowed to the AE - whether the aggregate period extended by the assessee to the AE which is more than the average credit period extended to the non-AE would constitute international transaction - Held that - After the insertion of explanation to section 92B(1), the payment or deferred payment or receivable or any debt arising during the course of business fall under the expression international transaction as per explanation. Therefore, in view of the expanded meaning of the international transaction as contemplated under clause (i) (e) of explanation to section 92B(1), the delay in realization of dues from the AE in comparison to non-AE would certainly falls in the ambit of international transaction. However, this transaction of allowing the credit period to AE on realization of sale proceeds is not an independent international transaction but it is a closely linked or continuous transaction along with sale transaction to the AE. The credit period allowed to the party depends upon various factors which also includes the price charged by the assessee from purchaser. Therefore, the credit period extended by the assessee to the AE cannot be examined independently but has to be considered along with the main international transaction being sale to the AE. The transaction of sale to the AE and credit period allowed in realization of sale proceeds are closely linked as they are inter linked and the terms and conditions of sale as well as the price are determined based on the totality of the transaction and not on individual and separate transaction. The approach of the TPO and DRP in analyzing the credit period allowed by the assessee to the AE without considering the main international transaction being sale to the AE will give distorted result by disregarding the price charged by the assessee from AE. Though extra period allowed for realization of sale proceeds from the AE is an international transaction, however, for the purpose of determining the ALP, the same has to be clubbed or aggregated with the sale transactions with the AE. Even by considering it as an independent transaction the same has to be compared with the internal CUP available in the shape of the credit allowed by the assessee to non AE. When the assessee is not making any difference for not charging the interest from AE as well as non-AE then the only difference between the two can be considered is the average period allowed along with outstanding amount. If the average period multiplied by the outstanding amount of the AE is at arm s length in comparison to the average period of realization and multiplied by the outstanding from non AEs then no adjustment can be made being the transaction is at arm s length. The third aspect of the issue is that the arm s length interest for making the adjustment. Both the TPO and DRP has taken into consideration the lending rates, however, this is not a transaction of loan or advance to the AE but it is only an excess period allowed for realization of sales proceeds from the AE. Therefore, the arm s length interest in any case would be the average cost of the total fund available to the assessee and not the rate at which a loan is available. Accordingly, we direct the Assessing Officer/TPO to re-do the exercise of determination of ALP in terms of above observation. - Decided in favour of assessee for statistical purpose.

Summary

Issues Involved:
1. Whether the "Continuing debit balance" with associate enterprise constitutes an "international transaction".
2. Whether the extended credit period to the AE amounts to short-term funding without interest, thus constituting an international transaction.
3. The appropriateness of the interest rate adopted by the Assessing Officer/TPO/DRP on outstanding amounts from Associate Enterprises.
4. Levy of interest u/s 234B & 234C of the Income Tax Act.
5. Initiation of penalty proceedings u/s 271(1)(c).

Issue-wise Detailed Analysis:

1. Continuing Debit Balance as International Transaction:
The assessee argued that the continuing debit balance or amount outstanding from the AE due to delayed realization does not amount to an international transaction. This was seen as a result of another international transaction, namely, export. The Tribunal, however, noted that after the insertion of explanation to section 92B(1) by the Finance Act 2012, the payment or deferred payment or receivable or any debt arising during the course of business falls under the expression international transaction. Therefore, the delay in realization of dues from the AE in comparison to non-AE is considered an international transaction as per the expanded definition.

2. Extended Credit Period as Short-Term Funding:
The TPO observed that the AE benefitted from making late payments to the assessee, leading to a proposed adjustment of Rs. 2,49,95,139/- by applying an interest rate of 18.816% as arm's length interest. The assessee contended that the extension of the credit period to the AE on realization of sale proceeds is not a separate international transaction but arises from the international transaction of sale to the AE. The Tribunal agreed that the credit period allowed to AE is not an independent international transaction but closely linked with the sale transaction to the AE. The credit period extended to AE should be considered along with the main international transaction of sale to the AE.

3. Interest Rate on Outstanding Amounts:
The TPO applied an interest rate of 18.816% on the overdue amounts, which the DRP later reduced to 7%. The assessee argued that the interest rate should not exceed the cost of funds, which is based on LIBOR plus 2.5%. The Tribunal noted that the arm's length interest should be the average cost of the total fund available to the assessee and not the rate at which a loan is available. The Tribunal directed the Assessing Officer/TPO to re-determine the ALP considering the average cost of funds.

4. Levy of Interest u/s 234B & 234C:
The Tribunal noted that this ground is consequential in nature and does not require a separate finding.

5. Initiation of Penalty Proceedings u/s 271(1)(c):
The Tribunal found this ground premature and not arising from the impugned orders of the authorities below, thus dismissing it.

Conclusion:
The appeal of the assessee was partly allowed for statistical purposes, with the Tribunal directing the Assessing Officer/TPO to re-evaluate the determination of ALP in light of the observations made. The order was pronounced in the open court on 14.01.2015.