2020 (3) TMI 1192 - AT - Income Tax

Arm s Length adjustment in respect of outstanding receivables - argument of the AR that the receivables are not independent transactions separate from the transaction of sale; that receivables are merely an offshoot of commercial transactions and cannot be viewed on standalone basis - HELD THAT - There is no denial of the fact that operating profit margin earned by the assessee from the services rendered to AEs is 45.88% and the same is significantly higher than the working capital adjusted results for comparables at 22.07%. Working capital adjustment is an adjustment for the opportunity cost of capital for investments made in working capital, which require capital and operating assets and an uncontrolled entity is expected to earn a market rate of return on that required capital independent of the services that it provides. The amount of capital required to support the services is dependent upon the level of inventory, debtors and creditors measured at a particular percentage of the total cost and had impact on the profits from investing at different levels of working capital due to the differences in the cash collection cycle which imply differences in credits granted to the customers which activity is similar to an additional service for which the markets would pay. In Kusum Healthcare Private Ltd. 2017 (4) TMI 1254 - DELHI HIGH COURT held that working capital adjustment takes into account the impact of outstanding receivables on the profitability. Not in dispute that the assessee is a debt free company as is reflected in the profit and loss account wherein the interest charges are only ₹ 30,278/-. It is, therefore, clear that the assessee does not have any interest where borrowed funds were utilized for extending any kind of loan to its AEs, so that transfer pricing adjustment could be made. In the case of BC Management Services Pvt. Ltd. 2017 (12) TMI 255 - DELHI HIGH COURT held that notional income on account of delayed payment cannot be treated as part of income and be made subject matter of adjustment. It is, therefore, clear that re-characterisation of the outstanding receivables as loan is impermissible unless the transactions are found to be substantially at variance with the stated form. There is no denial of the fact that in the assessment year 2012-13, this question of adjustment on account of receivables was dealt by the CIT(A) and by referring to the decision of Hon ble jurisdictional High Court in the case of Kusum Healthcare Private Ltd.(supra), deleted the entire adjustment suggested by ld. TPO on account of interest on outstanding receivables. We, agree with the submission of the ld. AR that because the ld. CIT(A) did not have the benefit of decision of Hon ble jurisdictional High Court in the case of Kusum Healthcare Pvt. Ltd. (supra), the issue was held otherwise for the assessment year 2009-10. Addition made on account of arm s length price adjustment in respect of outstanding receivables cannot be sustained and we, therefore, while allowing grounds Nos. 1 to 3, direct the ld. Assessing Officer to delete the addition. Disallowance u/s. 14A read with Rule 8D - HELD THAT - On a reading of the order in 2019 (7) TMI 1590 - ITAT DELHI for assessment year 2011-12 in assessee s own case, we find that this issue stands covered and in the absence of any reason to show why the view taken by the Tribunal in assessee s own case on identical facts and circumstances should not be followed, we find that mechanical application of Rule 8D is not tenable and the addition made on this account has to be deleted.

Summary

Issues Involved:
1. Arm’s Length Price (ALP) adjustment in respect of outstanding receivables.
2. Disallowance under section 14A read with Rule 8D.

Issue-wise Detailed Analysis:

1. Arm’s Length Price (ALP) Adjustment in Respect of Outstanding Receivables:

The primary issue in this case was whether the outstanding receivables from the assessee’s Associated Enterprises (AEs) should be treated as loans and subjected to interest adjustments. The Ld. Assessing Officer, based on the Ld. TPO’s recommendations, re-characterized the outstanding receivables as loans and proposed an addition of ?69,73,350/- by applying an ad hoc interest rate of 17.77%. The Ld. CIT(A) modified this by directing the interest rate to be LIBOR + 1.5%.

The assessee argued that receivables are not independent transactions but an integral part of the commercial transactions and should not be treated as loans. They cited various judicial precedents, including the Hon’ble Delhi High Court’s decision in Pr. CIT vs. BC Management Services Pvt. Ltd., to support their stance that such re-characterization is not permissible.

The Tribunal observed that the assessee’s operating profit margin from services rendered to AEs was significantly higher than the working capital adjusted results for comparables. It emphasized that working capital adjustment takes into account the impact of outstanding receivables on profitability, as held in Kusum Healthcare Private Ltd. vs. ACIT and affirmed by the Hon’ble jurisdictional High Court.

The Tribunal also noted that the assessee is a debt-free company, indicating no interest-bearing funds were used to extend loans to AEs. Therefore, transfer pricing adjustment on this basis was not warranted. Citing various decisions, including Indo American Jewellery Limited and Nimbus Communication, the Tribunal concluded that re-characterization of outstanding receivables as loans is impermissible unless transactions are substantially at variance with their stated form.

The Tribunal also referenced the CIT(A)’s decision for the assessment year 2012-13, where similar adjustments were deleted based on the jurisdictional High Court’s decision in Kusum Healthcare Private Ltd. Consequently, the Tribunal directed the deletion of the addition made on account of ALP adjustment in respect of outstanding receivables.

2. Disallowance Under Section 14A Read with Rule 8D:

The second issue was the disallowance of ?26,223/- under section 14A read with Rule 8D, related to the assessee’s dividend income. The Ld. Assessing Officer had invoked these provisions, which was upheld by the Ld. CIT(A).

The assessee contended that the investments in mutual funds were made in earlier years, and dividends accrued automatically without any direct or administrative expenses involved. They highlighted that in the preceding assessment year 2008-09, under identical circumstances, the CIT(A) had deleted the addition.

The Tribunal found that the issue was covered by its order in the assessee’s own case for the assessment year 2011-12, where it was held that mechanical application of Rule 8D is not tenable. In the absence of any reason to deviate from this view, the Tribunal directed the deletion of the disallowance made under section 14A read with Rule 8D.

Conclusion:

The Tribunal allowed the appeal of the assessee, directing the deletion of the addition made on account of ALP adjustment in respect of outstanding receivables and the disallowance under section 14A read with Rule 8D. The order was pronounced in the open court on 5th March 2020.