Finance & Accounting

Outstanding Receivable- Controversy in Transfer Pricing

Under the Indian Transfer Pricing Regulations, outstanding receivable has been one of the major issues. In this article, we shall look at the outstanding receivables in the light of changes in the IT (Income Tax) Act 1961^[1] and also look at the High Courts judgements.

What are Outstanding Receivable?

It is a term used for the remaining money, which is due to a firm for goods or services delivered or used but which is not yet paid by customers. They are listed on the balance sheet as a current asset.

Controversy regarding Outstanding Receivables

The question related to whether outstanding receivable is an international transaction surfaced in the case of leading interactive automotive solution provider for AY 2004-05 wherein the Income Tax Appellate Tribunal affirmed the imputation of notional interest on delayed receivables.

The controversy came out due to the pre-amended definition of the international transaction under Section 92B of the Act, which was not specific. The decision was followed by ITAT judgements on the issue, some were in favour of the taxpayer and some against.

Major issues in the context of Outstanding Receivables (OR) before Income Tax Appellate Tribunal (ITAT)

There have been quite a few issues that have arisen in the context of outstanding receivables before Income Tax Appellate Tribunal. They are as follows:

• Validity of re-characterisation of OR as interest free loan;
• Retrospective or prospective applicability of the amendment to Section 92 B of the IT (Income Tax) Act 1961;
• If OR beyond agreed/reasonable time can be considered a separate international transaction independent of the principal transaction;
• If interest on receivables is warranted in respect of debt free companies;
• If working capital adjustment assimilate the effect of OR;
• Consideration of credit policy followed with AE concerning non-AE as a valid Comparable Uncontrolled Price;
• Interest rate to be considered for the purpose of bench marking;
• Giving credit for the inter-company payables as well as interest imputation in net payable position during the year.

Case Laws- Verdicts from the High Court

There are numerous judicial judgements, but here we look at some of the recent verdicts from the High Courts.

• Judgement of the Delhi HC in the case of Indian Pharmaceutical Company (AY 2010-11)-

The Delhi HC upheld the opinion of the Appellate tribunal that OR isn’t a separate international transaction and therefore is not needed to be independently benchmarked. The Court went onto address some arguments as provided below.

The HC maintained that the inclusion in the Explanation to Section 92B of the Act of the expression receivables doesn’t mean that the context every item of receivables in the accounts of an entity that could have dealings with foreign enterprises, would automatically be characterised as the International transaction. The delay on monies collection for supplies made should be scrutinised from case to case.

The HC concurred with the contention of the taxpayer that working capital adjustment takes into account the OR impact on profitability. Therefore there should be appropriate adjustments which must be considered in order to bring parity in the taxpayers’ working capital investment rather than looking independently at the receivable.

The HC stated that focusing on receivables of one year could hardly reflect any pattern to justify that the receivables beyond a prescribed time constitute an international transaction. The onus was placed on the revenue authorities to discern a pattern.

• Judgement of the HC in the case of Indian Subsidiary of a management consultancy group (AY 2011-12)

The HC seconded the view initially of the revenue department and affirmed the expression that debt arising in the course of business in general term encompasses, inter alia, any trading debt arising from the sale of goods or services rendered in the course of carrying on business.

Once such debt is ordained by the legislature as international transaction, it would be inferred that delay in the realization of the debt is liable to be visited with the TP adjustment via imputation of the arms’ length interest.

• Judgement of the HC in the case of Indian Subsidiary of the engineering, procurement, and construction group  (AY-2010-11)

In this case, the Income Tax Appellate Tribunal held that considering that the taxpayer is a debt-free company, it isn’t justifiable to presume that funds borrowed have been used to pass on the facility to associated enterprises, and therefore no separate adjustment for interest on receivables is warranted. The HC agreed with the findings of the Income Tax Appellate Tribunal.

The Supreme Court set aside the Special Leave Petition filed before it by the revenue department, stating that no question of law arise here for TP adjustment to be made for overdue accounts receivable.

Conclusion

Today the treatment of the Outstanding Receivable for the transfer pricing purpose remains to be a contentious subject. While examining the orders of the HC, it can be concluded that there are many grey areas which are addressed by the higher appellate authorities.

Read our article: What are Outstanding Receivables and how can you reduce them?