Interest on Outstanding receivables - Indian Transfer pricing Perspective

Interest on Outstanding receivables - Indian Transfer pricing Perspective in a recent judgement of OSI Systems (Hyderabad ITAT)

Sections of Income tax Act, 1961 - 92B

The issue of outstanding receivables for an unusually long period, to be treated as loan from Indian Tranfser Pricing perspective is a very litigious issue. Certain nuances which can arise in relation to the said issue can be as follows;

1. What if the receivables are arising out of transaction, which is accepted at Arm's Length by the Tax authorities; does the treatment of loan for outstanding receivables is still justified?
2. Can Outstanding receivables emanating from an International Transaction, constitutes a different transaction other than the original transaction itself?
3. What should be the credit period usually allowed to the AEs?
4. What Interest rate should be adopted by the tax authorities for computing interest on such deemed Loan transaction?
5. In case of treatment of outstanding receivables for long period is to be treated as loan, can Outstanding payables be netted off against the same to arrive at net Loan / receivable amount?

In a recent judgement of the Hon'ble Hyderabad Income Tax Tribunal ('ITAT') in case of OSI systems Private limited, a lot of such nuances are put to rest. The same is discussed as below. The copy of judgement can be referred to by clicking on the link here.

Facts in Brief:

Assessee had carried out international transaction with its AEs. There were outstanding receivables of INR 59 crores which were outstanding for 353 days. The tax authorities applied interest rates on the said amount and made adjustment of the interest amount to the Income of the Assessee. The case will be more clear while answereing the nuances mentioned above.

1. Original transaction are accepted at ALP by the tax authorities, receivables arising out of such transactions.

The ITAT has clearly mentioned that the Interest on outstanding receivables shall be computed if the receivables are outstanding for beyond the agreed period as per the terms of agreement with the AE. It is pertinent to note that here the ITAT has relied on the credit period agreed between the parties, and not the prevailing market credit period, Credit period prevailing in the relevant Industry, etc.

2. Outstanding receivables emanating from an International Transaction, constitutes a different transaction

The ITAT in this respect has mentioned that the outstanding receivables are covered as per Section 92B(c) - Capital financing. Further there is no specific exclusion of Outstanding Receivables as per the section. Hence the argument of the Assessee is not acceptable, and appropriate adjustment can be made on the outstanding receivables which are outstanding beyond agreed credit period.

3. What should be the credit period usually allowed to the AEs?

As mentioned above, the ITAT has mentioned that usual credit period as agreed in the terms of agreement with the AE. In the current case, the Assessee did not provide the agreement details to the DRP / tax authorities, and hence the agreed credit period was not ascertainable. The ITAT in the current case adopted the credit period of 120 days as usual credit period on the basis of other judgements. The ITAT mentioned that the Interest amount should be computed on amount outstanding for a period of more than 120 days.

4. Interest rate should be adopted by the tax authorities for computing interest on such deemed Loan transaction

As per the settled practise and as per various judgements, in case the transaction is carried out in foreign currency, the interest rate to be adopted is LIBOR + Margin Approach. The Tax authorities in the instant case had applied SBI lending rates at 14.5%. The ITAT held that the interest rate in the instant case to be LIBOR + 200 bps. The margin of 200 bps was derived on the basis of other previous ITAT judgement.

5. Netting off of Outstanding Payables with outstanding receivables for the same AE

Here the ITAT held that the Assessee failed to provide the details before the tax authorities in relation with netting off. Hence on this basis, the ITAT rejected the claim of the Assessee for netting of outstanding payables with receivables. In case the details were provided by the Assessee, the judgement would have been somewhat different; however no conclusion can be drawn from the current wordings used in the Judgement.

Trust the above summary must have been helpful for your understanding. In case of any query, do drop a comment below; or alternatively mail your queries at christopher.rebello5@gmail.com