International Transaction -Receivable in the course of Business-Analysis
Finance Act 2012 added new
wings to the definition of word “international transaction” u/s 92B of Income Tax Act, 1961 by adding
an explanation to said section.
Among the various clauses of
said explanation, under clause (i) (c ) “ debt arising during the course of
business “ (Receivable)is given a
recognition of being International Transaction.
·
Does it mean that Receivable was earlier not an
International transaction but now made it or it was so previously, but now made
it more explicit?
a) In
normal course Receivable arising in the course of business is not a transaction;
it is a consequence/cause of transaction of sale of good on credit.
b) A
transaction of sale of goods inter-alia includes arrangement/understanding on
the part of seller as regard execution of accompanied functions/risk like
transportation of goods, credit terms, after sale services etc.
c) As
per clause (v) of section 92F, transaction includes arrangement, understanding,
and action in concert.
d) It
seems that by virtue of afore-said provision u/s 92F, legislature must have
assigned to arrangement/understanding on credit terms, the status of
international transaction, which was hitherto not an international transaction
but rather one of the facet of transaction of sale of good.
e) The
function of Explanation in a statute is to explain the meaning of certain
phrases and expressions contained in the statutory provisions.
f) The
“Sale transaction”, already an international transaction by virtue of
Substantive provision of section 92B, does not require aid of explanation to
explain its meaning, which is an unambiguous in itself.
g) Can
an explanation deem a function/risk associated with Sale transaction as an
international transaction without corresponding amendment in the substantive
provision of section 92B or do an explanation have power to render anything as
international transaction, when the same is not mandated by fundamental provision
to which explanation is appended?
h) Can
said explanation be understood in the context of one limb of section 92B , “any
other transaction having a bearing on the profit, income, losses or assets of
enterprise” , so as to include within
its ambit the transaction of capital financing characterized in the Form of
debt arising in the course of business i.e one entity financing its associated
enterprise through credit sale of good and not collecting the corresponding Receivable
over long period of time.
i)
It seems that true to Interpretation principles,
Receivable shall be treated as an international transaction in the latter case only
i.e where it is intended as mean of capital financing and not when same
originate and collected in normal course of business.
·
If one ignores the afore-said enunciation, treat every
Sale transaction and its associated Receivable, as separate International
transactions in each and every case, the point of consideration is how to determine
the ALP of Receivable:-
a) Whether
to determine ALP of Receivable independently of main transaction (sale of goods)
to which it is sub-set or
b) Whether
ALP of Receivable is to be determined in juxtaposition with principal
transaction from which it originate?
Ø Do Receivable merit independent ALP
benchmarking
a) Separate
analysis of Receivable dehors the primary sale transaction, do not stand the
test of Transfer pricing principles.
b) For
transfer pricing analysis, following are pre-requisites:-
ü An
International Transaction
ü Income
or expenses associated with an International Transaction or expected to arise
from an International transaction in Arm’s Length Scenario.
ü Existence
of Comparable transaction.
Now evaluate
how Receivable falls into afore-said criterion
1. Receivable
is an international transaction by virtue of Explanation to section 92B.
2. In ordinary course of business, no separate compensation
is intended from Receivable but rather only profit from principal sale
transaction is contemplated. However if Receivable extends beyond a threshold
level, interest is considered as separate compensation for such Receivable. The
threshold level would be dependent upon business exigencies and market trend. Thus in normal course, compensation for Receivable
is embedded in Profit from sale transaction.
3. Comparability
§ Receivable
cannot be compared solely with the unsecured loan to determine appropriate rate
of interest as compensation for Receivable, as both the transactions are not
comparable. In loan transaction, the entire compensation is in the form of
Interest and in Receivable, the compensation is incorporated in separate
international transaction, being sale of goods.
§ There
may be the case, where one person is charging interest on Receivable. Does this
transaction (Charging Interest on Receivable) become a comparable case, so that
tested party should also charge interest on Receivable? Consider a situation of following two persons in same line of
business, where normal credit period is business is 2 months
i)
Mr. A Charging Sale price of 1020/unit
ii)
Mr. B is charging sale Price of Rs. 1000/unit +
Rs. 20 as Interest for credit period extended
Can anybody
said, on the basis of transaction of Mr. B, that Mr. A should also charge Rs.
20 as Interest on his Receivable, without comparing the Sale price of both the
parties.
The obvious
answer seems to be NO. On account of cost involved in extending credit period,
one person has compensated himself through enhanced sale price, while other
person has explicitly charged separate consideration for the same, through
Interest
§ Since the compensation for Receivable is
inextricably linked with sale price, the appropriate comparable would always be
comparable sale transaction but not an unsecured loan transaction.
Conclusion
a) Though
Receivable have been grouped under the category of capital financing in
explanation to section 92B, it does not mandate that every Receivable should
earn interest to satisfy benchmark of being at ALP.
b) Enterprise
envisages consolidated profit from sale transaction, which is meant to
remunerate various associated functions like transportation, extending credit,
after sale service etc. If law deems any
of such function as separate international transaction, it does not mean that
assessee should charge separate compensation for the same, unless statue overtly
provides for reducing the sale price because the recompense for such function
(deemed transaction) is already included in principal sale transaction.
c) The
Transfer Provisions are part of anti-abusive measures which seeks to solicit
rational behavior on the part of assessee; it cannot force assessee to do
business in particular manner.
d) Since
income determination and comparability analysis of Receivable cannot be done in
isolation with sale transaction, Arm length benchmarking of Receivable has to
be in done in collocation with Primary Sale transaction Discrete Transfer
Pricing analysis of Receivable in sequestration and derogation of primary sale
transaction, of which it is sub-set, is not true comparability/benchmarking
from Transfer pricing perspective in current scenario.
Ø ALP determination of Receivable in
association with Sale Transaction
o Legal Position
a) Section
92 requires that income arising from International Transaction should be
determined on Arm’s length basis, advocating transaction by transaction
approach in application of Arm’s Length Principles.
b) Rule
10A(d) provides that transaction includes closely linked Transactions,
empowering to treat closely linked transactions as single transaction for ALP
benchmarking.
c) The
words closely linked transaction has not been defined in the Act or rule.
d) Para
3.9 OECD Transfer Pricing guidelines provides that where pricing of two
transactions are so closely linked that it is impractical to determine price of
individual transactions, these transactions should be evaluated on combined
basis.
e) ICAI guidance note on Transfer pricing
provides that two or more transactions can be said to be linked when these
transactions emanate from a common source being an order or a contract or an
agreement or an arrangement and the nature, characteristics and terms of these
transactions are substantially flowing from the said common source.
f) Receivable
and Sale transaction not only originate from common contract but also their
pricing cannot be determined on individual basis.
g) Thus
literature behind statutory provisions allows the evaluation of Sale
Transaction and Receivable on aggregate basis.
o Modus-operandi
Since the
compensation for Receivable is part and parcel of sale transaction, ALP
benchmarking of sale transaction in conjunction with the credit terms, will be
due compliance of Transfer Pricing study of Sale Transaction and Receivable on
aggregate/combined basis, as currently in practice.
a) In
case of CUP method, the adjustment in sale price of comparable to account for
different credit terms shall be considered as due benchmarking and evaluation
of Sale transaction & Receivable of Tested party
b) In
case of Margin Methods (CPM & TNMM), the margin of tested party duly
adjusted for working capital difference shall be deemed as due ALP
determination of Sale Transaction & Receivable.
·
Take another case: Suppose as per terms of Contract in
international transaction, the credit period is two months, but in actual
transaction, credit period is between 2-4 months. Can AO take a stand that
compensation associated with 2 months credit period is incorporated in sale price
and for balance terms of Receivable, Interest should be charged.
The stand of AO may be counter
as under:-
a) Evaluating
credit term in sale transaction is a part of functional analysis establishing
the credit risk taken by seller.
b) In
OECD guidelines, it is emphasized that we need to evaluate whether purported
allocation of risk is consistent with economic substance of transaction and in
this regard the parties’ conduct should generally be taken as best evidence of
concerning the true allocation of risk.
c) So
if contract provides for credit period of 2 months, but actual conduct of parties
convey credit period of 2-4 months, then seller shall be assumed to taking
credit risk of 2-4 months based on actual conduct.
d) Thus
arrangement or understanding in transaction must be gathered from actual conduct
of parties, rather than professed by parties.
e) Thus
if cumulative ALP determination of sale transaction in concurrence with actual
credit terms is in consonance with Comparable sale transaction, then no
separate Interest adjustment is required.
Summary
1. It
is not that compensation associated with Receivable was untaxed before deeming
the Receivable as International Transaction. The ALP determination of Sale
transaction duly takes into consideration the credit terms, thus compensation
for cost associated with Receivable is duly factored into while evaluating the
sale transaction. Thus said amendment has not plugged any existing loophole.
2. On
the principle of valuing each and every word of statue and principle of
Harmonious Construction, it seem that deeming credit arrangement between
associated enterprises, as discrete International Transaction warranting
separate charge of interest on the same, should be taken in the sense of
Capital financing only, in current setting of statue
3. Treating
Receivable as international Transaction should not empower assessing
authorities to take Interest as appropriate ALP of Receivable in normal course,
without statute explicitly providing of reducing the sale price/Margin for
compensation for Receivable already rooted therein, because if one goes by
literal interpretation and treat every Receivable as International Transaction,
Sale Transaction and Receivable are
already evaluated on combined basis
No comments:
Post a Comment