Penalty Provision - Section 270A of Income Tax Act, 1961 - Analysis

Penalty Provision – Section 270A- Analysis

Section 270A under Income Tax Act, 1961, as inserted by Finance Act, 2016, seems to herald the non-adversarial regime by introducing objectivity in subjective penalty provision for reporting incorrect income. In this write up, attempt is made to touch upon the finer aspects in the implementation of section 270A. The analysis is done under following 3 categories:-

1.       Basis of Charge & Quantification of Penalty

2.       Addition to returned Income but not a under-reported income

3.       MAT vs Penalty

Ø  Basis of Charge & Quantification of Penalty.

Section 270A is complete code in itself providing for basis of charge and quantification of penalty as under:-

a)      Basis of Charge – Under-reported Income

b)      Quantification basis :-

a)      Under-reported income on account of under-reporting – 50% of tax payable on under-reported income.

b)      Under-reported income on account of misreporting – 200% of tax payable on under-reported income.

At this juncture, one may argue that Under-reported income on account of under-reporting or Under-reported income on account of misreporting is basis of charge in itself and  aspects of under-reporting & misreporting do not fall in domain of quantification criterion.

On this basis, can one take the position that if it is proved that there is no misreporting, then assessee will be exonerated from penalty proceedings? To me the answer is NO, as same is not correct interpretation emanating from section 270A, on account of following simple reasoning:-

i)                    Once it is established that there is under-reported income, then penalty is must. The next step is only quantification of penalty and for that purpose under-reported income has to firstly get it filter from misreporting parameters.

ii)                   If it fails, then penalty is @ 200% of tax payable on under-reported income

iii)                 If it sails through; the penalty is @ 50% of tax payable on under-reported income.

Thus under-reporting and misreporting falls in quantification jurisdiction only.

Now questions for consideration are as under:-

a)      Whether for initiating the penalty proceedings, Assessing Officer (AO) is required to state basis of charge only or basis of charge is to be accompanied by quantification basis, in assessment order?

b)      If assessment order contain the basis of charge and basis of quantification of penalty, can in actual penalty proceedings, AO change the quantification basis?

Reply to question (a)

1.       Though in principle, at the time of initiating penalty proceeding, the only requirement is to state the basis of charge. The quantification of penalty is to be concluded in penalty proceedings only, based on submission and explanation of assessee.

2.       But in view of provision of section 270AA, it seem imperative that quantification basis is mandatory in assessment order, explained as under:-

a)      Section 270AA empowers assessee to make an application to AO to grant immunity from penalty u/s 270A.

b)      AO will not grant immunity where initiation of penalty proceedings is on account of misreporting of income.

c)       Thus section 270AA mandates that at penalty initiation stage, stating of quantification basis is mandatory and where penalty is on account of misreporting of under-reported income, assessee will not be entitled to immunity u/s 270AA.

Reply to question (b)

1.       Assessment proceedings and penalty proceedings are two different actions, assessment proceedings leads to initiation of penalty and penalty proceedings leads to quantification & culmination of penalty.

2.       Thus where penalty proceedings are initiated on misreporting of under-reported income and assessee satisfied AO, that conditions of section 270A(9) for misreporting are  not applicable, he will be justified in levying penalty on the basis of under-reporting of under-reported income.

3.       In my opinion, theoretically reverse case is also possible i.e initiation is based on under-reporting but the same being concluded into misreporting but its practical happening seems remote.

4.       In the case referred to at s.no.2 assessee will lose the opportunity of availing the benefits of obtaining penalty immunity u/s 270AA. Thus it becomes imperative that assessee properly present his case in assessment proceedings, so that basis of initiation of penalty proceedings, if any, is on account of under-reporting of under-reported income.

Ø  Addition to returned Income – No Under-Reported Income

1.       Section 270A(6) prescribe situations, when addition to retuned income will not be considered as under-reported income. In this respect following two clauses merit attention, relevant words being emphasized.

Section 270A(6)  commences as under:-

“The under-reported income, for the purposes of this section, shall not include the following, namely :-“

a)      Section 270A(6)(a) - the amount of income in respect of which the assessee offers an explanation and the Assessing Officer or the Commissioner (Appeals) or the  Commissioner or the Principal Commissioner, as the case may be, is satisfied that the explanation is bona fide and the assessee has disclosed all the material facts to substantiate the explanation offered

b)      Section 270A(6)(c) - the amount of under-reported income determined on the basis of an estimate, if the assessee has, on his own, estimated a lower amount of addition or disallowance on the same issue, has included such amount in the computation of his income and has disclosed all the facts material to the addition or disallowance.

2.       Section 270A(6)(a) – Issue explain as under:-

a)      Suppose in assessment, there is an addition of Rs. 10,00,000 to returned income on following grounds:-

S.No	Grounds	Amount	Remarks – penalty Perspective	Under-Reported Income as per  270A(6)(a)
1.	Expenditure Disallowed	5,00,000	Offers bona fide explanation to the satisfaction of AO	YES
2.	Income Added	2,00,000	Offers bona fide explanation to the satisfaction of AO	NO
3.	Transfer Pricing- ALP adjustment	3,00,000	Condition of clause (d) of section 270A(6) met	NO

b)      Clause (a) uses the words “income” not “expenditure”. Thus even where disallowance of expenditure is satisfied to the satisfaction of AO on the basis of bona fide explanation, possibility of the same being excluded from purview of under-reported income seems litigative, in view of literal meaning of clause (a) of section 270A(6).

c)       In my opinion, had the word “ under-reported income” being used in place of “income” in clause (a),  as used in other clauses of section 270A(6), the purpose would have been achieved.

d)      Section 119(2) has been amended to empower CBDT to issue order for relaxation of provision of section 270A. I hope CBDT in exercise of power u/s 119(2) will issue appropriate order, in this context, for avoiding genuine hardship to assessee.

3.       Section 270(6)(c ) – Issue explain as under:-

a)      Clause (c) exclude levy of penalty in cases, where addition to returned income is on account of difference of estimate between Assessee and AO. Let’s us take following cases:-

S.No	Particulars	Assessee Estimate	AO Estimate	Under-Reported Income as per  270A(6)(c )
1.	Income attributable to Business Connection u/s 9(1)(i)	NIL	10,00,000	Yes
2.	Income attributable to Business Connection u/s 9(1)(i)	2,00,000	10,00,000	NO
3.	Disallowance of Personal expenditure u/s 37	NIL	50,000	Yes
4.	Disallowance of Personal expenditure u/s 37.	20,000	50,000	NO

b)      The clause (c) benefit will be available where assessee has estimate lower addition to income or lower disallowance of expenditure than estimated by AO on same issue rather NIL addition or disallowance.

c)       Thus in above example, protection under clause (c) will be denied in case mentioned at S.No.(1) & (3) as assessee himself  has estimated NIL income or NIL disallowance.

Ø  Penalty vs MAT

1.       Consider the following case:-

i)                    Income as per general Provision-                              Rs. 10,000

ii)                   Book Profit u/s 115JB                                                     Rs. 1,00,000

iii)                 Tax on Income as per general provision                 Rs. 3,000

iv)                 Tax on books profit u/s 115JB                                     Rs. 18,500

v)                  Deemed Total income                                                   Rs. 1,00,000

vi)                 Assessment u/s 143(3) on income under

General provision                                                            Rs. 25,000

vii)               Deemed Total Income u/s 143(3)                              Rs. 1,00,000

2.       Section 270A proceeds in sequential  manner as under:-

a)      Section 270A(2)-  Provide situations when person is considered to have Under-reported income.

b)      Section 270A(3) – Determination of amount of Under-reported income.

c)       Section 270A(10) – Determination of tax payable on under-reported income for quantification of penalty i.e 50%/200% of tax payable on under-reported income.

3.       On income being assessed u/s 115JB in above example, the critical issues involved in levy of penalty u/s 270A  falls under section 270A(2) & 270A(10) explained in ensuing paragraph

4.       Section 270A(2)

a)      Clause (a) read as under:-

“the income assessed is greater than the income determined in the return processed under clause (a) of sub-section (1) of section 143”

b)      The assessment and determination of income u/s 143(1)(a) is made on TOTAL INCOME, but legislature has intentionally used word “income” in  clause (a).

c)       Clause (d) provides that person shall be considered to have under-reported income, when amount of deemed total income assessed as per provision of section 115JB is greater than deemed total determined u/s 143(1)(a)

d)      In case of companies, firstly total income is computed as per normal provision of Act and if tax payable on total income so computed is less than 18.5% of book profit, then book profit is deemed as total income and tax @ 18.5% is payable thereon.

e)      In above example,

i)                    Deemed total income is same as per assessment and as determined u/s 143(1)(a) and thus there is no under-reported income based on total income, if one goes by clause (d).

ii)                   Is the intention of legislature in using the word ‘income” instead of “total income’ in clause (a) to mean income assessed or computed as per general provision (other than section 115JB) of Act, so as to rope in the case of above example within the ambit of Under-reported income.

iii)                 Had the words Total income being used in clause (a), it would have rendered clause (d) redundant, because when MAT is applicable, book profit is total income under Income tax Act, which clause (a) would have taken care of, if words ‘Total income” had been used instead of “income”.

iv)                 If comparison is confined on the basis of total income, there would never be the case of under-reported income in example cited above and thus penalty provision will fail on account of want of basis of charge of penalty i.e under-reported income. I don’t think legislature intend to exempt such cases from levy of penalty. Thus it seems that clause (a) will provide the benchmark to determine case of under-reported income in example coined.

v)                  I hope suitable amendment or judicial interpretation will only remove the ambiguity.

5.       Section 270A(3)

a)       The said section provides for determination of quantum of under-reported income. In case, where MAT is applicable, the amount of under reported income is determined as under:-

i)                    (A-B) + (C-D)

ii)                   A = Total income  assessed as per general provision of Act other than 115JB (25,000)

iii)                 B = Total income assessed as per general provision of Act other than 115JB less under reported income (10,000)

iv)                 C = Total income assessed as per provision of section 115JB (1,00,000)

v)                  D = Total income assessed as per provision of section 115JB less under-reported income (1,00,000)

b)      In example taken, the amount of under-reported income will be Rs. 15,000 (25,000-10,000)+(1,00,000-1,00,000)

6.       Section 270A(10)

a)      In case where return is filed with positive income, the tax payable on under-reported income will be as under:-

i)                    X-Y

ii)                   X = the amount of tax calculated on the under-reported income as increased by the total income determined under clause (a) of sub-section (1) of section 143

iii)                 Y = the amount of tax calculated on the total income determined under clause (a) of sub-section (1) of section 143.

b)      What command thoughtfulness at this stage is explained as under:-

i)                    Section 270A(6) used the concept of total income twice – total income as per general provision and total income as section 115JB

ii)                   Section 270A(10) simply used the words total income once i.e total income, as comprehend on the facts of the case.

iii)                 For determining the tax payable on under-reported in instance case, the total income will be book profit, as deemed by section 115JB and tax payable thereon accordingly will be @ 18.5%.

c)       The tax payable (ignoring surcharge & education cess for illustration purpose) on under-reported income in the instant case will be as under:-

i)                    X = 18.5% of  (1,00,000+15,000) = 21,275

ii)                   Y = 18.5% of 1,00,000 = 18,500

iii)                 Tax on under-reported income = 2,775

iv)                 Penalty @ 50% of tax payable on under-reported income will be 1388.

Foreign Tax Credit - Draft Rules - Critical Analysis

Draft Rule for grant of Foreign Tax Credit (FTC) – Critical Analysis

Section 295(2)(ha) of Income Tax Act empower CBDT to notified rules providing for procedure for granting relief or deduction of Foreign tax u/s 90 or 90A or 91, against Income Tax payable under the Act.

CBDT has issued Draft Rules in connection with grant of Foreign tax Credit

The analysis of the Draft Rules is carried out in 3 parts:-

a)      Existing provisions of section 90 & 91 relating to Foreign Tax Credit and what these sections provide.

b)      The vacuum/lacuna, which proposed rule intends to supplement.

c)       The Contradiction between proposed rule and section 91.

Ø  Existing Provisions

The Provisions relating to grant of FTC is regulated by existing provisions of Income Tax Act, as under:-

1.       Double Taxation Avoidance Agreement (DTAA) entered  with other Countries u/s 90

2.       Section 91 in cases, where foreign tax relates to country with which India does not DTAA

DTAA entered into by India and Section 91 provides the methodology for Quantification of FTC as under:-

S.No.	Particulars	DTAA (In general)	Section 91
1.	Method	Credit Method	Credit Method
2.	Quantification of FTC	Foreign Tax paid by resident of India, will be allowed credit of such taxes against Indian tax payable on foreign source income, which is subjected to tax in foreign Country and India. The amount of FTC will be lower of foreign Tax paid or that proportion of Indian tax which Foreign source income bear to Total Income of Resident.	Foreign Tax paid by resident of India, will be allowed credit of such taxes, against Indian tax payable on doubly taxed income. The amount of FTC will be the lower of sum calculated by applying Indian rate of tax or rate of tax of foreign country, on doubly taxed income. (Refer Note)

Note:

1.       India rate of Tax – Amount of Indian Income Tax (before Relief u/s 91)/Total Income

2.       Rate of tax of foreign Country – Income Tax paid in Foreign Country/Income assessed in Foreign Country.

The difference in the operation of DTAA and section 91 with respect to quantification of FTC is illustrated as under:-

a)      Foreign Source Gross Income – Rs. 1,00,000

b)      Tax rate on Gross basis in Foreign Country – 15%

c)       Tax paid in foreign country – 15,000

d)      Net Expenses in India on such Foreign source Income – Rs. 40,000

e)      Net Income in India – Rs. 60,000

f)       Tax rate in India – 30%

S.No	Particulars	Relief under DTAA	Relief u/s 91
1.	Tax in India (A)	18,000	18,000
2.	Proportion of Foreign Income to Total Income (60,000 (net of Expenses)/60000)	100%
3.	Foreign Tax paid	15,000
4.	FTC (B) (Foreign tax is less than Indian tax)	15,000
5.	Foreign Tax on doubly taxed income by applying rate of tax of foreign Country – 15% of Rs. 60,000,since same is less than Indian rate tax of 30%.		9,000
6.	FTC (C )		9,000
7.	Net Indian Tax after FTC (A-B)/(A-C)	3,000	9,000

Thus where foreign tax is based on gross basis and Indian tax is applicable on net basis (net of expenses), the amount of Foreign tax available for credit will always be less than actual foreign taxes paid u/s 91.

Ø  Draft Rules

The draft rules proposes to abrogate the following ambiguities surrounding the FTC procedure:-

1.       Year in which FTC can be claimed – An assessee can claim FTC in the year in which foreign source income is offered for tax in India- Rule 1

2.       Taxes against which FTC can be claimed – The FTC will be available against the amount of tax, (Including MAT) surcharge & cess payable under Income Tax Act but not in respect of Interest, fee or penalty payable under the Act.- Rule 3 & 6

3.       Foreign Tax paid in Dispute – whether eligible for FTC – No credit will be available in respect of amount of foreign tax paid  , which is disputed by assessee – Rule 4

4.       Documents required for Claiming FTC – TDS Certificate from Foreign Payer, Bank acknowledgement (where foreign tax is paid by assessee himself) & declaration that foreign tax paid is not under dispute.- Rule 8

5.       Conversion of Foreign Taxes into INR – Conversion is to be done on Telegraphic Transfer buying rate on the date on which tax has been paid or deducted in foreign country.- Rule 5

6.       Computation of Foreign taxes – Individual basis or Aggregate basis – The draft rule suggest reckoning of Foreign taxes on Individual basis (Rule 5), elucidated as under:-

a)      Foreign Income in Country A – Rs. 1,00,000, Tax paid – Rs. 20,000

b)      Foreign Loss in Country B – Rs. 80,000

c)       Income in India – Rs. 1,80,000, tax rate in India – 30%

d)      Total Income in India – 2,00,000 (1,80,000+1,00,000-80,000)

e)      Total Tax in India @ 30% - Rs. 60,000

f)       Foreign Tax Credit

i)                    Aggregate Approach – Total Foreign Income is Rs. 20,000, which is 10% of Total Income (20,000/2,00,000). Foreign Tax Credit will be lower of Rs. 20,000 (Foreign Tax) or 10% of Rs. 60,000 (Indian tax) i.e 6,000. Thus FTC will be restricted to Rs. 6,000

ii)                   Individual Approach – Foreign Income of Country A – Rs. 1,00,000, which is 50% of Total Income. Foreign Tax Credit will be lower of Rs. 20,000 (Foreign tax) or 50% of Rs. 60,000 i.e Rs. 30,000. Thus FTC will be Rs. 20,000. No such working will be done for Country B, since no foreign tax is paid in Country B.

iii)                Thus Rule 5 advocates Individual approach for determination for foreign Taxes for credit purpose..

This rule seems to be in conformity with ratio laid down by Bombay High Court in CIT vs. Bombay Burmah Trading Corporation Ltd 259 ITR 423

Ø  Contradiction between Draft Rules & Section 91

1.       Rule 5 postulates that credit for foreign taxes shall be the lower of the tax payable under Income Tax Act on foreign source income and the foreign tax paid on such income.

2.       There seems to be incongruity between said rule and provision of section 91 as regard the quantification of FTC.

3.       Under section 91, the actual foreign tax paid is not compared with Indian tax on foreign source income to determine the lower amount to arrive at FTC. It is a Foreign Tax rate which is compare with Indian tax rate and lower of them is applied on foreign source Net income to determine the amount of FTC. The latter part makes difference, when an income is taxable on Gross basis in foreign country and on net basis in India, as exemplified above. Thus rule 5 needs to be modified to bring it in harmony with section 91 or else it should be restricted to the following only:-

a)      Determination of amount of Foreign Taxes for credit on Individual basis

b)      Conversion of Foreign Taxes into INR.

The draft rules should cover only those aspects of FTC procedure, which is not provided in the statue and quantification of FTC, which is already taken care by section 91, should not be embroil in the Procedure again.

International Transaction -Receivable in the course of Business-Analysis

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