- Bookmark
- Share
- CaseIQ
Principal Commissioner of Income-tax v. Kusum Health Care (P.) Ltd.
Factual and Procedural Background
The assessee, Kusum Health Care (P.) Ltd., engaged in exporting pharmaceutical products to overseas associated enterprises and third parties, filed its income tax return for the assessment year declaring a total income of Rs. 2,06,64,960. The return was selected for scrutiny, and notices under sections 143(2) and 142(1) of the Income-tax Act, 1961 ("the Act") were issued. Due to international transactions with associated enterprises, the case was referred to the Transfer Pricing Officer (TPO) under section 92CA of the Act.
The assessee declared international transactions involving exports of manufactured and traded medicines, benchmarked using the transactional net margin method. The assessee’s operating profit margins were higher than comparable companies, indicating arm's length pricing.
The TPO proposed an adjustment adding Rs. 1,57,54,943 to the assessee’s income, focusing on extended credit periods allowed to associated enterprises compared to unrelated parties. The Assessing Officer incorporated this adjustment in the draft assessment order. The assessee objected before the Dispute Resolution Panel (DRP), which rejected the objections. The final assessment order added Rs. 93,69,275 to the income.
The assessee appealed to the Income-tax Appellate Tribunal (ITAT), which by order dated March 31, 2015, set aside the assessment order. The ITAT held that the working capital adjustment had already been factored into the assessee’s pricing and any further adjustment based on outstanding receivables was unwarranted.
The Revenue filed the present appeal under section 260A of the Act challenging the ITAT order. The court also considered applications for exemption and condonation of delay in re-filing the appeal.
Legal Issues Presented
- Whether the outstanding receivables from associated enterprises, particularly those exceeding the agreed credit period, constitute a separate international transaction requiring transfer pricing adjustment under section 92B of the Income-tax Act, 1961.
- Whether the Income-tax Appellate Tribunal erred in setting aside the transfer pricing adjustment on the basis that working capital differences had already been accounted for in the assessee’s benchmarking analysis.
Arguments of the Parties
Revenue's Arguments
- The definition of "international transaction" under Explanation (i)(c) to section 92B includes "payments or deferred payment or receivable or any other debt arising during the course of business," thus outstanding receivables themselves constitute an international transaction.
- The OECD Transfer Pricing Guidelines support the need to adjust for differences such as working capital between controlled and uncontrolled transactions, emphasizing investigation when significant differences exist.
- The Transfer Pricing Officer correctly treated the outstanding receivables as a separate international transaction requiring benchmarking.
Court's Response to Arguments
- The court rejected the Revenue's interpretation that every receivable automatically qualifies as an international transaction outside contextual analysis.
- The court emphasized the necessity of a detailed inquiry by the Transfer Pricing Officer over a period to identify a pattern indicating that the receivables arrangement benefits the associated enterprise.
- The court found that focusing on a single assessment year’s receivables without broader analysis was insufficient to justify the adjustment.
- Since the assessee had already factored in working capital impact in its transfer pricing analysis, further adjustments based solely on outstanding receivables would distort the pricing and were impermissible.
Table of Precedents Cited
| Precedent | Rule or Principle Cited For | Application by the Court |
|---|---|---|
| Cit v. Ekl Appliances Ltd [2012] 209 Taxman 200/345 ITR 241 (Delhi) | Prohibition against re-characterizing transactions and improper transfer pricing adjustments beyond working capital considerations. | The court relied on this precedent to reinforce that adjustments solely based on outstanding receivables, when working capital impact is already accounted for, are impermissible and distort the transfer pricing analysis. |
Court's Reasoning and Analysis
The court analyzed the statutory definition of "international transaction" under section 92B of the Act, particularly the inclusion of receivables. It held that this inclusion does not automatically classify every receivable as an international transaction without contextual and temporal analysis. The court stressed the requirement for the Transfer Pricing Officer to conduct a thorough inquiry over a period to detect a pattern indicating that the receivables arrangement is designed to benefit the associated enterprise.
The court found that the Assessing Officer’s reliance on a single assessment year’s data failed to establish such a pattern. Further, since the assessee had already incorporated working capital effects in its transfer pricing report, any additional adjustment based solely on outstanding receivables would distort the arm’s length pricing and re-characterize the transaction unlawfully. The court thus upheld the ITAT’s decision to set aside the transfer pricing adjustment.
Holding and Implications
The appeal by the Revenue is dismissed.
The court affirmed the ITAT’s order setting aside the transfer pricing adjustment relating to outstanding receivables. The direct effect is that the assessee’s transfer pricing treatment, including working capital adjustments, stands upheld without additional adjustments on receivables. No substantial question of law was found to warrant interference. This decision does not establish new precedent but confirms the necessity of careful, contextual analysis in transfer pricing adjustments related to receivables.
JUDGMENT
CM No. 40894 of 2016 (exemption)
1. Allowed, subject to all just exceptions.
CM No. 40895 of 2016 (for condonation of 309 days' delay in re-filing the appeal)
2. For the reasons stated in the application, the delay of 309 days in re-filing the appeal is condoned.
I.T. A. No. 765 of 2016
3. This appeal, under section 260A of the Income-tax Act, 1961 ("the Act"), by the Revenue is directed against the order dated March 31, 2015 passed by the Income-tax Appellate Tribunal, Delhi Bench "1", New Delhi ("ITAT") in Kusum Health Care (P.) Ltd. v. Asstt. CIT [2015] 62 taxmann.com 79 (Delhi - Trib.) .
4. The facts in brief are that the assessee is engaged in the business of exporting pharmaceutical products to its overseas associated enterprises ("AEs") as well as to third parties. The assessee filed its return for the assessment year in question on October 13, 2010 declaring a total income of Rs. 2,06,64,960. The return was picked up for scrutiny and notices under section 143(2)/142(1) of the Act were issued by the Assessing Officer ("AO"). Since the assessee had, during the assessment year in question, entered into international transactions with its associated enterprises, the case was referred to the Transfer Pricing Officer ("TPO") under section 92CA of the Act.
5. As far as the assessee was concerned, it declared the following inter national transactions i.e. export of manufactured medicines and export of traded medicines. Both the transactions were benchmarked applying transactional net margin method. The profitability of the assessee from its manufacturing and trading segments was benchmarked with the average operating profit margin earned by comparable companies performing similar manufacturing and trading functions. In both sets of transactions, the profit level indicators (PLIs) showed the operating profit margin of the assessee to be higher than that of the comparable companies. Accordingly, the international transactions were projected by the assessee as having been undertaken at the arm's length price ("ALP").
6. The Transfer Pricing Officer, however, in his order dated January 29, 2014 proposed an adjustment by way of addition of Rs. 1,57,54,943 to the income of the assessee. The Transfer Pricing Officer noted that the credit period for the debtors as mentioned in the sale contract with unrelated entities was 180 days. However, in the case of the associated enterprises they were "allowed to linger for long". The said receivables qua the associated enterprises was treated as a separate international transaction.
7. The aforementioned transfer price adjustment as proposed by the Transfer Pricing Officer was incorporated by the Assessing Officer in the draft assessment order. The respondent/assessee filed its objections to the said draft assessment order, before the Dispute Resolution Panel ("DRP") which, by the order dated September 24, 2014, rejected the objections. The Transfer Pricing Officer gave effect to the aforementioned directions of Dispute Resolution Panel on November 13, 2014. On November 14, 2014 the Assessing Officer passed the final assessment order by making an addition of Rs. 93,69,275 to the income of the assessee.
8. Aggrieved by the said order, the assessee filed an appeal before the Income-tax Appellate Tribunal. By the impugned order dated March 31, 2015, the Income-tax Appellate Tribunal set aside the assessment order. The Income-tax Appellate Tribunal noted that the assessee had undertaken working capital adjustment for the comparable companies selected in its transfer pricing report. It was further noted that "the differential impact of working capital of the assessee vis-a-vis its comparables had already been factored in the pricing/profitability" which was more than the working capital adjusted margin of the comparables and, therefore, "any further adjustment to the margins of the assessee on the pretext of outstanding receivables is unwarranted and wholly unjustified".
9. Mr. Raghvendra Singh, learned counsel appearing for the Revenue sub mitted that the Income-tax Appellate Tribunal overlooked the fact that the expression "international transaction" as defined in Explanation (i)(c) to section 92B of the Act included "payments or deferred payment or receivable or any other debt arising during the course of business", and therefore, the outstanding receivables could by themselves constitute an international transaction. He further referred to the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations. Paras 3.48 and 3.49 under Chapter III para A.6.1 of the said guidelines titled "Different types of comparability adjustments" spoke of the need to eliminate differences that may arise from different accounting practices between controlled and uncontrolled transactions. In particular, it was noted under para 3.49 that "a significantly different level of relative working capital between the controlled and uncontrolled parties may result in further investigation of the comparability characteristics of the potential comparable". Mr. Singh submitted that the Income-tax Appellate Tribunal erred in disagreeing with the Transfer Pricing Officer, who had characterised the outstanding receivables as an international transaction by itself which required benchmarking.
10. The court is unable to agree with the above submissions. The inclusion in the Explanation to section 92B of the Act of the expression "receivables" does not mean that dehors the context every item of "receivables" appearing in the accounts of an entity, which may have dealings with foreign associated enterprises would automatically be characterised as an international transaction. There may be a delay in collection of monies for supplies made, even beyond the agreed limit, due to a variety of factors which will have to be investigated on a case to case basis. Importantly, the impact this would have on the working capital of the assessee will have to be studied. In other words, there has to be a proper inquiry by the Transfer Pricing Officer by analysing the statistics over a period of time to discern a pattern which would indicate that vis-a-vis the receivables for the supplies made to an associated enterprise, the arrangement reflects an international transaction intended to benefit the associated enterprise in some way.
11. The court finds that the entire focus of the Assessing Officer was on just one assessment year and the figure of receivables in relation to that assessment year can hardly reflect a pattern that would justify a Transfer Pricing Officer concluding that the figure of receivables beyond 180 days constitutes an international transaction by itself. With the assessee having already factored in the impact of the receivables on the working capital and thereby on its pricing/profitability vis-a-vis that of its comparables, any further adjustment only on the basis of the outstanding receivables would have distorted the picture and re-characterised the transaction. This was clearly impermissible in law as explained by this court in Cit v. Ekl Appliances Ltd…. [2012] 209 Taxman 200/345 ITR 241/345 ITR 241(Delhi) .
12. Consequently, the court is unable to find any error in the impugned order of the Income-tax Appellate Tribunal giving rise to any substantial question of law for determination. The appeal is, accordingly, dismissed.
Alert