ENEM NOSTRUM REMEDIES LIMITED,MUMBAI vs. ASST. CIT -9(2)(2), MUMBAI

2. Appellant has raised following rounds of appeal: “1. The Learned Commissioner of Income Tax (Appeals) erred in upholding a notional adjustment of Rs. 64,20,578/- for the purpose of upward revision of income received from the associated enterprise. The learned Commissioner of Income Tax (Appeals) failed to appreciate that there should be income from the international transaction and "notional income" cannot be benchmarked.

The learned Commissioner of Income Tax (Appeals) failed to appreciate that realisation in sale proceeds is not an independent transaction being inextricably linked with the sale transaction, which itself has been subjected to benchmarking. Therefore, at the threshold, sec. 92B of the Act is not attracted and there is no need for benchmarking under sec. 92.

The learned Commissioner of Income Tax (Appeals) failed to appreciate that in respect of sales price for rendering export services to its AE, the appellant has charged the mark-up of 40% on cost as against 29% prescribed by Safe Harbour Rule for pharmaceutical industry, which has duly factored the imputed interest cost associated with time lag between invoicing and realisation and separate addition of notional interest attributable to such delay in realisation is not warranted.

The learned Commissioner of Income Tax (Appeals) failed to appreciate the commercial reality that the delay of realization occurred on account of economic crisis which prevailed in the United States and the Reserve Bank of India, recognising this fact, has itself extended the period of realisation of foreign exchange.

Without prejudice to the ground no. 1 to 5 and strictly in the alternative, the learned Commissioner of Income Tax (Appeals) erred in not granting even the normal credit period of 180 days as agreed in MOU entered by the appellant with its AE.

The Appellant is a private limited company, engaged in the business of research and development of novel drug delivery systems as well as conventional formulations. The Appellant filed its return of income for the Assessment Year 2013-14 on 20.11.2013 declaring total income of INR 1,06,50,660/-. The case of the Appellant was selected for scrutiny. During the assessment proceedings, the Assessing Officer noticed that the Appellant had entered into international transactions with Associated Enterprises (AEs) and therefore, reference was made under Section 92CA(1) of the Act to the Transfer Pricing Officer (TPO) for the determination of Arm‟s Length Price (ALP).

The TPO accepted the Transaction Net Margin Method (TNMM) adopted by the Appellant to benchmark the international transactions of export of services undertaken by the Appellant with its AEs during the relevant previous year. However, on verification of the financial statements the TPO observed that the Appellant had outstanding receivables from the AEs amounting to USD 35,00,400/- and therefore, sought explanation from the Appellant vide order-sheet noting dated 19.09.2016 as to why transfer pricing addition should not be made for interest not charged by the Appellant from the AEs on the same. The Appellant filed reply dated 23.09.2016. However, not being satisfied, the TPO, vide order, dated 21.06.2016, passed order under Section 92CA(3) of the Act proposing transfer pricing adjustment of INR 64,20,578/- on account of interest income on outstanding receivables. The 4 Assessment Year: 2013-14 Appellant objected to the proposed adjustment before the Assessing Officer. However, the Assessing Officer concluded that the TPO had rightly rejected the contentions of the Appellant and therefore, the Assessing Officer made an addition of INR 64,20,578/- to the business income of the Appellant while passing the assessment order passed under Section 143(3) read with Section 144C(3) of the Act.

The Ld. Authorised Representative for the Appellant appearing before us submitted that for attracting provisions of section 92 there should be real income from the international transaction and mere 'notional' income cannot be benchmarked. The balance receivable from the AEs on account of delay in realization of sale proceeds is not an independent/stand-alone transaction, and therefore, cannot be independently benchmarked once TNMM is accepted as most appropriate method. Accordingly, no separate adjustment is called for in respect of outstanding receivables from AEs since the operating profit have been accepted as reasonable. 5 Assessment Year: 2013-14 Without prejudice to the aforesaid, the Ld. Authorised Representative for the Appellant submitted that the Appellant has earned higher margin than comparable companies, and such higher margins compensate for the credit period extended to AEs, and therefore, no further transfer pricing adjustment is called for. The Ld. Authorised Representative for the Appellant, thereafter, concluded her argument by making an alternative submission that, without prejudice to the aforesaid, only those invoices, which became due after expiry of 180 days and were outstanding as on 31.03.2013, could be considered for computation of notional interest. In this regard she referred to the details of invoices and interest working placed on record. To support her contentions, the Ld. Authorised Representative for the Appellant relied upon the following judgments - Kusum Healthcare (P) Ltd. (Del HC) (398 ITR 66) Kusum Healthcare (P) Ltd., (Del trib) 170 TTJ 411), Rusabh Diamonds (Mum) (178 TTJ 0425, Micro Ink Ltd. (Ahm) (157 ITD 132), and M/s Gimpex Pvt. Ltd. (Chny) [IT(TP)A No. 57/Chny/2019, dated 28.12.2020] and M/s Fieldcore Service Solutions International India Pvt. Ltd. (Erstwhile known as Granite Pvt. Ltd.) vs. ACIT (ITA No. 7692/Del/2017, dated 04.12.2020)

In response, the Ld. Departmental Representative submitted that interest needs to be charged on the amount of outstanding balance receivable from the AEs as the same constitutes a separate international transaction akin to granting of loan by the Appellant to its AEs and relied upon the order passed by the TPO and CIT(A) to support the transfer pricing addition of INR 64,20,578/- made in the assessment order. The Ld. Departmental Representative further submitted that the judicial precedents on which reliance has been placed by the Ld. Authorised 6 Assessment Year: 2013-14 Representative for the Appellant are not applicable since the same pertain to assessment years prior to the introduction of amendment by way of Finance Act, 2012.

We note that the transfer pricing provisions, introduced by Finance Act, 2001 with the object of preventing tax base erosion, are in the nature of a Specific Anti-Abuse Rules (for short „SAAR‟). Section 92 of the Act provides that any income arising from an international transaction shall be computed having regard to the arm‟s length price. According to Section 92B of the Act an international transaction, inter alia, means a transaction between two AEs, at least one being a non-resident, in the nature of lending or borrowing. Explanation to Section 92B, inserted by the Finance Act, 2012, clarified that an International Transaction shall include any type of advance, payments or deferred payments or receivables or any other debt arising during the course of business. The Assessment Year before us is 2013-14 and therefore, in our view, there is no dispute that capital financing by way of deferred payments or receivables arising during the course of business constitutes an International Transaction under Section 92B of the Act.

The Ld. Authorised Representative for the Appellant has placed reliance on judgments some of which have been rendered in relation to the provisions as the stood prior to amendments introduced by way of Finance Act, 2012 and therefore, the Ld. Departmental Representative had taken stand that the same would not be applicable to the present case. While we agree with the contention of the Revenue that the judicial precedents relied 7 Assessment Year: 2013-14 upon by the Ld. Authorised Representative of the Appellant rendered in relation to Section 92B of the Act prior to the aforesaid amendment, per se, would not apply to the amended provisions, we are of the view that the same would continue to provide guidance for understanding the commercial nature of the international transaction and its impact on the business as well as profit margins.

On a closer examination of the above judgments, following points of convergence emerge as regards commercial nature of transaction sale of goods/services and its link with receivables. Firstly, the sale price, which is the result of bargain struck between the parties, is arrived at after considering all the terms and conditions of the transactions including the credit period. Higher the credit period, higher would be the sale price of goods/services to compensate for cost for higher working capital requirement or cost of financing capital by way of deferred payments or receivables, thus, protecting/maintaining the profit margins. In our view, it is in this context that the decisions relied upon by the Ld. Authorised Representative of the Appellant hold that interest levy for late realization of debtors is inextricably connected with the sales and forms part of operating income. This continues to be the commercial reality even after introduction of the legislative amendment by way of Finance Act, 2012 which recognizes capital finance by way of deferred payments or receivables as a separate international transaction permitting the Revenue to benchmark interest on receivable from the AEs as a separate international transaction. However, in our view, the aforesaid amendment does not provide for charging interest on receivables in all cases. Take for example a case where the sales price for goods/services are 8 Assessment Year: 2013-14 modified/increased keeping in view the impact/cost of providing higher credit period on profit margins. In our view, this is the reason why the Hon‟ble Delhi High Court has, in the case of Kusum Healthcare (P.) Ltd. (supra), held that the inclusion of Explanation to Section 92B of the Act does not mean that dehors the context every items of receivables appearing in the accounts of an entity, which has dealing with AEs, would automatically be characterized as an international transaction in absence of proper enquiry by the Revenue discerning a pattern that would indicate benefit to AEs in some manner. In other words, there must be some benefit that must accrue to AEs on account of delay in realization of receivables or an account of longer credit period. Accordingly, in the case of M/s Gimpex Pvt. Ltd. (supra), it was held by the Tribunal that there was complete uniformity in not charging any interest from any party whether AE or non-AE and therefore, no separate adjustment was required in the facts of that case since TNMM was accepted as the most appropriate method and the profit margin worked out would automatically take care of notional interest cost on delayed realization of receivables. Similarly, in the case of Fieldcore Service Solutions International India Pvt. Ltd. (Supra) the Tribunal concluded that there was no need to provide any further adjustment only on the basis of the receivables since the assessee had already factored in the impact of the receivables on the working capital and thereby, on pricing/profit margins vis-a-vis the comparables. On perusal of the aforesaid decisions, it becomes clear that the pivotal issue in all the above cases was whether any extra benefit has been obtained by an AE for which no compensation or insufficient compensation was charged.

Now coming to the facts of the present case we note that the Appellant had benchmarked the transaction of export of services by using TNMM method with „Operating Profit/Income‟ and „Operative Profit/Cost‟ as profit level indicators at entity level. For the 7 comparables selected by the Appellant, Average Operating Profit/Income came to 16.88% which was less than 23.33% for the Appellant. Similarly, Average Operating Profit/Cost for the aforesaid 7 comparables came to 20.39% which was same as the Appellant. The entity level margins were been accepted by the TPO to be appropriate and at arm‟s length while accepting the benchmarking done by the Appellant using TNMM at entity level. The Ld. Departmental Representative was not able to controvert the submission of the Appellant that the Appellant has charged the mark-up of 40% on cost as against 29% prescribed by Safe Harbour Rule for pharmaceutical industry which has duly factored the imputed interest cost associated with delay in realisation of receivables. In our view, this raises presumption (though rebuttable by Revenue) that the longer credit period offered by the Appellant to AEs and outstanding receivables did not adversely impact the profit margins of the Appellant as the impact of the same was factored in at the time of negotiating/determining the price of export of services by the Appellant to AEs. We note that it is not the case of Revenue that credit period of 180 days granted by the Appellant to the AE was in excess of the industry standards. The thrust of arguments of the Ld. Department Representative that since capital financial by way of deferred payments or receivables has been recognized as a separate international transaction, the TPO was justified in benchmarking the same separately. We note that there is no dispute to the preposition that capital financial by way of deferred payment or receivables has been recognized as a 10 Assessment Year: 2013-14 separate international transaction and the same can be benchmarked separately. Even TNMM can be applied at the transaction level. However, TPO has accepted the TNMM as applied by the Appellant at entity level. In our view, in the aforesaid facts, the Assessing Officer/TPO cannot be permitted to additionally make upwards adjustment in relation to interest on receivables for the credit period of 180 days agreed between the Appellant and AEs. More so when nothing has been brought on record by TPO/Assessing Officer to show that the credit period of 180 days allowed to AEs is more than what would normally be allowed by the Appellant to an independent party, thus, providing extra benefit to the AEs.

Now it is admitted position that during the relevant previous year, the Appellant was engaged in the export of services which were in the nature of research and development services pertaining to pharmaceuticals formulations to its AEs and was not able to realize payments within the aforesaid credit period of 180 days. In our view, it cannot be said that the extra credit period over and above 180 days availed by the AEs was in the contemplation of the Appellant and the AE‟s at the time of determining the price of sale of services. Therefore, in our view, in the facts and circumstances of the present case the interest on receivables pertaining to delay in realization beyond the period of 180 days has to be benchmarked separately as an international transaction.

In view of the above, we hold that charging of interest of receivables for the credit period of 180 days from the date of raising invoice upon AE is not sustainable. Accordingly, we set aside the order of CIT(A) to this extent and direct the Assessing 11 Assessment Year: 2013-14 Officer/TPO to re-compute interest on receivables in respect of each days delay in realizing the invoice amount beyond a period of 180 days from the date of invoice falling during the relevant previous year by taking the LIBOR Rate of 4.234% determined by the TPO vide order, dated 21.10.2016.

Accordingly, Ground No. 1 and 2 raised by the Appellant are rejected, while Ground No. 3, 4, 5, 6 and 7 are partly allowed. Ground No. 8 and 9 have been disposed off as being not pressed.

In the result, appeal filed by the Appellant is partly allowed.