“working capital adjustment”
The decision most relied on for working capital adjustment is Sony India (P) Ltd. v. DCIT (114 ITD 448), cited in 131 judgments on BharatTax.
Leading authorities on working capital adjustment
For transfer pricing purposes, functionally dissimilar entities that have significant business differences must be excluded from the list of comparables for benchmarking analysis. It also provides guidance on the non-allocation of advertisement, marketing, and promotion (AMP) expenses to other entities when incurred solely for the assessee's business.
Not every item of receivables appearing in the accounts of an entity dealing with foreign associated enterprises automatically constitutes an international transaction under Section 92B. A separate adjustment for interest on outstanding receivables is not permissible if the working capital adjustment has already factored in their impact.
A working capital adjustment is mandated and a prerequisite for correctly determining the Arm's Length Price (ALP) under Rule 10B(1)(e) and Rule 10B(3) of the Income Tax Rules, 1962. This adjustment accounts for differences in working capital and outstanding receivables between the assessee and comparable companies.
The Delhi High Court holds that a detailed functional and working capital analysis, considering various factors, is essential before treating outstanding receivables as a separate international transaction for transfer pricing adjustments on notional interest. Simply making an adjustment based on receivables alone without such study distorts the transaction's character.
For Minimum Alternate Tax (MAT) under Section 115JB, the book profit must reflect the true working results of the company. Capital receipts that are not income cannot be included in book profit, and adjustments based on notes on accounts can be made to arrive at the real profit.
Working capital adjustments are permissible and crucial for comparability analysis when determining the arm's length price of international transactions, especially when an assessee's claim for such adjustment has been denied.
In transfer pricing analysis, demanding daily balances for working capital adjustments is impractical and improper; adjustments should be based on opening and closing working capital. Transfer pricing inherently involves estimation to ensure comparability.
Companies with significantly different turnovers (e.g., one above Rs. 200 crores and another below) cannot be considered comparable in transfer pricing analysis. Turnover is a relevant factor in assessing comparability.
