Share via

Background

• The Taxpayer was engaged in providing Knowledge Process Outsourcing (‘KPO’) services to its USA-based parent entity (‘AE’).
• The Taxpayer had opted for Safe Harbour Rules (‘SHR’) and, accordingly, earned a 25% mark-up as per the
• The Taxpayer had outstanding receivables from its AE in respect of invoices that had remained unrealized beyond the credit period of 60 days as agreed in the inter-company agreement.
• The Revenue Authorities adjusted the outstanding receivables by charging interest at the rate of LIBOR + 400 basis points.

Contentions of the Taxpayer

The Taxpayer argued that since the entire income was offered to tax at a cost-plus 25% markup by adhering to the SHR, no transfer pricing adjustment should be made in relation to the interest on outstanding receivables.

Delhi Tribunal Ruling:

• Interest on outstanding receivables is not an ‘Eligible International Transaction’ as defined in SHR.
• The Tribunal held that outstanding receivables and interest thereon are not eligible international transactions for the applicability of SHR.
• Hence, transfer pricing adjustment in relation to interest on outstanding receivables will not get subsumed in the markup of 25% offered under SHR.
• However, considering various Tribunal rulings across India, the interest rate on outstanding receivables was restricted to LIBOR + 200 basis points.

KNAV Comments

• The terms and conditions agreed to in the inter-company agreement are binding upon both parties. Any deviation may lead to questions or adjustments by Revenue or any other authorities.
• SHR covers only ‘eligible international transactions’. Accordingly, if any particular transaction is not an eligible international transaction, it cannot be referenced to SHR and needs to be benchmarked separately.
• The Taxpayer could have adopted external benchmarking analysis to support its argument that the 25% markup it earns is significantly higher than the industry benchmark, and hence, no notional addition of interest on outstanding receivables should be made.
• The Taxpayer could also have analyzed the applicability of working capital adjustment or any other adjustments.