Thursday 27 March 2014

Transfer pricing audits slap notional interest

India Inc is increasingly finding a notional interest slapped on it where outstanding payments are due from related parties, such as overseas group companies, against supply of goods or services.

Tax authorities admit that the quantum of such adjustments in ongoing transfer pricing audits, on a pan-India level, could run into several hundred crores of rupees.

If such payments are outstanding beyond the credit period, which is either laid down in the agreements between the parties or according to the industry benchmark, transfer pricing officers (TPOs) tend to make a notional interest adjustment to the income of the Indian company, which is the supplier. Thus, tax has to be paid on the enhanced income. While levying notional interest was commonplace in instances of loans given to related parties, tax experts are increasingly seeing its application in trade transactions



The ambit of the nature of transactions that could be covered by transfer pricing was expanded to include 'capital financing' by the Finance Act, 2012. However, this was introduced with a retrospective effect from April 1, 2002. Consequently, greater attention is being paid by TPOs to outstanding due from related parties.

"Scrutiny on this aspect has increased and for ongoing transfer pricing audits for the fiscal year 2009-10 (which are getting time-barred by January 31, 2014) the scenario will be no different,"


A company cannot escape from the levy of notional interest during a transfer pricing audit merely because it is not charging interest on credit outstanding both to related and non-related third parties.

"Typically, the facts of the case are examined. There could be a difference in volume of transactions - those with third parties could be insignificant or stray transactions (not routinely undertaken) and in such circumstances would fail to stand up to a transfer pricing comparability benchmark,"

"Further, TPOs have been seen to make adjustments even if the credit period available to related and non-related customers is the same. However, in fairness, in most cases, transactions undertaken by taxpayers with unrelated parties are given due weightage," adds Gajaria.

The rate at which interest is levied continues to be a sore point. Gandhi points out, "TPOs are applying prime lending rates of PSU Banks; at most the rate of interest should be that prevailing in the international market for trade financing, which would be lower that the PSU bank rate."

In this backdrop, tax experts say that it is advisable to document the credit period which is provided to related and non related parties, the business and commercial reasons for not charging interest for payments that are outstanding beyond the credit period, and also the commercial reasons for not charging interest to related parties (say because it is a nascent company or is loss-making).

"In one case, we demonstrated that though interest is not charged, dividend payout from the related party to its Indian parent company was sufficient to compensate for loss of interest even if it would have been charged," illustrates Gandhi.

Gajaria adds, "India Inc could also consider maintaining internal documents to show that pricing adopted also considers cost of funds blocked in credit period which is inbuilt into sales price (this could be suitable in cases where credit period delays are inevitable on account of the general industry practice)."

Tax experts also say that companies could take further preventing measures in their transfer pricing study itself. Any difference in the credit period norms or delays in recoveries could be adjusted by suitably enhancing the margins of comparable companies - this is known as working capital adjustment.

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