Customer Care No.

91-1145562222

Interest on Continuing
Debit Balance Notional or
Real
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Introduction
Over the years since the introduction of the Indian
Transfer pricing regulations, the transfer pricing audits
based on the experience and learnings gained have seen
numerous interpretations of the provisions, thereby
leading to transfer pricing adjustments. The Indian
transfer pricing litigation scenario has seen the trend of
adjustments shifting from mere dispute on comparable
companies to larger issues such as location savings,
management cross charges, intangibles, share
valuations, business restructuring, etc.
One such issue being the continuing debit balance in the
financials of multinational companies (MNC). Globally due
to the financial exigencies, the MNCs often commercially
require to defer the payables / receivables. The
continuing debit balance / receivables have been treated
by the tax authorities as an international transaction and
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sought
impute arm's length interest on

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The Section 92B of the Indian transfer pricing regulations provides the coverage of the
transactions that could be treated as international transaction. Vide Finance Act 2012, a
clarificatory Explanation was inserted with retrospective effect from 1 April 2002. By virtue of
the said Explanation, inter alia the expression 'international transaction' included capital
financing such as any type of long-term or short-term borrowing, lending or guarantee,
purchase or sale of marketable securities or any type of advance, payments or deferred
payment or receivable or any other debt arising during the course of business.
In spite of the clarification being provided, the question whether the continuing debit balance
is an international transaction or not has been contested by both the Assessee and the
Revenue. In this relation, various judicial rulings have held in favour of the Assesseethat the
continuing debit balance is not an international transaction and that there is no legal
justification for imputing notional interest when there is no real income arising in the hands of
the Assessee. Though, the clarificatory Explanation has as such over-ruled the said rulings
which held that outstanding receivables is not an international transaction, there are some of
the following instances of favorable rulings which were pronounced after April 2012 (even
though pertaining to assessment year prior to April 2012):
(a) Indo American Jewellery Ltd - The Bombay HC held that if there is complete uniformity in
the act of the taxpayer in not charging interest from both the AE and the non AE and the delay
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in realization
export proceeds in both the scenarios is the same, then no
notional

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(c) Gold Star - The Mumbai ITAT held that allowing credit period to the AE for realization of the
sale proceeds is not a separate international transaction but is intrinsically linked to the sale
transaction to the AE.
(d) Kusum Healthcare (P) Ltd v ACIT - The Delhi ITAT held that where the transaction with the
AEs earns higher margins as compared to the comparable companies, then such high margins
compensates for credit period extended to the AEs and accordingly no adjustment is required.
Yet again, in the recently adjudicated ruling by the Mumbai Tribunal in the case of Rusabh
Diamonds, it has been held that outstanding receivables is not an international transaction and
also as long as the sales are benchmarked on Transaction Net Margin Method ('TNMM'), there
cannot be any occasion to make a separate adjustment for delay in realization of outstanding
receivables. This ruling provides the much needed clarity for taxpayers on the effect of the
explanation to section 92B inserted by Finance Act, 2012, that is, whether the effect is
retrospective or prospective and it also provided certain guidance post 1 April 2012.
We have in the ensuing paragraphs discussed the ruling and the key outcomes:
Brief of the Ruling
The Assessee, Rusabh Diamonds was engaged in the business of manufacturing, import and
export of cut and polished diamonds. During the financial year (FY) 2009-10, the Assessee had
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The TPO further noted that the Assessee has paid interest on certain borrowings which could
have been avoided had the Assessee realized the receivables on time. Accordingly, the TPO
imputed interest plus mark up on the outstanding receivables on the ground that it is an
international transaction pursuant to the insertion of the Explanation to section 92B. The
contention of the Assessee that outstanding receivables is not an international transaction was
disregarded. The Dispute Resolution Panel (DRP) upheld the adjustment made by the TPO,
however with a direction to delete the mark up component. The Assessee aggrieved, filed an
appeal against the interest adjustment in relation to the delay in realization of sale proceeds
from AE. The Revenue alsobeing aggrieved, filed an appeal against the deletion of the mark up
on the arm's length interest rate.
Key take away from the Ruling
(a) Imputation of interest on the delay in realization of outstanding receivables Validity
The Mumbai ITAT has made an important observation that on the premise of the Explanation to
Section 92B if it is considered that continuing debit balance is an international transaction then
separate adjustment is not warranted when the export sale has been benchmarked on TNMM
basis and concluded to be at arm's length. The justification being that while computing the
operating profits for the purpose of computing the profit level indicator (PLI) all operating
income (including
interest, if any) and expenses are considered and if that margin
is above the
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(b) Effect of the Explanation to section 92B - Retrospective or prospective
The ITAT highlighted that when there are plethora of rulings in relation to an issue, it is not an
uncommon occurrence to nullify the judicial interpretation through legislative amendment. However,
the same has always been prospective in effect. The ITAT noted that the insertion of the clarificatory
Explanation to section 92B being retrospective, has been made before the understanding of the
effects of such retrospective taxation.
The ITAT has placed reliance on the recent case of New Skies Satellite wherein the High Court has
observed that the legislature is competent to amend the provisions retrospectively or prospectively.
However, when the disputes on account of such amendments arise before the courts then it is the
substance of the amendment that will determine the operation and not the bare language of the
amendment. It has been emphasized by the ITAT that adjustment in relation to continuing debit
balance would bring the notional income in the tax net, without any legal basis and legal
jurisdiction.In order to mitigate such effect, the ITAT held that the clarificatory Explanation to the
section 92B pertaining to treating the continuing debit balance as an international transaction is
effective from 1 April 2012. Accordingly considering that the assessment year of the case being
discussed is 2009-10, the said Explanation to section 92B has no application and the adjustment of
imputing interest on account of delayed realization of outstanding receivables is not just.

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