Over the years, several criteria have been established to increase the examination of transfer pricing agreements. Another area where there has been litigation is overdue unpaid receivables. According to the tax authorities, transfer pricing between firms takes into account a variety of criteria, including the credit term. As a result, if the actual reception exceeds what the parties agreed upon, such an extended credit period is generally considered as a loan advance that demands a fee. Simultaneously, several courts have granted relief by allowing for working capital adjustments and accepting the practical and commercial realities. In this blog, we are going to talk about the same in detail:
What is Outstanding Receivable?
Debts owing to a firm are referred to as receivables. If a company promises to supply goods or services in exchange for payment later, such as 30-day or 90-day periods, such items are considered outstanding receivables until they are paid off. Credit accounts are a typical receivable; if your company sells things on credit, the accounts become outstanding receivables until they are settled.
Understanding Outstanding Accounts Receivables
Accounts receivables are shown on a company’s balance sheet and are generally reserved for credit-worthy clients with a track record of regular payments. Accounts receivables are short-term assets that should be turned into cash within one year of the initial transaction. Companies may, however, reduce sums due to clients who pay ahead of their designated payment periods to promote quick payments. This can assist businesses in increasing cash flow during accounting periods when they are having difficulty covering staff wages, material purchases, or other normal expenses.
Tracking Outstanding Accounts Receivables
Several financial indicators may be used to track accounts receivables. The accounts receivable turnover ratio calculates how many times a company’s accounts receivable amount has been collected in a given reporting period. A high ratio implies that a company’s receivables are being collected quickly and efficiently. Days sales outstanding (DSO) is another measure that illustrates how long it takes a firm to collect on its accounts receivables after a sale has been completed. A high DSO implies that the firm is prone to waiting for extended periods, implying inefficiencies in management.
Benefits of Outstanding Receivables
Outstanding receivable is a critical component of a company’s basic analysis. As a current asset, outstanding receivable reflects a company’s liquidity, or its ability to meet short-term obligations without generating new cash flows.
Outstanding receivable is frequently analyzed in the context of turnover, also known as the accounts receivable turnover ratio, which indicates the number of times a company’s accounts receivable amount has been collected within an accounting period. Days sales outstanding study, for example, examines the average collection duration for a company’s receivables balance over a certain period.
Controversies regarding Outstanding Receivables
The Income Tax Appellate Tribunal confirmed the imputation of notional interest on delayed receivables in the case of major interactive automotive solution providers for AY 2004-05, raising the question of whether outstanding receivables are international transactions.
The dispute arose owing to the lack of specificity in the pre-amended definition of an international transaction under Section 92B of the Act. The judgment was followed by ITAT decisions on the matter, some of which were favorable to the taxpayer and others which were not.
Major issues in the context of Outstanding Receivables (OR) before Income Tax Appellate Tribunal (ITAT)
There have been several concerns raised before the Income Tax Appellate Tribunal in the context of overdue receivables. The following are the details:
- Validity of reclassifying OR as a zero-interest loan;
- Applicability of the change to Section 92 B of the Income Tax (Income Tax) Act 1961 in the past or the future;
- If OR occurs outside of the agreed/reasonable time frame, it might be deemed a distinct international transaction from the main transaction;
- If interest on receivables is justified in debt-free firms; If working capital adjustment is used to account for the effect of OR;
- Consideration of AE’s credit policy about non-AE as a legitimate Comparable Uncontrolled Price
- Interest rate to be considered for benchmarking
- Giving credit for inter-company payables as well as interest imputation in the year’s net payments position.
Case laws- verdict for the high court
There are countless court decisions, however, we will focus on a few recent High Court decisions.
Judgment of the Delhi HC in the case of Indian Pharmaceutical Company (AY 2010-11)-
The Delhi High Court affirmed the Appellate Tribunal’s conclusion that OR is not a distinct foreign transaction and hence does not require independent benchmarking. The Court then went on to consider some of the arguments, which are listed below.
The HC stated that the presence of the term receivables in the Explanation to Section 92B of the Act does not imply that every item of receivables in the accounts of an organization that may interact with foreign companies is automatically classified as an international transaction. The time it takes to gather money for supplies should be examined on a case-by-case basis.
The HC agreed with the taxpayer’s argument that working capital adjustment accounts for the OR’s impact on profitability. As a result, rather than looking at the receivable separately, suitable modifications should be addressed to bring balance in the taxpayers’ working capital investment.
According to the HC, focusing on one-year receivables could barely reflect any pattern to demonstrate that receivables beyond a certain time represent an international transaction. The revenue officials were given the task of detecting a trend.
Judgment of the HC in the case of Indian Subsidiary of a management consultancy group (AY 2011-12)
The HC agreed with the revenue department’s original position and upheld the phrase “debt originating in the course of business” to include, among other things, any trading debt emerging from the sale of products or services supplied in the course of doing business.
Once a debt is designated as an international transaction by the legislature, it is presumed that any delay in the repayment of the obligation will result in TP adjustment by the imputation of the arms’ length interest.
Judgment of the HC in the case of Indian Subsidiary of the engineering, procurement, and construction group (AY-2010-11)
The Income Tax Appellate Tribunal concluded in this instance that because the taxpayer is debt-free, it isn’t reasonable to assume that money borrowed was used to pass the facility on to affiliated companies, and so no separate adjustment for interest on receivables is required. The HC concurred with the Income Tax Appellate Tribunal’s conclusions.
The Supreme Court dismissed the revenue department’s Special Leave Petition, noting that there is no issue of law about the TP adjustment for past-due accounts receivables.
Several criteria have been developed throughout time to improve the assessment of transfer pricing agreements. Overdue unpaid receivables are another area where there has been litigation. Transfer pricing between businesses, according to the tax authorities, considers several factors, including the credit period. As a result, if the actual receipt exceeds what the parties agreed to, the extended credit period is usually seen as a fee-based loan advance. Several courts have given relief at the same time by allowing for working capital changes and acknowledging the practical and commercial realities.
Accounts receivables are included on a company’s balance sheet and are often reserved for credit-worthy customers that pay on time. Accounts receivables are short-term assets that should be converted into cash within a year of purchase. Companies may, however, decrease amounts owed to clients who pay ahead of their scheduled payment dates to encourage prompt payments. This might help firms boost cash flow during accounting times when they’re having trouble meeting employee paychecks, material purchases, or other routine costs.