Imputation of notional interest on overdue receivables

Transferpricing adjustments of “Interest on overdue receivables” holds a prominent place in the list of adjustments carried out by taxauthorities. In a TP environment, long overdue receivables (O/R) often being alleged as deemed loan/ capital financing / working capital finance among AssociatedEnterprises (“AE”) thereby construed as an international transaction u/s 92B by Revenue

Globally, few countries like UAE, Korea, in their law also impose arm’s length compensation from the taxpayers i.e., interest, in case receivables are not settled consistently.

In audit proceedings the tax authorities call for debtors ageing and in the event O/R falls due beyond the credit period (30/60 days), they tend to impute notionalinterest on the basis of SBI Prime Lending Rate (PLR) / bond yield rate/ LIBOR (ARR) plus BPS, etc.,

This issue has been subject matter of various tax proceedings and various principles have emanated from those rulings. Considering the same, key pointers one needs to evaluate are:

1. Transaction needs to be looked into from the angle of uncontrolled situation – between unrelated parties- charging interest to third parties
2. Whether the taxpayer is paying any interest in case of delayed payment on overdue payables to AEs
3. Option of knocking off of interest on overdue payables with that of the overdue receivables can be explored as a defense strategy
4. Taxpayers can resort to claiming workingcapital adjustment, as additional imputation of interest on O/R is not warranted if the pricing/profitability of taxpayer is more than working capital adjusted margin of comparables companies
5. In case of debt free companies one could take a position that there is no impact on working capital and hence no opportunity cost on account of delayed realisation of receivables
6. O/R cannot be treated as a separate transaction as it originates from the main transaction of Sale, which has already been benchmarked

Taxpayers’ nature of business (manufacturing/trading/service) has a strong bearing on O/R and hence it has to be treated accordingly. For eg., Service recipient gets benefitted as soon as Service provider renders the work, whereas in case of manufacturing & sales, though invoice is raised immediately, the buyer (in case of overseas sales) will not make any payment before the goods are received. Hence, one needs to also factor in the shipping lead time before imputing such interest for product sale companies.

Further one has to ensure that the actual outcome of O/R is aligned with the terms of the agreement/invoice to see if there are any gaps.

It is imperative to have a clear understanding of the business model, market dynamics and third party receivables which might help in arriving at a conclusion whether or not to deem the Accountsreceivable as an advance subject to interest charge.