The New Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has held that where an assessee is a branch office of a foreign company and is a debt-free entity with all its working capital requirements met by the Head Office, with no borrowings and no interest cost claimed in its profit and loss statement, the TPO cannot make a working capital adjustment to the operating profits of comparable companies and consequently determine an ALP adjustment on the ground that the assessee’s funds were locked up in sundry debtors due to delayed recovery from its AEs.
The ITAT explained that the working capital adjustment is premised on the existence of borrowings and borrowing costs; in their absence, the entire exercise is based on mere presumptions without substance. The Tribunal further held that where the credit policy is that of the parent company extended through its branch for the benefit of the group as a whole, there is no opportunity loss to the overall group.
The Division Bench comprising Vimal Kumar (Judicial Member) and S. Rifaur Rahman (Accountant Member) observed that the assessee, being a branch office in India, provides services to its group companies (AEs) and incurs expenditures on their behalf, charging a mark-up of 5% on direct costs while reimbursements of third-party expenses are recovered without any mark-up. The core issue was that the assessee recovered reimbursements with an abnormal delay of approximately 530 days, and the TPO was of the view that the working capital was locked up for such a long period, amounting to a foregoing of opportunity cost, which justified the working capital adjustment to the comparable companies’ operating profits, resulting in an adjusted margin of 21.83%.
The Tribunal noted from the submissions that the assessee had extended credit to its own sister concerns and that all working capital requirements were met from the Head Office, with no requirement to borrow funds from outside. There was no cost of capital, nor had the assessee claimed any interest cost in its profit and loss statement. The Tribunal therefore concluded that the assessee was a debt-free entity.
The Tribunal examined the Balance Sheet of the assessee, prepared as a branch office of the US company, and observed that there were absolutely no borrowings and all working capital requirements were met by the Head Office. The Tribunal held that the TPO could make a working capital adjustment only if the assessee had borrowings and claimed significant borrowing costs. In the absence of any borrowings, the TPO could not proceed to make working capital adjustments to all comparables and then make an ALP adjustment in the case of the assessee. The Tribunal characterized the entire exercise as based on presumptions without any substance, noting that it was the policy of the US company to allow credit facilities to its own sister concerns through its branch office for the benefit of the group companies as a whole, and there was no opportunity loss to the overall group.
Briefly, Coca Cola Inc., a corporation incorporated under the laws of Delaware, USA, established a Branch Office in India (CCI-India Branch), which operates as a foreign company providing consultancy and support services to its Associated Enterprises (AEs) in India. In return for these advisory and support services, the assessee receives a consultancy fee computed at a mark-up of 5% on costs incurred, which include salaries and allowances, moving and relocation expenses, and service charges for use of assets. Additionally, the assessee received a reimbursement of Rs. 29.99 crores on expenses incurred on behalf of its AEs, on which no mark-up was charged.
The assessee filed its return declaring income of Rs. 35.70 crores, which was subsequently selected for scrutiny, and since the assessee had entered into international transactions during the year, the matter was referred to the Transfer Pricing Officer (TPO) under section 92CA. The total value of international transactions declared by the assessee was Rs. 78.64 crores, comprising services provided valued at Rs. 48.65 crores (under TNMM) and reimbursement of expenses valued at Rs. 29.99 crores.
The TPO, after conducting a Functional, Asset and Risk (FAR) analysis, observed that third-party vendors raised invoices upon the assessee and not upon the AEs, meaning all contractual obligations, TDS deductions, and timely payments were borne by the assessee. The assessee first made payments to vendors and then recovered them from its AEs after substantial delays, approximately 537 days. The TPO took the view that the assessee’s working capital was locked up for an extended period, amounting to a foregoing of opportunity cost, and proceeded to make a working capital adjustment to the operating profits of the comparable companies using the Prime Lending Rate (PLR) of 11% for FY 2001-02. The TPO determined the arm’s length price at Rs. 90.30 crores, resulting in a TP adjustment of Rs. 13.97 crores.
On appeal, the CIT(A) directed the AO/TPO to delete the transfer pricing adjustment after verifying that the assessee is a debt-free company on the basis of its Audit Report.
