The Hyderabad Bench of the Income-tax Appellate Tribunal rejected a transfer pricing assessment made with respect to “notional interest” on outstanding receivables between the taxpayer and its foreign related party, and excluded five comparable companies selected by the Transfer Pricing Officer on functionality grounds.
The case is: Pegasystems Worldwide India Private Ltd. v. ACIT (ITA No. 1758/HYD/2014)
The taxpayer—a wholly owned subsidiary of a U.S. entity—provided software development services to the U.S. parent company. The arm’s length price of the international transactions (software development services) was determined using the Transactional Net Margin Method (TNMM) and taking “operating profit to operating cost” (OP/OC) ratio as the profit level indicator.
The profit level indicator of the taxpayer was determined to be 14.03% whereas the average for 21 comparable companies selected by the taxpayer was 11.26%.
The Transfer Pricing Officer rejected the taxpayer’s transfer pricing study; selected 18 comparable companies; and proposed a transfer pricing adjustment based on a profit level indicator of 25.08% of the selected comparable companies (compared to the taxpayer’s profit level indicator of 14.03%). Also, the Transfer Pricing Officer found that the taxpayer had outstanding receivables that were not reported and for which no benchmarking analysis had been made in the transfer pricing study. Interest was computed on these receivables at a rate of 12%.
The adjustment was upheld in part by the Dispute Resolution Panel, but it accepted the taxpayer’s claim for interest on the outstanding receivables at the LIBOR rate plus 250 basis points.
The tribunal held that there was no notional interest on the outstanding receivables, and that the outstanding receivables arising from services provided by the taxpayer to its foreign related party are not to be characterized as “capital financing.”
Read an October 2015 report [PDF 447 KB] prepared by the KPMG member firm in India: Outstanding receivables from the services rendered are not ‘Capital financing’ warranting levy of hypothetical and notional interest