Tuesday, January 11, 2011

Debit balance not an ‘International Transaction’: What was the Tribunal thinking?

The Mumbai Income Tax Appellate Tribunal in its recent ruling of Nimbus Communications Limited v. Assistant Commissioner of Income Tax[1], has held that a ‘debit balance’ would not constitute to be an ‘International Transaction’ per se under section 92B of the Income Tax Act, 1961 (“Act”), but is merely a result of such transaction. Essentially the case concerns whether the arm’s length price adjustment that was computed by the transfer pricing officer and the commissioner of income tax was justified. However, for the purpose of this discussion, I wouldn’t delve into that aspect but concentrate on whether the transaction in question qualified to be an ‘International Transaction’ under the Act. In order to ascertain that, it is essential to look at the definition of the same under the Act.
Section 92B defines an international transaction as
“…transaction between two or more associated enterprises, either or both of whom are non-residents, in the nature of
·         purchase, sale or lease of tangible or intangible property, or
·         provision of services, or
·         lending or borrowing money, or
·         any other transaction having a bearing on the profits, income, losses or assets of such enterprises 
For a transaction to fall within the ambit of the section, it needs to be in the nature of one of the aforementioned transactions. The Tribunal in the present case without determining the nature of the transaction between the assessee and its associated enterprises has stated that an ‘overdue payment’ or ‘a continuing debit balance’ to the assessee from its associated enterprise will not satisfy any of the above heads. It has failed to look into the origin of such overdue payment. In my opinion the source of the debt is of utmost importance to decipher the true nature and substance of the commercial transaction between the related parties. The judgement does not discuss the commercial relation between the two related parties; hence we do not know if there had been a sale, lease, rendering of services or lending-borrowing.
However, interestingly, the Tribunal has examined the last limb of the definition: the residuary clause i.e., whether the debit balance would have a bearing on the profits, incomes, losses or assets of the assessee. Though the Tribunal, without giving any sufficient justification, has rejected the proposition that a debit balance could have any impact on profits, incomes, losses or assets of the assessee, I think there is much depth in this aspect than what was considered by the judges.
In plain accounting terms, a debit balance is an amount which is due to a company. If this amount is legally and validly due, it constitutes a ‘receivable’ vis-a vis that company and wouldn’t feature in its balance sheet until paid. An asset of an enterprise is defined as a resource controlled by the enterprise as a result of past events and from which future economic benefits are expected to flow to the enterprise. Thus, irrespective of the source transaction from which it accrues, such ‘receivable’ that is lawfully due would definitely have an impact or bearing on the assets of the company.  Therefore, the debit balance would definitely fall under the last sub clause of section 92B- as to having a bearing on the ….assets of the company and thus qualify as an international transaction.
In cases pertaining to transfer pricing and arm’s length adjustment, cases are distinguished on the basis of their factual matrix. Whether or not provisions pertaining to transfer pricing can be applied solely depends upon the fact whether the transaction in question falls with Section 92B. The Tribunal has not delved into the facts of the case and has not analyzed the nature of the transaction. In my opinion, the Tribunal’s ruling is patently erroneous and thus, it is dubious if the case can set a strong precedent for future transfer pricing cases involving overdue payments.

[1] ITA No.: 6597/Mum/09, Assessment year: 2004-05

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