ITAT Rules Cash Flow Hedge Revenue as Non-Operating Income

Mylan Laboratories vs. ACIT: Case Background

In the case of Mylan Laboratories Ltd. vs. ACIT, the ITAT addressed the treatment of Cash Flow Hedge Revenue in the company’s accounts. Specifically, this type of revenue, unrelated to core business operations, should be classified as non-operating income, with professional guidance on accounting for non-operating income. Furthermore, both the appellant and the Revenue filed appeals against the CIT(A)’s order for Assessment Year 2016-17.

The appellant reported a total loss of Rs. 1,143,75,70,959 under normal provisions of the Income Tax Act, 1961. Additionally, it declared a book loss of Rs. 306,42,31,817 under Section 115JB. Consequently, the case underwent scrutiny under CASS, and the Transfer Pricing Officer (TPO) reviewed international transactions with associated enterprises (AEs) to determine the arm’s length principle (ALP).

Transfer Pricing Proceedings and Key Observations

During the transfer pricing proceedings, the TPO examined Form 3CEB and identified multiple international transactions between Mylan Laboratories and its associated enterprises. Following a review of the appellant’s submissions and business model, the TPO rejected the submitted transfer pricing documentation.

The TPO aggregated all interlinked transactions into a single basket, reasoning that the business segments could not be separated. As a result, the case underwent scrutiny under CASS, and the TPO reviewed international transactions with associated enterprises (AEs) to determine the arm’s length principle (ALP), highlighting the importance of transfer pricing support for compliance.

Additionally, the CIT(A) upheld most additions made by the TPO, including adjustments for sales and closely linked transactions, disallowance of interest on External Commercial Borrowings (ECB) and Compulsory Convertible Debentures (CCD). However, the CIT(A) partially accepted the appellant’s grounds regarding interest on delayed trade receivables and depreciation on goodwill.

ITAT Rulings on Key Issues Including Cash Flow Hedge Revenue

The ITAT issued detailed rulings on multiple grounds in the Mylan Laboratories Ltd. vs. ACIT case, emphasizing accurate classification of revenue and correct application of transfer pricing principles, backed by financial reporting and compliance expertise. Importantly, the tribunal clarified the treatment of cash flow hedge revenue as non-operating income, thereby highlighting its lack of direct relation to core business operations.

1. Aggregation of International Transactions

Specifically, the ITAT directed the TPO to reconsider the aggregation method for the appellant’s international transactions.

• Exclude FDF and injectable transactions covered under the Advance Pricing Agreement (APA).
• Compute margins at the entity level based on the remaining transactions.

This ensures a more precise benchmark for transfer pricing compliance.

2. Amortization of Goodwill as Operating Cost

Moreover, if the TPO fails to identify goodwill amortization from comparables, he may adopt the ‘Cash-PLI’ approach.

• If the TPO fails to identify goodwill amortization from comparables, he may adopt the ‘Cash-PLI’ approach.
• This method should be used to compute margins for both the appellant and comparable companies.

This ruling confirms the careful consideration required for including intangible asset costs in operating income calculations.

3. Cash Flow Hedge Revenue: Non-Operating Income Treatment

Specifically, the ITAT held that cash flow hedge revenue is not directly linked to the business operations of Mylan Laboratories. Therefore:

• Therefore, it cannot be considered operating income.
• Consequently, it should be classified as non-operating income for accurate reporting and transfer pricing purposes.

Therefore, this distinction ensures financial statements reflect true operational performance.

4. CCD Interest and Cash Flow Hedge Revenue Implications

The ITAT found errors in benchmarking interest on CCDs:

• Government securities’ interest rates are risk-free, unlike CCDs issued by the appellant.
• Importantly, the TPO’s arbitrary use of 50% of the coupon rate for benchmarking was incorrect.
• The CIT(A) incorrectly sustained the AO’s addition; the ITAT directed deletion of this adjustment.

5. Interest on External Commercial Borrowings (ECB)

For ECBs, the ITAT clarified:

• In contrast, interest paid by the appellant complied with RBI Circular No. 26.
• Applying USD LIBOR + 200 bps for benchmarking was erroneous.
• CIT(A) failed to consider relevant facts; the ITAT set aside the CIT(A) order and instructed the AO/TPO to delete the addition.

6. Interest on Delayed Trade Receivables

The ITAT highlighted that:

• The TPO incorrectly computed interest using a 60-day credit period for the entire year.
• Interest must be calculated for the actual period of delay in receivables realization.
• As a result, the TPO was directed to verify supporting evidence and recalculate interest accordingly.

Our comments

Overall, this ruling highlights the proper Non-operating Income Treatment of Cash Flow Hedge Revenue, confirming that revenue unrelated to core business operations should not be treated as operating income. Furthermore, it underscores the importance of Advance Pricing Agreements and accurate benchmarking for cross-border intercompany transactions, thereby ensuring compliance with transfer pricing regulations.

[2025] 175 taxmann.com 577 (Hyderabad – Trib.)