2014 (12) TMI 884 - AT - Income Tax

Determination of Arm s Length Price on international transactions - Foreign exchange transaction loss adjustment to be granted or not Risk is borne by AE or not - Assessee is engaged in the distribution and marketing of Bearings and other products Held that - DRP was rightly of the view that the assessee has worked out the adjustment on the premise that he fixes the sale and purchase in advance and the forex fluctuation loss has to be borne by him there was no documentary evidence found in support of the claim that price negotiations had happened in advance - assessee has to sell the AEs goods at the list price decided by the AE - If this is so, then the AE must bear the forex loss, because the prices are fixed in advance by the AE - the assessee has to establish with documentary evidence that he had fixed the sale price in the beginning of the year itself, that assessee was to bear the forex risk alone and that he could not have passed on the effect of Rupee depreciation to the customers thus, there is no justification for allowing adjustment for the rupee depreciation. The assessee company has not produced any sort of evidence to show that the assessee had pre-determined the sale price - when advance fixation of sale price is not proved by any documentary evidence, it is not possible to accept the contention of the assessee that the de-valuation loss is a fait accompli that foreign exchange fluctuation loss could be adjusted in the hands of the assessee company, only if the assessee company has successfully proved with documentary evidence that the sales were made against predetermined rates DRP rightly was of the view that it is not possible to accept the adjustment of that loss thus, the order of the DRP is upheld Decided against assessee. Transfer pricing adjustment Held that - Assessee pleaded that it is not possible for a company in the first year of its operation to achieve the optimum possible return of profits CA rightly contended that this is the first year of the assessee s business operation - it is understandable that the assessee cannot jump into full swing operation and achieve the optimum level of profit in the first year - a reasonable amount of adjustment is called for on this ground thus, a deduction of 10% of the income computed on the basis of the TP assessment is allowed Decided partly in favour of assessee.

Summary

Issues Involved:
1. Characterization of the assessee's business.
2. Methodology for determining the Arm's Length Price (ALP).
3. Adjustment for foreign exchange fluctuation loss.
4. Correct computation of transfer pricing adjustment.

Issue-wise Detailed Analysis:

1. Characterization of the Assessee's Business:
The assessee company characterized its business as that of Normal Risk, but the Transfer Pricing Officer (TPO) characterized it as a Limited-Risk Distributor (LRD). The Dispute Resolution Panel (DRP) accepted the assessee's characterization as a Routine Distributor, rejecting the TPO's classification of LRD.

2. Methodology for Determining the Arm's Length Price (ALP):
The TPO followed the Berry Ratio method to work out the Profit Level Indicator (PLI), but the DRP directed the TPO to apply the Transactional Net Margin Method (TNMM) instead. The DRP accepted the contention that the proper basis of comparison should be TNMM by way of operating profit/sales.

3. Adjustment for Foreign Exchange Fluctuation Loss:
The assessee claimed a foreign exchange loss of Rs. 2,45,12,653/- as an item of adjustment. The DRP held that the assessee did not provide documentary evidence to support the claim that price negotiations had taken place in advance. The DRP concluded that the foreign exchange fluctuation loss should not form part of the operating expenses and should be excluded while computing the PLI.

4. Correct Computation of Transfer Pricing Adjustment:
The TPO initially proposed an upward adjustment of Rs. 6.76 crores, which was revised to Rs. 3,14,30,933/- after the DRP's directions. The assessee contended that this adjustment was incorrect. The Tribunal found merit in the assessee's argument and accepted a revised computation, determining the ALP addition at Rs. 2,06,60,608/-. Further, considering that it was the first year of operation for the assessee, the Tribunal allowed a 10% deduction on the computed income, resulting in a final taxable income of Rs. 87,50,160/-.

Conclusion:
The Tribunal partly allowed the appeal, reducing the TP addition and considering adjustments for the first-year operational challenges. The Stay Petition filed by the assessee was dismissed as infructuous. The order was pronounced on September 2, 2014, in Chennai.