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2017 (7) TMI 1349 - AT - Income TaxGain arising due to foreign exchange fluctuation - receivables from A.E. on account of export/rendering of services - whether revenue earned by the assessee from the activity of rendering services to the A.E. and cannot be excluded from the revenue for the purpose of computing margins of the assessee while comparing the same with the comparables - HELD THAT - We concur with the earlier views of the Tribunal wherein it has been held that if the loss or gain arising due to fluctuation of foreign exchange on account of revenue receivables on exports then the same will be treated as part of operating cost or operating revenue of the assessee as well as comparable companies. Though the Ld. D.R. has placed reliance on Rule 10TA however we find that the definition as provided under Rule 10TA of the Income Tax Rules are only for specific purpose to consider the price under Advance Price Agreement. Therefore to avoid any further ambiguity and uncertainty in the process of advance pricing agreements the definition has been provided under Rule 10TA which may not be adopted for the purpose of taking the actual margins of the assessee as well as the comparable companies for the purpose of determining the ALP under TNMM method. Thus in view of the above facts where the gain earned by the assessee due to foreign exchange fluctuation on the receivables which are revenue in nature the claim of the assessee is allowed and consequently the A.O./TPO is directed to compute the margins of the assessee as well as the comparable by considering the loss or gain arising due to foreign exchange fluctuation on revenue receivables as part of the operating cost or operating revenue as the case may be. This ground of the assessee appeal is allowed. Adjustment claimed by the assessee on account of idle personnel and rent paid in respect of new office as an abnormal cost to be excluded from the operating cost for the purpose of computing the margins of the assessee - The assessee is a wholly owned subsidiary of VTC Varginia USA. The assessee is engaged in designing transformer components etc. under the projects provided by its A.E. VTC USA. Since the entire work has been outsourced by its A.E. to the assessee and therefore the assessee is working only as a captive service provider of designing of transformers and transformer components. The assessee is remunerated by its A.E. on the basis of 250% of the remuneration of service engineers who are assigned to work on A.Es project. When it was found that the assessee could not utilise its capacity to the optimum level in comparison to the comparable companies and therefore the Tribunal has taken a consistent view that substantial difference in the capacity utilisation warrants a proper adjustment in the margins of the comparable so that the loss to the assessee on account of un- utilisation can be equalised. In this case it is not the case of the assessee that their capacity is un-utilisation comparison to the comparables. Therefore the decisions relied upon by the Ld. A.R. of the assessee will not help the case of the assessee on the issue of claim of abnormal cost to be excluded for the purpose of computing the margins of the assessee. We find that the rent paid by the assessee for the new office as well as the salary paid to the engineers hired by the assessee is not an abnormal cost as the assessee has not brought any material on record to show that these office building as well as engineers who were hired from 1st April 2008 could not be used for the purpose of execution of the work but it may the assessee s own decision not to charge its A.E. to compensate the assessee in respect of the remuneration of these engineers which was otherwise agreed between the parties as per clause-10 of the agreement. Thus when the assessee was to be compensated by the A.E. at 250% of the remuneration of service engineers then the salary paid to the service engineer cannot be considered as an abnormal cost. Hence in view of the above discussion we do not find any subsistence or merit in the claim of the assessee. Selection of comparable - WAPCOS Ltd. is a Government of India undertaking and once the TPO has accepted that the Government of India undertaking cannot be considered as a good comparable of the assessee then to maintain the rule of consistency this company cannot be considered as a good comparable solely on this ground. Accordingly once this company is found to be a Government of India undertaking this cannot be accepted as a comparable to the assessee as per the TPO s own finding in respect of other Government of India undertaking. Hence we direct the TPO/A.O. to exclude this company WAPCOS Ltd. from the set of comparable. L T Ramboll Cons. - maximum tolerance range on related party transaction should not exceed 25%. Though the assessee has not disputed the filter of 25% applied by the TPO regarding related party transaction however once the TPO has applied this filter for the purpose of selecting the comparable companies it is incumbent upon TPO to verify the relevant record of each and every company considered for the selection in the set of comparable to see whether the related party transactions of the comparable companies are within the tolerance raised as applied by the TPO. We do not find any force in the contention of the Ld. D.R. that assessee has failed to produce the authentic record and complete details of this company because of the reason that it is the duty of the TPO to verify the relevant record at the time of selection of comparable companies. Therefore once the Ld. A.R. of the assessee has filed the details of related party transaction of this company which show more than 25% then this issue requires a proper verification and examination. Accordingly in the facts and circumstances of the case we set aside this issue of verification of the related party transaction of this company namely L T Ramboll Cons. to the record of the TPO/A.O. and then consider the comparability of this company only on the issue of related party transactions. Appeal of the assessee partly allowed.
Issues Involved:
1. Disregard of mandatory CBDT instructions in determining arm's length price. 2. Confirmation of income addition as adjustment at arm's length price. 3. Misclassification of services provided by the assessee. 4. Rejection of the cost-plus method for benchmarking international transactions. 5. Non-adjustment for functional differences in operating profit. 6. Denial of 5% variation benefit in arm's length price adjustments. 7. Treatment of foreign exchange gain as revenue. 8. Adjustment for idle personnel and rent as abnormal costs. 9. Exclusion of certain comparable companies. Issue-wise Detailed Analysis: 1. Disregard of mandatory CBDT instructions in determining arm's length price: The assessee argued that the Assessing Officer (AO) erred in referring the determination of the arm's length price (ALP) to the Transfer Pricing Officer (TPO) when the international transactions with Associated Enterprises (AE) were less than Rs. 5 crores. This issue was not elaborately discussed in the judgment, indicating that it might not have been a central point of contention. 2. Confirmation of income addition as adjustment at arm's length price: The AO and TPO confirmed an addition of Rs. 41,59,420/- as an adjustment at ALP of international transactions. The assessee contended that this adjustment was not justified, arguing that the authorities erred in their calculations and assumptions. 3. Misclassification of services provided by the assessee: The assessee claimed it provided only manpower for low-end engineering services, whereas the authorities treated it as providing full engineering services. This misclassification led to discrepancies in the assessment of the ALP. 4. Rejection of the cost-plus method for benchmarking international transactions: The authorities rejected the cost-plus method chosen by the assessee for benchmarking international transactions with AE and instead applied the Transactional Net Margin Method (TNMM). The assessee argued that the cost-plus method was the most appropriate method, given the nature of its transactions. 5. Non-adjustment for functional differences in operating profit: The assessee contended that the authorities failed to make necessary adjustments in operating profit for functional differences, including market risk, credit risk, working capital adjustment, and warranty risks. This oversight led to an inaccurate comparison with comparable companies. 6. Denial of 5% variation benefit in arm's length price adjustments: The assessee argued that it was entitled to a 5% variation benefit while determining the adjustments of Rs. 41,59,420/- based on the ALP of international transactions, as per the proviso to section 92C(2) of the Income Tax Act, 1961. The authorities denied this benefit, leading to a higher adjustment amount. 7. Treatment of foreign exchange gain as revenue: The TPO and Dispute Resolution Panel (DRP) disallowed the foreign exchange gain claimed by the assessee as revenue. The assessee argued that the gain due to foreign exchange fluctuation on receivables from AE should be included in the revenue for computing margins. The Tribunal concurred with the assessee, stating that such gains are part and parcel of the revenue earned from services rendered to AE. The Tribunal directed the AO/TPO to include foreign exchange gains in the operating revenue for margin computation. 8. Adjustment for idle personnel and rent as abnormal costs: The assessee claimed adjustments for costs incurred on idle personnel and rent for a new office as abnormal costs. The Tribunal found no merit in this claim, stating that the employment of engineers and office rent were normal business activities. The Tribunal noted that the assessee was fully reimbursed by AE for the remuneration of service engineers, and thus, these costs could not be considered abnormal. 9. Exclusion of certain comparable companies: The assessee sought the exclusion of two comparable companies, WAPCOS Ltd. and L&T Ramboll Cons., from the set of comparables used for determining the ALP. The Tribunal agreed to exclude WAPCOS Ltd. on the grounds that it was a Government of India undertaking, consistent with the exclusion of other government enterprises. For L&T Ramboll Cons., the Tribunal remanded the issue to the TPO/AO for verification of related party transactions, as the assessee claimed these transactions exceeded the 25% threshold applied by the TPO. Conclusion: The Tribunal partly allowed the appeal, directing the AO/TPO to include foreign exchange gains in the operating revenue and to exclude WAPCOS Ltd. from the comparables. The issue of related party transactions for L&T Ramboll Cons. was remanded for further verification. Other claims of the assessee were dismissed.
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