2017 (11) TMI 324 - AT - Income Tax

Transfer pricing adjustment - exclusion of Exchange loss from total expenses - TPO treated such amount as of non-operating nature and hence excluded it from the ambit of total expenses for working out operating costs - Held that - As the assessee could not link exchange loss of 112.40 million with the borrowings effected by the assessee from its holding company. It is patent that foreign exchange loss on account of trade receivables and payables has to be taken as an item of operating expenditure and exchange loss on account of financing transactions will be considered as non-operating. Since the AR could not link the amount of foreign exchange loss of 112.40 million with the transaction of borrowing from the assessee s AE we cannot uphold the argument put forth before us without verification. We set aside the impugned order and remit the matter to the file of Assessing Officer/TPO for ascertaining if exchange loss of 112.40 million pertains to loan transactions from the assessee s AE or trading transactions as well. A part of such exchange loss which pertains to borrowing made by the assessee from Teva Pharmaceuticals Finance Netherlands B.V. should be considered as non-operating and the remaining amount if any pertaining to trading transactions should be taken as operating expense. Needless to say the assessee will be allowed a reasonable opportunity of hearing before taking any decision for the purposes of computing the assessee s Operating costs to find out its OP/OC. Selection of comparable - Held that - The assessee s aggregated international transaction under consideration is manufacturing and contract R&D and companies functionally dissimilar with that of assessee need to be deselected from final list.

Summary

Issues Involved:
1. Exclusion of Exchange loss from total expenses.
2. Inclusion or exclusion of certain comparables in the transfer pricing analysis.

Detailed Analysis:

1. Exclusion of Exchange Loss from Total Expenses:
The primary issue challenged is the exclusion of an exchange loss amounting to ?112.40 million from total expenses. The TPO treated this amount as non-operating and excluded it from the operating costs. The DRP directed the TPO to verify if the foreign exchange gain was on account of sales and, if so, to treat it as operating gains. The TPO was directed to take foreign exchange fluctuation as operating while computing margins of the company.

Upon hearing both sides, it was noted that the DRP’s direction implied that foreign exchange gain/loss from trading transactions should be treated as operating in nature, whereas those from financing transactions should be considered non-operating. This view aligns with the Supreme Court judgment in CIT vs. Woodward Governor India P. Ltd. The assessee’s counsel claimed that the exchange loss pertained to a loan from its holding company, but could not substantiate this linkage. Therefore, the tribunal remitted the matter back to the AO/TPO to ascertain whether the exchange loss pertained to loan transactions or trading transactions. The AO/TPO was instructed to treat the loss accordingly and allow the assessee a reasonable opportunity of hearing.

2. Inclusion or Exclusion of Certain Comparables:
The next issue revolved around the inclusion or exclusion of certain comparables in the transfer pricing analysis.

(i) Auro Laboratories Ltd.:
The assessee treated Auro Laboratories Ltd. as comparable, but the TPO excluded it, noting it failed the sales filter. The DRP directed the TPO to include it if it passed all filters. The TPO later excluded it for failing the net fixed assets to sales filter. The tribunal found that the TPO did not include 'Capital work in progress' in the fixed assets calculation, which was incorrect. Including 'Capital work in progress' would allow the company to pass the filter. Therefore, the tribunal ordered the inclusion of Auro Laboratories Ltd. in the list of comparables.

(ii) Neuland Laboratories Limited:
The TPO excluded Neuland Laboratories Limited, citing functional differences. The DRP noted it was engaged in API manufacturing and directed the TPO to include its API segment if segmental data was available and it passed all filters. The assessee contended that Neuland Laboratories Ltd. was engaged in sales of bulk drugs, similar to the assessee, and no segmental data was required. The tribunal found that Neuland Laboratories Ltd. was indeed engaged in manufacturing bulk drugs, matching the assessee’s functional profile. Thus, the tribunal ordered its inclusion in the list of comparables.

(iii) Suven Life Sciences Ltd.:
There was no dispute on the functional comparability of Suven Life Sciences Ltd. The assessee argued that the TPO erred in computing OP/OC by treating 'Loss of forward contracts' and 'MTM of forward contracts' as non-operating items. The tribunal noted that this issue was not raised before the DRP and directed the AO/TPO to examine this contention and decide as per law.

Conclusion:
The tribunal set aside the impugned order on the issue of transfer pricing adjustment and remitted the matter to the AO/TPO for fresh determination of the ALP of the combined international transaction of Manufacturing and Service segments, in accordance with the tribunal’s directions. The assessee was to be given a reasonable opportunity of being heard in the fresh proceedings.

Result: The appeal was allowed for statistical purposes. The order was pronounced in the open court on 03.11.2017.