2015 (9) TMI 1172 - AT - Income Tax

Transfer pricing adjustment - Revenue is aggrieved by the direction of the DRP who had directed the TPO to exclude the forex loss from the computation of operating cost of the assessee - Held that - In transfer pricing matters, comparisons are drawn in regard to transactions made by the assessee with its Associated Enterprises (AE) and transactions between the business entities who are unrelated parties. In that context operating cost of the assessee company which has transactions with its AEs is compared with operating cost of business entities that are not related to each other. While determining the operating cost, various factors come into play, which may be both internal as well as external. The decisions of each entity in respect of various factors controlling the cost will affect the operating cost. Various risk factors are taken into consideration while making financial commitments, one among them is risk pertaining to foreign exchange fluctuations. Since the holding period with respect to sundry creditors who are raw materials suppliers or debtors arising out of sale transactions is with the management which exposes the entities to forex risks. Therefore, the profit or loss arising out of foreign exchange fluctuations will be directly attributable to the operational cost which has to be essentially taken into consideration while arriving at the operating cost of the entities while computing the profit level indicator (PLI) in transfer pricing matters. Unless there is an abnormal situation resulting in abnormal forex fluctuations, the profit or loss arising due to forex fluctuations cannot be ignored while arriving at the operating cost for deriving the PLI in Transfer pricing matters. It is pertinent to mention here that in arriving at the operating cost in transfer pricing matters the principles of Cost Accounting will not be strictly applicable where cost of finance may be treated differently. For the afore-stated reasons we do not find any merit in the arguments advanced by the Ld. A.R. We hereby hold that profits or loss arising out of foreign exchange fluctuations has to be taken into consideration while arriving at the operation cost in transfer pricing matters. Accordingly, we hereby set aside the order of the Ld.DRP and uphold the order of the Ld. Assessing Officer who has only adopted the order of the Ld. TPO. - Decided in favour of revenue.

Issues Involved:
1. Inclusion of forex loss in the computation of operating cost for transfer pricing purposes.
2. Applicability of OECD guidelines and various tribunal decisions on forex loss treatment.
3. Determination of whether forex loss is an operating or financial expenditure.

Issue-wise Detailed Analysis:

1. Inclusion of Forex Loss in Operating Cost:
The primary issue in this case is whether forex loss should be included in the computation of operating cost for transfer pricing purposes. The Transfer Pricing Officer (TPO) included the forex loss in the operating expenses, citing OECD guidelines and previous tribunal decisions which held that forex loss/gains should be considered as a part of operating income. The assessee argued that forex losses should be excluded from operating expenses as they are financial transactions, not operating transactions.

2. Applicability of OECD Guidelines and Tribunal Decisions:
The TPO relied on OECD guidelines, which suggest that forex loss/gain related to revenue transactions should be included in margin calculations. The TPO supported this with decisions from SAP Labs, Four Soft, and Trilogy Ebusiness, which considered forex loss/gains as part of operating income. The assessee countered with the decision in DHL Express (India) Pvt Ltd, where it was held that exchange fluctuations do not form part of operational income. The DRP accepted the assessee's contention and directed the TPO to exclude forex loss from the operating profit margin computation.

3. Determination of Forex Loss as Operating or Financial Expenditure:
The assessee argued that forex loss should be treated as a financial cost, not an operating cost, citing various reasons including Accounting Standard (AS)-11 and guidance from the Institute of Cost Accountancy of India. They emphasized that forex loss results from global factors beyond the assessee's control and should not be considered part of normal business operations. The assessee also referenced tribunal decisions in Sumitomo Corporation of India P Ltd and Honda Trading Car India Pvt Ltd, which supported the exclusion of forex loss from operating expenses.

Tribunal's Analysis and Decision:
The tribunal analyzed rival submissions and relevant decisions. It emphasized that in transfer pricing matters, the operating cost of transactions with Associated Enterprises (AEs) should be compared with that of unrelated entities. The tribunal noted that forex fluctuations are inherent to business transactions and should be considered in operating cost calculations unless they result from abnormal situations. The tribunal cited several decisions, including those in Westfalia Separator India Pvt. Ltd., Cisco Systems Services B. E. India Branch, CSR India Pvt. Ltd., S Narendra, Trilogy E-Business Software India Pvt. Ltd., and SAP Labs India (P) Ltd., which supported including forex gains/losses in operating costs.

Conclusion:
The tribunal concluded that forex gains/losses should be included in the operating cost for transfer pricing purposes. It set aside the DRP's order and upheld the TPO's decision to include forex loss in the operating expenses. The appeal of the Revenue was allowed.

Order Pronouncement:
The order was pronounced on 17th July 2015 at Chennai, allowing the Revenue's appeal.

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