2021 (2) TMI 938 - AT - Income Tax

TP Adjustment - calculation of the amount of transfer pricing adjustment - ALP of AE transactions computed by the TPO by reducing non-AE sales from the figure of total arm's length costs of the assessee - HELD THAT - On one hand, the TPO took arm's length cost of the entity at ₹ 6364.17 lakh and on the other, he reduced the figure of non-AE sales of ₹ 4566.96 lakhs, which also contains the profit element apart from cost. What ought to have been done was to first compute the total cost in relation to the AE transactions and then increase it with the PLI of comparables for ascertaining the arm's length sale price. The resultant total cost in relation to the AE transactions, under this mechanism, comes to ₹ 1369.23 lakh, which is obtained by multiplying total cost of ₹ 5453.68 lakh with AE sales of ₹ 1530.98 lakh as divided by total sales of ₹ 6097.94 lakh. It is this cost of the transactions with AE which needs to be loaded with the margin of the comparables at 16.64% to find out ALP of the AE transactions at ₹ 1597.06 lakh (₹ 1369.23 lakh x 1.1664 lakhs), calling for further action. TPO erred in computing the assessee's PLI and that of the comparables by treating foreign exchange fluctuation gain as non-operating revenue, which also got echoed at the level of the DRP - No discussion in the TPO's order on the exclusion of the foreign exchange fluctuation gain from the operating revenue in computation of the assessee's operating profit margin. The DRP has held at para 3.4 of its direction that foreign exchange fluctuation gain cannot be considered as operating income by mainly relying on Rule 10TA(k) of the Safe Harbour Rules. Determination of the ALP shall be done in accordance with the safe harbour rules in terms of section 92CB of the Act and ex consequenti, the application of other rules will be ousted. The sequitur is that where such an option is not availed, neither section 92CB gets triggered nor the relevant rules including 10TA(k). In that scenario, determination of the ALP is done de hors the safe harbour rules. Once these rules are kept out of compass, the otherwise settled position by virtue of the judgment of the Hon'ble Delhi High Court in B.C. Management Services Pvt. Ltd. 2017 (12) TMI 255 - DELHI HIGH COURT and various Benches of the Tribunal across the country holding foreign exchange gain/loss as operating revenue/loss in the ALP determination, comes to the fore. Thus foreign exchange gain/loss earned/incurred by the assessee and the other comparables needs to be considered as a part of operating revenue/cost not only for the reason that the assessment year under consideration is prior to the applicability of the safe harbour rules but also that there can be no question of applying Rule 10TA(k) in the absence of the assessee having or exercising option to be subjected to the safe harbour Rules. We set aside the impugned order on this issue and send the matter back to the file of AO/TPO for fresh determination of the ALP of the international transactions under consideration in accordance with the above directions.

Summary

Issues:
Legal tenability of final assessment order under Income-tax Act, 1961 for assessment year 2012-13; Confirmation of transfer pricing adjustment.

Analysis:
1. The appeal challenges the final assessment order dated 16-01-2017 passed by the Assessing Officer under Income-tax Act, 1961 for the assessment year 2012-13, specifically focusing on the transfer pricing adjustment of ?1,03,98,000.

2. The case involves an assessee engaged in manufacturing valves and actuators for industries. The Transfer Pricing Officer (TPO) determined the Arm's Length Price (ALP) using the Transactional Net Marginal Method (TNMM) and external comparables. Disputes arose regarding the calculation of transfer pricing adjustment based on the TPO's methodology.

3. The Dispute Resolution Panel (DRP) partially upheld the TPO's decision, resulting in the transfer pricing addition challenged before the Tribunal. The core issue revolved around the correct calculation of the amount of transfer pricing adjustment.

4. The Tribunal clarified that the TNMM was accepted for benchmarking transactions, with no dispute on comparables or their Profit Level Indicator (PLI). The disagreement centered on the calculation of transfer pricing adjustment, particularly concerning the Arm's Length Price of AE transactions.

5. The Tribunal identified discrepancies in the TPO's computation methodology, notably in excluding foreign exchange fluctuation gain from operating revenue. The Tribunal referenced legal precedents and rules to determine the treatment of foreign exchange gain in operating revenue calculations.

6. The Tribunal emphasized that the application of safe harbour rules, specifically Rule 10TA(k), was optional for eligible assessees. In the absence of opting for safe harbour rules, the ALP determination should not be bound by the exclusion of foreign exchange gain from operating revenue as per Rule 10TA(k).

7. Consequently, the Tribunal set aside the order and directed a fresh determination of the ALP of international transactions, considering foreign exchange gain as part of operating revenue. The appeal was partly allowed for statistical purposes, with no other grounds pressed by the appellant.

In conclusion, the judgment addressed the legal tenability of the final assessment order, focusing on transfer pricing adjustments and the treatment of foreign exchange gain in operating revenue calculations. The Tribunal's decision emphasized the optional nature of safe harbour rules and provided clarity on the correct methodology for determining the Arm's Length Price of international transactions.