2019 (11) TMI 1847 - AT - Income Tax

TP Adjustment - determination of ALP of Forex - CIT(Appeal) on this issue held that the TPO calculated the PLI of the assessee as negative (3.26%) as against the PLI computed by the assessee at 2.95% - HELD THAT - We find that the view taken by the Ld. CIT(Appeal) is in conformity with the view taken by the Tribunal in the case of INA Bearings India Pvt. Ltd. 2019 (6) TMI 478 - ITAT PUNE that the foreign exchange fluctuation (gain/loss) on operating transactions should be considered as operating in nature. Therefore we sustain the relief provided to the assessee on this issue by the First Appellate Authority. Thus ground Nos. 1 and 2 of the Revenue s appeal are dismissed.

Summary

The core legal questions considered by the Tribunal in this appeal and cross objection pertain primarily to the determination of the Arm's Length Price (ALP) with respect to foreign exchange (forex) gains or losses arising from international transactions. Specifically, the issues revolve around:

• Whether foreign exchange gain or loss arising from operating transactions should be treated as operating income/cost or as non-operating income/cost for the purposes of transfer pricing and ALP determination.
• The correctness of the Transfer Pricing Officer's (TPO) computation of the Profit Level Indicator (PLI) excluding or including forex gain/loss.
• The applicability and relevance of safe harbour rules and judicial precedents concerning the treatment of forex gain/loss in transfer pricing assessments for the relevant assessment year.
• Consequentially, the validity of the assessee's cross objection contingent upon the dismissal of the Revenue's grounds.

Regarding the first and primary issue concerning the treatment of foreign exchange gain/loss in ALP determination, the Tribunal considered the relevant legal framework and precedents as follows:

• The Transfer Pricing Officer had computed the PLI as negative (-3.26%) excluding forex gain/loss, while the assessee computed it at 2.95% including forex gain/loss.
• The CIT(Appeal) held that forex gain/loss arising from operating transactions should be regarded as operating in nature, thereby allowing the assessee's contention.
• The Tribunal relied heavily on its own earlier decision in INA Bearings India Pvt. Ltd. Vs. DCIT, which addressed the identical issue of whether forex gain/loss should be included in operating revenue/cost for ALP computation.
• In INA Bearings, the Tribunal observed that the forex gain/loss directly emanated from international trading transactions and could not be severed from the export proceeds or trading revenue. The Tribunal emphasized that the forex fluctuation gain or loss is an integral part of the export transaction and is essentially a translation difference of the invoice value from foreign currency to Indian rupees.
• The Special Bench decision in ACIT Vs. Prakash I. Shah was cited, which held that forex gain/loss arising from exports cannot be treated separately from the export proceeds and must be considered part of the operating revenue.
• The Tribunal rejected the Revenue's reliance on safe harbour rules, noting these rules were not applicable for the assessment year under consideration. Moreover, the safe harbour provisions treat forex gain/loss as non-operating only from the year they were introduced, and prior to that, judicial pronouncements favored inclusion of forex gain/loss in operating income for transfer pricing purposes.
• Further judicial support was drawn from the Delhi High Court's ruling in Principal Commissioner of Income Tax Vs. Ameriprise India Pvt. Ltd. and Pr. CIT Vs. B.C. Management Services Pvt. Ltd., which held that forex fluctuation related to trading transactions prior to the introduction of safe harbour rules should be treated as operating gain or loss.

The Tribunal's interpretation and reasoning were grounded on the principle that the nature of forex gain/loss cannot be detached from the underlying international transaction to which it pertains. It reasoned that since the forex gain/loss arises directly from the trading transactions, it must be treated as operating revenue or cost, both for the assessee and the comparables used in transfer pricing analysis.

In applying the law to the facts, the Tribunal affirmed the CIT(Appeal)'s decision allowing the assessee's treatment of forex gain/loss as operating income/cost. The Tribunal found no merit in the Revenue's contention to exclude such forex gain/loss from operating revenue for ALP computation. The Tribunal explicitly followed its earlier decision in INA Bearings, thereby ensuring consistency in judicial approach.

Regarding competing arguments, the Revenue's reliance on safe harbour rules and certain judicial decisions to treat forex gain/loss as non-operating was systematically addressed and rejected. The Tribunal clarified that safe harbour rules were not applicable for the relevant assessment year and that earlier judicial precedents favored inclusion of forex gain/loss in operating revenue. The Tribunal also distinguished the Revenue's submissions by emphasizing the integral connection between forex gain/loss and the underlying international trading transactions.

Consequently, the Tribunal dismissed the Revenue's grounds 1 and 2 related to the ALP determination of forex income. Since the assessee's cross objection was contingent upon the dismissal of these grounds, it was held to be infructuous and was dismissed accordingly.

Grounds 3 and 4 of the Revenue's appeal were conceded by the assessee and allowed by the Tribunal. Ground 5 was general and did not require adjudication.

Significant holdings of the Tribunal include the following verbatim legal reasoning:

"...the exchange rate gain or loss cannot have a different character from the transaction to which it pertains. The Bench found fallacy in the submission made on behalf of the Revenue that the exchange rate difference should be detached from the exports and be considered as an independent transaction. Eventually, the Special Bench held that such exchange rate fluctuation gain/loss arising from exports cannot be viewed differently from sale proceeds."

"...the amount of foreign exchange gain/loss arising out of trading transactions is required to be considered as an item of operating revenue/cost, both for the assessee as well as the comparables."

The core principle established is that foreign exchange gains or losses arising from international trading transactions must be included in operating revenue or costs for the purpose of transfer pricing and ALP determination, unless specifically excluded by applicable safe harbour rules, which were not effective for the assessment year in question.

In final determinations, the Tribunal:

• Dismissed the Revenue's appeal on grounds 1 and 2 regarding the exclusion of forex gain/loss from operating income for ALP computation.
• Allowed grounds 3 and 4 of the Revenue's appeal as conceded by the assessee.
• Dismissed the assessee's cross objection as infructuous following the dismissal of the Revenue's grounds 1 and 2.