2019 (5) TMI 2034 - AT - Income Tax

TP Adjustment - international transactions under dispute are with regard to purchase of raw material and sale of financed goods to AE - comparable selection - assessee has submitted that 10 out of 12 comparables brought by TPO were engaged into core auto component as against non-core producers/manufactures by the assessees which are mostly horns HELD THAT - Assessee is mainly into manufacturing of various types of horns i.e. trumpet horns air horns disc horns buzzers. The horn per se cannot be said to be a core auto component and therefore if we go by the distinction drawn by the safe harbor rules as point of reference or understanding the what is core and noncore components then the products of the assessee falls in the category of non-core auto components. The distinction between core and non-core auto components assumes great significance in analysing the FAR analysis because specific characteristics of the auto component manufactured and sold commands different terms of price negotiations margins and kind of assets deployed in terms of technology R D skilled man power etc All the comparable companies are manufacturing core components which are the vital for the running and performance of the vehicle. The distinction between the core and non-core component in an automobile industry assumes great importance because manufacturing of a core component can definitely command much higher price looking to its utility in the vehicle and use of high-end technology and highly skilled human resources as compared to noncore auto component manufacturers. The FAR analysis of the core and non-core in automobile industries are different and that is why statue has recognised this difference and has been introduced in Safe Harbor Rules though brought from prospective date. But such a distinction can always acts like a guide in deciding the difference in FAR and comparability analysis. The reasoning given by the DRP for rejecting comparables are based on sound principles and are thus upheld. Accordingly the transfer pricing adjustment made by the TPO based on such comparables cannot be sustained and hence same are directed to be deleted. DRP s direction to recompute the profit margin of the assessee after treating forex loss as non-operating in nature - HELD THAT - Here in this case the PLI of the comparables has been worked out based on operating profit by total cost. If forex gain/loss has been removed/adjusted as operating cost not only from the tested party but also as well as comparables then it would not affect the working of the PLI. In any case the safe harbor rules which though is not applicable for the year under consideration however have defined the operating expenses and operating revenue. The assessee though has not applied for the Safe Harbor rules but it always be adopted as guidance for interpretation of such items specifically when they have not been defined anywhere in law. The safe harbor has not changed the classification of foreign exchange items but has merely clarified the position by providing the same in the statute specifically when there were many decisions that any item which is not directly connected with the international transaction cannot be considered for bench marking provisions. The safe harbor rules have only clarified the further reinforced the said position. Accordingly we hold that forex loss/gain cannot be treated as operating income/operating cost. Thus the grounds raised by the revenue is dismissed.

Summary

ISSUES:

Whether comparables engaged in manufacturing core auto components can be rejected for transfer pricing analysis when the tested party manufactures non-core auto components.Whether foreign exchange gain/loss should be treated as operating or non-operating item in computation of profit margin under transfer pricing regulations.Whether the internal Comparable Uncontrolled Price (CUP) method can be applied to transactions with the same Associated Enterprise (AE) during the same year based on pre-AE and post-AE periods.Whether transfer pricing adjustments should be made at entity level or proportionate to international transactions with AE.Whether adjustments under Transactional Net Margin Method (TNMM) can be made on both sales and purchase transactions.

RULINGS / HOLDINGS:

Comparables engaged in manufacturing core auto components were correctly rejected by the Dispute Resolution Panel (DRP) because the tested party manufactures non-core auto components; the distinction between core and non-core auto components is recognized and material to Functional Analysis and comparability, as "core auto components are crucial part of automobile that requires sophisticated technology" and "without the core part neither the automobile can run nor can it function."Foreign exchange gain/loss must be treated as a non-operating item in computing profit margins for transfer pricing purposes, consistent with the definitions in Safe Harbor Rules which exclude "loss arising on account of foreign currency fluctuations" from operating expenses and "income arising on account of foreign currency fluctuations" from operating revenue.The internal CUP method cannot be applied to compare pre-AE and post-AE transactions with the same party during the same year, as the relationship of AE is continuous for the whole year.Transfer pricing adjustments should be made only in relation to international transactions with the AE (proportionate adjustment), not at the entity level.Under TNMM, adjustments cannot be made on both sales and purchase transactions; since sales transactions with AE were higher, adjustments if any are to be restricted to sales transactions on a proportionate basis.

RATIONALE:

The Court applied the statutory definitions of "core auto components" and "non-core auto components" as provided in Rule 10TA of the Income Tax Rules (Safe Harbor Rules), using these definitions as a guiding principle for Functional Analysis and comparability despite the rules not being applicable for the year under consideration.The Court recognized that core components (e.g., engine parts, transmission, steering) are vital for the functioning of a vehicle and require higher technology and bargaining power, whereas non-core components (e.g., horns) are ancillary and do not affect the vehicle's running, thus justifying exclusion of core component manufacturers as comparables for a non-core component manufacturer.The Court relied on judicial precedents and Safe Harbor Rules to hold that foreign exchange fluctuations are not part of normal operating income or expenses and thus must be excluded from operating profit calculations in transfer pricing studies.The Court upheld the DRP's consistent approach that the AE relationship subsists throughout the year, precluding internal CUP comparisons based on different periods within the same year.The Court noted that the Safe Harbor Rules provide clarity on operating expenses and revenue definitions, reinforcing that foreign exchange gains/losses are non-operating and should be excluded from profit level indicator computations.The Court dismissed the Revenue's contention that Safe Harbor Rules are inapplicable for the year under consideration, holding that the definitions therein serve as useful interpretative guidance.The Court treated the assessee's cross-objections relating to the internal CUP method as infructuous due to deletion of transfer pricing adjustments.