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2025 (6) TMI 1047 - AT - Income TaxTP Adjustment - Safe Harbour Rules application - working Profit Level Indicator the TPO has invoked Income Tax Rule 10TA - HELD THAT - In this case Assessee has not exercised any such option. Therefore TPO suo-moto is precluded from invoking Rule-10TA. It is also observed that TPO has not discussed why the Foreign Exchange Gain is not Operating Income Assessee has provided I.T. Services to its AEs. Assessee receives revenue from operations entered with AEs in Foreign Exchange. Therefore Gain due to Foreign Exchange Fluctuation is directly linked to the Revenue Receipt. Therefore there is no reason to exclude Foreign Exchange Gain as non-operating. It is also noted that the TPO has considered Foreign Exchange Loss incurred by Assessee on derivative transactions as operating and accordingly reduced it. Therefore TPO is not consistent in his approach. DRP has also upheld it without discussing the reasons. The Hon ble Delhi High Court in the case of Pr.CIT Vs. Fiserve India Pvt. Ltd. 2016 (1) TMI 1276 - DELHI HIGH COURT held that Safe Harbour Rules are not applicable and also upheld ITAT order. No contrary decision has been brought to our notice. Rather ld.DR for the Revenue accepted that treatment should be same for Foreign Exchange Gain and Loss. In these facts and circumstances of the case we hold that the OP/OC calculated by Assessee at 12.89% as Correct. Accordingly Ground No.3 raised by the Assessee is allowed.
1. ISSUES PRESENTED and CONSIDERED
The core legal questions considered by the Appellate Tribunal (AT) in this appeal are: (a) Whether the Assessing Officer (AO) and Dispute Resolution Panel (DRP) erred in enhancing the income of the assessee by rejecting the international transaction pricing on the ground that the provision of IT services was not at arm's length price under the Income Tax Act. (b) Whether the conditions under Section 92C(3) of the Income Tax Act were satisfied to warrant re-determination of the arm's length price by the Transfer Pricing Officer (TPO), and whether the TPO erred in disregarding the transfer pricing analysis submitted by the assessee. (c) Whether the AO and TPO erred in passing the final assessment order without incorporating the DRP's directions, specifically regarding the treatment of foreign exchange expenses in operating margin calculations. (d) Whether the AO and DRP erred in applying additional quantitative filters to reject comparable companies selected by the assessee in its transfer pricing study. (e) Whether the AO and DRP erred in selecting functionally dissimilar companies as comparables for benchmarking. (f) Whether the AO and DRP erred in not granting economic adjustments for differences in risk levels and functional profiles, particularly marketing functions, between the comparables and the assessee. (g) Whether the AO and DRP erred in computing the Profit Level Indicator (PLI) by modifying the operating/non-operating nature of certain income and expense items, especially foreign exchange gains and losses. (h) Additional legal ground raised by the assessee regarding the validity of the assessment order passed beyond the prescribed time limit under Section 153 of the Income Tax Act, relying on a recent High Court decision. 2. ISSUE-WISE DETAILED ANALYSIS Issue (g): Treatment of Foreign Exchange Gain/Loss in Operating Margin Computation Relevant legal framework and precedents: The assessment and transfer pricing proceedings invoked Rule 10TA of the Income Tax Rules, which are the Safe Harbour Rules applicable to eligible assessees who voluntarily opt for them under Rule 10TB and 10TE. The issue revolves around whether foreign exchange gains and losses arising from business operations should be treated as operating or non-operating income/expense for computing the operating profit margin under the Transactional Net Margin Method (TNMM). Precedents relied upon by the assessee include Pune ITAT decisions in Dana India Private Limited, Delval Flow Controls (P.) Ltd., Robertshaw Controls India (P.) Ltd., and others, which held that foreign exchange gains and losses arising from business transactions are operating in nature and should be included in operating income/expenses for transfer pricing purposes. The DRP and TPO relied on Safe Harbour Rules and certain rulings (DIHL Express and NetHawk Networks) to treat foreign exchange gains as non-operating and losses as operating, leading to inconsistent treatment. Court's interpretation and reasoning: The Tribunal observed that Rule 10TA is applicable only to eligible assessees who opt for Safe Harbour Rules, which the assessee had not done. Hence, the TPO was not justified in suo-moto applying Rule 10TA to reclassify foreign exchange gains as non-operating income. The Tribunal noted the inconsistency in the TPO's approach, as foreign exchange losses on derivatives were considered operating expenses, while gains were excluded. The Tribunal emphasized that the assessee provides IT services to its Associated Enterprises (AEs) and receives revenue in foreign exchange. Therefore, foreign exchange fluctuations are directly linked to revenue receipts and form part of normal business operations. Consequently, foreign exchange gains and losses should be treated consistently as operating income/expense. Key evidence and findings: The assessee's TP study included foreign exchange gain and loss as operating items, resulting in an operating margin of 12.89%, which was within the working capital adjusted arm's length range of 9.49% to 14.05% derived from nine comparable companies. The TPO recalculated the operating margin at 5.72% by excluding foreign exchange gains and inconsistently including losses, which was upheld by the DRP without adequate reasoning. Application of law to facts: The Tribunal relied on the Pune ITAT precedents and commercial principles to hold that foreign exchange gains/losses arising from business transactions are operating in nature. It held that the TPO's reliance on Safe Harbour Rules was misplaced as the assessee had not opted for them, and the TPO lacked jurisdiction to apply them suo-moto. Treatment of competing arguments: The Tribunal rejected the Revenue's argument based on Safe Harbour Rules and rulings cited by the DRP, noting the absence of applicability in the present facts and the inconsistency in treatment of gains and losses. It accepted the assessee's argument supported by consistent judicial precedents. Conclusions: The Tribunal held that the operating profit margin computed by the assessee, inclusive of foreign exchange gains and losses, at 12.89% was correct. Ground No.3 was allowed in favor of the assessee. Issues (a), (b), (c), (d), (e), (f): Transfer Pricing and Arm's Length Price Determination Relevant legal framework: Sections 92C(1), 92C(2), and 92C(3) of the Income Tax Act govern the determination of arm's length price for international transactions between associated enterprises. The AO and TPO have the power to examine and re-determine the arm's length price based on transfer pricing analysis and comparables selected. Court's interpretation and reasoning: The Tribunal noted that the assessee had complied with the provisions of Sections 92C(1) and 92C(2) by submitting a Transfer Pricing Study using the Transactional Net Margin Method (TNMM) and selecting nine comparable companies with appropriate adjustments. The AO and DRP had rejected the comparables based on additional quantitative filters and selected functionally dissimilar companies without granting economic adjustments for differences in risk and functional profiles. However, since the Tribunal accepted the assessee's operating profit margin inclusive of foreign exchange gains and losses, it noted that no further adjustments were necessary, and the other grounds challenging the AO/DRP's treatment were not pressed by the assessee. Key evidence and findings: The TP study report prepared by the assessee identified comparable companies and calculated arm's length range and margins. The AO/TPO's rejections and adjustments were based on applying Safe Harbour Rules and additional filters, which were not justified. Application of law to facts: The Tribunal found that the AO/TPO's invocation of Safe Harbour Rules without the assessee's election was improper, and the rejection of comparables and lack of economic adjustments were not substantiated. However, since the acceptance of the assessee's operating margin resolved the primary dispute, the Tribunal did not delve deeper into these issues. Treatment of competing arguments: The assessee argued that the AO/DRP erred in rejecting comparables and in not granting economic adjustments, while the Revenue supported the DRP and TPO's findings. The Tribunal found merit in the assessee's submissions but limited its ruling to the foreign exchange gain/loss treatment. Conclusions: The Tribunal allowed the appeal partly by accepting the assessee's operating profit margin and did not adjudicate the other transfer pricing grounds on merit, as they became academic. Issue (h): Validity of Assessment Order Passed Beyond Time Limit Relevant legal framework: Section 153 of the Income Tax Act prescribes the time limit for completing assessments, including those referred to the Transfer Pricing Officer under Section 92CA. Court's interpretation and reasoning: The assessee raised an additional ground based on a recent High Court ruling that the 33-month time limit under Section 153 applies to the final order and not to draft orders, and that assessment orders passed beyond this limit are null and void. The Tribunal observed that since the primary ground (foreign exchange gain/loss treatment) was decided in favor of the assessee and no further adjustments were pressed, it did not find it necessary to adjudicate the additional legal ground. Conclusions: The additional legal ground was dismissed as unadjudicated. 3. SIGNIFICANT HOLDINGS "The Rule-10TA is applicable only to 'Eligible Assessee's' who voluntarily exercise option of Safe Harbour Rules, in accordance with Rule-10TB and Rule-10TE. In this case, Assessee has not exercised any such option. Therefore, TPO suo-moto is precluded from invoking Rule-10TA." "Assessee provides I.T. Services to its Associated Enterprises and receives revenue in Foreign Exchange. Therefore, Gain due to Foreign Exchange Fluctuation is directly linked to the Revenue Receipt. There is no reason to exclude Foreign Exchange Gain as non-operating." "Several benches of the Tribunal including a recent decision of the Pune Benches have held that foreign exchange gain/loss arising from business transactions is operating revenue/cost." "The operating profit margin calculated by the assessee at 12.89% inclusive of foreign exchange gain and loss is held to be correct." "Since the operating profit margin of the assessee is accepted, no further adjustments are required and other grounds of appeal are not pressed." "The additional legal ground concerning the time limit under Section 153 is dismissed as unadjudicated."
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