WESTFALIA SEPARATOR INDIA (P) LTD. Vs. ASSISTANT COMMISSIONER OF INCOME TAX
LAWS(IT)-2014-7-37
INCOME TAX APPELLATE TRIBUNAL
Decided on July 18,2014

Appellant
VERSUS
Respondents

JUDGEMENT

R.S.Syal, Member (A) - (1.) THESE cross -appeals - -one by the assessee and the other by the Revenue arise out of the order passed by the CIT(A) on 30th Aug., 2007 in relation to the asst. yr. 2003 -04. The assessee has filed revised grounds. The first issue pressed before us is against the treatment of foreign exchange fluctuation loss as operating cost. Briefly stated, the facts of the case are that the assessee is engaged in the business of rendering services and marketing of separators and decanters and spare parts related to separators and decanters. The assessee has two separate units for 'trading functions' and 'Assembly functions' located at Delhi and Mumbai, respectively. The assessee declared three international transactions in its audit report. Two transactions relating to 'Trading business' are not disputed as the TPO accepted such transactions at arm's length price (ALP). The entire controversy rotates around the international transaction of 'Purchase of components of Plate Heat Exchanger and Braze Plate Heat Exchanger' amounting to Rs. 4.96 crore under the 'Assembly segment.' The assessee applied Transactional Net Margin Method (TNMM) as the most appropriate method. In its transfer pricing study, the assessee showed operating profit margin at 5.83 per cent under this segment, as against the average profit margin at 6.55 per cent of 14 independent comparables. That is how, the assessee claimed that its international transaction under 'Assembly segment' was at ALP. In computing the operating profit margin under this segment, the assessee made certain adjustments to the operating profits. In this appeal, we are concerned only with the adjustment for loss clue to foreign exchange fluctuation (hereinafter also called 'forex loss'). The assessee claimed that forex loss of Rs. 50.04 lac under this segment was an item of non -operating expense. The same was, therefore, expunged from the operating costs. The TPO did not accept the assessee's contention on this issue. He held that foreign exchange loss was required to be considered as part of operating cost. In this manner, he reduced the operating profit margin with such foreign exchange loss and determined the assessee's fresh profit margin at 1.42 per cent. Since the arithmetical mean of the margin of comparables declared by the assessee stood at 6.55 per cent, which was not tinkered by the TPO, he proposed transfer pricing adjustment of Rs. 53.55 lacs on the basis of difference between the operating profit margin of the assessee and that of the comparables. The AO giving effect to the TPO's order, made such addition on account of transfer pricing adjustment. The assessee challenged it before the learned CIT(A) contending that Euro had" shot up like anything from the preceding year's closing of Rs. 42.94 to Rs. 51.91 as on 31st March, 2003. Since such fluctuation was not anticipated, the same was claimed to be in the nature of extraordinary item eligible for exclusion from operating costs. The learned CIT(A) re -examined the entire transfer pricing adjustment made by the AO. Out of 14 comparable cases considered by the TPO, he excluded the case of HMT Bearings Ltd., for the reasons given in the impugned order. The assessee is not aggrieved against the exclusion of this case from the list of comparables. By considering the remaining 13 comparables and restricting the calculation of OP/sales to current year's data alone, instead of multiple year data done by the assessee, the learned CIT(A) finally computed the OP/sales of the remaining comparables at an average of 5.72 per cent. He did not accept the assessee's contention for treating forex loss as non -operating expense. In this way, the assessee's profit margin at 1.40 per cent was considered to be outside the permissible range of the comparables at 5.72 per cent. He increased the amount of transfer pricing adjustment to Rs. 84.15 lac as against Rs. 53.55 lac made by the AO. In this exercise done on page 45 of the impugned order, he applied 5.72 per cent on total sales to work out the above addition. At this stage, it is relevant to mention that the assessee agitated such computation by the CIT(A) through rectification application filed under s. 154 contending, firstly, that transfer pricing adjustment was not to be made with 5.72 per cent, but with the difference between the assessee's profit margin and that of comparables and, secondly, even the calculation by the application of the rate of 5.72 per cent was incorrect, as the resultant figure came at Rs. 64.54 lac instead of Rs. 84.54 lac. The learned CIT(A) agreed with the assessee's point of view in respect of calculation mistake, but did not accept that the point of differential rate between 5.72 per cent and 1.40 per cent for the purpose of transfer pricing adjustment.
(2.) THE assessee is aggrieved against the TP addition sustained by the learned CIT(A) primarily on account of treatment of forex loss as operating expense. We have heard the rival submissions and perused the relevant material on record. The forex gain or loss is the difference between the price at which an import or export transaction was recorded in the books of account on the basis of rate of foreign exchange then prevailing and the amount actually paid or received at the rate of foreign exchange prevailing at the time of actual payment or receipt. Since such forex loss or gain is a direct outcome of the purchase or sale transaction, it partakes of the same character as that of the transaction to which it relates. The Special Bench of the Tribunal in the case of Asstt. CIT vs. Prakash I. Shah : (2008) 118 TTJ (Mumbai) (SB) 577 : (2008) 13 DTR (Mumbai)(SB)(Trib) 353 : (2008) 115 ITD 167 (Mumbai)(SB) has held that foreign exchange fluctuation gain is a part of export turnover. Though such decision was rendered in the context of s. 80HHC, but the same logic applies generally as well. The essence of the matter is that any gain or loss arising out of change in foreign currency rate in respect of transaction for import or export of goods is nothing, but inherent part of the price of import or the value of export. The Hon'ble Supreme Court in Sutlej Cotton Mills Ltd. vs. CIT : 1978 CTR (SC) 155 : (1979) 116 ITR 1 (SC) has held that: 'where profit or loss arises to an assessee on account of appreciation or depreciation in the value of foreign currency held by it, on conversion into another currency, such profit or loss would ordinarily be trading profit or loss if the foreign currency is held by the assessee on revenue account or as a trading asset or as part of circulating capital embarked in the business'. When we read the ratio of the case of Sutlej Cotton (supra) in juxtaposition to that of the Special Bench in case of Prakash I. Shah (supra), there remains no doubt that forex gain or loss from a trading transaction is not only an item of revenue nature, but is, in fact, a part of the price of import or value of export transaction, as the case may be. Operating expense is ordinarily an expense that a business incurs as a result of performing its normal business operations. As the business of 'assembly' done by the assessee under this segment is not possible without purchases and forex gain is in relation to such purchase transactions, we have no hesitation in holding that it is an item of operating cost. 3.2. The learned Authorised Representative disputed the inclusion of foreign exchange loss in the operating cost by arguing that rate of Euro had increased beyond proportions. It was stated that Euro had shot up like anything. Since such fluctuation was not anticipated, the learned Authorised Representative claimed that it was in the nature of extraordinary item and hence liable to be expelled from operating costs. This contention is again bereft of any force. Extraordinary item is normally distinct and unusual from the ordinary activity of the business that is carried on by the assessee. We fail to comprehend as to how the amount of forex loss can be considered as unusual from the ordinary activity of the purchase carried on by the assessee throughout the year from its AE. As it is direct incident of or rather a part and parcel of purchase transaction itself, the same cannot be viewed as an extraordinary item of expense. 3.3. Without prejudice to the above arguments, the learned Authorised Representative contended in the alternative that if forex loss was to be considered as part of operating cost, then, the forex loss in relation to the international transaction undertaken during the year alone should be considered. He invited our attention towards four components of such forex loss tabulated on p. 13 of the impugned order, being, on account of purchases made during the year; on account of earlier year's purchases finally paid in this year; on account of translation difference of outstanding amounts at the end of the year; on account of purchase transactions with unrelated parties. His submission was that only the first component, being the forex loss in respect of international transactions undertaken during the year should be considered. 3.4. We again find this contention to be untenable. The obvious reason is that the calculation under TNMM proceeds on the basis of method of account consistently followed by the assessee. In the case of companies, it is only mercantile system of accounting which is applicable. Under mercantile system of accounting, any income arising out of transactions during the year is accounted for irrespective of its actual receipt. Similarly expenses are recorded at the time of incurring of liability irrespective of the actual payment. TNMM does not require the splitting of expenses and incomes into actually paid and received and then determining the profit margin. It is simple that profit margin is calculated with the figures from the Trading and P & L a/c which are recorded on accrual basis. TNMM does not mandate to first recast the Trading and P & L a/c with the figures of actual receipt or payments in respect of international transaction and then calculate the profit margin. If we accept the contention of the learned Authorised Representative, then it would not only disturb the calculation of operating profits, but also the method of accounting on which TNMM is based. 3.5. There is one more independent reason for which this contention deserves to be rejected because it results in absurdity. It is simple and plain that outstanding creditors out of imports made during the year would be paid in the subsequent year. It is in such subsequent year that the forex gain/loss would eventually arise. So forex gain/loss in respect of an international transaction entered in year one and settled by payment in the year two, would not find its place in the operating cost/revenue either in the year one of entering into international transaction or in the year two at the time of actual payment. The reason is obvious that during the year one in which international transaction of import took place, the amount would be unpaid and during the year two, when payment is made, there would be no matching international transaction. This contention is, therefore, jettisoned. 3.6. Still another argument was raised by the learned Authorised Representative that the forex loss to the extent it is abnormal, be ignored from inclusion in the operating cost. By inviting our attention towards pp. 4K to 4T of the paper book, the learned Authorised Representative submitted that the average rate of Euro during the period 1st April, 2001 to 31st March, 2002 was Rs. 41.52 as against the higher and lower rates of Rs. 44.81 and Rs. 38.68 respectively. It was submitted that any payment of foreign currency at the rate above Rs. 44.81 was abnormal loss, liable to be ignored from operating cost. 3.7. We are again unable to accept this proposition put forth on behalf of the assessee for the reason that forex loss is a natural incident of import. Each item of import leads to forex gain/loss when there is a difference between the rate of foreign currency at the time of purchase and payment. When buying of goods is a core business of the assessee and there is a change in the rate of foreign exchange at the time of payment for goods purchased, such forex gain/loss is simply a recurring item and not any abnormal or non -recurring item of income or expense. Such forex loss/gain may be high or low, but cannot be construed as abnormal or non -recurring nature. The learned Authorised Representative accentuated on the forex loss as an abnormal expense and claimed that any payment of foreign currency at the rate above Rs. 44.81 was abnormal loss liable to be ignored from operating cost. In order to evaluate this contention, it is significant to note that the assessee applied TNMM as the most appropriate method. The calculation of ALP under this method is prescribed in r. 10B(1)(e). Clause (ii) of this sub -rule provides that the: 'net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base'. Clause (iii), which is quite relevant for our purpose provides that: 'the net profit margin referred to in sub -cl. (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market'. The position which follows on conjoint reading of cls. (ii) and (iii) is that net profit margin realized from comparable uncontrolled transactions is adjusted for differences between the international transaction and uncontrolled transactions. It follows that the adjustment is made in respect of the net profit margin of comparable uncontrolled transactions to bring it at par with the international transaction and not vice versa. Secondly, the adjustment is contemplated if there is difference between the assessee's international transaction and comparables which could materially affect the amount of net profit margin in the open market. Coming back to our context, we find that the assessee is claiming that difference in the foreign exchange rate of Euro beyond a particular point is abnormal and hence the same be not considered as recurring expense. This contention is devoid of any merit because of the obvious reason that fluctuation in the foreign currency is across the board and is applicable not only to the assessee but to the comparables as well. It was fairly admitted that in some of the comparable cases, there is a figure of forex gain/loss. This shows that such change in the foreign exchange rate is not assessee -specific so as to warrant any adjustment. As it is applicable to one and all, there can be no case for treating some part of the forex loss as normal and the other as abnormal so as to warrant exclusion of the second part from operating cost by treating it as an abnormal loss. It is further relevant to note that the assessee earned forex gain of around Rs. 18.40 lac under the 'Trading segment'. As such, the contention of the assessee claiming exclusion of some part of the forex loss from the ambit of operating expenses on the basis of the abnormal loss theory, is not sustainable. 3.8. The learned Authorised Representative relied on r. 10T(j) to contend that loss arising on account of foreign currency fluctuations cannot be included in the operating expense. We are not persuaded to give any mileage to the learned Authorised Representative on this count for the simple reason that r. 10T is a part of safe harbour rules notified on 18th Sept., 2013 which are not applicable to the assessment year under consideration. 3.9. Now we will deal with the decisions relied by the learned Authorised Representative in support of his case. The decision of the Delhi Bench in Sumitomo Corporation India (P) Ltd. vs. Dy. CIT [reported at, (2014) 107 DTR (Del)(Trib) 386 - -Ed.] is in the context of interest which the Tribunal held to be non -operating income. There is no reference to any foreign exchange fluctuation gain or loss in that case. The Delhi Tribunal decision in Honda Trading Corp. India (P) Ltd. vs. Asstt. CIT does not stand in view of our above discussion about the non -acceptability of abnormal loss theory in the context of forex loss. The decision of the Mumbai Tribunal in DHL Express (India) (P) Ltd. vs. Asstt. CIT : (2012) 70 DTR (Mumbai)(Trib) 162 does not throw any light on the preliminary question as to whether such forex loss/gain resulted from a trading or a capital transaction. 3.10. In contrast to the above, we find that there is a plethora of decisions rendered by various benches of the Tribunal across the country holding that forex gain/loss is part of operating revenue/cost. To cite a few, the Delhi Bench of the Tribunal in Techbooks International (P) Ltd. vs. Asstt. CIT to which one of us, namely, the AM is party) has held vide its order dt. 28th April, 2014 [reported at, (2014) 106 DTR (Del)(Trib) 185 - -Ed.] that foreign exchange gain or loss is a part and parcel of operating revenue/operating cost. The Bangalore Bench of the Tribunal in SAP Labs India (P) Ltd. vs. Asstt. CIT : (2010) 6 ITR (Trib) 81 (Bang) has also held that foreign exchange gain should be added to the operating revenue. The Mumbai Bench of the Tribunal in Rushabh Diamonds vs. Asstt. CIT in ITA No. 7217 vide its order dt. 26th April, 2013 [reported at : (2013) 155 TTJ (Mumbai) 386 : (2013) 89 DTR (Mumbai)(Trib) 57 - -Ed.] (to which the AM is party) has also held foreign exchange gain as a part of operating profit. 3.1In view of the foregoing discussion, we hold that the learned CIT(A) has taken an unimpeachable view by considering the forex loss of Rs. 50.04 lac as a part of operating cost. The same is, therefore, countenanced.
(3.) 1. The next issue raised by the learned Authorised Representative is against the denial of working capital adjustment. Admittedly, this issue was not before the TPO. The assessee took it before the learned CIT(A) in the form of an additional ground and requested for the grant of working capital adjustment. The learned CIT(A) refused to admit this additional ground. 4.2. Having heard the rival submissions and perused the relevant material on record, we find that the assessment year under consideration is 2003 -04, being the second year of introduction of transfer pricing provisions. Normally, it takes some time in understanding the concepts and modalities of a new provision. This difficulty has also been appreciated by the Special Bench of the Tribunal in Dy. CIT vs. Quark Systems (P) Ltd. : (2010) 132 TTJ (Chd)(SB) 1 : (2010) 42 DTR (Chd)(SB)(Trib) 414. The fact of the matter is that if an assessee is entitled to a particular deduction as per law, the same cannot be refused because of technicalities or ignorance. As the transfer pricing provisions were in rudimentary stage at the material time, the rightful due to the assessee should not have been denied simply because it was not claimed before the TPO but before the CIT(A) for the first time. 4.3. Now coming to the merits of the claim, we find that the Delhi Bench of the Tribunal in Agilent Technologies International (P) Ltd. vs. Dy. CIT (ITA No. 1837/Del/2014) vide its order dt. 15th July, 2014 [reported at, (2014) 165 TTJ (Del) 54 :, (2014) 108 DTR (Del)(Trib) 374 - -Ed.] has held that the assessee cannot be deprived of the working capital adjustment, if it is rightly due. Similar view has been taken in Mercer Consulting (India) (P) Ltd. vs. Dy. CIT in ITA No. 966/Del/2014 [reported at : (2014) 165 TTJ (Del) 28 : (2014) 108 DTR (Del)(Trib) 348 - -Ed.]. In view of the foregoing discussion, we are of the considered opinion that the claim of the assessee for working capital adjustment cannot be rejected at the outset. The impugned order on this issue is set aside and the matter is sent back to the AO/TPO for verifying the calculation so made by the assessee in support of its working capital adjustment, and then allow it as per law, if available, after allowing a reasonable opportunity of being heard to the assessee.;


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