Foreign exchange gains must be treated as operating items in transfer pricing calculations, tribunal confirms

ITAT Bangalore ruled in favor of the appellant on transfer pricing adjustments. The tribunal held that foreign exchange gains should be treated as operating items and either included in operating income or reduced from operating costs, following precedent from SAP Labs case and Delhi HC decision in Ameriprise India. Write-back of liabilities no longer required was also deemed operating in nature since original liabilities were operating expenses. The tribunal directed TPO to reconsider CG Vak Software Exports as a comparable company by properly computing employee costs, noting that employee cost disclosure issues prevented accurate filter application rather than actual failure to meet the 25% revenue threshold.

---

---

Issues Involved:
1. Computation of Operating Profit to Total Cost (OP/TC) and treatment of foreign exchange gain and liabilities written back.
2. Inclusion and exclusion of specific comparable companies in Transfer Pricing analysis.
3. Application of the filter for Related Party Transactions (RPT).

Detailed Analysis:

1. Computation of OP/TC and Treatment of Foreign Exchange Gain and Liabilities Written Back:
The primary issue was the computation of the Assessee's net margin by the Transfer Pricing Officer (TPO). The TPO recomputed the margin by excluding liabilities no longer required written back from operating income and treating foreign exchange gain as non-operating. The Tribunal held that foreign exchange gain should be treated as operating in nature if it relates to the turnover of the relevant assessment year, following precedents like SAP Labs India (P.) Ltd. and Trilogy E Business Software India (P.) Ltd. The Tribunal also ruled that liabilities written back, which were originally operating expenses, should be considered as operating items based on decisions like Sony India (P.) Ltd. and Logica (P.) Ltd.

2. Inclusion and Exclusion of Comparable Companies:
The Assessee contested the inclusion and exclusion of several comparable companies. The Tribunal directed the inclusion of CG-VAK Software and Exports Ltd. if its employee costs met the required filter, following the precedent in Autodesk India (P.) Ltd. The Tribunal also directed the exclusion of Bodhtree Consulting Ltd., KALS Information Systems Ltd., Tata Elxsi Ltd., Infosys Ltd., L&T Infotech Ltd., Persistent Systems Ltd., and Sasken Communication Technologies Ltd. due to functional dissimilarities and differences in business operations, relying on previous rulings in similar cases like Infinera India (P.) Ltd. and Novell Software Development (India) (P.) Ltd.

3. Application of the Filter for Related Party Transactions (RPT):
The Assessee argued that the TPO's application of the RPT filter (>25% of sales) was against the reasonable limit of 15% as held by the Tribunal in the case of 24/7 Customer Com Private Limited. The Tribunal agreed that this filter should be applied consistently and directed the TPO to adhere to the 15% threshold.

Conclusion:
The Tribunal partly allowed the appeals, directing the TPO to recompute the Arm's Length Price (ALP) considering the Tribunal's guidance on the treatment of foreign exchange gain, liabilities written back, and the inclusion/exclusion of specific comparable companies. The Tribunal emphasized the importance of functional comparability and consistent application of filters in Transfer Pricing analysis.

---