2017 (3) TMI 267 - AT - Income Tax

Tribunal revises Transfer Pricing calculations, excludes abnormal forex loss, and adjusts comparables.

Pangea3 and Legal Database Systems Pvt. Ltd. Versus Income Tax Officer, Ward-3 (2) (4), Mumbai and Vice-Versa

The tribunal directed the Transfer Pricing Officer to rework the Profit Level Indicator after excluding the abnormal forex loss and to reconsider the ... TPA - determining the net profit margin - whether all operating expenses should be taken into account and once any item is appearing as an operating cost which is taken into determining the PLI, then there cannot be any reason to exclude any part of the cost subsequently in the garb of making comparability adjustment? - Held that:- We are unable to fully subscribe to such proposition above because, even if an item is taken as an operating cost, however the rule as enshrined under 10B (1)(e)(iii) and 10B(3) clearly contemplates that any difference or abnormality or any extraordinary item which materially affects the cost base or profit, the same needs to be adjusted so as to eliminate the material effect of such difference. Because, the whole spirit of the transfer pricing exercise is to determine the appropriate arms length price. Such an adjustment definitely warrants at times the tinkering of PLI in the exercise of determination of arms length price. If any peculiar abnormality or extraordinary event which has arisen specific in the case of the ‘tested party’ then same needs to be analysed, firstly, by comparing it with uncontrolled transactions with independent entity; and secondly, if such peculiarity is not found in the case of the uncontrolled comparable transactions then the rule envisages that reasonable accurate adjustment should be made which materially affects the cost or profit. Hence, the contention put forth by Ld. CIT DR in our humble opinion is not acceptable. Whether Forex loss is to be reckoned as operating cost or not? - Held that:- As in this case as stated earlier it has not been brought on record that such kind of an exposure of hedging loss on cancellation of forward contracts is there in every comparable uncontrolled transaction, that is, in the case of the other comparables. Risk assumed by the assessee as well as by the comparable entity may be similar but quantum and scale of a risk factor if undermines the computation of PLI of the assessee vis-à-vis the comparables, then our rules under the Indian Transfer Pricing provisions also enshrines that any material difference affecting the cost or profitability between the international transaction and comparable uncontrolled transaction needs to be eliminated by making suitable adjustments. Here in this case, a material difference has arisen in the case of the assessee due to abnormal feature which is qua the assessee in this particular year, (which is abnormal loss on cancellation of forward contract) which admittedly is absent in the cases of comparables with whom the assessee’s transaction is being bench marked, therefore, a suitable adjustment has to be made to factor in the material difference in the PLI. Thus, in our opinion, the loss amounting to ₹ 2,22,52,786/- on account of cancellation of forward contracts out of total forex loss of ₹ 3,41,44,774/- needs to be eliminated from the operating cost and this adjustment is proposed to be made in the case of the assessee which is the tested party. We accordingly direct the TPO/AO to make the adjustment of this amount in the operating cost and rework the PLI. Selection of comparables - Held that:- Assessee company cannot be regarded as low end ITES service provider because engagement of qualified and professional lawyers for providing legal outsourcing services is definitely high end services Issues Involved:1. Transfer Pricing Adjustment2. Treatment of Forex Loss3. Inclusion and Exclusion of Comparables4. Working Capital AdjustmentDetailed Analysis:1. Transfer Pricing Adjustment:The core issue revolves around a transfer pricing adjustment of Rs. 5,36,00,000/- made under the provisions of ITES support services. The assessee company, registered as an STPI unit, provides ITES services to its AE, including legal support services, data processing, and administrative support. The remuneration for these services is cost plus a 15% markup. The assessee selected TNMM as the most appropriate method for benchmarking the international transaction. The TPO, however, recalculated the PLI by including foreign exchange loss as an operating expense and rejected certain comparables proposed by the assessee, leading to a higher adjustment.2. Treatment of Forex Loss:The assessee argued that the foreign exchange loss of Rs. 3.41 crores, particularly Rs. 2.22 crores due to the cancellation of forward contracts, should be treated as non-operating expenses. The TPO considered the forex loss as an operating expense, reducing the PLI to 2.85%. The tribunal held that while forex loss is generally an operating cost, the loss due to the cancellation of forward contracts in this case was an abnormal event. Therefore, the tribunal directed the TPO to exclude the loss on cancellation of forward contracts from the operating cost and rework the PLI.3. Inclusion and Exclusion of Comparables:The tribunal examined the inclusion and exclusion of various comparables:- Acropetal Technologies Ltd.: Excluded due to its involvement in software services and an extraordinary event of acquisition.- Accentia Technologies Ltd.: Remitted back to the TPO to verify the impact of mergers and acquisitions on its profit margin.- eClerx Services Ltd.: Remitted back to the TPO to examine the outsourcing activity and its impact on comparability.- R-Systems International Ltd.: Accepted as comparable since the financial data for the relevant period was available.- Allsec Technologies Ltd.: Remitted back to the TPO to examine the impact of mergers and acquisitions on its loss.- Microland Ltd.: Accepted as comparable as the ITES segment data was available.- Omega Healthcare Management Services Pvt. Ltd.: Accepted subject to the availability of financial data.- IKF Technologies Ltd., Lee & Nee Software Exports Ltd., and Jindal Intellicom Pvt. Ltd.: Remitted back to the TPO for proper comparability analysis.4. Working Capital Adjustment:The tribunal directed the TPO to examine the issue of working capital adjustment in light of the details submitted by the assessee and relevant judicial precedents.Conclusion:The tribunal directed the TPO to rework the PLI after excluding the abnormal forex loss and to reconsider the inclusion and exclusion of certain comparables. The appeal of the assessee was partly allowed for statistical purposes, and the appeal of the Revenue was dismissed.