Tribunal Directs TNMM Over CUP Method, Corrects Errors, Includes Forex Loss in Operating Expenses

The Tribunal upheld the Transfer Pricing Officer's rejection of the Comparable Uncontrolled Price (CUP) method, directing the use of the Transactional Net Margin Method (TNMM) for benchmarking. It disagreed with treating foreign exchange fluctuation loss as non-operating and corrected the Profit Level Indicator calculation error. The Tribunal allowed the Revenue's appeal, instructing inclusion of foreign exchange fluctuation loss as operating expenses for comparables.

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Issues Involved:

1. Rejection of the Comparable Uncontrolled Price (CUP) method by the Transfer Pricing Officer (TPO).
2. Treatment of foreign exchange fluctuation loss as non-operating expense.
3. Correct calculation of the Profit Level Indicator (PLI) of the comparables and the assessee.

Issue-wise Detailed Analysis:

Issue 1: Rejection of the CUP Method by the TPO

The TPO rejected the CUP method adopted by the assessee for benchmarking its international transactions, arguing that the assessee operated as an independent entrepreneur and should be tested on the basis of its own financial results using the Transactional Net Margin Method (TNMM). The TPO noted geographical, product, timing, and quantity differences in the transactions compared by the assessee and concluded that the CUP method was not reliable. The TPO directed the assessee to carry out an analysis of arm’s length on the basis of TNMM, retaining 15 comparables and calculating the arm’s length price with an arithmetic mean of 5.05% profit margin.

The CIT-(A) upheld the CUP method, stating that the TPO did not provide factual analysis and evaluation of the CUP data. The CIT-(A) noted that the prices paid by the assessee were lesser than those paid by third parties and concluded that the CUP method was valid for arm's length transactions. The CIT-(A) also mentioned that in the subsequent assessment year, the TPO accepted the CUP method for similar transactions.

The Tribunal, however, found that the quality of products and regulatory norms in Europe and India were different, making the CUP method inappropriate for comparison. The Tribunal upheld the TPO's approach of using TNMM, considering the assessee's status as an independent entrepreneur and the comparability of profit margins with other companies in similar market conditions.

Issue 2: Treatment of Foreign Exchange Fluctuation Loss

The CIT-(A) held that foreign exchange fluctuation loss should be treated as non-operating in nature, citing the case of DHL Express (India) Pvt. Ltd., where it was held that such losses do not form part of operational income for a manufacturer not dealing in foreign currency. The CIT-(A) recalculated the arm's length price after excluding the foreign exchange fluctuation loss, concluding that the assessee fell within the +/- 5% range of the ALP as per the provisions of section 92(c) of the Act.

The Tribunal disagreed, referencing the case of McKinsey Knowledge Centre Private Limited, where it was held that foreign exchange gain/loss arising from revenue transactions should be considered as an item of operating revenue/cost for both the assessee and comparables. The Tribunal noted that safe harbour rules excluding such losses were not applicable for the assessment year under consideration. Consequently, the Tribunal set aside the CIT-(A)'s finding and upheld the TPO's inclusion of foreign exchange fluctuation loss as part of operating expenses.

Issue 3: Correct Calculation of the Profit Level Indicator (PLI)

The CIT-(A) identified a clerical mistake by the TPO in using OP/sales as the PLI for comparables but multiplying the mean margin with the cost base of the assessee instead of sales. The CIT-(A) rectified this mistake, but since the assessee did not appeal or file a cross-objection, the Tribunal did not consider arguments regarding the incorrect PLI adopted by the TPO.

Conclusion:

The Tribunal allowed the Revenue's appeal for statistical purposes, directing the AO/TPO to consider foreign exchange fluctuation loss as part of operating expenses for comparables as well. The decision was pronounced in the open court on 15.09.2017.

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