ITAT excludes domestic transactions from transfer pricing adjustments under Section 92BA following Karnataka HC precedent

The ITAT Chennai ruled in favor of the assessee on several transfer pricing issues. The tribunal directed the TPO to exclude specified domestic transactions from transfer pricing adjustments, following the Karnataka HC decision in Texport Overseas P. Ltd., which held that omission of clause (i) of Section 92BA rendered such provisions non-existent. The tribunal also restricted TP adjustments to international transactions only, not entire revenues, and directed treatment of bill discounting charges as finance costs and product development expenses as non-operating. However, adjustments for depreciation, forex losses, and customs duty were denied as these were considered normal business operations.

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1. ISSUES PRESENTED and CONSIDERED

The core legal questions considered in this appeal pertain to the application and scope of Transfer Pricing (TP) provisions under the Income Tax Act, specifically:

• Whether specified domestic transactions (SDTs) are subject to TP adjustments for Assessment Year (AY) 2014-15, given the amendment by Finance Act, 2017 excluding clause (i) of section 92BA.
• Whether TP adjustments can be applied at the entity level or must be restricted only to international transactions with associated enterprises (AEs).
• The validity and correctness of denial or allowance of various economic adjustments claimed by the assessee, including:
• Classification of bill discounting charges as finance cost.
• Adjustment for incremental depreciation on fixed assets.
• Treatment of foreign currency fluctuation loss as operating or non-operating in nature.
• Adjustment for customs duty paid on imports.
• Adjustment for product development expenses incurred.

2. ISSUE-WISE DETAILED ANALYSIS

Issue 1: Applicability of Transfer Pricing Provisions to Specified Domestic Transactions (SDTs)

Relevant Legal Framework and Precedents: Section 92BA defines specified domestic transactions for TP purposes. Clause (i) of Section 92BA was omitted by Finance Act, 2017 with effect from 01.04.2017. The key precedent relied upon is the decision of the Hon'ble Karnataka High Court in Texport Overseas P. Ltd., which held that the omission of clause (i) is curative and retrospective, effectively rendering the TP provisions inapplicable to SDTs for AYs including 2014-15.

Court's Interpretation and Reasoning: The Tribunal observed that the omission of clause (i) of Section 92BA means the TP provisions for SDTs never existed for the relevant AY. Consequently, any reference made to the Transfer Pricing Officer (TPO) for SDTs for AY 2014-15 is bad in law.

Application of Law to Facts: The assessee entered into SDTs amounting to over Rs. 105 crores with related parties who had themselves declared the income. The Tribunal directed exclusion of SDTs from TP adjustments, aligning with the Karnataka High Court ruling.

Conclusions: The Tribunal allowed the assessee's ground to exclude SDTs from TP adjustments for AY 2014-15.

Issue 2: Scope of Transfer Pricing Adjustments - Entity Level vs. International Transactions

Relevant Legal Framework and Precedents: TP adjustments, by definition, apply to international transactions with AEs. The Tribunal referred to the decision of the Chennai Tribunal in Doosan Power Systems India Pvt. Ltd., which held that TP adjustments cannot be applied at the entity level as that would include unrelated party transactions, leading to unjustified tax implications.

Court's Interpretation and Reasoning: The Tribunal agreed with the assessee that applying TP adjustments at the entity level would amount to double taxation and inclusion of unrelated transactions. It directed the TPO to restrict TP adjustments strictly to international transactions with AEs.

Application of Law to Facts: The TPO had proposed a higher entity-level adjustment of Rs. 33.95 crores, but the Tribunal found this approach incorrect and directed adjustment only on international transactions.

Conclusions: The Tribunal allowed the ground for restricting TP adjustments to international transactions only.

Issue 3: Treatment of Bill Discounting Charges as Finance Cost

Relevant Legal Framework and Precedents: Bill discounting is a common financial arrangement used for working capital management, effectively a borrowing mechanism.

Court's Interpretation and Reasoning: The Dispute Resolution Panel (DRP) had rejected the claim that bill discounting charges constitute finance cost, reasoning that it does not involve borrowing or debt. The Tribunal disagreed, holding that bill discounting is inherently a finance operation and should be treated as finance cost.

Application of Law to Facts: The assessee's claim for adjustment of bill discounting charges as finance cost was accepted, and the TPO was directed to consider this adjustment.

Conclusions: The Tribunal allowed the assessee's claim for bill discounting charges as finance cost.

Issue 4: Depreciation Adjustment

Relevant Legal Framework and Precedents: Depreciation adjustments in TP analysis are considered when fixed asset investments are extraordinary or impact comparability.

Court's Interpretation and Reasoning: The TPO and DRP held that the assessee's investment in fixed assets and business expansion were normal business activities, not extraordinary events warranting adjustment. The assessee failed to demonstrate operational differences affecting comparability.

Application of Law to Facts: Given the assessee's long-standing business since 1991, the Tribunal concurred that depreciation adjustment was not justified.

Conclusions: The Tribunal upheld denial of depreciation adjustment.

Issue 5: Foreign Currency Fluctuation Loss

Relevant Legal Framework and Precedents: Forex gains or losses related to export/import transactions are generally considered operating in nature unless proven otherwise.

Court's Interpretation and Reasoning: The assessee claimed that forex loss was extraordinary and non-operating due to significant currency fluctuations. However, the Tribunal noted that the assessee was engaged in exports and imports, and forex fluctuations are inherent to such business operations. The precedent of the Madras High Court in Pentasoft Technologies Ltd. was noted, which held forex losses linked to exports cannot be treated separately.

Application of Law to Facts: The Tribunal rejected the assessee's claim for non-operating treatment of forex loss.

Conclusions: Forex fluctuation losses were held to be operating in nature and no adjustment was allowed.

Issue 6: Customs Duty Adjustment

Relevant Legal Framework and Precedents: Customs duty paid on imports forms part of cost of goods. Adjustments are generally considered if comparable entities have significantly different customs duty burdens.

Court's Interpretation and Reasoning: The assessee argued for customs duty adjustment due to higher import content. However, the Tribunal found the assessee's data generalized and insufficient to demonstrate extraordinary circumstances or comparability differences.

Application of Law to Facts: Without clear, acceptable data, the Tribunal declined the customs duty adjustment.

Conclusions: No customs duty adjustment was allowed.

Issue 7: Product Development Expenses

Relevant Legal Framework and Precedents: Product development or research and development expenses may be adjusted if they do not relate to the year under consideration or if benefits are uncertain.

Court's Interpretation and Reasoning: The assessee contended that product development expenses were not incurred in the year under consideration and benefits may or may not accrue. The Tribunal noted that such adjustment was allowed by the TPO in AY 2012-13 and directed the TPO to consider the same for AY 2014-15, subject to the assessee furnishing substantiating data.

Application of Law to Facts: The Tribunal allowed this adjustment on condition of adequate proof.

Conclusions: Product development expense adjustment was allowed subject to data submission.

3. SIGNIFICANT HOLDINGS

"The resultant effect of omission of clause (i) of Sec. 92BA by Finance Act, 2017 with effect from 01.04.2017 would be that these provisions had never been passed and to be considered as a law never been existed and therefore, the reference made to TPO for AYs 2013-14 and 2014-15 would be bad in law."

"TP adjustments are to be restricted only to international transactions and not to entire revenues earned by the assessee. This adjustment should not be applied at entity level since the same would include the transactions of unrelated parties also."

"Bill discounting is connected with finance operations only and should be considered as finance cost."

"Investment in fixed assets and expansion of business is normal activity in the course of business and not an extraordinary event warranting depreciation adjustment."

"Forex gains / losses are part of normal business operations only and cannot be treated as extraordinary in nature."

"In the absence of clear-cut data, customs duty adjustment cannot be granted."

"Product development expenses not incurred in the year under consideration and benefits uncertain may be considered for adjustment subject to substantiation."

Final Determinations:

• Specified domestic transactions are excluded from TP adjustments for AY 2014-15.
• TP adjustments must be restricted to international transactions with AEs and not applied at entity level.
• Bill discounting charges are to be treated as finance costs and allowed as adjustment.
• Depreciation adjustment is denied as investment in fixed assets is normal business activity.
• Forex fluctuation loss is operating in nature and no adjustment is allowed.
• Customs duty adjustment is denied due to lack of clear data.
• Product development expenses adjustment is allowed subject to submission of supporting data.

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