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Facts
The assessee, KGK Creations Private Limited, appealed against an assessment order concerning transfer pricing adjustments. The dispute involved additions on account of international transactions related to the sale/purchase of jewelry and diamonds, and charging interest on overdue receivables.
Held
The Tribunal held that foreign exchange gains/losses and reversals of provisions for leave encashment and gratuity should be treated as operating items. It also directed the deletion of additions related to the non-charging of interest on overdue receivables, as the assessee did not charge interest to associated enterprises or non-associated enterprises.
Key Issues
Whether foreign exchange gains/losses and provision reversals are operating or non-operating items, and whether interest adjustment is permissible when no interest is charged on overdue receivables from associated and non-associated enterprises.
Sections Cited
143(3), 144C(13), 144B, 254(1), 92C(1), 92C(2), 92C(A)(3), 10TA
AI-generated summary — verify with the full judgment below
Order under section 254(1) of Income Tax Act. PER: PAWAN SINGH, JUDICIAL MEMBER: 1. This appeal by assessee is directed against the Assessment Order dated 25/10/2024 passed u/s. 143(3) read with Section 144C(13) read with Section 144B of the Income Tax-Act, 1961, passed in pursuance of direction of Dispute Resolution Panel-2 New Delhi(DRP) dated 18.12.2023. The Assessee has raised following grounds: 1. “Based on the facts and circumstances of the case, the Appellant craves leave to prefer an appeal against the order passed by the Assessment Unit, Income Tax Department National Faceless Assessment Centre ("NFAC") (hereinafter referred to as the "Assessing Officer" / "AO"] under section 143(3) read with section 144C(13) read with 144B of the Indian Income-tax Act, 1961 ("the Act") in pursuance of the directions issued by the Hon'ble Dispute Resolution Panel-II, Delhi ("DRP") on the following grounds of appeal, which are without prejudice to each other:
A. General ground 1. The Learned Additional / Joint Commissioner of Income-Tax, Transfer Pricing Officer, 2(3), Delhi, (hereinafter referred to as "TPO"), The Hon'ble DRP and Learned Assessing Officer (following the directions of KGK Creation Private Ltd (AY-2021-22) the Hon'ble DRP) erred on facts and in law, in making addition of Rs. 6,24,92,982/- to the value of international transactions undertaken by KCPL. B. Relating to transfer pricing adjustment of Rs. 5,61,68,896/- on international transactions of Sale/ Purchase of Jewellery/ Diamonds 2. The learned AO / TPO erred in facts and in law by not taking into consideration the segmental profitability submitted by the Assessee (certified by statutory auditor) between jewellery manufacturing and diamond trading activity separately and incorrectly adopted entity level margins to test the arm's length price of international transactions pertaining to jewellery manufacturing and diamond trading activity.
The learned AO/TPO erred in facts and in law by ignoring the submission made by the assessee with respect to the computation of operating profit margins of the assessee. The learned AO / TPO erred in considering the following items as non-operating in nature while computing the entity level profitability of the Assessee. Foreign exchange gain INR 4,79,38,136 Sundry balance written off-INR 1,57,099 Reversal of Leave Encashment Provision - INR 23,49,013 Reversal of Gratuity Provision - INR 82,90,502 4. The learned AO / TPO erred in facts and in law by rejecting the following comparable company accepted by the Assessee, by incorrectly stating that the company fails Related Party Transaction Filter of 25%, and subsequently erred in facts and in law by rejecting these same companies stating they fail export filter i.e. > 75% when the export filter itself was rejected a. Bhakti Gems & Jewellery Ltd. b. Zar Jewels Pvt. Ltd. c. Padmavati Chains Pvt. Ltd. d. Sky Gold Ltd. e. Everest Gold Mart Pvt. Ltd. f. Starlineps Enterprises Ltd.
5. The learned AO / TPO erred in facts and in law by rejecting the following comparable companies selected by the Assessee on ground that they are functionally not comparable to the Assessee and subsequently erred in facts and in law by rejecting these same KGK Creation Private Ltd (AY-2021-22) companies stating they fail export filter i.e. > 75% when the export filter itself was rejected a. Ausom Enterprise Ltd. b. Gautam Gems Ltd. c. Zodiac-Jrd-Mkj Ltd. d. Parshva Enterprises Ltd.
6. The learned AO / TPO erred in facts and in law by rejecting Ausom Enterprise Ltd. (i.e. comparable companies selected by the Assessee); on the ground that it fails related party filter i.e. > 25%.
The Learned AO/TPO, on the facts and in the circumstances of the case and in law, erred in rejecting the profit level indicator (PLI) working of the comparable company computed by the Assessee, without giving any cogent reason for the same. The Learned TPO re- computed the profitability of the comparable company without providing any detailed PLI working.
8. The Learned AO / TPO erred in facts and in law, in not providing to the Assessee, detailed search process for arriving at the set of comparable companies selected, thus failing to discharge the onus bestowed by the Act to re-compute the arm's-length price in accordance with Sections 92C(1) and (2) of the Act. C. Relating to transfer pricing adjustment of Rs. 62,94,086/- on international transactions of charging interest on overdue receivables 9. The learned TPO/AO, on the facts and in the circumstances of the case and in law, erred in making an adjustment by considering overdue receivables as a separate international transaction and erred in re- characterizing overdue receivables as interest bearing loans and proposing an interest thereof.
Without prejudice to above, on the facts and in the circumstances of the case and in law, the learned TPO/AO erred in ignoring the fact that the assessee has not charged any interest on delayed export realization from AE and non-AE both which can be seen as an internal comparable for the realization policy of the assessee.
KGK Creation Private Ltd (AY-2021-22)
The learned TPO/AO erred in facts and in law by inappropriately adopting an ad-hoc 60 days as an arm's length credit period to determine overdue receivables from associated enterprises without providing any basis for the same and disregarding the actual credit period of 180 days by the assessee.
The learned TPO/AO, on the facts and in the circumstances of the case and in law, erred in not appreciating the fact that the assessee does not have a policy to either charge interest on overdue receivables or pay interest on overdue payables; in the given case payable to AE significantly exceeded the amount receivable from AE.
13. The learned TPO/AO erred in facts and in law by inappropriately adopting mark up of 425 basis points over LIBOR to determine interest on overdue receivables from associated enterprise and without appreciating that there is no risk faced by the assessee in extending the credit period to the associated enterprises and hence, there is no question of adding any mark up on the notional interest rate considered. The Appellant craves, to consider each of the above ground of appeal
without prejudice to each other and craves leave to add, alter, delete or modify all or any of the above grounds of appeal.”
2. The assessee has filed following modified ground No.3 of the appeal: “The learned AO / TPO erred in facts and in law by ignoring the submission made by the assessee with respect to the computation of operating profit margins of the assessee. The learned AO / TPO erred in considering the following items as non-operating in nature while computing the entity level profitability of the Assessee. Foreign exchange gain - INR 3, 14,81,860/- Sundry balance written off - INR 1,57,099/- Reversal of Leave Encashment Provision - INR 23,49,013/- Reversal of Gratuity Provision - INR 82,90,502/- The Appellant craves, to consider each of the original grounds of appeal without prejudice to each other and craves leave to add, alter, delete or modify all or any of the original / modified grounds of appeal.”
3. Rival submission of both the parties have been heard and record perused. The Learned Authorised Representative (Ld. AR) of the assessee submit KGK Creation Private Ltd (AY-2021-22) that, though the assessee has raised multiple grounds of appeal
, however, there are two substantial grounds of appeal: I. Addition on account of transfer pricing adjustment of Rs. 5.61 crore on account of internation transaction of sale/purchase of jewellery and diamonds. II. Transfer pricing adjustment of Rs. 62.94 lakhs on account of internation transaction of charging of interest of overdue receivable.
4. The Ld. AR of the assessee submit that assessee is in the business of diamond and jewellery. The assessee was having transaction with its Associated Enterprises (AE). The assessee while filing return of income furnish transfer pricing study report, reporting transaction with its Associated Enterprises (AE) Arm’s Length Price (ALP). The Assessing Officer (AO) made reference to Transfer Pricing Officer (TPO) for determination of Arm’s Length Price in respect of transactions reported by assessee in its transfer pricing report (TPSR). During the proceedings before Transfer Pricing Officer (TPO) the assessee furnished required information along with which its Transfer Pricing Study Report. The Transfer Pricing Officer (TPO) was of the view that price charge by the assessee from its AE is not at Arm’s Length and made recommendation of adjustment of Rs. 6.28 crore while passing his order dated 30/10/2023, passed under section 92(C)(A)(3) of the Act on account of sale and purchase of jewellery and diamonds with its Associated Enterprises (AE). The Transfer Pricing Officer (TPO) also recommended adjustment of Rs. 62.94 lakhs on account of delay in receivable from AE. The Assessing Officer on the basis of report/order of Transfer Pricing Officer KGK Creation Private Ltd (AY-2021-22)
(TPO) made addition in draft Assessment Order passed on 18/12/2023. The draft assessment order was served on the assessee. The assessee exercised its option to filed objection before Dispute Resolution Panel (DRP). The DRP upheld the order TPO in its order dated 30/09/2024. On receipt of direction of DRP, the Assessing Officer passed final Assessment Order on 25/10/2024, which is impugned before this bench. The ld AR of the assessee submits that Ground No. 1 in general in nature and is not pressed. Ground No.2 relates to denial of TPO to recognized two different segments i.e. manufacturing and trading segments of assessee. The Ld. AR. of assessee submit that in case Ground No. 3 to Ground No. 7 which relates to transfer pricing adjustment of sale and purchase, is allowed in favour of assessee, the assessee was not press Ground No. 2, however, this should not be considered against the assessee.
Ground No. 3 relates to transfer pricing adjustment in treating certain items at non-operating in nature, which consist of foreign exchange gain, sundry balance written off, reversal of leave encashment provision and reversal of Gratuity provisions. Out of four items, the ld AR of the assessee submits that he is not pressing the item of sundry balance written off. So far as foreign exchange gain is concern, the correct figure of foreign exchange gain is of Rs. 3.14 crore only and not Rs. 4.79 crore as reported, the assessee has already filed modified ground of appeal to this effect. Thus, the claim of assessee may be considered at lower amount to the extent of Rs. 3.14 crore. Such mistake is erupted as the assessee omitted to consider foreign exchange fluctuation loss of Rs. 1.64 crore, details of which is KGK Creation Private Ltd (AY-2021-22) available at Page No. 30 of paper book (PB). The Ld. AR. of assessee carried us through such details, which we find as per the submissions of ld AR of the assessee, thus, the figure of foreign exchange gain for our consideration is of Rs. 3.14 Crore. Thus, we shall adjudicate the modified ground No.3 of appeal, instead of original ground No. 3 of appeal. The ld AR of the assessee submits that each of the foreign exchange item either gain or loss is arising out of purchase and sale transaction, the details of such transaction are available at Page No.439 to 461 of paper book (PB), thus, these are revenue in nature. The gain/loss is arising out of normal business operation. The TPO as well as Dispute DRP while holding the same as non-operating, relied upon Rule 10TA of Income Tax Rules-1962, which pertains to safe Harbor Rules. Safe Harbor Rules are optional and the same is applicable only in case where the assessee has opted for it. Various Higher Courts had taken view that the Foreign Exchange gain or loss arising out of normal business operation is to be considered as operating in nature. Such view has been taken by Courts after considering effect of Safe Harbor Rule to support his contention the Ld. AR. of the assessee relied upon the decision of: Delhi High Court in Pr. CIT v. Ameriprise India Private Limited (ITA No. 206 of 2016), Delhi High Court in the Pr. CIT v. Freescale Semiconductor India Private limited (ITA No. 19 of 2019), Delhi High Court in Pr. CIT v. Samsung India Electronic Private Limited (ITA No. 453 of 2024), Karnataka High Court in the Pr. CIT v. Subex Limited (ITA No. 492 of 2016) and Chennai Tribunal in LS Automotive India Private Limited v. ACIT and others A.Y. 2012-13 and others in (ITA No. 585/Chny/2017).”
KGK Creation Private Ltd (AY-2021-22)
The ld AR of the assessee submits that in series of decision, it has been held than foreign exchange gain or loss to be operating in nature including by Bombay High Court in CIT Vs. Tetra Pak India Private Limited (ITA No. 876 of 2016). The assessee was consistently following practice of treating such foreign exchange gain or loss as operating in nature and which has been accepted by TPO in other years thus, such Foreign Exchange (FE) gain/loss of Rs. 3.14 crore may be directed to treat as operating in nature. On other item of reversal of provision of leave encashment and gratuity, the Ld. AR. of the assessee submit that admittedly this item pertaining to the main activities of assessee. The credit on account of reversal of provisions should be given the same treatment. In each of earlier years, the provisions have been treated as operating item therefore, for this year similar treatment or treating both the items as operating in nature may be directed. The ld AR of the assessee submitted that in case exchange fluctuation gain or loss, reversal of provision of leave encashment and gratuity are considered as operating in nature, other grounds of appeal
that is 4 to 7, which are related with TP issues will also become academic. Further, he is not pressing ground No. 8.
7. On the other hand, the ld Sr. DR for the revenue supported the order of TPO and the DRP. The ld Sr DR for the revenue submits that DRP has passed as detailed order and in para 4.16 has already directed TPO/ AO that items of income/ expenditure treated as non-operating in the nature on the basis of Rule 10TA and in the case of assessee, it should be treated as non- operating. In case of comparable it was treated as non-operating in nature, KGK Creation Private Ltd (AY-2021-22) so there is no anomaly in the margin of comparable. On other two remaining items of reversal of leave encashment and gratuity the ld Sr DR for the revenue supported the order of TPO/ AO.
We have considered the rival submissions of the assessee and have gone through the order of the lower authorities carefully. We have also deliberated on the various case laws relied by the ld AR of the assessee. Since, the ld AR of the assessee has not pressed the item of Sundry balance written off, thus, this part of ground of appeal is dismissed as not pressed. So far as foreign exchange fluctuation is concerned, we find that the TPO treated the same as non-operating in nature on the treated on relying Rule- 10TA. We find that such Rule 10TA pertains to Safe Harbour Rules, and such rules are applicable only when the assessee opted for it. We find that in series of decisions various bench of Tribunal has consistently held that foreign exchange fluctuation either gain or loss is an operating item. Further, Hon’ble Delhi High Court in Pr CIT Vs Ameriprise India Pvt Ltd in also held that foreign exchange fluctuation loss or gain is to be considered as item of revenue/ cost. It was also held that foreign exchange fluctuation loss directly resulted from trading item, it could not be considered as non-operating loss. Similar View was taken by Karnataka High Court in PCIT Vs Subex Ltd in dated 01.10.2021. Thus, in view of aforesaid legal position, we direct the AO/ TPO to treat foreign exchange fluctuation loss/ gain as operating in nature. Turning to the items of reversal of provisions of leave encashment and gratuity, we find that both the items are revenue items. Furthermore, ld AR of the assessee KGK Creation Private Ltd (AY-2021-22) vehemently argued that both these items in earlier years were allowed as operating items, such fact is not controverted by the revenue. Therefore, we direct the AO /TPO to treat both these items as operating items. In the result, Ground no. 3 of the appeal is partly allowed.
9. Considering the facts that we have accepted the primary submissions of the ld AR of the assessee on adjustment, which is subject matter of ground no.3 and allowed relief to the assessee, thus, adjudication on ground No.2, 4 to 8 have become academic.
10. Ground No.9 to 13 relates to Transfer Pricing Adjustment of Rs.62,94,086/- on account of non-charging interest from AE on overdue receivable. The learned AR of the assessee submits that during the hearing before the TPO, the TPO raised issued that the assessee ought to have realized the sale proceed from its AE within a period of 60 days from the date of issuance of invoices. The TPO calculated notional interest and suggested adjustment of Rs.62,94,086/- on account of delay in receivable from AEs. The learned AR of the assessee submitted that before TPO, assessee contended that they have no policy of charging interest with customers. The assessee had never charged interest from its AEs as well as from non-AEs. Before TPO, it was explained that there was average delay of 185 days in realization of sale proceed in case of AEs, whereas in cases of non-AEs it is 545 days. The assessee has not charged any interest either from AEs or from non-AEs, and that is assessee has been keeping his practice in consonance with the business practice as well as members of Gems and Jewellery Expert Promotion Council. Letter of adopting such practice was also furnished KGK Creation Private Ltd (AY-2021-22) before TPO. The TPO as well as the DRP disregarded and ignored submission of assessee which were duly supported by a series of decision relied upon by learned AR of the assessee. The learned AR of the assessee submits that it is a settled position in law that when assessee was not charging interest to its AE as well as non-AEs, TP adjustment in receipt of overdue interest cannot be made. Otherwise, non-charging of interest to non-AE is a valid internal comparable and hence TPO cannot enforce charging of such interest to AE. To support such contention, the learned AR of the assessee relied upon the following decisions of various Hon’ble High Courts and Tribunal. CIT vs. Indo American Jewellery Ltd., in of 2012 (Bom HC), CIT vs. Livingstones in of 2014 (Bom HC), Evonik Degussa India Pvt. Ltd. Vs ACIT in ITA No.7653/Mum/2011 (Mum)(Tribunal), Agilisys IT Services India Pvt. Ltd. v. ITO-9(1) in ITA No.7622 of 2014, Lintas India Pvt. Ltd. vs. ACIT in ITA No.2024 of 2007 (Mum)(Tribunal), S. Vinodkumar Diamonds Pvt. Ltd. vs. DCIT-5(3), in ITA No.79 of 2015 (Mum)(Tribunal) 11. On the other hand, the learned Sr. DR for the Revenue supported the order of TPO/DRP. The learned Sr. DR for the revenue submitted that non charging interest from AEs the assessee has extended benefit to its AE. The TPO has thus rightly computed interest which is on Arms’ Length.
12. We have considered the submissions of both the parties and have gone through the orders of the lower authorities carefully. We find that the TPO suggested adjustment by taking view that there is delay in receivable from AEs. The TPO was of the view that amount should be realised within 60 days from issuance of invoice. The TPO worked out the notional interest KGK Creation Private Ltd (AY-2021-22) and suggested adjustment. Ld DRP confirmed the action of AO/TPO. Before us, the ld AR of the assessee vehemently argued that the assessee was not charging any interest either from its AEs or from non-AEs as per their practice. Such contention of the assessee was not refuted by TPO. We find that before TPO, the assessee specifically contended that there was average delay of 185 days in realization of sale proceed in case of AEs, whereas in cases of non-AEs it is 545 days. The assessee has not charged any interest either from AEs or from non-AEs, and that is assessee has been keeping his practice in consonance with the business practice as well as members of Gems and Jewellery Expert Promotion Council. We find that in a series of decisions as recorded in para-10 (supra), it has been consistently held that when the assessee is not charging interest on account of delay in receivable either from its AEs or from non-AEs, no adjustment of interest in respect of overdue receivable can be made. Thus, respectfully following the decisions of various judicial forums, we direct the AO/TPO to delete such additions. In the result, ground No. 9 to 13 are allowed.
Considering the facts that we have allowed relief to the assessee on ground No. 3 and Ground 9 to 13, therefore all other grounds of appeal
. i.e Ground No. 2 and 4 to 8 have become academic.
14. In the result, the appeal of the assessee is partly allowed. Order announced in open court on 28, March, 2025.