M/S. DOOWON AUTOMOTIVE SYSTEMS INDIA PVT. LTD.,KANCHEEPURAM vs. JCIT (OSD),, CHENNAI

आदेश /O R D E R

PER CHANDRA POOJARI, ACCOUNTANT MEMBER

“1. The directions of the Dispute Resolution Panel (DRP), the consequential transfer pricing order and the final assessment order is erroneous in so far as determining and quantifying a downward adjustment to the value of international transaction (imports) of the Appellant.

2. The AO/DRP erred in confirming the action of the TPO in not accepting the economic adjustments undertaken by the Appellant.

3. The AO/DRP erred in confirming the action of TPO by not allowing the differential adjustment for basic customs duty without appreciating facts of the case.

4. The AO/DRP erred in confirming the order of the TPO in not providing working capital adjustment while determining the net profit margins of the appellant.

5. The AO/DRP erred in confirming the order of the TPO in treating foreign exchange loss suffered by the assessee as operating expense.

6. The AO/DRP erred in not appreciating the fact that the TPO proceeded to consider foreign exchange loss as non-operating without issuing a Show-Cause notice in respect of this issue and as such to this extent the Transfer Pricing Order is void ab initio.”

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Aggrieved by the order of ld. Assessing Officer consequent to the directions of the DRP, the assessee is in appeal before us.

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6. After hearing both the parties and perusing the material on record, the similar issue came for consideration before this Tribunal in assessee's own case in ITA No.692/Mds./2016 for assessment year 2011-12 vide order dated 25.01.2017 wherein it was held as follows:-

“5. We heard the rival submissions, perused the material on record and judicial decisions. The Ld. AR explained that the company was incorporated in the year 2006 and in the second year of operation. The raw material component include import cost which constitute a major cost and claim adjustment of custom duty (non-cenvatable) before TPO. We rely on co-ordinate bench decision of Motonic India Automotive Pvt. Ltd Vs. ACIT, dated 17.08.2016 at page 5 Para 6 which read as under:-

"6. The ld. AR submitted that in respect of custom duty component suitable adjustment to be made while determining the ALP. In our opinion, the plea of the assessee is justified. The TPO has not considered the custom duty adjustment on the reason that it is equivalent to central excise in commercial market. This is not correct. The Tribunal consistently holding that while determining ALP, there should be suitable adjustment in respect of custom duty, which was considered in the following cases : i) Skoda Auto India (P) Ltd. v. ACIT, Aurangabad (30 SOT 319)[Pune]

- - 5 ITA 2560/Mds/16 ii) Toyota Kirloskar Motors Pvt. Ltd. v. ACIT, Bangalore – iii) Putzmeister Concrete Machines Pvt. Ltd. v. DCIT, Panaji – ITA No. 107/PNJ/2012 iv) Demag Cranes & Components (India) Pvt. Ltd. v. DCIT, Pune in ITA No.120/PN/2011

6.1 At this stage, it is pertinent to mention the finding of the Pune Bench in the case of Demag Cranes & Components (India) Pvt. Ltd. v. DCIT(supra) dated 4.1.2012 in which is as follows :

“37. We have heard the parties and perused the available material on records in the light of the second limb of the ground 4(b). It is relevant mentioned that we have already analysed the relevant provisions of Income Tax rules vis a vis the scope of the adjustments in the preceding paragraphs in the context of the adjustments on account of the ‘working capital’. In principles, our findings on the issue remain applicable to the adjustments on account of the import cost mentioned in ground 4(b) too. The difference between the AL Margin before and after the said adjustments on account of ‘import cost’ works out to 0.57% (7.18%-6.61%). Revenue has not disputed the said working of the assessee. In these factual circumstances and in the light of the scope of adjustments discussed above, in our opinion and in principle, the assessee should win on this ground too. One such decision relied upon by the assessee’s counsel supports our finding relates to the decision of this bench of the Tribunal in the case of - - 6 ITA 2560/Mds/16

Skoda Auto India p Ltd 122 TTJ 699 (Pune) dated March 2009 wherein, it is held (in para 19 of the order) that, “No doubt , a higher import content of raw material by itself does not warrant an adjustment in operating margins, as was held in Sony India (P) Ltd.’s case (supra), but what is to be really seen is whether this high import content was necessitated by the extraordinary circumstances beyond assessee’s control. As was observed by a Co-ordinate Bench of this Tribunal in the case of E-Gain Communication (P) Ltd. (supra) “the differences which are likely to materially affect the price, cost charged or paid in, or the profit in the pen market are to be taken into consideration with the idea to make reasonable and accurate adjustment to eliminate the differences having material effect”. We do not agree with the AO that every time the assessee pays the higher import duty, it must be passed on to the customers or it must be adjusted for in negotiating the purchasing price. All these things could be relevant only when higher import content is a part of the business model which the assessee has consciously chosen but then if it is a business model to import the SKD kits of the cars, assemble it and sell it in the market, that is certainly not the business models of the comparables that the TPO has adopted in this case. The adjustments then are required to be made for functionally differences. The other way of looking at the present situation is to accept that business model of the assessee company and the comparable companies are the same and it is on account of initial stages of business that the unusually high costs are incurred. The adjustments are thus required either

- - 7 ITA 2560/Mds/16 way. It is, therefore, permissible in principle to make adjustments in the costs and profits in fit cases. We also do not agree with the authorities below that the onus is on the assessee to get all such details of the comparable concerns so as to make this comparison possible. The assessee cannot be expected to get the details and particulars which are not in public domain. In such a situation, i.e. when information available in public domain is not sufficient to make these comparisons possible, it is inevitable that some approximations are to be made and reasonable assumptions are to be made. The argument before us was that it was first year of assessee’s operations and complete facilities ensuring a reasonable indigenous raw material content was not in place. The assessee’s claim is that it was in these circumstances that the assessee had to sell the cars with such high import contents, and essentially high costs, while the normal selling price of the car was computed in the light of the costs as would apply when the complete facilities of regular production are in place. None of these arguments were before any of the authorities below. What was argued before the AO was mere fact of higher costs on account of higher import duty but then this argument proceeded on the fallacy that an operating profit margin for higher import duty is permissible merely because the higher costs are incurred for the inputs. That argument has been rejected by a Co-ordinate Bench and we are in respectful agreement with the views of our esteemed colleagues. This additional argument was not available before the authorities below and it will indeed be unfair for us to adjudicate on this factual aspect

- - 8 ITA 2560/Mds/16 without allowing the TPO to examine all the related relevant facts. We, therefore, deem it fit and proper to remit this matter to the file of the TPO for fresh adjudication in the light of our above observations.”

Accordingly, we direct the A.O. to give suitable adjustment against the custom duty component while determining the ALP.”

6.1 Accordingly, this issue is remitted to the file of AO for custom duty adjustment on similar directions given in the above Order of Tribunal.

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7.1 After hearing both the parties and perusing the material on record, the similar issue came for consideration before this Tribunal in assessee's own case in ITA No.692/Mds./2016 for assessment year 2011-12 vide order dated 25.01.2017 wherein it was held as follows:-

“7. The Ld. AR argued that the Assessing Officer/DRP has confirmed the action of the TPO in not providing working capital adjustment while determining net profit margin of the assessee. In the assessee's own case in the assessment year 2009-10, DRP in its order dated 20.12.2013 has directed the TPO to examine the issue and consider working capital adjustment. Whereas, the Ld. TPO observed that the assessee company is actually buying the parts from the AE and working capital adjustment to be allowed if the assessee demonstrates with AE of allowing the credit period to the assessee and DRP confirm the action of the TPO and the Ld. AR demonstrated the Arithmetic Mean of 4.58% of seven comparables selected at Page

41 of paper book and referred to the working capital adjustment PLR of 12.26% with the comparables current assests being sundry

10 - - ITA 2560/Mds/16 creditors, sundry debtors and inventories at Page 42 and supported working capital adjustment of comparables company based on the financial statements. The Ld. DR relied on the order of TPO and prayed for no adjustment is required. Considering the facts and material on record the financial statements and the paper book, there is necessity for working capital adjustment and accordingly we remit the issue to the file of AO to consider the material for fresh consideration.”

7.2 Accordingly, this issue is remitted to the file of AO for custom duty adjustment on similar directions given in the above Order of Tribunal.

8.1 The TPO erred in treating the entire foreign exchange loss suffered by the assessee as operating expense. The TPO grossly erred in treating foreign exchange loss as operating expense without issuing show-cause notice as per Proviso to sec.92C(3) and as such to this extent the Transfer Pricing (“TP”)

11 - - ITA 2560/Mds/16 order is vide ab initio. The TPO order treating foreign exchange loss as operating expense without providing an opportunity to the assessee is opposed to the principle of natural justice and fair play. The TPO erred in not appreciating the fact that the assessee has imported the raw materials at the same price every year and the foreign exchange loss suffered by the assessee is on account exchange fluctuations in currency during the relevant financial year. The assessee has raised the objection during the AY 2011-12 that the TPO erred in not considering foreign exchange gain as operating income while determining the net profit margin of the assessee.”

8.2. The DRP observed during the present year i.e. 2012-13 that the assessee is claiming the reverse of what was claimed last year. The inconsistency in the claims made by the assessee in the two years has not been explained. Last year, the DRP has given the following reasons:-

“The AO is hereby directed to verify the existence or absence of forward contract. In case of forward contract being present, the AO is hereby directed to allow the loss

12 - - ITA 2560/Mds/16 only on the basis of actual realization as termination of the contracts before the end of the financial year.

In this aspect, the department’s stand on this issue is very clear that exchange losses are to be recognized only in the year of actual payment/termination. The claim of ‘Marked to Market losses’ be it for hedging for speculation, is notional and disallowable as per CBDT Instruction

No.03 of 2010 dated 23.03.2010.

As seen from the CBDT Instruction No.03 of 2010,

“Marked to Market losses are ‘notional’ and ‘contingent’ despite that ‘Marked to Market’ settlement is a transparent accounting practice. In terms of this Instruction even actual losses i.e. hedge loss are allowable as non- speculative only if the transaction quality under clause (d) of the proviso to section 43(5). “Marked to Market” losses claimed as notional losses prior to settlement has to be treated as speculative loss in terms of section 43(5).

In case forward contract is not present, the decision of Ltd. Vs. ACIT (2011) 44 SOT 156 (Bang.) is applicable.

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Following the same, objection of the assessee is to be accepted and Assessing Officer / TPO is directed to consider the foreign exchange fluctuation in respect of the assessee as well as the comparables as operating in nature while determining the ALP in the case of the assessee”.

8.3 The TPO has observed that in fact, in the cash flow statement, it is admitted by the assessee under head ‘Cash flow from financing activity’, the entire forex loss of 13.84 crores.

The long term loss as on 31/03/11 was only 1,10,73,388 and as on 31/03/12 it is 2,22,02,204. Therefore, it was clear that it was not on account of financing activities. Therefore, the presentation of the assessee in the financial and in the cash flow statement are contradictory. Under the circumstances, in the absence of clear cut evidence submitted by the assessee as to what was the loss incurred by the assessee as part of its normal transactions and what was the notional loss recognized by the assessee on account of monetary items in the balance sheet as on 31.03.2012, the assessee’s claim that entire loss of 13.84

14 - - ITA 2560/Mds/16 crores has to be treated as non-operating in nature cannot be accepted.

8.4 The arguments of the assessee before the DRP were that the TPO had considered foreign exchange loss as non-operating while issuing the show-cause notice dated 18th December 2015.

However, while passing the final order, the TPO considered the same as operating an enhanced the adjustment. Further, the assessee contended that the TPO did not provide an opportunity for personal hearing or to the assessee to submit the details of the foreign exchange loss suffered by the company. There is nothing contradictory in the financial statements. In cash flow statement, while computing the margins from operations the auditor has rightly excluded the entire forex loss as the same is not due to operations but because of external factors not under the control of management. The Safe Harbor guidelines issued by the CBDT vide also states that loss / gain arising out of foreign exchange fluctuation should not be considered in calculating the operating margins of the assessee. According to the assessee, it is pertinent to note that the price of the raw material imported by the assessee has remained the same every

15 - - ITA 2560/Mds/16 year in $ terms and the foreign exchange loss suffered by the company is on account of the fluctuation in the exchange rates.

8.5 According to the DRP, the claim of the assessee is contradictory in two assessment years on the same facts. The claim of the assessee is that if it is gain then it is operating gain

(AY 11-12), but if it is loss it is non-operating (AY 12-13). This objection / argument of the assessee is inconsistent on the same facts. Further, the Safe Harbor guidelines issued by the CBDT are not applicable for the current year.

8.6 In relation to objection regarding treating foreign exchange gain / loss as non-operating in nature by the TPO, the decision of the ITAT, Chennai (2015) 61 taxmann.com 49 / 70 SOT 410 in the case of Deputy Commissioner of Income-tax, Co. Circle-II(3),

Chennai v. Infac India (P.) Ltd. is applicable. The same is extracted as under:-

“2. The Revenue has raised three elaborate grounds in its appeal; however the crux of the issue is that the Revenue is aggrieved by the direction of the DRP who had directed the TPO to exclude the forex loss from the computation of operating cost of the assessee.------- 7. We have heard the rival submissions, carefully perused the decisions cited by both the parties and arguments advanced by them. In transfer pricing matters, comparisons are drawn in regard to transactions made by the assessee with its Associated Enterprises (AE) and transactions between the 16 - - ITA 2560/Mds/16 business entities who are unrelated parties. In that context operating cost of the assessee company which has transactions with its AEs is compared with operating cost of business entities that are not related to each other. While determining the operating cost, various factors come into play, which may be both internal as well as external. The decisions of each entity in respect of various factors controlling the cost will affect the operating cost. Various risk factors are taken into consideration while making financial commitments, one among them is risk pertaining to foreign exchange fluctuations. Since the holding period with respect to sundry creditors who are raw materials suppliers or debtors arising out of sale transactions is with the management which exposes the entities to forex risks. Therefore, the profit or loss arising out of foreign exchange fluctuations will be directly attributable to the operational cost which has to be essentially taken into consideration while arriving at the operating cost of the entities while computing the profit level indicator (PLI) in transfer pricing matters. Unless there is an abnormal situation resulting in abnormal forex fluctuations, the profit or loss arising due to forex fluctuations cannot be ignored while arriving at the operating cost for deriving the PLI in Transfer pricing matters. It is pertinent to mention here that in arriving at the operating cost in transfer pricing matters the principles of Cost Accounting will not be strictly applicable where cost of finance may be treated differently. For the afore-stated reasons we do not find any merit in the arguments advanced by the Ld. A.R. Further in the following decisions it is made clear that profits or loss arising out of foreign exchange fluctuations ought to be taken into consideration while arriving at the operation cost in transfer pricing matters. --------

Therefore following the decision of the Tribunal and the Special Bench of the Tribunal and for the reasons discussed hereinabove, we hereby hold that profits or loss arising out of foreign exchange fluctuations has to be taken into consideration while arriving at the operation cost in transfer pricing matters. Accordingly, we hereby set aside the order of the Ld.DRP and 17 - - ITA 2560/Mds/16 uphold the order of the Ld. Assessing Officer who has only adopted the order of the Ld.TPO. 8. In the result, the appeal of Revenue is allowed.” Against this, the assessee is in appeal before us.

“8. The next ground is with regard to variation in exchange rate adjustment while determining the ALP. According to the ld. AR, the assessee entered into contract in adverse prices fixed on the prevailing exchange rate and due to fluctuation in exchange rate, there is loss and that exchange fluctuation to be considered while determining the ALP.”

9.1. However, in the present case as rightly pointed out by the ld.D.R that earlier year the assessee claimed foreign exchange loss as operating expenditure. This year assessee has shifted its stand and claimed it as non operating expenditure. There is no 18 - - ITA 2560/Mds/16 consistency in its approach and also no reason has been given for such a change. Being so, in our opinion, foreign exchange loss is to be treated as operating nature only. Hence, this ground is dismissed.