The Delhi Bench of the Income Tax Appellate Tribunal has held that foreign exchange fluctuation arising from an assessee’s ordinary business transactions must be treated as an operating item while computing margins for transfer-pricing purposes.

The bench of Satbeer Singh Godara (Judicial Member) and Manish Agarwal (Accountant Member) directed the Transfer Pricing Officer to recompute the arm’s length price after treating the foreign exchange fluctuation loss as operating in nature.

The principal issue raised by the assessee concerned the treatment of foreign exchange fluctuation while calculating the Net Cost Plus margin of the assessee and the selected comparable companies.

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The assessee argued that the TPO, Assessing Officer and Commissioner of Income Tax (Appeals) had incorrectly classified the fluctuation arising from foreign exchange movements as non-operating. It submitted that the fluctuation was incidental to its regular business activities and should consequently form part of the operating results.

Accepting the assessee’s contention, the Tribunal observed that the issue was already covered by its earlier decision in Westfalia Separator India Pvt. Ltd. v. ACIT.

The Bench explained that a foreign exchange gain or loss represents the difference between the value at which an import or export transaction is initially recorded and the amount eventually paid or received after considering the exchange rate prevailing on the settlement date.

Since such gain or loss directly arises from the underlying purchase, sale or service transaction, it assumes the same character as the transaction itself. Therefore, where the underlying transaction is undertaken in the ordinary course of business, the corresponding exchange fluctuation cannot ordinarily be separated from operating revenue or operating costs.

The Tribunal further noted that foreign exchange fluctuation is a natural incident of international business. A change in the value of foreign currency may result in either a gain or a loss, but that circumstance does not make it an extraordinary or non-operating item.

Accordingly, the Bench held that the lower authorities had erred in treating the assessee’s foreign exchange fluctuation loss as non-operating. The TPO was directed to undertake the consequential transfer-pricing computation afresh after treating the fluctuation as an operating item.

In its appeal, the Income Tax Department challenged the CIT(A)’s directions concerning several companies considered for benchmarking the assessee’s international transactions.

The disputed companies included R Systems International Ltd., Accentia Technologies Ltd., Acropetal Technologies Ltd., E-Clerx Services Ltd., Infosys BPO Ltd. and TCS E-Serve Ltd.

R Systems International Ltd. followed a financial year different from the assessee’s accounting period. The TPO had rejected the company on the ground that its financial data did not comply with Rule 10B(4) of the Income Tax Rules.

The CIT(A), however, issued a conditional direction that R Systems could be accepted as a comparable if the assessee produced publicly available quarterly financial data from which figures corresponding to the relevant financial year could be reliably compiled.

Upholding that direction, the Tribunal observed that the CIT(A) had not granted unconditional inclusion of the company. Its inclusion remained subject to the production of relevant financial information satisfying Rule 10B(4). The Revenue could not demonstrate any reason for interfering with this conditional direction.

The Revenue also sought the inclusion of Accentia Technologies Ltd. in the final set of comparables.

The CIT(A) had found that Accentia was involved in product development and sales and therefore failed the functions, assets and risks test applicable to the assessee. The company’s segment-wise financial information was also unavailable.

The Tribunal affirmed these findings and upheld the exclusion of Accentia Technologies.

Acropetal Technologies Ltd. was another company the Revenue wanted to restore to the comparable set.

The Tribunal noted that the CIT(A) had followed the treatment adopted in the assessee’s case for Assessment Year 2009-10. That earlier decision had attained finality. Consequently, the Revenue’s objection against the exclusion of Acropetal Technologies was rejected.

The Tribunal also upheld the exclusion of E-Clerx Services Ltd.

The CIT(A) had found that E-Clerx operated in the knowledge process outsourcing segment, whereas the assessee was engaged in business process outsourcing activities.

The Tribunal relied on the Delhi High Court’s ruling in Rampgreen Solutions Pvt. Ltd. v. CIT, which recognised the material functional differences between KPO and BPO service providers. On that basis, the Bench rejected the Revenue’s attempt to include E-Clerx in the comparable set.

The Tribunal sustained the exclusion of Infosys BPO Ltd. because the company had undergone an extraordinary business event during the relevant year.

The record showed that Infosys BPO acquired the entire voting interest in Portland Group Pty. Ltd. on January 4, 2012. The Tribunal agreed that such an acquisition constituted an exceptional event capable of affecting the company’s financial results and comparability.

The department’s ground seeking the inclusion of Infosys BPO was therefore dismissed.

The department  further challenged the exclusion of TCS E-Serve Ltd.

The Tribunal noted that the CIT(A) had relied upon several judicial precedents holding that TCS E-Serve was not a suitable comparable in the IT-enabled services segment. Finding no reason to depart from those rulings, the Bench rejected the Revenue’s ground.

Apart from the transfer-pricing dispute, the Revenue challenged the deletion of a ₹20.23 lakh disallowance made under Section 14A of the Income Tax Act read with Rule 8D of the Income Tax Rules.

The Assessing Officer had attributed the expenditure to the earning of exempt income. However, the CIT(A) found that the assessee had not earned any exempt income during the relevant previous year.

The Tribunal upheld the deletion by relying on the Delhi High Court’s decision in Cheminvest Ltd. v. CIT. It reiterated that a disallowance under Section 14A cannot be sustained where the assessee has not earned exempt income during the year concerned.

Accordingly, the Revenue’s challenge to the deletion of the ₹20.23 lakh disallowance was rejected.

The assessee had initially contested the disallowance of employees’ contributions to the recognised provident fund, Employees’ State Insurance and Labour Welfare Fund.

The disallowance had been made because the contributions were allegedly deposited after the due dates prescribed under the respective welfare laws, even though the payments were stated to have been made before the due date for filing the income tax return.

During the hearing, however, the assessee informed the Tribunal that it did not wish to press those grounds, subject to the matter not being treated as a precedent. The Tribunal dismissed the grounds in those terms.

The Delhi ITAT ultimately dismissed all the grounds raised by the Income Tax Department. It partly allowed the assessee’s appeal by accepting its additional ground concerning the operating character of foreign exchange fluctuation.

The TPO was directed to recompute the transfer-pricing adjustment after treating the foreign exchange fluctuation loss as an operating item.

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