The Delhi Bench of the Income Tax Appellate Tribunal (ITAT) has held that foreign exchange gains arising from regular business operations must be treated as operating income while determining the operating margins under the Transactional Net Margin Method (TNMM). 

The bench of Sudhir Kumar (Judicial Member) and M. Balaganesh (Accountant Member) has  ruled that the Transfer Pricing Officer (TPO) erred in reallocating common expenses based on turnover and in excluding functionally comparable companies without justification, directing a fresh benchmarking exercise. 

The appellant/assessee is engaged in manufacturing machinery and equipment used in oil well drilling and production. Its operations are divided into two segments—Capital Goods and Commodity Products. The transfer pricing dispute related to the sale of finished goods by the Commodity Division to its Associated Enterprise (AE) in the United States, involving international transactions valued at ₹51.68 crore. 

Buy Now: Income Tax (Direct Tax) Judgments Monthly E-Magazine – May 2026

The assessee had benchmarked the transaction using the Transactional Net Margin Method (TNMM), reporting an operating profit margin of 6.61%, which exceeded the average margin of its selected comparables. Accordingly, it concluded that the transaction was at arm’s length. 

The Transfer Pricing Officer disagreed with the assessee’s computation by including foreign exchange gain of ₹2.38 crore from operating income; reallocating common expenses between business divisions based on turnover instead of the company’s long-standing allocation methodology; and rejecting four out of five comparable companies selected by the assessee.

These changes reduced the assessee’s operating margin to (-)1.39%, resulting in a transfer pricing adjustment of ₹3.65 crore. 

The Tribunal rejected the TPO’s approach of treating foreign exchange gain as non-operating income.

Relying on earlier Delhi and Bangalore Tribunal decisions, including D.E. Shaw India Advisory Services Pvt. Ltd., Ericsson India Pvt. Ltd., Global E Business Operations Pvt. Ltd., and Rampgreen Solutions Pvt. Ltd., the Bench held that foreign exchange gains arising from normal business activities are intrinsically linked with operating activities.

Accordingly, the Tribunal directed the TPO to include the foreign exchange gain of ₹2.38 crore as part of operating income while computing the operating margin. 

The Tribunal also found fault with the TPO’s decision to allocate common expenses between the Delhi and Dehradun units based on turnover.

It noted that the assessee had consistently allocated such expenses based on profitability. The same methodology had been accepted in earlier assessment years. There was no material change in facts warranting a different approach.

The Tribunal referred to its earlier ruling in Fujitsu India Ltd., observing that turnover-based allocation may distort profitability and that allocation based on gross profit margins is a more logical and realistic method.

The TPO was accordingly directed to recompute the operating margins using the appropriate allocation methodology. 

Another major issue concerned the rejection of four comparable companies by the TPO.

The Tribunal observed that several of these companies had been accepted as valid comparables by the Department itself in earlier assessment years and that there was no change in the functional profile (FAR analysis) during the relevant year.

It also held that functional similarity under TNMM should be assessed broadly, rather than insisting on identical products.

With respect to Gontermann Pieper, the Tribunal rejected the TPO’s view that it was a persistent loss-making company. It noted that the company had not incurred losses for three consecutive years and therefore failed to satisfy the accepted test for a persistent loss-making comparable.

Consequently, the Tribunal directed the TPO to include all five comparable companies and undertake a fresh benchmarking exercise. 

Apart from the transfer pricing dispute, the Tribunal also examined the disallowance of ₹51.95 lakh claimed as interest expenditure under Section 57(iii).

The assessee had borrowed funds through an External Commercial Borrowing (ECB), invested part of the funds as equity in its wholly owned US subsidiary, and advanced the remaining amount as an interest-bearing loan. While the assessee received taxable interest income from the loan, the Assessing Officer disallowed a proportionate part of the borrowing cost relating to the equity investment, since no dividend income had been earned.

The Tribunal relied on the Supreme Court judgment in CIT v. Rajendra Prasad Moody (115 ITR 519) and held that deduction under Section 57(iii) does not depend upon actual earning of income during the year, provided the expenditure is incurred for the purpose of earning income.

Accordingly, it directed the Assessing Officer to allow the interest deduction of Rs. 51.95 lakh. 

The Delhi ITAT partly allowed the appeal for statistical purposes by restoring the transfer pricing issues to the TPO for fresh computation in accordance with its directions. It also granted full relief on the interest deduction issue while dismissing the challenge to penalty proceedings as premature. 

Membership Required to Access Case Details & Order Copy

To view the complete Case Details and Download Order Copy, you must have an active membership. Please subscribe to continue.

Read More: Bank Attachment Quashed as Madras HC Quashes GST Order Issued Against Deceased Person