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Claas India Pvt. Ltd., A-39, First Floor, New Friends Colony, New Delhi. Vs. DCIT, Circle-3(1), New Delhi.
August, 13th 2015


                          ITA No.3883/Del/2010
                         Assessment Year : 2006-07

Claas India Pvt. Ltd.,               Vs. DCIT,
A-39, First Floor,                       Circle-3(1),
New Friends Colony,                      New Delhi.
New Delhi.

  (Appellant)                                (Respondent)

            Assessee By          :    Shri S.P. Singh, CA,
                                      Shri Manomeet Dalal, Advocate &
                                      Shri Vishnu Goel, Advocate
            Department By        :    Shri Amrendra Kumar, CIT, DR &
                                      Ms Y. Kakkar, Sr.DR

         Date of Hearing                 :   10.08.2015
         Date of Pronouncement           :   12.08.2015

     This appeal by the assessee arises out of the final order dated

15.6.2010 passed by the Assessing Officer (AO) u/s 143(3) read with
                                                         ITA No.3883/Del/2010

section 144C of the Income-tax Act, 1961 (hereinafter also called `the

Act') in relation to the assessment year 2006-07.

2.   The first two grounds are general which do not require any specific

adjudication. The ld. AR did not press these grounds as well. These

grounds, therefore, stand dismissed.

3.   Ground no. 3 has three parts. The first part is against some of the

aspects relating to the computation of the Profit Level Indicator (PLI),

being, the Operating Profit/Total Cost (OP/TC) of the assessee.

4.   Briefly stated, the facts of the case are that the assessee was

established as an Indian company in 1990 as a wholly owned subsidiary

of a Claas KGaA mbH, Germany. Until 31.8.2002, the assessee was

known as Escorts Claas Ltd., with 60:40 joint venture between Escorts

India Ltd., and Claas, Germany. Thereafter, the entire shareholding was

acquired by Claas, Germany. The assessee's main activity is

manufacture and sale of harvester combines in India and export of

harvester combines and engine harvester combines and engine related

products, licensed by Claas Group. The assessee manufactures two

                                                         ITA No.3883/Del/2010

types of harvester combines, namely, wheel based and track based.

Certain international transactions were reported by the assessee

including purchase of raw materials and components; sale of harvesters

and spare parts; Import of computer; payment for services; and

allocation of cost. To demonstrate that its international transactions

were at arm's length price (ALP), the assessee applied the Transactional

Net Margin Method (TNMM) as the most appropriate method with the

Profit Level Indicator (PLI) of Operating Profit/Total Cost (OP/TC). All

the international transactions were aggregated and a combined OP/TC

was computed. The first dispute is against the Advances written off,

Fixed assets written off and Loss on foreign exchange, treated by the

TPO as operating costs as against non-operating costs claimed by the


5.    We have heard the rival submissions and perused the relevant

material on record. The first item is `Advances written off' amounting

to   Rs.1,56,007/-.   This amount       finds place   under   Schedule-B

(Administrative and other expenses) in the assessee's Profit and loss

                                                            ITA No.3883/Del/2010

account.     The assessee treated this amount as non-operating in the

calculation of its OP/TC. The TPO held it to be an operating cost. On a

pertinent query, it was admitted by the ld. AR that the Advances so

written off were given in relation to trading items. Like debts becoming

bad from the sale of goods assuming the character of operating cost, the

advances given in relation to trading items, becoming non-recoverable,

also cannot be considered as anything other than an item of operating

cost.     In our considered opinion, such amount has rightly been

considered as an operating cost.

6.      In so far as the Fixed assets written off are concerned, we find that

the amount of Rs.3,84,196/- is distinct from the amount of depreciation

claimed by the assessee at Rs.1.45 crore. This represents a loss on the

fixed assets which has been written off. The purchase of fixed assets is

capital expenditure. As such, the amount of fixed assets when written

off, otherwise than by depreciation, falls for consideration as an item of

non-operating cost. We, therefore, accept the assessee's contention for

treating this sum of Rs.3,84,196/- as non-operating.

                                                          ITA No.3883/Del/2010

7.    The third item is loss on foreign exchange amounting to

Rs.31,22,119/-. On a pertinent query, it was admitted by the ld. AR that

this loss relates to trading transactions.

8.    We find merit in the contention raised on behalf of the assessee

about the inclusion of foreign exchange gain/loss in the operating

revenue/costs of the assessee as well as that of the comparables. When

we advert to the nature of such foreign exchange gain earned by the

assessee, it has been admitted by the ld. AR that the same is in relation

to the trading items emanating from the international transactions. When

the foreign exchange loss directly results from the trading items, we fail

to appreciate as to how such foreign exchange fluctuation loss can be

considered as non-operating.

9.    The Special Bench of the Tribunal in ACIT Vs Prakash I. Shah

(2008) 115 ITD 167 (Mum)(SB) has held that the gain due to fluctuations

in the foreign exchange rate emanating from export is its integral part

and cannot be differentiated from the export proceeds simply on the

ground that the foreign currency rate has increased subsequent to sale

                                                             ITA No.3883/Del/2010

but prior to realization. It went on to add that when goods are exported

and invoice is raised in currency of the country where such goods are

sold and subsequently when the amount is realized in that foreign

currency and then converted into Indian rupees, the entire amount is

relatable to the exports. In fact, it is only the translation of invoice value

from the foreign currency to the Indian rupees. The Special bench held

that the exchange rate gain or loss cannot have a different character from

the transaction to which it pertains. The Bench found fallacy in the

submission made on behalf of the Revenue that the exchange rate

difference should be detached from the exports and be considered as an

independent transaction. Eventually, the Special Bench held that such

exchange rate fluctuation gain/loss arising from exports cannot be

viewed differently from sale proceeds.

10.     In the context of transfer pricing, the Bangalore Bench of the

Tribunal in SAP Labs India Pvt. Ltd. Vs ACIT (2011) 44 SOT 156

(Bangalore) has held that foreign exchange fluctuation gain is part of

operating profit of the company and should be included in the operating

                                                         ITA No.3883/Del/2010

revenue. Similar view has been taken in Trilogy E Business Software

India (P) Ltd. Vs DCIT (2011) 47 SOT 45 (URO) (Bangalore). The

Mumbai Bench of the Tribunal in S. Narendra Vs Addtl. CIT (2013) 32 196 has also laid down to this extent. In view of the

foregoing discussion, we are of the considered opinion that the amount

of foreign exchange gain/loss arising out of revenue transactions is

required to be considered as an item of operating revenue/cost, both of

the assessee as well as comparables. We, therefore, hold that the AO

was justified in considering forex loss as operating cost as against the

assessee's claim of non-operating cost.

11.   The second component of the first ground is against the

computation of transfer pricing adjustment in respect of transaction with

Associated Enterprises (AEs) and non-AEs. Computation of the arm's

length price (ALP) by the TPO on the penultimate page of his order

divulges that he took total costs at Rs.54,72,86,629/-.     By applying

arithmetic mean of the comparables at 12.25%, he proposed a transfer

pricing adjustment of Rs.3,12,57,833/-. The ld. AR contended that no

                                                         ITA No.3883/Del/2010

transfer pricing adjustment is possible in respect of transactions with


12.   It is uncontroverted, as is also apparent from the TPO's order, that

the transfer pricing adjustment has been made by considering the total

costs incurred by the assessee in respect of transactions with the

associated enterprises (AE) and non-AEs. An addition towards transfer

pricing adjustment is made by comparing the assessee's profit rate from

the international transaction with that of comparable uncontrolled

transactions. Under the TNMM, the process is simple in initially finding

out the operating profit margin of the assessee and then the average

adjusted operating profit margin of comparable cases. Such adjusted

profit margin of the comparables constitutes benchmark margin, which

is then compared with the operating profit margin from the assessee's

international transactions with its AE. It is not permissible to make

transfer pricing adjustment, by applying the average operating profit

margin of the comparables, on the assessee's universal transactions

entered into with both the AEs and non-AEs. As the entire exercise

                                                         ITA No.3883/Del/2010

under Chapter-X is confined to computing total income of the assessee

from international transactions having regard to the arm's length price,

there is no scope for computing income from non-international

transactions having regard to the ALP. As the TPO has computed the

transfer pricing adjustment qua all the transactions carried out by the

assessee with reference to the base of `total costs', also inclusive of

costs relevant for transactions with non-AEs, we vacate the impugned

order on this issue and restore the matter to the file of the TPO/AO for

recalculating the amount of addition of transfer pricing adjustment by

taking into consideration the international transactions only under this

segment, to the exclusion of transactions with non-AEs. Needless to say

the assessee will be allowed a reasonable opportunity of being heard.

13.   The third component of this ground is against not considering

operating profit margin from internal comparables in computing the

ALP of international transactions.       The ld. AR was fair enough to

concede that this issue was not taken up before the TPO. However, our

attention was drawn towards the objections taken before the Dispute

                                                          ITA No.3883/Del/2010

Resolution Panel, relevant part of which is available on page 82 of the

paper book, contending that the internal comparables be also taken into

consideration. The direction given by the DRP is silent on this issue.

14.   Clause (i) of Rule 10B(1)(e) stipulates that the net profit margin

from an international transaction with an AE is computed in relation to

cost incurred or sales effected or assets employed etc. Clause (ii) is

material for the present purpose. It provides that the net profit margin

realized by the enterprise or by an unrelated enterprise from a

comparable uncontrolled transaction or a number of such transactions is

computed having regard to the same base. On splitting clause (ii) into

two parts, it divulges that the reference is made to internal and external

comparables. One part of clause (ii) refers to 'the net profit margin

realised by the enterprise .... from a comparable uncontrolled transaction'

and the other part talks of 'the net profit margin realised .... by an

uncontrolled enterprise from a comparable uncontrolled transaction'. It

transpires that whereas the first part refers to the profit margin from

internal comparable uncontrolled transactions, the second part refers to

                                                           ITA No.3883/Del/2010

profit margin from an external comparable uncontrolled transaction.

Thus it is discernible that what is to be compared under this method is

the profit from a comparable uncontrolled transaction. The word

'comparable' may encompass internal comparable as well as external

comparable. There is a signal in the rule itself as to preference to be

given to internal comparable uncontrolled transactions vis-à-vis external

comparable uncontrolled transactions. It is because the delegated

legislature has firstly referred to the net profit margin realized by the

enterprise (internal) from a comparable uncontrolled transaction and,

thereafter, it points out towards the net profit margin realized by an

unrelated   enterprise   (external)        from   comparable   uncontrolled

transaction. Thus where a potential comparable is available in the shape

of an uncontrolled transaction of the same assessee, it is likely to have

higher degree of comparability vis-a-vis the comparables identified

amongst the uncontrolled transactions of third parties. The underlying

object behind the computation of the ALP of an international transaction

is to find out the profit which such enterprise would have earned if the

transaction had been with some third party instead of related party.
                                                          ITA No.3883/Del/2010

When the data is available showing profit margin of that enterprise itself

realized from a third party, it is advisable to have recourse to an

internally comparable uncontrolled transaction. The reason is patent that

the various factors having bearing on the quality of output, assets

employed, input cost etc. continue to remain, by and large, same in case

of an internal comparable. The effect of difference due to such inherent

factors on comparison made with the third parties, gets neutralized when

comparison is made with internal comparable. Ex consequenti, it follows

that an internal comparable uncontrolled transaction is more noteworthy

vis-a-vis its counterpart i.e. external comparable. However, the caveat is

that the internal transaction sought to be compared with should, in fact,

be comparable in a proper manner. Various Benches of the Tribunal

have repeatedly held that internal comparables should be preferred over

external comparables, if these are actually comparables. The Mumbai

bench of the tribunal in Gharda Chemicals Ltd. vs. DCIT (2010) 130

TTJ (Mumbai) 556 has held that internal comparables should be

preferred over the external comparables. Similar view has been taken by

the Pune Bench of the Tribunal in ACIT vs. MSS India (P) Ltd. (2009)
                                                          ITA No.3883/Del/2010

123 TTJ Pune 657.     Since this issue was not taken up before the TPO

and the DRP has not given any finding on specific objection taken

before it in this regard, we are of the considered opinion that the ends of

justice would meet adequately if the impugned order on this score is set

aside and the matter is restored to the file of the TPO/AO with a

direction to decide this issue afresh, as per law, after allowing a

reasonable opportunity of being heard to the assessee.

15.   The only other ground which survives in this appeal is against

confirmation of disallowance of Rs.72,92,082/- on account of expenses

incurred for improving the existing product.

16.   Both the sides are in agreement that the facts and circumstances of

this ground are mutatis mutandis similar to ground no. 3 of the

assessee's appeal for the AY 2005-06. Vide our separate order passed

for the said earlier year, we have accepted the assessee's claim in this

regard by relying on an earlier order passed by the Tribunal in the

assessee's own case for the AY 2007-08. This ground is, therefore,

allowed. In view of our decision on ground no. 3 in favour of the

                                                                 ITA No.3883/Del/2010

assessee, ground no. 4 taken up in the memorandum of appeal, has

become infructuous. The same is therefore, dismissed.

17.       In the result, the appeal is partly allowed.

          The order pronounced in the open court on 12.08.2015.

               Sd/-                                             Sd/-

   [A.T. VARKEY]                                      [R.S. SYAL]
 JUDICIAL MEMBER                                  ACCOUNTANT MEMBER

Dated, 12th August, 2015.
Copy forwarded to:
     1.   Appellant
     2.   Respondent
     3.   CIT
     4.   CIT (A)
     5.   DR, ITAT

                                                         AR, ITAT, NEW DELHI.

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