forex and tp

2. FOREX AND ITS IMPACT ON
TRANSFER PRICING
21st
January 2017
Suresh Kumar B.S
Associate Director
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3. CONTENTS
Definition of Forex Exchange Risk
Kinds of Forex Exchange Risk
Impact of Forex Fluctuation on TP
Case Laws
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4. Forex Exchange
 Forex Exchange Risk is a financial risk that exists
when a financial transaction is denominated in a
currency other than that of the base currency of
the Reporting.
 Forex exchange risk also exists when the
company or a entity maintains financial
statements in a currency other than the reporting
currency of the consolidated entity.
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5. Different kinds of Forex Risk
 Transaction Risk
 Translation Risk
 Economic Risk
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6. Transaction Risk
 Transaction FX risk arises when a party agrees to
purchase or sell goods at a specified foreign
currency price, but does not actually make or
receive payment on a later date.
 The forex risk changes in the estimated value of
contract between its quoting, signing and its
execution. Movement of currency may be
tracked and there are unexpected changes in
foreign exchange rates due to economic policy,
Geo political and environmental issues.
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7. Example of Transaction Risk
 Suppose there is a three day lag between a
transaction’s and settlement. The company is
receiving payments in USD which they must
convert into Rupee – Local Currency.
 Here the risk of converting USD into Rupee may
decrease the exchange rate during the contract
days, that risk is called transaction risk.
 time lag between the Transaction date, recording
date, settlement date and payment dates
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8. Translation Risk
 Arises because financial statements of foreign
affiliates which are typically stated in foreign
currencies need to be restated (translated) in
terms of the currency of the parent company
reporting country
 When a home country entity is required to
consolidate its foreign subsidiaries’ income
statements and balance sheets into home currency,
the exchange rates may change.
 Year end financials may be different date
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9. How Does It Arise?
 Arises because financial statements of foreign
affiliates which are typically stated in foreign
currencies need to be restated (translated) in
terms of the currency of the parent
 Main purpose of translation - preparation of
consolidated financial statements
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10. Examples of Translation
Methods
 Plant and equipment, common stock, long-term
debt, and inventory were acquired when the
exchange rate was 66Rs/Dollar
 At the time of Consolidation of financial
statements the exchange rate was 65Rs/Dollar
(at end of period)
 Here the risk of converting Rupee into USD may
decrease the exchange rate during the
consolidation, that risk is called transaction risk.
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11. Economic Risk
 Economic risk, also known as operational or
competitive FX risk, arises when changes in FX
rates alter the competitive position of a business.
 This typically occurs when the business generates
sales in one currency and incurs costs in another.
 Long period of contract execution to be take care
while finalizing the contract.
 There may be clause in the contract to change the
pricing with base currency exchange rate adopted
and to be reviewed with +/- movement
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12. Economic Risk Cont…
 Changes in exchange rate can affect
 Firms directly engaged in international trade
 Purely domestic firms
 Example:
Company XYZ importing goods from Japan to sell in
the US. If the Japanese yen were gain against the
dollar, it would make it more expensive for
Company XYZ to purchase goods for import,
thereby hurting its operations.
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13. Impact of Forex Fluctuation on TP in
India
 Due to Forex gain/loss the revenue of the company
may increase or decrease.
 Forex fluctuation may lead to vary the companies
net operating margin.
 Impact of exchange rates on transfer pricing may
effect the findings of the study.
 Accounting standard (AS -11) and Income tax Act
 capital item - Capitalisation / Charge off
 Revenue item - Income/Expenditure
 Year end revaluation
 Underlining business contracts
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14. Impact of Forex Fluctuation on TP
Cont…
 Operational income - Transfer Pricing reporting
 3CEB – reporting only the transaction value
 Gain or loss is reported as other income
 It is a part of operational income for the purpose of
working of TP margin comparisons (TNMM)
 It is a part of the unit profit for 10A exempt unit
 It is a part of the export income
 It is not part of export income – Assessee if opted
for Safe Harbour rules – specifically excluded in
the rules.
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CASE LAWS

16. M/s. Cisco Systems Services B.E. India Branch vs.
ADIT [ITA(TP) No.270/Bang /2014]
 In this case the TPO had considered foreign exchange
fluctuation gains to be non-operational in nature.
 Where the DRP has stated that Foreign Exchange
Fluctuation has do nothing with the business operations of
tax payers.
 And later when assessee submitted the breakup of
foreign exchange gains, there was an verdict by
the ITAT that Foreign exchange fluctuation
gains/loss to be considered as operational income
while computing the operating margin.
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17. DCIT vs. M/s. Luxottica India Eyewear Pvt. Ltd.
[ITA No.617/Del/2014]
 In this case also there was a issue whether foreign
exchange loss should be treated as operating/ non-
operating expenses.
 Where the sole objective of the revenue is against the
direction of DRP is to apply safe harbour rules.
 But later there was a view from Ld Counsel that
safe harbour rules should not be applied while
considering foreign exchange loss/gain while
arriving at net operating margin.
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18. M/s S Narendra vs. AddlCIT [ITA No.
6839/Mum/2012]
 In this case also there was an argument whether to take
foreign exchange fluctuation as operating/non operating
income.
 Further the tribunal has held that the foreign
exchange gain of the assessee is to be considered as
part and parcel of the profit of the assessee and
therefore should be included for the purpose of
computing the profit margin of the Assessee.
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19. M/s. Kenexa Technologies Pvt. Ltd. Vs. Dy.CIT
[ITA No.243/HYD/2014],
 In the given case there was foreign exchange loss arising
due to the service rendered to it’s A.E and now there was a
question whether the loss has to be treated as operating
expense or not?
 Further the ITAT has held that the foreign exchange
loss of the assessee is to be considered as part and
parcel of the profit of the assessee and therefore
should be included for the purpose of computing the
profit margin of the Assessee.
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