Income Tax Appellate Tribunal - Delhi
Net Freight (India) Pvt. Ltd, New Delhi vs Department Of Income Tax on 31 December, 2013
1
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCHES : "G" NEW DELHI
BEFORE SHRI J.SUDHAKAR REDDY, A.M.
AND SHRI RAJPAL YADAV, J.M.
ITA no. 4670/Del/2009
Assessment Year : 2004-05
ITO, Ward 7(1) vs. Net Freight (India)P.Ltd.
R.No.305, C.R.bldg. A 250, Lane no.6, NH 8
New Delhi Mahipalpur Extn.
New Delhi 110 037
(Appellant) (Respondent)
Appellant by:- Smt.Renuka Jain Gupta, Sr.D.R
Respondent by:- Shri Suresh Ramachandran, C.A.
Shri Sanjesh Jawarani, C.A.
ORDER
PER J.SUDHAKAR REDDY, AM
This is an appeal by the Revenue against the order of the Ld.Commissioner of Income Tax (Appeals)-XX, New Delhi dt. 13.10.2009 pertaining to the A.Y. 2004-05, on the following grounds.
"1. Ld.Commissioner of Income Tax (Appeals) erred in law and on the facts and circumstances of the case, in deleting the addition of Rs.43,69,441/- made by the A.O. on account of international transactions with its associate enterprises.
2. The appellant craves to amend, modify, alter, add or forego any ground of appeal at any time before or during the hearing of this appeal."
2. Facts of the case: The assessee is a company and is in the business of air freight, ocean freight and land transport and also in the business of freight 2 contractors and agents, forwarding packing, hauling and transport agents and also to arrange for the transportation of person and of goods, wares and merchandise of every kind nature and description by all means of transport by air, land sea and inland waterway. It filed its return of income declaring 'nil income' after adjusting total income against brought forward losses on 01.11.2004. The issue before us is transfer pricing adjustment.
3. The facts relating to the issue of transfer pricing are brought out at pages 2 to 5 of the Ld.Commissioner of Income Tax (Appeals)'s order. For ready reference we extract pages 2 to 5 of the same.
"ADJUDICATION OF TRANSFER PRICING ISSUE
3. During the assessment proceedings, the AO noticed the following International Transactions entered into by the appellant during the financial year 2003-04, as reported in Form 3CEB, filed along with the return of income.
S. Type of International Transactions Method selected Value of No. transactions 1. Cost Collection Received Profit Split Method 4,43,99,085 2. Cost Collection Paid Profit Split Method 6,69,842 3. Interest on Loan CUP 52,21,940 4. Cost Allocation CUP 2,52,445
4. A reference was made by the AO under Section 92CA(1) of the Act to the Transfer Pricing Officer (TPO) for computation of Arm's Length Price in respect of the above International Transactions. The TPO however, didn't agree with the analysis undertaken by the appellant for determination of arm's length price of the International Transaction the appellant had with its Associated Enterprises and consequently the TPO suggested an adjustment of Rs.43,69,441 on account of difference in arm's length price to the value of International Transactions. 3 TRANSFER PRICING REPORT
5. S-Net Freight (India) Pvt. Ltd is a subsidiary of S-Net (Holdings) Pvt. Ltd, Singapore. It provides freight forwarding services to the customers in India. S-Net Indian and its fellow subsidiaries mutually appoint each other as the others exclusive agents with respect to the transportation of shipment to and from these territories.
In order to determine the arm's length price of the International Transaction with its Associated Enterprises the appellant used the Profit Split Method for cost collection received and cost collections paid.
5.1 In the documents filed by the appellant the application of the most appropriate method has been described as under:
"The Company's dealing with its Associates consists of an arrangement of profit sharing ratio of 50% of all transactions of in bound and out bound shipments (specimen enclosed). All these transactions are subject to supplementary agreement enclosed".
5.2 In the Transfer Pricing study the appellant rejected the Transaction Net Margin Method (TNMM) as the most appropriate method because of the reason that the search did not lead to satisfying results and the companies with which comparison was made selected from the public domain, were either courier or transport companies and not Freight Forwarding Companies. The appellant finally after making appropriate functions, assets, and risk (FAR) analysis settled on Residual Profit Split Method as most appropriate method, in order to determine the arm's length nature of the International Transaction with its Associate Enterprises.
TRANSFER PRICING ORDER
6. After going through the Transfer Pricing documentation and other details filed by the appellant during the transfer pricing proceedings, the TPO came to the conclusion that since the sufficient information was not available to determine whether the arrangement of profit sharing rate of 50% is appropriate or not, therefore in the appellant's case the TNMM (and not the profit split method) is the Most Appropriate Method (MAM) to determine whether the International Transaction undertaken by the appellant with its AE is at arm's length or not.
The TPO therefore used TNMM method in the appellant's case and determined the Arm's Length Price of the International Transaction after taking into account the following:-
4
(i) In order to reach to the conclusion that in appellant's case TNMM is the Most Appropriate Method (MAM), the TPO stated that as per guidelines of statutory provisions of Rule 10C the most appropriate method is dependent (a) On availability of complete and reliable data,
(b) Degree of comparability between controlled and uncontrolled companies,
(c) The number, magnitude and accuracy of adjustment.
(ii) The TPO visited the public database "Capitaline and Prowess" and after using the industry specification as «Cargo and Couriers", Freight Forwarding Services" and «Logistics Services" and applying certain filters came to the conclusion that following 7 companies are broadly comparable with the appellant and after using the current year data found that the average net operating margin of the comparable was 7.17% as against 2.56% that of the appellant.
Sl.No. Company Name Net Profit
Margin (%)
1. ABC India Ltd. 4.85
2. Blue Dart Express Ltd. 13.68
3. Gati Limited 4.57
4. Patel On Board Couriers Ltd. 3.61
5. Transport Corporation of India Ltd. 7.82
6. South Asia Corporation 8.10
7. Inter State Oil Carriers Ltd. 7.61
Average: 7.17%
(iii) Since the appellant's operating margin of 2.56% was less than the average margin of the comparables of 7.17%, TPO therefore made an adjustment of Rs.43,69,441 on account of arm's length margin.
4. On appeal the Ld.Commissioner of Income Tax (Appeals) accepted the plea of the assessee and deleted the T.P. adjustment. Aggrieved the Revenue has filed this appeal before us.
5
5. We have heard Smt.Renu Jain Gupta, Ld.Sr.D.R. on behalf of the Revenue and Shri Suresh Ramachandran, C.A. the Ld.Counsel for the assessee.
6. Ld.D.R. submitted that the assessee in its T.P.report determined profit split method as the most appropriate method for determining the ALP. She submitted that the same is not in accordance with Rule 10(1)(D) of I.T.Rules. She supported the order of the TPO as well as the A.O. and submitted that when the profit related method is not applicable and when the assessee does not properly apply the said method, then the Assessing Officer is entitled to determine the most appropriate method, which in this case was TNMM method. She stated that the assessee in its T.P. study stated that no bench marking was made for profit split method, which is against the rules.
7. The Ld.Counsel filed a paper book running into 102 pages. He filed a synopsis and also relied on the following case laws:
(a) ITA 4427/Mum/2010 - ACIT vs. Danzas Lemuir P.Ltd.
(b) ACIT vs. Agility Logistics P.Ltd. 2012 (136) ITD 0046-TBOM,ITAT, Mumbai
(c) Philips Software Centre P.Ltd. vs ACIT, 26 SOT 226, ITAT, Bangalore
(d) MSS India P.Ltd. 25 DTR 119, Pune Bench of ITAT He submitted that PSM is the only method which is most appropriate method on the facts and circumstances of the case. He submitted that the requisite documents were submitted to the A.O. in the remand proceedings and there 6 was no default on the part of the assessee on the issue of compliance. He argued that the A.O. while adopting TNMM has taken the comparables without any application of mind and that an addition by adopting the net profit rate at 7.15 as against 2.56% declared by the assessee. He disputed the comparables taken by the A.O. He submitted that the A.O. cannot substitute the most appropriate method. The Ld.Counsel submitted that the department has not rejected the assessee's adoption of Profits Split Method, in all the subsequent AYs i.e. 2007-08/2008-09 and 2009-10. Assessment orders were filed in support of its contentions. Thus on the principle of consistency he submits that the Revenue's appeal should be dismissed.
8. Rival contentions heard. On a careful consideration of the facts and circumstances of the case and on a perusal of the papers on record as well as the orders of the authorities below and case laws cited, we hold as follows.
9. The assessee has come to a conclusion that profit split method is the most appropriate method. Under Rule 10 B(1)(d) profit split method is as follows.
10(B)(1)(d) : Profit split method, which may be applicable mainly in international transactions involving transfer of unique intangibles or in multiple international transactions which are so inter related that they cannot be evaluated separately for the purpose of determining the arm's length price of any one transaction, by which -
(i) The combined net profit of the associated enterprises arising from the international transaction in which they are engaged, is determined;7
(ii) The relative contribution made by each of the associated enterprise to the earnings of such combined net profit, is then evaluated on the basis of the functions performed, assets employed or to be employed and risks assumed by each enterprise and on the basis of reliable external market data which indicates how such contribution would be evaluated by unrelated enterprises performing comparable functions in similar circumstances;
(iii) The combined net profit is then split amongst the enterprises in proportion to their relative contributions, as evaluated under sub clause
(ii);
(iv) The profit thus apportioned to the assessee is taken into account to arrive at an arm's length price in relation to the international transaction:
Provided that the combined net profit referred to in sub-clause (i) may, in the first instance, be partially allocated to each enterprise so as to provide it with a basic return appropriate for the type of international transaction in which it is engaged, with reference to market returns achieved for similar types of transactions by independent enterprise and thereafter, the residual net profit remaining after such allocation may be split amongst the enterprises in proportion to their relative contribution in the manner specified under sub clauses (ii) and (iii), and in such a case the aggregate of the net profit allocated to the enterprise in the first instance together with the residual net profit apportioned to that enterprise on the basis of its relative contribution shall be taken to be the net profit arising to that enterprise from the international transaction; (Emphasis ours).
9.1. A plain reading of the Rules demonstrate that profit split method is applicable mainly in international transactions: (a) involving transfer of unique intangibles; (b) in multiple international transactions which are so interrelated that they cannot be valuated separately.8
9.2. The method specifies in Clause (ii) that the relative contribution made by each of associated enterprise should be evaluated on the basis of FAK analysis and on the basis of reliable external data. Thus, bench marking by selection of comparables is mandatory under this Method.
9.3. The Special Bench of the Tribunal in the case of Aztek Software vs. ACIT, Bangalore (SB) 294 ITR (AT) 32 at page 126 observed as follows.
"181. This method may be applicable in cases where transactions involved transfer of unique, intangible or any multiple interrelated international transactions, which cannot be evaluated separately for determining the ALP of any one transaction.
The profit split method first identifies the profit to be split for the associated enterprise from the controlled transactions in which the associated enterprises are engaged. It then splits those profits between the associated enterprises on an economically valid basis that approximates the division of profits that would have been anticipated and reflected in an agreement made at arm's length. The combined profit may be the total profit from the transactions or a residual profit intended to represent the profit that cannot be readily assigned to one of the parties, such as the profit arising from high value, some times unique, intangibles.
The contribution of each enterprise is based upon a functional analysis and valued to the extent possible by any available reliable external market data. The functional analysis is an analysis of the functions performed (taking into account assets used and risks assumed) by each enterprise. The external market criteria may include, for example, profit split percentages or returns observed among independent enterprises with comparable functions. Transactional Net Margin Method (TNMM) : Rule 10B(1)(e) describes TNMM as under:
(i) the net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base;9
(ii) 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;
(iii) the net profit margin referred to in sub clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market;
(iv) the net profit margin realized by the enterprise and referred to in sub clause (i) is established to be the same as the net profit margin referred to in sub clause (iii);
(v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction.
9.4. Under the transfer pricing rules described the assessee can adopt:
(a) Either a contribution PSM, namely where the entire system profits are split among the various AEs who are parties to the transaction in question or;
(b) Residual PSM, namely where each of the AEs who are parties to the transaction in question are first assigned routine basic returns for the routine functions performed by them, and there after the residual profits are split among the AEs.
9.5. The profits need to be split among the AEs on the basis of reliable external market data, which indicate how unrelated parties have split the profits in similar circumstances. For practical application, we are of the view that, bench marking with reliable external market data is to be done, in case of residual profit split method, at the first stage, where the combined net profits are partially allocated to each enterprise so as to provide it with an appropriate base returns keeping in view the nature of the transaction. The residual profits may be split as per relative contribution of the Associated Enterprise. In our view at this stage of splitting of residual profits, no bench 10 marking is necessary, as it is not practicable. Nevertheless, for splitting the residuary profits a scientific basis for allocation may be applied. 9.6. In view of the above discussion, we find that the transfer pricing report furnished by the assessee is not in accordance with rules prescribed in this regard. The PSM has not been correctly applied as per law. No bench marking has been done. Hence we are unable to approve the same. In our view the most appropriate method in this type of function/transaction would be profit split method only. Only the method was not applied as per law. 9.7. At the same time we are also unable to approve the findings of the Ld.TPO as TNMM has been applied at the entity level. Such determination of ALP by comparison of profits at entity level has been held as bad in law by the Special Bench in the case of L.G.Electronics. Transaction level comparison and bench marking has to be done.
9.8. Coming to the decisions relied by the Ld.Counsel for the assessee in the case of ITA 4427/Mum/2010 for the Assessment Year 2004-05 in the case of DHL Danzas Lemuir P.Ltd. order dt. 12.12.2012 we find that the same is not applicable as in that case the assessee has applied transactional net margin method. In the case of ACIT vs. HDL Logistics the assessee had adopted CUP method. Coming to the argument that the TPO has not made any adjustment in the next three AYs, we are of the considered opinion that the TPO was wrong 11 and that he had not followed the law on this issue. When the method is not applied in accordance with law, the question of approving the wrong done by the TPO does not arise on the ground of res judicata.
9.9. We are conscious of the fact that these years were the formative years, when transfer pricing was introduced and the law was developing. Due to this reason, we set aside the issue to the file of the Assessing Officer for fresh adjudication, while giving the assessee an opportunity to file a fresh transfer pricing study with comparables, in accordance with law. The Assessing Officer/TPO shall take into account the fresh transfer pricing study, if furnished by the assessee and adjudicate the matter de novo in accordance with law. In the result the appeal of the Revenue is allowed for statistical purposes.
10. In the result the appeal of the Revenue is allowed for statistical purposes.
Order pronounced in the Open Court on 31st December, 2013.
Sd/- Sd/-
(RAJPAL YADAV) (J.SUDHAKAR REDDY)
JUDICIAL MEMBER ACCOUNTANT MEMBER
Dated: the 31st December, 2013
*manga
12
Copy of the Order forwarded to:
1. Appellant; 2.Respondent; 3.CIT; 4.CIT(A); 5.DR; 6.Guard File By Order Asst. Registrar