TMI Blog2016 (6) TMI 635X X X X Extracts X X X X X X X X Extracts X X X X ..... We find considerable force in the argument of the assesse with respect to risk adjustment on account of foreign exchange fluctuation as it is apparent from the account that there is no foreign exchange loss incurred by the assesse therefore we set aside this ground to the file of AO for once again perusing the risk adjustment claimed by the assesse and adjudicate the issue. - ITA No. 961/Del/2010 - - - Dated:- 12-4-2016 - SHRI A. T. VARKEY, JUDICIAL MEMBER AND SHRI PRASHANT MAHARISHI, ACCOUNTANT MEMBER For The Assessee : Sh. Rohit Tiwari, CA, Ms. Sonal Arora, CA For The Revenue : Shri Amendra Kumar, CIT DR ORDER PER PRASHANT MAHARISHI, A. M. 1. This appeal filed by the assessee is directed against the order dated 29- 12-2009 of ld. CIT(A)-XX New Delhi for Assessment Year 2003-04 confirming the additions made by the Learned Assessing officer [ in short AO ] in order passed u/s 143(3) of the act dated 27/03/2006 pursuant to the order dated 08/02/2006 of Transfer Pricing officer ( In short TPO ) u/s 92CA(3) of THE Income tax Act 1961 ( hereinafter referred in short The Act ). 2. The grounds of appeal raised by the assessee are as under:- 1. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... od' for the determination of arm's length price of the royalty and franchisee fees payable by Appellant to associated enterprise, by placing reliance on the section 92A(2)(g) of the Act and Rule 10B(2)(d) of the Rules. ii) The TPO/CIT(A) inappropriately concluded that all the three transactions related to rendering market support services, payment of royalty and franchisee fee to MDC are closely linked 7. That the TPO/AO/CIT(A) have failed to make appropriate adjustments to account for differences in functions performed, and risks assumed and assets employed by the Appellant, vis-a-vis comparable companies identified by him. 8. That without prejudice to the generality of the grounds of appeal No.1 to 7, on the facts and in law, CIT(A) failed to adjudicate on the applicability of proviso to section 92C of the Act and to allow the Appellant an option for the downward variation of 5 percent in determining the arm's length price. 3. At the outset the Ld AR of the appellant submitted that that ground no 1 to 4 of the appeal are not pressed. Hence we dismiss ground no 1 to 4 of the appeal. 4. Ground No 5 of the appeal is against inclusion of Royalty ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the TPO for determination of Arm s Length Price of its transaction with its Associated Enterprises. The ld TPO adjusted the ALP by an amount of ₹ 4489948/- on account of following international transactions Transaction Amount(INR) Method applied by assesse Method applied by TPO ALP determined by TPO ( INR) Consequent adjustment ( INR) Payment of royalty 5208668 CUP TNMM 48331219 3755449 Payment of initial franchisee fee 1412200 CUP TNMM Consulting services rendered 11213750 TNMM TNMM 12022261 808511 8. The ld TPO rejected CUP method benchmarking of transactions pertaining to royalty payment and franchise fee and aggregated all the transactions of consultancy services, royalty payment and franchise fee. He applied TNMM method on aggregation basis and included royalty income received from t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cannot be a pass through cost. 10. The assesse carried matter before CIT(A) who held that because of the difference in geographical regions the CUP method adopted is not appropriate, the consultancy services rendered by the assesse are the back bone and basis on which royalty and franchisee fee received and thus aggregation of transaction has rightly been made by TPO and further as the MacDonald corporation has right to make good the default of payment of royalty by franchise by assesse and therefore franchise fee as claimed cannot be a pass through cost. Assesse being aggrieved by the order of ld. CIT(A) on confirmation of ALP determined by TPO has filed this appeal before us. 11. For this the ld AR of the appellant submitted that a. Ld. TPO and CIT (A) has not appreciated the basic fact that Royalty is payable to MDC by Restaurants for the use of McDonald Brand (owned by MDC) @ 5% of sales since MIPL is not running any restaurants itself, the question of any payment for Royalty by MIPL does not arise. This basic fact by itself makes it clear that MIPL merely receives Royalty fees for onward transmission to MDC. b. In fact, vide para no. 10.8 of order of ld. TPO dat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (A) while considering the royalty in working of PLI may be deleted. 12. Against this LD DR referred to page 265, 109,103 of PB to support the orders of LD TPO. He therefore submitted that royalty is not a pass through cost. He further referred to para no .8 of order of TPO to support that ld TPO has rightly not excluded royalty. He further submitted that there is a basis between collection of royalty and payment of royalty and pass through cost are generally same but here there is a difference too therefore it has some profit or loss element, hence, he submitted that it is not a pass through cost. 13. We have carefully considered the rival contention and also perused the relevant documents cited before us. Brief facts have already been noted. 14. Now coming to the issue of whether the royalty is a pass through cost or not. Brief facts of the case is assesse is collecting the royalty and franchisee services fess from the JVs based on the sub licensing agreement and also remits it back to McDonald corporation based on the master license agreement. The amount of royalty that was to be collected by JVs is 5% of gross sales from operation of McDonald restaurants and same amoun ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed as part of operating cost in the tax payer s computation of PLI. In fact it is required to be determined whether an independent enterprise in comparable circumstances would have either paid for the performed the service. In this case the assesse company was set up with that objective and is earning mark-up over the cost incurred separately. The pass through cost are required to be demonstrated in substance and with actual intent. The para No 2.93 of OECD transfer pricing guidelines is as under:- 2.93 In applying a cost based transactional net margin method, fully loaded costs are often used, including all the direct and indirect costs attributable to the activity or transaction, together with the an appropriate allocation in respect of the overheads of the business. The question can arise whether and to what extent it is acceptable at Arm s length to treat a significant portion of taxpayer s cost as pass-though costs to which no profit element is attributed (i.e. as costs which are potentially excludable from the denominator of the net profit indicator). This depends on the extent to which an independent party in comparable circumstances would agree not to earn a mark-up of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cern. The payment made by the assessee to third party vendor/media agencies for and on behalf of the principal has not been included in the total cost for determining the profit margin, though, on the other hand, the TPO has included the payment reimbursed by the assessee's associate enterprise to the assessee on account of payment made to third party vendor/media agencies. It is not in dispute that the assessee is engaged in undertaking advertising services for its customers/AEs in the capacity of an agent. As part of its business operation, the assessee facilitates placement of advertisement for its AE in the print/electronic etc. media and for that purpose, the assessee is required to make payment to third parties for rendering of advertisement space on behalf of its customers or AEs. It is, thus, clear that the assessee's business is not sale of advertising slots to its customers or associate concern. For performing the functions for and on behalf of AEs, the assessee is remunerated by its AEs on the basis of a fixed commission/charges based on expenses or cost incurred by the assessee for release of a particular advertisement. It is also to be noted that advertising sp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xcluded entirely from the calculation. 41. In the proposed revision of Chapter I-III of the Transfer Pricing Guidelines issued on 9th Sept., 2009 - 9th Jan., 2010 by OECD, it has been provided in para 2.134 as under : 2.134 In applying a cost-based transactional net margin method, fully loaded costs are often used, including all the direct and indirect costs attributable to the activity or transaction, together with an appropriate allocation in respect of the overheads of the business. The question can arise whether and to what extent it is acceptable at arm's length to treat a significant portion of the taxpayer's costs as pass-through costs to which no profit element is attributed (i.e. as costs which are potentially excludable from the denominator of the net profit margin indicator). This depends on the extent to which an independent party at arm's length would accept not to be remunerated on part of the expenses it incurs. The response should not be based on the classification of costs as 'internal' or 'external' costs, but rather on a comparability (including functional) analysis, and in particular on a determination of the value added ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... submission of JMIPL that it is obliged to procure the raw material on instructions of MUL at a price dictated by MUL from the source selected by MUL. JMIPL is entitled to a per unit fixed manufacturing charge over and above the actual cost of the raw material. The submission of JMIPL that entire cost of raw materials comprising of precious metals and substrates is passed on to or recovered from the ultimate customer without any mark-up has not been able to be countered by the Revenue. In other words the contention of JMIPL that its profit is not at all affected by the cost of raw materials remains uncontested. The submissions of the Revenue as to what are true pass through costs fail to acknowledge the actual arrangement between JMIPL and MUL as reflected in the clauses of the agreement as well as in other documents and letters placed on record. 37. The exclusion of pass through costs from the denominator of total costs where the financial ratio of OP to TC is used is acknowledged in para 2.93 and 2.94 of the OECD Guidelines. Para 2.93 states that the extent to which it would be acceptable at arm's length to treat a significant portion of the taxpayer's costs as pass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... submission of the Revenue that the international transaction between JMUK and JMIPL with regard to sale of precious metals may not be at ALP because JMIPL was a wholly owned subsidiary of JMUK does not appear to be based on any definite information but on suspicion. No convincing reason is forthcoming in the orders of the TPO, the CIT(A) or the ITAT for rejecting the alternate plea of JMIPL as regards the PLI being OP/TC-RMC. 19. Further coordinate bench while deciding the appeal in case of assessee for AY 2001-02 in ITA No 3890/DEL/2004 dated 30.10.2009 has held that as per the Master License agreement and franchises agreement, the assessee has to pass on the entire royalty which it has to receive from franchises and there is no income left to the assessee as per this Master License Agreement and franchises agreement. Further, the coordinate bench has also held that as per the Master License Agreement along with franchises agreement, the assessee is not earning anything on account of royalty and entire royalty is to be passed on to Mc Donald s Corporation USA. Coordinate bench has held so as under :- 8. We have heard the rival submissions and have gone through the mater ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nt expenditure which was otherwise to be borne by the franchises. The purpose is to increase the return on investment i.e. dividend and increase in net worth of investment. We have also noted that as per the Master License Agreement along with franchises agreement, the assessee is not earning anything on account of royalty and entire royalty is to be passed on to Me Donald's Corporation USA and hence, the Assessing Officer could have examined the allowability of such advertisement expenditure borne by the assessee which was otherwise to be borne by the franchises. Because the so-called increase in return on investment of the assessee will be in the form of dividend income which is an exempt income and hence any expenditure incurred for earning an exempt income is not allowable u/s 14A of the income Tax Act, 1961. The Assessing Officer could have examined the allowability of such advertisement expenditure on this basis but this was dot done by him. Be that as it may. In the present appeal, we have to decide regarding applicability of section 92 with regard to advertisement expenditure partly borne by the assessee which was to be otherwise borne by the franchises, [n this regard, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ompanies identified by TPO carry lot of risk. The ld TPO did not make any adjustment in this regard and has held that assesse carried a risk on account of delay in payment of royalty fees and initial franchisee fees to the McDonald corporation in time and therefore there is a risk of cancellation of the agreement and in anyway the assesse carries the risk of foreign exchange fluctuation. 24. Before us the assesse contended that view of the TPO is incorrect. He submitted that cancellation of agreement is not risk on the assesse but the risk is on JVs who losses the business and on McDonald corporation who losses the franchisee fees and royalty fees. Further it was submitted that there is no such failure has happened for last 15 years since Jv are operating in India. He further submitted that only real risk needs to be considered and hypothetical risk which are not based on reality cannot be assumed. Regarding foreign exchange fluctuation loss it was submitted that the royalty and franchisee fees are required to be remitted within five days from the close of the month and therefore no significant risk is assumed by the assesse on account of foreign exchange fluctuation. It was fur ..... X X X X Extracts X X X X X X X X Extracts X X X X
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