TP – A.O. cannot reject method adopted in earlier years if facts are identical

IN THE ITAT MUMBAI BENCH ‘A’

Agility Logistics (P.) Ltd.

v/s.

Deputy Commissioner of Income-tax-8(1), Mumbai

IT Appeal No. 8648 (Mum.) of 2011

[Assessment year 2007-08]

April 13, 2012

ORDER

N.K. Billaiya, Accountant Member 

The present appeal is directed by the assessee against the order of the assessment dated 10th October, 2011 passed in pursuance to the directions issued by the Dispute Resolution Panel [ DRP ]. The appellant has assailed the assessment order r.w the directions of the DRP r.w the order of the Transfer Pricing Officer [ TPO ] by raising two grounds of appeal. Ground No. 1 is of general in nature and ground no. 2 has 6 sub-grounds of appeal. The sum and substance of sub-grounds of appeal is that the appellant is aggrieved by the rejection of comparable uncontrolled price [CUP] method and determining the adjusted arm’s length price at Rs. 110700000.00. Briefly stated the facts of the case are that Agility Logistics Private Limited (‘Agility India’ or ‘the Assessee’) is a logistics services provider, offering a comprehensive portfolio of international, domestic and specialized freight handling services. It is an indirect subsidiary of Geologistics Corporation, US (‘Geo US’). Agility India and its associated enterprises in the Geonetwork may be characterized as freight handling companies with normal risk operating in the international logistics business. Agility India and other companies perform mirror freight handling functions at each end of the base line port to port/ airport to airport product and deploy similar assets in the execution of these services.

2. The original return of income for the A.Y.2007-08 was e-filed by the assessee on 29.10.2007, declaring total income at Rs. 122150240/-. Thereafter, the assessee has e-filed its revised return of income on 30.03.2009, declaring total income at Rs. 124694684/-.

3. As the assessee company had transactions with the Associated Enterprises exceeding Rs. 15 crore, a reference was made to the Transfer Pricing Officer, Mumbai to ascertain the Arms Length Price. Vide order u/s.92CA(3) of the I.T. Act, 1961 dated 20.10.2010, the Addl. Commissioner of Income Tax, Transfer Pricing Officer – I(1), Mumbai has proposed an adjustment of Rs. 110700000, in respect of Assessee’s international transactions with its associated enterprises (‘AEs’) pertaining to freight receipts and expenses.

4. Against draft of the proposed order of assessment issued in accordance with the provisions of sub-section (1) of Section 144C of the Act, the assessee filed his objections before the Dispute Resolution Panel in accordance with the provisions of clause(b) if sub-section(2) of Section 144C of the Act. The Dispute Resolution Panel-I, Mumbai, after perusing the draft assessment order and after examining the assessee’s objections, issued Direction u/s. 144C(5) of the Act on 12.09.2011, thereby approving the adjustment made in the draft assessment order. Accordingly, the sum of Rs. 110700000/- is hereby added to income of the assessee company. No deduction under Section 10A or 10B or Chapter VIA of the I.T. Act, 1961 is allowed on this addition.

5. The international transactions of the assessee are summarized as under:-

6. The assessee has employed CUP as the primary method for benchmarking its transactions.

7. It has been stated that it is the corporate policy of the AEs all over the world that after payment of the costs the profits shared equally between the AEs that have participated in the transaction. It has further been illustrated that the AEs in UK and US have also entered into similar contracts of equal profit sharing with non-AE companies, in the countries where the group does not have its own presence. The assessee has therefore stated that this practice of the company which is prevalent between the AEs and also the non AEs represents a clear cut Comparable Uncontrolled Transactions and therefore the profits derived duly be benchmarked on CUP basis. The issue was examined in detail and show cause was issued to them. The assessee has filed a reply. I have gone through the submissions and the evidences, but I do not entirely agree with the contentions of the assessee, for the reasons discussed below.

8. We may now examine the case of the assessee. The assessee company is a point to point logistic service provider. The assessee company is a part of Geologistics Corporation, US which operates from about 1000 locations in 100 countries around the globe through a network of over 900 independent offices/agents. The various transactions under taken by the assessee can be as under:

 1.  Export of goods from a seller in India. Normally assessee would take the responsibility of carrying the goods from the warehouse of the exporter and delivering the same to the warehouse of the buyer outside India.

 2.  Import of goods on behalf of buyer in India. In such transaction the assessee will bear the responsibility to pick up the goods from the warehouse of the suppliers and deliver the same to the godown of the importer.

 3.  To deliver the goods received from overseas in respect of a contract entered into by its AE for export of goods to India.

 4.  To obtain and dispatch the goods out of India in respect of a contract entered into by its AE for import of goods in the AEs country.

The point of collection and delivery may vary depending on the terms for e.g. Some clients may like to deliver/collect the goods from the port itself. While others may insist on delivery at their factory/office.

9. The assessee in his submissions had stated in proceedings in the earlier years and as relevant in this year :

With respect of the CUP data i.e. use of 50:50 gross-profit split basis, we would like to draw your kind attention to the following facts:

  •  The 50:50 gross-profit split basis is a globally accepted industry norm, followed by many logistics companies worldwide.

  •  In every market that is serviced by the Agility Group, the services rendered to the customers are essentially the same. Further, the contractual terms agreed between the Agility Group and the network members (that are unrelated third parties) are also the same – i.e., the residual gross profit is shared between the origin company and the destination company in 50:50 ratio.

  •  Accordingly, in each geographical location, while the cost and profitability of the said network members may vary, the same has no impact on the rate per se at which the gross profit is split between the origin company and the destination company. Such rate continues to be 50:50 ratio.

  •  Rule 10B(3) of the Rules provide that an uncontrolled transaction shall be comparable uncontrolled transaction shall be comparable to an international transaction if none of the differences if any between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in ………… such transactions in the open market. Since the economic conditions are policies of the government in each geographic location has no impact on the rate (50:50 ratio) at which the gross profit is split between the origin company and the destination company, the above Rule 10B(3) squarely applies in the company’s case.

Accordingly, the rate (50:50 ratio) at which GeoUKMgt and the network members (that are unrelated third parties) split their residual gross profit, clearly constitutes a CUP to the rate at which the assessee splits its residual gross profit with its associated enterprises in its international transactions.

  •  It is pertinent to note that even in India’s neighboring countries, where the economic conditions are similar to those in India, the contractual terms agreed between GeoUKMgt and the third party network members are the same – i.e. the residual gross profit is shared between eh origin company and the destination company in a 50-50 ratio.

10. He has further sought reliance on the facts that it has entered into similar profit sharing arrangements with the third parties in countries where it does not have its own presence. He has also given some examples of its AE in UK which has entered into such arrangements with other licences. The analysis of four agency agreement used by the assessee is reproduced below:

10.1 The said transaction between GeoUKMgt could not be considered as an internal CUP due to the following reasons:

(i)  GeoUKMgt is situated in UK whereas the assessee is operating in India. Application of CUP using data of companies operating in different geographical locations would not provide a realistic measure because of differences in economic conditions and policies of the government which would affect the cost and profitability.

(ii)  Clause 2 of Rule 10B of the Income Tax Rules 1962 also states that, for the purposes of comparability, geographical location is an important factor to be considered.

(iii)  Additionally, the agreements are entered into on a Profit split basis and not on the basis of a rate. Therefore, there is in fact no internal CUP.

(iv)  The arguments of the assessee is again without force in the sense that the AE may be a gainer in such contracts as it would be otherwise loosing a contract due to its non presence in the other territory. Even otherwise due to a small territorial area and very well developed shipping, air and land infrastructure in UK, the functional and the risks elements of the UK entity would invariably be less than that of its corresponding AE.

10.2 As rightly emphasized by the OECD in para 1.30 reproduced above economics circumstances have a very material impact on the comparability of transactions. Therefore, where the entities are operating all over the world in different markets which have their own separate charactistics and risks. The comparable uncontrolled price method cannot determine the arms length pricing. As a policy of the company it may bring about ease in accounting and the various group entities may be willing to sacrifice a share of their income for the sake of the remaining profit that they would be getting because of their affiliation of the group. But such a model cannot be an acceptable model for the transfer pricing analysis.

10.3 An arm’s length pricing has to taken into account the functions, the assets employed and the risks involved in the various transactions to determine the extent of profits accruing to the entity. A thumb rule analysis of equally distributing the profit and losses cannot be accepted as an appropriate method.

10.4 If we consider the nature of the transactions that are required to be bench marked. The main transactions are in respect of the freight expenses and freight revenue. The income arising out of these two transactions would necessarily be on account of the better negotiation a party can made with its client and the shipping agent. This will again depend on the entity entering into the contract and not the transaction. Why should the other AE reap a benefit or incur a loss on account of the efficiency or inefficiency of the other party. What the assessee emphasizes is the equivalent distribution of profits while what we are bench marking is the freight revenue and the freight expenses.

10.5 Even considering the argument of distribution of profits on a 50-50 basis, one has to consider whether all costs have been appropriated. One such cost shall be the interest. The party who does a bulk booking has to pay the money in advance, the cost of those funds is not taken as a cost. Similarly in to collect and prepaid transactions interest has to be an element to constitute a cost. Secondly there are various intangibles in the transactions which cannot be measured. One AE may have better negotiations skills and therefore can obtain better bargains from clients and the shipping lines, while other may not. In such a case why should the first AE not be entitled to a higher share. Such adjustments are not feasible and therefore CUP cannot be applied.

The CUP Method is therefore not the Most Appropriate Method.

10.6 The CUP method adopted by the appellant was thus rejected and adjustment to the tune of Rs.110700000.00 was accordingly made as arm’s length price. Aggrieved, the assessee is before us .

11. At the outset the ld counsel appearing for the appellant submitted that the facts and circumstances of the year under appeal are identical to the facts as they were for the AY 2004 -05 , AY 2005-06 & 2006-07 and accordingly prayed that the order of the tribunal for these years should be followed. The ld DR submitted that for the AY 2006 -07 the tribunal has restored the matters back to the files of the DRP and there fore requested that the issues in the present appeal may also be restored back to the files of the DRP . The ld counsel retorted that the order of the DRP for the AY 2006 -07 was laconic and not a speaking order therefore the tribunal has restored the matter back to the files of the DRP for passing a speaking order . ld AR drew our attention to the order of the Income Tax Appellate Tribunal ‘A’ bench for the AY 2004 -05,& 2005-06 in ITA No. 2000/Mum/2010, ITA No.6004/Mum/2010 & respectively .

12. We have gone through the order of the lower authorities and the submissions of the Ld AR and also perused the order of the Income Tax Appellate Tribunal in appeal numbers mentioned here in above for the assessment years 2004 -05 and 2005-06 and find force in the contention of the ld AR that the facts of the year under consideration are identical with the facts of the previous two assessment years as mentioned here in above. The tribunal while deciding the appeals for the assessment year 2004 – 05 has given its findings on page 17 as under :

“5. We have considered the rival arguments made by both the sides, pursued the orders of the Assessing Officer and the CIT(A) and the paper book filed on behalf of the assessee. We have also considered the various decisions cited before us. From the various submissions made by the assessee in the paper book as well as submissions before the ld. CIT(A), we find the assessee was regularly adopting the CUP method on its international transactions relating to freight expenses and receipts which has been examined by the TPO and accepted in A.Y. 2002-03 and 2003-04. We find the TPO did not follow the earlier order of his predecessor and rejected the CUP method used by the assessee for the impugned assessment year. He also rejected the OP/VAE as the PLI and instead used OP/TC as the PLI on the ground that companies are operating in different geographical regions and agreements with third parties are entered into on a profit split method and not on the basis of rate. While doing so, he used the data of some private limited companies, the detailed information of which are not available in public domain and rejected the search undertaken by the assessee in the TP study. He further used the single year data for the purpose of TNMM analysis as against multiple year data applied by the assessee. It is the submission of the learned counsel for the assessee that the assessee had considered the CUP method as the most appropriate method to determine the ALP of the international transaction. According to him, the assessee company only coordinates with third party service providers and does not own any transportation assets such as trucks, ships, air crafts or any other transportation assets of similar nature and it owns only office premises and computers. The above submission of the ld. counsel for the assessee could not be controverted by the ld. D.R. We find force in the submission of the ld. counsel for the assessee that both the origin company and the destination company assume comparable risks with the risk of bad debts being minimal and that there is no inventory risk since the assessee company enters into a contract with the shipping line/air line for booking space on a ship/air craft only upon receipt of confirmed orders from the customers. From the various agency agreements between Geologistics group and unrelated parties produced by the assessee, we find the terms and conditions are substantially same. The profit split information contained in all the agreements is typical to the industry. We also find merit in the submission of the ld. counsel for the assessee that the TPO in his TP study report has considered certain companies which are not available in the public domain being private limited companies or they are not comparable to the assessee companies. From the various submissions made by the assessee and the detail submissions in the paper book, we find the four companies rejected by the TPO are functionally comparable to the assessee and therefore should have been retained in the comparable study . “

12.1 The tribunal further pointed out that :

“5.2 We further find the Delhi Bench of the Tribunal in the case of Schefenacker Motherson Ltd. v. ITO reported in 2009-TIOL-376-ITAT-DEL while considering the facts of the tax payer interpreted “net profit” for the application of the TNMM to mean “cash profits” i.e. excluding depreciation. The relevant observation of the order of the Tribunal (at para 19 of the order) reads as under:-

“”…There is no formula which would be applicable universally and in all circumstances. “Net profit” used in Rule 1OB can be taken to mean commercial profit as held by the TPO and confirmed on appeal by the Id. CIT(A). But depreciation in such profit on commercial principles has to be the “actual” amount by which the assets of business got depleted between the two dates separated by a year. It cannot be depreciation under tax or companies rules or as per policy of the company. In the case in hand, revenue authorities went wrong in disregarding the context and purpose for which the “net profit” was to be computed. Depreciation, which can have varied basis and is allowed at different rates is not such an expenditure which must be deducted in all situations. It has no direct connection or bearing on price, cost or profit margin of the international transactions. Principles emphasized in the case of Bangalore Clothing by Bombay High Court are attracted here. Object and purpose of the transfer pricing to compare like with the like, and to eliminate differences, if any, by suitable adjustment is to be seen. Therefore, there was justification on the part of the taxpayer in pleading that profits be taken without deduction of depreciation as depreciation was leading to large differences in margins for various reasons.”

5.3 We find the OECD in the revised T.P. guidelines of 2010 has recognized the use of different measures of profit under the profit split method. The relevant para of the guideline reads as under:-

“2.131 Generally, the combined profits to be split in a transactional profit split method are operating profits. Applying the transactional profit split in this manner ensures that both income and expenses of the MNE are attributed to the relevant associated enterprise on a consistent basis. However. occasionally, it may be appropriate to carry out a spilt of gross profits and then deduct the expenses incurred in or attributable to each relevant enterprise (and excluding expenses taken into account in computing gross profits). In such cases, where different analyses are being applied to divide the gross income and the deductions of the MNE among associated enterprises, care must be taken to ensure that the expenses incurred in or attributable to each enterprise are consistent with the activities and risks undertaken there, and that the allocation of gross profits is likewise consistent with the placement of activities and risks. For example, in the case of an MNE that engages in highly integrated worldwide trading operations. involving various types of properly, it may be possible to determine the enterprises in which expenses are incurred (or attributed), but not to accurately determine the particular trading activities to which those expenses relate. In such a case, it may be appropriate to split the gross profits from each trading activity and then deduct from the resulting overall gross profits the expenses incurred in or attributable to each enterprise, bearing in mind the caution noted above”.

5.4 From the various submissions made by the assessee it is also clear that the geographical difference is not material so far as it applies to the logistics industry. From the various agreements we find there is splitting of gross profit equally at 50:50 even in Pakistan, Bangladesh and Sri Lanka which fall under the same geographical region. In view of the above and in view of the detailed reasoning given by the ld. CIT(A) we do not find any infirmity in the CUP method (50:50 module) adopted by the assessee. Accordingly, the order of the ld. CIT(A) on this issue is upheld and the ground raised by the Revenue is dismissed.”

12.2 While deciding the appeal for the AY 2005 – 06, the tribunal observed as under :

“9. Ground of appeal No. 2 by the Revenue reads as under:-

“On the facts and in the circumstances of the case and in law, the ld. CIT(A) erred in deleting the adjustment u/s 92CA(3) of the I.T. Act, 1961, of freight related receipts and expenses amounting to Rs. 14,62,12,134/- made by the Transfer Pricing Officer & the Assessing Officer, as per the Arms Length Price by a sum of Rs. 27,54,34,623/-.”

9.1 After hearing both the sides we find the above ground is identical to ground No. 1 by the Revenue in ITA No. 2000/M/10. We have already decided the issue and the ground raised by the Revenue has been dismissed. Following the same ratio, this ground by the Revenue is dismissed.

12.3 And while deciding the appeal for the AY 2006 -07 the tribunal observed as under :

“14. Grounds of appeal Nos. 4 & 5 are as under:-

“Ground No. 4: On the facts and circumstances of the case, the learned DRP has erred in law in not disposing the objection raised by the assessee against the proposed addition of unexplained receipts of Rs. 21,42,582/-.

Ground No. 5 : On the facts and circumstances of the case, the learned A.O. has erred in law in confirming the proposed addition of unexplained receipts of Rs. 21,42,582/-.”

14.1 After hearing both the sides, we find the above two grounds have not been adjudicated by the DRP. Accordingly, the above two grounds are restored to the file of DRP for adjudication of the same in accordance with law and after giving due opportunity of being heard to the assessee. The above grounds are accordingly allowed for statistical purpose.

15. Ground No. 6 by the assessee reads as under;-

“The learned Assessing Officer for the purpose of computing the demand for the year under consideration has erred in considering the refund withdrawn for A.Y. 2007-08 of Rs. 2,91,29,970/- and thereby also erred in levying interest under section 234D of Rs. 24,76,047/-.”

15.1 After hearing both the sides, we find this ground by the assessee is consequential in nature. Accordingly the same is restored to the file of the A.O. for calculation of interest in accordance with law. This ground is accordingly allowed for statistical purpose.”

12.4 After going through the order of the tribunal quoted here in above we find that the tribunal has allowed the appeals of the appellant for the AYs 2004 -05 and 2005 – 06 and restored matter back to the files of the DRP for AY 2006 – 07, as the tribunal found that the order of the DRP for AY 2006 -07 was laconic.

12.5 As the facts in issue for the year under appeal are identical with facts of the AY 2004 -05 & 2005 -06, respectfully following the decisions of the tribunal mentioned here in above in the appellants own case for the AY 2004 -05 & 2005 -06, we allow the appeal filed by the assessee and hold that the additions on account adjustment in arm’s length price to the tune of Rs.110700000.00 is uncalled for and accordingly the adjustment is rejected on the facts of the case discussed here in above . The submissions of the ld DR that the matter be restored back to the files of the DRP as was done in AY 2006 – 07 does not hold any water as we find that for the year under consideration the DRP has passed a speaking order where as in AY 2006 -07 the order of the DRP was laconic as found by the tribunal while deciding the appeal for the AY 06 – 07 and there fore we reject the submissions of the ld DR .

13. The appellant has also raised an alternative ground vide ground no.3. However, we have allowed the appeal on ground No. 2 with all its sub grounds of appeal, we therefore, find no merit in this alternative ground of appeal and accordingly dismiss it.

14. In the result the appeal filed by the assessee is partly allowed .