Matter remanded to TPO as comparables were never examined before Trnasfer Pricing adjustments

IN THE ITAT MUMBAI BENCH ‘K’

Deputy Commissioner of Income-tax 2(1), Mumbai

Versus

CMA CGM Global India (P.) Ltd.

IT Appeal No. 5979 (Mum) of 2010

C.O. No. 130 (Mum.) of 2011

[Assessment year  2005-06]

NOVEMBER 21, 2012

ORDER

Per Bench 

The revenue has preferred this appeal, against order dated 5-5-2010, passed by CIT(A)-15, Mumbai for the quantum of assessment passed under Section 143(3) r.w.s. 92CA(3) of the Act, for the assessment year 2005-06 on the following grounds :-

“1.  The order of the CIT(A) is opposed to law and facts of the case.

 2.  On the facts and in the circumstances of the case and in law, the learned CIT(A) has erred in holding that Transaction Net Margin Method (TNMM) is the most appropriate method in the facts of the present case and ignoring Comparable Uncontrolled Method (CUP) adopted by TPO & AO after detailed discussion with regard to Container Control Fees of Rs. 91,07,412/- and communication expenses of Rs.67,13,584/-.

 3.  For these and other grounds that may be urged at the time of hearing, the decision of the CIT(A) may be set aside and that of the AO restored.”

2. The assessee has also filed Cross Objection mostly in support of the order passed by the CIT(A) in deleting the addition of Rs. 1,58,20,996/- made on account of adjustment in Arms Length Price (ALP) on various alternative grounds.

3. The facts in brief are that the assessee company CMA CGM Global India Private Limited (in short GIPL), was incorporated in September, 2003 and is a subsidiary of CMA CGM, France, which is one of the major world wide Container Shipping Lines and is a tax resident of France. The assessee company is a joint venture between CMA CGM holding 51% equity shares and Maritime Commerce Agency India Private Limited holding 49% shares. The assessee was appointed as a shipping agent of CMA CGM for undertaking its shipping business in India based upon the terms and conditions of the agency agreement dated 17th September, 2003. Prior to incorporation of the assessee, the CMA CGM had appointed Container Maritime Agencies Private Limited as its shipping agent and such agency continued upto August 2003 based on terms and conditions mentioned in the agency agreement dated 20th October, 1999. Thus, from the year 2003, the assessee is acting as a representative agent of CMA CGM in India in respect of vessels owned, operated, chartered or managed by CMA CGM. The activity performed by the assessee include freight collection, transportation of containers, etc.. It is compensated by way of commission income for various functions performed like export freight, import freight, container control fee etc. During the relevant year, the assessee was also appointed as a representative agent of ANL Singapore Pte Ltd., which is a subsidiary of ANL Container Line Pty. Ltd. Australia and is a group company of CMA CGM. Thus, ANL Singapore is also a kind of AE. The assessee has received besides commission income, container control fees and communication expenses from the two of its AEs, (i.e. CMA CGM & ANL Singapore Pte. Ltd.), which was a part of host of services rendered. During the relevant financial year, the assessee had shown its turn over at Rs.26.52 Crores with a net profit of Rs.15.13 Crores. The operating margin on the operating cost was at 133.43%. In its transfer pricing analysis, which was based mainly on Comparable Uncontrolled Method (CUP) was also corroborated with Transactional Net Margin Method (TNMM).

4. The Transfer Pricing Officer (TPO), to whom matter was referred under Section 92CA(1) by the Assessing Officer, observed that the assessee has entered into following international transactions :-

From the above, he further noted that the assessee had shown aggregate total fees of Rs. 93.58 Lakhs on account of ‘container control fees’ in respect of rendering its services to its two AEs. The assessee has benchmarked the said transaction by using the CUP Method and has considered the activities carried out by erstwhile Container Marine Agency Pvt. Ltd. as independent third party for benchmarking the rate for various activities performed by the assessee for its AEs. This is because untill September, 2003, this company was rendering similar services to CMA CGM and other shipping lines as per market practices in an uncontrolled transactional regime. While examining the agency agreement entered into with the said party by CMA CGM and also with the assessee company, the TPO noted that the assessee is charging container control fees’ of US $2.5 per container, whereas the earlier third party was charging US$5 per container for the same services. Similarly, the assessee was charging US $5 per container from ANL Singapore an other associate enterprises. There was also difference in recovery of ‘communication expenses’ as the assessee recovered US$3.5% per container from its AEs, whereas earlier third party was charging US$5 per container. He, therefore, required the assessee as to why the adjustment should not be made in the ALP on these two transactions.

5. The assessee submitted that its overall composite activity carried on with the AEs is part of one business activity only and the assessee is receiving more income than the erstwhile third party which is evident that the commission received by the assessee is more than the third party, which was given earlier. The relevant submissions of the assessee before the TPO in this regard are as under :-

“(a)

(1) “As you are kindly aware, all streams of remuneration selected for the CUP method flow from the same principal to us, as the agent. Therefore, we request you to consider the remuneration received as a whole, rather than a review of each stream independently. We substantiate this with an example. The erstwhile agent was paid commission on export freight @2.5%, where we are paid @3%, addition 0.5% paid to us is equivalent to Rs. 1,58,64,073/- (i.e. commission which is Rs. 9,51,84,437 less 2.5% commission Rs. 7,93,20,364). This amount more than compensate the reduction container control fees of Rs. 91,07,412/-. Therefore, we again request you to review remuneration in totality.

(2) CUP was selected because there was a direct comparable available in previous year, which is permitted as per Rules. However, since it is not a comparables for the current year, we request you to the use of CUP data with corroborative TNMM data for the current year, which you will agree does meet the arms length does meet the arms-length requirements.

(b) It is a practice in shipping industry that when a principal negotiates an agreement with a new agent, it considers the business prospects for foreseeable future and accordingly negotiates finalizes rates, since the rates remain valid for many years. Once of the reasons mentioned in the analysis is the volume increase that led to revised rates. The increase in container volume handled, over the years, is demonstrated by the following numbers:

FY 2003-04(as extrapolated) ; 50,700

FY 2004-05 (year under scrutiny) : 82,000 (which is a 61% increase over previous year)

FY 2007-08 : 195,870 (which is 286% increase over FY 2003-04) In FY 2007-08 also the agency earned Container Control Fee @USD 2.5 per container, which by logic of a one to one comparison can be much lower than this.

We therefore again request you that having earned a very healthy margin, it may be concluded that we, as agent, have been compensated on arms-length basis.”

6. The TPO rejected the said contention of the assessee and after applying the CUP Method as followed by the assessee, he came to the conclusion that the assessee has under charged CMA CGM in respect of ‘container control fees’, which should be US $ 5 instead of US $ 2.5 per container. Accordingly, he made an adjustment of Rs. 91,07,412/-. Likewise, he made similar adjustment in recovery of ‘communication expenses’ and made an upward adjustment of Rs.67,13,584/-.

7. In the first appeal before the CIT(A), the assessee submitted that the TPO and the AO has erroneously considered that the stream of income i.e. ‘container control fee’ and recovery of ‘communication expenses’, in isolation with other stream of incomes without appreciating that income of the assessee from CMA CGM has to be seen as composite activity having various stream of income. Secondly, it was argued that CUP is not a correct method as they are no independent comparables available for the income earned by the assessee during the year and the comparable which has been chosen do not pertain to the year under appeal as they are for the earlier years. Thirdly, the TPO has erroneously relied upon the amount received from the ANL Singapore as reflecting the ALP without appreciating that for TP analysis the comparables chosen should be from uncontrolled transactions and not with the AEs, who are having related party transactions. Fourthly, the most appropriate method for determining the ALP in the case of the assessee should be TNMM Method which was canvassed before the TPO and in its study it had shown that the arithmetic mean of the comparables were at 14.94%, whereas the assessee’s operating margin was very huge at 133.43%. Lastly, if without prejudice CUP is to be considered to be most appropriate method, then all the streams of income viz. export commission, ‘container control fee’ and others have to be considered on a composite basis as they are arising out of the same business activities and then compare with the income which could be as per the arrangement and as per the agreed rates with the comparable company. If such an exercise would be carried out, then there would be surplus profit of Rs.43,047/-. Besides this, other arguments were also made.

8. Learned CIT(A) duly appreciated the assessee’s contention and observed that if the CUP is taken to be most appropriate method for ‘container control fees’ then similarly the ‘export commission’ should also have been benchmarked accordingly. As considering one stream of the income i.e. container control fees/realization of communication expenses in isolation of mainstream of income i.e. export commission, which comprises of 71.78% of the income, is not a correct way of determining the ALP for international transaction of the year. If the entire composite activity is taken into consideration then the assessee will have more profit by Rs. 43,077/- in this year, then what it could have generated by the erstwhile arrangement of the third party. Regarding comparison of rates with ANL Singapore, he held that it is an AE of the assessee and has related party transactions, therefore, same cannot be considered as appropriate comparable for T.P. analysis. Thereafter the CIT(A) required the assessee to furnish a summary regarding what should be the profit earned in India, had the rates at which earlier third party was doing the business with the CMA CGM. The assessee furnished a comparative chart reflecting the revenue which could have been earned as per the rates of earlier third party, the same is incorporated in the appellate order at page 10, which is also reproduced herein below for the sake of ready reference :-

“Actual revenues as per the existing arrangement with the assessee.

Amount in Rupees

Estimated Revenues as per the Erstwhile Arrangement

From the above table, it is seen that if the composite income is taken into consideration then the assessee has earned more in contrast to the rates to which earlier third party has charged.

9. Regarding contention of adoption of TNMM Method for determining the ALP, he held that there are no external comparables available for adopting the CUP Method for the year under appeal and the earlier year data of third party will not be applicable while applying the CUP, therefore, the same cannot be applied and TNMM Method would not be most appropriate method. In coming to his conclusion that even though the assessee had adopted a particular method in his TP Study Report, however, it is always open to the assessee or the TPO to deviate from such method and adopt most appropriate method for determining the ALP, he relied upon the decision of Special Bench of Chandigarh Tribunal in the case of Dy. CIT v. Quark Systems (P.) Ltd. [2010] 38 SOT 307 and the decision of ITAT Mumbai Bench in the case of A.M. Tod Co. India (P.) Ltd. v. ITO, passed in ITA No.492/Mum/2006, vide order dated 24-6-2009. Thus, he held that the TNMM Method should be applied and the three comparables, which were identified by the assessee in its TP Study Report, gives arithmetic mean of operating profit on total cost of 14.94%, which is far less than the assessee’s operating profit of 133.43%. Accordingly, he deleted the entire adjustment.

10. The learned CIT DR after analyzing the facts in detail, which has been mostly incorporated above, drew our attention to the terms and conditions of agreement entered into by the CMA CGM and third party i.e. Container Maritime Agency Pvt. Ltd. and also similar terms and conditions entered into by the assessee by the CMA CGM. From there, he pointed out that on similar sets of services and conditions, there is a wide difference between the payment of rates on container control fees and recovery of communication expenses. He further submitted that it is not necessary that entire composite income has to be seen, as one particular stream of income or transaction can always be benchmarked. He, thus, strongly relied upon the reasonings given by the TPO. After a query put by this Bench to him at the time of hearing as to whether earlier agreement, which was entered in the year 1999 can be held to be comparable with the present agreement, which was entered into 2003 and whether such rates can be applied in the CUP Method. To this, he fairly admitted that if the rates applied do not fall within the same financial year, the earlier years rates cannot be compared in CUP Method. He further admitted that there are no internal comparables or external comparables, therefore, TNMM Method can be held to be the most appropriate method. However, he vehemently objected the reasoning and conclusion drawn by the CIT(A) as well as by the TPO as neither of them have examined the comparables nor any other appropriate comparables having similar nature of business were looked into. In case if it is held that TNMM Method is to be applied, then matter should be restored back to the file of the TPO to carry out fresh search of comparables and evaluate the ALP.

11. On the other hand, learned counsel on behalf of the assessee strongly relied upon the reasonings given by the CIT(A) and submitted that not only in the TP Study Report the assessee has given the detail analysis of comparables and applicability of TNMM Method as a corroborative method but also made detail submissions before the TPO as well as the AO. He drew our attention to such reply submitted before the TPO and submitted that this aspect of the matter has been considered by the TPO even though he has not mentioned specifically in his order. Alternatively, he submitted that the assessee was a shipping agent and was receiving the income on composite activities and one has to see the entire activity for the benchmarking the ALP, even as per the method adopted by the TPO. However, his main contention was that the appropriate method should be TNMM Method and the assessee has already undertaken the exercise of searching for the comparables and has provided the arithmetic mean of operating margin of such comparables which has not been rebutted by the TPO. He, therefore, submitted that the order passed by the CIT(A) should be upheld.

12. We have carefully considered the rival submissions, perused the material placed on record and the orders of the CIT(A) and the TPO. The assessee, which is a subsidiary of CMA CGM, France, is acting as its shipping agent under an agency agreement dated 17th September, 2003. Prior to that the same services was provided by a third party Container Maritime Agency Pvt. Ltd. under a similar agency agreement dated 20th October, 1999 which had expired in August, 2003. Hence, the assessee as well as the TPO have compared and relied upon the rates of various fees and commissions with the earlier third party with that of the assessee for benchmarking the ALP while applying the CUP Method. The difference in approach is only on account of the fact that the assessee had taken the composite stream of income, whereas, the TPO has taken only two streams i.e. container control fee and communication expenses, wherein there was difference in the rates of container. The assessee’s main contention before the TPO as well as before the CIT(A) was that the assessee is charging more export commission from CMA CGM than the earlier third party and if overall revenue and income is taken into consideration, then the assessee has earned more than profit. This has been demonstrated before the CIT(A), which has also been incorporated in the foregoing paragraphs. While applying CUP Method, there could be internal CUP or external CUP. The internal CUP could be available if the assessee or one of its group entities entered into comparable transaction with an unrelated party where the goods or services under consideration are same or similar. On the other hand, in an external CUP, transaction between two independent enterprises involved comparable goods or services under comparable conditions. Here, in this case, the internal CUP, ‘ANL Singapore’ cannot be applied as it is an AE having related party transactions. There are also no external CUP for making any comparison in the relevant year as the earlier agency agreement with the third party CMAPL had expired prior to September, 2003 and rates which were applicable in the earlier years cannot be made applicable in this year. Thus, the rates of the earlier agreement will not be appropriate parameter for determining the ALP for the international transaction undertaken by the assessee with its AE in the current assessment year. In these circumstances, the CUP Method fails in this case for benchmarking the ALP.

13. Now, coming to the applicability of most appropriate method, both the parties have agreed that TNMM Method should be most appropriate method for benchmarking the ALP. The contention of learned CITDR is that before the TPO, even though this plea of applicability of TNMM Method was taken by the assessee by way of corroborated method, has neither considered the same nor examined it properly. Whereas, the argument of the learned counsel has been that the assessee has provided all the relevant data based on TNMM Study not only in the TP Study Report but also during the course of Transfer Pricing proceedings and no fault has been found in the comparables shortlisted by the assessee. In view of these facts and in our considered opinion, though we agree with the conclusion drawn by the CIT(A) that TNMM Method should have been adopted, however, on the perusal of the record, we find that the TPO has neither examined the comparables nor the application of TNMM Method for benchmarking the ALP in relation to the international transactions. Even the CIT(A) has not called for any remand report from the TPO or the AO asking for any comment upon the comparables shortlisted by the assessee. The comparables have to be examined objectively and the TPO should be given an opportunity to rebut the same. In this case, during the course of Transfer Pricing proceedings both the parties were heavily relying upon CUP Method and data of erstwhile third party, which now admittedly cannot be applied. Therefore, there was no occasion to examine the comparables and the applicability of TNMM . Thus, in the interest of justice, we restore the matter back to the file of the TPO, who will require the assessee to furnish comparables into similar line of business and activities and examine the same for benchmarking the ALP. The assessee will provide necessary information and material to carry out proper assessment of ALP. Once, the TNMM method is applied, other issue relating to taking of composite income or considering only one stream of income will not arise as TNMM would be applied at entity level and this dispute will automatically be taken care of. Thus, the entire matter is set aside to the file of the TPO to carry out the fresh search of comparables with regard to determination of ALP after adopting TNMM Method. It is needless to say that the TPO/AO will provide due and sufficient opportunity of hearing to the assessee for representing its case. Thus, the appeal filed by the department is treated as partly allowed for statistical purposes.

14. In view of our finding given in the departmental appeal, the cross objections raised by the assessee, which are mainly in support of order of the CIT(A), have become academic as the entire matter has been restored back to the file of the TPO to carry out for fresh determination of ALP after following the TNMM Method for benchmarking the ALP. Hence, the cross objections filed by the assessee are also treated as partly allowed for statistical purposes.

15. In the result, appeal filed by the revenue is treated as partly allowed for statistical purposes and the cross objection filed by the assessee is also treated as partly allowed for statistical purposes.