Depreciation eligible on Goodwill Resulting from Acquisition of Business Unit

DCIT Vs DHL Logistics Pvt. Ltd. (ITAT Mumbai)

The issue under consideration is whether assessee is eligible for Depreciation on Goodwill resulting from acquisition of business unit?

ITAT states that the issue as regards the entitlement of the assesses towards claim of depreciation on intangible (i.e goodwill) is squarely covered by the orders of the coordinate benches of the Tribunal in the assesses own case for A.Y. 2008-09, A.Y. 2009-10 and A.Y 2012-13. Accordingly, finding no reason to take a different view, ITAT respectfully follow the view taken by the Tribunal as regards the entitlement of the assessee towards claim for depreciation on intangibles (i.e goodwill) during the year under consideration i.e A.Y. 2010-11. On the basis of our aforesaid observations, the disallowance of depreciation on intangibles (i.e goodwill) made by the A.O/DRP is deleted. Accordingly appeal is allowed.

FULL TEXT OF THE ITAT JUDGEMENT

1. These two cross appeal and cross objections by assessee in revenue’s appeal are directed against the assessment order dated 27.01.2013 under section 143(3) read with section 144C(13), passed in pursuance of the directions of Dispute Resolution Panel-1, Mumbai [the DRP] dated 28.12.2015. The revenue in its appeal has raised the following grounds of appeal:

1. On facts and in circumstances of the case, the DRP has erred in directing to accept back to back third party charges of Rs 115.19 Cr as pass through cost.

2. On the facts and in circumstance of the case, the DRP has erred in accepting the additional evidence from the assessee without providing opportunity of being heard to the TPO in violation of section 144C(11) of I.T.Act,1961 and in violation of principles of natural justice.

3. On the facts and in circumstance of the case, the DRP has failed to address the TPO’s finding that same head of expense was treated as pass through in one transaction and not as pass through in the other transaction while at the same time claiming that the entire debit to the expense head as pass through and reducing from the cost base.

4. On the facts and in circumstance of the case, the DRP has erred in ignoring the fact that the assessee has also failed to discharge its onus to show that comparable companies are also treating these third party cost as pass through cost.

5. Where there is no material on record to show the amount of pass through cost incurred by the comparable companies, Hon’ble DRP has erred in excluding only from the assessee’s cost base the pass through cost of Rs 115.19 crores.

6. On the facts and in circumstance of the case, the DRP has erred in accepting the contention of assessee for allowing pass through cost of Rs. 1,15.19 crores, which is claimed by assessee as back to back charges under the head Airline/ Shipping line Delivery Order Charges, Air custodian Charges + Demurrage charges, EDI Charges, Container Detention charges, Container Detention charges, Container Freight Station (‘CFS’) Charges inclusive of ground rent, Union Charges, Survey Charges as per its, reply dated 13.01.2015 without appreciating the fact that the assessee has failed to provide the breakup of pass though cost under these heads and has also not submitted the corresponding invoices thereof because of which its contention regarding pass through cost remains unverified.

7. On the facts and in circumstance of the case, the DRP has erred in concluding based on additional evidence filed by the assessee vide its reply dated 15.06.206 mentioned at page no. 768, 769, 774,776,782,783, 784,785, 786, 787,788,7 89,790,791 that the cost of Rs. 151.19 crore is pass though cost.

a. Hon’ble DRP has erred in holding that as per page no. 768 and 769 referred above that CMA charges are pass through cost without appreciating that CMA charges are not appearing in the list of various sub heads of pass though cost submitted by the assessee filed as per its reply dated 13.01.2015.

b. Hon’ble DRP has erred in holding that as per page no. 774 and 776 referred above that the assessee has demonstrated the pass through cost without noticing that none of the heads of expense claimed as pass through cost are matching with third party invoice or break up of pass though cost referred in the submission of assessee dated 13.01.2015.

c. Hon’ble DRP has erred in holding that as per page no. 782 and 783 referred above pass though cost ignoring the fact that TSP charges (which is neither a component of pass through cost admittedly as per assessee’s letter dated 13.01.2015) are different in both the invoices and EDI charges are appearing only in one invoice.

d. Hon’ble DRP has erred in holding that as per page no. 784 and 785 referred above that the charges are pass though cost ignoring the fact that that no cost is evident to be pass through cost in this case.

e. Hon’ble DRP has erred in holding that as per page no. 786 and 787 referred above that the assessee has demonstrated the pass through cost without noticing that none of the heads of expense claimed as pass through cost i.e. DO charges and EDI charges are matching with third party invoice or break up, of pass though cost referred in the submission of assessee dated 13.01.2015.

f. Hon’ble DRP has erred in holding that as per page no. 788 and 789 referred above that the assessee has demonstrated the pass through cost without noticing that the DO charges in the assessee’s invoice and the third party invoice are different. Also the EDI charges which are claimed by the assessee as pass though cost are not appearing in the third party invoice.

g. Hon’ble DRP has erred in holding that as per page no. 790 and 791 referred above that the assessee has demonstrated the pass through cost without noticing that the invoice is related to the custom duty, which has already been considered by the TPO as pass through cost.

8. The appellant craves leave to add, amend, vary, omit or substitute any of the aforesaid grounds of appeal at any time before or at the time of hearing of the appeal.

2. The assessee in its Cross Objection has raised the following grounds of appeal:

1. On the facts and in the circumstance of the case and in law, the Ld. AO; TPO erred in not appreciating that there is no disputed that up to assessment years 2009-10 pass through cost did not form part of cost base for computing the operating margin and, there being no change in the facts in this year, a different view should not be taken.

2. On the facts and circumstances of the case and in law, the Ld. AO / Ld. TPO erred in disregarding the netted off cost from the financial statements as pass through cost thereby disregarded the fact that the financial statements are prepared in compliance with the statutory provisions of the Companies Act, 1956. Further, Ld. AO / TPO also erred in not adjudicating on the views of the statutory auditor that these pass through cost, under no circumstances should the same form part of the cost base for computing the operating margin.

3. On the facts and circumstances of the case and in law, the Ld. AO / Ld. TPO erred in disregarding the illustrative list of broad heads of expenses submitted by the Assessee and alleging that break-up of heads of expenses not provided. Further, Ld. AO / Ld. TPO erred in alleging that various charges in the sample third party invoices as well as of Assessee are not matching thereby ignoring the fact of different nomenclature used for classification of expenses by the Assessee as well as third party.

3. The assessee in its appeal in ITA No. 1385/Mum/2016 has raised the following grounds of appeal:

1. On the facts and circumstances of the case and in law, the Ld. Dispute Resolution Panel (‘DRP’) erred in upholding the action of the Ld. Assessing Officer (‘AO’) / Ld. Transfer Pricing Officer (‘TPO’) in confirming the addition of INR 39,03,70,784 /- to the income of the Appellant by holding that its international transactions pertaining to its freight forwarding segment do not satisfy the arm’s length principle envisaged under the Income Tax Act,1961 (‘the Act’).

2. In doing so, The Ld. DRP / Ld. TPO/Ld. AO grossly erred in:

2.1. disregarding the arm’s length price (,ALP’) and the scientific benchmarking process carried out by the Appellant in the Transfer Pricing (‘TP’) documentation maintained by the Appellant in terms of section 92D of the Act read with Rule 10D of the Income-tax Rules, 1962 (‘Rules’);

2.2. failing to appreciate the economic rationale of using “Operating Profit/Value Added Expenses” (,OP /V AE’) as the Profit Level Indicator (‘PLI’), and instead using “Operating Profit/ Total Cost” (,OP /TC’) as the PLI.

2.3. without prejudice to the ground 2.2 above in relation to using OP/VAE as the most appropriate PLI for the Appellant, grossing up of pass through cost in the nature of recovery of inbound freight as mentioned in Note 9Ca) of the schedule 13 to the Notes to the Financial Statements of the Appellant for AY 2011-12 and artificially enhancing the cost base for the purpose of computing the operating margin COP /TC) of the Appellant.

2.4. not allowing the use of multiple year data as prescribed under Rule 10B(4) of the Rules read with the OECD TP Guidelines, and determining the arm’s length price on the basis of financial information of the comparables for the year ended March 31, 2011. The AO/ TPO/ DRP erred in rejecting the contemporaneous documentation maintained by the Appellant as required under the Indian TP regulations;

2.5. including certain comparables , which were not functionally comparable;

2.6. not including certain com parables selected by the Appellant in its TP Study

The Appellant prays that the book value of the international transactions pertaining to the freight forwarding segment of the Appellant should be held to be the arm’s length price of the said transactions as per the Appellant’s Transfer Pricing documentation, and the addition made on account of the above grounds should be deleted.

3. Depreciation on goodwill resulting from acquisition of business unit of Lee & Muirhead Pvt. Ltd. in AY 2008-09

3.1. On the facts and in the circumstances of the case and in law, the Ld. AO erred in not allowing depreciation of INR 16,77,05,859 under section 32 of the Act on goodwill consisting of various intangible assets arising out of the acquisition of business unit of Lee & Muirhead Pvt. Ltd.

3.2. Without prejudice to above Ground no. 3.1, on the facts and in the circumstances of the case and in law, the Ld. AO erred in not allowing depreciation under section 32 of the Act on intangible assets being contracts and customer relationships (valued at INR 33,70,00,000) arising out of acquisition of business unit of Lee & Muirhead Pvt. Ltd.

3.3. Without prejudice to above Ground no. 3.1, on the facts and in the circumstances of the case and in law, the Ld. AO erred in not allowing depreciation under section 32 of the Act on intangible assets being right to use trade name (valued at Rs. 13,60,00,000) arising out of acquisition of business unit of Lee & Muirhead Pvt. Ltd.

3.4. On the facts and in the circumstances of the case and in law, the Ld. DRP erred in rejecting the valuation report taken from an independent expert valuer without properly appreciating facts of the present case.

3.5. Without prejudice, and in any case the Ld. DRP erred in not apportioning purchase consideration (i.e. Rs. 1,59,01,00,000) towards various assets acquired on the acquisition of business unit of Lee & Muirhead Pvt. Ltd. in AY 2008-09 and granting depreciation on the same.

3.6. On the facts and in the circumstances of the case and in law, the Ld. AO has erred in holding that the ratio laid by the Hon’ble Supreme Court in case of Smifs Securities Ltd. (348 ITR 302) is not applicable in the present case and consequently erred in disallowing depreciation on intangible assets including goodwill.

It is prayed that the Ld. AO be directed to allow depreciation of INR 16,77,05,859 on intangible assets including goodwill.

4. Penalty proceedings

4.1. On the facts and in the circumstances of the case and in law, the learned AO erred in initiating penalty proceedings under section 271(1)(C) of the Act without appreciating that the Appellant has neither concealed any particulars of its income nor furnished any inaccurate particulars of the income.

That the AO be directed to re-calculate the interest levied under section 234B and 234D after considering the relief granted by the Hon’ble Tribunal in respect of the grounds raised by the Appellant.

4. Brief facts of the case are that the assessee is a logistics services provider and offering comprehensive portfolio of international, domestic and specialized freight handling services. Assessee filed its return of income of for A.Y. 2011-12 on 29.11.2011 declaring income of Rs. 136,63,91,748/-. Along with the return of income, the assessee furnished report under Form 3CEB reporting certain international transaction, including of freight receipt and freight expenses. The assessee adopted Transaction Net Margin Method (TNMM) as most appropriate method and selected seven (7) comparables companies. The assessee has shown its Profit Level Indicator (PLI) at 41.64%. The assessee selected itself as a tested party. The margin of comparable company were at 31.46%, thus, the assessee claimed its transaction at Arm’s Length. The Assessing Officer made reference to the TPO for bench marking the said international transaction. The TPO vide its order dated 29.01.2015 suggested TP Adjustment of Rs. 152,19,20,807/-. The TPO while passing its order under section 92CA(3) followed the direction of DRP for A.Y. 2010-11. The TPO while passing the order rejected Operating Profit/Value Added Expenses as a PLI and adopted operating profit/ turnover cost (OP/TC) as a appropriate PLI for determining Arm’s Length Price and suggested addition of recovery of freight on inbound shipments of Rs. 486 crore and recovery of back to back third party charges of Rs. 115 crore. The TPO also excluded Personnel and Administrative Cost from assessee as well as comparable cost base for margin computation on the basis of direction of DRP for A.Y. 2020-11.

5. On receipt of report of TPO, the Assessing Officer passed the Draft Assessment Order. The Assessing Officer while passing the Draft Assessment Order also disallowed claim for depreciation of Rs. 16.77 Crore, in respect of intangible assets (goodwill), on the basis of earlier year’s orders. The assessee exercised its option for filing objection before the Dispute Resolution Penal (DRP). The DRP granted partial relief to the assessee with regard to the extent of excluding “recovery of back to back third party charges” from cost base while applying the OP/TC as PLI. The DRP rejected the contention of assessee of taking OP/VAE as the PLI. The DRP passed its direction vide order dated 28.12.2015 under section 144C(5). On receipt of direction of DRP, the Assessing Officer passed final assessment order under section 143(3) r.w.s. 144C(13). The Assessing Officer in final assessment order as per the direction of DRP, reduced the adjustment of international transaction to Rs. 39 crore with respect to transaction in DHF segment. Aggrieved, thereafter, both the parties have filed their cross appeals by raising the grounds of appeal as recorded above. The assessee has also filed cross objection in the appeal of revenue.

6. We have heard the submission of parties and perused the orders of lower authorities carefully. We have noted that the revenue has raised as many as nine (9) grounds of appeal, however, the substantial ground of appeal raised by revenue relates to pass through cost/ back to back third party charged. The ld. DR for the revenue submits that for A.Y. 2011-12, the TPO has computed pass through cost being (i) freight on inbound shipment, (ii) recovery of back to back third party cost and (iii) recovery of custom duty. This has been reduced from the turnover costs while computing assessee’s margin. The TPO has accepted the recovery of custom duty as a pass through cost, however, with regard to other cost, the TPO was of the view that these cost cannot be claimed as a pass through cost. With regard to freight on inbound shipment, the TPO noted that no evidence has been produced by the assessee that the charge are in the nature of back to back pass through cost with respect to third party costs at Ports, TPO came to the conclusion that few invoices were produced and only some portion may be treated as back to back cost and other are mere estimates. TPO also noted that third party invoices are not available for verification. The ld. DR further submits that with regard to pass through cost, the DRP admitted the claim of assessee with respect to netting of or exclusion of back to back third party charges of Rs. 115.20 crore from the cost base as assessee provided on sample basis invoices to demonstrate that expenses are recorded, subject to verification by AO/TPO. The ld. DR submits that DRP accepted inbound freight of Rs. 486.56 crore after extensively examining the claim of assessee regarding recovery from the consignee on actual basis to be remitted to the Associated Enterprises (AE) as per rate card. The ld. DR for the revenue further submits that OP/VAE has been recognized by Organization for Economic Cooperation and Development (OECD), as PLI, to be used in rare cases where the tested party does not any risk at all and also does not deploy any asset with respect to cost embedded in Profit & Loss Account. Mostly, such PLI is used in case of Pure Risk Free Distribution to do not carry out any function other than merely being a conduit of the goods supplied by the manufactures in the territory of distributor. In support of its submission relied upon the decision of Hon’ble High Court in Mitsubishi Corporation India Pvt. Ltd. [48 taxman.com 45 (Del.)]. The ld. DR for the revenue submits that Hon’ble Delhi High Court in the said case held that in respect of trading activity of such company, that they are liable to be bench-marked with reference to similar comparables, in respect of activities such Sogoshosha Entities which render support function and did not carry inventory of risk are liable to be bench-marked adopting berry ratio. The assessee is not meeting any of the criteria set out for use of berry ratio for PLI of OP/VAE. The assessee is in the field of logistic management and carry out part of activity related to delivery of goods from one place to another, thus, the assessee assumes the entire responsibility, whether it is from client directory or from the AE to forward the goods for deliver. The assessee is not a mere spectator to the entire delivery management chain, but actually handles the same. It cannot correct for assessee to claim that it is a merely facilitates. The assessee involved in guaranteeing proper, safe and timely delivery of goods and responsible to clients to provide details of current status of goods. The ld. DR for revenue submits that the TPO has rightly invoked the provision of section 92C(3) by rejecting the TP Study of assessee based on a wrong PLI and incorrect appreciation of its risk profit and rightly adopted a PLI of OP/OC. The ld DR for the revenue also furnished his written synopsis by incorporating all his submissions, which we have recorded above.

7. On the other hand, the ld. Authorized Representative (AR) for the assessee supported the order of DRP. The ld. AR of the assessee submits that facts for the year under consideration are identical to the facts for A.Y. 2020-11. There is no change in the function performed, asset employed and risk assumed (FAR) by the assessee and its AEs during the course of provision of freight handling services and the international transactions entered in by the assessee with its AEs in AY 2011-12 have also remained the same as compared to A.Y. 2020-11. The ld. AR of the assessee further submits that since the facts of A.Y. 2011-12 are identical to A.Y. 2020-11; the decision laid by Income Tax Appellate Tribunal (ITAT) for A.Y. 2020-11 in assessee’s own case is applicable for A.Y. 2011-12 as well. The Tribunal in case for A.Y. 2010-11 in ITA No. 1030/Mum/2015 dealt the identical issue in para-24 of its order and accepted the contention of assessee that ALP of the international transaction is to be determined by taking OP/VAE as the PLI while applying TNMM. Therefore, the same may be applied for the Assessment Year under consideration. The submissions made by ld. DR for the revenue have already been considered by Tribunal in earlier year and were rejected. Hence, the grounds of appeal raised by revenue are squarely covered against the revenue and in favour of assessee by the order of Tribunal. The ld. AR of the assessee submits that reference by ld. DR in his submission with regard to the finding of DRP in respect in inbound cost being included in the total cost is irrelevant as the said discussion was with reference to the computation of ALP by applying the PLI of OP/TC, which has specifically rejected by Tribunal in A.Y. 2010-11 and accepted OP/VAE. The ld. AR of the assessee in his without prejudice submission submits that the observations of DRP are in any case, factually incorrect. The DRP made observation with regard to bad-debts without appreciating that bad-debts do not pertain to inbound freight. The AE of assessee is the principle contracting entity with consigner outside India and hence, the amount build to the customers with respect to the said consignment is recorded by the AE in its financial statement. The assessee merely collects the same from consignee in India. The amount inbound freight is not reflected in the account of assessee. It does not impact the profit and loss or the balance-sheet of assessee and is merely reflected as a note. There is no question of any bad-debt on alleged “inbound freight” affecting the profit of the assessee. Thus, the observation of ld. DRP with reference to inbound freight is wholly erroneous.

8. We have considered the submission of both the parties and also gone through the orders of lower authorities and the decision of Tribunal for earlier year (A.Y. 2010-11). We have noted that on similar issue, the co-ordinate bench passed the following order:

“24. We have deliberated at length on the issue under consideration i.e rejection by the lower authorities of the PLI of OP/VAE by the assessee and substitution of the same by PLI of OP/TC. As is discernible from the orders of the lower authorities the PLI of OP/VAE had been rejected for the reasons viz. (i). that, as the freight element booked in the books by the assessee has a component of profit (or value added), therefore, the assessee claiming the same as pass through costs had wrongly reduced the same from its turnover and costs while computing its margins; (ii). that, the recovery of third party costs at ports except for in few instances where invoices were produced by the assessee, in the absence of any evidence had wrongly been treated by the assessee as back to back costs; and (iii). that, the VAE could not be safely gathered from the ‘books of account’ of the comparables. We shall deliberate on the aforesaid aspects, as under:

(i). For a proper appreciation of the business module of the assessee, we shall briefly deliberate on the transactions undertaken by the assessee during the year under consideration:

(a). Inbound Collect – Air Shipments :

> Shipper (outside India) hands over the consignments to DHL India’s AE to forward the same via air to the consignee in India. DHL AE takes the assistance of DHL India for the same.

> DHL AE negotiates the terms of the transactions with the shipper. The consignee is assigned by the shipper to pay for the International freight. Accordingly, DHL AE assigns the collection responsibility (from the consignee) to DHL India. DHL AE pays the freight to the carrier.

> DHL India invoices and collects from the consignee the Origin Charges (‘OC’), Freight (Air) and Destination Charges (‘DC’).

> DHL AE invoices and collects from DHL India the OC and Freight. Only DC is considered as revenue for DHL India.

> Given that the actual amount of OC and Freight (Air) agreed between the Shipper and DHL AE are merely collected by DHL India from the consignee and passed on back to back basis to DHL AE, the OC and Freight (Air) are netted off in the Profit & Loss Account of DHL India i.e the assessee.

(b). Inbound Collect – Ocean Shipments :

> The Shipper (outside India) hands over the consignment to DHL AE to forward the same via ocean to the consignee in India. DHL AE takes the assistance of DHL India for the same.

> DHL AE negotiates the terms of the transaction with the Shipper. In this case, the consignee pays for the freight (ocean).

> DHL India invoices and collects from the consignee the OC, Freight (ocean) and the DC. Freight and DC are considered as revenue for DHL India.

> DHL AE invoices and collects from DHL India the OC and Freight (ocean).

(c). Inbound Prepaid :

> The Shipper (outside India) hands over the consignment to DHL AE to forward the same to the consignee in India. DHL AE takes the assistance of DHL India for the same.

> DHL AE negotiates the terms of the transaction with the Shipper. DHL AE invoices the shipper for OC and Freight. The Shipper pays for OC and Freight to DHL AE. DHL AE further pays the freight to the carrier.

> DHL India invoices and collects from the consignee the DC. The same is accounted as revenue by DHL India.

(d). Outbound Collect :

> Shipper (India) hands over the consignment to DHL India to forward the same to the consignee (outside India). DHL India takes the assistance of DHL AE for the same.

> DHL India negotiates the terms of the transaction with the Shipper. The consignee pays the freight to DHL AE.

> DHL India pays the freight to the carrier. DHL India invoices and collects from the Shipper the OC. The same is booked as revenue.

> DHL AE invoices and collects from the consignee the freight and DC.

(e). Outbound Prepaid :

> Shipper (India) hands over the consignment to DHL India to forward the same to the consignee (outside India). DHL India takes the assistance of DHL AE for the same.

> DHL India negotiates the terms of the transaction with the Shipper. In the present case the Shipper pays for the freight.

> DHL India invoices and collects from the Shipper the OC and freight. The same is considered as revenue for DHL India.

> DHL India further pays the Freight to the carrier company.

> DHL AE invoices and collects from the consignee the DC.

On a perusal of the aforesaid transactions carried out by the assessee in the course of its international logistic transactions, it can safely be gathered that the ‘Origin charges’(‘OC’) in case of outbound shipments and ‘Destination charges’ (‘DC’) in case of inbound shipments, only form part of the revenue receipts/income of the assessee.

(ii). As observed by the TPO, the main component of the income of the assessee is on account of differential freight element which it is able to obtain from the shipping companies on account of bulk booking of space on the liner. It was observed by the TPO, that the carriers in view of heavy turnover of the assessee group would provide them very competitive rates which otherwise would not be available to a normal exporter or importer. TPO observed, that the assessee group in anticipation of the expected shipments would book cargo spaces in bulk around the world at the competitive rates so offered to them by the shipping companies. The TPO held a conviction that the assessee after making bulk bookings with the carriers would enter into bargains depending upon the time, space and the paying capacity of the client. It was observed by the TPO, that though the assessee would collect freight from the customers at an amount in excess of the rate it had negotiated with the shipping company, however, it would issue a “House Airway Bill” of a similar amount of fare and the difference would be collected as handling charges. On the basis of his aforesaid observations, it was concluded by the TPO that the additional amount charged by the assessee from its client would in fact represent the ‘mark up’ on freight. Accordingly, it is in the backdrop of his aforesaid observations that the TPO had concluded that the handling charges which were charged by the assessee varied from customer to customer because they were dependent upon the ‘mark up’ on freight which it was obtaining from them on the basis of negotiations. Accordingly, it was observed by the TPO that the fright element booked by the assessee in its books of accounts had a component of profit in it. In order to fortify his aforesaid observations, it was further observed by the TPO that the fact that the assessee had debited the ‘freight expenses’ and credited the ‘freight receipts’ in its books of accounts revealed that the operating profit of the assessee comprised not only of its ‘handling charges’ but also the differential freight i.e the excess of the freight which it charged from its clients as against that paid to the shipping line. On the basis of the aforesaid observations, the TPO/DRP had rejected the adoption of PLI of OP/VAE by the assessee and had advocated the substitution of the same by PLI of OP/TC.

(iii). We have perused the aforesaid observations of the TPO and are unable to persuade ourselves to subscribe to the same. As observed by us hereinabove, the costs pertaining to services obtained by the assessee from third parties viz. shippers/airliners, clearing and forwarding agents, transport service provider etc. neither involved any service element of the assessee nor the assessee had carried any risk or employed any of its assets with respect to the same. In our considered view, the net margin realised by the assessee pursuant to its international transactions with its AE’s are to be determined only with reference to the cost incurred directly by the assessee itself and its profit margin cannot be imputed on the basis of the cost incurred by the third party or unrelated parties. We are of the considered view that the payment made by the assessee to the third party for and on behalf of the AE which had thereafter been reimbursed by the AE, cannot be included in the total costs of the assessee for the purpose of determining its profit margin. In fact, we find that Rule 10B(1)(e) does not enable consideration or imputation of cost incurred by third parties or unrelated enterprises to compute the assesse’s ‘net profit’ margin for application of TNMM. Rule 10B(1)(e) provides that the ‘net profit’ margin realized by the enterprise from an international transaction entered into with an AE is to be computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise. As such, it contemplates determination of ALP with reference to the costs, assets, sales etc. of the enterprise in question, i.e the assessee, as opposed to the AE or any third party. In our considered view, the considering of the freight cost of the airlines/ship liners in the total cost base of the assessee had resulted to a distorted picture of the ‘net margin’ realized by the assessee from its international transactions. Our aforesaid view is fortified by the order of the ITAT, Mumbai in the case of FedEx Express Transportation and Supply Chain Services India Pvt. Ltd. Vs. Dy. CIT, Range 8(1), Mumbai [ITA No. 435/Mum/2014; dated 10.12.2014]. In the said case, it was observed by the Tribunal that the payment made by the assessee to the third party for and on behalf of the AE which had been reimbursed by the AE, could not have been included in the total costs of the assessee for the purpose of determining its profit margin. Also, the Hon’ble High Court of Delhi in the case of LI and Fung India Pvt. Ltd. Vs. CIT (2014) 361 ITR 85 (Del), had observed, that for applying the TNMM the assesse’s net profit margin realised from the international transactions had to be calculated only with reference to the cost incurred by it and not by any other entity either third party vendors or the associated enterprise. It was further observed by the Hon’ble High Court, that Rule 10B(e)(i) of the Income-tax Rules, 1962, does not enable consideration or imputation of cost incurred by third parties or unrelated parties for the purpose of computing the assesse’s ‘net profit’ margin for application of the TNMM. Accordingly, it was concluded by the Hon’ble High Court, that attribution by the TPO of the costs of the third party, when the assessee did not engage in that activity, and more importantly when those costs were clearly not the assesse’s cost, but those of a third party, was clearly impermissible.

(iv). Apart from that, we find that from a perusal of the ‘agreements’ which the assessee had entered into with various carriers (i.e airlines) who are members of IATA, and also the sample ‘invoices’ raised by the assessee on its clients, it can safely be concluded that the assessee while providing logistics support services in “air business” had merely acted as an agent of the airlines. A perusal of the terms and conditions of “Cargo agency agreements” which the assessee had entered into with various airline carriers which were members of IATA, reveals that the assessee was to act as an ‘agent’ for the various member carriers. [(Page 804) of the assesse’s ‘Paper book’ (for short ‘APB’)]. As per the ‘agreement’, the assessee was vested with a limited authority to represent various member carriers while selling the air cargo transportation services to the customers and was bound to adhere to the various terms and conditions imposed by the member carriers.(Page 805 of ‘APB’) In sum and substance, the assessee at all times was governed by the carriers. Also, as per the terms of the ‘agreement’ the assessee was bound to represent itself as an “agent” in all its communications viz. letterheads, telephone listings, office signs etc. with the customers, and was specifically prohibited from representing or projecting itself as a “Principal” (Page 806 of ‘APB’). Further, the ‘agreement’ also provided for indemnification of the assessee by the member carrier in the event of a loss/damage arising in the course of transportation pursuant to the sale made by the assessee.(Page 807 of ‘APB’). As such, the assessee did not assume any risks while undertaking its business. In order to fortify his aforesaid claim, the ld. A.R had drawn our attention to a sample “house airway bill” (Page 813-817 of ‘APB’) that was issued by the assessee to its customer which revealed that the assessee had executed the same as an agent of the carrier. Also, we find that the functions (carriage of goods) and liabilities (indemnification of the loss etc.) assumed by the assessee vis-a-vis the customer (as per its standard terms and conditions) corresponds to those assumed by the carrier vis-à-vis assessee. Accordingly, we are of the considered view that the functions and liabilities were effectively delegated by the assessee to the carrier and no part of the same was effectively assumed by the assessee. On a similar footing, we find that in the case of “ocean business” also the assessee had merely acted as an agent. Further, we find that all the ‘agreements’ entered into by the assessee with the carriers (under both air and ocean business) were soft block agreements which provided an option to the assessee to cancel the same without incurring any penalty, therefore, no inventory risk was assumed by the assessee. (Page 860 to 865 of ‘APB’). As regards the observation of the TPO, that the main component of the income of the assessee is on account of the differential freight element which it is able to obtain from the shipping companies on account of bulk booking of space on the liner, we are in agreement with the contention advanced by the ld. A.R that the advantage to the assessee on account of bulk booking was on account of its value addition activities i.e generating more customers and not on account of transportation function. In fact, we are persuaded to subscribe to the claim of the ld. A.R that transportation cost could have been included as a base only if the assessee had undertaken the transportation activity itself or would have undertaken the risks associated with the transportation function. However, as in the present case, in the absence of either of the aforesaid factor there would be no justification for including the said third party costs i.e transportation costs as apart of the base.

(v). As per the TPO, the element of freight could be considered as a pass through expense only if no profit or mark up is obtained on freight. However, as observed by the TPO, the case of the present assessee would not fall in the said category as the handling charges which were charged by the assessee varied from customer to customer, as they depended on the ‘mark up’ which it obtained from its customers based on negotiations. In our considered view, there is substantial force in the claim of the assessee that in order to characterize a particular item as pass through in nature an analysis has to be made with respect to the FAR of the assessee qua such activity. As the assessee does not perform any additional functions with respect to the third party cost, neither employs its assets, nor any risks are assumed for the same, therefore, it can safely be concluded that the assessee does not undertake any activity in relation to the said costs.

(vi). As regards the observation of the TPO that PLI of OP/VAE could not be safely applied as the reporting of various companies as regards classification of various expenses is not uniform, we are unable to find favour with the same. In our considered view, the assessee had only selected companies which had provided their VAE separately.

Accordingly, in the backdrop of our aforesaid observations, we are of the considered view, that as in the case before us the costs pertaining to the services obtained by the assessee from the third parties viz. shippers/airliners, clearing and forwarding agents, transport service provider etc. neither involved any service element of the assessee nor the assessee had carried any risk or employed any of its assets with respect to the same, therefore, inclusion of the freight cost in the total cost base of the assessee by the TPO was not permissible. We thus are persuaded to subscribe to the claim of the assessee that the TPO/DRP were in error in rejecting the PLI of OP/VAE adopted by the assessee and substituting the same by PLI of OP/TC. As such, we herein restore the matter to the file of the A.O/TPO for the purpose of benchmarking the international transactions of the assessee by adopting the PLI of OP/VAE. Grounds of appeal Nos. 1, 3.1 and 3.2 are allowed in terms of our aforesaid observations.”

9. We have noted that the ld. DR made similar submission in A.Y. 2010-11, which has been duly recorded in para-23 of the order dated 20.12.2019 and after considering the submission, the co-ordinate bench restored the matter to the file of AO/TPO for bench marking the transaction by adopting PLI of OP/VAE. So far as the ground related with the additional evidences are concerned (Ground No. 7), we have noted that no new evidences were furnished by assessee before DRP. Moreover, ld DRP directed the TPO to verify the sample invoices to his satisfaction with regard to back to back third party charged as recorded in para 4.3.7.6 of the directions. Thus, considering the decision of co-ordinate bench of Tribunal and the order of the ld DRP, which is sound reasoning, we do not find any merit in the ground of appeal raised by revenue.

10. In the result, appeal of the revenue is dismissed.

IT(TP) A No. 1385/Mum/2016 by assessee

11. At the outset of hearing, the ld. AR of the assessee submits that Ground No.1 and 2.1 of the appeal are general in nature and needs no adjudication. Ground No.2.2 relates to treating the PLI of assessee as OP/TC (Operating Profit/Total Cost) instead of OP/VAE. The ld. AR of the assessee submits that this ground of appeal is covered by the decision of Tribunal in assessee’s own case for A.Y. 2010-11.

12. On the other hand, the ld. DR for the revenue supported the order of lower authorities.

13. We have considered the submission of parties and gone through the order of Tribunal. We have noted that Tribunal in assessee’s own case for A.Y. 2010-11 has accepted PLI of assessee on the basis of OP/VAE as noted in para-7 of this order. Considering the submission of ld. AR of assessee and the decision of Tribunal for A.Y. 2010-11, ground no.2.2 of the appeal is allowed.

14. Ground No. 2.3 and 2.4 are raised as without prejudice to the ground No. 2.2. Considering the facts that we have allowed ground no. 2.2, therefore, the discussion on these grounds of appeal have became academic.

15. Ground No. 2.5 relates to including comparables, not functionally comparable with the assessee. The ld. AR of the assessee submits that Om Logistics Ltd. is not comparable with the assessee. This comparable was included by TPO during the T.P. Adjustment. The ld. AR further submits that these comparable was excluded by Tribunal in appeal for A.Y. 2010-11, therefore, it should be excluded from the final set of comparable and in case this comparable is excluded the mean margin of the assessee would be within tolerance range.

16. On the other hand, the ld. DR for the revenue relied upon the order of lower authorities.

17. We have considered the contention of both the parties and perused the order of lower authorities. We have noted that the assessee in its T.P. Study Report selected 7 following comparable company for bench marking its transaction under TNMM, which are as under:

18. The assessee claimed that three years mean margin of comparable company on the basis of OP/VAE is 31.465 and the freight forwarding segmental OP/VAE margin of assessee is 41.64%, thus the assessee’s margin is within arms lengths.

19. The TPO while bench marking the transaction substituted the PLI of assessee by applying OP/TC. The TPO also rejected the comparable no. 2, 3 & 7 shown in the above list. The TPO further included Om Logistics Ltd. in final set of comparable and worked out the margin of final set of comparable in the following manner:

20. On the basis of the final set of comparables the TPO suggested adjustment of Rs. 153.19 crore. Before us, the ld. AR of the assessee only pressed for exclusion of Om Logistics Ltd. from the final set of comparable on the basis of order of Tribunal in immediately earlier year. We have noted that the Tribunal in assessee’s own case on similar set of fact in A.Y. 2010-11 directed to exclude the Om Logistics Ltd. by passing the following order:

“(iii) Om Logistics Ltd:

(a). It was the claim of the assessee that as the aforesaid company owned transportation assets and had started warehousing business, therefore, it could not have been selected as a comparable to the assessee. However, the TPO had observed that the ‘annual report’ of the aforesaid company for financial year 2008-09 and financial year 2009-10 revealed that its composition of assets had remained the same. In fact, it was observed by the TPO that in financial year 2008-09 the assets of the aforesaid company were more than those during the year under consideration i.e financial year 2009-10. Also, it was observed by the TPO that the operations as well as the background of the aforesaid company had remained the same as in the last two preceding years. Accordingly, on the basis of his aforesaid observations the aforesaid claim of the assessee was rejected by the TPO. As regards the claim of the assessee that the aforesaid company was having super profit, it was observed by the TPO that merely for the said reason the same could not be rejected as a comparable. In fact, the TPO had observed that for rejecting a company as a comparable, for the reason, that it had shown super profit, it has to be shown by the assessee that there were exceptional events or situation leading to higher than the normal profits in the case of such comparable. Accordingly, it was observed by the TPO that as no such exceptional circumstances or events had been shown by the assessee, therefore, the plea of the assessee that the aforesaid company be rejected as a comparable did not merit acceptance. Apart therefrom, it was observed by the TPO that as the OP/TC margin of the company was ranging from 9.76% to 17.37%, and in fact the same had gone down to 14.46% in the next year, therefore, there was no pattern to suggest any abnormality in the profit of the assessee. On the basis of his aforesaid deliberations the TPO had declined to accept the claim of the assessee that the aforesaid company was to be excluded from the final list of comparables.

(b). Admittedly, the aforesaid company was selected by the assessee in its TP study report, but then as observed by us hereinabove, an assessee cannot be barred in law from withdrawing from its list of comparables a company, which had either been included on account of a mistake on facts or is not found to be comparable. Our aforesaid view is fortified by the judgment of the Hon’ble High Court of Bombay in the case of The Commissioner of Income-tax-7 Vs. M/s Tata Power Solar Systems Ltd. (2017) 245 Taxman 93 (Bom) and Pr. CIT Vs. J.P Morgan India Pvt. Ltd. (ITA No. 912 of 2016, dated 14.01.2019)(Bom). It is in the backdrop of our aforesaid conviction, that we shall deliberate upon the aspect as to how the aforesaid company could not have been feasibly selected as a comparable for determining the arm’s length price of its international transactions for the year under consideration. On a perusal of the ‘annual report’ of the aforesaid company for the year under consideration viz. F.Y 2009-10, we find, that unlike the assessee company it has a significant asset base. For the sake of clarity, the ‘Fixed asset’ schedule of the aforesaid company for the F.Y 2009-10 is reproduced as under:

“Schedule 5: Fixed assets

Schedule 6: Intangible assets

Also, a perusal of the ‘annual report’ of the aforesaid company reveals that unlike the assessee it has various warehouses across the country and has increased the fleet of its vehicles. In order to fortify his aforesaid claim, the ld. A.R had drawn our attention to Page No. 7 of the ‘annual report’ of the aforesaid company, which reads as under :

“Strengthening the Infrastructure

As envisaged in the last report, Your company has taken various steps during the year to strengthen its infrastructure base across the country. We have succesfuly launched the warehouses at Jamalpur (Delhi NCR region), Sanad near Ahmedabad and Sriperambadur near Chennai and plan to setup more warehouses in near future at strategic locations throughout the country.

Your company also set up about 20 more branches at strategic locations. Further the fleet strength owned by the company was also increased to smoothen the operational activities.”

As observed by us hereinabove, as the assesee company is not an asset owning company, therefore, the aforesaid company viz. M/s Om Logistics Limited which has a significant asset base, thus being functionally different could not have been feasibly selected as a comparable for the purpose of determining the arm’s length price of its international transactions for the year under consideration. Accordingly, we direct the A.O/TPO to exclude the aforesaid company from the final list of comparables for the purpose of benchmarking its international transactions for the year under consideration.”

21. Considering the decision of Tribunal for earlier year, when no material difference on facts with regards to segmental data, is brought to our notice for the year under consideration, thus, respectfully following the order of coordinate bench, we direct the Assessing Officer to exclude the Om Logistics Ltd. from list of comparable for the purpose of benchmarking of international transaction for the year under consideration.

22. Ground No. 3 relates to disallowance of depreciation on goodwill. Ld. AR of the assessee submits that this ground of appeal is also covered by the decision of Tribunal in assessee’s own case for earlier year (A.Y. 2011-12).

23. On the other hand, the ld. DR for the revenue supported the order of lower authorities.

24. We have considered the submission of both the parties and have seen that the Assessing Officer while passing the Draft Assessment Order disallowed the depreciation on goodwill by taking view that similar is the subject matter pending adjudication before the Tribunal from A.Y. 2008-09 to 2010-11. The DRP affirmed the action of Assessing Officer by following the direction of DRP for A.Y. 2010-11. We have noted that the co-ordinate bench of Tribunal in assessee’s own case for A.Y. 2010-11 on similar set of fact and considering the order of Tribunal for A.Y. 2008-09, 2009-10 and 2012-13 passed the following order:

“38. We find that the issue as regards the entitlement of the assesses towards claim of depreciation on intangible (i.e goodwill) is squarely covered by the orders of the coordinate benches of the Tribunal in the assesses own case for A.Y. 2008-09, A.Y. 2009-10 and A.Y 2012-13. Accordingly, finding no reason to take a different view, we respectfully follow the view taken by the Tribunal as regards the entitlement of the assessee towards claim for depreciation on intangibles (i.e goodwill) during the year under consideration i.e A.Y. 2010-11. On the basis of our aforesaid observations, the disallowance of depreciation on intangibles (i.e goodwill) of Rs.22,36,07,813/- made by the A.O/DRP is deleted. Ground of appeal No. 5 is allowed in terms of our aforesaid observations.”

25. Considering the decision of Tribunal for earlier years, which was followed by co-ordinate bench in appeal for A.Y. 2010-11, therefore, respectfully following the same, this ground of appeal is also allowed. In view of the aforesaid discussion on various issues raised by assessee, the Assessing Officer/TPO is directed to recompute the adjustment in accordance with the directions hereinabove.

26. In the result, appeal of the assessee is allowed.

C.O. No. 159/Mum/2016 by assessee

27. The ld. AR of the assessee submits that in case appeal of the revenue is dismissed, the grounds of appeal raised in the present Cross Objection would become infructuous. Considering the submission of ld. AR of the assessee, the grounds of appeal raised by assessee are dismissed as infructuous.

28. In the result, appeal of the assessee is allowed and appeal of the revenue is dismissed and the cross objection of assessee is also dismissed being infructuous.

Order pronounced on 10/08/2020 as per Rule 34(4).