Pass- through costs that are incurred for non value- added purposes should not form part of the cost base while determin

The ruling upholds and reiterates the OECD position on pass -through costs that are not incurred for value-added purposes. It will provide clarity and guidance to taxpayers and tax administration alike on the issue of determination of cost base in si

The New Delhi bench of the Income Tax Appellate Tribunal (Tribunal) recently pronounced its ruling in the case of Cheil Communications India Private Limited Vs. Dy. Commissioner of Income Tax (New Delhi Bench), ITA No: 712/Del/2010, on transfer pricing issues arising from provision of advertising and other related services rendered by the Taxpayer to its Associated enterprises (AEs). The Tribunal ruled in favour of the Taxpayer stating that the pass through costs which are not in the nature of value added cost for the taxpayer should not be taken into account while computing return/mark-up on total costs of the taxpayer on application of the Transactional Net Margin Method (TNMM).


Cheil Communications India Pvt. Ltd., a wholly owned subsidiary of Cheil Communications Inc. Korea (Cheil Korea), is engaged in providing advertising, communication and other related services to its AEs. The Taxpayer charges a fixed commission/charge to its AE depending on different types of services rendered.

As a part of its business operations of preparation of advertisements and provision of related consultancy services, the Taxpayer facilitates placements of such advertisements on hoardings and print and electronic media. For this purpose, Taxpayer makes payments to third parties (advertisement agencies, printing presses, etc.) for renting of advertising hoardings, air-time on television, etc. The Taxpayer makes the payments on behalf of its clients (AEs) to these third parties only upon the receipt of an equivalent am ount from its client on a back to back basis. Such third party payments do not represent any value-added functions undertaken by the appellant.

In its transfer pricing documentation report prepared for the FY 2004-05, the Taxpayer computed the mark-up by including all the value-added costs (costs incurred for the agency functions carried out by the taxpayer) and excluded all the costs in the nature of pass through costs i.e. the costs of renting advertising space on behalf of the AEs. The Taxpayer during the proceedings before the TPO substantiated its stand by stating that the corresponding costs were disclosed „net? of pass-through costs in the books of account and hence the Taxpayer had computed the net profit margin accordingly.

However, the Transfer Pricing Officer (TPO) rejected the approach followed by the Taxpayer and held that the Taxpayer should account for gross receipts as operating revenue and the corresponding gross costs (including the pass through costs) should form a part of the operating expenses in the taxpayer?s profit and loss account to arrive at the net profit margin.

The TPO further held that the comparability analysis needs to be conducted on the basis of current  year data. The TPO also rejected all the nine comparables considered by the taxpayer in its transfer pricing report on the ground that the comparable companies are functionally different, have different revenue realization model, and are based outside India,etc. .The TPO proceeded with his own chosen comparable set of two companies to compute the arm?s length price and made an  upward adjustment to the extent of  Rs.  3,52,25,101 to the book value of the international transactions declared by the Taxpayer.

Being aggrieved by the said transfer pricing order, the Taxpayer filed an appeal before the Commissioner of Income Tax – Appeals i.e. the CIT (A). The CIT (A) deleted the adjustment made by the TPO and stated in his order that the agreements along with the supporting invoices for expenditure incurred with regard to advertisement placements supported and substantiated the fact that the Taxpayer operates only as an agent for its AEs and hence the costs incurred for the above activity do not warrant a mark-up.

The Revenue filed an appeal against the order of the CIT (A).

Ruling of the Tribunal

The salient aspects of the Tribunal?s order are as follows :-

• The Tribunal accepted the net basis of accounting followed by the Taxpayer and upheld that the mark up should be applied to the cost incurred by the Taxpayer Company in performing its agency function and not to the cost of renting advertising space on behalf of the AEs. This is because the Taxpayer just acts as an intermediary between the AEs so as to facilitate the placement of advertisements and hence the same is not in the nature of value-added function.

• The payment made by the Taxpayer to the third party vendors for the advertisement slots is recovered by the taxpayer from its AEs on a cost-to cost basis and hence the bad debt risk is borne by the third party vendor and not by the Taxpayer.

• The Tribunal endorsed the OECD?s view that it may not be appropriate to determine the arm’s length price after including the cost of services (cost of renting the advertising hoardings, air¬time on television, etc.) for which no value added services were performed. These costs can be passed to the customers/ AE without any mark-up, and to apply a mark-up only on the costs which are incurred by the Taxpayer in performing agency function.

• The Tribunal also observed that since the department had accepted the method followed by the Taxpayer in computation of the net revenue in earlier years, there was no reason to depart from the same.


The ruling upholds and reiterates the OECD position on pass -through costs that are not incurred for value-added purposes. It will provide clarity and guidance to taxpayers and tax administration alike on the issue of determination of cost base in situations where a part of the cost base comprises of pass-through, back to back expenses incurred by an agent on behalf of a principal. Also, the ruling is significant in respect of its support to the principle that tax administration should not depart from its previous position on the same set of facts.

Categories: Income Tax


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