Transfer Pricing – Management service charges paid to AE

Delhi Tribunal Ruling –- Management service charges paid to AE by the assessee, which is closely linked to core business activities of the assessee, benchmarked by applying TNMM at entity level is held to be appropriate. Need and benefit from intra-group management services demonstrated by the assessee upheld – [McCann Erickson India Pvt. Ltd. v. ADCIT (ITA No. 5871/D/2011)]

Facts:

McCann Erickson India Private Limited (the assessee or the taxpayer) is engaged in the business of advertising and allied services[1]. The assessee is a part of one of the largest advertising and marketing services conglomerates[2] which consists of numerous agencies around the world.

During the financial year (FY) 2006-07, the assessee had entered into various[3] international transactions with its Associated Enterprises (AEs). The assessee treated all its international transactions as closely linked transactions having nexus with the core revenue generating advertising business activity. Applying the Transactional Net Margin Method (TNMM) as the most appropriate method (MAM), the assessee considered it suitable to compare its net operating profit margin (on cost) (at whole entity level) with that of the comparable companies. Accordingly, the assessee claimed to have confirmed the arm’s length pricing of all its international transactions since it earned more profit margin (26 percent) than the comparable companies (8 percent).

The Transfer Pricing Officer (TPO) and Assessing Officer (AO), however, objected to the pricing in relation to two out of eleven of assesse’s international transactions and made an upward adjustment of INR 40 mn (INR 4 crores) treating the arm’s length value of following transactions as zero (NIL), by rejecting the claim of actual receipt of such services by the assessee and also applying the Comparable Uncontrolled Price (CUP) Method:

• Availing management services from the AE (INR 36 mn or INR 3.6 crores)

• Availing Co-ordination services from the AE (INR 4 mn or INR 0.4 crore)

Upon contesting the order of AO/TPO by the assessee before the Dispute Resolution Panel (DRP), DRP directed the TPO to re-compute the adjustment after considering the all the evidences submitted by the assessee, admitting that actual receipt of service cannot be totally rejected.

While giving the effect of the DRP’s directions, TPO/AO gave a partial relief (amounting to approximately 40 percent of the transaction value pertaining only to management services) and confirming the original adjustment on account of co-ordination services.

The assessee preferred an appeal before the Income-tax Appellate Tribunal (Tribunal) against the order passed by the AO in pursuant to the direction given by the DRP.

Contention of the assessee before Tribunal

• All the international transactions are having close nexus with the core revenue generating business of the assessee i.e. advertising.

• Accordingly, it is infeasible and impractical to ascertain any independent value of management and coordination services. Hence, all transactions should be benchmarked together and not on a standalone basis.

• Under these circumstances, it is desirable to compare entity level profit margin with that if the comparable companies.

• TPO disregarded the detailed documents submitted by the assessee to demonstrate the economic benefit realized by the assessee. No contradictory material was brought on record by AO/TPO.

• The management services are aimed to enable the assessee in carrying out its business operations more efficiently in an increasingly globalised and competitive scenario.

• Without having access to such knowledge/ know-how, creativity and research reports, it would be difficult for the assessee to perform efficiently and keep up to the client expectations.

• The assessee claimed to have benefited from the services of the specialized personnel expert in their respective fields. Adequate documentary evidence [explanation in brief on the type of services received, how are these services received (in the form of e-mail, online web access, presentations, research material, workshop, conferences, CD, DVDs and training), benefits derived and back-up/supporting (samples)]  was submitted to prove the receipt of service, benefits derived there from and payment at arm’s length price.

• The assessee also referred to the detailed report obtained by the Group from the independent auditors in connection with the appropriateness of costs (relating to management and co-ordination charges). Evidence of cost incurred by the AE was also submitted.

• Principal of res judicata not followed: The TPO in earlier years had accepted the receipt of such services from AE to the assessee and had allowed ‘management service charges’ and ‘coordination fee’ paid to AE as allowable expenditure applying TNMM.

• The TPO did not provide reasons for selecting CUP method as the MAM rejecting TNMM.

• The TPO has not shown, with the help of any evidence, as to why such valuable services received by an assessee would not be compensated by an independent assessee under uncontrolled conditions.

• The assessee heavily relied on Delhi High Court’s judgment in case of Hive Communication Pvt. Ltd. (ITA No.306/2011)where it was held that ‘the legitimate business needs of the company must be judged from the view point of the company itself and must be viewed from the point of view of a prudent businessman…’

• The DRP, in principle, had accepted the objection of the assessee, however, TPO mis-appreciated the order of DRP and allowed part relief (of only approx. 40 percent) to the assessee on ad- hoc and imaginary basis.

• DRP’s order is final and TPO were duty bound to follow the same but the same has not been followed correctly.

Contention of the revenue before Tribunal

• Although the DRP has allowed relief to the assessee, the orders passed by AO and TPO are more appropriate in the eyes of law.

• The principle of res judicata is not applicable in the income-tax proceedings.

• It is not clear whether the good profitability of the assessee was a result of such services or whether other factors have led to it.

• No evidence of addition of new clients. Further, evidence of receipt of services appears to be a part of published book and hence, there was no need to make payment of the services.

• No need for the assessee to bear such a high cost for availing these services from abroad since such services are available in India.

 Observation and the order of the Tribunal

•The assessee is engaged in one class of business that is advertising and its allied services. In the business of the assessee, there are no segments or different activities which can be said independent of each other. In our considered view, the entity level benchmarking on TNMM method shall be most appropriate for all international transactions with AE.

•Although the principle of res judicata is not applicable to the income-tax proceedings, something material or adverse in nature, which is having direct bearing on the peculiar facts and circumstances of the case, has to be brought on record to draw the adverse inference. Although it is pleaded by revenue that this year, TPO and AO have done more intelligent analysis of facts, no adverse material has been brought on record by the revenue.

•Hon’ble Jurisdictional High Court in the case of Hive Communication Pvt. Ltd. (supra) has held that the legitimate business needs of the company must be judged from the view point of the company itself and must be viewed from the point of view of a prudent businessman. It is not for the tax officer to dictate what the business needs of the company should be. It is the businessman who only can judge the legitimacy of the business needs of the company from the point of view of a prudent businessman. The benefit derived and occurring to the company must also be considered from the angle of a prudent businessman.

•The assessee has produced the evidences showing description of type of services received and how these services have been received and in what manner the benefits have been derived from theses services. The revenue has not brought anything on record to negate the details provided. In view of these evidences brought on record by the assessee and considering the peculiar nature of business and facts and circumstances of the case, we find merits in the claim of the assessee.

Our View:

This is an important ruling by the Tribunal as regards the benchmarking of availing services. In this case it has been brought out that what types of documentary evidences (providing description of type of services received, how these services have been received and in what manner the benefits have been derived from theses services) that are required to be maintained by the recipient of such services for demonstrating the arm’s length nature of such transaction.

This judgment has reiterated   that the tax authorities cannot step into shoes of the businessman and dictate him on how business should be conducted. It also suggests that once the assessee has demonstrates the need, presence and benefit derived from the legitimate intra-group transaction, the burden of proof shifts to the revenue to prove otherwise.

This judgment given by the Delhi Tribunal is important for a number of taxpayers undergoing litigation at various levels of tax / appellate authorities as it provides several guiding principles that should be kept in mind while carrying out economic analysis for justifying the reasonableness of intra-group services.

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