TaxTMI 
TaxTMI 
2010 (11) TMI 630
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.... of the case in holding that the profitability ratio of the assessee should be determined on a net basis which is in absolute divergence to the actual procedure of business actually earned out by the assessee. 2(b) The learned CIT(A) has erred in law and facts of the case in determining the cost base of the profit level indicator (PLI) by taking income on net basis due to which various costs were ignored while computing cost of the assessee or PLI. 2(c) The learned CIT(A) has erred in law and facts in applying the principle of res judicata in this year ignoring the following judgments of the apex Court, Hon'ble Madras High Court and Hon'ble Tribunal, Delhi which apply squarely in this case : (i) CIT v. British Paints India Ltd. [1991] 91 CTR (SC) 108 : [1991] 188 ITR 44 (SC); ii) CIT v. Shaik Md. Rowther Shipping & Agencies (P.) Ltd. [2000] 160 CTR (Mad.) 203 : [2000] 246 ITR 161 (Mad.); (iii) Dy. CIT v. Carraro India Ltd. [2009] 120 TTJ (Delhi) 77 : [2008] 16 DTR (Delhi) (Trib.) 80 : [2009] 28 SOT 53 (Delhi) (URO)." 4. In this case, the assessee filed its return of income on 31st Oct., 2005 declaring total income of Rs. 4,54,28,436. ....
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....), who had taken a view that in the light of the facts and circumstances of the case, no adjustment to the declared value of international transactions entered into, with AEs is called for and he therefore, directed the AO to delete the addition. 9. Being aggrieved, the Revenue is in appeal before us. 10. We shall now deal with the order of TPO whereby TPO has made an upward adjustment of Rs. 3,52,25,101 to the declared value of international transactions with associate concerns. 11. With a view to determine, ALP under section 92CA(3) in respect of international transactions entered into by the assessee with AEs/concerns, the AO referred the matter to the TPO. The documentations prepared under rule 10D of the IT Rules were submitted by the assessee and were placed on record. The assessee is a wholly-owned subsidiary of Cheil Communications Inc. (Cheil Korea) and it was established to handle the Indian operations of Cheil Korea advertising business. During the year under consideration, the assessee was serving Samsung for creating its advertisement for brands of air-conditioners, mobiles, monitors, outdoor hoardings etc. Cheil Korea is a Samsung Group company. It is a globa....
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....ion services, print material for merchandising and other purposes, sales promotion and other services. The nature of all these services has been discussed by the TPO in his order and are not a matter of dispute between both the parties. The relevant portion of the agreement shall be discussed at the appropriate stage while deciding the main controversy arising in this appeal. 13. The media service agreement was entered into between Samsung India Electronics Ltd. and the assessee company, and as per this agreement, the assessee company was required to supply to Samsung India Electronics Ltd., the following services for effective and better promotion, advertisement and management of the brands listed in the scope of assignment by and through media : (1) Tactics (planning) (2) Investment, implementation and post-analysis (buying). 13.1 As per the agreement for the services, the assessee company will be remunerated as per Annex. B of the agreement. 13.2 Agreement for outdoor was also executed between M/s. Samsung India Electronics Ltd. and the assessee company. 13.3 Commission sharing agreement was executed between Cheil Communication Inc. a....
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.... notice, and submissions are misdirected, TPO further stated that the judgments relied upon by the assessee are completely out of context. The TPO was of the view that the role of TPO was to determine the ALP of international transactions undertaken by the assessee on the basis of documents maintained by the assessee, prescribed under rules and on the basis of five methods prescribed under rules. TPO further stated that he could utilize the information, which is available in the public domain to judge the ALP determined by the assessee as per the provisions of the IT Act and Rules. He further stated that when the assessee has applied TNMM as the most appropriate method with net cost plus margin as PLI, it was his duty to know as to whether method and the PLI applied was appropriate or not. Net cost plus margin is based on operating profit and total cost, He further stated that to determine the operating profit, determination of operating revenue is utmost important and if the billing is made and payment is received on gross revenue basis, it is very much within the power of TPO to scrutinize as to how the assessee has disclosed net revenue in its financial statement in spite of the....
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....sets 13,72,641 13,72,641 Preliminary expenses written off 13,72,641 Direct cost (as per Annex.-II of submission, dt. 6-10-2008) 1,05,04,14,001 1,05,04,14,001 Operating expenses (operating cost) 1,13,90,88,116 Operating profit 4,47,38,885 NCP% 3.93% 18. TPO then discussed about the use of data for multiple years and in that context, he has taken a view that comparability analysis is to be conducted on the basis of current year data as so held by the decision of Special Bench of Tribunal, Bangalore Bench in the case of Aztec Software & Technology Services Ltd. v. Asstt CIT [2007] 162 Taxman 119/107 ITD 141/15 SOT 49 which was followed by the Delhi Bench of Tribunal in the case of Mentor Graphics (Noida) (P.) Ltd. v. Dy. CIT [2007] 109 ITD 101/18 SOT 76. The TPO then proceeded to make comparability analysis of the comparable companies. The TPO found that in the transfer pricing report, the assessee has chosen nine comparable companies of which two are Indian companies namely, Cinerad Communication Ltd. and SSI Media India (P.) Ltd. Inf....
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....P of international transactions of the assessee is computed as under : Operating cost of assessee as computed above = 1,13,00,88,116 Profit at 7.02 per cent of revenue = 7,99,63,986 Profit booked by the assessee = 4,47,38,885 Difference = 3,52,25,101 The difference of Rs. 3,52,25,101 is attributable to the difference in the book value and the ALP of the international transactions. On the same lines, the ALP of international transactions in respect of advertising service and cost sharing/cost allocation arrangements is determined as under : Sl.No International transaction Book value Difference loaded ALP 1. Receipt for advertising services 2,93,95,488 1,90,76,042 4,84,71,530 2. Payment to Cheil Korea for cost sharing 2,48,85,114 1,61,49,059 87,36,055 In respect of cost to cost recharge, the assessee has not benchmarked the same and the same is accepted. The AO shall accordingly increase the income of the assessee by Rs. 3,52,25,101. Since the difference between the book value of the international transactions and the ALP so d....
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....omer. Such third party payments per se do not represent any value-added functions undertaken by the appellant. 26.1 The income earned by the assessee represents commission receivable by the assessee in respect of the provision of advertising services undertaken by it, and it recognizes the commission amount charged from the clients as its revenue/income in its P&L a/c i.e., financial statements, and accordingly, the advertising commission and service fee represents income from jobs completed by the assessee on behalf of its clients and are disclosed net of pass through costs. 26.2 The assessee undertakes advertising services for its customers in capacity of an agent. In this regard, it makes payment to third parties like media agencies, printing press, etc., for renting of advertising space etc., on behalf of its customers and recovers the same from the customer. Such third party payments do not represent any value-added functions undertaken by Cheil India/advertising agency. 26.3 As per the industry norms in this regard, the advertising space (be it media, print or outdoor) is let out by the third party vendors in the name of the ultimate customer/beneficiary of the adver....
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....e profitability analysis undertaken by the assessee for the purpose of transfer pricing analysis, it was submitted by the assessee that the same is based on the profit and loss position of the company as determined and reflected in the audited financial statements of the company for the relevant financial year. 26.9 The financial statements of the assessee company have thus been duly prepared in accordance with the relevant statutory requirements i.e., in accordance with the provisions laid down in the Companies Act, generally accepted accounting principles and standards issued by the ICAI and its accounts have been duly audited by an independent chartered accountant under section 44AB of the Act. 26.10 A reference was also made to the observations made and guidance provided by the Emerging Issues Task Force (EITF) formed in 1984 by Financial Accounting Standards Board (FASB) to provide assistance with timely financial reporting. The relevant extract of publication issued by the EITF on Gross v. Net Presentation of Revenue issue was pointed out stating that gross reporting treats the transaction as the company purchasing a product or service from the supplier and then selling....
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....e advertising agency; (b) in line with the industry practice in this regard, as typically all advertising services companies are remunerated for their advertising services based on a commission model and accordingly, commission/net revenue is considered as the total income from operations for such companies; (c) in accordance with the accounting principles generally accepted in India as well as Companies Act, 1956, duly certified by independent accountants." 28. In this connection, the guidelines of transfer pricing for multinational enterprises and tax administrations issued by the Organization for Economic Co-operation and Development (OECD guidelines) were also pointed out and detailed note thereupon was submitted before the learned CIT(A). 29. After considering the assessee's submissions, material available on record, TPO's report and AO's order, the learned CIT(A) had arrived at the following finding on this issue : "10.2 I have gone through the above submissions of the appellant and have examined them in the light of material available on record; the main bone of contention is whether operating profit is to be calculated after grossing ....
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....rs/media agencies, the appellant operates only as an agent of the customer and the relationship does not constitute a principal-to-principal relationship. Further it is also pertinent to mention here that though in the income-tax proceeding the rule of res judicata does not apply but when in the current year there are no new facts and circumstances and when in the TP proceedings for previous years the TPO has determined by operating profit on net revenue basis as per the industry's practice, I think TPO's action is not correct in the year under consideration to deviate from the established position of maintaining books on net revenue basis. 10.7 Based on the above and also placing reliance on accounting principles followed by advertising companies and the OECD guidelines, I am of the opinion that such costs are merely pass through in nature and do not represent any value adding activity undertaken by the appellant, and accordingly do not warrant any mark-up as such costs do not impact the profitability statement/position of the appellant for the purpose of computing the OP/TC margin of the appellant as well as for the comparables too, the net revenue basis of accounting as re....
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....ssee to the third parties vendor/media agencies were reimbursed by its customers or AEs to the assessee. He further pointed out that in respect of certain intra group services, the commission income is split between the AEs and the assessee based on 70:30 ratio depending on the effort expended by each party. 33. With regard to the method applied by the assessee to determine the ALP, the learned counsel for the assessee submitted that the assessee applied Transactional Net Margin Method (TNMM) which has also been applied by the TPO. In the TP report submitted by the assessee, the assessee applied the TNMM on an entity level using operating profit/total cost ("OP/TC") as the profit level indicator. The total cost was comprising the expenses incurred by the assessee towards provision of the advertisement and related service such as personnel expense, other administrative expenses etc. The learned counsel for the assessee further pointed out that in the financial accounts of the assessee, the assessee recognized revenues on a net basis, i.e., it recognized the commission/charges received in respect of its functions as revenue and the gross media spends i.e. paid to third party media....
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....relies on the following guidance provided by the OECD in its guidelines issued in 2009 (refer p. 13 of the compendium). '3.41. In applying the TNMM, various considerations should influence the choice of margin used. For example, these considerations would include how well the value of assets employed in the calculations is measured (e.g. to what extent there is intangible property the value of which is not captured on the books of the enterprise) and the factors affecting whether specific costs should be passed through, marked-up, or excluded entirely from the calculation.' 23. Further attention is also drawn towards the following observation made by the OECD in its proposed revision of Chapter I-III of the Transfer Pricing Guidelines (refer p. 83 of the compendium) : '2.134 In applying a cost-based TNMM, fully loaded costs are often used, including all the direct and indirect costs attributable to the activity or transaction, together with an appropriate allocation in respect of the overheads of the business. The question can arise whether and to what extent it is acceptable at arm's length to treat a significant portion of the taxpayer's costs as pass through costs to wh....
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.... which he has clearly mentioned that in case of advertising agencies the cost related to advertisement placement (purchase of advertising space) is a measure of service(s) provided by the media agencies and not by the advertising agency (refer p. 119 of the compendium), hence, in the aforesaid case, the ratio of billed commission to total operating costs, excluding the costs of advertising placement was considered as a measure of profitability. 27. It is further submitted that the 'net revenue recognition' model is also in line with the guidance provided by the Emerging Issues Task Force formed in 1984 by FASB (refer extract below and pp. 464 and 465 of the paper book and pp. 135 and 138 of the compendium) : 'Gross reporting treats the transaction as the company purchasing a product or service from the supplier and then selling that product or service to the end-user, while net reporting treats the transaction as the end-user making a purchase from the supplier, with the company acting as a sales agent. Indicators of net revenue reporting The supplier is the primary obligor in the arrangement-If the supplier is responsible for fulfilment and customer satisfaction, that ....
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.....) Ltd. v. CIT (supra), where it was held that the gross media spends should be included as the assessee's sales revenue, is totally misplaced in the light of the facts and circumstances of the present case. In that regard, the assessee relied upon the following decisions : (1) CIT v. Lakshmi Machine Works [2007] 290 ITR 667/160 Taxman 404 (SC); (2) CIT v. Catapharma (India) (P.) Ltd. [2007] 292 ITR 641/162 Taxman 155 (SC); and (3) CIT v. Sudarshan Chemicals Industries Ltd. [2000] 245 ITR 769/112 Taxman 511 (Bom). 37. The learned counsel for the assessee further submitted that even otherwise, without prejudice to the assessee's main contention that the net margin should be determined with reference to the net revenue, grossing up should be restricted to the quantum of international transactions, and in that regard a suitable adjustment is necessary to be made. The assessee's contentions in this regard given in writing are as under : "34. It may be noted that during the financial year 2004-05, out of the total pass-through cost amounting to approx. Rs. 105 crores incurred by the assessee, only an amount of approx. Rs. 1.8 crore rela....
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.... 39. Further contention was raised by the learned counsel for the assessee that in any event, the benefit of +/- 5 per cent range as per proviso to section 92C(2) of the Act is also allowable to the assessee and in that connection a reliance was placed on the decision of Tribunal, Delhi Bench in the case of Sony India (P.) Ltd. v. Dy. CIT [2008] 114 ITD 448 and also in the case of Development Consultants (P.) Ltd. v. Dy. CIT [2008] 23 SOT 455 (Kol.) 74 where also +/- 5 per cent range was allowed to the assessee around the ALP. One more decision in the case of Skoda Auto India (P.) Ltd. v. Asstt. CIT [2009] 30 SOT 319 (Pune) was also pressed into service on this point. 40. The rival contentions of both the parties have been considered and orders of the authorities below have carefully been perused. The only question that falls for our consideration is with regard to the method of computing profit/TC margin whether on gross basis as done by the TPO or net basis as worked out by the assessee. In this case the assessee has applied TNM method to determine ALP, which has also been accepted by the Revenue authorities. The comparables cited by the assessee has also been accepted by t....
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....by the advertising agency i.e. the assessee. It is, thus, clear that the assessee has not assumed any risk on account of non-payment by its customers or AEs. At this stage a useful reference may be made to ITS 2009 Transfer Pricing Guidelines accepted by the OECD where it is laid down that when an AE is acting only as an agent or intermediary in the provision of service, it is important in applying the cost plus method that the return or mark-up is appropriate for the performance of an agency function rather than for the performance of the services themselves, and, in such a case, it may not be appropriate to determine ALP as a mark-up on the cost of services but rather on the cost of agency function itself, or alternatively, depending on the type of comparable data being used the mark-up on the cost of services should be lower than would be appropriate for the performance of the services themselves. In this type of case, it will be appropriate to pass on the cost of rendering advertising space, to the credit recipient without a mark-up and to apply a mark-up only to the costs incurred by the intermediary in performing its agency function. These guidelines are as under : "3.41 I....
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....xample, an AE may incur the costs of rendering advertising space on behalf of group members, costs that the group members would have incurred directly had they been independent. In such a case, it may well be appropriate to pass on these costs to the group recipients without a mark-up, and to apply a mark-up only to the costs incurred by the intermediary in performing its agency function." 43. In the light of these guidelines, it would be, therefore, clear that a mark-up is to be applied to the cost incurred by the assessee company in performing its agency function and not to the cost of rendering advertising space on behalf of its AEs. We further find that the method adopted by the assessee while submitting transfer pricing study based on net revenue has been accepted by the Department in earlier year and, therefore, there is no reason to depart from that stand already accepted by the Department in earlier year. In the light of the view we have taken above, we therefore, uphold the order of the learned CIT(A) on this issue and reject the ground raised by the Revenue. 44. Before parting with this issue, we may observe that the following decisions relied upon by the Department....
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....fully following the decision of Hon'ble Tribunal in appellant's own case for assessment year 2004-05, as there are no changes in the facts and circumstances in the year under consideration, I allow the claim of the appellant on this issue on current year also." 46. Hence the Department is in appeal before us. 47. In the course of hearing of this appeal, it has been pointed out by the learned counsel for the assessee that identical issue has been decided in favour of the assessee by the Tribunal, Delhi Bench 'B', New Delhi in the assessment year 2004-05 holding that depreciation on monitors and scanners shall be allowable at the rate 60 per cent. 48. We have heard both the parties and gone through the material on record. We have also gone through the above referred Tribunal's order dt. 13th Feb., 2009 passed in the assessee's case pertaining to the assessment year 2004-05 where the Co-ordinate Bench of the Tribunal has decided this issue as under : "3. In the next ground of appeal, grievance of Revenue relates to grant of depreciation at the rate of 60 per cent on computer peripherals. On due consideration of the facts and circumstances, we find that the assessee had cla....