TaxTMI 
TaxTMI 
2016 (6) TMI 635
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....ab-initio as these orders passed suffer from material illegality and irregularity rendering them void. 2. The CIT (A) has erred in upholding the legality of the reference to the TPO made by the AO despite the fact that such reference was made without observing the requirements of law and in violation of the principles of natural justice; 3. That the CIT (A) failed to appreciate that the TPO's report to the AO was void ab initio for not having followed the due process of law as prescribed under the Act; and that the said report had been mechanically followed by the AO without taking into consideration to the several objections made by the Appellant thereto. 4. That on the facts and in the circumstances of the case, CIT(A) has erred in upholding the action of the AO in making an addition of Rs. 44,89,948 to the returned income of the appellant on account of alleged arm's length price. 5. That on the facts and in the circumstances of the case, CIT (A) erred in holding that TPO was correct in including royalty of Rs. 520,186,668/- as income for the purpose of determining of operating profits at 2.68%. CIT (A) did not appreciate that the receipts of royalty of Rs. 52....
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.... the assessee. 5. Brief fact of the case is that McDonald India Pvt.( hereinafter referred to in short 'MIPL', 'Assessee", Appellant) ltd has entered into master license agreement with McDonald corporation, US( hereinafter referred to in short " MDC) . Under this agreement a license has been granted to assesse with respect to McDonald system including marketing and operational rights on non exclusive basis. This right is for promoting and developing McDonald restaurant in India for which the assessee has to pay royalty of 5% on gross sales on all operations on restaurants in India. This right has been further sub licensed to other parties. As per the agreement royalty is to be remitted by assesse to McDonald corporation within 5 days of the end of the month. A further obligation is created on assessee to spend an equivalent of 5% of gross sales of all restaurants on advertising. Assessee has created two JVs With two other parties who in turn are the sub licensee and they are supposed to pay royalty at 5% and spend another 5% on advertisement. The assesse is further obliged to pay 45000 us $ for each of the new restaurant taken on franchise and which obligation has also been pass....
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....ble margin of 9.89% and made an adjustment of Rs. 4489948. Ld. TPO worked out operating profit of the assessee as under :- Particulars Amount Particulars Amount A Income Service Fees 11213750 Royalty 52637830 Other income 99046 Total operating income 63950626 B Expenditure Employee remuneration and benefit 60000 Administrative and other expenses 9842832 Depreciation 291485 Royalty 52086668 Total operating cost 62280985 Operating profit (loss) 1669641 Operating profit/ operating cost 2.68 % 9. Before TPO assessee submitted a letter dated 10.01.2006 submitting that Royalty is a pass through cost, it has no margins in that, it has not assumed any onerous responsibility in collection or payment of royalty and by conduct of the party it is risk free and non value addition transactions. However ld TPO rejected the contention of the assessee and hold that as the restaurants are....
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....ived from franchises and there is no income left to the assessee as per this Master License Agreement and franchises agreement". Further, the Tribunal has held (PB 464) that "We have also noted that as per the Master License Agreement along with franchises agreement, the assessee is not earning anything on account of royalty and entire royalty is to be passed on to Mc Donald's Corporation USA". d. Assesse is a service provider and is charging 10% margin on all the operating cost and royalty and initial franchisee fees are pass through cost. For this he placed reliance on para 2.93 of the OECD guidelines. e. He further relied on decision of the coordinate bench of in case of Cheil Communications India Pvt. Ltd ITA No.712/del/2010. He further read para 40 of that decision to support his claim. f. He further submitted that the issue is now squarely covered by the decision of Hon'ble Delhi High Court in the case of Jonson Matthey India Pvt.Ltd vs. DCIT dated 13.10.2015. He drew our attention to para Nos. 36, 37, 38 and 39 of that decision. He further submitted that therefore the pass through cost in form of royalty shall be excluded from income as well as expenses. g. He fu....
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....and reimbursement of the same to the MDC. During the year there is a collection of royalty fees of Rs. 52637830/-and there is a payment of royalty fees of Rs. 52086668/- during the year. The amount of Rs. 551162/- it was submitted could not be remitted because of the reason of RBI restriction and absence of approval to remit this money outside India. Therefore the above facts show that assesse has remitted the money to the McDonald corporation without any value addition. The originally the assesse was established only for the ease of administrative convenience for obtaining regulatory approvals for remittance of royalty and franchisee fees only. It is not the case of the revenue that assessee has commercially exploited or anyway enjoying the benefit of royalty and franchise fees. Further assesse also cannot keep the some collected on behalf of McDonald corporation because it is required to remit such funds being 5% on gross sales within five days of the end of each month. This also shows that even the benefit of credit or retaining money is also not available with the assesse on account of royalty and franchisee fees. 15. The pass through cost is those, which are incidental to t....
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.... to the AE. It has also not assumed any significant risk based on past practices or any experience. No instances have been pointed out by ld TPO or ld CIT(A) to show that risk of nonpayment by franchisee devolving on the assesse is imminent and a real risk. 17. Assessee has further relied on the decision of The decision relied upon 2011] 11 taxmann.com 205 (Delhi) Deputy Commissioner of Income-tax v. Cheil Communications India (P.) Ltd.* where in it is held after considering OECD guidelines as under :- "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 the TPO as appropriate. It is also found by us that in the regular financial accounts maintained by the comparable companies, the comparables recognize revenue on a net ....
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..... 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 In applying the transactional net margin method, various considerations should influence the choice of margin used for example, these considerations wo....
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....e 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." 18. The decision of Hon'ble Delhi High Court in [2015] 63 taxmann.com 2 (Delhi) Johnson Matthey India (P.) Ltd. v. Deputy Commissioner of Incometax* has also upheld that the cost which does not have any value addit....
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....cluding a pass through cost from the TC in the denominator. The expression "any other relevant base" occurring in Rule 10(1)(e)(i) of the Rules is wide enough to encompass a denominator that excludes pass through costs as long it is demonstrated to be at arm's length. 38. It is further importantly pointed out that the very purpose of transfer pricing is to benchmark transactions between related parties in order to discover the true price if such entities were unrelated. If MUL had bought the PGM directly from JMUK there would have been no application of transfer pricing since MUL and JMUK are unrelated entities. MUL would have purchased the PGM just like JMIPL did on negotiated prices. There is merit in the contention that the prices at which JMIPL purchased PGM from JMUK were already at arm's length and that it was for administrative convenience that MUL had outsourced this function to JMIPL. The submission of the Revenue that the accounting entries of JMUK do not treat the cost of PGM as a pass through cost fails to acknowledge that JMUK is in the business of selling PGM. It does not require to charge JMIPL for processing the raw material i.e. PGM as that is passed on ....
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....er License Agreement dated 1.1.1996, the assessee has to pay 5% of gross turnover to Me Donald's Corporation USA as Royalty and at the same time, the assessee has to spend minimum 5% of gross turnover for advertisement. As per franchises agreement of the assessee with Connaught Piaza restaurant Pvt. Ltd. also, we find that the franchises has to incur minimum of 5% of gross sales towards advertisement and the franchise has to pay to the assessee royalty @ 5% of the gross sales. This shows that as per the Master License agreement and franchises agreement, the assessee has to pass on the entire royalty which it has to receive from franchises and there is no income left to the assessee as per this Master License Agreement and franchises agreement. Thereafter, the assessee has entered into a Marketing Support Agreement with the franchises on 1.10.1997. As per this Marketing Support Agreement, the assessee has to contribute some part of the advertisement expenditure which is required to be borne by the franchises. As per clause (d) of this Marketing Support agreement dated 1.10.1997, it is noted that if the business of the franchises is expanded and its sales are increased, it will r....
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....gement between the assessee and a non resident to the effect that there is no profit to the assessee or lesser profit to the assessee." Therefore it is apparent that the transaction of royalty is a pass through cost which does not result in to any profit and loss to the assessee. 20. In view of the above facts and circumstances we are of the view that while working out PLI of the assessee transaction of Royalty income of Rs. 52637830/- should not be considered as operating income and royalty reimbursed to the MDC of Rs. 52086668/- shall not be considered as operating expenses of the assessee. We therefore reverse the finding of CIT (A) that royalty receipt from franchisee , JV is the operating income of the assessee and payment of royalty to MDC shall be the operating expenses of the assessee while working PLI of the assessee In the Result ground No o. 5 of the appeal is allowed with above direction. 21. Ground No 6 of the appeal is against other transfer pricing issues. At the time of hearing it was submitted by Ld AR that assessee does not contest the transfer pricing issues as covered by the ground no 6 of the appeal. and hence ground no 6 of the appeal is dismissed. ....