TaxTMI 
TaxTMI 
2016 (6) TMI 635
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....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. 520,186,668/- did not form part of the appellant....
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....t.( 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 passed on to JVs. This franchise fee was reduced to 22500 US $ from $ 450....
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....ty 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 not directly responsible for paying the amount to Macdonald Corporation USA it is not a pass through cost. Ld TPO further held that as the assessee is responsible for paying the royalty to MDC and it carries risk of cancellation of agreement in the event of nonpayment, such a risk bearing activity cannot be a pass through cost. 10. The assesse carried matter before CIT(A) who held that because of....
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....s 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 further submitted that while applying a cost based remuneration model a markup is to be provided only on value added services and in this case royalty and franchisee fee are not value added services and only are pass through cost. Therefore he submitted that the adjustment to ALP confirmed by ld. CIT (A) while considering the royalty in working of PLI may be deleted. 12. Against this LD DR referred to page 265, 109,1....
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....e 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 the main business activities of the multinational enterprises group. The assesse in case of pass through cost do not perform any significant function or assume any significant risk. The cost is reimbursed to the AE for whom the activities are performed and therefore they are not considered as part of operating cost in the tax payer's computation of PLI. In fact it is required to be determined whether an independent enterpris....
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.... (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 basis. The assessee has also recognized revenues on a net basis in its financial account, which had been duly audited by the auditor. The assessee has computed the margin of operative profit on the total cost on the basis of net revenue by way of mark-up received from the associate concern. The payment made by the assessee to third party vendor/media agencies for and on behalf of the principal has not been included in the total cos....
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....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 would include how well the value of assets employed in the calculations is measured (e.g. to that 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." 41. In the proposed revision of Chapter I-III of the Transfer Pricing Guidelines issued on 9th Sept., 2009 - 9....
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....ncy 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 addition should not form part of the PLI computation of the assesse as under :- "36. The clauses of the agreement between JMIPL and MUL which have been extracted hereinbefore indicate that JMIPL's profit margin is dictated by its negotiations with MUL. The clauses do bear out the submission of JMIPL that it is obliged to procure the raw material on instructions of MUL at a price dictated by MUL from the source selected by MUL. JMIPL is entitled to a per....
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....ties 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 to MUL's vendors and thereby to MUL. The fact that JMIPL is paid a fixed manufacturing charge per unit shows that costs associated with the possible fluctuations in the price of the raw material is passed on to the customers and does not affect the profits of JMIPL. The submission of the Revenue that the international transaction between JMUK and JMIPL with regard to sale of precious metals may not be at ALP because JMIPL was a wholly owned subsidiary o....
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....% 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 result into an increase in profitability and consequently it will increase the return on the investments as well as result in an increase in the net wealth of the franchisee company. This shows the purpose for which the assessee has agreed to bear a part of the advertisement expenditure which was otherwise to be borne by the franchises. The purpose is to increase the return on investment i.e. dividend and increase in net worth of investment. We have also noted ....
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....red 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. 22. Ground NO. 7 of the appeal is with respect to allowing appropriate adjustment of risk assumed vis-a viz-comparable company identified by ld TPO. 23. Before us it was contended that the appellant business does not involve any risk whereas the comparable companies identified by TPO carry lot of risk. The ld TPO did not make any adjustment in this regard and has held that assesse carried a risk on account of delay in payment of royalty fees and initial franchisee ....