2011 (5) TMI 196 - AT - Income Tax

Transfer pricing - Net Margin Method - The assessee in the present case is a company which is engaged in the business of providing logistic and related services - The assessee company had entered into international transactions involving freight expenses and freight receipts with its associated enterprises - For the purpose of bench marking the said transactions, the assessee company prepared a detailed T.P. study by applying Transactional Net Margin Method (TNMM) and using operating profit to value added expenses (OP/VAE) as the price level indicator - The DRP does not agree with the view of the assessee, because for working out proper margins, the gross receipts and the gross expenses are the proper figures and there is no provision for excluding any item of expenses or receipt from the gross sales or gross expenses on the ground that such receipts or expenses does not represent any element of profit - There is no provision for segregating the accounts for excluding such items because it will give distorted picture and comparison will not be possible with the others who are dealing in the similar activity not following such method - Thus, the AO has rightly rejected the method of working out profit margin by the assessee. The decision of the Hon ble Delhi High Court in the case of Vodafone Essar Ltd. as well as that of the coordinate bench of this Tribunal in the case of Gap International Sourcing India (P.) Ltd. and having regard to the fact that the DRP has passed the order giving directions to the AO under section 144C without giving proper consideration to the elaborate submissions made on behalf of the assessee on the main preliminary issue - Hence, set aside the said order and remit the matter to the file of the DRP with a direction to consider the objections of the assessee on this issue as well as the other issues once again and pass a proper and speaking order giving direction u/s 144C.

Summary

Issues Involved:
1. Determination of appropriate Profit Level Indicator (PLI) for Transfer Pricing (TP) adjustments.
2. Validity of the Transfer Pricing Officer's (TPO) method.
3. Consideration of the Dispute Resolution Panel's (DRP) order.

Detailed Analysis:

1. Determination of Appropriate Profit Level Indicator (PLI) for Transfer Pricing (TP) Adjustments:
The primary issue in this case is whether "Operating Profit/Value Added Expenses" (OP/VAE) or "Operating Profit/Total Cost" (OP/TC) should be used as the Profit Level Indicator (PLI) for benchmarking international transactions. The assessee argued that OP/VAE is the correct PLI due to the nature of its business, which involves significant "pass-through" costs that do not add value. The assessee contended that OP/TC would present a skewed picture of profitability as it includes these pass-through costs, which are not reflective of the company's operational efficiency. The OECD TP Guidelines support excluding pass-through costs from the denominator of the net profit indicator when they do not add value. The assessee cited the Berry Ratio concept, which also supports using value-added expenses as a base for calculating profitability in service-oriented businesses.

2. Validity of the Transfer Pricing Officer's (TPO) Method:
The TPO rejected the OP/VAE method and adopted OP/TC as the PLI, arguing that gross receipts and expenses are the proper figures for calculating margins and that excluding any item would distort the picture and hinder comparability with other companies. The TPO required the assessee to undertake a fresh search for comparable companies using the financial data of the year under consideration. This resulted in identifying 22 comparable companies, out of which five were rejected, leading to a TP adjustment of Rs. 25,21,77,854.

3. Consideration of the Dispute Resolution Panel's (DRP) Order:
The DRP upheld the TPO's method, dismissing the assessee's objections without adequate consideration. The DRP's order was criticized for not addressing the detailed submissions made by the assessee. The Tribunal noted that the DRP's order was laconic and lacked proper reasoning, similar to the situations in the cases of Gap International Sourcing India (P.) Ltd. v. Dy. CIT and Vodafone Essar Ltd. v. Dispute Resolution Panel-II. In these cases, the orders were remanded for fresh adjudication due to inadequate consideration of the assessee's submissions.

Conclusion:
The Tribunal found that the DRP did not give proper consideration to the assessee's detailed submissions regarding the appropriate PLI. Citing precedents, the Tribunal set aside the DRP's order and remitted the matter back to the DRP to reconsider the objections and pass a well-reasoned and speaking order. The appeal was treated as allowed for statistical purposes.