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2015 (11) TMI 1884 - AT - Income TaxTP adjustment u/s 92CA(3) - Pass-through costs/operating costs inclusion computing the ALP of the international transaction - HELD THAT - All the costs in providing the services are to be borne by the assessee alone and the AE has no relation with that. The assessee has made out a case that the expenses incurred in providing such services to the tourists amounting to Rs.13.93 crore are pass through costs and hence the same be ignored in computing the ALP of the international transaction. We find this contention to ill-founded and devoid of any merit. Pass-through costs, in the context of transfer pricing provisions, are ordinarily the costs for which payment is made by an Indian entity to third party on behalf of its foreign AE and the amount so paid to third party is recovered from the foreign AE and in this process there is no assumption of risk of nonpayment by the foreign AE. These are non value-adding costs, which are incidental to the primary business activity of the assessee for which it neither performs any significant functions nor assumes any risks. That is the reason for which such costs are not considered as operating costs. We fail to appreciate as to how the sum incurred by the assessee can at all be construed as Pass through costs inasmuch as these are not the costs incurred by the assessee for and on behalf of FAB to be recovered as such, but are the costs to be borne by it alone. Such costs are direct charge against its revenue. Pass-through costs do not involve any type of risk on the entity incurring them, as these are recoverable as such from its AE. At the cost of repetition, we reiterate that the assessee is liable to certain risks as discussed above, which has been noted from its own Transfer pricing study report. Under such circumstances, the argument of the ld. AR that a sum of Rs.13.93 crore represents pass-through costs is incapable of acceptance and ergo jettisoned. Whether the ld. CIT(A) was justified in comparing the assessee s net profit rate to total costs at 25.87% based on its service fees of Rs.71.54 lac minus indirect expenses of Rs.56.84 lac with the similar rate of two other comparable companies in determining the ALP of the international transaction of Tours and Travel Related and Customer Handling Services ? - The international transaction as per the assessee s audit report in Form No. 3CEB is Tours and Travel Related and Customer Handling Services with transacted value of Rs.14.65 crore. This amount is a sum total of direct costs incurred in providing services amounting to Rs.13.93 crore and service fee of Rs.71.54 lac. This is the total amount received by the assessee from its AE. It is this international transaction of Rs.14.65 crore whose ALP is required to be computed. The action of the ld. CIT(A) has resulted in restricting the international transaction to a sum of Rs.71.54 lac, being the amount of service fee alone, which is again contrary to the statutory provisions. We, therefore, hold that both the direct and indirect cost are required to be considered in determining the ALP under the Cost plus method . Action of the ld. CIT(A) in accepting the ratio of Net profit to total costs as a profit level indicator has led to the devising of a new method in its own, which has no sanction of law. As the most appropriate method in this case is undisputedly the Cost plus method , we fail to appreciate as to how the decision of the ld. first appellate authority in accepting such a ratio as a Profit level indicator under this method can be sustained. The comparison of this ratio is alien to the Cost plus method. Selection of only two companies is in sharp contrast to the assessee earlier choosing 14 companies as comparable in its Transfer pricing study report. By directing to do an analysis of some and not all the comparable companies, CIT(A) allowed the assessee to do cherry-picking by choosing only such companies which suit its purpose. Neither, there is an indication in the impugned order that the CIT(A) himself ensured that no comparable company was left out, nor did he ask the AO to find out other comparable companies. This has put the exercise done by the assessee during the course of first appellate proceedings, open to question. AO has worked out addition by way of transfer pricing adjustment amounting to Rs.91.80 lac by applying the arithmetic mean of the ratio of Net profit to Total costs of the comparables at 11.72% to the direct and indirect costs incurred by the assessee. As against this, the Cost plus method contemplates applying the ratio of Gross Profit to Total costs and not Net profit to Total costs . Again to this extent also, the action of the AO is unsustainable. In the given circumstances, we are of the considered opinion that the ends of justice would meet adequately if the impugned order is set aside and the matter is restored to the file of the AO. We order accordingly and direct him to compute the ALP of the international transaction afresh under the Cost plus method in conformity with our above discussion. Needless to say, the assessee will be allowed a reasonable opportunity of hearing in such fresh proceedings.
Issues Involved:
1. Deletion of addition on account of transfer pricing adjustment. 2. Determination of Arm's Length Price (ALP) under the Cost Plus Method. 3. Consideration of direct and indirect costs in computing ALP. 4. Use of multiple year data versus single year data. 5. Correctness of the approach by the CIT(A) and AO in determining ALP. Detailed Analysis: 1. Deletion of Addition on Account of Transfer Pricing Adjustment: The appeal by the Revenue challenges the deletion of the addition of Rs. 91,80,340/- made by the Assessing Officer (AO) on account of transfer pricing adjustment under Section 92CA(3) of the Income-tax Act, 1961. The AO made this addition by applying a profit rate of 11.72% to the total costs incurred by the assessee, which included both direct and indirect costs. The CIT(A) deleted this addition by comparing the assessee's net profit margin to that of comparable companies, excluding direct costs from the computation. 2. Determination of Arm's Length Price (ALP) under the Cost Plus Method: The assessee, engaged in the business of inbound tours and travels, reported an international transaction of `Tours and Travel Related and Customer Handling Services' with a transacted value of Rs. 14,65,34,048/-. The assessee adopted the Cost Plus Method to demonstrate that its international transaction was at arm's length price (ALP). The AO, however, did not accept the assessee's method of computing profit by excluding direct costs and made an addition based on the total costs incurred by the assessee. 3. Consideration of Direct and Indirect Costs in Computing ALP: The CIT(A) asked the assessee to analyze the net profit margin of comparable companies within the same trade. The assessee provided an analysis treating two companies as comparable. The CIT(A) found the assessee's profit margin within the permissible range and deleted the addition. However, the tribunal held that both direct and indirect costs must be considered in determining the ALP under the Cost Plus Method, as mandated by Rule 10B(1)(c). The tribunal rejected the assessee's contention that the direct costs incurred were pass-through costs, emphasizing that these costs were borne by the assessee alone and were not recoverable from the AE. 4. Use of Multiple Year Data versus Single Year Data: The AO computed the ALP using multiple year data, which the tribunal found incorrect. The tribunal referred to the Hon'ble Delhi High Court's decision in Chrys Capital Investment Advisors (India) P. Ltd. vs. DCIT, which held that multiple year data should ordinarily be avoided, and single year data should be considered. 5. Correctness of the Approach by the CIT(A) and AO in Determining ALP: The tribunal found flaws in both the CIT(A)'s and AO's approaches. The CIT(A) erred by comparing the net profit margin to total costs and ignoring direct costs, which is contrary to Rule 10B(1)(c). The AO, on the other hand, incorrectly used multiple year data and applied the ratio of net profit to total costs instead of gross profit to total costs. The tribunal set aside the impugned order and directed the AO to compute the ALP afresh under the Cost Plus Method, considering both direct and indirect costs and using single year data. Conclusion: The tribunal allowed the appeal for statistical purposes, directing the AO to recompute the ALP of the international transaction under the Cost Plus Method, considering both direct and indirect costs and using single year data, in conformity with the tribunal's discussion. The order was pronounced in the open court on 13.11.2015.
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