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TMI Blog2011 (5) TMI 196X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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. For comparative analysis, the assessee company identified four comparable companies engaged in the business of providing logistic services which had earned a mean operating OP/VAE margin of 23.67% as against the OP/VAE of 65.25% of the assessee. The assessee company accordingly claimed that its international transactions were at Arm's Length. 3. The Transfer Pricing Officer (TPO) rejected the OP/VAE taken by the assessee as profit level indicator and adopted operating profit to total cost (OP/TC) as the price level indicator. He also required the assessee to undertake a fresh search for comparable companies using the financial data of the year under consideration. A fresh search accordingly was undertaken by the assessee which gave a set of 22 comparable companies. Out of the said 22 comparable companies, the TPO rejected four companies being consistent loss makers and further rejected one more company being functionally different. As the main operating margin of the r ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ts of the case including especially the nature of assessee's business. He also filed a written note summarizing all his submissions as under : As detailed in paragraph 5.11 of the TP study report (filed with the TPO vide submission dated January 27, 2009), the Appellant had considered Operating Profit/Value Added Expenses ('OP/VAE') as the appropriate PLI to determine the arm's length price of the international transactions [Please refer Page No.42 of the paper book for the relevant reference in the TP report]. For your kind reference, the Appellant has detailed below the rationale for the use of PO/VAE as the PLI to benchmark the international transactions. Costs in logistics companies typically comprise of direct costs and value adding costs. Direct costs are expenses incurred by a Logistics company to procure services from third party service providers such as shippers/airlines, clearing and forwarding agents, transporters etc. On the other hand, value adding expenses are incurred by a logistics service provider on a day to day basis in support of its own operations. Personnel cost, selling costs, establishment and admi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... orted by the OECD TP Guidelines, which explain that agency/intermediary service providers need not apply a markup to "pass-through" expenses, which are passed on to customers. We have reproduced below the relevant extract (para 7.36) of the OECD Guidelines which for your ready reference. Para 2.93 In applying a cost-based transactional net margin method, 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 which no profit element is attributed (i.e. as costs which are potentially excludable from the denominator of the net profit indicator). This depends on the extent to which an independent party in comparable circumstances would agree not to earn a mark-up on part of the costs it incurs. The response should not be based on the classification of costs as "internal" or "external" costs, but rather on a comparability (including functional) analysis. See para 7.36. Par ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed expenses). The Appellant would like to submit that the choice of the PLI should be determined by the type of activity performed by the tested party and the economic circumstances of the related party transactions, as well as the reliability of available data for third party comparables. Also, the Appellant would like to submit that while undertaking the benchmarking analysis, the Appellant has excluded third party costs from its cost base as well as that of the comparable companies. The Appellant would like to humbly submit that its approach of undertaking the economic analysis is in line with the approach suggested by the OECD TP Guidelines. The Appellant would like to submit that for the service providers such as the Appellant, the ratio of OP/VAE is the appropriate yardstick to judge its profitability. At this stage, the Appellant would like to draw your kind attention to the concept of Berry Ratio which is a ratio of Gross Profit to Value Added Expenses ('GP/VAE'). In essence Berry Ratio considers the relationship between the level of VAE and the level of Gross Profits earned by the service providers. Conceptually, the Berry Ratio repr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... since the facts of the Appellant are similar to the principle stated above, the Appellant submits that use of OP/VAE as the PLI is the most appropriate approach. In view of the above discussion, a qualitative analysis of costs by differentiating between pass-through and agency/value adding costs is essential, so as to reach correct TP conclusions. This situation is also envisaged in Rule 10B(e)(i) of the Rules, which sets out the manner of application of the Transactional Net Margin Method ('TNMM') "(e) transaction net margin method, by which,- The net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base:.... As can be seen above, both the Rules and the OECD Guidelines envisage the determination of the PLI, viz., net profit margin in relation to different bases depending upon the facts and circumstances of each case, the intent being to select the appropriate PLI that best measures the relationship between pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... order as reproduced above, however, shows that the same have been brushed aside without giving proper and sufficient consideration. Most of the relevant points raised on behalf of the assessee on this important issue even do not find any mention in the order of the DRP, much less any discussion or consideration. In the case of Gap International Sourcing India (P.) Ltd. v. Dy. CIT [2011] 44 SOT 56/[2010] 8 taxmann.com 294 (Delhi), the coordinate bench of this Tribunal came across a similar situation wherein voluminous submissions made by the assessee were found to be brushed aside by the DRP without even a whisper in the order. The order passed by the DRP, therefore, was held to be laconic by the Tribunal and the matter was remitted back to the DRP to consider the same again and to pass a proper and speaking order. A similar situation arose in the case of Vodafone Essar Ltd. v. Dispute Resection Panel-II [2011] 196 Taxman 423 (Delhi) wherein the order passed by the DRP was quashed by the Hon'ble Delhi High Court and the matter was remanded for fresh adjudication observing that when a quasi judicial authority deals with a lis, it is obligatory on its part to ascribe cogent and germa ..... X X X X Extracts X X X X X X X X Extracts X X X X
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