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TMI Blog2014 (5) TMI 897X X X X Extracts X X X X X X X X Extracts X X X X ..... y the multinational groups and increase the after tax returns available for distribution to shareholders. The authority of the TPO is to conduct a transfer pricing analysis to determine the ALP and not to determine whether there is a service or not from which the assessee benefits - That aspect of the exercise is left to the AO Relying upon Dresser-Rand India Pvt. Ltd. v. Additional Commissioner of Income Tax [2011 (9) TMI 261 - ITAT MUMBAI] - the assessee had market research facilities in India does not correspond to the performance of services abroad, especially in relation to client interaction services located outside India - albeit for ultimately sourcing them into the Indian market - the details of the specific activities for which cost was incurred by both CWS and CWHK and the attendant benefit to the assessee, have not been considered till date - This must be provided, in addition to a consideration of the ALP vis- -vis the total cost claimed by these AEs the matter is remitted back to the AO for an ALP assessment by the TPO, followed by the AO s assessment order. Disallowance of referral fees paid Held that:- The jurisdiction of the AO u/s 37 and the TPO, u/s 92CA are dist ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d to several clients within and outside India. The assessee filed its return of income declaring an income of Rs.20,46,62,822/-, and reporting six international transactions under Section 92B of the Income Tax Act, 1961 ( the Act ). Of these, two are important in the present proceedings: payment of referral fee of Rs. 1,73,26,631/- by the assessee to several foreign AEs for referring clients, and Rs. 1,06,39,865/- as reimbursement to CWS and CWHK for costs incurred by them for certain coordination and liaison services in respect of their client, IBM. 3. The return was selected from scrutiny through a notice under Section 143(2) of the Act, and was processed under Section 143(1). Since the assessee had entered into international transactions, the AO referred the matter to the Transfer Pricing Officer ( TPO ) under Section 92CA(3) of the Act for determination of the arm s length price ( ALP ) of the transactions. The TPO by an order recommended an increase in the taxable income by Rs. 1,06,02,930/-, after considering the transfer pricing report provided by the assessee. As regards the payment of the referral fee, the TPO stated that no adverse inference is drawn . However, in respect ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e group will be responsible for undertaking the following activities on behalf of C W India: (a) to liaise and coordinate with offices of clients of C W India; (b) to develop from time to time a marketing plan in respect of potential clients, with likely revenue for C W India (c) to identify potential opportunities to provide additional services to existing clients and obtain instructions thereof; and (d) to assist C W India in setting out business brochures, financial planning and strategy in respect of Corporate Services generally for the India region. 3. Payment 3.1 In consideration of activities of Client Solutions Group, C W US would recharge the actual costs to C W HK (including salary and other attributable costs for concerned employees). As part of its share of total costs, C W India shall pay to C W HK such costs as may be allocated by C W HK to C W India on a reasonable basis taking into account the services actually performed by Client Solution Group and the benefits derived by C W India therefrom. 7. On the basis of these agreements, the reimbursement claimed, as per the assessee's Transfer Pricing Study, submitted along with its return of income, included expenses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... stipulated under the assessee- CWS agreement, and copies of several e-mails sent by Mr. Braganza containing references to services obtained by IBM as a result of his efforts. The TPO s holding that there is no documentary evidence to support the rendering of services (apart from incidental benefits) was thus reversed. A similar conclusion was returned as regards reimbursement of costs to CWHK for services rendered by Mr. Ashpreet Choudhary. 9. In respect of this issue, the following question of law arises for the Court s consideration: Is the Tribunal correct in holding that benchmarking was not necessary in respect of the cost reimbursement reported by the assessee that was later subject to disallowance by the AO, since the TPO held that ALP in respect of this component was nil? 10. Impugning the order of the ITAT, learned counsel for the Revenue, Mr. Sanjeev Sabharwal, argued that through the entire exercise no benchmarking of the costs claimed as reimbursement has been conducted. It was argued that the costs paid by CWS to the two AEs must be compared to costs paid on other similar transactions, on the basis of one of the methods of calculating the ALP. In the absence of such an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uments advanced before this Court appears to divide this issue in two parts: first, whether services have indeed been provided by CWHK and CWS to the assessee, and second, whether these services ought to be benchmarked to determine to ALP considering the provisions of Section 92(3). 14. The TPO, in this case, and so the AO, denied the reimbursement deduction claimed from the taxable income on the ground that no services were provided, whereas arguments advanced at the Bar concerned whether benchmarking ought to have been done, considering the services were provided (as held by the ITAT). 15. This distinction however divides two fundamentally connected matters (as the TPO s Report correctly notes). Deduction of business expenditure under Section 37 for work undertaken by the AEs allows only for deduction of such amounts as incurred for the benefit of the assessee. The reimbursement claimed by the assessee, therefore, should relate to work done by the AEs that has benefited it the presence of a benefit and the costs incurred in creating that benefit form part of the same matrix of consideration under Section 37. They cannot be segregated, as is the repercussion of the assessee s argu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in an international transaction or specified domestic transaction, two or more associated enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arm's length price of such benefit, service or facility, as the case may be. XXXXXX XXXXXX XXXXXX (3) The provisions of this section shall not apply in a case where the computation of income under sub-section (1) or sub-section (2A) or the determination of the allowance for any expense or interest under that sub-section, or the determination of any cost or expense allocated or apportioned, or, as the case may be, contributed under sub-section (2) or sub-section (2A), has the effect of reducing the income chargeable to tax or increasing the loss, as the case may be, computed on the basis of entries made in the books of account in respect of the previous year in wh ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ark this international transaction through any of the methods indicated under Rule 10C of the Income Tax Rules, 1961, to determine the ALP for these transactions. Neither was such an exercise conducted by the TPO, and accordingly, till date, that vacuum exists. This vacuum remains despite Section 92(3) of the Act. Section 92 creates a regime for determining the true value of a transaction between two related parties, in this case, the assessee and CWS/CWHK, to ensure that taxable income is not transferred to another entity or jurisdiction. The very purpose of Section 92 thus is to ensure that the total taxable income is reported correctly to increase tax collection. Naturally, clause (3) provides that if such an ALP results in a decrease in the tax incidence in India, the true value of the transaction will be the value stated by the assessee and not the ALP. In other words, if an assessee is paying greater income tax than would otherwise be paid in an uncontrolled transaction, Section 92 will not alter the income stated in the return. This conclusion, however, can only be reached after an assessment of the ALP and comparison with the income stated in the return. 20. The existence o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pecified domestic transaction to which it was party were carried out on the arm s length principle. 23. Section 92C (1) of the Act prescribes the procedure to calculate the arm s length price for an international transaction. As per Section 92C (1) the arm s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely: (a) Comparable uncontrolled price method; (b) Resale price method; (c) Cost plus method; (d) Profit split method; (e) Transactional net margin method; (f) Such other method as may be prescribed by the Board. Section 92C (2) of the Act provides that the most appropriate method referred to in sub-section (1) shall be applied, for determination of arm s length price, in the manner as may be prescribed. The proviso to Section 92C (2) provides that where more than one price is determined by the most appropriate method, the arm s length price shall be taken to be the arithmetical mean of suc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e] under the provisions of Chapter XVIIB, the income of the other associated enterprise shall not be recomputed by reason of such determination of arm s length price in the case of the first mentioned enterprise. 25. Section 92CA (1) of the Act provides that where any person, being the assessee, has entered into an international transaction in any previous year, and the Assessing Officer considers it necessary or expedient so to do, he may, with the previous approval of the Commissioner, refer the computation of the arm s length price in relation to the said international transaction under section 92C to the Transfer Pricing Officer. Section 92CA (2) of the Act provides that where a reference is made under sub-section (1), the Transfer Pricing Officer shall serve a notice on the assessee requiring him to produce or cause to be produced on a date to be specified therein, any evidence on which the assessee may rely in support of the computation made by him of the arm s length price in relation to the international transaction referred to in sub-section (1). 26. Section 92CA (3) of the Act provides that on the date specified in the notice under sub-section (2), or as soon thereafter a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction to furnish any information or document, which he was expected to maintain under section 92D (1). The person shall furnish the information or document called for within thirty days from the date of receipt of a notice issued in this regard. If, for any reason, the person is unable to produce the required information or documents within the stipulated period of thirty days, the Assessing Officer or Commissioner (Appeals) may, on an application made by the person, extend the period by a further period or periods not exceeding, in all, thirty days. Under section 92E, every person who has entered into an international transaction or specified domestic transaction during a previous year shall obtain a report from an accountant and furnish such report on or before the specified date in the prescribed form duly signed and verified in the prescribed manner by such accountant and setting forth such particulars as may be prescribed. Specified date shall have the same meaning as assigned to due date in the second Explanation to Section 139 (1). 29. The argument in this case is that the assessee only paid for the cost incurred, while an uncontrolled transaction would involve an additional ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ordinating entity for the Client Solutions Group. The cost allocation to the assessee is on the basis of a percentage of the cost relatable to the revenue generated by Cushman Wakefield Asia. This is explained through the following chart, on which the ITAT placed reliance:- NY Revenue Estimate C W Asia Revenue Estimate Allocation Country Net fee to local office (US$) % Allocation Asia Revenue Allocation (US$) $ Allocation 75% NY revenue allocation 25% Gross Revenue Allocation Total Allocation US $ BP % Allocation BP Allocation US$ India 30373 98 82.44 % 112209 32 42.7% 1739 90 30031 203 931 72.5 150.360 China 36900 0 10.01 % 585961 9 22.3% 2112 6 15682 368 09 13.1 146.243 Hong Kong 12006 5 3.26% 429285 1 16.3% 6874 11489 183 63 6.5 124.770 Korea 24252 0.66% 324499 2 12.4% 1389 8685 100 73 3.6 47.784 Singapore 13378 2 3.63% 165523 9 6.3% 7659 4430 120 89 4.3 47.926 C W Asia 36844 97 100 % 262736 33 100% 2109 49 70316 281 265 100 % 517.083 31. As explained, for 82.44% share of the revenue from the services of the Client Solution Group, the relatable cost allocation was 72.5%. The precise activities conducted by the Client Solutions Group for the benefit of the assessee out of the ent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... assessee s involvement. The assessee thus received only an incidental benefit from that relationship. The TPO further noted that no independent enterprise would be willing to engage a third party for such a transaction, and in any case, the AE s means to conduct market research vis- -vis the Indian market was questionable in the absence of any evidence to the contrary. Moreover, the TPO noted that the assessee itself had many offices in India which conducted market research, and in that sense, this was merely a duplication of services. The ITAT reversed this finding: The assessee has been shown to have earned substantial revenues from IBM and that cannot be the result of only incidental benefit received by the assessee and IBM. If one wants to obtain revenue upon dealing in real estate, certain work has to be done. All the primary facts were submitted to the Assessing Officer as well as the TPO. The names of the parties were mentioned. Without examining any such details, it cannot be said that the revenue earned by the assessee was only on account of incidental benefit. There is a force in the claim of the assessee that to enable it to earn revenue from IBM, it was necessary to pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of financial results, from these services. This analysis is also completely irrelevant, because whether a particular expense on services received actually benefits an Assessee in monetary terms or not even a consideration for its being allowed as a deduction in computation of income, and, by no stretch of logic, it can have any role in determining arm's length price of that service. When evaluating the arm's length price of a service, it is wholly irrelevant as to whether the assessee benefits from it or not; the real question which is to be determined in such cases is whether the price of this service is what an independent enterprise would have paid for the same. Similarly, whether the AE gave the same services to the assessee in the preceding years without any consideration or not is also irrelevant. The AE may have given the same service on gratuitous basis in the earlier period, but that does not mean that arm's length price of these services is 'nil'. The authorities below have been swayed by the considerations which are not at all relevant in the context of determining the arm's length price of the costs incurred by the assessee in cost contribution ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st the facts. The Transfer Pricing Officer has not disallowed any expenditure. Only the arm's length price was determined. It was the Assessing Officer who computed the income by adopting the arm's length price decided by the Transfer Pricing Officer at nil . This is a slender yet crucial distinction that restricts the authority of the TPO. Whilst the report of the TPO in this case ultimately noted that the ALP was nil , since a comparable entity would pay nil amount for these services, this Court noted that remarks concerning, and the final decision relating to, benefit arising from these services are properly reserved for the AO. 36. In this case, the issue is whether an independent entity would have paid for such services. Importantly, in reaching this conclusion, neither the Revenue, nor this Court, must question the commercial wisdom of the assessee, or replace its own assessment of the commercial viability of the transaction. The services rendered by CWS and CWHK in this case concern liaising and client interaction with IBM on behalf of the assessee activities for which, according to the assessee's claim interaction with IBM s regional offices in Singapore and the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... done by the group entity specifically in relation to the property transaction done but this has not been given by the assessee in its submissions. This makes it clear that the assessee company is in no position to clarify or substantiate the work done or services rendered by the group concerns to men this payment of referral fee to them at a high rate of 30%. 4.6 In the submissions given the assessee company has simply filed some invoices raised on the group entities where it is written that the referral fee @ 30% of the gross fee earned by C W India None of the agreements filed by the assessee company specify the exact percentage of fee to be received by CWS. No prudent business person will leave the issue of payment of fee open. The assessee has not been able to demonstrate the genuineness of the transaction, the services rendered by the group entities to merit this referral fee at a high rate nor the business purpose of the same. 4.8 On close scrutiny of the e-malls, copies of which have been given in the submissions, it is seen that most of them are cryptic mails in that most of them do not clearly mention either the client or the requirements of the client which is the mandato ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Board of Direct Taxes, by way of a circular, has directed the Assessing Officer to refer to all transactions beyond a specified limit, to the Transfer Pricing Officer for determining the arm's length price. When the Assessing Officer has no discretion in the matter, in view of the binding nature of the Central Board of Direct Taxes instructions dated 20th May 2003, directing all the officers of the Department to refer the matters to the Transfer Pricing Officer for determination of the arm's length price where the aggregate value of international transactions exceeds Rs. 5,00,00,000, the Assessing Officer has a very limited role. He has to mechanically follow these instructions. There is no application of mind. There is no formation of any opinion at the stage of reference. Thus, to presume that he has allowed a particular expenditure under section 37, does not seem to be the right view of the matter. In any event, this is not a case where the Transfer Pricing Officer or the Assessing Officer made a disallowance under section 37 of the Act. It is a case where an adjustment has been made under section 92C(4) of the Act, after the Transfer Pricing Officer determined the arm& ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 20000 0% For the portion between $20001- $150000 30% For the portion between $150001 - $500000 40% For the portion above $500001 50% 42. Whether these figures represented the ALP of such referral transactions was to be decided by the TPO, who concluded that no adverse inference is drawn . This determination is binding on the AO, who cannot consider the quantum of referral fees paid, but only whether such fees was backed by an actual referral by the AEs. In other words, the AO s jurisdiction in such case is to only verify whether the claim of the assessee is borne out by the materials relied on by it and finalize the assessment order. This as discussed is the distinction between the jurisdiction of the AO and the TPO; the TPO determines whether the stated transaction value represents the ALP or not (including whether the ALP is nil), while the AO makes the decision as to validity of the deduction under Section 37. This means the decision as to whether the expenditure was laid out or expended wholly and exclusively for the purposes of the business is a fact determination or verification to be undertaken by the AO. This includes whether the referrals actually occurred (and thus took p ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... entity specifically in relation to the property transaction done but this has not been given by the assessee in its submissions. This makes it clear that the assessee company is in no position to clarify or substantiate the work done or services rendered by the group concerns to merit this 4.6 None of the agreements filed by the assessee company specify the exact percentage of fee to be received by CWS. No prudent business person will leave the issue of payment of fee open. The assessee has not been able to demonstrate the genuineness of the transaction, the services rendered by the group entities to merit this referral fee at a high rate nor the business purpose of the same. 4.8 On close scrutiny of the e-mails, copies of which have been given In the submissions, it is seen that most of them are cryptic mails in that most of them do not clearly mention either the client or the requirements of the client which is the mandatory requirement for any entity referring to any other entity. There is no evidence submitted regarding the services provided by the group entities to merit the referral fee. Copies of some invoices are also given but again raising invoices does not substantiate o ..... X X X X Extracts X X X X X X X X Extracts X X X X
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