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TMI Blog2016 (6) TMI 635X X X X Extracts X X X X X X X X Extracts X X X X ..... te adjustment of risk assumed vis-a viz-comparable company identified by ld TPO - Held that:- We find considerable force in the argument of the assesse with respect to risk adjustment on account of foreign exchange fluctuation as it is apparent from the account that there is no foreign exchange loss incurred by the assesse therefore we set aside this ground to the file of AO for once again perusing the risk adjustment claimed by the assesse and adjudicate the issue. X X X X Extracts X X X X X X X X Extracts X X X X ..... being the 'most appropriate method' for the determination of arm's length price of the royalty and franchisee fees payable by Appellant to associated enterprise, by placing reliance on the section 92A(2)(g) of the Act and Rule 10B(2)(d) of the Rules. ii) The TPO/CIT(A) inappropriately concluded that all the three transactions related to rendering market support services, payment of royalty and franchisee fee to MDC are closely linked 7. That the TPO/AO/CIT(A) have failed to make appropriate adjustments to account for differences in functions performed, and risks assumed and assets employed by the Appellant, vis-a-vis comparable companies identified by him. 8. That without prejudice to the generality of the grounds of appeal No.1 to 7, on the facts and in law, CIT(A) failed to adjudicate on the applicability of proviso to section 92C of the Act and to allow the Appellant an option for the downward variation of 5 percent in determining the arm's length price. 3. At the outset the Ld AR of the appellant submitted that that ground no 1 to 4 of the appeal are not pressed. Hence we dismiss ground no 1 to 4 of the appeal. 4. Ground No 5 of the appeal is against ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lso referred to the TPO for determination of Arm's Length Price of its transaction with its Associated Enterprises. The ld TPO adjusted the ALP by an amount of ₹ 4489948/- on account of following international transactions Transaction Amount(INR) Method applied by assesse Method applied by TPO ALP determined by TPO ( INR) Consequent adjustment ( INR) Payment of royalty 5208668 CUP TNMM 48331219 3755449 Payment of initial franchisee fee 1412200 CUP TNMM Consulting services rendered 11213750 TNMM TNMM 12022261 808511 8. The ld TPO rejected CUP method benchmarking of transactions pertaining to royalty payment and franchise fee and aggregated all the transactions of consultancy services, royalty payment and franchise fee. He applied TNMM method on aggregation basis and included royalty income received from the JVS and paid to McDonald Corporation in operating income and operating expenses respectively while working out PLI of the assesse. Further he excluded the franchise fee received during the year from the operating income as it was not remitted to McDonald corporation in absence of necessary RBI approvals as it was not recogniz ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erely receives Royalty fees for onward transmission to MDC. b. In fact, vide para no. 10.8 of order of ld. TPO dated 8.2.2006, the learned TPO has excluded the receipts by way of initial franchisee fees from the working operating profit margins and cost base for applying mark-up. It is submitted that conceptually there is no difference between collection and remittance of initial franchisee fees on one hand and royalty fees on the other hand. Therefore, the TPO was not justified in holding that although initial franchisee fees had to be excluded, royalty fees had to be included. c. Further, this issue is covered by the order of Income Tax Appellate Tribunal, Bench-E dated 30.01.2009 in the appellant's own case for A.Y. 2001-2002 which is placed in the paper book at page 457-468. Vide para 8 (PB 463) of the aforesaid order, the Hon'ble Tribunal held that "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 received from franchises and there is no income left to the assessee as per this Master License Agreement and franchises agreement". Further, the Tribunal has held (PB 464) that "We have als ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s to be collected by JVs is 5% of gross sales from operation of McDonald restaurants and same amount is required to be remitted by the assesse within five days of the end of each month. Ld TPO as well as the ld CIT(A) did not agree to the contention of the assesse for the only reason that there is discretion available to McDonald to compel assesse to make good in case there is a default of payment of royalty by franchisee. Though there is a clause in agreement it cannot be read in isolation or complete ignorance of risk involved in those clauses of agreement on practical business matrix of the assessee. It was submitted that there is no such default which has occurred either in previous years or in subsequent years.. Therefore there is no risk assumed by the assesse in collection and onward remittance of Royalty. This argument of the assessee has not been controverted by Ld DR. Further it is contention of the assessee that there is no value addition to the collection of royalty amount and reimbursement of the same to the MDC. During the year there is a collection of royalty fees of ₹ 52637830/-and there is a payment of royalty fees of ₹ 52086668/- during the year. The a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to which an independent party in comparable circumstances would agree not to earn a mark-up of 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 paragraph 7.36." 16. The LD TPO as well as the ld CIT (A) has not shown that an independent service provider in comparable circumstances would not have performed such function of collection of royalty and onward remittance of the same to MDC when it is reimbursed for other services on cost plus mark up and there could have been payment of further remuneration on this aspect also. In this case assesse has submitted that it is being remunerated separately on cost basis, does not provide any value addition to the collection and payment of royalty and franchise fees and has not performed any significant function as the royalty and initial franchisee fee is collected by JV and paid to assesse who in turn remits to the AE. It has also not assumed any significant risk based on past practices or any experience. No instances have been pointed out by ld TPO or ld CIT(A) to show that risk of nonpayment by f ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee for release of a particular advertisement. It is also to be noted that advertising space (be it media, print or outdoor), has been let out by third party vendors in the name of ultimate customers and beneficiary of advertisement. We have gone through the invoices and purchase orders from third party vendors and find that they contain customers' name, and all the terms of advertisement are finalized after taking the approval from the customers. The assessee simply acts as an intermediary between the ultimate customer and the third party vendor in order to facilitate placement of the advertisement. The payment made by the assessee to vendors is recovered from the respective customers or AEs. In the event customer fails to pay any such amount to the advertisement agency the bad debt risk is borne by the third party vendor and not by the advertising agency i.e. the assessee. It is, thus, clear that the assessee has not assumed any risk on account of non-payment by its customers or AEs. At this stage a useful reference may be made to ITS 2009 Transfer Pricing Guidelines accepted by the OECD where it is laid down that when an AE is acting only as an agent or intermediary in the pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lity (including functional) analysis, and in particular on a determination of the value added by the tested party in relation to those costs." 42. Further, OECD in ITS 2009 Transfer Pricing Guidelines has laid down as under : "7.36 When an AE is acting only as an agent or intermediary in the provision of services, it is important in applying the cost plus method that the return or mark-up is appropriate for the performance of an agency function rather than for the performance of the services themselves. In such a case, it may not be appropriate to determine arm's length pricing as a mark-up on the cost of the services but rather on the costs of the 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. For example, an AE may incur the costs of rendering advertising space on behalf of group members, costs that the group members would have incurred directly had they been independent. In such a case, it may well be appropriate to pass on these costs to the group recipients without a mark-up, and to apply ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... "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. costs which are potentially excludable from the denominator of the net profit indicator)" would depend 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." Para 2.94 of the OECD Guidelines further acknowledges that "comparability issues may arise in practice where limited information is available on the breakdown of the costs of the comparables." This Court has in CIT v. EKL Appliances Ltd. [2012] 345 ITR 241 (Delhi) has noted that the OECD Guidelines have been recognised in our tax jurisprudence. What is however, is significant is that in the absence of any reliable comparable data, and in the absence of proper reasons, it would not be justified for the Revenue to simply reject a financial ratio adopted by the Assessee for computing the net profit margin by excluding a pass through cost from the TC in the denominator. The expression "any other relevant base" occurring in Rule 10(1)(e)(i) of the Rules is wide e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . Coordinate bench has held so as under :- "8. We have heard the rival submissions and have gone through the material available on record and the judgments cited by Ld AR of the assessee. We find that in view of Master License Agreement dated 1.4.1996 and Service Agreement dated 1.4.1999, the assessee is running two types of businesses although both are connected with Me Donald's Corporation USA. As per this agreement dated 1.1.1996 I.e. Master License Agreement, the assessee can operate restaurant system under Me Donald's System and the assessee can run it of its own or through franchises. In both these situations, the assessee has to pay royalty to Me Donald's Corporation USA @ 5% of gross turnover. Regarding advertisement, clause (vi) of this Master License Agreement is relevant as per which, licensee has to spend during each calendar year for advertisement or promotion of restaurant business for the general public and amount which is not less than 5% of its gross sales. In view of this, we find that as per Master License Agreement dated 1.1.1996, the assessee has to pay 5% of gross turnover to Me Donald's Corporation USA as Royalty and at the same time, the ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... isement expenditure partly borne by the assessee which was to be otherwise borne by the franchises, [n this regard, we are of the considered opinion that section 92 of the income Tax Act, 1961 is not applicable with regard to advertisement expenditure which has been borne by the assessee as a result of this agreement} with Indian franchises and the same has resulted into lesser profit/loss of the assessee and more profit to the franchises and it has no impact on the income of the Me Donald's Corporation USA because whether the advertisement expenditure is borne by the assessee or by the franchises, the benefit of Me Donald's Corporation USA will remain the same. The benefit of McDonald's' USA remains unchanged. Me Donald's Corporation USA will get the same amount of royalty whether advertisement expenditure is borne by the assessee or by its franchises and hence, it cannot be said that by agreeing to bear a part of the advertisement expenditure 'which was to be borne by the franchises, there is any arrangement between the assessee and a non resident to the effect that there is no profit to the assessee or lesser profit to the assessee." Therefore it is app ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e no significant risk is assumed by the assesse on account of foreign exchange fluctuation. It was further submitted if the accounts of the assess are properly perused it may be found that assesse has not incurred any risk of foreign exchange fluctuation as it has not incurred any losses on that count. It was further submitted that in AY 2002-03 the TPO has determined ALP keeping in mind that there is a minimal risk being credit risk is borne by the assesse and therefore he submitted that there is no justification for TPO to change the stand. He relied on the following decision of various coordinate benches as under :- i) Kodiak Networks (India) Pvt. Ltd. V. ACIT (ITA No. 970/Bang/2011). ii) Drilbits International P. Ltd. V. DCIT (ITA No. 1361/PN/2010). iii) Intelliinet Technologies India Pvt. Ltd. V. ITO (ITA No. 1237/Bang/2010). 25. Ld DR on the other hand relied on the orders of lower authorities and stated that assesse is carrying risk associated business transaction and therefore no further adjustment can be granted. 26. We have carefully considered rival contention and we find considerable force in the argument of the assesse with respect to risk adjustment on account of ..... X X X X Extracts X X X X X X X X Extracts X X X X
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