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Income Tax Appellate Tribunal, DELHI BENCHES : I-2 : NEW DELHI
Before: SHRI R.S. SYAL, AM & MS SUCHITRA KAMBLE, JM
per which the assessee (FITPL) is rendering tour and travel related and customer handling services to its parent company Fritidsresor AB, Sweden (FAB). The functions performed, as indicated in this report, show that the assessee : ‘mainly caters to the inbound tourist traffic centred in and around India. The main service performed by FITPL is in the field of handling the tourists when they come to India. FAB enters into tourism contracts for their outbound tours to India. Thereafter, it enters into a contract with FITPL under which FITPL renders service to FAB in respect of the tour and travel arrangements to be made in respect of the tours.’ The main tourist centric activities carried out by the assessee have been broadly classified into two categories in this transfer pricing report on the same page, which are reproduced as under:-
“Charters: The services provided mainly include to and fro transfers from the airport to the respective hotels and hotel bookings. The company handles both the transfers and hotel bookings. Excursions: While the tourists are in Goa, the Representatives (Reps) of the overseas tour operators sell various excursions to the tourists directly, collect money from them, and after deducting the commission (as agreed) deposit the money with the FITPL which arranges for all the excursions.”
Then, there is amplification of risk analysis in the Transfer pricing study report. It has been mentioned that the assessee bears nominal market risk, credit risk, foreign exchange fluctuation risk, product price risk and contract risk associated with this line of business. The entire service liability risk, namely, relating to non-performance of the services under the contract has to be borne by the assessee alone. 6
An overview of the narration given in the assessee’s Transfer pricing study report, more specifically, the activities carried out by it having been classified in two broader categories, namely, Charters and Excursions, shows that the contracts with tourists are finalized by foreign AE and the assessee has to organize the entire tour in India by raising the bills on the AE. The broader activity of ‘Excursions’ as set out above indicates that while the tourists are in Goa, the representatives of its foreign AE sell ‘various excursions to the tourists directly, collect money from them, and, after deducting their commission (as agreed), deposit the money with the FITPL’, being the assessee, which arranges for all the excursions. Going by this mention, it turns out that the foreign AE is simply concerned with arranging customers, finalizing their tours in India and receiving the total revenue from such customers, which after appropriate deductions inclusive of their commission, is handed over to the assessee. On tourists reaching India, the entire exercise of making arrangements for their stay, travel and sightseeing etc. is to be done by the assessee at its cost. The assessee has canvassed a view before the authorities below that its job is confined to making 7 arrangements for the customers in India on net service fees of Rs.71.54 lac and all the hotels etc. are booked directly by FAB and it is simply paying such costs and passing through the same to FAB. On being called upon to substantiate this submission and show how the amount of its service fee of Rs.71,54,896/- was computed, the ld. AR could not give any direct reply except for stating that this was in consonance with certain agreements, but, there was no fixed percentage of commission settled between the assessee and foreign AE. When the ld. AR was required to draw our attention towards the Agreement between the assessee and the foreign AE under which the assessee was rendering services and receiving remuneration, initially it was stated that there was no formal agreement between the two AEs, but, later on, the ld. AR sought time of one day for producing such Agreement, if any. On the next date of hearing, the ld. AR placed on record a copy of `Rate sheet for the period 1st October till 16th April, 2005’ of the assessee to its AE, which reads as under:-
“RATES SHEET FOR 2005 - 2006 - CLASSICAL INDIA TOUR (IND) NET EFFECTIVE 01 OCTOBER TILL 16th April 2005 NO OF UNITS RATES Minimum of 10 - 14 Paying USD 600 Per Person 15 - 19 + 1 Free USD 565 Per Person 20 - 24 + 1 Free USD 560 Per Person 25 - 29 + 1 Free USD 555 Per Person Single room Supplement USD 316 Per Single Air fare Goa- Delhi - Goa For minimum 10 Paying & above using Sahara Airlines USD 452 Per person HOTEL ENVISAGED CITY NAME HOTEL NO OF NIGHTS Goa Majestic 01 New Delhi Oberoi Maidens 01 Jaipur Country Inn 02 (Radisson) Agra Jaypee Palace 02 New Delhi Oberoi Maidens 01 Rates include the following:- A. HOTELS • 07 Nights/ 08 days accommodation on Twin sharing basis including all existing taxes. B. MEALS •Accommodation on half board basis at all places with meals on fixed menu only.
C. TRANSPORT. • Meeting and assistance on arrival / departure by le passage to India representative • Transfer from airport to hotel and vice-versa. (Except in Goa) • Sightseeing, excursion and surface travel as per programme. • Cost based on using air-conditioned transport as under.
NO OF UNITS TYPE OF TRANSPORT 02 OR 03 PAYING Medium Car 04 - 06 Paying Tempo Traveller 07 - 14 Paying Mini Coach 15 Paying Onward Large Coach D. PORTEAGE/ENTRANCE • Porterage of baggage at airport/Hotel. • Entrance at the places of visit.
E. GUIDE English speaking accompanying guide from Delhi to Delhi not staying in same hotels.
COST DOES NOT INCLUDE • ITEMS OF PERSONAL NATURE - such as laundry, table drinks, telephone bills, tips to room boys, drivers, guides, personal clothing including sleeping bags etc. • Any Air fare (See Supplement- subject to change)”
Then, our attention was invited towards page 1 of the Paper Book, which is a copy of invoice dated 19.1.2006 raised by the assessee on FAB in respect of services provided at the rates which are in conformity with the ‘Rate sheet’ as reproduced above. Albeit the Transfer pricing study report states that the Excursions are sold by the representatives of the foreign AE, who after deducting its commission, give the deposit amount to the assessee, we find that there has been improper reporting in such report. The correct position, as borne out from the `Rate sheet’ and the corresponding invoices raised by the assessee on its AE, is that the assessee gets a composite fixed amount from its AE and it has to bear all the costs in making arrangements for the stay and travel of tourists in India. When we peruse the aforequoted Rate sheet, it becomes manifest that the assessee is charging at a specified fixed rate per person for the tour. For example, if there are 10-14 guests and the tour is of seven nights and eight days, the assessee gets USD 600 per person. The rate so charged is quid pro quo for the provision of hotel, meals, transport, porteage/entrance and guides to the foreign tourists. If the assessee manages to get good discount from hotels and economical transportation etc., its profit correspondingly gets swelled and vice versa. It can be understood with the help of a simple illustration. If the assessee incurs expenses on hotels, meals, and transport, etc. to the tune of USD 500 per person, its profit turns out to be USD 100 per person. If such costs get reduced to, say, USD 450 per person, the assessee’s profit increases to USD 150 per person. If, on the other hand, such costs go up to, say, USD 550 per person, the assessee’s profit shrinks to USD 50 per person.
Similar is the position regarding the composite charge by the assessee on account of air fare of Goa-Delhi-Goa for the entire period, namely, 1st October, 2004 till 16th April, 2005, at USD 452 per person. This is again a uniform fixed rate irrespective of the actual air fare that the assessee may have to incur for tourists. It is a common knowledge that the air fares keep on fluctuating for a variety of reasons over a period of time. If the assessee manages to obtain air tickets at a lower rate, then, it adds to its profit and vice versa. To illustrate, if the assessee gets air tickets at say, 400 USD per person, its profit is 52 USD per person, but if the air tickets cost 420 USD per person, then its profit stands reduced 12 to USD 32 per person. To put it simply, the assessee charges a fixed composite `all inclusive’ amount from its AE, which is irrespective of the actual costs defrayed by it in providing the services to the tourists at pre-determined standards. Having received the amount as per `Rate sheet’ from its AE, it becomes the duty of the assessee to arrange and pay for the provision of the contracted services at its own without any involvement of the AE. The obligation undertaken by the assessee with its AE is to provide the desired services to the foreign tourists. The manner in which such services are to be provided is the duty of the assessee alone, who has to arrange and pay for such services at its own.
Higher the actual costs incurred in providing such pre-settled services, lower the profit and vice versa. In other words, 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 13 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 non- payment 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.
The contention of the ld. AR that the expenditure of Rs.13.93 crore incurred on hotel, transportation and air fare etc. for tourists, is pass through costs, pre-supposes that such expenses are incurred by the assessee for and on behalf of its foreign AE, which are recoverable as such from its AE. If the costs are not recoverable from the AE, then such costs shed the character of pass through costs. We find that the entire amount of Rs.13.93 crore represents the costs incurred by the assessee in its role of a principal and not as an agent of its foreign AE inasmuch as this is not an amount recoverable per se from its AE. Our view is further fortified and substantiated by copies of certain invoices raised by hotels, 14 etc. on the assessee directly. Page no.136 is a copy of invoice dated 7.2.2006 of Radisson Hotel raised on the assessee. Similarly, page no. 138 is a copy of invoice raised by Hotel Crowne Plaza on the assessee.
On the other hand, the assessee has raised invoices on its foreign AE at the rates as per `Rate sheet’, which is a fixed and all inclusive charge having no link with the actual amount incurred or to be incurred by the assessee. It is this amount of Rs.14.65 crore received from the AE that forms its gross revenue, from which all the direct and indirect expenses on providing services and facilities to the tourists are met by the assessee, leaving the remainder as its profit. Once this is the correct position, we fail to appreciate as to how the sum of Rs.13.93 crore 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. Further, we have noticed supra that the 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 15 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.
The next question which arises for our consideration is 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’. There is no dispute on the fact that the assessee applied the `Cost plus method’ for demonstrating that its international transaction was at ALP. The AO has also accepted the application of this method.
Further, there was no challenge before the ld. CIT(A) as to the application of this method. This evidences that there is no dispute on the application of `Cost plus method’ as the most appropriate method. The making and deletion of addition by the AO and ld. CIT(A) respectively has not been due to any conflict on the decision in the choice of the most appropriate method but due to the application of the `Cost plus method’ in one way by the AO and in the other by the ld. CIT(A). Whereas the AO has computed the ALP by taking the total costs incurred by the assessee at Rs.13.93 crore, the ld. CIT(A) has upheld the assessee’s contention that this amount should be ignored in totality and only the indirect costs incurred totaling Rs. 56.84 lac should be considered for the purpose.
Before addressing the correctness of the approach, we consider it expedient to note down the relevant provisions in this regard. Section 92(1) of the Act provides that: ‘any income arising from an international transaction shall be computed having regard to the arm’s length price.’ Section 92C deals with the computation of arm’s length price. This section provides that the ALP of an international transaction shall be determined by any of the methods given in the provision, which also includes `(c) Cost plus method’. The manner of determination of ALP under different methods has been set out in Rule 10B. Clause (c) of Rule 10B(1) deals with the determination of ALP under the `Cost plus method’, which reads as under:-
`(c) cost plus method, by which,—
(i) the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined ;
(ii) the amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined ;
(iii) the normal gross profit mark-up referred to in sub-clause (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market ;
(iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii) ;
(v) the sum so arrived at is taken to be an arm’s length price in relation to the supply of the property or provision of services by the enterprise ;’
Sub-clause (i) provides that the direct and indirect costs incurred by an enterprise in providing services are first determined. The emphasis is on considering both the direct and indirect costs in providing services.
Sub-clause (ii) provides for determining the normal gross profit mark-up on the direct and indirect costs resulting from the provision of services by an unrelated enterprise in a comparable uncontrolled transaction.
Here again, the emphasis is on determining the normal gross profit mark up earned in a comparable uncontrolled situation on both direct and indirect costs of providing services. Sub-clause (iii) calls for making adjustment to the normal gross profit mark-up as computed under sub- clause (ii) on account of differences between the international transaction and comparable uncontrolled transaction. Sub-clause (iv) provides that the direct and indirect costs incurred by the assessee in providing services to its AE are increased by the adjusted profit mark-up arrived at under sub-clause (iii), which is taken as the ALP of the provision of services by the enterprise.
12.1. On going through the mandate of rule 10B(1)(c), it is explicit that for determining the ALP under the `Cost plus method’, both the direct and indirect costs of providing services are to be considered in the hands of the assessee as well as comparable uncontrolled companies.
Adverting to the facts of the instant case, we find that a sum of Rs.13.93 crore is in the nature of hotel, transport expenses and local air fare expenses etc. incurred by the assessee in providing services to the tourists, which are the direct costs. Personnel expenses, Operating expenses and Exchange rate difference totaling Rs.56.84 lac are the indirect costs incurred by the assessee. The assessee has made out a case that the direct costs incurred totaling Rs.13.93 crore are in the nature of pass-through costs and hence liable to be ignored. We have dealt with this contention supra by holding that these are not pass through costs incurred by the assessee. In fact, these are the direct costs incurred in providing services to the tourists for which the assessee is getting revenue from its AE. Going by the language of the rule 10B(1)(c), it is clear that both the direct and indirect costs are to be considered. The ld. CIT(A) in deleting the addition has ignored the direct costs and approved the computation of the ALP under this method by confining himself only to the indirect costs, which is contrary to the instruction of the rule. It is impermissible to alter the prescription of Rule 10B(1)(c) by applying the gross profit rate only to the indirect costs 20 in total disregard to the mandate of considering both the direct and indirect costs.
12.2. The ld. AR contended that the manner in which the assessee recorded the transactions in its books of account by crediting only service fee of Rs.71.54 lac to its Profit & Loss Account and then debiting indirect expenses to the tune of Rs.56.84 lac is an accepted accounting practice which has been approved by the Hon’ble Delhi High Court in CIT vs. International Travel House Ltd. (2012) 344 ITR 554 (Del). This was countered by the ld. DR by submitting that maintenance of accounts on `net basis’ is one of the permissible methods and the accounts can be maintained on `gross basis’ as well. We find that in the case before the Hon’ble Delhi High Court, the assessee credited income after netting discount from gross commission income. The CIT, exercising his revisional power u/s 263, set aside the assessment order and directed the AO to verify the net commission transferred to the Profit & Loss Account. The assessee filed appeal before the Tribunal, which noticed that gross income was credited to the Profit & Loss Account in one case whereas net income was credited in other cases and the tax effect under both the methods was same and, hence, the exercise of power u/s 263 was improper. The Hon’ble Delhi High Court dismissed the appeal filed by the Revenue by observing that both the accounting systems, namely, gross as well as net, are tax neutral.
12.3. We are unable to understand as to how this case justifies the assessee’s stand of considering only the indirect costs in the computation of the ALP under the `Cost plus method’. Obviously, we are not dealing with a situation in which the dispute is about the net or gross method of accounting to be followed. Rather, the controversy is the determination of ALP of the international transaction of `Tours and travel related and customer handling services’ with transacted value of Rs.14.65 crore.
The manner in which accounts are maintained cannot be determinative of computing the ALP of an international transaction. The ALP is required to be computed in accordance with the prescription of the methods given under Rule 10B(1), which is irrespective of the method in which accounts are maintained. When this position was put across, the ld. AR was fair enough to concede that the judgment in the case of International Travel House Ltd. (supra) is only relevant in so far as accounting practice is concerned and it has nothing to do with the transfer pricing provision.
12.4. The ld. AR heavily relied on the judgment of the Hon’ble Delhi High Court dated 30.10.2015 in Johnson Matthey India Pvt. Ltd. vs. DCIT (ITA No.14/2013) to bolster his argument supporting the correctness of the assessee’s computing profit margin on indirect costs alone, to the exclusion of direct costs of Rs.13.93 crore. The assessee in that case, was obliged to procure the raw material on instructions of MUL at a price dictated by MUL from the sources selected by MUL.
That assessee was entitled to a per unit fixed manufacturing charge over and above the actual cost of raw material. This shows that the assessee in that case incurred pass-through costs for and on behalf of MUL which were recoverable as such and that assessee was entitled only to a fixed
per unit manufacturing charge over and above the actual cost of raw material. So, in that case the question for consideration was the deductibility or otherwise of such pass through costs in determining the ALP under the Transactional net margin method (TNMM), which has been answered in the assessee’s favour. There can be no doubt that the pass-through costs are liable to be ignored in computing the ALP under the TNMM.
12.5. We fail to draw any parallel of this case insofar as the instant case is concerned for certain reasons set out hereinafter. Firstly, the amount of Rs.13.93 crore is not a pass-through cost as has been held by us in an earlier part of the order. Secondly, the Hon’ble High Court in holding that the denominator should exclude pass through costs took note of the expression ‘any other relevant base’ occurring in Rule 10B(1)(e)(i) of the IT Rules. It is pertinent to mention that Rule 10B(1)(e) deals with the determination of the ALP under the TNMM.
Sub-clause (i) of rule 10B(1)(e) particularly provides for the computation of net profit margin in relation to costs incurred or sales effected, etc. ‘or having regard to any other relevant base.’ The computation of net profit margin in relation to the expression ‘any other relevant base’ is peculiar to the determination of ALP under the TNMM.
In contrast to this, we are concerned with the computation of ALP in the present case under the `Cost plus method’ as per Rule 10B(1)(c). The manner of computation of the ALP under these two methods, namely, TNMM and Cost Plus Method, is totally different. There is no analogous provision in Rule 10B(1)(c) to consider ‘any other relevant base’ for determining the ALP under the `Cost plus method’. Au contraire, this Rule specifically provides a modus operandi for determining the ALP by considering both the direct and indirect costs.
In contrast to the facts of Johnson Matthey India Pvt. Ltd. (supra), the extant assessee has neither incurred any pass through costs nor used the TNMM as the most appropriate method. Thus, this judgment has no application to the facts of the instant case.
12.6. The ld. AR has relied on some other orders of the Tribunal, all of which are based primarily on the application of TNMM in which the pass through costs were actually incurred and such costs have been directed to be excluded. These decisions, in our considered opinion, again have no relevance in so far as the issue under consideration is concerned.
12.7. Another factor which needs to be accentuated is that 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’.
The second reason for our not countenancing the impugned order is that the ld. CIT(A) has accepted the yardstick of comparing the assessee’s ratio of `Net profit to Total costs’ with the similar ratio of two comparables. Ratio of `Net profit to total costs’ has no place in the mechanism provided for computing the ALP under the `Cost Plus method’ as can be seen from the extraction of rule 10B(1)(c) above.
Even under the TNMM, the formula is the ratio of `operating profit’ to a suitable base, as has been held by the Hon’ble Apex Court in DIT (I.T.)
VS. Morgan Stanley & Co. (2007) 162 Taxman 165 (SC). What is relevant under the TNMM is `operating profit’ and not `net profit’. The 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.
The third reason for not upholding the impugned order is affixing the seal of approval by the ld. CIT(A) to the selection by the assessee of only two companies as comparable. Relevant part of para 2.9 of the impugned order provides that : `the appellant was further asked to do an analysis of the NCP margin of some listed companies with in the same trade of Tour & Travel’. It is in pursuance to this direction of the ld. CIT(A) that the assessee came out with two comparable companies, namely, International Travel House Ltd. and Cox & Kinds (India) Pvt. Ltd. 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, the ld. 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 ld. 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. 28
In view of the foregoing reasons, we are unable to persuade ourselves to approve the reasoning given by the ld. CIT(A) in deleting the addition.
16.1. We find that there are certain flaws in the determination of the ALP by the AO as well.
16.2. A casual look at the 14 companies tabulated at page 4 of the assessment order giving weighted average profit rate of 11.72% applied by the AO divulges that such profit rate has been computed on the basis of the figures of these companies for three years. The Hon’ble Delhi High Court, after considering the mandate of Rule 10B(4) r .w. r. 10D(4) has held in ChrysCapital Investment Advisors (India) P. Ltd. VS. DCIT (2015) 93 CCH 29 DelHC that the multiple year data should be ordinarily avoided. Consideration of the single year data was earlier approved by the Special bench of the tribunal in Aztec Software & Technology Services Ltd. [(2007) 107 ITD 141 (Bang.) (SB). In spite of these decisions, the determination of the ALP has been made on the basis of multiple year data and not the current year data alone, which is not correct.
16.3. The 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.
In the result, the appeal is allowed for statistical purposes.
The order pronounced in the open court on 13.11.2015.