Facts
Agility Logistics Pvt. Ltd. (“the Taxpayer”), an indirect subsidiary of Geologistics Corporation US, is engaged in the business of logistical services. The Taxpayer had adopted Comparable Uncontrolled Price (“CUP”) method wherein the contracts with Associated Enterprise (“AE”) and independent third parties were based on 50:50 net revenue split. This split was the difference between collections from customers and payments made to third party service providers. The Transactional Net Margin Method (“TNMM”) was applied as a secondary method with Operating Profit/ Value Added Expenses (“OP/VAE”) as the profit level indicator.
During TP audit, the Transfer Pricing Officer (“TPO”) rejected CUP method adopted by Taxpayer primarily on account of different geographical market - the AE “GeoUKMgt” was situated in UK whereas the Taxpayer operates in India. The TPO opined that CUP method did not provide realistic results due to differences in economic conditions and government policies which affect costs and profitability. While the Taxpayer explained that the Group TP policy was based upon equal sharing of net revenue between contracting AEs, the TPO maintained that the inter-company agreements were based on profit split as against a specific rate. Hence, the TPO applied the TNMM method on a different set of comparables including private limited companies. The PBIT/ Total Cost of comparables was determined at 18% vis-à-vis the Taxpayer at 2%. Accordingly, the TPO made an upward adjustment of INR 275,434,623 to the total income of the Taxpayer for AY 2004-05.
Aggrieved with the TP order, the Taxpayer filed an appeal before the Commissioner of Income Tax (Appeals) (“CIT(A)”) wherein the primary arguments of the Taxpayer were:
The application of CUP method was justified as the AE and independent third parties followed an approach of splitting residual profit on 50:50 basis, which is typical for logistics and freight forwarding service providers.
Though differences in geographical locations exist, it did not influence profit sharing as contractual terms in agreements between AE and independent third parties remained identical.
Both the origin company and destination company in the network performed comparable functions including coordination with third party service providers to provide logistical services to customers. Further, the composition of assets is office infrastructure whereas the risks assumed in case of loss or delay of cargo for both companies is similar. Therefore, in view of the integrated nature of operations, the sharing of risk and reward at 50:50 ratio is appropriate.
That OP/VAE was an appropriate measure of profitability since operational efficiency is best measured in terms of whether the gross margin is adequate to cover costs associated with its functions and not those of airlines/ other freight carriers in respect of which the Taxpayer adds little value.
In TP audit proceedings of AY 2002-03 and AY 2003-04, the TPO had accepted the CUP method based on 50:50 net revenue sharing. This pricing arrangement of the Taxpayer has remained unchanged over the years.
Based on the aforementioned arguments of the Taxpayer, the CIT(A) deleted the TP adjustment as the Taxpayer’s contentions regarding the CUP method were adequately supported by third party agreements and robust functional-asset-risk analysis. The CIT(A) also quoted the Tribunal Ruling of MSS India Pvt. Ltd. by the Pune bench which held TNMM to be a method of last resort which is to be presented only when the “traditional methods” cannot be reasonably applied.
The Revenue filed an appeal against the order of the CIT(A) before the Tribunal.
Ruling of the Tribunal
The salient aspects of the Ruling are as follows:
The Tribunal accepted that the Taxpayer had previously adopted CUP method in AY 2002-03 and AY 2003-04 which had been accepted by the TPO. Further, as demonstrated by the Taxpayer, the revenue sharing was 50:50 in Pakistan, Bangladesh and Sri Lanka. Since the terms and conditions of various agency agreements between AE and independent third parties remained unchanged, it implied that geographical difference was not material to the logistics industry where revenue split was a typical phenomenon.
It was held that the functional-asset-risk (“FAR”) profile of the origin company and destination company was similar with the activities being limited to coordination with nil inventory risk and minimal bad debt risk.
In its capacity as an agent of the airline/ sealine, the Taxpayer merely issued bills to customers. Since it was not responsible for actually transporting the consignment, the exclusion of freight charges paid to independent service providers was reasonable. Therefore, the guideline under Para 7.36 of OECD was upheld that application of cost plus mark-up in performance of an agency function is more important than that of the service itself.
Private limited companies that had been considered by the TPO as comparables despite non-availability of data in the public domain should have been excluded. Further, functionally comparable companies rejected by the TPO should have been included.
Conclusion
This Ruling highlights the importance of the following aspects:
Comprehensive FAR analysis supported by industry characteristics strengthens the taxpayer’s position.
The Tribunal accepted the consistency with which the CUP method had been adopted by the Taxpayer since AY 2002-03 till AY 2006-07, thereby emphasizing the uniformity in approach.
The position of the OECD Guidelines on “pass-through costs” not being marked-up has been upheld with the rationale that these costs are not incurred for value-added activities.
It was incorrect of the Revenue to include comparables whose data is not available in public domain for the TP analysis.
Source: Agility Logistics Pvt. Ltd. Vs. Dty. Commissioner of Income Tax (Mumbai, Bench), ITA No: 2000/Mum/2010
Agility Logistics Pvt. Ltd. (“the Taxpayer”), an indirect subsidiary of Geologistics Corporation US, is engaged in the business of logistical services. The Taxpayer had adopted Comparable Uncontrolled Price (“CUP”) method wherein the contracts with Associated Enterprise (“AE”) and independent third parties were based on 50:50 net revenue split. This split was the difference between collections from customers and payments made to third party service providers. The Transactional Net Margin Method (“TNMM”) was applied as a secondary method with Operating Profit/ Value Added Expenses (“OP/VAE”) as the profit level indicator.
During TP audit, the Transfer Pricing Officer (“TPO”) rejected CUP method adopted by Taxpayer primarily on account of different geographical market - the AE “GeoUKMgt” was situated in UK whereas the Taxpayer operates in India. The TPO opined that CUP method did not provide realistic results due to differences in economic conditions and government policies which affect costs and profitability. While the Taxpayer explained that the Group TP policy was based upon equal sharing of net revenue between contracting AEs, the TPO maintained that the inter-company agreements were based on profit split as against a specific rate. Hence, the TPO applied the TNMM method on a different set of comparables including private limited companies. The PBIT/ Total Cost of comparables was determined at 18% vis-à-vis the Taxpayer at 2%. Accordingly, the TPO made an upward adjustment of INR 275,434,623 to the total income of the Taxpayer for AY 2004-05.
Aggrieved with the TP order, the Taxpayer filed an appeal before the Commissioner of Income Tax (Appeals) (“CIT(A)”) wherein the primary arguments of the Taxpayer were:
The application of CUP method was justified as the AE and independent third parties followed an approach of splitting residual profit on 50:50 basis, which is typical for logistics and freight forwarding service providers.
Though differences in geographical locations exist, it did not influence profit sharing as contractual terms in agreements between AE and independent third parties remained identical.
Both the origin company and destination company in the network performed comparable functions including coordination with third party service providers to provide logistical services to customers. Further, the composition of assets is office infrastructure whereas the risks assumed in case of loss or delay of cargo for both companies is similar. Therefore, in view of the integrated nature of operations, the sharing of risk and reward at 50:50 ratio is appropriate.
That OP/VAE was an appropriate measure of profitability since operational efficiency is best measured in terms of whether the gross margin is adequate to cover costs associated with its functions and not those of airlines/ other freight carriers in respect of which the Taxpayer adds little value.
In TP audit proceedings of AY 2002-03 and AY 2003-04, the TPO had accepted the CUP method based on 50:50 net revenue sharing. This pricing arrangement of the Taxpayer has remained unchanged over the years.
Based on the aforementioned arguments of the Taxpayer, the CIT(A) deleted the TP adjustment as the Taxpayer’s contentions regarding the CUP method were adequately supported by third party agreements and robust functional-asset-risk analysis. The CIT(A) also quoted the Tribunal Ruling of MSS India Pvt. Ltd. by the Pune bench which held TNMM to be a method of last resort which is to be presented only when the “traditional methods” cannot be reasonably applied.
The Revenue filed an appeal against the order of the CIT(A) before the Tribunal.
Ruling of the Tribunal
The salient aspects of the Ruling are as follows:
The Tribunal accepted that the Taxpayer had previously adopted CUP method in AY 2002-03 and AY 2003-04 which had been accepted by the TPO. Further, as demonstrated by the Taxpayer, the revenue sharing was 50:50 in Pakistan, Bangladesh and Sri Lanka. Since the terms and conditions of various agency agreements between AE and independent third parties remained unchanged, it implied that geographical difference was not material to the logistics industry where revenue split was a typical phenomenon.
It was held that the functional-asset-risk (“FAR”) profile of the origin company and destination company was similar with the activities being limited to coordination with nil inventory risk and minimal bad debt risk.
In its capacity as an agent of the airline/ sealine, the Taxpayer merely issued bills to customers. Since it was not responsible for actually transporting the consignment, the exclusion of freight charges paid to independent service providers was reasonable. Therefore, the guideline under Para 7.36 of OECD was upheld that application of cost plus mark-up in performance of an agency function is more important than that of the service itself.
Private limited companies that had been considered by the TPO as comparables despite non-availability of data in the public domain should have been excluded. Further, functionally comparable companies rejected by the TPO should have been included.
Conclusion
This Ruling highlights the importance of the following aspects:
Comprehensive FAR analysis supported by industry characteristics strengthens the taxpayer’s position.
The Tribunal accepted the consistency with which the CUP method had been adopted by the Taxpayer since AY 2002-03 till AY 2006-07, thereby emphasizing the uniformity in approach.
The position of the OECD Guidelines on “pass-through costs” not being marked-up has been upheld with the rationale that these costs are not incurred for value-added activities.
It was incorrect of the Revenue to include comparables whose data is not available in public domain for the TP analysis.
Source: Agility Logistics Pvt. Ltd. Vs. Dty. Commissioner of Income Tax (Mumbai, Bench), ITA No: 2000/Mum/2010
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