Destination of the World (Subcontinent) Pvt. Ltd.,-vs.- Asstt. CIT (ITAT Delhi) The Tribunal held that in the first instance, the attempt should be made to determine arm’s length price of controlled transactions by comparing the same with internal uncontrolled transactions undertaken in same or similar economic scenario.
The Tribunal relied on the following in arriving at this conclusion :
- OECD Transfer Pricing Guidelines in paragraph 3.26 suggest preference for internal comparables, and suggest use of external independent enterprises only when such internal comparison is not possible.
- The Tribunal ruling in the case of UCB India Pvt. Ltd. (above), indirectly concludes that internal comparables are preferable to external comparables. Also, in the case of Birlasoft (India) Ltd. (above), the Tribunal ruled that the taxpayer was justified in undertaking internal comparison.
- Internal comparison is valid under all methods.
- In the current case, the Revenue had not made a case for economic scenarios of controlled and uncontrolled transactions to be different.
Destination of the World (Subcontinent) Pvt. Ltd.,-vs.- Asstt. CIT
C. L. Sethi (JM) & K.G. Bansal (AM)
ITA No. 5534(Del)/2010
Date of Decision – 08th July 2011
PER K.G. BANSAL : AM
The facts of the case are that the assessee filed its return on 22.11.2006 declaring loss of Rs. 2,86,62,238/-. The return was processed u/s 143(1) of the Income-tax Act, 1961, on 01.03.2008, and thereafter it was taken up for scrutiny by serving notice u/s 143(2) dated 27.09.2007 by post. Another notice under section 143(2) was served on the assessee by hand on 11.11.2008. The assessee-company has been carrying on the business of out-bound and in-bound travel services. It undertook international transactions with the Associated Enterprises (“AEs” for short) of the value of more than Rs. 5.00 crore. Therefore, reference was made to the Transfer Pricing Officer (“TPO” for short) for determining arm’s length value of the international transactions undertaken with the AEs. In order dated 15.10.2009, the TPO suggested upward revision in the value recorded in the books by an amount of Rs. 2,07,07,267/-. This revision was incorporated in the draft order. The assessee objected to the upward revision on this ground before the Dispute Resolution Panel-I, New Delhi (“the DRP” for short). In order dated 09.09.2010, the ld. DRP approved the draft order. Consequently, the assessment order was passed on 16.09.2010 determining the loss at Rs. 79,30,570/-as under:
Loss as per return of income 2,86,62,838/-
Add: On account of arm’s length price 2,07,07,267/-
Add: on account of ROC expenses 25,000/- 2,07,32,267/-
Total Loss: 79,30,571/-
Rounded off u/s 288A (-) 79,30,571/-
2. Coming to the order of the TPO, it is mentioned that the assesseecompany is a wholly owned subsidiary of Destination of the World Holding Establishment, Liechtenstein. The assessee started its operations in June, 2005, with the main objects of rendering in-bound, out-bound and domestic travel services in the territories of India, Nepal and Bangladesh. The in-bound services comprise of car rentals, airport transfers, site tours, travel insurance and customized packages. The domestic travel services are rendered through online reservation system to individuals and groups. The out-bound services comprise of meetings, conferences, exhibitions and travel to various destinations of the world. In this year, the assessee has undertaken following international transactions:
S.No. Description of transaction Method Value (In Rs.)
1 Outbound travel related services RPM 93803233
2 Outbound travel related services CPM 10017466
3 Charge back of expenses by assessee - 565599
4 Charge bank of expenses to assessee - 1402521
5 Counter Guarantee of cash credit limit - 1300000
2.1 The assessee has used re-sale price method in respect of out-bound travel with gross profit margin on sales as the profit level indicator (“the PLI” for short). In order to prove that such transactions with the AEs are at arm’s length, the assessee has drawn segmental accounts in the transfer pricing report. Further, the PLIs in respect of uncontrolled and controlled transactions have been worked out. Re-sale price method has been justified on the ground that the assessee does not add any value in this segment. The PLI in respect of controlled transactions has been shown at 10.87% against 11.84% in uncontrolled transactions. Thus, it is contended that if option of reduction by 5% is exercised, such transactions are at arm’s length.
2.2 In regard to in-bound travel services, the assessee has applied cost plus method with the PLI being gross margin as a percentage of cost. Segmental account has been drawn for this purpose, which has been segregated into controlled and uncontrolled transactions. The PLI in respect of controlled transactions is 6.66% against 8.93% in respect of uncontrolled transactions. Therefore, following the earlier argument regarding reduction by 5%, it has been contended that the transactions are at arm’s length.
2.3 The TPO examined the FAR analysis furnished in the transfer pricing report. It is mentioned that the report does not distinguish between in-bound and out-bound segments and, therefore, it can be concluded that functions performed and assets utilized in both the segments are similar. The report has not furnished the risk analysis in the two segments. It is further mentioned that the auditors have not certified that segmental accounts have been maintained. Therefore, it has been held that such segregation is a convenient devise to canvass that the controlled transactions have been undertaken at arm’s length.
2.4 Further, the TPO has examined the segmental accounts, which have been prepared from the consolidated annual accounts. It is mentioned that segmental accounts have not been maintained separately for transfer pricing purposes. In this connection, references have been made to the tax audit report, which show various discrepancies, namely, that
(a) only on set of accounts are maintained for the whole business;
(b) the segmental accounts have been prepared by arbitrarily allocating cost; and
(c) the basis of allocation between the two segments has not been disclosed or explained.
2.5 In view of the aforesaid deficiencies or discrepancies, it is concluded that the segmental accounts have been drawn with the sole purpose of justifying the price of international transactions undertaken with the AEs. Although the assessee has shown overall loss, the segmental accounts prepared have been manipulated to camouflage the loss at entity level, but reporting profits at the segmental level. In view of these conclusions, the arm’s length price is determined at the entity level. For this purpose, TNMM has been used. In order to apply this method at entity level, two comparable cases have been cited, namely, Indo-Asia Leisure Services Ltd. and Shree Raj Travels & Tours Ltd. Their results have been tabulated as under:
OP/TC OP/Sales
1. Indo Asia Leisure Services Ltd. 6.84% 6.40%
2. Shree Raj Travels & Tours Ltd. 23.97% 19.33%
Mean(OP/TC) 15.40% 12.86%
2.6 Accordingly, the mean of the PLI at 12.86% has been applied to the controlled international transactions. The methodology of computing PLI in the case of the assessee has been aligned with the results of the aforesaid comparable cases and the corresponding revenue in case of the assessee from controlled international transactions has been computed at Rs. 8,24,96,107/-. The corresponding cost has been worked at Rs. 7,30,95,666/-. The assessee booked international transactions of Rs. 9,38,03,233/-. Thus, the difference has been worked out at Rs. 2,07,07,267/-, which constituted 22.07% of the international transactions. Adjustment of Rs. 2,07,07,267/-has been worked out as under:
S.No. International transaction Book
value Difference loaded Arm’s
length
price Difference
(%)
1. Purchase of tours 93803822 18709273 75094549 19.95%
2. Sale of tours 10017466 1997994 12015460 19.95%
Total 103821288 20707267
3. The assessee has challenged the aforesaid adjustment on various grounds mentioned in various paragraphs of ground no. 2, which read as under:
2. “That the Assessing Officer/TPO erred on facts and in law in making adjustment of Rs. 2,07,07,267 to the income of the appellant on account of alleged difference in the arm’s length price of the international transactions undertaken during the relevant previous year.
2.1 That the assessing officer/TPO erred on facts and in law in disregarding the internal benchmarking undertaken by the appellant for determining the arm’s length price of the international transactions applying Resale Price method (“RPM”) in respect of international transaction of outbound travel related services and Cost Plus Method “CPM”) in respect of international transaction of inbound travel related services.
2.2 That the assessing officer/TPO erred on facts and in law in disregarding RPM and CPM as the most appropriate method and arbitrarily applying TNMM by comparing the net operating profit margin of the appellant with net operating profit margin of comparable uncontrolled companies.
2.3 That the assessing officer/TPO erred on facts and in law in not appreciating that with respect to the international transactions of inbound and outbound travel related services, the appellant was only acting as an intermediary/reseller and benchmarking analysis is to be undertaken applying RPM/CPM considering gross profit margin from such international transactions.
2.4 That the assessing officer/TPO erred on facts and in law in holding that the appellant has artificially bifurcated its account in two segments, inbound and outbound, without appreciating that the functions performed by the appellant in both the segments were entirely difference.
2.5 That the assessing officer/TPO erred on facts and in law in disregarding the segmental analysis of profitability of inbound travel related services in the Transfer Pricing documentation, holding as under:
a. The assessee has not maintained separate audited financials for these segments;
b. The segmental information has been credited to arbitrarily to allocate the costs and thereby reduce losses;
c. Since as per tax auditor report, the assessee has not maintained segmental account for two different alleged lines of business (as claimed in transfer pricing report), the allocation of expenditure between these two segments. Without any explained or disclosed allocation key cannot be relied upon to determine correct segmental results.
d. The FAR profile of the segments is identical and hence both the segments are similar.
2.6 That the assessing officer/TPO erred on facts and in law in considering the following companies as comparable companies without appreciating that the same are not functionally similar to the appellant and hence not comparable:
OP/TC% OP/Sales%
(i) Indo Asia Leisure Services Ltd. 6.84% 6.40%
(ii) Shree Raj Travels & Tours Ltd. 23.97% 19.33%
Mean 15.40% 12.86%
2.7 That the assessing officer/TPO erred on facts and in law in considering the said companies as comparable companies without appreciating that they follow B2C (i.e., business to customer) business model as compared to the appellant which is into B2B (i.e., business to business) business model.
2.8 That the assessing officer/TPO erred on facts and in law in holding Shree Raj Travels & Tours Ltd. as a comparable and not appreciating that the net income (after reducing cost of purchase) has been recorded as income in the profit and loss account, instead of reflecting sales/revenue from the tours and the cost of sales separately in the profit and loss account while the appellant on the other hand had accounted sales revenue from tours/travels in the credit side of profit and loss account and corresponding cost of sales are shown as the expenditure in the profit and loss account.
2.9 That the assessing officer/TPO erred on facts and in law in not appreciating that because of the above difference in the method of accounting and sales revenue, the operating profit margin computed by the assessing Officer of Shree Raj Travels & Tours Ltd. was not comparable with that of the appellant.
2.10 That the assessing officer/TPO erred on facts and in law in holding Indo Asia Leisure Services Ltd. as a comparable and not appreciating that the company is earning revenue from sale of products which is dissimilar to the services rendered by the appellant.
2.11 That the assessing officer/TPO erred on facts and in law in holding the abovementioned companies as comparables without appreciating that the companies have been in existence for a long time as against the appellant which is a start up enterprise.
2.12 Without prejudice that the TPO erred in law in not allowing variation to the extent of (+/-) 5%, while determining the arm’s length price of the ‘international transactions’.”
The grounds inter-alia include the arguments in support of the main ground that the AO was not justified in making the aforesaid adjustment of Rs. 2,07,07,267/-to the loss declared by the assessee. These grounds are disposed off on the basis of submissions made by the ld. counsel for the assessee and the ld. CIT, DR before us.
4. The ld. counsel furnished the brief background about the functioning of the assessee-company. It is submitted that it is a wholly owned subsidiary company of Destination of the World Holding Establishment, Liechtenstein, and it is engaged in the business of providing in-bound, out-bound and domestic travel services. The business is based on business to business (“B2B” for short) platform as against business to customers (“B2C”) platform utilized by other travel agents. In the inbound services, a customer coming to India from a foreign destination makes booking through the travel agent for hotel reservation and other services. The agent makes the booking at the DOTW’s office on the basis of the rate reflected in the website. The DOTW office in turn buys services from the Indian offices of DOTW as reflected in its website. DOTW India in turn buys these services in bulk from hotels and other suppliers. Coming to out-bound services, it is submitted that a customer traveling from India to overseas destination approaches a travel agent for booking the hotel, site seeing, transfers etc. The travel agent buys these services from DOTW India. DOWT India in turn buys these services from the foreign office of DOTW at the rates reflected in the website. The foreign office in turn purchases bulk reservations and services from the hotels or suppliers, as the case may be. In respect of domestic travel services, it is submitted that the same are rendered through online reservation systems to individuals and groups.
4.1 The in-bound and out-bound travel related services have been undertaken with the AEs and non-AEs. The aggregate value of outbound travel services has been recorded at Rs.9,38,03,233/-in the books of account, and in-bound travel services have been recorded at Rs. 1,00,17,466/-. Apart from that, there are other international transactions, which have not been disturbed in respect of their valuation by the TPO. The assessee has applied re-sale price method in respect of out-bound travel services and cost plus method in respect of in-bound travel services. These are the most appropriate methods under Rule 10B. The reason is that the assessee does not add any value in respect of out-bound services. However, in respect of in-bound services cost plus method has been employed in the transfer pricing study report.
4.2 Segmental accounts have been drawn in respect of both kinds of services. The position in respect of out-bound services is as under:
Particulars Segment A (AE) Segment B
(Non-AE)
Net sales (Net of taxes) 106,725,795 42,354,272
Cost of sales (tours purchased) 95,109,233 37,341,416
Gross Margin 11,618,562 5,012,856
Gross margin as a % of sales 10.89% 11.84%
The position in respect of in-bound services is as under:
Particulars Segment A Segment B
Net Sales (Net of taxes) 9,624,775 41,468,947
Cost of sales (tours purchased) 9,023,920 38,069,266
Gross Margin 600,856 3,399,682
Gross margin as a% of cost 6.66% 8.93%
4.3 The TPO rejected the internal comparison by mentioning that:
(a) the assessee had not maintained separate audited accounts for the two segments;
(b) the segmental information has been created arbitrarily with the purpose of hiding the loss at entity level;
(c) the TP report submitted by the assessee contains FAR analysis which does not distinguish between in-bound and out-bound segments and, therefore, the services rendered in the two segments stand at par; and
(d) the transactions with associated enterprises and other enterprises are so closely inter-linked that they cannot be evaluated separately.
4.4 In view of the aforesaid the AO rejected the report and applied TNMM by choosing two comparables, namely, -(i) Indo Asia Leisure Services Ltd., and (ii) Shree Raj Travels & Tours Ltd. Accordingly, adjustment of Rs. 2,07,07,267/-has been suggested.
4.5 Coming to the functioning of the assessee and maintenance of accounts, it is submitted that there is no obligation cast on it for maintaining segmental information in the audited accounts. In this connection, reliance has been placed on the decision in the case of Birlasoft (India) Ltd. Vs. DCIT in ITA No. 3839(Del)/2010, a copy of which has been placed before us. It is further submitted that a customized ERP system has been installed in various offices of DOTW all over the world which records and allocates the cost. Thus, there is no scope of any manual intervention, which means that no manipulation could have been done. It is also submitted that even under TNMM, internal uncontrolled comparable transactions are to be preferred over external comparables as mentioned in paragraph no. 3.26 of the OECD guidelines and as held in the case of UCB India Pvt. Ltd. Vs. ACIT, (2009) 30 SOT 95. Therefore, it is argued that the findings of the TPO regarding manipulation of segmental accounts for hiding entity level loss are misplaced and he ought to have utilized internal comparables rather than external comparables. The assessee has rightly applied re-sale method for outbound services as no value addition is made. Similarly, cost plus method was rightly applied in respect of in-bound services. It is also submitted that on the basis of annual accounts of the comparables selected by the TPO, the PLI of the assessee and the comparables are as under:
Particulars DOTW Indo Asia Shree Raj Travels
Sales Value 2,025.78 4,720.93 1,510.07
Operating Income 18.12 38.91 -
Total Operating income 2,043.90 4,759.83 1,510.07
Other income - 4.35 4.23
Total income 2,043.90 4,764.18 1,514.30
Employee cost 285.33 214.20 252.67
Operating expenses 2,019.25 4,188.15 1,060.52
Preliminary expenses written off 13.25
Depreciation 27.41 91.75 39.76
Non-operating expenses - - 11.00
Total expenses 2,345.24 4,494.10 1,363.95
Profit before tax (301.35) 270.09 150.35
Operating profit (301.35) 265.74 157.12
Operating profit % to total sales -14.88% 5.63% 10.41%
4.6 Before concluding the submissions of the ld. counsel, we may reproduce paragraph no. 3.26 of the OECD guidelines, which read as under:
“3.26 The transactional net margin method examines the net profit margin relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realizes from a controlled transaction or transactions that are appropriate to aggregate under the principles of Chapter I). Thus, a transactional net margin method operates in a manner similar to the cost plus and resale price methods. This similarity means that in order to be applied reliably, the transactional net margin method must be applied in a manner consistent with the manner in which the resale price or cost plus method is applied. This means in particulars that the net margin of the taxpayer from the controlled transaction (or transactions that are appropriate to aggregate under the principles of Chapter I) should ideally be established by reference to the net margin that the same tax payer earns in comparable uncontrolled transactions. Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise may serve as a guide. A functional analysis of the associated enterprise and, in the latter case, the independent enterprise is required to determine whether the transactions are comparable and what adjustments may be necessary to obtain reliable results”. (emphasis supplied)
5. In reply, the ld. DR referred to the reasons recorded by the AO/TPO for rejecting transfer pricing report submitted by the assessee and justification provided for applying TNMM. It is submitted that the lower authorities have not analyzed the data for working out the PLI of uncontrolled transactions by applying TNMM. Therefore, the computation provided by the assessee regarding gross margin in respect of combined in-bound and out-bound transactions now require scrutiny. The computation is as under:
Inbound services (CPM) Outbound Services (RPM) Consolidated
AE Non-AE Total AE Non-AE Total AE Non-AE
Net sales (tours purchased 9624775 41468947 51093722 106727795 42354272 149082067 116352570 83823219
Cost of sales (tours purchased) 9023920 38069266 47093186 95109233 37341416 132450649 104133153 75410682
Gross margin 600855 3399681 4000536 11618562 5012856 16631418 12219417 8412537
Gross margin (% sales) 6.24% 8.20% 7.83% 10.89% 11.84% 11.16% 10.50% 10.04%
Gross margin (% cost) 6.66% 8.93% 8.49% 12.22% 13.42% 12.56% 11.73% 11.16%
6. We have considered the facts of the case and submissions made before us. On the basis of the same, the first question which requires decision according to us is-whether, the AO was justified in taking recourse to external comparables when internal comparables were available?
6.1 Briefly, the facts are that the assessee is carrying on the business of providing services for in-bound, out-bound and local travels. The dispute is in regard to in-bound and out-bound travel services. The assessee maintains consolidated accounts. Segmental accounts have not been maintained separately in respect of various kinds of services. However, in respect of both in-bound and out-bound services segmental accounts have been culled out. Thereafter, in respect of each segment, controlled and uncontrolled transactions have been segregated. In so far as in-bound travels are concerned, the assessee had utilized cost plus method to justify the arm’s length value of controlled transactions, comparing them with the value of uncontrolled transactions undertaken by it. However, in respect of out-bound travel services, Resale method has been employed on the ground that no value addition is made in respect of these services. The objection of the AO is that while the assessee has incurred loss, the expenses in respect of in-bound and out-bound travel services have been so arranged as to show that the PLIs are comparable with uncontrolled transactions. In other words, the accounts cannot be segregated as separate books of account have not been maintained. On the other hand, the case of the ld. Counsel is that internal comparables are preferable to external comparables because of difference in business environment. The assessee has utilized a system for maintenance of accounts which is not amenable to manual manipulation and, therefore, the charge of manipulating the accounts is not justified. Having considered these matters, we find that OECD guidelines, reproduced in paragraph no. 4.6 (supra), mention that net margin of the tax payer from the controlled transactions should be established with reference to net margin which the same taxpayer earns in comparable uncontrolled transactions. Where this is not possible, the net margin that would have been earned in comparable transactions by an independent enterprise may serve as a guide. Thus, these guidelines suggest preference for internal comparables and reference has to be made to the results of independent enterprises only when former course of action is not possible. The ld. counsel has also relied on the decision of UCB India Pvt. Ltd. (supra), a copy of which has been placed before us. In this case, the assessee wanted to support the value of controlled transactions by comparing with external comparables. However, it appears that the same could have been compared by having recourse to internal comparables of the parent company, for which the data was not furnished on the ground that the two companies are separate entities. The Tribunal did not find favour with this line of argument, which indirectly leads to a conclusion that internal comparables should be preferred to external comparables. Further, in the case of Birlasoft (India) Ltd. (supra), it has been clearly held that the assessee was justified in undertaking internal comparison on stand alone basis by placing on record working of operative profit margin from international transactions with AEs and transactions with uncontrolled parties undertaken in similar functional and economic scenario. Such internal comparison is valid in all the methods. Therefore, it is held that in the first instance, the attempt should be made to determine arm’s length price of controlled transactions by comparing the same with internal uncontrolled transactions undertaken in same or similar economic scenario. No argument has been made by the ld. DR that economic scenarios of controlled and uncontrolled transactions were different. Therefore, it is held that the transfer pricing analysis should have been done by taking recourse to internal uncontrolled transactions.
6.2 The second question is-whether, the method employed by the assessee should have been accepted by the AO? The case of the ld. DR is that segmental accounts have not been maintained and the TPO has given a clear finding that segmental accounts have been drawn in such a manner as to hide the entity level loss. We find that no particular fact has been mentioned in this regard except that there is a loss incurred by the assessee in the overall transactions. The other arguments of the ld. DR is that separate segmental accounts have not been maintained, which leaves a scope for justifying the transactions on cost plus and re-sale method. Such a situation will not arise if TNMM is used, which means that the profitability of controlled and uncontrolled transactions have to be examined in respect of both the segments. The case of the ld. counsel in this connection is that even under this method, the value of controlled transactions placed by the assessee in the books stands justified. We have tabulated the results in respect of both the segments in paragraph no. 5 (supra) of this order. Having considered these facts and submissions, we are of the view that the assessee has not been able to show, on the basis of FAR analysis, that there are material difference in in-bound and outbound services. However, the profitability in the two segments may be different due to geographical area of the service. Therefore, we are of the view that it will be more appropriate on the facts of this case to compute arm’s length price in respect of two segments separately on TNMM. The figures furnished in the table in paragraph no. 5 have not been vetted by the AO or the ld. CIT(Appeals). In view thereof, the matter is restored to the file of the AO to examine the figures supplied by the assessee and thereafter arrive at the arm’s length price after hearing the assessee.
7. In the result, the appeal is treated as allowed for statistical purposes.
The order was pronounced in the open court on 8 July, 2011.
