DCIT v. DHL Logistics (P) Ltd. [ITA No.
1923/Mum/2016, CO No. 159/Mum/2016, IT(TP) A No. 1385/Mum/2016, dt. 10-8-2020]
: 2020 TaxPub(DT) 3123 (Mum-Trib)
Transfer pricing addition in freight forwarding business
applying Berry ratio
Facts:
Assessee in the international freight forwarding business
had adopted the Berry ratio as its Transfer pricing benchmarking by selecting
certain comparable entities adopting TNMM Method. Assessee's method of
benchmarking for Berry ratio was Operating Profit (OP) (Gross profit)/Value
Added Expenses (OP/VAE). While adopting the Berry ratio OP/VAE assessee removed
the items which were primarily pass thru costs and incomes in the process which
comprised overseas freight charged by AE on its inbound collect shipments
besides various third party pass thru costs like Terminal handling charges,
Delivery order charges, Container freight station charges, Detention charges,
Demurrage, Customs duties etc. and thus claimed that on their own core billing
their margin was better than that of the peer comparable entities under TNMM.
This did not find eye with the TPO who adopted the OP/TC - Operating
profit/Total cost as the correct benchmarking and thus sustained addition of
Rs. 115 crores on its freight forwarding business. The plea of the TPO was that
by collecting freight there was certainly a margin in the freight which gets
eliminated in the consideration of the pass thru concept thus the profit earned
by the assessee is insufficient comparable to its peer groups or in other terms
the margin on the freight subsidizes the rest of the billed items on the
invoice thereby assessee Indian entity, losing in the process that much
revenue. DRP upheld the views of the TPO. On higher appeal --
Held in favour of the assessee that the OP/VAE adopted by
the assessee was the correct benchmarking based on the assessee's own case of
the earlier years.
Editorial Note: the
complexity of freight forwarding business its profit benchmarking in the domain
of Transfer pricing has never been understood by the revenue especially the
business models and the type of dynamics which are available in it which make
it a unique industry. There is no consensus on the fact as to what is
"revenue" in the first place in freight forwarding even in GAAP. Will
it include the pass thru costs or is the freight forwarder only a mere agent as
DHL has canvassed in its case here or a limited risk marketeer like a Sogha
Sosha company i.e. Mitsubishi/Li Fung case where a limited risk distributor was
held only akin to a commission agent thus margin is only the commission or the
value addition only on the price differential. There are divergent decisions in
this domain. In the case of Agility logistics benchmarking of 50/50 profit
sharing of Agility logistics with its AE's was held to be at ALP. On the
contrary there are complicated aspects of FAR -- Functional, Risk Analysis
which are warranted to be examined for freight forwarding business. Would the
Profit Split method (PS) be the apt choice in freight forwarding business
especially if the AE and the Indian assessee are profit/business joint risk
sharers. If PS method, then adopting what as the base like the case of the
assessee DHL like Operating profit or OP/VAE or OP/TC as TPO which one is apt
assumes the key question.
Berry Ratio: Is the ratio of
Gross Profit/Operating Expenses (GP/OE) named after an American Economist
Professor Charles Berry who first applied it in the TP case of E I Du Pont
Nemours & Co. v. US 608 F.2d 445 (Ct. Cl.1979). The Du Pont case involved a
case of a distributor which also performed related marketing services. Thus
comparing GP/OE of Du Pont with third party comparable manifested that Du Pont
made better gross profit compared to its costs vis-a-vis its competitors who
were also similar distributors. For more on this below URL may be referred to
--
https://www.pwc.com/jp/en/taxnews-transfer-pricing/assets/tp-news-2014-04-e.pdf