UNILEVER INDIA EXPORTS LTD.,MUMBAI vs. DY CIT RANGE 1(3)(2), MUMBAI

Now coming to the transfer pricing adjustment on export of finished goods in A.Y.2015-16, the assessee has challenged adjustment of Rs.154,36,00,000/-, whereby the ld. TPO had adopted internal TNMM, i.e., comparing the transactions with the non-AE segments. The brief facts of the issue involved are that the assessee is a wholly owned subsidiary of Hindustan Unilever Limited which is engaged in the business of fast selling consumer goods. The assessee company acts as contract manufacturer for its group companies, i.e., AE and also manufacture and sale of goods to unrelated parties on an entrepreneurial basis for its non-AE segment. As per the inter company supply agreement, the assessee was paid margin of 9.16% on its cost undertaking manufacturing activity. For the purpose of agreement, the assessee used budgeted cost and not actual cost. In the TP study report, the assessee benchmarked the said transaction using TNMM and taking entity level margin for comparability analysis with the third party comparables. The assessee’s margin and the margins of the comparable companies in both the years were as under:- Particulars AY 15-16 AY 16-17 Appellant's AE 10.83% 14.74% segment margin Median of 5.10% 5.60% comparable companies 1465/Mum/2021 M/s. Unilever India Exports Ltd. Range of 2.30% to 6.02% 2.07% to 8.10% comparable companies

The ld. TPO revisited the assessee’s account especially the segmental accounts and recasted the accounts assuming that AE’s segment margin cannot be more than 9.16%. The ld. TPO prepared the profit attributable to sales to AE and non-AE in the following manner for the A.Y.2015-16:

The basic premise of the ld. TPO was that, assessee had almost similar nature of business while transacting with AE and non-AE given the fact that all the products sold to AE and non- AE are branded products of “Unilever group”. Finally, he adopted internal TNMM as the Most Appropriate Method based on which addition of Rs.279.51 Crores was computed for the A.Y. 2015-16; and addition of Rs.198.40 Crores was computed in A.Y.2016-17. However, in A.Y.2015-16 rectification application was filed by the assessee pointing out certain mistakes, the ld. TPO passed rectification order on 23/05/2019 reducing the addition / adjustment to Rs.154.36 Crores.

The ld. DRP after taking note of all the objections finally held that similar adjustment on similar reasoning has been upheld by the ld. DRP in A.Y.2013-14 and therefore, following the earlier year order, the ld. DRP confirmed the adjustments. Further, the ld. DRP also gave certain findings for the year under consideration, in support of the methodology adopted by the ld. TPO and the observation against the comparable companies chosen by the assessee for external TNMM benchmarking analysis.

Before us, the ld. Counsel for the assessee submitted that the Tribunal in the earlier years has accepted that external TNMM should be applied. For the sake of ready reference, para 17 of the order of the Tribunal reads as under:- “17. Having held so, the next issue, which arises for consideration is, whether the internal TNMM, as applied by learned DRP to determine the arm’s length price of the export of HPC and beverages to the AEs, is the most appropriate method? As discussed earlier, the assessee had benchmarked the aforesaid transaction with the AEs by applying external TNMM. Learned DRP has rejected the benchmarking of the assessee on the reasoning that similar transactions were entered into with both the AEs and non–AEs, hence, the transaction with non–AEs can be considered for comparability analysis with the AE transaction to determine the margin. As could be seen, while objecting to applicability of internal TNMM, the assessee has made elaborate submissions before learned DRP stating various factors which make benchmarking of the transaction under internal TNMM impossible. On a perusal of learned DRP’s directions, it appears, learned DRP has not at all considered the objections of the assessee in an objective manner. In fact, the segmental results of AE and non–AE segments furnished by the assessee have been rejected by learned DRP on the flimsy ground that the auditor’s certificate showing such segmental results is not acceptable since he had not initially audited the books of account of the assessee. What was required to be examined by learned DRP is the correctness of assessee’s claim and not who has audited the books of account of the assessee. Further, learned DRP has not provided any valid reason why the benchmarking done by the assessee under external TNMM is not acceptable. Merely because the assessee had entered into transactions both with the AEs and non–AEs, it does not render applicability of external TNMM redundant. More so, when learned DRP has recorded a factual finding that the products 1465/Mum/2021 M/s. Unilever India Exports Ltd. sold to AEs and non–AEs are different except in case of only five items. It is relevant to observe, in course of hearing of the present appeal, the learned Sr. Counsel for the assessee has brought to our notice various factors which can make a significant difference between the transactions with AEs and non–AEs and would have impact on profitability. As could be seen, insofar as the AE segment is concerned, the assessee acts as a contract manufacturer, accordingly, bears limited risk as the major risk is taken by the AEs. The marketing and distribution are performed by the AE who source the products. Whereas, in case of non–AE segment, the entire risk and reward is with the assessee, as, it not only has to explore the market but has to promote its products. It has to appoint distributors and incur various other expenditures including advertisement, sales promotion, etc. Similarly, for A.E. segment, any new capacity is required to support supplies, the AE underwrites the capital spends. Further, any cost incurred by the assessee with regard to plant and machinery, moulds, etc., will be amortized over the period of three years. Whereas, in case of non–AE segment, the assessee has to add new capacity in anticipation of growing demand and any risk relating to unutilized capacity is borne by the assessee and cannot be recovered from customer in any eventuality. Further, while in case of AE business, the assessee manufactures the products in accordance with the requirement of the AEs. However, in case of non–AEs, business innovations have to be on the basis of assessee’s own requirement and looking at market condition/competition, etc. The product offering and specification shall be determined by the assessee and it will not be under any obligation to continue the supply of all or any of the products. Further, in case of AE business, the AEs provide the full year volume estimation for capacity and in case of huge increase in requirement compared to projections, the assessee can refuse to support the additional demand. Whereas, in case of non–AE business the assessee has to make long term planning including capacity, though, along with the customer but it is not binding on the customer. It 1465/Mum/2021 M/s. Unilever India Exports Ltd. is noticed, to demonstrate that the transactions between the AEs and non–AEs are not comparable the assessee had furnished various documentary evidences before learned DRP. Moreover, various documentary evidences to support the external TNMM applied to benchmark the transactions were furnished not only before the Transfer Pricing Officer but also before learned DRP. In case of Wrigley India Pvt. Ltd. v/s ACIT, in ITA no.5648/Del./2012, etc., dated 31st December 2014, the Tribunal has held that as long as business model of sales to AE and sales to non–AEs are different, the transactions under these business models cannot be comparable transactions for the purpose of Transfer Pricing. While in the transactions with the AEs creation of market and the end users is not the responsibility of the assessee but in the transaction with non– AEs, it is the responsibility of the assessee to create and maintain the market and end users. Thus, it affects the FAR profile materially which ultimately would have an impact on the profitability. It is quite noticeable, various submissions made by the assessee regarding non–applicability of internal TNMM have been disregarded/ignored by learned DRP without proper examination. Similarly, learned DRP has not provided any valid reasoning why external TNMM is not applicable. It is relevant to observe, in case of Piaggio Vehicles Pvt. Ltd. v/s DCIT, [2012] 26 taxmann.com 60 (Pun.), the Tribunal, Pune Bench, has also expressed the view that unless the business models of the AE and non–AE are completely similar, they cannot be treated as comparable. Viewed in the aforesaid perspective, the decision of learned DRP in determining the arm’s length price of the export of HPC and beverages to the AEs by applying internal TNMM cannot be supported. Therefore, the adjustment proposed by learned DRP deserves to be deleted.”

Thus, following the order of the Tribunal for A.Y.2013-14, the ld. TPO’s and ld. DRP’s action for choosing internal TNMM is rejected and assessee’s use of external TNMM is accepted for the 1465/Mum/2021 M/s. Unilever India Exports Ltd. reasons given in the Tribunal order which are also applicable in the present years as similar reasons were given by the ld. TPO and Ld. DRP in the earlier years. 9.1. However, the ld. Counsel submitted that this matter should not be restored back to the ld. TPO for consideration of the comparable companies shortlisted in the transfer pricing study report. She pointed out that during the TP assessment proceedings, the ld. TPO had sought updated margin of the external comparable companies chosen by the assessee in the TP study report and also during the course of TP assessment proceedings the ld. TPO also suggested certain companies to be included in the set of comparable companies for which assessee had filed detailed reasons for not accepting comparables. She also pointed out that detailed submissions were made before the ld. TPO justifying the comparable companies chosen by the assessee and why it should not be included and why the companies proposed by the ld. TPO should not be included. The ld. TPO has also not given any adverse comments against 11 comparable companies selected by the assessee; therefore, the ld. TPO has accepted the comparable companies. 9.2. In so far as A.Y.2016-17 is concerned, again during the course of TP assessment proceedings, as required by the ld. TPO updated margins of the external comparables chosen by the assessee were filed and ld. TPO has considered these companies selected by the assessee however, has not provided any adverse comments. She further submitted that findings of the ld. DRP of 1465/Mum/2021 M/s. Unilever India Exports Ltd. external comparables are also not correct in view of the following reasons:-  The DRP observed that in the business description of comparable companies, most of the comparable companies are not 'contract manufacturer of home and hygiene care products. (AY 15-16 PB Pg. 1225) (AY 16-17 DRP Order Pg. 62) However, the DRP failed to appreciate that search conducted by the Appellant had applied appropriate filters like rejecting companies having AMP expenses and R&D expenses (over 3%) (AY 15-16 PB Pg. 142) (AY 16-17 PB Pg. 200), which resulted in a selecting limited risk manufacturers that are akin to the contract manufacturing activity of the Appellant.  The DRP also observed that an export filter of 75% ought to be adopted and once applied none of the comparable companies pass it. (AY 15-16 PB Pg. 1226) (AY 16-17 DRP Order Pg. 62, 63) The Appellant most respectfully submits that export filter is not appropriate In this case, Firstly, there aren't adequate number of companies that survive after application of this filter. Quantitative filters are used to narrow down the search from the entire universe of companies to relevant companies which ought to be scrutinized thoroughly. In case application of a quantitative filter does not result in any company, then it renders the entire benchmarking exercise redundant. Secondly, export filter would not be relevant as we are comparing the function of manufacturing in India carried out by the Appellant vis-à-vis other Indian FMCG contract manufacturing companies.

From the perusal of the impugned orders, we find that though assessee had filed detailed benchmarking analysis of the comparable companies as given in the TP Study Report (TPSR) and certain submissions were also made with regard to exclusions of comparables suggested by TPO. However, the ld. TPO has not analysed those comparables on the ground that he has gone with internal TNMM for making the adjustment and there is no analysis or reasoning for accepting or rejecting external comparables selected by the assessee. Therefore, we agree with the contention of the ld. DR that this issue should be restored back to the ld. TPO to analyse the comparable companies selected by the assessee and decide this issue afresh in accordance with the provisions of law after giving an opportunity of hearing to the assessee to substantiate and justify the comparability analysis of the third party comparables. Accordingly, the ground No.2 – 2.7 are treated as partly allowed for statistical purposes.

Now coming to the TP adjustment on account of payment related to central fee for services. The brief facts are that the assessee company has made payment to its AE viz. Unilever PLC towards central service charge in the following categories:-  Corporate services  Category and category related services  Global Markets Leadership and Global Business  Product related services 12.1. Unilever PLC has granted a non-exclusive license to Unilever India Exports Ltd. i.e. assessee; firstly for using technical documentation, information, technical knowhow and improvements; and secondly, for central services vide common- technology, trade mark license and simple service agreement, effective from 01/02/2013. The copy of agreements has been filed before us in the paper book. In so far as payment made by the assessee to Unilever PLC for using technical documentation, information, technical knowhow and improvements, the ld. DRP deleted the adjustment made by the ld. TPO in both the assessment years. Accordingly, this is not the issue in dispute. However, the only issue is with regard to central services flowing from the aforesaid agreement. Admittedly, the same agreement was in operation for both the assessment years and therefore, the nature of services rendered in terms of the agreement was also same. The assessee has paid Rs.4.58 Crores based on 0.5% of the estimated turnover in A.Y.2015-16 and Rs.7.32 Crores based on 0.75% estimated turn over in A.Y.2016-17.

The assessee before the ld. TPO submitted that central service payment were considered at the time of application of markup on cost of 9.16% and accordingly, the Central services fee was effectively borne by the AEs which constituted over 70% of the total sale and not the assessee. The ld. TPO held that Assessee Company has not satisfied the exact nature of the services which are categorized under the Central services. He further observed that there is a vague description of the services without any details being available and further, assessee did not submit any evidence in relation to the actual receipt of services. The relevant observations of the TPO in this regard read as under:-

During the course of hearing in response to our querry, the ld. Counsel drew our attention to the various documents filed in the paper book to examine the redemption of central services by giving over PLC to the assessee and commensurate benefits desired from such services. These were highlighted in the following manner vis-à-vis the documents given in the paper book.

It has been further submitted that the Tribunal in assessee’s own case for A.Y.2012-13 and 2013-14 have decided this issue 1465/Mum/2021 M/s. Unilever India Exports Ltd. in favour of the assessee. The relevant observation of the Tribunal reads as under:- “30. We have considered rival submissions and perused the material on record. Undisputedly, the assessee has benchmarked the payment of royalty under central service agreement by applying CUP method. Whereas, the Transfer Pricing Officer has determined the arm's length price of the royalty payment at nil on purely conjecture and surmises without following any prescribed method. In fact, the observations of the Transfer Pricing Officer on the issue are very cryptic and non–speaking. Therefore, simply for the reason that the determination of arm's length price by the Transfer Pricing Officer is not in accordance with the statutory provisions, the adjustment made deserves to be deleted. In any case of the matter, it is noticed by us that under the very same agreement, the AE is paid royalty by Hindustan Unilever Ltd. for domestic sales and by the assessee in respect of export sales. While examining the royalty payment in case of Hindustan Unilever Ltd. in assessment year 2013–14, the Transfer Pricing Officer has accepted royalty paid to the AE to be at arm's length. Similarly, in the order passed under section 92CA(3) of the Act in respect of AE, the Transfer Pricing Officer has accepted the royalty payment to be at arm's length. That being the case, the arm's length price of royalty payment at the hands of the assessee cannot be determined at nil. In any case of the matter, it is not disputed that the assessee is remunerated by the AE on cost plus mark–up basis. That being the case, royalty paid to the AE forms part of the cost base of the assessee on which it has charged mark–up @ 9%. In the aforesaid circumstances, if the payment of royalty to the AE is disallowed by determining the arm's length price at nil, then logically the income of the assessee also should be reduced. This is the view expressed by the Co–ordinate Bench in Mercer Consulting Pvt. Ltd. (supra). Thus, considering the overall facts and circumstances of the case and keeping in view the ratio laid down in the decisions 1465/Mum/2021 M/s. Unilever India Exports Ltd. cited before us, we are of the view that the adjustment made by determining the arm's length price of royalty payment at nil deserves to be deleted. Accordingly, we do so. Grounds are allowed.”

Thus, in sum and substance, the observation of the Tribunal is summarized as under:-  The Assessee had benchmarked this transaction using CUP method, whereas the TPO has determined the ALP as Nil on purely conjectures and surmises without following any prescribed method  Under the very same agreement, Hindustan Unilever Ltd. pays royalty on domestic sales and the Assessee pays for export sales. In HUL's case for AY 2013-14, the TPO had accepted the payment to be at ALP.  Even in the case of Unilever Plc, the TPO had accepted the transaction to be at ALP for AY 2013-14  The Assessee is remunerated by the AE on cost-plus and the royalty paid to the AE forms part of the cost base of the Assessee on which it has charged mark-up. In such a case, disallowance of royalty would reduce the income of the Assessee, which is not given the overall facts and circumstances, the Tribunal deleted the adjustment.

After considering the facts and material on record and the relevant finding given in the impugned order as well as the order of the Tribunal in earlier years, we find that before the authorities below, the assessee has given all the detailed 1465/Mum/2021 M/s. Unilever India Exports Ltd. submission and analysis not only demonstrating the rendition of central services but also commensurate benefits derived from such services to the assessee. This is evident from the details discussed above has called upon by us during the course of hearing. Accordingly, it cannot be held that either there was no rendition or no benefit as observed by the ld. TPO. Apart from that the CUP analysis done by the assessee by taking four comparables in both the assessment years in providing advisories, management advisory, strategic planning, business administration services, marketing plan, protocols, procedures, etc., wherein mean margin determined was 2.75% in A.Y.2015- 16 and 5.75% in A.Y.2016-17; whereas the assessee has made payment at 0.50% in A.Y.2015-16 and 0.75% in 2016-17. Thus, the payment made by the assessee for Central services are at ALP and the adjustments made by the ld. TPO is deleted.

Now coming to the issue of disallowance u/s.14A r.w.r. 8D. Brief facts are that the ld. AO noted that assessee has made substantial investment which had yielded exempt income. In A.Y.2015-16, we observe that assessee made investment of Rs.48,79,28,239/- in equities and mutual funds as on 31/03/2015 and Rs.28,89,610/-as on 31/03/2014. Similarly, in A.Y.2016-17, it is noted that assessee has made investment of Rs.99,98,84,364/- in equities and mutual funds. In A.Y.2015-16 assessee has made suo-moto disallowance of Rs.1,77,479/-, based on its working of the expenses attributable towards earning of exempt income. Similarly, in A.Y.2016-17 assessee 1465/Mum/2021 M/s. Unilever India Exports Ltd. has made suomoto disallowance of Rs.69,621/-. Both ld. AO and ld. DRP has rejected assessee’s working and after following Rule 8D(2)(iii), have computed the proportionate interest (Rs.7,886/-) plus 0.5% of the average investments (Rs.12,27,045), minus the sum already disallowed by the assessee (Rs.1,77,479/-). The disallowance worked out to Rs.10,57,452/-.

In A.Y.2016-17, the ld. AO rejected the assessee’s working and followed Rule 8D (ii) & (iii). As per this, the ld. AO computed the addition u/s.14A on proportionate interest (Rs.87,278/-) plus 0.5% of the average investments (Rs.37,19,532), minus the sum already disallowed by the assessee (Rs.69,621/-). The disallowance worked out to Rs.37,36,888/-. The ld. DRP upheld the ld. AO’s action.

Before us the ld. Counsel for the assessee demonstrated that assessee had sufficient own funds as compared to the quantum of investment which are as under:- For AY 15-16  At the start of the year the Appellant's share capital was Rs. 2.97 Crores and the reserves and surplus were Rs. 350.34 Crores, thus total surplus funds of Rs. 353.31 Crores.  As compared to this the investment at the start of the year was only Rs. 0.29 Crores  At the end of the year the Appellant's share capital was Rs. 2.97 Crores and the reserves and surplus were Rs. 378.31 Crores, thus total surplus funds of Rs. 381.28 Crores.

With regard to the issue of disallowance u/s.37(1) of unrealized foreign exchange, in A.Y.2015-16, the assessee has incurred an unrealized foreign exchange loss of Rs.47,46,000/- and in A.Y.2016-17, the assessee has incurred an unrealized foreign exchange loss of Rs.36,94,325/-. The assessee claimed the above as deduction in terms of the Hon’ble Supreme Court judgment in the case of CIT vs. Woodward Governor India Pvt. Ltd (2009)179 Taxman 326 (SC).

Since, this issue is similar to the appeal decided by the Tribunal in the case of Unilever Industries Private Limited,.

Thus, following the aforesaid decision, the addition stands deleted.

Now coming to the issue of disallowance of Employee Share Option Scheme Expense, the assessee has submitted that it had debited its profit and loss account with an amount of Rs. 1.5 Crores in AY 15-16 and Rs. 1.3 Crores in AY 16-17 towards benefit provided to employees in respect of 'Employee Share Option Scheme (ESOP) administered by the holding company and ultimate holding company.

The assessee, in AY 15-16 vide submission dated 12/12/2018 and in AY 16-17 vide submission dated 06/12/2019 had explained in detail the various schemes and benefits being provided to the employees. The assessee claimed this amount to be allowable in terms of the Special Bench decision of this Tribunal in the case of Biocon Ltd. v. DCIT [2014] 144 ITD 21 (Bang. Trib.)

This issue again is covered by the decision of the Tribunal in the case of Unilever Industries Pvt. Ltd. supra where the Tribunal has followed the decision of the Hon’ble Karnataka High Court in the case of M/s. Biocon Ltd, the relevant observation of the Tribunal reads as under:- 10. The Ld. AR has made elaborate submissions on the ESOP scheme & expenditure and provisions of law on the allowability of claim. We found that the Honble High Court of Karnataka in the case of CIT(LTU) VS M/S Biocon Ltd in ITA.No.653 of 2013 dated 11-11- 2020 has observed as under: 9. In the instant case, the ESOPs vest in an employee over a period of four years i.e., at the rate of 25%, which means at the end of first year, the employee has a definite right to 25% of the shares and the assessee is bound to allow the vesting of 25% of the options. It is well settled in law that if a business liability has arisen in the accounting year, the same is permissible as deduction, even though, liability may have to quantify and discharged at a future date On exercise of option by an employee, the actual amount of benefit has to be determined is only a quantification of liability, which takes place at a future date. The tribunal has therefore, rightly placed reliance on decisions of the Supreme Court in Bharat Movers supra and Rotork Controls India P. Ltd., supra and has recorded a finding that discount on issue of ESOPS is not a contingent liability but is an ascertained liability.

From perusal of Section 37(1), which has been referred to supra, it is evident that an assessee is entitled to claim deduction under the aforesaid provision if the expenditure has been incurred. The expression 'expenditure' will also include a loss and therefore, Issuance of shares at a discount where the assessee absorbs the difference between the price at which it is Unilever Industries Pet Lad, Mumbai.

It is also pertinent to mention here that for Assessment Year 2009-10 onwards the Assessing Officer has permitted the deduction of ESOP expenses and in view of law laid down by Supreme Court in Radhasoami Satsang vs. CIT. (1992) 193 ITR 321 (SC), the revenue cannot be permitted to take a different stand with regard to the Assessment Year in question In view of preceding analysis, the substantial questions of law framed by a bench of this court are answered against the revenue and in favour of the assessee. In the result, we do not find any merit in this appeal, the same fails and is hereby dismissed.