M/S HERBALIFE INTERNATIONAL INDIA PRIVATE LIMITED,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX, CIRCLE-3(1)(1), BANGALORE

IN THE INCOME TAX APPELLATE TRIBUNAL ‘A’ BENCH : BANGALORE BEFORE SHRI CHANDRA POOJARI, ACCOUNTANT MEMBER AND SMT. BEENA PILLAI, JUDICIAL MEMBER IT(TP)A No. 905/Bang/2022 Assessment Year : 2018-19 M/s. Herbalife International India The Deputy Pvt. Ltd., Commissioner of RMZ Pinnacle, No. 15, Income-tax, Commissariat Road, Circle – 3(1)(1), Bengaluru – 560 025. Bangalore. Vs. PAN: AAACH8025R APPELLANT RESPONDENT : Shri Percy Pardiwala, Assessee by Sr. Advocate Revenue by : Shri D.K. Mishra, CIT (DR) Date of Hearing : 01-06-2023 Date of Pronouncement : 06-06-2023 ORDER PER BEENA PILLAI, JUDICIAL MEMBER Present appeal is filed by assessee against the final assessment order dated 27.07.2022 passed by the assessment unit for A.Y. 2018-19 on following grounds of appeal: “The grounds mentioned herein by the Appellant are without prejudice to one another 1. On the facts and in circumstances of the case and in law, the assessment order framed under section 143(3) read with section 144C(13) and section 144B of the Income-tax Act, 1961 ('the Act) passed by the Assessment Unit, Income-tax Department ('learned Assessing Officer' or 'learned AO') dated July 27, 2022, to the extent prejudicial to the Appellant, is bad in law, contrary to the facts and circumstances of the case and is liable to be quashed.

Page 2 IT(TP)A No. 905/Bang/2022 Grounds relating to transfer pricing (‘TP’) matters 2. On the facts and in the circumstances of the case and in law, the Hon’ble Dispute Resolution Panel ('Hon'ble DRP') erred in not appreciating that the order of the learned Deputy Commissioner of Income-tax (Transfer Pricing) — 1(3)(1), Bangalore ('learned Transfer Pricing Officer' or 'learned TPO’) passed under section 92CA of the Act is contrary to law and, thus, liable to be quashed. 3. On the facts and in the circumstances of the case and in law, the Hon'ble DRP/ learned AO/ learned TPO, erred in determining the arm's length price of an alleged international transaction of an alleged advertising, marketing and sales promotion ('AMP') expenses of INR 2,705,042,061. 4. Adjustment with respect to alleged advertising, marketing and promotion expenses On the facts and in the circumstances of the case and in law, the Hon'ble DRP / learned AO erred in upholding the learned TPO's approach of 4.1 assuming that there is an arrangement and understanding between the Appellant and its Associated Enterprise ('AE') to promote the brand or trade name owned by the AE which constitutes an international transaction merely on the basis of an alleged excess spend, unilaterally incurred by the Appellant for the sale of its products to third parties, on what is alleged as expenditure on advertisement, marketing and sales promotion; 4.2. not appreciating that incurring of AMP expenditure by the Appellant does not constitute an 'International Transaction' in terms of Section 92B of the Act thereby, not applying the principles laid down in the judgement of the Delhi High Court in the case of Maruti Suzuki India Limited (ITA 110/ 2014) with respect to incurring of AMP not being an international transaction: 4.3. not considering that the advertisement and sales promotion expenses incurred by the Appellant are in the nature of selling expenses incurred for the sale of its own products to third parties. 4.4 disregarding the concept of economic ownership and construing the alleged AMP expense to be a service consequent to development, enhancement, management, protection and exploitation (DEMPE') functions performed by the Appellant, resulting in brand building for the AE and not appreciating that the alleged AMP expenses were incurred for the purpose of business of the Appellant in India and no benefit was intended to be passed on to the AE: 4.5. not providing any documents/ evidences on records to substantiate the findings relating to DEMPE functions of

Page 3 IT(TP)A No. 905/Bang/2022 the Appellant and alleged AMP expenses as mentioned in para 4.4 above. 4.6. alleging the various non-marketing and advertising expenses such as selling expenses incurred by the Appellant to be AMP expenses; 4.7. making an adjustment using 'Other Method' as the most appropriate method (‘MAM’) and adopting an approach similar to the Bright Line Test (‘BLT’) without appreciating that no such method is prescribed under the Act or the Rules; 4.8. interpreting the functional, assets and risks ('FAR') profile as furnished in the TP documentation and misquoting the facts leading to erroneous conclusions for the risks assumed by Appellant and its AEs; 4.9. disregarding the economic characterization of the Appellant as a licensed manufacturer achieving arm's length operating margins under transactional net margin method ('TNMM') higher than the comparables for the subject year, concluding that the Appellant is a contract manufacturer and has asserted that separate compensation is required for the alleged excess AMP expenses; 4.10 disregarding the multiple submissions furnished by the Appellant to provide a detailed representation of facts in relation to the FAR profile of the Appellant and its AEs; 4.11 determining the ALP separately for the alleged excess AMP expenses and disregarded that marketing function forms an intrinsic part of the manufacturing along with sales process of the Appellant; 4.12. concluding that the alleged excessive AMP expenditure amounted to a 'service' being rendered by the Appellant to its AE and that a mark-up was required to be charged in respect of such services; 4.13 rejecting the comparability analysis carried out by the Appellant in the TP documentation and in conducting a fresh comparability analysis for the licensed manufacturing segment. 4.14 the learned TPO has erred in performing a fresh comparability analysis to determine the alleged excess AMP expense. In addition, the Hon'ble DRP / learned AO / learned TPO erred in: a. rejecting filters applied by the Appellants in its TP documentation; b. applying modified or additional filters; c. excluding companies, which are functionally comparable to the Appellant (including the additional comparable companies suggested by the Appellant from the search process adopted by the learned TPO); d. including additional purported companies in the comparability analysis, which do not satisfy the test of

Page 4 IT(TP)A No. 905/Bang/2022 comparability in relation to the licensed manufacturing activities performed by the Appellant; 4.15. computing the AMP / Sales ratio of the comparable companies by inconsistently considering certain line items while arriving at sale and total AMP expenditure amount and disregarding the submissions filed with correct computation of the AMP/Sales ratio along with supporting documents; 4.16 performing a comparability analysis to determine the mark-up to be applied on the alleged AMP expenses, whereunder the Hon'ble DRP / learned AO / learned TPO erred in: a. including companies that are not akin to a marketing service provider; b. excluding companies, which are akin to a marketing service provider thereby adopting a cherry-picking approach 4.17. not considering the submissions of the Appellant against the functional comparability of the companies selected by the learned TPO and the arguments supporting the comparable companies selected in the TP documentation rejected by the learned TPO (Tax Effect: INR 936,160,956) Grounds relating to other than TP matters 5 Disallowance of deduction under section 80G of the Act 5 1. On the facts and in the circumstances of the case and in law, the learned AO erred in disallowing the claim of deduction of INR 9,300,000 under section 80G of the Act by holding that amount paid out of Corporate Social Responsibility (CSR) expenditure is ineligible for such deduction. 5.2. On the facts and circumstances of the case, the learned AO failed to appreciate the fact that the disallowance cannot operate based on supposed intention and the Assessee has discretion to choose the project/programme for the purpose of donation as long as such donation is compliant with the provisions of the Act. 5.3 On the facts and in the circumstances of the case, the learned AO failed to give due merit to the assessee's contentions, the favourable order obtained in the Assessee's own case and the jurisdictional judicial precedents pronounced by the Hon'ble Bangalore Bench of the Income-tax Appellate Tribunal, pursuant to which the CSR expenditure which is eligible for deduction under section 803 of the Act should be allowed subject to satisfaction of the conditions mentioned therein. 5 4. On the facts and in the circumstances of the case, the learned AO failed to distinguish the Assessee's

Page 5 IT(TP)A No. 905/Bang/2022 reliance on favourable judicial precedents on the issue. (Tax Effect: INR 3,218,544) 6. Incorrect levy of interest 6.1. On the facts and in the circumstances of the case, the learned AO erred in computing the interest under section 234B of the Act amounting to INR 473,078,485. (Tax Effect: INR 473,078,485) 7. Penalty Proceedings 7.1. On the facts and in the circumstances the Learned AO erred in initiating penalty proceedings under section 274 read with section 270A of the Act and penalty proceedings under section 274 read with section 271AA of the Act. That the Appellant craves leave to add to and/or to alter, amend, rescind, modify the grounds herein below or produce further documents before or at the time of hearing of this Appeal.” 2. Brief facts of the case are as under: 2.1 The assessee company filed its original return of income for A.Y 2018-19 on 20.11.2018 returning a total income of Rs.243,54.49,740/-. Subsequently, statutory notices were issued and the assessee submitted its response accordingly. During the course of reassessment proceedings for A.Y 2018-19, a reference u/s 92CA(1) of the Act was made to the TPO by the Ld. AO. The TPO passed the order u/s 92CA(3) of the Act vide dated 30.07.2021 proposing following adjustments u/s 92CA of the Act. Amount of Particulars adjustment(INR) SWD 11,50,20,735 AMP Expenses 284,54 84 699 Total Adjustment 296,05.05,433 u/s 92CA 2.2 The draft assessment order incorporating the proposed adjustment u/s 92CA(3) was passed making upward adjustment to the Arm's length Price by Rs.296,05,05,433/-.

Page 6 IT(TP)A No. 905/Bang/2022 2.3 Against the draft assessment order, the assessee filed objections before the Dispute Resolution panel The DRP passed order u/s 144C(5) of the Act on 03.06.2022 wherein certain directions were given to the Ld.TPO/AO in order to enable to complete the assessment order. Further, certain directions were also issued to Ld.TPO in the SWD and AMP Segment. The Ld.TPO passed order u/s 144C of the Act on 27.06.2022 giving effect on TP issues in the case of the assessee based on DRP directions. The assessment was then passed u/s. 144C(13) considering the directions issued by the DRP u/s 144C(5) dated 03.06.2022 and simultaneously incorporating the effect order u/s 144C of the Act dated 27.06.2022. The addition thus made in the impugned order was as under: AMP Adjustment Rs. 270,50,42,061/- Disallowance u/s. Rs. 93,00,000/- 80G 2.4 Aggrieved by the order of the Ld.AO, assessee is in appeal before this Tribunal. 3. At the outset, the Ld.Counsel submitted that ground no. 1 is general in nature and therefore do not require adjudication. 4. Ground nos. 2-4 is in respect of the AMP expenditure computed in the hands of the assessee by adopting bright line test. The Ld.Counsel submitted that this issue has been considered by Coordinate Bench of this Tribunal in assessee’s own case for A.Y. 2017-18 in IT(TP)A No. 440/Bang/2022 by order dated 17.05.2023. He submitted that the factual position of assessee in the immediately preceding assessment year is identical and similar with the present year under consideration. He has relied on and referred to the arguments advanced therein in support of these grounds for the year under consideration.

Page 7 IT(TP)A No. 905/Bang/2022 On the contrary, the Ld.DR placed reliance on orders passed by authorities below. We have perused the submissions advanced by both sides in the light of records placed before us. 4.1 We note that this issue has been considered by Coordinate Bench of this Tribunal in the following manner: “We have perused the submissions advanced by both sides in the light of records placed before us. 3.15 In rejoinder the Ld.Counsel submitted that the DRP without appreciating the Business model adopted by the assessee took the view in 2.3.19 that the assessee merely purchases the products from AE and sells it further to the distributors / dealers in India. The DRP failed to appreciate that the products are sold to end customers by Direct Selling model and all the incentives / payouts to the agents are subjected to TDS. 3.16 He also referred to para 2.3.16 wherein the DRP is accepting that the assessee do not require to incur any advertisement expenses as they are one of the leading multilevel marketing company. He thus submitted for the adjustment to be deleted. 3.17. Indian subsidiaries of foreign entities may carry out certain activities as part of their business in India. Generally, they may undertake manufacturing, advertising, or promotion activities and the costs incurred are known as advertising, marketing, promotion expenditure (‘AMP expenditure’). The inclusion of AMP expenditure by an associated company in transfer pricing analysis has been a point of contention in India. The contentions emerge as assessing officers allege that these expenses result in the creation of intangibles like brand identity and image which are part of the intellectual property rights of the foreign entity. And in general, these costs are in excess of the costs that would be incurred by unrelated parties. Hence, they argue that it should come under ‘international transaction’ and should be included in the transfer pricing study. However, Indian subsidiaries contend that such expenditure is carried out for their own purposes to build the business in India and is not meant to contribute to the global business. 3.18. Indian authorities have also adopted the “bright-line test” to determine whether such transactions can be

Page 8 IT(TP)A No. 905/Bang/2022 included in the transfer pricing. This test was laid down by the United States Courts. The test states that the AMP expenditure which is in excess of the expenses incurred by comparable companies in a controlled transaction has to be compensated to the overseas enterprise. The Indian authorities consider this excessive expenditure as an enhancement of the global branch and a step towards creating marketing intangibles. 3.19. This issue was been heavily contended for years. In 2010, in the case of Maruti Suzuki, reported in (2010)192 Taxman 317, Hon’ble Delhi High Court had held that that the AMP expenditure amounted to an international transaction. A similar matter was then again heard by Hon’ble Delhi Special Bench in case of LG Electronics, reported in [2013] 29 taxmann.com 300, wherein it was held that, bright-line test can be used to determine if the AMP expenditure is an international transaction. The second decision in case of Maruti Suzuki by Hon’ble Delhi High Court reported in [2015] 64 taxmann.com 150, held that there should be an understanding between the domestic company and the associated enterprises for incurring AMP expenditure for it to be considered an international transaction. 3.20. Now, it is fairly well established that determination of arm's length price of AMP expenditure by applying BLT method is not valid. In a catena of decisions, the Hon'ble Delhi High Court while disapproving the decision of Hon’ble Delhi Special Bench in L.G. Electronics India (P.) Ltd. (supra) have held that, BLT method is invalid as it is not prescribed in the statute. In this context, we may refer to the decision of the Hon'ble Delhi High Court in Maruti Suzuki India Ltd. (supra). Following the decision of the Hon'ble Delhi High Court in Maruti Suzuki India Ltd. (supra) and various other decisions, different Benches of the Tribunal have also held that in absence of an express arrangement/agreement between the assessee and the AE for incurring AMP expenditure to promote the brand of the AE, AMP expenditure incurred by making payment to third parties for promoting and marketing the product manufactured by the assessee, does not come within the purview of international transaction. Thus the sum and substance of the ratios in various decisions by Hon’ble High Courts, consistently followed by the Tribunals are that:  Bright-line test alone cannot be considered an indicator that the AMP expenditure constitutes an international transaction under the Income Tax Act.

Page 9 IT(TP)A No. 905/Bang/2022  Even if the foreign entity is to gain by the AMP services carried out by the domestic entity, that will not be proof of an international transaction if the services were carried out specifically for the development of the domestic entity in India.  Transfer pricing officers must look for further evidence such as subsidies, grants, or contractual arrangements between the associated enterprises to prove that such expenses were a part of an international transaction.  If the AMP is shown to be an international transaction, then it must be added as part of the computation of the arm’s length price. 3.21 Admittedly, in the present facts of the case, the assessee is a distributor and is functioning its activities under the MLM sales model. On perusal of the records and the activities carried out by the assessee described in the TP study reports, no action foised it as an international transaction. The entire sales of the assessee is effectuated in India and the entire profits are also assessee’s own profit. The expenditure incurred by assessee is to carry out its day to day business activity of distribution and are directly linked with the business carried out by assessee in India. It is not disputed by the revenue that TDS has been deducted by the assessee on the royalty earning, production bonus u/s. 194H of the Act, and thus payouts are made only when the members / associates /distributors effectuate a successful sale. In any event, all these expenses have been considered by the assessee while computing the margin under the manufacturing segment which already has been held to be at arms length by the Ld.TPO in the transfer pricing order u/s. 92CA. 3.22 In this context, we draw specific reference to the observation of Hon’ble Delhi High Court in case of Sony Ericsson Mobile Communication India (P) Ltd. (supra) which is as under: "101. However, once the Assessing Officer/TPO accepts and adopts TNM Method, but then chooses to treat a particular expenditure like AMP as a separate international transaction without bifurcation/ segregation, it would as noticed above lead to unusual and incongruous results as AMP expenses is the cost or expense and is not diverse. It is factored in the net profit of the inter-linked transaction. This would be also in consonance with Rule 10B(J)(e), which mandates only arriving at the net profit margin by comparing the profits and loss account of the tested party with the comparable. The TNM Method proceeds on the assumption that functions, assets and risk being

Page 10 IT(TP)A No. 905/Bang/2022 broadly similar and once suitable adjustments have been made, all things get taken into account and stand reconciled when computing the net profit margin. Once the comparables pass the functional analysis test and adjustments have been made, then the profit margin as declared when matches with the com parables would result in affirmation of the transfer price as the arm's length price. Then to make a comparison of a horizontal item without segregation would be impermissible" 3.23 We also find merit in the submission of the Ld.Counsel that, if the net profit margin meets the Arm's length price, then no separate addition needs to be made. Considering the fact that no adverse inference is drawn by the Ld.TPO in respect of the Manufacturing segment which means that the Ld.TPO has accepted the overall margins of the said segment and respectfully following decision of the Hon'ble Delhi Court in the case of Sony Ericsson (supra), we direct the Ld.TPO to delete the adjustment made towards the AMP. Accordingly ground nos. 2 to 4 raised by assessee stands allowed.” Respectfully following the above view, we direct the Ld.AO/TPO to delete the adjustment made towards the AMP expenditure. Accordingly, ground nos. 2-4 raised by assessee stands allowed. 5. Ground no. 5 has been raised by assessee against the disallowance of deduction claimed u/s. 80G amounting to Rs.93,00,000/-. The Ld.Counsel submitted that this issue stands settled by the decision of Coordinate Bench of this Tribunal in following cases: a) Sling Media (P.) Ltd. vs. DCIT reported in (2022) 135 taxmann.com 164 b) First American (India) (P.) Ltd. vs. ACIT in ITA No. 1762/Bang/2019 by order dated 29.04.2020 The Ld.DR placed reliance on the orders passed by the authorities below.

Page 11 IT(TP)A No. 905/Bang/2022 We have perused the submissions advanced by both sides in the light of records placed before us. 5.1 We note that in the draft assessment order dated 25.09.2021, the Ld.AO disallowed the claim of 80G by holding it to be on account of CSR activities. Similar is the issue dealt with by this Tribunal in the decisions relied hereinabove by the Ld.Counsel. 5.2 We note that in the decision of First American (India) (P.) Ltd. vs. ACIT (supra) was relied by the Coordinate Bench of this Tribunal in Sling Media (P.) Ltd. vs. DCIT (supra) to decide identical issue. Following were the observations of the Coordinate Bench in case of Sling Media (P.) Ltd. vs. DCIT (supra). “6.1 We note that assessee has suo moto disallowed the expenditure towards the CSR responsibilities u/s. 37(1) of the Act and claimed deduction u/s. 80G to the extent of donations paid to eligible charitable institutions. The observations of co-ordinate bench of this Tribunal in case of First American (India) Pvt. Ltd. vs. ACIT (supra) on the same issue is as under. “15. In our view, expenditure incurred under section 30 to 36 are claimed while computing income under the head, 'Income form Business and Profession", where as monies spent under section 80G are claimed while computing "Total Taxable income" in the hands of assessee. The point of claim under these provisions are different. 16. Further, intention of legislature is very clear and unambiguous, since expenditure incurred under section 30 to 36 are excluded from Explanation 2 to section 37(1) of the Act, they are specifically excluded in clarification issued. There is no restriction on an expenditure being claimed under above sections to be exempt, as long as it satisfies necessary conditions under section 30 to 36 of the Act, for computing income under the head, "Income from Business and Profession". 17. For claiming benefit under section 80G, deductions are considered at the stage of computing "Total taxable income". Even if any payments under section 80G forms part of CSR payments( keeping in mind ineligible deduction expressly provided, the same would already

Page 12 IT(TP)A No. 905/Bang/2022 stand excluded while computing, Income under the head, "Income form Business and Profession". The effect of such disallowance would lead to increase in Business income. Thereafter benefit accruing to assessee under Chapter VIA for computing "Total Taxable Income" cannot be denied to assessee, subject to fulfillment of necessary conditions therein. 18. We therefore do not agree with arguments advanced by Ld.Sr.DR. 19. In present facts of case, Ld.AR submitted that all payments forming part of CSR does not form part of profit and loss account for computing Income under the head, "Income from Business and Profession". It has been submitted that some payments forming part of CSR were claimed as deduction under section 80G of the Act, for computing "Total taxable income", which has been disallowed by authorities below. In our view, assessee cannot be denied the benefit of claim under Chapter VI A, which is considered for computing 'Total Taxable Income". If assessee is denied this benefit, merely because such payment forms part of CSR, would lead to double disallowance, which is not the intention of Legislature. 20. On the basis of above discussion, in our view, authorities below have erred in denying claim of assessee under section 80G of the Act. We also note that authorities below have not verified nature of payments qualifying exemption under section 80G of the Act and quantum of eligibility as per section 80G(1) of the Act. 21. Under such circumstances, we are remitting the issue back to Ld.AO for verifying conditions necessary to claim deduction under section 80G of the Act. Assessee is directed to file all requisite details in order to substantiate its calim before Ld.AO. Ld.AO is then directed to grant deduction to the extent of eligibility.” 6.2 Respectfully following the above view, we direct the Ld.AO verify the payments made by assessee towards CSR that also forms part of deduction u/s. 80G. Ld.AO shall then grant the deduction claimed u/s. 80G of the Act in accordance with law.” Respectfully following the above view, we direct the Ld.AO to verify the payments made by assessee towards CSE that also

Page 13 IT(TP)A No. 905/Bang/2022 forms part of deduction u/s. 80G. The Ld.AO then shall grant the deduction claimed u/s. 80G in accordance with law. Accordingly, these grounds raised by assessee stands allowed as indicated hereinabove. In the result, the appeal filed by the assessee stands allowed. Order pronounced in the open court on 06th June, 2023.

Sd/- Sd/- (CHANDRA POOJARI) (BEENA PILLAI) Accountant Member Judicial Member Bangalore, Dated, the 06th June, 2023. /MS / Copy to: 1. Appellant 2. Respondent 3. CIT 4. DR, ITAT, Bangalore 5. Guard file By order

Assistant Registrar, ITAT, Bangalore