M/S HERBALIFE INTERNATIONAL INDIA PVT LTD ,BANGALORE vs. DEPUTY COMMISSIONER OF INCOME TAX CIRCLE-11(4), BANGALORE

Page 2 of 29 & 2068/Bang/2017 ORDER PER BENCH Present appeals are filed by assessee against separate orders both dated 29/08/2017 passed by Ld.CIT(A)-3, Bangalore for A.Ys. 2003-04 2005-06 on following grounds of appeal: (AY: 2003-04) “Based on the facts and circumstances of the case and in law, Herbalife International India Private Limited ("Herbalife India" or the "Company" or the "Appellant") respectfully craves leave to prefer an appeal under section 253 of the Income-tax Act, 1961 ("the Act") against the order dated 29 August 2017 passed by Commissioner of Income-tax (Appeals) , Circle — 3 ["CIT(A)"], Bangalore under section 250 of the Act on the following grounds: On the facts and circumstances of the case and in law, the Honorable CIT(A) erred in upholding the order of the learned Deputy Commissioner of Income Tax— Circle 12(1), New Delhi ("learned AO") which has been passed after taking into account the order of the learned Additional Commissioner of Income tax (Transfer Pricing Officer - I), New Delhi ("learned TPO") whereby the learned TPO and the learned AO have : A) Grounds of appeal relating to Transfer pricing (`TP') adjustment

1. Erred in making an addition of INR 12,59,12,420 to the total income of the Appellant on account of adjustment in the arm's length price with respect to the international transactions of the Appellant. International transaction relating to Export of Finished Goods to Associated Enterprise VAE")

2. Erred in making an upward TP adjustment of INR 7,75,62,042 to the international transaction of Export of Finished goods to AE.

3. Erred in not considering various submissions, workings and evidences furnished by the Appellant to justify the commercial expediency behind export of goods.

4. Erred in considering the net realizable value of local sales as arm's length price for testing the goods exported to AE without appreciating the business and economic factors.

5. Unlawfully presumed estoppel on choice of most appropriate method and unjustly insisted on CUP contrary to law ignoring alternative analysis.

Page 3 of 29 & 2068/Bang/2017 International transaction relating to payment of administrative fees to AE 6. Erred in determining the arm's length value of administrative fees paid to AE as NIL and thereby making adjustment of INR 4,83,50,378 to said the international transaction of the Appellant.

relating to Corporate tax disallowance

11. Erred in not considering the issue of inventory write off amounting to INR 125,431,371 which was disallowed in AY 2002-03 by the learned CIT(A) stating that the same should be considered in AY 2003-04.

12. Erred in not observing that non-consideration of the inventory write off in AY 2003-04 would lead permanent disallowance of the claim and would be against the principles of natural justice.

13. Erred in dismissing above ground holding that the same was not arising out of the order of AO for AY 2003- 04.

14. Erred in not considering that CIT(A) has the right to consider additional grounds even if not raised before the AO

15. Adopting pedantic and hyper technical approach resulting in denial of substantial justice.

16. Erred in levying interest under the provisions of Income Tax Act, 1961.

Page 4 of 29 & 2068/Bang/2017 Further, the Appellant craves leave to add, alter, vary, omit, substitute or amend the above grounds of appeal

, at any time before or at, the time of hearing, of the appeal.” ITA No. 2068/Bang/2017 (AY: 2005-06) “Based on the facts and circumstances of the case and in law, Herbalife International India Private Limited ("Herbalife India" or the "Company" or the "Appellant") respectfully craves leave to prefer an appeal under section 253 of the Income-tax Act, 1961 ("the Act") against the order dated 29 August 2017 passed by Commissioner of Income-tax (Appeals) , Circle — 3 ["CIT(A)"], Bangalore under section 250 of the Act on the following grounds: On the facts and circumstances of the case and in law, the Honorable CIT(A) erred in upholding the order of the learned Assistant Commissioner of Income tax, Circle — 11(4), Bangalore ("learned AO") which has been passed after taking into account the order of the learned Additional Director of Income tax, Transfer Pricing- I. Bangalore ("learned TPO") whereby the learned TPO and learned AO have: A) Grounds of appeal relating to Transfer pricing (`TP') adjustment

1. Erred in making an addition of INR 4,38,20.000 to the total income of the Appellant on account of adjustment to the arms length price with respect to the international transaction relating to payment of administrative fees to the Associated Enterprise ("AE").

2. Erred in determining the arm's length value of administrative fees paid to AE as NIL without appreciating the commercial expediency of payment of administrative fees by the Appellant.

3. Erred in rejecting Transactional Net Margin method ("TNMM") as the most appropriate method to determine the arm's length price of the international transaction of payment of administrative fees by the Appellant.

4. Erred in considering the international transaction of payment of administrative fees in isolation of other international transactions of the Appellant in order to benchmark the same and thereby rejecting aggregation approach adopted by the Appellant to substantiate arm's length nature of the said international transaction.

5. Erred in plainly holding that the benefit received by the Appellant should be direct and substantial while not appreciating the actual benefits and corresponding Page 5 of 29 & 2068/Bang/2017 economic value derived as a result of receipt of administrative services by the Appellant.

6. Erred in holding that the Appellant did not produce any document in relation to receipt of administrative services in complete disregard of the submissions made and evidences filed by the Appellant.

7. Erred in adopting inconsistent approaches across years in determining the arm's length value of administrative fee paid to AE.

8. Erred in not appreciating that in the current case there is no intent on the Appellant's part to shift profits from India, given that the rate of Corporate Income tax in USA (country in which AE is resident) is higher than the income tax rate applicable in India and in absence of such a motive, the question of making this adjustment becomes academic.

9. Erred in levying interest under the provisions of Income Tax Act, 1961. Further, the Appellant craves leave to add, alter, vary, omit, substitute or amend the above grounds of appeal

, at any time before or at, the time of hearing, of the appeal.”

2. Brief facts of the case for AY 2003-04 are as under: 2.1 Assessee was incorporated in the year 1998 and started its manufacturing activity in the Indian market through third party contract manufacturers. It is submitted that the in its initial years of operations, it manufactured certain products which did not prove to be viable in the Indian domestic market. Considering that the Herbalife products have low shelf life and are perishable in nature, some products were written off in the AY 2002-03 In cases where the rework/reuse was perceived to be possible so as to be fit for human consumption. The same were reworked and sold to its AE, Herbalife International of America Inc., US, in the AY 2003-04. 2.2 It is again submitted that the assessee had a policy of accumulating finished goods inventory equivalent to 16 weeks' sale in anticipation of the growing demand of products. However, during FY 2001-02, the sales slumped significantly as opposed to Page 6 of 29 & 2068/Bang/2017 the anticipated sales. On account of this decline, there was a huge stock pile up and to add to that the assessee was facing serious logistics issues relating to storage and warehousing the huge inventory. 2.3 It is submitted that during a normal quality control testing, foul smell was detected as emanating from these products. Accordingly, these products were rendered useless and marketable. This is also evident from the financial statements of the company for previous year i.e. AY 2002-03 where inventory amounting to INR 12.54 Cr (of which INR 3.86 Cr pertains to finished goods) have been written off. The remaining products which were forming part of the closing stock for AY 2002-03 were assessed and where possible, were reworked and sold to AE for further sale in the US market. The goods exported to AE in AY 2003-04 also formed part of the closing stock list of AY 2002-03. The export of finished goods as above amounting to INR 2,46,43,632 consisted of the following products. Description Export rate Qty Total Multivitamin tablet (90 93.84 1,90,000 1,78,29,182 tablets) 500 gms Chocolate 139.37 10,590 14,75,875 200 gms Chocolate 65.53 16,110 10,55,623 200 gms Mango 60.64 7,880 4,77,811 500 gms Vanilla 128.61 9,815 12,62,278 500 gms Mango 119.81 21,225 25,42,861 Total 2,46,43,632 2.4 The assessee submitted that after the goods were delivered at the port the US, it was found during the inspection by the US Food and Drug Administration FDA) that the same were unfit for human consumption. Hence, they were destroyed as per the customs procedures. In general, the FDA in the US and the Page 7 of 29 & 2068/Bang/2017 customs teams inspect all goods which are imported into the country and only if they meet the specified norms, they are allowed to enter the US domestic market Else. they need to be sent back or destroyed as per the prescribed procedures. 2.5 The assessee in the transfer pricing report benchmarked the international transaction as under:

AY 2003-04 SI.No Nature of service Amount in USD (FPB 780 and 115) 1 Sales and Marketing Services 3,95,788 2 Distributor Services 1,09,071 3 Worldwide Distribution Operations 67,951 5 Financial and Accounting services 52,158 4 Information Systems Services 2,18,872 6 Corporate and Distributor Compliance 22,121 7 Other Services 1,85,260 Total 10,51,221 Restricted to USD 1 million (in line with 10,00,000 RBI approval) Amount paid in INR 4,83,50,378 2.6 The Ld.AO note that assessee specified CUP as its benchmarking method in Form 3CEB however in the transfer pricing study report, assessee also substantiated the international transaction by using a secondary method which is TNMM. While doing so, assessee had aggregated its other international transaction and computed its margin at entity level of 12% with comparables margins of 4% and concluded that the international transaction for A.Y. 2003-04 at arms length. 2.7 The Ld.TPO distributed the manner of computing the margin. The Ld.TPO was of the view that the products sold to AE were also sold to unrelated parties, the controlled prices were available in an internal CIP. The Ld.TPO thus computed the margin by using CUP as the most appropriate method. It was also observed

Page 8 of 29 & 2068/Bang/2017 by the Ld.TPO that assessee did not submit invoices of sales with unrelated party however the assessee had compared the per unit sale price of the obsolete stock sold with the per unit manufacturing cost of production and arrived at the gross profit of products sold to unrelated parties at 77% and the net realisable value was arrived by reducing the GP% i.e. 77% from the per unit sale price of the products by further discounting at 46%. This above method under CUP was rejected by the Ld.TPO as arbitrary. The Ld.TPO determined the discount of products at 50% of the MRP and computed the TP adjustment by proposing the shortfall at Rs.7,75,62,041/-. 2.8 The next international transaction that was considered by the Ld.TPO was in respect of administrative service fee paid by assessee amounting to Rs.5.67 Crores to its associated enterprises. It was submitted that the recharges were made on actual cost to cost based with regard to payment of administrative service fees wherein the associated enterprises provided services for back office functions like operations and administration, sales and communications, logistics, finance and accounting, information technology, legal manufacturing and distribution services, corporate marketing and public relations. 2.9 The Ld.TPO observed that assessee had RBI approval of remittance for towards administrative fee upto USD 1 million during the year and for any further approval assessee was to approach RBI. The Ld.TPO observed that the payment made during the relevant year was more than that was approved by RBI for which assessee did not furnish any explanation. The Ld.TPO observed that assessee did not provide any detail in Page 9 of 29 & 2068/Bang/2017 respect of the description of services rendered by AE and failed to demonstrate the rendition of services by the AE. He thus disallowed sum of Rs.4,83,50,378/- paid by assessee towards administrative service fee. 2.10 On receipt of the transfer pricing order, the Ld.AO passed the final assessment order on 14/03/2006 by making an addition in the hands of the assessee at Rs.12,59,12,420/-. Aggrieved by the order passed by the Ld.AO, assessee filed appeal before Ld.CIT(A). The Ld.CIT(A) on the issue of the determination of the ALP as well as administrative services, decided as under:

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. The same relate to allowing of write off of inventory during the year under consideration. The appellant has prayed for the admission of the same. On perusal of record it is observed that these grounds are not arising out of the order of the Assessing Officer (AO). These issues were never raised by the appellant before the AO. Further these are not legal issues. it would require fresh investigation into facts as to whether the write off of inventory was to be allowed in the year under consideration or not. The CIT(A) as well as AO have just given remarks that the matter can only be considered in AY 2003-04. Nowhere is it stated that any such allowance needs to be given to the appellant in AY 2003- 04 without any verification. Considering above, these additional grounds of appeal are not admitted.” Aggrieved by the order of Ld.CIT(A), assessee is in appeal before this Tribunal.

4. Ground no. 1 raised by assessee is general in nature and therefore do not require adjudication.

5. Ground nos. 2-5 is in respect of the export of finished goods to the associated enterprises wherein an upward TP adjustment Page 18 of 29 & 2068/Bang/2017 was made. The Ld.AR submitted that the products reproduced in para 2.3 sold to the AE was one time export and did not constitute and a regular business activity of the assessee. 5.1 The Ld.AR submitted that the above sale transaction constituted only 5% of the total revenue of the assessee which also forms part of the closing stock list for the year under consideration. He submitted that due to low / no demand in the Indian market huge stock piled up in AY 2002-03 considering the perishable nature to these products, the assessee sold the same to the AE to be sold in US market. The Ld.AR submitted that once these goods reached the US Port, they were subjected to US Food and Drug Administration verification (FDA) and the FDA found the goods to be unfit for human consumption and the same were destroyed in accordance with the US custom procedures. The Ld.AR has filed before us, the details of the closing stock that was the goods sold to the AE which is scanned and reproduced as under:

Page 19 of 29 & 2068/Bang/2017 5.2 The Ld.AR also placed reliance on various pages of the paper book wherein the quantity of the products and the invoices were placed along with delivery ticket noting the destruction of such goods along with related affidavit in terms of the cartons for each product. The Ld.AR has also placed the details of lading in terms of the number of carton and items for each product which he submitted that it could be correlated. A summary of the details has been filed in a tabulated form referring to the relevant page numbers. For the sake of convenience, the same is scanned and reproduced as under:

Page 20 of 29 & 2068/Bang/2017 5.3 The Ld.AR thus submitted that though the goods were exported to AE, the same were not consumed by AE as they were considered as unfit for human consumption even before it could enter AE’s premises. He thus submitted as under: “Considering the perishable nature of the products; these goods were sold to AE for sale in the US market as the option only realistically available. From the commercial perspective, the intent of this transaction was to recoup the manufacturing costs, rather than scrapping the products and incurring a loss on the cost of production (PB Pg 68). Hence, the ALP of the subject international transaction would be Nil.” 5.4 The Ld.AR also drew support from the OECD guidelines wherein in para 4.9, it is stated that the taxpayer’s commercial judgment regarding the application of arms length principle needs to be taken into account by the tax authorities so that the transfer pricing analysis is tied to the business realities.

Page 21 of 29 & 2068/Bang/2017 5.5 Assessee in its TP study submitted that in its TP report, compared its entity level margin of 12% with the comparables’ margin of 4% and concluded that all its international transactions for A.Y. 2003-04 to be at arm’s length. 5.6 On the contrary, the Ld.DR submitted that the export of unsalable products in India to the AE itself is primarily unacceptable and it is a made up story. It was submitted by the Ld.DR that the products that are not saleable in India cannot anyway cross the boundaries of India as it requires necessary approvals being food products for consumption and certificate of quality assurance has to be submitted. The Ld.DR supported the transfer pricing addition in respect of the international transaction of export of finished goods to the AE. We have perused the submissions advanced by both sides in the light of records placed before us. 5.7 We appreciate the argument advanced by the Ld.DR however there are various documents filed by the assessee in support of the products that are submitted to be remodified and was made to be fit for consumption. However, such modification did not fit into the strict criteria of verification as per the FDA norms and therefore stood rejected and destroyed. We note that these details and evidences filed by assessee the summary of which are reproduced hereinabove in a tabulated form has not been considered by the Ld.AO/TPO. It is also admitted fact that margin of assessee at 12% was compared with the comparables being 4% for the year under consideration and therefore some value has been received by assessee as submitted by the Ld.AR against such destroyed products by the US customs which Page 22 of 29 & 2068/Bang/2017 deserves to be bench marked. We direct the Ld.AO to reconsider the claim of assessee in the light of the evidences filed and to compute the margin of assessee in accordance with law by following the principles of transfer pricing regulations. Accordingly Ground nos. 2 to 5 raised by assessee stands allowed for statistical purposes.

Page 24 of 29 & 2068/Bang/2017 “11. Having heard both the parties and having considered the rival contentions and also the material on record, we find that the assessee has filed before us on 14-7-2014, the break-up of the expenditure as per profit and loss account during the financial year 2007- 08. From the said details, it is seen that the services rendered by Cisco India to the assessee are in the nature of Financial and Accounting services, legal and tax related issues information system and related issues, Treasury services, Asset Management/residual value analysis, credit analysis and deal execution. The AO has not doubted the rendering of services by Cisco India to the assessee but has restricted the allowable expenditure to 5% of the operating expenses which means that he has only doubted the reasonableness of the quantum of payment. But to invoke the provisions of sec.40A(2) of the Act, as rightly pointed out by the learned counsel for the assessee, the AO cannot make an ad hoc disallowance u/s 40A of the Act but has to determine the expenses which are excessive and unreasonable. The AO, in the case before us, has failed to point out any particular expenditure which according to him, is excessive or unreasonable but has made an ad hoc disallowance which is not sustainable. Further, as rightly pointed out by the learned counsel for the assessee, disallowance u/s 40A(2) can be made only if the alleged excessive and unreasonable payment is made to any person enumerated under clause (b) of sub-sec.(2) of sec.40A of the Act. In the case before us, the AO has not brought out anything on record to show that Cisco India Ltd., falls in any of the categories of persons enumerated under clause (b) of sub-section (2) of sec.40A of the Act. The recipient of the payment i.e. Cisco India, definitely does not fall under any of the categories of persons under clause (b) of sub-sec.(2) of sec.40A. The AO has not carried out any exercise to bring on record that Cisco India has got substantial interest in the business or profession of the assessee or that it falls in any of the categories of persons. In view of the same, we are of the opinion that the disallowance u/s 40A(2)(b) of the Act is not called for. 11.1 As regards the alternative contention of the learned counsel for the assessee that the transaction between the assessee and Cisco India Ltd., being an international transaction, the same has already been referred to the TPO for determination of the ALP and therefore it cannot be considered for disallowance u/s 40A of the Act, since we have already held that the Page 25 of 29 & 2068/Bang/2017 provisions of sec.40A are not attracted, we do not see the need to adjudicate this contention of the assessee. ” 10.6 In the case in hand, when the AO has not conducted any inquiry or brought out any material on record to prove that payment made by the assessee is excessive and unreasonable making an adhoc disallowance by invoking the provisions of sec.40A(2) of the Act is not justified. Accordingly by following the decision of the co-ordinate bench of the Tribunal as well as in view of the facts and circumstances of the case as discussed above, we set aside the orders of the authorities below qua this issue and delete the addition made under section 40A(2) of the Act.” The Ld.AO is directed to carry out necessary verification based on the evidences filed by assessee in accordance with the observations of this Tribunal reproduced hereinabove for A.Y. 2008-09. Accordingly, these grounds raised by assessee stands allowed for statistical purposes.

7. Ground nos. 11 to 14 are in respect of the disallowance of inventory written off. 7.1 For the AY 2002-03, the assessee had filed its return of income on 31 October 2002. In the return, the assessee claimed the deduction towards of INR 12,54.31,371 (comprising of inventory of raw materials at INR 8,93,57,960 and inventory of finished goods at INR 3.60,73,411). The said claim was disallowed during the assessment proceedings. AO observed that the inventories were written off as per the authorization memo between 21 October 2002 to 24 October 2002, i.e., six days before filing return of income. Accordingly, the AO expressed the view that the assessee. if at all is required to write off the inventory should have written off in the succeeding year, i.e., in the financial year 2002-03 relevant to the AY 2003-04. On appeal Page 26 of 29 & 2068/Bang/2017 against the assessment order, the learned CIT(A) had upheld the disallowance with the below noting: "Therefore, I agree with the conclusion of the assessing officer that the deduction for inventory write off was not allowable in the present assessment year. The allowability of inventory write off could only have been considered in the following assessment year relating to financial year 2002-03." 7.2 On further appeal, Hon'ble ITAT vide in order for AY 2002-03 dated 4 February 2022 had upheld the disallowance observing that the disposal notes which form basis of write off of inventory is received on 24 October 2002 i.e.. in FY 2002- 03 (AY 2003-04). 7.3 Based on the noting in the order of CIT(A), the Company had raised additional grounds before CIT(A) for AY 2003-04. vide letter dated 26 October 2016, for allowing the claim for write off inventory in AY 2003-04. 7.4 The Ld.CIT(A) vide order dated 29 August 2017, observed that said ground are not arising out of the order of the AO for AY 2003 04 as no claim was made before the AO. Relevant extract of CIT(A) order is re-produced below '(Refer page 8-9 of the paper book): "Vide letter dt 26.10.2016, the appellant has raised more additional grounds of appeal. The same relate to allowing of write off of inventory during the year under consideration. The appellant has prayed for the admission of the same. On perusal of record it is observed that these grounds are not arising out of the order of the Assessing Officer (AO). These issues were never raised by the appellant before the AO. Further these are not legal issues. It would require fresh investigation into facts as to whether the write off of inventory was to be allowed in the year under consideration or not. The CIT(A) as well as AO have just given remarks that the matter can only be considered in A Y 2003-04. Nowhere is it stated that any such allowance needs to be given to the appellant in A Y Page 27 of 29 & 2068/Bang/2017 2003-04 without any verification. Considering above, these additional grounds of appeal are not admitted.” 7.5 The Tribunal for A.Y. 2002-03 in assessee’s own case while considering this issue observed as under: “The AO also observed that the inventories were written off as per the authorization memo between 21.10.02 to 24.10.02, i.e., six days before filing return of income. Accordingly, the AO took the view that the inventory has been actually written off in the succeeding year and not during the year under consideration. Accordingly, the AO expressed the view that the assessee, if at all is required to write off the inventory, should have written off in the succeeding year, i.e., in the financial year 2002-03 relevant to the assessment year 2003-04. Accordingly, the AO held that the claim of the assessee is not allowable. Accordingly he disallowed the claim of write off of inventory amounting to Rs.12,54,31,371/-.” Based on the above submission, we deem it fit and proper to remand this issue to the Ld.AO for verification and to consider it in accordance with law. Accordingly, the grounds raised by assessee stands allowed for statistical purposes.

8. Ground no. 15 is general in nature and therefore do not require adjudication.

9. Ground no. 16 is consequential. Accordingly the appeal filed by assessee for A.Y. 2003-04 stands allowed as indicated hereinabove. Assessment Year 2005-06:

10. The facts being identical as submitted by both sides, the Ld.AR submits that only one issue arises out of the present appeal is in respect of the disallowance of administrative fee by considering its transaction value to be at Nil by the Ld.TPO. He relied on the arguments that was raised by him for A.Y. 2003-04 which is recorded hereinabove. The Ld.DR also submitted similarly. The Ld.AR has also filed an application for admission of additional Page 28 of 29 & 2068/Bang/2017 evidence being a certificate in relation to the fee paid towards administrative services issued by Chartered Accountant dated 29/10/2021. He submitted that the said certificate has been obtained from an independent Chartered Accountant and may be considered while adjudicating the issue. We have perused the submissions advanced by both sides in the light of records placed before us.