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Income Tax Appellate Tribunal, “C’’ BENCH : BANGALORE
Before: SHRI B.R BASKARAN & SHRI PAVAN KUMAR GADALE
Per B.R Baskaran, Accountant Member :
These two appeals of the assessee are directed against the orders passed by the assessing officer for assessment years 2013- 14 and 2014-15 u/s 143(3) r.w.s 144C(13) of the Act in pursuance of directions given by Ld Dispute Resolution Panel (DRP).
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 2 of 52
The appeal pertaining to assessment year 2013-14 was disposed of by the Tribunal along with the appeal relating to AY 2012-13, by a common order dated 10-05-2019. Subsequently the assessee moved a miscellaneous application pointing out that the Tribunal has not adjudicated the ground Nos.32 to 41 urged in AY 2013-14 while passing the common order, referred above. Accordingly, vide order dated 25-09-2019 passed in M.P No.102/Bang/2019, the Tribunal recalled the order of AY 2013-14 for the limited purpose of adjudicating the ground nos.32 to 41. These grounds relate to the Transfer pricing adjustment of Rs.58.35 crores made by the AO/TPO in respect of AMP expenditure as an alternative proposition. It may be noticed that the TPO had made Transfer pricing adjustment of AMP expenditure to the tune of Rs.207.42 crores in AY 2013-14. The assessee is also engaged in the business of distribution of laptops, monitors, projectors and peripheral products imported from its AE. This division was named as “trading segment”. The assessee had benchmarked its trading segment transactions under “Resale Price Method”. The TPO, however, adopted TNMM method as most appropriate method and computed transfer pricing adjustment of Rs.58.35 crores. It is pertinent to note that the TPO had computed the operating margin of the assessee by considering the AMP expenses as part of operating cost. Since the TPO has already made T.P Adjustment of Rs.207.42 crores under AMP expenses, he did not make separate addition of Rs.58.35 crores with the rider that if the AMP adjustment is reduced or deleted on appeal at a later stage, then this adjustment requires to be revived.
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 3 of 52
The Tribunal, vide its order dated 10-05-2019 (referred above) had deleted the Transfer pricing adjustment of Rs.207.42 crores made under AMP expenses. Hence, as per the order of TPO, the TP adjustment of Rs.58.35 crores shall revive. The assessee had challenged this alternative adjustment in ground nos.32 to 41, which were not disposed of initially in the common order dated 10- 05-2019. Hence the said grounds are being adjudicated now.
As noticed earlier, the assessee had incurred AMP expenses and part of the same was reimbursed by its AE. The TPO, however, took the view that the assessee’s AMP expenditure is more than the average amount spent by other comparable companies and accordingly made adjustment of Rs.207.42 crores out of AMP expenses incurred by the assessee. The assessee had benchmarked its trading segment by adopting “Resale Price Method” as the most appropriate method. The TPO, however, took the view that the “Resale Price Method” is not appropriate method on the reasoning that the assessee is not mere distributor, but is doing added services in the form of protecting trademark of AE in India by incurring advertisement and marketing expenses. The observations made by the TPO are extracted below, for the sake of convenience:-
“The taxpayer is doing added services apart from activity of a mere distributor by protecting trademarks of the AE in India, incurring advertising and marketing expenses, promoting the sale of goods of the AE, using the brand of the AE thereby increasing the visibility of AEs brand, keeping the AE informed of the market conditions thereby providing market support
IT(TP)A No.2837 /Bang/201 /Bang/2017& IT(TP)A No.3391/Bang/201 /Bang/2018 services, etc. The taxpayer, in the distribution(trading) c. The taxpayer, in the distribution(trading) c. The taxpayer, in the distribution(trading) segment, has not confined itself just to distribution of trading segment, has not confined itself just to distribution of trading segment, has not confined itself just to distribution of trading goods but has performed additional functions as mentioned goods but has performed additional functions as mentioned goods but has performed additional functions as mentioned above. Therefore, the company needs to be adequately above. Therefore, the company needs to be adequately above. Therefore, the company needs to be adequately compensated for such additional fu compensated for such additional functions undertaken by it. In nctions undertaken by it. In such circumstances, without considering these functions such circumstances, without considering these functions such circumstances, without considering these functions performed by the assessee company, it is not right to conclude performed by the assessee company, it is not right to conclude performed by the assessee company, it is not right to conclude that the transactions are at Arm's length just by comparing the that the transactions are at Arm's length just by comparing the that the transactions are at Arm's length just by comparing the gross gross margin earned by gross margin earned by margin earned by the assessee company. The the assessee company. the assessee company. expenditure relating to the additional function carried out by expenditure relating to the additional function carried out by expenditure relating to the additional function carried out by the assessee in the form of the AMP are not reflected in the assessee in the form of the AMP are not reflected in the assessee in the form of the AMP are not reflected in computing the gross margin as they are captured below the computing the gross margin as they are captured below the computing the gross margin as they are captured below the line. Therefore, line. Therefore, the gross margin analysis carried out by the gross margin analysis carried out by the assessee is the assessee is flawed.
6.1.3. Perusal of the profit and loss account of the 6.1.3. Perusal of the profit and loss account of the 6.1.3. Perusal of the profit and loss account of the taxpayer it is seen that, the taxpayer has incurred huge taxpayer it is seen that, the taxpayer has incurred huge taxpayer it is seen that, the taxpayer has incurred huge expenditure towards advertisement, marketing and expenditure towards advertisement, marketing and expenditure towards advertisement, marketing and sales promotion as below: sales promotion as below: .
IT(TP)A No.2837 /Bang/201 /Bang/2017& IT(TP)A No.3391/Bang/201 /Bang/2018
6.14. The taxpayer has performed certain value added 6.14. The taxpayer has performed certain value added 6.14. The taxpayer has performed certain value added functions which a routine trader/ manufacturer would tions which a routine trader/ manufacturer would tions which a routine trader/ manufacturer would not have performed, if the taxpayer had been a routine not have performed, if the taxpayer had been a routine not have performed, if the taxpayer had been a routine trader/ manufacturer, like any other routine trader / trader/ manufacturer, like any other routine trader / trader/ manufacturer, like any other routine trader / manufacturer considered as a comparable in the TP manufacturer considered as a comparable in the TP manufacturer considered as a comparable in the TP study, the assessee should have made profit on s study, the assessee should have made profit on sale of ale of goods. But in case of the assessee, it is observed But in case of the assessee, it is observed But in case of the assessee, it is observed that there is net loss in the trading business. The that there is net loss in the trading business. The that there is net loss in the trading business. The Net operating loss during the year as shown in the Net operating loss during the year as shown in the Net operating loss during the year as shown in the P&L a/c is Rs.(300,200,451).The tax payer been P&L a/c is Rs.(300,200,451).The tax payer been P&L a/c is Rs.(300,200,451).The tax payer been making losses or opearating on a wafer making losses or opearating on a wafer-thin ove thin over a period of time. Deatails of the operating result of period of time. Deatails of the operating result of period of time. Deatails of the operating result of the trading segment last 3 years is as under. the trading segment last 3 years is as under.
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From the above table, it can be seen that the taxpayer's losses From the above table, it can be seen that the taxpayer's losses From the above table, it can be seen that the taxpayer's losses have been increasing over a period of time. A routine trader have been increasing over a period of time. A routine trader have been increasing over a period of time. A routine trader would not incur would not incur tosses in the above manner year after year. tosses in the above manner year after year.
6.1.5. In the case of the taxpayer, it is necessary to look below 6.1.5. In the case of the taxpayer, it is necessary to look below 6.1.5. In the case of the taxpayer, it is necessary to look below the gross margin level to understand why in trading segment, the gross margin level to understand why in trading segment, the gross margin level to understand why in trading segment, the assessee is incurring such huge losses. It is obvious that the assessee is incurring such huge losses. It is obvious that the assessee is incurring such huge losses. It is obvious that there are many functi there are many functions which the assessee performs which ons which the assessee performs which are not suitably compensated by the assessee's AE. It is also are not suitably compensated by the assessee's AE. It is also are not suitably compensated by the assessee's AE. It is also evident that, the functions performed by the assessee and their evident that, the functions performed by the assessee and their evident that, the functions performed by the assessee and their reflection, in Profit Moss Account in terms of revenue reflection, in Profit Moss Account in terms of revenue reflection, in Profit Moss Account in terms of revenue expenditure, are spread across the en expenditure, are spread across the entire P&L Account. This tire P&L Account. This impact cannot be captured if one confines himself to the impact cannot be captured if one confines himself to the impact cannot be captured if one confines himself to the comparison at the gross margin level. comparison at the gross margin level.
6.1.6. Where the taxpayer engages in high intensity of DEMPE 6.1.6. Where the taxpayer engages in high intensity of DEMPE 6.1.6. Where the taxpayer engages in high intensity of DEMPE functions (Developing, Enhancing, Maintaining, Protecting and functions (Developing, Enhancing, Maintaining, Protecting and functions (Developing, Enhancing, Maintaining, Protecting and Exploiting the marketing intangibles), RPM may not be a e marketing intangibles), RPM may not be a e marketing intangibles), RPM may not be a IT(TP)A No.2837 /Bang/201 /Bang/2017& IT(TP)A No.3391/Bang/201 /Bang/2018 suitable method for benchmarking the international transaction suitable method for benchmarking the international transaction suitable method for benchmarking the international transaction of purchase and distribution of finished goods. The Hon'ble of purchase and distribution of finished goods. The Hon'ble of purchase and distribution of finished goods. The Hon'ble High Court of Delhi examined the applicability of resale price High Court of Delhi examined the applicability of resale price High Court of Delhi examined the applicability of resale price method in the context of AM method in the context of AMP dispute in paragraphs 157 to 168 P dispute in paragraphs 157 to 168 of their order in the case of Sony Ericsson (ITA 16/2014). In of their order in the case of Sony Ericsson (ITA 16/2014). In of their order in the case of Sony Ericsson (ITA 16/2014). In cases where the taxpayer adds substantial value to the resale cases where the taxpayer adds substantial value to the resale cases where the taxpayer adds substantial value to the resale transaction through substantial AMP expenditure, the Hon'ble transaction through substantial AMP expenditure, the Hon'ble transaction through substantial AMP expenditure, the Hon'ble Court has observed that RPM can be u Court has observed that RPM can be used as the most sed as the most appropriate method only if the comparables are also carrying appropriate method only if the comparables are also carrying appropriate method only if the comparables are also carrying out similar level of AMP functions. out similar level of AMP functions.
The taxpayer has selected a set of The taxpayer has selected a set of 6 uncontrolled comparables uncontrolled comparables for comparability analysis under RPM. It is seen that the ratio for comparability analysis under RPM. It is seen that the ratio for comparability analysis under RPM. It is seen that the ratio of AMP expenditure to Sales incurred by the comparable of AMP expenditure to Sales incurred by the comparable of AMP expenditure to Sales incurred by the comparable companies selected by the taxpayer, is much lower than the companies selected by the taxpayer, is much lower than the companies selected by the taxpayer, is much lower than the ratio of AMP expenditure to Sales, incurred by the t ratio of AMP expenditure to Sales, incurred by the taxpayer. axpayer.
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Following the decision of the Hon'ble Delhi High Court Following the decision of the Hon'ble Delhi High Court Following the decision of the Hon'ble Delhi High Court in the case of MIs. Sony Ericsson (Supra), since the in the case of MIs. Sony Ericsson (Supra), since the in the case of MIs. Sony Ericsson (Supra), since the comparables used by the taxpayer have much lower comparables used by the taxpayer have much lower comparables used by the taxpayer have much lower "AMP" spend than the taxpayer, RPM as a method for "AMP" spend than the taxpayer, RPM as a method for "AMP" spend than the taxpayer, RPM as a method for benchmarking analysis is not s benchmarking analysis is not suitable.
6.1.7. It is clear that in this case, the taxpayer has 6.1.7. It is clear that in this case, the taxpayer has 6.1.7. It is clear that in this case, the taxpayer has taken up additional functions, for which it has not been taken up additional functions, for which it has not been taken up additional functions, for which it has not been suitably compensated resulting in loss. The RPM can be suitably compensated resulting in loss. The RPM can be suitably compensated resulting in loss. The RPM can be applied to the taxpayers who are engaged in pure applied to the taxpayers who are engaged in pure applied to the taxpayers who are engaged in pure trading activity of buying trading activity of buying and selling. Hence, in the case Hence, in the case of the taxpayer, RPM is not the correct method for of the taxpayer, RPM is not the correct method for of the taxpayer, RPM is not the correct method for determination of ALP and the TPO proposes to apply determination of ALP and the TPO proposes to apply determination of ALP and the TPO proposes to apply TNMM for this purpose. TNMM for this purpose.”
The assessee strongly objected to the proposal of the TPO The assessee strongly objected to the proposal of the TPO The assessee strongly objected to the proposal of the TPO to adopt TNMM as most appropriate method. The main to adopt TNMM as most appropriate method. The main to adopt TNMM as most appropriate method. The main contention of the assessee was that the “trade discounts and contention of the assessee was that the “trade discounts and contention of the assessee was that the “trade discounts and IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 9 of 52 sale commission and scheme discount expenses incurred by the Assessee are in the nature of product selling expenses and cannot be considered as incurred for the purpose of promotion of brand of the AE and hence the same should not be considered to be in the nature of brand advertisement and promotion as they in no way result in brand promotion. However, the TPO did not accept the contentions of the assessee and accordingly rejected the same with the following observations:- “As explained above, the tax payer’s submission concentrates on why the AMP expenditure should not be separately benchmarked. It has been accepted by the tax payer that functions in the nature of advertisement, marketing and sales promotion are undertaken to sell the goods in India. The argument of the tax payer is that such functions are not carried out at the behest of its Associated Enterprises, but in its own interest for increasing the volume of sales and consequently the volume of profits. When functions in the nature of sales promotion, advertisement and marketing are undertaken, benchmarking the transactions in the trading segment at gross level using RPM method cannot be accepted. The correct profits to be compared are the profits at the net level. Therefore, Transaction Net Margin Method (TNMM) is selected as the Most Appropriate Method.”
Accordingly, the TPO selected Profit Level Indicator (PLI) as OP/OR. The TPO computed PLI of the assessee (by including
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 10 of 52 the AMP expenses as part of operating cost) at (-) 1.58%. The average PLI of the comparable companies was worked out at 1.49%. Accordingly, the TPO made adjustment of RS.58.35 crores. As stated earlier, no separate addition was made by the TPO, as telescoped this adjustment against the adjustment of AMP expenses made by him. Since the Tribunal has deleted the adjustment made towards AMP expenses, this addition shall revive. The Ld DRP also confirmed the addition.
The dispute here is about the method to be adopted for benchmarking the trading transactions. According to the assessee the Resale Price Method is the most appropriate method, while the TPO has held that the TNMM is the most appropriate method.
The Ld A.R submitted that the assessee is importing the computer and other items and sells them in India. He submitted that the TPO has taken the view that the AMP expenses incurred by the assessee constitutes value addition, which is misconceived. He submitted that the assessee is incurring AMP expenses for its own purposes for the purpose of increasing expenses and major portion of AMP expenses consists of trade discounts, sales commission and scheme discounts. Accordingly he submitted that the TPO was not justified in holding those expenses as representing value addition items. Accordingly he submitted that the “Resale Price Method” is most appropriate method for the trading
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 11 of 52 operations undertaken by the assessee. In support of his contentions, he placed reliance on the following case law:- (a) M/s Celio Future Fashion P Ltd (ITA No.1928/Mum/2016) (b) M/s Videojet Technologies (I) P Ltd (ITA No.6956/Mum/2012) (c) M/s A.O.Smith India Water Heating P Ltd (ITA No.176/Bang/2015)
On the contrary, the Ld D.R strongly placed his reliance on the order passed by Ld DRP/TPO.
9. We heard the parties on this issue and perused the record. The details of AMP expenses incurred by the assessee have been extracted by TPO at page 24 of his order as under:-
- Sales Promotion and Advertisement - 39,94,28,670 Sales and Trade discounts 38,20,32,185 Sales Commission - 10,12,89,783 Scheme Discounts - 116,43,10,673 -------------------- Total - 204,70,61,311 ============= It can be noticed that the actual advertisement and Sales promotion expenses incurred by the assessee was Rs.39.94 crores, which constitute 19.5% of the total expenses incurred under this head. The remaining expenses represent discounts, commission etc given to the distributors. The total turnover achieved by the IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 12 of 52 assessee for the year under consideration was 2892 crores and the actual sales promotion and advertisement expenses constitute only 1.38% of the total sales. In view of the above, it was contended that the opinion expressed by the TPO that the assessee is protecting trademarks of the AE in India, is not correct. The view of the TPO, however, is that the assessee was wantonly incurring operating loss in its trading business only by incurring excessive AMP expenses and the same results in protection of trademark of AE.
In our considered view, the view so entertained by TPO is based on surmises and conjectures. He has merely relied upon the fact that the assessee was making losses in its trading segment. We notice that the AO has not brought any material on record to support his view. There is no dispute with regard to the fact that the assessee does not make any value addition to the products imported by it from its AE. When there is no value addition and the imported products are sold as it is, then “Resale Price method” is held to be most appropriate method in the cases relied upon by Ld A.R. In the case of M/s Celio Future Fashion P Ltd (supra), the Mumbai bench of Tribunal held so by following the decision rendered by Delhi bench of Tribunal in the case of Burberry India P Ltd (ITA No.758 & 7684/Del/2017 dated 22.06.2018). Identical issue was considered by the Bangalore bench of Tribunal in the case of M/s A.O.Smith India Water Heating P Ltd (supra), wherein the Tribunal, after considering various case laws on the matter, held that the RPM is the most appropriate method in case of a distributor of products. For the sake of convenience, we extract
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 13 of 52 below the relevant observations made by the Tribunal in the case of A.O Smith India Water Heating P Ltd (supra):-
14. Now the assessee is before us with the submission that it is an accepted principle that the computation of ALP based on a direct method like RPM, which tests the results at gross level unlike the TNMM which tests the results at net level, extinguishes the requirement o making adjustment in relation to the difference in operating expenses, which could be different from enterprise to enterprise. It was further contended that as provided in Rule l0B, under RPM price of international transaction needs to be computed on the basis of gross profit margin earned in uncontrolled transactions, while under TNMM price of international transaction is computed on the basis of net profit margin of uncontrolled transactions. As per Rule 100(1), the most appropriate method for determining the ALP depends upon the facts and circumstances of each case. Similarly, the operating expenses incurred by the assessee is different from the operating expenses incurred by comparable companies. The learned counsel for the assessee has highlighted that I incurs certain expenses which does not affect sale/purchase price of the goods sold. Therefore, in a situation where incurrence of item expenses affects only the net profit of the entity without corresponding effect of gross profit or price of IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 14 of 52
transactions, the TNMM will not provide the most reliable arms length results. The selection of TNMM would require making reliable adjustment to arrive at the operating profit i.e., adjustment for expenditure incurred in the current year, the benefit of which will be received in the future year. In the absence of reliable adjustment, the selection of TNMM will not result in arriving at the ALP of the international transaction. In transactions method like RPM or Cost Plus method, the effect of these factors may be eliminated as natural consequences of insisting upon greater product of function similarity. Depending upon the facts and circumstances of the case and particular on the effect of functional differences on the cost structure and the revenue of the potential comparables, the net profit indicators can be less sensitive than the gross margin to the difference in the extent of complexity of function and difference in the level of risk.
15. It was further contended that comparability should not be interpreted in isolation because of the conditions and circumstances of the controlled transactions should be taken into consideration while comparing the net margin. Under the facts and circumstances of the assessee, the net margin comparability is more volatile than the gross margin comparable. In the light of the facts, it was contended
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 15 of 52 that if the cost structure is such that costs are effecting in net profit directly without affecting the price or gross margin, then there can be no two opinions that RPM should be preferred over the TNMM method. In support of these contentions, he placed reliance upon the following judgments-.-
(1) Horiba India Pvt. Ltd., v. OCIT, 81 taxmann.com 209 (2) Bose Corporation Pvt. Ltd., v. ACIT, Circle 3(1), New Delhi, 77 taxmann.com 194 (3) ITO v. L'Oreal India Pvt. Ltd., (2015) 24 taxmann.corn 192 (Born) (4) Mattel Toys India Pvt. Ltd., v. DOlT in ITA No.2476/Mum/2008.
The Id. DR placed reliance upon the order of the AO and the DRP.
Having heard the rival submissions and from a careful perusal of the record, we find that undisputedly the assessee is a trading company and carries out distribution and marketing of products of AOS group in India. It imports water filters from AO Smith China and sells them in India. AO Smith India is, according to the TP document, a distributor of AOS Water Heaters in India. The Tribunal has examined the most
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 16 of 52 appropriate method in the case of distributor to determine the ALP for the international transactions. In the case of Horiba India Pvt. Ltd. (supra), the Tribunal has held that in the case of a distributor where the goods are purchased from the AE and resold to other independent entities without any value addition, then the resale price method should be reckoned as most appropriate method. One of the main reason given by the TPO as well as the DRP is that the assessee is full fledged/full risk distributor and performing host of functions, therefore RPM should not be taken as the most appropriate method, because all these functions require huge cost which may not represent the gross profit margin. This contention of the revenue was rejected by the Tribunal and it was held that in comparable controlled transaction scenario, a normal distributor will undertake all kinds of functions which are related to sales of the product. The things like market research, sales & marketing, warehousing, controlled quality and also risks like market risk, credit risk, etc. are undertaken by any distributor for the sale of the products. The Tribunal further held that what is important to see is whether there is any value addition or not on the cost purchased for resale. If there is no value addition to the finished goods purchased from the AE are sold in the market as it is, then gross profit margin earned on such transactions become
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 17 of 52 determining factor to analyse the gross compensation after the cost of sales. Accordingly the Tribunal held that the RPM is the most appropriate method.
17. Similarly, in the case of Bose Corporation Pvt. Ltd. v ACIT (supra), the assessee company was engaged in the business of distribution of sound and audio assistant for individual customers and public places. It was a wholly owned subsidiary of Bose Corporation, USA. During the relevant year, assessee purchased furnished goods from its AE and resold the same in India to unconnected parties. The assessee adopted resale price method (RPM) as most appropriate method (MAM) for determining the ALP of the said international transactions. The profit level indication (PLI) adopted by the assessee was gross profit/sale and the assessee has made itself tested party for the purpose of international transactions. The TPO rejected the transfer pricing study of the assessee and opined that transactional net margin method was to be applied for determining ALP of international transactions under question. While determining the issue as to which is the most appropriate method in case of distributor, the Tribunal has held that the resale price method (RPM) is the most appropriate method and directed the TPO to calculate margin of the comparables by using RMP.
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The relevant observation of the Tribunal is extracted hereunder for the sake of reference: “8.1 At this juncture, we note the mandate of Rule 10C which defines the 'Most appropriate method'. Sub-rule (1) of Rule 10C states that: "For the purposes of sub- section (1) of section 92C, the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction, and which provides the most reliable measure of an arm's length in relation to the international transaction." Sub-rule (2) of Rule 10C lists certain factors which should be taken into account in selecting the most appropriate method as specified in sub-rule (1). These factors, inter olio, include ©, the availability coverage and reliability of data necessary application of the method'; and (d) the degree of comparability existing between the international transaction and the uncontrolled transaction...........’ 8.2 An overview of the factors prescribed for choosing the most appropriate method indicates that firstly, the data necessary for application of the given method should be available and secondly, the uncontrolled transactions should be functionally similar, if not identical. A company, in order to be ranked as comparable under the RPM, should preferably be engaged in doing similar activity as that of the assessee or at least of the some genus of the activity,
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 19 of 52 with a different product. The Ld. TPO himself has categorized the corn parables chosen by the assessee as traders akin to computer industry or engaged in trading of instruments. As the basic requirements under rule 10(c)(1) are fulfilled by these corn parables and that the Ld. TPO has not brought on record any evidence to prove material difference between the assessee and the corn parables so selected, we direct the Ld. TPO to calculate the margin of the comparables by using RPM."
18. In the case of CIT Vs. L'Oreal India Pvt. Ltd., similar dispute was raised before the Hon'ble High Court of Bombay. In that case, assessee had business in 2 segments viz., manufacturing and distribution, In respect of business of distribution, the TPO suggested transfer pricing adjustment by applying the TNMM and rejected the resale price method (RPM) adopted by the assessee because the TPO found that assessee was incurring loss consistently and hence the price police was not at arm's length. The Hon'ble High Court, having examined all aspects have finally concluded that RPM is the most appropriate method. The relevant observation of the Hon'ble High Court is extracted hereunder for the sake of reference: “7. After having perused the relevant part of the order passed by the Commissioner and this Tribunal on this question, we are in agreement with Mr.
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Pardiwalla that the Tribunal did not commit any error of law apparent on the face of the record nor can the findings can be said to be perverse. The Tribunal has found that the TPO has passed an order earlier accepting this method. The Tribunal has noted in para 19 of the order under challenge that this method is one of the standard method and the OECD (Organization of Economic Commercial Development) guidelines also state in case of distribution or marketing activities when the goods are purchased from associated entities and there are soles effected to unrelated parties without any further processing, then, this method can be adopted. The findings of fact are based on the materials which have been produced before the Commissioner as also the Tribunal. Further, it was highlighted before the Commissioner as also the Tribunal that the RPM has been accepted by the TPO in the preceding as well as succeeding assessment years. That is in respect of distribution segment activity of the Assessee. In such circumstances, and when no distinguishing features were noted by the Tribunal, it did not commit any error in allowing the Assessee's Appeal. Such findings do not raise any substantial question of law. The Appeal is devoid of merits and is, therefore, dismissed. There would be no orders as to costs."
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Copy of the order of the Tribunal in the case of L'Oreal India Pvt. Ltd., is also placed on record to demonstrate as to under what circumstances the RPM was considered to be most appropriate method. Similarly, in the case of Mettal Toys India Pvt. Ltd., v. DCIT (supra), the Tribunal again reaffirmed its view that in the case of distributor, the RPM is the most appropriate method by holding that ultimate aim of the transfer pricing is to examine whether price of the margin arising from the international transactions with a related party is at ALP or not. The determination of the approximate ALP is a key factor for which most appropriate method is to be followed. Therefore, if at any stage of the proceedings, it is found that by adopting one of the prescribed method other than choosing earlier, the most appropriate ALP can be determined, the assessng authorities as well as the appellate authorities should take into consideration such a plea raised before them provided it is demonstrated as to how a change in the method will produce better or more appropriate ALP on the facts of the case. The Tribunal accordingly rejected the contention of the Revenue and directed the TPO to adopt RPM instead of TNMM for computing the ALP.
Turning to the facts of the case, we find that undisputedly, assessee is a distributor of AO Smith China which is involved in the manufacture of water
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 22 of 52 heaters and sells the water heater imported from AO Smith China in India without making any value addition to the product. in a similar type of case, it has been repeatedly held by the Tribunal and the Hon'ble High Court of Bombay that in case of distributor, whether the product is being sold to the uncontrolled entities without making any value addition RPM is the most appropriate method and should be preferred over TNMM. Accordingly, we set aside the order of the AO, passed consequent to the direction of the DRP in this regard and direct the AOITPO to adopt the RPM as the most appropriate method.”
11. Since the facts are identical in this case, we hold that the Resale Price Method is most appropriate method in the facts and circumstances of the present case. Accordingly we direct the AO/TPO to adopt Resale Price Method as most appropriate method and determine the ALP of the transactions accordingly. ASSESSMENT YEAR 2014-15 12. We shall now take up the appeal filed by the assessee for assessment year 2014-15. The grounds urged by the assessee give rise to following two issues:- (a) Validity of Transfer pricing adjustment made in respect of AMP expenses. (b) Validity of Transfer pricing adjustment made in respect of Trading segment by changing the method of benchmarking.
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 23 of 52
The first issue relates to the Transfer pricing adjustment made in respect of AMP expenses. In this year also, the assessee had incurred Sales promotion and advertisement expenses and the same was partially reimbursed by the AE of the assessee. The TPO took the view, as taken in the earlier years, that the assessee has performed value added fuctions, which would not have been done by a routine trader. Accordingly he took the view that the assessee is promoting the brand value of its AE through the AMP expenses. Accordingly, by comparing the average AMP expenses incurred by other comparable companies, the TPO made an adjustment of Rs.227.79 crores.
The second issue relates to the Transfer Pricing adjustment made in respect of trading segment. As in AY 2013-14, the TPO rejected the “Resale Price Method” (RPM) adopted by the assessee to bench mark its trading segment on the reasoning that the AMP expenses should also be included in the cost, as the assessee is, in effect, making value addition to the brand of its AE by incurring AMP expenses. Accordingly the TPO adopted TNMM method as most appropriate method and made an adjustment of Rs.42.96 crores. However, he did not make any addition in this regard by holding that this addition is not warranted, since T.P adjustment has been made in respect of AMP expenses. The TPO also observed that, if the TP adjustments made in respect of AMP expenses is deleted or reduced in the appeal at a later stage, the T.P adjustment of Rs.42.96 crores made in respect of trading/distribution segment requires to be revived.
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 24 of 52
The Ld A.R submitted that the first issue relating to Transfer Pricing adjustment in respect of AMP expenses was considered by this bench in AY 2012-13 in the assessee’s own case in IT(TP)A No.502/Bang/2017, wherein, following the decision rendered by Hon'ble Delhi High Court in the case of Maruti Suzuki Ltd (381 ITR 117) and the decision rendered by Delhi bench of Tribunal in the case of L G Electronics India P Ltd (ITA No.6253/Del/2012 dated 14-01-2019), it was held that, in the absence of revenue showing that there existed any international transaction in respect of AMP expenses, the AO/TPO was not justified in making T.P adjustment on account of AMP expenses.
16. We heard Ld D.R on this issue and perused the record. As submitted by the Counsel for the assessee, an identical issue has been considered by this bench in the assessee’s own case in AY 2012-13 (supra) and the operative portion of the order is extracted below, for the sake of convenience:-
“20. We heard rival contentions on this issue and perused the record. The Hon’ble Delhi High Court has held in the case of Maruti Suzuki Ltd (supra) that the revenue needs to establish the existence of international transaction before undertaking benchmarking of AMP expenses. In the instant case, we notice that the TPO has entertained the belief on the basis of presumptions that the assessee’s AMP expenses have promoted the brand value of its AE, i.e., no material has been brought on record to show the existence of International transaction.
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Before us, the Ld A.R placed his reliance on various case laws. We notice that the decision rendered by Delhi bench of ITAT in the case of L.G. Electronics India P Ltd vs. ACIT (ITA No.6253/DEL/2012 dated 14-01-2019) is applicable to the facts of the present case, wherein also identical T.P adjustment had been made. For the sake of convenience, we extract below the relevant observations made and decision taken by the Delhi bench of Tribunal:-
“8. The TPO observed that since AMP expenses incurred by the assessee as percentage of sales was more than similar percentage for comparable companies, the assessee had incurred such AMP expenditure on brand promotion and development of marketing intangibles for the AE. The TPO further added a mark-up of 15%, which was subsequently reduced to 12.5% by the DRP and, accordingly, adjustment of Rs. 2,64,96,17,750/- was made, which was computed as under:
Computation of TP adjustment Rs. Value of sales 8605,67,65,713 AMP/Sales of the comparables 4.93% Arms Length Price (as per Bright Line) 424,25,98,549 Expenditure on AMP by the appellant 689,60,79,670 Expenditure in excess of bright line 265,34,81,121 Mark-up at 12.5% on excessive AMP as 33,16,85,139 per DRP direction
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Reimbursement that appellant should 298,51,66,260 have received. Reimbursement that appellant has 33,55,48,510 received. Adjustment to assessee's income 264,96,17,750
Before us, the ld. AR has vehemently stated that the TPO has proceeded by inferring the expenses of international transaction by applying BLT by drawing support from the judgment of the Special Bench of the Tribunal in the case of assessee in ITA No. 5140/DEL/2011.
10. At the outset, we have to state that the Hon'ble High Court of Delhi in the case of Sony Ericsson Mobile Communications India Pvt Ltd vs CIT 374 ITR 118 has discarded the BLT. The Hon'ble High Court, at para 120 held as under:
"120. Notwithstanding the above position, the argument of the Revenue goes beyond adequate and fair compensation and the ratio of the majority decision mandates that in each case where an Indian subsidiary of a foreign AE incurs AMP expenditure should be subjected to the bright line test on the basis of comparables mentioned in paragraph 17.4. Any excess expenditure beyond the bright line should be regarded as a separate international transaction of brand building. Such a broad-brush
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 27 of 52 universal approach is unwarranted and would amount to judicial legislation. During the course of arguments, it was accepted by the Revenue that the TPOs/Assessing Officers have universally applied bright line test to decipher and compute value of international transaction and thereafter applied Cost Plus Method or Cost Method to compute the arm's length price. The said approach is not mandated and stipulated in the Act or the Rules. The list of parameters for ascertaining the comparables for applying bright line test in paragraph 17.4 and, thereafter, the assertion in paragraph 17.6 that comparison can be only made by choosing comparable of domestic cases not using any foreign brand, is contrary to the Rules. It amounts to writing and prescribing a mandatory procedure or test which is not stipulated in the Act or the Rules. This is beyond what the statute in Chapter X postulates. Rules also do not so stipulate."
Respectfully following the judgment of the Hon'ble High Court of Delhi [supra], we hold that BLT has no mandate under the Act and accordingly, the same cannot be resorted to for the purpose of ascertaining if there exists an international transaction of brand promotion services between the assessee and the AE.
In our considered opinion, while dealing with the issue of bench marking of AMP expenses, the Revenue needs to establish the existence of IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 28 of 52 international transaction before undertaking bench marking of AMP expenses and such transaction cannot be inferred merely on the basis of BLT. For this proposition, we draw support from the judgment of the Hon'ble Delhi High Court in the case of Maruti Suzuki India Ltd 381 ITR 117.
13. In this case, the Hon'ble High Court held that existence of an international transaction needs to be established de hors the Bright Line Test. The relevant finding of the Hon'ble High Court reads as under:
"43. Secondly, the cases which were disposed of by the judgment, i.e. of the three Assessees Canon, Reebok and Sony Ericsson were all of distributors of products manufactured by foreign AEs. The said Assessees were themselves not manufacturers. In any event, none of them appeared to have questioned the existence of an international transaction involving the concerned foreign AE. It was also not disputed that the said international transaction of incurring of AMP expenses could be made subject matter of transfer pricing adjustment in terms of Section 92 of the Act.
However, in the present appeals, the very existence of an international transaction is in issue. The specific case of MSIL is that the Revenue has failed to show the existence of any agreement, understanding or arrangement between MSIL and SMC regarding the AMP
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 29 of 52 spend of MSIL. It is pointed out that the BLT has been applied to the AMP spend by MSIL to (a) deduce the existence of an international transaction involving SMC and (b) to make a quantitative 'adjustment' to the ALP to the extent that the expenditure exceeds the expenditure by comparable entities. It is submitted that with the decision in Sony Ericsson having disapproved of BLT as a legitimate means of determining the ALP of an international transaction involving AMP expenses, the very basis of the Revenue's case is negated.
XXX
The result of the above discussion is that in the considered view of the Court the Revenue has failed to demonstrate the existence of an international transaction only on account of the quantum of AMP expenditure by MSIL. Secondly, the Court is of the view that the decision in Sony Ericsson holding that there is an international transaction as a result of the AMP expenses cannot be held to have answered the issue as far as the present Assessee MSIL is concerned since finding in Sony Ericsson to the above effect is in the context of those Assessees whose cases have been disposed of by that judgment and who did not dispute the existence of an international transaction regarding AMP expenses.
XXX
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 30 of 52
As far as clause (a) is concerned, SMC is a non- resident. It has, since 2002, a substantial share holding in MSIL and can, therefore, be construed to be a non-resident AE of MSIL. While it does have a number of 'transactions' with MSIL on the issue of licensing of IPRs, supply of raw materials, etc. the question remains whether it has any 'transaction' concerning the AMP expenditure. That brings us to clauses (b) and (c). They cannot be read disjunctively. Even if resort is had to the residuary part of clause (b) to contend that the AMP spend of MSIL is "any other transaction having a bearing" on its "profits, incomes or losses", for a 'transaction' there has to be two parties. Therefore for the purposes of the 'means' part of clause (b) and the 'includes' part of clause (c), the Revenue has to show that there exists an 'agreement' or 'arrangement' or 'understanding' between MSIL and SMC whereby MSIL is obliged to spend excessively on AMP in order to promote the brand of SMC. As far as the legislative intent is concerned, it is seen that certain transactions listed in the Explanation under clauses (i) (a) to (e) to Section 92B are described as 'international transaction'. This might be only an illustrative list, but significantly it does not list AMP spending as one such transaction.
The submission of the Revenue in this regard is: "The mere fact that the service or benefit has been provided by one party to the other would by itself constitute a transaction irrespective of whether the consideration for IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 31 of 52 the same has been paid or remains payable or there is a mutual agreement to not charge any compensation for the service or benefit." Even if the word 'transaction' is given its widest connotation, and need not involve any transfer of money or a written agreement as suggested by the Revenue, and even if resort is had to Section 92F (v) which defines 'transaction' to include 'arrangement', 'understanding' or 'action in concert', 'whether formal or in writing', it is still incumbent on the Revenue to show the existence of an 'understanding' or an 'arrangement' or 'action in concert' between MSIL and SMC as regards AMP spend for brand promotion. In other words, for both the 'means' part and the 'includes' part of Section 92B (1) what has to be definitely shown is the existence of transaction whereby MSIL has been obliged to incur AMP of a certain level for SMC for the purposes of promoting the brand of SMC.
XXX 68....................In other words, it emphasises that where the price is something other than what would be paid or charged by one entity from another in uncontrolled situations then that would be the ALP. The Court does not see this as a machinery provision particularly in light of the fact that the BLT has been expressly negatived by the Court in Sony Ericsson. Therefore, the existence of an IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 32 of 52 international transaction will have to be established de hors the BLT."
14. In the light of the aforesaid finding of the Hon'ble High Court, before embarking upon a benchmarking analysis, the Revenue needs to demonstrate on the basis of tangible material or evidence that there exists an international transaction between the assessee and the AE. Needless to mention, that the existence of such a transaction cannot be a matter of inference.
15. The Hon'ble Delhi High Court in case of Whirlpool of India Ltd vs DCIT 381 ITR 154 has held that there should be some tangible evidence on record to demonstrate that there exists an international transaction in relation with incurring of AMP expenses for development of brand owned by the AE. In our considered opinion, in the absence of such demonstration, there is no question of undertaking any benchmarking of AMP expenses. The relevant findings of the Hon'ble High Court in the case of Whirlpool of India Ltd [supra] read as under:
"32. Under Sections 92B to 92F, the pre-requisite for commencing the TP exercise is to show the existence of an international transaction. The next step is to determine the price of such transaction. The third step would be to determine the ALP by applying one of the five price discovery methods specified in Section 92C. The fourth step would be to compare the price of the transaction that IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 33 of 52 is shown to exist with that of the ALP and make the TP adjustment by substituting the ALP for the contract price. XXX
34. The TP adjustment is not expected to be made by deducing from the difference between the 'excessive' AMP expenditure incurred by the Assessee and the AMP expenditure of a comparable entity that an international transaction exists and then proceed to make the adjustment of the difference in order to determine the value of such AMP expenditure incurred for the AE.
It is for the above reason that the BLT has been rejected as a valid method for either determining the existence of international transaction or for the determination of ALP of such transaction. Although, under Section 92B read with Section 92F (v), an international transaction could include an arrangement, understanding or action in concert, this cannot be a matter of inference. There has to be some tangible evidence on record to show that two parties have "acted in concert".
XXX
The provisions under Chapter X do envisage a 'separate entity concept'. In other words, there cannot be a presumption that in the present case since WOIL is a subsidiary of Whirlpool USA, all the activities of WOIL are in fact dictated by Whirlpool USA. Merely because
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 34 of 52 Whirlpool USA has a financial interest, it cannot be presumed that AMP expense incurred by the WOIL are at the instance or on behalf of Whirlpool USA. There is merit in the contention of the Assessee that the initial onus is on the Revenue to demonstrate through some tangible material that the two parties acted in concert and further that there was an agreement to enter into an international transaction concerning AMP expenses.
XXX
It is in this context that it is submitted, and rightly, by the Assessee that there must be a machinery provision in the Act to bring an international transaction involving AMP expense under the tax radar. In the absence of any clear statutory provision giving guidance as to how the existence of an international transaction involving AMP expense, in the absence of an express agreement in that behalf, should be ascertained and further how the ALP of such a transaction should be ascertained, it cannot be left entirely to surmises and conjectures of the TPO.
XXX
For the aforementioned reasons, the Court is of the view that as far as the present appeals are concerned, the Revenue has been unable to demonstrate by some tangible material that there is an international transaction involving AMP expenses between WOIL and Whirlpool
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 35 of 52 USA. In the absence of that first step, the question of determining the ALP of such a transaction does not arise. In any event, in the absence of a machinery provision it would be hazardous for any TPO to proceed to determine the ALP of such a transaction since BLT has been negatived by this Court as a valid method of determining the existence of an international transaction and thereafter its ALP."
16. The case of the Revenue is that Indian subsidiary incurred certain expenses for the promotion of brands in India and for development of the Indian market and the creation of marketing intangibles in India which remain the functions of the parent company which is the entrepreneur. The brands are owned by the parent company. The Indian subsidiary only acts on behalf of the parent company. The Revenue alleges that eventual beneficiary of the acts of the Indian subsidiary is the parent company. Any benefit that may accrue to the Indian subsidiary is at best incidental to the entire exercise. This action of the Indian subsidiary amounts to rendering of a service to its foreign AE for which arm's length compensation was payable by foreign AE to its Indian subsidiary.
17. It is the say of the ld. DR that the functions carried out by the assessee are in the nature of development, enhancement, maintenance, protection and exploitation of IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 36 of 52 the relevant intangibles and thus, the assessee deserves compensation.
18. The case of the ld. DR is that the act of incurring of AMP expenses by the assessee is not a unilateral act and is an international transaction for following reasons:- i) Though, the AMP expenditure may be for the purpose of business of the assessee but it is in performance of function of market development for the brands and products of the AE that enhances the value of the marketing intangibles owned by the foreign AE, and hence there is a transaction of rendering of service of market development to the AE. ii) The short term benefit of the transaction accrues both to assessee and AE in terms of higher sales but long term benefit accrues only to the AE. iii) The benefit to the AE is not incidental but significant. Once, it is established that the act of incurring of AMP expenditure is not a unilateral act of the assessee; the AE needs to compensate the assessee for AMP expenses. iv) It is a fact that brands are valuable and even loss making enterprises having no real assets are purchased for substantial value for their brand and marketing intangibles.
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 37 of 52 v) The issue is not that of transfer of marketing intangibles to AE as the brands and marketing intangibles are already owned by the AE. The issue is that of addition in the value of marketing intangibles owned by the AE owing to the services of development of brand and markets by the assessee for the AE and that of compensation for rendering these services not provided unilaterally by the assessee.
19. We do not find any force in the aforesaid contentions of the ld. DR. As mentioned elsewhere, the Revenue needs to establish on the basis of some tangible material or evidence that there exists an international transaction of provisions of brand building service between the assessee and the AE. We find support from the decision of the Hon'ble Delhi High Court in the case of Honda Seil Power Products Ltd vs DCIT ITA No 346/2015.
20. The Hon'ble Delhi Court in its recent decision in the case of CIT vs Mary Kay Cosmetic Pvt Ltd (ITA No.1010/2018), too, dismissed the Revenue's appeal, following the law laid down in its earlier decision (supra) and held as under:
"We have examined the assessment order and do not find any good ground and reason given therein to treat advertisement and sales promotion expenses as a separate and independent international transaction and not to regard and treat the said activity as a function
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 38 of 52 performed by the respondent-assessee, who was engaged in marketing and distribution. Further, while segregating / debundling and treating advertisement and sales promotion as an independent and separate international transaction, the assessing officer did not apportion the operating profit/ income as declared and accepted in respect of the international transactions."
21. In our understanding of the facts and law, mere agreement or arrangement for allowing use of their brand name by the AE on products does not lead to an inference that there is an "action in concert" or the parties were acting together to incur higher expenditure on AMP in order to render a service of brand building. Such inference would be in the realm of assumption/surmise. In our considered opinion, for assumption of jurisdiction u/s 92 of the Act, the condition precedent is an international transaction has to exist in the first place. The TPO is not permitted to embark upon the bench marking analysis of allocating AMP expenses as attributed to the AE without there being an 'agreement' or 'arrangement' for incurring such AMP expenses.
The aforesaid view that existence of an international transaction is a sine qua non for invoking the transfer pricing provisions contained in Chapter X of the Act, can be further supported by analysis ofsection 92(1) of the Act, which seeks to benchmark income / expenditure arising
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 39 of 52 from an international transaction, having regard to the arm's length price. The income / expenditure must arise qua an international transaction, meaning thereby that the (i) income has accrued to the Indian tax payer under an international transaction entered into with an associated enterprise; or (ii) expenditure payable by the Indian enterprise has accrued / arisen under an international transaction with the foreign AE. The scheme of Chapter X of the Act is not to benchmark transactions between the Indian enterprise and unrelated third parties in India, where there is no income arising to the Indian enterprise from the foreign payee or there is no payment of expense by the Indian enterprise to the associated enterprise. Conversely, transfer pricing provisions enshrined in Chapter X of the Act do not seek to benchmark transactions between two Indian enterprises.
The Revenue further contends that the assessee is not an independent manufacturer but is manufacturing for the benefit of the group entities and his status is akin to that of a contract manufacturer. Hence AMP activity is not for the sole benefit of the assessee but for the group as a whole.
It is the say of the ld. DR that pricing regulations are to applied keeping in mind the overall scheme of the tax payer's business arrangement. The contention of the ld. DR can be summarized as under:
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 40 of 52 a) The assessee being part of a group is not completely independent in its pricing policies including price of raw material purchased from AE, payments in respect of copyrights and patents payable to the AE. Even their product pricing is not completely independent. Linder such circumstances, the benefits emanating from the AMP function cannot be enjoyed by the assessee alone. The assessee is not an independent manufacturer who takes all the risks and enjoys all the benefits of the functions performed by them. b) The assessee is not engaged only in manufacture. It is also engaged in distribution of goods by its own admission. In fact, the assessee has a dual function of manufacturer and distributor. In any case, given its distribution function, the assessee is covered by the judgement of Hon'ble Delhi High Court in M/s Sony Ericsson. c) The benefits to the AE from AMP function continue to be the same as in the case of distributor like increase in sale of raw material, components and spare parts, increase in dividend, and increase in copyright and patent payments apart from creation/enhancement of Brand value. Therefore, the argument advanced by the assessee would not have any bearing on the existence of 'international transaction' just because it is engaged in manufacture has not merit.
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 41 of 52
Considering the aforesaid contention of the Revenue, we are of the considered view that the Hon'ble High Court in the case of Maruti Suzuki India Ltd [supra] held that the findings of the Hon'ble High Court with regard to existence of international transaction was only with respect to the case of three limited risk distributors namely, Sony Ericsson, Canon and Reebok etc., wherein the existence of international transaction was admitted and not in dispute. The Court accordingly held that such findings in the case of Sony Ericsson cannot be applied to the case of the manufacturers.
The Hon'ble High Court held as under:
"43. Secondly, the cases which were disposed of by the Sony Ericsson judgment, i.e. of the three Assessees Canon, Reebok and Sony Ericsson were all of distributors of products manufactured by foreign AEs. The said Assessees were themselves not manufacturers. In any event, none of them appeared to have questioned the existence of an international transaction involving the concerned foreign AE. It was also not disputed that the said international transaction of incurring of AMP expenses could be made subject matter of transfer pricing adjustment in terms of Section 92 of the Act. XXX 45. Since none of the above issues that arise in the present appeals were contested by the Assessees who
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 42 of 52 appeals were decided in the Sony Ericsson case, it cannot be said that the decision in Sony Ericsson, to the extent it affirms the existence of an international transaction on account of the incurring of the AMP expenses, decided that issue in the appeals of MSIL as well."
At this stage, it would not be out of place to refer to para 6.38 of the OECD Transfer Pricing Guidelines which apply only to limited risk distributors and not to full risk manufacturers like the assessee. The said para from OECD TP Guidelines read as under:
"6.38 Where the distributor actually bears the cost of its marketing activities (i.e. there is no arrangement for the owner to reimburse the expenditures), the issue is the extent to which the distributor is able to share in the potential benefits from those activities. In general, in arm's length transactions the ability of a party that is not the legal owner of a marketing intangible to obtain the future benefits of marketing activities that increase the value of that intangible will depend principally on the substance of the rights of that party. For example, a distributor may have the ability to obtain benefits from its investments in developing the value of a trademark from its turnover and market share where it has a long-term contract of sole distribution rights for the trademarked product. In such cases, the distributor's share of benefits should be determined based on what an independent distributor
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 43 of 52 would obtain in comparable circumstances. In some cases, a distributor may bear extraordinary marketing expenditures beyond what an independent distributor with similar rights might incur for the benefit of its own distribution activities. An independent distributor in such a case might obtain an additional return from the owner of the trademark, perhaps through a decrease in the purchase price of the product or a reduction in royalty rate."
The Hon'ble High Court in the case of Sony Ericsson Mobile Communications India Pvt Ltd (supra) has further held that no transfer pricing adjustment in respect of AMP expenses can be made where the assessee (Indian entity) has economic ownership of the brand/logo/trademark in question, in the case of long term right of use of the same. This principle also squarely covers the present case. The assessee has a long term agreement for the use of the trademark 'LG' in India. This clearly evidences the fact that the economic benefit arising out of the alleged promotion of the AE's logo is being enjoyed by the assessee. There is a clear opportunity and reasonable anticipation for the assessee to benefit from the marketing activities undertaken by it. This is clearly evidenced by the significantly higher profits made by assessee compared to its industry peers and also the very sizeable year on year increase in its turnover. In view of the aforesaid, it is respectfully submitted that the economic
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 44 of 52 ownership of the trademark 'LG' rests with the assessee. The Hon'ble High Court in the case of Sony Ericsson Mobile Communications India Pvt Ltd (supra) disagreed with the finding of the Special Bench that the concept of economic ownership is not recognized under the Act. The relevant observations in paras 151 to 154 of the judgement are reproduced hereunder:
"151. Economic ownership of a trade name or trade mark is accepted in international taxation as one of the components or aspects for determining transfer pricing. Economic ownership would only arise in cases of long- term contracts and where there is no negative stipulation denying economic ownership. Economic ownership when pleaded can be accepted if it is proved by the assessed. The burden is on the assessed. It cannot be assumed. It would affect and have consequences, when there is transfer or termination of economic ownership of the brand or trademark.
Determination whether the arrangement is long-term with economic ownership or short-term should be ordinarily based upon the conditions existing at the start of the arrangement and not whether the contract is subsequently renewed. However, it is open to the party, i.e. the assessed, to place evidence including affirmation from the brand owner AE that at the start of the IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 45 of 52 arrangement it was accepted and agreed that the contract would be renewed.
Economic ownership of a brand is an intangible asset, just as legal ownership. Undifferentiated, economic ownership brand valuation is not done from moment to moment but would be mandated and required if the assessed is deprived, denied or transfers economic ownership. This can happen upon termination of the distribution-cum-marketing agreement or when economic ownership gets transferred to a third party. Transfer Pricing valuation, therefore, would be mandated at that time. The international transaction could then be made a subject matter of transfer pricing and subjected to tax.
Brand or trademark value is paid for, in case of sale of the brand or otherwise by way of merger or acquisition with third parties. .... ..... .....
Re-organisation, sale and transfer of a brand as a result of merger and acquisition or sale is not directly a subject matter of these appeals. As noted above, in a given case where the Indian AE claims economic ownership of the brand and is deprived or transfers the said economic ownership, consequences would flow and it may require transfer pricing assessment." (emphasis supplied)
As held by the Hon'ble Delhi High Court in the case of Sony Ericsson Mobile Communications (supra), if the IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 46 of 52 Indian entity is the economic owner of the brand and is incurring AMP expenses for the purpose of promotion of such brand, benefit is only received by the Indian entity. It was submitted that the economic ownership of the brand rests with the assessee and accordingly, the assessee cannot be expected to seek compensation for the expenditure incurred on the asset economically owned by it. No Transfer Pricing adjustment on account of AMP expenses would be warranted. The aforesaid test is fully satisfied in the case of the assessee and the Transfer Pricing adjustment on account of AMP expenses made by the TPO is liable to be deleted.
The assessee being a full-fledged manufacturer, entire AMP expenditure is incurred at its own discretion and for its own benefit for sale of LG products in India. In the case of the appellant, the advertisements are aimed at promoting the sales of the product sold under trademark 'LG' manufactured by the assessee and not towards promoting the brand name of the AE. In such circumstances, the alleged excess AMP expenditure does not result in an international transaction and the assessee cannot be expected to seek compensation for such expenses unilaterally incurred by it from the AE.
The Revenue has strongly objected for the aggregated bench marking analysis for the AMP. According to the Revenue, the assessee company has not been able to IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 47 of 52 demonstrate that there is any logic or rationale for aggregation or that the transactions of advertisement expenditure and the other transactions in the distribution activity are inter-dependent, the clubbing of transactions cannot be allowed. According to the Revenue, bench marking of AMP transaction is to be carried out using segregated approach and for determination of ALP of such transactions, Bright Line is used as the tool.
This contention of the Revenue is no more good as BLT has been discarded by the Hon'ble High Court of Delhi as mentioned elsewhere. The Hon'ble High Court of Delhi in the case of Sony Ericsson Mobile Communications India Pvt Ltd in Tax Appeal NO. 16 of 2014 has held that if the Indian entity has satisfied Transactional Net Margin Method (TNMM), i.e., as long as the operating margins of the Indian enterprise are higher than the operating margins of comparable companies, no further separate compensation for AMP expenses is warranted. The Hon'ble Court held 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
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 48 of 52 of the inter- linked transaction. This would be also in consonance with Rule 10B(1)(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 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 comparables 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."
Considering the aforementioned findings of the Hon'ble Jurisdictional High Court of Delhi In the case in hand, the operating profit margin of the assessee is at 5.01% in the manufacturing segment and 4.52% in the distribution segment and the same is higher than that of the comparable companies at 4.04% in the manufacturing segment and 4.46% in the distribution segment. TNMM has undisputedly been satisfied. Since the operating margins of the assessee are in excess of the selected comparable companies, no adjustment on account of AMP expenses is warranted.
IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 49 of 52
Considering the facts of the case in hand in totality, we are of the view that the Revenue has failed to demonstrate by bringing tangible material evidence on record to show that an international transaction does exist so far as AMP expenditure is concerned. Therefore, we hold that the incurring of expenditure in question does not give rise to any international transaction as per judicial discussion hereinabove and without prejudice to these findings, since the operating margins of the assessee are in excess of the selected comparable companies, no adjustment is warranted. Ground Nos. 3 to 3.34 of the assessee are allowed.”
We notice that the above said decision squarely applies to the facts of the present case. In his arguments, the Ld A.R also submitted that the economic ownership of brand lies in the hands of the assessee. As noticed earlier, the revenue has not shown that there existed any international transaction on account of incurring of AMP expenses. Accordingly, following the above said decision, we hold that the AO/TPO was not justified in making T.P adjustment on account of AMP expenses. Accordingly we hold that no adjustment needs to be done in respect of AMP expenses and accordingly delete the addition made by the AO in this regard.”
Since the facts are identical, following the decision rendered in AY 2012-13 in the assessee’s own case, we hold that no IT(TP)A No.2837 /Bang/2017& IT(TP)A No.3391/Bang/2018 Page 50 of 52 adjustment needs to be done in respect of AMP expenses and accordingly direct the AO to delete the impugned addition.
The second issue relates to the T.P adjustment made by the TPO in respect of trading/distribution segment. Identical issue was considered by us in AY 2013-14 in the preceding paragraphs and we have held that the RPM is the appropriate method in the facts of the present case. Following the said decision, we hold that the Resale Price Method is most appropriate method in the facts and circumstances of the present case. Accordingly we direct the AO/TPO to adopt Resale Price Method as most appropriate method and determine the ALP of the transactions accordingly.
19. In the result, the grounds relating to T.P adjustment of trading segment in AY 2013-14 are allowed. The appeal of AY 2014-15 is allowed.
Order pronounced in the open court on 5th March, 2020.