LOREAL INDIA P.LTD,MUMBAI vs. DCIT, CIRCLE 7(1)(2), MUMBAI

Appellant by: Shri Niraj Sheth, A.R Respondent by: Shri Anand Mohan, CIT D.R Date of Hearing : 09.07.2019 Date of Pronouncement: 23.08.2019 O R D E R

PER RAVISH SOOD, JM

15. November 2017 (received on 20. November 2017) under section 143(3) read with section 144C(13) of the Income-tax Act, 1961 ('the Act') [hereinafter referred to as 'the learned AO] in pursuance of the directions issued by the Hon‘ble Dispute Resolution Panel - 1, (hereinafter referred to as the ‗Hon‘ble DRP') on the following grounds, each of which are without prejudice to one another.

P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) On the facts and in the circumstances of the case and in law, learned AO/ Joint Commissioner of Income- tax, Transfer Pricing-3(1), Mumbai ('learned TPO') /Hon‘ble DRP on fact and in law has: Following grounds are without prejudice to each other: General

1. Erred in assessing the total income at Rs 401.38 crores as against Rs.46.65 crores computed by the Appellant. A. Adjustment on account of Advertisement, Marketing and Promotion ('AMP') expenses Presumption of fictitious transaction in the nature of 'provision of brand promotion services' 2. erred in making an adjustment in respect of AMP expenses of Rs 354.73 (Rs. 254.58 crore for the manufacturing segment and Rs. 100.05 crore for the distribution segment) alleging that the AMP expense incurred by the Appellant is an international transaction under Section 92B; 3. erred in ignoring that the Appellant has not rendered any service to the Associated Enterprises (AEs) and hence erroneously treating and categorizing AMP expenses incurred by the Appellant on its own behalf, as an international transaction between the Appellant and AEs under Section 92B of the Act; 4. erred in not appreciating that there is no arrangement whatsoever between the Appellant and its AEs for promotion of AEs brand by incurring AMP expenses on behalf of the AEs: 5. erred in concluding that the Appellant is engaged in performing development, enhancement, maintenance, protection or exploration (DEMPE') services which includes market development, value addition, creation of marketing intangibles etc and there is mutual agreement/ arrangement between the Appellant and its AE for discharging market development functions; 6. erred in alleging that the various information that were called for, were not submitted by the Appellant while treating the AMP expenses incurred by the Appellant as an international transaction; 7. erred in standing that no details have been submitted not giving cognizance to the fact that the appellant has provided the details.

8. Erred in overriding the charging provisions of the Sec.4 of the Act by the machinery provisions of Sec.92 of the Act to bring to tax fictional/assumed/hypothetical income/benefit; Business and commercial expediency 9. erred in holding that the Appellant incurred AMP expenses for promoting the brands owned by overseas AE, instead of appreciating that the Appellant was only carrying out its business by using the well- established brands and any benefit derived by the AE is purely incidental; Most appropriate method 10. erred in applying bright line test ('BLT‘) and treating the same as routine ALP determination method under ―Other Method‖ to determine the arm's length price of the AMP expenses incurred by the Appellant; P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) 11. without prejudice to the above, erred in not considering the profit level indicator of 'AMP adjusted gross profit' for benchmarking AMP transaction; Manufacturing segment - comparable set 12. without prejudice to the above, erred in assuming that the alleged AMP expenses incurred by the Appellant was in proportion to the net sales earned in respective segment, without requesting for such data/ information from the Appellant; 13. without prejudice to the above, erred in computing the BLT of the comparables as 10.41% instead of 11.28%; 14. without prejudice to the above, erred in rejecting the analysis submitted by the Appellant and not adopting a scientific search process to identify companies comparable to the Appellant's manufacturing segment for benchmarking of the AMP expenses and considering inappropriate comparables, not having similar product/ brand profile as the Appellant; Distribution segment - comparable set 15. without prejudice to the above, erred in assuming that the alleged AMP expenses incurred by the Appellant in its distribution segment was in proportion to the net sales earned in respective segment, without requesting for such data/ information from the Appellant; 16. without prejudice to the above, erred in computing the BLT of the comparables as 8.78% instead of 10.52%; Sales related expenses 17. without prejudice to the above, erred in holding that items of selling expenditure such as rent cost for window display, point of sales materials etc. amounting to Rs. 99.94 crores should be considered for making an adjustment without appreciating the fact that none of these expenses can in any way be considered as incurred for brand promotion but were for effecting sales for the Appellant; 18. Without prejudice to the above, erred in artificially bifurcating the advertisement and sales promotion expense of comparable companies in the ratio of Appellant's alleged advertisement and sales promotion expense (le 83.5:16.5), in case of comparable companies: Mark-up on AMP expenses 19. without prejudice to the above, erred in disregarding that even if the Appellant had to be compensated for the excessive AMP, in absence of any service element, the Appellant should be entitled to reimbursement of "actual" excessive AMP expenses incurred, rather than a mark-up on the same; 20. without prejudice to the above, erred in holding that the Appellant should have earned a mark-up of 16.90% on the alleged excessive AMP expenses in relation to manufacturing and distribution segment which are to be reimbursed to the Appellant without adopting a scientific search process to identify comparable companies: 21. without prejudice to the above, erred in computing mark-up over alleged excessive AMP expenses incurred without appreciating that addition if any, shall be commensurate with agency function, if any, undertaken by the Appellant; P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) B. Alternate Adjustment on manufacturing segment on account of payment of royalty for use of technical know-how and trademark 22. erred in making an arbitrary alternate adjustment of Rs 56.37 crores (Rs 34.20 crores for technical know- how and Rs 22.17 crores for trademark) in respect of payment of royalty to the AEs by the Appellant for use technical know-how and trademark; 23. erred in not accepting the benchmarking analysis undertaken by the Appellant using the Comparable Uncontrolled Price Method ('CUP'), wherein reliance was placed on a royalty benchmarking study undertaken by independent consultant - NERA Economic Consulting, in accordance with the provisions of the Act, read with the Rules, for the determination of arm's length price of the aforesaid international transaction Payments made to AEs for use of technical know-how 24. erred in treating arm's length price of payment of royalty for use of technical know-how at an adhoc rate of 2.3% as against 5% paid by the Appellant: 25. erred in resorting to cherry picking of comparable agreements (out of 12 comparable agreements identified by the Appellant through a royalty benchmarking search undertaken) while allegedly determining the alleged arm's length comparable rate for payments made by the Appellant to its AE. for use of technical know-how; Payments made to AEs for use of trademark 26. erred in holding that the Appellant has carried out significant AMP expenses and thereby assuming Appellant being economic owner, no trademark royalty is payable by the Appellant. In holding the same, the learned AO/ TPO erred in determining the arm's length price for payment of trademark royalty as Nil vis-a-vis the actual payment of Rs. 22.17 crores made by the Appellant; 27. failed to appreciate that in absence of payment of trademark royalty as stipulated in the license agreement, the Appellant would not have the legal right to use the ‗L‘Oreal‘ Trademark; 28. erred in not using any of the method prescribed under section 920 of the Act for benchmarking the said international transaction of payment of trademark royalty and determining the arm's length price of royalty Alternate adjustment on the distribution segment - International transaction of import finished goods from AEs for resale 29. erred in making an arbitrary alternate adjustment amounting to Rs.60.03 crores to the distribution segment of the Appellant on account of alleged differences in intensity of AMP functions performed by the Appellant vis- a-vis the comparable companies to align the functions, assets and risks (FAR') profile of the Appellant with that of the comparable companies; 30. erred in rejecting the economic analysis undertaken by the Appellant by use of resale price method ('RPM') to benchmark the aforesaid transaction without giving an opportunity with regard to the proposed adjustment; 31. erred in holding that the Appellant incurred AMP expenses for promoting the brands owned by overseas AE. instead of appreciating that the Appellant was only carrying out its business by using the well- P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) established brand name of "L'Oreal" and any benefit derived by the AE is purely incidental: 32. based on the above assumptions (ie brand promotion for AE was undertaken by the Appellant on behalf of AE and that differences existed vis-a-vis FAR of comparable companies), erred in proposing use of adjusted RPM by calculating adjusted cost as the most appropriate method, to benchmark the said international transaction: 33. erred in disregarding the fact that intensity based comparability adjustment would result in re- characterization of the business of the Appellant; 34. without prejudice to the above, in an attempt to account for difference in intensity of AMP functions, erred in inadvertently making an adjustment based on the total 'General and Administrative Expenses' incurred by the comparable companies, instead of AMP expenses itself, as stated in the TP order; 35. without prejudice to the above, erred in applying adhoc markup for 16.90% (without providing any backup) to arrive at the adjusted sales for computation of margins of the comparable companies. 36. without prejudice to the above, erred in not providing the benefit of the variation/ reduction of 3 percent from the value of the international transaction as provided in proviso to section 920(2) of the Act, while determining the arm's length price; 37. without prejudice to the above, erred in not following Learned TPO's own approach in Appellant's own case for AY 2012-13 using which the alternate adjustment value would have been Rs. 33.89 crore as against Rs. 60.03 crore; 38. without prejudice to the above, erred in not considering the profit level indicator of 'AMP adjusted gross profit' under RPM: C. Levy of interest and initiation of penalty proceedings 39. erred in charging interest under section 234B, 2340, 234D of the Act; 40. erred in initiating penalty proceedings under section 271(1)(C). The appellant craves the leave to amend or alter any ground or add a new ground which may be necessary.‖ 2. Briefly stated, the assessee viz. L‘Oreal India Pvt. ltd. (hereinafter referred to as ‗L‘Oreal India‘) is a wholly owned subsidiary of L‘Oreal S.A. France (hereinafter referred to as ‗L‘Oreal France‘). The assessee had entered into a license agreement dated 02.01.2012 with L‘Oreal France, which was effective from 01.01.2012. As per the ‗agreement‘, the assessee was awarded the exclusive right to import, manufacture (or have manufactured by another L‘Oreal affiliate), market, distribute and sell branded products of L‘Oreal Group. The assessee has its own manufacturing facility at Chakan, Pune and derives its revenues from the professional products division, consumer products division and the active cosmetics division. The professional products division P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) consists of the high end premium products like L‘Oreal professional, whereas the consumer products division consists of the mid-market brands such as L‘Oreal Paris, Garnier, Maybelline etc. The major portion of the total sales revenue of the assessee is generated from its consumer products division.

3. The assessee company had e-filed its return of income for A.Y. 2013-14 on 29.11.2013, declaring its total income at Rs.46,65,64,620/-. The return of income filed by the assessee was processed as such under Sec.143(1) of the Act. Subsequently, the case of the assessee was selected for scrutiny assessment under Sec.143(2). The A.O in the course of the assessment proceedings made a reference to the Transfer Pricing Officer (for short ‗TPO‘) under Sec. 92CA(1) of the Act for determining the ‗Arm‘s Length Price‘ (for short ‗ALP‘) of the transactions between the assessee and its ‗associate enterprises‘ (for short ‗AEs‘).

4. The TPO in the course of the proceedings observed that the assessee company had entered into the following international transactions with its AEs which were reported to be arm‘s length in its Form 3CEB:

Nature of transaction Value of international transaction (Rs.) Import of raw material/packing material for 89,629,740/- manufacture of finished goods Export of raw material/packing material 1,29,554/- Import of finished goods for resale in India 980,077,220/- Export of finished goods manufactured by L‘Oreal 531,884,820/- India Rendering evaluation and technical testing services 567,680,621/- Royalty payments for use of technical know-how, 854,994,314/- brand name, trademark, etc. Availing international marketing support services 341,404,193/- Availing consultancy services 216,607,263/- P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2)

Import of fixed assets 12,009,395/- Reimbursements receivable 61,555,224/- Reimbursement payable 390,953,415/- The TPO proposed the following disallowances/additions to the returned income reported by the assessee:

International Transactions Amount disallowed (INR) Observations/reason of adjustment (as (In Crores) per TPO) AMP expenses incurred in 254.68 Primary Adjustment- The TPO held that manufacturing segment the assessee incurred AMP expenses with (allegedly treated as a view to enhance the brand image of international transaction by L‘Oreal and hence provided ‗brand the learned TPO) building services‘ to the AEs, for which it should be compensated. Payment of royalty for use 56.37 (primary Alternate Adjustment on the of technical knowhow and adjustment is INR 254.68 manufacturing segment- If the above trademarks crores) does not sustain in appellate stage, an alternate adjustment has been proposed by the TPO by treating arm‘s length price of payment of royalty for use of technical know-how @ 2.3% as against 5% paid by the assessee and also by cherry picking the comparable agreements. Further, the TPO completely disallowed payments for trademark stating that assessee was engaged in developing L‘Oreal trademarks in India by incurring AMP expenses. Hence royalty payment for use trademark was not mandated. AMP expenses incurred in 100.05 Primary Adjustment – The TPO held that Distribution Segment the Assessee has carried out (allegedly treated as development, exploitation, maintenance, international transaction by protection and exploitation (‗DEMPE‘) the learned TPO) functions by incurring AMP expenses for which it should be remunerated by the AEs. However, as suggested by BEPS report, since the intensity is very high as compared to comparable, it should be compensated. Import of finished goods to 60.03 Alternate Adjustment- If the above does AEs for resale not sustain in appellate stage, an alternate adjustment on ALP of the import/resale transaction by adjustment for intensity of AMP functions was proposed. Total (excluding alternate 354.73 adjustment)

5. The A.O after receiving the order passed by the TPO under Sec.92CA(3), dated 31.10.2016 gave effect to the recommended total adjustments of Rs.354.73 crores viz. (i) adjustment on account of distribution segment: Rs.100.05 crores; and (ii) adjustment on account of manufacturing segment: Rs.254.68 crores. Accordingly, on the basis of the aforesaid recommendations of the TPO the A.O vide P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) his draft assessment order passed under Sec.143(3) r.w.s 144C(1), dated 27.12.2016 inter alia made an addition of Rs.354.73 crores and proposed to assess the income of the assessee at Rs.426,77,40,190/-.

6. Aggrieved, the assessee filed its objections with the Dispute Resolution Panel-1 (WZ), Mumbai (for short ‗DRP‘). The assessee objected to the alleged presumption of ‗provision of brand promotion services-AMP expenditure‘ as an International transaction by the TPO. It was averred that the TPO had erred in alleging that the AMP expenses incurred by the assessee was an international transaction. In fact, it was the claim of the assessee that the aforesaid expenses were exclusively incurred for its business and not for the brand promotion of its AE. However, the DRP did not find favour with the contentions advanced by the assessee. It was observed by the DRP that as the expenses incurred by the assessee clearly revealed that the same were in the nature of advertisement expenses, therefore, the claim of the assessee that the same be treated as sale expenses and not AMP expenses did not merit acceptance. The claim of the assessee that the TPO was in error in selecting comparables which were not functionally comparable to the business of the assessee, also did not find favour with the DRP. It was observed by the DRP that as the TPO had selected all companies which alike the assessee were into FMCG industry, therefore, no infirmity did emerge from the selection of comparables by the TPO. Further, it was observed by the DRP that in the case before them the international transaction being considered was not the AMP expenditure incurred per se, but the benefit that was conferred on the AEs in the form of brand-value augmentation through incurring of excessive AMP by the assessee. Accordingly, the DRP was in agreement with the A.O/TPO regarding the determining of the non-routine AMP expenses which could be recovered from the AE.

P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) It was observed by the DRP that in A.Y. 2011-12 the issue was decided by the DRP in favour of the assessee by relying on certain decisions of the Hon’ble High Court of Delhi in the case of (i). Maruti Suzuki India Ltd. Vs. Addl. CIT/TPO (2010) 328 ITR 210 (Del); (ii). Whirlpool of India Vs. CIT [ITA No. 228/2015 & CM No. 5751/2015]; (iii). Bausch & Lomb Eyecare (India) Pvt. Ltd. Vs. Addl. CIT & Ors (2016) 381 ITR 227 (Del); and (iv).Honda Siel Power Products Ltd. Vs. DCIT (2016) 237 Taxman 304 (Delhi), wherein it was held that in absence of an explicit arrangement between the assessee and its AEs for incurring of AMP expenses there could be no international transaction between the assessee and its AEs. It was observed by the DRP that the department had not accepted the aforesaid decision and had carried the matter in appeal before the Tribunal. Also, it was observed by him that the decision of the Hon‘ble High Court of Delhi in the case of Maruti Suzuki (I) Ltd. Vs. Addl. CIT/TPO (2010) 328 ITR 210 (Del) was assailed by the revenue by way of a ‗Special Leave Petition‘ (for short ‗SLP‘) before the Hon‘ble Supreme Court, which had been admitted by the Hon‘ble Apex Court. In the backdrop of the aforesaid facts, the DRP keeping in view the changed legal scenario as per which an issue decided on its part in favour of an assessee was no longer appealable by the department, therefore, in order to keep the issue alive and protect the interest of the department rejected the objections raised by the assessee and upheld the order of the TPO. The DRP while concluding as hereinabove, observed viz. (i) that, the TPO had used a reasonable method to determine whether the AMP spent by the assessee was in line with the other comparables or was excessive; (ii) that, the TPO had rightly observed that excessive AMP expenditure leads to promotion of brand of the AE for which the assessee was required to be compensated; (iii) that, the TPO had rightly observed that excessive P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) AMP expenditure represents an international transaction under the provisions of Sec. 92B of the Act; and (iv) that, the TPO was right in concluding that excessive AMP expenditure needs to be benchmarked separately and not through a bundled approach. As regards the objection of the assessee in respect of adjustment proposed by the TPO on account of payment of ‗royalty‘ for use of technical knowhow and trademark, it was observed by the DRP, that the assessee had made payments @ 6.75% on sales, which was comprised of viz. (i). royalty for technical knowhow :5%; and (ii). royalty for trademarks: 1.75%. It was observed by the DRP that the TPO had rejected the entire royalty that was paid by the assessee to its AE towards trademarks, for the reason, that in view of the AMP expenditure that was incurred by the assessee towards DEMPE functions as regards the brands of its AE, any payment towards royalty for trademark was unwarranted. The DRP concurred with the view taken by the TPO and upheld the disallowance of the entire claim of royalty paid by the assessee to its AE for trademarks. As regards the royalty for technical knowhow, it was observed by the DRP that the TPO had done a detailed working and had arrived at an arms length percentage of the same. The DRP holding a conviction that the working of the royalty for technical knowhow by the TPO was fair and reasonable, therefore, concurred with his view and rejected the objection of the assessee. To sum up, the payment of royalty @ 4.45% viz. (i) royalty for trademark:1.75%; and (ii) royalty for technical knowhow: 2.7% [5% (- )2.3%] was held by the DRP to be excessive in nature.

7. The A.O after receiving the order passed by the DRP under Sec.144C(5), dated 22.09.2017, therein passed the final assessment order under Sec.143(3) r.w.Sec.144C(13), dated 15.11.2017. The A.O while framing the assessment carried out adjustment of P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) Rs.354,73,00,000/- to the ALP of the international transactions of the assessee and assessed its income at Rs.401,38,64,620/-.

9. We shall first advert to the primary contention of the ld. Authorised representative (for short ‗A.R‘) for the assessee, that in the absence of any ‗agreement‘ with its AE for incurring of AMP expenses for carrying out DEMPE functions for the intangibles owned by the AE, the AMP expenses incurred by the assessee would not fall within the realm of the meaning of an international transaction envisaged in Sec. 92B of the Act. As is discernible from the orders of the lower authorities, we find, that the primary focus of the ld. A.R is to impress upon us that the lower authorities had erred in not appreciating that P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) the AMP expenses incurred by the assessee cannot be held as an international transaction under Sec.92B of the Act. It was vehemently averred by the ld. A.R that the assessee had incurred the AMP expenses for its own business and not by way of any service to its AE. The ld. A.R in order to fortify his aforesaid claim had taken us through the ‗agreement‘ dated 02.01.2012 (effective from 01.01.2012) entered into between the assessee and its AE viz. L‘Oreal S.A., France. It is the claim of the ld. A.R that as there was no arrangement whatsoever between the assessee and its AE for promotion of the brand of its AE viz. L‘oreal S.A., France by incurring AMP expenses for and on their behalf, therefore, the lower authorities had erred in attributing the AMP expenses incurred by the assessee toward brand promotion of its AE. On the contrary, it is the claim of the revenue, that the assessee by incurring heavy AMP expenditure had carried out intensive market functions which had led to creation of valuable marketing intangibles for the AE, for which no compensation was received by it either in the form of direct compensation or by way of discount in its price. It is submitted by the ld. D.R, that the assessee had rendered DEMPE services which included market development, value addition, creation of marketing intangibles etc. The ld. D.R rebutted the claim of the assessee that there was no explicit arrangement whatsoever between the assessee and its AE for promotion of the brand of the AE by incurring AMP expenses on their behalf. It was submitted by the ld. D.R, that a perusal of the facts and circumstances of the case and also the material available on record clearly revealed that there was an arrangement, understanding and action in concert between the assessee and its AE for incurring AMP expenses in order to facilitate rendering of DEMPE services for the intangibles owned by the AE. In order to fortify his aforesaid contention the ld. D.R had taken us through the definition of international transaction as prescribed in P a g e | 13 AY.2013-14 M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) Sec.92B of the Act. In sum and substance, it was the claim of the ld. D.R that the assessee by incurring the significant AMP expenditure had promoted the brands/intangibles which were owned by the AE, for which it had not been compensated.

10. We shall before adverting any further briefly cull out the business profile of the assessee company. As is discernible from the orders of the lower authorities, L‘Oreal Group is a French Conglomerate founded in 1907 by the chemist Eugen Schueller, and is a leading player in the global cosmetic industry. It is also active in the dermatology sector. L‘Oreal group has its business in more than 130 countries with offices in 66 countries and employs more than 68,900 people. It has lots of consumer brands recognised all over the world. Some of the major brands of L‘Oreal Group include L‘Oreal Paris, Garnier, Ralph Lauren, Biotherm, Maybelline etc. As observed by us hereinabove, the assessee company viz. L‘Oreal India Pvt. Ltd. is a wholly owned subsidiary of L‘Oreal S.A., France. The assessee company had commenced its operations in India in the year 1994. The assessee had entered into a license agreement dated 02.01.2012 (effective from 01.012012) with L‘Oreal S.A., France, as per which it was awarded the exclusive right to import, manufacture (or have manufactured by another L‘Oreal affiliate) market, distribute and sell branded products of L‘Oreal Group. A perusal of the orders of the lower authorities reveals that the assessee derives revenues from two primary activities viz. (i) manufacturing of cosmetic products; and (ii) distribution of cosmetic products imported from associate enterprises. 11. We find that the assessee had determined the arm‘s length price (for short ‗ALP‘) of its international transactions in the ‗manufacturing segment‘ and the ‗distribution segment‘ by applying ―Cost Plus Method‖ (for short ‗CPM‘) and ―Resale Price Method‖ (for short ‗RPM‘), P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) respectively. It had taken the gross margin to sales ratio as the ‗Profit Level Indicator‘ (for short ‗PLI‘) in the ‗manufacturing segment‘ and ‗distribution segment‘. As per the TP study report, in the ‗manufacturing segment‘ the PLI of the assessee is worked out at 217.65%, whereas the average PLI of the comparables is arrived at 98.44%. As the price charged in the international transaction was greater than the arithmetic mean price, therefore, the same had been treated by the assessee as being at arm‘s length. In the ‗distribution segment‘, the PLI of the assessee company as per the TP study report had been worked out at 58.20% on sales, whereas the average PLI of the comparables is arrived at 36.02%. As the price charged in the international transactions in the ‗distribution segment‘ was greater than the arithmetic mean price, therefore, the assessee had contended that the price charged in the international transactions were found to be at arms length. Also, the assessee company had during the year paid ‗royalty‘ for the exclusive right to manufacture and distribute the licensed products using the technology and trademark of its overseas associated enterprise in accordance with the terms envisaged in the ‗agreement‘ entered into with its AE. As the international transactions had taken into account both the segments i.e ‗manufacturing segment‘ and ‗distribution segment‘, therefore, the transfer pricing analysis was also undertaken by the assessee company independently in respect of both of the segments.

12. In the course of the TP study proceedings, it was observed by the TPO that the assessee during the year under consideration viz. A.Y. 2013-14 had spent an amount of Rs.561.41 crores on advertisement, marketing and promotion (AMP). The aforesaid expenses incurred by the assessee worked out to 34% of its net sales of Rs.1651.40 crore. The TPO was of the view that the assessee by incurring the aforesaid P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) AMP expenditure had created valuable marketing intangibles for its AE viz. L‘Oreal S.A., France, for which no compensation was received by it either in the form of direct compensation or by way of discount in its price. Accordingly, the TPO was of the view that as the assessee was carrying out marketing functions for brand building of its AE, therefore, the same were also required to be benchmarked. While concluding as hereinabove, the TPO had drawn support from the BEPS report published by OECD. The TPO called upon the assessee to furnish the breakup of the AMP expenditure. The assessee furnished the bifurcation details of the AMP expenditure which were claimed to have been incurred by it for the promotion of its own products in India, as under:

Sr. No. Head of expense Amount (Rs.) 1. Product advertisement expenses 3,325,647,907/- 2. Marketing Fees (DMI fees paid to Overseas AE) 341,404,193/- 3. Pure sales promotion expenses 1,947,090,162/- Total 5,614,142,262/- It was the claim of the assessee that out of the aforesaid AMP expenses of Rs.561.41 crores (34% on sales) an amount of Rs.366.71 crores (21.44%) had been spent on ‗advertisement‘ (including DMI fees paid to the overseas AE amounting to INR 34,14,04,193/-) and the balance amount of Rs.194.71 crores (11.38%) was spent on ‗sales promotion‘. However, the TPO after necessary verifications was not persuaded to subscribe to the aforesaid claim of the assessee. It was observed by him that in respect of the following items to the tune of Rs.228,84,94,357/- the assesses claim that they were pure selling expenses could not be accepted:

Sr. No. Item of Expenditure Amount of Submission of the assessee Comments of the TPO Rs. 1. Promotions- 9,13,95,843 Gifts (like, purse, T-shirts, After verification of the P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2)

Promotional Gifts, Umbrella etc) given to submission of the Special Ops consumers on purchases. It assessee, the contention is in the nature of of the assessee is promotional activity. accepted and the expenditure is held to be in the nature of selling expenditure.

4. Point of Sale (POS) 25,41,24,318 Business promotion As per the explanation Materials expenses is cost of material given by the assessee, like hangers, danglers, these are the expenses display units etc installed at on display at malls, various point of Sales (POS) shops, stores and like malls, shops, stores, retailers etc. Obviously retailers etc. these expenses are for DEMPE functions and hence cannot be categorised as selling expenses. Hence, the same are considered to be in nature of advertisement expenses.

DEMPE functions and hence cannot be categorised as selling expenses. Hence, the same are considered to be in nature of advertisement expenses.

8. Value System 6,76,91,569 Reimbursement/Discounts After verification of the Reimbursement given to Salons for achieving submission of the annual turnover assessee, the contention of the assessee is accepted and the expenditure is held to be in nature of selling expenditure.

On the basis of his aforesaid observations the TPO concluded that the total AMP expenses of Rs.561,41,42,262/- comprised of ‗Selling expenses‘ of Rs.93,18,20,741/- (which worked out to 16.5% of total AMP expenses). Accordingly, it was observed by him that the balance amount ofRs.468,23,21,521/- (which worked out to 83.5% of total AMP expenses) were to be considered as the base figure of AMP expenses for determination of the amount for which the assessee was to be compensated by its AE. On the basis of the aforesaid calculation of the advertisement expenses at Rs.468,23,21,521/-, it was observed by the TPO that the same worked out at 28.35% of the ‗net sales‘ of the assessee company. As the assessee despite specific directions of the TPO failed to furnish the bifurcated details of the advertisement expenses of Rs.468.23 crores incurred in respect of its respective business segments viz. (i) manufacturing segment; and (ii) distribution segment, therefore, the TPO bifurcated the same in the ratio of the respective sales of both the said segments, as under:

Particulars Manufacturing Distribution Total Net Sales 1214.09 cr 437.309 cr 1651.40 cr Total AMP expenses considered 344.25 cr 123.98 cr 468.23 cr for DEMPE functions AMP expenses as a % of net 28.35% 28.35% 28.35% sales Further, it was observed by the TPO, that for carrying out a feasible comparison between the assesses AMP expenditure as against that of its comparables, as the selling expenses had been excluded in the case of the assessee, therefore, a similar approach had to be adopted in the case of the comparables. However, it was observed by him that as the details of the selling expenses in the case of the comparables was not available in the public domain, therefore, the same ratio of P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) advertisement expenses to selling expenses as was worked out in the case of the assessee i.e. 83.5%:16.5% could fairly be adopted in the case of the comparables for benchmarking purposes. Alternatively, it was observed by the TPO that in case the allocation of advertisement expenses to selling expenses on pro rata basis in the case of the comparables was not upheld by the appellate authorities, then the entire AMP expenditure (without excluding selling expenses) of the assessee will have to be compared to the entire AMP expenditure of the comparables.

(A) Manufacturing Segment:

The comparables selected by the assessee were rejected by the TPO for the following reasons:

Sr. No. Name of the comparables Findings of the TPO 1. Gillette India Ltd. One common feature, in respect of these comparables is that the intangibles in all these 2. Procter & Gamble Hygiene and Health Care Ltd. cases are owned by the foreign AE. Hence the AMP transaction in all these cases is controlled 3. Reckitt Benckiser (India) Ltd. transactions. It is a basic tenet of the transfer 4. Colgate Palmolive India Ltd. pricing regulations that a controlled transaction has to be compared with an uncontrolled transaction. A controlled transaction cannot be compared with another controlled transaction. Hence these comparables cannot be taken into account for determination of the AMP adjustment. It is no where the contention of the assessee that these brands are owned by the comparables entity itself. Hence the contention of the assessee on this point stands rejected.

5. Reckitt Benckiser India Ltd. Annual accounts N.A.

The TPO after rejecting the aforesaid comparables selected 5 fresh comparables for benchmarking the AMP transactions in respect of the ‗manufacturing segment‘ of the assessee, as under :

P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2)

Sr. No. Name of the Net sales AMP AMP as % Proportionate AMP in the Adjusted company for F.Y. Expenses of Net ratio of 83.50:16.50 with AMP to Sales 2012-13 Sales sales promotion (%) expenses (Rs. Cr.) (Rs. Cr.) (Rs.Cr.) 1. Dabur India 4349.39 502.37 11.55% 419.48 9.64% Ltd.

2. Marico Ltd. 3457.30 382.18 11.05% 319.12 9.23% 3. Godrej 3581.02 577.38 16.12% 482.11 13.46% Consumer Products Ltd.

―Net Sales of the taxpayer = Rs.1214.09cr. Arm‘s Length % of AMP Expenditure = 10.41% Arm‘s Length AMP (10.41 % * Rs.1214.09 cr) = 126.39 cr. Expenditure incurred by the taxpayer on AMP (Manufacturing sector) = Rs.344.25 Expenditure incurred for developing the intangibles P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) [Rs.344.17 (-) Rs.126.26 cr.] = Rs.217.86 cr. Add Mark up @ 16.90% (16.90% * Rs.232.23 Cr) = Rs.36.82 cr. Arm‘s Length value for AMP activity = Rs.254.68 cr. Value received by the taxpayer = Nil Difference = Rs.254.68 cr.‖ On the basis of his aforesaid calculations, it was observed by the TPO, that an adjustment of Rs. 254.68 crore towards AMP expenditure incurred by the assessee (manufacturing segment) for services rendered towards DEMPE functions for the intangibles owned by the AE was required to be carried out.

(B) Distribution Segment:

The TPO accepted the comparables which were selected by the assessee in its TP study report. Accordingly, the AMP expenditure incurred by the assessee (distribution segment) for services rendered towards DEMPE functions for the intangibles owned by the AE was benchmarked by the TPO, as under:

Sr. No. Name of the Comments of the assessee Findings of the TPO comparables 1. J.K. Helene Curtis The company is forming part of The comparables is Ltd. study report and is being accepted accepted for the past three years by the TPO itself. 2. J.L. Morison (India) The company is forming part of The comparables is Ltd. study report and is being accepted accepted. for the past three years by the TPO itself.

After accepting the aforesaid comparables the TPO determined the reimbursement by the AE for services rendered towards DEMPE functions performed by the assessee, as under:

Sr. Name of the Net Sales for AMP AMP as Proportionate AMP in the Adjusted No. company F.Y. 2012-13 Expenses % of ratio of 83.50:16.50 with AMP to Sales Net sales promotion expenses (%) (Rs. Cr.) (Rs. Cr.) Sales (Rs. Cr.) 1. J.K. Helene 248.91 40.96 16.45% 34.20 13.74% Curtis Ltd 2. J.L. Morison 113.94 5.22 4.58% 4.35 3.83% (India) Ld. Average (%) 8.78% P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2)

Accordingly, it was observed by the TPO that the ALP of the AMP spending for the ‗distribution segment‘ worked out at 8.78%. In other words, he was of the view that AMP spending of 8.78% was to be treated as the permissible expenditure to have been incurred by the assessee (distribution segment) in the normal course of its business. As against that, it was observed by the TPO that as the assessee had incurred AMP expenditure of 28.35%, therefore, the expenditure i.e 19.57% [28.35% (-) 8.78%] was to be treated to have been incurred in excess of the permissible limit. On the basis of his aforesaid observations, the TPO concluded that the assessee (distribution segment) was required to be compensated along with a suitable ‗mark up‘ for the AMP expenditure that was incurred by it for the DEMPE functions performed in respect of brand building of the intangibles owned by its AE at Rs.100.05 crore, as under:

―Net Sales of the taxpayer in the distribution segment = Rs.437.31 cr Arm‘s Length % of AMP Expenditure = 8.78% Arm‘s Length AMP (8.78 * Rs.437.31 cr = Rs.38.40 cr Expenditure incurred by the taxpayer on AMP = Rs.123.98 cr Expenditure incurred for developing the intangible [Rs.123.98 (-) 38.40 cr.] = Rs.85.58 cr Add Mark up @ 16.90% (16.90% *Rs.85.58cr) = Rs.14.46 cr Arm‘s Length value for AMP activity = Rs.100.05 cr Value received by the taxpayer = Nil Difference = Rs.100.05 cr‖ Accordingly, on the basis of his aforesaid deliberations, it was concluded by the TPO that the total adjustment in respect of the AMP expenditure incurred by the assessee in respect of DEMPE functions for the intangibles owned by its AE for both the segments worked out at 354.73 crores viz. (i) manufacturing segment : Rs. 254.68 crores; and (ii) distribution segment : Rs. 100.05 crore.

P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) 14. We find that on the basis of his aforesaid observations, the TPO was of the view, that the assessee had not only rendered its services as a ‗distributor‘ but had also incurred huge AMP expenses (28.35% of its ‗sales‘) towards rendering of DEMPE functions for the brand owned by its AE, viz. L‘Oreal S.A., France. It was observed by the TPO that for benchmarking the international transactions of its ‗distribution segment‘ the assessee had adopted RPM as the most appropriate method for carrying out the comparability analysis. The TPO held a conviction that as the AMP expenses incurred by the assessee were taken below the line of Profit & loss account, therefore, if RPM was applied at gross profit level, the marketing function carried out by the assessee would not be considered in the course of the said benchmarking analysis. In fact, the TPO was of the view that in order to make the comparables selected by the assessee/TPO similar to the assesses functions, assets employed and risk assumed, suitable adjustment was required to be made as per Rule 10B(2) of the Income- tax Rules. The TPO worked out the intensity of the AMP expenses on the profit level indicator of Operating profit/Sales percentage at 7.75%. Accordingly, the TPO on the basis of the adjusted RPM method proposed an adjustment of Rs. 60.03 crores in respect of the ALP of the goods imported by the assessee from its AE.

P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2)

(A). Trademark Royalty : It was observed by the TPO that the assessee had not paid any royalty on account of exploiting of the trademark till A.Y 2005-06. The TPO was of the view that the assessee by incurring AMP expenses had as a matter of fact generated the trademark of L‘Oreal products in India, the legal ownership of which remained vested with the AE. Further, it was noticed by the TPO that the assessee was not entitled to any benefits at the time of termination of the license agreement. In fact, the TPO drawing support from the BEPS report was of the view that as the assessee had carried out significant AMP expenses for DEMPE functions, therefore, no such royalty was payable by the assessee. Accordingly, the TPO treated the ALP of the trademark royalty at Rs. Nil and rejected the payment of royalty @1.75% of the total sales by the assessee towards trademark royalty.

(B). Technical Knowhow Royalty : It was observed by the TPO that the assessee had benchmarked the royalty @5% of sales towards ‗technical knowhow‘ by relying on the royalty study carried out by NERA Economic Consulting in November, 2013. The TPO observed that as per the said study the comparables considered were mainly the companies making payments for trademark royalties. It was observed by him that out of 12 comparables selected by the assessee only 4 comparables were having the payment for both marketing & processing royalty and the remaining 8 comparables were related to payment of exclusive marketing royalty. Further, it was observed by him that the average royalty paid for the marketing intangible by the 8 comparables was 6.1% and the average payment of royalty for both marketing & processing royalty by the remaining 4 comparables was 8.4%. On the basis of his aforesaid observations, it was concluded by the TPO that P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) the average payment of processing/technical knowhow royalty worked out at 2.3% [8.4% (average payment of royalty for both marketing & processing royalty) – 6.1% (average payment of royalty for marketing intangible)]. Accordingly, it was observed by the TPO, that the ALP of the payment of royalty for technical knowhow was to be taken at 2.3%. In the backdrop of his aforesaid deliberations the TPO being of the view that payment of royalty of 4.45% [Technical knowhow royalty: 2.7% (+) Trademark royalty: 1.75%] was excessive in nature. On the basis of his aforesaid observations the TPO proposed an adjustment of Rs. 56,36,62,918/- (out of the total royalty of Rs. 85,49,94,314/-).

“12. We have also perused the agreement of assessee with its AE dated 4th January 2011 executed between assessee and its AE. Clause 7 of the P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) agreement descries about right of distribution of licensed product in the territory. As per Clause 8 of the said agreement the assessee is responsible for the advertising the licensed product in the territory. The ‗territory‘ is defined under clause 1.5 of the agreement, which means the territory of Nepal, Bhutan, Bangladesh, Maldives, Mauritius, India and Sri Lanka. However, it excludes any free trade zone, which may exist or may be created. Further it excludes duty free shops located in the duty free or travel retail area which is specialized in sales against foreign currency to foreigner or diplomatic corps, ship chlanders, airlines companies or shipping companies. Though the AE has reserves its right for the zones of excluded areas. The contentions of the ld. A.R for the assessee is that clause 8 of the agreement does not obligates the assessee to incur expenses on AMP so as to promote the brand owned by its AE‘s. And that the expenses are incurred by assessee in the normal course of its business. The perusal of the Clause 7 and 8 reveals that there is no agreement between the assessee and the AE‘s for sharing the expenses and the payments made by the assessee for the expenses of AMP. The TPO has also not brought any fact on record that there exist any agreement between the assessee and its AE to share or reimburse the AMP expenses. Moreover, we have seen that there is no material change in the facts for the year under consideration. Therefore, considering the above factual discussions and the decision of the coordinate bench of Tribunal for A.Y. 2008-09 to 2010—11, on the identical issue the ground No. 2 to 21 of the appeal is allowed.‖ We thus in terms of our aforesaid observations, finding ourselves to be in agreement with the view taken by the Tribunal in the assesses own case for A.Y 2012-13 viz. M/s L‘Oreal India Pvt. Ltd. Vs. ACIT-7(1)(2), Mumbai [ITA No. 1417/Mum/2017; dated 30.01.2019],therefore, respectfully follow the same. Accordingly, being of the considered view that as the revenue had failed to discharge the ‗onus‘ that was cast upon it as regards proving that there was any 'understanding' or an 'arrangement' or 'action in concert' as per which the assessee had agreed for incurring of AMP expenses for brand building of its AE, viz. L‘Oreal S.A., France, the TP adjustment of Rs. 354.73 crores in respect of AMP expenses cannot be sustained and is liable to be vacated. The Grounds of appeal No. 1 to 21 are allowed in terms of our aforesaid observations.

No. 26 to 28 are allowed for statistical purposes.

24. We shall now advert to the claim of the assessee that the TPO/DRP had erred in making/sustaining a TP adjustment of 2.70% as regards the royalty payment towards technical knowhow @5% (on net sales) that was paid by the assessee (manufacturing segment) to its AE viz. L‘Oreal., S.A., France. It was observed by the TPO that the P a g e | 37 AY.2013-14 M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) assessee had benchmarked the royalty of 5% of sales towards ‗technical knowhow‘ by relying on the royalty study carried out by NERA Economic Consulting in November, 2013. The TPO observed that as per the said study the comparables considered were mainly the companies making payments for trademark royalties. It was observed by him that out of 12 comparables selected by the assessee only 4 comparables were having the payment for both marketing & processing royalty and the remaining 8 comparables were related to payment of exclusive marketing royalty. Further, it was observed by him that the average royalty paid for the marketing intangible by the 8 comparables was 6.1% and the average payment of royalty for both marketing & processing royalty by the remaining 4 comparables was 8.4%. On the basis of his aforesaid observations, it was concluded by the TPO that the average payment of processing/technical knowhow royalty worked out at 2.3% [i.e. 8.4% (average payment of royalty for both marketing & processing royalty) (minus) 6.1% (average payment of royalty for marketing intangible)]. Accordingly, it was observed by the TPO, that the ALP of the payment of royalty for technical knowhow was to be taken at 2.3%. In the backdrop of his aforesaid deliberations, it was observed by the TPO, that payment of royalty of 4.45% [Technical knowhow royalty: 2.7% (+) Trademark royalty: 1.75%] was excessive in nature. On the basis of his aforesaid observations the TPO proposed an adjustment of Rs. 56,36,62,918/- (out of the total royalty of Rs. 85,49,94,314/-).

25. We have given a thoughtful consideration to the TP adjustment of 2.7% (on sales) carried out by the TPO as regards the royalty payment of 5% (on sales) by the assessee (manufacturing segment) towards usage of ‗technical knowhow', and are unable to persuade ourselves to subscribe to the same. We have perused the novel P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) methodology adopted by the TPO for working out the average ALP of royalty payments by the comparables and do not find favor with the same. Admittedly, as observed by the TPO, out of 12 comparables selected by the assessee only in the case of 4 comparables payments were made for both marketing & processing royalty, while for in the case of the 8 comparables the payments were exclusively towards marketing royalty. The determination of ALP of the royalty payment for technical knowhow by the TPO at 2.3% viz. [average payment of royalty for both marketing & processing of 4 comparables: 8.4% (minus) average payment of royalty for marketing of the remaining 8 comparables : 6.1%] clearly reflects an arbitrary approach on his part. In our considered view, the TPO either ought to have restricted himself to the average royalty of 8.4% for both marketing & processing of the 4 comparables and made suitable adjustments as per rule 10B(1)(a)(ii) of the Income-tax Rules, 1962 to the same for arriving at the ALP of the royalty for technical knowhow, or in the alternative could have searched for fresh comparables as regards royalty payment on technical knowhow. In our considered view, the method adopted by the TPO for arriving at a TP adjustment of 2.7% as regards royalty on technical knowhow does not inspire any confidence. Be that as it may, we find that the Tribunal while disposing off the appeal of the assessee for the immediately preceding year viz. A.Y 2012-13 had restored the matter pertaining to TP adjustment as regards royalty paid by the assessee towards technical knowhow to its AE, viz. L‘Oreal., S.A, France to the file of the DRP for fresh adjudication. Accordingly, not finding ourselves to be in agreement with the novel method adopted by the TPO for benchmarking the royalty for technical knowhow of 5% (on sales) paid by the assessee (manufacturing segment) to its AE during the year under consideration i.e. A.Y. 2013-14, which we are afraid is neither backed by the mandate of law nor any logical reasoning, P a g e | M/s L’Oreal India Pvt. Ltd. Vs. Deputy Commissioner of Income Tax, Circle 7(1)(2) therefore, in consistence with the view taken by the Tribunal in the aforementioned preceding year viz. A.Y 2012-13, on similar terms restore the matter to the file of the DRP. The DRP shall in the course of the ‗set aside‘ proceedings readjudicate the issue afresh. Needless to say, the DRP shall in the course of the ‗set aside‘ proceedings afford a reasonable opportunity of being heard to the assessee, who shall be at a liberty to substantiate its claim that the payment of royalty on technical knowhow @5% (on sales) was at ALP and no adjustment was called for in respect of the same. The Grounds of appeal No. 24& 25 are allowed for statistical purposes.