M/S THE HIMALAYA DRUG COMPANY,BANGALORE vs. DCIT, BANGALORE

Per Jason P Boaz, Accountant Member

This appeal by the assessee is directed against the final order of assessment for Assessment Year 2010-11 passed under section 143(3) of the Income Tax Act, 1961 (in short ‘the Act’) vide dated 29.12.2014; pursuant to the directions issued by the Dispute Resolution Panel – II, (DRP), Bangalore, under section 144C(5) of the Act dated 03.12.2014.

IT(TP)A No.187/Bang/2015 Page 2 of 50 2. Briefly stated, the facts of the case are as under:

2.1 The assessee, a firm, engaged in the business of manufacture and sale of ayurvedic medicaments and preparations, consumer or personal care products and animal health care products, filed its return for Assessment Year 2010-11 on 06.10.2010 declaring income of Rs.47,84,57,080/-. The return was processed under section 143(1) of the Act and the case was subsequently taken up for scrutiny for this Assessment Year. The Assessing Officer (AO) made a reference to the Transfer Pricing Officer (TPO) under section 92CA of the Act for determination of the arms length price (ALP) of the international transactions entered into by the assessee with its Associated Enterprises (AE) during the year under consideration. The TPO passed an order under section 92CA of the Act dated 30.01.2014 proposing TP adjustments totally amounting to Rs.65,45,44,303/0; comprising (i) an adjustment of Rs.38,84,32,314/- in respect of sale of finished goods and (ii) an adjustment of Rs.26,61,11,989/- for advertisement, marketing and sales promotion (AMP) activity. The AO completed the draft order of assessment under section 143(3) of the Act vide order dated 08.03.2014, wherein the assessee’s income was computed at Rs.115,63,22,141/-, in view of, inter alia, the TP adjustments of Rs.65,45,44,303/- and disallowance of interest paid under section 36(1)(iii) of the Act amounting to Rs.2,91,89,882/-.

2.2 The assessee filed its objections to the additions / disallowances in the draft order of assessment before the DRP; who issued its directions under section 144C(5) of the Act on 03.12.014, dismissing the objections raised by the assessee. Pursuant thereto, the AO passed the final order of assessment under section 143(3) r.w.s. 144C of the Act vide order dated 29.12.2014 wherein the assessee’s income was determined at Rs.115,63,22,141/- in view of the aforesaid TP adjustments and disallowance of interest under section 36(1)(iii) of the Act.

IT(TP)A No.187/Bang/2015 Page 3 of 50 3. The assessee initially filed XVI grounds of appeal. However it subsequently filed the following concise grounds of appeal for consideration which are extracted hereunder:

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5.1 These grounds (supra), as per the submissions of the learned AR of the assessee at the outset of the hearing, are not pressed by the assessee in this appeal. In view of the assessee not pressing ground Nos. 3, 4, 11, 13 and 14 raised in this appeal, they are rendered infructuous and accordingly dismissed as not pressed.

IT(TP)A No.187/Bang/2015 Page 9 of 50 6. Transfer Pricing Issues - Ground Nos. 5 to 9

6.1 Ground No. 5 (supra), is raised in respect of the rejection of the assessee’s TP study / documentation which was carried out by adopting TNMM as the most appropriate method (MAM).

Ground No.6 (supra) challenges the flaws in the determination of ALP based on CPM being applied by the TPO as the MAM.

In ground No.7 (supra), the assessee is aggrieved by the action of the TPO/DRP in not allowing adjustments as per Rule 10B(1)(c)(iii) without prejudice to the objection on adoption of CPM as the MAM.

Ground No.8 (supra) is in respect of denial of the benefit of proviso to section 92C(2) of the Act.

Ground No.9 (supra), is in respect of the TP adjustment towards AMP expenditure.

As these grounds relate to the TP adjustments of Rs.38,84,32,314/- made by the TPO in respect of sale of finished goods, and of Rs.26,61,11,989/- in respect of AMP activity, we deem it appropriate to consider these grounds together.

6.2 At the outset of the hearing, the learned AR for the assessee placed on record a copy of the order of the Co-ordinate Bench in the assessee’s own case for Assessment Year 2011-12 in IT(TP)A No.807/Bang/2016 dated 04.07.2018; wherein according to the learned AR, identical TP adjustments were deleted by the Co-ordinate Bench. It was submitted that the facts of the case, the basis of

IT(TP)A No.187/Bang/2015 Page 10 of 50 and reasons for making TP adjustments are identical for the year under consideration as compared to Assessment Year 2011-12 and therefore the decision is squarely applicable for this year i.e., Assessment Year 2010-11 also.

6.3 Per contra, the learned DR for Revenue vehemently supported the TPO’s order in making the impugned TP adjustments.

6.4.1 We have considered the rival contentions and submissions and perused the material on record; including the judicial pronouncements cited. The assessee firm is engaged in the business of manufacture and sale of (a) herbal pharmaceutical products; (b) consumer and personal care products; and (c) animal health care products.

The manufactured products (supra) are sold both in India and are also exported to AEs / entities outside India to related parties and also to unrelated parties in CIS countries. In India pharmaceutical / ayurvedic products are driven by prescription of Doctors and so also in CIS Countries. However, in other countries, the international business for these products is largely driven by marketing and advertisement and not by prescription; as is the case with the personal care range of products in India; which undertakes full fledged marketing, including advertisement, sales promotion, etc. However, in respect of exports to AEs / related parties outside India, the entire marketing activities is done by the AEs and the assessee only manufactures the goods as per requirement of the AEs and dispatches the same to them.

6.4.2 In the year under consideration, the assessee exported products amounting to Rs.68,42,36,809/- to its AEs. In its TP study, the assessee selected TNMM as the MAM for determination of the ALP of the international

IT(TP)A No.187/Bang/2015 Page 11 of 50 transactions with its AEs. As per its TP study, the net loss (-) 10.16% in its personal care division in the domestic segment was compared to the net margin of 13.39% from export to its AEs.

6.4.3 According to the assessee, the pharmaceutical range of products are on par with the personal care range of products exported outside India but the margin of the domestic pharmaceutical division was not comparable as the parameters of marketing, manufacturing, competition, exposure and acceptance of ayurvedic products by customers, govt. control, etc., are entirely different. On the other hand, the personal care division products are sold through distributors and the same is market driven and therefore the profitability of the personal care division was considered with export to AEs for comparability. Since the net margin from export to AEs was higher than the net loss from domestic sales to unrelated parties, the assessee concluded that its exports to AEs were at arms length.

6.4.4 The TPO, after examining the assessee’s TP study, issued a show cause notice to the assessee proposing to substitute CPM as the MAM in place of TNMM adopted by the assessee. In this regard, the TPO compared the gross margin earned on exports at 18.68% against gross profit of 48.13% earned by the domestic consumer product division and proposed a TP adjustment. After considering the objections / contentions raised by the assessee against the proposed adoption of CPM as the MAM, the TPO passed an order under section 92CA of the Act dated 30.01.2014 wherein he adopted CPM as the MAM and considered the gross profit margin in the consumer product division for bench marking purposes. The TPO was also of the view that the assessee acted as a contract manufacturer in respect of products manufactured and exported to the AEs as it did not undertake the distribution, advertisement, marketing and selling expenditure and held that the goods are sold at a mark up of 15% on cost. The

IT(TP)A No.187/Bang/2015 Page 12 of 50 TPO then computed the TP adjustment in respect of sale of finished goods at Rs.38,84,32,314/- as per the working extracted hereunder:-

6.4.5 We find that the facts of the case, and the basis and reasons for making the aforesaid TP adjustment of Rs.38,84,32,314/- on account of sale of finished goods are identical to the facts of the case for Assessment Year 2011- 12. The grounds raised and the contentions / arguments put forth are also similar to Assessment Year 2011-12. The Co-ordinate Bench in the assessee’s own case in its order in IT(TP)A No.807/Bang/2016 dated 04.07.2018 for Assessment Year 2011-12 at paras 8.5.1 to 8.5.16 has held as under:

“8.5.1We have heard the rival contentions, perused and carefully considered the material on record; including the judicial pronouncements cited. The first issue for consideration is that of what would be the MAM in the facts and circumstances in the case on hand. As per Sec. 92C(1) of the Act, the ALP in relation to an international transaction hall be determined by any of the following methods, being the MAM, having regard to the nature of transaction or class of transaction OR class of associated persons OR functions performed by such persons OR such other relevant factors as the Board may prescribe, viz., a)Comparable Uncontrolled Price Method; b)Resale Price Method; c)Cost Plus Method; d)Profit Split Method; e)Transactional Net Margin Method; f)Such other method as may be prescribed by the Board.

IT(TP)A No.187/Bang/2015 Page 13 of 50 Sub-section2 of Section 92C of the Act provides that the MAM referred to in sub- section (1) shall be applied, for determination of the ALP, in the manner as may be prescribed. Rule 10B of the IT Rules, 1962 provides for the determination of ALP under Section 92C of the Act. The TPO in the case on hand has applied CPM as the MAM. Rule 10B(1)(c) deals with the determination of ALP as per CPM and the same is extracted hereunder :- “(c)cost plus method, by which,— (i)the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined; (ii)the amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of the same or similar property or services by the enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction, or a number of such transactions, is determined; (iii)the normal gross profit mark-up referred to in sub-clause (ii) is adjusted to take into account the functional and other differences, if any, between the international transaction55b[or the specified domestic transaction]and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect such profit mark-up in the open market; (iv)the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii); (v)the sum so arrived at is taken to be an arm's length price in relation to the supply of the property or provision of services by the enterprise;”

8.5.2 As per CPM, the direct and indirect costs of production incurred by the enterprise in respect of property transferred to an AE is increased by the ‘adjusted profit mark up’ to determine the ALP. The ‘adjusted profit mark up’ is determined by making adjustments to ‘normal gross profit mark up’ to take into account the functional and other differences, if any, between the international transaction and the comparable uncontrolled transactions OR between the enterprises entering into such transactions, which could materially affect such profit mark up in the open market. The ‘normal gross profit mark up’means the gross profit mark up on direct and indirect costs of production arising from the

IT(TP)A No.187/Bang/2015 Page 14 of 50 transfer of the same OR similar property by the enterprise or by an unrelated enterprise, in a comparable uncontrolled transaction ORa number of such transactions. 8.5.4 In the case on hand, the assessee compared the net profit margin from domestic consumer product division with the net profit margin for exports to AEs. At page 46 of his order, the TPO has held that the exports to AEs is comparable in terms of nature of goods to the domestic consumer product division and therefore this section is considered as comparable to exports to AEs. Thus, there is no dispute on the domestic consumer product division being compared with exports to AEs. The TPO, however, compared the gross margin of domestic consumer product division with the gross margin of exports to the AEs. In doing so, we find the TPO disregarded the mandate of Rule 10B(1)(c) of the Rules which require determination of ‘adjusted profit mark up’ by making adjustments to the ‘normal gross profit mark up’ by taking into account the functional and other differences between the international transactions and the comparable uncontrolled transactions. 8.5.5 It is an undisputed fact on record that, in respect of finished goods exported to AEs, the entire marketing, adjustment, distribution and sales activities are performed by the AEs and not by the assessee. The TPO has acknowledged / accepted this fact at various places in his order under Section 92CA of the Act; viz. at the 1stpara on page 3 and 6, last para of page 4, 2ndpara on page 5, etc. The TPO, however, rejected TNMM as the MAM and adopted CPM for determination of ALP of sale of finished goods to the assessee for the reason that, even though the products sold in the domestic consumer product division are comparable to the products sold to AEs, the functions performed, assets employed and risks undertaken in both the segments are not the same. The selling price and gross profit of products sold in the domestic consumer division is higher than that of the products exported to AEs for the reason that the assessee in the domestic consumer product division undertakes all function and incurs expenditure on distribution, marketing, advertisement, transportation, sales promotion, commission, travel, salary, travelling, administrative costs and also undertakes risks such as market risk, debt risk, etc. Therefore the selling price and gross profit of products sold in the domestic consumer products are fixed at a higher level than in the case of export of finished goods to AEs where the selling price is the ex-factory price; the freight at actual is collected by the assessee and also as all other expenditure mentioned above like distribution, marketing, advertisement, transportation, sales promotion, etc. are entirely incurred by the AEs and not by the assessee. Therefore, since the assessee does not undertake the above functions and risks, the selling price of products sold to Assessing Officer are fixed considering a net margin of 15% on the estimated costs.

IT(TP)A No.187/Bang/2015 Page 15 of 50 8.5.6 In our considered view, the TPO has completely disregarded the above important differences in functions performed, assets employed and risks undertaken by the domestic consumer product division and export to AEs; the pricing policy followed by the assessee due to these differences in both segments. In this view of the matter, we are of the considered opinion that the TPO’s approach, in applying the gross profit margin of the domestic consumer product division to the cost of goods sold in exports to AEs to determine the ALP, is factually erroneous and contrary to the mandate of Rule 10B(1)(c) of the Rules.

8.5.7 As per Rule 10B(2), the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following namely :- "(a)the specific characteristics of the property transferred or services provided in either transaction; (b)the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions; (c)the contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d)conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail.” As per Rule 10B(3), an uncontrolled transaction shall be comparable to an international transaction if :- “ (3) An uncontrolled transaction shall be comparable to an international transaction if— (i)none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii)reasonably accurate adjustments can be made to eliminate the material effects of such differences.”

IT(TP)A No.187/Bang/2015 Page 16 of 50 The effect of Rule 10B(2) and (3) is to compare an international transaction with an uncontrolled transaction with reference to the parameters as explained at (a) to (d) above and to make reasonably accurate adjustments to eliminate the material effects of differences between the international transactions and uncontrolled transactions. 8.5.8 In the case on hand, as discussed above, the assessee mentions a higher gross margin in the domestic market because it incurs significant administration, selling and distribution expenses, etc. In case of group concerns (AEs) since the administration, selling, distribution and other expenses are incurred by the group concerns themselves, necessitating the levying of higher margins for the group concerns / AEs and consequently, keeping correspondingly lower margin for the assessee. Before the TPO, the assessee put forth the above discussed explanations in respect of functional differences between exports to AEs and the domestic consumer product division (extracted at pages 16 to 21, pages 31 to 33 of TPO’s order). Several other differences like public awareness of ayurvedic products in India and outside India, popularity of Brand ‘Himalaya’ in India and abroad, support of doctors and Govt. of India and abroad, etc. were explained before the TPO. The assessee also submitted that if CPM is considered as the MAM, then the gross profit margin earned in the domestic market should be reduced on account of the many/ various differences like, freight to move goods to the sales depots and subsequently to the stockists, commission to C&F Agents through whom the sales are achieved, filed staff salaries, sales commission to employees, travelling cost to promote and achieve sales all over India, communication charges, brand premium, allowances for negative publicity in the international market, etc. 8.5.9 Rule 10B(1)(c) r.w. Rule 10B(3) provides for making reasonably accurate adjustments to eliminate the material effects of differences between transactions being compared. In the case on hand, from the details on record, the differences between domestic sales and export sales are large in number and some being qualitative, unless reasonably accurate adjustments are made to normal gross profit mark up to eliminate the material effects of the many differences between domestic sales and export sales, the two margins cannot be compared. In our view, to give a mathematical number to all these differences would mean indulging in the exercise within a realm of subjectivity which is to be avoided. We are conscious of the principle that CPM can be applied in the case of a manufacturer selling goods to both AEs and non-AEs. However, in our considered view, in the peculiar factual matrix of the case on hand, as discussed and laid out above, we are of the view that CPM cannot be considered as the MAM. In coming to this view, we are fortified by the decision of the Pune Bench of the ITAT in the case of Drilbits International Pvt. Ltd. Vs. DCIT (2011) 142 TTJ 86, wherein on similar facts and circumstances, it was held that gross profit

IT(TP)A No.187/Bang/2015 Page 17 of 50 mark up on domestic sales cannot be compared with gross profit on export sales to AE, reasonably accurate adjustments cannot be made to eliminate the differences between the domestic sale; export sales and consequently CPM cannot be considered as the MAM; and in this regard at para 50 thereof held as under :- “ 50.Considering the above submissions, vis-à-vis the method i.e. CPM (cost plus method) adopted by the learned TPO to determine the ALP, which has been relied upon by the learned Departmental Representative, we find that the learned TPO while adopting CPM has failed to appreciate several material aspects of the issue as discussed above. In our view, the learned TPO was not justified in comparing the gross margin in export segment vis-a-vis gross margins in domestic segment. There are various differences in the functions performed and the risk assumed in these two segments and therefore, the same cannot be considered as comparable cases for determining the ALP. There is no marketing risk in the export segment, no risk of bad debts, no product liability risk in export segments whereas the assessee has to bear all these risks in the domestic segment. The contractual statements also defer in the domestic segment vis-a-vis export segments. There are different characteristics and contractual terms in the two segments and further geographical and marked differences are also present. Thus, we are of the view that it is very difficult to make suitable adjustments for these differences, hence the CMA method is not appropriate method for determining the ALP. The learned TPO, in our view, has thus erred in adopting the CMA method as appropriate method.”

8.5.10 Similarly, the ITAT, Pune Bench in the case of Alfa Lavel (I) Ltd. Vs. DCIT (2014) 46 taxmann.com 394 (Pune –Trib), rejected CPM as the MAM. In its decision in that case, where the assessee was engaged in the business of manufacture and sale of various industrial products such as decanters, separators, etc. to its AE located abroad as well as in the domestic sector, in view of the fact that there were various differences in export segment and domestic segment, such as market fluctuations, geographic differences, volume difference, credit risk, RPT, etc., the Bench held that the TPO was not justified in adopting CPM as the MAM as suitable adjustments are not possible. 8.5.11 The learned Departmental Representative for Revenue placed reliance on the decision of the Delhi Bench of ITAT in the case of Wrigley India (P) Ltd. Vs. Addl. CIT (2011) 14 taxmann.com 91 to put forward the proposition that CPM should be considered as the MAM for manufacture and sale of finished goods in the domestic markets and exports to AEs. In fact, in this decision (supra), the Tribunal held that ‘since the marketing and advertisement expenditure has to be also incurred by the AEs to market the product in their respective territories, therefore this aspect for making adjustments as provided in Rule 10B(1)(c)(iii)

IT(TP)A No.187/Bang/2015 Page 18 of 50 has to be considered. It is thus seen that the above decision relied on by the learned Departmental Representative also recognizes that adjustments have to be made as per Rule 10B(1)(c)(iii) under CPM also. No doubt, as a proposition, the above principle holds good, however, as we have held that, in the case on hand reasonably accurate adjustments cannot be made to determine the adjusted profit mark up as per Rule 10B(1)(c), CPM cannot be considered as the MAM. 8.5.12 The learned Departmental Representative also placed reliance on the decision in the case of Diamond Dye Chem Ltd. Vs. DCIT in ITA No.3073/Mum/2006 dt.14.5.2010, wherein the Tribunal accepted CPM as MAM for the following reasons as held at para 35 thereof, which is extracted hereunder:- “ 35. We find the assessee is manufacturing Optical Brightening Agents (OBAs) which are being used in textile and paper industries and which are exported by the assessee to the AEs as well as Non-AEs. Therefore, we do not find any merit in the contention of the assessee that there is product dissimilarity between goods exported to AEs and unrelated parties and, therefore, the Cost Plus Method is not applicable. Further the learned counsel for the assessee also could not satisfactorily explain as to what are the substantial differences in the functional and risk profiles of the activities undertaking by the assessee in respect of the exports made to the AEs and Non-AEs. Therefore, we do not find merit in the submission of the learned counsel for the assessee that in cases where the differences in functional profile are so material that the same cannot be reasonably adjusted while carrying out a gross profit analysis, it may be appropriate to consider a net level analysis using operating margin in view of Rule 10B(1)(c)(iii). Therefore, the submission of the learned counsel for the assessee that if at all an internal comparison has to be carried out in the instant case then it should be carried out at the operating level i.e., using the net/operating margin. Further we find force in the submission of the learned DR that since the cost data for the manufacture of products are available as per cost audit report, the reliability there of is assured and therefore Cost Plus Method is the most appropriate method. In this view of the matter and in view of the detailed discussion by the learned CIT(A), we hold that the Cost Plus Method (CPM) is the most suitable method for the international transactions with AEs in the instant case.” In this decision (supra), the Tribunal accepted CPM as the MAM considering the fact that the assessee was not able to satisfactorily explain the substantial difference in the FAR analysis in respect to exports to AEs and non-AEs and therefore did not accept that comparison should be made at the operating level using the net operating margin. In the case on hand, however, the assessee has brought on record many functional, quantitative and qualitative differences

IT(TP)A No.187/Bang/2015 Page 19 of 50 between the domestic consumer product division and the exports to AEs. As discussed earlier, reasonably accurate adjustments cannot be made in the case on hand to determine the adjusted profit mark up as per Rule 10B(1)(c) and therefore CPM cannot be considered as the MAM. Consequently, the aforesaid decision relied on by the learned Departmental Representative is not applicable to the facts of the case on hand. 8.5.13 The OECD, TP Guidelines, 2010 relied on by the assessee provides that CPM may become less reliable when there are differences between the controlled and uncontrolled transactions and those differences have a material effect on the attribute being used to measure arm’s length conditions. It further states that when there are material differences that affect the gross margins earned in controlled and uncontrolled transactions, adjustments should be made to account for such differences. The extent and reliability of those adjustments will affect the relative reliability of the analysis. 8.5.14 On the other hand, the OECD,TP Guidelines, 2010, provides that TNMM is less affected by the transactional and functional differences as seen form Part III, B.2 at 2.68 thereof :- “2.68 One strength of the transactional net margin method is that net profit indicators (e.g. return on assets, operating income to sales, and possibly other measures of net profit) are less affected by transactional differences than is the case with price, as used in the CUP method. Net profit indicators also may be more tolerant to some functional differences between the controlled and uncontrolled transactions than gross profit margins. Differences in the functions performed between enterprises are often reflected in variations in operating expenses. Consequently, this may lead to a wide range of gross profit margins but still broadly similar levels of net operating profit indicators. In addition, in some countries the lack of clarity in the public data with respect to the classification of expenses in the gross or operating profits may make it difficult to evaluate the comparability of gross margins, while the use of net profit indicators may avoid the problem. 8.5.15 Rule 10B(1)(c) deals with the determination of ALP a per TNMM. As per this Rule, the net profit margin from a comparable uncontrolled transaction is adjusted to take into account the differences between the international transactions and comparable uncontrolled transactions, which could materially affect the amount of net profit margin in the open market. This is compared with the net profit margin from the international

IT(TP)A No.187/Bang/2015 Page 20 of 50 transactions entered into with an AE. TNMM requires establishing comparability at a broad functional level, requiring comparison between net margins derived from the operation of the uncontrolled transactions and net margin derived in similar international transactions. Thus, TNMM removes the limitations of other methods and since the comparison is made at the net profit level, it is the only method where comparison is possible when there are differences in the transactions and further making reasonable adjustments to the comparable transaction is impossible. The Hon'ble Delhi High Court 17 the case of Sony Ericcson Communications India P. Ltd. Vs. CIT (2015) 55 taxman.com 240 held that the TNMM is a preferred TP Method determination of ALP of international transactions for its proficiency, convenience and reliability and in TNMM preference should be internal or in-house comparables; as held in paras 89 and 90 thereof:- " 89. The TNM Method has seen a transition from a dis favoured comparabe method, to possibly the most appropriate Transfer Pricing method due to ease and flexibility of applying the compatibility criteria and enhanced availability of comparables. Net profit record/data is assessable and within reach. It is readily and easily available, entity-wise in the form of audited accounts. The TW Method is a preferred transfer pricing arm's length principle for its proficiency. convenience and reliability. Ideally, in TNM Method preference should be given to internal or in-house comparables. In absence of internal comparables, the taxpayer can and would need to rely upon external comparables, 1e comparable transactions by independent enterprises. For several reasons, database providers, it is apparent, have the requisite information and data of external comparables to enable comparability analysis of the controlled and adjustment to obtain reliable results under TNM Method. This method also works to the benefit and advantage of the tax authorities in view of convenience and easier availability of data not only from third party providers, but on their own level, i.e. assessment records of other parties. 90. The strength of the TNM Method is that net profit indicators are less affected by transactional differences in comparison with some other methods. This method is more tolerant to functional differences between controlled and uncontrolled transactions in comparison with resort to gross profit margins……….."

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8.5.16 In the case on hand, the net margin earned by the assessee in respect of personal care division in the domestic segment at 11.30% was compared to the net margin from exports to AEs at 15.80%. Since the net margin from exports to AEs was higher than the net margin from domestic sales to unrelated parties, the assessee concluded that its exports to AEs were at arm's length. The TPO has taken AE sales comprising of both pharma and personal care products and compared the same with the personal care products of the domestic segment. Since the products compared are different, consequently the gross profits are also different. Further, the number of differences and adjustments to be carried out for comparison purposes as detailed from page 19 of the TPO's order are large in number and therefore where differences are many, CPM cannot be considered as MAM. Consequently, in our considered view, TNMM is the MAM in the peculiar facts and circumstances of the case on hand.”

6.5.1 As regards the view of the TPO that the assessee is a contract manufacturer, the Co-ordinate Bench in the assessee’s own case for Assessment Year 2011-12 (supra) at para 9.1 and 9.2 of its order has held as under:

“9.1 The TPO held that the assessee acted as a contract manufacturer in respect of products exported to AEs since the products are sold to AEs at cost plus 15% and the assessee does not undertake any other functions. The OECD, TP Guidelines, 2010 explain the meaning of contract manufacturing with an example wherein a 100% subsidiary company assembles products (a) at the expense/risk of the holding company; (b) based on all necessary component, know how provided by the holding company (c) based on guarantee provided by the holding company for purchase of products. The OECD, TP Guidelines further states that in contract manufacturing, the producer may get extensive instructions about what to produce, in what quantity and of what quality and therefore in such circumstances, the producing company bears low risk. The Guidelines also provide that a contract manufacturer under control of principal, manufactures the product on behalf of the principal, using technology that belongs to the

IT(TP)A No.187/Bang/2015 Page 22 of 50 principal, where purchase of the products manufactured and remuneration are guaranteed by the principal, irrespective of whether and if so at what price the principle is able to re-sell the product.

9.2 In the case on hand, the products involved are standard goods manufactured by the assessee and selling them in the ordinary course of its business, both in the domestic and overseas markets. The assessee does not depend on the technology of the AEs for manufacture of products; whose specifications whether technical or otherwise are decided by the assessee itself. At para 1.2 on page 3 of his order under Section 92CA of the Act, the TPO has accepted that the assessee has its own range of products and the AEs only choose from the standard products which are manufactured by the assessee for the Indian Market. In our view, the TPO’s understanding of a contract manufacturer will make every manufacturer of goods in India who would not only make domestic sales but also effect sales to an overseas distributor as a contract manufacturer. A co-ordinate bench of this Tribunal in the case of Essilor Manufacturing India (P) Ltd. Vs. DCIT (2016) 67taxman.com 377 (Bang-Trib) held that an assessee carrying out its independent activity of manufacturing cannot be treated as a contract manufacturer. It was held that in such circumstances CPM cannot be applied and TNMM will be the MAM. In view of the overall consideration of the peculiar facts and circumstances of the case, as discussed above, we hold that CPM adopted by the TPO is incorrect and contrary to the facts of the instant case and that the assessee is justified in adopting TNMM for determining the ALP in respect of finished goods exported to AEs. In this view of the matter, the Transfer Pricing Adjustment ofRs.41,12,32,939 made by the TPO by adopting CPM is accordingly deleted. Consequently, ground No.VIII & IX raised by the assessee are allowed. ”

IT(TP)A No.187/Bang/2015 Page 23 of 50 6.6 For the year under consideration also, the TPO has accepted the fact that in respect of sale of products in India, the assessee has undertaken marketing, selling and administrative functions and the assessee has not performed any such functions in respect of sales to AEs. The number of differences and adjustments to be carried out for comparability purposes as laid out at page 17 of the TPO’s order are many in number and therefore, where differences are many, CPM cannot be considered as the MAM. In this view of the matter and following the decision of the Co-ordinate Bench of this Tribunal in the assessee’s own case for Assessment Year 2011-12 (supra), we hold that TNMM is the MAM. Under the said method, the assessee has earned net margin of 13.39% from exports to its AEs whereas the net loss suffered by the assessee in respect of the personal care division in the domestic segment is (-) 10.16%. As the net margins from the assessee’s exports to its AEs is higher when compared to the result of its margins in respect of transactions in the personal care division in the domestic segment, the price of the sale of finished goods are at arms length. In this factual view of the matter, the TP Adjustment of Rs.38,84,32,314/- made by the TPO by adopting CPM as the MAM is accordingly deleted. Consequently, grounds 5 to 7 are disposed off as above.

7.1 In this ground (supra), the assessee contends that it be allowed the benefit of the second proviso to section 92C(2) of the Act. In the course of proceedings, it was fairly submitted by the learned AR of the assessee that the assessee’s ground is untenable and we therefore dismiss the ground No.8 raised by the assessee.

IT(TP)A No.187/Bang/2015 Page 24 of 50 8. Ground No. 9 – TP Adjustment on AMP Expenditure

8.1 In this ground (supra) the assessee challenges the TP adjustment made / upheld by the authorities below in respect of Advertisement, Marketing, sales promotion (AMP) activity. The learned AR submitted that this issue is also covered in favour of the assessee by the decision of the Co-ordinate Bench of this Tribunal in the assessee’s own case in IT(TP)A No.807/Bang/2016 dated 04.07.2018 for Assessment Year 2011-12 and the facts are identical for both Assessment Year 2011-12 and the year under consideration.

8.2 Per contra, the learned DR for Revenue relied on the TPO’s order contending that the TPO was right in making the said TP adjustment on ‘AMP’.

8.3.1 We have considered the rival contentions / submissions and perused the material on record and the judicial pronouncements cited. In the case on hand, the TPO has computed the ALP in respect of ‘AMP’ expenditure as under:-

8.3.2 The TP Adjustment on ‘AMP’ expenditure for Assessment Year 2011-12 was also carried out in a similar manner by the TPO and the

IT(TP)A No.187/Bang/2015 Page 25 of 50 same was deleted by the Co-ordinate Bench of the Tribunal in its order in the assessee’s own case for Assessment Year 2011-12 in IT(TP)A No.807/Bang/2016 dated 04.07.2018 holding as under at paras 11.4.1 to 11.4.4 thereof:

“11.4.1 We have heard the rival contentions, perused and carefully considered the material on record; including the judicial pronouncements cited. The question of whether incurring AMP expenditure result in an international transaction was considered at length by a co-ordinate bench of this Tribunal in the case of Essilor India P. Ltd. Vs. DCIT (2016) 178 TTJ 69 (Bangalore –Trib.) which decision was followed by another co-ordinate bench of this Tribunal in the case of DCIT Vs. Nike India Pvt. Ltd. in IT(TP)A No.232/Bang/2014 dt.14.12.2016. In the case of Nike India Pvt. Ltd. (supra), after considering various judicial pronouncements on the subject, the co-ordinate bench held that in the absence of any arrangement between the assessee and the foreign AE for incurring AMP expenditure, no Transfer Pricing Adjustment can be made in respect of AMP expenditure. In this regard, we find that at paras 19 to 22 of its order in the case of Essilor India Pvt. Ltd. Vs. DCIT (2016) 178 TTJ 69 (Bangalore-Trib.), it was held as under :-

“ 19. In the present case, the assessee-company imports the lens from its foreign AE and after some processing, sells the products on its own. However, the amount of value addition on account of processing in terms of total revenue is not clear from the material on record. That apart, the assessee-company has been throughout contesting before all the authorities the very existence of international transaction on account of incurring AMP expenditure between assessee-company and its AE and therefore, the contentions that the law laid down by the Hon’ble Delhi High Court in Sony Ericsson Mobile Communication India (P) Ltd. (supra) should be applied to the case on hand, is not correct.

IT(TP)A No.187/Bang/2015 Page 26 of 50 Therefore, the submission of the learned Departmental Representative that the matter be remanded to the file of TPOD for fresh decision in the light of law laid down by the Hon’ble Delhi High Court in the case of Sony Ericsson Mobile Communication India (P) Ltd.(supra), cannot be acceded to.20. Subsequent to the decision in the case of Sony Ericsson Mobile Communication India (P) Ltd.(supra), the Hon’ble Delhi High Court had rendered five decisions on the same issue. Those decisions are (i) Maruti Suzuki India Ltd. Vs. CIT (282 CTR 1), (ii) CIT vs. Whirlpool of India Ltd. (129 DTR (169), (iii) Bausch & Lomb Eyecare (India) (P) Ltd. Vs. Addl.CIT (129 DTR 201) and (iv) Yum Restaurants (India) Pvt. Ltd. Vs. ITO (ITA No.349/2015 dated 13/01/2016) and (v) Honda SeilProducts

In the above-mentioned decisions, the issue of the very existence of international transaction on incurring AMP expenditure and the method of determination of ALP was the subject matter of appeal before the Hon’ble Delhi High Court. The Hon’ble Delhi High Court had categorically held that in the absence of agreement between Indian entity and foreign AE whereby the Indian entity was obliged to incur AMP expenditure of a certain level for foreign entity for the purpose of promoting the brand value of the products of the foreign entity, no international transaction can be presumed. It was further held that the fact that there was an incidental benefit to the foreign AE, it cannot be said that AMP expenditure incurred by an Indian entity was for promoting brand of foreign AE. One more aspect highlighted by the Hon’ble High Court is that in the absence of machinery provisions, bringing an imagined transaction to tax was not possible. While coming to this conclusion, the Hon’ble High Court had placed reliance on the decisions of the Hon’ble Apex Court in the cases of CIT vs. B.C.Srinivasa

IT(TP)A No.187/Bang/2015 Page 27 of 50 Setty (128 ITR 294) and PNB Finance Ltd. Vs. CIT (307 ITR 75). The Hon’ble Delhi High Court after referring to its earlier decision in the case of Maruti Suzuki India Ltd (supra) and Whirlpool of India (P) Ltd.,(supra) had considered the question of existence of the international transaction and computation of ALP thereon in the case of Bausch & Lomb Eyecare (India) (P) Ltd.(supra) vide para 51 to 65 as under:

“51. The central issue concerning the existence of an international transaction regarding AMP expenses requires the interpretation of provisions of Chapter X of the Act, and to determine whether the Revenue has been able to show prima facie the existence of international transaction involving AMP between the Assessee and its AE.52. At the outset, it must be pointed out that these cases were heard together with another batch of cases, two of which have already been decided by this Court. The two decisions are the judgement dated 11th December 2015 in ITA No. 110/2014 (Maruti Suzuki India Ltd. v. Commissioner of Income Tax) and the judgment dated 22nd December 2015 in ITA No. 610 of 2014 (The Commissioner of Income Tax-LTU v. Whirlpool of India Ltd.) and many of the points urged by the counsel in these appeals have been considered in these two judgments.

IT(TP)A No.187/Bang/2015 Page 28 of 50

IT(TP)A No.187/Bang/2015 Page 29 of 50 lease of tangible or intangible property or provision of service or lending or borrowing money or any other transaction having a bearing on the profits, incomes or losses of such enterprises, and (c) shall include a mutual agreement or arrangement between two or more AEs for allocation or apportionment or contribution to the any cost or expenses incurred or to be incurred in connection with the benefit, service or facility provided or to be provided to one or more of such enterprises.

IT(TP)A No.187/Bang/2015 Page 30 of 50 (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 SMCfor the purposes of promoting the brand of SMC."

“The other limb of the concept requires two or more persons joining together with the shared common objective and purpose of substantial acquisition of shares etc. of a certain target company. There can be no "persons acting in concert" unless there is a shared common objective or purpose between two or more persons of substantial acquisition of shares etc. of the target company. For, de hors the element of the shared common objective or purpose the idea of "person acting in concert" is as meaningless as criminal conspiracy without any agreement to commit a criminal offence. The idea of "persons acting in concert" is not about a

IT(TP)A No.187/Bang/2015 Page 31 of 50 fortuitous relationship coming into existence by accident or chance. The relationship can come into being only by design, by meeting of minds between two or more persons leading to the shared common objective or purpose of acquisition of substantial acquisition of shares etc. of the target company. It is another matter that the common objective or purpose may be in pursuance of an agreement or an understanding, formal or informal; the acquisition of shares etc. may be direct or indirect or the persons acting in concert may cooperate in actual acquisition of shares etc. or they may agree to cooperate in such acquisition. Nonetheless, the element of the shared common objective or purpose is the sine qua non for the relationship of "persons acting in concert" to come into being.”

IT(TP)A No.187/Bang/2015 Page 32 of 50 TPO "to examine the ‘international transaction’ as he actually finds the same.”62. In the present case, the mere fact that B&L, USA through B&L, South Asia, Inc holds 99.9% of the share of the Assessee will not ipso facto lead to the conclusion that the mere increasing of AMP expenditure by the Assessee involves an international transaction in that regard, with B&L, USA. A similar contention by the Revenue, namely, that even if there is no explicit arrangement, the fact that the benefit of such AMP expenses would also enure to the AE is itself sufficient to infer the existence of an international transaction has been negatived by the Court in Maruti Suzuki India Ltd. (supra) as under:

"68. The above submissions proceed purely on surmises and conjectures and if accepted as such will lead to sending the tax authorities themselves on a wild-goose chase of what can at best be described as a 'mirage'. First of all, there has to be a clear statutory mandate for such an exercise. The Court is unable to find one. To the question whether there is any 'machinery' provision for determining the existence of an international transaction involving AMP expenses, Mr. Srivastava only referred to Section 92F (ii) which defines ALP to mean a price "which is applied or proposed to be applied in a transaction between persons other than AEs in uncontrolled conditions". Since the reference is to ‘price’ and to ‘uncontrolled conditions’ it implicitly brings into play the BLT. 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 SonyEricsson. Therefore, the existence of an international transaction will have to be established de hors the BLT.

IT(TP)A No.187/Bang/2015 Page 33 of 50 ...........

..........

IT(TP)A No.187/Bang/2015 Page 34 of 50 under the Explanation to Section 92B of the Act. The problem does not stop here. Even if a transaction involving an AMP spend for a foreign AE is able to be located in some agreement, written (for e.g., the sample agreements produced before the Court by the Revenue) or otherwise, how should a TPO proceed to benchmark the portion of such AMP spend that the Indian entity should be compensated for?

"75. As an analogy, and for no other purpose, in the context of a domestic transaction involving two or more related parties, reference may be made to Section 40 A (2)(a) under which certain types of expenditure incurred by way of payment to related parties is not deductible where the AO "is of the opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods." In such event, "so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction." The AO in such an instance deploys the 'best judgment' assessment as a device to disallow what he considers to be an excessive expenditure. There is no corresponding 'machinery' provision in Chapter X which enables an AO to determine what should be the fair 'compensation' an Indian entity would be entitled to if it is found that there is an international transaction in that regard. In practical terms, absent a clear statutory guidance, this may encounter further difficulties. The strength of a brand, which could be product specific, may be impacted by numerous other imponderables not limited to the nature of the industry, the geographical peculiarities, economic trends both international and domestic, the consumption patterns, market behaviour and so on. A simplistic approach using one of the modes similar to the ones

IT(TP)A No.187/Bang/2015 Page 35 of 50 contemplated by Section 92C may not only be legally impermissible but will lend itself to arbitrariness. What is then needed is a clear statutory scheme encapsulating the legislative policy and mandate which provides the necessary checks against arbitrariness while at the same time addressing the apprehension of tax avoidance."

IT(TP)A No.187/Bang/2015 Page 36 of 50 transaction. The onus lies on the revenue to prove the existence of international transaction involving AMP expenditure between the assessee-company and its foreign AE. We also hold that that in the absence of machinery provisions to ascertain the price incurred by the assessee-company to promote the brand values of the products of the foreign entity, no TP adjustment can be made by invoking the provisions of Chapter X of the Act.

IT(TP)A No.187/Bang/2015 Page 37 of 50

11.4.2 In the case on hand, the TPO has made the Transfer Pricing Adjustment in respect of AMP expenses on the ground that the said expenditure has resulted in promotion of the brand ‘Himalaya’ owned by M/s. Himalaya Global Holdings Ltd., Cayman Islands and has applied the ‘Bright Line Test ’for this purpose. However, neither the TPO nor the Assessing Officer has brought on record any material evidence to substantiate the existence of any agreement or arrangement, either express or implied between the assessee and ‘HGH’, Cayman Islands for promotion of its brand. The Hon'ble High Court of Delhi in a series of decisions, inter alia, including the case of Maruti Suzuki India Ltd. Vs. CIT (2015) 64 taxman.com 150 (Delhi) emphasized the importance of Revenue having to first discharge the initial burden upon it with regard to showing the existence of an international transaction between the assessee and the AE. In the case of Maruti Suzuki India Ltd. Vs. CIT (supra), at para 64it was held as under :-

“ 64. The transfer pricing adjustment is not expected to be made by deducing from the difference between the 'excessive' AMP expenditure incurred by the Assessee andthe 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. And, yet, that is what appears to have been done by the Revenue in the present case. It first arrived at the 'bright line' by comparing the AMP expenses incurred by MSIL with the average percentage of the AMP expenses incurred by the comparable entities. Since on applying the BLT, the AMP spend of MSIL was found 'excessive' the Revenue deduced the existence of an international transaction. It then added back the excess expenditure as the transfer pricing 'adjustment'. This runs counter to legal position explained in CIT v. EKL Appliances Ltd.(2012) 345 ITR 241 (Del), which required a TPO "to examine the

IT(TP)A No.187/Bang/2015 Page 38 of 50 ‘international transaction’as he actually finds the same.” In other words the very existence of an international transaction cannot be a matter for inference or surmise.”

At para 76 of its order, the Hon'ble High Court has held as under:-

“ 76. As explained by the Supreme Court in CIT v. B.C. Srinivasa Setty (1979) 128 ITR 294 (SC) and PNB Finance Ltd. vs. CIT (2008) 307 ITR 75 (SC) in the absence of any machinery provision, bringing an imagined international transaction to tax is fraught with the danger of invalidation. In the present case, in the absence of there being an international transaction involving AMP spend with an ascertainable price, neither the substantive nor the machinery provision of Chapter X are applicable to the transfer pricing adjustment exercise.”

11.4.3 In our considered view, the requirement of there being an international transaction has not been satisfied in the case on hand. In fact, it is not the case of the TPO that there exists an arrangement between the assessee and ‘HGH’ to promote the brand by incurring AMP expenses. The case of the TPO is that the AMP expenditure incurred by the assessee has resulted in a benefit to the legal owner of the brand and the logo, i.e. M/s. Himalaya Global Holdings, Cayman Islands. The contentions of the TPO that the foreign AE has benefitted on account the AMP expenditure incurred and therefore the AMP expenditure cannot be said to have been incurred by the assessee for its own business, etc. have been rejected by the Hon'ble Delhi High Court. In the case of Sony Ericsson India P. Ltd. (supra), the Hon'ble Delhi High Court at para 121 of its order observed that there is nothing in the Act on Rules to hold that it is obligatory that AMP expenses must be necessarily be subjected to the ‘Bright Line Test’ as this would amount to adding words in the statute and Rules and introducing a new concept which has not been recognized and accepted as per

IT(TP)A No.187/Bang/2015 Page 39 of 50 the general principles of international taxation accepted and applied universally. In the case of Maruti Suzuki India Ltd. Vs. CIT (supra), the Hon'ble Delhi High Court at paras 84 to 86 thereof have held as under :-

“ 84. The Court next deals with the submission of the Revenue that the benefit to SMC as a result of the MSIL selling its products with the co-brand ‘Maruti-Suzuki’ is not merely incidental. The decision in Sony Ericsson acknowledges that an expenditure cannot be disallowed wholly or partly because its incidentally benefits the third party. This was in context on Section 57(1) of the Act. Reference was made to the decision in Sassoon J David & Co Pvt. Ltd. v. CIT (1979) 118 ITR 26 (SC). The Supreme Court in the said decision emphasised that the expression 'wholly and exclusively' used in Section 10 (2) (xv) of the Act did not mean 'necessarily'. It said: "The fact that somebody other than the Assessee is also benefitted by the expenditure should not come in the way of an expenditure being allowed by way of a deduction under Section 10 (2) (xv) of the Act if it satisfies otherwise the tests laid down by the law."85. The OECD Transfer Pricing Guidelines, para 7.13 emphasises that there should not be any automatic inference about an AE receiving an entity group service only because it gets an incidental benefit for being part of a larger concern and not to any specific activity performed. Even paras 133 and 134 of the Sony Ericsson judgment makes it clear that AMP adjustment cannot be made in respect of a full- risk manufacturer.

MSIL's higher operating margins

IT(TP)A No.187/Bang/2015 Page 40 of 50 which mandates only arriving at the net profit by comparing the profit and loss account of the tested party with the comparable. As far as MSIL is concerned, its operating profit margin is 11.19% which is higher than that of the comparable companies whose profit margin is 4.04%. Therefore, applying the TNMM method it must be stated that there is no question of TP adjustment on account of AMP expenditure.”

11.4.4 In the case on hand, the net margin from exports to AEs at 15.80% is more than the net margin earned by the assessee in respect of personal care product division in the domestic argument at 11.30%. In the factual matrix of the case, as discussed above, the ALP of the assessee's international transactions with its AEs were at Arm’s Length and therefore no separate adjustment for AMP expenditure is called for. We, consequently hold that the Transfer Pricing Adjustment of Rs.31,69,02,034 made by the TPO in respect of AMP expenditure is to be deleted. Ground No.XI is accordingly allowed.”

8.3.3 In our view, the aforesaid findings of the Co-ordinate Bench in the assessee’s own case for Assessment Year 2011-12 (supra) are squarely applicable for the year under consideration as the facts, basis and reasons for the TPO making the ‘AMP’ adjustment is identical to that of the earlier year, and, therefore, respectfully following the same, we delete the TP Adjustment of Rs.26,61,11,989/- made on account of AMP expenditure. Further, as the net margin from the assessee’s exports to AEs at 13.39% is higher as compared the net loss of (-)10.16% from the personal care division in the domestic segment, the assessee’s international transactions with its AEs are at arms length and therefore no separate adjustment for ‘AMP’ expenditure is warranted. Consequently, ground No.9 of the assessee’s appeal is allowed.

IT(TP)A No.187/Bang/2015 Page 41 of 50 9. Ground No.10 – Treatment of Interest Expenditure – Rs.2,91,89,882/-

9.1 In this ground (supra), the assessee challenges the DRP order in upholding the action of the AO in denying deduction of interest on borrowed capital amounting to Rs.2,91,89,882/- on the grounds that it was capital in nature. The AO disallowed the said expenditure claimed by the assessee for the reason that the same relates to the period prior to the date on which the fixed assets / installations were put to use. In coming to this view, the AO relied on the tax audit report, wherein the said expenditure was treated as capital in nature. The assessee’s submissions that the interest expenditure was in respect of loans used for construction of additional building in an already existing facility and that there is no extension of an existing business did not find favour with the AO. The AO held that the interest of Rs.2,91,89,882/- relates to the period prior to the date on which the fixed assets / installations were put to use and therefore disallowed the same under section 36(1)(iii) of the Act; but allowed depreciation thereon amounting to Rs.58,69,124/-. The DRP concurred with the findings of the AO and rejected the objections raised by the assessee in this regard.

9.2 Before us, the learned AR for the assessee submitted a copy of the order of assessment for Assessment Year 2009-10 wherein a similar disallowance under section 36(1)(iii) of the Act was made by the AO and depreciation was allowed on the interest capitalized. The learned AR contends that since depreciation has been allowed in the order of assessment, admittedly the building / installation has been put to use and therefore the interest paid on borrowings in the year under consideration should not have been disallowed under section 36(1)(iii) of the Act. It was submitted that as per the proviso to section 36(1)(iii) of the Act, interest paid on borrowed capital till the date on which the asset was first put to use shall not be allowed as deduction. According to the learned AR, in the case on hand, the asset was put to use in the earlier previous year, i.e.,

IT(TP)A No.187/Bang/2015 Page 42 of 50 relevant to Assessment Year 2009-10, and wherein the AO has allowed depreciation. It was submitted that, as the asset in question was already put to use, the conditions laid down in the proviso to section 36(1)(iii) of the Act is not satisfied. The learned AR also contended that the interest expenditure was in respect of a facility in an already existing factory building and argued that it was only an expansion of the existing business and therefore the proviso to section 36(1)(iii) of the Act would not be applicable or attracted in the case on hand. In this regard, inter alia, the learned AR placed reliance on the decisions of the ITAT – Hyderabad Bench in the case of ITW Signode India Ltd., Vs. DCIT (2007) 110 TTJ 170 and of the ITAT – Delhi Bench in the case of AT & T Global Network Services (India) (P) Ltd., Vs. DCIT (2017) 86 taxmann.com 158.

9.3 Per contra, the learned DR for Revenue relied on the findings in the order of assessment and contended that the AO was justified in making the impugned disallowance.

9.4.1 We have considered the rival contentions and carefully perused the material on record; including the judicial pronouncements cited. For Assessment Year 2009-10, the AO disallowed the interest expenditure of Rs.3,12,25,891/- for the similar reason that the said expenditure relates to the period prior to the date on which the fixed asset was put to use. The AO, however, allowed depreciation on the interest capitalized. Therefore, admittedly, the fact is that the building / asset in question was put to use and consequently the AO granted depreciation. In this regard, the relevant portion of the final order of assessment for Assessment Year 2009-10 in the case on hand is extracted hereunder:-

IT(TP)A No.187/Bang/2015 Page 43 of 50

IT(TP)A No.187/Bang/2015 Page 44 of 50

IT(TP)A No.187/Bang/2015 Page 45 of 50

IT(TP)A No.187/Bang/2015 Page 46 of 50

9.4.2 Depreciation under section 32 of the Act is allowed if the asset is put to use for the purpose of business. The DRP and the AO having allowed depreciation in Assessment Year 2009-10 have accepted the fact that the new building / asset forms part of an existing block of asset and has been put to use. Having accepted the factum of user for Assessment Year 2009-10, the AO cannot disallow interest expenditure of Rs.2,91,89,882/- incurred on loans taken for the purpose of the asset, already in use, as capital in nature. As submitted by the learned AR, which fact remains undisputed / uncontroverted, the whole new building was a part of the entire factory located at Makali, Bangalore, which also included the following:-

(a) New material store (b) New finished goods store and (c) New quality assurance block;

which is clearly an addition to an already existing building. The proviso to section 36(1)(iii) of the Act, for the year under consideration provides for the disallowance of interest paid in respect of capital borrowed for acquisition of an asset for extension of existing business. The ITAT, Hyderabad Bench in the case of ITW Signode India Ltd., Vs. DCIT (2007) 110 TTJ 170 (Hyd) held that the terms ‘extension’ connotes that the assessee has extended its operations from the present activity to another activity and on the other hand ‘expansion’ indicates that the assessee has merely expended its present operations. It was held that ‘expansion’ is generally meant to be expansion of its present installed capacities. It was

IT(TP)A No.187/Bang/2015 Page 47 of 50 also held that ‘extension’ means that the assessee is entering into altogether a new line of activity or is setting up an undertaking which is independent of the present undertaking. The relevant portion of the aforesaid order in the case of ITW Signode India Ltd., (supra) at paras 6 and 7 thereof is extracted hereunder:-

“6. ……………..The expression used is “extension” and not “expansion”. The former connotes that the assessee has extended its "Operations from the present activity to another activity. On the other hand, the latter indicates that the assessee has merely expanded its present operations. The expansion is generally meant to be the expansion of its present installed capacities. The capacity may be expanded either at the same location or at a different location. But the legislature has not used the word "expansion" and that is with a purpose. If there is merely an expansion, then it may not be necessary for the assessee to incur the type of expenditure envisaged in s. 35D. On the other hand, if there is extension or where altogether a new industrial unit is set up, such extension or setting up of a new unit may be preceded with the preparation of a feasibility report or. a project report or conducting market survey and so on. These preliminary expenses are envisaged in s. 35D for the reason that the extension or setting up of a new unit presupposes that the assessee is entering into altogether a new line of activity or is setting up an undertaking which is independent of the present undertaking. With this background, let us consider the facts of the present case. 7. The assessee company is in manufacture of state of art packaging systems. It manufactures several products like steel strapping, sealing tools, industrial packaging machines, stretch wrapping and packing systems, paper conversion products etc. It is not unknown to anyone that the market gets flooded with new innovative products everyday. It is also not uncommon that the manufacturers of such products always try to package them in a sophisticated way to attract customers. Secondly, automation in every activity is the order of the day and hence new machines are also being evolved to hasten the process of packaging with efficiency and efficacy. The assessee therefore has to keep on innovating new products and improving the existing products to cope up with the expanding market and consumerism. For this it requires dedicated department which keeps on conducting surveys of various types. It is in connection with this

IT(TP)A No.187/Bang/2015 Page 48 of 50 department that the assessee has incurred various expenses. As mentioned by the assessee, this department has been treated as a separate cost centre and hence its expenses are shown separately. To cope up with its expanding activities and production, the assessee has to install new plants or new machinery. Installing such new plants or machinery is sometimes loosely referred to as setting up a new unit. The contention of the assessee before the CIT(A) that it has set up new units was in this context and not in the context in which it is envisaged in s. 35D. Therefore, there is no gainsaying that the assessee has put up new industrial unit and hence the expenditure in connection therewith should be amortised under s. 35D. In the two Tribunal decisions, the assessee had launched altogether a new product and had incurred huge advertisement expenditure. In both the cases, the expenditure was treated as deferred revenue expenditure by the assessee in its books of account. The assessee had claimed the entire expenditure in the return of income as revenue expenditure. In both the cases, the expenditure was treated as deferred revenue expenditure by the assessee in its books of account. The assessee had claimed the entire expenditure in the return of income as revenue expenditure. The Tribunal allowed the entire expenditure by observing that by its very nature, deferred revenue expenditure presupposed that the expenditure was in revenue field. It was also observed that though the expenses may have enduring benefit, no estimate can be made about the period for which the assessee may be benefited. Therefore, on these grounds, the Tribunal allowed the expenditure. The assessee's case in the present appeal is on a much better footing insofar as that the assessee has not launched any new product worth its name. The production of Edge Board which is a new product introduced during the year is too insignificant to be considered. Thus, considering the overall facts of the case, we do not see any reason to apply the provisions of s. 35D. The AO is directed to allow full deduction of the expenditure as claimed by the assessee.”

9.4.3 Similarly, the ITAT – Delhi Bench in the case of AT & T Global Services (India) P Ltd., Vs. DCIT (2017) 86 taxmann.com 158 (Delhi – Trib); relying on the decision of the Hon’ble Apex Court in the case of DCIT Vs. Gujarat Alkalies & Chemicals Ltd., (2008) 299 ITR 85; at para 18 thereof has held as under:-

IT(TP)A No.187/Bang/2015 Page 49 of 50 “18. ______ …………………………The word "extension" has not been defined in the Income-tax Act, 1961 and one has to resort to the popular meaning of the term. The dictionary meaning of the word "extend" is a part that is added to something to enlarge or prolong it, addition, add-on, adjunct, addendum, augmentation, supplement, appendage, appendix; annexe, supplementary etc. The assessee submitted that the assets have been acquired only in connection with its existing telecommunication business. In our view, there is a very thin line of demarcation between the term expansion and extension, which can be differentiated basis the facts and evidences brought on record. Neither the Ld AO or the Ld DRP has brought on record. Neither the Ld AO or the Ld DRP has brought any evidence on facts to suggest that there was an extension of business during the year under consideration and the interest paid should be disallowed under section 36(1)(iii) of the Act. Further, the assessee also distinguished the decisions relied upon by the lower authorities on facts of the present case. While arriving at the above finding we also draw support from the decision of Hon`ble Supreme Court in the case of Dy. CIT v. Gujarat Alkalies & Chemicals Ltd. [2008] 299 ITR 85/167 Taxman 203 cited by the Ld. AR wherein it was held that 'extension' implies starting of a new business activity. Keeping in view the above said meaning we are of the view that the telecom equipment purchased by the Appellant using the ECB loans was for continuation of the existing business only and not for the extension of business. Hence, the said proviso to Section 36(1)(iii) does not apply to the facts of the present case. In the result, the ground No. 3 of the appeal of the assessee is allowed.”

9.4.4 In the case on hand, it is an undisputed fact that the assessee is engaged in the business of manufacture and sale of ayurvedic medicaments and preparations, consumer or personal care products and animal health care products. As per the material on record, no other business is carried on by the assessee. The addition to the building is a part of the already existing factory building located at Makali, Bangalore which included the following viz., (i) new raw material stores (ii) new finished goods stores and (iii) new quality assurance block. This is in addition to the already existing building and ostensibly the same products manufactured at the existing facility were produced at the new facility. Therefore, in our considered view this was an ‘expansion’ of the existing business as explained in the above cited judicial pronouncements. In the factual matrix of the case and in the light of the Tribunal decisions cited and considered (supra), we are of the view that the disallowance of interest expenditure by the AO amounting to Rs.2,91,89,882/- under section 36(1)(iii) of the Act is untenable and

IT(TP)A No.187/Bang/2015 Page 50 of 50 is accordingly deleted. Consequently ground No.10 of assessee’s appeal is allowed.

Order pronounced in the open court on this 30.04.2019.

Sd/- Sd/- Sd/- (LALIET KUMAR) (JASON P BOAZ) Judicial Member Accountant Member Bangalore. Dated: 30.04.2019. /NS/* Copy to: 1. Appellants 2. Respondent 3. CIT 4. CIT(A) 5. DR 6. Guard file By order

Assistant Registrar, ITAT, Bangalore.