LOREAL INDIA P.LTD,MUMBAI vs. ASST CIT 7(1)(2), MUMBAI

O R D E R Per Shamim Yahya, A. M.: These are cross appeals by the Revenue and assessee and cross objection by the assessee arising out of the order of the Assessing Officer passed u/s. 143(3) r/w s. 144C(13) of the Income Tax Act, 1961 (‘the Act' for short) dated 14.01.2016 pursuant to the direction of the Dispute Resolution Panel (‘DRP' for short) dated 28.12.2015.

2 M/s. Loreal India Private Ltd. 2. The grounds raised in Revenue’s appeal read as under:

3. The issue raised in assessee’s appeal read as under:

1. REFERENCE TO TPO IS WITHOUT JURISDICTION The CIT(A) erred in making a reference to the learned TPO without recording a finding that he considers it 'necessary or expedient' to do so as required under section 92CA(1) of the Act, hence the reference made by the learned AO to learned TPO suffers from jurisdictional error;

2. POWER OF TPO IN REMAND The CIT(A) erred in making alternate adjustment on account payment for royalty and intra-group services to its AE (in the remand report), without appreciating that the Hon'ble DRP had issued remand only on the applicability of Delhi High Court decision in case of Sony Ericsson Mobile Communication India Pvt Ltd in the facts of the present case, thereby exceeding the jurisdiction of remand;

3 M/s. Loreal India Private Ltd. The CIT(A) erred in suggesting alternate adjustment in the remand proceedings, without appreciating that the international transactions on account royalty and intra-group services are independent transactions as against alleged international transaction of AMP expenses, thereby grossly erred in recommending alternate adjustment in remand proceedings having accepted the same in the draft order;

3. ENHANCEMENT DONE BY THE PRP IS BEYOND JURISDICTION The Hon'ble DRP erred in taking cognizance of remand report (which were issued beyond jurisdiction) and thereby proceeded to make adjustment on alternate grounds (which were accepted at arm's length by TPO in order under section 92CA of the Act) without providing sufficient opportunity/ considering the submissions made by the Appellant, is beyond jurisdiction and bad in law;

PART I - TRANSFER PRICING ADJUSTMENTS 4. Adjustment in respect of trademark royalty paid to AE of Rs.13.49 Crores ALP of trade-mark royalty determined at Nil The CIT(A) erred in determining the ALP of trade mark royalty at NIL and making adjustment of Rs.13.49 Crores on account of trademark royalty paid to AE; The CIT(A) erred in concluding on the basis of factual assumption that the Appellant is the economic owner of the intangibles and hence should not pay any trademark royalty to its AE; Rejection of transfer pricing analysis under CUP The CIT(A) erred in rejecting the transfer pricing analysis undertaken by the Appellant by applying CUP with respect to payment of trademark royalty to AE without providing any cogent reasons for the same;

5. Adjustment in respect of technical know-how royalty paid to AE of Rs.17.99 Crores The CIT(A) erred in restricting the ALP of technical know-how royalty at 3% instead of 5% and thereby making adjustment of Rs.17.99 Crores on account of excess technical know-how royalty paid to AE; Inappropriate use of CUP The CIT(A) erred in rejecting the transfer pricing analysis undertaken by the Appellant by applying CUP with respect to payment of technical know-how royalty to AE without providing any cogent reasons for the same; without prejudice to above, the CIT(A) erred in considering the technology agreement between L'Oreal and Mennen in isolation as internal CUP for determining ALP of technical know-how royalty at 3%, without considering other comparable transaction available; 6. Adjustment in respect of intra-group services availed from AE of Rs.18.44 Crores Determining ALP of transaction at Nil based on surmises and assumptions

4 M/s. Loreal India Private Ltd. The CIT(A) erred in making an adjustment of Rs.18.44 Crores to the total income of the Appellant under Section 92CA(3) of the Act on account of determining the arm's length price of the international transaction pertaining to availing of intra-group services at Nil; The CIT(A) erred in making conclusions based on surmises, assumptions and referring to some ' factual documents (not pertaining to Appellant), without appreciating that no opportunity whatsoever was provided either by the learned TPO/ Hon'ble DRP before determining the ALP at Nil; Failure to consider benefit test without prejudice to above, failed to appreciate the business model and business realities of the Appellant and the role of its AEs and concluding that there is no significant benefit received by the Appellant from the services being rendered by the AEs; without referring to Transfer pricing documentation wherein the benefit test was substantiated;

PART II - CORPORATE TAX ADJUSTMENTS 7. Non-grant of MAT Credit The CIT(A) erred in non-granting MAT credit claimed by the Appellant of Rs.3,21,99.634/-;

8. Levy of interest under section 234B of the Act The CIT(A) erred in charging of interest under section 234B of the Act;

9. Levy of interest under section 234C of the Act The CIT(A) erred in charging of interest under section 234C of the Act; Initiation of penalty proceedings under section 274 read with section 271(1)(c) of the Act

1. Erred in objecting Dispute Resolution Panel ('DRP') directions without appreciating that Advertising, Marketing and Promotion ('AMP') expenses is not an international transaction; 2. Erred in objecting DRP directions without appreciating that Bright Line Test ('BLT) is not recognised method and cannot be used to determine the existence of international transaction; 3. Without prejudice to above, the learned Transfer Pricing Officer (TPO')/DRP should be directed not to make any separate AMP adjustment as excess gross profit earned by respondent adequately compensates the respondent for the alleged excessive AMP expenses; 4. Without prejudice to above, the learned TPO/DRP should be directed not to make any separate AMP adjustment as AMP adjusted margin of respondent are better than AMP adjusted margin of its comparables; 5 M/s. Loreal India Private Ltd.

6 M/s. Loreal India Private Ltd. 5. The assessee is a private limited company incorporated in India which is a wholly owned subsidiary of L’oreal S. A. France. The assessee is engaged in the business of manufacturing and distribution of cosmetics and beauty products. In the transfer pricing order, the Transfer Pricing Officer (TPO for short) observed that L’oreal India has acted as a distributor of cosmetic products that are not manufactured by it. It was noted that L’oreal India purchased finished products from its overseas Associated Enterprises (‘AE’ for short) and resells the same in the Indian market without any value addition. The associated enterprise is a L’oreal group which is a French conglomerate. As per the transfer pricing adjustment report, the assessee company had entered into with following international transactions with its AEs:

Nature of transaction Value of international transaction (Rs.) Import of raw material / packing material 96,222,828 for manufacture of finished goods Export of raw material / packing material 120,394 for manufacture of finished products Import of finished goods for resale in India 525,349,576 Export of finished goods manufactured by 1,001,228,856 L'Oreal India Rendering evaluation and technical testing 7,645,866 services Royalty payments for use of technical 584,766,594 know-how,brand name, trademark, etc. Availing marketing support services 184,491,457 Availing consultancy services 26,100,995 Import of fixed assets 1,987,666 Reimbursement of expenses (receipts) 44,707,919 Reimbursement of expenses (payments) 105,533,065

7 M/s. Loreal India Private Ltd. 6. The arm's length price of the international transactions in the manufacturing segment and in the distribution segment is determined by applying cost plus method and the resale price method respectively, which is stated to be the most appropriate method in the facts and circumstances of the case. The gross margin to sales ratio is taken as the profit level indicator (PLI) in the manufacturing segment and distribution segment. In the manufacturing segment, the PLI of the company is arrived at 168.16% on input cost whereas the average PLI of the comparables is arrived at 129.35% as per the analysis in the TP document. It is seen that the PLIs of the comparable companies have been worked out by adopting the data for the year 2010-11. As the price charged in its international transactions is greater than the said arithmetical mean price, the price charged in the international transactions is treated as at arm's length.

• The rights to manufacture the licensed products in its territory, using license technology, trademarks and designs • The right to import and distribute the licensed products.

As the international transactions take into account both the segments that is manufacturing segment and distribution segment, the transfer pricing analysis has been undertaken independently in respect of both the segments by the assessee company.

That by spending huge amounts on advertisement and marketing, L’oreal India is enhancing the brands ‘L’oreal’, ‘Garnier’ and others in India. The TPO rejected the assessee’s submission that AMP expenses are payments to third parties in India and hence not an international transaction. The TPO further rejected the assessee’s reliance

9 M/s. Loreal India Private Ltd. upon several decisions of the ITAT to contend that AMP expenditure incurred by the assessee for the product sold by it in India, do not result in any kind of direct benefit to its foreign affiliates. The TPO further referred to the decision of the Special Bench of the ITAT in the case of L G Electronics Ltd. 152 TTJ (Del)(SB) 273 and held that the assessee’s reliance on tribunal’s order is no longer relevant. The Assessing Officer (A.O. for short) proceeded to compute the AMP expenses and mark up thereon to be covered from the AE. He proceeded to compute a sum of Rs.1,90,23,50,373/- as an adjustment towards AMP on the advertisement expenditure incurred by the assessee for the brand owned by the AE for the manufacture segment. However, he computed an amount of Rs.53,34,40,068/- as adjustment towards AMP expenditure on advertisement expenditure incurred by the assessee for the brand owned by the AE for distribution segment. The TPO's summary is as under:

In view of the discussion above, the Transfer Pricing Officer is proposing to apply Bright Line Method and the adjustment to arm’s length price is determined at Rs.243,57,90,441/-. Thus, an amount of Rs.243,57,90,441/- is treated as an adjustment under section 92CA of the Income Tax Act, 1961 being shortfall in the compensation that the assessee company should have been received from its AE.

10 M/s. Loreal India Private Ltd. High Court and determine the adjustment on account of AMP adjustment vide DRP letter dated 19.11.2015. The said letter reads as under:

"2. In this case as per TP order dated 27.01.2015, TP adjustment of Rs. 53.34 crores has been made. The adjustment includes AMP expenses etc. 2.1. While making the AMP adjustment, BIT has been applied and thereafter the excess AMP expenses have been determined at Rs. 49.04 crores. Mark-up of 8.41% has been added for the services to the AE regarding excessive AMP expenses. 2.2. Subsequently, Delhi High Court in the case of Sony Ericsson Mobile 'Communication India Pvt. Ltd. in their order dated 16.03.2015 have inter-alia held that BIT is not appropriate method to bench mark AMP transactions. Further High Court has also held that AMP analysis in the case of distributor would be different from the AMP analysis in case of a manufacturer. 2.3. The assessee is a distributor and also a manufacturer. Applying Delhi High Court decision, BIT cannot be applied. I, therefore, request you to examine the AMP transaction in the light of Delhi High Court decision and recompute the adjustment and give your report by 30.11.2015.

The conclusion of the TPO’s response was noted by the DRP which are as under:

Conclusion : The adjustment proposed by the TPO in his order u/s.92CA for this year may be upheld as the Revenue has not accepted the decision of the Hon'ble Delhi High Court in the case of Sony Ericson regarding rejection of BLTand SLP has been filed against the said decision before the Supreme Court.

3. In case, the Hon'ble DRP is of the view that the transaction of AMP expenditure incurred by the assessee is an international transaction and, the decision of Hon'ble Delhi High Court in the case of Sony Ericson is applicable only to the distribution segment, and if BLT is to be rejected and aggregate approach is to be followed then, an adjustment of Rs.22.03 crore for the distribution segment may be upheld. In addition the alternative submission for disallowance of Rs.31,48,74,320/- out of royalty and Rs.18.44 crores out of intra group services towards availing market support services may be considered.

11 M/s. Loreal India Private Ltd.

3.20. We also find that Delhi High Court have passed similar order in the case of Whirlpool of India Ltd. On 22nd December, 2015. On the basis of all these judgments of Delhi High Court, it emerges that unless there exist an agreement or arrangement or understanding between the assessee and its AE for AMP expenses, any international transaction cannot be said to have been undertaken. ! Bright Line Test has no statutory sanction to benchmark any international transaction including AMP. Since on facts of this case it cannot be said that there exist any agreement or understanding or arrangement between the assessee and the AE and the TPO has not shown anything except BLT to benchmark the alleged excess AMP expenses, the adjustment made by the TPO in this regard is therefore directed to be deleted. The objections of the assessee in this respect are therefore directed to be deleted. The objections of the assessee in this respect are therefore accepted.

12 M/s. Loreal India Private Ltd. Regarding the trademark royalty, we have considered the facts of the case and submissions made by the assessee on 23.12.2015. We agree with the TPO that there is no reason for payment of trademark royalty on facts of the case. Therefore the.AO is directed to made adjustment on account of trademark royalty as proposed by TPO of Rs. 13,49,46,137/- @ 1.5% of sales. We find that the Mennen agreement is an internal CUP for know-how royalty. Though agreement was entered in F.Y. 2005-06 but it is still a valid agreement and acted on by the parent of the assessee, therefore we are of the considered opinion that royalty @ 3% charged by the parent to Mennen is a valid internal CUP available to benchmark the royalty paid by the assessee. Accordingly excess royalty paid of Rs. 17,99,28,183/- is also directed to be disallowed as TP adjustment for technical know-how royalty. We have considered the facts of the case and submissions made. Before the Panel also, the assessee has not submitted any evidence in support of rendition of services by the AE and receives of the services by the assessee. Therefore ALP of such services in absence of evidence has to be determined at Rs. Nil. The A.O. is directed accordingly.

In view of the judicial precedents as well as the facts on record, we are of the view that the assessee has failed to demonstrate that it has received services or that it benefited from such services as claimed or that the services were provided. It has further failed to demonstrate the incurrence of cost by the AE as well as its allocation among the various group entities. We are of the view that the TPO has not questioned the commercial expediency of such transaction entered into by the assessee, rather, has only worked out the arms length price of the purported service. We are further of the view that no services are rendered nor received by the assessee and what is received (if at all) do not take character of chargeable service. The perusal of the e-mails and other contemporaneous record only goes to show that incidental and passive association benefits have been provided by the AE. In this view of the matter, there could neither be any cost contribution or payment for such service to the AE. Further, as no expenditure would have been incurred, there is no necessity to apply a particular method to arrive at such conclusion. The TPO has been more than fair in granting the deduction on estimates based on the evidence produced. Therefore, the AO is directed to make TP adjustment of Rs. 18.44 crores on account of Intra-group services.

Furthermore, the ld. Departmental Representative also referred to paragraph 191 of Sony Ericson Mobile Communications (India) Pvt. Ltd. order wherein the Hon’ble High Court

14 M/s. Loreal India Private Ltd. had held that other issues are also relevant. The Hon’ble High Court has observed as under:

191 The fact that royalty has been paid would be a relevant consideration and factum, when we consider arm’s length price of the international transaction of distribution and marketing. Tax treatment of royalty payments being different, the royalty transaction, therefore, may be benchmarked separately. However, payment of royalty even if justified and appropriate on applying arm’s length principle, can be a relevant factor when the question of compensation of the domestic AE for undertaking distribution and marketing functions arises for consideration.

21. Upon careful consideration, we admit the submission of the ld. Counsel of the assessee that proper opportunity was not given to the assessee to make the submissions on the alternatives. However, we also do not agree with the ld. Counsel of the assessee that since on one of the alternative, the DRP's direction is silent, it can be understood that this issue has been considered by the DRP. Hence, we remit these issues on the alternative suggested by the TPO to the DRP. The DRP shall consider the same after giving the assessee an opportunity of being heard. The ld. Counsel of the assessee has fairly agreed to the above proposition.

Order pronounced in the open court on 11.09.2018