LIUGONG INDIA PVT. LTD.,NEW DELHI vs. ACIT, NEW DELHI

IN THE INCOME TAX APPELLATE TRIBUNAL, DELHI BENCH ‘I-1’ NEW DELHI BEFORE SHRI I.C. SUDHIR, JUDICIAL MEMBER & SHRI L.P. SAHU, ACCOUNTANT MEMBER ITA No. 1482/Del./2015 Asstt. Year : 2010-11 Liugong India Pvt. Ltd., vs. A.C.I.T., Circle 15(2), 82, Ground Floor, New Delhi. Okhla Indl. Estate, Ph-III, New Delhi [PAN: AABCL3456H] (Appellant) (Respondent) Appellant by : Sh. Manoj Pardasani, CA Respondent by : Sh. Amrendra Kumar, CIT/DR Date of hearing : 04.01.16 & 01.04.2016 Date of pronouncement : 28.06.2016 ORDER Per L.P. Sahu, Accountant Member: This is an appeal filed against the order of the Assessing Officer dated 28.02.2014 u/s. 143(3) r.w.s. 144C of the Income-tax Act (hereinafter referred to as ‘the Act’) and subsequent directions dated 21.11.2014 of DRP u/s. 144C(5) of the Act and final assessment order dated 30.01.2015 passed in pursuance to directions of DRP for the assessment year 2010-11.

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agreement made between GLMCL and LIPL, updated time to time, on GF basis. The payments is made to GLMCL with regards to machines and its parts under agreement by executing telegraph transfer with deferred maximum 180 days from the date of invoice payment term and letter of credit maximum of 160 days. As per the agreement, the Company cannot deal in other brands products. 3. Custom Clearance Functions: LIPL perform the function of getting its import purchases cleared from custom formalities and transportations of goods at company place, tt appoints the personnel for performing reasonable steps in this regard. 4. Examination of Products: The Company performs the examination of products when they are received and notify the Liugong in writing within 30 days of shipment receipt date, about any problems concerning shortages or damages of the Products and get them replaced from Liugong, China. 5. Sales and Support Functions: The Company directly quotes its customers, with pricing of products at its discretion but keeping in mind the "Dealers rules" made by Liugong and its dealers. The Company establishes sales and service team and has several service center outlets from the products. The Company deputes, on regular basis, service personnel to company's headquarters for training for around 1 month. 6. Price Negotiation: The sales team of the LIPL is responsible for the price negotiation and entering into contracts with customers. 7. Marketing Function: LIPL develops the marketing strategy for the sale of its products, carry on the promotional and advertising functions to promote its products in its territory decided by agreement. It trace the customers requiring the products and dealing with them.

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2 Building (Office) 118,960,678 3 Building (Office) 263,757,004 4 Plant & Machinery 159,559,104 5 Motor Vehicles 2,250,684 6 Computer 2,358,491 7 Office Equipments 1,228,519 8 Furniture & 7,602,787 Fixtures 9 Electric 45,103,409 Equipments Computer Software 1,283,424 TOTAL 653,533,002

RISKS ASSUMED In any business, an organization has to bear many kinds of risks to earn a return. Following are risks associated with LIPL: 1. Financial Risk: Financial risk is the risk of non-payment of dues by the customers to whom credit have been extended. UPL is fully exposed to this risk in relation to its customers. 2. Market Risk: Market Risk arises for a business due to increased competition and relative pricing pressures, change in demand patterns and needs of customers, inability to develop/penetrate in a market, etc. UPL has significant exposure to this risk so far as sales of finished products to its customers are concerned. It is caused by an increased competition in the market related pricing pressure, change in demand pattern and needs of customers. 3. Product Quality Level Risk Risks associated with product/service failures including non- performance to generally accepted or regulatory standards.

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This could results in product recalls and possible injuries to end-users. As LIPL products range involves heavy machines, it has full exposure to product quality level risks. It has to take care of warranty given to its customers for product and its parts replacements. 4. Research & Development Risk Research & Development risk is risk associated with R&D performed by an enterprise i.e., it may or may not be successful. LIPL did not carry on any R&D activities. So it is not exposed to research & development activities. 5. Inventory Risk Inventory Risk is the risk associated with the management of the inventory. In case of overstocking or slow/non moving inventory resulting from a rapidly changing and technology/price sensitive market, the enterprise may be forced to bear a loss of margin on the inventory or incur other additional costs to dispose the same. LIPL purchase goods on the basis of sales forecast. So, LIPL is fully exposed to inventory risk as it purchase in advance from its associate, which may be result in overstocking or under stocking. 6. Foreign Exchange Risk This risk relates to the potential impact on profits that may arise because of changes in foreign exchange rates. With movements in the foreign exchange rates, the amounts receivables payables can vary for both the Indian and Foreign entity, depending on the currency of invoicing. LIPL is fully exposed to this risk with respect to its foreign currency transactions. 7. Human capital/manpower risk Every company has to employ people and train them adequately so as to suit the requirements of the company and

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thereby converting them into the assets of the company. There always exists a risk of the trained staff leaving the company and other factors affecting quality standards, productivity and efficiency, LIPL is fully exposed to this risk as in providing the quality standards services to its customers. The Company has to train its personnel for selling its products by demos to its prospective customers. 8. Legal and Statutory Risk This risk primarily arises on non-compliance with any iegal/contractual/statutory provisions. LIPL is fully exposed to this risk so far as compliance with the Indian Rules & Regulations are concerned. 9. Political risk This risk primarily arises on account of operating in geographical jurisdictions with unstable political regimes/unfavorable government policies. LIPL is very little exposed to this risk so far as its Indian operations are concerned, because infrastructure and constructions companies in India are encouraged to develop more and more infrastructure.

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assessee at an income of Rs.25,96,09,506/- by making following additions/disallowances : I. Addition on account of transfer pricing adjustments 26,65,36,577/- II. Disallowance u/s. 40(a)(ia) 84,88,503/- III. Disallowance u/s. 14A 1,308/-

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(vi) Miscellaneous 3,73,498 Nil Rs.3,73,498 expenses Total adjustment under section 92CA Rs.26,65,36,577

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pertaining to plant and machinery. The TPO also made an adjustment of Rs. 7,35,63,856/- on account of interests on overdue receivables considering Rs. 45,67,22,388/- as receivable due from the AE, as reported in the related party disclosure in the financial statements of the assessee and applying interest rate of 14.88% for computing interest on overdue receivables.

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entering into such transaction. Then the net profit margin realized by the enterprise from an international transaction entered into with an associated enterprise is established with the net profit margin computed out of comparable uncontrolled transaction and the net profit margin thus established, shall be taken into account to arrive at the arm's length price.This method compares the Normal Net Profit Margin computed in relation to costs incurred or sales effected or assets employed or having regard to any other relevant base realized by associated enterprise to the net profit margin realized by unrelated enterprises from comparable uncontrolled transactions. Under the TNMM, comparable transactions need to be only broadly similar. Significant product diversity and some functional diversity between the controlled and uncontrolled parties are acceptable. Assessee took this method as most appropriate method.

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ground regarding disallowance u/s. 40(a)(ia), was accepted and disallowance u/s. 14A was also upheld. Against the directions passed by the DRP, the ld. Assessing Officer passed the final assessment order on 30.01.2015 wherein based on the directions of the DRP, the total adjustment proposed on ALP was reduced to 13,69,92,899/- instead of Rs.19,29,72,721/- computed earlier and thereafter final assessment was passed assessing the total income of the assessee at Rs.19,51,51,180/-. 14. Against this, the assessee is in appeal on the following grounds : Transfer Pricing - Purchase of Machinery, Heavy Earthmoving Machines and Spare Parts – Rs.9,56,91,501 1. On the facts and in law, the Honourable Dispute Resolution Panel ("Hon'ble DRP')/ Learned Assessing Officer ('Ld. AO)/ Learned Transfer Pricing Officer (Ld. TPO) erred in violating provisions of Section 92C of the Income Tax Act, 1961 ('the Act") read with Rule 10C of the Income Tax Rules, 1962 ('the Rules"), in disregarding and ignoring the Comparable Uncontrolled Price('CUP’) submitted for international transactions pertaining to purchase of machinery of Rs. 40,55,59,818. 2. On the facts and in law, the Hon'ble DRP/ Ld. AO/ Ld. TPO erred in violating provisions of Section 92C of the Act read with Rule 10C of the Rules, in enhancing the value of the international transactions of purchase of finished goods. CKD/SKDs and spare parts by Rs. 9,56,91,501. 3. On the facts and in law, the Hon'ble DRP/ Ld. AO/ Ld. TPO erred in contravening the provisions of the Rule 10B(1)(e), in incorrectly computing the net profit margin realized by the Appellant at (8.45)% from the international transactions with its AEs instead of 4.49%.

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international transaction pertaining to plant and machinery without appreciating the facts of the case. Adjustment on account of miscellaneous expenses - Rs. 3,73,498 plus penalty 18. On the facts and in law, the Hon'ble DRP/ Ld. AO/ Ld. TPO erred in making an adjustment of Rs. 3,73.498 by considering the arm's length price of miscellaneous expenses as NIL without providing any opportunity of being heard to the Appellant to demonstrate the arm's length nature of the transaction. 19. On the facts and in law, the Ld. TPO erred in proposing to levy a penalty of 2% towards nondisclosure of international transaction of payment of miscellaneous expenditure in the Form No. 3CEB. Penalty on international transaction pertaining to issue of shares 20. On the facts and in law, the Ld. TPO erred in proposing to levy of penalty of 2% of the issued share capital for non-disclosure of transaction pertaining to issue of equity shares by the Appellant in the Form 3CEB. Corporate Tax - Section 14A - Rs. 1,308 21. On the facts and in law, the Hon'ble DRP/ Ld. AO/ Ld. TPO erred in disallowing an amount of Rs. 1,308 under Section I4A.”

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5.6.1. The application of TNMM requires the selection of an appropriate Profit Level indicator (PLI). The PLI measures the relationship between (i) profits and (ii) either costs incurred, revenues earned, or assets employed. A variety of profit level indicators may be used. 5.6.2. TNMM aims at arriving at the arm's length operating profit (i.e. profit before financial and non-operating expenses). Factors relevant to the selection of the appropriate PLI include the reliability of the available data and the extent to which the PLI takes into account costs that would be considered by independent parties. 5.6.3. Net Profit Margin is selected to reliably measure the income of the tested party that it would have earned, had it dealt with uncontrolled parties at arm's length. Net Profit margin (NPM), the ratio of operating profit to sales, is normally a good indicator of total return to the business activity. This measure accounts for operating expenses as well as cost of goods sold and thus is less likely, than the gross margin, to be distorted by differences in functions or accounting conventions. Thus, it is generally considered as an acceptable PLI when sales are made to third parties. 5.6.4. The arm's length result of profitability can be established by one of several financial indicators. A variety of indicators may be used in a given analysis; the choice between measures depends upon the activities of the tested party, the reliability of the data for comparable uncontrolled companies and the extent to which the indicator will produce a reliable measure of an arm's length result.”

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“CUP The taxpayer has rejected this method by stating that a) it acts as a sole distributor of its AE in India, b) lack of availability of data of comparable companies. The TPO remarks – If the taxpayer is acting as sole distributor then in that case, it holds monopoly in India market for Liugong Products and can charge any price from its customers, but still it is operating in losses. Further, it is always true that in case of sole distributor, comparable data may not be available, however, in case it’s AE is selling similar products to other countries, then after claiming adjustment for geographical differences, CUP method can easily be applied for which no extra efforts have been put on record. RPM Taxpayer has rejected this method by stating that technically this method is applicable, but rejected due to lack of availability of data for computation of gross margins. TPO’s remarks – Here, Taxpayer itself acknowledge that being a trading organization, RPM is the best method in its case, however, no efforts have been put on record to justify its applicability, which clearly shows that methods are being rejected on baseless parameters by simply referring to lack of availability of data. CPM Taxpayer rejected this method by stating that a) absence of reliable data on functional comparability between international transactions and uncontrolled transactions, b) information regarding direct and indirect cost of production is not available in external database, c) by referring to judgment of Aztec Software & Technology Services Ltd. TPO’s remarks – Surprisingly, it is stated that information regarding cost bifurcation is not available in external database. The important question arises here that why and for what reasons, to know its own direct and indirect cost, a company is required to refer external database, whereas the same must be

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available with the taxpayer himself. It is important to state here that by simply writing that data is not available, onus cannot be said to be discharged by the taxpayer. Here, again, nothing has been put on record in TP study that efforts were made to cull-out the details for applying CPM but the same is not available with different reasons along with supporting thereof. PSM Taxpayer rejected this method by stating that a) this method is complex and b) absence of reliable market data. TPO’s remarks – It is very much clear that taxpayer has not even tried to apply this method and simply rejected this method based on its complexity and not on actual facts and circumstances. Further, it is hard to igest that for application of PSM what kind of market data is requird. TNMM Taxpayer selected this method by stating that it is simple method to apply rather any other method. TPO’s remarks – It is itself cleared that for the purpose of ease and convenience only, taxpayer has selected this residual method.”

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different geographical locations. By way of written synopsis, the assessee further submitted as under : During the year, the Assessee imported machinery from its AE, Guangxi Liugong Machinery Co. Ltd. for sale in India. As mentioned in the Form No. 3CEB of the Assessee, it had imported 192 pieces of machines for Rs. 40,55,59,818 from its AE. The Assessee, in its TP Report, rejected CUP as the most appropriate method due to non -availability of comparable data in the public domain. However, during the assessment proceedings, the Assessee had submitted before the Ld. TPO, the details of sales made by the AE to the independent third parties and to the Assessee as Annexure 3 to submission dated 10 July 2013. (refer pages 579 to 607 of the paper book) It was demonstrated that the model-wise average sale price (at FOB values) per unit at which these machines were sold by the AE to the Assessee were much less than the average sale price (at FOB values) per unit at which the same models were sold by the AE to independent third parties. The summary of the same is reproduced below for your Honour's ease of reference; s. Model Details of products sold to Details of products sold to No. Name LIPL by the AE during FY Independent Distributors in 2009-10 Other countries1 by the AE during FY 2009-10 No. of units Average sale No. of units Average sale price price for sale for sale to to LIPL (in independent USD) (FOB) distributors (in USD) (FOB) 1 CLG 856 83 54,033 19 75,437

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2 CLG 835 36 25,301 116 36,308 "i ZL30E 26 19,934 101 20,273

s. Model Details of products sold to Details of products sold to No. Name LIPL by the AE during FY Independent Distributors in 2009-10 Other countries by the AE during FY 2009-10 No. of units Average sale No. of units Average sale price price for sale for sale to to LIPL (in independent USD) (FOB) distributors (in USD) (FOB) 4 CLG418 3 63,283 9 72,401 5 CLG614 14 21,243 9 30,395 6 CLG 24 56,308 8 76,643 205C 7 B230 2 1,11,750 6 1,12,739 8 CPCD 30 2 8,838 48 10,090 9 CPCD 20 2 7,838 3 15,118

The details of sales made by the AE to the independent third parties and to the Assessee as Annexure 3 to submission dated 10 July 2013. (Page 579 to 607 of the paper book) In addition to the above, the Assessee also shall submit the copies of the invoices for the machinery sold by the AE to independent third party distributors and to the Assessee

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during FY 2009-10 in support of above claim as Additional Evidence during the course of the proceedings before Your Honour. 10.1.2 Appropriate adjustments to enhance comparability For application of CUP method, as highlighted in paragraphs above, the Assessee made suitable adjustments for differences in freight owing to difference in geographical locations, to enhance the price level comparability between the Assessee and independent third party distributors. • Factual explanation To explain, the significant difference arising on account of difference in geographical locations is reflected in 'Ocean Freight' and other GIF expenses. In order to take care of such difference, the Assessee submits that the data provided by the AE contains the comparison of prices adjusted as follows: -> Sale price of the AE to the Assessee as well as to independent customers -> Less: Freight incurred by the AE -> = FOB sale price The same adjustment was made on the sale to the Assessee as well as to the independent customers by the AE for comparison purposes. Legal Provisions relied upon by the Assessee Here, the Assessee would like to emphasize the intent of the legislature, that even if there are differences in 'Economic Circumstances ' including difference in geographical location of the tested party and the comparable uncontrolled transactions, then reasonable and accurate adjustments should be made to eliminate such differences. Reference is drawn to the following extract of Rule 10B of the Income-tax Rules. 1962 ("the Rules"'):

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Rule 10B(1) of the Rules "Determination of arm's length price under section 92C. 10B. (1) For the purposes of sub-section (2) of section 92C, the arm 's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely:— (a) comparable uncontrolled price method, by which,— (i) the price charged or paid for property transferred or services provided in a comparable uncontrolled transaction, or a number of such transactions, is identified: (ii) such price is adjusted to account for differences, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises entering into such transactions, which could materially affect the price in the open market; (iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arm 's length price in respect of the property transferred or services provided in the international transaction; Rule 10B(3) of the Rules " (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."

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Support in OECD Guidelines In support of above contentions, the Assessee would also like to draw your Honour's kind attention to the following extract from the Guidelines issued by the Organisation for Economic Co-operation and Development for Multinational Enterprises ("OECD Guidelines") July 2010 which states the following: "D. 1.2.4 Economic circumstances 1.55 Arm's length prices may vary across different markets even for transactions involving the same property or services; therefore, to achieve comparability requires that the markets in which the independent and associated enterprises operate do not have differences that have a material effect on price or that appropriate adjustments can be made. As a first step, it is essential to identify the relevant market or markets taking account of available substitute goods or services. Economic circumstances that may be relevant to determining market comparability include the geographic location; the size of the markets; the extent of competition in the markets and the relative competitive positions of the buyers and sellers; the availability (risk thereof) of substitute goods and services; the levels of supply and demand in the market as a whole and in particular regions, if relevant; consumer purchasing power; the nature and extent of government regulation of the market; costs of production, including the costs of land, labour, and capital; transport costs; the level of the market (e.g. retail or wholesale); the date and lime of transactions; and so forth. The facts and circumstances of the particular case will determine whether differences in economic circumstances have a material effect on price and whether reasonably accurate adjustments can be made to eliminate the effects of such differences. " As provided in the Indian legislature and recommended by the OECD guidelines, uncontrolled transactions can be compared with the controlled transactions, provided reasonable & accurate adjustments are performed lo

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eliminate the differences that may have material effect on the comparability of controlled and uncontrolled transactions. As explained above and also provided in the legislature, reasonable and approximate (close to accurate) adjustment has already been made by the AE, on account of difference in geographical locations captured by the difference in freight and other CIF expenses) of the Assessee and the independent customers, in compiling the above mentioned comparative data. • Judicial Precedents relied upon by the Assessee where Geographical adjustments in CUP method have been upheld In this regard, the Assessee would like to rely on following judicial precedents, discussed as under: Bharti Airtel Limited (ITA No. 5 63 6/Del/2011 AY 2007-08 "49 xx..xx...The TPO has rejected all but one of these comparables on the ground that the remaining comparables are with respect to geographically different markets but, as we have seen above, a difference in geographical location of the market, unless resulting in different market conditions, is not a reason good enough to reject a comparable under the CUP method. There is no mention whatsoever of any commercial differences, i.e. differences in market conditions, in the market of the uncontrolled transaction and the intra AE transaction. Since the TPO has rejected these comparables, the onus is on him to demonstrate that the market conditions are so different that the uncontrolled transactions cease to be comparable with the intra AE transactions. Not only that this onus is not discharged, there is not even a suggestion that the market conditions of the uncontrolled transactions are materially different. In view of these discussions, as also bearing in mind entirety of this case, the very basis of exclusion of other comparables is devoid of legally sustainable reasons. "

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M/s. Isagro (Asia) Agrochemicals Pvt. Ltd: v. The DCIT, Cir. 8(2), Mumbai. (ITA No.2044/Mum/2010] "The contention of the Id. DR that the difference in geographical locations makes its impact on benchmarking, in our considered opinion is well founded. However, when we consider the facts of the instant case in which the effect of such geographical differences has been removed by comparing FOB value of transactions with AEs and Non-AEs, the relevance of such factor gets mitigated. M/s Clear Plus India Pvt. Ltd v. Dy. C.I.T., Circle- 3(l),(I.T.A. No.3944/D/2010] Recently, the Supreme Administrative Court of Czech Republic, in the case of Rodusek JMSNMEREPUBIJKY, In re JU DR. LENKA KANIOVA, PRESIDENTAND JUDR. MARIE, J. JUDGMENT NO. 1 AFS 101/2012-31 JANUARY 23, 2013 ([2013] 35 taxmann.com 197 (CRSAC)), adjudicated as under: (i) The Supreme Administrative Court held that target market conditions were irrelevant for the application of the comparable uncontrolled price (CUP) method; (ii) The difference in price levels in the various markets and countries were not relevant for determination of the arm's length price; (iii)The consideration had not to be given to the target market in setting the prices and the difference in margins generally had to be attributed to the distributor and not to the producer. Further, in the following cases also, the geographical differences were considered to be irrelevant in the Assessee's case: M/s. Wrigley India Private Limited v. Addl. CIT, Range IS, New Delhi [ITA 5224/Del./2010]

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M/s Agility Logistics Private Limited v. Deputy Commissioner of Income Tax-8(l), ITA No. 8648/Mum/2011] From the above submission and supporting evidences, it is evident that after making suitable adjustments above, the Assessee has been charged at a lower rate than the market determined prices for the independent customers. In other words, it can be reasonably inferred that there is no instance of overpricing in the instant case; and the international transactions of import of machines can be considered to meet the arm's length standard. Hence, there is no reason to draw an adverse inference in the instant case. However, the Ld. TPO ignored the data/ submission furnished by the Assessee pertaining to CUP data and stated that the Assessee has not put any extra efforts on record to benchmark its international transaction pertaining to purchase of machines, which is factually incorrect. Judicial Precedents on application of CUP method being used in case of data availability. In this regard, the Assessee would like to rely upon the Hon'ble Madras Tribunal's ruling in case of Alden Prepress Services (ITA No. 927/ Mds/ 2008 AY 2004-05), wherein the Hon'ble Tribunal held as under: 6.9. It is very difficult to find an exactly identical comparable uncontrolled transaction. The above fact is also recognized by the Bangalore Special Bench of IT A T in the case of Aztec Software & Technology Services Ltd. v AC1T (2007) 109 TTJ 893 (Bang) (SB). In applying CUP, similarity of the products and size/ type of markets are vital factors. Purchases by the Alden Group Ltd., U.K. from the assessee company as well as from unrelated suppliers are on bulk basis and have to be held as comparable if products are similar. The learned

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Transfer Pricing Officer has nowhere questioned similarity of products. In view of the above facts, it is held that the invoices of the Alden Group Ltd., U.K. of purchases from unrelated parties as well as quotations will have to be considered as Comparable Uncontrolled Transactions and the learned Transfer Pricing Officer has clearly erred in ignoring such important data. It can be seen from the details submitted by the assessee company that there is a Comparable Uncontrolled Price available for all the products (where the learned Transfer Pricing Officer has recomputed the ALP) in the form of purchase invoice or quotation from unrelated party and the price charged by the assessee- company is within ± 5% variation from the Comparable Uncontrolled Price. " "6.11. xx..xx.. Therefore, in the light of above decision of the Delhi Bench of the Tribunal, it is held that the Transfer Pricing Officer or the Assessing Officer should not have rejected the arm's length price determined by the appellant without showing how the pricing worked out by the appellant was incorrect or perverse. " The above case law clearly suggests that in case of availability of data for the application of CUP the same should be used by the Ld. TPO Further, the Assessee would also like to bring to the notice of your Honour's that application of CUP method has also been upheld by various Appellate Authorities.Some of such judicial precedents are quoted below: In case of M/s Agility Logistics Pvt. Ltd (ITA No.2000/Mum/2010), the Hon'ble Mumbai Tribunal upheld the preference of CUP method over TNMM. The relevant extracts are reproduced below:- "2.13. xx...xx. The appellant therefore asserted that where a valid CUP does exist for benchmarking an international transaction, any analysis of the net profit margin is not warranted. "

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In case of M/s Bayer Material Science P. Ltd. (ITA No. 7977/Mum/20l0), the Hon'ble Mumbai Tribunal upheld the appropriateness of CUP method. The relevant extracts are reproduced below:- "26. xx..xx. -On the other hand, the CUP method is useful where the A.Es buy or sell similar goods or services. In the present case, we are concerned with the rendering of services by one A.E. to another. In that view of the mailer. CUP method appears to be the most appropriate method in the given circumstances. It is further relevant to note that the question of applying one method or the other can arise if the data of the comparable cases concerning such method is available. " In case of M/s Arvind Mills Ltd. (ITA No.l304/Ahd/2006), the Hon'ble Ahmedabad Tribunal upheld the appropriateness of CUP method. The relevant extracts are reproduced below:- "6. xx. ..xx. There is no dispute that in the instant case CUP method, one of the prescribed method, was considered to be the most appropriate method by the assessee and the TPO in determining the ALP in respect of international transactions relating to payment of commission to the aforesaid two AEs. " In case of M/s Clear Plus India Private Limited (ITA No. 3944/D/2010), the Hon'ble Delhi Tribunal upheld the appropriateness of CUP method. The relevant extracts are reproduced below:- "7.7 xx…xx..Therefore, the CUP method could validly be employed provided product comparability is established. " In case of DCIT, Circle-2(2), Mumbai v. M/s. Nhava Sheva International Container [ITA No.4078/M/2009], on applicability of CUP Method, the Hon'ble Mumbai Tribunal held as under:

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"As regards the services mentioned in clauses (d) & (e) relating to procurement services and technology transfer services CIT(A) observed that these services would be required mostly in initial years and would gradually get reduced thereafter. Therefore though some payments may be required for these services, quantum of payment was not justified. Further there was no evidence for marketing services as mentioned in clause (f) and also in respect of other services mentioned in clause (g). CIT(A) also absented that the assessee had followed TNMM method of analysis which was not a very accurate method. The proper method could have been CUP method in respect of which the assessee had not given the study report. We therefore see no infirmity in the order of CIT(A) which is a reasoned and speaking order and the same is therefore upheld. " In case of M/s RBS Equities (India) Limited/I. T.A. No. 3077/Mum/2009 & [I.T.A. No. 1236/Mum/2010], on applicability of CUP Method, the Hon'ble Mumbai Tribunal held as under: "12. We have considered the rival submissions and also perused the relevant material on record. As regards the method to be adopted for comparability analysis, we agree with the contention of the learned OR that CUP is the most appropriate method in the facts and circumstances of the case including especially the fact that internal CUPs are available for the comparability analysis. We, therefore, find no infirmity in the action of the AO/TPO in adopting CUP method for comparability analysis instead of TNMM applied by the assessee. " In case of M/s Knorr-Bremse India Pvt. Ltd, [ITA no. 5097/Del/2011], on applicability of CUP Method, the Hon'ble Delhi Tribunal held as under: "7.2. The appellant in the present case also did not demonstrate as to how the transaction by transaction approach in his case is not possible. It has also not been

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shown as to whether there has been any real or tangible benefit by carrying such international transactions with the AEs. The comparable uncontrolled price method ("CUP " method), for the subject transactions being most direct method for determining arm 's length price and chosen as most appropriate method in this case by TPO, therefore, cannot be faulted with. We, therefore, do not find any error in rejecting the TNMM method applied by the assessee and determination of ALP by applying CUP method for Benchmarking international transactions in a case like this. " In case of ACIT vs. Mss India Pvt. Ltd. (32 SOT 132) (Pune) [ITA No. 393/PN/07J, on applicability of CUP Method, the Hon'ble Pune Tribunal held as under: "As long as the assessee has entered into raw material purchase transaction with the AE at an arm 's length price, it is of no consequence whether or not the assessee makes sufficient profits on manufacturing products from such raw material. There are a number of factors governing the profits that the assessee earns in its business and merely because the assessee's business results are not showing profits, or showing lesser profits than industry averages, such profits per se cannot lead to conclusion that purchase of raw material is not at an arms length price. On the given facts, particularly when the comparable uncontrolled prices of the raw materials are readily available, it is not at all necessary to jump to TNMM method. The only factor which has prevailed on the Transfer Pricing Officer in rejecting the method adopted, or canvassed, by the assessee is the fact that the assessee has incurred loss in the relevant previous year, but. in our humble understanding, such a consideration is wholly irrelevant. The Transactional Net Margin Method, on a conceptual note, is described as one of the method of last resort and is put into service only when no standard or traditional method of ALP determination is appropriate for determination of arms length price."

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In case of M/s Hero MotoCorp Limited (ITA No.5I30/Del/2010], on applicability of CUP Method, the Hon'ble Delhi Tribunal held as under: "We have carefully considered the arguments of both the sides and perused the material placed before us. After considering the facts of the case and the arguments of both sides, we agree with the Revenue that for determining the ALP of purchase of the spare parts/components, CUP method would be most appropriate method. Therefore, we uphold the selection of CUP method by the TPO. However, while applying the CUP method, it is to be ascertained whether similar goods were available indigenously. If the goods were not available indigenously, then naturally the rate of indigenous goods cannot be applied for determining the ALP. It is the contention of the assessee that when the goods were not available indigenously then only the same were purchased from AE. However, no evidence in this regard is produced by the assessee. " In case of M/s Delphi TVS Diesel Systems Ltd. v. The Assistant Commissioner of Income Tax, Company Circle 1(4), Chennai [IT.A. No. 2163/Mds/2010], on applicability of CUP Method, the Hon'ble Madras Tribunal held as under: "The said OECD guidelines is reproduced hereunder:- "3.27 One strength of the transactional net margin method is that net margins (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. The net margins 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, enterprises may have a wide range of gross profit margins but still earn broadly similar levels of net profits. "

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The above guidelines do not say that even where there were substantial differences between the items manufactured, a candidate for TNM method could be selected. In such circumstances, the TPO was perfectly justified in rejecting the TNM method having found that the comparable entities selected by the assessee had substantial related party transactions and difference in functionality which eroded the comparability materially. As against this, assessee itself has admitted that it had similar items of import from both AEs and non-AEs. In our opinion, adoption of CUP method was appropriate especially when such items could be identified. " Similar view was also upheld in case of M/s Twilight Jewellery Pvt, Ltd. [ITA No. 728I/Mum/20I2], M/s INDIAN ADDITIVES LIMITED v. ASSISTANT COMMISSIONER OF INCOME TAX COMPANY CIRCLE-II(3), CHENNAI (ITA No.703/Mds/2009], Vipin Enterprises (HC) (ITA No.30/2013) and Truetzcheler India P. Ltd. (ITA No. 798/MUM/2010 A Y 2006-07) Further, the Assessee would also like to bring to the notice of your Honour's that application of CUP method has been preferred over other prescribed methods by various Appellate Authorities. Some of such judicial precedents are quoted below: In case of M/s Isagro (Asia) Agrochemical Pvt. Ltd (ITA No.2044/Mum/2010), the Hon'ble Mumbai Tribunal held that CUP method is preferred over TNMM. The relevant extracts are reproduced below:- "4. xx. ..xx. Il is obvious that when the price of similar goods or services as sold or provided to the non-AEs is available, such a price constitutes the best guide to find out whether the price charged or paid to the AEs is at ALP or not. It is more so when such comparable uncontrolled transactions is infernal. When similar goods as traded with AEs constituting international transactions are traded with Non-AEs, it is always proper to consider the price of goods traded with

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non-AEs, for benchmarking price of goods traded with AEs. In our considered opinion the Id. C1T(A) was justified in upholding the preference of CUP method over TNMM. " (emphasis supplied) In case of M/s. J.P. Morgan India Private Limited (ITA No. 670/Mum/2006), on applicability of CUP Method, the Hon'ble Mumbai Tribunal held as under: "3. We have heard both the parties and their contentions have carefully considered. The facts of the case have already been discussed in detail in the above part of this order. We are in agreement with the observations of Ld. CIT(A) that in case of availability of internal CUP method, TNMM could not be applied. What was necessary was that assessee should have been allowed the relief as pet-difference in the activities in the services rendered by it to related and unrelated parties. The said difference has been described in the aforementioned tables submitted by the assessee to the TPO vide letter dated 29/11/2004. However, TPO did not discuss those figures in his order but these figures are discussed in the order of Ld. CIT(A). The TPO did not point out any defect in such calculation of the assessee. It has been described in the above submission that assessee had to incur additional cost to the tune of 0.29% in relation to services rendered by it to unrelated parties when the same is compared to the similar services rendered to the related parties. In view of these facts, we are of the opinion that Ld. C1T(A) was right in grunting relief to the assessee and we decline to interfere in his findings on this issue. " In case of Serdia Pharmaceutical (India) Private Limited vs. ACIT (2011-TII-02-ITAT-MUM-TP), on applicability of CUP Method, the Hon'ble Mumbai Tribunal held as under: "Whether we proceed on the basis that (here is an order of preference in which transfer pricing methods are to be applied, or whether we proceed without any such priority order, the traditional transaction methods, and particularly CUP, are preferred methods in the sense that all other things

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being equal, CUP and traditional transaction methods lead to more reliable results vis-a-vis the results obtained by applying transaction profit method. As a result, when CUP method can be reasonably applied in determining the arm's length price of an international transaction in a particular fact situation, and unless another method is proven to be more reliable a method visa-vis the fact situation of that particular case, the CUP method is to be preferred" In case of M/s. Livingstones (ITA No. 7303/ Mum/2011 A Y 2007-08), on applicability of CUP Method, the Hon'ble Mumbai Tribunal held as under; "Once a direct method of internal CUP is available then there is no need to resort to TNMM method. " In case of Noble Resources & Trading India Pvt. Ltd, (ITA No. 5722/ Del/ 2010 A Y 2006-07), on applicability of CUP Method, the Hon'ble Delhi Tribunal held as under: "If the assessee succeeds in providing appropriate data relevant for comparison under the CUP method, then the TPO should determine the ALP under the CUP method." Based on the above, it is respectfully submitted that the Ld. TPO has erred ignored the CUP data submitted by the Assessee. The Assessee would again like to reiterate its reliance on the Hon'ble Madras Tribunal's ruling in case of Alden Prepress Services (ITA No. 927/ Mds/ 2008 AY 2004-05), wherein the Hon'ble Tribunal held that "the invoices of purchases from unrelated parties as well as quotations will have to be considered as Comparable Uncontrolled Transactions and the learned Transfer Pricing Officer has clearly erred in ignoring such important data.". The Assessee further submits that comparative analysis of the FOB (per unit) sale values of the goods sold by the AE to the independent distributors as well as to the Assessee during FY 2009-10. Since in all the instances, FOB sale

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price charged by the AE from the Assessee was less than the average FOB sale price charged by the AE to the independent customers for the same model, the international transactions of import of machines should be considered to be consistent with arm's length standard. It is humbly requested that your Honour may please give due cognizance to the comparable prices submitted by the Assessee, demonstrating compliance with the arm's length standard in relation to its international transaction pertaining to import of machines from the AE and direct the Ld. TPO to delete the adjustment of Rs. 12,71,34,142 made to the value of aforesaid international transaction.”

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AE. He stated that these data is effectively comparable uncontrolled price for the models sold by its AE as well as independent third parties. He further stated that since the price paid by the assessee to its AE is less than the price paid by the independent distributors, therefore, it corroborates the ALP nature of the international transaction of purchase of goods. Therefore, his submission was that the contention of TPO supports the contention of the assessee that in case AE is selling similar products to other countries, then after claiming adjustment for geographical difference, CUP method can be easily applied for which no extra efforts have been put on record. He submitted that FOB value of the goods are comparable for which the assessee has submitted enough data. Therefore, the contention of the TPO, in principle, accepts the CUP method. He further stated that the ld. DRP has incorrectly observed that comparable price indicated by the assessee is charged to related parties. In the end, he submitted that though the assessee has taken TNMM as the most appropriate method in its TP study report, however, subsequently has given adequate reasons for adoption of CUP method and for comparability, sufficient data has also been provided for. He further stated that the ld. DRP did not verify that the details of products sold to various independent third party distributors in other countries were provided and they were, in fact, not the related party. Further as per submissions dated

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10.07.2013, the assessee has worked out average FOB value for independent distributors in other countries, therefore, there is a reliable basis for comparability analysis. Regarding the other terms and conditions and its comparability, he stated that at page No. 2098 onwards, the geographical region wise sale price which is shown to be CIF value and adequate adjustment of freight and expenses have been made to arrive at FOB value and therefore, the observation of DRP regarding absence of adequate comparable data, is not correct. In view of this, his submission was that CUP method is the most appropriate method for comparability analysis and adequate data are available. Therefore, TNMM method is not the most appropriate method. He further submitted that when the error comes to the notice of the assessee, it was submitted before the TPO as well as before DRP that the assessee requested for adoption of CUP method. In the end, he reiterated all his submissions made before the ld. DRP.

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all data relied upon, has held that it acts as sole distributor of its AE in India and according to the own admission of the assessee, due to lack of availability of data of comparable companies, CUP was rejected as most appropriate method. He further stated that ld. DRP has also held that there is no reliable basis for verifying data which is submitted by the assessee. He also challenged the data which is submitted by the assessee as per its submissions dated 10.07.2013.

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material factors affecting price, cost or the profit arising from such transaction. Adequate weightage is also required to be given to the market condition of different geographical locations. Therefore, CUP method could validly be employed provided product comparability is first established. On looking to the facts and circumstances, we are of the view that CUP method is the most appropriate method provided the valid data which can be tested for comparison is available. Though before the ld. DRP, the appellant has relied on many judicial precedence regarding applicability of CUP method, we are of the view that there is no dispute between the parties about applicability of CUP as the most appropriate method. However, the doubt is about the reliability of the data provided by the assessee. Merely for the reason that in its TP study report, the assessee has adopted TNMM as the most appropriate method, cannot prevent the assessee now submitting before the DRP that CUP method should be applied and there is reasonable data available for comparability analysis. There is no basis in ld. DRP sating that there is no reliable basis for verifying the data. It would always be the onus of the assessee to show the basis of comparability analysis and veracity of the data used for comparability. In the price submitted by the assessee, it has made adjustment between CIF price and free on board price. Therefore, it has also made the adjustment arising out of the geographical dissimilarities in the transactions. However, as

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at the state of TPO, the CUP method has been rejected at the threshold both by the assessee as well as ld. TPO, there is no occasion to go to comparability analysis and verify the transactions and price. In view of the above, we hold that (i) the CUP method is the most suitable method in the case of assessee; (ii) that as the assessee is the sole distributor of its AE in India, the assessee has stated that its price should be compared with the sale of goods which are similar and to independent third parties, but in different geographical locations, therefore it shall be the duty of the assessee to provide the sale data of the AE in terms of sale price of assessee in India as well as other geographical locations, which are claimed to be comparable price; (iii) that the assessee shall also provide quantitative data of purchase in different geographical locations and other terms and conditions attached to those sales including the terms of payment; (iv) Assessee shall be further duty bound to support its T P STUDY report for robust comparability of the International transaction by providing requiste information required by ld TPO for determining ALP applying CUP as MAM (v) on the basis of above data provided, the ld. TPO/AO shall compute the ALP using this data applying CUP

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method. If at any stage, the data is found to be not adequate and the terms and conditions of sales are materially different or that no adjustment can be made to the price, then the AO and TPO shall proceed to determine the ALP in accordance with other methods and then determining the most appropriate method. (vi) Needless to say that the appellant-assessee may be granted adequate opportunity of producing data, its own comparability analysis and its own revised TP study report on the basis of CUP method. If there is any difference of opinion then the ld. TPO shall grant adequate opportunity of hearing to the appellant. 22. In view of this, ground No. 1 of appeal of the assessee is set aside to the file of ld. AO/TPO with the above directions. In the result, ground No. 1 of the appeal of the assessee is allowed.

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it has quoted three transactions, i.e., purchase of machines, purchase of spare parts and commission income and thereafter applied net marginal method adopting PLI of net operating profit by sales and then determining the comparable PLI at 1.17% with assessee’s PLI of 2.21%. As we have held in ground No. 1 that for the purchase of heavy earth moving machines and jig- fixtures, the CUP method is most appropriate method and thereafter directed for fresh comparability analysis for the same. As the purchase of heavy earth moving machines is now taken out by applying different method and now fresh working of PLI is required to be determined of comparable vis a vis assessee. Therefore, in view of this, ground No. 2 and 3 of the assessee become pre-mature. Therefore, we set aside ground No. 2 of the appeal back to the file of ld. TPO for fresh comparability analysis in terms of our directions contained in ground No. 1.

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high possibility that these expenditures are to expand the reach of the brand of AE in India. Therefore, a show cause notice was issued that selling and distribution expenses to the extent of Rs.5,07,37,429/- is 9.68% of the total sales and therefore, using two comparables why adjustment on account of ALP should not be made. Against this, the assessee replied that the expenditures incurred by the assessee are not in the nature of AMP expenses, but commission on sales, warrantee expenses and outward freight. The contention of the assessee was rejected and then the ld. TPO held that the appellant is incurring AMP expenses that is creating value marketable intangibles in favour of its AE which is an international transaction. It was further held that commission expenses, warrantee expenses and freight is also part of AMP expenses. The AMP expenses were determined at 0.99% of sales compared to 9.68% in case of assessee and determining a mark-up of 15%, the adjustment to the assessee’s total income was proposed at Rs.5,23,82,317/-.

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L.G. Electronics India Ltd., the Bright Line Test on the AMP expenditure identifies the expenditure attributable to the requirement of over and above this requirement and therefore, upheld the adjustment on account of AMP expenses made by the ld.TPO.

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catena of decisions of Hon’ble Delhi High Court is no more a good law. Hon’ble Delhi High Court in the case of Maruti Suzuki and Sony Erriction held that it is not an international transaction and bright line test cannot be applied in view of it and it does not have sanction of IT Act & Rules. Recently Hon’ble Delhi High Court in 381 ITR 117 in Maruti Suzuki India Limited V CIT has held as under :

“41. Having considered the above submissions the court proceeds to analyse the decision in Sony Ericsson to determine if it conclusively answers the issue concerning the existence of an international transaction as a result of incurring of AMP expenditures by an assessee. 42. As already noticed, the judgment in Sony Ericsson does not seek to cover all the cases which may have been argued before the Division Bench. In particular, as far as the present appeal I. T. A. No. 110 of 2014 is concerned, although it was heard along with the batch of appeals, including those disposed of by the Sony Ericsson judgment, at one stage of the proceedings on October 30, 2014, the appeal was delinked to be heard separately. 43. Secondly, the cases which were disposed of by the Sony Ericsson judgment, i.e., of the three assessees Canon, Reebok and Sony Ericsson were all of distributors of products manufactured by foreign associated enterprises. The said assessees were themselves not manufacturers. In any event, none of them appeared to have questioned the existence of an international transaction involving the concerned foreign associated enterprise. It was also not disputed that the said international transaction of incurring of Page No : 0139

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AMP expenses could be made subject matter of transfer pricing adjustment in terms of section 92 of the Act. 44. However, in the present appeals, the very existence of an international transaction is in issue. The specific case of MSIL is that the Revenue has failed to show the existence of any agreement, understanding or arrangement between MSIL and SMC regarding the AMP spend of MSIL. It is pointed out that the bright line test has been applied to the AMP spend by MSIL to (a) deduce the existence of an international transaction involving SMC and (b) to make a quantitative "adjustment" to the arm's length price to the extent that the expenditure exceeds the expenditure by comparable entities. It is submitted that with the decision in Sony Ericsson having disapproved of bright line test as a legitimate means of determining the arm's length price of an international transaction involving AMP expenses, the very basis of the Revenue's case is negated. 45. Since none of the above issues that arise in the present appeals were contested by the assessees who appeals were decided in the Sony Ericsson case, it cannot be said that the decision in Sony Ericsson, to the extent it affirms the existence of an international transaction on account of the incurring of the AMP expenses, decided that issue in the appeals of MSIL as well. In this context, para 52 of the decision in Sony Ericsson has to be read as a whole. It reads as under (page 157 of 374 ITR) : "The contention that AMP expenses are not international trans actions has to be rejected. There seems to be an incongruity in the submission of the assessee on the said aspect for the simple reason that in most cases the assessee have submitted that the international transactions between them and the associated enterprise, resident abroad included the cost/value of the AMP expenses, which the assessee had incurred in India. In other words, when the assessee raise the aforesaid argument, they accept that the declared price of the international transaction included the said element or function of AMP expenses, for which they stand duly

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compensated in their mar gins or the arm's length price as computed." 46. The said passage has to be read in the context of the discussion preceding it which concerns the assessees whose appeals were being disposed of by the said judgment. It is in the context of those assessees that para 52 notes that "in most cases the assessee have submitted that the international transactions between them and the associated enterprise, resident abroad included the cost/value of the AMP expenses . . . .". 47. As regards the submission regarding the bright line test having been rejected in the decision in Sony Ericsson is concerned, the court notes that the decision in Sony Ericsson expressly negatived the use of the bright line test both as forming the base and determining if there is an international transaction and secondly for the purpose of determining the arm's length price. Once bright line test is negatived, there is no basis on which it can be said in the present case that there is an international transaction as a result of the AMP expenses incurred by MSIL. Although the Revenue seems to contend that the bright line test was used only to arrive at the quantum of the transfer pricing adjustment, the order of the Transfer Pricing Officer in the present case proceeds on the basis that an international transaction can be inferred only because the AMP expenses incurred were significantly higher that what was being spent by comparable entities and it was also used for quantifying the amount of the transfer price adjustment. Consequently, the court does not agree with the submission of the learned Special counsel for the Revenue that dehors the bright line test, which has been rejected in the Sony Ericsson judgment, the existence of an international transaction on account of the incurring of the AMP expenses can be established. 48. The submission also proceeds on the basis that since MSIL pays royalty to the foreign associated enterprise and makes payment in respect of the use of copyright and patent, the benefit emanating from the AMP function cannot be said to be enjoyed by MSIL alone. It also proceeds on the basis that

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the benefits to the associated enterprise from AMP function would be same as in the case of a distributor namely increase in sale of raw material, increase in royalty, and increase in copyright and patent payments, etc. The court finds that these submissions are not based on any empirical data and proceeds more on the basis of surmises. Royalty payments have been separately assessed for transfer pricing purposes. Likewise, payments for copyrights and patents have also been separately treated. 49. As far as the benefit to the associated enterprise, i.e., SMC, is concerned, the Revenue has been unable to counter the submission on behalf of the MSIL that by the time SMC acquired a controlling interest in MSIL in 2002, the Maruti brand had already built a huge reputation. A significant amount of AMP expenses had already been incurred by MSIL on its products. These products carried the co-branded mark "Maruti-Suzuki" which had a high degree of name recognition. The Revenue has been unable to dispute that MSIL has the highest market share of automobiles manufactured in India (about 45 per cent. ) and year on year growth of turnover of about 21 per cent. In other words, the AMP expenses incurred by it have substantially benefitted MSIL. 50. The second aspect which the Revenue has been unable to dispute is that SMC's AMP expenditure worldwide has been 7.5 per cent. of its sales whereas MSIL is spending only 1.87 per cent. of its total sales towards AMP. Therefore, this belies the possibility of any "arrangement" or "understanding" between MSIL and SMC whereby MSIL is obliged to incur the AMP expenditure for and on behalf of SMC. 51. The result of the above discussion is that in the considered view of the court the Revenue has failed to demonstrate the existence of an international transaction only on account of the quantum of AMP expenditure by MSIL. Secondly, the court is of the view that the decision in Sony Ericsson holding that there is an international transaction as a result of the AMP expenses cannot be held to have answered the issue as far as the present assessee MSIL is concerned since finding in Sony

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Ericsson to the above effect is in the context of those assessees whose cases have been disposed of by that judgment and who did not dispute the existence of an international transaction regarding AMP expenses. Effect of the earlier decision in the writ petition by MSIL 52. Another preliminary major issue that has been raised by the Revenue concerns the effect of the earlier decision of this court in the writ petition filed by MSIL and the decision of the Supreme Court in the special leave petition filed against the said decision. 53. It is submitted on behalf of the Revenue that in light of the said judgment of this court, the findings which have not been disturbed by the Supreme Court, it can no longer be contended by MSIL that there is no international transaction resulting from the incurring of AMP expenses. This submission is countered by the assessee by pointing out that the earlier decision in MSIL's writ petition virtually set aside the order of the Transfer Pricing Officer and Assessing Officer and required the Transfer Pricing Officer to proceed de novo. The Supreme Court in its turn did not express any view on the existence of an international transaction and, therefore, it was incorrect to contend that the judgment of the Supreme Court impliedly affirmed the finding of the High Court regarding the existence of an international transaction. 54. The court finds that the Division Bench in Sony Ericsson had occasion to deal with this very issue. In Sony Ericsson in para. 156 after discussing the issue it was observed as under (page 219 of 374 ITR) : "A Division Bench of the Delhi High Court in the writ petition challenging the Transfer Pricing Order had dealt with transfer pricing issues and had enrolled and culled out legal ratios and principles. Directions were issued. At the same time, an order of remand to the Transfer Pricing Officer to compute the arm's length price on the basis of said principles was passed. It would not be correct to hold that the Supreme Court had accepted and had given seal of approval and not

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interfered with the principles/ratio enunciated in the judg ment by the Delhi High Court. The Supreme Court as is lucid did not want to examine the principles or ratio as enunciated and express their opinion on the merits, though the directions issued by the High Court, it was observed, conclude the matter. The Supreme Court per ceived and accepted that the issue of the arm's length price should be re-examined by the Transfer Pricing Officer without being curtailed or restrained by the legal principles/ratio delineated. As the Supreme Court itself was not examining the principles/ratio on the merits, it did not pass any order in favour or against the assessee or the Revenue. Accordingly, the aforesaid observations. The effect thereof was that the judgment of the Delhi High Court would not operate as res judicata between the parties and merits, if required, would be examined and gone into in the appellate proceedings. The majority judgment has incorrectly inferred that the legal principles and directions issued by the Delhi High Court would continue to be binding decidendi and had attained finality, viz. the tax authorities and the Tribunal. It is not so indicated. If the legal principles/ratio was not binding on the writ petitioner, i.e., the assessee in the said case, it would be malapropos and inappropriate to treat the directions as binding ratio, in respect of third parties. Therefore, we have not treated the decision of the Delhi High Court in the case of Maruti Suzuki Ltd. (supra) as a binding precedent. Importantly, the Revenue has relied upon the final conclusions as recorded and the assessee have relied upon the earlier portions of the judgment. We have con sidered the reasoning given in the aforesaid decision and have reached our own conclusion." 55. Consequently, this court in Sony Ericsson proceeded on the basis that the decision of this court in the writ petition by MSIL was not a binding precedent. Be that as it may, there are other reasons why the earlier decision in the writ petition filed by MSIL cannot be held to survive. A careful reading of the judgment of the Supreme Court reveals that the Supreme Court asked the Transfer Pricing Officer to proceed with the matter in accordance with law "uninfluenced by the observations/directions given by the judgment in the

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impugned order dated July 1, 2010". That virtually nullifies the judgment of the High Court on all aspects. A further reason is that even this court in disposing of the writ petition of MSIL proceeded on the basis of there being an international transaction only on account of the excessive AMP expenses incurred by MSIL. In other words, this court disposing of MSIL's writ petition also applied the bright line test to determine the existence of an international transaction whereas throughout it has been MSIL's case that the fact that its AMP spend is significantly higher cannot ipso facto lead to the conclusion regarding the existence of an international transaction in that regard between MSIL and SMC. With the decision in Sony Ericsson having jettisoned the bright line test, the very basis of the judgment of this court in the writ petition must be held to be no longer binding. In any event, as far as MSIL is concerned, it did question the decision of the Division Bench and succeeded in its appeal in the Supreme Court in so far as the Transfer Pricing Officer was asked to determine the issue afresh uninfluenced by the order of the High Court. 56. The upshot of the above conclusion is that, in the considered view of the court, the earlier judgment of the Division Bench of this court in the writ petition by MSIL cannot be said to preclude MSIL from contesting the finding regarding the existence of an international transaction concerning AMP expenses. Is there an international transaction concerning AMP expenses ? 57. The court next turns to the principal contention of the Revenue that in a particular situation of independent distributors/licensed manufacturers matters relating to promotion of a brand of a foreign associated enterprise would necessarily be a matter of negotiation between the parties and not necessarily be reduced to writing as part of an agreement between them. 58. It is necessary at this juncture to discuss the reasons for enactment of Chapter X in the Act with the whole new scheme

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of provisions concerning transfer pricing in the form of sections 92B to 92F. 59. Nevertheless, there is no specific mention of AMP expenses as one of the items of expenditure which can be deemed to be an international transaction. For this purpose, section 92B(1) read with section 92(1) becomes significant. Under section 92B(1) an "international transaction" means :— "(a) a transaction between two or more associated enterprises, either or both of whom are nonresident (b) the transaction is in the nature of purchase, sale or lease of tan gible 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 associated enterprises 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 pro vided to one or more of such enterprises." 60. As far as clause (a) is concerned, SMC is a non-resident. It has, since 2002, a substantial share holding in MSIL and can, therefore, be construed to be a non-resident associated enterprise of MSIL. While it does have a number of "transactions" with MSIL on the issue of licensing of IPRs, supply of raw materials, etc. the question remains whether it has any "transaction" concerning the AMP expenditure. That brings us to clauses (b) and (c). They cannot be read disjunctively. Even if resort is had to the residuary part of clause (b) to contend that the AMP spend of MSIL is "any other transaction having a bearing" on its "profits, incomes or losses", for a "transaction" there has to be two parties. Therefore for the purposes of the "means" part of clause (b) and the "includes" part of clause (c), the Revenue has to show that there exists an "agreement" or "arrangement" or "understanding" between MSIL and SMC whereby MSIL is

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obliged to spend excessively on AMP in order to promote the brand of SMC. As far as the legislative intent is concerned, it is seen that certain transactions listed in the Explanation under clauses (i)(a) to (e) to section 92B are described as "international transaction". This might be only an illustrative list, but significantly it does not list AMP spending as one such transaction. 61. The submission of the Revenue in this regard is : "The mere fact that the service or benefit has been provided by one party to the other would by itself constitute a transaction irrespective of whether the consideration for the same has been paid or remains payable or there is a mutual agreement to not charge any compensation for the service or benefit". Even if the word "transaction" is given its widest connotation, and need not involve any transfer of money or a written agreement as suggested by the Revenue, and even if resort is had to section 92F(v) which defines "transaction" to include "arrangement", "understanding" or "action in concert", "whether formal or in writing", it is still incumbent on the Revenue to show the existence of an "understanding" or an "arrangement" or "action in concert" between MSIL and SMC as regards AMP spend for brand promotion. In other words, for both the "means" part and the "includes" part of section 92B(1) what has to be definitely shown is the existence of transaction whereby MSIL has been obliged to incur AMP of a certain level for SMC for the purposes of promoting the brand of SMC. Step wise analysis of statutory provisions 62. If a step by step analysis is undertaken of sections 92B to 92F, the sine qua non for commencing the transfer pricing exercise is to show the existence of an international transaction. The next step is to determine the price of such transaction. The third step would be to determine the arm's length price by applying one of the five price discovery methods specified in section 92C. The fourth step would be to compare the price of the transaction that is shown to exist with the arm's length price and make the transfer pricing

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adjustment by substituting the arm's length price for the contract price. 63. A reading of the heading of section 92 of Chapter X ("Special provisions relating to avoidance of tax") and section 92(1) which states that any income arising from an international transaction shall be computed having regard to the arm's length price, section 92C(1) which sets out the different methods of determining the arm's length price, makes it clear that the transfer pricing adjustment is made by substituting the arm's length price for the price of the transaction. To begin with there has to be an international transaction with a certain disclosed price. The transfer pricing adjustment envisages the substitution of the price of such international transaction with the arm's length price. 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 and the AMP expenditure of a comparable entity that an international transaction exists and then proceed to make the adjustment of the difference in order to determine the value of such AMP expenditure incurred for the associated enterprise. 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 bright line test, 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 (Delhi), which required a Transfer Pricing Officer "to examine the '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. 65. As already noticed, the decision in Sony Ericsson has done away with the bright line test as means for determining the

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arm's length price of an international transaction involving AMP expenses. The Revenue's contentions 66. It is contended by the Revenue that the mere fact that the Indian entity is engaged in the activity of creation, promotion or maintenance of certain brands of its foreign associated enterprise or for the creation/promotion of new/existing markets for the associated enterprise, is by itself enough to demonstrate that there is an arrangement with the parent company for this activity. It is urged that merely because MSIL and SMC do not have an explicit arrangement/agreement on this aspect cannot lead to the inference that there is no such arrangement or the entire AMP activity of the Indian entity is unilateral and only for its own benefit. According to the Revenue, "the only credible test in the context of transfer pricing provisions to determine whether the Indian subsidiary is incurring AMP expenses unilaterally on its own or at the instance of the associated enterprise is to find out whether an independent party would have also done the same." It is asserted : "An independent party with a short-term agreement with the multi-national company will not incur costs which give long-term benefits of brand and market development to the other entity. An independent party will, in such circumstances, carry out the function of development of markets only when it is adequately remunerated for the same". 67. Reference is made by Mr. Srivastava to some sample agreements between Reebok (UK) and Reebok (South Africa) and IC Issacs and Co and BHPC Marketing to urge that the level of AMP spend is a matter of negotiation between the parties together with the rate of royalty. It is further suggested that it might be necessary to examine whether in other jurisdictions the foreign associated enterprise, i.e., SMC is engaged in AMP/ brand promotion through independent entities or their subsidiaries without any compensation to them either directly or through an adjustment of royalty payments.

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Absence of a machinery provision 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 arm's length price to mean a price "which is applied or proposed to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions". Since the reference is to "price" and to "uncontrolled conditions" it implicitly brings into play the bright line test. 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 arm's length price. The court does not see this as a machinery provision particularly in light of the Page No : 0147 fact that the bright line test has been expressly negatived by the court in Sony Ericsson. Therefore, the existence of an international transaction will have to be established dehors the bright line test. 69. There is nothing in the Act which indicates how, in the absence of the bright line test, one can discern the existence of an international transaction as far as AMP expenditure is concerned. The court finds considerable merit in the contention of the assessee that the only transfer pricing adjustment authorised and permitted by Chapter X is the substitution of the arm's length price for the transaction price or the contract price. It bears repetition that each of the methods specified in section 92C(1) is a price discovery method. Section 92C(1) thus is explicit that the only manner of effecting a transfer pricing adjustment is to substitute the transaction price with the arm's length price so determined.

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The second proviso to section 92C(2) provides a "gateway" by stipulating that if the variation between the arm's length price and the transaction price does not exceed the specified percentage, no transfer pricing adjustment can at all be made. Both section 92CA, which provides for making a reference to the Transfer Pricing Officer for computation of the arm's length price and the manner of the determination of the arm's length price by the Transfer Pricing Officer, and section 92CB which provides for the "safe harbour" rules for determination of the arm's length price, can be applied only if the transfer pricing adjustment involves substitution of the transaction price with the arm's length price. Rules 10B, 10C and the new rule 10AB only deal with the determination of the arm's length price. Thus for the purposes of Chapter X of the Act, what is envisaged is not a quantitative adjustment but only a substitution of the transaction price with the arm's length price. 70. What is clear is that it is the "price" of an international transaction which is required to be adjusted. The very existence of an international transaction cannot be presumed by assigning some price to it and then deducing that since it is not an arm's length price, an "adjustment" has to be made. The burden is on the Revenue to first show the existence of an international transaction. Next, to ascertain the disclosed "price" of such transaction and thereafter ask whether it is an arm's length price. If the answer to that is in the negative the transfer pricing adjustment should follow. The objective of Chapter X is to make adjustments to the price of an international transaction which the associated enterprises involved may seek to shift from one jurisdiction to another. An "assumed" price cannot form the reason for making an arm's length price adjustment. 71. Since a quantitative adjustment is not permissible for the purposes of a transfer pricing adjustment under Chapter X, equally it cannot be permitted in respect of AMP expenses either. As already noticed hereinbefore, what the Revenue has sought to do in the present case is to resort to a quantitative adjustment by first determining whether the AMP spent by the assessee on application of the bright

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line test, is excessive, thereby evidencing the existence of an international transaction involving the associated enterprise. The quantitative determination forms the very basis for the entire transfer price exercise in the present case. 72. As rightly pointed out by the assessee, while such quantitative adjustment involved in respect of AMP expenses may be contemplated in the taxing statutes of certain foreign countries like U.S.A., Australia and New Zealand, no provision in Chapter X of the Act contemplates such an adjustment. An AMP transfer pricing adjustment to which none of the substantive or procedural provisions of Chapter X of the Act apply, cannot be held to be permitted by Chapter X. In other words, with neither the substantive nor the machinery provisions of Chapter X of the Act being applicable to an AMP transfer pricing adjustment, the inevitable conclusion is that Chapter X as a whole, does not permit such an adjustment. 73. It bears repetition that the subject matter of the attempted price adjustment is not the transaction involving the Indian entity and the agencies to whom it is making payments for the AMP expenses. The Revenue is not joining issue, the court was told, that the Indian entity would be entitled to claim such expenses as revenue expense in terms of section 37 of the Act. It is not for the Revenue to dictate to an entity how much it should spend on AMP. That would be a business decision of such entity keeping in view its exigencies and its perception of what is best needed to promote its products. The argument of the Revenue, however, is that while such AMP expense may be wholly and exclusively for the benefit of the Indian entity, it also enures to building the brand of the foreign associated enterprise for which the foreign associated enterprise is obliged to compensate the Indian entity. The burden of the Revenue's song is this : an Indian entity, whose AMP expense is extraordinary (or "non- routine") ought to be compensated by the foreign associated enterprise to whose benefit also such expense enures. The "non-routine" AMP spent is taken to have "subsumed" the portion constituting the "compensation" owed to the Indian entity by the foreign associated enterprise. In such a scenario

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what will be required to be benchmarked is not the AMP expense itself but to what extent the Indian entity must be compensated. That is not within the realm of the provisions of Chapter X. 74. The problem with the Revenue's approach is that it wants every instance of an AMP spent by an Indian entity which happens to use the brand of a foreign associated enterprise to be presumed to involve an international transaction. and this, notwithstanding that this is not one of the deemed international transactions listed 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 associated enterprise 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 Transfer Pricing Officer 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 40A(2)(a) under which certain types of expenditure incurred by way of payment to related parties is not deductible where the Assessing Officer "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 Assessing Officer 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 Assessing Officer 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

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both international and domestic, the consumption patterns, market behaviour and so on. A simplistic approach using one of the modes similar to the ones 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. 76. As explained by the Supreme Court in CIT v. B. C. Srinivasa Setty [1981] 128 ITR 294 (SC) and PNB Finance Ltd. v. 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. Economic ownership of the brand 77. The next issue is concerning the economic ownership and legal ownership of the brand. According to the Revenue, viewing legal ownership as something distinct from economic ownership "may not be the right way of looking at things". 78. It is necessary at this juncture to examine the history of the relationship between MSIL and SMC. When the licence agreements were originally entered in 1982, MSIL was known as Maruti Udyog Limited ("MUL") and SMC did not hold a single share in Maruti Udyog Limited. In 2003 SMC acquired the controlling interest in MSIL. There are various models of Suzuki motor cars manufactured by MSIL and each model is covered by a separate licence agreement. Under these agreements SMC grants licence to MSIL to manufacture that particular car model ; provides technical know- how and information and right to use Suzuki's patents and technical information. It also gives MSIL the right to use Suzuki's trade mark and logo on the product. Pursuant to the above agreement, MSIL has been using the co-brand, i.e., Maruti-

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Suzuki trade mark and logo for more than 30 years. As already noted, this co-brand cannot be used by SMC and is not owned by it. 79. The clauses in the agreement between MSIL and SMC indicate that permission was granted by SMC to MSIL to use the co-brand "Maruti- Suzuki" name and logo. The mere fact that the cars manufactured by MSIL bear the symbol "S" is not decisive as the advertisements are of the particular model of the car with the logo "Maruti-Suzuki". The Revenue has been unable to contradict the submission of MSIL that the co- brand mark "Maruti-Suzuki" in fact does not belong to SMC and cannot be used by SMC either in India or anywhere else. The decision in Sony Ericsson requires that the mark or brand should belong to the foreign associated enterprise. The Revenue also does not deny that as far as the brand "Suzuki" is concerned its legal ownership vests with the foreign associated enterprise, i.e., SMC. The Revenue proceeds on the basis that the benefit of the economic ownership also accrues to the foreign associated enterprise by way of increased royalty, increased raw material sales, increased brand value, etc. 80. The Revenue is proceeding on a presumption regarding the comparative benefits to MSIL and SMC as a result of the AMP expenditure incurred by MSIL. The Revenue is unable to deny that MSIL's expenditure on AMP is only 1.87 per cent. of its total sales whereas SMC's expenditure worldwide on AMP is 7.5 per cent. of its sales. In the circumstances, in the absence of some data, it cannot be simply asserted that the benefit of MSIL's AMP spend to SMC is not merely incidental. The court is unable to accept the assertion of the Revenue that the mere fact of incurring AMP expenditure should lead to an inference of the existence of an international transaction. 81. It must be recalled here that the royalty paid to SMC for use of its logo on the product manufactured with its technical know-how is separately subject to transfer pricing. Likewise, payments for use of patents or copyrights are separately assessed. What the present appeals are concerned with is only the AMP expenditure incurred and nothing more. As pointed

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out by the Revenue the issue is not about the expenditure incurred by MSIL in engaging Indian third parties for AMP but the extent to which the AMP spend can be attributed to enure to the benefit of SMC's brand. This can be a complex exercise and in the absence of clear guidance under the statute and the rules, can result in arbitrariness as a result of proceeding on surmises or conjectures. The Transfer Pricing Officer will need to access data as regards the strength of the foreign associated enterprise's brand and what it commands in the international market and to what extent the presence of the brand in the advertisement actually adds to the benefit of the brand internationally. 82. Para. 6D of the OECD Guidelines deals with "Marketing activities undertaken by enterprises not owning trade marks or trade names". It contains a discussion on promotion of trade marks by distributors of branded goods. It acknowledges the difficulties in determining the extent to which the expenses have contributed to the success of a product. It is stated : "For instance, it can be difficult to determine what advertising and marketing expenditures have contributed to the production or revenue, and to what degree. It is also possible that a new trade mark or one newly introduced into a particular market may have no value or little impression on the market (or perhaps loses its impact). A dominant market share may to some extent be attributable to marketing efforts of a distributor. The value and any changes will depend to an extent on how effectively the trade mark is promoted in the particular market. More fundamentally, in many cases higher returns derived from the sale of trade marked products may be due as much to the unique char acteristics of the product or its high quality as to the success of adver tising and other promotional expenditures. The actual conduct of the parties over a period of years should be given significant weight in evaluating the return attributable to marketing activities."

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operating margins of the Indian enterprise are much higher than the operating margins of the comparable companies, no further separate adjustment for AMP expenditure was warranted. This is also in consonance with rule 10B 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 per cent. which is higher than that of the comparable companies whose profit margin is 4.04 per cent. Therefore, applying the transactional net margin method it must be stated that there is no question of transfer pricing adjustment on account of AMP expenditure.” [ Pages from ITRonline Extracted] 33. In view of the decisions of Hon’ble Delhi High Court, we set aside the issue back to the file of Assessing Officer to decide the issue afresh. In view of this ground No. 6 to 14 relating to AMP expenses are set aside to the file of ld. TPO.

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commission income of Rs.2,04,40,169/- on direct sales by its AE to the customers in Indian territory. The ld. TPO obtained the details of commission income from the assessee and found out certain discrepancies. The assessee explained the anomalies pointed out. However, the ld.TPO held that the taxpayer has not performed proper far analysis and it is accepting the commission income which is credited by its associate enterprise. After that the ld. TPO computed the total commission income receivable by the assessee amounting to Rs.3,05,83,501/- and after that reduced this amount by the income of commission shown by the assessee of Rs.2,04,40,169/- and thereafter made a proposed adjustment of Rs.1,01,43,332/-.

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We reject such an arbitrary approach adopted by the ld. DRP which did not have any support of any comparability analysis. We also find that despite the directions of ld. DRP, the ld. TPO has changed the dealers standard price and LIPS transferred price. In view of the above contrary orders of the lower authorities and confusion on the prices, we set aside the issue of the commission income of the assessee back to the file of ld. TPO with direction to compute the commission income of the assessee in accordance with the provisions of the Act and supporting calculations and margin, if any, with proper comparables. In the result, we set aside the ground No. 15 and 16 to the file of ld. TPO.

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total purchase of plant and machinery of Rs.3,23,33,749/-, 10% Mark-up was worked out amounting to Rs.29,39,432/- and upward adjustment was made to the total income of the assessee.

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error in the direction given by the ld. DRP and ground No. 17 of the appeal of the assessee is dismissed.

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It does not show any bona fide with respect to this item for non-levy of penalty. Therefore, ground No. 18 and 19 of appeal are dismissed.

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DRP. Before us also, the issue is pre-mature and hence, ground No. 20 of appeal is dismissed. 53. Ground No. 21 is regarding disallowance of an amount of Rs.1308/- u/s. 14A. The ld. Assessing Officer disallowed Rs.1308/- u/s. 14A applying Rule 8D. Before the ld. DRP, only legal issues were raised, which were rejected. The ld. DRP has further held that the AO has taken aggregate of expenses directly attributed to earning of exempt income and has correctly worked out the disallowance u/r 8D. Before us, no arguments were pressed on this ground and therefore, this ground of appeal is rejected. 54. In the result, the appeal of the assessee is partly allowed, as indicated above. Order pronounced in the open court on 28.06.2016. Sd/- Sd/- (I.C. SUDHIR) (L.P. SAHU) Judicial Member Accountant Member Dated : 28.06.2016 *aks/- Copy of order forwarded to: (1) The appellant (2) The respondent (3) Commissioner (4) CIT(A) (5) Departmental Representative (6) Guard File By order Assistant. Registrar Income Tax Appellate Tribunal Delhi Benches, New Delhi