NIPPON PAINT INDIA PRIVATE LIMITED,CHENNAI vs. ACIT, CHENNAI

आदेश / O R D E R

PER D.S.SUNDER SINGH, ACCOUNTANT MEMBER

This is an appeal filed by the assessee against the Assessment Order

passed u/s.143(3) r.w.s.144C of Income tax dated 01/01/2016 by the

Assistant Commissioner of Income tax, Corporate Circle-4(2), Chennai.

The assessee raised the following grounds in the appeal.

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1.0 General:

On the facts and the circumstances of the case, the impugned Order passed by the Learned Assistant Commissioner of Income Tax/Assessing Officer(‘AO’) is erroneous and contrary to the principles of natural justice and bad in law

2.0 Grounds in relation to transfer pricing adjustment:

The Learned transfer Pricing Officer (‘TPO’) and the Learned AO, under the directions issued by the Hon’ble Dispute Resolution Panel (‘DRP’)

Advertising, Marketing and Promotion (‘AMP’) Expenses:

2.1 Erred on facts and in law in considering expenditure incurred by the Appellant wholly and exclusively for its domestic business operations, within the realm of international transactions based purely on his conjectures and surmises, violating section 92(B) and section 92(1) of the Income-tax Act, 1961 (‘the Act’).

2.2 Erred on facts and in the circumstances of the case by alleging that the AMP expenses incurred by the Appellant were aimed to promote the “Nippon” Brand in India and the excess costs incurred by the Appellant towards AMP expenses have to be reimbursed by the Associated Enterprise (‘AE’).

Erred on facts in alleging that the assesseee has rendered services to the AEs by incurring ‘excessive’ AMP expenses and by holding that a mark-up has to be earned by the Assesseee in respect of the “alleged excessive” AMP expenses.

Erred in facts in alleging that the Assesseee has offered services bearing the brand/trademark owned by the AE based purely on his conjectures and surmises, without considering the fact that there was no explicit or implicit arrangement/agreement to provide any brand promotion services to the AE.

2.3 Erred in law and on facts by separately testing the AMP expenses as an international transaction and grossly erred in segregating the AMP expenses from the manufacturing and trading function. The TPO failed to appreciate that AMP is cost / expense which is factored when the Appellant is tested at the net margin level.

2.4 Erred in law by applying the Bright Line Test using AMP expenses / Sales as a basis for imputing an arrangement of creation of marketing intangible by the Appellant on behalf of AEs when it is not a prescribed method under section 92C(1) of the Act read with Rule 10B of the Income-tax Rules, 1962 (‘the Rules’).

2.5 Erred on facts by comparing the Appellant with the well established companies in applying the BLT. Further, erred on facts and in law in making transfer pricing adjustment without considering suitable adjustments to account for the differences in functional profile and economic circumstances with the alleged comparable companies selected by the TPO in applying the BLT.

2.6 Without prejudice to the above, erred on facts and in law in considering selling and sales promotion expenses as a part of AMP expenses of the Appellant, while applying alleged Bright Line Test.

2.7 Erred in law and on facts in applying mark-up for the alleged excess AMP expenditure incurred by the Appellant.

Grossly erred in law and on facts in selecting companies engaged in providing media advertisement services for benchmarking against the Assessee’s business of manufacture and trading of paints, varnishes, primers and other related chemicals, for the computation of mark-up on alleged excessive AMP expenses.

2.8 Erred in law in not appreciating that such transfer pricing adjustment could not be made/in respect of AMP expenses which were found to constitute legitimate, bona fide

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and/deductible business expenditure and the Appellant was the economic owner of the benefit of such AMP expenses. Other Transfer Pricing Grounds 2.9 Erred in law and on facts in disregarding the Transfer Pricing study maintained by Assessee and rejecting the Resale price method adopted by the Appellant. 2.10 Erred in law and on facts by selecting Asian Paints Limited as a comparable to Appellant without considering the significant difference in scale of operations. 2.11 Erred in law and on facts in not allowing appropriate economic adjustment such as idle capacity and non-cenvatable customs duty, as provided under Rule 10B of the Rules account for functional differences between the Appellant and the alleged companies. Other Transfer Pricing grounds 2.9 Erred in law and on facts in disregarding the Transfer Pricing study maintained by the Assessee and rejecting the Resale price method adopted by the Appellant. 2.10 Erred in law and on facts by selecting Asian Paints Limited as a comparable to the Appellant without considering the significant difference in scale of operations. 2.11 Erred in law and on facts in not allowing appropriate economic adjustment such as idle capacity and non-cenvatable customs duty, as provided under Rule 10B of the Rules to account for functional differences between the Appellant and the alleged comparable companies. 3.0 Grounds in relation to corporate tax 4.0 Erred in law and on facts in initiating penalty u/s 271(1)(c) of the act.

Ground No.1 is general in nature which does not require specific

adjudication.

2.0 Ground No.2.1 to 2.8 are related to the arm’s length adjustment of

brand promotion fee of ₹14,11,82,140/- expenditure incurred towards the

Advertising, Marketing and Promotion (in short ‘AMP’) expenses. The

assessee company is engaged in manufacturing-cum-trading of paints,

varnishes, primers and other related chemicals. During the assessment

proceedings, the AO found the following international transactions with

AE.

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Quantum of S.No. Description of transaction transaction (in ₹) 1 Purchase of Raw Material and 4,91,55,474-00 Packaging Material 2 Purchase of Finished Goods 9,35,09,410-00 3 Purchase of Capital Goods 8,19,116-00 4 Purchase of Software License 49,58,656-00 5 Management Consultancy 39,32,125-00 6 Reimbursement 1,25,23,653-00 Total 16,48,98,434-00

2.1 The above transactions were referred to the TPO to determine the

arm’s length price (ALP) of the International transactions. As per Form

No.3CEB, the assessee made TP study, FAR Analysis and adopted the Re-

sale Price Method (RPM) as most appropriate method for international

transaction and arrived at gross profit margin of comparables at 13.40 %

as against the assessee’s gross profit margin of 27.02% and came to

conclusion that all the international transactions are at arm’s length and

hence no adjustment was made.

2.2 The TPO has gone through the details furnished by the assessee and

reworked the PLI of the tested party at (-) 15.67% as under:

(in ₹) 2,16,53,29,347-00 Less: Operating Expenses: Material cost 1,58,02,52,723-00 Personnel Expenses 23,65,70,322-00 Selling, Marketing, 39,83,62,994-00 Distribution expenses Gen. & Admn. Expenses 25,19,31,021-00 --------------------- 2,46,71,17,060-00 Depreciation 3,76,22,018-00 --------------------- 2,50,47,37,078-00 Operating Profit (-) 33,94,09,731-00 ---------------------- Operating Profit Margin = OP/OI = ( -)15.67%.

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2.3 The TPO made independent study of transfer pricing study and

found that the assessee has not maintained the segmental finances for

manufacturing and trading activities separately. The assessee purchases

the raw materials and further used partly in manufacturing activity and

not directly sold in the open market. In such scenario, the assessee could

not explain the applicability of RPM in international transaction to the TPO.

Hence, the TPO held that the TNMM was most appropriate method for

computing the ALP in relation to the international transaction and selected

the following set of comparables:

Name of the S.No. OP/OI(%) Company 1 Asian Paints 14.14 2 Berger Paints 8.05 3 Kansai Nerolac Ltd. 8.9 Average 10.36

Against the comparable margin of 10.36% the tested Party/the

assessee’s operating margin was (OP/OI) of (-)15.67% and hence the

TPO issued the show cause notice to adopt the above comparables for

bench marking the International transaction and to adopt TNMM as most

appropriate method. The assessee submitted the reply and after

considering the reply the TPO rejected the RPM as MAM and adopted the

TNMM as MAM.

2.4 During the TP proceedings, the TPO found the following expenses

were incurred by the assessee as Advertising, Marketing and Promotion

(AMP) expenses.

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S. Amount Particulars Explanation (in ₹) No. Advertisement in various TV channels, magazines, 1 Advertising 14,72,76,198-00 outdoor display, media campaign, etc., for marketing the products including creative works. Business Generated through conducting Architect/Painter/Dealer promotions, Loyalty programs to painter and dealers, scheme benefits 2 Sales promotion 6,86,93,564-00 by way of credit notes/gifts to dealers for achieving their targets. Brand awareness created through conducting various exhibitions, events and seminars. Total 21,59,69,762-00

The TPO issued show cause notice to the assessee company as to

why advertising, marketing and promotion expenses should not be treated

as separate international transaction of brand promotion expenses to be

reimbursed by the AE. The assessee filed its reply by stating that the

expenses were normal business expenses and do not have direct bearing

to the turnover. The negative profit was due to advertisement, selling and

distribution employee cost, depreciation and general overheads. The

assessee also objected for the set of comparables taken by the TPO. The

AO held that the advertisement expenses are aimed to promote the

Nippon brand in India, the legal ownership of the brand rests with the AE

M/s.Nippon Trading Co. Ltd., Japan and placing reliance on M/s.LG Electronics

(P) Ltd. vs. ACIT (2013) 22 ITR (Trib.)1, the Special Bench of the Hon’ble ITAT, held the AMP

expenses as a separate international transaction. The TPO made

comparable study for arriving margin separately for advertisement with

the companies engaged in manufacturing and trading of paints and

selected three comparables – Asian Paints, Berger Paints, Kansai Nerolac Ltd., and

worked out the average mean of expenses to 3.98% as under:

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Advt. Name of the Advt. S.No. Sales exp/Sales Company Expenses (%) 1 Asian Paints 282.35 7035.45 4.02 2 Berger Paints 103.20 2288.20 4.5 3 Kansai Nerolac Ltd. 82.11 2481.02 3.4 Mean 3.98%

The average advertising expenses of the assessee was at 9.50%. The

TPO bench marked, the AMP expenses at ₹9,00,82,878/- @ 3.98% on

total sales against the actual expenses of ₹21.59 lakhs and worked out the

difference of ₹12,58,86,884/- towards the reimbursement of expenses

from AE on account of AMP expenses.

2.5 The TPO selected seven comparables and worked out the mark-up of

12.15% on AMP expenses as under:

Sl.No. Name of the Company PLI 1 ACME Advertisements Pvt. Ltd. 1.4 2 Concept Communications Ltd. 4.52 3 Digital Radio (Delhi) Broadcasting Ltd. 22.77 4 Digital Radio (Mumbai) Broadcasting Ltd. 29.07 5 Gaur & Nagi Ltd. 5.48 6 Marketing Consultants & Agencies Ltd. 8.95 7 Quadrant Communications Ltd. 12.84 Arithmetic Mean 12.15

Mark up on AMP expenses @12.15% worked out to ₹1,52,95,256/-

and the aggregate of AMP expenses and the mark-up on AMP was worked

out to ₹14,11,82,140/- was suggested for adjustment towards the brand

promotion under AMP expenses by the TPO. The AO issued draft

Assessment Order proposing the addition of ₹14.11 Cr. as AMP expenses

and the assessee filed objection before the Dispute Resolution Panel

(DRP). The assessee raised 3 objections before the DRP on AMP stating

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that the TPO’s observation that the advertisement expenses were incurred

by Nippon Paint were aimed to promote Nippon Brand in India is factually

incorrect and the entire expenses were incurred exclusively for the

purpose of Nippon Paints in India. Secondly, the TPO has erred in

applying Bright Line Test for making adjustment towards Advertising,

Marketing and Promotion (AMP) expenses which was not a method

prescribed u/s.92C of Income Tax Act r/w Rule 10B & 10C. Thirdly, the

AO erred in applying mark-up at 12.95% on AMP expenses and the AO

has no power to make such adjustments. The DRP has considered the

objections of the assessee and confirmed the Order of the TPO. The DRP

relied on the following judicial pronouncements:

2.6 Aggrieved by the order of the DRP, the assessee filed appeal before

the Tribunal.

Appearing for the assessee Mr.Raghunathan Sampath, Advocate,

has argued that the assessee has incurred the AMP expenses on sales and

marketing related activities in India with domestic third party vendors to

cater to the local requirements and the said expenditure was not at the

instance of the AE. The AMP expenses were incurred by Nippon India for

its business purposes and the benefits of AMP expenses have accrued to

Nippon India in the form of higher sales and better profitability position in

the subsequent years, since the Nippon India is economic owner of Nippon

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brand in India, the contention of the TPO that the excess AMP spent

results in benefits to the AE is erroneous and based on conjectures and

surmises. The Ld.AR also submitted that there was substantial increase in

sales and reduction of AMP expenses in relation to sales in the subsequent

years as follows:

Particulars FY 2010-11 FY 2011-12 FY 2012-13 FY 2013-14 FY 2014-15 Gross sales 226.34 326.29 455.55 532.91 595.76 (in crores) Advertisement and Sales Promotion 21.60 41.80 24.64 36.12 51.65 expenses (in crores) AMP/Sales (%) 9.54% 12.81% 5.41% 6.78% 8.67% Increase in sales 37.71% 44.16% 39.61% 16.98% 11.79% (%) PBT (in crores) (37.83) (34.60) (45.28) (6.71) (0.46) PBT/Gross sales -14.50% -10.61% -9.94% -1.26% -0.08% (%)

2.6.1 The Ld. A.R argued that the assessee is an independent

manufacturer and has not incurred the expenditure on behalf of the AE to

build up the AE brand in India. There was no agreement binding by the AE

to incur any AMP expenses by the assessee on behalf of the AE. The

assessee submitted that the trade mark Nippon is already existing brand

operating globally. Nippon India incurred AMP expenses to expand the

renowned existing brand and not to develop the brand for Japan.

2.6.2 The Ld.AR further argued that the advertisement expenses incurred

and quantified by TPO at ₹21.59 Cr. included a sum of ₹11.98 Cr. related

to the sales expenses and not advertising expenses. Sales related

expenses required to be excluded from the AMP and the advertisement

expenses alone amounting to ₹9.61 Cr. required to be taken as

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advertising expenses. Therefore, the Ld.AR contended that even if the

TPO considers that the advertisement expenses were separate

international transaction for AMP expenses only the amount of ₹9,61,42,574/- should be considered as the AMP expenses and necessary

credit should be allowed for adjustment as per Rule 10B. the Ld.AR

further submitted that the AO considered the comparables with huge turn

over and long standing companies without making any adjustment hence

the necessary adjustment should be given. Further, the Ld.AR argued

that the TPO compared the expenses to sales ratio using the Bright Line

Test as envisaged by Hon’ble Delhi High Court in the case of Maruti Suzuki

India Ltd., Vs. ACIT [(2010) 192 Taxman 317 (Delhi)] and Special Bench

of the Delhi Tribunal in the case of LG Electronics India Pvt. Ltd., vs. ACIT

([2013] 140 ITD 41 (Delhi) (SB)]. The above rulings have been nullified or

over ruled in the subsequent cases. In the subsequent decision of the

Maruti Suzuki, Hon’ble High Court of Delhi has ruled in favour of the

assessee. The case of LG Electronics was overruled by Delhi High Court

and the other High Courts. Sec.92C of the Act provides that ALP of

international transaction shall be determined by any of the five methods

i.e.

1) CUP method 2) Re-sale Price method 3) Cost plus method 4) Profit slip method 5) Transaction net margin method (TNMM)

2.6.3 Out of which one of the method has to be applied as most

appropriate method to determine the ALP of international transaction for

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bench marking the AMP expenses. None of the five methods have been

applied by the TPO. The AO applied Bright Line Test method and the

Hon’ble Delhi High Court held that the ITAT is not right in directing a fresh

bench mark in LG Electronics. Delhi High Court also held that the

application of Bright Line Test is not a correct method as per the Indian TP

Regulations to bench mark the transactions pertaining to AMP expenses.

The Ld.AR relied on the following decisions in the cases of –

• Maruti Suzuki India Ltd., Vs. CIT ([2016] 381 ITR 117), • Sony Ericsson Mobile Communications Vs. CIT([2015] 374 ITR 118) Goodyear India Ltd., Vs. DCIT (ITA No.5650/Del/2011, 6240/Del/2012 and 916/Del/2017. • Delhi High Court in Whirlpool India Ltd. (ITA No.610 of 2014 & 228 of 2015). • Bausch & Lomb Eyecare (India) (P.) Ltd. Vs. ACIT Delhi High Court ITA No.643, 675 to 677 of 2014, 165, 166 and 950 of 2015. • Honda Siel Power Products Ltd. vs. DCIT Delhi High Court (2016) 283 CTR (Del) 322.

2.6.4 According to the Ld.AR, the expenditure incurred by the assessee

under the head AMP was a sales related expenditure which is subject to

allow ability u/s.37(1) of Income Tax Act and it is not a separate

international transaction.

2.6.5 As per the decision of Hon’ble Delhi High Court, the Bright Line

Test method was not provided in Sec.92C of Income Tax Act and cannot

be applied for AMP expenses. The AO also not correct in application of

mark-up on AMP expenses.

2.7 On the other hand, Shri Pathalavath Peerya, Ld.CIT, Ld.DR argued

that the assessee company is 100% wholly owned by NipponSea

International and Nippon Painting Co. Ltd., AE of the assessee. The brand

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Nippon owned by Nippon Co. Ltd., and does not belong to the assessee

company. The economic ownership rests with the parent company only

and the Trade mark, logo belong to the AE but not the Indian company.

The assessee is manufacturing and trading the Nippon brand goods in

India. Since, the economic ownership does not belong to the assessee

company, the expenditure incurred by the assessee company towards the

AMP expenses spent on the brand name of AE. As seen from the details, the assessee company had incurred a sum of ₹21.59 Cr. towards AMP

expenses which were around 9.5% of the turnover. If the advertisement

expenses are included, the assessee’s trading, resulted in loss of ₹3,39,49,731/-. No prudent businessman will incur such huge

expenditure when the brand name and trade name is held by the other

company i.e. AE. Though, the Ld.AR stated that, out of total expenditure of ₹21.59 Cr., a sum of ₹11.98 Cr. was sales related expenditure which

does not represent AMP, the details of expenditure clearly shows that the

expenses are in the nature of AMP which should be considered for Brand

promotion of AE. Since, the economic ownership belonged to the AE, the

brand belongs to the AE and the expenses incurred towards AMP would

build the brand image of the AE. Hence, the expenditure towards AMP

required to be considered as separate international transaction. It is

beyond doubt that the assessee’s company is acting within the limits of

the royalty agreement entered with the assessee company and the AE has

not permitted the assessee company to own the brand name of Nippon.

Though, AMP expenses were not included as an international transaction

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in Sec.92B, the Government has inserted Sec.92F(v) to include an

arrangement understanding or action in concert as an international

transaction. The agreement need not be formal, it may be oral or implied

agreement or arrangement. Therefore, the Ld.DR contended that the AMP

spent was due to oral and informal arrangement between the assessee

and the AE. Further, Ld.DR relied on the decision of Delhi High Court in

the case of Sony Ericsson Mobile India Co. vs. CIT [54.Taxman.com 240]

wherein it was held that AMP expenses incurred in India by the assessee

subsidiary of MNC, can be categorized as an international transaction

u/s.92B. According to the Ld.DR, AMP transactions are international

transactions. The ld.D.R further submitted that the AO has applied Bright

Line Test method which was as one of the approved methods as per the

rulings of Special Bench and the subsequent judgment of Delhi High Court

in Sony Ericson. However, later on Hon’ble Delhi High Court disapproved

the Bright Line Test method hence the case should be remitted back to the

AO to adopt correct most appropriate method and to determine the ALP of

AMP. Further, mark-up of 12.15% on AMP expenses are also reasonable

but required to be reconsidered by AO in the light of the above

submissions in connection with AMP expenses.

2.8 We heard the rival submissions and perused the material placed

before us. We have gone through the decisions relied upon by both the

parties. The TPO has noticed that the assessee spent amounts towards

advertisement, marketing and promotion expenses and held that the

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expenses were spent towards the brand building of the parent AE

M/s.Nipon Trading Co. Ltd., Japan, and suggested for upward adjustment of difference of ₹12,58,86,884/- as AMP expenses and the mark-up @ 12.15% amount to ₹1,52,95,256/- as brand promotion. The assessee

stated that there was no agreement enforcing to promote the brand name

Nippon India, which obligated the assessee to spend towards the AMP.

The assessee’s AR also argued that the entire expenditure was a business

expenditure of Nippon India Ltd., which improve their sales in the future years. The AO/TPO has not brought any evidence on record to show and

demonstrate that the expenditure was incurred for the brand building of

Nippon, Japan.

2.9 The AO followed the Bright Line Test method for determining the

Arm’s Length Price of AMP. When assessee has contested vehemently

that the expenditure was not incurred for the purpose of brand promotion

of Nippon, Japan/AE, it is the burden of the AO/TPO to examine, make

enquiries and bring an evidence to show that the expenditure was incurred

for brand building of the AE. No such exercise was made by the AO in this

case. The AO/TPO simply applied Bright Line Test method and

benchmarked the difference as AMP expenses and made a mark-up of

@12.15% on the cost of AMP. There was no evidence with the Revenue to

show that the assessee company has not incurred the expenditure

towards its sales promotion which is allowable deduction u/s.37(1) of

Income Tax Act and no evidence to prove that the expenditure in question

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was in fact a brand building expenditure incurred towards Nippon, Japan.

In the TP study report of the assessee, there was no mention of any AMP

expenditure obliged by the assessee by way of any

agreement/arrangement or any other mode mentioned in the Income Tax

Act. As per Sec.92B(1) of Income Tax Act, international transaction

means a transaction between two or more AEs, either or both of whom are

non-residents in the nature of purchase, sale or lease of intangible or

intangible property or provision of services or borrowing money or any

other transaction having bearing on the profits, income, losses or receipts

or assets of such enterprise. In the assessee’s case, the transaction is not

between the AE and the assessee as far as AMP is concerned. The Ld.AR

of the assessee stated that there was no arrangement or agreement or

action in concert are understanding for incurring the AMP expenditure by

the assessee to bring it under the ambit of Sec.92B(1) of the Income Tax

Act.

2.10 In this connection, the assessee relied on the decision of Maruti

Suzuki India Ltd., reported in 381 ITR 117 Delhi. The Hon’ble High Court,

Delhi, disapproved the decision of Hon’ble Special Bench in the case of LG

Electronics and held that the ruling of Hon’ble ITAT Special Bench in the

case of LG Electronics was not right in directing a fresh bench marking

comparative analysis to be undertaken by the TPO. The Ld.AR brought to

our notice, the decision of Delhi Hon’ble High Court in the case of Sony

Ericsson in relation to application of Bright Line Test and upheld that

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Bright Line Test is not a correct method as per the Indian TP Regulations

to bench mark the transaction to AMP expenses. In this connection, the

Ld.AR has invited our attention to Para No.120 & 194 of the Hon’ble High

Court, Delhi, decision in the case of Sony Ericsson reported in 374 ITR 118

Delhi.

194 “Question-5: Whether the Income-tax Appellate Tribunal was right in directing that fresh bench marking/comparability analysis should be undertaken by the Transfer Pricing Officer by applying the parameters specified in paragraph 17.4 of the order dated January 23, 2013, passed by the Special Bench in the case of L. G. Electronics India (P) Ltd.?.“

In terms of and subject to the discussion under the headings D to P, we held that the legal ratio accepted and applied by the Tribunal relying upon the majority decision in L. G. Electronics India Pvt. Ltd. (supra) is erroneous and unacceptable. For the reasons set out above, we have passed an order of remand to the Tribunal to examine and ascertain facts and apply the ratio enunciated in this decision. For the purpose of clarity, we would like to enlist our findings:

(x) Parameters specified in paragraph 17.4 of the order dated January 23,2013, in the case of LG Electronics India Pvt. Ltd. (supra) are not binding on the assessee or the Revenue The “bright line test” has no statutory mandate and a broad-brush approach is not mandated or prescribed. We disagree with the Revenue and do not accept the overbearing and orotund submission that the exercise to separate “routine” and “non-routine” AMP or brand building exercise by applying the “bright line test” of non-comparables should be sanctioned and in all cases, costs or compensation paid for AMP expenses would be “nil”, or at best would mean the amount or compensation expressly paid for the AMP expenses. It would be conspicuously wrong and incorrect to treat the segregated transactional value as “nil” when in fact the two associated enterprises had treated the international transactions as a package or a single one and contribution is attributed to the aggregate package. Unhesitatingly, we add that in a specific case this criteria and even zero attribution could be possible but facts should so reveal and require. To this extent, we would disagree with the majority decision in L. G. Electronics India Pvt. Ltd. (supra). This would be necessary when the arm’s length price of the controlled transaction cannot be adequately or reliably determined without segmentation of the AMP expenses.

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2.11 The assessee also placed reliance on the decision of Delhi Tribunal

in the case of Goodyear India Ltd., Vs. DCIT (ITA No.5650/Del/2011,

6240/Del/2012 & 916/Del/2014) and we extract the relevant paragraph as

under:

2.12 Hon’ble Delhi High Court in the case of 381 ITR 117 in Maruti Suzuki

India Ltd., held that AMP expenses incurred by the assessee is not an

international transaction in Paragraph No.71 which is reproduced here as

under:

“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 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.”

2.13 Similar view was expressed in the case of Whirlpool of India Ltd. by

the Hon’ble High Court Delhi. The Co-ordinate Bench of Delhi Tribunal in

the case of Goodyear India Ltd., vs. DCIT ITA Nos.5650/Del/2011,

6240/Del/2011 & 916/Del/2014 following the decision of Hon’ble High

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Court Delhi has deleted the adjustment made by the in Para No.38 as

under:

2.14 The TPO relied on Sec.92F(v) of Income Tax Act for taxing AMP’s

spent as an international transaction. Hon’ble Delhi High Court in the case

of Maruti Suzuki in Paragraph No.61 held as under:

“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 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.”

2.15 From the above discussion, it is clear that the TP Regulations would

be applicable to any transaction which is held to be an international

transaction. In the instant case, the AO has referred the international

transaction in the case of purchase of raw materials, finished goods,

purchase of goods, purchase of software management consultancy

reimbursement for TP Study and to determine the ALP. During the TP

proceedings, the TPO found that there was a huge AMP spent and brought

it under the purview of international transaction. The AMP spent was not

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obligated by AE. The expenditure was incurred by the assessee as sales

promotion expenses for the purpose of it’s own cause. According to the

assessee, there was no binding agreement to promote the brand of

Nippon India by the assessee. The Revenue could not demonstrate that

there was an agreement or arrangement or action of concert formal or

informal to promote the brand of Nippon in India and to spend towards

AMP. The Revenue has not proved that the benefits of AMP expenses are

for improving the Nippon brand in India who is the economic owner of

Nippon Japan. Therefore, we hold that the AO/TPO/DRP is not correct in

making upward adjustment of brand promotion expenses and the mark-up

on brand promotion. The case of assessee is squarely covered by the

decision of Maruti Suzuki India Ltd., vs. DCIT 381 ITR 117 cited supra.

2.16 Respectfully following the judicial pronouncements discussed above,

we hold that the AMP spent of the assessee is not an international

transaction and the addition is deleted and Ground Nos.2.1 to 2.8 of the

assessee are allowed.

3.0 Ground Nos.2.9 to 2.11 are related to the other transfer pricing

adjustments.

3.1 Ground No.2.9 is related to selection of most appropriate method.

The assessee company has adopted Resale Price Method as most

appropriate method to determine the ALP of international transaction. The

ITA No.779/Mds/2016 :- 20 -:

assessee company has not maintained segmental financials for

manufacturing and trading account segment separately. Further, the

assessee purchased raw materials and some of the goods were used in

manufacturing process. Therefore, AO viewed that TNMM method is most

appropriate method.

3.2 During the appeal, the assessee did not raise any objections before

the DRP regarding adoption of TNMM and no argument was advanced by

the assessee’s counsel before us during the appeal. Therefore, we hold

that TNMM is most appropriate method and Ground No.2.9 is dismissed.

4.0 Ground No.2.10 is related to the comparable of Asian Paints Ltd.

The assessee has objected for selecting the Asian Paints as comparable to

the appellant, since there was a huge difference in scale of operations.

The assessee in TP study selected the four companies as comparables as

under:

1) Berger Paints India Ltd. 2) Asian Paints Ltd. 3) AKZO Nobel India Ltd. 4) Kansai Nerolac Paints Ltd.

4.1 The AO excluded the AKZO Nobel India Ltd., and retrained the

three comparables selected by the assessee. The DRP has rejected the

objection of the assessee relying on the decision of the Hon’ble ITAT,

Mumbai, in M/s Symantec Software Solutions Pvt. Ltd., (2011)

taxmann.com 264(mum) that the taxpayer has not demonstrated as to

ITA No.779/Mds/2016 :- 21 -:

how the difference in turnover has resulted in the influence of

comparables. Unless and until, it is not brought on record that the

turnover of such comparables has undue influence on the margin, it is not

general rule to exclude the same. The DRP also relied on Bayer Material

Sciences Pvt. Ltd., 18 taxman.com 60 (Mum) ITAT.

4.2 The Ld.A.R objecting for selection of Asian Paints as comparable

argued that companies having varied turnover cannot be compared as the

difference in scale of operations have direct impact on their profitability.

The Ld AR also relied on the decision of ITAT Hyderabad bench in the case

of Hello soft India (P) Ltd in ITA No.645/Hyd/09. On the other hand, the

Ld.D.R argued that the assessee itself selected the Asian paints as

comparable in their T.P study and further submitted that mere quantum of

turnover cannot be sole reason for exclusion from comparables and

assessee should demonstrate that the huge turnover had undue influence

on the margins.

4.3 We heard the rival submissions and gone through the material

placed before us. It is seen from the TP study of the assessee that the

assessee has selected the Asian Paints Ltd as comparable and worked out

the gross margin. The TPO has retained the comparable selected by the

assessee. The assessee has not brought on record any other factor which

has material effect and can influence the margin such as functions and

Risks except the turnover. Hence we do not find any reason or merit in the

ITA No.779/Mds/2016 :- 22 -:

assessee’s contention for exclusion of Asian Paints Ltd., as comparable.

The case law relied upon by the assessee is distinguishable on the set of

facts discussed above. Therefore, we do not find any reason to exclude

the Asian Paints Ld., as comparables and this ground of appeal is

dismissed.

5.0 Ground No.2.11 is related to idle capacity adjustment and customs

duty adjustment as provided under Rule 10B(3) of Income Tax Rules.

5.1 With regard to the idle capacity adjustment, the assessee submitted

that the assessee was in the initial year of operation and it would not

utilize its full capacity and, therefore, could not absorb the fixed costs

incurred during the period which has resulted in operational losses.

During the FY 2010-11, Nippon India operated at a capacity of 28%

thereby incurring substantial amount of idle capacity costs and significant

under recovery of cost resulting lower margins. Comparable companies

have been conducting operations for many years and are in the mature

stage of their economic life cycle. The average capacity utilized by the

comparable companies for the FY 2010-11 was 78%. Hence, there is a

need to eliminate the material difference in terms of capacity utilization

between Nippon India and the comparable companies. The initial cost of

production was higher as FY 2010-11 was the second year of operations

after commencing the manufacture facility at Sriperumbudur Factory.

There were more experiments in terms of new raw material sourcing for

ITA No.779/Mds/2016 :- 23 -:

both new products and existing products. The economic operations were lower in comparison to the competitors. The company has started

expanding the network of decorative paint business by opening new

depots across the country. As on 31.03.2010, there were eight depots

and in the FY 2010-11, the company has opened 10 new depots in South,

North and West Zones. The nationwide distribution network demanded

more costs in terms of logistics and administration, freights, rental

security communication, travelling, etc. In short, there were fixed

overheads from the date of opening, whereas the sales picked up

gradually in these depots.

5.2 On the other hand, the Ld.AR argued that the assessee is not in first

year of operation. It was submitted by the Ld.DR that the company was

incorporated in 2006 and it was not initial year of operation. Therefore,

the Ld.D.R. contended that there is no case for idle capacity adjustment.

5.3 We have gone through the submissions made by the assessee as

well as the revenue. The assessee has utilized the capacity to the extent

of 28% against the average utilization by the comparable companies

@71%. Idle capacity is one of the factor which can influence the margins

substantially. This view is upheld by the Hon’ble ITAT in the case of Mando

India Steering Systems Pvt. Ltd., and NSK Sales Company Pvt. Ltd.

However, the reasons for non-utilization of capacity required to be verified

with respect to the resources available and the functions performed by the

ITA No.779/Mds/2016 :- 24 -:

comparable companies. The assessee is in manufacturing and trading and

the comparable companies are engaged in manufacturing activity.

Therefore we direct the AO to make necessary adjustments for idle

capacity taking in to consideration of all the factors. Accordingly, the issue

is remitted back to the file of A.O to consider the submissions of the

assessee and to allow the idle capacity adjustment.

6.0 The next claim of assessee was adjustment of customs duty. The

assessee has not furnished the pricing model of the products. Assessee

has not furnished the basis of working its price and comparability cost of

forming part of the cost basis. Prima facie, margins at gross levels are

shown that assessee is able to absorb as part of its selling price, the raw

material cost, which includes the BCD element. Only the down line

expenses are not able to be absorbed by gross profit leaving an arm’s

length return to assessee which is comparable to profit margin of peers

industry. In the case of the assessee, the assessee himself has selected

the comparables and stated in the TP document that the gross margin is

more than the comparable companies. Since, the assessee himself

claimed that selected comparables and worked out the gross profit margin

was more than at arm’s length, we do not find any reason to make

adjustment towards the customs duty. This ground of the assessee is

dismissed.

ITA No.779/Mds/2016 :- 25 -: Ground No. 3 related to the addition of ₹2,89,897/-under the head 7.0 business promotion expenses. The expenses were disallowed for non production of bills and vouchers by the AO. Before us also the A.R did not produce any evidence. Therefore, the addition made by the AO is confirmed. The ground of the assessee’s appeal is dismissed.

8.0 Ground No.4 is related to the initiation of penalty proceedings which are consequential in nature. Therefore this ground of appeal is dismissed.

9.0 In the result, the appeal of the assessee is partly allowed.

Order pronounced in the Open Court on 10th February, 2017, at Chennai. Sd/- Sd/- (एन.आर.एस. गणेशन) (�ड.एस. सु�दर �संह) (N.R.S. GANESAN) (D.S.SUNDER SINGH) �या�यक सद�य/JUDICIAL MEMBER लेखा सद�य/ACCOUNTANT MEMBER

चे�नई/Chennai, �दनांक/Dated: 10th February, 2017. tln

आदेश क� ��त�ल�प अ�े�षत/Copy to: 1. अपीलाथ�/Appellant 4. आयकर आयु�त/CIT 2. ��यथ�/Respondent 5. �वभागीय ��त�न�ध/DR 6. गाड� फाईल/GF 3. आयकर आयु�त (अपील)/CIT(A)