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Income Tax Appellate Tribunal, DELHI BENCH “I-2”: NEW DELHI
Before: SHRI PRASHANT MAHARISHI & SHRI K.N.CHARY
O R D E R PER PRASHANT MAHARISHI, A. M.
This appeal is filed by the assessee against the order of the learned Additional Commissioner Of Income Tax, special range – 8, New Delhi passed u/s 143 (3) read with section 144C of The Income Tax Act dated 14/9/2017 pursuance to the direction of The Learned Dispute Resolution Panel issued under section 144C (5) dated 18/8/2017 wherein the order of the learned Joint Commissioner Of Income Tax, Transfer Pricing Officer – 3 (1), New Delhi passed u/s 92 CA (3) of the income tax act 1961 dated 19/10/2016 incorporated in the draft assessment order was the subject.
The learned authorised representative submitted that without prejudice to various grounds raised
in the appeal
3. The assessee has raised the following grounds of appeal in Assessment Year 2013-14:- “1. That on the facts and circumstances of the case and in law, Ld. AO erred in assessing the income of the Appellant at INR 1,03,69,94,470/- as against the returned income of INR 52,91,51,466/-.
2. That on the facts and circumstances of the case and in law, the Final Assessment order passed under section 143(3) read with section 144C of the Income Tax Act, 1961 (“the Act”) by the Ld. AO is bad in law as the same does not consider complete and relevant, facts, are not in accordance with provisions of law and principles of law as laid down by Hon‟ble courts. Transfer Pricing Adjustment in respect of Import of finished goods on account of alleged additional Advertisement, Marketing and Promotion related functions (“AMP functions'‟) carried out by the Appellant
3. The Ld TPO/AO have erred in law and tacts of the case by not analysing the transaction as entered into but re-writing the same on imaginary basis.
4. Without prejudice to all other grounds, the Ld. TPO/AO have erred in law and facts of the case by not considering Credit Note received by the Appellant against its purchases as an operating item and Hon‟ble DRP has erred by giving ambiguous directions for the treatment, of Credit Note received by the Appellant.
5. Without prejudice to all other grounds, Hon‟ble DRP has erred, in noting that two companies considered comparable by AO/TPO, i.e., Lava International Limited and Micromax Informatics Limited are not, brand owners and hence need to be deleted.
6. Without prejudice to all other grounds, the Ld. TPO/AO have erred in not giving complete effect to directions of the Hon‟ble DRP thereby resulting in erroneous computation of demand arising from the substantive; adju.stment.
7. The Ld. TPO/AO and Hon‟ble DRP have erred in law and circumstances of the case in concluding that Appellant is engaged in performing DEMPE function and such function alleged to be performed by the Appellant are adding value to the intangibles of ALL
8. That on the facts and circumstances of the case and in law, the Ld. AO/ Ld. TPO/ Hon‟ble DRP have erred in using intensity adjustment to adjust the net profit margin of comparable companies without appreciating that intensity adjustment in principle uses the same parameters which were being used for application of Bright Line Test („BLT‟) which has already been held to be unlawful by the Delhi High Court in the case of multiple taxpayers.
9. That on the facts and circumstances of the case arid in law. the Ld. AC)/ Ld. TPO/ Hon‟ble DRP have erred in using intensity adjustment to adjust the net profit margin of comparable companies without appreciating that intensity adjustment is not required within Transactional Net Margin Method (TNMM). 10. That on the facts and circumstances of the case and in law and without prejudice to our other grounds, the Ld. AO/ Ld. TPC)/ Hon‟ble DRP have failed to appreciate that no reliable adjustment can be made for difference in intensity of functions if any, in absence of adequate and accurate data avail able in public domain. 11. That on the facts and circumstances of the case and in law and without prejudice to our other grounds, the Ld. AO/ Ld. TPO/ Hon‟ble DRP have failed to appreciate that intensity of functions is dependent on the actual conduct of the Appellant vs the comparable arid not the quantum of spend. 12. That on the facts and circumstances of the case and in law, the Ld. AO/ Ld. TPO/ Hon‟ble DRP have erred in using intensity adjustment to adjust the net profit margin of comparable companies without appreciating that intensity adjustment leads to the assumption that Appellant has not earned any benefit in terms of sales/profit out of AMP expenses and in arm‟s length situation, it would have earned a 8.5% return on every extra AMP spend. This assumption was negated by Hon‟ble Delhi High Court while rejecting BLT test. 13. Without prejudice to all other grounds, Ld TPO/AO erred in performing the intensity adjustment on all indirect expenses instead of considering the quantum of marketing related function and Hon‟ble DRP erroneously upheld the approach of the Ld. TPO/AO. 14. The Ld. TPO/ AO have erred in law and circumstances of the case in concl uding that FAR of the comparables is not similar to the FAR of the Appellant and thus, intensity adjustment is required for a fair analysis and Hon‟ble DRP erroneously upheld the approach of the Ld. TPO/AO. 15. Without prejudice to all other grounds the Ld. AO/TPO erred in making inappropriate selection of comparables and rejected the comparables proposed by Appellant based on either factually incorrect reasons or by applying inappropriate filters, for the purpose of comparability analysis and Hon‟ble DRP erroneously upheld the approach of the Ld. TPO/AO.
16. Without prejudice to all other grounds, the Ld. AO/TPO1 erred in making inappropriate selection of comparables providing marketing support services for benchmarking marketing function and Hon‟ble DRP erroneously upheld the approach of the Ld. TPO/AO. Transfer Priding Adjustment in respect of inter-national transaction for Marketing and Development of Market Services (“MMDS”) based on E11LT approach (Protective adjustment) 17. That on the facts and circumstances of present case, the Ld. AO/Ld. TPO and the Hon‟ble DRP have erred in retaining protective assessment based on the BLT even though the same has been held to be unlawful by the Hon‟ble Delhi High Court in multiple cases.
18. Without prejudice to other grounds, the Ld. AO/Ld. TPO and Hon‟ble DRP while computing the protective adjustment have erred in quantifying excessive and/or non-routine MMDS expenses by considering rebates and discounts and selling and distribution expenses as brand building expenses while performing arm‟s length analysis contrary to the principles and findings laid down by the Hon‟ble Delhi High Court in the case of Sony Ericson Mobile Communications India Private Limited.
19. Without prejudice to the above grounds, the Hon‟ble DRP has erred in not giving directions for the grounds filed against the protective adjustment and gave an ambiguous direction for retaining the same as protective adjustment.
20. That on the facts and circumstances of present case and in law, Ld. AO/TPO and Hon‟ble DRP have erred in holding that MMDS expenditure incurred by the Appellant, is an „international transaction‟, thereby disregarding the findings of the Hon‟ble Delhi High Court in the cases of Maruti Suzuki India Ltd., Whirlpool of India Ltd., Bausch & Lornb Eye Care India Pvt. Ltd and Honda. Siel Power Products Ltd 21. That the Ld. AO/ Ld. TPO/ Hon'ble DRP have erred in not appreciating that MMDS expenses incurred by the Appellant iri the normal course of its business were not for the sole benefit of its associated enterprise and thus did not fall within the purview of an "international transaction" pertaining to rendition of service, as defined in section 92B of the Act, distinct from its functional profile and responsibility as a distributor.
22. Without prejudice to other grounds, the Ld. TPO/AO and Hon'ble DRP erred in applying the BLT method to determine the excessive/non-routine MMDS expenses in complete disregard of the Transfer Pricing Regulations in India, commercial circumstances of the case and the principles and findings laid down by the Hon‟ble Delhi High Court.
23. Without prejudice, even if MMDS expenses are held to be "non- routine" and "excessive", the Appellant was not required to be compensated by its AE, considering that the purported benefit caused to the AE on account of incurring of MMDS expenses incurred by the Appellant was only incidental. 24. Without prejudice, even if MMDS expenses are held to be "non- routine" and "excessive", the Ld. TPO/AO and Hon‟ble DRP erred in not appreciating that the functions performed by the Appellant had already been adequately compensated by the AE since the Appellant‟s business model allows it to earn an arm ‟s length margin on all costs incurred including MMDS expenses. 25. That the Ld. AO/ Ld. TPO/ Hon'ble DRP failed to appreciate that once the net operating margins of the Appellant had met the arm's length test, no further adjustment was required for any non-routine function or non-routine MMDS expenditure 26. Without prejudice to all other grounds, the Ld. TPO/AO/Hon‟ble DRP have erred in fact and in law by determining the arm‟s length level of routine MMDS expenses by considering inappropriate companies. 27. Without prejudice to other grounds, that the Ld. TPO/AO have erred in levying a further mark-up of service providers on MMDS expenses for determination of the arm‟s length price of the alleged brand- promotion services rendered by the Appellant to its AEs.
28. Without prejudice to other grounds, that the Ld. TPO/AO erred in making inappropriate selection of comparables for the mark-up on alleged MMDS expenditure while computing adjustment in protective assessment.
29. Without prejudice to the other grounds, the Ld. TPO/AO have erred in facts and circumstances of the case and in law by ignoring the fact that even if the Appellant' s remuneration model is to be re- characterized to a service fee for MMDS activities, the profit earned by the Appellant over and above the return earned by a distributor undertaking no or limited MMDS activities should be considered as a remuneration for its MMDS activities as stipulated by the Hon‟ble Delhi High Court in the in the case of Sony Ericson Mobile Communications India. Private Limited.
Miscellaneous contentions 30. Ld. AO has erred in initiating penalty proceedings under Section 271(1 )(c) of the Act on account of an adjustment that was a result of a protective assessment.”
The learned authorised representative submitted that the facts are identical to the ITA number 6372/del/2017 for assessment year 2013 – 14 in case of M/s Sony India private limited.
The learned authorised representative submitted a written note which is as under:- General Background: During Ay 13-14 Sony Mobile Communications India Private Limited was engaged in distribution of mobile phones in India. International transactions were benchmarked by using TNNM as Most Appropriate Method. Two adjustments were made under Chapter X of Income Tax Act, 1961, to returned income i.e., (1) "intensity as comparability adjustment" (kindly refer internal page 33 para 20 of TPO order) which was confirmed by DRP as "substantive adjustment" (refer internal page 8 ground 8 of DRP order) to international transaction of distribution AND (2) adjustment on account of AMP expenditure by applying Bright line test (kindly refer internal page 32 para 18 of TPO order) which was confirmed by DRP as "protective adjustment" (refer internal page 24 of DRP order). Broadly speaking adjustment of Rs. 50,78,43,000/- being substantive adjustment or intensity adjustment and Rs. 203,90,03,000/- as protective adjustment by applying Bright line Test, are the subject matter of present appeal. Without prejudice to various grounds raised in appeal memorandum and additional grounds of appeal (filed on 13th March 2018) inter-alia challenging validity of intensity adjustment, BLT, process adopted for selection of comparable companies as well as comparability of final set of companies etc., it is the respectful submission of Appellant, that if only relief as prayed for under Ground of Appeal 5, Ground of appeal 20 and Additional Ground of appeal 32 are adjudicated as preliminary grounds both impugned adjustments (substantive as well as protective) would
get deleted. Appellant therefore, prays for appropriate consideration of these three grounds and craves leave to make submissions thereafter, in relation to all the other grounds, in the event any portion of such adjustments survive. Additional Ground of Appeal 32 As can be seen from page 196 of Appeal set order (dated 12.9.2017) giving effect to DRP directions margin earned by Appellant is computed by recasting Profit & loss account (kindly refer page 36 of paper book submitted during hearing) and comparing the same with net profit (OP/OR) earned by set of 13 companies and an adjustment of Rs. 50,78,43,000 /- is determined. Pursuant to request of Appellant, Ld. TPO provided reconciliation of total operating cost of Rs. 136261.03 lacs considered in this working ( kindly refer page 11 of paperbook - second order of TPO u/s 154 dated 27.12.2017. It was noticed from above reconciliation that Rs. 2.89 lacs and Rs. 2929.01 lacs were added to operating costs by considering the same as Reimbursement received. Such amounts were taken suo moto by TPO from schedule showing 'Transactions with related parties' and forming part of audited financials of appellant (kindly refer to item vi under caption "Reimbursement of Expenses" to Sony mobile communications AB and Sony India private limited at page 53 of Paper book handed over at hearing) and added to operating costs reported in audited profit & loss account, incorrectly considering same as Reimbursement received although these were clearly reimbursements paid. Such reimbursement paid were already part of the expenditure booked in Profit & loss account and addition made by TPO is double counting. This error resulted in suppressing the margin earned by appellant. Vide rectification application dated 19th January 2018, Appellant requested rectification of above error (kindly refer page 19 to 24 of paper book filed at hearing) and pointed out (refer page 23 of such paper book) that by correcting this error intensity adjustment would be deleted. However, Ld. TPO denied benefit of correction (kindly refer paragraphs 4 and 5 on page 26 and 27 of paper book - third order u/s 154 dated 13.3.2018). Strangely Ld. TPO observed that in the financials it was mentioned as 'reimbursement' and it was not clear if it was received or paid.
Apart from the fact that such observation is ex-facie contrary to record (kindly see page 53 as cited above) it is absurd, because if it was not clear as claimed by Ld. TPO making addition to total operating cost recorded in Profit & loss account was not at all justified without ascertaining facts. Further Ld. TPO unjustly refused to rectify above error by stating that "rectification of same is out of purview of section 154". This necessitated filing of additional Ground of appeal
32. Ground of Appeal
5. Companies owning brands were not includible in set of comparable companies for making intensity adjustment. Reference to internal pages 17 and 19 of DRP order would show that in case of Micromax informatics and Lava international, DRP incorrectly attempted ascertain by reference to financial statements of those companies, completely failing to appreciate that self-generated assets like brand may not be accounted for in audited accounts. Consequently, margins earned by these 2 companies were part of the average margin used for intensity adjustment (refer set of 13 companies at para 4 on page 196 of appeal set - order giving effect to DRP order). As the entire comparability exercise under Chapter X of Income Tax Act, 1961 is with reference to information available in public domain, by inviting attention to information available on website of Government of India, Ministry of commerce & industry, Department of Industrial policy & promotion, Controller General of Patents Design & Trade Marks (refer pages 57 to 71 of paperbook filed at hearing) Appellant filed request for rectification before Ld. DRP seeking direction to exclude these 2 companies as they own the brand unlike in case of Appellant where the overseas AE owns the brand. It was respectfully submitted that Ld. DRP conclusions on ownership of brand by looking into financials of respective companies was not justified or correct. However, under pretext of technical difficulties Ld. DRP refused to issue directions for exclusion of these 2 companies (kindly refer page 6 of paperbook filed at hearing - part of order dated 22.11.2017 passed by Ld. DRP in application under Rule 13 of DRP rules) and observed " would amount to review of previous decision, which is not permitted Rule 13 of DRP Rules".
If these 2 companies are excluded from the set of companies used for making so called intensity adjustment the average margin of the set would come down. The above 2 reliefs if granted viz., correction of reimbursement wrongly included in total operation cost for working out tested party margin AND exclusion of 2 companies owning brands would result in NIL adjustment even under the intensity method (though unknown to law) as adopted by TPO and approved by DRP. Ground of Appeal 20 Protective adjustment made by Ld. TPO and Approved by Ld. DRP by application of Bright Line Test being contrary to law laid down by jurisdictional High court in Sony Ericsson (374 ITR 118) deserves to be deleted. Prayer: Appellant prays for correction of above errors and consequent relief by way of deletion of substantive adjustment and further deletion of protective adjustment being contrary to law laid down by jurisdictional High Court. In case Appellant succeeds on above Grounds, the other Grounds of appeal would become academic for this Assessment year. In the unlikely event of any adjustment surviving post adjudication of above reliefs, Appellant prays for suitable opportunity of being hearing on all other Grounds of appeal.
The learned authorised representative reiterated his submission and referred the impugned issues by submitting a detailed paper book. He referred to various pages of the paper book while making the above arguments.
The learned departmental representative vehemently supported the order of the learned dispute resolution panel, transfer pricing officer on the impugned subject. 8. We have carefully considered the rival contentions and perused the orders of the lower authorities. The only dispute in this appeal is the transfer pricing adjustment made on substantive basis with respect to advertisement marketing promotion expenditure on intensity basis and protective adjustment by applying the Bright line test. The assessee has also requested for testing the selection of micromax informatics and lover international as comparable companies. Identical facts and circumstances have been considered by us in the another group concern Sony India private limited vs Additional Commissioner Of Income Tax in ITA number 6372/del/2017 for assessment year 2013 – 14 as per order of even date as under:- 12. We have carefully considered the rival contentions and perused the orders of the learned transfer pricing officer and the learned dispute resolution panel which were later on rectified. There are only 2 disputes left in this appeal. The 1st dispute is regarding the correct computation of the margin of the assessee and the 2nd dispute is with respect to the 2 comparables namely Micromax informatics and Lava international whether they can be included in the comparability analysis.
Coming to the 1st dispute, looking at the order passed by the learned transfer pricing officer on 27/12/2017 while working out the operating cost which is tabulated at page number 8 of the paper book on 3rd page of the order, he has made an addition of reimbursement received on account of advertisement of INR 5 338 and warranty of INR 7 37 2,00,000 to the „ Other operating expenses” of the assessee. The above figure have been extracted by the learned transfer pricing officer from note number 13 pertaining to the „related party disclosure as per accounting standard 18‟ wherein the reimbursement of expenses received credited to respective expenses of INR 5 33 8,00,000 in case of advertisement and INR 7 37 2,00,000 in case of warranty was mentioned. The contention of the learned authorised representative is that that should also been included in the part of income reported in profit and loss account is rejected as these are not the operating revenue of the assessee. However when the learned transfer pricing officer has included the direct cost of INR 96820/– lakhs, (77619+801+18400), he has included the advertisement expenses of INR 5 33 8,00,00 and Rs 7 37 2,00,000 of warranty in the above cost, therefore there is no requirement of further making an addition on this account. On looking at para number 33 of the balance sheet it is apparent that reimbursement of expenses received were credited to the respective expenses account. By that it means that when the original expenses were incurred they were also included by debiting those expenditure to those expenditure accounts. Once those expenditure have been debited whenever they were incurred and at the time of reimbursement they were credited to the same expenditure account, both should have been excluded. Therefore addition of INR 12710/– lakhs to the operating expenses of assessee amounts to double addition to the operating cost by the sum. Therefore it is apparent that the adjustment made by the learned transfer pricing officer by increasing the operating expenses by this amount is erroneous and incorrect. Therefore the learned TPO is directed to remove the addition made of INR 1 2710/– lakhs to the other operating expenses of the assessee.
Coming to the acceptability of 2 comparable companies being Micromax informatics Ltd and Lava international Ltd where the assessee has claimed that both these companies have the brand available to them have been shown to be correct by producing the extracts from the website of controller general of patents, designs and trademarks, government of India. Such evidences are placed at page number 77 – 82 of the paper book. On perusal of page number 77 of the paper book it is apparent that Micromax informatics Ltd have certain brand available to it. However the status of such brand in some of them are mentioned as “abandon”in 2 cases and registered in case of one registration. Further on perusal of page number 79 of the paper book in case of Lava international Ltd, several brands are found to be registered. Therefore, apparently it cannot be said that both these company does not have any brand. The learned dispute resolution panel has also given a finding that on the basis of the annual report of these companies there does not exist any brand in the annual accounts. Naturally if the brands are self generated then they do not find any mention in the annual accounts. However even self generated brands may also impact the profitability of the brand owner. The learned dispute resolution panel has rejected the contention of the assessee only because of the reason that these 2 companies do not have any brand recorded as its fixed assets in its annual accounts. But on verification of the website extract provided by the assessee shows that both these companies have certain intangible assets. Further the website extract produced before us is based on search dated 29/08/2017. The report itself shows that certain brands or intangible assets are also abandoned. The impugned assessment year before us is 2013 – 14. Therefore it is not known whether the above companies were having these brands registered in their name for assessment year 2013 – 14 or not. In view of this, we set aside the issue with respect to the selection of comparable companies with respect to these 2 companies back to the file of the learned transfer pricing officer to determine whether there is any brand registered in the name of this companies for assessment year 2013 – 14 or not and then to find ut whether such brands have made any impact on their profitability. Such information may be obtained by the learned transfer pricing officer by exercising powers u/s 133 (6) of the income tax act. On receipt of such information, it should be provided to the assessee to submit its contention, and then decide about whether such companies can be selected as a comparable companies are not.
Hence for the 2 issues raised by the assessee before us we direct the learned transfer pricing officer accordingly.
As assessee has raised only 2 issues before us and submitted that if those 2 issues are decided it would result in Nil adjustment even under the so-called intensity method.
With respect to the protective adjustment made by the learned transfer pricing officer by bright line test method it was submitted by the learned authorised representative that it is contrary to the decision of the honourable Delhi High Court in Sony Ericsson 374 ITR 118. Therefore respectfully following the decision of the honourable Delhi High Court we hold that bright line test cannot be used for making an adjustment of excessive advertisement marketing promotion expenditure.
In view of above facts, we direct the learned assessing officer/transfer pricing officer to not to make adjustment by addition of reimbursement received of INR 1 2710/– lakhs to the operating expenses of the assessee and also to examine the 2 comparable companies afresh discussed above.
Therefore, leaving all other issues open to be adjudicated, we dispose of the appeal of the assessee with above directions.”
We do not find any change in the facts of that case with the case before us in this ITA. Accordingly we direct the learned transfer pricing officer to reduce the reimbursement received of Rs. 29,31,91,000 from the other operating expenses which adjustment is incorrect. Further we also direct the learned transfer pricing officer in a similar manner to test the comparability of micromax informatics and Lava international. Similarly we also direct the learned transfer pricing officer to delete the protective adjustment made on the basis of bright line test.
Accordingly leaving all other issues open for adjudicated, we dispose of this appeal of the assessee with above direction. Order pronounced in the open court on 08/03/20199. -Sd/- -Sd/- (K.N.CHARY) (PRASHANT MAHARISHI) JUDICIAL MEMBER ACCOUNTANT MEMBER Dated: 08/03/2019