DCIT CIR 6(3), MUMBAI vs. MATTEL TOYS(INDIA) P. LTD, MUMBAI

Order u/s.254(1)of the Income-tax Act,1961(Act) लेखा सद� राजे� के अनुसार PER RAJENDRA, AM- Challenging the order of the CIT(A)-11,Mumbai,dated31.03.2014,the Assessing Officer(AO)and the assessee have filed cross appeals for the AY.2008-09.For the next AY.the AO has filed appeal and the assessee has filed cross objections. Assessee-company,incorporated in India,is an indirectly wholly owned subsidi - ary of Mattel Inc,USA and is engaged in the manufacturer and sales of toy products of the Mattel Group in India.Considering the fact that issues involved in both the years are almost identical,we are passing only one order.

3.First ground of appeal is about disallowance of depreciation on plant and machinery of Rs.2.23 lakhs.During the course of assessment proceedings,the AO noted that the assessee had a manufacturing plant at Nagpur wherein no production activities were carried on over the last several years.In absence of any manufacturing activities,the depreciation claim on the plant and machinery amounting to Rs 2,23,991/-was disallowed.The First Appellate Authority(FAA)upheld the disallowance.

3.1It was brought to our notice that it was a recurring issue and on the similar facts,the Tribunal for AY.2001-02 in Mum/2008, vide order dated,12.06.2013,had set aside this issue to the AO to determine whether some assets forming part of the plant and machinery on which depreciation was claimed,was actually used for other than manufacturing

4350+3Matteltoys purposes.It was directed by the Tribunal that in case the assets were found to have been actually used during the year, depreciation should be allowed on such assets. Following the above order,we restore back the matter to the file of the AO,who would follow the directions of the Tribunal given for the AY.2001-02.First ground of appeal stands partly allowed.

4.Next ground of appeal deals with advertising,marketing and promotional (AMP)expenditure.During the year under consideration, the assessee had incurred advertising and selling expenditure to the tune of Rs 8.43 Crores as against net sales of Rs.52.

23. Crores.Out of the said expenditure,the TPO recognized Rs 3.7 Crores to be routine selling and distribution expenses and determined the remaining amount of Rs 5.35 Crores as AMP expenditure, which amounted to 10.24% of the sales revenue during the year.He selected the list of comparable companies adopted by the assessee for its distribution activities and computed the average arm's length AMP expenditure to income as 2.87%.The TPO,on the basis of his view that it had incurred excessive non-routine expenditure to develop marketing intangibles for the AE,adopted the 'bright line test' and made an adjustment to income declared by the assessee to the extent of such 'excessive AMP expenditure' determin -ed with reference to the bright line together with a mark-up of 10 %.This resulted in an adjustment of Rs.4.36 Crores the assessee's income.

5.In the appellate proceedings,before the FAA,it was submitted that the assessee entered into an agreement with its AE,based on which certain trade -marks,copyrights and other rights in the design, style, character, etc, owned by its AE,were licensed to the assessee without any royalty being charged. Using these royalty free intangibles provided by the AE, the assessee earned

4350+3Matteltoys a sub-license fee of Rs 2,90,94,785/-during the period under consideration. In this background,the FAA accepted the assessee's plea that the income earned by way of sub-license fees by the assessee from the royalty fee intangibles should be deducted from the AMP expenses actually incurred before computing the excess AMP expenditure for the transfer pricing adjustment.However,the FAA,for the purpose of reducing sub-license fees earned by the assessee from the AMP adjustment,adopted a figure of Rs 2,61,71,917/-instead of the actual sub-license fee earned of Rs 2,90,94,785/-. The adjustment made by the TPO was restricted by the FAA as per the table below:

Particulars Amt (INR) Total Sales made 52,23,92,407 ALP of AMP expenses © 2.66% of sales 1,38,95,638 Actual AMP expenses 5,35,67,584 Less: License income from third party manufacturers 2,61,71,917 Net AMP expenses 2,73,95,667 Amount spent on marketing intangibles (Rs 2,73,95,667 – Rs. 1,38,95,638) 1,35,00,029 Mark-up ©10% 13,50,003 Adjustment on account of AMP expenses after reducing license income 1,48,50,032 6.Before us,the AR argued that AMP expenses were unilaterally incurred by the assessee toward independent third party as part of its business operations, that it could not be considered as an IT under the TP provisions, that there was no agreement, understanding or arrangement between the assessee and the AE for incurring of such expenditure by the assessee on behalf of the AE , that the AMP expenditure, not being an IT, did not require a separate benchmarking analysis, that the AO had not brought out any evidence of existence of evidence for incurring AMP expenditure by the assessee for its AE.s, that the TPO had failed to demonstrate that AMP expenditure incurred by it had benefited the 4350+3Matteltoys brand of AE rather than the product of the assessee,that the sales promotion and advertisement activities undertaken by it were specific to the products sold in India,that it was selling the goods in India and had not sought any approval from the AE to incur the said expenditure, that it undertook the sales promotion and advertisement activities on its own.Further, it was argued that the BLT applied by the AO for computing the ALP for brand promotion was not a recognised method under the provisions of the Act, that the comparables adopted by the TPO were operating under different segments and were functionally dis-similar, that they were not valid comparables. The AR relied upon the cases of Diego Ltd.(ITA/7545/Mum/2012) and Heinz India Pvt. Ltd. (ITA/7732/ Mum/ 2010), Maruti Suzuki India (64taxmann 150), and Bausch & Lomb (Eyecare) (ITA 643 of 2013 of Hon’ble Delhi High Court).

6.1The DR stated that in the case of LG Electronics (140ITD41)the special bench of the Tribunal had held that AMP was a separate IT,that it had approved the BLT for the purposes of determination of ALP of international transaction of AMP,that the Hon’ble High Court of Delhi,in the case of Sony Ericsson Mobile Communication had held AMP to be an international transaction,that BLT was not approved by the Court,that the Hon’ble court had laid down certain important principles of TP,that the court had laid emphasis on conducting detailed functional analysis that would include AMP functions/expenses,that the court had observed that selection of comparables also required to be matched with the functions and obligations performed by tested parties including AMP expenses, that bundled transaction approach had to be followed in such cases and that detailed functional analysis had to be conducted.He referred to eight cases, decided by the Delhi Tribunal,wherein the issue of AMP expenditure was restored back to the file of the AO in light of the judgment of Sony Ericsson. With regard to the decision of Hon’ble Delhi High

4350+3Matteltoys Court in the case of Maruti Suzuki,the DR stated that up to the date of decision i.e.11/ 12/2015,the departmental authorities did not have the benefit of the decision,that they were following the order of the LG Electronics (supra)using BLT, that in some cases BLT had been followed and the expenditure on AMP had been sliced into two portions,that the non routine expenditure in excess of BLT was considered separately as international transaction and benchmarked accordingly for the purpose of ALP,that non-routine excess expenditure taken out for benchmarking of AMP would be required to be considered as the part of cost base/expenditure He referred to the cases of Toshiba India Private Limited, India Medtronics Private Limited, Johnson & Johnson India Ltd,Essilor India Private Limited and Molson Coors India Ltd.and stated that the Tribunal had restored back the issue of AMP expenses to the file of the AO.s in all the cases,that the case under consideration should also be sent back to the file of the AO.

7.We have heard the rival submissions and perused the material before us. Before proceeding further,it would be useful to understand the philosophy of the TP provisions.It is said that the purpose and object of introduction of the provisions contained in Chapter X is to prevent an assessee from avoiding payment of tax by transferring income yielding assets to non-residents even while retaining the power to enjoy the fruits of such transactions i.e. the income so generated.The present provisions were been incorporated vide Finance Act, 2001.Same were further amended vide Finance Act,2002 and are being amended from time to time to meet the new challenges thrown up by the dynamism of the current commercial and business realities.Having regard to the object for which provisions have been enacted,applicability of the said provisions has to be limited to situations where there is diversion of profits out of India or where there may be erosion of tax revenue in intra group transac-

4350+3Matteltoys tion.So,intra-group transaction is the first pre-condition for invoking the TP provisions.Calculation of ALP is the next and logical step.But,if the first step itself is missing,the AO cannot go to the second stage. Here,we would also like to mention that there exists a fundamental and basic distinction between the provisions of section 37 and section 92 of the Act-as the first is expense oriented and the second is pricing oriented.The TPO and the FAA have tried to incorporate the ingredients of Section 37 while dealing with the TP adjustments, when they talked of the‘higher expenditure’.In our opinion,the approach of both the authorities were not in accordance with the basic philosophy of the TP provisions.In our opinion,it is the assessee who has to decide how much to spend for earning his income.The tax authorities are prevented from entering into the proverbial shoes of the assessee to decide the justification of the expend -itureThe Act stipulates that in certain conditions only the so-called higher expenditure can be questioned.The FAA had not proved that the expenditure incurred by the assessee for advertisement etc.was covered by those sections.If it was the case then the transaction would not fall under section 92 of the Act. So,in our opinion the FAA had adopted a totally incorrect approach, while dealing the allowability of AMP expenditure.We further hold that there is no evidence to prove that the claim made by the assessee that it had incurred the AMP expenditure for catering its own business needs.

7.1.We hold that there exists a fine but very important distinction between products promoted and nurtured by an assessee and the brand owned and supported by its AE.In the modern world both exist and play different and specified roles.Therefore,until and unless some -thing positive is brought on record about sharing/ incurring AMP expenditure under the head by an assessee on behalf of its AE,it cannot be held that it should have recovered some amount from the AE as the expenditure by it indirectly helped in augmenting the brand

4350+3Matteltoys value owned by its overseas AE.If the AMP expenditure incurred by an assesee benefits the AE indirectly it would not mean that it was an IT. The basic purpose of introducing the various provisions of chapter X,as stated earlier,was to prevent tax evasion in the transactions undertaken between an Indian entity and its overseas AE.In our opinion,a perceived/notional indirect benefit to the AE,due to incurring of certain expenditure by an assessee in India, is not covered by the TP provisions. It is a fact that the payment under the head AMP expenditure was made to third parties and that those parties were located in India.

7.2.In the cases of Bausch & Lomb Eyecare(India)Pvt.Ltd(supra),the issue of AMP expenses had been deliberated upon extensively and each and every argument raised by the departmental authorities have been analysed thread bare. We would like to reproduce relevant portion of the said judgment and same reads as under: “53.Areading of the heading of Chapter X['Computation of income from international transactions having regard to arm's length price"]and Section 92 (1) which states that any income arising from an international transaction shall be computed having regard to the ALP and Section 92C (1) which sets out the different methods of determining the ALP, makes it clear that the transfer pricing adjustment is made by substituting the ALP 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 ALP.

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56.Thus, under Section 92B(1) an 'international transaction' means- (a) a transaction between two or more AEs, either or both of whom are non-resident (b) the transaction is in the nature of purchase, sale or lease of tangible or intangible property or provision of service or lending or borrowing money or any other transaction having a bearing on the profits, incomes or losses of such enterprises, and (c) shall include a mutual agreement or arrangement between two or more AEs for allocation or apportionment or contribution to the any cost or expenses incurred or to be incurred in connection- with the - benefit, service or facility provided or to be provided to one or more of such enterprises.

4350+3Matteltoys whereby BLI is obliged to spend excessively on AMP in order to promote the brand of B&L, USA. 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 an 'International transaction'. This might be only an illustrative list, but significantly' it does not list AMP spending as one such transaction.

4350+3Matteltoys acquisition of shares etc. of the target company, For, de hors the element of the shared common Objective' or purpose the idea of "person acting in concert" is as meaningless as criminal conspiracy without any agreement to commit a criminal offence. The idea of "persons acting in concert" is not about a fortuitous relationship coming into existence by accident or chance. The relationship' can come into being only by design, by meeting of minds between two or more persons leading to the shared common objective or purpose of acquisition of substantial acquisition of shares etc. of the target company. It is another matter that the common objective or purpose may be in pursuance of an agreement' or an understanding, formal or informal; 'the acquisition of shares etc. may be direct or indirect or the persons acting in concert may cooperate in actual acquisition of shares etc. or they may agree to, cooperate in such acquisition. Nonetheless, the element of the shared common objective or purpose is the sine qua non for the relationship of "persons acting in concert" to come into being. "

Revenue, namely the fact that even if there is no explicit arrangement, the fact that the benefit of such AMP expenses would also encure to the AE is itself self sufficient to infer the existence of an international transaction has been negatived by the Court in Maruti Suzuki India Ltd. (supra) as under: "68. The above submissions proceed purely on surmises and conjectures and if accepted as such will lead to sending the tax authorities themselves on a wild-goose chase of what can at best be described as a 'mirage'. First of all, there has to be a clear statutory mandate for such an· exercise. The Court is unable to find one. To the question whether there is any 'machinery' provision for determining the existence of an international transaction involving AMP expenses, Mr. Srivastava only referred to Section 92F (ii) which defines ALP to mean a price "which is applied or proposed to be applied in a transaction between persons other than AEs in uncontrolled conditions",Since the reference is to 'price' and to 'uncontrolled conditions' it implicitly brings into play the BLT. In other words, it emphasises that where the price is something other than what would be paid or charged by one entity from another in uncontrolled situations then that would be the ALP. The Court does not see this as a machinery provision particularly -in-light of the fact that -the-BLT has been expressly negatived by the Court in Sony Ericsson. Therefore, the existence of an international transaction will have to be established de hors the BLT, 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 ALP, an adjustment had 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 ALP. If the answer to that is in the negative the TP adjustment should follow.The objective of Chapter X is to make adjustments to the price of an international transaction which the AEs involved may seek to shift from one jurisdiction to another.An 'assumed' price cannot form the reason for making an ALP adjustment. " 71- Since a quantitative adjustment is not permissible for the purposes of a TP adjust - ment under Chapter X,equally it cannot be permitted in respect of AMP expenses either. As already noticed hereinbetore,what the Revenue has sought to do in the present. case is to resort to a quantitative adjustment by first determining whether the 4350+3Matteltoys

AMP spend of the Assessee on- application of the BLT,is excessive,thereby evidenc - ing the existence of an international transaction involving the AE. The quantitative determination forms the very basis for the entire TP exercise in the present case. 74.The problem with the Revenue's approach is that it wants every instance of an AMP spend by an Indian entity which happens to use the brand of a foreign AE 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 928 of the Act.The problem does not stop here.Even if a transaction involving an AMP spend for a foreign AE is able to be located in some agreement, written (for e.g., the sample agreements produced before the Court by the Revenue) or otherwise, how should a TPO proceed to benchmark the portion of such AMP spend that the Indian entity should be compensated for? 63. Further, in Maruti Suzuki India Ltd. '(supra) the Court further explained the absence of a 'machinery provision qua AMP expenses by the following analogy: "75. As an analogy; and for-no other purpose; in the- context of a domestic transaction involving two or more related parties, reference may' be made to Section 40 A (2) (a) under which certain types of expenditure incurred by way of payment to related parties is not deductible where the AO is of the opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods." In such event, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction." The AO in such an instance deploys the 'best judgment' assessment as a device to disallow what he considers to be an excessive expenditure. There is no corresponding 'machinery' provision in Chapter X which enables' an AO to determine what should be the fair 'compensation' an Indian entity would be entitled to if it is found' that there is an International transaction in that regard. In practical terms, absent a clear statutory guidance, this may encounter further difficulties. The strength of a brand,which could be product specific, may be "impacted by numerous other imponderables not limited to the nature of the industry, the geographical peculiarities, economic trends both international and domestic, the consumption patterns, market behaviour and so on.A simplistic approach using one of the modes similar to the ones 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 4350+3Matteltoys mandate which provides the necessary checks against arbitrariness while at the same time addressing the apprehension of tax avoidance.”

4350+3Matteltoys crossing the first threshold second cannot be approached,as stated earlier.In the case under consideration,we are of the opinion that AMP expenditure is not an IT and therefore we are not inclined to restore back the issue to the file of the AO.Considering the facts and circumstances of the case under consideration,we are of the opinion that the FAA was not justified in upholding the order of the TPO.Therefore,reversing his order,we decide second ground in favour of the assessee.

8.The third Ground of appeal is about TP adjustment made in relation to purchase of Raw material from its AE.s amounting to Rs.57,63,364/-.During the TP proceedings,the TPO observed that the assessee had imported raw material of Rs.1.13 crores from its AE.s,that it had applied the cost plus method(CPM)for bench-marking the transaction, that the assessee had earned GP to input cost of 98.05% in case of import of raw material as against 55. 20% in the case of comparables.The TPO rejected the CPM on the ground that it could be applied when the tested party was supplier of goods, that in the case under consideration the assessee was a purchased of raw material, that the gross profit margin was not the correct Profit Level Indicator(PLI), that the same price reflected not only the cost of raw material used but also the efforts taken by the assessee in respect of intangibles used, supervisions of quality control and marketing etc.He held that TNMM was the most appropriate method to determine the ALP of the transaction.While retaining the same comparables as used in the TP study report, the TPO arrived at a PLI of 13.04% and made an adjustment of Rs.57.63 lakhs in respect of import of raw material.

9.During the appellate proceedings before the FAA,the assessee made elabor -ate submissions on preferability of CPM over TNMM and contended that no 4350+3Matteltoys adjustment was required to be made with regard to import of raw material. Alternatively,it was argued that the adjustment should be restricted to IT transaction only. 9.1After considering the submission of the assessee and the order of the TPO/ AO,the FAA held that the assessee had not countered the specific reasons given by the TPO for rejection of CPM,that the TNMM would consider the net margin and was less affected by the transactional differences,that the net margin used in TNMM were more tolerant towards some functional differences between the control and uncontrolled transactions,that the TNMM was more appropriate method to determine the ALP of the transaction in question.With regard to alternate submission made by the assessee that while computing the ALP of the purchase cost of raw material from its AE.s the TPO had considered the entire difference as relatable to purchases from concerned AE.s, the FAA held that no TP adjustment was permissible for any transaction unless it was entered into with an AE,that the difference between the actual operating cost and ALP of such operating cost would have to be treated as emanating form the transaction with AE,that the computation made by AO was in order.Finally,the FAA upheld the order of the AO.

10.Before us,the AR argued that in the subsequent year the TPO had not objected to the method adopted by the assessee with regard to purchase of raw material,that even if TNMM had to be applied it had to be applied for the IT transactions only.He referred to the judgment of the Hon’ble Bombay High Court delivered in the case of Tara Jewels Export Pvt.Ltd.(Income tax Appeal No.1814 of 2013).The DR supported the order of the FAA.

4350+3Matteltoys 11.We have heard the rival submissions and perused the material before us.In our opinion,provision of section 92 are applicable to the IT only.Transactions entered in to by an assessee with the Non-AE.s are not governed by the provisions of Chapter X of the Act.So,there was no justification for applying the TP provisions to entire purchases.We find that in the case of Tara Jewels Export Ltd.(supra)the Hon’ble Bombay High Court has dealt the issue of considering the transaction entered with AE for the purpose of determination of ALP.The facts of the case have been narrated at para-3 of the order as under:- “3.The respondent-assessee engaged in manufacturing and export of studded precious jewelery. Along with it's return, the respondent –assessee disclosed the international transactions entered in respect of it’s sales/exports to it's Associated Enterprises (AE) determining it's Arm's Length Price (ALP) in respect of transactions with AE's by using Cost Plus Method. The Transfer Pricing Officer (TPO) rejected the same and applied the Transaction Net Margin Method (TNMM). On application of TNMM, the TPO arrived at the rate of 4.79% being the margin by which the transaction value would have to be enhanced to determine the ALP. However the TPO while applying the margin of 4.79% applied the same in respect of the universe of sales of respondent -assessee i.e. both to AE's and non-AE's sales. Thus leading to enhancement sales consideration even in respect of transaction entered into with non-AEs which are undisputedly done at ALP.” The Hon’ble Court has dealt the issue and arguments at paragraph No.5-7 of the order and the same reads as under : “5. On appeal, the Tribunal by the impugned order recorded the only grievance of the respondent-assessee before it was the application of the margin of 4.79% computed by the TPO under the TMM across all it's sales and not restricted only to the international transactions entered into by it with it's AE. The Tribunal by the impugned order held that the entire exercise of determining the ALP is done in accordance with Chapter X of the Act and in particular to Section 92A and 92B of the Act require the transfer pricing adjustment to be done only in respect of the transaction entered into between the respondent -assessee with it’s AEs and not with the non-AEs. In the above circumstances, the Tribunal set aside the order of the Assessing Officer /TPO and directed the Assessing Officer to compute the ALP by enhancing the consideration by 4.79% only in respect of the international transactions entered into between the respondent-assessee with its AEs only.

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Respectfully following the same,we direct the AO/TPO to restrict the adjustment to the transactions entered into between the assessee and its AE.s only. Ground No.3 is allowed,in part,in favour of the assessee.

2008-09) 12.The solitary GOA raised by the AO is about direction given by the FAA with regard to sub-license fee received from third party manufactures amount -ing to Rs.2.61crores.While dealing with the issue of AMP expenditure,in the earlier part of our order,we have discussed the facts arising out of the order of the TPO. We have observed that the assessee had pointed out before the FAA that regard must be given to the terms of agreement between the AE and the assessee in the form of royalty fee rights granted by the concerned AE to the assessee for the use of license.It was further argued that the assessee had in turn granted sub license to various third party manufacturers

4350+3Matteltoys in India,that it had earned license fee of Rs.2.61 crores during the year under consideration.After considering the submission of the assessee the FAA had deducted the license fee income i.e.Rs.2.61crores from actual ALP expenses of Rs.5.35crores.

13.Before us,the DR stated that there was no justification for deducting the license income received from the third party manufacturers.The AR support - ed the order of the FAA. 13.1We have heard the rival submissions and perused the material before us.We find that while the assessee had earned sub-license-fees from third- party manufacturers it had not paid any royalty/fee to its AE.s,that it resulted in additional operating revenue,that the assessee had not paid any royalty was a relevant factor to determine the ALP of the transaction,that the sub license fee earned by the assessee was from the same brands that were being promoted through the AMP expenses under consideration,that the sub license fee received by it were the net receipts in its hands,that it was in the nature of cost saving from the gross ALP expenses incurred by it.Therefore, in our opinion the FAA had rightly excluded the said amount for calculating the ALP expenses.We are not inclined to interfere with his order.So,confirming his order,we dismiss the ground raised by AO.

ITA 84/M/2015,AY.2009-10: 14.The only ground raised by the AO,is about license fee of Rs.3.12 crores received from third party manufacturers while calculating the ALP of AMP expenditure.While deciding the appeal for earlier AY.,we have decide the issue against AO. Following the same effective ground of appeal raised by AO is decided against him. CO No.33/M/2015,AY.2009-10:

4350+3Matteltoys 15.First Ground of Appeal is general in nature hence requires no adjudication. Second ground deals with disallowance of depreciation on plant & machinery amounting to 2.75 lakhs. Following our order for earlier AY.,we restore back the issue to the file of AO.Ground No.2 decided in favour of the assessee,in part.

16.Ground No.3 deals with adjustment made under the head AMP expenditure. While dealing with identical issue in earlier AY.,we had allowed the appeal filed by the assessee.Following the same,third ground is decided in favour of the assessee.