INTERNATIONAL MERCHANDISING CORPORATION, INDIA BRANCH OFFICE,GURGAON vs. DDIT, NEW DELHI

Addition on account of mark-up to be recovered by the appellant on reimbursement of expenses received from Associated Enterprises (AE) and re-computation of arms length price (ALP) on account of provision for services of Rs.9,42,641/- and Rs.49,812/- respectively.

International Merchandising Corporation (‘IMC’) is a foreign company incorporated under the laws of United States of America (USA). It is a tax resident of USA within the meaning of Article 4 of the Double Taxation Avoidance Agreement entered into between India and USA (India-US Treaty). In India, IMC is operating through a Branch Office set up after obtaining approval of Reserve Bank of India and hence, assessed as a foreign company. The assessee company represents athletes, performing artists, writers, fashion models, broadcasters, leading corporation world-class events cultural institutions and recreational resorts. The production centers are located in New York, London, Hong Kong, Sydney and New Delhi. It is the largest independent producer package and distributor of sports programming in the world. International Merchandising Corporation, Inc. USA (IMC Inc., USA) is a part of the IMG Group. IMG commenced operations in India by establishing a branch office of IMC Inc. The Indian Branch is engaged in the following activities:

During the year under consideration, the Assessee was primarily engaged in the business of marketing, organizing and management of international sport events and fashion events, television production and management of commercial rights of sports persons and sports associations in India.

During the year under consideration, the assessee filed its return of income on 31.10.2004 declaring loss of Rs. 28,162,488/-. Subsequently, a revised return of income u/s. 139(5) of the Act was filed on 31.03.2006 wherein the assessee revised the loss to Rs. 30,038,768/-. The Assessing Officer passed the assessment order under Section 143(3) of the Act dated 26.12.2006, wherein the loss of the assessee under the Act was reduced to Rs. 12,882,028/-. The following disallowances/additions were made by the Assessing Officer:

In respect of reimbursement of Rs. 1,05,21,562/-, the Assessing Officer held that these services provided by the assessee to its AE’s and worked out upward adjustment of Rs. 20,58,017/- and in respect of provision for services of Rs. 24,29,844/-, the Assessing Officer worked out upward adjustment of Rs. 2,43,227/-. The Assessing Officer had also not allowed the benefit of 5% range to the assessee, while determining the proposed addition on account of “arm’s length price”.

Aggrieved by the said Assessment Order, the assessee filed appeal before the CIT (A).

The CIT(A) held that the expenses represent payments made for hotels, airlines, mobile service providers, photographers, printing press, car hire charges, security agencies, sports goods, courier charges etc. the same was apparent from perusal of these expenses that the assessee was providing logistic services to its AE’s. The payments made by it on behalf of its AE’s do not represent pass through costs per se. The services provided by the assessee to its AE’s do require arm’s length mark-up on its cost base. The CIT(A) decided the said issue against the assessee. As relates to benefit of 5% range to the assessee on account of “arm’s length price”, the CIT(A) held that the provision of section 92C(2) state that if difference between arm’s length price and transfer price does not exceed 5% of arm’s length price, then no TP adjustment should be made. The CIT(A) further held that where such difference exceeds 5%, then entire difference has been added to the Income without giving any sort of standard deduction out of it and has to be treated as TP adjustment. Thus the CIT(A) decided this issue against the assessee. Now the assessee is in appeal.

The Ld. AR submitted the payment of Rs.1,922,663/- was made to Association of Tennis Professionals, USA (ATP)during the year under consideration, the Assessee had organized a Men’s Professional Tennis Championship in India (‘Chennai Open’/’tournament’). For organizing the tournament, the Assessee had obtained the sanctions/approvals from ATP (which is the governing body of worldwide Men’s Professional Tennis) to recognize the event as an ATP’s event, and thus, this event was recognized as an official ATP Men’s International Series Tennis Championship. Such payments have been grouped under the head ‘sanction and rights’ in the profit and loss accounts. It was further stated that without obtaining the approvals from ATP, the event would have not got international recognition and in absence of such recognition, no international player would have agreed to play in the tournament. Further, since the income from the tournament has been duly offered to tax by IMC in India, the expenditure incurred for earning the said income is allowable as legitimate business expenditure. For the aforesaid expenses the Ld. Counsel for the assessee furnished a chart which read as under:

The Ld. AR submitted in respect of Ground No. 2 relating to Levy of mark-up on cost to cost reimbursement of expense received from Associated Enterprises (‘AEs’) – Additions of Rs. 942,641/- that in the course of its business, the Assessee reimburses the amount incurred by the group companies in various countries on its behalf and similarly, it receives reimbursement of expenses incurred by it on behalf of group companies on cost to cost basis. The details of the amount paid to the group companies and the amount received from group companies towards reimbursement of costs on cost to cost basis as per Form 3CEB for the A.Y 2004-05 under Rule 10E, Section 92E of the Act (paper book page number 158) is as under:

The Ld. AR submitted that the A.O in the assessment order treated the amount of reimbursement received from group companies by the Assessee on cost to cost basis, as services rendered by the Assessee to AEs and applied a mark-up of 19.56% (the mark-up computed by the A.O for event/production management services provided to group companies) and made the following additions:

The Ld. AR submitted that the cost to cost reimbursements is not in nature of rendering services, but it is merely for administrative convenience. It was further submitted that the net amount of Rs.8,126,215 represents reimbursements received from group companies being third party costs paid by the Assessee in the first instance and recovered from the group companies, as a measure of administrative convenience. It was pointed out that the CIT(A) on the basis of the copies of the bills submitted (paper book page numbers 420 to 474), has stated that the expenses represent payment made for hotels, airlines, mobile service providers, photographers, printing press, car hire charges, security agencies, courier charges, sports goods, etc. and has concluded that the Assessee is providing logistics services to its AEs. It was further submitted that the reimbursements received from AEs by the Assessee are purely of cost to cost reimbursement nature and that by administratively facilitating payments to Indian third party petite vendors, there is no intent of the Assessee to render any services to AEs, therefore, the cost reimbursements do not require arm’s length mark-up on the cost base. It was also submitted that similar costs paid by group companies on reciprocal basis are reimbursed by the Assessee without any mark-up, such types of reimbursements on reciprocal basis are only due to administrative convenience and cannot be equated to rendering of services requiring bench marking for mark-up. It was contended that the perusal of expenses demonstrates that the expenses reimbursed included travel/accommodation and other miscellaneous third party expenses incurred by the Assessee on behalf of AEs, these expenses represents third party expenditure paid by the Assessee on behalf of AEs merely for administrative convenience and do not involve any services rendered by the Assessee. Thus, from an arm’s length perspective, these expenses should be permitted to be ‘pass through expenses’ which should be reimbursed only on cost to cost basis.

As regards to re-determination of arm’s length price margin for Income from production and Event Management services of the Assessee, the Ld. A.R submitted that the AO in the assessment order made addition by reworking the mark-up on production / event management services from 9.55% to 19.56% which has been reduced to 11.60% by the Ld. CIT(A). The net addition made is as under:

The Ld. A.R also submitted the chart showing NCP margin of comparables as per following detail:-

The Ld. AR further submitted that an inappropriate rejection of foreign comparable companies by the CIT(A) has given the constraint of non- availability of suitable Indian companies, the Assessee had selected foreign comparables (as mentioned at S. No. 4 to 6 in the above table) in order to broad base the set of comparable companies. It was stated that the CIT(A) erroneously concluded that such comparables should not be considered and out rightly rejected these comparables on account of having operations in different geographical markets. The Ld. AR further submitted that, even considering the NCP margin as determined by the CIT(A) the NCP margin of the Assessee falls within the +/- 5% arm's length range and no adjustment needs to be made. It was also submitted that actual NCP mark-up earned i.e. 9.55%, by the Assessee falls within the range of 6.02% to 17.18. Thus, in light of proviso to section 92C(2) of the Act, the erroneous upward adjustment as made by the CIT(A), was not called for. In support of the above contention the Ld. A.R furnished the following calculations:- Computation of +/-5% Range as per proviso to Section 92C(2) of the Income Tax

The Ld. AR submitted that the assessee is a foreign based company’s branch and the main company is situated in USA. The AR submitted that Ground No. 1 is covered against the assessee in assessee’s own case for the subsequent assessment years. The AR submitted that only thing in the subsequent year’s decision by the ITAT was that it has not taken into consideration that payment of tournament fee and players welfare contribution are two different aspects and players welfare contribution cannot be treated as the fees. Thus, the said amount should be exempted from the tax purview. In fact the US entities are tax exempted association.

As relates to Ground No. 2, the assessee relied upon the decision of the I.T.A.T Hyderabad in the case of HSBC Electronic Data Processing India Ltd. Vs. Add. CIT 2(2) reported at TS-174-ITAT-2013 (Hyd.) wherein the re- imbursement issue was decided in favour of the assessee. The assessee relied upon the decision of ACIT, Circle 3(1), New Delhi Vs. City Financial Consumer Finance India Ltd. in & 6305/Del/2012, order dated 17/08/2015, wherein the ITAT has held that if the ALP falls within the range of +/- 5% of the range then no addition should be made.

The Ld. DR relied upon the order of the Assessing Officer. The Ld. DR also pointed out that there was an additional evidence furnished by the assessee and the CIT(A) should have not considered the same. As regards to re-imbursement of expenses, the Ld. DR relied upon the CIT(A)’s order as well as Assessing Officer’s order.

We have perused all the records and heard both the parties Ground No. 1 in assessee’s appeal is already covered by the ITAT Delhi Bench in assessee’s own case for the subsequent years i.e A.Y’s 2006-07 to 2009-10 in & 525/Del/2011 and 686 & 687/Del/2013 respectively wherein it has been held in Para 11 of the order dated 25/3/2015 as under:-

As related to Ground No. 2, the reimbursement costs has to be excluded as the same do not involve any functions to be performed so as to consider it for profitability purposes. Thus we direct AO/TPO to exclude reimbursement costs while working out the operating costs. Besides the said issue is decided in case of M/s. HSBC Electronic Data Processing India Ltd. Vs. Addl. CIT [ITA No. 1624/HYD/2010 decision dated 28.06.2013 Hyd. (Tri.)] in favour of the assessee and the facts of the assessee’s case are similar to that of HSBC Electronic Data Processing India Ltd. (Supra). Hence, Ground No. 2 of the assessee’s appeal is allowed.

As relates to Ground No. 3, the directions given in case of ACIT vs. M/s. Citi Financial Consumer Finance India Ltd. [ITA No. 2848/DEL/2012 decision dated 17.08.2015 Del. (Tri.)] has to be followed wherein it has been held that if the Arms Length Price comes within the range of +/ - 5% of the range then no addition has to be made. We have considered the submissions of both the parties and carefully gone through the material available on the record. In the present case, it appears that the grievance of the department only relates to the exclusion of Mega Soft Ltd. as comparable and inclusion of Orient Information Technology Ltd. in the set of comparables. As regards to the inclusion of Orient Information Technology Ltd. is concerned, the TPO had not given any particular reason for its exclusion. The said company also designs, develops and deploys customized software solution and application, so its functionality was comparable with the assessee. The said company was not considered by the TPO because it was a loss making company but that cannot be a reason to exclude it from the set of comparable, in view of the decision of the ITAT Delhi Bench in the case of Yum Restaurants India Ltd. in wherein it has been held that merely a company showing loss would not lose its status of comparable if other criteria depicted status of comparable. Same view has been taken by the ITAT Delhi Bench in the case of Sony India Ltd. reported at 114 ITD 448. Thus this issue is remanded back to the Assessing Officer for verification of the calculations furnished by the Ld. A.R of the assessee and to be decided afresh in accordance with law.

In result, the appeal is partly allowed for statistical purposes.

The grounds of appeal are as follows:-

The Ld. DR submits that the Assessing Officer has properly taking into account all the relevant material. Thus the Comparables having negative NCP margin for the year 2004 and the relief given to the assessee on the issue of determination of ALP by the CIT(A) is without any application of mind. As regards to Ground No. 2, the Ld. DR submitted that the Assessing Officer has already taken into account all the aspects in consideration and has rightly rejected the contentions of the assessee at the relevant time related to the expenses and allowance of sanctions. As regards to Ground No.3, the Ld. DR submitted that the personal expenses were rightly rejected by the Assessing Officer.

As regards to Ground No. 1, the Ld. AR submitted that the A.O in the assessment order has excluded Concept Marketing & Advertising Ltd from the list of comparables while determining arm’s length mark-up in relation to production/event management services provided by the Respondent assessee to its AEs, on the ground that it is a loss making company. However, the CIT(A) accepted the submission of the Respondent assessee that this comprabale company is not a consistent loss making company and has positive net worth and hence cannot be excluded. The Department is in appeal against the aforesaid decision of the CIT(A). The Ld. AR submitted that the A.O erred in alleging that the comparable company is continuously loss making. It is submitted that Concept Marketing & Advertising Ltd has incurred lossess only in the subject ASSESSMENT YEAR (PB page No. 436 for computation of the margins earned by the comparable company over a period of 3 years). The net worth of the comparable company in the subject A.Y was around 0.93 crores. The inclusion or exclusion of comparable company on the ground that it is a loss making company is contrary to the OECD draft notes on comparability released for public comments on May 10, 2006. The assessee also relied on the decision of the ITAT, Delhi in the case of Sony India (P) Ltd Vs. DCIT (ITA No. 1189/Del/2005, 819/Del/2007 & 820/Del/2007, (2008-TIOL-439-ITAT- DEL).

As regards to Ground No. 2 the Ld. AR submits that during the A.Y 2004-05, the Respondent assessee incurred expenditure under the head ‘sanctions and rights’ in Indian Rupees paid/payable to Indian Residents amounting to INR 1,07,57,455 and to Non-Residents in foreign currency amounting to INR 24,80,983 aggregating to INR 1,32,38,483 (debited to the Profit & Loss account). It was further submitted that the Deputy Director of Income Tax, Circle 1(2), International Taxation, New Delhi (‘the A. O’) in the assessment order disallowed ‘sanctions and rights’ expenses amounting to INR 128,63,376, out of the total expenditure of INR 1,32,38,483, under section 40(a) (i) of the Act for non-deduction of tax at source, wrongly treating the entire expenditure as paid/payable to Non-Residents in foreign currency. It was pointed out that during the course of the assessment proceedings, in reply to the A.O’s query regarding ‘sanctions and rights’ expenses paid in foreign currency and tax deducted at source thereon, the assessee vide letter dated 21 December 2006 submitted the details of INR 54,40,230 which represented the payments in foreign currency to various foreign parties in A.Y 2004-05. While furnishing the above details, inadvertently the details were furnished in respect of amount remitted/paid instead of the amount incurred and debited to the Profit and Loss account during A.Y 2004-05. Secondly, the aforesaid details of INR 54, 40,230 included an amount of INR 10, 92,105 which was incurred in Indian Rupees and payable to Indian Residents. Therefore, the ‘sanctions and rights’ expenses payable to non-residents in foreign currency was only INR 35,73,088 (Reconciliation provided in para 6.5 at Page no.7 of the order of the CIT(A). It was submitted that the AO disallowed INR 1,28,63,376, which is almost the entire expenditure out of the total expenditure of INR 1,32,38,483, under section 40 (a) (i) of the Act, wrongly assuming it to be payable to Non- Residents (which included INR 1,07,57,455 paid/payable to Indian Residents), without giving any further opportunity to the assessee to explain. It was further submitted that during the proceedings before the CIT (A), the assessee submitted the details of ‘sanctions and rights’ expenses incurred in Indian Rupees and a copy of agreement entered into with Shaw Wallace Distilleries Ltd (SWDL) as additional evidence under Rule 46A. The A.O filed his remand report dated 25th June 2009 against the details/additional evidence sent by the Ld. CIT (A) for his comments. The assessee filed the rejoinder dated 14th September 2010 against the aforesaid remand report of the A.O. The CIT(A) after duly considering the remand report of the A.O admitted the additional evidence vide para 7 of his order, which is reproduced as under:

It is submitted that the A.O has never asked/confronted the assessee to reproduce any documentary evidence to substantiate that sanctions and rights incurred in foreign currency were not liable to withholding of taxes, no further opportunity was given to explain the facts/provide supporting documents for the disallowance made by the A.O. It was stated that Rule 46A of the I.T. Rules read along with Section 250(4) of the Act lays down the circumstances under which an assessee may be permitted to produce before the first appellate authority any evidence that was not produced or could not be produced during the course of the proceedings before the A.O. The Ld. A.R furnished a chart in respect of the amounts paid/payable to Non-Residents, the deduction allowed/disallowed as per the order of the CIT (A) is as under:

It was submitted that from the above details it is clear that the assessee submitted the additional evidence only in respect of expenditure in Indian Rupees payable to Indian Residents, which has been allowed by CIT (A) since the provisions of Section 40(a)(i) of the Act do not apply to payments made to Indian Residents.

The Ld. AR further submitted that the A.O has made the disallowance in the assessment order u/s 40(a)(i) of the Act under the heading “Sanctions and rights expenses incurred in foreign currency” (page 2 of the assessment order,). From the assessment order, it is submitted that the A.O has disallowed the expenditure incurred in Indian Rupees payable to Indian Residents also while disallowing the expenditure incurred in foreign currency u/s 40(a)(i) of the Act which deals with disallowances of amount paid to Non-residents without deducting applicable tax at source. Therefore, provisions of Section 40(a)(i) of the Act do not apply in respect of expenditure/amount payable to Indian Residents and thus, these expenses cannot be disallowed u/s 40(a)(i) of the Act. The Ld. AR further submitted that Section 40(a)(i) of the Act relating to disallowance of certain expenditure payable to a resident for non-deduction of tax at source was inserted by the Finance Act, 2004 with effect from 1 April 2005 and is therefore, applicable from A.Y 2005-06. Hence, the provisions of Section 40(a)(i) of the Act do not apply to A.Y 2004-05 which is the assessment year under consideration. Therefore, no disallowance can be made in respect of expenditure incurred in Indian Rupees payable to Indian Resident on allegation of non-deduction of tax at source in respect of A.Y 2004-05 as there was no such enabling provision in the statute. Therefore, the CIT(A) rightly deleted the disallowances in respect of expenditure incurred in Indian Rupees payable to Indian Residents

As regards to Ground No. 3, the Ld. AR submitted that during A.Y 2004- 05, the assessee has grouped various expenses incurred amounting to Rs.82,51,631 under the head miscellaneous expenses in the P &L A/c. The A.O disallowed 20% of the miscellaneous expenses debited to P &L A/c on adhoc basis, stating that the payments/reimbursements made by the assesses to its employees are of personal nature, ignoring the submissions made by the assessee.

It was further submitted that during the A.Y 2004-05, the assessee has not debited any personal expenses relating to its employees. In this regard, reference was also made to clause 17(b) of Form 3CD for the year ended 31st March 2004, wherein it was clearly disclosed that no expense of personal nature had been debited to P &L A/c. It was stated that in the case of a company, such adhoc disallowance cannot be made and that the assessee had a policy for managing the expenses pertaining to credit cards issued to the employees, whereby any expenses incurred by the employees for official purposes, through the credit cards were to settle by them personally. They were entitled to the reimbursement for expenses incurred by them for official purpose by getting suitable approvals and verifications from the respective supervisors/departments. Thus the Ld. AR submitted that the CIT (A) has rightly deleted the adhoc estimated disallowance of miscellaneous expenses, and this ground of the Department appeal is liable to be dismissed.

The Ld. AR refuted all the contentions of the DR and relied in following case laws:-

We have perused all the records and considered submissions of both the parties. The issue relating to proper ALP by taking into negative NCP margin the same is already discussed in assessee’s own case in our findings given there in shall apply with the same force. As regards to Ground No. 2 relating to the additional evidence furnished by the assessee, we are of the view that it was rightly allowed by the CIT (A) under Rule 46A of the Income-tax Rules 1962. In our opinion the Ld.CIT(A) appreciated the facts in right perspective and his findings given in Para 7.2 and 7.3(e) of the impugned order are well reasoned which do not require any interference on our part. As regards to disallowance of personal expenses, we are of the view that the A.O has not given any basis for making the adhoc disallowance. On the contrary the ld, CIT (A) properly appreciated the facts and rightly deleted the disallowance made by the A.O.

In result, the appeal of the Revenue is partly allowed.