SANYO INDIA PRIVATE LIMITED,BANGALORE vs. DCIT, BANGALORE

Appellant By : Shri Chavali Narayan, C.A. Respondent By : Shri Farhat Hussain Qureshi, CIT(D.R) Date of Hearing : 17.03.2015. Date of Pronouncement : 14.5.2015. O R D E R Per Shri Jason P. Boaz, A.M. : This appeal by the assessee is directed against the final order of assessment for Assessment Year 2007-08 under Section 143(3) rws 144C(13) of the Income Tax Act, 1961 (in short 'the Act') dt.29.9.2011, passed in pursuance of the directions of the Dispute Resolution Panel, Bangalore (‘DRP’) issued under Section 144C(5) rws 144C(8) of the Act vide order dt.26.9.2011.

2.2 On receipt of the order of the TPO under Section 92CA(3) of the Act dt.28.10.2010, the Assessing Officer passed a draft order of assessment for Assessment Year 2007-08 under Section 144C(1) of the Act dt.3.12.2010 wherein the assessee's loss was determined at Rs.5,77,18,810 in view of the following adjustments to the returned loss of Rs.20,78,58,970 :- i) Disallowance of Expenditure under the head Advertisement & Rs.5,75,17,222. Publicity : ii) T.P. Adjustment : Rs. 9,26,20,941.

2.3 Aggrieved by the draft order of assessment for Assessment Year 2007-08 dt.3.12.2010, the assessee preferred its objections thereto before the DRP, Bangalore. The DRP issued its directions vide order under Section 144C(5) rws 144C(11) of the Act

3 IT(TP)A No.1195 /Bang/2011 Sanyo India Pvt. Ltd. (A.Y. 2007-08) dt.26.9.2011, confirming the additions / disallowances proposed by the Assessing Officer / TPO. 2.4 On receipt of the directions of the DRP dt.26.9.2011 issued under Section 144C(5) rws 144C(11) of the Act, the Assessing Officer in pursuance thereof, passed the final order of assessment for Assessment Year 2007-08 under Section 143(3) rws 144C(13) of the Act determining the loss of the assessee at Rs.5,77,18,810; incorporating the following additions / disallowances to the returned loss of Rs.20,78,56,970 :- i) Disallowance of Expenditure under the head Advertisement & Rs.5,75,17,222. Publicity : ii) T.P. Adjustment : Rs. 9,26,20,941.

3.1 Aggrieved by the order of assessment for Assessment Year 2007-08 passed under Section 143(3) rws 144C(13) of the Act dt.29.8.2011, the assessee is in appeal before this Tribunal raising the following grounds :-

“ 1. The Deputy Commissioner of Income Tax has grievously erred in completely relying on the Arm’s Length Price difference as determined by the Additional Director of Income Tax(TP)-II(2),Bangalore vide his order dated 28.10.2010 as that was determined on the basis of Transaction Net Margin Method and as approved by the DRP. DRP has totally failed to appreciate the facts of the case in the correct perspective.

2. The addition of Rs.9,26,20,941/- made under Transfer Pricing provisions requires to be deleted as the assessing authority himself has given a clear finding that the advertisement expenditure has given enduring benefit to your assesse to improve its sales and hence it could not have been an item of expenditure which has given benefit to the associated enterprise warranting recovery from other party.

6. Ground II i. The assessing authority has in addition treated a sum of Rs. 8,62,75,833/- out of the sum of Rs. 9,26,20,941/- disallowed as above by the TPO as deferred revenue expenditure even when it is offered to mandatory accounting standard. The Accounting Standard 26 which is a mandatory accounting standard applicable to all companies as prescribed in the Accounting Standard Rules, 2006 has clearly mentioned that advertisement and publicity expenditure is revenue expenditure and is required to be charged off to the profit and loss account of the year in which it is incurred. As the company is following these accounting standards consistently as it is mandatorily required to be followed, disallowance of the same as deferred revenue expenditure is opposed to all principles of accounting standards and cannons of tax laws and hence may be directed to be allowed in full. ii. Para 56 of the Accounting Standard 26 clearly identifies expenditure on advertisement and promotional activities as one of the items which is required to be charged off to the profit and loss account of the year in which it is incurred irrespective of the fact that benefit of such advertisement and promotional activities may accrue in later years also.

5 IT(TP)A No.1195 /Bang/2011 Sanyo India Pvt. Ltd. (A.Y. 2007-08) 7. Without prejudice to our contention that no part of the expenditure is to be considered as deferred revenue expenditure, we wish to submit that the advertisement and publicity expenditure aggregating to Rs.8,62,75,833/- treated as deferred revenue expenditure has been already considered while computing arm’s length price by the TPO. Considering this once again has resulted in a sum of Rs.5,75,17,222/- being disallowed as expenditure although it has already been disallowed as expenditure that ought to have been recovered from the associated enterprise resulting in the same amount being disallowed twice. Once the expenditure is recovered, the net expenditure will be that much lower and hence the amount to be deferred will also be lower to that extent.

8. Under any circumstances, 1/3rd of similar expenditure incurred in the previous year of which 2/3rd was disallowed in that year ought to have been allowed in the draft assessment order to the extent of Rs.1,01,89,785/-. GENERAL GROUND 9. For these and other grounds that maybe adduced at the time of hearing the order of the assessing authority may be modified to the extent appealed against.” 3.2 Subsequently, the assessee vide submissions dt.4.2.2014 filed the following additional grounds of appeal :- “

1. The learned A.O. has erred in law and in facts, by treating the advertisement and publicity expenses amounting to Rs.8,62,75,833 as deferred revenue expenditure by deferring the allowability of the said expense over a period of three years.

2. The learned A.O. has placed incorrect and inappropriate reliance on the judicial precedent in the case of Kedarnath Jute Mfg. Co. Ltd. Vs. CIT (Central), Calcutta (82 ITR 363) (SC) without considering the facts of the case.

3. The learned A.O. has erred in law, by carrying out an arbitrary adjustment on account of advertisement and publicity expense by deferring the expense over a period of three years.

4. The learned A.O. has erred in law and on facts by not appreciating the nature of advertisement and publicity expense while concluding that the advertisement and publicity expenses gives benefit to the petitioner over a period of time.

5. The learned A.O. has erred in law and on facts, by proposing an arbitrary, unscientific and unreasonable period of three years to defer the advertisement and publicity expenses without giving the petitioner an opportunity of being heard, thereby grossly violating the principles of natural justice.

6. The learned A.O. has erred in law and on facts, in disallowing advertisement and publicity expenses amounting to Rs.575,17,222 while passing order under Section 143(3) of the Act even though the same has already been considered by the learned 6 IT(TP)A No.1195 /Bang/2011 Sanyo India Pvt. Ltd. (A.Y. 2007-08) TPO, in making adjustment to the arm’s length price under Section 92CA read with section 92C of the Act.

filed in Form NO.36 may be treated as withdrawn and the additional grounds filed (supra) may be treated as the grounds to be adjudicated. We accordingly treat the original grounds of appeal at S.Nos.1 to 9 (supra), since withdrawn, as infructuous and consequently dismiss the same.

4. Additional Grounds at S.No.1 to 6 : Disallowance of Expenditure under “Advertisement & Publicity”. 4.1 During the year under consideration, the assessee incurred a sum of Rs.8,62,75,833 on various items of expenditure that fall under the head “Advertisement & Publicity”. According to the Assessing Officer, the benefits arising from out of the above expenditure would relate to more than one year and held that 1/3rd of the said expenditure alone could be allowed in the relevant previous year and the remaining 2/3 rd of the said expenditure was to be disallowed. In coming to this conclusion, the Assessing Officer relied on the Guidance Note on Accrual issued by the Institute of Chartered Accountants (ICAI) and the decision of the Hon'ble Apex Court in the case of Kedarnath Jute Manufacturing Ltd. V CIT (1971) 82 ITR 363 (SC). 4.2 Before us, the learned Authorised Representative assailed the order of the Assessing Officer, submitting that the incurring of the said expenditure in the period under consideration was not disputed by the Assessing Officer. It was contended that 8 IT(TP)A No.1195 /Bang/2011 Sanyo India Pvt. Ltd. (A.Y. 2007-08) there was no concept of deferred revenue expenditure under the Income Tax Act, 1961 and that once the expenditure was incurred wholly for the business of the assessee, it had to be allowed, unless it was capital in nature. The learned Authorised Representative further submitted that the co-ordinate bench of this Tribunal, in the assessee's own case for Assessment Year 2008-09 in IT(TP)A No.1022/Bang/2012 dt.17.10.2014, has decided this issue in favour of the assessee and placed a copy of this order before the Bench. The learned Authorised Representative submitted that in view of the aforesaid decision of the co-ordinate bench of this Tribunal, the issue ought to be held in favour of the assessee.

4.3 Per contra, the ld. D.R. relied on the orders of the authorities below.

4.4.1 We have heard the rival contentions and perused and carefully considered the material on record; including the judicial decision placed reliance upon by the assessee. We find that a co-ordinate bench of this Tribunal in the assessee's own case for Assessment Year 2008-09 in IT(TP)A No.1022/Bang/2014 has considered this issue and decided the matter in the assessee's favour at para 6 thereof which is extracted hereunder :- “ 6. We have perused the orders and heard the rival contentions. We find that assessee had in its books of accounts treated the advertisement expenditure as a revenue outgo, in full. Assessee had not attempted any amortization. Audit reports of the assessee for the relevant previous year did not have any qualification in this regard. If the assessee had not followed the matching principles or the relevant accounting standards of the ICAI, necessary comments and qualification would have appeared in the audit reports giving the quantitative effect on the profits. The nature of expenditure does not show any acquisition of capital asset as such. As pointed out by the learned Authorised Representative concept of deferred revenue expenditure is unknown to the income tax act. Wherever it is permitted it is 9 IT(TP)A No.1195 /Bang/2011 Sanyo India Pvt. Ltd. (A.Y. 2007-08) specifically mentioned like section 35DD, 35D and 35DDA. The matching principles of accounting do require matching of expenditure with income. This does not allow an arbitrary estimation of the period for which an assessee would receive the benefit. Hon'ble Allahabad High Court in the case of M/s. Modi Olivetti Limited (supra), had held that charge of tax is exigible only on the real income and once expenditure incurred by the assessee was revenue in nature, it had to be allowed as deduction. Hon'ble Madras High Court in the case of Brilliant Tutorials (P) Ltd. (supra), had held that section 37(1) did not impose any conditions other than those which were explicitly set out therein. The case of the Special Bench of this Tribunal in Mahindra Holidays & Resorts India Pvt. Ltd. (supra), relied on the A.O. was on an entirely different factual scenario. The question there was division of income received in lumpsum at the time of issuing time share membership, and was not related to any expenditure claimed by the assessee. We are, therefore, of the opinion that this decision of Special Bench would not further the stand taken by the revenue. The disallowance of advertisement & publicity expenses was not called for. Such disallowance stands deleted.” 4.4.2 As the issue and the facts under consideration in the present appeal are the same as those considered by the co-ordinate bench in the assessee's own case for Assessment Year 2008-09 (supra), we hold that the disallowance of advertisement & publicity expenditure amounting to Rs.5,75,17,222 was not called for. We, therefore, delete the said disallowance made. Consequently, additional grounds raised at S.No.1 to 6 are allowed. TRANSFER PRICING ADJUSTMENT 5.1 In the course of proceedings before the TPO, it was ascertained that the assessee had incurred the following expenditure on selling expenses and Advertisement & Publicity Expenses (‘AMP’) :- Selling Expenses Rs.1,43,27,887 Advt. & Publicity Expenses Rs.8,62,75,832 Reimbursement of Advt. Expenses. Rs.2,27,55,265 Total : Rs.123,358,984

10 IT(TP)A No.1195 /Bang/2011 Sanyo India Pvt. Ltd. (A.Y. 2007-08) 5.2 According to the TPO, the selling expenses and the expenditure on Advertisement and Publicity were incurred to create brand awareness and were creating marketing intangibles to promote the brand name “Sanyo” thereby increasing the sale of “Sanyo” products. After issuing the assessee show cause notice and considering its submissions thereto, the TPO held that the assessee had rendered intra group services to its Associated Enterprises (‘AEs’) which require remuneration at Arm’s Length. After applying the ‘Bright Line Test’, the TPO determined the mark up @ 12% and computed the TP Adjustment as under : Rs. Expenditure on AMP 123,358,984 Value of Gross Sales 539,642,279 AMP/Sales of the assessee 22.86% Arm’s Length AMP % (Brightline) 3.77% Brightline AMP expenditure 20,344,514 Excessive AMP expenditure 103,014,470 Excessive AMP expenditure with a mark-up (12%) 115,376,206 Reimbursement received 22,755,265 TP adjustment (reimbursement that should have 92,620,941 been reimbursed) Accordingly, the TPO passed the order under Section 92CA(3) of the Act proposing the above adjustment of Rs.9,26,20,941. On confirmation of the same by the DRP, the Assessing Officer passed the order of assessment, incorporating the above adjustment in computing the income/loss of the assessee.

5.3 Before us, the assessee reiterated the contention put forth before the authorities below that there is no transaction involved; leave alone any international transactions, as 11 IT(TP)A No.1195 /Bang/2011 Sanyo India Pvt. Ltd. (A.Y. 2007-08) there is no understanding for promoting the brand of the AEs. It is contended that the objective of incurring AMP expenses is to increase the sales in India and cannot be construed as brand building for the AEs. It was further submitted that the TPO had erred in applying the ‘Bright Line Test’ as a method to bench mark the marketing expenditure, as it does not fall under any of the prescribed methods in Indian T.P. regulations. It was further submitted that the sales expenses are purely for sales activity like AMC charges, dealer conference expenses, dealer commission and exhibition expenses, etc. and are not in the nature of sales promotion and therefore should not have been considered for the purpose of making the adjustment.

5.4 Per contra, the learned Departmental Representative placed reliance on the decision of the Hon'ble Special Bench of the ITAT, New Delhi in the case of L.G. Electronics India Pvt. Ltd. in of Jan., 2013 and submitted that there is a transaction between the assessee and the foreign AE for the promotion of the brand in India, which is owned by the assessee. The learned Departmental Representative submitted that in this view of the matter, the assessee's appeal on this issue ought to be dismissed.

5.5.1 We have heard the rival contentions and perused and carefully considered the material on record in respect of this issue; including the judicial decisions cited. The issue of AMP expenditure as “international transaction” was considered by the Special Bench of the ITAT, Delhi in the case of L.G. Electronics India Pvt. Ltd. in ITA No.5140/Del/2011. The majority judgement in the case of L.G. Electronics India Pvt. Ltd. (supra) has decided

12 IT(TP)A No.1195 /Bang/2011 Sanyo India Pvt. Ltd. (A.Y. 2007-08) the issue against the assessee by holding it to be “international transaction”. On the question of nature and scope of AMP expenses, it was held that the sale related expenses i.e. trade discount, volume rebate, cash discount, commissions, etc. should be excluded while computing the T.P. Adjustment.

5.5.2 The issue of AMP expenditure was carried in appeal before the Hon'ble Delhi High Court in the case of Sony Ericcson Mobile Communications India Pvt. Ltd. in and others. It was held by the Hon'ble High Court of Delhi that AMP expenses incurred by the assessee in India can be treated and categorized as an international transaction under Section 92B of the Act. The relevant portion of the order at paras 56 & 57 thereof is extracted hereunder :-

“ 56. Chapter X of the Act being a specific statutory provision has to be given effect to and in view of the said provisions arm‘s length price can be determined. The arm‘s length procedure prescribed in Chapter X, once applicable has to be given full application. Impact of Chapter X of the Act cannot be controlled or curtailed by reference to the allowability of expenditure under Section 37(1) of the Act. As noticed above and subsequently, provisions of Chapter X are applicable to international transactions between two related enterprises. The purpose of determination of arm‘s length price is to find out the fair and true market value of the transaction and accordingly the adjustment, if required, is made. The said exercise has its own object and purpose.

“ 127. We agree and accept the position in the portion reproduced above in bold and italics. The object and purpose of Transfer Pricing adjustment is to ensure that the controlled taxpayers are given tax parity with uncontrolled taxpayers by determining their true taxable income. There should be adequate and proper compensation for the functions performed including AMP

13 IT(TP)A No.1195 /Bang/2011 Sanyo India Pvt. Ltd. (A.Y. 2007-08) expenses. Thus, 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 ‗bright line test‘ of non-comparables and in all case, costs or compensation paid for AMP expenses would be ‗NIL‘, or at best would mean the amount or compensation expressly paid for AMP expenses. 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).”

135. It is, therefore, incorrect to suggest or observe that international tax jurisprudence or commentaries recognise ―bright line test‖ for bifurca�on of rou�ne and non-routine AMP expenditure, and non-routine AMP expenses is an independent international transaction which should be separately subjected to arm‘s length pricing.

5.5.4 The Hon'ble High Court in its order (supra) has given a gist of the findings made in the same order, observing as under :-

“ (i) In case of a distributor and marketing AE, the first step in transfer pricing is to ascertain and conduct detailed functional analysis, which would include AMP function/expenses.

(ii) The second step mandates ascertainment of comparables or comparable analysis. This would have reference to the method adopted which matches the functions and obligations performed by the tested party including AMP expenses.

(iii) A comparable is acceptable, if based upon comparison of conditions a controlled transaction is similar with the conditions in the transactions between independent enterprises. In other words, the economically relevant characteristics of the two transactions being compared must be sufficiently comparable. This entails and implies that difference, if any, between controlled and uncontrolled transaction, should not materially affect the conditions being examined given the methodology being adopted for determining the price or the margin. When this is not possible, it should be ascertained whether reasonably accurate adjustments can be made to eliminate the effect of such differences on the price or margin. Thus, identification of the potential comparables is the key to the transfer pricing analysis. As a sequitur, it follows that the choice of the most appropriate method would be dependent upon availability of potential comparable keeping in mind the comparability analysis including befitting adjustments which may be required. As the degree of the comparability increases, extent of potential differences which would render the analysis inaccurate necessarily decreases.

(iv) The assessed, i.e. the domestic AE must be compensated for the AMP expenses by the foreign AE. Such compensation may be included or subsumed in low purchase price or by not charging or charging lower royalty. Direct compensation can also be paid. The method selected and comparability analysis should be appropriated and reliable so as to include the AMP functions and costs.

(v) Where the Assessing Officer/TPO accepts the comparables adopted by the assessed, with or without making adjustments, as a bundled transaction, it would be illogical and improper to treat AMP expenses as a separate international transaction, for the simple reason that if the 14 IT(TP)A No.1195 /Bang/2011 Sanyo India Pvt. Ltd. (A.Y. 2007-08) functions performed by the tested parties and the comparables match, with or without adjustments, AMP expenses are duly accounted for. It would be incongruous to accept the comparables and determine or accept the transfer price and still segregate AMP expenses as an international transaction.

(vi) The Assessing Officer/TPO can reject a method selected by the assessed for several reasons including want of reliability in the factual matrix or lack / non-availability of comparables. (see Section 92C(3) of the Act).

(vii) When the Assessing Officer/TPO rejects the method adopted by the assessed, he is entitled to select the most appropriate method, and undertake comparability analysis. Selection of the method and comparables should be as per the command and directive of the Act and Rules and justified by giving reasons.

(viii) Distribution and marketing are inter-connected and intertwined functions. Bunching of inter-connected and continuous transactions is permissible, provided the said transactions can be evaluated and adequately compared on aggregate basis. This would depend on the method adopted and comparability analysis and the most reliable means of determining arm‘s length price.

(ix) To assert and profess that brand building as equivalent or substantial attribute of advertisement and sale promotion would be largely incorrect. It represents a coordinated synerge�c impact created by assortment largely represen�ng reputa�on and quality. ―Brand‖ has reference to a name, trademark or trade name and like ‘goodwill‘ is a value of attraction to customers arising from name and a reputation for skill, integrity, efficient business management or efficient service. Brand creation and value, therefore, depends upon a great number of facts relevant for a particular business. It reflects the reputation which the proprietor of the brand has gathered over a passage or period of time in the form of widespread popularity and universal approval and acceptance in the eyes of the customer. Brand value depends upon the nature and quality of goods and services sold or dealt with. Quality control being the most important element, which can mar or enhance the value.

(x) Parameters specified in paragraph 17.4 of the order dated 23rd January, 2013 in the case of L.G. Electronics India Pvt Ltd (supra) are not binding on the assessed 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 ‘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 AMP expenses. It would be conspicuously wrong and incorrect to treat the segregated transactional value as ‘NIL‘ when in fact the two AEs 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 AMP expenses.

15 IT(TP)A No.1195 /Bang/2011 Sanyo India Pvt. Ltd. (A.Y. 2007-08) (xi) The Assessing Officer/TPO for good and sufficient reasons can debundle interconnected transactions, i.e. segregate distribution, marketing or AMP transactions. This may be necessary when bundled transactions cannot be adequately compared on aggregate basis.

(xii) When segmentation or segregation of a bundled transaction is required, the question of set off and apportionment must be examined realistically and with a pragmatic approach. Transfer pricing is an income allocating exercise to prevent artificial shifting of net incomes of controlled taxpayers and to place them on parity with uncontrolled, unrelated taxpayers. The exercise undertaken should not result in over or double taxation. Thus, the Assessing Officer/TPO can segregate AMP expenses as an independent international transaction, but only after elucidating grounds and reasons for not accepting the bunching adopted by the assessed, and examining and giving benefit of set off. Section 92(3) does not bar or prohibit set off.

(xiii) CP Method is a recognised and accepted method under Indian transfer pricing regulation. It can be applied by the Assessing Officer/TPO in case AMP expenses are treated as a separate international transaction, provided CP Method is the most appropriate and reliable method. Adoption of CP Method and computation of cost and gross profit margin comparable must be justified.

(xiv) The object and purpose of Transfer Pricing adjustment is to ensure that the controlled taxpayers are given tax parity with uncontrolled taxpayers by determining their true taxable income. Costs or expenses incurred for services provided or in respect of property transferred, when made subject matter of arm‘s length price by applying CP Method, cannot be again factored or included as a part of interconnected international transaction and subjected to arm‘s length pricing.” 5.5.5 Respectfully following the decision of the Hon'ble High Court of Delhi in the case of Sony Erickson Mobile Communications India P. Ltd. (supra), we hold that AMP expenditure is an international transaction liable to be covered under Transfer Pricing provisions of the Act and IT Rules, 1962 in this regard. We are, however, of the view that the issue of computing the T.P. Adjustment has to be examined de novo by the TPO in the light of the detailed clarifications and observations rendered by the Hon'ble Delhi High Court in its order (supra). In this view of the matter, we deem it appropriate to remand the issue back to the file of Assessing Officer / TPO for fresh consideration in the light of the above observations of the Hon'ble High Court of Delhi and adjudicate the issue in 16 IT(TP)A No.1195 /Bang/2011 Sanyo India Pvt. Ltd. (A.Y. 2007-08) accordance with law and after affording the assessee adequate opportunity of being heard and to file details / submissions required. It is ordered accordingly. Consequently, the additional grounds raised at S.Nos.7 to 13 are treated as allowed for statistical purposes.

Order pronounced in the open court on 14th May, 2015.