DISCOVERY COMMUNICATIONS INDIA,NEW DELHI vs. DCIT, NEW DELHI

IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCHES : I-1 : NEW DELHI

BEFORE SHRI R.S. SYAL, AM & SHRI KULDIP SINGH, JM

ITA No.5490/Del/2012 Assessment Year : 2008-09

Discovery Communications India, Vs. DCIT, 9/1B, Secular House, Circle 10(1), Room Qutab Institutional Area, No.406, CR Building, Aruna Asaf Ali Marg, New Delhi. New Delhi. PAN: AAACD4746K (Appellant) (Respondent)

Assessee By : Shri Manoj Pardasani, CA Department By : Shri Amrendra Kumar, CIT, DR

Date of Hearing : 02.12.2015 Date of Pronouncement : 03.12.2015

ORDER PER R.S. SYAL, AM: This appeal by the assessee is directed against the final order passed by the Assessing Officer (AO) u/s 144C read with Section 143(3)

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of the Income-tax Act, 1961 (hereinafter also called ‘the Act’) in relation

to the assessment year 2008-09.

Rs.12,15,11,974/- on account of transfer pricing adjustment of

advertisement, marketing and promotion (AMP) expenses.

Tribunal vide its order dated 13.9.2013 restoring the computation of

ALP of AMP expenses to the TPO to be decided in accordance with the

Special Bench decision in the case of LG Electronics India (P) Ltd. vs.

ACIT (2013) 152 TTJ 273 (Del) (SB). The assessee appealed against the

Tribunal order. The Hon’ble jurisdictional High Court has disposed of

the assessee’s appeal in a batch of appeals with the leading order in Sony

Ericson Mobile Communication India (P) Ltd. vs. CIT (2015) 374 ITR

118 (Del) restoring the matter to the Tribunal for a fresh decision in

terms of the guidelines laid down by their Lordships in this judgment.

That is how this appeal has come up for a fresh consideration before us.

ITA No.5490/Del/2012

subsidiary of Discovery Channel (Mauritius) Pvt. Ltd. with Discovery

Communication Inc., USA as the parent company of this group. The

assessee is engaged in the distribution of Discovery Channel, Discovery

Travel and Living Channel and Animal Planet Channel in India region

and also sale of advertisement inventory on the channels. The assessee

reported three international transactions which have been enlisted on

page 2 of the order passed by the Transfer Pricing Officer (TPO). The

assessee employed Transactional Net Margin Method (TNMM) as the

most appropriate method for demonstrating that its international

transactions were at arm’s length price (ALP). On a reference made by

the AO for determining the ALP of the international transactions, the

TPO accepted the reported international transactions at ALP. He,

however, observed that the assessee incurred AMP expenses to the tune

of Rs.20,54,57,391/-. For determining the ALP of the international

transaction of AMP expenses, he chose certain companies as

comparables. By applying the bright line test, he worked out non-routine

expenses incurred for developing intangibles in excess of bright line at 3

ITA No.5490/Del/2012

Rs.10,56,62,586/-. Adding the mark up of 15%, he worked out a

transfer pricing adjustment of Rs.12,15,11,974/-. The assessee remained

unsuccessful before the Dispute Resolution Panel (DRP). Eventually,

the AO, vide his final order, made an addition of Rs.12.15 crore and odd

on this issue. The assessee is aggrieved against this addition.

material on record. Special Bench of the Tribunal in the case of LG

Electronics India Pvt. Ltd. Vs. ACIT (supra), by its majority decision

held, inter alia, that AMP is a transaction and also an international

transaction within the meaning of section 92B of the Act and that the

TPO has jurisdiction to compute the ALP of this international

transaction despite the same not having been specifically referred to by

the AO. On the question of determination of the ALP of this

international transaction, the Special bench approved the application of

bright line test for working out the amount of non-routine AMP

expenses and held that the ALP of AMP expenses should be determined

on Cost plus method by treating AMP transaction as a separate and

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distinct from other international transactions. It was further held that the

selling expenses directly incurred in connection with the sales do not

lead to brand promotion and hence should not be brought within the

ambit of AMP expenses. The Special bench laid down certain

parameters to be taken into consideration for determining the ALP of

AMP expenses. In the ultimate analysis, the matter was sent back to the

TPO for undertaking the exercise afresh in the light of its directions.

cases involving AMP expenses, restoring the matter to the file of

AO/TPO for deciding this issue in conformity with the directions given

by the Special Bench in LG Electronics (supra). Several assessees as

well as the Revenue preferred their respective appeals before the

Hon’ble High Courts against the tribunal orders following the Special

bench order. A batch of such appeals, also including the case of the

assessee for the year under consideration, led by Sony Ericson Mobile

Communications India Pvt. Ltd. Vs. CIT (supra) has been disposed of

by Their Lordships of the Hon’ble Delhi High Court, upholding the

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majority view of Special Bench in LG Electronics (supra) treating AMP

as an international transaction and also conferring jurisdiction in the

TPO to determine the ALP of the international transaction of AMP

expenses. The Hon’ble High Court has held, inter alia, that the

international transaction of AMP expenses should be bundled or

aggregated with other international transaction carried out by the

assessee as a distributor, who either simply acts an agent of

manufacturer or purchases goods from the manufacturer for resale at his

own account. However, in the case of a manufacturer, the import of raw

material has been held to be an independent transaction of marketing and

distribution. In the case of a distributor, the Hon’ble High Court held

that where TNMM has been applied as the most appropriate method,

which method has not been disturbed by the TPO, then, the international

transactions of AMP and distribution activities should be clubbed. It

further held that for determining the ALP of such transactions under a

combined approach, only such comparables should be chosen which

conform to the AMP functions and other distribution functions

conducted by the assessee. If there is some difference in the functions 6

ITA No.5490/Del/2012

under these international transactions, including that of AMP, between

the assessee and the comparables, then, suitable adjustment should be

made to bring both the transactions at par. If probable comparables are

not performing similar functions as done by the assessee and no

adjustment is possible for bringing the international transactions of the

assessee in an aggregate manner at par with those undertaken by the

comparables, then, segregation should be done and the international

transaction of AMP spend should be separately processed under the

transfer pricing provisions for the purposes of determining its ALP

separately. In such determination of ALP of AMP expenses in a

segregated manner, proper set off on account of excess purchase price

adjustment should be allowed. The view taken by the Tribunal in

segregating routine and non-routine expenses on the basis of bright line

test has been set aside by the Hon’ble High Court. The view taken by

the Special Bench that the expenses concerned with the sales, such as,

rebates and discounts etc., should be excluded from the ambit of AMP

expenses, has been upheld.

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� AMP expense is an international transaction [Paras 52 & 53 of the judgment] ; � The TPO has jurisdiction to determine the ALP of the international transaction of AMP expenses [Para 50 of the judgment]; � Inter-connected international transactions can be aggregated and section 92(3) does not prohibit the set-off [Paras 80 & 81]; � AMP is a separate function. An external comparable should perform similar AMP functions. [Paras 165 &166] ; � Bright line test cannot be applied to work out non-routine AMP expenses for benchmarking [Para 194(x)]; � ALP of AMP expenses should be determined preferably in a bundled manner with the distribution activity [Paras 91, 121 & others] ;

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� For determining the ALP of these transactions in a bundled manner, suitable comparables having undertaken similar activities of distribution of the products and also incurring of AMP expenses, should be chosen [Paras 194(i), (ii), (viii) & others]; � The choice of comparables cannot be restricted only to domestic companies using any foreign brand [Para 120] ; � If no comparables having performed both the functions in a similar manner are available, then, suitable adjustment should be made to bring international transactions and comparable transactions at par [Para 194 (iii)] ; � If adjustment is not possible or comparable is not available, then, the TNMM on entity level should not be applied [Paras 100, 121, 194(iii) & (vi)] ; � In the above eventuality, international transaction of AMP should be viewed in a de-bundled manner or separately [Paras 121& 194(xi)] ;

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� In separately determining the ALP of AMP expenses, the TPO is

free to choose any other suitable method including Cost plus method [Para 194(xiii)]; � In so making a TP adjustment on account of AMP expenses, a

proper set off/purchase price adjustment should be allowed from the other transaction of distribution of the products [Para 93] ; � Selling expenses cannot be considered as part of AMP expenses [Paras 175 & 176 of the judgment].

of the Hon’ble jurisdictional High Court, let us examine the contention

put forth by the ld. AR in support of the deletion of addition.

Manufacturer. It was however admitted that considering the totality of

the nature of business, the assessee is more akin to that of a Distributor rather than a Manufacturer. The Hon’ble High Court has dealt with the

case of the assessee in a group of cases who are either distributors or

ITA No.5490/Del/2012

manufacturers. There is no separate discussion qua the assessee in the

judgment on the determination of the ALP of AMP expenses. This

shows that the assessee has not been considered by the Hon’ble High

Court as belonging to a separate class other than a Distributor or a

Manufacturer. Since the ld. AR has admitted that out of these two

options, it is more close to a `Distributor’, we are proceeding

accordingly by classifying it as a Distributor.

appropriate method. Since the profit margin declared by the assessee

was favourably comparable with the average margin of the comparables,

which fact has not been disputed by the TPO, then, no adjustment should

be made on account of AMP expenses because such expenses stand

subsumed in the overall operating profit. This was countered by the ld.

DR with reference to certain paras of the judgment in Sony Ericsson

(supra) not permitting the acceptance of such a wide proposition.

assessee for deletion of the addition towards AMP expenses on the plain

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logic of the assessee’s profit margin matching with those of

comparables. There is a basic fallacy in the argument of the ld. AR. It

is pertinent to note that the TPO examined and got satisfied with the

assessee’s profit margin vis-à-vis the comparables only qua the

international transactions of distribution function. He determined the

ALP of AMP expenses by applying bright line test and in this process

simply compared the quantitative figures of AMP expenses incurred by

the assessee and comparables for working out the non-routine expenses.

He did not examine the AMP functions carried out by the assessee and

the comparables. As the bright line test primarily concentrates on the

quantitative aspects of the AMP expenses alone, it overlooks the

examination of the AMP functions carried out by the assessee on one

hand and the comparables on the other. Now, the Hon’ble High Court in

Sony Ericson Mobile (supra) has held that AMP expense is a separate

international transaction and also bright line test is not applicable for

determining the ALP of AMP expenses. The manner for the

determination of the ALP of the distribution activity and AMP activity

has also been set out by the Hon’ble High Court to be conducted, firstly, 12

ITA No.5490/Del/2012

in a bundled manner by considering the distribution and AMP functions

performed by the assessee as well as the probable comparables, and if

probable comparables having performed both the functions are not

available, then to determine the ALP of AMP expenses in a segregated

manner. As such, it becomes immensely important to separately examine

the Distribution and AMP functions undertaken by the assessee as well

as probable comparables. It is vital to highlight the difference between

the AMP expenses and AMP functions. Whereas the AMP functions are

the means by which the AMP activity is performed, the AMP expenses

are the amount spent on the performance of such means (functions). To

put it simply, an examination of AMP functions carried out by the

assessee and the probable comparables is sine qua non in the process of

determination of the ALP of the international transaction of AMP spend,

either in a segregate or an aggregate manner. What Their Lordships have

held is to bundle the Distribution activity with the AMP activity, being

two separate but connected international transactions, for the purposes of

determination of the ALP of both these international transactions in a

combined manner. The argument of the ld. AR, if taken to a logical 13

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conclusion, will make the AMP spend as a non-international transaction,

which, in our considered opinion, is not appropriate. Once AMP

expense has been held to be an international transaction, it is, but,

natural that the functions performed by the assessee under such a

transaction need to be compared with similar functions performed by a

comparable case. If AMP functions performed by the assessee turn out

to be different from those performed by a probable comparable

company, then, an adjustment is required to be made so as to bring the

AMP functions performed by the assessee as well as the comparable, at

the same pedestal. If we concur with the contention of the ld. AR that

the addition on account transfer pricing adjustment of AMP expenses be

deleted without any examination of the AMP functions carried out by

the assessee as well as comparables, this will amount to snatching away

the tag of international transaction from AMP expenses, assigned by the

Hon’ble High Court. What Their Lordships have held in the judgment is

that the Distribution activity and AMP expenses are two separate but

related international transactions. It is only for the purposes of

determining their ALP that these two should be aggregated. The process 14

ITA No.5490/Del/2012

of such aggregation does not take away the separate character of the

AMP transaction, albeit related. An analysis and examination of the

Distribution and AMP functions carried out by the assessee must be

necessarily done in the first instance, which should be then compared

with similar functions performed by some probable comparables. If the

Distribution and AMP functions performed by the assessee turn out to be

different from those performed by probable comparables, then, a

suitable adjustment should be made to the profits of the comparable so

as to balance the effect of such differences. If however differences exist

in such functions, but no adjustment can be made, then, such probable

comparable should be dropped from the list of comparables. If, in doing

this exercise, there remains no company doing comparable distribution

and AMP functions, then, both the international transactions are required

to be segregated and then examined on individual basis by finding out

probable comparables doing such separate functions similarly. For the

international transaction of AMP spend, this can be done by, firstly,

seeing the AMP functions actually performed by the assessee and then

comparing it with the AMP functions performed by a probable 15

ITA No.5490/Del/2012

comparable. If both are found out to be similar, then the matter ends and

a comparable is found and one can go ahead with determining the ALP

of such a transaction. If the AMP functions performed by the two

entities are found to be different, then adjustment is required to be made

in the case of a probable comparable, so as to make it uniform with the

assessee. The assessee may have possibly done, say, four different AMP

functions as against the probable comparable having done, say, only

three. In such a scenario, again the adjustment will be warranted. In

another situation, the AMP functions performed by the assessee and

probable comparable may be similar but with varying standards, which

will also call for an adjustment. Crux of the matter is that the AMP

functions performed by the assessee must be similar to those done by the

comparable, in the same manner as such functions are compared in any

other international transaction. However, in computing ALP of AMP

spend, the adjustment or set off, if any, available from the Distribution

function, should be made. The essence of the judgment in the case of

Sony Ericson Mobile (supra) is that the two international transactions of

Distribution and AMP should be examined on the touchstone of transfer 16

ITA No.5490/Del/2012

pricing provisions, but on an aggregate basis. Determining the ALP of

two transactions in an aggregate manner postulates making a comparison

of both the functions of Distribution and AMP carried out by the

assessee with the comparables, so that surplus from the distribution

activity could be adjusted against the deficit in the AMP activity. The

Hon’ble High Court has no where laid down that the AMP functions

performed by the assessee should not be compared with those performed

by the comparable parties. On the contrary, it turned down the

contention raised by the ld. AR urging for not treating AMP as a

separate function, which is apparent from the extraction from para 165

of the judgment : `On behalf of the assessee, it was initially argued that

the TPO cannot account for or treat AMP as a function. This argument

on behalf of the assessee is flawed and fallacious for several reasons.

There are inherent flaws in the said argument’. It held vide para 165 of

the judgment that : `An external comparable should perform similar

AMP functions.’ Thus it is manifest that comparison of AMP functions

is vital which cannot be dispensed with. Let us we go a step further with

the alternative prescription of the judgment that if ALP of both the 17

ITA No.5490/Del/2012

transactions of Distribution and AMP cannot be determined in a

combined manner, then the ALP of AMP function should be separately

done. The submission advanced by the assessee of considering the

profit on an entity level without making comparison of AMP functions

done by the assessee as well as the comparable, will render this

alternative approach incapable of compliance. Canvassing such a view

amounts to treating AMP spend as a non-international transaction, which

is patently incapable of acceptance.

accepted TNMM as the most appropriate method and did not make any

TP adjustment on account of the reported international transactions

carried out by the assessee during the course of its business. He,

however, espoused the AMP expense as a separate and distinct item.

Treating the AMP spend as a separate international transaction, he

applied the Cost plus method and proposed the extant adjustment. In

doing so, he segregated routine AMP expenses incurred by the assessee

for his business from the non-routine AMP expenses by treating such

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non-routine AMP expenses leading to the creation of marketing

intangible for its AE. This bifurcation of total AMP expenses was done

by applying bright line test. It is obvious that in the entire exercise

carried out by the TPO, he proceeded on an altogether different line in

examining the quantum of AMP expense for determining the value of

the international transaction of AMP, without looking at the AMP

functions carried out by the assessee and the comparables. Distinct

examination of AMP functions does not find place in this method of

computing the value or the ALP of AMP spend. Now, when we look at

the ratio laid down by the Hon’ble jurisdictional High Court, it becomes

crystal clear that the approach adopted by the TPO for determining ALP

of AMP expenses has been rendered incorrect. However, the fact

remains that as per the verdict of the Hon’ble High Court, the AMP

spend is an international transaction, which is required to be processed

under Chapter X of the Act by taking into account the AMP functions

performed by the assessee and then comparing such functions with those

performed by comparable entities, though, firstly in a combined manner

with the distribution functions. We find no reference to the AMP 19

ITA No.5490/Del/2012

functions carried out by the assessee in the order of the TPO. As such,

there can be no question of making any comparison of the assessee’s

AMP functions with those of the comparables. Going by the ratio in the

case of Sony Ericson Mobile (supra), it is mandatory to make a

comparison of the AMP functions performed by the assessee and

comparables and then making an adjustment, if any, due to differences

between the two, so that the AMP functions performed by the assessee

and comparable are brought to a similar platform. In fact, this is also the

prescription of Rule 10B(1)(e), which provides as under :-

` (e) transactional net margin method, by which,— (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base ; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base ; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market ; 20

ITA No.5490/Del/2012

(iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii) ; (v) the net profit margin thus established is then taken into account to arrive at an arm’s length price in relation to the international transaction.’

margin under a comparable uncontrolled transaction as determined

under sub-clause (ii) should be: “adjusted to take into account the

differences, if any, between the international transaction and the

comparable uncontrolled transactions.” It is only such adjusted net

profit margin in sub-clause (iii) of Rule 10B(1)(e) which is compared

with the net profit margin realized by the assessee as per the mandate of

sub-clause (iv) of Rule 10B(1)(e).

rule (1)’, the comparability of an international transaction with an

uncontrolled transaction shall be judged with reference to the following,

namely — (a) the specific characteristics of the property transferred or

services provided in either transaction ; (b) the functions

ITA No.5490/Del/2012

performed, taking into account assets employed or to be employed and

the risks assumed, by the respective parties to the transactions ; (c)

the contractual terms (whether or not such terms are formal or in

writing) of the transactions which lay down explicitly or implicitly how

the responsibilities, risks and benefits are to be divided between the

respective parties to the transactions ; (d) conditions prevailing in the

markets in which the respective parties to the transactions operate,

including the geographical location and size of the markets, the laws and

Government orders in force, costs of labour and capital in the markets,

overall economic development and level of competition and whether the

markets are wholesale or retail. Sub-rule (3) of Rule 10B stipulates that

an uncontrolled transaction shall be comparable to an international

transaction if (i) none of the differences, if any, between the

transactions being compared, or between the enterprises entering into

such transactions are likely to materially affect the price or cost charged

or paid in, or the profit arising from, such transactions in the open

market ; or (ii) reasonably accurate adjustments can be made to

eliminate the material effects of such differences. 22

ITA No.5490/Del/2012

10B, it becomes palpable that the international transaction and the

uncontrolled transaction with which comparison is sought to be made for

determining the ALP, in the first instance, must have overall similar

characteristics. It is vivid that if the goods/services are different, then

no effective comparison can be made. Once the goods/services under

both the transactions are broadly similar but there is a difference in them

because of certain specific characteristics; and/or the products/services

in both the transactions are identical, but still there are certain

differences due to the contractual terms or the geographical location,

etc., then, a reasonably accurate adjustment should be made for

eliminating the material effects of such differences so as to bring the

international transaction and the comparable uncontrolled transaction on

the same podium. If due to one reason or the other, no reasonable

accurate adjustment can be made due to such differences, then, such

uncontrolled transaction should not be considered as a comparable

transaction.

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harmony with the ratio of the judgment in the case of Sony Ericson

Mobile (supra), to the effect that the AMP functions carried out by the

assessee are required to be necessarily compared with the AMP

functions carried out by a comparable entity in determining the AMP of

ALP expenses. Difference between the functions, if capable of

adjustment, should be given effect to in the profit rate of the comparable

and if such difference cannot be given effect to, then, the probable

comparable should be eliminated from the list of comparables. Going

further, if no proper comparable survives, then the TNMM should be

discarded and an alternative method, may be, Cost plus or any other

suitable method be applied for determining the ALP of AMP expenses.

AMP functions are two separate international activities, which need to

be compared with uncontrolled transactions. Because of their inter-

twinning, it is only for the purposes of determining their ALP that both

these transactions can be aggregated in the first instance, so that the

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surplus from one could be adjusted against the deficit from the other in

an overall approach. It does not mean that because of aggregation, the

AMP expense transaction sheds its character of a separate international

transaction and hence the AMP functions should not be matched with

the AMP functions carried out by probable comparables. If suitable

comparables can be found having performed both Distribution and AMP

functions, then, their ALP should be determined on aggregate basis. If,

however, there is some difference in the Distribution or AMP functions

performed by the assessee vis-à-vis the probable comparables, then an

attempt should first be made to iron out such difference by making a

suitable adjustment to the profit margin of comparables. If such an

adjustment is not possible, then such probable comparable should be

eliminated. If, by making a comparative analysis of the Distribution and

AMP functions jointly, there remains no comparable case performing

such distribution and AMP functions, then, the international transaction

of AMP should be segregated and its ALP be determined separately by

applying a suitable method. However, in so determining the ALP of

such an international transaction of AMP expenses on separate basis, a 25

ITA No.5490/Del/2012

proper set off, if any, available from the distribution activity, should be

allowed.

of the AMP functions performed by the assessee is available on record.

Similarly, there is no reference in the order of the TPO to any AMP

functions performed by comparables. In fact, no such analysis or

comparison has been undertaken by the TPO because of his applying the

bright line test for determining the value of the international transaction

of AMP expense and then applying the cost plus method for determining

its ALP. The ld. AR also failed to draw our attention towards any

material divulging the AMP functions performed by the assessee as well

as comparables. As such, we are handicapped to determine the ALP of

AMP expenses at our end, either in a combined or a separate approach.

The ld. AR has also disputed the base of total AMP expenses taken by

the TPO. He argued that some of expenses, which are in the nature of

selling expenses directly incurred in connection with sales not leading to

brand promotion in any manner, should be excluded. In principle, we

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agree with the contention of the ld. AR that Selling expenses incurred

for making sales are distinct from AMP expenses and, hence, should not

be included in the base amount for consideration. The Hon’ble

jurisdictional High Court in Sony Ericson Mobile Communication India

(P) Ltd. (supra) has also held so. As there is inappropriate discussion

about the precise nature of expenses which have been assailed before us,

we consider it expedient to direct the AO to first ascertain the correct

nature of such expenses. If these expenses are found to be in the nature

of Selling expenses directly in connection with sales, then, they should

be removed from the base amount for computing the ALP of AMP

expenses. In the otherwise scenario, the AMP expenses, which are not in

the nature of Selling expenses incurred directly for sales, should

continue to include in the base amount. Under such circumstances, we

set aside the impugned order and send the matter back to the file of the

TPO/AO for determining the ALP of the international transaction of

AMP spend afresh in accordance with the manner laid down by the

Hon’ble High Court in Sony Ericson Mobile (supra).

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The order pronounced in the open court on 03.12.2015.

Sd/- Sd/-

[KULDIP SINGH] [R.S. SYAL] JUDICIAL MEMBER ACCOUNTANT MEMBER

Dated, 03rd December, 2015. dk Copy forwarded to: 1. Appellant 2. Respondent 3. CIT 4. CIT (A) 5. DR, ITAT

AR, ITAT, NEW DELHI.