NIKON INDIA PVT. LTD.,GURGAON vs. DCIT, GURGAON

O R D E R

PER A.T. VARKEY, JUDICIAL MEMBER :

Act, 1961 (hereinafter also called 'the Act') in relation to the assessment year 2010-11.

2.1 The assessee e-filed its return declaring loss of Rs. (-) 22,93,287/- which was duly processed u/s 143(1) on 31.05.2011.

2.2 During the course of assessment proceedings, it was noticed that the assessee reported certain international transactions with its associated enterprises (AEs) which are enlisted hereunder :-

Sr. Nature of Transaction Method Value of No. transaction (Rs.) 1 Purchases of products, spares, RPM 1,59,06,94,564 promotional and other supplies 2 Purchase of fixed assets TNMM 3,09,931 3 Sales and service support income TNMM 1,19,11,847 4 Commission income TNMM 17,51,40,980 5 Purchase of fixed assets CUP 16,74,880 6 Cost of reimbursements received CUP 2,29,50,609 7 Cost of reimbursements paid CUP 28,54,154

2.3 The assessee employed the Transactional Net Margin Method (TNMM) in respect of three international transactions; the Comparable Uncontrolled Price (CUP) method in respect of three transactions; Resale Price Method in respect of one international transaction. On a reference made by the AO for determining the arm's length price (ALP) of the international transactions, the TPO noted that for (i) Purchase of fixed assets (ii) Sales and service support income (iii) Commission income, the assessee had used transactional net margin method ("TNMM") as the most appropriate method with operating profit/sales as the profit level indicator and selected the following comparable companies in the TP study to benchmark its international transactions:

Sr.No. Name of the comparable company Gross OP/Sales (%) Margin(%) 1 Allied Photographics India Ltd. 9.83 0.85 2 CCS Infotech Ltd. 6.31 2.31 3 Compuage Infocom Ltd. 6.03 2.41 4 Computer Point Ltd. 6.27 -0.48 5 Empower India Ltd. 2.89 0.03 6 General Sales Ltd. 23.66 -4.79 7 MVL Industries Ltd. 11.08 8.58 8 Mobile Telecommunications Ltd. 6.20 0.51 9 Salora international ltd. 9.32 2.24 10 Spice Mobiles Ltd. 18.87 2.07 Average 10.05 1.37 Nikon India 17.65% -1.76% 2.4 The assessee's contention was that for above mentioned international transactions, the PLI being operating profit/sales of comparable was 1.37% as compared to -1.76% of assessee i.e. within +-5% range as per proviso to section 92C(2) of the Act.

Therefore, it was contended that international transactions were at arm's length. The TPO thereafter accepted the reported international transactions at ALP. He, however, from the audited accounts for the year, noticed that the assessee incurred Advertisement, Marketing and Promotion (AMP) expenses to the tune of Rs. 37,62,75,469/- during the year in question.

2.5 The TPO observed that the international transactions relating to marketing expenditure have been benchmarked by aggregating it with other transactions in different business segments which have been analyzed under RPM/TNMM without any further analysis as can be observed from the TPO’s order which reads as under:

“(Benchmarking of international transactions relating to Advertisement and Sales Promotion:-

2. It is seen from your audited financials that a sum of 37,62,75,469/- has been incurred by you on advertisement and marketing and sales promotion (AMP). This transaction does not appear to have been benchmarked in your TP report. It appears that the international transactions relating to marketing expenditure incurred by you on the brands of the AEs and for developing marketing intangibles have been benchmarked by aggregating with the other transactions in different business segments which have been analyzed under RPM/TNMM without any further analysis.”

2.6 The TPO after considering the TP documentation observed that the assessee, by incurring expenditure on advertisement marketing and promotional activities (AMP), was developing marketing intangible for Nikon Japan. The TPO, for benchmarking the AMP expenditure, took the following companies as comparable and rejected the other companies by stating that some of these companies are either developing brands or are not comparable companies. For benchmarking the AMP expenditure, we require companies which are not developing brands. Hence, only following companies can be taken as comparable:

Sr.No. Company name Sales AMP AMP% 1 Allied Photographics India 11.08 0.4 3.61 Ltd. 2 CCS Infotech Ltd. 63.79 0.53 0.83 3 Compuage Infocom Ltd. 1087.8 0 0.00 4 Computer Point Ltd. 116.17 0.03 0.03 5 Empower India Ltd. 67.67 0 0.00

6 MVL Industries Ltd. 437.51 0.49 0.11 7 Mobile Telecommunications 55.32 0.15 0.27 Ltd. 8 Salora international ltd. 524.55 3.45 0.66 Average 0.69 2.7 The TPO computed the mean of the “expenditure incurred on AMP/Sales” of such comparable companies is the “bright line”.

Any expenditure in excess of the bright line is for the development of marketing intangible (which is owned by the AE) that needs to be suitably compensated by the AE. The amount which represents the bright line and the amount that should have been compensated to the assessee company were computed as under:

Particulars Amount Advertising 20,10,75,600 Business Promotion 17,51,99,869 Total AMP expenditure 37,62,75,469 Net Sales 203,87,33,264 AMP/Sales ratio 18.46% 2.8 Accordingly, the arm’s length price of this international transaction was proposed to be worked out as follows:

Total Sales Rs.203,87,33,264 Arm’s length level of AMP expense (0.69% of Rs. 1,40,67,260 sales) AMP expenses actually incurred Rs. 37,62,75,469 AMP expenditure which should have been Rs. 36,22,08,209 reimbursed 2.9 Further, the TPO conducted a search in respect of business services companies by applying the following filters: (i) Use of correct keywords (ii) Use of current year data (iii) Reject companies having different financial year (iv) Reject companies where turnover is less than Rs. 1 Crore (v) Select companies where the ratio of service income to total income is at least 75% (vi) Reject companies where related party transactions exceed 25% of sales (vii) Reject companies that have employee cost less than 25% of total cost (viii) Reject companies that have interest cost more than 25% of total cost (ix) Reject companies that are affected by some peculiar economic circumstances (x) Select companies providing advertising and marketing services 2.10 Based on the search process, following comparables were selected for the mark-up on AMP services:

Sr. Company name OP/OC No. (w/o FX) 1 Crystal Hues Ltd. 9.10% 2 Quadrant Communications Ltd. 13.11% 3 Cyber Media Research Ltd. 14.85% Average 12.36% 2.11 The TPO further computed the opportunity cost for the funds blocked by the assessee on the basis that half of the funds should have been reimbursed and considering a nominal interest rate of 12% on half of funds, opportunity cost comes out to be 6%, therefore, total mark-up was held to be 18.36% (12.36% + 6%) which in his view should have been charged by the assessee and calculated the arm’s length price of the international transaction related to the AMP expenditure leading to the creation of a marketing intangible as below:-

Total Sales Rs.203,87,33,264/- Arm’s length level of AMP expense (0.69% of Rs. 1,40,67,260/- sales) AMP expenses actually incurred Rs. 37,62,75,469/- AMP expenditure which should have been Rs. 36,22,08,209/- reimbursed Mark-up @ 18.36% Rs. 6,65,01,427/- Adjustment u/s 92CA Rs. 42,87,09,637/-

2.12 The Assessee in its reply dated 03.01.2014 raised the following contentions :- (i) AMP expense is not an international transaction (ii) Benefit of AMP expenditure accrue to the assessee only and so expenditure is wholly and exclusively for assessee’s business – No disallowance u/s 37(1) possible (iii) Any benefit to AE is incidental in nature (iv) Arguments on the use of ‘Bright line’ concept (v) India’s position as stated in UN transfer pricing manual needs to be applied (vi) Assessee has a long term royalty free distribution right (vii) Selling expenses (expense in connection with sales) should be excluded from AMP expenses (viii) Quantitative adjustments to be made to determine the value of AMP expenditure/Sales ratio. (ix) Choice of comparables for determining bright line is not correct (x) Mark up charged on the AMP amount above bright line is incorrect, 2.13 Further, after considering the assessee’s reply, TPO has held as under :-

(i) The TPO has dealt the issue in detail and held that the AMP expenditure is an international transaction (Paras 7.2 & 7.3 of the TPO order) (ii) Bright Line concept can be applied to the assessee. (Para 8.4 of the TPO order) (iii) The benefit of AMP expenditure will not be with the assessee but with the AE as it is the legal owner of the brand. Hence, the assessee is working for the benefit of AE by promoting its brand by making excessive AMP expenditure for penetration of brands in India which is much more than the functionally comparable companies taken by the assessee. (Para 9.4 of the TPO order) (iv) The payment for additional functions is deferred till the termination and not given in the due course regularly. Secondly, the royalty might have been embedded in the price of the product that the assessee is importing from the AE. (Para 10.3 of the TPO order) (v) The benefit of AE is significant and only incidental benefit is received to the asessee. (Paras 11.8, 11.9, 11.10 and 11.11 of the TPO order) (vi) As regards the argument about the binding nature of the India’s position, the court has found the same to have persuasive value and not a final word which is determined by the statute. Un view of the same, the argument of the assessee is not acceptable. (Para 12.3 of the TPO order) (vii) Selling expenses should not be excluded in assessee’s case. (Para 13.4 of the TPO order) (viii) The Ld. TPO in Para 14.4 of his order held that the adjustment which the assessee is seeking to make in respect of advertisement of new products is not permissible in view of LG’s case. Because, bright line is for determining the routine expenditure which is incurred just for exploitation of already established brand while the excessive expenditure is in respect of expenditure for brand penetration. Hence, on account of new products, in fact the expenses are clearly in the nature of brand penetration and hence should fall outside the bright line Hence, in view of non-availability of data in respect of comparables, adjustment cannot be granted.

2.14 The TPO used the ‘Cost Plus Method’ for the benchmarking of the AMP expenses and selected the following comparables for determining mark-up on AMP expenses :-

Sr. Company name OP/OC No. 1 Crystal Hues Ltd. (corrected margin by the 8.68% assessee) 2 Quadrant Communications Ltd. 13.11% 3 Cyber Media Research Ltd. 14.85% Average 12.21% 2.15 Further, a mark-up of 6% was proposed to be charged to cover the return on funds that have been blocked and remuneration for the services provided, i.e. interest rate of 12% on half of funds which should have been reimbursed. The assessee contended the same and as per the inter-company agreement, Nikon India is allowed a credit period of 60 days. As per the agreement, if the company pays beyond 60 days, then an interest rate of LIBOR +2% would be charged. However, it is noted that the AE has not charged any interest on the outstanding amount. In view of the assessee’s explanation, interest mark-up of 6% was not charged and total mark-up 12.21% was computed .

2.16 After taking into account the above arguments, the ld. TPO computed the arm’s length price of value of the remuneration for services at Rs. 40,64,33,832/- which is shown as under :-

Total Sales Rs.203,87,33,264/- Arm’s length level of AMP expense (0.69% of Rs. 1,40,67,260/- sales) AMP expenses actually incurred Rs. 37,62,75,469/- AMP expenditure which should have been Rs. 36,22,08,209/- reimbursed Mark-up @ 12.21% Rs. 4,42,25,622/- Adjustment u/s 92CA Rs. 40,64,33,832/-

2.17 The AO, accordingly, after giving opportunity to the assessee, passed the draft assessment order dated 18.03.2014 by making addition of Rs. 40,64,33,832/-.

2.18 The assessee, inter alia, filed the following objections before ld. DRP :-

“1 That on the facts and circumstances of the case and in law, the draft order passed by the ld. Assessing Officer (“AO”) is bad in law and void ab-initio 2 The ld. AO/ld. Transfer Pricing Officer (“TPO”) erred on facts and circumstances of the case in determining the arm’s length adjustment to the assessee’s alleged international transaction with Associated Enterprises(“AEs”), thereby resulting in the enhancement of returned income of the assessee by Rs. 40,64,33,832 3 That the reference made by the ld. AO suffers from jurisdictional error as the ld. AO has not recorded any reasons in the draft assessment order based on which he reached the conclusion that it was “expedient and necessary” to refer the matter to the ld. TPO for computation of the arm’s length price, as is required under section 92CA(1) of the Income Tax Act, 1961 (“Act”)

4 The Ld. AO/Ld. TPO erred on facts and in law in enhancing the income of the assessee by INR 406,433,832 by holding that the assessee incurs ‘excessive’ AMP (advertisement, marketing and promotion) expenses in relation to its business activities thereby qualifying the alleged excessive AMP expenditure as ‘services’ as per the arm’s length principle envisaged under the Act, and in doing so have grossly erred in:

4.1 disregarding that the AMP expenses incurred by the Assessee represent purely domestic transaction(s) undertaken towards third parties, not covered under the purview of section 92 of the Act and that the analysis of “domestic” transactions undertaken with third parties, in respect of which no TP reference has been made by the Ld. AO to the Ld. TPO, is beyond the powers vested with the TPO under section 92CA of the Act.

4.2 disregarding the detailed submissions made by the Assessee on the functional, asset and risk analysis of the Assessee related to its marketing function as an independent decision maker and hence should also assume the cost associated with its functions and decisions

4.3 disregarding the contractual arrangements between the Assessee and the AE wherein the Assessee acts as a long term, exclusive distributor and has the right to receive an arm’s length compensation in case of any termination of the inter-company distribution agreement

4.4 disregarding detailed submissions made by the assessee to demonstrate that the AMP expenses incurred by the Assessee were in respect of its own business requirement/ considerations/ purposes and that all benefit resulting from such expenditure are to its own account

4.5 incorrectly computing the AMP expenses/ sales by treating the selling expenditure incurred by the Assessee as part of sales promotion expenditure

4.6 not providing quantitative adjustments to take into account the differences in comparability between the assessee and the companies selected for the Bright line analysis. Specifically, the Ld. TPO/AO have not provided for quantitative adjustment to account for: a. no payment for royalty made by the Assessee to the AE for the right to use the brand name/trademark b. differences in expenses incurred by the assessee visa vis comparable companies because of the introduction of new products by the Assessee when there were no similar economic facts applicable to the companies selected for the bright line test by the Ld. TPO

4.7 by rejecting companies that owned domestic brands for the purpose of computing the bright line test and thereby erroneously selecting companies which are not comparable in their asset and risk profile to the Assessee;

4.8 erroneously holding that the Assessee has rendered services to the AEs by incurring ‘excessive’ AMP expenses and by holding that a mark-up has to be earned by the Assessee in respect of the “alleged excessive” AMP expenses;

4.9 applying a mark-up of 12.21% on the “alleged excessive” AMP expenses, for determining the compensation/ service fee towards “alleged AMP service” by the assessee to its AEs by disregarding the new comparables selected by the Assessee.

5 The Ld. AO erred in facts and in law in charging and computing interest under section 234A, 234B, 234C and 234D of the Act

6 That on the facts and circumstances of the case and in law, the Ld. AO has erred in initiating penalty proceedings u/s 271(1)(c) of the Act mechanically and without recording any adequate satisfaction for such initiation

That the above grounds are independent and without prejudice to each other.

The Assessee craves leave to add, amend, alter, delete, rescind, forgo or withdraw any of the above grounds of objection either before during the course of the Dispute Resolution Panel proceedings in the interest of the natural justice.”

2.19 The Ld. DRP after considering the assessee’s objections, concluded as under :-

“(i) Ground of objection nos. 1 & 2 are general in nature therefore no specific direction is required on these grounds. (ii) Ground of objection nos. 3 to 4.9: Ld. DRP has placed his reliance on the judgment of LG Electronics India Pvt.Ltd. vs. ACIT reported in 29 taxmann.com 300 (Del)(SB) and the above Grounds of Objection are rejected in the instant case. (iii) Ground of objection no 5: Initiation and imposition of interest is prerogative of the AO while passing the assessment order and is based on the facts and circumstances of the case. Hence the DRP is not required to issue any direction on this ground at this stage and objection is therefore rejected as being premature. (iv) Ground of objection no 6: Initiation and imposition of penalty is prerogative of the AO while passing the assessment order and is based on the facts and circumstances of the case. Hence the DRP is not required to issue any direction on this ground at this stage and objection is therefore rejected as being premature.”

2.20 Accordingly, ld. AO, as per the directions of Ld. DRP, passed the Final Assessment order dated 05.01.2015 upholding the adjustment made of Rs. 40,64,33,832/- by the ld. TPO in his order dated 29.01.2014 u/s 92CA of the Act.

“1 That on the facts and circumstances of the case and in law, the AO has erred in assessing the total income of the appellant u/s 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961 (“the Act”) for the relevant assessment year at INR 40,41,40,545 as against the returned loss of INR 22,93,287/- 2 That on the facts and circumstances of the case and in law, the DRP/AO have erred in not appreciating that suo moto adjustments proposed by the TPO in relation to advertisement, marketing and promotion (“AMP”) expenses incurred by the appellant, without any reference from the AO, was beyond jurisdiction and bad in law. 3 That on the facts and circumstances of the case and in law, the DRP/AO/TPO erred in making/upholding the Transfer Pricing (“TP”) adjustment of INR 40,64,33,832 on account of AMP expenditure, alleging the same to be not at arm’s length as per provisions of sections 92C(1) and 92C(2) of the Act, read with Rule 10D of the Income Tax Rules 192 (the “Rule”) 4 That on the facts and circumstances of the case and in law, the DRP/AO/TPO erred in making TP adjustments, alleging that the unilateral AMP expenditure, being payments made to third parties, is an “international transactions” as per the provision of section 92B of the Act, without appreciating that there was no agreement, understanding or arrangement between the appellant and the Associated Enterprises (“AE”) for incurrence of such expenditure. 5 That on the facts and circumstances of the case and in law, the DRP/AO/TPO have erred in not appreciating that no such TP adjustment can be made in respect of AMP expenses being legitimate, bonafide and deductible business expenditure incurred by the appellant towards payments to independent parties the benefit of which accrues to the appellant.

6 That on the facts and circumstances of the case and in law, the DRP/AO/TPO have erred, in concluding that the appellant, by incurring excessive AMP expenditure, was rendering intra group services to its AE resulting in creation of marketing intangibles and should have been remunerated at arm’s length.

7 That on the facts and circumstances of the case and in law, the TPO has erred in re-characterising the functions of incurring AMP expenditure and holding the appellant to be the services provider engaged in brand building services.

8 That on the facts and circumstances of the case and in law, the DRP/AO/TPO have erred in using the “Bright Line” test, which is not a prescribed method under the TP regulations in place in India, as a method for benchmarking the AMP expenditure incurred by the appellant without correctly applying any of the methods in the manner prescribed under Rule 10B of the Rules.

9 That on the facts and in the circumstances of the case and in law, the DRP/AO/TPO have erred in applying the “Bright line theory” as articulated in Transfer Pricing regulations of foreign jurisdictions and decisions rendered by foreign courts (based on specific transfer pricing regulations of those countries).

10 That on the facts and circumstances of the case and in law, the DRP erred in disposing the objections of appellant by passing a non speaking order, thus, the order passed is non est and bad in law.

Without prejudice to the above grounds of the appellant that the AMP expenditure incurred by it does not constitute an international transaction under Chapter X of the Act, the appellant craves to raise following grounds of appeal on merits.

11 That on the facts and circumstances of the case and in law the DRP/AO/TPO erred in not appreciating that all the transactions of the appellant were established to be at arm’s length by applying the Transactional Net Margin Method (TNMM) on entity-wide basis, and thereafter the AMP expenses cannot be alleged to be excessive, separately.

12 That on the facts and circumstances of the case and in law, the DRP/AO/TPO have erred in considering certain expenses which are inextricably linked to the product sales and did not lead to brand promotion and should have been excluded from the AMP expenditure at the outset, while benchmarking the alleged excessive AMP expenditure. 13 That on the facts and circumstances of the case and in law, the DRP/AO/TPO have erred in not granting the benefit of quantitative adjustments (such as non-payment of royalty/expenditure incurred on new product launches), while computing the alleged excessive AMP expenditure. 14 That on the facts and circumstances of the case and in law, the AO/TPO have erred in arbitrarily rejecting and selecting comparable companies for benchmarking the AMP expenditure and, further erred in not considering the functionally comparable companies for such alleged brand building services and the DRP further erred in not adjudicating the grounds of objections raised in relation thereto. 15 That the DRP/AO/TPO erred on the facts and circumstances of the case and in law in not appreciating that mark-up could not be levied on the AMP expenditure incurred by the appellant. 15.1 Without prejudice to the above and not admitting, if at all a mark up should have been charged by the appellant assuming it to be a brand building service provider, the said markup could have been charged only on the value addition expenses incurred by the appellant for such alleged brand promotion service and not the entire amount incurred/paid to third party vendors. 16 That on the fact and circumstances of the case and in law, the AO has erred in charging interest u/s 234A, 234B, 234D and 244A of the Act.”

LG Electronics India (P.). Ltd. v. Asstt. CIT [2013] 140 ITD 41/29 taxmann.com 300 (Delhi - Trib.), 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 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. Following the said order, various benches of the Tribunal decided several 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 India (P.) Ltd. (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 led by Sony Ericsson Mobile Communications India (P.) Ltd. v. CIT [2015] 231 Taxman 113/55 taxmann.com 240 (Delhi) has been disposed of by Their Lordships of the Hon'ble Delhi High Court, delivering judgment on 16th March, 2015, upholding the majority view of Special Bench in LG Electronics India (P.) Ltd. (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 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.

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] ; • 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];T • 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)] ; • 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].

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.

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 Ericsson Mobile Communications India (P.) Ltd. (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, 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 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 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 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 counterbalance 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 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 Ericsson Mobile Communications India (P.) Ltd. (supra) is Distribution and AMP should be examined on the touchstone of transfer 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 166 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. Similarly the comparable should not be the legal owner of the brand name, trade mark etc. In case a comparable does not perform AMP functions in the marketing operations, a function which is performed by the tested party, the comparable may have to be discarded. Comparable analysis of the tested party and the comparable would include reference to AMP expenses. In case of a mismatch, adjustment could be made when the result would be reliable and accurate. Otherwise, RP Method should not be adopted. If on comparable analysis, including AMP expenses, gross profit margins match or are within the specified range, no transfer pricing adjustment is required. In such cases, the gross profit margin would include the margin or compensation for the AMP expenses incurred. Routine or non-routine AMP expenses would not materially and substantially affect the gross profit margins when the tested party and the comparable undertake 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

ALP of both the 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.

is so inter- related that it will be more reliable means of determining the arm's length consideration for the controlled transactions. It was further observed that there are often situations where separate transactions are inter wined and linked or are continuous that they cannot be evaluated adequately on separate basis. Secondly, the controlled transaction should ordinarily be based on the transaction actually undertaken by the AEs as has been struck by them. Hon'ble jurisdictional High Court cautioned that it was not advocating a broad-brush approach but, a detailed scrutinized ascertainment and determination whether or not the aggregation or segregation of transactions would be appropriate and proper while applying the particular method.

internal comparables. In para 166 of the said judgement it is seen that the arguments of the assessee were held to be flawed and fallacious for several reasons. However their Lordships further in para 167 observed that the Revenue before the Hon'ble High Court did not plead that the R.P.Method should not have been adopted.

Qua the same their Lordships observed that no final pronouncement was being made. A perusal of the para 168 shows that the Tribunal had upheld adoption of CP method after applying the bright-line test. The finding was found to be not correct as approach and procedure for ascertaining/determining arm's length price under the resale price method is different. The discussion on the most appropriate method by their Lordships would further support the view taken as the said exercise needs to be done in the facts of the present case. For ready-reference, we reproduce the aforesaid hereunder:—

"162. In the case of Reebok India Co. Ltd., the assessee has applied RS Method using internal comparable. Contrary to the general rule, the internal comparable possibly may not be appropriate when the assessed has incurred considerable (not necessarily extra-ordinary or non- routine) AMP expenses. The reason is obvious; there is no comparability analysis possible. In such cases, it is not possible to examine and compare the functional comparability between the controlled tested transaction and uncontrolled internal party transaction on account of AMP expenses. Internal comparable would not account for the credible gross profit rate, which an AE should be ensured when it incurs AMP expenses. Functionally the comparable is merely a manufacturer and thus, the said function is compared. AMP expenses do not get factored and compared. As an abundant caution, we would still add that where adjustments clause (iv) can give reliable and accurate results, internal comparables could still be applied. This would likely happen, when AMP expenses are insignificant in quantum.

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 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

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, 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 in the order of the TPO of making any comparison of the assessee's AMP functions with those of the comparables. Going by the ratio in the case of Sony Ericsson Mobile Communications India (P.) Ltd. (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 ; (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.'

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).

expenses on separate basis, a proper set off, if any, available from the distribution activity, should be allowed.

“15. Coming back to the facts of the instant case, we find that no detail 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. 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 Ericsson Mobile Communications India (P.) Ltd. (supra). Ex consequenti, the ground raised about the TPO having no jurisdiction to determine the ALP of AMP expenses, is dismissed following the judgment in the case of Sony Ericsson Mobile Communications India (P.) Ltd. (supra).”

“1. 59 taxmann.com 148 (Del) Perfetti Van Melle India (P.) Ltd. vs. DCIT

“15. Turning to the facts of the case, we find that the TPO/AO have followed the Special bench decision in LG Electronics India (P.) Ltd. (supra) for determining the ALP of AMP expenses. There is no discussion about the AMP functions carried out by the assessee or comparables. Now since the Special bench order has been partly modified by the Hon'ble Delhi High Court, including the non-applicability of the bright line test, and no material has been placed on record by the ld. AR to, firstly, demonstrate the AMP functions carried out by the assessee and then, to compare such functions with those done by comparables, this issue cannot be decided at our end. Under such circumstances, we set aside the impugned order and remit the matter to the file of the AO/TPO for deciding it afresh as per law. In this fresh exercise, the TPO will follow the parts of the judgment in Sony Ericsson Mobile Communication (P.) Ltd. (supra) as are common to both Manufacturers and Distributors; apply the parts of the judgment as are applicable to a 'Manufacturer'; and ignore the parts of the judgment which pertain exclusively to a 'Distributor'. Needless to say, the assessee will be allowed a reasonable opportunity of hearing in such fresh proceedings.”

2. 58 taxmann.com 375 (Del) Casio India Co. (P.) Ltd. vs. DCIT

“15. Coming back to the facts of the instant case, we find that no detail 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. 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 Communications India (P.) Ltd. (supra). It is, however, made clear that the TPO/AO, while computing adjustment, if any, on account of AMP expenses will not Selling expenses directly incurred in connection with sales in the overall base of AMP expenses.” 3. dated 24.08.2015 Maruti Suzuki India Ltd. vs. Addl. CIT “13.15. Turning to the facts of the case, we find that the TPO/AO have computed disallowance of AMP expenses on the basis of bright line test. There is no discussion about the AMP functions carried out by the assessee or comparables. Now since the Special bench order has been partly modified by the Hon’ble Delhi High Court, including the non applicability of the bright line test, and no material has been placed on record by the ld. AR to, firstly, demonstrate the AMP functions carried out by the assessee and then, to compare such functions with those done by comparables, this issue cannot be decided at our end. Under such circumstances, we set aside the impugned order and remit the matter to the file of the AO/TPO for deciding it afresh as per law. In this fresh exercise, the TPO will follow the parts of the judgment in Sony Ericson (supra) as are common to both Manufacturers and Distributors; apply the parts of the judgment as are applicable to a `Manufacturer’; and ignore the parts of the judgment which pertain exclusively to a `Distributor’. Needless to say, the assessee will be allowed a reasonable opportunity of hearing in such fresh proceedings. 13.16. Now we espouse the contention of the ld. AR to send the matter back to the TPO/AO for deciding this issue in conformity with the decision yet to be rendered by the Hon’ble High Court in its own case, for which hearing is still going on. This contention, in our considered opinion, is devoid of any merit. It is axiomatic that there can be no direction to follow a forthcoming judgment which is not in existence at the time of giving direction. A direction can be given by a higher authority to the lower authority to follow only such a decision which is available for consideration at the time of giving direction by the higher authority. There can be no direction to follow a decision, which itself has not yet seen the light of the day at that point of time. Presently, we have the benefit of the judgment of the Hon’ble Delhi High Court in Sony Ericsson (supra), which has also dealt with the treatment to be given in the context of a manufacturer. The Delhi bench of the tribunal in some decisions including Perfetti Van Melle India (supra) has dealt with the manner of computation of the ALP of the AMP expenses incurred by manufacturers in the light of the judgment in the case of Sony Ericsson (supra). No reasons, except the pendency of the matter in the Hon’ble High Court in assessee’s own case, have been given by the ld. AR to claim departure from the view taken by the tribunal in earlier cases. We, therefore, turn down the request of the ld. AR in this regard. With these observations, we send the matter back to the file of TPO/AO for a fresh determination of the ALP of the AMP expenses in accordance with our above observations. In view of our decision in restoring the issue of calculation of ALP of AMP expenses to the TPO/AO, the assessee’s appeal against the order passed by the AO/TPO u/s 154, enhancing the amount of TP adjustment, would automatically be taken care of in such fresh proceedings. We want to clarify that in such fresh proceedings, the assessee will be at liberty to lead any fresh evidence in support of its case.”

AMP spend afresh in accordance with the manner laid down by the Hon'ble High Court in Sony Ericsson Mobile Communications India (P.) Ltd. (supra). Ex consequenti, the ground raised about the TPO having no jurisdiction to determine the ALP of AMP expenses, is dismissed following the judgment in the case of Sony Ericsson Mobile Communications India (P.) Ltd. (supra).

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

Order pronounced in open court on this 28th day of September, 2015.