2015 (8) TMI 1386 - AT - Income Tax

Transfer pricing adjustment on account of advertisement, marketing and promotion expenses - Held that - If the expenses which are included by the TPO as part of AMP are excluded from the AMP expenses being the expenses directly linked with the sales and marketing as well as trade discounts allowed by the assessee as incentive to the distributors than, the AMP to sales ratio of the assessee comes to 0.74%. There is no ambiguity, a it is manifest from the items of expenditure included by the TPO in the category of AMP expenses that the same are directly related with the sales, marketing and other sales promotion expenses in the shape of trade discounts allowed to the distributors. Therefore, these expenses cannot be included as part of the AMP expenses for the purpose of determining the arm s length price. The TPO has not disputed the operating margin of the assessee at 6.25% in comparison to the margin of the comparables at 0.13%. Therefore, there is enough scope of accommodating the AMP to sales ratio at 0.74% if the said transaction is clubbed with the other international transaction of the assessee. Even after giving effect to the AMP expenditure of the assessee the margins of the assessee would still the higher than the margin of the comparable which is 0.13%. Thus, in the facts and circumstances of the case, the inclusion of the sales related expenditure in the category of AMP is not justified as held in the light of the judgment of the Hon ble Delhi High Court in the case of M/s Sony Ericsson Mobile Communication Ltd (2015 (3) TMI 580 - DELHI HIGH COURT ). Accordingly, we delete the addition made by the TPO on account of AMP adjustment. Adjustment on account of Royalty payment - Held that - TPO has not undertaken any exercise as per the provisions of transfer price rules and regulation to determine the arm s length price of royalty payment by the assessee to the AE. The assessee has also not furnished a separate comparable analysis to establish that the payment of royalty is at arm s length. We find that the issue was not raised by the assessee before the DRP because the TPO did not make any adjustment on account of royalty payment on the ground that the same has got subsumed in the AMP adjustment. Thus, it is clear that neither the TPO has undertaken proper process of determining the arm s length price nor this issue was raised before the DRP. Therefore, this issue requires a proper examination and verification as the assessee has not submitted any separate transfer pricing analysis on this issue except TNM method analysis in respect of the purchase and sale transaction with AE. Accordingly, in facts and circumstances of the case, we set aside the issue to the record of the TPO/AO for adjudication of the issue afresh in the light of the jurisdictional High Court in the case of CA Computers Associates Pvt. Ltd (2012 (7) TMI 560 - BOMBAY HIGH COURT ).

Summary

Issues Involved:
1. Adjustment on account of Advertisement, Marketing, and Promotion (AMP) expenses.
2. Adjustment on royalty payment.

Detailed Analysis:

Adjustment on Account of Advertisement, Marketing, and Promotion (AMP) Expenses:

Background:
The assessee, a subsidiary of a German company, incurred AMP expenses and claimed them as part of its business operations in India. The Transfer Pricing Officer (TPO) made an upward adjustment of Rs. 97,87,309/- on these expenses, arguing that they enhanced the brand value of the associated enterprise (AE). The TPO applied the bright line test to determine the arm's length price of the AMP expenses and included various selling expenses in the AMP category, which the assessee contested.

Assessee's Argument:
The assessee argued that:
- The AMP to sales ratio of 0.74% should be considered instead of the TPO's 6.06%.
- Selling expenses like free samples, discounts, and trade discounts should not be part of AMP expenses as they are directly linked to sales and marketing, not brand promotion.
- The Transaction Net Margin Method (TNMM) should subsume all operating expenses, including AMP, and no separate adjustment is required if the overall transactions are at arm's length.

Revenue's Argument:
The Revenue contended that:
- The TPO correctly applied the bright line test and included selling expenses in AMP.
- The AMP expenses should be treated as a separate transaction.
- The TPO's findings were supported by the Special Bench decision in the case of L.G. Electronics India Pvt. Ltd.

Tribunal's Findings:
The Tribunal held that:
- Selling expenses such as trade discounts and volume discounts are not in the nature of brand promotion but are directly linked to sales.
- These expenses should not form part of AMP expenses, as established by the Delhi High Court in the case of Sony Ericsson Mobile Communication India Pvt. Ltd.
- Excluding these selling expenses, the AMP to sales ratio of the assessee comes to 0.74%, which is less than the comparable companies' ratio of 4.99%.
- The TPO's adjustment on AMP expenses was deleted.

Adjustment on Royalty Payment:

Background:
The assessee paid royalty to its AE at 3% of sales, which was approved by the Foreign Investment Promotion Board (FIPB). The TPO determined the arm's length price for the royalty payment as NIL, arguing that no royalty was required to be paid.

Assessee's Argument:
The assessee contended that:
- The royalty payment was at arm's length as it was less than the FIPB-approved rate.
- The TNMM method showed that the overall transactions, including royalty, were at arm's length with an operating margin of 6.25%, higher than the comparables' margin of 0.13%.

Revenue's Argument:
The Revenue argued that:
- The FIPB approval does not substitute for the determination of arm's length price under the Income Tax Act.
- The TPO's determination of NIL royalty was justified.

Tribunal's Findings:
The Tribunal held that:
- The FIPB approval cannot replace the arm's length price determination under the Income Tax Act.
- The TPO did not follow proper procedures to determine the arm's length price of the royalty payment.
- The issue requires proper examination and verification. The Tribunal set aside the matter to the TPO/AO for fresh adjudication in light of the jurisdictional High Court's decision in CA Computer Associates Pvt. Ltd.

Conclusion:
- The appeal on ground nos. 1 to 9 (AMP adjustment) was allowed, deleting the TPO's adjustment.
- Ground no. 10 (royalty adjustment) was allowed for statistical purposes, remanding the issue back to the TPO/AO for fresh consideration.

Order Pronounced:
The appeal filed by the assessee was partly allowed.