2019 (10) TMI 845 - AT - Income Tax

TPA - Advertising and Marketing Promotion (AMP) Expenditure Adjustment - Whether AMP expenditure incurred by the assessee during the year is an international transaction? - can the value of the AMP transaction be extended or expanded beyond the amount received as reimbursement under the MDF agreement? - HELD THAT - For any transaction of AMP entered into between the assessee and another enterprise which is not an AE u/s 92A of the Act, this understanding or arrangement has to be shown to exist. If the assessee denies having any such arrangement or understanding with its AE or when there is no apparent material on record to show that there exists any agreement, arrangement or action in concert between the two related parties, the onus rests on the Revenue to demonstrate the same before it can apply the provisions of Chapter X on the AMP expenditure. In the present case, the only ground on which the Ld. TPO and the Ld. DRP have concluded that the AMP expenditure constitutes an international transaction is the excessive quantum of expenditure which is stated to be much above the bright line of the average AMP spend of the comparable companies. This approach, to our mind, is contrary to law and untenable. A perusal of the terms of the MDF agreement shows that the reimbursement of a portion of the advertising and marketing expenditure incurred by the assessee by its AE is on a preapproval basis and under an annual budget decided solely by the AE. The nature of reimbursement received is a form of assistance or subsidy and does not arise on account of any service rendered by the assessee. There is no obligation on the AE to approve any particular item of expenditure. It is solely on its own volition that the AE determines the activity it wants to finance/reimburse/assist. Therefore, it is not possible to infer the existence of an international transaction beyond what has been reimbursed. The arrangement and understanding were limited to the amounts agreed to be paid as assistance under the MDF Agreement. The amounts incurred as AMP expenditure by the appellant under the MDF Agreement have already been received as reimbursement/assistance and have indisputably been disclosed as an international transaction in Form 3CEB and form part of the transfer pricing study conducted under Rule 10D. The AMP expenditure which is outside the ambit of reimbursement received under the MDF Agreement, has been incurred by the appellant on its own volition as per its own requirements and without any interference of the AE and have been paid to third parties. We hold that the scope and value of international transaction cannot be expanded beyond the reimbursements received under MDF agreement to cover the entire gamut of AMP expenditure incurred by the assessee during the year. Whether Bright Line Test a valid test that can be used by the TPO to determine the existence of an international transaction and also for the determination of its arm s length value? - bright line approach is untenable in law either as a way to determine the existence of an international transaction or as a method to determine the ALP of an international transaction pertaining to AMP. No international transaction can be presumed to exist merely on the basis of bright line of expenditure incurred by comparable companies. If TNMM has been adopted at segmental/entity level, then can individual component of AMP be segregated? - In the present facts, we find that the TPO has subjected various international transactions of the assessee to TNMM analyses under various segments and made transfer pricing adjustments on the basis of external comparables chosen by him. Several of these comparable companies included/excluded by him form subject matter of the present appeals. It implies that the TPO has applied his mind on the suitability of TNMM and made adjustments. Having adopted TNMM in a considered manner, it is not open for him to take up AMP as a separate transaction and subject to the same to a Cost Plus type of benchmarking because the entire AMP expenditure forms part of the operating expenditure that has been taken into account while computing the profit level indicator (net profit margin). Brand building exercise equivalent to incurring AMP expenditure - it would be erroneous to treat any and all AMP expenditure as being a brand building exercise. There is no basis to presume that there is a positive correlation between AMP expenditure and brand-value. Brand value is a far more complex concept than mere AMP expenditure. Brand is an intangible asset that encapsulates the reputation of an entity and a reputation is built over a long period of time primarily on the basis of trust it invokes. Year to year AMP expenditure may vary due to market conditions, but the brand value does not get altered in proportion to expenditure. AMP function itself is a complex activity involves several nuanced aspects of marketing management targeted towards increasing sales. Such an exercise is sometimes premised on product promotion and sometimes brand messaging and occasionally for brand familiarization. But the core of brand value is not determined by the quantum of expenditure incurred but the overall level of trust inspired in the minds of the consumers. If the Indian distributor has been deprived of the opportunity of recovering its investment in AMP, it could be a valid reason for a transfer pricing adjustment because third parties would not agree to a premature termination of this kind without demanding compensation. Therefore, the question of compensating the taxpayer for any loss suffered due to excess AMP spend would arise only at the time of such premature termination and not during the pendency of the distributorship arrangement. Thus, in case of a routine distributor, disallowance/adjustment on account of AMP spend on the mere assumption that the supplier may terminate the agreement in the future is not sustainable. A taxpayer cannot be penalized on the presumption of a future event (which may not even occur) while ignoring the present facts and circumstances. It is also worthwhile to note that in the present case, the assessee has not paid any trade-mark or brand royalty to its AE for having used its brand. Whether it is permissible for the TPO to make a substantive and protective assessment on the same issue using two alternative approaches? - It is settled law that protective addition along with substantive addition of an item of income can be made only when the identity of the real owner of the income is unclear. See MSD PHARMACEUTICALS PRIVATE LIMITED VERSUS ADDITIONAL COMMISSIONER OF INCOME TAX SPECIAL RANGE 6, NEW DELHI 2017 (11) TMI 1783 - ITAT NEW DELHI Adjustment in respect of transactions undertaken by the appellant with its AEs in Class II segment - As underlying difference between the transfer price and arm s length price does not exceed 5% of the latter and thus, the case is squarely covered by the proviso to section 92C (2) of the Act. - HELD THAT - In view of the details submitted by the assessee which have not been disputed or controverted by the Ld. CIT(DR), it is apparent that by applying the permissible 5% margin under the second Proviso to Section 92C(2), no adjustment is warranted. Accordingly, this ground is allowed and the adjustment made by the Ld. CIT (A) is directed to be deleted. Excluding certain comparables while benchmarking international transactions under Class I Manufacturing and Class II Distribution Segment - HELD THAT - The Assessee is engaged in manufacturing of consumer electronics, home appliances colour monitors (known as Class IManufacturing segment) which includes the import of raw materials, import of spare parts, export of finished goods, purchase of samples and purchase of sales promotion material thus companies functionally dissimilar with that of assessee need to be deselected. Lower the level of RPT, more accurate the result is likely to be. However, if sufficient number of comparables is not available due to paucity of data or comparables, the RPT threshold may have to be relaxed upwards for reasons of practicality. However, in situations where sufficient numbers of comparables are available by applying a lower threshold, the same should be preferred as the results are likely to be more accurate. The same view has been expressed by the coordinate Bench in the case of Motorola Solutions India Pvt. Ltd 2014 (10) TMI 358 - ITAT DELHI . We accordingly hold that since in the given situation sufficient numbers of comparables are available even by following the lower level of threshold of 15%, the same should be followed. Deferred revenue expenditure - AO held that the benefit of expenditure on recruitment and training of employees is not restricted to one year and accordingly has to be apportioned over 6 years - HELD THAT - The said issue is covered by decision of Hon ble Delhi High Court in Assessee s own case for AY 1999-2000, 2002-03 and AY 2003-04 wherein the Delhi High Court affirmed the decision of this Hon ble Tribunal allowing the deduction of expenditure incurred on recruitment and training of employees. The Ld. Counsel submitted that the Ld. AO erred in treating it as a deferred revenue expenditure on the assumption that recruitment expenses will result in long term benefit. He failed to appreciate that such expenditure was revenue in nature, incurred for the purpose of business and therefore allowable under section 37(1) of the Act Depreciation on UPS - classifying them to be plant and machinery OR computers - @ 15 % OR 60% - HELD THAT - We are in agreement with the Ld. Counsel of the Appellant that this issue is no longer res integra as this Tribunal has already taken a view that for depreciation purposes, UPS falls under the category of Computers being a computer peripheral. The law in this regard has been settled by various decisions, particularly the decision of the Hon ble Jurisdictional High Court in the case of CIT v. BSES Rajdhani 2010 (8) TMI 58 - DELHI HIGH COURT Allowable revenue expenditure - training and recruitment expenditure is fully allowable as revenue expenditure in the year in which it is incurred. There being no enduring benefit it cannot be treated as capital expenditure or deferred revenue expenditure. Allowability of loss recognized under accounting standards under marked to market (MTM) guidelines in respect of forward forex contract which are open and unexpired on the last date of the balance sheet on account of restatement of amounts payable and receivable in foreign exchange confirmed Disallowance u/s 40(a)(i)/(ia) - assessee has reversed the provision created in the previous year - HELD THAT - Section 40(a)(i) or (ia) has no application as there is no expense which has been incurred. The allowability of the reversal of the provision is a deduction that is claimed on the basis of alignment of the books of accounts with the taxable income. Therefore, the reasoning of the Ld. AO that as no tax has been deducted and deposited the said reversal of provision should not be allowed to be reduced from taxable income is on completely wrong footing because claim of the assessee pertains to reversal of excess provision created in preceding year for which vendors were not identifiable, and thus the question of deducting tax on the same does not arise. AO and the DRP have erred in not appreciating that in the preceding year at the time of creation of the said provision, the same was already suo-moto added back to the income under the head Profits and Gains of business or Profession, for the reason that it is not allowable under the Act. Therefore, in the current year, on the reversal of the said amount, the same should be allowed to be reduced in computing the total income else it would lead to double taxation of the same. The decision of the coordinate Bench in the case of Johnson Matthey India Pvt. Ltd. 2013 (8) TMI 830 - ITAT DELHI cited by the appellant is applicable to the present facts - we allow this ground and direct the AO to allow this deduction.

Summary

Issues Involved:
1. Transfer Pricing Adjustment on Advertising and Marketing Promotion (AMP) Expenditure.
2. Selection and Rejection of Comparable Companies for Benchmarking International Transactions.
3. Treatment of Recruitment and Training Expenses.
4. Depreciation on UPS Systems.
5. Loss on Exchange Fluctuation.
6. Proportional Adjustment of Transfer Pricing.
7. Deduction under Section 10A of the Income Tax Act.
8. Disallowance under Section 40(a)(i)/(ia) of the Income Tax Act.

Detailed Analysis:

1. Transfer Pricing Adjustment on Advertising and Marketing Promotion (AMP) Expenditure:
The Tribunal examined whether AMP expenditure incurred by the assessee constitutes an international transaction. It was held that AMP expenditure is a function carried out by the assessee to drive its sales in India and is not an international transaction under Section 92B unless there is an understanding or arrangement with the AE. The Tribunal rejected the "Bright Line Test" used by the TPO to determine the existence of an international transaction and its arm's length value, following the Delhi High Court's decision in Sony Ericsson. The Tribunal also held that once TNMM is adopted at the segmental/entity level, individual components like AMP cannot be segregated. The Tribunal concluded that brand-building expenses are not equivalent to incurring AMP expenditure and cannot be treated as a separate international transaction.

2. Selection and Rejection of Comparable Companies for Benchmarking International Transactions:
The Tribunal addressed various issues related to the selection and rejection of comparable companies for benchmarking international transactions under TNMM. It was held that companies with persistent losses or extraordinary economic situations should be excluded. For instance, Videocon Industries Ltd. and Samtel Colour Ltd. were excluded due to functional dissimilarity and substantial related party transactions, respectively. The Tribunal also emphasized the need for accurate segmental data and rejected companies like PCS Technology Ltd. and Spice Mobile Ltd. due to the absence of such data. The Tribunal allowed the inclusion of companies if quarterly results are available in the public domain, as in the case of R Systems International Ltd.

3. Treatment of Recruitment and Training Expenses:
The Tribunal held that recruitment and training expenses are fully allowable as revenue expenditure in the year they are incurred. It was emphasized that these expenses do not result in an enduring benefit and cannot be treated as capital expenditure or deferred revenue expenditure.

4. Depreciation on UPS Systems:
The Tribunal consistently held that depreciation on UPS systems should be allowed at the rate of 60% under the category of 'computer' and not at 15% under 'plant and machinery'. This decision was based on various judicial precedents, including the Delhi High Court's decision in CIT v. BSES Rajdhani.

5. Loss on Exchange Fluctuation:
The Tribunal allowed the deduction of losses arising from revaluation of open forward forex contracts on the last date of the balance sheet. This decision was based on the Supreme Court's ruling in CIT v. Woodward Governor India Pvt. Ltd., which held that such losses are not notional or contingent and should be allowed under Section 37 of the Act.

6. Proportional Adjustment of Transfer Pricing:
The Tribunal directed that transfer pricing adjustments should be restricted to the proportionate value of international transactions with AEs. This decision aligns with the principle that transfer pricing exercises should be limited to transactions with related parties and not unrelated transactions.

7. Deduction under Section 10A of the Income Tax Act:
The Tribunal allowed the deduction under Section 10A for units relocated from one place to another for business expansion. It was held that such relocation does not amount to splitting or reconstruction of an existing business, following the Tribunal's earlier decision in ITA No. 6508/Del/2012, which was confirmed by the Delhi High Court.

8. Disallowance under Section 40(a)(i)/(ia) of the Income Tax Act:
The Tribunal held that the reversal of provisions created in the previous year should be allowed as a deduction in the current year if the provision was already disallowed and offered to tax in the previous year. This decision was based on the principle that disallowance under Section 40(a)(i)/(ia) applies only to expenses claimed without TDS deduction and not to reversals of provisions.

Conclusion:
The Tribunal's detailed analysis and decisions addressed various complex issues related to transfer pricing, selection of comparables, treatment of expenses, and deductions under the Income Tax Act. The decisions were based on established judicial precedents and principles of transfer pricing and accounting standards.