2015 (5) TMI 307 - AT - Income Tax

Transfer Pricing Adjustment on AMP Expenses - Whether the Income Tax Appellate Tribunal was right in distinguishing and directing that selling expenses in the nature of trade/volume discounts, rebates and commission paid to retailers/dealers etc. cannot be included in the AMP Expenses? - Whether the additions suggested by the Transfer Pricing Officer on account of Advertising/Marketing and Promotion Expenses ( AMP Expenses for short) was beyond jurisdiction and bad in law as no specific reference was made by the Assessing Officer, having regard to retrospective amendment to Section 92CA of the Income Tax Act, 1961 by Finance Act, 2012? - Held that - The substantial question of law is answered in favour of the Revenue and against the assessee. Whether AMP Expenses incurred by the assessee in India can be treated and categorized as an international transaction under Section 92B? - Held that - The majority decision of the Tribunal in L.G. Electronics India Pvt Ltd. 2013 (6) TMI 217 - ITAT DELHI accepted and applied by the Tribunal is erroneous and unacceptable - For reasons set out above, we have passed an order of remand to the Tribunal to examine and ascertain facts and apply the ratio enunciated in this decision. For the purpose of clarity, we would like to enlist our findings - In case of a distributor and marketing AE, the first step in transfer pricing is to ascertain and conduct detailed functional analysis, which would include AMP function/expenses. The second step mandates ascertainment of comparables or comparable analysis. This would have reference to the method adopted which matches the functions and obligations performed by the tested party including AMP expenses. A comparable is acceptable, if based upon comparison of conditions a controlled transaction is similar with the conditions in the transactions between independent enterprises. In other words, the economically relevant characteristics of the two transactions being compared must be sufficiently comparable. The assessed, i.e. the domestic AE must be compensated for the AMP expenses by the foreign AE. Such compensation may be included or subsumed in low purchase price or by not charging or charging lower royalty. Direct compensation can also be paid. The method selected and comparability analysis should be appropriated and reliable so as to include the AMP functions and costs. Where the Assessing Officer/TPO accepts the comparables adopted by the assessed, with or without making adjustments, as a bundled transaction, it would be illogical and improper to treat AMP expenses as a separate international transaction, for the simple reason that if the functions performed by the tested parties and the comparables match, with or without adjustments, AMP expenses are duly accounted for. It would be incongruous to accept the comparables and determine or accept the transfer price and still segregate AMP expenses as an international transaction. The Assessing Officer/TPO can reject a method selected by the assessed for several reasons including want of reliability in the factual matrix or lack / non-availability of comparables. (see Section 92C(3) of the Act).When the Assessing Officer/TPO rejects the method adopted by the assessed, he is entitled to select the most appropriate method, and undertake comparability analysis. Selection of the method and comparables should be as per the command and directive of the Act and Rules and justified by giving reasons. Distribution and marketing are inter-connected and intertwined functions. Bunching of inter-connected and continuous transactions is permissible, provided the said transactions can be evaluated and adequately compared on aggregate basis. This would depend on the method adopted and comparability analysis and the most reliable means of determining arm s length price. To assert and profess that brand building as equivalent or substantial attribute of advertisement and sale promotion would be largely incorrect. It represents a coordinated synergetic impact created by assortment largely representing reputation and quality. Brand has reference to a name, trademark or trade name and like goodwill is a value of attraction to customers arising from name and a reputation for skill, integrity, efficient business management or efficient service. Brand creation and value, therefore, depends upon a great number of facts relevant for a particular business. It reflects the reputation which the proprietor of the brand has gathered over a passage or period of time in the form of widespread popularity and universal approval and acceptance in the eyes of the customer. Brand value depends upon the nature and quality of goods and services sold or dealt with. Quality control being the most important element, which can mar or enhance the value. Parameters specified of the order dated 23rd January, 2013 in the case of L.G. Electronics India Pvt Ltd (supra) are not binding on the assessed or the Revenue. The bright line test has no statutory mandate and a broad-brush approach is not mandated or prescribed. We disagree with the Revenue and do not accept the overbearing and orotund submission that the exercise to separate routine and non-routine AMP or brand building exercise by applying bright line test of non-comparables should be sanctioned and in all cases, costs or compensation paid for AMP expenses would be NIL , or at best would mean the amount or compensation expressly paid for AMP expenses. It would be conspicuously wrong and incorrect to treat the segregated transactional value as NIL when in fact the two AEs had treated the international transactions as a package or a single one and contribution is attributed to the aggregate package. Unhesitatingly, we add that in a specific case this criteria and even zero attribution could be possible, but facts should so reveal and require. To this extent, we would disagree with the majority decision in L.G. Electronics India Pvt. Ltd. (supra). This would be necessary when the arm s length price of the controlled transaction cannot be adequately or reliably determined without segmentation of AMP expenses. The Assessing Officer/TPO for good and sufficient reasons can de-bundle interconnected transactions, i.e. segregate distribution, marketing or AMP transactions. This may be necessary when bundled transactions cannot be adequately compared on aggregate basis.When segmentation or segregation of a bundled transaction is required, the question of set off and apportionment must be examined realistically and with a pragmatic approach. Transfer pricing is an income allocating exercise to prevent artificial shifting of net incomes of controlled taxpayers and to place them on parity with uncontrolled, unrelated taxpayers. The exercise undertaken should not result in over or double taxation. Thus, the Assessing Officer/TPO can segregate AMP expenses as an independent international transaction, but only after elucidating grounds and reasons for not accepting the bunching adopted by the assessed, and examining and giving benefit of set off. Section 92(3) does not bar or prohibit set off. CP Method is a recognised and accepted method under Indian transfer pricing regulation. It can be applied by the Assessing Officer/TPO in case AMP expenses are treated as a separate international transaction, provided CP Method is the most appropriate and reliable method. Adoption of CP Method and computation of cost and gross profit margin comparable must be justified.The object and purpose of Transfer Pricing adjustment is to ensure that the controlled taxpayers are given tax parity with uncontrolled taxpayers by determining their true taxable income. Costs or expenses incurred for services provided or in respect of property transferred, when made subject matter of arm s length price by applying CP Method, cannot be again factored or included as a part of inter-connected international transaction and subjected to arm s length pricing. Transfer pricing adjustment made on account of payment of royalty - Held that - The finding of the Tribunal that the question of payment of Royalty cannot be determined on the basis of profitability or earnings was upheld as once it is accepted that knowhow was provided the same cannot be questioned. Suitable profits relatable it was not held to relevant by approving the finding of the Tribunal. The justification given by the assessee for explaining lower profits claimed to be on account of bad debt, high rent, increase in legal costs etc. accepted by the Tribunal was also not interfered by the Hon ble High Court. The said issue in para 197 has been answered against the Revenue. Accordingly we find that the stand of the Revenue that the issue can be decided at this stage cannot be accepted when examined from any angle as the facts will need to be considered afresh at length by the TPO on the basis of agreements and facts and evidences on the record in the light of the direction of the Hon ble High Court. It is unfortunate that none of these facts were addressed by the Revenue. Even the opportunity so provided after the inappropriate behaviour of a duly appoint standing counsel who obdurately abdicated his onerous responsibility was followed by ill prepared representation by the Revenue as addressed in para 7 above where the entire responsibility to address the Court meaningfully was evidently shirked by the Revenue. Serious note of the casual manner of representation by the Revenue needs to be taken note of and addressed. Courts functioning cannot be allowed to be curtailed at whims and fancies of the officers reluctant to assist the Court. Accountability for the unseemly and inappropriate representation may need to be fixed. Legal and professional expenses disallowed - Held that - It can be seen from the detail of the expenditure extracted herein above from the DRP s order that the said expenditure cannot be considered to be legal and professional charges and the argument that it is related to the business of the assessee appears to be correct as per the narrations extracted in the order. However the claim cannot be decided in terms of the narrations given by the assessee and since the primary vouchers in support of the narrations given are claimed to be available and infact were made available in the assessment proceedings the issue is restored back to the file to the TPO who may consider the allowability of the same in accordance with law after giving the assessee a reasonable opportunity of being heard. - Decided in favour of assessee for statistical purposes.

Summary

Issues Involved:
1. Validity of the assessment order under Section 143(3) read with Section 144C of the Income Tax Act, 1961.
2. Transfer Pricing Adjustment on Advertisement, Marketing, and Sales Promotion (AMP) expenses.
3. Disallowance of legal and professional expenses.
4. Levy of interest under Section 234B and Section 234C of the Income Tax Act.

Issue-wise Detailed Analysis:

1. Validity of the Assessment Order:
The assessee challenged the assessment order framed by the AO under Section 143(3) read with Section 144C, claiming it was bad in law, violative of natural justice, and void ab initio. The AO computed the income at Rs. 72,76,13,235 against the returned income of Rs. 19,66,32,480.

2. Transfer Pricing Adjustment on AMP Expenses:
The DRP/TPO made a transfer pricing adjustment of Rs. 52,98,12,391 related to AMP expenses. The assessee argued that the AMP expenses incurred unilaterally could not be regarded as a 'transaction' without any understanding/arrangement with the associated enterprise (AE). The DRP/TPO's characterization of AMP expenses as an international transaction under Section 92B was disputed, as was the assertion that the expenses resulted in the promotion of the AE's brand, creating marketing intangibles. The assessee contended that the AMP expenses did not create any marketing intangibles and any benefit to the AE was incidental. The DRP's reliance on the Special Bench decision in the L.G. Electronics case, which was later found erroneous by the High Court, was also challenged. The High Court in the Sony Ericson case criticized the broad-brush approach of the Special Bench and emphasized the need for a detailed functional analysis and appropriate method selection for benchmarking AMP expenses. Consequently, the ITAT restored the issue to the AO/TPO for fresh consideration in light of the High Court's directions.

3. Disallowance of Legal and Professional Expenses:
The AO disallowed Rs. 11,68,364 out of the total legal and professional expenses of Rs. 4,93,05,419 on an ad-hoc basis. The DRP upheld this disallowance, citing that the expenses were not in the nature of legal and professional charges. The assessee argued that these expenses were business-related and should be allowed. The ITAT restored the issue to the AO for re-examination of the allowability of these expenses, directing a fresh review of the primary vouchers and evidence.

4. Levy of Interest under Section 234B and Section 234C:
The assessee contested the levy of interest under Sections 234B and 234C, which was noted as consequential and did not require specific adjudication.

Conclusion:
The ITAT allowed the appeal for statistical purposes, restoring the issues of transfer pricing adjustments on AMP expenses and disallowance of legal and professional expenses to the AO/TPO for fresh consideration. The stay petition filed by the assessee was rendered infructuous. The order was pronounced in the open court on 22nd April 2015.