2020 (9) TMI 319 - AT - Income Tax

TP Adjustment - addition on account of AMP expenditure incurred by the taxpayer in a trading segment as well as network segment - TPO used the intensity approach by comparing the VAE (Value Added Expenditure)/Sales ratio of each comparable with that of the taxpayer - HELD THAT - We are of the considered view that merely by applying the BLT method which has no legal existence and merely on the basis of MDF agreement vide which taxpayer has received part reimbursement of the AMP expenses incurred by it duly disclosed this expenditure in Form 3CEB and in TP study, so called excessive AMP expenditure of the taxpayer cannot be treated as international transactions u/s 92B of the Act. So, we cannot infer the existence of international transactions qua AMP expenses between taxpayer and AE beyond the reimbursement already made by the AE under MDF Agreement. TPO by adopting the intensity approach qua trading segment and network segment proceeded to make alternative benchmarking as a substantive adjustment. In AY 2012-13, similar adjustment was made by the ld. TPO by adopting the intensity approach which was held not to be sustainable by the coordinate Bench of the Tribunal for AY 2012-13 order 2020 (1) TMI 404 - ITAT DELHI in taxpayer s own case by following the order passed by the coordinate Bench of the Tribunal in taxpayer s own case in earlier years. Scope and value of the international transactions cannot be extended to the so-called excessive expenditure incurred by the taxpayer on account of nonroutine AMP beyond the reimbursement already received by the taxpayer under MDF agreement and as such, adjustment made by the TPO on account of AMP expenses is not sustainable in the eyes of law, hence ordered to be deleted. Comparable selection - Functional dissimilarity - HELD THAT - OTS E-Solutions Private Ltd. (OTSE) is a routine distributor/supply chain shows that the functions performed, risk assumed and expected reward is not comparable to the taxpayer. The taxpayer is also performing critical functions such as quality control and post sale/warranty support as a routine distributor whereas OTSE being an aggregator provides a platform for sale of electronic products of multiple brands and as such having a different business model vis- -vis taxpayer having routine buy-sell model. So, in these circumstances, we are of the considered view that OTSE is not a suitable comparable vis- -vis the taxpayer hence ordered to be excluded. Exclusion of Sataytej as a comparable on ground of different business profile as well as on the ground that the TPO has resorted to cherry picking by using Sataytej and at the same time, rejected other comparables, namely, ADS Diagnostics Ltd., Advanced Micronic Devices Ltd. and Frontline Electro Medical Ltd. on the same reasoning that these comparables are engaged in sale of medical equipments - Sataytej is into the sale of surgical and medical equipment which is not comparable to taxpayer. Even otherwise, when the taxpayer has himself rejected other 3 comparables on the ground that those comparables are engaged in sale of medical equipments which is not comparable to the business of the taxpayer, he is required to adopt the principle of consistency. However, since it is a factual issue the same must be reexamined by the TPO. So, this comparable is remitted back to the TPO to examine afresh after providing an opportunity of being heard to the taxpayer. Spice Mobility Ltd - DRP have rejected this comparable on the ground that it fails different financial year ended filter. We are of the considered view that no comparable can be rejected merely on the ground that its financial year is different particularly when result can be extrapolated using quarterly results. This position of law has not been disputed by the ld. DR for the Revenue. So, in these circumstances, this comparable is also remitted back to the ld. TPO to decide afresh by proving an opportunity of being heard to the taxpayer and shall provide necessary data to extrapolate the results by using quarterly results. Incorrect Margin computation by taxpayer of comparables - Since this is a factual aspect and taxpayer s computation stated to be consistent throughout in the earlier years and accepted by the ld. TPO, the issue is remitted back to the TPO to decide afresh after providing an opportunity of being heard to the taxpayer. Working capital adjustment - DRP allowed the working capital adjustment to the taxpayer but TPO at the time of giving effect to the ld. DRP order has failed to grant the working capital adjustment. The taxpayer has already given the detailed working capital calculation before the TPO as well as DRP, as is evident, during the TP as well as DRP proceedings. Working capital adjustment was also granted to the taxpayer consistently from AYs 2005-06 to 2011-12. So, in these circumstances, TPO is directed to grant the working capital adjustment to the taxpayer after due verification. Adjustment made to the proportion of international transactions with AE - HELD THAT - Since this is a factual issue not controverted by the ld. DR for the Revenue the issue is remitted back to the TPO to make correct computation of proportionate adjustment of international transactions of the taxpayer with its AE after providing an opportunity of being heard to the taxpayer. Disallowance of salary expenditure paid to the expatriate employee of SEC, Korea u/s 37(1) - HELD THAT - This issue is covered in case of taxpayer s parent company, SEC, Korea 2018 (3) TMI 1206 - ITAT DELHI . In these circumstances, disallowance made by the AO and accepted by the ld. CIT (A) is ordered to be deleted.

Summary

Issues Involved:
1. Total income assessment error.
2. Transfer pricing adjustment on AMP expenses.
3. Disallowance of salary expenditure for expatriate employees.
4. Substantive adjustment in AMP expenses.
5. Classification of AMP expenses as international transactions.
6. Non-demonstration of an 'understanding' or 'arrangement' for AMP spend.
7. Creation of marketing intangibles and compensation for AMP expenses.
8. Adoption of intensity-based approach.
9. Application of mark-up on AMP adjustment.
10. Duplicative adjustment for AMP expenses.
11. TNMM application inconsistency.
12. AMP expenditure in the networking segment.
13. Inclusion of value-added expenses in AMP.
14. Exclusion of sales-related expenses from AMP.
15. Modification of comparable set.
16. Incorrect computation of margins.
17. Protective adjustment using the Bright Line Test (BLT).
18. Protective adjustment when substantive adjustment exists.
19. Application of the BLT.
20. Further mark-up on AMP expenses.
21. Adjustment in the trading segment.
22. Incorrect margin computation.
23. Foreign exchange gain classification.
24. Denial of working capital adjustment.
25. Incorrect computation of proportionate adjustment.
26. Disallowance of salary expenditure for expatriate employees.
27. Employer-employee relationship for expatriate employees.
28. Expatriate employees working for the taxpayer.
29. Interest under Sections 234B and 234C.
30. Penalty proceedings under Section 271.

Detailed Analysis:

1. Total Income Assessment Error:
The taxpayer contested the assessment of total income at ?56,44,23,32,210/- against the returned income of ?40,66,96,11,000/-. This issue was general and required no specific adjudication.

2. Transfer Pricing Adjustment on AMP Expenses:
The TPO made a transfer pricing adjustment of ?1409,51,89,261/- for AMP expenses and international transactions in the trading segment, alleging they were not at arm's length. The taxpayer argued that these expenses were focused on generating domestic sales and any benefit to the AE was incidental.

3. Disallowance of Salary Expenditure for Expatriate Employees:
The AO disallowed ?167,75,31,950/- incurred for expatriate employees under section 37(1), arguing no employer-employee relationship existed with the taxpayer. The Tribunal found the expatriate employees were engaged under local contracts and the salary was paid in India with tax deducted under section 192.

4. Substantive Adjustment in AMP Expenses:
The TPO made a substantive adjustment of ?802,61,48,069/- for AMP expenses using the intensity-based approach. The Tribunal noted that this approach was not a prescribed method under the Income-tax Rules, 1962.

5. Classification of AMP Expenses as International Transactions:
The TPO held that AMP expenses incurred by the taxpayer were international transactions. The Tribunal found no evidence of an arrangement or understanding between the taxpayer and AE for AMP spend.

6. Non-Demonstration of an 'Understanding' or 'Arrangement' for AMP Spend:
The TPO did not demonstrate the existence of an 'understanding' or 'arrangement' for AMP spend. The Tribunal ruled that mere reimbursement under the MDF agreement did not constitute an international transaction.

7. Creation of Marketing Intangibles and Compensation for AMP Expenses:
The TPO held that AMP expenses led to the creation of marketing intangibles, requiring compensation from the AE. The Tribunal found this approach unsustainable as there was no evidence of such an arrangement.

8. Adoption of Intensity-Based Approach:
The TPO adopted the intensity-based approach for AMP adjustment. The Tribunal rejected this method, citing previous decisions that found it invalid for determining AMP expenses.

9. Application of Mark-Up on AMP Adjustment:
The TPO applied a mark-up on AMP adjustment. The Tribunal found this inappropriate as the AMP expenses were not considered international transactions.

10. Duplicative Adjustment for AMP Expenses:
The TPO made a duplicative adjustment for AMP expenses already included in the arm's length determination of the trading segment. The Tribunal found this approach unsustainable.

11. TNMM Application Inconsistency:
The TPO's application of TNMM was inconsistent with the taxpayer's method. The Tribunal found that no separate arm's length analysis was required for AMP expenses under TNMM.

12. AMP Expenditure in the Networking Segment:
The TPO made an adjustment for AMP expenditure in the networking segment, where the taxpayer operated under a B2B model. The Tribunal found no AMP activities in this segment.

13. Inclusion of Value-Added Expenses in AMP:
The TPO included all value-added expenses in AMP. The Tribunal found many of these expenses were operational and not related to brand promotion.

14. Exclusion of Sales-Related Expenses from AMP:
The TPO did not allow the exclusion of sales-related expenses from AMP. The Tribunal found that such exclusions were allowed in prior years.

15. Modification of Comparable Set:
The TPO modified the comparable set, including companies not comparable to the taxpayer. The Tribunal found this approach incorrect and remitted the issue for re-examination.

16. Incorrect Computation of Margins:
The TPO incorrectly computed the margins of the taxpayer and comparables. The Tribunal remitted the issue for correct computation.

17. Protective Adjustment Using the Bright Line Test (BLT):
The TPO made a protective adjustment using BLT. The Tribunal found BLT invalid for determining AMP expenses.

18. Protective Adjustment When Substantive Adjustment Exists:
The TPO made a protective adjustment despite a substantive adjustment. The Tribunal found this approach unsustainable.

19. Application of the BLT:
The TPO applied BLT to identify AMP transactions. The Tribunal found BLT had no statutory mandate and was invalid.

20. Further Mark-Up on AMP Expenses:
The TPO levied a further mark-up on AMP expenses. The Tribunal found this approach inappropriate.

21. Adjustment in the Trading Segment:
The TPO made an adjustment of ?606,90,41,192/- in the trading segment by rejecting the Resale Price Method and applying TNMM. The Tribunal remitted the issue for re-examination.

22. Incorrect Margin Computation:
The TPO incorrectly computed the margins of the taxpayer and comparables. The Tribunal remitted the issue for correct computation.

23. Foreign Exchange Gain Classification:
The TPO classified foreign exchange gain as non-operating. The Tribunal remitted the issue for re-examination.

24. Denial of Working Capital Adjustment:
The TPO denied working capital adjustment. The Tribunal directed the TPO to grant the adjustment after verification.

25. Incorrect Computation of Proportionate Adjustment:
The TPO incorrectly computed the proportionate adjustment. The Tribunal remitted the issue for correct computation.

26. Disallowance of Salary Expenditure for Expatriate Employees:
The AO disallowed salary expenditure for expatriate employees. The Tribunal found the disallowance unsustainable and ordered its deletion.

27. Employer-Employee Relationship for Expatriate Employees:
The AO argued no employer-employee relationship existed. The Tribunal found the expatriate employees were engaged under local contracts and the salary was paid in India with tax deducted under section 192.

28. Expatriate Employees Working for the Taxpayer:
The AO argued expatriate employees were not working exclusively for the taxpayer. The Tribunal found they were working under the taxpayer's control.

29. Interest Under Sections 234B and 234C:
The issue was consequential and required no specific findings.

30. Penalty Proceedings Under Section 271:
The issue was consequential and required no specific findings.

Conclusion:
The Tribunal allowed the taxpayer's appeal for statistical purposes, remitting several issues for re-examination and directing the deletion of disallowances and adjustments found unsustainable. The Tribunal emphasized the need for evidence and adherence to legal principles in transfer pricing adjustments and disallowances.