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TMI Blog2015 (6) TMI 130X X X X Extracts X X X X X X X X Extracts X X X X ..... ter Fruit, Center Shok, Chater Patar, Chlor-mint, Choco-tella, Cofitos, Happydent White, Protex Happydent, Marbels, Mentos, etc. The assessee reported 14 international transactions, which have been enlisted on page 2 of the order passed by the Transfer Pricing Officer (TPO). The assessee employed the Transactional Net Margin Method (TNMM) in respect of six international transactions; the Comparable Uncontrolled Price (CUP) method in respect of three transactions; Cost Plus Method in respect of one international transaction; and no method for four international transactions of Reimbursement of expenses by AEs, Reimbursement of SAP licence, Reimbursement of IT support services and Reimbursement paid to AEs. On a reference made by the AO for determining the arm's length price (ALP) of the international transactions, the TPO accepted all the reported international transactions at ALP. He, however, noticed that the assessee incurred Advertisement, Marketing and Promotion (AMP) expenses to the tune of Rs. 183,73,82,000/-. To determine the ALP of the international transaction of AMP expenses, the TPO chose certain comparable companies. By applying the bright line test, he worked out ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... batch of appeals in relation to `Distributors' (not Manufacturers) led by Sony Ericson Mobile Communications India Pvt. Ltd. Vs. CIT 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 (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. Dealing with the computation of ALP of such transactions by a Distributor, the Hon'ble High Court has held, inter alia, that the international transaction of AMP expenses should be bundled/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. The Hon'ble High Court held that where the TNMM has been applied as the most appropriate method by a Distributor, which method has not been disturbed by the TPO, then, the international transaction of AMP and distribution activities should be clubbed. It further held that for determining the ALP of such transactions u ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sen [Paras 194(i), (ii), (viii) & others]; * 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]. 7. The bright line test, disapproved by the Hon'ble High Court, primarily co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction, which, in our considered opinion, is contrary to the verdict of the Hon'ble Delhi High Court in Sony Ericsson (supra). 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... judgment in the case of Sony Ericson Mobile (supra) is that the two international transactions of 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 nowhere 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 165 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 si ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rket ; (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.' 9. A perusal of the sub-clause (iii) of this Rule divulges that net profit margin under a comparable uncontrolled transaction as determined under sub-clause (ii) should be: "adjusted to take into 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). 10. Sub-rule (2) of Rule 10B provides that 'for the purposes of subrule (1)', the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely - (a) the specific characteristics of the property transferred or services provided in either transaction ; (b) the funct ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... at the prescription of Rule 10B is in complete harmony with the ratio of the judgment in the case of Sony Ericson Mobile (supra), to the effect that the AMP functions carried out by the assessee are required to be necessarily compared with the AMP functions carried out by a comparable entity in determining the AMP of ALP expenses. Difference between the functions, if capable of adjustment, should be given effect to in the profit rate of the comparable and if such difference cannot be given adjusted, then, the probable comparable should be eliminated. 13. We have noticed above that the assessee is a `Manufacturer' and not a `Distributor'. The judgment in the case of Sony Ericson Mobile (supra) deals with a case of Distributor, though the initial discussion about the character of AMP spend as an international transaction and the jurisdiction of the TPO etc. are common to a distributor and also a manufacturer. Similarly there are some other observations in this judgment, which are common to both. Though this judgment lays down at length some broader principles for the determination of ALP of AMP expenses in the case of a `Distributor', still certain principles dealing exclusively wit ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t the application of TNM Method is not appropriate and proper in case the assessee is engaged in manufacturing activities. In such circumstances, the import of raw material for manufacture would be an independent international transaction viz. marketing and distribution activities or functions. The core of the above para is that in the case of a `Manufacturer', the international transactions concerned with the manufacturing activity cannot be aggregated with the AMP activities as both are separate and distinct. Once both are held to be separate and TNMM is not to be applied, the only thing which remains is that the AMP transaction should be separately and independently processed under the Chapter X of the Act as per any suitable method (other than TNMM) including Cost plus method, but by excluding the selling expenses from the overall base of AMP expenses. 15. Turning to the facts of the case, we find that the TPO/AO have followed the Special bench decision in LG Electronics (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 ..... X X X X Extracts X X X X X X X X Extracts X X X X
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