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TMI Blog2015 (10) TMI 1008X X X X Extracts X X X X X X X X Extracts X X X X ..... sment proceedings, it was noticed that the assessee reported certain international transactions with its associated enterprises (AEs) which are enlisted hereunder :- Sr. No. Nature of Transaction Method Value of transaction (Rs.) 1 Purchases of products, spares, promotional and other supplies RPM 1,59,06,94,564 2 Purchase of fixed assets TNMM 3,09,931 3 Sales and service support income TNMM 1,19,11,847 4 Commission income TNMM 17,51,40,980 5 Purchase of fixed assets CUP 16,74,880 6 Cost of reimbursements received CUP 2,29,50,609 7 Cost of reimbursements paid CUP 28,54,154 2.3 The assessee employed the Transactional Net Margin Method (TNMM) in respect of three international transactions; the Comparable Uncontrolled Price (CUP) method in respect of three transactions; Resale Price Method in respect of one international transaction. On a reference made by the AO for determining the arm's length price (ALP) of the international transactions, the TPO noted that for (i) Purchase of fixed assets (ii) Sales and service support income (iii) Commission income, the assessee had used transactional net margin method ("TNMM") as the most appropriate m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rring expenditure on advertisement marketing and promotional activities (AMP), was developing marketing intangible for Nikon Japan. The TPO, for benchmarking the AMP expenditure, took the following companies as comparable and rejected the other companies by stating that some of these companies are either developing brands or are not comparable companies. For benchmarking the AMP expenditure, we require companies which are not developing brands. Hence, only following companies can be taken as comparable: Sr.No. Company name Sales AMP AMP% 1 Allied Photographics India Ltd. 11.08 0.4 3.61 2 CCS Infotech Ltd. 63.79 0.53 0.83 3 CompuageInfocom Ltd. 1087.8 0 0.00 4 Computer Point Ltd. 116.17 0.03 0.03 5 Empower India Ltd. 67.67 0 0.00 6 MVL Industries Ltd. 437.51 0.49 0.11 7 Mobile Telecommunications Ltd. 55.32 0.15 0.27 8 Salora international ltd. 524.55 3.45 0.66 Average 0.69 2.7 The TPO computed the mean of the "expenditure incurred on AMP/Sales" of such comparable companies is the "bright line". Any expenditure in excess of the bright line is for the development of marketing intangible (which is owned ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of sales) Rs. 1,40,67,260/- AMP expenses actually incurred Rs. 37,62,75,469/- AMP expenditure which should have been reimbursed Rs. 36,22,08,209/- Mark-up @ 18.36% Rs. 6,65,01,427/- Adjustment u/s 92CA Rs. 42,87,09,637/- 2.12 The Assessee in its reply dated 03.01.2014 raised the following contentions :- (i) AMP expense is not an international transaction (ii) Benefit of AMP expenditure accrue to the assessee only and so expenditure is wholly and exclusively for assessee's business - No disallowance u/s 37(1) possible (iii) Any benefit to AE is incidental in nature (iv) Arguments on the use of 'Bright line' concept (v) India's position as stated in UN transfer pricing manual needs to be applied (vi) Assessee has a long term royalty free distribution right (vii) Selling expenses (expense in connection with sales) should be excluded from AMP expenses (viii) Quantitative adjustments to be made to determine the value of AMP expenditure/Sales ratio. (ix) Choice of comparables for determining bright line is not correct (x) Mark up charged on the AMP amount above bright line is incorrect, 2.13 Further, after considering the assessee's reply, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tions Ltd. 13.11% 3 Cyber Media Research Ltd. 14.85% Average 12.21% 2.15 Further, a mark-up of 6% was proposed to be charged to cover the return on funds that have been blocked and remuneration for the services provided, i.e. interest rate of 12% on half of funds which should have been reimbursed. The assessee contended the same and as per the inter-company agreement, Nikon India is allowed a credit period of 60 days. As per the agreement, if the company pays beyond 60 days, then an interest rate of LIBOR +2% would be charged. However, it is noted that the AE has not charged any interest on the outstanding amount. In view of the assessee's explanation, interest mark-up of 6% was not charged and total mark-up 12.21% was computed . 2.16 After taking into account the above arguments, the ld. TPO computed the arm's length price of value of the remuneration for services at Rs. 40,64,33,832/- which is shown as under :- Total Sales Rs.203,87,33,264/- Arm's length level of AMP expense (0.69% of sales) Rs. 1,40,67,260/- AMP expenses actually incurred Rs. 37,62,75,469/- AMP expenditure which should have been reimbursed Rs. 36,22,08,209/- Mark-up ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... wherein the Assessee acts as a long term, exclusive distributor and has the right to receive an arm's length compensation in case of any termination of the inter-company distribution agreement 4.4 disregarding detailed submissions made by the assessee to demonstrate that the AMP expenses incurred by the Assessee were in respect of its own business requirement/ considerations/ purposes and that all benefit resulting from such expenditure are to its own account 4.5 incorrectly computing the AMP expenses/ sales by treating the selling expenditure incurred by the Assessee as part of sales promotion expenditure 4.6 not providing quantitative adjustments to take into account the differences in comparability between the assessee and the companies selected for the Bright line analysis. Specifically, the Ld. TPO/AO have not provided for quantitative adjustment to account for: a. no payment for royalty made by the Assessee to the AE for the right to use the brand name/trademark b. differences in expenses incurred by the assessee visa vis comparable companies because of the introduction of new products by the Assessee when there were no similar economic facts applicable to the compan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t required to issue any direction on this ground at this stage and objection is therefore rejected as being premature." 2.20 Accordingly, ld. AO, as per the directions of Ld. DRP, passed the Final Assessment order dated 05.01.2015 upholding the adjustment made of Rs. 40,64,33,832/- by the ld. TPO in his order dated 29.01.2014 u/s 92CA of the Act. 3. Being aggrieved with the order of AO, the assessee is in appeal before us and has taken following grounds of appeal as under :- "1 That on the facts and circumstances of the case and in law, the AO has erred in assessing the total income of the appellant u/s 143(3) r.w.s. 144C(13) of the Income Tax Act, 1961 ("the Act") for the relevant assessment year at INR 40,41,40,545 as against the returned loss of INR 22,93,287/- 2 That on the facts and circumstances of the case and in law, the DRP/AO have erred in not appreciating that suo moto adjustments proposed by the TPO in relation to advertisement, marketing and promotion ("AMP") expenses incurred by the appellant, without any reference from the AO, was beyond jurisdiction and bad in law. 3 That on the facts and circumstances of the case and in law, the DRP/AO/TPO erred in making/upho ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ctions of appellant by passing a non speaking order, thus, the order passed is non est and bad in law. Without prejudice to the above grounds of the appellant that the AMP expenditure incurred by it does not constitute an international transaction under Chapter X of the Act, the appellant craves to raise following grounds of appeal on merits. 11 That on the facts and circumstances of the case and in law the DRP/AO/TPO erred in not appreciating that all the transactions of the appellant were established to be at arm's length by applying the Transactional Net Margin Method (TNMM) on entity-wide basis, and thereafter the AMP expenses cannot be alleged to be excessive, separately. 12 That on the facts and circumstances of the case and in law, the DRP/AO/TPO have erred in considering certain expenses which are inextricably linked to the product sales and did not lead to brand promotion and should have been excluded from the AMP expenditure at the outset, while benchmarking the alleged excessive AMP expenditure. 13 That on the facts and circumstances of the case and in law, the DRP/AO/TPO have erred in not granting the benefit of quantitative adjustments (such as non-paymen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion for determining the ALP of AMP expenses. In the ultimate analysis, the matter was sent back to the TPO for undertaking the exercise afresh in the light of its directions. Following the said order, various benches of the Tribunal decided several cases involving AMP expenses, restoring the matter to the file of AO/TPO for deciding this issue in conformity with the directions given by the Special Bench in LG Electronics India (P.) Ltd. (supra). Several assessees as well as the Revenue preferred their respective appeals before the Hon'ble High Courts against the tribunal orders following the Special bench order. A batch of such appeals led by Sony Ericsson Mobile Communications India (P.) Ltd. v. CIT [2015] 231 Taxman 113/55 taxmann.com 240 (Delhi) 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 India (P.) Ltd. (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. The Hon'ble High Court has held, inter alia, that the international ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t]; * Inter-connected international transactions can be aggregated and section 92(3) does not prohibit the set-off [Paras 80 & 81]; * AMP is a separate function. An external comparable should perform similar AMP functions. [Paras 165 &166] ; * Bright line test cannot be applied to work out non-routine AMP expenses for benchmarking [Para 194(x)]; * ALP of AMP expenses should be determined preferably in a bundled manner with the distribution activity [Paras 91, 121 & others] ; * For determining the ALP of these transactions in a bundled manner, suitable comparables having undertaken similar activities of distribution of the products and also incurring of AMP expenses, should be chosen [Paras 194(i), (ii), (viii) & others];T * 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arily concentrates on the quantitative aspects of the AMP expenses alone, it overlooks the examination of the AMP functions carried out by the assessee on one hand and the comparables on the other. Now, the Hon'ble High Court in Sony Ericsson Mobile Communications India (P.) Ltd. (supra) has held that AMP expense is a separate international transaction and also bright line test is not applicable for determining the ALP of AMP expenses. The manner for the determination of the ALP of the distribution activity and AMP activity has also been set out by the Hon'ble High Court to be conducted, firstly, in a bundled manner by considering the distribution and AMP functions performed by the assessee as well as the probable comparables, and if probable comparables having performed both the functions are not available, then to determine the ALP of AMP expenses in a segregated manner. As such, it becomes immensely important to separately examine the distribution and AMP functions undertaken by the assessee as well as probable comparables. It is vital to highlight the difference between the AMP expenses and AMP functions. Whereas the AMP functions are the means by which the AMP activity ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... itable adjustment should be made to the profits of the comparable so as to counterbalance the effect of such differences. If however differences exist in such functions, but no adjustment can be made, then, such probable comparable should be dropped from the list of comparables. If, in doing this exercise, there remains no company doing comparable distribution and AMP functions, then, both the international transactions are required to be segregated and then examined on individual basis by finding out probable comparables doing such separate functions similarly. For the international transaction of AMP spend, this can be done by, firstly, seeing the AMP functions actually performed by the assessee and then comparing it with the AMP functions performed by a probable comparable. If both are found out to be similar, then the matter ends and a comparable is found and one can go ahead with determining the ALP of such a transaction. If the AMP functions performed by the two entities are found to be different, then adjustment is required to be made in the case of a probable comparable, so as to make it uniform with the assessee. The assessee may have possibly done, say, four different AMP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e, RP Method should not be adopted. If on comparable analysis, including AMP expenses, gross profit margins match or are within the specified range, no transfer pricing adjustment is required. In such cases, the gross profit margin would include the margin or compensation for the AMP expenses incurred. Routine or non-routine AMP expenses would not materially and substantially affect the gross profit margins when the tested party and the comparable undertake similar AMP functions." Thus it is manifest that comparison of AMP functions is vital which cannot be dispensed with. Let us we go a step further with the alternative prescription of the judgment that if ALP of both the transactions of Distribution and AMP cannot be determined in a combined manner, then the ALP of AMP function should be separately done. The submission advanced by the assessee of considering the profit on an entity level without making comparison of AMP functions done by the assessee as well as the comparable, will render this alternative approach incapable of compliance. Canvassing such a view amounts to treating AMP spend as a non-international transaction, which is patently incapable of acceptance. 8. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... needs to be done in the facts of the present case. For ready-reference, we reproduce the aforesaid hereunder:- "162. In the case of Reebok India Co. Ltd., the assessee has applied RS Method using internal comparable. Contrary to the general rule, the internal comparable possibly may not be appropriate when the assessed has incurred considerable (not necessarily extra-ordinary or non-routine) AMP expenses. The reason is obvious; there is no comparability analysis possible. In such cases, it is not possible to examine and compare the functional comparability between the controlled tested transaction and uncontrolled internal party transaction on account of AMP expenses. Internal comparable would not account for the credible gross profit rate, which an AE should be ensured when it incurs AMP expenses. Functionally the comparable is merely a manufacturer and thus, the said function is compared. AMP expenses do not get factored and compared. As an abundant caution, we would still add that where adjustments clause (iv) can give reliable and accurate results, internal comparables could still be applied. This would likely happen, when AMP expenses are insignificant in quantum. 163. Thus ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... risk assumed. It is at stage (iv) of the RP Method that the Assessing Officer/TPO can make adjustments if he finds that an assessee has incurred substantial AMP expenses in comparison to the comparables. Once adjustments are made, then the appropriate arm's length price can be determined. In case, it is not possible to make adjustments, then RP Method may not be the most appropriate and best method to be adopted. 167. Before us, the Revenue has not pleaded or submitted that the RP Method should not have been adopted. The TPO and the Assessing Officer did not reject the RP Method adopted by the assessee. The assessed submit that the Revenue accepts functional parity and in fact, without adjustment. Contra, Revenue would argue that the Assessing Officer/TPO and the Tribunal have adopted and applied the CUP Method for determining arm's length price of AMP expenses. We do not pronounce a firm and final opinion on the said lis as it should be at first examined by the Tribunal. 168. The Tribunal has upheld adoption of CP Method after applying 'bright line test' in the case of Reebok India Co. Ltd. and Canon India Pvt. Ltd. The 'bright line test' adopted to demar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n of the AMP functions performed by the assessee and comparables and then making an adjustment, if any, due to differences between the two, so that the AMP functions performed by the assessee and comparable are brought to a similar platform. In fact, this is also the prescription of Rule 10B(1)(e), which provides as under :- "(e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base ; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base ; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could mat ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e material effects of such differences. 13. On a comparative reading of sub-rules (1), (2) and (3) of Rule 10B, it becomes palpable that the international transaction and the uncontrolled transaction with which comparison is sought to be made for determining the ALP, in the first instance, must have overall similar characteristics. It is vivid that if the goods/services are different, then no effective comparison can be made. Once the goods/services under both the transactions are broadly similar but there is a difference in them because of certain specific characteristics; and/or the products/services in both the transactions are identical, but still there are certain differences due to the contractual terms or the geographical location, etc., then, a reasonably accurate adjustment should be made for eliminating the material effects of such differences so as to bring the international transaction and the comparable uncontrolled transaction on the same podium. If due to one reason or the other, no reasonable accurate adjustment can be made due to such differences, then, such uncontrolled transaction should not be considered as a comparable transaction. 14. It is discernible that ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on of AMP expenses on separate basis, a proper set off, if any, available from the distribution activity, should be allowed. 16. The AR of the assessee stressed that AMP functions of the comparables have been examined by the TPO in this case. On being asked to show the examination of AMP functions of the assessee along with comparables, the AR took our attention to pages 7-8 of TPO order but those were only figures of expenditure of AMP incurred by the comparables and NOT the functional analysis of the comparable done by the TPO 17. Without prejudice to his aforementioned arguments, ld. counsel further submitted that, in any view of the matter, while determining the AMP expenditure, the components relating to selling and distribution expenses have to be excluded. In view of decision of Hon'ble Delhi High Court in the case of Sony Ericsson Mobile Communications India (P.) Ltd. (supra), ld. counsel submitted that in order to determine the AMP functions performed by assessee vis-a-vis comparables, then the matter should be restored back to the file of ld. TPO with following direction that Selling and distribution expenses to be excluded as has been held by Hon'ble Delhi High ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... set aside the impugned order and remit the matter to the file of the AO/TPO for deciding it afresh as per law. In this fresh exercise, the TPO will follow the parts of the judgment in Sony Ericsson Mobile Communication (P.) Ltd. (supra) as are common to both Manufacturers and Distributors; apply the parts of the judgment as are applicable to a 'Manufacturer'; and ignore the parts of the judgment which pertain exclusively to a 'Distributor'. Needless to say, the assessee will be allowed a reasonable opportunity of hearing in such fresh proceedings." 2. 58 taxmann.com 375 (Del) Casio India Co. (P.) Ltd. v. DCIT "15. Coming back to the facts of the instant case, we find that no detail of the AMP functions performed by the assessee is available on record. Similarly, there is no reference in the order of the TPO to any AMP functions performed by comparables. In fact, no such analysis or comparison has been undertaken by the TPO because of his applying the bright line test for determining the value of the international transaction of AMP expense and then applying the cost plus method for determining its ALP. The ld. AR also failed to draw our attention towards any mate ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... coming judgment which is not in existence at the time of giving direction. A direction can be given by a higher authority to the lower authority to follow only such a decision which is available for consideration at the time of giving direction by the higher authority. There can be no direction to follow a decision, which itself has not yet seen the light of the day at that point of time. Presently, we have the benefit of the judgment of the Hon'ble Delhi High Court in Sony Ericsson (supra), which has also dealt with the treatment to be given in the context of a manufacturer. The Delhi bench of the tribunal in some decisions including Perfetti Van Melle India (supra) has dealt with the manner of computation of the ALP of the AMP expenses incurred by manufacturers in the light of the judgment in the case of Sony Ericsson (supra). No reasons, except the pendency of the matter in the Hon'ble High Court in assessee's own case, have been given by the ld. AR to claim departure from the view taken by the tribunal in earlier cases. We, therefore, turn down the request of the ld. AR in this regard. With these observations, we send the matter back to the file of TPO/AO for a fres ..... X X X X Extracts X X X X X X X X Extracts X X X X
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