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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 ..... , 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 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 material divulging the AMP functions performed by the assessee as well as comparables. As such, we are handicapped to determine the ALP of AMP expenses at our end, either in a combined or a separate approach. Under such circumstances, we set aside the impugned order and send the matter back to the file of the TPO/AO for determining the ALP of the international transaction of AMP spend afresh in accordance with the manner laid down by the Hon'ble High Court in Sony Ericsson Mobile Communications India (P.)Ltd. (2015 (3) TMI 580 - DELHI HIGH COURT). ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 method with operating profit/sales as the profit level indicator and selected the following comparable companies in the TP study to benchmark its international transactions: Sr.No. Name of the comparable company Gross Margin(%) OP/Sales (%) 1 Allied Photographics India Ltd. 9.83 0.85 2 CCS Infotech Ltd. 6.31 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... brands of the AEs and for developing marketing intangibles have been benchmarked by aggregating with the other transactions in different business segments which have been analyzed under RPM/TNMM without any further analysis. 2.6 The TPO after considering the TP documentation observed that the assessee, by incurring 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... es having different financial year (iv) Reject companies where turnover is less than ₹ 1 Crore (v) Select companies where the ratio of service income to total income is at least 75% (vi) Reject companies where related party transactions exceed 25% of sales (vii) Reject companies that have employee cost less than 25% of total cost (viii) Reject companies that have interest cost more than 25% of total cost (ix) Reject companies that are affected by some peculiar economic circumstances (x) Select companies providing advertising and marketing services 2.10 Based on the search process, following comparables were selected for the mark-up on AMP services: Sr. No. Company name OP/OC (w/o FX) 1 Crystal Hues Ltd. 9.10% 2 Quadrant Communications Ltd. 13.11% 3 Cyber Media Research Ltd. 14.85% Average 12.36% 2.11 The TPO further computed the opportunity cost for the funds blocked by the a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the assessee is working for the benefit of AE by promoting its brand by making excessive AMP expenditure for penetration of brands in India which is much more than the functionally comparable companies taken by the assessee. (Para 9.4 of the TPO order) (iv) The payment for additional functions is deferred till the termination and not given in the due course regularly. Secondly, the royalty might have been embedded in the price of the product that the assessee is importing from the AE. (Para 10.3 of the TPO order) (v) The benefit of AE is significant and only incidental benefit is received to the asessee. (Paras 11.8, 11.9, 11.10 and 11.11 of the TPO order) (vi) As regards the argument about the binding nature of the India's position, the court has found the same to have persuasive value and not a final word which is determined by the statute. Un view of the same, the argument of the assessee is not acceptable. (Para 12.3 of the TPO order) (vii) Selling expenses should not be excluded in assessee's case. (Para 13.4 of the TPO order) (viii) The Ld. TPO in Para 14.4 of his order held that the adjustment which the assessee is seeking to make in respect of adverti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ₹ 36,22,08,209/- Mark-up @ 12.21% ₹ 4,42,25,622/- Adjustment u/s 92CA ₹ 40,64,33,832/- 2.17 The AO, accordingly, after giving opportunity to the assessee, passed the draft assessment order dated 18.03.2014 by making addition of ₹ 40,64,33,832/-. 2.18 The assessee, inter alia, filed the following objections before ld. DRP :- 1 That on the facts and circumstances of the case and in law, the draft order passed by the ld. Assessing Officer ( AO ) is bad in law and void ab-initio 2 The ld. AO/ld. Transfer Pricing Officer ( TPO ) erred on facts and circumstances of the case in determining the arm's length adjustment to the assessee's alleged international transaction with Associated Enterprises( AEs ), thereby resulting in the enhancement of returned income of the assessee by ₹ 40,64,33,832 3 That the reference made by the ld. AO suffers from jurisdictional error as the ld. AO has not recorded any reasons in the draft assessment order based on which he reached the conclusion that it was expedient and necessary to refer the matter to t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ssessee visa vis comparable companies because of the introduction of new products by the Assessee when there were no similar economic facts applicable to the companies selected for the bright line test by the Ld. TPO 4.7 by rejecting companies that owned domestic brands for the purpose of computing the bright line test and thereby erroneously selecting companies which are not comparable in their asset and risk profile to the Assessee; 4.8 erroneously holding that the Assessee has rendered services to the AEs by incurring 'excessive' AMP expenses and by holding that a mark-up has to be earned by the Assessee in respect of the alleged excessive AMP expenses; 4.9 applying a mark-up of 12.21% on the alleged excessive AMP expenses, for determining the compensation/ service fee towards alleged AMP service by the assessee to its AEs by disregarding the new comparables selected by the Assessee. 5 The Ld. AO erred in facts and in law in charging and computing interest under section 234A, 234B, 234C and 234D of the Act 6 That on the facts and circumstances of the case and in law, the Ld. AO has erred in initiating penalty proceedings u/s 271(1)(c) of the Act mech ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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/upholding the Transfer Pricing ( TP ) adjustment of INR 40,64,33,832 on account of AMP expenditure, alleging the same to be not at arm's length as per provisions of sections 92C(1) and 92C(2) of the Act, read with Rule 10D of the Income Tax Rules 192 (the Rule ) 4 That on the facts and circumstances of the case and in law, the DRP/AO/TPO erred in making TP adjustments, alleging that the unilateral AMP expenditure, being payments made to third parties, is an international transactions as per the provision of section 92B of the Act, without appreciating that there was no agreement, understanding or arrangement between the appellant and the Associated Enterprises ( AE ) for incurrence of such expenditure. 5 That on the facts and circumstances of the case and in law, the DRP/AO/TPO have erred in not appreciating that no such TP adjustment can be made in respect of AMP expenses being legitimate, bonafide and deductible business expenditure incurred by the appellant towards paymen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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-payment of royalty/expenditure incurred on new product launches), while computing the alleged excessive AMP expenditure. 14 That on the facts and circumstances of the case and in law, the AO/TPO have erred in arbitrarily rejecting and selecting comparable companies for benchmarking the AMP expenditure and, further erred in not considering the functionally comparable companies for such alleged brand building services and the DRP further erred in not adjudicating the grounds of objections raised in relation thereto. 15 That the DRP/AO/TPO erred on the facts and circumstances of the case and in law in not appreciating that mark-up could not be levied on the AMP expenditure incurred by the appellant. 15.1 Without prejudice to the above and not admitting, if at all a mark up should have been charged by the appellant assuming it to be a brand building service provider, the said markup could have been charged only on the value addition expenses incurred by the appellant ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ating 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 transaction of AMP expenses should be bundled or 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. However, in the case of a manufacturer, the import of raw material has been held to be an independent transaction of marketing and distribution. In the case of a distributor, the Hon'ble High Court held that where TNMM has been applied as the most appropriate method, which method has not been disturbed by the TPO, then, the international transactions of AMP and distribution activities should be clubbed. It further held that for determining the ALP of such transactions under a combined approach, only such comparables should be chosen which conform to the AMP functions and other distribution functions conducted by the assessee. If there is some difference in the functions under these international ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld 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]. 6. With the above background of the ratio decidendi of the judgment of the Hon'ble jurisdictional High Court, let us examine the contention put forth by the ld. AR in support of the deletion of addition. He submitted that Resale price Method (RPM) was selected as the most appropriate method for the distribution activities. For the purpose of applying th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ions 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 is performed, the AMP expenses are the amount spent on the performance of such means (functions). To put it simply, an examination of AMP functions carried out by the assessee and the probable comparables is sine qua non in the process of determination of the ALP of the international transaction of AMP spend, either in a segregate or an aggregate manner. What Their Lordships have held is to bundle the distribution activity with the AMP activity, being two separate but connected international transactions, for the purposes of determination of the ALP of both these international transactions in a combined manner. The argument of the ld. AR, if taken to a logical conclusion, will make the AMP spend as a non-international transaction, which, in our considered opinion, is not appropriate. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ities 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 functions as against the probable comparable having done, say, only three. In such a scenario, again the adjustment will be warranted. In another situation, the AMP functions performed by the assessee and probable comparable may be similar but with varying standards, which will also call for an adjustment. Crux of the matter is that the AMP functions performed by the assessee must be similar to those done by the comparable, in the same manner as such functions are compared in any other international transaction. However, in computing ALP of AMP spend, the adjustment or set off, if any, available from the distribution function, should be made. The essence of the judgment in the case of Sony Ericsson Mobile Communications India (P.) Ltd. (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 postu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arable, 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. Further, the Hon'ble Delhi High Court in the case of Sony Ericsson Mobile Communication India (P.) Ltd. case (supra) in para 137 has observed that the aggregation and disaggregation of transactions in the TNM method or even in other methods is sought to be applied, must have reference to the strength and weakness of the TNM method or the applicable method. It was observed that aggregation of transactions is desirable and not merely permissible, if the nature of transaction(s) taken as a whole is so inter- related that it will be more reliable means of determining the arm's length consideration for the controlled transactions. It was further observed that there are often situations where separate transactions are inter wined and linked or are continuous that they cannot be evaluated adequately on separate basis. Secondly, the controlled transaction should ordinarily be based on the transaction actually undertaken by the AEs as has been struck by them. Hon'ble j ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ld 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, in such cases, external comparables where said parties are performing similar functions including AMP expenses would give more accurate and precise results. 164. However, it would be wrong to assert and accept that gross profit margins would not inevitably include cost of AMP expenses. The gross profit margins could remunerate an AE performing marketing and selling function. This has to be tested and examined without any assumption against the assessed. A finding on the said aspect would require detailed verification and ascertainment. 165. An external comparable should perform similar AMP functions. Similarly the comparable should not be the legal owner of the brand name, trade mark etc. In case a comparable does not perform AMP functions in the marketing operations, a function which is performed by the tested party, the comparable may have to be discarded. Comparable analysis of the tested party and the comparable would include reference to AMP expenses. In ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... mined 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 demarcate the routine and non-routine AMP expenditure is predicated on selection of a domestic distributor and marketing company that does not own intangible brand rights. Contract value would be treated as NIL. In terms of our finding recorded above, the said finding would not be correct. The approach and procedure for ascertaining /determining arm's length price under the RP Method is different. For this reason, and other grounds recorded, we have passed an order of remit to the Tribunal for examination of the factual matrix. 10. Adverting to the facts of the instant case, we find that the TPO espoused the AMP expense as a separate and distinct. Treating the AMP spend as a separate international transaction, he applied the Cost plus method and proposed the extant adjustment. In doing so, he segregated routine AMP expenses incurred by the assessee for his business from the non-routine AMP expenses by treating such non-routine AMP expenses leading to the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntrolled 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 materially affect the amount of net profit margin in the open market ; (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.' 11. 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). 12. Sub-rule (2) of R ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion 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 the prescription of Rule 10B is in complete harmony with the ratio of the judgment in the case of Sony Ericsson Mobile Communications India (P.) Ltd. (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 effect to, then, the probable comparable should be eliminated from the list of comparables. Going further, if no proper comparable survives, then the TNMM should be discarded and an alternative method, may be, Cost plus or any other suitable method be applied for determining the ALP of AMP expenses. 15. At the cost of repetition, we summarize that the distribution and AMP functions are two separate international activi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ne 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 Court in Sony Ericsson Mobile Communications India (P.) Ltd. case (supra) 18. Reliance was placed on the decision of coordinate Bench in the case of Toshiba India Pvt. Ltd. v. DCIT 41 ITR(Tri) 300 (Del) wherein it has been held as under: 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 material divulging the AMP functions performed by the assessee as well as comparables. As such, we are handicapped to determine the ALP of AMP ex ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dertaken 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 material divulging the AMP functions performed by the assessee as well as comparables. As such, we are handicapped to determine the ALP of AMP expenses at our end, either in a combined or a separate approach. Under such circumstances, we set aside the impugned order and send the matter back to the file of the TPO/AO for determining the ALP of the international transaction of AMP spend afresh in accordance with the manner laid down by the Hon'ble High Court in Sony Ericson Mobile Communications India (P.) Ltd. (supra). It is, however, made clear that the TPO/AO, while computing adjustment, if any, on account of AMP expenses will not include Selling expenses directly incurred in connection with sales in the overall base of AMP expenses. 3. ITA Nos. 5120/Del/2010 dated 24.08.2015 Maruti Suzuki India Ltd. v. Addl. CIT 13.15. Turning to the facts of the case, we find that the TPO/AO have computed disallowance of AMP exp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ee'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 fresh determination of the ALP of the AMP expenses in accordance with our above observations. In view of our decision in restoring the issue of calculation of ALP of AMP expenses to the TPO/AO, the assessee's appeal against the order passed by the AO/TPO u/s 154, enhancing the amount of TP adjustment, would automatically be taken care of in such fresh proceedings. We want to clarify that in such fresh proceedings, the assessee will be at liberty to lead any fresh evidence in support of its case. 20. In final analysis, 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 apply ..... X X X X Extracts X X X X X X X X Extracts X X X X
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