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TMI Blog2015 (11) TMI 15X X X X Extracts X X X X X X X X Extracts X X X X ..... ) TMI 580 - DELHI HIGH COURT). Ex consequenti, the ground raised about the TPO having no jurisdiction to determine the ALP of AMP expenses, is dismissed following the judgment in the case of Sony Ericsson Mobile Communications India (P.) Ltd. (supra). - Decided in favour of assessee for statistical purposes. - ITA No.789/Del./2015 - - - Dated:- 28-8-2015 - SHRI R.S. SYAL, ACCOUNTANT MEMBER and SHRI A.T. VARKEY, JUDICIAL MEMBER For The Assessee : S/Shri Mukesh Butani Gourav Gupta, Advocates S/Shri Suchint Majmuder Nipun Arora, CAs For The Revenue : Shri Anurag Sharma, Senior DR ORDER PER A.T. VARKEY, JUDICIAL MEMBER : This appeal by the assessee under section 253(1) of the Income Tax Act, 1961 is directed against the final order passed by the Transfer Pricing Officer (TPO) / Assessing Officer (AO) on 05.01.2015 u/s 143(3) read with section 144C of the Income-tax Act, 1961 (hereinafter also called the Act ) in relation to the assessment year 2010-11. 2. Briefly stated, the facts of the case are that the assessee, is a wholly owned subsidiary of Nikon Corporation, Japan ( Nikon Japan ). It is engaged in the distribution and marketing services for N ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 2.31 3 Compuage Infocom Ltd. 6.03 2.41 4 Computer Point Ltd. 6.27 -0.48 5 Empower India Ltd. 2.89 0.03 6 General Sales Ltd. 23.66 -4.79 7 MVL Industries Ltd. 11.08 8.58 8 Mobile Telecommunications Ltd. 6.20 0.51 9 Salora international ltd. 9.32 2.24 10 Spice Mobiles Ltd. 18.87 2.07 Average 10.05 1.37 Nikon India 17.65% -1.76% 2.4 The assessee s contention was that for above mentioned international transactions, the PLI being operating profit/sales of comparable was 1.37% as co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0.83 3 Compuage Infocom 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 by the AE) that needs to be suitably compensated by the AE. The amount which represents the b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for the funds blocked by the assessee on the basis that half of the funds should have been reimbursed and considering a nominal interest rate of 12% on half of funds, opportunity cost comes out to be 6%, therefore, total mark-up was held to be 18.36% (12.36% + 6%) which in his view should have been charged by the assessee and calculated the arm s length price of the international transaction related to the AMP expenditure leading to the creation of a marketing intangible as below:- Total Sales Rs.203,87,33,264/- Arm s length level of AMP expense (0.69% of sales) ₹ 1,40,67,260/- AMP expenses actually incurred ₹ 37,62,75,469/- AMP expenditure which should have been reimbursed ₹ 36,22,08,209/- Mark-up @ 18.36% ₹ 6,65,01,427/- Adjustment u/s 92CA ₹ 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) Benefi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of new products is not permissible in view of LG s case. Because, bright line is for determining the routine expenditure which is incurred just for exploitation of already established brand while the excessive expenditure is in respect of expenditure for brand penetration. Hence, on account of new products, in fact the expenses are clearly in the nature of brand penetration and hence should fall outside the bright line Hence, in view of non-availability of data in respect of comparables, adjustment cannot be granted. 2.14 The TPO used the Cost Plus Method for the benchmarking of the AMP expenses and selected the following comparables for determining mark-up on AMP expenses :- Sr. No. Company name OP/OC 1 Crystal Hues Ltd. (corrected margin by the assessee) 8.68% 2 Quadrant Communications Ltd. 13.11% 3 Cyber Media Research Ltd. 14.85% Average 12.21% 2.15 Further, a mark-up of 6% was proposed t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arm s length price, as is required under section 92CA(1) of the Income Tax Act, 1961 ( Act ) 4 The Ld. AO/Ld. TPO erred on facts and in law in enhancing the income of the assessee by INR 406,433,832 by holding that the assessee incurs excessive AMP (advertisement, marketing and promotion) expenses in relation to its business activities thereby qualifying the alleged excessive AMP expenditure as services as per the arm s length principle envisaged under the Act, and in doing so have grossly erred in: 4.1 disregarding that the AMP expenses incurred by the Assessee represent purely domestic transaction(s) undertaken towards third parties, not covered under the purview of section 92 of the Act and that the analysis of domestic transactions undertaken with third parties, in respect of which no TP reference has been made by the Ld. AO to the Ld. TPO, is beyond the powers vested with the TPO under section 92CA of the Act. 4.2 disregarding the detailed submissions made by the Assessee on the functional, asset and risk analysis of the Assessee related to its marketing function as an independent decision maker and hence should also assume the cost associated with its functions ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion That the above grounds are independent and without prejudice to each other. The Assessee craves leave to add, amend, alter, delete, rescind, forgo or withdraw any of the above grounds of objection either before during the course of the Dispute Resolution Panel proceedings in the interest of the natural justice. 2.19 The Ld. DRP after considering the assessee s objections, concluded as under :- (i) Ground of objection nos. 1 2 are general in nature therefore no specific direction is required on these grounds. (ii) Ground of objection nos. 3 to 4.9: Ld. DRP has placed his reliance on the judgment of LG Electronics India Pvt.Ltd. vs. ACIT reported in 29 taxmann.com 300 (Del)(SB) and the above Grounds of Objection are rejected in the instant case. (iii) Ground of objection no 5: Initiation and imposition of interest is prerogative of the AO while passing the assessment order and is based on the facts and circumstances of the case. Hence the DRP is not required to issue any direction on this ground at this stage and objection is therefore rejected as being premature. (iv) Ground of objection no 6: Initiation and imposition of penalty is prerogative of the AO w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on the facts and circumstances of the case and in law, the DRP/AO/TPO have erred, in concluding that the appellant, by incurring excessive AMP expenditure, was rendering intra group services to its AE resulting in creation of marketing intangibles and should have been remunerated at arm s length. 7 That on the facts and circumstances of the case and in law, the TPO has erred in re-characterising the functions of incurring AMP expenditure and holding the appellant to be the services provider engaged in brand building services. 8 That on the facts and circumstances of the case and in law, the DRP/AO/TPO have erred in using the Bright Line test, which is not a prescribed method under the TP regulations in place in India, as a method for benchmarking the AMP expenditure incurred by the appellant without correctly applying any of the methods in the manner prescribed under Rule 10B of the Rules. 9 That on the facts and in the circumstances of the case and in law, the DRP/AO/TPO have erred in applying the Bright line theory as articulated in Transfer Pricing regulations of foreign jurisdictions and decisions rendered by foreign courts (based on specific transfer pricing regu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arty vendors. 16 That on the fact and circumstances of the case and in law, the AO has erred in charging interest u/s 234A, 234B, 234D and 244A of the Act. 4. We have heard the rival submissions and perused the relevant material on record. The Special Bench of the Tribunal in the case of LG Electronics India (P.). Ltd. v. Asstt. CIT [2013] 140 ITD 41/29 taxmann.com 300 (Delhi - Trib.), by its majority decision held, inter alia, that AMP is a transaction and also an international transaction within the meaning of section 92B of the Act and that the TPO has jurisdiction to compute the ALP of this international transaction despite the same not having been specifically referred to by the AO. On the question of determination of the ALP of this international transaction, the Special bench approved the application of bright line test for working out the amount of nonroutine AMP expenses and held that the ALP of AMP expenses should be determined on Cost plus method by treating AMP transaction as a separate and distinct from other international transactions. It was further held that the selling expenses directly incurred in connection with the sales do not lead to brand promotion and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ould be made to bring both the transactions at par. If probable comparables are not performing similar functions as done by the assessee and no adjustment is possible for bringing the international transactions of the assessee in an aggregate manner at par with those undertaken by the comparables, then, segregation should be done and the international transaction of AMP spend should be separately processed under the transfer pricing provisions for the purposes of determining its ALP separately. In such determination of ALP of AMP expenses in a segregated manner, proper set off on account of excess purchase price adjustment should be allowed. The view taken by the Tribunal in segregating routine and non-routine expenses on the basis of bright line test has been set aside by the Hon ble High Court. The view taken by the Special Bench that the expenses concerned with the sales, such as, rebates and discounts etc., should be excluded from the ambit of AMP expenses, has been upheld. 5. We can summarize the relevant position emanating from the judgment of the Hon ble High Court, as under :- AMP expense is an international transaction [Paras 52 53 of the judgment] ; The TPO ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he profit margin declared by the assessee was favorably comparable with the average margin of the comparables, which fact has not been disputed by the TPO, then, no adjustment should be made on account of AMP expenses because such expenses stand subsumed in the overall operating profit. This was countered by the ld. DR with reference to certain paras of the judgment in Sony Ericsson (supra) not permitting the acceptance of such a wide proposition. 7. We are unable to accept the argument advanced on behalf of the assessee for deletion of the addition towards AMP expenses on the plain logic of the assessee that all the transactions were established to be at arm s length by applying TNMM on entity wide basis. There is a basic fallacy in the argument of the ld. AR. It is pertinent to note that the TPO examined and got satisfied with the assessee s profit margin vis- -vis the comparables only qua the international transactions of distribution function. He determined the ALP of AMP expenses by applying bright line test and in this process simply compared the quantitative figures of AMP expenses incurred by the assessee and comparables for working out the nonroutine expenses. He did no ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se 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 these two should be aggregated. The process of such aggregation does not take away the separate character of the AMP transaction, albeit related. An analysis and examination of the distribution and AMP functions carried out by the assessee must be necessarily done in the first instance, which should be then compared with similar functions performed by some probable comparables. If the distribution and AMP functions performed by th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... so that surplus from the distribution activity could be adjusted against the deficit in the AMP activity. The Hon ble High Court has no where 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 166 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 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 case of a mismatch, ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er or not the aggregation or segregation of transactions would be appropriate and proper while applying the particular method. 9. Accordingly on a consideration of the entirety of the facts and submission of the parties, we find that reference may also be made to paras 162 and 168 of the said judgement where reference has been made to the position in 2008-09 Assessment year where the assessee is found to have applied resale price method using internal comparables. In para 166 of the said judgement it is seen that the arguments of the assessee were held to be flawed and fallacious for several reasons. However their Lordships further in para 167 observed that the Revenue before the Hon ble High Court did not plead that the R.P.Method should not have been adopted. Qua the same their Lordships observed that no final pronouncement was being made. A perusal of the para 168 shows that the Tribunal had upheld adoption of CP method after applying the bright-line test. The finding was found to be not correct as approach and procedure for ascertaining/determining arm s length price under the resale price method is different. The discussion on the most appropriate method by their Lordships ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ysis, 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. 166. 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. Moreover, the contention of the assessed in these appeals would mandate rejection of the RP Method, as an appropriate or most appropriate method. Comparison or comparative analysis is undertaken at stage (ii) Adjustments are permissible and undertaken at stage (iv). Under clause (iii), i.e. at stage (iii), from the price ascertained at stage (ii), expenses incurred by the enterprise in connection with the purchase of property or obtaining of services is reduced. Under clause (iv), adjustments have to be made on acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... O, he proceeded on an altogether different line in examining the quantum of AMP expense for determining the value of the international transaction of AMP, without looking at the AMP functions carried out by the assessee and the comparables. Distinct examination of AMP functions does not find place in this method of computing the value or the ALP of AMP spend. Now, when we look at the ratio laid down by the Hon ble jurisdictional High Court, it becomes crystal clear that the approach adopted by the TPO for determining ALP of AMP expenses has been rendered incorrect. However, the fact remains that as per the verdict of the Hon ble High Court, AMP spend is an international transaction, which is required to be processed under Chapter X of the Act by taking into account the AMP functions performed by the assessee and then comparing such functions with those performed by comparable entities, though, firstly in a combined manner with the distribution functions. We find no reference in the order of the TPO of making any comparison of the assessee s AMP functions with those of the comparables. Going by the ratio in the case of Sony Ericsson Mobile Communications India (P.) Ltd. (supra), it ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... specific characteristics of the property transferred or services provided in either transaction; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, such terms are formal or in writing) of the transactions which lay down explicitly or implicitly how the responsibilities, risks and benefits are to be divided between the respective parties to the transactions; (d) conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. Sub-rule (3) of Rule 10B stipulates that an uncontrolled transaction shall be comparable to an international transaction if (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market ; or (ii) reasonably accurate adjustm ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nce, so that the surplus from one could be adjusted against the deficit from the other in an overall approach. It does not mean that because of aggregation, the AMP expense transaction sheds its character of a separate international transaction and hence the AMP functions should not be matched with the AMP functions carried out by probable comparables. If suitable comparables can be found having performed both distribution and AMP functions, then, their ALP should be determined on aggregate basis. If, however, there is some difference in the distribution or AMP functions performed by the assessee vis- -vis the probable comparables, then an attempt should first be made to iron out such difference by making a suitable adjustment to the profit margin of comparables. If such an adjustment is not possible, then such probable comparable should be eliminated. If, by making a comparative analysis of the distribution and AMP functions jointly, there remains no comparable case performing such distribution and AMP functions, then, the international transaction of AMP should be segregated and its ALP be determined separately by applying a suitable method. However, in so determining the ALP of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... saction 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. (supra). Ex consequenti, the ground raised about the TPO having no jurisdiction to determine the ALP of AMP expenses, is dismissed following the judgment in the case of Sony Ericsson Mobile Communications India (P.) Ltd. (supra). 19. Also, in the following cases, similar view has been expressed as under :- 1. 59 taxmann.com 148 (Del) Perfetti Van Melle India (P.) Ltd. vs. DCIT 15. Turning to the facts of the case, we find that the TPO/AO have followed the Special bench decision in LG Electronics India (P.) Ltd. (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 ble Delhi High Court, including the non-applicability of the bright line test, and no material has been placed on record by the ld. AR to, firstly, demonstrate the AMP functions carried out by the assessee and then, to compare such functions with those done by comparables, this issue cannot be decided at our en ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ability of the bright line test, and no material has been placed on record by the ld. AR to, firstly, demonstrate the AMP functions carried out by the assessee and then, to compare such functions with those done by comparables, this issue cannot be decided at our end. Under such circumstances, we 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 Ericson (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. 13.16. Now we espouse the contention of the ld. AR to send the matter back to the TPO/AO for deciding this issue in conformity with the decision yet to be rendered by the Hon ble High Court in its own case, for which hearing is still going on. This contention, in our considered opinion, is devoid of any merit. It is axiomatic that there can be no direction to follow a forthc ..... X X X X Extracts X X X X X X X X Extracts X X X X
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