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TMI Blog2015 (12) TMI 634X X X X Extracts X X X X X X X X Extracts X X X X ..... ITAT followed its decision in LG Electronics India Pvt. Ltd. v. ACIT 2013 22 ITR (Trib) I and held that the Assessing Officer ('AO') was entitled to make a transfer pricing adjustment under Chapter X of the Act in respect of the AMP expenditure incurred by MSIL on the ground that such expenditure created brand value and marketing intangibles in respect of the brands/trademarks belonging to MSIL's Associated Enterprise ('AE'), Suzuki Motor Corporation, Japan (hereinafter 'SMC'). Background facts 4. MSIL is engaged in the manufacture of passenger cars in India. It is a subsidiary of SMC. As on 31st March 2006, SMC held 54.21% shares in MSIL. 10.27% of the shares were held by the Government of India and the balance was held by the Indian public and others. 5. MSIL started its business in 1982 as a Government of India owned company. SMC was selected as the business partner independently by MSIL. It is stated that the co-branded trademark 'Maruti-Suzuki' was used since the inception of MSIL. A licence agreement was entered between MSIL and SMC in October 1982 for its models M-800, Omni and Gypsy. By the said agreement, MSIL was permitted to use the co-branded trademark 'Maruti-Su ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion expenses as a percentage of sales of MSIL was higher than that incurred by the comparable companies, the TPO concluded that the excess must be regarded as having been incurred for promoting the brand 'Suzuki' owned by SMC. Accordingly, the adjustment on account of AMP expenses was computed at Rs. 154.12 crores. 9. On the basis of aforementioned order of the TPO, the AO issued a draft assessment order dated 31st December 2010 for AY 2005-06 under Sections 143 (3) and 144-C (1) of the Act. The total income was proposed at Rs. 16,38,06,61,370. 10. Aggrieved by the aforementioned draft assessment order, the Assessee filed objections before the Dispute Resolution Panel ('DRP') under Section 144-C (2) of the Act. By its order dated 23rd September 2011, the DRP upheld the addition made by the TPO on account of AMP expenses. 11. The AO completed the assessment in terms of the directions of the DRP and passed the final assessment order on 28th October 2011, assessing the total income of MSIL at Rs. 16,34,18,35,040 after making an addition of Rs. 154.12 crores on account of the AMP expenses. 12. The appeal filed against the above order by the MSIL, being ITA No. 5237/Del/2011 for AY ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he transaction are the same but the arrangements made in relation to the transaction, viewed in their totality differ from those which would have been adopted by the individual enterprise behaving in a commercially rational manner" governed the situation where the AMP expenses incurred by the Assessee was higher or different from what was incurred by independent enterprises behaving in a commercially rational manner. The question to be answered was: "Whether an independent enterprise behaving in a commercially rational manner would incur the expenses to the extent the assessee has incurred". If the answer to this question was affirmative, then the transaction cannot be re-characterised. If however, the answer is in negative then the transaction needs to be probed further for determining whether it required re-characterization. In other words, the majority of the ITAT in LG Electronics was advocating the use of the bright line test for the purposes of determining the existence as well as ALP of an international transaction involving AMP expenses. (iv) The concept of economic ownership of the brand, although relevant in a commercial sense, was not recognized for the purposes of the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... otion directly led to brand building, expenses in connection with sales was only sales specific. If the expenditure was not in the nature of AMP, it ought to be excluded at the outset. (ix) The correct approach under the transactional net margin method ('TNMM') was to consider the operating profit for each international transaction in relation to the total cost or sales or capital employed etc. of such international transaction and not the net profit, total costs, sales, capital employed by the Assessee as a whole at the entity level. (x) The contention of the Revenue that the method for determining the AMP can be a combination of methods prescribed under Section 92C(1) was devoid of force. On a plain reading of Section 92C(1) with Rule 10 B(1), it was neither possible to invent a new method nor to substitute a new methodology in place of the one prescribed in Rule 10B (1). 15. In the case of LG Electronics, the majority of the Special Bench of the ITAT held that the DRP as well as the AO were right in applying the spirit of the 'cost plus method' by first identifying the cost/value of service provided to the Assessee and thereafter adding mark-up. It was held that a reading of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... gements were "proved from the conduct of the assessee". After undertaking a comparability analysis of the AMP expenses incurred by other comparable entities for the AY in question, the TPO concluded: "The assessee had incurred above expenditure, in excess of bright line limit of Rs. 136.76 Crores for brand promotion and market development for the AE, which would lead to creation of marketing intangibles legal ownership of which was with the associated enterprise of the assessee". After applying a 'mark up' the TPO recommended that the AO should enhance the income of the assessee by an amount of Rs. 154.12 Crores on account of compensation to be received from its AE for promoting the brand name of its AE." Order of the High Court in the writ petition 19. In the final order passed in the writ petition, i.e. MSIL v. ACIT/TPO (2010) 328 ITR 210 (Del.), the Division Bench of this Court came to the following conclusions: (i) The contractual obligations on MSIL under the agreement dated 12th December 1992 to use the joint trademark 'Maruti Suzuki' as well as the parts manufactured and/or sold by MSIL in India showed that SMC wanted to popularize its name in India at the cost of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... urt. The order of the Supreme Court, reported as MSIL v. ACIT (2011) 335 ITR 121 (SC), reads as under: "By consent, the matter is taken up for hearing. In this case, the High Court has remitted the matter to the Transfer Pricing Officer ("the TPO" for short) with liberty to issue fresh show-cause notice. The High Court has further directed the Transfer Pricing Officer to decide the matter in accordance with law. Further, on going through the impugned judgment of the High Court dated July 1, 2010, we find that the High Court has not merely set aside the original show cause notice but it has made certain observations on the merits of the case and has given directions to the Transfer Pricing Officer, which virtually conclude the matter. In the circumstances, on that limited issue, we hereby direct the Transfer Pricing Officer, who, in the meantime, has already issued a show cause notice on September 16, 2010, to proceed with the matter in accordance with law uninfluenced by the observations/directions given by the High Court in the impugned judgment dated July 1, 2010. The Transfer Pricing Officer will decide this matter on or before December 31, 2010. The civil appeal is, acc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xplained that all the above six Assessees were engaged in distribution and marketing of imported branded products. In other words, none of the Assessee whose appeals were decided was a manufacturer. The second common factor noted by the Court was: "There is no dispute or lis that the assesse are AEs who had entered into controlled transactions with the foreign associated enterprises". Thirdly, the Court noted: "It is also uncontested that the controlled international transactions can be made subject-matter of the transfer pricing adjustment in terms of Chapter X of the Income Tax Act, 1961". 27. The Court further explained the features particular to three of the said Assessees i.e Sony Mobile Communications India Pvt. Ltd., Reebok India Company and Canon India Pvt. Ltd. In the case of Sony Mobile Communications India Pvt. Ltd., TNMM had been followed. In respect of Reebok India, the TNMM had been followed for the sourcing of goods and exports from India, the CUP method had been followed in respect of the royalty paid by the Indian entity to the foreign AE and for import of apparels and footwear for re-sale, the re-sale price ('RP') method had been followed. In the case of Cannon I ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... whereas Section 40A(2)(b) dealt with the reasonability of quantum of expenditure. (v) TNMM applied with equal force on single transaction as well as multiple transactions as per the scheme of Chapter X and the TP Rules. Thus, the word 'transaction' would include a series of closely linked transactions. (vi) The TPO/AO could overrule the method adopted by the Assessee for determining the ALP and select the most appropriate method. The reasons for selecting or adopting a particular method would depend upon functional analysis comparison, which required availability of data of comparables performing of similar or suitable functional tasks in a comparable business. When suitable comparables relating to a particular method were not available and functional analysis or adjustment was not possible, it would be advisable to adopt and apply another method. (vii) Once the AO /TPO accepted and adopted the TNMM, but chooses to treat a particular expenditure like AMP as a separate international transaction without bifurcation/segregation, it would lead to unusual and incongruous results as AMP expenses was the cost or expense and was not diverse. It was factored in the net profit of the inte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or product differences are less likely to have material effect on the profit margins as they do on the price. (xiii) Determination of cost or expense can cause difficulties in applying cost plus (CP) Method. Careful consideration should be given to what would constitute cost i.e. what should be included or excluded from cost. A studied scrutiny of CP Method would indicate that when the said Method is applied by treating AMP expenses as an independent transaction, it would not make any difference whether the same are routine or non-routine, once functional comparability with or without adjustment is accepted. (xiv) The task of arm's length pricing in the case of tested party may become difficult when a number of transactions are interconnected and compensated but a transaction is bifurcated and segregated. CP Method, when applied to the segregated transaction, must pass the criteria of most appropriate method. If and when such determination of gross profit with reference to AMP transaction is required, it must be undertaken in a fair, objective and reasonable manner. (xv) The marketing or selling expenses like trade discounts, volume discounts, etc. offered to sub-distributors or ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in Sony Ericsson (supra). However, as far as ITA 110 of 2014 (pertaining to AY 2005-06), no questions of law were separately framed. On 30th September, 2014, the Court passed the following order in all the appeals being heard together at that time, including ITA 110 of 2014: "Arguments on behalf of some of the assessees have been heard. It transpires that in some of the appeals, in addition to advertisement, marketing and sales promotion expenses, other issues and questions have been raised either by the assessees or by the revenue. Substantial questions of law have been framed in some appeals, but, substantial questions of law in other appeals are yet to be framed. It will be desirable if the counsel for the assessees as well as the Standing Counsel for the Department-revenue sit down and prepare a chart of cases which can be disposed of on the basis of arguments relating to Transfer Pricing adjustment on account of advertisement, marketing and sales, promotion expenses. We can also include appeals, which are already covered or do not require lengthy or detailed arguments on other unconnected aspect." 31. Thereafter on 29th October 2014, the following questions were framed in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r under Section 154 read with Section 92CA(v), enhancing addition by Rs. 34,39,96,700 and recomputing the AMP adjustment to Rs. 158.64 crores. The AO passed rectification order dated 12th April 2012 under Section 154, enhancing the total addition by the above sum while computing the total income. 34. The ITAT by its order dated 24th August 2015 partly allowed MSIL's appeals against both the orders dated 20th October 2010 and 12th April 2012 and sent the matter back to the file of TPO/AO for determination of the AMP in the light of the Sony Ericsson (supra). By an order dated 10th September 2015, this Court framed identical questions of law as framed in ITA 110 of 2014 and directed both appeals to be heard together. Preliminary issues 35. One preliminary issue that requires to be addressed is whether on account of the decision in Sony Ericsson it would be open to MSIL to question the existence of an international transaction involving it and the AE i.e. SMC as far as AMP expenses are concerned? 36. It is contented of Mr. G.C. Srivastava, learned Special counsel for the Revenue, that after the decision in Sony Ericsson the existence of an international transaction between MSI ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s pointed out by Mr. S. Ganesh, learned Senior counsel for MSIL, that the contention of the Revenue that the question regarding existence of an international transaction on account of the incurring of AMP expenditures by the Assessee has been decided by the Sony Ericsson case is based on a patent misreading of that judgment. Reference is made to para 3 of the judgment which notes the admitted facts in those three cases. It is submitted that once the BLT has been rejected by the decision in Sony Ericsson, the question of there being an international transaction does not arise. It is submitted that the TPO's order and the Assessee's case makes it clear that the BLT has been used first to infer the existence of an international transaction and thereafter quantify the amount of the TP adjustment. After the judgment in Sony Ericsson, BLT cannot be used for either of the purposes. 40. Independent of the above, it is submitted by Mr. Ganesh that the Revenue has to show the existence of an agreement or an arrangement or an understanding between MSIL and SMC prior to incurring of the AMP expenditure, in terms of which MSIL would incur AMP expenditure in excess of the bona fide requirements ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sted by the Assessees who appeals were decided in the Sony Ericsson case, it cannot be said that the decision in Sony Ericsson, to the extent it affirms the existence of an international transaction on account of the incurring of the AMP expenses, decided that issue in the appeals of MSIL as well. In this context, para 52 of the decision in Sony Ericsson has to be read as a whole. It reads as under: "52. The contention that AMP expenses are not international transactions has to be rejected. There seems to be an incongruity in the submission of the assessee on the said aspect for the simple reason that in most cases the assessed have submitted that the international transactions between them and the AE, resident abroad included the cost/value of the AMP expenses, which the assessee had incurred in India. In other words, when the assessed raise the aforesaid argument, they accept that the declared price of the international transaction included the said element or function of AMP expenses, for which they stand duly compensated in their margins or the arm's length price as computed." 46. The said passage has to be read in the context of the discussion preceding it which concern ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ubmission on behalf of the MSIL that by the time SMC acquired a controlling interest in MSIL in 2002, the Maruti brand had already built a huge reputation. A significant amount of AMP expenses had already been incurred by MSIL on its products. These products carried the co-branded mark 'Maruti-Suzuki' which had a high degree of name recognition. The Revenue has been unable to dispute that MSIL has the highest market share of automobiles manufactured in India (about 45%) and year on year growth of turnover of about 21%. In other words, the AMP expenses incurred by it have substantially benefitted MSIL. 50. The second aspect which the Revenue has been unable to dispute is that SMC's AMP expenditure worldwide has been 7.5% of its sales whereas MSIL is spending only 1.87% of its total sales towards AMP. Therefore, this belies the possibility of any 'arrangement' or 'understanding' between MSIL and SMC whereby MSIL is obliged to incur the AMP expenditure for and on behalf of SMC. 51. The result of the above discussion is that in the considered view of the Court the Revenue has failed to demonstrate the existence of an international transaction only on account of the qu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the principles or ratio as enunciated and express their opinion on merits, though the directions issued by the High Court, it was observed, ―conclude the matter. The Supreme Court perceived and accepted that the issue' of arm's length price should be re-examined by the TPO without being curtailed or restrained by the legal principles/ratio delineated. As the Supreme Court itself was not examining the principles/ratio on merits, it did not pass any order in favour or against the assessee or the Revenue. Accordingly, the aforesaid observations. The effect thereof was that the judgment of the Delhi High Court would not operate as res judicata between the parties and merits, if required, would be examined and gone into in the appellate proceedings. The majority judgment has incorrectly inferred that the legal principles and directions issued by the Delhi High Court would continue to be binding decidendi and had attained finality, viz. the tax authorities and the Tribunal. It is not so indicated. If the legal principles/ratio was not binding on the writ petitioner, i.e. the assessed in the said case, it would be malapropos and inappropriate to treat the directions as bind ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... saction concerning AMP expenses? 57. The Court next turns to the principal contention of the Revenue that in a particular situation of independent distributors/licensed manufacturers matters relating to promotion of a brand of a foreign AE would necessarily be a matter of negotiation between the parties and not necessarily be reduced to writing as part of an agreement between them. 58. It is necessary at this juncture to discuss the reasons for enactment of Chapter X in the Act with the whole new scheme of provisions concerning transfer pricing in the form of Sections 92B to 92F. 59. Nevertheless, there is no specific mention of AMP expenses as one of the items of expenditure which can be deemed to be an international transaction. For this purpose, Section 92B(1) read with Section 92(1) becomes significant. Under Section 92B(1) an 'international transaction' means- (a) a transaction between two or more AEs, either or both of whom are non-resident (b) the transaction is in the nature of purchase, sale or lease of tangible or intangible property or provision of service or lending or borrowing money or any other transaction having a bearing on the profits, incomes or loss ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ther formal or in writing', it is still incumbent on the Revenue to show the existence of an 'understanding' or an 'arrangement' or 'action in concert' between MSIL and SMC as regards AMP spend for brand promotion. In other words, for both the 'means' part and the 'includes' part of Section 92B (1) what has to be definitely shown is the existence of transaction whereby MSIL has been obliged to incur AMP of a certain level for SMC for the purposes of promoting the brand of SMC. Step wise analysis of statutory provisions 62. If a step by step analysis is undertaken of Sections 92B to 92F, the sine qua non for commencing the transfer pricing exercise is to show the existence of an international transaction. The next step is to determine the price of such transaction. The third step would be to determine the ALP by applying one of the five price discovery methods specified in Section 92C. The fourth step would be to compare the price of the transaction that is shown to exist with the ALP and make the transfer pricing adjustment by substituting the ALP for the contract price. 63. A reading of the heading of Chapter X ["Computation of income from internatio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... have an explicit arrangement/agreement on this aspect cannot lead to the inference that there is no such arrangement or the entire AMP activity of the Indian entity is unilateral and only for its own benefit. According to the Revenue, "the only credible test in the context of TP provisions to determine whether the Indian subsidiary is incurring AMP expenses unilaterally on its own or at the instance of the AE is to find out whether an independent party would have also done the same." It is asserted: "An independent party with a short term agreement with the MNC will not incur costs which give long term benefits of brand & market development to the other entity. An independent party will, in such circumstances, carry out the function of development of markets only when it is adequately remunerated for the same." 67. Reference is made by Mr. Srivastava to some sample agreements between Reebok (UK) and Reebok (South Africa) and IC Issacs & Co and BHPC Marketing to urge that the level of AMP spend is a matter of negotiation between the parties together with the rate of royalty. It is further suggested that it might be necessary to examine whether in other jurisdictions the foreign AE ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... TPO for computation of the ALP and the manner of the determination of the ALP by the TPO, and Section 92CB which provides for the "safe harbour" rules for determination of the ALP, can be applied only if the TP adjustment involves substitution of the transaction price with the ALP. Rules 10B, 10C and the new Rule 10AB only deal with the determination of the ALP. Thus for the purposes of Chapter X of the Act, what is envisaged is not a quantitative adjustment but only a substitution of the transaction price with the ALP. 70. What is clear is that it is the 'price' of an international transaction which is required to be adjusted. The very existence of an international transaction cannot be presumed by assigning some price to it and then deducing that since it is not an ALP, an 'adjustment' has to be made. The burden is on the Revenue to first show the existence of an international transaction. Next, to ascertain the disclosed 'price' of such transaction and thereafter ask whether it is an ALP. If the answer to that is in the negative the TP adjustment should follow. The objective of Chapter X is to make adjustments to the price of an international transaction ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 9;non-routine') ought to be compensated by the foreign AE to whose benefit also such expense enures. The 'non-routine' AMP spend is taken to have 'subsumed' the portion constituting the 'compensation' owed to the Indian entity by the foreign AE. In such a scenario what will be required to be benchmarked is not the AMP expense itself but to what extent the Indian entity must be compensated. That is not within the realm of the provisions of Chapter X. 74. The problem with the Revenue's approach is that it wants every instance of an AMP spend by an Indian entity which happens to use the brand of a foreign AE to be presumed to involve an international transaction. And this, notwithstanding that this is not one of the deemed international transactions listed under the Explanation to Section 92B of the Act. The problem does not stop here. Even if a transaction involving an AMP spend for a foreign AE is able to be located in some agreement, written (for e.g., the sample agreements produced before the Court by the Revenue) or otherwise, how should a TPO proceed to benchmark the portion of such AMP spend that the Indian entity should be compensated for? 75. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cording to the Revenue, viewing legal ownership as something distinct from economic ownership "may not be the right way of looking at things." 78. It is necessary at this juncture to examine the history of the relationship between MSIL and SMC. When the licence agreements were originally entered in 1982, MSIL was known as Maruti Udyog Limited ('MUL') and SMC did not hold a single share in MUL. In 2003 SMC acquired the controlling interest in MSIL. There are various models of Suzuki motor cars manufactured by MSIL and each model is covered by a separate licence agreement. Under these agreements SMC grants license to MSIL to manufacture that particular car model; provides technical know-how and information and right to use Suzuki's patents and technical information. It also gives MSIL the right to use Suzuki's trade mark and logo on the product. Pursuant to the above agreement, MSIL has been using the co- brand i.e. Maruti-Suzuki trade mark and logo for more than 30 years. As already noted, this co-brand cannot be used by SMC and is not owned by it. 79. The clauses in the agreement between MSIL and SMC indicate that permission was granted by SMC to MSIL to use the co-brand 'Maruti- ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... esence of the brand in the advertisement actually adds to the benefit of the brand internationally. 82. Para 6 D of the OECD Guidelines deals with 'Marketing activities undertaken by enterprises not owning trademarks or trade names'. It contains a discussion on promotion of trade marks by distributors of branded goods. It acknowledges the difficulties in determining the extent to which the expenses have contributed to the success of a product. It is stated: "For instance, it can be difficult to determine what advertising and marketing expenditures have contributed to the production or revenue, and to what degree. It is also possible that a new trademark or one newly introduced into a particular market may have no value or little impression on the market (or perhaps loses its impact). A dominant market share may to some extent be attributable to marketing efforts of a distributor. The value and any changes will depend to an extent on how effectively the trademark is promoted in the particular market. More fundamentally, in many cases higher returns derived from the sale of trademarked products may be due as much to the unique characteristics of the product or its high qua ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ested party with the comparable. As far as MSIL is concerned, its operating profit margin is 11.19% which is higher than that of the comparable companies whose profit margin is 4.04%. Therefore, applying the TNMM method it must be stated that there is no question of TP adjustment on account of AMP expenditure. Allowable expenditure under Section 37 (1) 87. The decision in Sony Ericsson also holds that "the issue of arm's length price per se does not arise when deduction under Section 37(1) is claimed." Further the decision of an Assessee whether or not to incur an expenditure cannot be substituted and disallowed by the AO. In the context of the AMP expenses incurred by manufacturer exclusively for its own business, it is arguable that once such expense is allowed under Section 37(1) of the Act, it cannot be disallowed for the purpose of Chapter X by attributing some part of the said expenditure to promoting the brand of the foreign AE. The key words as far as Section 37(1) is concerned are 'wholly and exclusively'. 88. However, the Court does not consider it necessary to further dwell on this aspect since it is not required for the answers to the central questions arising in thi ..... X X X X Extracts X X X X X X X X Extracts X X X X
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