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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 ..... O making any transfer pricing adjustment in respect of such transaction Chapter X does not arise and, therefore, question (3) is answered in the negative and in favour of the Assessee and against the Revenue. Whether the Income Tax Appellate Tribunal was right in directing that fresh bench marking/comparability analysis should be undertaken by the Transfer Pricing Officer by applying the parameters specified in paragraph 17.4 of the order dated 23.01.2013 passed by the Special Bench in the case of LG Electronics India (P) Ltd. [2013 (6) TMI 217 - ITAT DELHI ]?” - Held that:- Question is answered in the negative i.e. in favour of the Assessee and against the Revenue. It is held that the ITAT was not right in directing a fresh benchmarking comparative analysis to be undertaken by the TPO in view of the decision of the Special Bench of the ITAT in LG Electronics India Pvt. Ltd. - ITA 110/2014, ITA 710/2015 - - - Dated:- 11-12-2015 - S. Muralidhar And Vibhu Bakhru, JJ. For the Appellant : Mr. S. Ganesh, Senior Advocate with Mr. Neeraj Jain and Mr. Udit Naresh, Advocates For the Respondent : Mr. P. Roy Choudhary, Advocate with Mr. Ishant Goswami, Advocate JUDGMENT ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in relation to the international transactions undertaken by MSIL with its AE, SMC. This included purchase of components, consumables and spare parts, sale of vehicles, purchase of capital items, technical/other services, sale of spares and components, warranty and product recall charges, purchase of CBUs, cost sharing and payment of royalty for technology/trademark. 7. On the basis of the above reference, the TPO passed an order dated 21st December 2010 under Section 92CA(3), determining the ALP of the aforementioned international transactions between MSIL and SMC. The TPO proposed an addition of ₹ 252.26 crores to the returned income of MSIL. The TPO made an adjustment of ₹ 98.14 crores as regards the royalty paid by MSIL attributing the same towards payment for use of foreign trademark of SMC on the ground that the brand had no value. The said adjustment was later deleted by the ITAT. The remaining adjustment of ₹ 154.12 crores was towards the AMP expenses by imputing a notional/purported arm s length compensation towards the AMP expenses incurred by MSIL for SMC. 8. The case of MSIL is that while undertaking the above exercise, the TPO, on his own, bench ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The two questions considered by the Special Bench of the ITAT in LG Electronics were: 1. Whether, on the facts and in circumstances of the case, the Assessing Officer was justified in making transfer pricing adjustment in relation to advertisement, marketing and sales promotion expenses incurred by the Assessee? 2. Whether the Assessing Officer was justified in holding that the assessee should have earned a mark up from the associated enterprise in respect of advertising, marketing and promotion expenses alleged to have been incurred for and on behalf of the associated enterprise? 14. It may be mentioned at this stage that several companies, including MSIL, intervened in the proceedings. By a judgment dated 23rd January 2013, the majority of the ITAT came to the following conclusions: (i) The scope of Section 92CA(2B) covers all types of international transactions in respect of which the Assessee had not furnished a report. The TPO had jurisdiction to give a report on a different international transaction as long as reference of an international transaction is made to him for determination of the ALP. (ii) The word 'transaction' under Section 92F (v) i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... se of exploiting it for the business purpose . (v) Unless a transaction was an international transaction, within the meaning of Section 92B, it could not be subjected to the transfer pricing provisions. The meaning assigned to international transaction in terms of Clause (iv) of Section 92B was inclusive and not limited to the types of transactions in sub-clauses A to C and E of Clause (i). The bright line test was a way of finding out the cost and value of the international transaction, which was the first variable under Section 92 of the Act. If the Assessee failed to supply the cost/value of the international transaction and did not come forth to suggest any cogent way of determining such cost/value, then the onus was on the TPO to determine it on some rational basis. This could be by first identifying the comparable domestic cases. (vi) The exercise of separating the amount spent by the Assessee in relation to the international transaction of building brand for its foreign AE in terms of Section 92 of the Act cannot be considered as a case of disallowance of AMP expenses under Section 37(1) of the Act. Both the Sections 37(1) and 92 operated in different domains. (vi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion as determined by the TPO and restored the case to the file of the TPO/AO for determining of the value afresh. Proceedings in the writ petition of MSIL in this Court 16. The decision of the majority of the Special Bench of the ITAT in LG Electronics also separately dealt with the case of the MSIL which was an intervener. Even while the decision of the Special Bench was awaited, MSIL filed W.P.(C) 6876 of 2008 in this Court challenging the notice issued by the TPO for determining the ALP of the AMP expenses purportedly incurred by MSIL. By an interim order dated 19th September 2008, this Court directed that the proceedings before the TPO may go on but the final order passed would not be given effect to. Thereafter the TPO passed a final order on 30th October 2008. The writ petition was then amended to challenge the said order. Final order of the TPO 17. In the final order, the TPO came to the conclusion that the trade mark Suzuki owned by the SMC had piggybacked on the trade mark Maruti , without any compensation being paid by SMC to MSIL. He also came to the conclusion that the trade mark Maruti had acquired the status of a 'super brand' whereas the tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the benefit obtained by Suzuki in the form of marketing intangibles including the benefit on account of compulsory use of the joint trademark Maruti Suzuki , the TPO would have to determine the ALP by finding out what payment, if any, a comparable independent domestic entity would have made in respect of an agreement of this nature . (iii) Mere use of a foreign brand name by an AE in an intangible promotional activity does not by itself entail payment by the owner of the foreign brand name. The question was obviously whether a comparable independent entity would have incurred such expenditure or not. Unless it is shown that the expenditure incurred was disproportionate, there could be no justification for apportioning the AMP expenses between a domestic entity and the foreign entity. (iv) The order passed by the TPO in making adjustment was based on no evidence and the procedure followed by him was faulty. The order passed by him was arbitrary and irrational. The TPO was accordingly directed to re-determine the appropriate AMP in respect of the international transaction entered into by MSIL with SMC in terms of Section 92C of the Act. (v) While giving the above direc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce . However, the ITAT was of the view that the decision of the High Court on the AMP expenses incurred by the MSIL towards brand building of SMC was neither commented upon nor considered by the Supreme Court. Therefore, the contention that the entire judgment of the High Court was not set aside was rejected by the majority of the ITAT. It was held that the direction by the Supreme Court that the TPO has to make determination of the ALP inherently recognizes that there is a transaction of brand building between the assesse and the foreign AE, which is an international transaction as per section 92B and the TPO has the jurisdiction to determine the ALP of such transaction. 22. The conclusion of the majority of the ITAT in LG Electronics on the two questions were as under: (i) A transfer pricing adjustment in relation to AMP expenses incurred by the Assessee for creating and improving the marketing intangibles for its foreign AE was permissible. (ii) Earning the mark up from the AE in respect of AMP expenses incurred by the foreign AE was also allowed. 23. The matter was restored to the file of the TPO for fresh determination. The decision of this Court in Sony Erics ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion Expenses (AMP Expenses' for short) was beyond jurisdiction and bad in law as no specific reference was made by the Assessing Officer, having regard to retrospective amendment to Section 92CA of the Income Tax Act, 1961 by Finance Act, 2012. (ii)Whether AMP Expenses incurred by the assessee in India can be treated and categorized as an international transaction under Section 92B of the Income Tax Act, 1961? (iii) Whether under Chapter X of the Income Tax Act, 1961, a transfer pricing adjustment can be made by the Transfer Pricing Officer/ Assessing Officer in respect of expenditure treated as AMP Expenses and if so in which circumstances? (iv) If answer to question Nos.2 and 3 is in favour of the Revenue, whether the Income Tax Appellate Tribunal was right in holding that transfer pricing adjustment in respect of AMP Expenses should be computed by applying Cost Plus Method. (v) Whether the Income Tax Appellate Tribunal was right in directing that fresh bench marking/comparability analysis should be undertaken by the Transfer Pricing Officer by applying the parameters specified in paragraph 17.4 of the order dated 23.01.2013 passed by the Special Bench in the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce the comparables pass the functional analysis test and adjustments have been made, then the profit margin as declared when matches with the comparables would result in affirmation of the transfer price as the arm s length price. Then to make a comparison of a horizontal item without segregation would be impermissible. (viii) The Bright Line Test was judicial legislation. By validating the Bright Line Test the Special Bench in LG Electronics Case went beyond Chapter X of the Act. Even international tax jurisprudence and commentaries do not recognise BLT for bifurcation of routine and non-routine expenses. (ix) Segregation of aggregated transactions requires detailed scrutiny without which there shall be no segregation of a bundled transaction. Set off of transactions segregated as a single transaction is just and equitable and not prohibited by Section 92(3). Set-off is also recognized by international tax experts and commentaries. (x) Segregation of bundled transactions shall be done only if exceptions laid down in the EKL Appliances Case are justified. Re-categorisation and segregation of transactions are different exercises; former would require separate comparables an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... . The brand building connect is too remote and faint. To include and treat the direct marketing expenses like trade or volume discount or incentive as brand building exercise would be contrary to common sense and would be highly exaggerated. Direct marketing and sale related expenses or discounts/concessions would not form part of the AMP expenses. (xvi) The prime lending rate cannot be the basis for computing mark-up under Rule 10B(1)(c) of the Rules, as the case set up by the Revenue pertains to mark-up on AMP expenses as an international transaction. Mark up as per sub-clause (ii) to Rule 10B(1)(c) would be comparable gross profit on the cost or expenses incurred as AMP. The mark-up has to be benchmarked with comparable uncontrolled transactions or transactions for providing similar service/product. (xvii) The exceptions laid down in EKL Appliances Case were neither invoked in the present case nor were the conditions satisfied. (xviii) An order of remand to the ITAT for de novo consideration would be appropriate because the legal standards or ratio accepted and applied by the ITAT was erroneous. On the basis of the legal ratio expounded in this decision, facts have to b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xpenses ('AMP Expenses' for short) was beyond jurisdiction and bad in law as no specific reference was made by the Assessing Officer with regard to retrospective amendment to Section 92CA of the Income Tax Act, 1961 by the Finance Act, 2012. 2. Whether AMP Expenses incurred by the Assessee in India can be treated and categorized as an international transaction under Section 92B of the Income Tax Act, 1961? 3. Whether under Chapter X of the Income Tax Act, 1961, a transfer pricing adjustment can be made by the Transfer Pricing Officer Assessing Officer in respect of expenditure treated as AMP Expenses and if so in which circumstances? 4. If answer to questions Nos.2 and 3 is in favour of the Revenue, whether the Income Tax Appellate Tribunal was right in holding that transfer pricing adjustment in respect of AMP Expenses should be computed by applying the Cost Plus Method. 5. Whether the Income Tax Appellate Tribunal was right in directing that fresh bench marketing/comparability analysis should be undertaken by the Transfer Pricing Officer by applying the parameters specified in paragraph17.4 of the order dated 23.01.2013 passed by the Special Bench in t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er AMP expenses incurred by the Assessee in India can be treated and categorised as an international transaction under Section 92B in the affirmative. It is further submitted that the Sony Ericsson case does not distinguish the cases of the manufacturers from those of the distributors except observing that TNMM may not be an appropriate method in the case of entities which are performing complex functions like manufacturing or making substantial value addition to the material imported from the AE. 37. It is further submitted by Mr. Srivastava that the distinction sought to be drawn in cases of manufacturers and distributors is untenable for the following reasons: (i) The Appellants are not independent manufacturers who take all the risk. They are not completely independent in their pricing policies including price of raw material purchased from the AE, royalty payable to the AE and payments made to the AE for copyrights and patents. Even their product pricing is not completely independent. Therefore, benefits emanating from the AMP function cannot be enjoyed by the Appellant by their own. (ii) The Appellants are engaged in not only manufacturing but in distribution of goo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t be considered as an international transaction. 41. Having considered the above submissions the Court proceeds to analyse the decision in Sony Ericsson to determine if it conclusively answers the issue concerning the existence of an international transaction as a result of incurring of AMP expenditures by an Assessee. 42. As already noticed, the judgment in Sony Ericsson does not seek to cover all the cases which may have been argued before the Division Bench. In particular, as far as the present appeal ITA No. 110 of 2014 is concerned, although it was heard along with the batch of appeals, including those disposed of by the Sony Ericsson judgment, at one stage of the proceedings on 30th October 2014 the appeal was delinked to be heard separately. 43. Secondly, the cases which were disposed of by the Sony Ericsson judgment, i.e. of the three Assessees Canon, Reebok and Sony Ericsson were all of distributors of products manufactured by foreign AEs. The said Assessees were themselves not manufacturers. In any event, none of them appeared to have questioned the existence of an international transaction involving the concerned foreign AE. It was also not disputed that the sai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cases the assessed have submitted that the international transactions between them and the AE, resident abroad included the cost/value of the AMP expenses... . 47. As regards the submission regarding the BLT having been rejected in the decision in Sony Ericsson is concerned, the Court notes that the decision in Sony Ericsson expressly negatived the use of the BLT both as forming the base and determining if there is an international transaction and secondly for the purpose of determining the ALP. Once BLT is negatived, there is no basis on which it can be said in the present case that there is an international transaction as a result of the AMP expenses incurred by MSIL. Although the Revenue seems to contend that the BLT was used only to arrive at the quantum of the TP adjustment, the order of the TPO in the present case proceeds on the basis that an international transaction can be inferred only because the AMP expenses incurred were significantly higher that what was being spent by comparable entities and it was also used for quantifying the amount of the TP adjustment. Consequently, the Court does not agree with the submission of the learned Special counsel for the Revenue tha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... onal transaction as a result of the AMP expenses cannot be held to have answered the issue as far as the present Assessee MSIL is concerned since finding in Sony Ericsson to the above effect is in the context of those Assessees whose cases have been disposed of by that judgment and who did not dispute the existence of an international transaction regarding AMP expenses. Effect of the earlier decision in the writ petition by MSIL 52. Another preliminary major issue that has been raised by the Revenue concerns the effect of the earlier decision of this Court in the writ petition filed by MSIL and the decision of the Supreme Court in the SLP filed against the said decision. 53. It is submitted on behalf of the Revenue that in light of the said judgment of this Court, the findings which have not been disturbed by the Supreme Court, it can no longer be contended by MSIL that there is no international transaction resulting from the incurring of AMP expenses. This submission is countered by the Assessee by pointing out that the earlier decision in MSIL's writ petition virtually set aside the order of the TPO and AO and required the TPO to proceed de novo. The Supreme Court in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... i Suzuki Ltd. (supra) as a binding precedent. Importantly, the Revenue has relied upon the final conclusions as recorded and the assessed have relied upon the earlier portions of the judgment. We have considered the reasoning given in the aforesaid decision and have reached our own conclusion. 55. Consequently, this Court in Sony Ericsson proceeded on the basis that the decision of this Court in the writ petition by MSIL was not a binding precedent. Be that as it may, there are other reasons why the earlier decision in the writ petition filed by MSIL cannot be held to survive. A careful reading of the judgment of the Supreme Court reveals that the Supreme Court asked the TPO to proceed with the matter in accordance with law uninfluenced by the observations/directions given by the judgment in the impugned order dated July 1, 2010. That virtually nullifies the judgment of the High Court on all aspects. A further reason is that even this Court in disposing of the writ petition of MSIL proceeded on the basis of there being an international transaction only on account of the excessive AMP expenses incurred by MSIL. In other words, this Court disposing of MSIL's writ petition ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... allocation or apportionment or contribution to the any cost or expenses incurred or to be incurred in connection with the benefit, service or facility provided or to be provided to one or more of such enterprises. 60. As far as clause (a) is concerned, SMC is a non-resident. It has, since 2002, a substantial share holding in MSIL and can, therefore, be construed to be a non-resident AE of MSIL. While it does have a number of 'transactions' with MSIL on the issue of licensing of IPRs, supply of raw materials, etc. the question remains whether it has any 'transaction' concerning the AMP expenditure. That brings us to clauses (b) and (c). They cannot be read disjunctively. Even if resort is had to the residuary part of clause (b) to contend that the AMP spend of MSIL is any other transaction having a bearing on its profits, incomes or losses , for a 'transaction' there has to be two parties. Therefore for the purposes of the means part of clause (b) and the 'includes part of clause (c), the Revenue has to show that there exists an 'agreement' or 'arrangement' or 'understanding' between MSIL and SMC whereby MSIL is obliged to ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... income arising from an international transaction shall be computed having regard to the ALP, Section 92C (1) which sets out the different methods of determining the ALP, makes it clear that the transfer pricing adjustment is made by substituting the ALP for the price of the transaction. To begin with there has to be an international transaction with a certain disclosed price. The transfer pricing adjustment envisages the substitution of the price of such international transaction with the ALP. 64. The transfer pricing adjustment is not expected to be made by deducing from the difference between the 'excessive' AMP expenditure incurred by the Assessee and the AMP expenditure of a comparable entity that an international transaction exists and then proceed to make the adjustment of the difference in order to determine the value of such AMP expenditure incurred for the AE. And, yet, that is what appears to have been done by the Revenue in the present case. It first arrived at the 'bright line' by comparing the AMP expenses incurred by MSIL with the average percentage of the AMP expenses incurred by the comparable entities. Since on applying the BLT, the AMP spend of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... aries without any compensation to them either directly or through an adjustment of royalty payments. Absence of a machinery provision 68. The above submissions proceed purely on surmises and conjectures and if accepted as such will lead to sending the tax authorities themselves on a wild-goose chase of what can at best be described as a 'mirage'. First of all, there has to be a clear statutory mandate for such an exercise. The Court is unable to find one. To the question whether there is any 'machinery' provision for determining the existence of an international transaction involving AMP expenses, Mr. Srivastava only referred to Section 92F (ii) which defines ALP to mean a price which is applied or proposed to be applied in a transaction between persons other than AEs in uncontrolled conditions . Since the reference is to price and to uncontrolled conditions it implicitly brings into play the BLT. In other words, it emphasises that where the price is something other than what would be paid or charged by one entity from another in uncontrolled situations then that would be the ALP. The Court does not see this as a machinery provision particularly in light ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 39;assumed' price cannot form the reason for making an ALP adjustment. 71. Since a quantitative adjustment is not permissible for the purposes of a TP adjustment under Chapter X, equally it cannot be permitted in respect of AMP expenses either. As already noticed hereinbefore, what the Revenue has sought to do in the present case is to resort to a quantitative adjustment by first determining whether the AMP spend of the Assessee on application of the BLT, is excessive, thereby evidencing the existence of an international transaction involving the AE. The quantitative determination forms the very basis for the entire TP exercise in the present case. 72. As rightly pointed out by the Assessee, while such quantitative adjustment involved in respect of AMP expenses may be contemplated in the taxing statutes of certain foreign countries like U.S.A., Australia and New Zealand, no provision in Chapter X of the Act contemplates such an adjustment. An AMP TP adjustment to which none of the substantive or procedural provisions of Chapter X of the Act apply, cannot be held to be permitted by Chapter X. In other words, with neither the substantive nor the machinery provisions of Chap ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... transaction involving two or more related parties, reference may be made to Section 40 A (2) (a) under which certain types of expenditure incurred by way of payment to related parties is not deductible where the AO is of the opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods. In such event, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction. The AO in such an instance deploys the 'best judgment' assessment as a device to disallow what he considers to be an excessive expenditure. There is no corresponding 'machinery' provision in Chapter X which enables an AO to determine what should be the fair 'compensation' an Indian entity would be entitled to if it is found that there is an international transaction in that regard. In practical terms, absent a clear statutory guidance, this may encounter further difficulties. The strength of a brand, which could be product specific, may be impacted by numerous other imponderables not limited to the nature of the industry, the geographical peculiarities, economic trends both international ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed by MSIL bear the symbol S is not decisive as the advertisements are of the particular model of the car with the logo Maruti-Suzuki . The Revenue has been unable to contradict the submission of MSIL that the co-brand mark Maruti-Suzuki in fact does not belong to SMC and cannot be used by SMC either in India or anywhere else. The decision in Sony Ericsson requires that the mark or brand should belong to the foreign AE. The Revenue also does not deny that as far as the brand Suzuki is concerned its legal ownership vests with the foreign AE i.e. SMC. The Revenue proceeds on the basis that the benefit of the economic ownership also accrues to the foreign AE by way of increased royalty, increased raw material sales, increased brand value etc. 80. The Revenue is proceeding on a presumption regarding the comparative benefits to MSIL and SMC as a result of the AMP expenditure incurred by MSIL. The Revenue is unable to deny that MSIL's expenditure on AMP is only 1.87% of its total sales whereas SMC's expenditure worldwide on AMP is 7.5% of its sales. In the circumstances, in the absence of some data, it cannot be simply asserted that the benefit of MSIL's AMP spend t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tional expenditures. The actual conduct of the parties over a period of years should be given significant weight in evaluating the return attributable to marketing activities. 83. The OECD Guidelines set out broad parameters for determining the existence of international transaction and for ascertaining the ALP of such transaction. They may not ipso facto become applicable in situations where no studies have been conducted on a scientific basis on the behaviour of market and assessment of brand value. Incidental benefit to SMC 84. The Court next deals with the submission of the Revenue that the benefit to SMC as a result of the MSIL selling its products with the co-brand Maruti-Suzuki is not merely incidental. The decision in Sony Ericsson acknowledges that an expenditure cannot be disallowed wholly or partly because its incidentally benefits the third party. This was in context on Section 57(1) of the Act. Reference was made to the decision in Sassoon J David Co Pvt. Ltd. v. CIT (1979) 118 ITR 26 (SC). The Supreme Court in the said decision emphasised that the expression 'wholly and exclusively' used in Section 10 (2) (xv) of the Act did not mean 'necess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s framed 89. To answer the questions framed by the orders dated 29th October 2014 and 10th September 2015 in ITA Nos. 110 of 2014 and 710 of 2015 respectively: (i) Question No.1 stands answered by the judgment in Sony Ericsson viz., that the TPO could have examined the question whether AMP expenses by themselves constitute an international transaction in the absence of any specific reference being made in that behalf by the AO. (ii) Question No.2 is answered in the negative i.e. in favour of the Assessee and against the Revenue. In other words, it is held that AMP expenses incurred by MSIL cannot be treated and categorised as an international transaction under Section 92B of the Act. (iii) Since answer to Question No.2 is in favour of the Assessee, the question of the TPO making any transfer pricing adjustment in respect of such transaction Chapter X does not arise and, therefore, question (3) is answered in the negative and in favour of the Assessee and against the Revenue. (iv) In view of the answer to Question No.2, Question No.4 does not arise for consideration. (v) Question No.5 is answered in the negative i.e. in favour of the Assessee and against the Revenu ..... X X X X Extracts X X X X X X X X Extracts X X X X
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