9911796707
TMI Blog2015 (12) TMI 1333X X X X Extracts X X X X X X X X Extracts X X X X ..... Assessee and against the Revenue. Existence of an international transaction - whether the Revenue has been able to discharge the initial onus of showing that there was an international transaction concerning the Assessee and its foreign AEs - Held that:- During the financial year 2007-2008 relevant to the AY in question, of the total turnover of 251.06 crore only 9.57 crore, constituting 3.81 per cent, is towards distribution activity whereas the balance revenue of 241.48 crore was from the manufacturing activity. Further it is pointed out that the contention of the Revenue that market development in India is the function of the AE is factually incorrect. It is pointed out that para 4.30 of the TP documentation has stated that the Assessee plans and executes its own marketing strategy as it considers necessary and appropriate. Further as an independent manufacturer the Assessee bears all the risks associated with its business of manufacturing and sale of products in India and abroad. The condition in the license agreement that the technology will be used for sale of goods in designated jurisdictions or specified territories is not an unusual arrangement. The question of re-characte ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... M vi. Payment of Royalty 8,77,14,255 CUP/TNMM vii Payment of Technical Guidance Fee 17,464,121 TNMM viii. Payment towards Commission on Exports 51,996,673 TNMM ix. Expenses Reimbursement Received 199,078 TNMM x. Payment for purchase of fixed assets 12,600,659 TNMM xi. Expenses Reimbursement Paid 513,920 TNMM 4. The Assessee filed its return of income for the AY in question on 30th September, 2008, declaring a total income of ₹ 37,15,72,026. The return was picked up for scrutiny and notices under Sections 143(2) and 142(1) of the Income Tax Act, 1961 ('Act') were issued. During the course of the assessment proceedings, the Assessing Officer invoked Section 92CA(1) of the Act and referred the case of the Appellant to the Transfer Pricing Officer (TPO) for determination of Arm's Length Price ('ALP') in relation to the international transactions undertaken by the Appellant with its AEs. 5. The total advertisement, marketing and sales promotion ('AMP') expenses of the Assessee was ₹ 12,39,19,327/-, which was 4.46 per cent of its sales, and comprised the following: S.No. Name of Expenses Amount (Rs.) 1. Commission on sales 1,22,95,327 2. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ent 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. 10. The majority of the ITAT adopted the BLT for determining the existence of an international transaction involving AMP expenses as well as for determining its ALP. If the expense incurred by the Assessee on AMP was higher than what was incurred by an independent entity behaving in a commercially rational manner, then the TPO would determine whether the said transaction required re-characterisation. If the Assessee failed to supply the details of the value of such international transaction, the onus was on the TPO to determine its ALP it on some rational basis by identifying the comparable domestic cases. It was further held that the initial burden to show that the international transaction with the AE was at ALP was on the Assessee. The decision of this Court in Sony Ericsson 11. The correctness of the decision of the Special Bench of the ITAT in LG Electronics (supra) was considered by this Court in Sony Ericsson Mobile Com ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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.?" 13. The summary of the conclusions of the Division Bench in Sony Ericsson (supra) was as under: (i) The Court concurred with the majority of the Special Bench of the ITAT in the LG Electronics case qua the applicability of 92CA (2B) and how it cured the defect inherent in 92CA (2A). The issue concerning retrospective insertion of 92CA (2B) was decided in favour of the Revenue. (ii) AMP expenses were held to be international transaction as this was not denied as such by the assessees. (iii) Chapter X and Section 37(1) of the Act operated independently. The former dealt with the ALP of an international transaction whereas the latter deals with the allowability/disallowability of business expenditure. Also, once the conditions for applicability of Chapter X were satisfied nothing shall impede the law contained therein to come into play. (iv) Chapter X dealt with ALP adjustment whereas Section 40A (2)(b) dealt with the reasonability of quantum of expenditure. (v) TNMM applied with equal forc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Case are justified. Re-categorisation and segregation of transactions are different exercises; former would require separate comparables and functional analysis. (xi) Economic ownership of a brand would only arise in cases of long-term contracts and where there is no negative stipulation denying economic ownership. Economic ownership of a brand or a trade mark when pleaded can be accepted if it is proved by the Assessee. The burden is on the Assessee. It cannot be assumed. (xii) After the order of the Supreme Court in the Maruti Suzuki case, the judgment of the Delhi High Court does not continue to bind the parties. This position was misunderstood by the majority of the Special Bench in the LG Electronics Case. (xiii) The RP Method loses its accuracy and reliability where the reseller adds substantially to the value of the product or the goods are further processed or incorporated into a more sophisticated product or when the product/service is transformed. RP Method may require fewer adjustments on account of product differences in comparison to the CUP Method because minor product differences are less likely to have material effect on the profit margins as they do on the pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ratio accepted and applied by the ITAT was erroneous. On the basis of the legal ratio expounded in this decision, facts have to be ascertained and applied. If required and necessary, the assessed and the Revenue should be asked to furnish details or tables. The ITAT, in the first instance, would try and dispose of the appeals, rather than passing an order of remand to the AO /TPO. An endeavour should be to ascertain and satisfy whether the gross/net profit margin would duly account for AMP expenses. When figures and calculations as per the TNM or RP Method adopted and applied show that the net/gross margins are adequate and acceptable, the appeal of the assessed should be accepted. Where there is a doubt or the other view is plausible, an order of remand for re-examination by the AO/TPO would be justified. A practical approach is required and the ITAT has sufficient discretion and flexibility to reach a fair and just conclusion on the ALP. 14. However, as far as the present case is concerned, at the time the ITAT decided the appeal of the Assessee, the decision in Sony Ericsson (supra) had not been rendered. The ITAT accordingly followed the decision of the Special Bench in LG El ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nue before this Court against the decision of the Special Bench of the ITAT in LG Electronics and other decisions of the ITAT that followed the decision of the Special Bench in LG Electronics. Although arguments were heard in all the appeals, the Court decided the appeals of only six Assessees i.e. Sony Ericsson Mobile Communications India Pvt. Ltd, Discovery Communications India, Daikin Air-conditioning India Pvt. Ltd., Haier Appliances (India) Pvt. Ltd., Reebok India Company and Canon India Pvt. Ltd. 26. The Court explained 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 assessee 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 s ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d of BLT as a legitimate means of determining the ALP of an international transaction involving AMP expenses, the very basis of the Revenue's case is negated." 22. The Court is of the view that the above decision in MSIL (supra) holding that the decision in Sony Ericsson (supra) would not cover the case of MSIL would also apply as far as the present Appellant is concerned. As noticed in MSIL (supra) the facts of the cases of the Assessees in Sony Ericsson (supra) did not give rise to a dispute that there is no international transaction involving the Assessee therein and its AEs. In fact each of the Assessees were receiving subsidies/subventions from their respective AEs. 23. The second factor taken note of by the Court is that as BLT was invalidated as a means of determining the existence of an international transaction, the onus was on the Revenue to show the existence of an international transaction. In the present case, the existence of such a transaction was ascertained only by applying the BLT. For the above reasons, the Court is satisfied that the case of the present Appellant would not stand covered by the decision in Sony Ericsson (supra). Question (i) is accordingly ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... India." 28. A reference is made by the Revenue to the Export Agreement whereunder the Assessee has been granted rights to export products to certain 'permitted countries' for payment of royalty of 8 per cent of the export price, which was subsequently raised to 12.25 per cent from 1st February 2008. Honda, Japan reserved the right to change the permitted countries at any time. According to the Revenue this indicates that the Assessee has not been an independent manufacturer and is only functioning as a contract manufacturer for the AE. It is also pointed out that the list of countries to which export is permitted by Honda, Japan included the countries falling in the same geographical location as India. It is stated that the terms of the agreement with such distributors in other countries "could have worked as a sound comparable" but that the Assessee had not chosen to make any such attempt in its TP documentation. 29. In response, it is pointed out on behalf of the Assessee that the payment of royalty fee for the HONDA trademark are separately benchmarked by the Assessee. That is not the subject matter of the dispute in the present case. It is further pointed out that the agreeme ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ce of Tax "] and Section 92 (1) which states that any 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 TP adjustment envisages the substitution of the price of such international transaction with the ALP. 33. The TP 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. 34. It is for the above reason that the BLT has been rejected as a valid method for either determining the existence of international transaction or for the determination of ALP of such transaction. Although, under Section 92B read with Section 92F (v), an international transa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ffect that: "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 was 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". In MSIL (supra) the above submission was rejected by the following reasoning: "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. Srivast ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 which the AEs involved may seek to shift from one jurisdiction to another. An '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 e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. As an analogy, and for no other purpose, in the context of a domestic 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 exces ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ourt in the said decision emphasised that the expression 'wholly and exclusively' used in Section 10 (2) (xv) of the Act (Indian Income Tax Act, 1922) did not mean 'necessarily'. It said: "The fact that somebody other than the Assessee is also benefitted by the expenditure should not come in the way of an expenditure being allowed by way of a deduction under Section 10 (2) (xv) of the Act (Indian Income Tax Act, 1922) if it satisfies otherwise the tests laid down by the law." 39. The OECD Transfer Pricing Guidelines, para 7.13 emphasises that there should not be any automatic inference about an AE receiving an entity group service only because it gets an incidental benefit for being part of a larger concern and not to any specific activity performed. Even paras 133 and 134 of the Sony Ericsson judgment makes it clear that AMP adjustment cannot be made in respect of a full-risk manufacturer. 40. Certain additional facts have been mentioned by the Assessee in its written note of submissions. It is pointed out that during the financial year 2007-2008 relevant to the AY in question, of the total turnover of ₹ 251.06 crore only ₹ 9.57 crore, const ..... 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