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TMI Blog2020 (1) TMI 82X X X X Extracts X X X X X X X X Extracts X X X X ..... selling expenditure and was incurred for the business needs of the assessee and is to be allowed as revenue expenditure. Accordingly, we direct the Assessing Officer to allow the expenditure of 24.13 crores. Expenditure booked under the head Advertising, Marketing and Promotion ( AMP ) - There is no provision either in the Act or in the Rules to justify the application of BLT for computing the arms length price and also in the absence of BLT, the existence of an international transaction vis - vis the AMP expenditure cannot exist. Further, we hold that there cannot be a quantification of adjustment for determining the AMP expenses incurred by the assessee after applying the BLT, to hold the same to be excessive and thereby an existence of international transaction between the assessee and its AE. We find no merit in exercise carrying of Assessing Officer/DRP/TPO in this regard and delete the Transfer pricing adjustment made on account of AMP expenditure. Accordingly, we delete the adjustment on account of transfer pricing analysis of AMP expenditure. Distribution segment - The RPM method identifies the price at which product purchased from the AE is resold to unrelated party; then ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r section 92CA of the Income Tax Act, 1961 ("the Act") is bad in law and erroneous, which was relied upon by the Ld. AO and Hon'ble DRP while passing the order under section 144C(1) of the Act. 3. That the Ld. AO/ Ld. TPO/ Hon'ble DRP erred on facts and in law in not appreciating that the comparables selected by the Appellant in its transfer pricing documentation are functionally comparable with the distribution activity undertaken by the Appellant. 4. The Ld. AO/ Ld. TPO/ Hon'ble DRP has erred in including Liva Healthcare Ltd. in the final comparable set as the said comparable fails the related party to sales filter of 25%. 5. The Ld. AO/ Ld. TPO/ Hon'ble DRP erred in including certain non-operating expenses and" excluding operating income for the purpose of computing the operating margin of the Appellant. 6. The Ld. AO/ Ld. TPO/ Hon'ble DRP erred in considering the Transactional Net Margin Method ("TNMM") as the most appropriate method and disregarding the Resale Price Method ("RPM") to benchmark the distribution activities of the Appellant. 7. The Ld. AO/ Ld. TPO/ Hon'ble DRP erred in not including subvention income as part of operating income or deducting subvent ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iness of the Appellant and have not been incurred to enure any benefit to the associated enterprise. 17. That the Ld. AO/ Ld. TPO/ Hon'ble DRP erred on facts and in law in not appreciating that the AMP expenses are incurred by the Appellant at its own volition and for its own benefit and any benefit accruing to the associated enterprise is incidental for which no compensation is warranted. 18. That the Ld. AO/ Ld. TPO/ Hon'ble DRP have disregarded the judicial pronouncements in India in undertaking the TP adjustment. Corporate tax issues 19. That the Ld. AO erred on facts and in law, in proposing to disallow depreciation amounting to ₹ 3,12,061 out of the total depreciation claimed by the Appellant on account of UPS, computer cables & wirings etc. 20. That the Ld. AO/ Ld. TPO/ Hon'ble DRP have disregarded the judicial pronouncements in India in disallowing depreciation. Other Grounds 21. The Ld. AO/Hon'ble DRP has erred both on facts and in law in initiating the penalty under section 274 read with section 271(1)(c) of the Act. 22. The Ld. AO/Hon'ble DRP has erred both on facts and in law in charging interest under section 234C of the Act. 23. That the Appell ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sses. He further observed that in case the subvention income was not considered as operating then the results were even worse. Show cause notice was issued to the assessee in this regard and it was pointed out that the analysis done by assessee at gross level was not reliable; even the comparables used by using multiple year data to benchmark the international transactions of trading in medicine and drugs, was not accepted by the TPO. The TPO also noted that the assessee had incurred significant advertisement, marketing and promotion expenses in order to develop the brand of its AE. The TPO thus observed that the assessee could be characterized as a distributor undertaking significant functions and value additions. Accordingly selection of RPM as the most appropriate method to benchmark the international transaction was not the correct approach. Hence the assessee was asked to explain why net level analysis should not be done. The assessee in reply submitted that under the TP regulation, the selection of most appropriate method was generally based on functional profile and characterization of the assessee. He further pointed out that RPM was appropriate in cases involving purchase ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ad incurred expenditure of ₹ 24.13 Crores on sales and marketing team and ₹ 57.84 Crores on marketing, development and promotion. The TPO was of the view that the marketing expenditure incurred by it was part of brand building expenses. He further applied the Bright Line Test and was of the view that the issue of marketing intangible falls squarely within the definition of transaction as per section 92F(v) of the Act. Further relying on the explanation on (i)(a) under section 92B of the Act inserted by Finance Act, 2012, the TPO observed that the assessee had used intangible property and therefore expenditure incurred towards promotion of marketing intangible was an international transaction. Since the aforesaid expenditure on AMP was incurred to promote brand name "MSB", which was owned by the AE, such expenditure thus resulted in the brand building and the same had to be benchmarked as an international transaction. It was observed that where the expenditure incurred by the assessee company was for the international transaction of its AEs, since the brand / trade name "MSB: was owned by the AE, then in such a situation, the assessee company should have been suitably co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uld be sold in India. It was further pointed out that the expenditure on the sales and marketing team of ₹ 24.13 Crores, was expenditure on the personnel of the assessee, would not in any way promote the business of the AE; but these were the direct expenses of the assessee, incurred as regular distributor. Referring to para 6.2 onwards of the order of the TPO, it was pointed out that the Bright Line Test was applied and also explanation under section 92B inserted by Finance Act, 2012 was applied, to benchmark the aforesaid transaction as international transaction. The learned AR for the assessee stressed that the transaction undertaken by the assessee was not international transaction and the reliance of the AO on different decisions of the Tribunal was misplaced, especially because of the decision of Hon'ble Delhi High Court in the Maruti Suzuki India Ltd. vs CIT (in short "Maruti Suzuki") in ITA No.110/2014 order dated 11.12.2015 [2015] 64 taxmann.com 150 (Del.) and Sony Ericsson Mobile Communications India (P.) Ltd. vs CIT-III (in short "Sony Ericsson") [2015] 374 ITR 118 (Delhi). It was again stressed by the learned AR that the onus was on the Revenue to establish that t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ne Test was only a statistical tool to estimate the routine expenses incurred for building brand and the method to be applied was cost plus method. 11. We have heard the rival contentions and perused the record. The issue which needs to be adjudicated is whether the AMP expenditure incurred by the assessee on sales plus marketing Team of ₹ 24.13 crores and Marketing, Advertisement and Promotion expenses of ₹ 57.84 crores, is an international transaction and benchmarking of the same is to be carried out by treating it as an international transaction. The assessee was the subsidiary of its foreign AE and was dealing in finished good pharmaceuticals i.e. Anti Diabetics Drugs and also Thereupatic and critical care drugs. The case of the assessee was that for sale of the drugs, no advertisement can be made. The expenditure which was booked under the head AMP was the direct selling expenses incurred by the assessee in order to increase awareness of the drugs and thus promote the sales of the said drug. In order to benchmark the said transaction as an international transaction, the first step is whether the assessee was promoting the drugs of the AE or was the promoting the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... iture of ₹ 24.13 crores. 13. Now, coming to the 2nd set of expenditure of ₹ 57.84 crores booked under the head Advertising, Marketing and Promotion (in short "AMP"). The assessee claims that since it was dealing with only specialized drugs, which were imported by the assessee form its AE and distributed within the territory of India, then it was incumbent upon the assessee to spread awareness of the contents/formulations of the drugs dealt in by the assessee. It was dealing in specialized drugs i.e. anti-daibatic drugs and thereupatic drugs. Under the domestic laws, no advertisement of the said drugs could be made in India. The expenditure incurred for promoting the sales of the aforesaid drugs thus could not be benchmarked as an AMP expenditure. The case of the Revenue was that the expenditure booked by the assessee being AMP expenditure resulted in promotion of brand of Assessing Officer, was an international transaction undertaken by the assessee and consequently BLT was applied to benchmark the said transaction. The Assessing Officer acknowledges that no part of the expenditure was reimbursed by the AE, but applying the ratio laid down by the Special Bench in L.G. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... er 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 case of LG Electronics India (P) Ltd.?" 17. The Hon'ble Delhi High Court in later decision decided on 11.12.2015 in the case of Maruti Suzuki (supra) vide para 29 has summarized conclusion of the Division Bench of Sony Ericsson (supra) 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 internationa ..... X X X X Extracts X X X X X X X X Extracts X X X 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 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 th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e 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. (xviii) The exceptions laid down in EKL Appliances Case were neither invoked in the present case nor were the conditions satisfied. (xix) 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 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 mar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r/TPO to (a) decide the existence of an international transaction involving; and (b) to make quantitative adjustment to the Arm's Length Price to the extent that the expenditure exceeded the expenditure by comparable entities. Another aspect which was pointed out was that in Sony Ericsson (supra) where the Hon'ble High Court disapproved the BLT as a legitimate means for determining the Arm's Length Price of an international transaction involving AMP expenses, then there was no case of the revenue. The Hon'ble High Court in Maruti Suzuki (supra) vide para 47 held as under:- 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tion' means- (a) a transaction between two or more AEs, either or both of whom are nonresident (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 losses of such enterprises, and (c) shall include a mutual agreement or arrangement between two or more AEs for 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 t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 of the fact that the BLT has been expressly negatived by the Court in Sony Ericsson. Therefore, the existence of an international transaction will have to be esta ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... MP 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 Chapter X of the Act being applicable to an AMP TP adjustment, the inevitable conclusion is that Chapter X as a whole, does not permit such an adjustment. 73. It bears repetition that the subject matter of the attempted price adjustmen ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is was sought to be explained by stating that Section 37 and Chapter X operate in different domains and merely because an expense was incurred wholly or exclusively for the Indian entity it would not mean that it is also not incurred for the foreign AE. The question then is to what extent the Indian entity should be compensated for the expenses incurred by it on behalf of the foreign AE. What will then be required to be benchmarked is not the AMP expenditure but the extent to which the Indian entity must be compensated. ………………… 45. The decisions in CIT v. B.C. Srinivasa Setty (1981) 128 ITR 294 (SC) and PNB Finance Ltd. v. CIT (2008) 307 ITR 75 (SC) make it explicit that in the absence of any machinery provision, bringing an imagined transaction to tax is not possible. Here, therefore, where the existence of an international transaction involving AMP expense with an ascertainable price is unable to be shown to exist, even if such price is nil, Chapter X provisions cannot be invoked to undertake a TP adjustment exercise. 46. As already mentioned, merely because there is an incidental benefit to Whirlpool USA, it cannot be said t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lso refer to the stand of the Ld. DR before us that the Hon'ble Delhi High Court in Sony Ericsson (supra) had laid down the proposition that incurrence of the AMP expenditure in respect of brand not owned by the assessee was to be treated as an international transaction. The Hon'ble Delhi High Court in the case of Maruti Suzuki (supra) explained the ratio laid down in Sony Ericsson (supra) and has not accepted the said proposition and has also observed that BLT has not been accepted in Sony Ericsson (supra) and in the absence of application of BLT to arrive at arms length price, the incurring of AMP expenditure cannot be said to be an international transaction. The Ld.DR for the Revenue relied on the several decision of Delhi Tribunal in support of its arguments including in the case of BMW (supra) relating to Assessment Year 2010-11. The Ld.AR for the assessee before us pointed out that the Tribunal itself in the subsequent decision in the case of BMW (supra) relating to Assessment Year 2011-12 vide order dated 25.01.2019 has relied on the decision of Hon'ble Delhi High Court and held as under:- 38. "In our understanding of the facts and law, mere agreement or arrangement for al ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e the price of the said transaction by applying BLT. In the facts before us, we hold that the expenses which were booked by the assessee were for promotion of drugs, which undoubtedly have been imported by the assessee from its AE, but while spreading awareness to promote its sales, it cannot be said, in the absence of any agreement or arrangement to the contrary, that the assessee was promoting the brands of its AE. Since the expenditure incurred by the assessee was neither incurred at the instance or behest of its AE nor there was any understanding or arrangement between the parties to allocate or contribute any part of the expenditure or towards reimbursement of any part of AMP expenditure, then no transaction or international transaction could be said to be involved between the assessee and its AE. In the absence of the same, the incurring of the expenditure by the assessee for its needs of the business is purely a domestic transaction and not governed by any of the transfer pricing regulations. The Courts upheld that the onus is upon the Revenue to demonstrate that there existed an arrangement between the assessee and its AE under which the assessee was obliged to incur excess ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... orders of the authorities below and pointed out that under RPM, there was requirement of high level comparability, whereas under the Transactional Net Margin Method there was tolerance range. 36. We have heard the rival contentions and perused the record. For deciding the aforesaid issue raised by the assessee under the distribution segment, we may refer to our decision in the paras above, wherein we have held that the expenditure incurred on promotion, advertisement and marketing by the assessee is not an international transaction to be benchmarked in the hands of the assessee. The case of the Assessing Officer/TPO in this regard was that since the assessee while undertaking the activities of the distribution had also incurred expenses which resulted in value additions and hence, RPM could not be applied. As we have already held that no adjustment is to be made on account of transfer pricing adjustment of AMP expenses in the hands of the assessee, the case of the Assessing Officer/TPO falls in the absence of any value addition. Accordingly, we hold that in the case of the assessee, RPM is the most appropriate method to be applied. In this regard, we find support from the ratio ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the draft assessment order and objections were rejected by the DRP and final assessment order was passed against the assessee. The assessee has raised Ground of appeal No.7 with regard to non-inclusion of subvention income as part of operating income. 38. The assessee has also raised additional grounds vis-à-vis the decision of the Assessing Officer/TPO on reliance of Safe Harbour Rules. 39. We have heard the rival contentions and both the authorized representatives. First of all the issue relates to the subvention income received by the assessee amounting to ₹ 77.12 crores. As per the understanding between the parties vide clause 5 to schedule (A) of the sales agreement between MSD India and MSD BV, it was agreed upon that since in the initial years of operation, it was anticipated that the assessee would incur significant start up operating cost and would incur losses in these years, so in order to assist the assessee in its initials years of operation, for transfer pricing purposes, MSD BV would make subvention payments to the assessee to reimburse part of operating expenses. The amount of the subvention payments were to be mutually agreed upon between the parties ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 139 of Paper Book and also from consequential Memo for approval of subvention and relevant e-mails and relevant documents thereto. The assessee received sum of ₹ 65,19,47,000/- towards subvention. The assessee had offered the said amount as taxable in its hands initially but before the DRP, it was pleaded that the same was not taxable in its hands. The issue vis-à-vis its taxability i.e. receipt of subvention from parent company now stands settled by recent decision of Hon'ble Supreme Court in Siemens Public Communication Network (P.) Ltd. Vs. CIT (supra). The Hon'ble Supreme Court had held that voluntary payments made by parent company to its loss making Indian company can also be understood to be payments made in order to protect the capital investment of assessee company. It was further held that if that is so, then the payment in question could not be held to be revenue receipts, hence they were capital receipts in the hands of assessee. Similar proposition has been laid down by the Hon'ble High Court of Kolkata and Hon'ble Delhi High Court in different decisions. 16. Applying the said proposition to the facts of present case, where the assessee had rec ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion laid down was since the subvention income had been offered to tax, then the same would be available to the assessee for set off against TP adjustment proposed by TPO. The said proposition will not be applicable to the issue raised before us since the Hon'ble Apex Court has decided the taxability of subvention income to be capital in nature and hence, the said income is not taxable in the hands of assessee and same would not be available as set off as against TP adjustment made by Assessing Officer/TPO. Accordingly, there is no merit in the directions of DRP in this regard. We in the final analysis hold that subvention income is capital receipt in the hands of assessee, hence not taxable. Further, we hold that the said subvention amount is operating in nature and has to be included as operating income while computing PLI in the hands of assessee restricted to the amount relatable to the instant assessment year. Thus, ground of appeal No.2 raised by assessee against taxability of subvention income is allowed and ground of appeal No.11 also stands allowed in favour of assessee." 41. Following the same parity of reasoning, we hold that the subvention amount received by the assesse ..... X X X X Extracts X X X X X X X X Extracts X X X X
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