2025 (7) TMI 1370 - AT - Income Tax

TP Adjustment - AMP expenses incurred by the Appellant in India as an international transaction u/s 92B - HELD THAT - We find that the Co-ordinate Bench of the Tribunal in assessee s own case in M/s. Edwards Lifesciences (India) Pvt. Ltd. 2019 (7) TMI 2063 - ITAT MUMBAI while deleting the Transfer Pricing Adjustment made on account of incurring AMP expenses by the assessee. It is pertinent to note that the objective of the entire exercise of Transfer Pricing Benchmarking analysis is to arrive at an arm s length remuneration which the assessee should have earned from rendering the distribution services to its Associated Enterprises and once the assessee has shown that the income earned by it including the subvention income has resulted in an arm s length margin in India vis- -vis the margin earned by the comparable companies any further adjustment is unwarranted and uncalled for particularly when the subvention income received by the assessee is much more than the entire Transfer Pricing Adjustment made by the TPO. Therefore on this basis alone we do not find any merits in the Transfer Pricing Adjustment made by the TPO and upheld by the learned DRP. TPO for making the impugned addition has adopted the Bright Line Test which was held to be not having any statutory mandate in Sony Ericson Mobile Communications (India) Pvt. Ltd. 2015 (3) TMI 580 - DELHI HIGH COURT We find that this was also one of the basis for deleting a similar Transfer Pricing Adjustment by the Co-ordinate Bench of the Tribunal in the decision cited supra. Accordingly in view of our aforesaid findings without going into any other aspect of the issue involved the impugned Transfer Pricing Adjustment is deleted. As a result Ground No.2 raised in assessee s appeal is allowed.

Summary

The core legal questions considered in this appeal are:

1. Whether the Transfer Pricing Officer (TPO) and the Dispute Resolution Panel (DRP) erred in confirming the Transfer Pricing adjustment on account of Advertisement, Marketing, and Promotional (AMP) expenses incurred by the assessee, treating these expenses as creating marketing intangibles and constituting an international transaction under section 92B of the Income Tax Act, 1961 ("the Act").

2. Whether the AMP adjustment made by applying the Bright Line Test (BLT) is valid, given the absence of statutory mandate for such method under the Act and Rules.

3. Whether the subvention income received by the assessee from its Associated Enterprises (AEs) effectively compensates for the AMP expenses, thereby nullifying the basis for additional Transfer Pricing adjustment.

4. Whether penalty proceedings initiated under section 270A of the Act for under-reporting of income are justified.

5. Whether interest levied under section 234B of the Act is appropriate.

Issue-wise Detailed Analysis:

1. Transfer Pricing Adjustment on AMP Expenses and Existence of International Transaction

Legal Framework and Precedents: The provisions of sections 92B and 92C of the Act govern international transactions and determination of arm's length price (ALP). The Transfer Pricing Officer (TPO) is empowered under section 92CA to examine and determine ALP of international transactions. The concept of marketing intangibles and brand-building expenses as international transactions has been judicially examined in various precedents. The Tribunal's earlier decisions in the assessee's own case for AY 2012-13 and 2013-14 are relevant, as is the decision of the Delhi High Court rejecting the Bright Line Test in Transfer Pricing matters.

Court's Interpretation and Reasoning: The TPO held that the AMP expenses incurred by the assessee created marketing intangibles for the AEs, constituting an international transaction requiring benchmarking. The TPO applied the Bright Line Test (BLT), comparing the AMP-to-sales ratio of the assessee with that of comparable companies, and added a mark-up of 7.02% to compute the ALP adjustment of INR 9,212,742. The DRP upheld this view, finding an arrangement or understanding between the assessee and AEs for brand-building services without adequate compensation.

The assessee contended that it is a limited risk distributor incurring AMP expenses solely for its own business benefit, primarily to increase sales in India, and that the benefits do not flow to the AEs. It further submitted that it received substantial subvention income (INR 39,17,89,834) from AEs under supplementary distribution agreements to ensure it earned arm's length margins, effectively compensating for all distribution-related expenses including AMP.

The Tribunal examined the nature of expenses, noting they were incurred for scientific meetings, training, and awareness campaigns to educate doctors about products, which are typical distributor activities. The Tribunal relied heavily on its own coordinate bench decisions for AY 2012-13 and 2013-14, which had deleted similar adjustments on the ground that the subvention income received by the assessee was much higher than the Transfer Pricing adjustment proposed, thus negating any need for additional adjustment.

The Tribunal also noted that the lower authorities failed to consider or address the detailed submissions and evidence regarding the subvention income and its impact on the arm's length margin. The Tribunal further pointed out that the annual report relied upon by the lower authorities was of a different AE and could not be considered as evidence of an arrangement with the assessee.

Key Evidence and Findings: The assessee's detailed expense breakdown, the supplementary distribution agreement, and the subvention income received were critical. The Tribunal found that the subvention income raised the assessee's operating margin to 6.92%, which was higher than the margins of comparable companies, indicating the assessee was adequately compensated.

Application of Law to Facts: The Tribunal applied the principle that Transfer Pricing adjustments should not be made if the assessee has already been compensated at arm's length for its functions and risks. The mere incurrence of AMP expenses does not automatically create an international transaction unless there is tangible evidence of benefit to the AE. The Tribunal also held that the Bright Line Test, used by the TPO and DRP, lacks statutory backing and was rejected by the Delhi High Court.

Treatment of Competing Arguments: The Department argued that the subvention income itself proved the existence of an arrangement for marketing functions on behalf of the AE, justifying the adjustment. The Tribunal rejected this, holding that the subvention income was compensation for all distribution activities and thus precluded any further adjustment. The Tribunal also rejected the Department's reliance on the Bright Line Test and the AE's annual report.

Conclusion: The Transfer Pricing adjustment on AMP expenses was deleted as the assessee had been adequately compensated through subvention income, and the method adopted by the TPO was not legally sustainable.

2. Validity of Bright Line Test Application

Legal Framework and Precedents: The Bright Line Test (BLT) is a method comparing AMP expenses as a percentage of sales with comparable companies to determine excess expenditure. The Delhi High Court in Sony Ericsson Mobile Communications (India) Pvt. Ltd. vs. CIT held that BLT has no statutory mandate under the Income Tax Act or Rules.

Court's Interpretation and Reasoning: The Tribunal found that the TPO's application of BLT was contrary to the Delhi High Court's ruling and thus not justified. The Tribunal observed that the BLT is a numerical averaging method, which does not consider the qualitative nature of AMP expenses, and its application was therefore inappropriate.

Conclusion: The use of BLT by the TPO and DRP to justify the Transfer Pricing adjustment was held to be legally unsustainable.

3. Penalty Proceedings under Section 270A

Legal Framework: Section 270A provides for penalty for under-reporting and misreporting of income.

Court's Interpretation and Reasoning: The Tribunal held that initiation of penalty proceedings under section 270A was premature, as the substantive Transfer Pricing adjustment itself was not sustainable.

Conclusion: The penalty proceedings were dismissed.

4. Interest under Section 234B

Legal Framework: Section 234B provides for interest on default in payment of advance tax.

Court's Interpretation and Reasoning: The interest levied was consequential to the assessment order and thus did not require separate adjudication.

Conclusion: No separate order on interest was necessary.

Significant Holdings:

"The objective of the entire exercise of Transfer Pricing Benchmarking analysis is to arrive at an arm's length remuneration, which the assessee should have earned from rendering the distribution services to its Associated Enterprises and once the assessee has shown that the income earned by it including the subvention income ... has resulted in an arm's length margin in India vis-`a-vis the margin earned by the comparable companies, any further adjustment is unwarranted and uncalled for, particularly when the subvention income received by the assessee is much more than the entire Transfer Pricing Adjustment..."

"The application of Bright Line Test has been negatived by the Hon'ble Delhi High Court ... Hence, the action of the lower authorities would not be justified even on that count."

"The initiation of penalty proceedings under section 270A of the Act for under reporting of income in consequence of misreporting is premature in nature."

Core principles established include:

- Transfer Pricing adjustments must be grounded in evidence that the assessee has not been adequately compensated at arm's length for the functions and risks undertaken.

- Mere incurrence of AMP expenses by a limited risk distributor for its own business benefit does not automatically create an international transaction benefiting the AE.

- Subvention income received under supplementary distribution agreements can constitute adequate compensation, negating the need for further Transfer Pricing adjustments.

- The Bright Line Test is not a valid method under the Income Tax Act for determining Transfer Pricing adjustments.

- Penalty proceedings under section 270A cannot be sustained if the underlying Transfer Pricing adjustment is not justified.