TMI Blog2013 (9) TMI 155X X X X Extracts X X X X X X X X Extracts X X X X ..... cting the internal TNMM adopted by the assessee in the transfer pricing report benched marked the operating profit margin with that of the 15 external comparables and made an upward adjustment of ₹ 1.56 crores. The main reason for rejecting the assessee's internal TNMM was that there was a huge expenditure on advertisement and promotion of sales in both the segments – Held that:- Reliance has been put on decision of the Tribunal in L.G. Electronics India P. Ltd. [2013 (6) TMI 217 - ITAT DELHI]. Further held that with regard to the issue that such a nature of transaction is an international transaction within the ambit of section 92B r/w section 92F, has been settled by the Special Bench deciding that it does fall within the realm of international transaction and, hence, transfer pricing mechanism is triggered. In the present case, the TPO has chosen 15 external comparables by applying TNMM for bench marking the percentage of cost of advertisement and brand promotion expenses with the net sales and by taking the average cost of 7.95% to be bright line and over and above this line, the expenditure is deemed to increase the value of brand intangible for the A.E. The DRP ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cross the country and also has sales officer in various parts of the countries. For the year ending 31st March 2007, the assessee had entered into following international transactions with Diageo Group entities. Purchase of raw material 6,72,31,741 Purchase of flavor 10,60,365 Purchase of Vodka 14,671 Provisions of sales support services 11,30,66,250 Provision of other administrative services 1,01,84,412 Recovery of Expenses 78,88,012 Reimbursement of Expenses 16,65,738 4. The assessee, after obtaining manufacturing licence from 1st April 2006, has started manufacturing Scotch, Whisky and other alcoholic beverages and some of them in its own name. In the Profit Loss Account the assessee has shown revenue of Rs. 127.75 crores. However, its expenditure exceeded the revenue and had shown operating loss of Rs. 26,42,60,496. The TPO to whom the matter was referred to by the A.O. for determination of ALP with reference to all the transactions reported in Form 3CEB, required the assessee to furnish the details/bifurcation of the turnover and to work out the net o ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 14. United Breweries (Holdings) Ltd. (6.52) 15. McDowell Co. Ltd. (Units Spirits Ltd. "USL) 0.39 (0.96) 6. However, the assessee's operating profit upon total sales has been worked out to (-) 20.71%. Based on the average profit margin of 0.96% of the comparables, the assessee worked out the arm's length price (ALP) in view of the proviso to section 92C(2) in the following manner:- WORKSHEET OF ALP AS PER PROVISO TO SECTION 92C(2) Heads Assessee's Transactions (Crores) ALP as determined (crores) Sales/Income : (Constant) 44.08 44.08 Purchases/Exp. (Variable) : From A.E: 6.83 5.27 From Non A.E 39.23 39.23 Operating Profit/Loss 9.13 (0.42) OP/Sales (4.49)% (0.96)% 7. The TPO rejected the internal TNMM adopted by the assessee and after taking 15 comparables as furnished by the assessee and bench marked the the average arithmetic mean of 0.96% as arrived with that of the assessee's operating margins and made the adjustment of Rs. 1.56 crores. The main rea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 5 external comparables. In support of the contention that in such a situation, internal comparables should be given priority, he relied upon the Third Member decision of Mumbai Bench of the Tribunal in M/s. Teconimont ICB Pvt. Ltd. v ACIT, ITA no.4608/Mum./2010, for assessment year 2005-06, etc., vide order dated 17th July 2012. 9. He further brought to our notice that the Tribunal in assessee's own case for the assessment year 2006-07, has rejected the internal TNMM on the ground that whisky segment and other then whisky segment are not functionally comparable because as per the observations made by the Tribunal, whisky is an established product with a mass base whereas other alcoholic beverages are yet to be established in Indian Market. In support of this reasoning, some article in Time Magazine was referred to by the Tribunal. He specifically drew our attention to Paras-14 and 15 of the Tribunal order in ITA no.8602/Mum./2010. He submitted that the said Tribunal order cannot be relied upon at all for the reasoning that under the TNMM, product similarity is not required and that too for making a distinction between whisky and non-whisky products which are in fact under same bu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... th that of the 15 external comparables and made an upward adjustment of Rs. 1.56 crores. The main reason for rejecting the assessee's internal TNMM was that there was a huge expenditure on advertisement and promotion of sales in both the segments. 12. On a perusal of the segmental details, as referred to by the learned Sr. Counsel with regard to the transactions with the A.E. wherein manufacturing and selling of whisky was undertaken and transactions with unrelated enterprise wherein other than whisky products like Vodka, Gin, Brandy, Rum, etc., was carried out, it is seen that there is functional similarity not only with regard to the business line but also the entire operations of business functions, assets employed and other variables of cost and operating expenses. These segmental details as placed before us, is reproduced herein below for the sake of ready reference:- Particulars Reference Transaction with A.E. Transaction with unrelated claim Total Sales 440841531 834891844 Total operating income A 440841531 893943152 Expenditure Materials consumed B 220 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... yed. On splitting clause (ii) into two parts it divulges that the reference is made to internal and external comparables. One part of clause (ii) refers to 'the net profit margin realised by the enterprise.... from a comparable uncontrolled transaction' and the other part talks of 'the net margin realised.... by an uncontrolled enterprise from a comparable uncontrolled transaction'. It transpires that whereas the first part refers to the profit margin from internal comparable uncontrolled transactions, the second part refers to profit margin from an external comparable uncontrolled transaction. Thus it is discernible that what is to be compared under this method is profit from a comparable uncontrolled transaction. The word 'comparable' may encompass internal comparable or external comparable. There is cue in the rule itself as to preference to be given to internal comparable uncontrolled transactions vis- -vis externally comparable uncontrolled transactions. It is because the delegated legislature has firstly referred to the net profit margin realized by the enterprise (internal) from a comparable uncontrolled transaction and, thereafter, it points towards net profit margin realiz ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... her alcoholic beverages. The relevant observations and findings of the Tribunal in Paras- 14 and 15 is reproduced herein below:- "14. In our considered view, whiskey segment and other than whiskey segment of assessee's business are not functionally comparable inasmuch as while whiskey is an established product with a mass base, other alcoholic beverages are yet to be so firmly established in Indian market and are in comparably initial stages. India is traditionally a whiskey market. An article appearing in Time Magazine (23rd December 2009 issue) titled 'Tapping into India's Growing Alcohol Market', inter alia, states as follows: Drinking patterns in India are unlike those of any other major market. Hard liquor is far more popular than beer and wine, with spirits accounting for about 70% of the market. Nearly all of that is whiskey a legacy of the colonial fondness for Scotch. India is the largest whiskey market in the world, so American whiskey producers figure they've got a head start in India compared to other new markets. "Indians are preordained whiskey drinkers," says Frank Coleman, senior vice president of the Distilled Spirits Council of the United States, a trade gro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ween whisky and non-whisky as two different products is wholly undesirable and cannot be a ground for rejecting internal comparability and, therefore, such a finding and observation of the Tribunal cannot be said to be a binding precedence in the present case. In view of the discussion made above, the adjustment of Rs. 1.56 crores made by the TPO/DRP is uncalled for and the same is hereby deleted. 17. The second major dispute in the transfer pricing adjustment is adjustment of Rs. 64.81 crores on account of advertisement and business promotion expenses which has been modified by the DRP by giving partial relief on certain directions. 18. Relevant facts, apropos this issue, are that the TPO on a perusal of audited financial statement observed that the assessee has incurred an amount of Rs. 94,95,59,128, on advertisement and business promotion expenses which works out to 58.75% of the total turnover of Rs. 127.57 crores. He was of the opinion that the benefit derived from such advertisement, results into brand promotion of the brands owned by the A.E. The assessee which is engaged in manufacturing and distribution of various brands are, in fact, international brands and expenditu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed substantial advertising expenditure. This would result in creation of a marketing intangible. The value of the brand in the concerned markets would increase. It is to be noted that the assessee manufactures and distributes various brands of liquor like Smirnoff Red, VAT 69, Black White, Archers Peach Snapps, Gin, Christain Brothers Brand etc. These are international brands and any amount of expenditure incurred by the assessee on advertisement promotes the brand value of the AE. This would benefit the owner of the brand. Suppose the owner subsequently decides to sell the brand then it would be able to sell the brand for these markets at a much higher premium. The assessee would not benefit from the same. It also indicates that the assessee may not be able to benefit from the marketing and distribution expenditure it incurs at its own risk. The assessee has acted to increase the value of the brand name owned by AE. AE should have therefore compensated the assessee for promoting the brand." 21. He further held that incurring of such expenditure is not only international transactions but also requires determination of ALP for recovery of advertisement and business promotion exp ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... amely "Shark Tooth" for which it has incurred an amount of Rs. 15.31 crores has nothing to do with the brand owned by the A.E. and, therefore, to this extent, no addition should be made, the DRP, in principle, agreed with the objections of the assessee that the expenditure incurred by it to promote its own brand should be excluded from the advertisement and business promotion expenses adjustment. Further, whether the amount of Rs. 15.31 crores was actually incurred for promotion of non-brand could not be verified in the absence of proper details. The DRP directed the TPO to make revised adjustment after verifying the amount incurred for promotion of assessee's own brand with reference to the books of account, invoice and ratio of sales; (iv) Regarding assessee's objection that such an expenditure incurred for advertisement is not an international transactions, the same has been rejected on the ground that apportionment of extra ordinary advertisement and business promotion expenses to the A.E. is an international transactions within the meaning of section 92B(1); (v) Regarding assessee's objection that the TPO has erred in considering sales related expenses which is included in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... herefore, all the sales value should be included to arrive at the percentage of advertisement and promotion expenses. In the earlier year, the assessee's income was mainly from bottling arrangement with the third parties which has been considered as sales, therefore, in this year, it cannot be excluded from the sales. Regarding various other directions and conclusions of the DRP, he made his elaborate submission. However, he submitted that in the wake of Special Bench decision of the Tribunal in L.G. Electronics India Pvt. Ltd v. ACIT, [2013] 22 ITR (Trib.) 1 (SB), most of the contentions raised by the assessee has undergone a huge change and as the primary contention that advertisement and promotion expenses does not lead to benefit to the A.E. and is not an international transaction has been decided against the assessee. However, he submitted that the ratio of the Special Bench decision cannot be applied in totality on the facts of the assessee's case as there are various distinguishing features which was elaborated before us in detail. On the issue whether such an expenditure on advertisement for the promotion of the brand is international transaction or not, he submitted that t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d to the file of the TPO for adjudication afresh following the ratio laid down by the Special Bench of the Tribunal in L.G. Electronics India P. Ltd. (supra). 25. We have carefully considered the rival contentions, perused the relevant findings of the orders passed by the TPO and the DRP, which has been discussed above and also the Special Bench decision of the Tribunal in L.G. Electronics India P. Ltd. (supra). The main issue before us for adjudication is whether the amount spent on advertisement and brand promotion expenses of Rs. 74,95,59,128, can be held to giving rise to benefit to the A.E. and, hence, it is an international transaction within the ambit of section 92B. With regard to the issue that such a nature of transaction is an international transaction within the ambit of section 92B r/w section 92F, has been settled by the Special Bench deciding that it does fall within the realm of international transaction and, hence, transfer pricing mechanism is triggered. In the present case, the TPO has chosen 15 external comparables by applying TNMM for bench marking the percentage of cost of advertisement and brand promotion expenses with the net sales and by taking the averag ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... xamine and verify such kind of expenses after calling for the details from the assessee and exclude the same while determining such cost/value of advertisement expenses; (iii) Insofar as applicability of methodology is concerned, the DRP has applied CUP method and, therefore, the TPO will apply CUP method after selecting the comparables which are involved in similar type of business and if required fresh comparables should also be looked into from the same genus of comparables and other relevant factors such as products, market share, assets employed, functions performed and other similar attributes. Suitable adjustment if required should also be made in naturalising the effect of difference, if any; and lastly, (iv) In assessee's case, CUP method has been applied for making adjustment on account of advertisement and brand promotion expenses and no mark-up has been applied either by the TPO or by the DRP. Thus, the TPO will consider this aspect while applying the ratio of Special Bench in L.G. Electronics India P. Ltd. (supra). 27. In the light of the above observation, this matter is restored to the file of the TPO/A.O. for fresh adjudication in the light of the Special Benc ..... X X X X Extracts X X X X X X X X Extracts X X X X
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