TMI Blog2015 (3) TMI 580X X X X Extracts X X X X X X X X Extracts X X X X ..... , separate reference/approval was not required. Reference of the bundled transaction under sub-section (1) to Section 92CA is sufficient. Section 92CA has to be interpreted pragmatically. Therefore, once reference of a composite/bundled or packaged international transaction is made, it will be difficult for the assessee to contest applicability of sub-section (1) in cases of segregation or when the TPO invokes sub-section (2B) to Section 92CA of the Act. This flaw as it existed stands corrected with insertion of Sub-Section (2B) to Section 92CA with retrospective effect. It clarifies and ‘cures‘ the deficiency and shortcoming of the earlier provision. In view of insertion of sub section (2B) to Section 92CA of the Act, the decision of the Delhi High Court in the case of Commissioner of Income Tax versus Amadeus India Pvt. Ltd. [2011 (11) TMI 73 - DELHI HIGH COURT] and of the Gujarat High Court in Veer Gems versus Assistant Commissioner of Income Tax [2011 (10) TMI 262 - GUJARAT HIGH COURT] would no longer be applicable as the ratio of the said decisions reflects the position of the statute before enactment of Sub-Section (2B) with retrospective effect. - Decided in favour of the Re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... decision of the assessee, whether or not to incur the said expenditure; the quantum thereof, cannot be a subject matter of challenge or disallowance by the Assessing Officer, once it is accepted that the expenditure was wholly, i.e. the quantum of expenditure incurred was fully, and exclusively for business purpose. 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? - Held that:- Section 40A(2) clause (b) is a provision for computing arm‘s length price in case of two related parties as defined and applies even when the conditions stipulated in Section 37(1) of the Act are satisfied. The said provision relates to reasonability of the quantum. Similarly, Chapter X of the Act relates to arm‘s length pricing adjustment. Chapter X is not concerned with disallowance of expenditure but relates to determination of arm‘s length price/cost of an international transaction between the two AEs. It relates to income or receipts, and also expenses and interest but in a different context. Thus, Section 37(1) and Chapt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e comparables adopted by the assessed, with or without making adjustments, as a bundled transaction, it would be illogical and improper to treat AMP expenses as a separate international transaction, for the simple reason that if the functions performed by the tested parties and the comparables match, with or without adjustments, AMP expenses are duly accounted for. It would be incongruous to accept the comparables and determine or accept the transfer price and still segregate AMP expenses as an international transaction. The Assessing Officer/TPO can reject a method selected by the assessed for several reasons including want of reliability in the factual matrix or lack / non-availability of comparables. (see Section 92C(3) of the Act).When the Assessing Officer/TPO rejects the method adopted by the assessed, he is entitled to select the most appropriate method, and undertake comparability analysis. Selection of the method and comparables should be as per the command and directive of the Act and Rules and justified by giving reasons. Distribution and marketing are inter-connected and intertwined functions. Bunching of inter-connected and continuous transactions is permissible, pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... is would be necessary when the arm‘s length price of the controlled transaction cannot be adequately or reliably determined without segmentation of AMP expenses. The Assessing Officer/TPO for good and sufficient reasons can de-bundle interconnected transactions, i.e. segregate distribution, marketing or AMP transactions. This may be necessary when bundled transactions cannot be adequately compared on aggregate basis.When segmentation or segregation of a bundled transaction is required, the question of set off and apportionment must be examined realistically and with a pragmatic approach. Transfer pricing is an income allocating exercise to prevent artificial shifting of net incomes of controlled taxpayers and to place them on parity with uncontrolled, unrelated taxpayers. The exercise undertaken should not result in over or double taxation. Thus, the Assessing Officer/TPO can segregate AMP expenses as an independent international transaction, but only after elucidating grounds and reasons for not accepting the bunching adopted by the assessed, and examining and giving benefit of set off. Section 92(3) does not bar or prohibit set off. CP Method is a recognised and accepted me ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nation of arm‘s length price. TNM Method or RP Method has been adopted and accepted as the most appropriate method. TNM Method, as noticed above, obligates analysis of profit and loss account and the test is benchmarking of operating profits with the relevant PLI and comparison with reference to the comparable. Discount and incentives offered, reduce the operating profits and, therefore, the benchmarking exercise with comparables, reflects and accounts for the same. We have examined the impact and consequences of applying CP Method, by factoring and treating AMP expenses and trade discounts and incentives as an independent international transaction, when we continue to treat the said expenses as a component of a packaged international transaction, which is separately benchmarked. This would not lead us to accurate and reliable results. There is need and requirement to check over or double taxation. 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 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... marketing. Tax treatment of royalty payments being different, the royalty transaction, therefore, may be benchmarked separately. However, payment of royalty even if justified and appropriate on applying arm‘s length principle, can be a relevant factor when the question of compensation of the domestic AE for undertaking distribution and marketing functions arises for consideration. - Decided in favour of assessee. - ITA No.16/2014 , 70/2014, 92/2014& 93/2014, 99/2014, 100/2014& 101/2014, 109/2014, 132/2014, 155/2014, 213/2014, 214/2014, 215/2014, 218/2014, 498/2014 & 618/2014, 512/2014 & 513/2014, 621/2014, 622/2014 & 642/2014, 521/2013 - - - Dated:- 16-3-2015 - Sanjiv Khanna And V. Kameswar Rao JJ. For the Appellant : Mr. N. Venkataraman, Sr. Advocate with Mr. Deepak Chopra and Mr. Harpreet Singh Ajmani, Advocates. For the Respondent : Mr. G.C. Srivastava, Advocate with Mr. Rohit Madan, Mr. P. Roychaudhri, Mr. Ruchir Bhatia and Mr. Akash Vajpai, Advocates JUDGMENT SANJIV KHANNA, J. This common judgment will dispose of these appeals and cross-appeals by the assessee and the Revenue in which one of the primary issue that emanates for consideration is whet ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. 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 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. 5. 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.? The common subs ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s from India; Comparable Uncontrolled Price Method ( CUP Method , for short) has been followed in respect of royalty paid by the Indian AE to the foreign AE and in respect of which separate substantial question of law has been framed and Resale Price Method ( RP Method , for short) has been followed for import of apparels and footwear for re-sale. In the case of Canon India Pvt. Ltd., RP Method was adopted by the assessee for import of finished goods for resale. In the said case, the order passed by TPO is detailed and is a lucid exposition of the stand of the Revenue. SONY MOBILE COMMUNICATION PVT.LTD. ITA No.16/2014 (By the Assessee) and ITA No.155/2014 (By the Revenue) Assessment year 2008-09 5. The assessed was a subsidiary of a Sweden based entity, Sony Ericsson Mobile Communications AB , a 50:50 joint venture of Sony Corporation (Japan) and Telefonaktiebolaget LM Ericsson (Sweden). The assessed was engaged in importing/buying and selling, and distribution, promotion and marketing of mobile handsets under the brand name Sony Ericsson , and providing post sale support/warranty services in India. The assessee in the transfer pricing report accepted that the g ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s Sales 16,386,808,123 AMP/Sales of Comparables 3.35% Amount that represents bright line 548,958,072 Expenditure on AMP by assessee 1,157,215,159 Expenditure in excess of bright line 608,257,087 Mark-up at 15% 91,238,563 Reimbursement that assessee should have received 699,495,650 Reimbursement actually received NIL Adjustment to assessee s income 699,495,650 8. The Dispute Resolution Panel ( DRP , for short) substantially rejected the assessee s objections but reduced the mark up from 15% to 12.5% observing it to be the reasonable mark-up. 9. The Tribunal in the impugned order dated 30th August, 2013, observed that the Function, Asset and Risk analysis ( FAR analysis , for short) of the assessee and the comparables was not disputed by the TPO and hence accepted. The bright line test ratio of 3.35% as applied on recalculation would be 4.02 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e assessee had adopted RP Method for arm s length determination of transaction No.1. The gross margin earned and declared by the assessed from controlled transactions was 42.95%, compared to 42.52% earned from internal comparables, i.e. transactions of the assessed with unrelated parties. Thus, it was claimed that the price of uncontrolled transaction was at arm s length. 13. The TPO quoted and relied on the clauses of the agreement dated 1st March, 1995, with Reebok International Ltd., England, to highlight that the functions of the Indian AE were to promote and develop the market for selling and distributing the Reebok branded products in India and to support and cooperate in execution of global marketing plans and strategies. Referring the OECD s report on transfer pricing guidelines from Multi-national Enterprises and Tax Administrations, paragraphs 6.4 and 6.36 to 6.39, the TPO observed that when a distributor bears the cost of extraordinary marketing activities, he should be compensated with return on the intangible created because of such expenditure. Distinction between short-term and long-term relationship was highlighted. He referred to Australian Tax Code as well as ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t through discount and attractive offers, creating familiarity and market for the products. Thus, the said expenditure should be added to AMP expenses. Accordingly, ₹ 16,61,12,065/- on account of selling and distribution was added to the advertisement and publicity expenditure of ₹ 39,01,24,915/- to reach a figure of ₹ 55,62,36,980/-, which gave the ratio of AMP to sales of 12.33%. 15. On the question of bright line comparables, the TPO rejected companies like Colgate India Ltd., Dabur India Ltd., GlaxoSmithKline Consumer Healthcare Ltd., Hindustan Unilever Ltd., Marico Ltd., Trent Ltd., and Emami Ltd., with the ratio of AMP to sales of ₹ 12.52%, observing that these companies were engaged in promotion of their own name and the AMP expenses incurred by them were non-routine. Another list of five comparables was rejected on different grounds. This list included Khadim India Ltd. and Liberty Retail Revolutions Ltd. engaged in similar business of footwear. 16. The TPO adopted the following comparables for bright line limit: S.No. Name of the Company AMP Expenses/sales (%) 1. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 7 Sales staff business expense 1,811,849 8 Store brokerage charges 1,646,169 9 Store expenses 2,850,634 10 Store Registration Charges 1,895,050 11 Tax reimbursement credit notes 3,493,251 12 VAT paid on purchases 2,960,787 13 Sample courier charges 11,064,039 14 Gym charges 355,988 15 Sample expenses for manufacture, suppliers and trade shows. 23,396,979 16 Export forwarding and clearing expenses 3,569,537 17 Misc. Expenses 3,960,471 18 Sales incentive expenses 2,869,355 19 Warehouse running and maintenance expenses ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 169,75,21,034 2. Export of Software (Credited to P/L A/c) TNMM OP/OC OP/Sales 13,28,40,833 ---- 3. Provision of software Service (Credited to Service Income in P/L) TNMM OP/OC 5,78,81,229 ---- 4 Reimbursement of professional charges Not bench- marking 16,27,161 5 Cost allocation in respect of computer management fees. Not bench- marking ---- 12,16,326 12,16,326 6 Receipt of special purpose subsidy No bench- marking ---- 12,10,48,124 ---- 7 Reimbursement of expenses At cost ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ort was akin to discount and reduction of sale price, relying on the written submission of the assessee, bifurcating the subsidy in the following manner: Computation of subsidy Description Amount (INR) Price support for government tender 43,65,000 Advertisement activities for DV 15,66,296 Channel schemes and consumer promos 22,52,385 Consumer promo awareness building 23,51,211 Product launches and market research report 26,16,549 Retail activities and road show etc. 8,74,420 Photo Asia and channel promotion programme 30,93,044 Dealer channel promotion for digital cameras 31,82,441 Channel schemes and consumer promos 28,15,870 Advertisement and sales promotion support for fax machines 19,84,606 Advertisement and sales pro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... development support for copiers 89,93,987 Market development support for copiers 98,72,372 market development support for faxes 27,10,972 market development support for faxes 13,57,566 Fabrication and display of neon signs 20,40,011 Advertisement and sales promotion support for scanners 12,86,044 LFP Advertisement and promotion 5,43,149 Major account support for market development and deliverables 9,10,000 Trade-in (buy back) for DC channel sales 14,62,000 Advertisement and promotion -LBP schemes 25,39,980 Advertisement and promotion - LBP support for GIL project through SI Acer 19,59,300 Advertisement and Promotion for DV -To implant promoters in stores for 6 months 2,86,250 Advertisement and promotion for DC -1 GB CF card for promo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of the assessee, Step 2: selection of comparables for determining bright line limit, out of the list of finally selected comparable by the assessee in its transfer pricing report for benchmarking of International transaction of purchase of Canon product from AE using RPM. In the selection x. process, each comparable was examined to ascertain whether these comparables are routine distributor or engaged in brand promotion and development of marketing intangible for the related party or itself being owner of brand trademark. After this analysis only those comparable which are engaged in routine distribution business and are not carrying out of non routine activities like trade mark promotion and development of marketing intangible are selected. Step 3: to determine AMP expenditure of the comparables finally selected for benchmarking of international transaction of subsidy. Step 4: the ratios of AMP. expenditure to the sales of uncontrolled comparables (routine distributors) were taken as comparable uncontrolled price which were compared with the ratio of AMP expenditure to the sales in the case of the assessee to determine bright line limit as discussed in paragraph 7.5 and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... not shown separately Universal print systems limited 759,065 NA 124,953,087 0.61 Trade discount not shown separately Xerox India limited 629,983,000 NA 5,342,437,000 11.79 . Trade discount not . .shown _separately Arithmetic mean (for comparables) 3.44 30. He observed that profile of Spice Systems Ltd. and Xerox India Ltd. should not be included in the comparables for that they were engaged in non-routine functions like development of marketing intangibles. The remaining 5, engaged in routine functions, should be selected for applying the bright line limit of routine AMP expenses. The arithmetical mean of percentage of AMP expenses to sales, was computed at 1.434% as per the following table. Company Name Percentage of Adv. Exp to sales Kilburn Office Automation Limited 2.08 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 8 AY 2008-09 Amount (INR) Amount (INR) Amount (INR) A AMP including trade discount and volume rebates and before reducing subsidy 378,897,359 (para 7.26 page 200 of PB 1) 581,062,073 (para 7.29 page 388 of PB 2) 958,063,110 (para 4.2 page 46 of PB 1) B Less: Subsidy 12,10,48,124 27,10,87,594 50,16,13,022 C Less: Trade Discount volume rebates 14,00,83,068 15,59,68,614 19,65,29,801 D Less: Cash Discount / Commission 2,06,76,094 - 51,49,784 E Total AMP expendi-ture to be consider-ed for purpose of comparison in light of Special Bench Order 9,70,90,073 15,40,05,865 25,47,70,503 35. On reducing the aforesaid figure from the AMP expenses of ₹ 37,88,97,359/-, the total AMP expenses were computed as ₹ 9 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ch agreement or understanding could be inferred and could also be oral. Reference was made to the definition of the terms transaction and international transaction including the retrospective insertions made by the Finance Act, 2012, to explain the two terms. (v) The TPO was entitled to re-categorize any transaction; (i) where the economic substance of the transaction differs from its form; (ii) where the form and substance of the transaction are the same, but the arrangements made in relation to the transaction, when viewed in their totality, differ from those which would have been adopted by an independent enterprise behaving in a commercially rational manner. Relying upon the decision of the Delhi High Court in CIT versus EKL Appliances Ltd. [2012] 345 ITR 241 (Del), which refers to the OECD Commentary carving out the two exceptions, it has been held that the second exception was applicable. Thus, the TPO could have re-categorized the international transaction as declared to determine arm s length price of the unravelled and deciphered international transaction as per the mandate of Section 92CA(2B) of the Act. (vi) In order to determine and decide whether an assessed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... st/value of the international transaction of brand/logo promotion by incurring AMP expenses by an Indian AE, for its foreign AE. The 14 point criteria stand recorded in paragraph 17.4, which has been quoted below:- 17.4 In our considered opinion, following are some of the relevant questions, whose answers have considerable bearing on the question of determination of the cost/value of the international transaction of brand/logo promotion through advertising, marketing and promotion expenses incurred by the Indian associated enterprise for its foreign entity : 1. Whether, the Indian associated enterprise is simply a distributor or is a holding a manufacturing licence from its foreign associated enterprise? 2. Where the Indian associated enterprise is not a full-fledged manufacturer, is it selling the goods purchased from the foreign associated enterprise as such or is it making some value addition to the goods purchased from its foreign associated enterprise before selling it to customers? 3. Whether, the goods sold by the Indian associated enterprise bear the same brand name or logo which is that of its foreign associated enterprise? 4. Whether, the goods sold bea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ange of products? 14. How the brand will be dealt with after the termination of agreement between associated enterprises? (xii) The contention of the assessee that comparable cases would be those using foreign brand was expressly rejected in paragraph 17.6. The Tribunal rejected the contention of the assessee that they were economic owners of the brand and in commercial sense their right in the brand name / trademark should be accepted. Concept of economic ownership of a brand, albeit relevant in commercial sense, was not recognized for the purposes of the Act. Retailers or dealers of electronic products etc. who sell branded products do not become economic owners of the branded products sold by them. Paragraph 17.6 reads: 17.6. In principle, we accept the contention of the ld. AR about the necessity of choosing properly comparable cases in the first instance before starting the exercise of making comparison of the AMP expenses incurred by them for finding out the amount spent by the assessee for its own business purpose. However the way in which such comparable cases should be chosen, as advocated by the ld. AR, is not acceptable. He submitted that only such comparable ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d in the value of the international transaction already disclosed and paid for by the foreign AE, was rejected for there could be no reason or ground for such assumption. (xv) The argument of the assessed that under the TNM Method, the net profit of the entity includes the effect of transactions subject matter of arm s length price between the two AEs, was also rejected on the ground that the effect of five methods prescribed under Chapter X was towards one end, i.e. determination of arm s length price of an international transaction and consequences of each method qua the international transaction cannot be at variance. Thus, TNM Method should not be applied at entity level. (xvi) The contention of the assessed that set off or adjustment of excessive / higher net profit declared on international transactions should be allowed, if the AMP expenses were treated as a separate international transaction, was rejected, relying upon Section 92(3) of the Act. Set off or adjustments cannot be allowed in respect of profits and gains of one international transaction against another international transaction. (xvii) The Assessing Officer/ TPO without specific reference had in subst ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... X of the Act. 39. We are not at this stage referring to the minority decision, though we will be referring to certain portions of the said decision when we take up and answer the issues on merits. 40. At the outset, we would like to begin our reasoning and decision with reference to findings recorded by the majority decision in the L.G. Electronics India Pvt Ltd. (supra) with which we concur and hold are as per the mandate of the law and the Act. C. Findings on which we concur with the Tribunal Section 92CA of the Act 41 Our decision in this and ensuing paragraphs would decide substantial question No.1. For our decision, we would like to reproduce Section 92CA Clauses (1), (2), (2A), (2B) and (2C) of the Act which read: 92CA. Reference to Transfer Pricing Officer.-(1) Where any person, being the assessee, has entered into an # international transaction or specified domestic transaction in any previous year, and the Assessing Officer considers it necessary or expedient so to do, he may, with the previous approval of the Commissioner, refer the computation of the arm s length price in relation to the said #international transaction or specified domestic tran ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sioner under sub-section (1) to Section 92CA of the Act. The controversy raised is that the Assessing Officer had not specifically referred and no previous approval of the Commissioner was sought or granted for reference of an international transaction relating to the AMP expenses. Thus, the valuation of the contract price and computation of the arm s length price, consequent assessments etc. are without jurisdiction and authority of law. 43. This argument on behalf of the assessees would have been weighty and perhaps justified, if the Legislature by the Finance Act, 2012 had not inserted sub-section (2B). The said Sub-Section is squarely applicable and negates the challenge. In these appeals under Section 260A of the Act, we are not concerned with the constitutional validity of the aforesaid retrospective amendment and are only required to interpret the said provision and apply the retrospective provision if it is applicable. Under sub-section (2B) to Section 92CA, a TPO to whom reference has been made under sub-section (1), is entitled to apply the provisions of the Chapter in respect of an international transaction for which the assessee has not furnished a report under Secti ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... said effect cannot be unwritten or erased. The argument of the assessee that sub-section (2B) to Section 92CA was enacted to protect the additions made by treating the AMP expenses as a separate international transaction, may or may not be correct. But once the legislative language is clear and express, we are only required to give effect to the said retrospective amendment in an appeal under Section 260A of the Act. 47. The majority decision of the Tribunal in L.G. Electronics India Pvt Ltd. (supra) has rightly drawn a distinction between sub-section (2B) and sub-section (2A) to Section 92CA of the Act. Sub-section (2A) was inserted in 2011, i.e. nearly one year before insertion of Section (2B) by the Finance Act, 2012. Sub-section (2A) has not been given retrospective effect and it applies only w.e.f. 1st June, 2011. Sub-section (2A) applies to any international transaction or specified domestic transaction of which reference has not been made to the TPO under sub-section (1). With effect from 1st June, 2011, the TPO can go into arm s length pricing of an international transaction or a specified domestic transaction not referred to him. The distinction between sub-section (2A) ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ction 92CA with retrospective effect. It clarifies and cures the deficiency and shortcoming of the earlier provision. In view of insertion of sub section (2B) to Section 92CA of the Act, the decision of the Delhi High Court in the case of Commissioner of Income Tax versus Amadeus India Pvt. Ltd. [2013] 351 ITR 92 (Del) and of the Gujarat High Court in Veer Gems versus Assistant Commissioner of Income Tax [2013] 351 ITR 35 (Guj) would no longer be applicable as the ratio of the said decisions reflects the position of the statute before enactment of Sub-Section (2B) with retrospective effect. 50. With the aforesaid observations, we decide the first substantial question of law in abstract without reference to the facts as a legal proposition, in favour of the Revenue and against the assessee. Transaction and International Transaction; Difference between Section 37(1) and Chapter X of the Act 51. The term international transaction has been defined in Section 92B. The section also had retrospective amendment which was inserted by the Finance Act, 2012 w.r.e.f. 1st April, 2002. Section 92B(1) reads as under: Meaning of international transaction. 92B - (1) For the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d by the Revenue. Revenue in their written submission accepts and has rightly stated that the test of allowability of expenditure under Section 37(1) is whether the said expenditure is incurred wholly or exclusively for the business consideration. So long as the expenditure is for business consideration, the Assessing Officer cannot question the quantum or the wisdom of the assessee in incurring the expense. Issue of arm s length price, per se does not arise, when deduction under Section 37(1) is claimed. Expenditure and decision of the assessee, whether or not to incur the said expenditure; the quantum thereof, cannot be a subject matter of challenge or disallowance by the Assessing Officer, once it is accepted that the expenditure was wholly, i.e. the quantum of expenditure incurred was fully, and exclusively for business purpose. In Sassoon J. Davit Co. Pvt. Ltd. versus CIT [1979] 118 ITR 261 (SC), it has been held that an assessee can claim deduction for expenditure incurred for business purposes and no one else has authority to decide whether or not the assessee should have incurred the said expenditure. The expenditure cannot be disallowed wholly or partly because it would ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Manual on Transfer Pricing, 2013, international transfers within MNE group entities which are called intra group transfers are growing steadily and account for more than 30% of the total international transactions. What is actually paid by one entity to another entity in the intra-group transfer is called the transfer price. Such transactions are controlled transactions because they are between two associated or connected enterprises as distinct from uncontrolled transactions which are between two entities which are not associated and operate on arm s length basis. Transfer Pricing adjustment enables the tax administration of a country to correct the transfer price and compute the same on arm s length price, to check, avoid and ensure correct payment of taxes. Arm s length price in simple words means fair market price. The reason is that each entity belonging to MNE is treated as a separate profit centre and every entity should necessarily make profit and loss at arm s length conditions. This is prevented by correcting either under charging or over charging by AE in intra group transactions. The key issue, therefore, in transfer pricing is valuation of the intra group transfers. Th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... , 92(2) and 92C of the Act, are reproduced herein for the sake of convenience, Computation of income from international transaction having regard to arm s length price. 92. (1) Any income arising from an international transaction shall be computed having regard to the arm s length price. Explanation.-For the removal of doubts, it is hereby clarified that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm s length price. (2) Where in an international transaction or specified domestic transaction, two or more associated enterprises enter into a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises, the cost or expense allocated or apportioned to, or, as the case may be, contributed by, any such enterprise shall be determined having regard to the arm s length price of such benefit, service or facility, as the case may be. xxx Computation of arm s length price. 92C. (1) The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ect of an international transaction for an assessment year and the variation between the arithmetical mean referred to in the said proviso and the price at which such transaction has actually been undertaken exceeds five per cent of the arithmetical mean, then, the assessee shall not be entitled to exercise the option as referred to in the said proviso. (2B) Nothing contained in sub-section (2A) shall empower the Assessing Officer either to assess or reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154 for any assessment year the proceedings of which have been completed before the 1st day of October, 2009. (3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that- (a) the price charged or paid in an international transaction [or specified domestic transaction] has not been determined in accordance with sub-sections (1) and (2); or (b) any information and document relating to an international transaction [or specifi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rom an international transaction. Sub-Section (2) is an adjunct and intrinsically connected with Sub- Section (1) to Section 92. It stipulates that Sub-Section (1) shall be applicable when two or more AEs enter into a mutual agreement or arrangement for allocation, apportionment or contribution to any cost, expense incurred or to be incurred in connection with benefit, service or facility provided or to be provided. An international transaction, therefore, means transaction between two or more AEs when either one or both are non-resident; the transaction should be in nature of sale, purchase or lease of tangible or intangible property or in the nature of provision for services or lending of money or any other transaction having bearing on the profits, income, losses or assets. A mutual agreement or arrangement for allocation of expenses would also be an international transaction. Section 92F defines the term transaction broadly and is a very wide definition, and we observe, that clause (v) thereof stipulates that an arrangement, understanding or action in concert would be a transaction whether or not such arrangements, etc. are formal or whether or not such arrangements are legal ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d, the price paid for the product by an independent third party, i.e. the resale price received by an AE is taken as the basis. The arm s length price is computed by a reverse exercise by determining the normal gross profit margin, i.e. gross profit margin, of an unrelated enterprise. Expenses incurred are thereafter, reduced and adjustments for differences in comparables is made to arrive at the arm s length price. This method has been explained below when examining the individual case of M/s Canon India Ltd. and Reebok India Company Ltd. Cost Plus Method ( CP Method , for short) requires determination of the appropriate gross profit margin which would be charged by a comparable and adding the same mark up to the expenditure/cost incurred by the AE to determine the appropriate profit in view of market conditions and functions performed. The aforesaid three methods are treated as traditional transactional methods. 66. TNM Method or Profit Split Method are called transactional profit methods or profit based methods. United Nations Practical Manual on Transfer Pricing in paragraph 1.5.10 observes that there is growing acceptance of practical importance of profits based methods. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arison of those conditions of the controlled transactions with uncontrolled transactions i.e. transactions between the two AEs taking into account the economically significant characteristics of the controlled transactions and the respective roles of the 5 comparability factors. The aforesaid analysis, therefore, requires selection of appropriate comparables i.e. an uncontrolled transaction which is to be compared with a tested party. The comparables can be internal i.e. when one of the AEs enters into a similar uncontrolled transaction with an independent enterprise; or external i.e. involving an independent enterprise in the same market or industry. It is obvious that an internal comparable could in several cases be more dependable and reliable, than an external comparable. A comparable is acceptable, if based upon comparison of conditions a controlled transaction is similar with the conditions in the transactions between independent enterprises. The comparison must be with reference to the comparability analysis as elucidated in paragraph 5.1.1 of the United Nations Practical Manual on Transfer Pricing. In other words, the economically relevant characteristics of the two transac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... performed, the significance of the functions in terms of their frequency, nature and value to the respective parties is an important factor. 70. Equally important is the question or assumption of risk, for increased risk has to be adequately compensated by increase in return. Similarly, recognition must be given to the economic circumstances in determining the comparable which include geographic location, size of market, extent of competition, position of buyers and sales availability or risk of competitive goods and services, level of demand and supply sold in a particular region, consumer purchasing power, nature and extent of government control, labour and capital, transportation, level of the market, i.e. retail or wholesale and so forth. The Rules and the analytical steps. 71. Sub-Sections (1) and (2) to Section 92C are applicable to the assessed, as well as the Assessing Officer invoking power under Sub-Section (3) to Section 92C of the Act. As noted above, sub-section (2) to Section 92C stipulates that most appropriate method, out of the methods specified in sub-section (1) shall be applied to determine the arm s length price in the manner as may be prescribed. Rule ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... class of the transaction; nature and class of AE entering into the transaction; functions performed by them taking into account asset employed or to be employed and risk assumed. They also refer to availability, coverage and reliability of data necessary for application of the method; degree of comparability between the controlled and uncontrolled transaction and between the enterprises; reliability and accuracy of adjustment, which can be made between the tested and uncontrolled transactions and between enterprises. Lastly and significantly, it refers to nature, extent and reliability of assumption required to be made for application of the method. 73. Rule 10B after elucidating on the five methods, in Sub-rule (2) states that comparability of an international transaction, i.e. the tested transaction, with an uncontrolled transaction shall be judged in the manner stipulated therein. The said Rule reads:- 10B. xxx (2) For the purposes of sub-rule (1), the comparability of an international transaction or a specified domestic transaction with an uncontrolled transaction shall be judged with reference to the following, namely:- (a) the specific characteristics of the pr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... olled transactions may be between residents or non-residents. This is immaterial. However, they should not be between two AEs. They should be between two independent enterprises. Sub-rule (3) to Rule 10B requires that the transactions should be similar in the manner that the differences between the transaction being compared or between the enterprises entered into, should not materially affect the price or the cost charged or profits arising from such transactions in open market. Uncontrolled transaction can be also treated as a comparable, when reasonably adequate adjustments can be made to eliminate material effect of difference(s). 76. It must be stated that transfer pricing is not an exact science but a method of legitimate quantification which requires exercise of judgment on the part of the tax administration and the taxpayer. It is method and formula based and, therefore, is rational and scientific. However, not being perfect or infallible, first and the second proviso to sub-section (2) along with stipulations in Sub-section (2A) and 2(B) of section 92C posit a getaway clause when the arm s length price so determined and the controlled price does not exceed 5%( reduced ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... balanced and rational exercise. The core object and purpose behind the said exercise is to determine the fair market price of a transaction, had the transaction been between two independent entities. Under the same method, we can reach different arm s length prices by relying upon variable factors and assumptions for the purpose of analysis. We should be more concerned and focused on reasonableness of the result for the determination is to ascertain a fair and just result. G. Section 92(3) of the Act and Bundled / Inter-Connected Transactions 79. At this stage and before we examine the TNM Method exhaustively, we deem it necessary to interpret and refer to in some detail sub-section (1) to Section 92C and reference to the term transaction with the vowel an , which has been interpreted by the majority judgment of the Tribunal to mean a single independent transaction and not a group or bundle of transactions. We do not think that use of vowel an or the word transaction instead of the word transactions should be given undue notability and prominence. One of the primary rules of statutory construction is that singular includes plural and vice-versa. This rule applies ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... le refers to services provided , functions performed , contractual terms (whether or not such terms are formal or in writing) of the transactions which lay down explicitly or impliedly the responsibilities, risks and benefits to be divided between the respective parties to the transactions. Use of plurality by way of necessity and legislative mandate is evident in the said Rule. 81. Similarly, sub-rule (3) to Rule 10B refers to transactions being compared or comparison of the enterprises entering into such transactions likely to affect the price or cost charged etc. A reading of Rule 10C reassures and affirms that the general principle of plurality is not abandoned or discarded. 82. There is considerable tax literature and text that CUP Method, i.e. Comparable Uncontrolled Price Method, RP Method, i.e. Resale Price Method and CP Method, i.e. Cost Plus Method can be applied to a transaction or closely linked, or continuous transactions. Profits Split Method and TNM Method grouped as transactional profit methods , can be equally effective and reliable when applied to closely linked or continuous transactions. Thus, it would be inappropriate to proceed with the arm s lengt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... in referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii); (v) the net profit margin thus established is then taken into account to arrive at an arm's length price in relation to the international transaction or the specified domestic transaction 85. Sub-clause (i) refers to net profit margin realized by an enterprise from an AE in an international transaction which could be with reference to cost incurred; sales affected; assets employed or to be employed in an enterprise or having regard to any other base. Thus, Sub-clause (1) refers to net profit in proportion to the selected base. The appropriate base is referred to as the Profit Level Indicator ( PLI ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of convenience and easier availability of data not only from third party providers, but on their own level, i.e. assessment records of other parties. 90. The strength of the TNM Method is that net profit indicators are less affected by transactional differences in comparison with some other methods. This method is more tolerant to functional differences between controlled and uncontrolled transactions in comparison with resort to gross profit margins. Yet the net profit indicators have potentiality to introduce an element of volatility, primarily for two reasons. Firstly, factors which do not affect gross profit margin and prices can influence net profit indicators due to variation of operating expenses or vice-versa. This potentiality has reference to variation in operational expenses including AMP expenses. The other factors include tax-payers competitive position in the form of price and margins and in some cases, it may be difficult to eliminate or compute the effect of these factors. These difficulties in applying or accepting the TNM Method arise when there is complexity of functions and each party to the transaction(s) makes valuable unique contribution. Reliability of th ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... The net profit margins can be affected by variation of operating expenses. Thus, the requirement to select appropriate comparable and adjustment. It would be inappropriate and unsound to accept comparables, with or without adjustment and apply TNM Method, and yet conjecturise and mistrust the arm s length price. TNM Method would not be the most appropriate method when there are considerable value additions by the subsidiary AEs. In paragraph 22.9, the majority decision has observed that all costs including the AMP expenses are independent of cost of material. This indicates that the observations have been made with reference to manufacturing activities. It would not be appropriate and proper to apply the TNM Method in case the Indian assessed is engaged in manufacturing activities and distribution and marketing of imported and manufactured products, as interconnected transactions. Import of raw material for manufacture would possibly be an independent international transaction viz. marketing and distribution activities or functions. We have earlier used the term plain vanilla distributor . When we use the words plain vanilla distributor we do not mean plain vanilla situations, b ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 26.5%. Even if the Assessing Officer does not reduce the AMP expenses from ₹ 150/- to ₹ 50/-, while computing the arm s length price by applying the TNM Method, it would yet result in unacceptable anomaly for the net profit margin would be ₹ 50/- plus ₹ 115/- or 16.15% instead of 5%. Besides, the said approach would be illogical and unacceptable for AMP expenses when segregated as an independent international transaction, must be treated so in all aspects. These anomalies arise on account of fact that there was no apportionment and division of the transactional compensation, but the packaged transaction has been bifurcated and divided into two. This position is not acceptable as it is irrational and unsound. 94. The example given by the Tribunal refers to efficiencies or better management skills of the assessed AE which is not duly accounted. Albeit, this could be accounted for by way of an adjustment under clause (iii) of Rule 10B(1)(e). 95. Illustratively, as indicated in the majority judgment of the Tribunal net profit margin would undergo a change in case the operating expenses are different in case 1 and case 2, as these relate to operational cos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n the effect on account of the differences for which appropriate adjustments can be made. Thus, selection of the comparable depends upon the functional analysis, similarity as to the several factors and whether or not it is possible to make adjustments to account for the material differences in such circumstances to accept or reject a comparable. Selection of the appropriate comparable ensures similar profit potential and accordingly taxation of the subsidiary AE in the country of its residence. 97. We would also reproduce paragraphs 3.9 to 3.12 of Chapter 3; comparability analysis from OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administration which reads as under: 3.9 Ideally, in order to arrive at the most precise approximation of arm's length conditions, the arm's length principle should be applied on a transaction-by-transaction basis. However, there are often situations where separate transactions are so closely linked or continuous that they cannot be evaluated adequately on a separate basis. Examples may include 1. Some long-term contracts for the supply of commodities or services, 2. Rights use intangible property, and. 3. pricing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... turn in order to provide benefits to another entity of the MNE group, see in particular paragraph 1.71. 3.11 While some separately contracted transactions between associated enterprises may need to be evaluated together in order to determine whether the conditions are arm's length, other transactions contracted between such enterprises as a package may need to be evaluated separately. An MNE may package as a single transaction and establish a single price for a number of benefits such as licences for patents, know-how, and trademarks, the provision of technical and administrative services, and the lease of production facilities. This type of arrangement is often referred to as package deal. Such comprehensive packages would be unlikely to include sales of goods, however, although the price charged for sales of goods may cover some accompanying services. In some cases, it may not be feasible to evaluate the package as a whole so that the elements of the package must be segregated. In such cases, after determining separate transfer pricing for the separate elements, the tax administration should nonetheless consider whether in total the transfer pricing for the entire package ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... alysis or adjustments is not possible, it would be advisable to adopt and apply another method. This would mean in the example given above, if the Assessing Officer/TPO notices that operating expenses in the case of the tested party are substantially lower than the comparable or indicative of greater and better efficiency, he can make suitable adjustments and then compute the operating profit. In case it is not possible to make adjustment, he may reject the method selected by the assessed and adopt another method. Several recourses may be available. Of course, justification and reasons must be stated and elucidated. 101. However, once the Assessing Officer/TPO accepts and adopts TNM Method, but then chooses to treat a particular expenditure like AMP as a separate international transaction without bifurcation/segregation, it would as noticed above, lead to unusual and incongruous results as AMP expenses is the cost or expense and is not diverse. It is factored in the net profit of the inter-linked transaction. This would be also in consonance with Rule 10B(1)(e), which mandates only arriving at the net profit margin by comparing the profits and loss account of the tested party w ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lt, as it seems to me, to say that goodwill is not property. Goodwill is bought and sold every day. It may be acquired. I think, in any of the different ways in which property is usually acquired. When a man has got it he may keep it as his own. He may vindicate his exclusive right to it if necessary by process of law. He may dispose of it if he will - of course, under the conditions attaching to property of that nature..............What is good-will? It is a thing very easy to describe very difficult to define. It is the benefit and advantage of the good name, reputation, and connection of a business. It is the attractive force which brings in custom. It is the one thing which distinguishes an old established business from a new business at its first start. The goodwill of a business must emanate from a particular centre or source. However, widely extended or diffused its influence may be, goodwill is worth nothing unless it has power of attraction sufficient to bring customers home to the source from which it emanates. Goodwill is composed of a variety of elements. It differs in its composition in different trades and in different businesses in the same trade. One element may pre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e mighty Oak of goodwill . It has been geographically described by locality. It has been historically explained as growing and crystallising traditions in the business. It has been described in terms of a magnet as the attracting force . In terms of comparative dynamics, goodwill has been described as the differential return of profit. Philosophically it has been held to be intangible, Though immaterial, it is materially valued. Physically and psychologically, it is a habit and sociologically it is a custom . Biologically, it has been described by Lord Macnaghten in Trego v. Hunt, 1896 AC 7 as the sap and life of the business. 105. There is a line of demarcation between development and exploitation. Development of a trademark or goodwill takes place over a passage of time and is a slow ongoing process. In cases of well recognised or known trademarks, the said trademark is already recognised. Expenditures incurred for promoting product(s) with a trademark is for exploitation of the trademark rather than development of its value. A trademark is a market place device by which the consumers identify the goods and services and their source. In the context of trademark, the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... future economic benefits attributable to the said asset will flow to the enterprise and the cost of the asset can be measured reliably. The estimate would represent the set off of economic conditions that will exist over the useful life of the intangible asset. At the initial stage, intangible asset should be measured at cost. The above proposition would not apply to internally generated goodwill or brand. Paragraph 35 specifically elucidates that internally generated goodwill should not be recognised as an asset. In some cases expenditure is incurred to generate future economic benefits, but it may not result in creation of an intangible asset in form of goodwill or brand, which meets the recognition criteria under AS-26. Internally generated goodwill or brand is not treated as an asset in AS-26 because it is not an identifiable resource controlled by an enterprise, which can be reliably measured at cost. Its value can change due to a range of factors. Such uncertain and unpredictable differences, which would occur in future, are indeterminate. In subsequent paragraphs, AS-26 records that expenditure on materials and services used or consumed, salary, wages and employment related ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d or made for creating an intangible capital asset. Appropriate in this regard would be to reproduce the observations in CIT versus Monto Motors Ltd, [2012] 206 Taxman 43 (Del), which read:- 4. Advertisement expenses when incurred to increase sales of products are usually treated as a revenue expenditure, since the memory of purchasers or customers is short. Advertisement are issued from time to time and the expenditure is incurred periodically, so that the customers remain attracted and do not forget the product and its qualities. The advertisements published/displayed may not be of relevance or significance after lapse of time in a highly competitive market, wherein the products of different companies compete and are available in abundance. Advertisements and sales promotion are conducted to increase sale and their impact is limited and felt for a short duration. No permanent character or advantage is achieved and is palpable, unless special or specific factors are brought on record. Expenses for advertising consumer products generally are a part of the process of profit earning and not in the nature of capital outlay. The expenses in the present case were not incurred onc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... hat the reputed and established brands had value and goodwill. But a new brand/ trade-mark/ trade-name would be relatively unknown. We have referred to the said position not to make a comparison between different brands but to highlight that these are relevant factors and could affect the function undertaken which must be duly taken into consideration in selection of the comparables or when making subjective adjustment, and thus, for computing the arm s length price. The aforesaid discussion substantially negates and rejects the Revenue s case. But there are aspects and contentions in favour of the Revenue which requires elucidation. J. Bright Line Test 113. The majority decision of the Tribunal holds that excessive AMP expenses beyond the bright line test should be treated as a separate international transaction for promoting the brand owned by the foreign AE. The minority opinion is to the contrary. Discussion on this issue would involve several aspects, whether the TPO/Assessing Officer can apply the bright line test to split the AMP expenses, as essential and non-routine; paragraph 17.6 rejecting AEs of reputed brands as comparables; whether the bright line tests ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... to the inference of some informal or implied agreement in this regard. 9.11. Adverting to the facts of the instant case, it is noticed that the ld. DR has amply shown that the assessee not only promoted its name and products through advertisements, but also the foreign brand simultaneously, which has remained uncontroverted on behalf of the assessee. This factor together with the fact that the assessee s AMP expenses are proportionately much higher than those incurred by other comparable cases, lends due credence to the inference of the transaction between the assessee and the foreign AE for creating marketing intangible on behalf of the latter. 9.12. The ld. AR has vehemently argued that when the assessee incurred AMP expenses for its business purpose and recorded them as such, the Revenue went wrong in recharacterizing this transaction by splitting it into two parts, viz., one towards advertisement expenses for the assessee s business and second towards the brand building for the foreign AE. He fortified this contention by relying on the judgment of EKL Appliances Ltd. (supra). There is absolutely no doubt that para 17 of the judgment unambiguously lays down that the tax admin ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ving in a commercially rational manner would do, tied with the fact of the assessee also simultaneously advertising the brand of its foreign AE. Reverting to the context of AMP expenses, one needs to find out as to how much AMP expenses would independent enterprises behaving in a commercially rational manner, incur. Once by making such a comparison, the result follows that the Indian AE, prominently displaying brand of its Foreign AE in its advertisements, has incurred expenses proportionately more than that incurred by independent enterprises behaving in a commercial rational manner, then it becomes eminent to recharacterize the transaction of total AMP expenses with a view to separate the transaction of brand building for the foreign AE. Even the United Nations Transfer Pricing Manual, which has only a persuasive value, provides for the allocation of such cost between the MNE and its subsidiaries. We, therefore, hold that in the facts and circumstances of the present case, there is a transaction between the assessee and the foreign AE under which the assessee incurred AMP expenses towards promotion of brand which is legally owned by the foreign entity. Economic vis- -vis lega ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ship of a brand, albeit relevant in commercial sense, is not recognized for the purposes of the Act. The above discussion leads us to irresistible conclusion that the advertisement done by the assessee also carrying the brand/logo of its foreign AE coupled with the fact that it spent proportionately higher amount on AMP expenses, gives clear inference of a `transaction between the assessee and its AE of building and promoting the foreign brand. xxx 11.4. However, we are not agreeable with the remaining part of the contention of the ld. AR that the legal character of one enterprise can be altered only where the Revenue positively proves the factum of the existence of influence of the foreign AE over the affairs of the Indian AE in general or in respect of specific transactions. In fact, it is due to this close relation between AEs of MNC that Chapter-X has been enshrined in the Act as an anti-tax avoidance measure. No doubt AEs in India and abroad are two separate legal entities subject to tax in different tax jurisdictions, but the fact that the economic behaviour of one depends on the wish of the other, can never be totally lost sight of. Due to this factor, it becomes signifi ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... herwise inseparable, then some mechanism needs to be devised for ascertaining the cost of the international transaction, being the amount of expenses incurred for the foreign AE. 15.7. As in the present case the assessee did not declare any cost/value of the international transaction of brand building, it became imperative for the TPO to find out such cost/value by applying some mechanism. In fact, the bright line test in our case is a way of finding out the cost/value of international transaction, which is the first variable under the TP provisions and not the second variable, being the ALP of the international transaction. Bright line is a line drawn within the overall amount of AMP expense. The amount on one side of the bright line is the amount of AMP expense incurred for normal business of the assessee and the remaining amount on the other side is the cost/value of the international transaction representing the amount of AMP expense incurred for and on behalf of the foreign AE towards creating or maintaining its marketing intangible. Now the pertinent question is where to draw such line. If the assessee fails to give any basis for drawing this line by not supplying the cos ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... if the ALP of the international transaction would have been determined by invoking bright line test. What is appropriate is the substance of the matter and not the nomenclature given to a transaction. In our considered opinion the name given to the method of computing the cost/value of international transaction, whether bright line test or otherwise, has no significance. Since in the present case it is the cost/value of the international transaction which has been determined by applying the bright line test, the contention raised by the learned counsel in this regard has been rendered without merit. xxx Paragraph Nos.17.4 and 17.6 have been quoted above. 114. Revenue during the course of arguments had made reference to the United Nations Practical Manual on Transfer Pricing for Developing Countries, Chapter 2 relating to business framework. The said chapter gives exhaustive background material on the MNEs, their cross-border operations, value chain analysis, organisation or legal/commercial structure, etc. In the said chapter, in Figure 2.1, exposits details of Value Chain Analysis of the MNEs and their interaction with third parties including the subsidiaries. The sai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n MNE would not incur costs which give long-term benefits of brand and market development advantage to another entity. It is fallacious to contend that brand promotion would benefit an independent entity, for increase in volume of sales largely benefits the manufacturer both in terms of the profit with increased sales and enhanced value to the brand. Benefit to the Indian entity is only marginal or incidental. The contention is that the action of the independent subsidiary amounts to rendering of service to the foreign AE for which arm s length compensation was/is payable. No third party distributor would incur expenditure on development of marketing and brand, which does not eventually belong to it. 117. We have already dealt with and examined the concept of brand as an intangible asset. Routine or day-to-day marketing or sale promotion expenses even, when excessive and exorbitant, would not amount per se to brand building expenses. The Revenue in the written submissions in fact have accepted in paragraph 8.8 that promotion of products go hand in hand and at most of the times brand is distinguishable from products as only by display of products in a particular manner or empha ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... dvertisements, etc. would necessarily involve expenditure both in terms of third party expenditure which the Indian assessee would liable to incur, as also towards the office maintenance and other overhead expenses. Even as one package or a bundle, the Indian subsidiary, i.e. an assessee, must be adequately compensated by adhering to the arm s length price. This is the core of the transfer pricing adjudication. Price paid by or compensation paid to the domestic AE must complement and reciprocate for the functions performed. 119. A pure distribution company would be a comparatively low risk company as compared to a marketing and distribution company. The profits and earnings or arm s length price would accordingly vary. The arm s length price in case of a pure distribution company would enure lower price/profit as compared to a company engaged in distribution and marketing. In most of the cases, distribution and marketing operations would go hand in hand. Marketing itself is a term of wide import and connotation, which includes development of marketing strategy which may have certain common worldwide elements and would normally be the creation and premised by the parent foreign A ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ade by choosing comparable of domestic cases not using any foreign brand, is contrary to the Rules. It amounts to writing and prescribing a mandatory procedure or test which is not stipulated in the Act or the Rules. This is beyond what the statute in Chapter X postulates. Rules also do not so stipulate. The argument and reasoning in paragraph 17.6 in a way loses focus on the main issue and controversy; whether the arm s length price fixed between the two AEs is adequate and justified and would have been paid if the transaction was between two independent enterprises. The two independent enterprises must be two unrelated parties having no connection. It does not matter whether the comparables are domestic enterprises or not. However, and it is manifest that the comparable should have similar rights, if any, as the tested party in the brand name, trademark, etc. 121. During the course of hearing before us, counsel for the Revenue had submitted that paragraph 17.4 should be treated as illustrations and not as binding comparables. We would prefer to observe, that an Assessing Officer/ TPO can go and must examine the question whether the assessee is performing functions of a pure di ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... by the IRS, in United States of America. 1.482-4 of 2009 Regulations, relating to methods to determine taxable income in connection with transfer of intangible property, elucidates that arm s length consideration for contribution by one controlled taxpayers that develops or enhances the value or may be reasonably anticipated to develop or enhance the value of an intangible property of the other AE, would depend upon several circumstances. If the consideration for such contribution is embedded within the contractual term for the controlled transaction, then ordinarily no separate allocation will be made for such contribution. Thereafter, examples have been given. It stands recorded that the comparability analysis would include consideration of all relevant factors, including compensation for the activities performed by the subsidiary and that it is provided in the transfer price, rather than provided by a separate agreement. Reference is also made to requirement to pay royalty and the effect thereof. In 1.482-6, in the context of Profit Split Method, it is recorded that allocation of income to controlled taxpayers, routine contribution will not reflect profit attributable to each co ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... elevant to the method or reasonably adequate adjustment can be made to eliminate the effect of the difference on the condition that is relevant to the method. Illustrations, six in number, draw distinction between long-term distribution or distribution-cum-marketing agreements and short-term contractual arrangements. The resident AEs must be compensated by the foreign AE for the services provided; whether it be in the nature of pure distribution or promotional services; or services as a marketer which also undertakes advertisement and sale promotion expenses resulting in return attributable to marketing intangibles. A long-term pure distributor, who bears no cost or risk of development and market, would not be entitled to any return on the marketing intangibles. Same would be the position in a short-term contract. In case of a long-term contract where marketing expenditures are not abnormal and the resident AE has been proportionately compensated for marketing activities, no separate addition towards compensation is warranted. In cases of long-term contract of exclusive and market distribution rights for a trademark product, where market development activities and extraordinary mar ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... risk distributor with marketing functions, except that the said distributor should be compensated for the marketing, including AMP function. A distributor with marketing function can be normal or a high risk distributor. Such distributors should be compensated but the quantum of compensation would be higher. Such cases have to be distinguished from cases of a true distributor, who is in an independent business, uses his own money for purchasing at a low price and selling at a high price and accordingly shoulders the burden in case of a bad judgment. Profits or losses, therefore, correspond to the risk and market consideration. There is also functional incompatibility between a distributor and a retailer. Retailers cannot be compared with distributor also performing marketing functions. Foreign global enterprises frequently adopt a subsidiary model, i.e. the products are distributed and marketed in a targeted country through a wholly owned subsidiary or a sales subsidiary. A comparable would be an unrelated identity with similar distribution and marketing functions. 125. The United Nations Manual in Chapter 10 relating to country specific practices notes the Indian stand, but ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t payments to ensure adequate profit margin. This ensures proper payment of taxes and curtails avoidance or lower taxes of the Indian subsidiary as a separate juristic entity. 127. We agree and accept the position in the portion reproduced above in bold and italics. The object and purpose of Transfer Pricing adjustment is to ensure that the controlled taxpayers are given tax parity with uncontrolled taxpayers by determining their true taxable income. There should be adequate and proper compensation for the functions performed including AMP expenses. Thus, we disagree with the Revenue and do not accept the overbearing and orotund submission that the exercise to separate routine and non-routine AMP or brand building exercise by applying bright line test of non-comparables and in all case, costs or compensation paid for AMP expenses would be NIL , or at best would mean the amount or compensation expressly paid for AMP expenses. Unhesitatingly, we add that in a specific case this criteria and even zero attribution could be possible, but facts should so reveal and require. To this extent, we would disagree with the majority decision in L.G. Electronics India Pvt. Ltd. (supra). ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ated by them, exercised option to purchase DHL trademark rights for US$ 20 million. Several questions arose in the said case including valuation of the trademark rights. One of the contentious issues related to attribution of the sale consideration paid for the trademark between DHL, U.S. and DHLI, Hong Kong. 131. On the question of ownership analysis, the appellate court referred to the plain language of the then governing 1968 Regulations to observe that legal ownership was not the proper test, for the 1968 regulations stipulated that the property would be treated as owned by the controlled taxpayer that had borne the greatest share of the cost of development. Thus, the 1968 regulations ignored legal ownership in favour of economic ownership. The 1994 Regulations superseded the aforesaid effect. Applying the concept of developer-assister rule to the factual matrix, it was observed that DHLI Hong Kong had incurred cost and risk for development of intangibles. Thus, DHLI Hong Kong had the status of a developer. 132. These decisions, contrary to the transfer pricing orders, do not assist or foster Revenue s stand. Paragraphs 6.36 to 6.39 of the OECD Transfer Pricing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ion rights for the trademarked product. In such cases, the distributor s share of benefits should be determined based on what an independent distributor would obtain in comparable circumstances. In some cases, a distributor may bear extraordinary marketing expenditures beyond what an independent distributor with similar rights might incur for the benefit of its own distribution activities. An independent distributor in such a case might obtain an additional return from the owner of the trademark, perhaps through a decrease in the purchase price of the product or a reduction in royalty rate. 6.39 The other question is how the return attributable to marketing activities can be identified. A marketing intangible may obtain value as a consequence of advertising and other promotional expenditures, which can be important to maintain the value of the trademark. However, it can be difficult to determine what these expenditures have contributed to the success of a product. For instance, it can be difficult to determine what advertising and marketing expenditures have contributed to the production or revenue, and to what degree. It is also possible that a new trademark or one newly intro ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and Set Off in Segregation of Bundled Transactions; whether Section 92(3) prohibits segregation. 136. This leads us to the question of set off when bundled transactions are segregated. Conceptually, this is justified and equitable, as tax is payable on the total income after transfer pricing computation in respect of international transactions (See Section 92(4) of the Act). 137. The question of aggregation and disaggregation of transactions when the TNM Method or even in other methods is sought to be applied, must have reference to the strength and weaknesses of the TNM Method or the applicable method. Aggregation of transactions is desirable and not merely permissible, if the nature of transaction(s) taken as a whole is so inter-related that it will be more reliable means of determining the arm s length consideration for the controlled transactions. There are often situations where separate transactions are intertwined and linked or are continuous that they cannot be evaluated adequately on separate basis. Secondly, the controlled transaction should ordinarily be based on the transaction actually undertaken by the AEs as has been struck by them. We should not be considere ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... good practice for taxpayers to disclose the existence of set-offs intentionally built into two or more transactions between associated enterprises and demonstrate (or acknowledge that they have relevant supporting information and have undertaken sufficient analysis to be able to show) that, after taking account of the set-offs, the conditions governing the transactions are consistent with the arm's length principle. 3.16 It may be necessary to evaluate the transactions separately to determine whether they each satisfy the. arm's length principle. If the transactions are to be analysed together, care should be. taken in selecting comparable transactions and regard had to the discussion at paragraphs 3.9 - 3.12. The terms of set-offs relating to international transactions between associated enterprises may not be fully consistent with those relating to purely domestic transactions between independent enterprises because of the differences in tax treatment of the set-off under different national tax systems or differences in the treatment of the payment under a bilateral tax treaty. For example, withholding tax would complicate a set-off of royalties against sales receipt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r loss shall not be decreased or increased by reason of Transfer Pricing computation. Thus, transfer pricing adjustments do not enure to the benefit or advantage the assessed, thereby reducing the income declared or enhancing the declared loss. Pertinently, the Sub-Section makes reference to the income chargeable to tax or increase in the loss on the basis of the entries in the books of account. The concept of set off or adjustments was/is well recognized and accepted internationally and by the tax experts/ commentators. In case the legislative intent behind sub-section (3) to Section 92 was to deny set off, the same would have been spoken about and asserted in different and categorical words. Legislative intent to the contrary should not be assumed. 141. Principle of literal interpretation would be applicable for a Section must be construed as it reads, without any addition or subtraction. Constitutional Bench of the Supreme Court in CIT versus Vatika Township P. Ltd. [2014] 367 ITR 466, has observed: Tax laws are clearly in derogation of personal rights and property interests and are, therefore, subject to strict construction, and any ambiguity must be resolved agains ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... therwise we deny ourselves benefit and advantage of the study and the dexterous and deliberated elucidations made in the extant OECD Transfer Pricing Guidelines or the U.N. Transfer Pricing Manual, as if they are redundant and superfluous. The Act, i.e. the Income Tax Act, 1961 and the Rules are supreme, but the OECD Transfer Pricing Guidelines or the U.N. Transfer Pricing Manual can be supplement and constitute a valuable and convenient commentary on the subject. They are not binding but surely their rational and articulacy requires cogitation, if not acceptance, when warranted. 143. It may be interesting to reproduce a portion of sub-paragraph (h) of paragraph 3 of the written submissions filed by the Revenue before us which reads: In fact, in a large number of cases the parent companies have reimbursed such expenses to Indian entities either by not charging the royalty, by subvention or by direct subsidy or by reimbursement of expenses. In the light of such glaring facts, the suggestion that the existence of an international transaction is being inferred by the revenue by applying some mathematical tool is not correct. It should not be understood that we are holding ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ition has to be proved de hors the overall net profit rate. It should be proved by the assessed by comparison with what was charged for similar goods supplied by other independent enterprises dealing with India. We with respect have reservation and do not agree with the commanding universal affirmative approach. This may be relevant in a given case if the arm s length price is computed transaction by transaction and not as a bundle. Albeit, net profit rate in TNM Method may be indicative, or in a given case, sufficient proof of adequate compensation. Onus would be on the assessed, but the relevant facts must be ascertained. The use of the expression special circumstances etc. in the majority decision is unacceptable. In fact, there cannot be any assumption against the assessed when arm s length price by applying the TNM Method is accepted, to discern and infer that the purchase price did not account and did not subsume the AMP expenses incurred by the Indian AE. 146. Whether higher net profit rate would indicate lower or reduced purchase price, we observe is a question of fact and not law. Subsidy paid could account for the bundled transaction, including the entire set of tra ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the factual matrix of L.G. Electronics case (supra) would be beyond our domain; however, we do not find any factual finding to this effect by the TPO or the Tribunal in any of the present cases. However, in L.G. Electronics decision (supra), it is observed that if the AMP expenses and when such expenses are beyond the bright line, the transaction viewed in their totality would differ from one which would have been adopted by an independent enterprise behaving in a commercially rational manner. No reason or ground for holding or the ratio, is indicated or stated. There is no material or justification to hold that no independent party would incur the AMP expenses beyond the bright line AMP expenses. Free market conditions would indicate and suggest that an independent third party would be willing to incur heavy and substantial AMP expenses, if he presumes this is beneficial, and he is adequately compensated. The compensation or the rate of return would depend upon whether it is a case of long-term or short-term association and market conditions, turnover and ironically international or worldwide brand value of the intangibles by the third party. 148. There is no material or data ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ic ownership. Economic ownership when pleaded can be accepted if it is proved by the assessed. The burden is on the assessed. It cannot be assumed. It would affect and have consequences, when there is transfer or termination of economic ownership of the brand or trademark. 152. Determination whether the arrangement is long-term with economic ownership or short-term should be ordinarily based upon the conditions existing at the start of the arrangement and not whether the contract is subsequently renewed. However, it is open to the party, i.e. the assessed, to place evidence including affirmation from the brand owner AE that at the start of the arrangement it was accepted and agreed that the contract would be renewed. 153. Economic ownership of a brand is an intangible asset, just as legal ownership. Undifferentiated, economic ownership brand valuation is not done from moment to moment but would be mandated and required if the assessed is deprived, denied or transfers economic ownership. This can happen upon termination of the distribution-cum-marketing agreement or when economic ownership gets transferred to a third party. Transfer Pricing valuation, therefore, would be manda ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e TPO to decide the matter in accordance with law. Further, on going through the impugned judgement of the High Court dated 1st July, 2010, we find that the High Court has not merely set aside the original show-cause notice but it has made certain observations on the merits of the case and has given directions to the TPO, which virtually concludes the matter. In the circumstances, on that limited issue, we hereby direct the TPO, who, in the meantime, has already issued a show-cause notice on 16th September, 2010, to proceed with the matter in accordance with law uninfluenced by the observations/directions given by the High Court in the impugned judgement dated 1st July, 2010. The TPO will decide this matter on or before 31st December, 2010. The civil appeal is, accordingly, disposed of with no order as to costs. 156. A Division Bench of Delhi High Court in the writ petition challenging the Transfer Pricing Order had dealt with transfer pricing issues and had enrolled and culled out legal ratios and principles. Directions were issued. At the same time, an order of remand to the TPO to compute the arm s length price on the basis of said principles was passed. It would not be corr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified; (ii) such resale price is reduced by the amount of a normal gross profit margin accruing to the enterprise or to an unrelated enterprise from the purchase and resale of the same or similar property or from obtaining and providing the same or similar services, in a comparable uncontrolled transaction, or a number of such transactions; (iii) the price so arrived at is further reduced by the expenses incurred by the enterprise in connection with the purchase of property or obtaining of services; (iv) the price so arrived at is adjusted to take into account the functional and other differences, including differences in accounting practices, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of gross profit margin in the open market; (v) the adjusted price arrived at under sub-clause (iv) is taken to be an arm's length price in respect of the purchase of the property or obt ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ansaction is comparable with the controlled transaction for the purpose of RP Method, only if two conditions are satisfied: that there is no difference between the functions, which would materially affect the normal gross profit margins in the open market; and reasonably accurate adjustments can be made to eliminate material effect of such differences. RP Method may require fewer adjustments on account of product differences in comparison to the CUP Method, i.e. Comparable Uncontrolled Price Method because minor product differences are less likely to have material effect on the profit margins as they do on the price. Compensation for performing similar functions tends to equalise across different activities, whereas in case of products, the equalisation is normally possible to the extent that products are substitute for each other. Nevertheless, similarity of the property as transferred in the controlled transaction for closer comparability of products/services would produce more accurate results. Sometimes, RP Method is adopted as more accurate or best method where controlled and uncontrolled transactions are comparable in all characteristic, other than the product itself. In some ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... idence. This would include justification for marketing expenditures that might be considered unreasonably high; for example, when part or most of the promotional expenditure was clearly incurred as a service performed in favour of the legal owner of the trademark. In such\a case the Cost Plus method may well supplement the RP Method. 161. The United Nations Manual on RP Method highlights that this method is based upon arm s length gross profits, rather than directly determining arm s length prices. As compared to CUP Method, RP Method requires less direct transactional (product) comparability than CUP Method. However, there must be functional comparability. A similar level of compensation is expected for performing similar functions across different activities. This uniformity and similitude is necessary because similar gross profits are being compared. If there are material differences that reflect in the gross profit margins between the controlled and uncontrolled transaction, adjustments should be possible on account of such differences. Functions performed can be simple and cover a limited field of sales, general or administrative expenses; to more complex one, adding sub ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d when it incurs AMP expenses. Functionally the comparable is merely a manufacturer and thus, the said function is compared. AMP expenses do not get factored and compared. As an abundant caution, we would still add that where adjustments clause (iv) can give reliable and accurate results, internal comparables could still be applied. This would likely happen, when AMP expenses are insignificant in quantum. 163. Thus, in such cases, external comparables where said parties are performing similar functions including AMP expenses would give more accurate and precise results. 164. However, it would be wrong to assert and accept that gross profit margins would not inevitably include cost of AMP expenses. The gross profit margins could remunerate an AE performing marketing and selling function. This has to be tested and examined without any assumption against the assessed. A finding on the said aspect would require detailed verification and ascertainment. 165. An external comparable should perform similar AMP functions. Similarly the comparable should not be the legal owner of the brand name, trade mark etc. In case a comparable does not perform AMP functions in the marketing op ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and the Tribunal have adopted and applied the CUP Method for determining arm s length price of AMP expenses. We do not pronounce a firm and final opinion on the said lis as it should be at first examined by the Tribunal. 168. The Tribunal has upheld adoption of CP Method after applying bright line test in the case of Reebok India Co. Ltd. and Canon India Pvt. Ltd. The bright line test adopted to demarcate the routine and non-routine AMP expenditure is predicated on selection of a domestic distributor and marketing company that does not own intangible brand rights. Contract value would be treated as NIL. In terms of our finding recorded above, the said finding would not be correct. The approach and procedure for ascertaining /determining arm s length price under the RP Method is different. For this reason, and other grounds recorded, we have passed an order of remit to the Tribunal for examination of the factual matrix. O. Cost Plus Method 169. CP Method as stipulated in Rule 10B (1)(c) is as under: 10B. (1) For the purposes of sub-section (2) of section 92C, the arms length price in relation to an international transaction shall be determined by any of the fo ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that when the said Method is applied by treating AMP expenses as an independent transaction, it would not make any difference whether the same are routine or non-routine, once functional comparability with or without adjustment is accepted. The gross profit of the comparable is applied and accepted, when there is no difference between the AMP and other functions being compared that would materially affect the gross profit mark up or when reasonably accurate adjustments can be performed. Thus, CP Method requires functional comparability. This comparability analysis would necessarily imply that the comparable must and should be performing similar functions, including the nature of costs and expenses incurred. If the discounts/incentives and for that matter entire distribution and marketing expenses are treated as costs, functional and comparable analysis comparison should be similar. Thus, the entire cost, i.e. marketing expense or distribution and marketing expense, can be made subject matter and included in cost , for determining arm s length price by applying CP Method. 172. The United Nations Manual discourages application of CP Method in transactions involving full-fledged ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r or higher. This situation would be different from subjecting the same international transaction to arm s length pricing by two different methods, which is permissible, in the manner stipulated in the first Proviso to Section 92C of the Act. P. Direct Marketing Expenses 175. The argument of the Revenue on direct marketing expenses is as under:- 1. Special Bench of the ITAT has decided in the case of LG Electronics India Pvt. Ltd. that selling expenses such as discounts and incentives/pricing adjustments should not be considered as part of AMP expenses. The argument against their inclusion in AMP expenses is that these expenses are nothing but a reduction in the price of product and do not create any marketing intangible. 2. The objective of the AMP activities is not to merely advertise the brand to the ultimate customers. It is also to make the brand popular to the dealers who will eventually push the XX brand over other brands in the market. Only when a reasonable amount of brand loyalty is built up among the dealers, the entire circle of AMP activities will be complete. The discounts and incentives that the assessing is passing on to the dealers is the too ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng expenses have an immediate connect with price/consideration payable for the goods sold. They are not incurred for publicity or advertisement. Direct marketing and sale related expenses or discounts/concessions would not form part of the AMP expenses. 177. In the present case, neither the assessed nor the Assessing Officer/TPO has adopted CUP Method for determination of arm s length price. TNM Method or RP Method has been adopted and accepted as the most appropriate method. TNM Method, as noticed above, obligates analysis of profit and loss account and the test is benchmarking of operating profits with the relevant PLI and comparison with reference to the comparable. Discount and incentives offered, reduce the operating profits and, therefore, the benchmarking exercise with comparables, reflects and accounts for the same. We have examined the impact and consequences of applying CP Method, by factoring and treating AMP expenses and trade discounts and incentives as an independent international transaction, when we continue to treat the said expenses as a component of a packaged international transaction, which is separately benchmarked. This would not lead us to accurate and re ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erprise would make payments for royalty which were not contributing to its profitability. The profitability data relied upon by the Assessing Officer reads as under: F.Ys. 2005-06 2006-07 2007-08 Sales (WSP) 252.5 366.2 451.23 Royalty 6.82 9.62 15.29 Net Profit 17.76 32.81 33.34 Net Profit/Sales 7.03% 8.96% 7.4% 181. The TPO accordingly determined the arm s length price of royalty as NIL in place on ₹ 15,28,77,527/- under CUP Method. The DRP affirmed the action of the TPO and consequently, an assessment order holding that the arm s length price of the royalty was NIL , in place of controlled transaction value of ₹ 15,28,77,527/-, was passed. 182. The Tribunal in the impugned order while allowing the appeal, has referred to the technology and know-how furnished in the form of PUMP technology, DMX technology ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r availing the right to use would depend upon corresponding price, which would have been paid by an independent or unrelated enterprise. This is judged by applying comparables. TPO has not rejected the quantum of royalty on the said principle. The reasoning given by the TPO is not only erroneous for the reasons stated above, but is also contrary to the Rules. Depending upon the method selected, net profit or gross profit of the assessed has to be compared with profit margins of related enterprise. The formula prescribed under the Rules does not accept the ratiocination adopted and applied by the TPO. 186. A similar controversy had arisen before the Delhi High Court in EKL Appliances Limited, (supra). The assessed in the said case was incurring losses and on this pretext, the TPO had disallowed the entire brand fee or royalty. The Tribunal disagreed with the Revenue. The appeal filed by the Revenue was dismissed stating that the considerations relied by the TPO were irrelevant considerations for the purpose of Rule 10B. The Division Bench of this Court rejected the argument that financial health of the assessee alone would determine whether or not the transfer price paid was appr ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ntum or arm s length price. When specific permission is granted, the issue may acquire a different dimension. We do not express any opinion, when specific permission is relied upon. 191. The fact that royalty has been paid would be a relevant consideration and factum, when we consider arm s length price of the international transaction of distribution and marketing. Tax treatment of royalty payments being different, the royalty transaction, therefore, may be benchmarked separately. However, payment of royalty even if justified and appropriate on applying arm s length principle, can be a relevant factor when the question of compensation of the domestic AE for undertaking distribution and marketing functions arises for consideration. R. Question of Remand 192. During the course of oral arguments, the assessed had filed tabulated computations to establish and show the inaccuracies, unsavoury and severe, if not bitter, consequences of the adjustments made by the TPO. For example, in the case of Canon India Private Limited, the reasoning of the TPO was challenged on the ground of absurdity and perversion, alleging that Indian turnover was a miniscule percentage of the global turn ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s an international transaction under Section 92B of the Income Tax Act, 1961. In terms of and subject to discussion under the heading C, paragraph Nos.51 to 57, the substantial question of law No.2 is answered in favour of the Revenue and against the assessee. Q.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? Q.4. 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. Q.5. 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.?. In terms of and subject to discussion under the headings D to P, we hold that the legal ratio accepted and appl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... he comparables adopted by the assessed, with or without making adjustments, as a bundled transaction, it would be illogical and improper to treat AMP expenses as a separate international transaction, for the simple reason that if the functions performed by the tested parties and the comparables match, with or without adjustments, AMP expenses are duly accounted for. It would be incongruous to accept the comparables and determine or accept the transfer price and still segregate AMP expenses as an international transaction. (vi) The Assessing Officer/TPO can reject a method selected by the assessed for several reasons including want of reliability in the factual matrix or lack / non-availability of comparables. (see Section 92C(3) of the Act). (vii) When the Assessing Officer/TPO rejects the method adopted by the assessed, he is entitled to select the most appropriate method, and undertake comparability analysis. Selection of the method and comparables should be as per the command and directive of the Act and Rules and justified by giving reasons. (viii) Distribution and marketing are inter-connected and intertwined functions. Bunching of inter-connected and continuous trans ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lectronics India Pvt. Ltd. (supra). This would be necessary when the arm s length price of the controlled transaction cannot be adequately or reliably determined without segmentation of AMP expenses. (xi) The Assessing Officer/TPO for good and sufficient reasons can de-bundle interconnected transactions, i.e. segregate distribution, marketing or AMP transactions. This may be necessary when bundled transactions cannot be adequately compared on aggregate basis. (xii) When segmentation or segregation of a bundled transaction is required, the question of set off and apportionment must be examined realistically and with a pragmatic approach. Transfer pricing is an income allocating exercise to prevent artificial shifting of net incomes of controlled taxpayers and to place them on parity with uncontrolled, unrelated taxpayers. The exercise undertaken should not result in over or double taxation. Thus, the Assessing Officer/TPO can segregate AMP expenses as an independent international transaction, but only after elucidating grounds and reasons for not accepting the bunching adopted by the assessed, and examining and giving benefit of set off. Section 92(3) does not bar or prohibit ..... X X X X Extracts X X X X X X X X Extracts X X X X
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