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Sony Ericsson Mobile Communications India Pvt. Ltd. (Now known as Sony India Limited) & others Versus Commissioner of Income Tax – III

2015 (3) TMI 580 - DELHI HIGH COURT

Transfer pricing adjustment - arm‘s length pricing of international transactions - Whether the additions suggested by the TPO on account of Advertising/Marketing and Promotion Expenses was 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? - Held that:- The majority decision of the Tribunal in L.G. Electronics India Pvt Ltd. [2013 (6) TMI 217 - IT .....

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arate 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 .....

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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 Revenue.

Whether AMP Expenses incurred by the assessee in India can be treated and categorized as an international transaction under Section 92B? - Transaction and International Transaction; Difference between Section 37(1) and Chapter X of the Act - Held that:- The contention that AMP expenses .....

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the said element or function of AMP expenses, for which they stand duly compensated in their margins or the arm‘s length price as computed. We also fail to understand the contention or argument that there is no international transaction, for the AMP expenses were incurred by the assessed in India. The question is not whether the assessed had incurred the AMP expenses in India. This is an undisputed position. The arm‘s length determination pertains to adequate compensation to the Indian AE for in .....

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allowed as deduction under Section 37(1) of the Act has not been challenged 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‘ .....

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ing 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 p .....

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ose of determination of arm‘s length price is to find out the fair and true market value of the transaction and accordingly the adjustment, if required, is made. The said exercise has its own object and purpose. - Decided in favour of revenue.

Transfer Pricing of International Transactions, Domestic Law, i.e. the Statutory Provisions of the Act, Section 92(3) of the Act and Bundled / Inter-Connected Transactions, TNM Method Enunciated, Brand and Brand Building, Bright Line Test, Aggre .....

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his decision. For the purpose of clarity, we would like to enlist our findings:-

In case of a distributor and marketing AE, the first step in transfer pricing is to ascertain and conduct detailed functional analysis, which would include AMP function/expenses.

The second step mandates ascertainment of comparables or comparable analysis. This would have reference to the method adopted which matches the functions and obligations performed by the tested party including AMP expe .....

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rging or charging lower royalty. Direct compensation can also be paid. The method selected and comparability analysis should be appropriated and reliable so as to include the AMP functions and costs. Where the Assessing Officer/TPO accepts the 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 th .....

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ssing 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, provided the said transactions can be evaluated and .....

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ill‘ is a value of attraction to customers arising from name and a reputation for skill, integrity, efficient business management or efficient service. Brand creation and value, therefore, depends upon a great number of facts relevant for a particular business. It reflects the reputation which the proprietor of the brand has gathered over a passage or period of time in the form of widespread popularity and universal approval and acceptance in the eyes of the customer. Brand value depends upon th .....

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bearing 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 should be sanctioned and in all cases, costs or compensation paid for AMP expenses would be ‘NIL‘, or at best would mean the amount or compensation expressly paid for AMP expenses. It would be conspicuously wrong and incorrect to treat the segregated transactional value as ‘NIL‘ when in fact the two AEs had treated the internati .....

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on 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 alloca .....

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or prohibit set off.

CP Method is a recognised and accepted method under Indian transfer pricing regulation. It can be applied by the Assessing Officer/TPO in case AMP expenses are treated as a separate international transaction, provided CP Method is the most appropriate and reliable method. Adoption of CP Method and computation of cost and gross profit margin comparable must be justified.The object and purpose of Transfer Pricing adjustment is to ensure that the controlled taxpayer .....

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s/dealers etc. cannot be included in the AMP Expenses? - Held that:- Costs or expenses incurred for services provided or in respect of property transferred, when made subject matter of arm‘s length price by applying CP Method, cannot be again factored or included as a part of inter-connected international transaction and subjected to arm‘s length pricing. This situation would possibly result in over, if not double taxation, contrary to the object and purpose of arm‘s length pricing, which is to .....

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in the cost while computing the arm‘s length price under the CP Method, the gross profit as a result of such transaction would be lower 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.In the present case, neither the assessed nor the Assessing Officer/TPO has adopted CUP Method for determination of arm‘s le .....

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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 .....

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d. Interest rate mark-up would apply to international transactions granting/ availing loans, advances, etc. - Decided in favour of the assessee.

Transfer pricing adjustment made on account of payment of royalty to an associated enterprise - Held that:- On the question whether the royalty should have been paid or not, we are in agreement with the finding of the Tribunal that question of payment of royalty cannot be determined on the basis of profitability or earnings of the assessed, o .....

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r profitability in one or more years cannot lead to the conclusion that no benefits were derived or technology was unproductive. The justification given by the assessee for lower profits on account of bad debts, high rent, increase in legal cost stand highlighted and accepted by the Tribunal. Royalty payable for 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 .....

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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. - Decided in favour of ass .....

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dhri, 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 whether advertisement, marketing and sale promotion expenditure ( AMP , for short) beyond and exceeding the bright line is a separate and independent international transaction undertaken by the resident Indian assessee towards brand building for t .....

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08-09 70/2014 Discovery Communications India 218/2014 2006-07 521/2013 Canon India Pvt. Ltd 132/2014 2008-09 92/2014 Daikin Air Conditioning (India) Pvt. Ltd 214/2014 2007-08 93/2014 Daikin Air Conditioning (India) Pvt. Ltd 215/2014 2008-09 99/2014 Haier Appliances Pvt. Ltd 642/2014 2006-07 100/2014 Haier Appliances Pvt. Ltd 621/2014 2007-08 101/2014 Haier Appliances Pvt. Ltd 622/2014 2008-09 109/2014 Reebok India Company 213/2014 2007-08 512/2014 Casio India Company Pvt. Ltd 618/2014 2008-09 51 .....

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ance 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 Incom .....

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ntial questions of law which are required to be dealt with in the appeals by the Revenue read: 1. Whether the Income Tax Appellate Tribunal was right in distinguishing and directing that selling expenses in the nature of trade/volume discounts, rebates and commission paid to retailers/dealers etc. cannot be included in the AMP Expenses? Additional question of law framed in CIT versus Reebok, ITA No.213/2014 reads:- Whether Income Tax Appellate Tribunal was right in setting aside/deleting transfe .....

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demark/ trade-name were owned by the foreign AEs. There is no dispute or lis that the assessed are AEs who had entered into controlled transactions with the foreign AEs. It is also uncontested that the controlled international transactions can be made subject matter of the transfer pricing adjustment in terms of Chapter X of the Income Tax Act, 1961 ( Act , for short). 4. In order to appreciate the controversy, we are reproducing in brief the findings of the Assessing Officer/TPO and the Income .....

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dent in ITA No.12/2014 filed by the Revenue relating to assessment year 2006-07. The said three assessees have been selected because in the case of Sony Mobile Communication Pvt. Ltd., Transactional Net Margin Method ( TNM Method , for short) has been followed and in the case of Reebok India Company Ltd., TNM Method has been followed in respect of goods sourcing and exports from India; Comparable Uncontrolled Price Method ( CUP Method , for short) has been followed in respect of royalty paid by .....

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(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 asse .....

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cheduling, marketing including advertisements and sale promotions, creating distribution channels, and servicing warranty claims. 6. As per the transfer pricing report, the assessed had declared net profit margin of 2.5% which was better than the average or mean of 18 comparables (wrongly mentioned as 19). The assessee had applied the TNM Method for computing the arm s length price and the Profit Level Indicator ( PLI , for short) adopted was total turnover, in proportion to the net profit rate. .....

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ratio of 7.06%. Business promotion and selling expenses of ₹ 49,66,58,381/- were included and added to arrive at the figure of AMP expenses of ₹ 115,72,15,159/-. Out of the 18 comparables suggested by the assessee, the TPO accepted 12 and rejected 6 for they were involved in brand promotion activities being the owners of the brand-name or the intangibles. The mean AMP to sales ratio of the 12 comparables was 3.35%. This figure of 3.35% was treated as the bright line and accordingly t .....

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e 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, o .....

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utation in terms of the decision dated 23rd January, 2013 of the Special Bench of the Tribunal, in L.G. Electronics India Pvt. Ltd. versus Assistant Commissioner of Income Tax, reported as (2013) 152 TTJ 273 (Del). Further, the mark up of 12.5% as sustained by the DRP, was not based upon any comparable. Lastly, failure to account for ₹ 73,83,70,409/- in the form of credit notes was not elucidated and explained by the Revenue. Accordingly, an order of remand was passed. REEBOK INDIA CO. LTD .....

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d Focus Energy Ltd., India. As per the details furnished by the assessee, they had entered into the following international transactions: S. No. Nature of Transaction Method used by assessee Amount 1. Import of apparels and footwear for resale RPM 34,75,63,922 2. Royalty CUP 15,28,77,527 3. Identification of factories in India for sourcing/exporting the goods TNMM 73,87,878 The aforesaid table also gives details of method adopted by the assessee. The assessee had received reimbursement of advert .....

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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 o .....

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e U.S. IRS Regulations. He held that in the OECD Guidelines and as per international tax practices and jurisprudence, the bright line test was an acknowledged and accepted tool to determine and ascertain routine and non-routine AMP expenses. He made reference to the cases of DHL and GlaxoSmithKline. Relying on the decision of the Delhi High Court in Maruti Suzuki India Ltd. versus Addl. CIT/TPO [2010] 328 ITR 210 (Del), he held that the assessed was engaged in brand promotion by incurring AMP ex .....

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. TPO observed that AMP expenditure had increased significantly as percentage of sale. Further, the assessee had offered discounts in the form of growth incentive scheme and business volume discount scheme. These expenses were not linked with advertisement functions, but they had worked to enhance the brand value by popularizing the use of the product through discount and attractive offers, creating familiarity and market for the products. Thus, the said expenditure should be added to AMP expens .....

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MP 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. Bhartiya Global Marketing Ltd. 2.15 .....

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imbursed ₹ 11,43,021/- for the aforesaid non-routine AMP activities and was entitled to re-imbursement for the entire expenditure, plus mark-up of 15% which he considered to be reasonable as it took care of the interest costs which the assessee had to bear on the money invested in developing and marketing intangibles. Accordingly, total upward adjustment of ₹ 66,11,58,078/- was suggested. 19. The DRP substantially rejected the objections of the assessee except that they reduced the m .....

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edit notes. 45,711,507 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 1 .....

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ting and promotions expense for determining the cost / value of the international transactions. However, the TPO shall examine the veracity of description and quantification of the amount of selling expenses and accordingly, allow the assessee's claim. ii) After deducting the selling price from the AMP expenses as mentioned above, the TPO shall decide the issue of AMP expenses by applying the proper comparables after hearing the assessee and keeping in view the Special Bench directions in th .....

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ers and cameras in India. Besides, the assessee was also engaged in software development and related services to Canon group of companies. As per the transfer pricing report, the assessee had entered into the following international transactions: Table 1 S N . Nature of transaction Method used by Assessee Value of transaction Method PLI Receipt Paid 1- Import of finished goods for resale RPM GP/ Sales - 169,75,21,034 2. Export of Software (Credited to P/L A/c) TNMM OP/OC OP/Sales 13,28,40,833 - .....

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rketing intangibles. The precise meaning of the term marketing intangibles was unclear from text or legal perspective but it would include trade-name, trademark, trade-dress and logos, the local market position of companies or its product know-how that surrounds a trademark such as knowledge of distribution channels, customer relationship, trade secrets, etc. Investment in marketing intangibles was derived from amongst others, the company s level of advertisement, marketing and promotion or AMP. .....

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sales volumes. Following the theories in the above Tax Court case, the cheese examples could require a return for the distributor investment in the marketing intangibles either in the form of a service fee arrangement with an appropriate profit margin or more robust operating margins to reflect the return for the developed marketing intangible. For the tax authorities sought to disallow a portion of the AMP expenditure under the notion that it was incurred on behalf of foreign trademark owner. 2 .....

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o bench mark international transaction of ₹ 12,10,48,124/-. He rejected the argument of the assessee that the subsidy was to lend financial support and this support 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 22,52,3 .....

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ales promotion support for printers and all in one 50,69,210 Advertisement and sales promotion support for large format printer . 3,87,854 Advertisement and sales promotion for photocopiers 31,40,325 Printers IP 1000 Liquidation support 22,12,320 Advertisement Campaign for EOS Gery 34,29,750 Advertisement and sales promotion support for DSLR 57,16,250 Advertisement and sales promotion, schemes and activities for DSLR 22,86,500 Advertisement and sales promotion, schemes and activities for DSLR 22 .....

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er for advertisement and sales promotion 23,18,237 Si printer - retail Partners support 28,33,888 Ill printer - market development support 14,56,455 Projector promotions 4,46,067 Digital cameras - road show POS and promo material 18,01,200 LV X5 DGS&D 20 sets 1,21,581 Against Nikon Exchange programme - advertisements and mailers 6,91,526 Market development support for copiers 89,93,987 Market development support for copiers 98,72,372 market development support for faxes 27,10,972 market deve .....

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ers in stores for 6 months 2,86,250 Advertisement and promotion for DC -1 GB CF card for promo 7,80,000 Advertisement and promotion for DC POS MERCHANDISING, PHOTOFAIR 19,02,556 Shows and seminar for copiers 18,94,916 Black & white and colour advertisement for copiers 18,53,126 Advertisement and promotion - Expenses BIS-PGA 3,12,236 Total 12,10,48,124 (The table is extracted from reply of the assessee dated 20.03.2009) 26. The Indian assessed was described by TPO, as limited risk distributor .....

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cted from Orbis database. 27. He did a comparison between percentage of AMP to gross sales of the Indian AE, i.e. the assessee and the profits margin of Canon Inc., Japan to observe that there was a co-relation between increase in the profit margin of the parent AE and the enhanced AMP of the Indian AE and there was a negative co-relation between the profitability of the Indian AE and the AMP expenditure incurred by Indian AE. 28. The TPO thus recorded that the Indian AE had borne significant co .....

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al 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 developm .....

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tep 5: the AMP expenditure of the assessee which was in excess of bright line limit determined on the basis of comparable uncontrolled AMP prices was held as arm's length price of-the subsidy. 29. Accordingly, the TPO observed that the total AMP expenditure of ₹ 37,88,97,359/-, inclusive of discount and volume rebate of ₹ 16,07,59,162/- gave a percentage of AMP expenditure to total turnover, of 12.08%. For the purpose of comparables, TPO rejected the comparables adopted by the as .....

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. advertisement publicity and entertainment net of reimbursements Kilbum Office automation Limited 6,099,997 NA 292,627,187 2.08 Trade discount not shown separately Savex computers Limited 96,628,689 NA 2,879,632,210 3.36 Trade discount not shown separately Spice Limited 61,046,000 NA 1,195,018,000 5.11 Trade discount not shown separately Spice systems Limited 49,146 NA 19,187,953 0.26 Trade discount not shown separately SPS international Limited 951,969 NA 110,577,806 0.86 Trade discount not sh .....

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s, 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 Savex computers Limited 3.36 Spice systems Limited 0.26 SPS international Limited 0.86 Universal print systems limited 0.61 Arithmetic mean (for comparables) 1.434% 31. The following table from TPO s order determines the .....

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rence with Value at which international transaction has taken place 175.88% 32. Arm s length price for non-routine AMP expenses was computed at ₹ 21,29,02,581/-, recording the arm s length difference of 175.88%. 33. The DRP upheld the suggested transfer pricing adjustment. 34. The Tribunal in the impugned order has observed that following the majority judgment in L.G. Electronics India Pvt Ltd. (supra), the legal grounds should be decided against the assessee. On the question of nature and .....

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scount, cash discount and commissions as quantified were:- Particulars AY 2006-07 AY 2007-08 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 Discoun .....

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in L.G. Electronics India Pvt Ltd. (supra). B. L.G. Electronics India Pvt. Ltd. versus CIT 37. In the impugned orders, the Tribunal has primarily relied upon and followed the majority judgment of the Special Bench of the Tribunal in L.G. Electronics India Pvt Ltd (supra). Learned counsels for the parties have extensively referred to both majority and minority judgment in their erudite and pensive arguments. The decision of the Special Bench in L.G. Electronics India Pvt Ltd. (supra) has not yet .....

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se of L.G. Electronics India Pvt Ltd. (supra). Both sides have pressed for immediate hearing. 38. The majority judgment in L.G. Electronics India Pvt Ltd. (supra) had reached the following findings:- (i) In terms of the Sub-Section 2B to Section 92CA, a TPO could have examined and applied transfer pricing provisions to a transaction, which comes to his notice, in respect of which the assessee has not furnished a report under Section 92E of the Act. Amendment by the Finance Act, 2012 incorporatin .....

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the assessed to independent parties in India. (iv) The contention that there was no express agreement apropos brand building for incurring AMP expenses was rejected, holding that such 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; .....

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rving 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 had an AMP international transaction with an AE, the TPO could rely upon the bright line test , both to determine and re-categori .....

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re statutory endorsement. (ix) On application of the bright line test , if it is ascertained and deduced that the assessed had incurred non-routine AMP expenses beyond what a similarly situated independent, non-brand owner Indian distributor would have incurred under the circumstances, this quantum of difference or excessive expenditure should be treated as an independent international transaction of brand building for the foreign AE, the owner of the said trademark or brand. (x) The Tribunal di .....

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s to find out some comparable uncontrolled cases. It goes without saying that a comparison can be made with the cases which are really comparable. A case is said to be comparable when it is from the same genus of products and also other relevant factors, such as, type of products, market share, assets employed, functions performed and risks assumed, are also similar. Once proper comparable cases are chosen, then the next step is to neutralize the effect of the differences in relevant facts of th .....

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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 no .....

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an associated enterprise or is it a joint logo of both the Indian entity and its foreign counterpart? 5. Whether, the Indian associated enterprise, a manufacturer, is paying any royalty or any similar amount by whatever name called to its foreign associated enterprise as a consideration for the use of the brand/logo of its foreign associated enterprise? 6. Whether, the payment made as royalty to the foreign associated enterprise is comparable with what other domestic entities pay to independent .....

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, whether the payment is only towards fees for technical services or includes royalty part for the use of brand name or brand logo also? 9. Whether the foreign associated enterprise is compensating the Indian entity for the promotion of its brand in any form, such as subsidy on the goods sold to the Indian associated enterprise? 10. Where such subsidy is allowed by the foreign associated enterprise, whether the amount of subsidy is commensurate with the expenses incurred by the Indian entity on .....

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ies? 12. Whether the year under consideration is the entry level of the foreign associated enterprise in India or is it a case of established brand in India? 13. Whether any new products are launched in India during the relevant period or is it continuation of the business with the existing range 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 forei .....

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em. 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 cases should be ch .....

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to make a meaningful comparison is to choose comparable domestic cases not using any foreign brand. Of course when effect will be given to the relevant factors as discussed above, it will correctly reflect the cost/value of international transaction. (xiii) Contention of the assessee that TNM Method required comparison of overall net profit of the assessee with the comparables, was rejected for the following reasons: (a) The TNM Method postulated in the Rule 10B(1)(e) of the Income Tax Rules, 1 .....

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s was not permissible and each international transaction has to be separately valued and accordingly arm s length price computed. Each transaction should be taken as an independent transaction, for computing arm s length price. (d) Profit of an entity would depend upon several factors which contribute in earning of profits. Thus, costs of AMP expenses were independent of cost of raw material/products. (e) The factum that the assessed had declared an overall higher profit rate in comparison with .....

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ound 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 .....

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TPO without specific reference had in substance applied the Cost Plus Method ( CP Method , for short) for computing the arm s length price of the international transaction, i.e. the AMP transaction between the AE resident abroad and the Indian assessed. The CP Method was one of the methods prescribed in Chapter X of the Act. (xviii) Mark-up is mandated under the CP Method. The mark-up had not been correctly computed with reference to comparables and, therefore, determination of quantum of mark- .....

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Ltd. (supra), was analysed, to hold that the decision of the High Court was not entirely overruled and the ratio decidendi of the Delhi High Court judgment on the question of incurring of the AMP expenditure by the Indian AE, whether it benefits the foreign AE, requirement to compensate the Indian AEs and other legal principles enrolled, were binding. What had been set aside by the Supreme Court were the observations on merits relating to facts, and not law. The legal principles enunciated by th .....

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ect determination of the arm s length price of an international transaction or income of the Indian assessee who has to pay tax in India. Accordingly, the TPO was entitled to make adjustment and compute the arm s length price, notwithstanding the legal position that AMP expenses were deductible under Section 37(1) of the Act. Determination and, if required, adjustment of the arm s length price is the mandate under Chapter X of the Act. 39. We are not at this stage referring to the minority decis .....

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ld 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 .....

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ternational transaction or specified domestic transaction referred to in sub-section (1). ***(2A) Where any other #international transaction or specified domestic transaction other than an #international transaction or specified domestic transaction referred under sub-section (1), comes to the notice of the Transfer Pricing Officer during the course of the proceedings before him, the provisions of this Chapter shall apply as if such other #international transaction or specified domestic transact .....

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contained in sub-section (2B) 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, proceedings for which have been completed before the 1st day of July, 2012. *Inserted by the Finance Act, 2002, w.e.f. 1-6-2002. *** Inserted by the Finance Act 2011, w.e.f. 1-6-2011. # Substituted by the Finance .....

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o 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 justif .....

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ection (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 Section 92E of the Act. Thus, where an assessee has failed or not furnished a report in respect of an international transaction, a specific reference for the said transaction under sub-section (1) is not required. It is sufficient, if arm s length pricing issue of any international transaction has been referred to the TPO. 44. On carefu .....

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for which the said assessed has not furnished a report under Section 92E, the TPO can go into the question of arm s length price and apply the provisions of Chapter X. No specific reference in respect of such hidden/unknown international transaction is required under sub-section (1) to Section 92CA of the Act. 45. The conditions and requirements referred to above are fairly stringent. The TPO has to record a finding on satisfaction of the said conditions to evaluate transfer price of an undeclar .....

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risdiction by recording an erroneous finding, deciding whether there was a hidden or unknown international transaction or whether a report in respect of the said international transaction under Section 92E was not furnished, are matters that can be argued and adjudicated in appeal. 46. After insertion of sub-section (2B) to Section 92CA of the Act, w.e.f. 1st June, 2002, we have to give full effect to the said provision and not negate or curtail the retrospective effect. A retrospective amendmen .....

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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 .....

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Section 92E is not furnished. 48. Decision in the case of CIT versus Max India Ltd., [2007] 295 ITR 282 (SC) is not applicable as it examines the power of the Commissioner under Section 263 of the Act. The said power it was held, in the context of Section 80HHC of the Act, was not rightly exercised at the time when it was exercised, because the order passed by the Assessing Officer on the said aspect was not erroneous or wrong. Revisionary power under Section 263 of the Act can only be exercise .....

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sed by the Assessing Officer was erroneous. The said pre-requisite was missing, on the date when the order under Section 263 of the Act was passed. 49. There is an additional reason why the assessee s contentions must fail. In the present case, the claim of the assessee is that they had disclosed the international transaction in their report under Section 92E which included AMP expenses incurred by them. This aspect relates to merits, i.e. whether or not there was one composite, bundled or a pac .....

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he 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. [2013] 351 ITR 92 (Del) and of the Gujarat High Court in Veer .....

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een 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 purposes of this section and sections 92, 92C, 92D and 92E, international transaction means a transaction between two or more associated enterprises, either or both of whom are non-re .....

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y provided or to be provided to any one or more of such enterprises. 52. The contention that AMP expenses are not international transactions has to be rejected. There seems to be an incongruity in the submission of the assessee on the said aspect for the simple reason that in most cases the assessed have submitted that the international transactions between them and the AE, resident abroad included the cost/value of the AMP expenses, which the assessee had incurred in India. In other words, when .....

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ndia. This is an undisputed position. The arm s length determination pertains to adequate compensation to the Indian AE for incurring and performing the functions by the domestic AE. The dispute pertains to adequacy of compensation for incurring and performing marketing and non-routine AMP expenses in India by the AE. The expenses incurred or the quantum of expenditure paid by the Indian assessee to third parties in India, for incurring the AMP expenses is not in dispute or under challenge. This .....

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eration, 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 w .....

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ference can be also made to the decision of Delhi High Court in CIT versus Nestle India Limited [2011] 337 ITR 103 (Del), holding that the question of reasonableness or measure of expenses to be allowed cannot be a subject matter of adjustment or disallowance under Section 37(1) of the Act. 55. 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 satisfie .....

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being a specific statutory provision has to be given effect to and in view of the said provisions arm s length price can be determined. The arm s length procedure prescribed in Chapter X, once applicable has to be given full application. Impact of Chapter X of the Act cannot be controlled or curtailed by reference to the allowability of expenditure under Section 37(1) of the Act. As noticed above and subsequently, provisions of Chapter X are applicable to international transactions between two r .....

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this stage but would refer to the same when we examine these aspects on merits. D. Transfer Pricing of International Transactions 59. A significant volume of global trade consists of international transfer of goods, services, capital and intangibles. As per the United Nations Practical 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 .....

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ice, 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. The arm s lengt .....

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transfer pricing order is to determine whether the transfer price is the same price which would have been agreed for by independent enterprises transacting with each other if the price is determined by market forces. In negates the distortions in the international transaction price when the transaction is between the two AEs. In nutshell, the basis of transfer pricing is that each individual entity must be taxed on the basis that they act at arm s length in the transaction with the other AE. 60. .....

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e of international trade, globalization and rapid rise in the number of MNEs has resulted in exhaustive and meticulous research and studies in this complex area. The transfer pricing methods have seen a measure of standardization, universal recognition and acceptability. Indian transfer pricing regulations have adopted and benefited, from the international framework. The OECD Transfer Pricing guidelines for multinational enterprises and tax administration and United Nations Practical Manual on T .....

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ion 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 int .....

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tation of arm s length price. 92C. (1) The arm s length price in relation to an international transaction or specified domestic transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely:- (a) comparable uncontrolled price method; (b) resale price method; .....

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ation between the arm s length price so determined and price at which the international transaction or specified domestic transaction has actually been undertaken does not exceed such percentage [not exceeding three per cent] of the latter, as may be notified by the Central Government in the Official Gazette in this behalf, the price at which the international transaction or specified domestic transaction has actually been undertaken shall be deemed to be the arm s length price. The following th .....

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planation.-For the removal of doubts, it is hereby clarified that the provisions of the second proviso shall also be applicable to all assessment or reassessment proceedings pending before an Assessing Officer as on the 1st day of October, 2009. (2A) Where the first proviso to sub-section (2) as it stood before its amendment by the Finance (No. 2) Act, 2009 (33 of 2009), is applicable in respect of an international transaction for an assessment year and the variation between the arithmetical mea .....

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sessee 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) a .....

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ish by a notice issued under sub-section (3) of section 92D, the Assessing Officer may proceed to determine the arm s length price in relation to the said international transaction [or specified domestic transaction] in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him: Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specif .....

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ed in respect of the amount of income by which the total income of the assessee is enhanced after computation of income under this sub-section : Provided further that where the total income of an associated enterprise is computed under this sub-section on determination of the arm s length price paid to another associated enterprise from which tax has been deducted 2[or was deductible] under the provisions of Chapter XVIIB, the income of the other associated enterprise shall not be recomputed by .....

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n 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 trans .....

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ding or action in concert would be a transaction whether or not such arrangements, etc. are formal or whether or not such arrangements are legally enforceable. Under Section 92 (1) and (2), the cost, expense allocated or apportioned or as the case may be contribution by an AE shall be determined having regard to the arm s length price of such benefit, service or facility. 64. Section 92C(1) is of significance and relevance as it stipulates that arm s length price in relation to an international .....

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Section 92C casts obligation on the assessed to compute arm s length price as per the methods prescribed. Consequently, the burden is on the assessed to select and justify the method adopted and the arm s length price declared. Under sub-section (3) to Section 92C, the Assessing Officer can proceed to determine the arm s length price in accordance with Section 92C(1) and (2) on the basis of material, information or documents in his possession, if any of the circumstances mentioned in clauses (a) .....

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tion or document required to be furnished as per notice under sub-section (3) to Section 92D. (See judgment dated 16th December, 2013 in ITA No. 306/2012 titled Li & Fung India Pvt. Ltd. vs. Commissioner of Income Tax of the Delhi High Court). Five Methods 65. Comparable Uncontrolled Price Method ( CUP Method , for short) compares price charged for the property or service in a controlled transaction with the price charged for comparable property or service in an uncontrolled transaction in c .....

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amining 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 Metho .....

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profits which would have been anticipated in an agreement made at arm s length. It requires working back from the profit to the price. Four Steps and Comparables 67. Without specifics and niceties, the steps involved in making a Transfer Pricing adjustment under each of the five methods, will involve four steps:- a) Ascertain whether there is an international transaction between the assessee and its AE, b) Ascertain the price at which that transaction has taken place, i.e. the transactional or c .....

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first step to be exercised is to identify the international transaction and the transfer price paid for the same by two AEs. The second step is to carry out functional analysis i.e. the functions to be performed by the two AEs taking into account the assets used, risk assumed, the contractual terms, the economic circumstances of the parties and the business strategy pursued by the parties. On the question of comparability analysis United Nations Practical Manual on Transfer Pricing in paragraph .....

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erms; (d) economic circumstances and (e) business strategies pursued. The second analytical steps is comparison 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 w .....

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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 transactions being compared must be sufficiently comparable. This entails and implies that difference, if any, between controlled and uncontrolled transaction, should not materially affect the condition .....

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ng in mind the comparability analysis including befitting adjustments which may be required. As the degree of the comparability increases, extent of potential differences which would render the analysis inaccurate necessarily decreases. 69. The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations is similarly worded. The selection comparables to be applied to the tested party, therefore, depends upon transfer pricing method, for there should be a degree of featu .....

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s. The function analysis test in selection of the comparables seeks to identify and compare economically significant activities and the responsibilities undertaken, the asset used and the risk assumed by the parties to the transaction. The functions, which an assessee may perform, would include design, manufacturing, assembling, research and development servicing, purchasing, distribution, marketing, advertising, transportation, etc. The principal function performed by the party under examinatio .....

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on 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- .....

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purposes of sub-section (1) of section 92C, the most appropriate method shall be the method which is best suited to the facts and circumstances of each particular international transaction or specified domestic transaction, and which provides the most reliable measure of an arm's length price in relation to the international transaction or the specified domestic transaction, as the case may be. (2) In selecting the most appropriate method as specified in sub-rule (1), the following factors s .....

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tional transaction or the specified domestic transaction and the uncontrolled transaction and between the enterprises entering into such transactions; (e) the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transaction or between the enterprises entering into such transactions; (f) the nature, extent and reliability of assumptions required .....

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e. Similarly, if the Assessing Officer/TPO disagree, they should stipulate and elucidate the reason for selecting or applying a particular method. Clauses (a) to (f) of sub-rule (2) are wide and prescribe a broad criteria which has reference to nature and 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 .....

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ability 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 property transferred or services provided in either transacti .....

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ons operate, including the geographical location and size of the markets, the laws and Government orders in force, costs of labour and capital in the markets, overall economic development and level of competition and whether the markets are wholesale or retail. 74. Clause (a) refers to specific characteristics of the property transferred or services provided. Clause (b) refers to functions performed, assets employed or to be employed and risk assumed. Clause (c) makes reference to contractual te .....

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l transaction or a specified domestic transaction if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences. To understand sub-rule (3), one must account for the definition of .....

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0B 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 exac .....

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w.e.f. 1st April, 2012). In such cases the actual price paid or received by the assessed from the foreign AE is not disturbed. In other cases, the transaction price gets substituted with the arm s length price so determined. Sub-section 2A to Section 92C was inserted by the Finance Act, 2012 with retrospective effect from 1st April, 2002. It states that where the arm s length price determined under sub-section (1) exceeds the arm s length price as declared by 5%, the assessee would not be entit .....

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ion (2) to Section 92C and claim reduction. Similarly, the first proviso to Section 92C stipulates that where more than one price is determined by most appropriate method, the arm s length price shall be taken to be the arithmetical mean of such prices. 77. As a concept and principle Chapter X does not artificially broaden, expand or deviate from the concept of real income . Real income , as held by the Supreme Court in Poona Electricity Supply Company Limited versus CIT, [1965] 57 ITR 521 (SC), .....

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is corrected. 78. The aforesaid methods are systematic and methodical and in spite of prescription, there is an element of discretion and flexibility involved in selection of appropriate method, selection of comparable, functional analysis or adjustments. This play in the joints and latitude is required and necessitated as arm s length price is not purely a mathematical formula but a balanced and rational exercise. The core object and purpose behind the said exercise is to determine the fair mar .....

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ely, 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 constructio .....

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eneric rule is not to be lightly inferred. Contrary intention is not assumed or formed by confining attention to a specific provision but it would be apposite to consider the provision in the setting and placement of the legislation. It is a substance and tenure of the statute which would be meaningfully and critically determinative. This is the mandate of Section 13(2) of the General Clauses Act, 1897 (see Newspapers Ltd. versus State Industrial Tribunal AIR 1957 SC 532, Narshimha Murthy versus .....

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of connected transactions. More important would be reference to meaning of the term transaction in Section 92F, clause (v), which as per the said definition includes an arrangement or understanding or action in concert whether or not the same is formal or in writing, whether or not it is intended to be enforceable by legal proceedings. Rule 10A in clause (d) states that for the purpose of this Rule and Rules 10AB and 10E , the term transaction would include a number of closely linked transactio .....

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ormed , 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 p .....

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ctive and reliable when applied to closely linked or continuous transactions. Thus, it would be inappropriate to proceed with the arm s length computation methods, with a pre-conceived suppositions on singularity as a statutory mandate. Clubbing of closely linked, which would include continuous transactions, may be permissible and not ostracized. Aggregation of closely linked transactions or segregation by the assessed should be tested by the Assessing Officer/TPO on the benchmark and the exempl .....

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entity to entity comparison. The discussion would also answer the question, when is clubbing or bunching or transactions permissible in TNM Method. H. TNM Method Enunciated 84. The TNM Method is elucidated in clause (e) to Rule 10B(1) of the Rules. We are reproducing the said Rule as it has been applied by the assessees in several cases and the TPO has also accepted application of the said method, but treated the AMP expenses as an independent transaction, a finding upheld by the majority judgme .....

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from an international transaction or a specified domestic transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction or a number of such transactions is computed having regard to the same base; (iii) the net profit m .....

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tablished 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 enter .....

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any other base. The selection, it is obvious, must be appropriate. 86. Under sub-clause (ii), the net profit margin realized from a comparable uncontrolled transaction or a number of such transactions is computed having regard to one of the base. 87. Under sub-clause (iii), the net profit margin computed under sub-clause (ii) has to be adjusted by taking into account difference, if any, between the international transaction and the comparable uncontrolled transactions or between the enterprises .....

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seen a transition from a disfavoured comparable method, to possibly the most appropriate Transfer Pricing method due to ease and flexibility of applying the compatibility criteria and enhanced availability of comparables. Net profit record/data is assessable and within reach. It is readily and easily available, entity-wise in the form of audited accounts. The TNM Method is a preferred transfer pricing arm s length principle for its proficiency, convenience and reliability. Ideally, in TNM Method .....

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is method also works to the benefit and advantage of the tax authorities in view 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 .....

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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 the TNM Method is sufficiently certain where one of the parties makes all contribution involved in the controlled transaction. This is the position even as per the Revenue s case in the present set of appeals. Revenue has as .....

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s method is on net profit amount in proportion to the appropriate base or the PLI. In fact, when transactions are inter-connected, combined consideration may be the most reliable means of determining the arm s length price. There are often situations where closely linked and connected transactions cannot be evaluated adequately on separate basis. Segmentation may be mandated when controlled bundled transactions cannot be adequately compared on an aggregate basis. Thus, taxpayer can aggregate the .....

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arned actual profit of ₹ 140/-, but returned reduced net profit of ₹ 120/- as the Indian AE had incurred brand building expenses to the tune of ₹ 20/- for the foreign AE, whereas the net profit on sales declared by comparable uncontrolled transactions was ₹ 100/- only. Thus, it was observed that the costs including AMP expenses are independent of cost of imported raw material/finished products having some correlation with overall profit. The example highlights the weaknes .....

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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 impor .....

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e 1 Case 2 Sales 1,000 1,000 Purchase Price 600 500 Gross Margin 400 (40%) 500 (50%) Marketing, Sale Promotion expenses 50 150 Overhead expense 300 300 Net profit 50 (5%) 50 (5%) The above illustrations draw a distinction between two distributors having different marketing functions. In case 2, a distributor having significant marketing functions incurs substantial expenditure on AMP, three times more than in case 1, but the purchase price being lower, the Indian AE gets adequately compensated a .....

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t off would be mandated to arrive at the arm s length price, if the AMP expenses are segregated as an independent international transaction. The position may be worse for the assessed, in case the Assessing Officer makes an addition of ₹ 100/- and adds 15% thereto by applying CP Method, i.e. Cost Plus Method. Consequently, the addition made would be of ₹ 115/-. When ₹ 115/- is added to the TNM Method computation of ₹ 150/-, it would result in the total income of ₹ 2 .....

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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). .....

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(iii) of Rule 10B(1)(e). If the said adjustment is made, and the actual net profit margin is computed, the difference of ₹ 20/- as pointed out by the majority judgment of the Tribunal would not arise. In the alternative, the comparable or even TNM Method can be rejected. 96. The United Nations Practical Manual on Transfer Pricing in paragraph 6.3.12.1 acknowledges that TNM Method is usually applied to broad comparable functions, rather than broad controlled transactions. Return on these f .....

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stribution and other functions that do not involve control over intangible assets as it allows appropriate return to the party controlling unique or difficult to value intangible assets. Success or efficacy of a particular method would depend upon functional analysis of the tested party and the comparable. Once we accept the comparable on the basis of functional analysis and if required, after making adjustments, then there should be no difficulty in accepting the international transfer price. I .....

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the comparable on functional analysis, but this would not be material where it is possible to reasonably ascertain 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 comparabl .....

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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 a range of closely linked products (e.g. in a product line) when it is impractical to determine pricing for each individual product or transaction. Another example would be the licensing of manu .....

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ther than consider the individual transactions on a separate basis. 3.10 Another example where a taxpayer's transactions may be combined is related to portfolio approaches. A portfolio approach is a business strategy consisting of a taxpayer bundling certain transactions for the purpose of earning an appropriate return across the portfolio rather than necessarily on any single product within the portfolio. For instance, some products may be marketed by a taxpayer with a low profit or even at .....

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ability of comparables. See paragraphs 1.59-1.63 on business strategies. However, as discussed in, paragraphs 1.70-1.72, these considerations will not explain continued overall losses or poor performance over time. Moreover, in order to be acceptable, portfolio approaches must be reasonably targeted as they should not be used, to apply a. transfer pricing method at the taxpayer's company-wide level in those cases where different transaction's. have different economic logic and should be .....

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actions 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 .....

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are subject to different tax treatment under domestic law or an income tax convention. For example, royalty payments may be subject to withholding tax but lease payments may be subject to net taxation. In such circumstances; it may still be appropriate to determine the transfer pricing on a package basis, and the tax administration could then determine whether for other tax reasons it is necessary to allocate the price to the elements of the package. In making this determination, tax administrat .....

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e are separate transactions which are closely linked and continuous. Paragraph 3.11 referred to package deal specially in cases where the transaction between two AEs is in form of one single agreement with number of arrangements. Paragraph 3.12 acknowledges the effect of domestic law or double taxation avoidance agreement which may mandate different tax treatments to a particular type of income or tax event. In such cases it would be appropriate to segregate the transactions. 99. Paragraph 3.12 .....

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lar method would depend upon functional analysis, comparison, which requires availability of data of comparables performing of similar or suitable functional tasks in a comparable business. When suitable comparables relating to a particular method are not available and functional analysis 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 t .....

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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 with the comparable. T .....

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rizontal item without segregation would be impermissible. I. Brand and Brand Building 102. We begin our discussion with reference to elucidation on the concept of brand and brand building in the minority decision in the case of L.G. Electronics India Pvt Ltd. (supra). The term brand , it holds, refers to name, term, design, symbol or any other feature that identifies one seller s goods or services as distinct from those of others. The word brand is derived from the word brandr of Old Norse langu .....

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d is an identifiable product, service, person or place, augmented in such a way that the buyer or user perceives relevant, unique, sustainable added values which match their needs most closely. The words of the Supreme Court in Civil Appeal No.1201/1966 decided on 12th February, 1970 in Khushal Khenger Shah versus Mrs. Khorshedbanu Dabida Boatwala, to describe goodwill , can be adopted to describe a brand as an intangible asset being the whole advantage of the reputation and connections formed w .....

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erent 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 brin .....

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ent businesses in the same trade. One element may preponderate here and another element there. To analyse goodwill and split it up into its component parts, to pare it down as the Commissioners desire to do until nothing is left but a dry residuum ingrained in the actual place where the business is carried on while everything else is in the air, seems to me to be as useful for practical purposes as it would be to resolve the human body into the various substances of which it is said to be compos .....

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a name, trademark or trade name. A brand like goodwill , therefore, is a value of attraction to customers arising from name and a reputation for skill, integrity, efficient business management or efficient service. Brand creation and value, therefore, depends upon a great number of facts relevant for a particular business. It reflects the reputation which the proprietor of the brand has gathered over a passage or period of time in the form of widespread popularity and universal approval and acce .....

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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. It has been horticulturally and botanically viewed as a seed sprouting or an acorn growing into the mighty Oak of goodwill . It has been geographical .....

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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 trade .....

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t trademark as a standalone asset and is difficult and complex to determine and segregate its value. Brand value depends upon the nature and quality of goods and services sold or dealt with. Quality control being the most important element, which can mar or enhance the value. 106. Therefore, to assert and profess that brand building as equivalent or substantial attribute of advertisement and sale promotion would be largely incorrect. It represents a coordinated synergetic impact created by assor .....

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not just related to advertisement. Advertisements may be the quickest and effective way to tell a brand story to a large audience, but just that is not enough to create or build a brand. Market value of a brand would depend upon how many customers you have, which has reference to brand goodwill, compared to a baseline of an unknown brand. It is in this manner that value of the brand or brand equity is calculated. Such calculations would be relevant when there is an attempt to sell or transfer th .....

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only if, it is probable that 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 generat .....

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ch 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 costs, overheads, etc. contribute in generating internal intangible asset. Thus, it is possible to compute goodwill or brand equity/value at a point of time, but its future valuation would be perilous and an iffy exercise. 108. In paragraph 44 of AS-26, it is stated tha .....

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y, (1981) 2 SCC 460 (SC), a decision relating transfer to goodwill. Goodwill, it was held, was a capital asset and denotes benefits arising from connection and reputation. A variety of elements go into its making and the composition varies in different trades, different businesses in the same trade, as one element may pre-dominate one business, another element may dominate in another business. It remains substantial in form and nebulous in character. In progressing business, brand value or goodw .....

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and impact need not be visibly felt for some time. Imperceptible at birth, it exits unwrapped in a concept, growing or fluctuating with numerous imponderables pouring into and affecting the business. Thus, the date of acquisition or the date on which it comes into existence is not possible to determine and it is impossible to say what was the cost of acquisition. The aforesaid observations are relevant and are equally applicable to the present controversy. 110. It has been repeatedly held by De .....

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nt 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 dura .....

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is difficult to hold that the expenses were incurred for setting the profit earning machinery in motion or not for earning profits. (Also see, CIT versus M/s Spice Distribution Ltd., ITA No.597/2014, decided by the Delhi High Court on 19th September, 2014; and CIT versus Salora International Limited, [2009] 308 ITR 199]) 111. Accepting the parameters of the bright line test and if the said parameters and tests are applied to Indian companies with reputed brands and substantial AMP expenses, wou .....

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d segregate AMP expenses towards brand building and creation, the results would be startling and unacceptable. The same is the situation in case we apply the parameters and the bright line test in terms of paragraph 17.4 or as per the contention of the Revenue, i.e. AMP expenses incurred by a distributor who does not have any right in the intangible brand value and the product being marketed by him. This would be unrealistic and impracticable, if not delusive and misleading. (Aforesaid reputed I .....

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Well known and renowned brands had extensive goodwill and image, even before they became freely and readily available in India through the subsidiary AEs, who are assessees before us. It cannot be denied that 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 func .....

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rate 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 comparables mentioned in paragraph 17.4 of the majority decision are justified and correct; whether the CP M .....

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independent entities be considered as conclusive to infer that some part of the advertisement expenses were incurred towards brand promotion for the foreign AE. Every businessman knows his interest best. It is for the assessee to decide that how much is to be incurred to carry on his business smoothly. There can be no impediment on the power of the assessee to spend as much as he likes on advertisement. The fact that the assessee has spent proportionately more on advertisement can, at best be a .....

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ith the assessee s own name. If it is so, the matter ends. The AO will have to allow deduction for the entire AMP expenses whether or not these are proportionately higher. But if it is found that apart from advertising the products and the assessee s name, it has also simultaneously or independently advertised the brand or logo of the foreign AE, then the initial doubt gets converted into a direct inference about some tacit understanding between the assessee and the foreign AE on this score. As .....

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roducts 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 i .....

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disregard the actual transaction and substitute other transactions for it. However, it is imperative to note that the proposition laid down in para 17 is not infallible or is not an unexceptionable rule. Caveat has been included in the immediately next para no. 18. Two exceptions have been carved out of the general rule against recharacterization of any transaction as set out in para 17, viz. (i) where the economic substance of a transaction differs from its form; and (ii) where the form and su .....

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been adopted by independent enterprises behaving in a commercially rational manner. The assessee incurred AMP expenses and explicitly showed them as such. Thus the form of showing the AMP expenses coincides with the substance of the AMP expenses. But the arrangement made in such transaction, viewed in totality, differs from that which would have been adopted by independent enterprises behaving in a commercially rational manner. Though the AMP expenses were shown as such but the overt act of sho .....

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ffirmative, then the transaction cannot be recharacterized. If, however, the answer is in negative, then the transaction needs to be probed further for determining as to whether its recharacterization is required. Such recharacterization can be done with the help of the ratio decidendi of this judgment itself, being, making a comparison with what independent enterprises behaving in a commercially rational manner would do, tied with the fact of the assessee also simultaneously advertising the bra .....

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aracterize 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 br .....

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d as an economic owner of the brand or logo of its foreign AE for the purposes of the Act and hence expenses incurred for brand building, which is legally owned by the foreign AE, should be allowed as deduction in its hands, then incongruous results will follow. It is patent that a manufacturer does not ordinarily sells its goods directly to the ultimate customers. There is normally a chain of middlemen ending with retailer. Going by that logic and descending in the line, the distributors or who .....

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urpose of exploiting it for the business purpose, which is otherwise legally owned by the foreign AE. Such economic ownership is nothing more than that. Suppose the foreign company, who is legal owner of the brand, sells its brand to a third party for a particular consideration, can it be said that the Indian assessee or for that purpose the wholesalers or retailers should also get share in the total consideration towards the sale of brand because they were also economic owners of such brand to .....

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eit 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 c .....

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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 significant to verify as to whether the decisions taken by the Indian AE are influenced by its foreign AE. If any decision taken by the Indian AE is found to be uninfluenced, then the transaction is accepted as such by the Revenue at its face value. If however it turns out that the behavior of the Indian AE has been influenced by .....

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sualizing the value of an international transaction between the two AEs; then ascertaining the ALP of such transaction; and then eventually computing the total income of the Indian AE having regard to the ALP of the international transaction. Initial burden is always on the assessee to prove that the international transaction with the foreign AE is at arm s length price. Xxx (V) Cost/Value of transaction xxx 15.3. The ld. DR countered the submissions put forth for the assessee. It was stated tha .....

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them in a separate account. The difficulty arises only when such expenses are either clubbed with certain other expenses incurred for the foreign AE or combined with certain similar expenses incurred by the Indian AE for its own business purpose. It is in such a later situation that the task of separating the costs incurred for the foreign AE and those for the business of the Indian AE, assumes significance. If such expenses in two classes are identifiable, one can separate them with ease. But, .....

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g 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 i .....

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some rational manner. 15.8. In the present case, the assessee did not declare any cost/value of the international transaction in the nature of brand building. As such, it fell upon the TPO to find out such amount out of the total AMP expenses incurred by the assessee. In the absence of any assistance from the assessee in determining such cost/value, logically it could have been by first identifying comparable independent domestic cases ; ascertaining the amount of advertisement, marketing and pr .....

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e amount of AMP expenses incurred by the assessee for the brand promotion of foreign AE. In other words, the amount coming up as per the last step is the cost/value of such international transaction. 15.9. The figure so deduced, by applying the above approach, representing the cost/value of the international transaction, in the instant case is ₹ 161.21 crore. The TPO impliedly considered the same figure as both representing the cost/value of international transaction and also its ALP. Howe .....

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transaction at ₹ 161.21 crore which has been determined by applying the bright line test. Position would have been different 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 significa .....

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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 said figure is as under:- 115. In the written arguments filed by the Revenue, it is stated that the various MNEs use different business models, sometimes country specific. Some of the c .....

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h a subsidiary for carrying out the distribution function. Examples of this include various appellants before this court. (iii) Establish a subsidiary for carrying out the distribution and manufacturing function. Maruti Suzuki Ltd. one of the appellants is an example of this business mode. (iv) Establish a subsidiary for manufacturing the product and use independent companies for distribution. Pepsi Foods Ltd. is an example of this type. It manufactures concentrate which is then sold to bottlers .....

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support activities. 116. It was urged by the Revenue that development of markets for the products is the core function of the entrepreneur, which in this case is the foreign company, an AE. Implementation depends upon the business models of MNEs and how they want this core function to be exercised. Performance of this function clearly benefits the brands and market intangibles owned by the parent company. The test to determine whether the Indian subsidiary was/is incurring the AMP expenses for .....

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ased 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 o .....

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(sic, product). Hence, it is difficult to compartmentalise promotion of product or promotion of brand expenses and record them as separate from each other. The aforesaid assertions reflect the thin edge and the difficult path Revenue has adopted in bifurcating AMP expenses into marketing or sale promotions and brand building by creating and adopting the bright line test . We have elaborately discussed the concept of term brand and brand building and observe that it would be incorrect to treat a .....

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fits consequent to higher manufacturing turnover would be taxed in the hands of the foreign AE, whereas higher profits as a result of increased turnover relatable to distribution and marketing functions would be taxed in the hands of the Indian subsidiary, i.e. the AE. The position would be different if the foreign AE has Permanent Establishment in India. The Revenue has generalised and the argument adopts a universal and ubiquitous approach in the contention that increased turnover would not be .....

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nd distribution as two headings, but this does not mean that marketing and distribution functions cannot be combined and treated as one package or a bundle. The functions performed could be both marketing and distribution. Marketing in the form of sale promotion, advertisements, 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 .....

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m 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 AE but the Indian assessee engaged in m .....

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vertisements, marketing and sale promotions, therefore, benefit both the Indian AE, i.e. the assessee and the foreign AE resident abroad. Same is true and correct position even in case of a distribution company, though in the said case sales would increase and there would not be any element of AMP. The fact that increased sales benefit the foreign manufacturer is the reason why services of Indian assessees have been engaged by the AEs resident abroad. This argument itself does not show that bran .....

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bjected to the bright line test on the basis of comparables mentioned in paragraph 17.4. Any excess expenditure beyond the bright line should be regarded as a separate international transaction of brand building. Such a broad-brush universal approach is unwarranted and would amount to judicial legislation. During the course of arguments, it was accepted by the Revenue that the TPOs/Assessing Officers have universally applied bright line test to decipher and compute value of international transac .....

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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 co .....

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he assessee is performing functions of a pure distributor or performing distribution and marketing functions, in the latter case, he must examine and ascertain whether the transfer price takes into consideration the marketing function, which would include AMP functions. This would ensure adequate transaction price and hence assure no loss of revenue. When the distribution and marketing functions are inter-connected and reliable comparables are available, arm s length price could be computed as a .....

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an appropriate method and compute the arm s length price of the two independently and even by applying separate methods. This will be in terms of the provisions of the Act and the Rules and also as per the general principles of international taxation accepted and applied universally. On the other hand, as recorded by us above, applying bright line test on the basis of parameters prescribed in paragraphs 17.4 and 17.6 would be adding and writing words in the statute and the Rules and introducing .....

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s drawn to United States ISR Regulations, 4.1.2004 Edition, section 1.482-4, Methods to determine taxable income in connection with a transfer of intangible property and also the final regulations 26 CPR Parts 1 and 31 and 602 effective from 31st July, 2009. These are specific regulations framed and applicable in the United States. Care and caution has to be used when we make reference or apply these regulations or interpretation placed by the IRS, in United States of America. 1.482-4 of 2009 Re .....

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hen 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 M .....

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by capital cost of differentiating the intangible property and all related improvements updates, less an appropriate amount of amortisation based on the useful life of each intangible property. In the present case, none of the parties had applied Profit Split Method and, therefore, the observations in paragraph 1.482-6 would not be of much relevance. Section 1.482-4, however, does state that development or enhancement of intangible property owned by another controlled taxpayer should be accounte .....

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identifying the most suitable method, it is observed that the most appropriate and relevant method should have regard to all factors including respective strength and weaknesses of possible methods in their application to actual conditions, the circumstances including functions performed, assets used and risk borne by the entities, availability of reliable information required to apply a particular method and degree of comparability between actual circumstances and comparable circumstances, inc .....

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terially affect a condition that is relevant 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 promotiona .....

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r 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 marketing expenditures are in excess of what comparable independent enterprise with similar rights would incur, adjustment may be required, provided such compensation has not been paid. Reference was made to paragraph 6.38 of the OECD Transfer Pricing Guidelines, wh .....

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fore, the consequent effect that a contract is or is not renewed, ordinarily would not be a factor in its initial pricing. This may be otherwise, if there is evidence at the start of the arrangement to indicate that the contract would be renewed. Therefore, in cases of short-term contract, adjustment would be justified, if there is no direct compensation; marketing expenditure incurred is not included in the profit element by reduction of price or royalty payable. This would be accounted for whi .....

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manufacturer for re-sale on its own accounts. The transaction between the two is a straightforward sale in which the distributor takes all economic risk of product distribution and ultimately gains or makes loss depending upon market and other conditions. The manufacturer is not concerned. In case of a low or no risk distributor and he virtually acts as an agent for the loss and gain is that of the manufacturer. There is no economic risk on distribution of profits. He is, therefore, entitled to .....

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e 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. .....

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ntion and the arms length principle embodied therein. However, there were disagreements on certain points in the sub-committees and Chapter 10 records individual country s view point and experiences for information of readers. This does not reflect a consistent or consensus view of the sub-committee (See paragraph 10.1.1.2) 126. The United Nations Manual Transfer Pricing in paragraph 10.4.8.15 records that determination of arm s length price in cases of marketing intangibles would involve functi .....

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ny in India, customer loyalty and the brand existence of dealer network whether the Indian entity is to provide after sales service the support, market and customer details, etc. It acknowledged that the stand of the Indian tax authorities, who have applied the concept of bright line test of no risk or limited risk distributor or to determine non-routine expenses, has led to multifarious challenges on several account. However, it stands recorded in sub-paragraph No.18 that the important issue in .....

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the subsidiary AE entity has been adequately and properly compensated for undertaking the said expenditure. Such compensation may be in the form of lower purchase price, non or reduced payment of royalty or by way of direct 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 .....

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les 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). Decisions in the case of GlaxoSmithKline and DHL 128. In respect of GlaxoSmithKline, v .....

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U.S. was invoked. The dispute, it appears was predicated on IRS s assertion that advertisement and marketing was more valuable in respect of the said drug, whereas Glaxo and the U.K. taxing authority believed that the high transfer price was reasonable because the research and development work was more valuable. In December, 2000, Glaxo merged with SmithKline Beecham Corporation. As noted above, SmithKline Beecham had earlier entered into an advance tax agreement with the IRS in respect of the s .....

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after about 14 years. 129. The dispute in the case of DHL Corporation, U.S.A. in appeal, was decided in favour of the assessed. DHL Corporation, U.S.A. was the registered owner of the trademark and had exclusive right to use and sub-licence DHL trademark in the United States. U.S. Corporation had entered into a long-term agreement with a group company, namely Document Handling Limited International, Hong Kong ( DHLI , for short) which was responsible for operations outside the U.S. No royalty w .....

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d 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 .....

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er Pricing Officers have referred to paragraphs 6.36 to 6.39. For the sake of completeness, we would quote the said paragraphs from the OECD Transfer Pricing Guidelines, which read:- 6.36 Difficult transfer pricing problems can arise when marketing activities are undertaken by enterprises that do not own the trademarks or tradenames that they are promoting (such as a distributor of branded goods). In such a case, it is necessary to determine how the marketer should be compensated for those activ .....

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g activities- the analysis requires an assessment of the obligations and rights implied by the agreement between the parties. It will often be the case that the return on marketing activities will be sufficient and appropriate. One relatively clear case is where a distributor acts merely as an agent, being reimbursed for its promotional expenditures by the owner of the marketing intangible. In that case, the distributor would be entitled to compensation appropriate to its agency activities alone .....

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benefits of marketing activities that increase the value of that intangible will depend principally on the substance of the rights of that party. For example, a distributor may have the ability to obtain benefits from its investments in developing the value of a trademark from its turnover and market share where it has a long-term contract of sole distribution rights for the trademarked product. In such cases, the distributor s share of benefits should be determined based on what an independent .....

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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 .....

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higher returns derived from the sale of trademarked products may be due as much to the unique characteristics of the product or its high quality as to the success of advertising and other promotional expenditures. The actual conduct of the parties over a period of years should be given significant weight in evaluating the return attributable to marketing activities. See paragraphs 3.75-3.79 (multiple year data). 134. The aforesaid paragraphs do not support the Revenue s submission, but stipulat .....

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ghts of the trade marked products, thereby acquiring economic ownership benefit. In some cases, where the distributor bears extraordinary marketing expenses, he would be entitled to additional or higher return, through decreased price or reduction of royalty rate. The difficulty in attributing advertisement and other promotional expenditures towards trademark valuation or towards marketing activities, i.e. contributing to manufacture and current income and the impracticability of division in the .....

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ection 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 weakn .....

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should ordinarily be based on the transaction actually undertaken by the AEs as has been struck by them. We should not be considered as advocating a broad-brush approach but, a detailed scrutinized ascertainment and determination whether or not the aggregation or segregation of transactions would be appropriate and proper while applying the particular Method, is necessary. 138. The OECD Commentary in this regard is relevant and reproduced below: 3.13 An-intentional set-off is one that associated .....

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n the transactions needs to be considered. for purposes of assessing tax liabilities. For example, an enterprise may license another enterprise to use a patent in return for the provision of know-how in another connection and indicate that the transactions result in no profit or loss to either party. Such arrangements may sometime be encountered between independent enterprises and should be assessed accordance with the arms length principle in order to quantify the value the respective benefits .....

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ss the benefits could be sufficiently accurately quantified and the contract is created in advance. Otherwise, independent enterprises normally would prefer to allow their receipts .and disbursements to flow independently of each other, taking any profit or loss resulting from normal trading. 3.15 Recognition of intentional set-offs does not change the fundamental requirement that for tax purposes the transfer prices for controlled transactions must be consistent with the arm's length princi .....

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arately 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 th .....

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text of mutual agreement procedures and corresponding adjustments (see Chapter V). 139. The majority judgment in the case of L.G. Electronics India Pvt. Ltd. (supra) opines that the Act, i.e. Chapter X of the Act, prohibits and does not permit set off or adjustment. Reference stands made to sub-section (3) to Section 92 of the Act. We would like to reproduce the said Section and understand the object and purpose behind the said provision. (3) The provisions of this section shall not apply in a c .....

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respect of the previous year in which the international transaction or specified domestic transaction was entered into. 140. Sub-section (3), we do not think incorporates a bar or prohibits set offs or adjustments. It states that Section 92, which refers to computation of income from international transaction with reference to arm s length price under sub-section (2) or (2A), would not have the effect of reducing income chargeable to tax or increase the loss, as the as may be, computed by the a .....

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favourable results as per the entries in the books of account, then the income chargeable to tax or 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 .....

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. 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 against imposition of the tax. In Billings v. U. S, the Supreme Court clearly acknowledged this basic and long-standing rule of statutory construction: "Tax Statutes ... should be construed, and, if any ambigu .....

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or such statutes are not to be extended by implication beyond the clear import of the language used. If the words are doubtful, the doubt must be resolved against the Government and in favour of the taxpayer. Gould v. Gould 245 U.S. 151, 153." ASN 51/53 WP-871-14 As Lord Cairns said many years ago in Partington v. Attorney-General: As I understand the principle of all fiscal legislation it is this: If the person sought to be taxed comes within the letter of the law he must be taxed, however .....

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The intention on the other hand of the Legislature is not what is propounded by the Revenue. Consistent, the stand of the Revenue, it is apparent is divergent from the internationally accepted practice relating to Transfer Pricing determinations. The Legislature when it wanted to deviate, has adopted such recourse as with the year data and use of inter-quartile range. We do not read any repugnancy on this aspect in Section 92(3) of the Act. Thus, where the Act, i.e. the Income Tax Act, 1961 or t .....

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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 .....

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ow that the Revenue is conscience and aware of commercial business realities and the need to account for set offs. It is commonly recognized and accepted. The object and purpose behind arm length principle is to tax the actual and commercial income which could have been earned by the AE in India. 144. Question of set off would only arise in case two transactions are separate and arm s length price should be computed separately. It would not arise for consideration in cases where there are closel .....

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nd the aggregation made by the assessee is wrong. In such cases, it would be grossly unfair and inequitable not to apportion or segregate the transactions as declared in a reasonable and logical manner. It would be conspicuously wrong and incorrect to treat the segregated transactional value as NIL when in fact the two AEs had treated the international transactions as a package or a single one and contribution is attributed to the aggregate package. It is noticeable that sub-section (3) to Secti .....

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will have reference to the declared bundled/packaged international transaction. 145. In the impugned decision, the majority decision has observed that there is no basis for a presumption that the international arm s length price of one transaction was lower and this position 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 h .....

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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 transactions included. The final findi .....

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and objectively. CIT versus EKL Appliances Ltd - Disregarding actual transaction 147. Tax authorities examine a related and associated parties transaction as actually undertaken and structured by the parties. Normally, tax authorities cannot disregard the actual transaction or substitute the same for another transaction as per their perception. Restructuring of legitimate business transaction would be an arbitrary exercise. This legal position stands affirmed in EKL Appliances Ltd. (supra). The .....

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viewed in their totality, differ from those which would have been adopted by the independent enterprise behaving in a commercially rational manner. The second exception also mandates that actual structure should practically impede the tax authorities from determining an appropriate transfer price. The majority judgment does not record the second condition and holds that in their considered opinion, the second exception governs the instant situation as per which, the form and substance of the tr .....

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PO 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 .....

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e third party. 148. There is no material or data on record to show that an independent enterprise acting in a commercially rational manner would not enter into an agreement for distribution and marketing as has been entered into by the Indian assessee, a subsidiary of the foreign AE. It would be incongruous and presumptuous to hold, without any data or good reason, that the transactions for distribution and marketing as a package are not executed between a foreign enterprise and an independent e .....

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arables. A simple example of re-categorisation would be cases of thin capitalisation . Aggregation or segregation of transactions accepts that the transactions per se do not require re-categorisation of transactions. However, in a given case when there is re-categorisation of transaction, as a consequence, segregation or aggregation may be required. However, the two aspects/principles prevail and operate in their own field. L. Economic Ownership 150. Value of tangible property may be affected by .....

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ble would be relevant when the comparability test is adopted and applied between the controlled transaction with the uncontrolled transactions. 151. Economic ownership of a trade name or trade mark is accepted in international taxation as one of the components or aspects for determining transfer pricing. Economic ownership would only arise in cases of long-term contracts and where there is no negative stipulation denying economic ownership. Economic ownership when pleaded can be accepted if it i .....

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ce 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 .....

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and asserted that the entire benefit was reaped by the parent entity and not by Reebok India Company Ltd.. Re-organisation, sale and transfer of a brand as a result of merger and acquisition or sale is not directly a subject matter of these appeals. As noted above, in a given case where the Indian AE claims economic ownership of the brand and is deprived or transfers the said economic ownership, consequences would flow and it may require transfer pricing assessment. In the written submissions fi .....

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marketing accrues to the appellant/the tested party in India for having promoted the sale of the products in India. Income-tax Act recognises this and therefore allows it as a revenue expense wholly and exclusively expended for the purposes of the business, the said issue has also been upheld by this court in the case of Agra beverages Corporation (P) Ltd vs. CIT [2011] 11 taxmann.com 350 (Refer Page no. 284 of the paperbook). M. Decision in the case of Maruti Suzuki and the order of the Suprem .....

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de 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, .....

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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 correct to hold that the Supreme Court had accepted and had given seal of approval and not interfered with the principles/ratio enunciated in the judgment by the Delhi High Court. The Supreme Court as is lucid did not want to examine the principles or ratio as enunciated and express their opinion on merits, though the d .....

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t of the Delhi High Court would not operate as res judicata between the parties and merits, if required, would be examined and gone into in the appellate proceedings. The majority judgment has incorrectly inferred that the legal principles and directions issued by the Delhi High Court would continue to be binding decidendi and had attained finality, viz. the tax authorities and the Tribunal. It is not so indicated. If the legal principles/ratio was not binding on the writ petitioner, i.e. the as .....

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our own conclusion. N. Resale Price Method 157. We begin by reproducing Rule 10B(1)(b) of the Rules:- Determination of arm's length price under section 92C. 10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction or a specified domestic transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- (a) xxx (b) Resale Price Method, by which,- (i) .....

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ansactions; (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 tra .....

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er this method the transfer price for the sale of products between the sales company (i.e. Associated Enterprise 2) and a related company (i.e. Associated Enterprise 1) can be described in the following formula: TP = RSP x (1-GPM), where: • TP = the Transfer Price of a product sold between a sales company and a related company; • RSP = the Resale Price at which a product is sold by a sales company to unrelated customers; and • GPM = the Gross Profit Margin that a specific sales co .....

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and re-sale of same or similar property and/or obtaining or providing similar services. From this amount, the expenses incurred by the AE in connection with the purchase of property or obtaining of services are further subtracted. At the fourth stage, adjustments are made taking into account the functional and other differences, including the accountancy practices, if any, between the tested international transaction and the comparable uncontrolled transactions to the extent they would materiall .....

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omparables including, if required, adjustment on account of functional and other differences with comparables. Uncontrolled transaction 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 requi .....

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e 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 cases, it may be a preferable and more reliable method in comparison to the CUP Method or CP Method. However, RP Method has its weaknesses. It loses its accuracy and reliabi .....

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ks or trade names) which are owned by an associated enterprise. In such cases, the contribution of the goods originally transferred to the value of the final product cannot be easily evaluated. 2.30 A resale price margin is more accurate where it is realised within a short time of the reseller's purchase of the goods. The more time that elapses between the original purchase and resale, the more likely it is that other factors - changes in the market; in rates of exchange; in costs etc. - wil .....

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eeing the goods, financing stocks, and other connected services. If the reseller in the controlled transaction does not carry on a substantial commercial activity, but only transfers the goods to a third party, the resale price margin could, in light of the functions performed, be a small one. The resale price margin could be higher where it can be demonstrated that the reseller has some special expertise in the marketing of such goods, in effect bears special risks, or contributes substantially .....

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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 uni .....

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stantially to the value of the product by assisting considerably in creation and maintenance of intangible products or where the goods are further processed into a more valuable or complicated product. Referring to the weaknesses of the said method, the commentary states:- The method can be used without forcing distributors to inappropriately make profits . The distributor earns an arm s length gross profit margin, however, but could have operating losses due, for example, to high selling expens .....

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e tested party. 6.2.11. When to Use the Resale Price Method 6.2.11.1. In a typical inter-company transaction involving a fully-fledged manufacturer (i.e. as compared, for example, with a limited risk company or contract manufacturer) owning valuable patents or other intangible properties and affiliated sales companies which purchase and resell the products to unrelated customers, the Resale Price Method is an appropriate method to use if: > The CUP Method is not applicable; > The sales com .....

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, it is not possible to examine and compare the functional comparability between the controlled tested transaction and uncontrolled internal party transaction on account of AMP expenses. Internal comparable would not account for the credible gross profit rate, which an AE should be ensured 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 .....

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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 operations, a function w .....

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s profit margin would include the margin or compensation for the AMP expenses incurred. Routine or non-routine AMP expenses would not materially and substantially affect the gross profit margins when the tested party and the comparable undertake similar AMP functions. 166. On behalf of the assessee, it was initially argued that the TPO cannot account for or treat AMP as a function. This argument on behalf of the assessee is flawed and fallacious for several reasons. There are inherent flaws in t .....

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iv), adjustments have to be made on account of functional difference which would include assets used and risk assumed. It is at stage (iv) of the RP Method that the Assessing Officer/TPO can make adjustments if he finds that an assessee has incurred substantial AMP expenses in comparison to the comparables. Once adjustments are made, then the appropriate arm s length price can be determined. In case, it is not possible to make adjustments, then RP Method may not be the most appropriate and best .....

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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 fi .....

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transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely : Xxx (c) cost plus method, by which, (i) the direct and indirect costs of production incurred by the enterprise in respect of property transferred or services provided to an associated enterprise, are determined; (ii) the amount of a normal gross profit mark-up to such costs (computed according to the same accounting norms) arising from the transfer or provision of .....

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fect such profit mark-up in the open market; (iv) the costs referred to in sub-clause (i) are increased by the adjusted profit mark-up arrived at under sub-clause (iii); (v) the sum so arrived at is taken to be an arm s length price in relation to the supply of the property or provision of services by the enterprise; 170. United Nations Manual in arithmetic terms has elucidated CP Method in the following manner: The formula for the transfer price in inter-company transactions of products is as f .....

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ers. Like RP Method, CP Method is a gross margin method as it attempts to derive the arm s length price on a mark-up of cost of goods or services provided. 171. Determination of cost or expense can cause difficulties in applying CP Method. Careful consideration should be given, what would constitute cost i.e. what should be included or excluded from cost. A studied scrutiny of CP Method would indicate that when the said Method is applied by treating AMP expenses as an independent transaction, it .....

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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. Th .....

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ot marketing intangibles. The assessed rely upon AEs valuable product intangibles. The issue can be answered after ascertaining facts and whether similar comparables are available. We have not pronounced a firm opinion. Obviously, the aforesaid caveat would not arise if and when, AMP as a transaction is separately benchmarked and tested. 173. This task of arm s length pricing in the case of tested party may become difficult when a number of transactions are interconnected and compensated but a t .....

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perty transferred, when made subject matter of arm s length price by applying CP Method, cannot be again factored or included as a part of inter-connected international transaction and subjected to arm s length pricing. This situation would possibly result in over, if not double taxation, contrary to the object and purpose of arm s length pricing, which is to tax the real income after correcting the negative impact, if any, of the controlled conditions. Therefore, if entire marketing and distrib .....

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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 adjust .....

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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 tool that it employs to create this brand loyalty among them. Once they are convinced that this company is passing on a greater benefit to them only then will they push the products of this company towards the ultimate customer, over other brands. 3. The dealer incentives and other selling expenses form part of the market penetr .....

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enses, over and above the normal discounts, if they are being incurred at the behest of the AE, as part of the market penetration strategy, they will qualify as AMP expenses. These expenses form part of the brand building strategy that is being executed by the Indian subsidiary on behalf of the AE. 176. The aforesaid argument, when AMP expenses are segregated from the composite transaction including distribution and marketing function, is flawed and has to be rejected. The respondent-assessees a .....

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to brand building exercise, but have a live link and direct connect with marketing and increased volume of sales or turnover. The brand building connect is too remote and faint. To include and treat the direct marketing expenses like trade or volume discount or incentive as brand building exercise would be contrary to common sense and would be highly exaggerated. These reduce the net profit margin. It would lead to abnormal financial results defying accountancy practices and commercial and busin .....

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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 t .....

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ses as an international transaction. Mark up as per sub-clause (ii) to Rule 10B(1)(c) would be comparable gross profit on the cost or expenses incurred as AMP. The mark-up has to be benchmarked with comparable uncontrolled transactions or transactions for providing similar service/product. The Revenue s stand in some cases applying the prime lending rate fixed by the Reserve Bank of India with a further mark-up, is mistaken and unfounded. Interest rate mark-up would apply to international transa .....

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l Ltd. USA @ 5% was taken as a valid comparable. In addition, the assessed relied upon Foreign Exchange Management (Current Account Transactions) Rules, 2000 authorising remission of royalty of upto 5% on domestic sales and upto 8% on exports under the automatic route to foreign technical collaborators. The TPO rejecting the claim, observed that the assessed had not established cost-benefit analysis for payment of royalty. No such exercise had been carried out. The TPO referred to technology lic .....

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yalty was not reflected in the profit margins or commensurate benefit. He, therefore, came to the conclusion that no independent enterprise 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 p .....

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cts were designed and developed after research and development at the Research & Development and Product Creation Centre in Canton, USA. These patented technologies were used in local development and manufacturing process for footwear and apparels. The entire business of the assessee in India was dependent upon the patented technology provided by the AE which could not have been used without licence/permission. Total revenue of the assessed had increased to ₹ 451.97 crores from ₹ .....

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greement with the finding of the Tribunal that question of payment of royalty cannot be determined on the basis of profitability or earnings of the assessed, once it is accepted that know-how and technical information was provided. It is not alleged or the case of the Revenue that the technology or know-how was hopeless and useless. The finding of the Assessing Officer/TPO, that the assessee had not derived any commercial benefit as technology and know-how had not resulted in any substantial pro .....

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e, recognise separate entity principle. Therefore, as a sequitur, it follows that the AE is a separate entity and when it avails and secures advantage of technical know-how, it should pay arm s length price for the right to use. The arm s length price would be the fair market price of the technical know-how, which is licensed. 185. Royalty payable for availing the right to use would depend upon corresponding price, which would have been paid by an independent or unrelated enterprise. This is jud .....

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fore 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 determin .....

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he said transaction with the AE. This is not the case set up by the Revenue. The assessed in the present case has made profits. 187. The Tribunal in the impugned order, therefore, had rightly applied the test of commercial expediency and has recorded that the assessed was free to conduct business in the manner it deems fit. We hasten to add that two exceptions have been carved out in the case of EKL Appliances Limited (supra), but the exceptions have not been invoked, nor are the conditions sati .....

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olten Corporation Japan with Adidas International Marketing BV for payment of royalty @ 12%. 189. The Tribunal has noted with disapproval the observation of the TPO that comparable instances were not given, observing that this was factually incorrect. 190. However, do not agree with the finding recorded by the Tribunal that as the Government of India had permitted remission of royalty through automatic route, the royalty paid can be per se or conclusively treated as the arm s length price. Appli .....

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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 prin .....

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the ground of absurdity and perversion, alleging that Indian turnover was a miniscule percentage of the global turnover and, thus, profit shifting by attributing higher or greater profits to Canon Inc. Japan, etc. was fallacious. Revenue has contested some of the submissions by filing their own charts/tables. 193. We would not like to go into several factual aspects for the first time, for the factual matrix has not been examined and ascertained by the Tribunal. Moreover, in terms with our legal .....

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s, rather than passing an order of remand to the Assessing Officer/TPO. The endeavour should be to ascertain and satisfy whether the gross/net profit margin would duly account for AMP expenses. When figures and calculations as per the TNM or RP Method adopted and applied show that the net/gross margins are adequate and acceptable, the appeal of the assessed should be accepted. Where there is a doubt or the other view is plausible, an order of remand for re-examination by the Assessing Officer/TP .....

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) was 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. In terms of and subject to discussion under the heading C, paragraph Nos.41 to 50, the substantial question of law No.1 is answered in favour of the Revenue and against the assessee. Q.2. Whether AMP Expenses incurred by the assessee in India can be treated and categorized as an internationa .....

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stion 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 Ben .....

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ur findings:- (i) In case of a distributor and marketing AE, the first step in transfer pricing is to ascertain and conduct detailed functional analysis, which would include AMP function/expenses. (ii) The second step mandates ascertainment of comparables or comparable analysis. This would have reference to the method adopted which matches the functions and obligations performed by the tested party including AMP expenses. (iii) A comparable is acceptable, if based upon comparison of conditions a .....

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it should be ascertained whether reasonably accurate adjustments can be made to eliminate the effect of such differences on the price or margin. Thus, identification of the potential comparables is the key to the transfer pricing analysis. As a sequitur, it follows that the choice of the most appropriate method would be dependent upon availability of potential comparable keeping in mind the comparability analysis including befitting adjustments which may be required. As the degree of the compara .....

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Where the Assessing Officer/TPO accepts the 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 pr .....

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rables 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 transactions is permissible, provided the said transactions can be evaluated and adequately compared on aggregate basis. This would depend on the method adopted and comparability analysis and the most reliable means of determining arm s length price. (ix) To assert and pr .....

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epends upon a great number of facts relevant for a particular business. It reflects the reputation which the proprietor of the brand has gathered over a passage or period of time in the form of widespread popularity and universal approval and acceptance in the eyes of the customer. Brand value depends upon the nature and quality of goods and services sold or dealt with. Quality control being the most important element, which can mar or enhance the value. (x) Parameters specified in paragraph 17. .....

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es, costs or compensation paid for AMP expenses would be NIL , or at best would mean the amount or compensation expressly paid for AMP expenses. It would be conspicuously wrong and incorrect to treat the segregated transactional value as NIL when in fact the two AEs had treated the international transactions as a package or a single one and contribution is attributed to the aggregate package. Unhesitatingly, we add that in a specific case this criteria and even zero attribution could be possible .....

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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 do .....

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ate international transaction, provided CP Method is the most appropriate and reliable method. Adoption of CP Method and computation of cost and gross profit margin comparable must be justified. (xiv) 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. Costs or expenses incurred for services provided or in respect of property transferred, when made subject matte .....

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