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2015 (6) TMI 130 - ITAT DELHI

2015 (6) TMI 130 - ITAT DELHI - TMI - Transfer pricing adjustment - Advertising, Marketing and Promotion (AMP) expenses - selection of comparable - Held that:- TPO/AO have followed the Special bench decision in LG Electronics (2013 (6) TMI 217 - ITAT DELHI) for determining the ALP of AMP expenses. There is no discussion about the AMP functions carried out by the assessee or comparables. Now since the Special bench order has been partly modified by the Hon’ble Delhi High Court, including the non- .....

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(2015 (3) TMI 580 - DELHI HIGH COURT) as are common to both Manufacturers and Distributors; apply the parts of the judgment as are applicable to a `Manufacturer’; and ignore the parts of the judgment which pertain exclusively to a `Distributor’. Needless to say, the assessee will be allowed a reasonable opportunity of hearing in such fresh proceedings. - Decided in favour of assessee for statistical purposes. - ITA No.407/Del/2015 - Dated:- 2-6-2015 - SHRI R.S. SYAL AND SHRI C.M. GARG, JJ. For .....

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180,63,50,055/- made by the AO on account of transfer pricing adjustment towards Advertising, Marketing and Promotion (AMP) expenses. 3. Briefly stated, the facts of the case are that the assessee, an Indian company, is a subsidiary of PVM. It is engaged in manufacturing a variety of confectionary products from its factories in Tamil Nadu, Haryana and Uttarakhand. The product brands of the assessee include Big Babool, Alpenlibe, Center Fresh, Center Fruit, Center Shok, Chater Patar, Chlor-mint, .....

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our international transactions of Reimbursement of expenses by AEs, Reimbursement of SAP licence, Reimbursement of IT support services and Reimbursement paid to AEs. On a reference made by the AO for determining the arm s length price (ALP) of the international transactions, the TPO accepted all the reported international transactions at ALP. He, however, noticed that the assessee incurred Advertisement, Marketing and Promotion (AMP) expenses to the tune of ₹ 183,73,82,000/-. To determine .....

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dd on this issue. The assessee is in appeal before us against this addition. 4. We have heard the rival submissions and perused the relevant material on record. It is an admitted position that the assessee under consideration is a Manufacturer and not a Distributor (high or low/no risk). The Special Bench of the Tribunal in the case of LG Electronics India Pvt. Ltd. Vs. ACIT (2013) 152 TTJ (Del) 273 (SB), by its majority decision, without drawing any distinction between manufacturers and distrib .....

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t the ALP of AMP expenses should be determined on Cost plus method by treating AMP transaction as a separate and distinct from other international transactions. It further held that the selling expenses directly incurred in connection with the sales do not lead to brand promotion and hence should not be brought within the overall ambit of AMP expenses. The Special bench laid down certain parameters to be taken into consideration for determining the ALP of AMP expenses. In the ultimate analysis, .....

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e tribunal orders following the Special bench order. A batch of appeals in relation to Distributors (not Manufacturers) led by Sony Ericson Mobile Communications India Pvt. Ltd. Vs. CIT has been disposed of by Their Lordships of the Hon ble Delhi High Court, delivering judgment on 16th March, 2015, upholding the majority view of Special Bench in LG Electronics (supra) treating AMP as an international transaction and also conferring jurisdiction in the TPO to determine the ALP of the internationa .....

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s the most appropriate method by a Distributor, which method has not been disturbed by the TPO, then, the international transaction of AMP and distribution activities should be clubbed. It further held that for determining the ALP of such transactions under a combined approach, only such comparables should be chosen which conform to the AMP functions and other distribution functions conducted by the assessee. If there is some difference in the functions under these international transactions, in .....

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under the transfer pricing provisions for the purposes of determining its ALP separately. In such a determination of ALP of AMP expenses in a segregated manner, proper set off on account of excess purchase price adjustment should be allowed. The view taken by the Special bench of the Tribunal in segregating routine and non-routine expenses on the basis of bright line test has been set aside by the Hon ble High Court. Further, the decision taken by the Special Bench to the effect that the expens .....

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gregated and section 92(3) does not prohibit the set-off [Paras 80 & 81]; AMP is a separate function. An external comparable should perform similar AMP functions. [Paras 165 &166] ; Bright line test cannot be applied to work out non-routine AMP expenses for benchmarking [Para 194(x)]; ALP of AMP expenses should be determined preferably in a bundled manner with the distribution activity [Paras 91, 121 & others] ; For determining the ALP of these transactions in a bundled manner, suita .....

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94 (iii)] ; If adjustment is not possible or comparable is not available, then, the TNMM on entity level should not be applied [Paras 100, 121, 194(iii) & (vi)] ; In the above eventuality, international transaction of AMP should be viewed in a de-bundled manner or separately [Paras 121& 194(xi)] ; In separately determining the ALP of AMP expenses, the TPO is free to choose any other suitable method including Cost plus method [Para 194(xiii)]; In so making a TP adjustment on account of AM .....

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the other. The Hon ble High Court in Sony Ericson Mobile (supra), has held that AMP expense is a separate international transaction and also bright line test is not applicable for determining the ALP of AMP expenses. The manner for the determination of the ALP of the distribution activity and AMP activity has also been set out by the Hon ble High Court to be conducted, firstly, in a bundled manner by considering the distribution and AMP functions performed by the assessee as well as the probable .....

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expenses are the amount spent on the performance of such means (functions). To put it simply, an examination of AMP functions carried out by the assessee and the probable comparables is sine qua non in the process of determination of the ALP of the international transaction of AMP spend, either in a segregate or an aggregate manner. What Their Lordships have held is to bundle the distribution activity with the AMP activity, being two separate but connected international transactions, for the pu .....

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uld be made on account of AMP expenses because such expenses stand subsumed in the overall operating profit. The argument of the ld. AR, if taken to a logical conclusion, will make the AMP spend a noninternational transaction, which, in our considered opinion, is contrary to the verdict of the Hon ble Delhi High Court in Sony Ericsson (supra). Once AMP expense has been held to be an international transaction, it is, but, natural that the functions performed by the assessee under such a transacti .....

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nation of the AMP functions carried out by the assessee as well as comparables, this will amount to snatching away the tag of international transaction from AMP expenses, assigned by the Hon ble High Court. What Their Lordships have held in the judgment is that the distribution activity and AMP expenses are two separate but related international transactions. It is only for the purposes of determining their ALP that these two should be aggregated. The process of such aggregation does not take aw .....

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comparable so as to counterbalance the effect of such differences. If however differences exist in such functions, but no adjustment can be made, then, such probable comparable should be dropped from the list of comparables. If, in doing this exercise, there remains no company doing comparable distribution and AMP functions, then, both the international transactions are required to be segregated and then examined on individual basis by finding out probable comparables doing such separate functi .....

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ade in the case of a probable comparable, so as to make it uniform with the assessee. The assessee may have possibly done, say, four different AMP functions as against the probable comparable having done, say, only three. In such a scenario, again the adjustment will be warranted. In another situation, the AMP functions performed by the assessee and probable comparable may be similar but with varying standards, which will also call for an adjustment. Crux of the matter is that the AMP functions .....

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isions, but on an aggregate basis. Determining the ALP of two transactions in an aggregate manner postulates making a comparison of both the functions of distribution and AMP carried out by the assessee with the comparables, so that surplus from the distribution activity could be adjusted against the deficit in the AMP activity. The Hon ble High Court has nowhere laid down that the AMP functions performed by the assessee should not be compared with those performed by the comparable parties. On t .....

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hould perform similar AMP functions. Thus it is manifest that comparison of AMP functions is vital which cannot be dispensed with. Let us we go a step further with the alternative prescription of the judgment that if ALP of both the transactions of Distribution and AMP cannot be determined in a combined manner, then the ALP of AMP function should be separately done. The submission advanced by the assessee of considering the profit on an entity level without making comparison of AMP functions don .....

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ed by the assessee and then comparing such functions with those performed by comparable entities. This can be done only by mandatorily making a comparison of the AMP functions performed by the assessee and comparables and then making an adjustment, if any, due to differences between the two, so that the AMP functions performed by the assessee and comparable are brought to a similar platform. In fact, this is also the prescription of Rule 10B(1)(e), which provides as under :- (e) transactional ne .....

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gard to the same base ; (iii) the net profit margin referred to in sub-clause (ii) arising in comparable uncontrolled transactions is adjusted to take into account the differences, if any, between the international transaction and the comparable uncontrolled transactions, or between the enterprises entering into such transactions, which could materially affect the amount of net profit margin in the open market ; (iv) the net profit margin realised by the enterprise and referred to in sub-clause .....

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ansaction and the comparable uncontrolled transactions. It is only such adjusted net profit margin in sub-clause (iii) of Rule 10B(1)(e) which is compared with the net profit margin realized by the assessee as per the mandate of sub-clause (iv) of Rule 10B(1)(e). 10. Sub-rule (2) of Rule 10B provides that for the purposes of subrule (1) , the comparability of an international transaction with an uncontrolled transaction shall be judged with reference to the following, namely - (a) the specific c .....

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conditions prevailing in the markets in which the respective parties to the transactions 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. Sub-rule (3) of Rule 10B stipulates that an uncontrolled transaction shall be comparable to an international transaction if (i) none of the differences, .....

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tion with which comparison is sought to be made for determining the ALP, in the first instance, must have overall similar characteristics. It is vivid that if the goods/services are different, then no effective comparison can be made. Once the goods/services under both the transactions are broadly similar but there is a difference in them because of certain specific characteristics; and/or the products/services in both the transactions are identical, but still there are certain differences due t .....

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t the prescription of Rule 10B is in complete harmony with the ratio of the judgment in the case of Sony Ericson Mobile (supra), to the effect that the AMP functions carried out by the assessee are required to be necessarily compared with the AMP functions carried out by a comparable entity in determining the AMP of ALP expenses. Difference between the functions, if capable of adjustment, should be given effect to in the profit rate of the comparable and if such difference cannot be given adjust .....

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oth. Though this judgment lays down at length some broader principles for the determination of ALP of AMP expenses in the case of a Distributor , still certain principles dealing exclusively with the determination of the ALP of AMP expenses in the case of a Manufacturer , have also been laid down. Such discussion has been made in para 92 of the judgment, the relevant part of which is reproduced here as under : - 92. The majority judgment refers to an example where the Indian AE may have earned a .....

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e TNM Method. The reasoning would be equally valid, where no AMP or ‗brand building' expenses are incurred. (See paragraph 21.8 to 22.10 of the majority decision). The net profit margins can be affected by variation of operating expenses. Thus, the requirement to select appropriate comparable and adjustment. It would be inappropriate and unsound to accept comparables, with or without adjustment and apply TNM Method, and yet conjecturise and mistrust the arm's length price. TNM Meth .....

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of imported and manufactured products, as interconnected transactions. Import of raw material for manufacture would possibly be an independent international transaction viz. marketing and distribution activities or functions. We have earlier used the term plain vanilla distributor'. When we use the words plain vanilla distributor' we do not mean plain vanilla situations, but value additions and each party making valuable unique contribution. 14. It is discernible from the italicized par .....

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