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2015 (6) TMI 514 - ITAT DELHI

2015 (6) TMI 514 - ITAT DELHI - [2015] 41 ITR (Trib) 188 (ITAT [Del]) - Transfer pricing adjustment - AO/ TPO had accepted and adopted TNMM method with regard to other international transaction, therefore, no separate bifurcation of AMP expenses is to be made as per assessee - Held that:- Submission of assessee cannot be accepted because TPO had applied the bright line test by considering those comparables which were routine distributors. He did not carry out any study with reference to the func .....

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both at same pedestals.

It is pertinent to note that comparables selected by assessee in its TP study for benchmarking the distribution activity and for benchmarking the AMP functions only Remi Elektrotechnik Ltd. is common in both. Therefore, the plea that since TPO has accepted TNMM method, therefore, AMP expenditure should not be separately considered is devoid of any merit.

In view of the decision of Hon’ble High Court in Sony Ericsson case (2015 (3) TMI 580 - DELHI HIG .....

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P to record a finding on the assessee’s claim as noted in the submissions of ld. authorized representative. - Decided in favour of assessee for statistical purposes. - ITA nos. 674/Del/2015 - Dated:- 5-6-2015 - Shri S.V. Mehrotra and Shri A.T. Varkey,JJ. For the Petitioner: Shri Himanshu S. Sinha Adv. For the Respondent: Shri Ajit Kumar Singh CIT(DR) & Shri Judy James Standing Counsel DR ORDER PER S.V. MEHROTRA, A.M:- This appeal, preferred by the assessee, is directed against the assessment .....

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erved that Zimmer India acts as a routine distributor exposed to normal risks relating to the distribution business. 3. The assessee had filed its return of income declaring total income of ₹ 11,47,33,153/-. The AO noticed that the assessee had entered into following international transactions: Nature of International transaction Method Selected Amount(In INR) Purchase of hip. Knee and trauma implants etc. TNMM 475,487,449 Purchase of instruments 21,494,576 Reimbursement of expenses receiv .....

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the AE as the brands owned by it were gaining in value due to the marketing efforts of the assessee. 6. Ld. TPO issued a detailed show cause notice which is reproduced in para 3 of his order. In this notice primarily TPO pointed out that the functional profiles as per TP documentation of the assessee, was as under: (i) Distribution operations (ii) Pricing of products (iii) Credit terms (iv) Marketing (v) Procurement, Order processing. (vi) Inventory management - inventory planning/ forecasting. .....

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n connection with the sale channels, like sales commissions, discounts etc. were also relevant to the issue of evaluating AMP expense. He pointed out that the kinds of products dealt by the assessee were not those that could be pushed by direct marketing or marketing strategies that would be applicable in the FMCG sector. The product could be advertised by and through persons like dealers of such products, hospitals etc. He, therefore, pointed out that expenses shown under the head advertisement .....

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ated below: S.No. Name Sales(Rs.) AMP Expenses (Rs.) AMP/Sales% 1. Hicks Thermometers (India) Ltd. This company is the owner of the well known and recognized brand. This cannot be called a routine distributor. This is not a suitable comparable. 2. Kusam Electrical Inds. Ltd. This company is functionally different. It is not a good comparable. 3. Remi Sales & Engg.Ltd. 781,192,364 Advertisement & Sales promotion 3,702,485 Commission on sales 4,220,610 Discount allowed 786,253 1.11 4. Sata .....

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s comparables for determining the bright line with reference to the AMP expenses incurred by them: S No. Name of the company AMP Head Sales Amount in INR AMP/Sales(%) 1. Remi Sales & Engg. Ltd. Advertisement & Sales promotion 3,702,485 781,192,364 Commission on sales 4,220,610 Discount allowed 786,253 Total 8,709,348 1.11 2. AFCO Industrial & Chemicals Ltd. Nil 6,829,960 0.00 3. Ambalal Sarabhai Enterprises Ltd. Selling commission 5,054,000 591,170,000 Wholesalers/distributors discou .....

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inconferences 1,778,000 Rebate & discount 456,780 Total 21,425,120 252,923,490 8.47 8. Sataytej Commercial Co. Ltd. Commission 1,054,000 Discount 172,084 Advertisement 7,129 Rent for hoarding 75,000 Total 1,308,213 35,947,789 3.64 Average AMP/Sales 2.41% 11. The assessee in its reply pointed out that discount and commission should not be included under the head of AMP. The sales and distribution expenses have no nexus with the creation of brand or trade mark. Ld. TPO pointed out that trauma .....

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spital and doctors. He pointed out that which particular expense will be part of the AMP expenses is a matter that will be decided by the nature of the business and the product that is being sold. What is the AMP for a product in the FMCG sector may not be so in another sector. Similarly, what is relevant AMP expenses in the case of marketing of trauma implants will be decided by the nuances of this industry. He did not accept the assessee s contention that the discount, commission and other inc .....

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onal transactions, related AMP expenditure leading to creation of marketing intangible benefiting the AE as under: Total sales made by you ₹ 77,47,89,626 Arm s length level of AMP exp. (3.40% of sale) ₹ 2,63,42,847 Amount actually spent on AMP exp. ₹ 5,25,19,355 Amount spent on creation of marketing intangible ₹ 2,61,76,508 Mark up @ 12.50% ₹ 32,72,063 Total ₹ 2,94,48,571 14. The AO had passed the draft assessment order in pursuance to the TPO s order. The ass .....

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y taking into account the items like discount allowed of ₹ 54,994/- and sales commission of ₹ 1,82,98,811/- which were purely linked with actual sales made by the assessee. (iii) The assessee objected to the application of the mark up of 12.50% in respect of assessee s AMP expenses. (iv) The assessee also objected to the selection of 5 comparable companies by TPO. (v) The assessee also objected to the use of bright line test. 15. The ld. DRP referred to the decision of special Bench .....

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nditure for the value addition of the brand owned by its foreign AE. 16. Ld. DRP also upheld the TPO s finding as regards the use of bright line test. Ld. DRP also approved the comparables selected by TPO. As regards the assessee s plea that items like discount and sale commission should not be part of AMP expenditure for benchmark purposes, ld. DRP confirmed TPO s action on this count, inter alia, observing that the brand royalty to be generated aims at all levels of the chain of transactions. .....

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by the assessee. Being aggrieved, the assessee has is in appeal before us and raised following grounds of appeal: 1. That on the facts and in the circumstances of the case and in law, the order passed by the Ld. Assessing Officer ( AO") is bad in law and void ab-initio 3. That on facts and circumstances of the case and in law, the Ld. AO/ Ld. Transfer Pricing Officer ( TPO")/ Ld. Dispute Resolution Panel ( DRP") erred on facts and circumstances of the case in determining the arm&# .....

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ot; to refer the matter to the Ld. TPO for computation of the arm's length price, as is required under section 92CA(1) of the Income Tax Act, 1961 ( Act"). 4. That the Ld. AO/ Ld. TPO/ Ld. DRP erred on facts and in law in enhancing the income of the Appellant by ₹ 29,448,571 by making a Transfer Pricing ( TP") adjustment on account of "alleged excessive" advertising, marketing and promotion ( AMP") expenses incurred by the Appellant and in doing so have grossly .....

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nd that all benefit resulting from such expenditure are to its own account 4.3 disregarding the nature of sales and sponsorship expenses incurred by the Appellant which clearly set forth that the expenses were incurred by Appellant on various events and conferences organized which were in the nature of selling expenses and thus had no nexus with brand promotion; and incorrectly holding that such expenses result in developing marketing intangible for the AEs; 4.4 without prejudice to its above co .....

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sactions are accepted to be at arm's length under Transactional Net Margin Method ("TNMM") as the primary method corroborated by Resale Price Method ("RPM"), challenging/ analysing individual elements of costs (like the AMP expenses) is inconsistent with the tenets of the application of TNMM; 4.6 ignoring the fact that 'bright line test' is simply a tool and not a method prescribed under the Act read with the Income-tax Rules, 1962 (lithe Rules") and hence th .....

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to excess AMP expenses and does not warrant a separate compensation in the form of reimbursement from the AEs; 4.8 by incorrectly determining the AMP expenses as excessive by comparing against the bright line limit arrived at arbitrarily using inappropriate comparables that: (i) are not operating on the same level of business value chain as that of the Appellant; and (ii) are wholly dissimilar to the Appellant in respect of the brands promoted by them; 4.9 erroneously holding that the Appellant .....

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s and circumstances of the case and in law, the Ld. AO has erred in initiating penalty proceedings u/s 271(1)(c) of the Act mechanically and without recording any adequate satisfaction for such initiation. 17. Ld. counsel for the assessee has primarily advanced two fold submissions. First is that since the assessee had adopted TNMM method in regard to benchmarking of international transactions, therefore, since the operating margin was 11.07% as against the operating margin of comparables of 4.0 .....

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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- (i) 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 compara .....

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on of a horizontal item without segregation would be impermissible. 18. To buttress his argument that the AMP expenses were subsumed in the overall profit margin, ld. counsel referred to page 118 of PB wherein schedule 2.4 - other expenses, is contained, which includes the three items taken as constituent of AMP expenses by TPO. 19. Ld. counsel referred to page 204 of the PB, wherein the TP study submitted by assessee is contained to demonstrate that the average PLI of six comparables, selected .....

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case of L.G. Electronics India (P) Ltd. (supra), for excluding direct marketing and sale related expenses or discount/ concession from AMP expenses. He pointed out that selling cost cannot be taken as part of AMP expenses. He, therefore, submitted that there is no dispute that discount allowed and sales commission are purely linked to sales and are not in the nature of advertisement and promotion activities 21. As regards sponsorship and sales promotion expenses, ld. counsel has given details o .....

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s on various events organized i.e. conferences, camps for creating patient awareness on orthopedic problems, educating surgeons and community at large on the usage of implants etc. 12,083,502 Advertisement 120,000 Business promotion Expenses on various events organized by the Medical education department for medical education and awareness. Further,it also includes the expenses incurred for cadaver workshops 6,560,648 Business Consulting Professional fee paid to delegates for presenting various .....

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ses had been incurred in connection with the product specific agreement in relation to orthopedic surgery and have no nexus with brand promotion or creation of marketing intangibles. Ld. counsel pointed out that at best advertisement of ₹ 1,20,000/- booked under the head Sales promotion can be taken as component of AMP. 23. Ld. CIT(DR) submitted that the matter should be restored back to the file of AO/ TPO as the ITAT does not have the expertise of examining the components of AMP expenses .....

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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 itself or at the instance of the AE was/ is to find out whether an independent party would have undertaken the same level of AMP expenses. An independent party with short-term agreement with an MNE would not incur costs which give longterm benefits of brand a .....

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was/is payable. No third party distributor would incur expenditure on development of marketing and brand, which does not eventually belong to it. 24. Ld. CIT(DR) further referred to para 121 of Sony Ericsson Mobile Communications India Pvt. Ltd & Ors. (supra) and pointed out that TPO had to examine the question whether the assessee was performing functions of a pure distributor or performing distribution and marketing functions and if the assessee was also performing marketing functions then .....

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s binding comparables. We would prefer to observe, that an Assessing Officer/ TPO can go and must examine the question whether the assessee is performing functions of a pure 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 distributi .....

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he price received or the compensation paid by the foreign AE towards distribution and marketing or AMP functions. The TPO can then apply 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 .....

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' and the non-routine AMP expenses as a separate transaction to be computed in the manner as stipulated. 25. Ld. CIT(DR) further referred to para 193 in the case of Sony Ericsson Mobile Communications India Pvt. Ltd & Ors. (supra) and pointed out that the Hon ble High Court taking into consideration the factual findings to be examined, has given sufficient discretion and flexibility to Tribunal to reach a fair and just conclusion on the ALP and if necessary to remand the matter to AO/ TP .....

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be made in view of para 101 of Sony Ericsson case (supra), reproduced earlier, cannot be accepted because TPO had applied the bright line test by considering those comparables which were routine distributors. He did not carry out any study with reference to the functions performed by comparables selected by him vis a vis functions performed by assessee in regard to its marketing and distribution activities. Ld. counsel has relied on para 101 of the judgment in Sony Ericsson s case. However, the .....

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s length pricing, which is a negative factor, and for this reason TNM Method is typically applied when the related parties are engaged in continuous series of transactions and one of the parties controls intangible assets for which arm's length price/return is not easy to determine. It is favourable to apply TNMM Method when one party is performing routine marketing, distribution and other functions that do not involve control over intangible assets as it allows appropriate return to the par .....

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ower than the comparable. A comparable should be accepted if it deals with the same or identical or similar property under the same or substantially the same circumstances as the controlled transaction so as to give reliable and more certain measure of arm's length result. All methods including the TNM Method acknowledge that there could be difference between tested part and the comparable on functional analysis, but this would not be material where it is possible to reasonably ascertain the .....

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In para 100, Hon ble High Court has observed as under:- 100. The TPO/ Assessing Officer can overrule the assessee as to the method adopted and select the most appropriate method. The reasons for selecting or adopting a particular 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 func .....

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ssessed and adopt another method. Several recourses may be available. Of course, justification and reasons must be stated and elucidated. 29. From the above observations, it is evident that the international transaction of AMP expenses can be clubbed with other international transactions carried out by assessee as distributor, if AMP functions performed by tested party and comparables are same. If there is difference in the functions between the assessee and comparables, the suitable adjustment .....

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f observations made by Hon ble High Court in regard to aggregation of transactions it is necessary that TPO has to record specific findings on these aspects particularly with reference to AMP functions of comparables vis a vis assessee. It needs to be examined whether comparables selected for bench marking distribution activity were also incurring AMP expenses or not and, if yes, the AMP functions performed by those comparables. 30. Para 101 relied upon by ld. counsel can come into play only whe .....

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