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Discovery Communications India, New Delhi. Versus DCIT, New Delhi.

Transfer pricing adjustment - transfer pricing adjustment on account of AMP expenses for marketing intangibles - Held that:- The Hon’ble High Court in assessee’s own case for the A.Y. 2008-09 has restored the computation of the transfer pricing adjustment on account of AMP expenses for marketing intangibles to the tribunal, which has been dealt with by us in a separate order. In disposing of the appeal of the assessee against the transfer pricing adjustment towards AMP expenses for the said A.Y. .....

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ting the entire amount of AMP expenses as deductible u/s 37(1), would amount to considering the entire AMP spend for business purpose, thereby leaving nothing for the promotion of brand of its AE, which will be contrary to the judgment of the Hon’ble High Court in assessee’s own case for the A.Y. 2008-09. Under such circumstances, we set aside the impugned order on this issue also and send it to the file of AO/TPO for deciding it afresh after hearing the assessee. Needless to say, the AO, while .....

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is appeal by the assessee is directed against the final assessment order passed by the Assessing Officer (AO) on 27.2.2015 u/s 143 (3) read with Section 144C of the Income-tax Act, 1961 (hereinafter also called the Act ) in relation to the assessment year 2010-11. 2. The first issue raised in this appeal is against the addition of ₹ 20,33,78,769/- made on account of transfer pricing adjustment due to difference in the arm s length price of the international transaction of incurring of adve .....

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assessee reported six international transactions which have been enlisted on page 2 of the order passed by the Transfer Pricing Officer (TPO). The assessee employed Transactional Net Margin Method (TNMM) as the most appropriate method for demonstrating that its first three international transactions were at arm s length price (ALP). The remaining three were At cost only. On a reference made by the AO for determining the ALP of the international transactions, the TPO accepted the reported intern .....

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of ₹ 26,25,58,229/-. In addition to that he noticed that the assessee had not charged any Interest on receivables from its AE. After entertaining objections from the assessee, the TPO worked out TP adjustment of interest on receivable to the tune of ₹ 1,16,33,235/-, thereby proposing total TP adjustments amounting to ₹ 27,41,91,464/-. The AO, inter alia, made these two additions on account of transfer pricing adjustments. The assessee challenged the additions so proposed in th .....

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erest on receivables. In the final order passed, the AO made addition for a sum of ₹ 21.50 crore and odd, comprising of ₹ 20,33,78,769/- towards AMP and ₹ 1,16,33,235/- towards interest on receivables. No argument has been advanced before us on account of addition on account of TP adjustment of Interest on receivable . The assessment order to that extent is, therefore, approved. 4. We have heard the rival submissions and perused the relevant material on record qua the addition .....

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cally referred to by the AO. On the question of determination of the ALP of this international transaction, the Special bench approved the application of bright line test for working out the amount of non-routine AMP expenses and held that 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 was further held that the selling expenses directly incurred in connection with the sales do not l .....

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sue in conformity with the directions given by the Special Bench in LG Electronics (supra). Several assessees as well as the Revenue preferred their respective appeals before the Hon ble High Courts against the tribunal orders following the Special bench order. A batch of such appeals, also including the case of the assessee for the year under consideration, led by Sony Ericson Mobile Communications India Pvt. Ltd. Vs. CIT (2015) 374 ITR 118 (Del) has been disposed of by Their Lordships of the H .....

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f manufacturer or purchases goods from the manufacturer for resale at his own account. However, in the case of a Manufacturer, the import of raw material has been held to be an independent transaction of marketing and distribution. In the case of a Distributor, the Hon ble High Court held that where TNMM has been applied as the most appropriate method, which method has not been disturbed by the TPO, then, the international transactions of AMP and Distribution activities should be clubbed. It fur .....

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r functions as done by the assessee and no adjustment is possible for bringing the international transactions of the assessee in an aggregate manner at par with those undertaken by the comparables, then, segregation should be done and the international transaction of AMP spend should be separately processed under the transfer pricing provisions for the purposes of determining its ALP separately. In such determination of ALP of AMP expenses in a segregated manner, proper set off on account of exc .....

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- AMP expense is an international transaction [Paras 52 & 53 of the judgment] ; The TPO has jurisdiction to determine the ALP of the international transaction of AMP expenses [Para 50 of the judgment]; Inter-connected international transactions can be aggregated 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-r .....

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ic companies using any foreign brand [Para 120] ; If no comparables having performed both the functions in a similar manner are available, then, suitable adjustment should be made to bring international transactions and comparable transactions at par [Para 194 (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 .....

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]. 7. With the above background of the ratio decidendi of the judgment of the Hon ble jurisdictional High Court, let us examine the contention put forth by the ld. AR in support of the deletion of addition. 8. The ld. AR initially contended that the assessee is a service company and hence cannot be considered either as a Distributor or a Manufacturer. It was however admitted that considering the totality of the nature of business, the assessee is more akin to that of a Distributor rather than a .....

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ributor , we are proceeding accordingly by classifying it as a Distributor. 9. The ld. AR submitted that the assessee applied TNMM as the most appropriate method. Since the profit margin declared by the assessee was favourably comparable with the average margin of the comparables, which fact has not been disputed by the TPO, then, no adjustment should be made on account of AMP expenses because such expenses stand subsumed in the overall operating profit. This was countered by the ld. DR with ref .....

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e;-vis the comparables only qua the international transactions of Distribution function. He initially determined the ALP of AMP expenses by applying bright line test, which mechanism was altered due to the directions given by the DRP and in doing so, he simply compared the quantitative figures of AMP expenses incurred by the assessee and comparables for working out the non-routine expenses. He did not examine the AMP functions carried out by the assessee and the comparables. As the bright line t .....

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e 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 comparables, and if probable comparables having performed both the functions are not available, then to determine the ALP of AMP expenses in a segregated manner. As such, it becomes immensely important to separately examine the Distribution and AMP functions undert .....

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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 purposes of determination of the ALP of both these international transactions in a combined manner. The argument of the ld. AR, if taken to a logical conclusion, will make the AMP spend as a non-international transaction, which, in our considered opinion, is not appropriate. O .....

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tal. If we concur with the contention of the ld. AR that the addition on account transfer pricing adjustment of AMP expenses be deleted without any examination 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 .....

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d by the assessee turn out to be different from those performed by probable comparables, then, a suitable adjustment should be made to the profits of the comparable so as to balance 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 internation .....

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g the ALP of such a transaction. If the AMP functions performed by the two entities are found to be different, then adjustment is required to be made 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 pr .....

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Mobile (supra) is that the two international transactions of Distribution and AMP should be examined on the touchstone of transfer pricing provisions, 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 .....

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ious for several reasons. There are inherent flaws in the said argument . It held vide para 165 of the judgment that : An external comparable should 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 separ .....

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did not make any TP adjustment on account of the reported international transactions carried out by the assessee during the course of its business. He, however, espoused the AMP expense as a separate and distinct item apart from Interest on receivables , which is not in dispute. Treating the AMP spend as a separate international transaction and after giving effect to the direction of the DRP, he applied the Cost plus method and proposed the extant adjustment. It is obvious that in the entire ex .....

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at the approach adopted by the TPO for determining ALP of AMP expenses has been rendered incorrect. However, the fact remains that as per the verdict of the Hon ble High Court, the AMP spend is an international transaction, which is required to be processed under Chapter X of the Act by taking into account the AMP functions performed by the assessee and then comparing such functions with those performed by comparable entities, though, firstly in a combined manner with the Distribution functions. .....

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ssessee 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 net margin method, by which,- (i) the net profit margin realised by the enterprise from an international 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 profi .....

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h could materially affect the amount of net profit margin in the open market ; (iv) the net profit margin realised by the enterprise and referred to in sub-clause (i) is established to be the same as the net profit margin referred to in sub-clause (iii) ; (v) the net profit margin thus established is then taken into account to arrive at an arm s length price in relation to the international transaction. 12. A perusal of the sub-clause (iii) of this Rule divulges that net profit margin under a co .....

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1) , the comparability of an international 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 transaction ; (b) the functions performed, taking into account assets employed or to be employed and the risks assumed, by the respective parties to the transactions ; (c) the contractual terms (whether or not such terms are formal or in writing) of the transact .....

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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, 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 s .....

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ence 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 to the contractual terms or the geographical location, etc., then, a reasonably accurate adjustment should be made for eliminating the material effects of such differences so as to bring the international transaction and the comparable uncontrolled transaction on the same podium. If due to one reason or the other, no reasonable .....

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ses. 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 effect to, then, the probable comparable should be eliminated from the list of comparables. Going further, if no proper comparable survives, then the TNMM should be discarded and an alternative method, may be, Cost plus or any other suitable method be applied for determining the ALP of AMP expenses. 16. At the cost of repetition, w .....

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racter of a separate international transaction and hence the AMP functions should not be matched with the AMP functions carried out by probable comparables. If suitable comparables can be found having performed both Distribution and AMP functions, then, their ALP should be determined on aggregate basis. If, however, there is some difference in the Distribution or AMP functions performed by the assessee vis-à-vis the probable comparables, then an attempt should first be made to iron out su .....

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e ALP of such an international transaction of AMP expenses on separate basis, a proper set off, if any, available from the distribution activity, should be allowed. 17. Coming back to the facts of the instant case, we find that no detail of the AMP functions performed by the assessee is available on record. Similarly, there is no reference in the order of the TPO to any AMP functions performed by comparables. In fact, no such analysis or comparison has been undertaken by the TPO for determining .....

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hich are in the nature of selling expenses directly incurred in connection with sales not leading to brand promotion in any manner, should be excluded. In principle, we agree with the contention of the ld. AR that Selling expenses incurred for making sales are distinct from AMP expenses and, hence, should not be included in the base amount for consideration. The Hon ble jurisdictional High Court in Sony Ericson Mobile Communication India (P) Ltd. (supra) has also held so. As there is inappropria .....

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hould continue to include in the base amount. Under such circumstances, we set aside the impugned order and send the matter back to the file of the TPO/AO for determining the ALP of the international transaction of AMP spend afresh in accordance with the manner laid down by the Hon ble High Court in Sony Ericson Mobile (supra). 18. Another corporate tax issue raised in this appeal is against the disallowance of proportionate advertisement expenses of ₹ 3,17,71,475/- out of total advertisem .....

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es allocable to total income from advertisement sales commission; and advertisement expenses allocable to advertisement revenues not offered to tax. The later amount of ₹ 3,17,71,475/- was added to the total income, against which the assessee has come up in appeal before us. 19. At the outset, the ld. AR submitted that this issue has been decided by the Tribunal in assessee s favour for the AYs 2002-03, 2003-04 and 2004-05 and the view taken by the Tribunal has been upheld by the Hon ble D .....

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ing intangibles of the assessee s AE in such earlier years, in contrast to such expenses having been actually incurred for the year under consideration for which TP adjustment of AMP expenses has been made and is subject matter of this appeal. It was submitted that there is a common pool of AMP expenses incurred both for the business of the assessee and the promotion of the brand of its AE. 20. We have heard the rival submissions and perused the relevant material on record. It is observed from t .....

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ness of the assessee and, hence, deductible in full. That is how, the addition was deleted. On a specific query from the Bench, the ld. AR stated that in the current year, the assessee received 20% of the total subscription fees in lieu of advertising and promoting the channels of its AEs and candidly admitted that the expenses incurred on advertisement and promotion of channels are common and form part of total AMP expenses considered by the TPO for recommending TP adjustment towards promotion .....

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