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TMI Blog2015 (12) TMI 1188X X X X Extracts X X X X X X X X Extracts X X X X ..... The case of the Revenue is that the arm's length price ('ALP') of the AMP expenses incurred by the Indian entity i.e the Assessee is required to be determined since it has been using, for marketing and promotion or otherwise the brand of its foreign AE and that the incurring of such AMP expenses, while enuring to the benefit of the Assessee, is also benefiting the brand of the foreign AE. The attempt by the revenue is to attribute some part of the AMP expenses incurred as having been incurred for the foreign AE for which the Assessee is to be compensated or reimbursed by the foreign AE. The ITAT's decision in LG Electronics 3. Before discussing the facts of the present case it requires to be noticed that the issue of making of TP adjustments to AMP expenses was considered by the Special Bench of the ITAT in a batch of cases. By a majority of 2:1, the Special Bench of the ITAT in LG Electronics India Pvt. Ltd. v. ACIT (2013) 140 ITD 41 (Del), inter alia decided: (i) A TP adjustment in relation to AMP expenses incurred by the Assessee for creating and improving the marketing intangibles for its foreign AE was permissible. (ii) Earning the mark up from the AE in respect of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... on Expenses (AMP Expenses' for short) 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. (ii)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? (iii) 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? (iv) If answer to question Nos.2 and 3 is in favour of the Revenue, whether the Income Tax Appellate Tribunal was right in holding that transfer pricing adjustment in respect of AMP Expenses should be computed by applying Cost Plus Method. (v) Whether the Income Tax Appellate Tribunal was right in directing that fresh bench marking/comparability analysis should be undertaken by the Transfer Pricing Officer by applying the parameters specified in paragraph 17.4 of the order dated 23.01.2013 passed by the Special Bench in the case of L ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... pass the functional analysis test and adjustments have been made, then the profit margin as declared when matches with the comparables would result in affirmation of the transfer price as the arm's length price. Then to make a comparison of a horizontal item without segregation would be impermissible. (viii) The Bright Line Test was judicial legislation. By validating the Bright Line Test the Special Bench in LG Electronics Case went beyond Chapter X of the Act. Even international tax jurisprudence and commentaries do not recognise BLT for bifurcation of routine and non-routine expenses. (ix) Segregation of aggregated transactions requires detailed scrutiny without which there shall be no segregation of a bundled transaction. Set off of transactions segregated as a single transaction is just and equitable and not prohibited by Section 92(3). Set-off is also recognized by international tax experts and commentaries. (x) Segregation of bundled transactions shall be done only if exceptions laid down in the EKL Appliances Case are justified. Re-categorisation and segregation of transactions are different exercises; former would require separate comparables and functional analysis. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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. Direct marketing and sale related expenses or discounts/concessions would not form part of the AMP expenses. (xvii) The prime lending rate cannot be the basis for computing mark-up under Rule 10B(1)(c) of the Rules, as the case set up by the Revenue pertains to mark-up on AMP expenses as an international transaction. Mark up as per sub-clause (ii) to Rule 10B(1)(c) would be comparable gross profit on 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. (xviii) The exceptions laid down in EKL Appliances Case were neither invoked in the present case nor were the conditions satisfied. (xix) An order of remand to the ITAT for de novo consideration would be appropriate because the legal standards or ratio accepted and applied by the ITAT was erroneous. On the basis of the legal ratio expounded in this decision, facts have to be ascertained and applied. If ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... that the Assessee had incurred "extremely high level" of AMP expenses, a reference was made by the Assessing Officer (AO) i.e., the Assistant Commissioner of Income Tax ('ACIT') to the TPO under Section 92CA (1) of the Act for determination of the ALP of the international transactions undertaken by WOIL. The documents prescribed under Rule 10D of the Income Tax Rules, 1962 ('Rules') and other details sought by the TPO were submitted by WOIL. The Assessee also submitted a transfer pricing study ('TP study') dated 24th September 2008 for the FY 2007-08. The order of the TPO 11. By an order dated 20th October 2011, the TPO determined that the extent of AMP expenditure incurred by the Assessee was to expand the reach of the AE's brand in India. The Assessee was, therefore, held to be creating "marketing intangibles" in favour of the AE. In particular a reference was made to the expenses incurred in the immediate three earlier AYs as well as the AYs in question in relation to the sales as under: AY 2008-09 AY 2007-08 AY 2006-07 AY 2005-06 Sales (Rs. in lakhs) 193,261 159,187 134,561 102,194 Advertisement Exp (Rs. in lakhs) 5,270 4,246 3,844 3,965 12 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 1,294,497,300. Since the brand building exercise also involved an amount of service, the TPO held that it called for a mark-up which was taken to equal to the prime lending rate of the State Bank of India which for the FY 2007-08 was 12.5%. This worked out to Rs. 161,812,162. However, considering the Assessee's proposition to reduce the ALP of the transactions related to the payment of technical and brand assistance fee to 'nil', that sum was increased as mark up that could have been charged as AMP expenses. As a result, the amount that the Assessee ought to have received from the AE for the AMP expenses was worked out at Rs. 1,294,497,300. Ultimately, the TPO determined the amount paid on the market intangibles at Rs. 1,807,310,769 being the difference between the actual AMP expense incurred and the ALP calculated at 0.87% of the sales. This sum was, therefore, directed to be added to the income of the Assessee. The orders of the AO 14. The AO drew a draft assessment order on 15th December 2011 on the basis of the above order of the TPO. The Assessee then took the matter before the Dispute Resolution Panel ('DRP') which by its order dated 28th September 2012, affirmed the order ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... r Sections 37 and 92 of the Act "it will result in double addition to the extent of the original amount incurred for the promotion of the brand of the foreign AE de hors the mark-up". It was, accordingly held that the AO was not justified in observing alternatively that a sum of Rs. 180 crores was not allowable under Section 37(1) of the Act. The matter was accordingly remitted to the AO/TPO for re-working the TP adjustment on account of the AMP expenses in the light of the decision of the Special Bench of the ITAT in LG Electronics (supra). Questions urged by the Revenue 19. In the appeal filed by the Revenue against the impugned order of the ITAT the following five questions have been urged for consideration: "(i) Whether the ITAT erred in directing the TPO to consider the combined effect of fourteen factors of determining the cost value of the international transaction which will make the whole process of comparability impractical and ineffective and not in accordance with Rule 1OB(3) of the Rules and other provisions of Chapter X of the Act? (ii) Whether the ITAT erred in directing the TPO to exclude the expenses incurred in connection with sales from AMP expenses by trea ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s and in the circumstances of the case, the ITAT erred in law in not quashing the adjustment made by the TPO using the "bright line test", without following any of the prescribed methods for determination of the ALP? (f) Whether on the facts and in the circumstances of the case, the ITAT erred in setting aside the order to the file of the assessing officer/ TPO for fresh benchmarking/ comparability analysis adopting only domestic comparable companies, not using foreign brand?" Questions framed for consideration 21. As far as the above questions projected by the Revenue are concerned, Questions (ii) and (iii) stand answered by the decision in Sony Ericsson (supra) in favour of the Assessee and against the Revenue. In that decision, this Court held that the expenses in connection with sales and marketing are to be excluded for the purposes of determination of AMP expenses. Question (i) also stands answered by that decision inasmuch as it has been held that fourteen factors specified in para 17.4 of the decision of the ITAT in LG Electronics are not binding on the Assessee or the Revenue. 22. According the following question is framed for consideration as far as the Revenue's app ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee was also a manufacturer of household products under the trademark 'Whirlpool'. (v) In order to benchmark an expense under Chapter X of the Act, having regard to the ALP, the sine quo non is that the expense should arise under an international transaction with a foreign AE. Chapter X does not envisage the benchmarking of transactions between the Indian entity and third parties in India where there is no income arising to an Indian enterprise from the foreign AE. (vi) The mere fact that the WOIL is a subsidiary of Whirlpool USA, does not mean that unilateral expense incurred on AMP by WOIL constitutes an international transaction involving WOIL and Whirlpool USA. The two are independent entities and the AMP expenses incurred by WOIL was wholly and exclusively for its own business. The benefit to Whirlpool USA was only incidental. On the strength of the decision of the Supreme Court in Sassoon J. David v. CIT (1979) 118 ITR 26, it was submitted that such expense incurred by WOIL wholly or exclusively for its business was allowable as such under Section 37 of the Act. (vii) Once the BLT has been discarded as a valid methodology either for deducing the existence of an inter ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s to neighbouring countries such as Nepal, Bangladesh, Sri Lanka, Maldives and African countries. The major sales of finished goods are to the AEs which constitutes an international transaction. Even in respect of such exports, the Assessee is undertaking marketing activities. It is submitted that the Assessee is not an independent manufacturer but is manufacturing "for the benefit of the group entities" and its status is akin to that of a contract manufacturer. Therefore the AMP activity is not for the sole benefit of the Assessee but for the group as a whole. 27. According to the Revenue, the TP report shows that the market risks with respect to the product including customer acceptance are borne by the Whirlpool Group. Therefore, it was "not open to urge that AMP functions of the appellant are solely for its own benefit". Considering the Assessee was paying brand fee @1% of the domestic and export sales to its AE and that the agreement leaves such crucial elements concerning the AMP for the development of the brand undefined, that mere fact "cannot lead to the inference that the activity of the Indian AE is unilateral or that it is entirely for its own benefit". 28. Analysing ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... orrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. (2) A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be a transaction entered into between two associated enterprises, if there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise." 32. Under Sections 92B to 92F, the pre-requisite for commencing the TP exercise is to show the existence of an international transaction. The next step is to determine the price of such transaction. The third step would be to determine the ALP by applying one of the five pri ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with the shared common objective and purpose of substantial acquisition of shares etc. of a certain target company. There can be no "persons acting in concert" unless there is a shared common objective or purpose between two or more persons of substantial acquisition of shares etc. of the target company. For, de hors the element of the shared common objective or purpose the idea of "person acting in concert" is as meaningless as criminal conspiracy without any agreement to commit a criminal offence. The idea of "persons acting in concert" is not about a fortuitous relationship coming into existence by accident or chance. The relationship can come into being only by design, by meeting of minds between two or more persons leading to the shared common objective or purpose of acquisition of substantial acquisition of shares etc. of the target company. It is another matter that the common objective or purpose may be in pursuance of an agreement or an understanding, formal or informal; the acquisition of shares etc. may be direct or indirect or the persons acting in concert may cooperate in actual acquisition of shares etc. or they may agree to cooperate in such acquisition. Nonetheless ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions" could be construed as a machinery provision. But then that provision refers to 'price' and to 'uncontrolled conditions'. It implicitly brings into play the BLT. In other words, it emphasises that where the price is something other than what would be paid or charged by one entity from another in uncontrolled situations then that would be the ALP. BLT as a determinative tool has been expressly invalidated by the Court in Sony Ericsson (supra).Therefore, it is not possible to view this as a machinery provision. The existence of an international transaction will have to be established de hors the BLT. There is nothing in the Act which indicates how, in the absence of the BLT, one can discern the existence of an international transaction as far as AMP expenditure is concerned. 41. Recently this Court has in its decision dated 11th December 2014 in ITA No. 110 of 2014 (Maruti Suzuki India Ltd. v. Commissioner of Income Tax) while interpreting the provisions of Chapter X of the Act observed: "the only TP adjustment authorised and permitted by Chapter X is the substitution of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s and merely because an expense was incurred wholly or exclusively for the Indian entity it would not mean that it is also not incurred for the foreign AE. The question then is to what extent the Indian entity should be compensated for the expenses incurred by it on behalf of the foreign AE. What will then be required to be benchmarked is not the AMP expenditure but the extent to which the Indian entity must be compensated. 44. Further in Maruti Suzuki India Ltd. (supra) this Court observed: "As an analogy, and for no other purpose, in the context of a domestic transaction involving two or more related parties, reference may be made to Section 40A (2) (a) under which certain types of expenditure incurred by way of payment to related parties is not deductible where the AO "is of the opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods." In such event, "so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction." The AO in such an instance deploys the 'best judgment' assessment as a device to disallow what he considers to be an excessive expenditure. The ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n of determining the ALP of such a transaction does not arise. In any event, in the absence of a machinery provision it would be hazardous for any TPO to proceed to determine the ALP of such a transaction since BLT has been negatived by this Court as a valid method of determining the existence of an international transaction and thereafter its ALP. 48. Question (i) in the Assessee's appeal viz., "Was there an international transaction between WOIL and its AE involving the AMP expenses within the meaning of Section 92B of the Act read with Section 92F(v) of the Act?" is answered in the negative, i.e., in favour of the Assessee and against the Revenue. Consequently Question (ii) in the Assessee's appeal is not required to be answered. Further, the only question framed in the Revenue's Appeal viz., "Whether the ITAT erred in deleting the addition of Rs. 180,73,10,769 made by the AO/TPO on account of AMP expenses under Section 37 of the Act?" is answered in the negative, i.e. in favour of the Assessee and against the Revenue. 49. The impugned order of the ITAT and the corresponding orders of the DRP and the TPO, on the above issues are hereby set aside. The appeal of the Asse ..... X X X X Extracts X X X X X X X X Extracts X X X X
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