TMI Blog2015 (12) TMI 1188X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 ₹ 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. - ITA 610/2014, ITA 228/2015 & CM No.5751/2015 - - - Dated:- 22-12-2015 - S. Muralidhar And Vibhu Bakhru, JJ. For the Appellant : Mr. G. C. Srivastava and Mr. D. S. Bhardwaj Advocates For the Respondent : Mr Ajay Vohra, Senior Advocate with Ms. Kavita Jha, Mr. Neeraj Jain and Mr Aditya Vohra, Advocates JUDGMENT Dr. S. Muralidhar, J. 1. These two appeals, one by the Revenue and the other by the Assessee, under Section 260 A of the Income Tax Act 1961 ('Act') are directed against the common order dated 13th January 2014 passed by the Income Tax Appellate Tribunal ( ITAT ) in ITA No. 426/Del/2013 for the Assessment Year ( AY ) 2008-09. The issue 2. These appeals concern the issue of ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Special Bench of the ITAT in LG Electronics (supra) was considered by this Court in Sony Ericsson Mobile Communications India P. Ltd. v. Commissioner of Income Tax (2015) 374 ITR 118 (Del). This Court heard a batch of appeals in the aforementioned decision and disposed of in particular the appeals concerning the Indian entities who were distributers of products manufactured by their respective foreign AEs including Sony Ericsson Mobile Communications India Pvt. Ltd, Discovery Communications India, Daikin Air-conditioning (India) Pvt. Ltd., Reebok India Company and Canon India Pvt. Ltd. The Court explained the features particular to three of the said Assessees i.e Sony Mobile Communications India Pvt. Ltd., Reebok India Company and Canon India Pvt. Ltd. In the case of Sony Mobile Communications India Pvt. Ltd., TNMM had been followed. In respect of Reebok India, the TNMM had been followed for the sourcing of goods and exports from India, the CUP method had been followed in respect of the royalty paid by the Indian entity to the foreign AE and for import of apparels and footwear for re-sale, the re-sale price ( RP ) method had been followed. In the case of Cannon India, the RP m ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... with ALP adjustment whereas Section 40A(2)(b) dealt with the reasonability of quantum of expenditure. (v) TNMM applied with equal force on single transaction as well as multiple transactions as per the scheme of Chapter X and the TP Rules. Thus, the word transaction would include a series of closely linked transactions. (vi) The TPO/AO could overrule the method adopted by the Assessee for determining the ALP and select the most appropriate method. The reasons for selecting or adopting a particular method would depend upon functional analysis comparison, which required availability of data of comparables performing of similar or suitable functional tasks in a comparable business. When suitable comparables relating to a particular method were not available and functional analysis or adjustment was not possible, it would be advisable to adopt and apply another method. (vii) Once the AO /TPO accepted and adopted the TNMM, but chooses to treat a particular expenditure like AMP as a separate international transaction without bifurcation/segregation, it would lead to unusual and incongruous results as AMP expenses was the cost or expense and was not diverse. It was facto ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... uct differences in comparison to the CUP Method because minor product differences are less likely to have material effect on the profit margins as they do on the price. (xiv) Determination of cost or expense can cause difficulties in applying cost plus (CP) Method. Careful consideration should be given to 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 would not make any difference whether the same are routine or non-routine, once functional comparability with or without adjustment is accepted. (xv) The 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 transaction is bifurcated and segregated. CP Method, when applied to the segregated transaction, must pass the criteria of most appropriate method. If and when such determination of gross profit with reference to AMP transaction is required, it must be undertaken in a fair, objective and reasonable manner. (xvi) The marketing or selling expenses like ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cerned the Assessee, Whirlpool of India Ltd ( WOIL ), is a subsidiary of Whirlpool Corporation, USA ( Whirlpool USA') and is engaged in production, sales and distribution of whirlpool appliances. The company s product portfolio includes washing machines, refrigerators, microwave ovens and air conditioners. There was a technical assistance and transfer agreement entered into between WOIL and Whirlpool USA on 12thMay 2005/13th December 2005 and a trade mark and trade name licence agreement ( TLA ) on 1st April 2005/13th December 2005. WOIL has been allowed to use the trademarks owned by the AE i.e. Whirlpool USA. WOIL pays brand assistance fees/royalty to the AE for grant of licences to use trademarks belonging to it. These transactions have been benchmarked separately. 9. During the financial year ( FY ) 2007-08, the international transactions entered into by WOIL were as follows:- Name of International transaction Method selected Value of international transaction (INR) Sale of finished goods TNMM 1,263,245,853 Sale of spares 30,117,767 ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ade name (which was a very strong name in the global consumer durables industry) and that the AMP expenses incurred by it was for furthering its own business and commercial interests . It further contended that all the marketing related decisions were taken by WOIL and not by Whirlpool USA. However, the TPO concluded that the increased sales would come up only when you are able to so position your brand in the market that it will have such powerful recall value that the customer will choose it over your competitors. This is the benefit that is accruing to the brand which is the end result of the increased level of AMP expenses incurred by you . Further, since admittedly it had required concerted effort on the part of the WOIL to ensure proper brand recognition in the Indian Market, the TPO concluded that it is your company that has established the 'Whirlpool' brand in the Indian market. The TPO proceeded to split up the AMP expenses at ₹ 52.7 crores towards advertisement and ₹ 1,433,626,136 towards discounts and incentives which aggregated to the total of ₹ 1,960,626,136. When compared to the total sales, the ratio of AMP sales worked out to 11.12%. T ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... RP is concerned, it decided that there should be a mark-up for the services rendered by the Assessee to an extent of 12.5%. As a result, the TPO again passed an order dated 10th October 2012 by re-computing the ALP with the mark-up of 12.5% proposing an adjustment of ₹ 2,033,224,615 under Section 92CA of the Act. 15. On the basis of the above orders, the AO passed the final order on 23rd November 2012 under Section 143 read with Section 144C of the Act, making the above TP adjustment to the AMP under Section 92CA of the Act. Impugned order of the ITAT 16. Aggrieved by the above order, WOIL filed ITA No. 426/2013 before the ITAT. In the impugned order dated 13th January 2014, the ITAT followed its judgment in LG Electronics (supra). The ITAT noted that there is a general proposition that if an expenditure is deductible under Section 37(1) of the Act as having been incurred wholly and exclusively for the business purpose, the same has to be allowed in entirety notwithstanding the fact that some third party (being the foreign AE in the present case) also got some advantage by such expenditure. 17. However, the ITAT pointed out that this proposition underwent a chan ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s expenses not adding to the value of marketing intangible legally owned by the AE by drawing analogy from Section 37 (3A) once present in the Act without giving any reasons for the same? (iii) Whether the ITAT erred in directing the TPO/AO to exclude the expenses incurred in connection with sales from AMP expenses when similar expenses have not been excluded by the TPO from the AMP expenses of comparables for the reasons that such expenses lead to benefit to the AE? (iv) Whether the ITAT erred in deleting the addition of ₹ 1,80,73,10,769/- made by AO/TPO on account of advertising and marketing promotion under Section 37 of the Act? (v) Whether the ITAT erred in directing the AO/TPO that no addition is called for i.e. amount of ₹ 1,80,73,10,769 under section 37 of the Act? Questions urged in the Assessee's appeal 20. As far as the Assessee is concerned, it also filed an appeal ITA No. 228 of 2015. The Assessee urged the following questions: (a) Whether on the facts and in the circumstances of the case, the ITAT erred in law in upholding, in principle, transfer pricing adjustment made by the assessing officer/TPO in respect of expenditure ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eration as far as the Revenue s appeal is concerned: Whether the ITAT erred in deleting the addition of ₹ 180,73,10,769 made by the AO/TPO on account of AMP expenses under Section 37 of the Act? 23. Turning to the Assessee s appeal, question (e) does not survive after the decision of this Court in Sony Ericsson, since it specifically overruled the decision of the majority of the Special Bench of the ITAT in L.G Electronics and held that the BLT could not be adopted for determining the ALP of an international transaction involving the AMP expenses. 24. The following questions are framed for consideration in the Assessee s appeal: (i) 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? (ii) If the answer to the above question is in affirmative, was the ITAT justified in remanding the matter to the AO/TPO for segregating the AMP expenses incurred into the extent attributable to promote the brand of the AE, and that that was wholly and exclusively for the business purposes of the Assessee, allowable under Section 37 of the Act? Submission ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... scarded as a valid methodology either for deducing the existence of an international transaction or for determining ALP, there has to be some other recognized method for first determining the international transaction involving AMP expense and thereafter ascertaining ALP for such transaction. The re-characterisation of a transaction is not permissible, as explained by this Court in CIT v. EKL Appliances Ltd. [2012] 345 ITR 241 (Del). A reference was made to the decision of this Court in Sony Ericsson (supra) which states that Internally generated goodwill or brand is not treated as an asset in AS-26 because it is not an identifiable resource controlled by an enterprise, which can be reliably measured at cost. Its value can change due to a range of factors. (viii) It was acknowledged in Sony Ericsson (supra) that even if marketing intangible is created as a consequence of non-routine AMP expenses incurred by the Indian entity, the economic ownership of such intangibles vested in the Indian entity, which could exploit the same for furthering its business interest. It cannot, therefore, be said that the marketing intangibles created by the WOIL was transferred to the AE only be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Indian AE is unilateral or that it is entirely for its own benefit . 28. Analysing the trademark and trade name license agreement ( TLA ) Mr. Srivastava submits that clause 3.2 thereof indicates that the Assessee has no rights in the trade name and that the manner of the use of the trademark has to be approved by Whirlpool USA; Clauses 6.1, 6.2 and 6.3 indicate that the contents of the advertisements for brand promotion also needs to be approved. It was seen that during the FY in consideration, the Assessee had received a grant of ₹ 1.66 crores from its AE. In the earlier year, it received ₹ 4.22 crores. The nature of this grant had not been specified and this was also not shown as an international transaction in the TP report. This according to him was a clear indication that the Assessee was getting certain amount of contribution from its AE towards the expenses incurred . This showed that the AE was sharing some part of the cost and it would be a matter to be examined whether such contribution is at arm s length . 29. Mr. Srivastava submits that Clause 19.2 of the TLA indicates that the AE s primary objective in entering into this agreement was furthe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... determine the price of such transaction. The third step would be to determine the ALP by applying one of the five price discovery methods specified in Section 92C. The fourth step would be to compare the price of the transaction that is shown to exist with that of the ALP and make the TP adjustment by substituting the ALP for the contract price. 33. A reading of the heading of Chapter X [ Special provisions relating to Avoidance of Tax ] and Section 92 (1) which states that any income arising from an international transaction shall be computed having regard to the ALP, Section 92C (1) which sets out the different methods of determining the ALP, makes it clear that the transfer pricing adjustment is made by substituting the ALP for the price of the transaction. To begin with there has to be an international transaction with a certain disclosed price. The TP adjustment envisages the substitution of the price of such international transaction with the ALP. 34. The TP adjustment is not expected to be made by deducing from the difference between the 'excessive' AMP expenditure incurred by the Assessee and the AMP expenditure of a comparable entity that an international t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ng in concert may cooperate in actual acquisition of shares etc. or they may agree to cooperate in such acquisition. Nonetheless, the element of the shared common objective or purpose is the sine qua non for the relationship of persons acting in concert to come into being. 37. The provisions under Chapter X do envisage a separate entity concept . In other words, there cannot be a presumption that in the present case since WOIL is a subsidiary of Whirlpool USA, all the activities of WOIL are in fact dictated by Whirlpool USA. Merely because Whirlpool USA has a financial interest, it cannot be presumed that AMP expense incurred by the WOIL are at the instance or on behalf of Whirlpool USA. There is merit in the contention of the Assessee that the initial onus is on the Revenue to demonstrate through some tangible material that the two parties acted in concert and further that there was an agreement to enter into an international transaction concerning AMP expenses. Absence of an international transaction involving AMP expense 38. The clauses of the TLA which had been referred to in extenso by Mr. Srivastava go to show that Whirlpool USA was protective of its brand. Howe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing the provisions of Chapter X of the Act observed: the only TP adjustment authorised and permitted by Chapter X is the substitution of the ALP for the transaction price or the contract price. It bears repetition that each of the methods specified in S.92C (1) is a price discovery method. S.92C (1) thus is explicit that the only manner of effecting a TP adjustment is to substitute the transaction price with the ALP so determined. The second proviso to Section 92C (2) provides a 'gateway' by stipulating that if the variation between the ALP and the transaction price does not exceed the specified percentage, no TP adjustment can at all be made. Both Section 92CA, which provides for making a reference to the TPO for computation of the ALP and the manner of the determination of the ALP by the TPO, and Section 92CB which provides for the safe harbour rules for determination of the ALP, can be applied only if the TP adjustment involves substitution of the transaction price with the ALP. Rules 10B, 10C and the new Rule 10AB only deal with the determination of the ALP. Thus for the purposes of Chapter X of the Act, what is envisaged is not a quantitative adjustment but only ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n. The AO in such an instance deploys the 'best judgment' assessment as a device to disallow what he considers to be an excessive expenditure. There is no corresponding 'machinery' provision in Chapter X which enables an AO to determine what should be the fair 'compensation' an Indian entity would be entitled to if it is found that there is an international transaction in that regard. In practical terms, absent a clear statutory guidance, this may encounter further difficulties. The strength of a brand, which could be product specific, may be impacted by numerous other imponderables not limited to the nature of the industry, the geographical peculiarities, economic trends both international and domestic, the consumption patterns, market behaviour and so on. A simplistic approach using one of the modes similar to the ones contemplated by Section 92C may not only be legally impermissible but will lend itself to arbitrariness. What is then needed is a clear statutory scheme encapsulating the legislative policy and mandate which provides the necessary checks against arbitrariness while at the same time addressing the apprehension of tax avoidance. 45. The ..... X X X X Extracts X X X X X X X X Extracts X X X X
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