TMI Blog2020 (1) TMI 82X X X X Extracts X X X X X X X X Extracts X X X X ..... be allowed as revenue expenditure. Accordingly, we direct the Assessing Officer to allow the expenditure of ₹ 24.13 crores. Expenditure booked under the head Advertising, Marketing and Promotion ( AMP ) - There is no provision either in the Act or in the Rules to justify the application of BLT for computing the arms length price and also in the absence of BLT, the existence of an international transaction vis - vis the AMP expenditure cannot exist. Further, we hold that there cannot be a quantification of adjustment for determining the AMP expenses incurred by the assessee after applying the BLT, to hold the same to be excessive and thereby an existence of international transaction between the assessee and its AE. We find no merit in exercise carrying of Assessing Officer/DRP/TPO in this regard and delete the Transfer pricing adjustment made on account of AMP expenditure. Accordingly, we delete the adjustment on account of transfer pricing analysis of AMP expenditure. Distribution segment - The RPM method identifies the price at which product purchased from the AE is resold to unrelated party; then in the case of resellers, who do not alter the tangible goods and se ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... Transfer pricing issues 2. That on the facts and in the circumstances of the case and in law, the order passed by the Ld. TPO under section 92CA of the Income Tax Act, 1961 ( the Act ) is bad in law and erroneous, which was relied upon by the Ld. AO and Hon ble DRP while passing the order under section 144C(1) of the Act. 3. That the Ld. AO/ Ld. TPO/ Hon ble DRP erred on facts and in law in not appreciating that the comparables selected by the Appellant in its transfer pricing documentation are functionally comparable with the distribution activity undertaken by the Appellant. 4. The Ld. AO/ Ld. TPO/ Hon ble DRP has erred in including Liva Healthcare Ltd. in the final comparable set as the said comparable fails the related party to sales filter of 25%. 5. The Ld. AO/ Ld. TPO/ Hon ble DRP erred in including certain non-operating expenses and excluding operating income for the purpose of computing the operating margin of the Appellant. 6. The Ld. AO/ Ld. TPO/ Hon ble DRP erred in considering the Transactional Net Margin Method ( TNMM ) as the most appropriate method and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... erpreted the provisions of section 92 of the Act while holding that expense incurred by the Appellant towards third parties constitute a transaction covered under the purview of Section 92 of the Act. 16. That the Ld. AO/ Ld. TPO/ Hon ble DRP erred on facts and in law in not appreciating that the AMP expenses unilaterally incurred by the Appellant are for the purpose of the business of the Appellant and have not been incurred to enure any benefit to the associated enterprise. 17. That the Ld. AO/ Ld. TPO/ Hon ble DRP erred on facts and in law in not appreciating that the AMP expenses are incurred by the Appellant at its own volition and for its own benefit and any benefit accruing to the associated enterprise is incidental for which no compensation is warranted. 18. That the Ld. AO/ Ld. TPO/ Hon ble DRP have disregarded the judicial pronouncements in India in undertaking the TP adjustment. Corporate tax issues 19. That the Ld. AO erred on facts and in law, in proposing to disallow depreciation amounting to ₹ 3,12,061 out of the total depreciation claimed by the Appellant on ac ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... and commenced its business operations in January, 2005. The assessee company operated within three therapeutic areas, namely critical care, metabolic and vaccines. The assessee had entered into various international transactions with its AEs. The TPO noted that the assessee was trading in pharmaceuticals and was also incurring heavy expenditure to promote its brand in the new market. He further observed that the expenditure incurred added economic value to the products. The contention of the assessee that it did not add any value to the product, was held to be not correct. The TPO analyzed the segment on net basis and observed that the assessee was incurring losses. He further observed that in case the subvention income was not considered as operating then the results were even worse. Show cause notice was issued to the assessee in this regard and it was pointed out that the analysis done by assessee at gross level was not reliable; even the comparables used by using multiple year data to benchmark the international transactions of trading in medicine and drugs, was not accepted by the TPO. The TPO also noted that the assessee had incurred significant advertisement ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... of income and should be excluded for computation of operating income of the assessee, as per para 5.28 at page 23 of the TPO s order. The OP over sales margin earned by the assessee were thus re-determined at minus 49.51%. The TPO thus proposed an upward adjustment of ₹ 96.38 Crores. The TPO further observed that even if subvention income was paid to compensate the losses of the assessee, then also there would be a shortfall of 19.27 Crores. The TPO thus proposed an enhancement of income by ₹ 19.27 Crores. 7. Coming to the issue of the AMP expenses and looking at the scope of AMP functions to be performed by the assessee, as understood by the assessee and its AE, the TPO noted that the assessee had incurred expenditure of ₹ 24.13 Crores on sales and marketing team and ₹ 57.84 Crores on marketing, development and promotion. The TPO was of the view that the marketing expenditure incurred by it was part of brand building expenses. He further applied the Bright Line Test and was of the view that the issue of marketing intangible falls squarely within the definition of transaction as per section 92F(v) of the Act. Further relying on the explanati ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 12 to 14 are also interconnected to the benchmarking of AMP expenses. The learned AR for the assessee further pointed out that ground no. 19 is against the corporate issue raised wherein the DRP had directed that depreciation be allowed at 60% whereas the AO in the final order allows the same at 15%. 9. Coming to the merits of the additions, the learned AR for the assessee pointed out that the first issue which needs to be adjudicated is whether AMP is an international transaction. It was pointed out by the learned AR for the assessee that the assessee was a distributor of specialized critical care drugs and in order to make the doctors prescribe the drug, the assessee had to make them aware of composition of the drug, so that the drugs could be sold in India. It was further pointed out that the expenditure on the sales and marketing team of ₹ 24.13 Crores, was expenditure on the personnel of the assessee, would not in any way promote the business of the AE; but these were the direct expenses of the assessee, incurred as regular distributor. Referring to para 6.2 onwards of the order of the TPO, it was pointed out that the Bright Line Test was applied and als ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... or not. He placed reliance on the decision of Sony Ericsson 374 ITR 118 (Del) wherein it is held to be international transaction and guidelines have been laid down. He further stressed that explanation (i)(a) of Section 92B of the Act was to be applied retrospectively. In this regard, reliance was placed on the order of the TPO. The learned DR for the Revenue pointed out that economic owner of the brand mark was the AE; when brand was ultimately promoted, which was owned by foreign company, then TPO correctly followed the statute to hold it to be international transaction. Where the assessee was ultimately promoting the brand of AE, adjustment had to be made in the hands of the assessee and expenditure could not be camouflaged as direct selling expenses. He further pointed out that in Sony Ericsson (supra) Bright Line Test has been negated but Bright Line Test was only a statistical tool to estimate the routine expenses incurred for building brand and the method to be applied was cost plus method. 11. We have heard the rival contentions and perused the record. The issue which needs to be adjudicated is whether the AMP expenditure i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... direct selling expenses of the assessee. The Hon ble High Court in Sony Ericsson (supra) had excluded similar expenditure out of the umbrella of AMP expenditure. The assessee has also booked this expenditure separately and the Assessing Officer had aggregated the same with Marketing, Advertisement and Promotion (in short MAP ) expenses and benchmarked the same, treating it to be an international transaction. We find no merit in the order of Assessing Officer/DRP/TPO in this regard and hold that the expenditure booked under the head sales and marketing team totaling to ₹ 24.13 crores, which was incurred by the assessee for spreading awareness of the products dealt in by the assessee, amongst doctors and others as part of direct selling expenditure and was incurred for the business needs of the assessee and is to be allowed as revenue expenditure. Accordingly, we direct the Assessing Officer to allow the expenditure of ₹ 24.13 crores. 13. Now, coming to the 2nd set of expenditure of ₹ 57.84 crores booked under the head Advertising, Marketing and Promotion (in short AMP ). The assessee claims that since it was dealing with only spe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... O could determine the Arm's Length Price on rationale basis by identifying the comparable cases. 16. The Hon ble Delhi High Court in Sony Ericsson and bunch of appeals (supra) considered the decision of the Special Bench of Tribunal in L.G. Electronics (supra) at length and following questions were formulated by the Division Bench:- (i) Whether the additions suggested by the Transfer Pricing Officer on account of Advertising/Marketing and Promotion 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? ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 factored in the net profit of the inter-linked transaction. The TNMM proceeded on the assumption that functions, assets and risks being broadly similar and once suitable adjustments have been made, all things get taken into account and stand reconciled when computing the net profit margin. Once the comparables 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. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 trade discounts, volume discounts, etc. offered to sub-distributors or retailers are not in the nature and character of brand promotion. They are not directly or immediately related to brand building exercise, but have a live link and direct connect with marketing and increased volume of sales or turnover. The brand building connect 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 ma ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e Hon ble High Court was disallowance uncontested that the control transaction can be made subject matter of transfer pricing adjustment in terms of Chapter X of Income Tax Act. All these facts were noted by the Hon ble Delhi High Court in a later decision in Maruti Suzuki (supra) and it was also further noted that the concern Maruti Suzuki was a manufacturer concern. The Hon ble High Court in Maruti Suzuki (supra) first addressed the preliminary issue on account of decision of Sony Ericsson (supra) that it would be open to Maruti Suzuki (supra) to question the existence of international transaction involving it and its AE. The contention of the Special Counsel for the Revenue in Maruti Suzuki (supra) was that as far as the decision of Sony Ericsson (supra) was concerned, it did not distinguish the case of the manufacturer from those of the distributors accept observing that Transactional Net Margin Method may not be an appropriate method in the case of the assessee, which were performing complex function like manufacturing or making substantial value addition to the material imported from the AE. 19. The Hon ble High Court in Maruti Suzuki (supra) then addressed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ew of the Court the Revenue has failed to demonstrate the existence of an international transaction only on account of the quantum of AMP expenditure by MSIL. Secondly, the Court is of the view that the decision in Sony Ericsson holding that there is an international transaction as a result of the AMP expenses cannot be held to have answered the issue as far as the present Assessee MSIL is concerned since finding in Sony Ericsson to the above effect is in the context of those Assessees whose cases have been disposed of by that judgment and who did not dispute the existence of an international transaction regarding AMP expenses. 21. The next issue which was taken up by the Hon ble High Court was as under and it was held as under:- Is there an international transaction concerning AMP expenses? 57. The Court next turns to the principal contention of the Revenue that in a particular situation of independent distributors/licensed manufacturers matters relating to promotion of a brand of a foreign AE would necessarily be a matter of negotiation between the parties and not necessarily be reduced to writing as part of an agreement be ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... are described as 'international transaction'. This might be only an illustrative list, but significantly it does not list AMP spending as one such transaction. 61. The submission of the Revenue in this regard is: The mere fact that the service or benefit has been provided by one party to the other would by itself constitute a transaction irrespective of whether the consideration for the same has been paid or remains payable or there is a mutual agreement to not charge any compensation for the service or benefit. Even if the word 'transaction' is given its widest connotation, and need not involve any transfer of money or a written agreement as suggested by the Revenue, and even if resort is had to Section 92F (v) which defines 'transaction' to include 'arrangement', 'understanding' or 'action in concert', 'whether formal or in writing', it is still incumbent on the Revenue to show the existence of an 'understanding' or an 'arrangement' or 'action in concert' between MSIL and SMC as regards AMP spend for brand promotion. In other words, for both the means part and the includes pa ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 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 a substitution of the transaction price with the ALP. 23. The Hon ble High Court then concluded by holding that the very existence of an international transaction cannot be presumed by assigning some price and then deducing that since it is not an ALP, an adjustment has to be made. The burden is on the Revenue to first ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... eeded to promote its products. The argument of the Revenue, however, is that while such AMP expense may be wholly and exclusively for the benefit of the Indian entity, it also enures to building the brand of the foreign AE for which the foreign AE is obliged to compensate the Indian entity. The burden of the Revenue's song is this: an Indian entity, whose AMP expense is extraordinary (or 'non-routine') ought to be compensated by the foreign AE to whose benefit also such expense enures. The 'nonroutine' AMP spend is taken to have 'subsumed' the portion constituting the 'compensation' owed to the Indian entity by the foreign AE. In such a scenario what will be required to be benchmarked is not the AMP expense itself but to what extent the Indian entity must be compensated. That is not within the realm of the provisions of Chapter X. 25. This proposition laid down by the Hon ble High Court in Maruti Suzuki (supra) was applied in later decisions. 26. The Hon ble High Court in Whirlpool of India Ltd. (supra) held that in the absence of any clauses in the agreement between the parties, where it is not discernible in ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the law . 28. The said proposition has been applied by the different Benches of the Tribunal in deciding the issue of the benchmarking of AMP expenses. The proposition laid down by the Hon ble High Court in various decisions including Maruti Suzuki (supra) and Whirlpool of India Ltd. (supra) have been applied that for an international transaction to exist within the meaning of section 92B of the Act, the onus was on the Revenue to show that there existed agreement, understanding or arrangement, that Indian entity would incur AMP expenditure for the assessee or on behalf of its AE, who owned the brand; in the absence of any such action in concert, there cannot be any presumption of arrangement and it cannot be held that incurring of AMP expenditure was in the realm of an international transaction. The incurring of any expenditure on AMP in order to boost its sales and to bring awareness of its products and where the expenditure was not incurred at the instance or behest of the AE and also where there is no arrangement or agreement or allocation or contribution by the AE towards reimbursement or any part of the AMP expenditure, then it cannot be sai ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... umption of jurisdiction u/s 92 of the Act, the condition precedent is that an international transaction has to exist in the first place. The TPO is not permitted to embark upon the bench marking analysis of allocating AMP expenses as attributed to the AE without there being an 'agreement' or 'arrangement' for incurring such AMP expenses. 39. The aforesaid view that existence of an international transaction is a sine qua non for invoking the transfer pricing provisions contained in Chapter X of the Act, can be further supported by analysis of section 92(1) of the Act, which seeks to benchmark income / expenditure arising from an international transaction, having regard to the arm's length price. The income / expenditure must arise qua an international transaction, meaning thereby that the (i) income has accrued to the Indian tax payer under an international transaction entered into with an associated enterprise; or (ii) expenditure payable by the Indian enterprise has accrued / arisen under an international transaction with the foreign AE. The scheme of Chapter X of the Act is not to benchmark transactions between the Indian enterprise and unre ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... lication of BLT for computing the arms length price and also in the absence of BLT, the existence of an international transaction vis - vis the AMP expenditure cannot exist. Further, we hold that there cannot be a quantification of adjustment for determining the AMP expenses incurred by the assessee after applying the BLT, to hold the same to be excessive and thereby an existence of international transaction between the assessee and its AE. We find no merit in exercise carrying of Assessing Officer/DRP/TPO in this regard and delete the Transfer pricing adjustment made on account of AMP expenditure. Accordingly, we delete the adjustment on account of transfer pricing analysis of AMP expenditure. 34. Now coming to the next issue raised, which is with regard to distribution segment. The Ld.AR for the assessee before us has pressed Ground of appeal No. 6 and pointed out that other transfer pricing issues would become academic in nature except Ground of appeal No.7 on the issue of subvention income whether operating revenue or not, if decided in favour of the assessee. So, we proceed to look at the said ground of appeal. The assessee is aggrieved by the orders of the au ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... e AE is resold to unrelated party; then in the case of resellers, who do not alter the tangible goods and services or use any intangible assets to add substantial value to the property or services i.e. resale is made without any value addition, then in such facts and circumstances, RPM method is to be applied as method to benchmark the international transaction undertaken. We hold so and allow the ground raised by the assessee on this issue. The Assessing Officer is directed to apply the RPM method in order to benchmark the international transaction undertaken by the assessee in the distribution segment, after allowing reasonable opportunity of hearing to the assessee. We only adjudicating Ground No.6 and all other grounds raised by the assessee in this regard, are not adjudicated, on the ground that the assessee itself had pleaded that the balance grounds of appeal would become academic in case Ground No.6 and the issue on AMP expenses is allowed in the case of the assessee. 37. Now, coming to the last issue which is raised regarding subvention income received by its AE. While computing the operation margin of the assessee, the Assessing Officer noted that the ass ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... be payable as per the groups normal inter company payment procedures . The Ld.AR for the assessee referred to page 60 65 of the Paper Book to point out that subvention income received by the assessee has been offered as other income and has been brought to tax. This aspect is not disturbed by the authorities below as the TPO had not disturbed the benchmarking of distribution segment. The assessee further points out that the subvention payment was inextricably linked to the distribution activity carried on by the assessee. In the initial years, the assessee had incurred losses as these were its initial years of operations. So to reimburse part of the operating expenses, the AE made subvention payments to the assessee which may be considered as operating receipt of the assessee. 40. We find that similar issue arose before the Pune Bench of the Tribunal in Nalco Water India Ltd. vs ACIT in ITA No.742/Pun/2017, relating to Assessment Year 2012-13 order dated 06.09.2019 wherein intention to pay subvention amount was for limited period so as to ensure that the assessee therein did not become sick company. The assessee therein had also offered the said subsidy as taxabl ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ed to by the Assessing Officer / TPO / DRP, the amount received by assessee from its parent company Nalco, USA was a capital receipt in the hands of assessee and hence, was not taxable in its hands. 17. Coming to the next aspect of treatment of said amount while determining the PLI of assessee, the assessee claims that the amount is to be taken as operating income since the said receipt was to make good losses incurred by assessee in earlier years and also current year. The assessee has time and again stressed that taxability of receipt under the Income Tax Act cannot affect the calculation of operating margins of assessee, as the amount which had been received was during the course of its business i.e. preventing the assessee from going into losses, hence the recomputation of PLI in the hands of assessee. 18. The first question which arises is whether the capital receipt in the hands of assessee can be held to be operating in nature. While deciding the said aspect as to whether Nalco, USA had granted the assessee a onetime promotional allowance in order to save it from becoming sick, this aspect is to be seen from the fact t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... t received by the assessee before us is operating in nature and the same has to be included as operating income, while computing PLI in the hands of the assessee. The assessee in the present appeal has not raised any issue about its taxability and hence, the said status is not disturbed. This Ground of appeal No.7 is allowed. 42. The Ground of appeal Nos. 1 2 raised by the assessee being general in nature, do not require any adjudication. Out of Ground Nos. 3 to 7 regarding distribution activity, Ground Nos. 6 7 of the assessee stand allowed and the rest are academic in nature. Coming to the remaining ground of appeal which are with regard to the transfer pricing adjustment, the same are allowed. 43. Now, coming to the last corporate issue raised vide Ground No.19 which is against the depreciation claimed on UPS, computer cables wiring etc. The limited issue which is raised before us is though the DRP directed to Assessing Officer to allow depreciation @ 16% but the same has still been allowed at 15%. We direct the Assessing Officer to allow depreciation @ 16%. 44. The additional ground of appeal raised by the assessee agains ..... 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