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TMI Blog2024 (6) TMI 1466X X X X Extracts X X X X X X X X Extracts X X X X ..... ng that the above expenditure is capital in nature and accordingly not allowable under section 37 of the Act, ignoring the fact that said expense has been incurred wholly and exclusively for the purpose of the business of the Appellant; Deduction in respect of education cess and secondary higher education cess under section 37(1) of the Act 4. Based on facts and the circumstances of the case and in law, the Appellant prays that education cess and secondary higher education cess on income tax for the year under consideration ought to be allowed as a deduction under section 37(1) of the Act while computing the total income. PART II - TRANSFER PRICING ("TP") GROUNDS: General Ground: erred in law and on facts, in making Transfer Pricing adjustment of INR 6,19,06,837 pertaining to purchase of raw materials and sale of finished goods to AE under Manufacturing segment and Transfer Pricing adjustment of INR 35,67,86,587 towards selling, marketing and distribution expense incurred by the Appellant; Rejection of TP study of the Appellant 5. erred in rejecting the economic analysis undertaken by the Appellant in accordance with the provisions of the Act read with the Rules and t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... d disregarding that the said companies is not passing the e RPT filter and should be rejected: * Wockhardt Ltd * Strides Pharma Science Ltd 13. erred in accepting the following companies as comparables though the same is not functionally comparable to the Appellant's business; * Natural Remedies Pvt Ltd * JB Chemicals & Pharmaceuticals Ltd * Ipca Laboratories Ltd. * Alkem Laboratories Ltd. * Cipla Ltd. * Centaur Pharmaceuticals Pvt. Ltd. * Shilpa Medicare Ltd. * Natco Pharma Ltd. * Divi'S Laboratories Ltd. 14. without prejudice to above, DRP erred in upholding the TPO's action of considering the selling, marketing and distribution expense incurred by the Appellant, towards value added function under Advertising, Marketing and Promotion ("AMP") activity and not excluding the corresponding expense while computing the Operating Cost ("OC") of manufacturing segment and thereby computing incorrect operating margin of the Appellant. 15. without prejudice to above, erred in not restricting the transfer pricing adjustment to the value of international transaction; 16. without prejudice to above, erred in not making suitable adjustments to account for diffe ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... for the purpose of determining excess AMP expenditure incurred by the Appellant; 25. without prejudice to the above, erred in considering 'Other method' as the Most Appropriate Method ("MAM") and identified companies engaged in advertisement/ marketing support services as comparable to determine the ALP for comparability purpose; 26. Without prejudice to the above, erred by not appreciating that even if the incurrence of excess AMP expenditure is considered as cost, the net margin of the Appellant computed based on TNMM is higher than the net margin earned by comparable companies and meaning thereby that Appellant has already been adequately remunerated/ compensated for AMP as well. 27. erred in levying a mark up of 12.98% on excessive selling, marketing and distribution expense incurred by the Appellant for alleged mark up on account of AMP expenditure thereby making a TP adjustment of INR 9,33,81,824 28. without prejudice to the above, erred in accepting the following companies as comparables though the same is not functionally comparable to the companies rendering marketing services: * Ugam Solutions Pvt Ltd. * Majestic Research Services & Solutions Ltd. * Killick ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... etween assessee and CBDT vide dated 16.6.2023 for the period from AY 2016-17 to AY 2020-21, wherein the issue in dispute in these grounds has been settled. Hence, these grounds are not pressed by assessee before us. Accordingly, dismissed as not pressed. 6. Ground Nos.2 to 3 are with regard to allowability of E-SOP expenses. 6.1 Facts of the issue are that the assessee company had debited a sum of Rs. 40,88,471/- towards employee stock Compensation Plan. The ld. AO had pressed to disallow the assessee's claim of expenses at Rs. 44,88,471/- in the draft assessment order. The ld. AO observed that E-SOP expenses claimed are capital in nature and hence they are not liable as expenses. The assessee contended that expenses are in revenue nature as it is part of salary/employee cost which was incurred in relation to employees of the assessee and they are paid as incentive with a view to motivate and encourage the employees. Restricted Stock Units (RSU) were issued at discounted premium to the employees under the incentive plan to compensate the employees for the continuity of their services and the company had stated that it neither raised any share capital under the incentive plan nor ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... nature of capital expenditure and the same needs to be allowed as revenue expenditure. Further, he submitted that the Special Bench has held that discount on issue of ESOP are to be allowed during the period of vesting. The relevant extract of the judgment has been provided below for our reference: "9.2.6 It is quite basic that the object of issuing shares can never be lost sight of. Having seen the rationale and modus operandi of the ESOP, it becomes out-and-out clear that when a company undertakes to issue shares to its employees at a discounted premium on a future date, the primary object of this exercise is not to raise share capital, but to earn profit by securing the consistent and concentrated efforts of its dedicated employees during the vesting period. Such discount is construed, both by the employees and company, as nothing but a part of package of remuneration. In other words, such discounted premium on shares is a substitute to giving direct incentive in cash for availing the services of the employees. There is no difference in two situations viz., one, when the company issues shares to public at market price and a part of the premium is given to the employees in lieu ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... apital but to earn profits by securing consistent services of the employees and therefore, the same cannot be construed as short receipt of capital. The tribunal therefore, in paragraph 9.2/7 and 9.2.8 has rightly held that incurring of the expenditure by the assessee entitles him for deduction under Section 37(1) of the Act subject to fulfillment of the condition." 7.4 Further, he submitted that the Hon'ble Bangalore Tribunal in the case of Kotak Mahindra Bank Ld. (ITA No. 934/Bang/2014) dated 5 August 2021 has followed the aforesaid Karnataka High Court decision and has allowed the deduction of ESOP expenses. 7.5 He submitted that in the case of Biocon Ltd (supra) shares of Biocon itself were issued to its employees, similar to the fact of the Assessee, shares of holding company were issued to the employees of the subsidiary and Bangalore Tribunal in the case of Novo Nordisk India Pvt. Ltd., Vs. DCIT (ITA No. 1275/Bang/2011), relying on the decision of jurisdictional co-ordinate Special Bench in case of Biocon Ltd (supra), held that the difference in the fair market value of shares of the parent company and price at which shares are issued to the employees of India subsidiary i ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... supra) and has held that expenditure claimed by the Company is not a capital expenditure and the same needs to be allowed as revenue expenditure. The relevant extract of the judgment has been provided below for our reference: "The facts in the present case and in the case of Novo Nordisk India Pvt. Ltd. Vs. DCIT (supra) are similar because in the case of Novo Nordisk India Pvt. Ltd. Vs. DCIT (supra) also, employees of its foreign affiliates of Novo Nordisk A/S, Denmark ("NNAS") were entitled to purchase shares of NNAS at a price less than the market price. In that case also, the difference between the fair market value of the shares of the parent company on the date of issue of shares and the price at which these shares were issued by assessee to its employees was reimbursed by the assessee to its parent company and this sum reimbursed was claimed as expenditure in the profit and loss account of the assessee company as employees cost. Hence there is no difference in facts. Hence, we find no reason for not following these two binding Tribunal orders rendered in the case of Novo Nordisk India Pvt. Ltd. vs. DCIT (supra) and Biocon Limited vs. DCIT (supra). Respectfully following the ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ut of its capital and hence, there is no change in the fixed capital of the assessee. In view this, it is allowable expenditure. However, we note that when assessee claims it as an expenditure as it is relating to the employees welfare, the assessee should have deducted the TDS subject to this claim of assessee is liable u/s 37 of the Act as held by Special Bench in para 11 to 11.5 of the order and confirmed by the Hon'ble Karnataka High Court in the case of Biocon Ltd. Accordingly, the issue is remitted to the file of ld. AO to verify whether there was due deduction of TDS on the expenditure debited to the P&L account towards ESoP in the assessment year under consideration and decide it afresh in the light of above judgement of jurisdictional High Court. Ordered accordingly. 10. Next ground Nos.17 to 28 for our consideration are with regard to AMP expenditure towards selling/marketing, distribution expenses incurred by the assessee. 11. The ld. A.R. submitted that the Ld. TPO considered the AMP expenses of INR 71,94,28,537 incurred by the Assessee during FY 2015-16 towards value added functions under the AMP activities. The Ld. TPO undertook a separate comparability analysis for ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... sessee submitted that Section 92B of the Act defines "international transaction" as under: "(1) For the purpose of this section and sections 92, 92C, 92D and 92E, "international transaction " means a transaction between two or more associated enterprises, either both of whom are non-residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing 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 appointment 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 or more of such enterprises. (2) A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purpose of sub-section (1), be [deemed to be an international 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 a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... such transaction. Therefore, the Assessee submitted that every expenditure forming part of the function cannot be construed as a "transaction". 11.7 He submitted that the AMP expenses incurred by the Assessee are only for increasing the sales of the Assessee in India and thus the Assessee do not enhance the brand of the AE in India warranting any additional compensation. Such AMP expenses are routine in nature and are incurred by the Assessee in the ordinary course of business. He drew reference to the Formulation, Packaging and Distribution ("FPD") agreement dated 20 June 2005, entered between the Assessee and the AE wherein Assessee is a Distributor. A copy of the said agreement has also been submitted as Annexure 2 with the TPO in the response to show cause notice issued by the TPO dated 11 October 2019. The relevant extracts of the said agreement are reproduced as under for our reference: "6. Distributor's resale obligations 6.1. The distributor shall use its best endeavors to promote and procure the resale of the products in the market in accordance with all relevant statutory requirements and in accordance with all relevant trade association or other voluntary standards. ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... idering the said agreement was unable to prove from the clauses of the agreement that there is an arrangement and merely on the basis presumption has stated that there is an arrangement between the Assessee and its AE. He submitted that the same is clearly evident from the relevant extracts of the TPO order reproduced as under for our reference: (Para 7.1.1. to 7.1.3 on page 34 to 35 of the TP order Para 8.4 on page 44 of the TP order): "7.1 Issue Of AMP: - 7.1.1 The taxpayer cannot be categorized as a simple manufacturer cum trader, as on perusal of the profit and loss account of the taxpayer it is seen that, the taxpayer has incurred huge expenditure towards marketing and selling amounting to R \ .719,428,537, The taxpayer has therefore performed some value addition functions, which a routine manufacturer cum distributor would not. 7.1.2 It is obvious that the taxpayer, being the part of entire group is not suitably compensated berth AE for performing the functions for advertisement and marketing. It is to be companied here that, the taxpayer has put in its efforts /finances for the promotion of brand name of the AE. No prudent businessman or concern shall put in his/ its e ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the actual transaction". (paragraph 1.46 in Section D.1.1. of chapter 1 of OECD guidelines revised through BEPS final report)" 11.10 Therefore, despite being in possession of the intercompany agreement, the Ld. TPO was not able to prove that there was an arrangement and has proceeded on a presumption that there is an arrangement between the Assessee and the AE for incurring AMP expenses on behalf of the AE. Thus, addition made on basis of such presumption is invalid and liable to be deleted. 11.11 Further the Assessee would like to submit that the aforesaid intercompany agreement was submitted to the ld. DRP vide submission dated 20 December 2019. The ld. DRP after considering the said agreement was unable to prove from the clauses of the agreement that there is an arrangement and merely on the basis presumption has stated that there is an arrangement between the Assessee and its AE. The same is clearly evident from the relevant extracts of the TPO order reproduced as under for our reference: (Para 2.4.1 of Pg. 31 of DRP directions): "2.4.1 Having considered the submissions, we note that the assessee has undertaken various advertisement, sales promotion, new product launches an ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... tween the Assessee and AE and thus, the transaction of AMP expense cannot be treated as a separate international transaction in absence of an arrangement between the Assessee and AE. In this regard, the he placed reliance on the Delhi High Court's ruling of Commissioner of Income tax Vs. Whirlpool of India Limited [ITA 610/2014, 228/2015 & CM No.5751/2015], whereby the Hon'ble Delhi High Court has held the following: "35. It is for the above reason that the BLT has been rejected as a valid method for either determining the existence of international transaction or for the determination of ALP of such transaction. Although, under Section 92B read with Section 92F(v), an international transaction could include an arrangement, understanding or action in concert, this cannot be a matter of inference. There has to be some tangible evidence on record to show that two parties have "acted in concert". 36. The expression "acted in concert" has been interpreted by the Supreme Court in Daiichi Sankyo Company Ltd. v. Jayaram Chigurupati 2010(6) MANU/SC/0454/2010, which arose in the context of acquisition of shares of Zenotech Laboratory Ltd. by the Ranbaxy Group. The question that was ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... n 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. However, it is not discernible from the clauses of the said TLA that WOIL was under any obligation to incur an extent of AMP expense for building the brand or mark of Whirlpool USA. The Revenue has been unable to explain why there should a presumption that as a result of the TLA, there must have been an understanding between Whirlpool USA and WOIL and that WOIL will spend 'excessively' on AMP in order to promote the 'Whirlpool' brand in India. In other words, it is not clear why a presumption should be drawn that since an incidental benefit might enure to the brand of Whirlpool USA, a proportion of the AMP expenses incurred must be attributed to it. ... Conclusion 47. For the aforementioned reasons, the Court is of the view that as far as the present appeals are concerned, the Revenue has been unable to demonstrate by some tangible material that there is an international transaction involving AMP expenses between WOIL and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... equires the assessee to mandatorily incur any AMP expenses in the absence of which it is very clear that no written agreement exists between the assessee and its AE requiring the assessee to incur the AMP expenses. We therefore hold that the incurring of AMP expenses cannot be regarded as an international transaction at all and therefore the impugned addition cannot be sustained and the same is directed to be deleted." 11.15 Further, the he placed reliance on the Hon'ble Mumbai Tribunal's ruling of India Medtronic Private Limited Vs. Deputy Commissioner of Income tax [ITA 1600/Mum/2015 - AY 2010-11], whereby the Hon'ble Mumbai Tribunal has held the following: "3.4. We have heard the rival submissions. We find that the TPO had held that assessee should have been compensated by its AE for the AMP expenditure incurred by it. We have gone through the agreements entered in to by the AEs with the assessee, that in the agreements there is no condition about sharing of AMP, that the agreements talks of using best efforts to market and distribute the product or promote the products in a commercially reasonable manner. In our opinion, these terms do not give any indication that the AE and ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... 0,00,000 from Dr. Reddy's Laboratories Ltd. and Rs. 31,50,00,000 from Sun Pharma Laboratories Ltd. totalling to Rs. 37,10,00,000. On perusal of the above, since the upfront fees recovered was in excess as compared to cost of marketing and promotion of new launch product of Rs. 12,48,03,318, no recovery was made from the group company in respect of said marketing and promotion expenses of new launch product since the Assessee had received excess amount from the third party. The tabulation of the same is as under for your Honours reference: Particulars Amount (Rs.) Cost of marketing and promotion of new launch product 12,48,03,318 Less: Upfront fees received from third party (37,10,00,000) Excess upfront fees (24,61,96,682) 11.20 Thus, he submitted that the said transaction is totally different and no mention about the same is also made in the Formulation and Packaging agreement and has no relation with AMP expenses. Further, said product launch expense has been treated as separate transaction by the Ld. AO/TPO and has not linked the same with AMP expenses and has also not discussed about the same. Thus, the argument raised by the Ld. Department Representative is baseless a ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... cur huge AMP expense that has no correlation with the volume of goods that it imports from the AE. 8.2.6 Similarly, in the case of a manufacturer, the Indian subsidiary may be sourcing all its raw material locally. The international transaction may only be payment of royalty and payment for technical services (which may be a lump sum agreed amount with no relation to sales). But to sell the goods locally (under the AEs brand), it may incur huge AMP expenses. Hence, it cannot be said with certainty that the transaction of manufacturing/distribution and the AMP functions are interconnected. The point being made here is that manufacturing, distribution and marketing are independent of each other, in the context of the international transactions that are associated with these functions. DRP directions" "2.4.12 Thus, it could be seen that it has been clearly laid down that Distribution and AMP are two different international transactions, but could be aggregated for the purpose of ALP analysis provided that the external comparables also perform similar AMP functions, and if no such comparable company could be identified, then the AMP transaction has be analysed separately by ado ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... reproduced as under for our reference: "6. Arm's Length Price 6.1. The Arm's Length price of the covered transactions shall be as follows: (a) The covered transactions mentioned in item (a) of sub-clause 3.1above shall be considered to be at arm's length in a previous ye if the Applicant maintains an OPM1 of not less than 9.7% manufacturing segment for the said previous year, (b) The covered transactions mentioned in item (b) of sub-clause 3.1 above shall be considered to be at arm's length in a previous year if the Applicant maintains an OPM2 of not less than 6.5% in trading segment for the said previous year, and 11.23 Thus, he submitted that the aforesaid Arm's length operating margin for manufacturing segment as well as trading segment as per APA has taken into consideration the AMP expenses while computing operating expense. Thus, no separate adjustment needs to be made with respect to AMP expenses. The computation of operating margin which substantiates that the AMP expenditure is already benchmarked and considered while computing operating margin as per APA for manufacturing and trading segments for AY 2016-17 is reproduced as under for our reference: Part ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ass 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." 11.25 Further, the ld. A.R. placed reliance on the Hon'ble Bangalore Tribunal's ruling of HP India Sales Private Limited Vs. The Joint Commissioner of Income tax [ITA No. 524/Bang/2017 -AY 2012-13], whereby the Hon'ble Bangalore Tribunal has held the following: "9. The decision of the Delhi High Court in Sony Ericsson Mobile Communications India (P.) Ltd. v. CIT [2015] 374 ITR 118 was followed and it was held that the bright line test followed by the Revenue in making the AMP TP adjustment cannot be accepted. In the present case also, no material is brought on record by the TPO to establish the existence of an arrangement, understanding or action in concert with the AE for incurring the AMP expenses for the benefit of the AE. Merely because the AE has a financial interest, it cannot be presumed that AMP expenses incurred by the assessee are at the instance or on behalf of the assoc ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ible." ...11. Respectfully following the above judgment of the Hon'ble Delhi High Court, we delete the AMP TP adjustment of Rs. 25,09,60,200 and the mark up thereon amounting to INR 3,93,75,655." 11.26 Further, the ld. A.R. placed reliance on the Hon'ble Bangalore Tribunal's ruling of Lenovo (India) Private Ltd Vs. The Deputy Commissioner of Income tax [ITA No. 2833/Bang/2017 - AY 2013-14], whereby the Hon'ble Bangalore Tribunal has held the following: "It is submitted that this Tribunal for A.Y. 2015-16 (supra) remanded the issue on AMP back to the Ld. TPO to verify the net operating margin earned by assessee with respect to the trading segment. The Ld.AR submitted that Hon'ble Delhi High Court in case of Sony Ericsson Mobile Communications P. Ltd. v. CIT reported in 374 ITR 118 (Del) on an identical issue has observed as under: "101. However, once the Assessing Officer/TPO accepts and adopts TNM Method, but then chooses 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 factore ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ing the ALP of the trading segment. Further, based on the categorical observation by the Ld. TPO regarding the trading segment to be at arm's length, we direct the Ld. AO/TPO to delete the adjustment proposed, in respect of the AMP expenses as it cannot be treated as international transactions in the present facts of the case." 11.27 Further, the he placed reliance on the Hon'ble Bangalore Tribunal's ruling of Herbalife International India Pvt. Ltd. [IT(TP) A No. 440/Bang/2022 - AY 2017-18], whereby the Hon'ble Bangalore Tribunal has held the following: "3.23 We also find merit in the submission of the Ld. Counsel that, if the net profit margin meets the Arm's length price, then no separate addition needs to be made. Considering the fact that no adverse inference is drawn by the Ld.TPO in respect of the Manufacturing segment which means that the Ld.TPO has accepted the overall margins of the said segment and respectfully following decision of the Hon'ble Delhi Court in the case of Sony Ericsson (supra), we direct the Ld.TPO to delete the adjustment made towards the AMP." 11.28 Further, the ld. A.R. submitted that in para 2.4.11 of the DRP directions, the Ld. DRP has rel ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... arate analysis and adjustment on the AMP transaction is liable to be rejected as there was no comparison made as to the AMP functions. while accepting the Distribution function to be at ALP. Such a plea raised before the ITAT in the above referred decisions were rejected. " (Emphasis supplied) 12.2 The ld. D.R. further submitted that the AMP expenditure is not covered under the Advance Pricing Agreement (APA) entered newly by assessee with CBDT and therefore, AMP adjustment made by the TPO being separate international transaction shall sustain. 13. We have heard the rival submissions and perused the materials available on record. The assessee relied on the latest decision of Chennai Bench in the case of Nissan Motor India Pvt. Ltd. in IT(TP)A No.91/Chny/2018 and others dated 29.5.2024, wherein on the similar argument of the assessee is considered and observed as under: "17. We have heard the rival contentions in the light of the evidences available on records, arguments put forth as well as judicial citations relied upon. Upon careful consideration of the impugned APA signed between the assessee and the CBDT, we find that the said APA is valid for AYs 2014-15 to 2018-19 and ..... X X X X Extracts X X X X X X X X Extracts X X X X
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