2014 (6) TMI 440 - AT - Income Tax

Tribunal overturns transfer pricing adjustment, directs new ALP determination

The Tribunal partly allowed the appeal by setting aside the transfer pricing adjustment of Rs.30.14 crore and directing a fresh determination of the Arm's ... Transfer pricing adjustment – International transaction of the provision of agency and marketing support services – Held that:- The findings returned by the TPO - the assessee assuming substantial risks; doing critical functions for its AEs; and allowing the user of its highly-valued intangibles to such AEs - are all in air without any bedrock - there is no reference to the names of such comparables in the TPO’s order - the TPO embarked upon the PSM throughout the length and breadth of his order - The alternative approach of TNMM was not given any serious consideration - Even there is no discussion about the comparables chosen by the assessee and how they were acceptable or not – thus, the matter is to be remitted back to the AO for fresh determination of the ALP of the disputed international transactions of `Provision of Agency and marketing support services’ - the assessee will be allowed a reasonable opportunity of being heard in such de novo determination of the ALP. Disallowance u/s 37(1) of the Act – 50% of club expenses – Held that:- Following CIT vs. Groz Beckert Asia Ltd. [2013 (2) TMI 375 - PUNJAB & HARYANA HIGH COURT] - payment of corporate membership fee has to be allowed as a revenue expenditure in the hands of the company - the amount spent on club membership fee of company’s directors is deductible as business expenditure – Decided partly in favour of Assessee. ISSUES PRESENTED AND CONSIDERED 1. Whether the Transfer Pricing Officer's application of the Profit Split Method (PSM) and consequent transfer pricing adjustment is sustainable where the assessee's role is alleged to be limited to agency and marketing support services, and whether alternate methods (notably TNMM) should instead be applied to determine arm's length price (ALP) for provision of agency and marketing support services. 2. Whether 50% of club membership fees/annual subscriptions paid by the company on behalf of directors is disallowable under section 37(1) as not being wholly and exclusively for business purposes, or is deductible as revenue expenditure. ISSUE-WISE DETAILED ANALYSIS Issue 1 - Applicability of Profit Split Method (PSM) vs TNMM for provision of agency and marketing support services Legal framework: Chapter X (transfer pricing) requires selection of the most appropriate method to determine ALP for international transactions. Methods include TNMM and PSM, applied based on functions performed, assets used and risks assumed (FAR analysis) and supported by evidence. Precedent treatment: Authorities below applied PSM relying on a prior Tribunal order which had apportioned global profits between agent and associated enterprises on the ground that the local entity performed majority and crucial services and assumed substantial risks. That prior Tribunal finding was subsequently reversed by the jurisdictional High Court on the ground that the finding of substantial risk was not supported by material. Interpretation and reasoning: The Tribunal undertook a fact-based FAR analysis. Key findings supporting rejection of PSM: (a) contemporaneous documents (a transaction structure chart and profit & loss data) show the assessee acted as mediator supplying marketing information and liaisoning, with limited capital employment and limited risk exposure; (b) significant services such as feasibility studies, industry analysis and project evaluation were performed for unrelated parties, not for associated enterprises; (c) no material was produced by Revenue to substantiate that the assessee developed or made available valuable intangibles to AEs or assumed substantial entrepreneurial/operational risk; (d) assertions by the TPO that the assessee performed critical functions and used intangibles were unelaborated and unsupported by evidence; (e) the TPO relied heavily on a prior Tribunal decision but did not account for that decision's reversal by the jurisdictional High Court; (f) the TPO's alternative TNMM benchmarking (nine comparables) was neither documented nor discussed in the order, depriving the assessee of a proper comparison and rendering that approach inadequately reasoned. Ratio vs. Obiter: Ratio - where an entity's documented role is limited to mediation, marketing information supply and liaison with minimal capital and limited risks, application of PSM on the bald assertion of valuable intangibles and significant risk (without evidentiary support) is unsustainable; TNMM may be the most appropriate method in such circumstances. Obiter - critical discussion of the appropriateness of specific profit-split percentages (70:30 v. 80:20) is ancillary and dependent on factual findings; reliance on a reversed Tribunal precedent is not persuasive. Conclusions: The Tribunal set aside the transfer pricing adjustment based on PSM (Rs.30.14 crore) because the authorities' findings that the assessee assumed substantial risks and used valuable intangibles lacked material foundation and were unduly influenced by a Tribunal decision later reversed by the High Court. The Tribunal held that TNMM is the most appropriate method on the present facts but remitted the matter to the TPO/Assessing Officer to undertake a fresh, de novo determination of ALP under an appropriate method (TNMM) with full disclosure of comparables and opportunity to be heard. Issue 2 - Deductibility of corporate club membership fees under section 37(1) Legal framework: Section 37(1) permits deduction of business expenditure that is not capital or personal and is incurred wholly and exclusively for business purposes. Corporate membership fees paid by a company on behalf of directors must be tested on this standard. Precedent treatment: Multiple High Court decisions (including a Full Bench decision of a State High Court and other High Courts) have held that corporate membership fees paid by companies are deductible as business expenditure where incurred for business purposes. Interpretation and reasoning: Given the prevailing judicial position favoring deductibility, and established authorities recognizing corporate membership fees as revenue expenditure where business nexus exists, the Tribunal followed the weight of precedent and allowed deduction. The AO's blanket 50% disallowance was therefore reversed. Ratio vs. Obiter: Ratio - corporate membership fees/annual subscriptions paid by a company on behalf of its directors are deductible as revenue expenditure under section 37(1) where incurred for company's business purposes, and a mechanical 50% disallowance is not warranted in the face of binding judicial precedents. Obiter - specifics of how much is deductible in differing factual matrices were not required to be decided here. Conclusions: The Tribunal deleted the addition of Rs.5,03,647 (50% of club expenses) and allowed the full deduction of corporate club membership fees paid by the company on behalf of directors under section 37(1), following established judicial authority. Cross-references and procedural directive Because PSM was set aside for lack of material and due to reliance on a precedent reversed by the High Court, the matter was remitted for fresh determination under Chapter X using TNMM (deemed most appropriate on facts) with proper disclosure of comparables and a reasonable opportunity for the assessee to be heard; all findings by the TPO relying on unsupported assertions of intangibles or substantial risk were rejected.