2018 (7) TMI 1991 - AT - Income Tax

High Court rules AMP expenses covered in compensation model for Associated Enterprises

The High Court ruled in favor of the assessee, determining that the compensation model already covered excess third-party expenses related to ... TP adjustment - adjustment relating to Advertisement, Marketing and Promotion [AMP] - HELD THAT:- No force in the findings of the lower authorities that the above said expenditure on AMP has been incurred exclusively to promote the brand/trade name ‘Sony Ericsson’ and such expenditure has resulted into brand building and increased awareness of the products bearing brand/trade name ‘Sony Ericsson’ and also that such expenditure incurred by the assessee company is for the advantage of its AE. Testing the functions performed by the assessee vis a vis AMP expenses incurred by it, we do not find that the assessee has incurred AMP for the benefit of its AE. All the expenditure incurred by the assessee are in relation to its business and its promotion. Moreover, as mentioned elsewhere, the net margin is much higher than the comparables and looking from that angle also, we do not find any merit in the transfer pricing adjustments. It is incorrect to say that the amount of ₹ 73.83 crores received by the assessee by way of credit notes represents the excess price charged by AE which has been credited to the assessee. The business model of the assessee with its AE is such that the AE ensures that the assessee achieves an arms’ length return on sales made by it. Assuming, yet not accepting that the assessee should have been compensated by its AE towards AMP and such compensation as worked out by the TPO is ₹ 69.94 crores, then also no adjustment is required since the assessee has received credit notes worth 74.83 crores and has been suitably compensated. If the AMP expenses are considered as an independent transaction and combined transaction approach is not considered, then also excessive profit derived by bench marking of distribution segment should be adjusted with alleged excessive AMP expenditure thereby providing benefit of set off. This view finds support from the judgment of SONY ERICSSON MOBILE COMMUNICATIONS INDIA PVT. LTD. (NOW KNOWN AS SONY INDIA LIMITED) & OTHERS VERSUS COMMISSIONER OF INCOME TAX – III [2015 (3) TMI 580 - DELHI HIGH COURT] But this will only be considered when the AO/TPO has rejected the comparables adopted by the assessee as a bundled transaction. In the case in hand, and as mentioned elsewhere, the Assessing Officer/TPO has accepted the comparables adopted by the assessee as bundled transaction and, therefore, it would be illogical and improper to treat the AMP expenses as separate international transaction as mentioned by the Hon'ble High Court in its list of findings at clause (v) at page 138 of its order. Considering the guidelines/findings of the Hon'ble High Court of Delhi [supra] and considering the facts of the case in hand from all possible angles, we are of the considered view that the assessee company has been suitably compensated by its AEs and, therefore, no further adjustment is required. - Decided in favour of assessee. Issues Involved:1. Adjustment relating to Advertisement, Marketing, and Promotion (AMP) expenses.2. Determination of Arm's Length Price (ALP) for international transactions.3. Use of the Transactional Net Margin Method (TNMM) and Brightline Test (BLT).4. Compensation for AMP expenses by Associated Enterprises (AE).5. Segregation of AMP expenses as an independent international transaction.6. Application of OECD Transfer Pricing Guidelines.7. Role of comparables in transfer pricing analysis.Detailed Analysis:1. Adjustment relating to Advertisement, Marketing, and Promotion (AMP) expenses:The case was restored by the Hon'ble High Court of Delhi for decision on the adjustment relating to AMP expenses of Rs. 69.95 crores. The assessee argued that the AMP expenses were for promoting its sales in India and not for brand promotion, thus not requiring reimbursement from AE. The TPO, however, believed that these expenses were for promoting the AE's brand and should have been compensated by the AE.2. Determination of Arm's Length Price (ALP) for international transactions:The TPO noted that the assessee incurred significant AMP expenses and questioned the ownership and compensation related to the brand name. The TPO treated the AMP expenses as an international transaction and determined the ALP using the Brightline Test, finding that the assessee incurred excess AMP expenditure which should have been compensated by the AE.3. Use of the Transactional Net Margin Method (TNMM) and Brightline Test (BLT):The assessee used TNMM with Operating Profit/Sales as the Profit Level Indicator (PLI), showing a margin of 2.50%, higher than the comparables' mean margin of 0.45%. The TPO applied the BLT, determining an excess expenditure of Rs. 98.02 crores beyond the brightline limit and proposed an adjustment of Rs. 1,127,273,275/-.4. Compensation for AMP expenses by Associated Enterprises (AE):The High Court rejected the application of the BLT, emphasizing that the domestic AE must be compensated for AMP expenses by the foreign AE. This compensation could be included in a low purchase price or by not charging royalty. The court highlighted that the assessee's net margin was higher than comparables, indicating that the compensation model already covered excess third-party expenses.5. Segregation of AMP expenses as an independent international transaction:The High Court stated that it would be illogical to treat AMP expenses as a separate international transaction if the comparables adopted by the assessee are accepted. The TPO should only segregate AMP expenses after elucidating reasons for not accepting the bunching adopted by the assessee and examining set-off benefits.6. Application of OECD Transfer Pricing Guidelines:The OECD guidelines suggest compensating the distributor with a service fee rather than a return on marketing intangibles. It indicates that where the distributor bears the cost of marketing activities, compensation should be based on contractual rights. The court found that the assessee's AMP expenses were not extraordinary and were for maintaining the brand rather than building it.7. Role of comparables in transfer pricing analysis:The court noted that the assessee's net margin, after considering AMP expenses, was higher than the comparables. The High Court emphasized that comparables should match the functions and obligations performed by the tested party, including AMP expenses. The TPO should only reject the comparables for valid reasons and select the most appropriate method for determining the ALP.Conclusion:The court concluded that the assessee was suitably compensated by its AE and no further adjustment was required. The AMP expenses were not considered an independent international transaction, and the appeal was allowed. The order was pronounced on 26.07.2018.