2021 (1) TMI 1266 - AT - Income Tax

Transfer Pricing Tribunal Invalidates Bright Line Method Adjustment for AMP Expenses, Rules in Favor of Taxpayer

The Tribunal found that the Transfer Pricing Officer's adjustment for Advertisement, Marketing, and Promotion (AMP) expenses using the 'Bright Line' ... Advertising, Marketing and Promotion expenses as international transaction - Bright Line Test - onus on Revenue to prove existence of international transaction - segregation versus aggregated benchmarking of AMP expenses - selling expenses exclusion from AMP - mark up on excessive AMP under Rule 10B(1)(c) / benchmarking principles - remand to Assessing Officer conditional on higher court reversalAdvertising, Marketing and Promotion expenses as international transaction - onus on Revenue to prove existence of international transaction - Adjustment treating AMP expenses as an international transaction is not sustainable where the Revenue has not discharged the onus of proving existence of an international transaction. - HELD THAT: - The Tribunal held that the Revenue must first establish the existence of an international transaction involving AMP expenditure before computing arm's length price. Mere application of a benchmarking test or finding of high AMP spend does not, by itself, prove an international transaction. The Tribunal relied on the line of decisions of the Hon'ble Delhi High Court emphasising that proof of an international transaction is a prerequisite to any ALP computation, and found no cogent material on record (beyond application of a bright line test) to establish that the AMP expenses incurred by the taxpayer were for the benefit of its associated enterprises. [Paras 21, 22, 25, 26, 28]Adjustment deleted as the Revenue failed to prove existence of an international transaction in respect of AMP expenses.Bright Line Test - segregation versus aggregated benchmarking of AMP expenses - Use of the Bright Line Test (BLT) / simple BLT comparison to determine existence of international transaction or to compute ALP is not sustainable. - HELD THAT: - The Tribunal agreed with the Hon'ble Delhi High Court decisions that BLT has no statutory mandate to establish the existence of an international transaction or to compute ALP for AMP expenses. The TPO's reliance on BLT and on AMP/GP comparisons to presume an international transaction or to quantify excessive expenditure was held to be impermissible. The DRP's attempt to apply a segregation approach by comparing AMP/GP ratios was also characterised as effectively re applying a bright line comparison and therefore flawed. [Paras 20, 22, 23]BLT based adjustments and pure BLT comparisons applied by TPO/DRP/AO are not sustainable and are set aside.Selling expenses exclusion from AMP - Direct marketing and point of sale selling expenses are to be excluded from AMP for the purposes of AMP benchmarking. - HELD THAT: - The Tribunal accepted the taxpayer's contention (as supported by the Delhi High Court in Sony Ericsson) that direct marketing and selling related expenses or discount concessions constitute selling expenses and do not form part of AMP intangibles. Consequently, such expenses cannot be treated as AMP international transactions absent evidence to the contrary. [Paras 27]Selling or direct marketing expenses excluded from AMP and cannot be the basis for AMP international transaction adjustments.Mark up on excessive AMP under Rule 10B(1)(c) / benchmarking principles - Application of a mark up (such as PLR based or GP/AMP based mark up) on alleged excessive AMP expenditures for computing reimbursement ALP is unsustainable where the existence of an international transaction is not first established. - HELD THAT: - The Tribunal noted the Delhi High Court's disapproval of revenue approaches that apply prime lending rate plus mark up and held that computation of any mark up on excessive AMP expenses presupposes proof of an international transaction. Thus, direction to apply a GP/COGS based mark up without establishing an international transaction was held to be impermissible. [Paras 26]Directions to apply mark up on alleged excessive AMP costs are not sustainable in the absence of proof of an international transaction.Remand to Assessing Officer conditional on higher court reversal - Matter is remitted to the Assessing Officer for fresh consideration; adjustment is set aside but AO may act afresh if higher court reverses the controlling High Court decisions. - HELD THAT: - While holding the present adjustment unsustainable in law, the Tribunal set aside the orders of authorities below and restored the matter to the AO for fresh action. The Tribunal expressly permitted the AO to revisit the issue and pass fresh orders in accordance with law if the decisions of the Jurisdictional High Court (which are under challenge before the Supreme Court) are modified or reversed; in that event the AO must afford the assessee an opportunity of being heard. [Paras 30, 31]Orders set aside and matter restored to AO for fresh consideration, subject to any binding change in law by the Supreme Court.Final Conclusion: The Tribunal deleted the AMP related transfer pricing adjustment for AY 2007 08, holding that the Revenue failed to prove an international transaction and that BLT based benchmarking and related mark up directions were unsustainable; the matter is remanded to the Assessing Officer for fresh consideration, with liberty to act in accordance with any future adverse decision of the Supreme Court after affording the assessee a hearing. Issues Involved:1. Validity of assessing the income higher than the returned income.2. Legality of the order passed by the AO under section 143(3) read with section 144C of the Income-tax Act, 1961.3. Transfer Pricing Adjustment concerning Advertisement, Marketing, and Promotion (AMP) Expenses.4. Determination of AMP expenditure as an international transaction.5. Application of the 'Bright Line' Method.6. Disallowance of Selling Expenses.7. De-bundling of Transactions.8. Initiation of penalty proceedings under section 271 (1)(c) of the Act.Detailed Analysis:1. Validity of Assessing the Income Higher than the Returned Income:The taxpayer contended that the AO erred in assessing the income at INR 195,817,140 as against the returned income of INR 192,663,625. This issue was raised as a general ground of appeal.2. Legality of the Order Passed by the AO:The taxpayer argued that the impugned order passed by the AO under section 143(3) read with section 144C of the Income-tax Act, 1961, is bad in law and void ab-initio. This contention was based on the procedural and substantive grounds of the assessment order.3. Transfer Pricing Adjustment concerning AMP Expenses:The taxpayer challenged the enhancement of income by INR 31,53,519 due to the TP adjustment on AMP expenses. The TPO had considered these expenses excessive and required reimbursement by the Associated Enterprises (AE). The taxpayer argued that the AMP expenditure was not an international transaction within the meaning of section 92B of the Act.4. Determination of AMP Expenditure as an International Transaction:The taxpayer contended that the AMP expenditure incurred was not an international transaction and that the AO/TPO erred in assuming it as such without any machinery provisions under Indian TP regulations for determining AMP expenditure as an international transaction. The taxpayer also argued that the AE did not derive any benefit from the AMP expenditure.5. Application of the 'Bright Line' Method:The taxpayer argued that the 'Bright Line' Method (BLT) applied by the TPO was rejected by the Delhi High Court in the case of Sony Ericsson Mobile Communication India Pvt. Ltd. vs. CIT. The taxpayer contended that the AO/TPO erred in comparing the AMP/GP ratio with that of comparable companies using the BLT, which has no statutory mandate.6. Disallowance of Selling Expenses:The taxpayer argued that the AMP expenses considered by the AO/TPO for AMP adjustment were primarily in the nature of 'point of sale expenditure' and thus should be regarded as selling expenses. The taxpayer contended that any expenses incurred for enhancing sales fall under the purview of selling expenses.7. De-bundling of Transactions:The taxpayer contended that since the entity-level operating margin under the transactional net margin method (TNMM) was higher than the comparable companies, no adjustment was warranted for excessive/non-routine AMP expenses. The taxpayer also argued that the DRP erred in not allowing the benefit of 'set off' by adjusting the excessive margin earned in other business segments against the AMP expenditure.8. Initiation of Penalty Proceedings:The taxpayer argued that the AO erred in initiating penalty proceedings under section 271 (1)(c) of the Act.Tribunal's Findings:1. The Tribunal noted that the TPO had used the BLT method to make an upward adjustment for AMP expenses, which was overruled by the DRP in light of the Delhi High Court's judgment in Sony Ericsson Mobile Communications India Pvt. Ltd. vs. CIT.2. The Tribunal observed that the DRP had directed the TPO to exclude routine selling and distribution expenses and apply a segregation approach for AMP expenses. However, the Tribunal found that this approach was akin to applying the BLT, which has no statutory mandate.3. The Tribunal held that the existence of international transactions cannot be presumed merely by applying the BLT and that the Revenue must first prove the existence of such transactions before determining the ALP.4. The Tribunal agreed with the taxpayer's contention that selling expenses should not be included in AMP expenses and that the Revenue failed to prove any specific arrangement or agreement between the taxpayer and its AE regarding AMP expenses.5. The Tribunal noted that the matter is pending before the Hon'ble Apex Court, and any decision by the Apex Court would be binding. However, the Tribunal set aside the orders of the authorities below and restored the matter to the AO for fresh consideration in light of the Apex Court's decision.6. The Tribunal concluded that the adjustment made by the TPO/DRP/AO on account of AMP expenses is not sustainable in law and deleted the adjustment. The taxpayer's appeal was allowed, and the Revenue's appeal was dismissed.Order Pronounced:The Tribunal pronounced the order on January 22, 2021, allowing the taxpayer's appeal and dismissing the Revenue's appeal.