2017 (3) TMI 1162 - AT - Income Tax

Transfer pricing treatment of AMP expenses and comparables affirmed, AMP excluded as international transaction with remand for idle capacity adjustment.

Transfer pricing regulations apply to transactions characterised as international transactions; allocation of advertising and marketing promotion (AMP) ... Advertising, Marketing and Promotion expenses - Bright Line Test - Most Appropriate Method (TNMM v. RPM) - Quantitative adjustment not permissible under Chapter X - Idle capacity adjustment under Rule 10B(3) - Section 92B(1) / Section 92F(v) - transaction, arrangement or action in concertAdvertising, Marketing and Promotion expenses - Bright Line Test - Quantitative adjustment not permissible under Chapter X - Section 92B(1) / Section 92F(v) - transaction, arrangement or action in concert - Whether AMP expenditure of the assessee constitutes an international transaction and whether the addition/transfer pricing adjustment in respect of AMP is sustainable - HELD THAT: - The Tribunal examined whether the AMP outlay was incurred pursuant to any arrangement or obligation in favour of the AE and whether revenue proved that benefits of AMP accrued to the AE. No evidence was produced by the AO/TPO to demonstrate an agreement, understanding or action in concert obliging the assessee to incur AMP for the AE or that the benefit economically accrued to the AE. The TPO applied the Bright Line Test and benchmarked AMP as a separate international transaction, and applied a mark-up; however, the Tribunal treated that approach as unsupported by the facts and noted authorities holding that the bright line test has no statutory mandate and that Chapter X does not permit quantitative adjustments merely by segregating AMP. On the facts the Tribunal found the AMP to be bona fide sales/marketing expenditure of the assessee, not an international transaction, and deleted the transfer pricing adjustment and mark-up.AMP expenditure is not an international transaction; the upward transfer pricing adjustment and mark-up in respect of AMP are deleted; Grounds 2.1 to 2.8 are allowed.Most Appropriate Method (TNMM v. RPM) - Appropriateness of method adopted for benchmarking (rejection of RPM and adoption of TNMM) - HELD THAT: - The assessee had adopted the Resale Price Method in its TP study; the TPO reworked the tested party's margins and, given absence of segmental finances and mixed manufacturing/trading activity, treated TNMM as the most appropriate method. The assessee did not pursue objections on this point before the DRP and did not press the point before the Tribunal. In the absence of contest and having regard to the functional profile and record, the Tribunal upheld the TPO/AO's view that TNMM was the most appropriate method.TNMM is the most appropriate method; Ground No.2.9 is dismissed.Comparability and selection of comparables - Validity of selecting Asian Paints Ltd. as a comparable - HELD THAT: - The assessee objected to Asian Paints on grounds of scale differences. The Tribunal noted the assessee itself had included Asian Paints in its TP study and that mere difference in turnover, without demonstration that turnover unduly influences margin, is insufficient to exclude a comparable. No material was produced to show that turnover difference affected margins; authorities relied upon by the assessee were distinguishable. Accordingly the Tribunal found no ground to exclude Asian Paints as a comparable.Objection to Asian Paints Ltd. as comparable rejected; Ground No.2.10 is dismissed.Idle capacity adjustment under Rule 10B(3) - Adjustment for idle capacity in benchmarking - HELD THAT: - The assessee asserted that low capacity utilisation (28%) in the relevant year materially depressed margins and sought an idle capacity adjustment; the revenue disputed the claim noting incorporation year. The Tribunal recognised idle capacity as a factor that can materially influence margins and noted precedent supporting adjustment, but also observed that reasons for under-utilisation and relevant comparables' circumstances must be verified. Therefore the Tribunal directed the AO to verify facts and make appropriate adjustments after considering all relevant factors.Issue remitted to AO for verification and appropriate allowance of idle capacity adjustment; Ground No.2.11 remitted.Customs duty adjustment - Claim for adjustment in respect of customs duty element - HELD THAT: - The assessee sought an adjustment for non-creditable customs duty. The record did not contain the pricing model or basis showing that BCD element impacted cost absorption such as to require adjustment. The Tribunal observed that the assessee's own TP document showed gross margins able to absorb the raw material cost including BCD and therefore found no basis for adjustment.Claim for customs duty adjustment rejected; ground dismissed.Allowability of business promotion expenses - Disallowance of business promotion expenses for non-production of bills and vouchers - HELD THAT: - The AO disallowed certain business promotion expenses for lack of supporting bills and vouchers. The assessee did not produce supporting evidence before the Tribunal. On the record, the Tribunal sustained the AO's disallowance.Addition in respect of business promotion expenses confirmed; ground dismissed.Penalty proceedings consequential relief - Maintainability/decision on penalty initiation under section 271(1)(c) - HELD THAT: - The penalty ground was consequential to the issues decided on assessment. Given the Tribunal's other findings and that penalty issue followed the assessment results, the Tribunal dismissed the penalty ground as consequential.Ground relating to initiation of penalty proceedings dismissed as consequential.Final Conclusion: The appeal is partly allowed: the transfer pricing adjustment and mark-up in respect of AMP expenses are deleted; TNMM is upheld as the most appropriate method; selection of Asian Paints as comparable is sustained; idle capacity adjustment is remitted to the AO for verification and appropriate relief; customs duty adjustment is rejected; the disallowance of business promotion expenses is confirmed; penalty ground dismissed as consequential. Issues Involved:1. General grounds regarding the assessment order.2. Transfer pricing adjustment related to Advertising, Marketing, and Promotion (AMP) expenses.3. Selection of the most appropriate method for transfer pricing.4. Comparability analysis and selection of comparable companies.5. Adjustments for idle capacity and customs duty.6. Addition under business promotion expenses.7. Initiation of penalty proceedings.Detailed Analysis:1. General Grounds:The general grounds raised by the assessee were deemed to be general in nature and did not require specific adjudication.2. Transfer Pricing Adjustment Related to AMP Expenses:The core issue revolved around the AMP expenses incurred by the assessee, which the Transfer Pricing Officer (TPO) and the Assessing Officer (AO) considered as a separate international transaction aimed at promoting the 'Nippon' brand in India. The TPO applied the Bright Line Test (BLT) to determine the excess AMP expenses and suggested an upward adjustment of Rs. 14,11,82,140/-. The assessee contended that these expenses were incurred for its domestic business operations and were not aimed at promoting the AE's brand. The Tribunal found that the AO/TPO did not provide evidence to demonstrate that the AMP expenses were for the brand building of the AE. The Tribunal relied on judicial precedents, including the Delhi High Court's ruling in Maruti Suzuki India Ltd. and Sony Ericsson Mobile Communications, which disapproved the BLT for AMP expenses. Consequently, the Tribunal held that the AMP expenses were not an international transaction and deleted the addition.3. Selection of the Most Appropriate Method for Transfer Pricing:The assessee adopted the Resale Price Method (RPM) for determining the Arm's Length Price (ALP) of international transactions. However, the TPO rejected RPM due to the lack of segmental financials for manufacturing and trading activities and adopted the Transactional Net Margin Method (TNMM) instead. The Tribunal upheld the TPO's decision to adopt TNMM as the most appropriate method, as the assessee did not raise objections before the Dispute Resolution Panel (DRP) or during the appeal.4. Comparability Analysis and Selection of Comparable Companies:The assessee objected to the selection of Asian Paints Ltd. as a comparable due to differences in scale of operations. The Tribunal noted that the assessee had initially selected Asian Paints as a comparable in its TP study and did not demonstrate any material factors influencing margins other than turnover. Therefore, the Tribunal upheld the inclusion of Asian Paints as a comparable.5. Adjustments for Idle Capacity and Customs Duty:The assessee sought adjustments for idle capacity and customs duty. The Tribunal acknowledged the need for idle capacity adjustments, considering the assessee's lower capacity utilization compared to comparable companies. The issue was remitted back to the AO for verification and necessary adjustments. Regarding customs duty adjustment, the Tribunal found no basis for adjustment as the assessee did not provide sufficient details on pricing models and comparability costs.6. Addition Under Business Promotion Expenses:The AO disallowed Rs. 2,89,897/- under business promotion expenses due to the non-production of bills and vouchers. The Tribunal upheld the disallowance as the assessee failed to provide evidence.7. Initiation of Penalty Proceedings:The ground related to the initiation of penalty proceedings under Section 271(1)(c) was dismissed as it was consequential in nature.Conclusion:The appeal was partly allowed, with the Tribunal deleting the addition related to AMP expenses and directing the AO to make necessary adjustments for idle capacity. Other grounds raised by the assessee were dismissed.