2010 (7) TMI 84 - HC - Income Tax

Arbitrary transfer pricing adjustments set aside; reassessment of arm's-length price required under Section 92C with assessee bearing onus

HC set aside the TPO's adjustments as arbitrary and without evidential basis, directing reassessment of arm's-length price under Section 92C. The Court ... Transfer pricing (TP) - Use of brand name / trademark - payment of royalty - income from an international transaction - Onus to prove - determining arm’s length price u/s 92C - foreign entity - Prior to 1993, the petitioner was using the logo ‘M’ on the front of the cars manufactured and sold by it - whether the expenses incurred by the domestic entity - From 1993 onwards, the petitioner started using the logo ‘S’, which is the logo of Suzuki, in the front of new models of the cars manufactured and sold by it, though it continued to use the Mark ‘Marut’ along with the word ‘Suzuki’ on the rear side of the vehicles manufactured and sold by it - HELD THAT:- Since we have come to the conclusion that the order passed by the TPO making adjustments to the income of the petitioner company is based on no evidence which amounts to an error of law by him, the procedure followed by him was faulty, the approach adopted by him was erroneous and the order passed by him is arbitrary and irrational, it will be open to this Court to set aside the order passed by him, in exercise of writ jurisdiction under Article 226 of the Constitution. Also, the Transfer Pricing Provisions being rather new to the tax regime in India and with the entry of more and more multinationals in our country, these provisions are likely to come up frequently for application by the TPOs as well as the Assessing Officers, we deem it appropriate to clarify those aspects of the transfer pricing provisions which come up for our consideration in this case, so that they are able to appreciate the scope of their powers under Transfer Pricing Provisions of the Act as well as the procedure to be followed and approach to be adopted by them while processing such cases. i. The onus is on the assessee to satisfy the AO/TPO that the arm's length price computed by it, was in consonance with the provisions contained in Section 92 of the Act. The AO/TPO can reject the price computed by the Assessee and determine it only where he finds that the assessee has not discharged the onus placed on it or he finds that the data used by the assessee is unreliable, incorrect or inappropriate or he finds evidence, which discredits the data used and/or the methodology applied by the assessee. ii. The TPO/AO, before he determines arm's length price in relation to the income from an international transaction, needs to give appropriate notice to the assessee, giving him an opportunity to produce evidence in support of the arm's length price computed by him. In case the TPO/AO proposes to make adjustments to the income of the assessee by revising the arm's length price computed by him, he needs to give a notice to the assessee, conveying the grounds on which the adjustment is proposed to be made, followed by an opportunity to reply to that notice and produce evidence to controvert the grounds, on which the adjustment is proposed. iii. If an independent domestic entity uses a foreign trademark and/or logo on its products or on their containers, packaging, etc., manufactured and/or sold in India, no payment to the foreign entity in this regard is necessary, unless agreed by it, irrespective of whether the use of the foreign trademark and/or logo is obligatory or discretionary. iv. If a domestic entity, which is an Associate Enterprise of a foreign entity within the meaning of Section 92A of the Act, uses a foreign trademark and/or logo on its products or on their containers, packaging, etc., manufactured and/or sold in India, no payment to the foreign entity on account of such user, is necessary, in case the use of the foreign trademark and/or logo is discretionary for the domestic entity. However, the income arising from such international transaction(s) needs to be determined at arm's length price, in terms of Section 92C of the Act. v. If the domestic entity which is an Associate Enterprise of the foreign entity within the meaning of Section 92A of the Income Tax Act is mandatorily required to use the foreign trademark and/or logo on its products and/or their containers, packaging, etc., appropriate payment in this regard should be made by the foreign entity to the domestic entity, on account of the benefit it derives in the form of marketing intangibles, obtained by it from such mandatory use of its trademark and/or logo. vi. Even in the cases where payment in terms of clause (v) above is to be made by the foreign entity, to the domestic entity, the arm's length price in respect of the income, from the international transaction between the two entities, needs to be determined, taking into consideration all the rights obtained and obligations incurred by the parties under the international transaction in question, including the value of marketing intangibles obtained by the foreign entity on account of compulsory use of its trademark and/or logo by the domestic entity. Suitable adjustments in this regards will have to be made considering the individual profiles of these entities and other facts and circumstances justifying such adjustments. vii. The expenditure incurred by an independent domestic entity on advertising, promotion and marketing of its products using a foreign trademark/logo does not require any payment or compensation by the owner of the foreign trademark/logo to the domestic entity on account of use of the foreign trademark/logo in the promotion, advertising and marketing undertaken by it, unless agreed by the domestic entity. viii. The expenditure incurred by a domestic entity, which is an Associate Enterprise of a foreign entity, on advertising, promotion and marketing of its products using a foreign trademark/logo does not require any payment or compensation by the owner of the foreign trademark/logo to the domestic entity on account of use of the foreign trademark/logo in the promotion, advertising and marketing undertaken by it, so long as the expenses incurred by the domestic entity do not exceed the expenses which a similarly situated and comparable independent domestic entity would have incurred. ix. If the expenses incurred by a domestic entity which is the Associate Enterprise of foreign entity, using a foreign brand trademark and/or logo while advertising, marketing and promoting its products, are more than what a similarly situated and comparable independent domestic entity would have incurred, the foreign entity needs to suitable compensate the domestic entity in respect of the advantage obtained by it in the form of brand building and increased awareness of its brand in the domestic market. x. In case the foreign entity is liable to compensate in terms of clause (ix) above, the TPO needs to determine the arm's length price in respect of the international transaction made by the domestic entity, with the foreign entity, which is its Associate Enterprise within the meaning of Section 92A of the Act, taking into consideration all the rights obtained and obligations incurred by the two entities, including the advantage obtained by the foreign entity. xi. In order to ascertain whether the expenses incurred by the domestic entity, which is an Associate Enterprise of a foreign entity, on the marketing, promotion and advertising of its products using the brand trademark/logo of the foreign entity, are more than what a similarly situated and comparable independent domestic entity would have incurred, or not, it would be necessary to identify appropriate comparables for the purpose of comparison of their expenditure with the expenditure incurred by the domestic entity in this regard. Suitable adjustments will have to be made considering the individual profiles of these entities and other facts and circumstances justifying such adjustments. Thus, the impugned order dated 30.10.2008 is hereby set aside and the TPO is directed to determine appropriate arm's length price in respect of the international transactions entered into by the petitioner Maruti Suzuki India Limited with Suzuki Motor Corporation, Japan, in terms of the provisions contained in Section 92C of the Income Tax Act and in the light of the observations made and the view taken by us in this order. The TPO shall determine the arm's length price within three months of the passing of this order. Issues Involved:1. Jurisdiction of the Transfer Pricing Officer (TPO).2. Alleged sale of the 'Marut' brand to Suzuki.3. Determination of arm's length price for royalty payments.4. Apportionment of advertisement and marketing expenses.5. Compliance with principles of natural justice.Detailed Analysis:Jurisdiction of the TPO:The petitioner challenged the jurisdiction of the TPO, arguing that the TPO did not respond to their jurisdictional challenge and continued proceedings without addressing the issue. The court noted that the TPO must provide clear, precise, and unambiguous notice to the assessee, detailing the grounds for proposed adjustments to income. The TPO failed to convey the grounds for the proposed adjustment adequately, leading to a procedural lapse. The court emphasized that the TPO must follow a fair and reasonable procedure, including issuing a fresh notice if the initial grounds for adjustment are abandoned.Alleged Sale of the 'Marut' Brand to Suzuki:The TPO initially alleged that replacing the 'M' logo with the 'S' logo symbolized the sale of the 'Marut' brand to Suzuki. However, the court found no evidence of such a transfer. The agreement between Maruti and Suzuki did not grant Suzuki any rights to use the 'Marut' brand or logo. Maruti continued to use its brand and logo, indicating no transfer of ownership. The court concluded that the TPO abandoned the original grounds set out in the show-cause notice and failed to establish a case of brand sale.Determination of Arm's Length Price for Royalty Payments:The TPO apportioned 50% of the royalty paid by Maruti to Suzuki for the use of the trademark, without any material justifying such apportionment. The court criticized this approach as arbitrary and lacking basis. The TPO did not attempt to determine what royalty a comparable independent entity would have paid for similar benefits derived from Suzuki. The court highlighted the need for the TPO to ascertain the price a comparable independent entity would have paid for a transaction of this nature to determine the arm's length price accurately.Apportionment of Advertisement and Marketing Expenses:The TPO compared Maruti's advertisement expenses with those of Hindustan Motors Limited, Mahindra and Mahindra Limited, and TATA Motors Limited, concluding that Maruti's expenses were disproportionately high. The court found the comparables chosen and the method adopted by the TPO to be faulty and unjustified. The TPO failed to identify and select entities truly comparable to Maruti. The court emphasized the need for a methodological approach to select appropriate comparables and make necessary adjustments considering individual profiles and other relevant factors.Compliance with Principles of Natural Justice:The court underscored the importance of fair hearing and proper notice. The TPO must provide clear, precise, and unambiguous notice to the assessee, detailing the grounds for proposed adjustments. The TPO failed to issue a fresh notice after abandoning the original grounds, violating the principles of natural justice. The court reiterated that the TPO must follow a fair and reasonable procedure, including giving the assessee an opportunity to produce evidence and respond to the grounds for adjustment.Conclusion:The court set aside the impugned order dated 30.10.2008 and directed the TPO to determine the appropriate arm's length price for the international transactions between Maruti Suzuki India Limited and Suzuki Motor Corporation, Japan, in accordance with Section 92C of the Income Tax Act and the observations made in the judgment. The TPO was instructed to complete this determination within three months.