Technical unit's TPO consultation valid but assessee wins on AMP expenses, CCD characterization, and interest adjustments under sections 92CA and 144B

ITAT Delhi dismissed assessee's challenge to TPO reference, holding technical unit's consultation with TPO valid under sections 92CA and 144B. However, ITAT allowed assessee's appeal on multiple grounds: deleted AMP expense adjustments following HC precedents in Sony Ericson and Maruti Suzuki cases, ruling AMP expenditure not international transactions; deleted CCD re-characterization as equity citing Kirloskar Pneumatic, holding CCDs remain debt until conversion; deleted interest receivable adjustments under CUP method following Kusum Health Care precedent; and set aside DRP findings on UC Singapore services, directing DRP to decide comparables issue afresh as section 144C(8) doesn't permit denovo remand.

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The primary legal issues considered in this appeal revolve around the validity and limitation of the reference to the Transfer Pricing Officer (TPO), the characterization and treatment of Advertising, Marketing, and Promotion (AMP) expenses as international transactions, the re-characterization of Compulsorily Convertible Debentures (CCDs) as equity, the imposition of interest on outstanding receivables, and the determination of arm's length price (ALP) for reselling designated services. Additionally, procedural issues concerning the powers of the Dispute Resolution Panel (DRP) under section 144C(8) were examined.

The first core issue pertains to whether the reference made to the TPO by the AO-Technical Unit under the faceless assessment regime was valid and in accordance with law, impacting the limitation period for assessment. The second major issue concerns the treatment of AMP expenses as international transactions and the validity of transfer pricing adjustments made on substantive and protective bases using the Intensity approach and Bright Line Test (BLT). The third issue involves the re-characterization of interest paid on CCDs as equity dividends, leading to disallowance of interest deductions. The fourth issue relates to the imposition of interest on outstanding inter-company receivables by treating them as separate international transactions. The fifth issue concerns the adjustment made on account of reselling designated UC Singapore services, particularly the rejection of comparables and the DRP's directions. Lastly, the correctness of interest levies under sections 234A, 234B, and 234C was briefly raised.

Regarding the validity of the reference to the TPO, the legal framework under section 92CA(1) empowers the Assessing Officer (AO) to refer computation of ALP to the TPO with prior approval. The faceless assessment regime under section 144B(3) defines the roles of various units including Technical Units (TU), which provide technical assistance on transfer pricing issues. The assessee contended that the Technical Unit itself is authorized to handle transfer pricing matters and cannot delegate to the TPO, making the reference invalid and the assessment time-barred. The Revenue countered that under the faceless regime, the AO and Technical Unit function jointly, and the reference to TPO is permissible. The Court interpreted the provisions harmoniously, holding that the Technical Unit may seek expert assistance from the TPO, and such reference is valid. Consequently, the limitation period under section 153(4) is applicable, and the assessment is not barred by limitation.

On the AMP expenses issue, the AO/TPO treated routine AMP expenses incurred by the appellant as international transactions benefiting the Associated Enterprises (AEs), making upward transfer pricing adjustments on both substantive and protective bases using the Intensity approach and BLT. The assessee argued that AMP expenses were incurred as part of its distributor role, without any agreement with AEs, and did not result in creation of intangibles benefiting AEs. It contended that BLT and Intensity methods are invalid, relying on precedents including the jurisdictional High Court's decision in Sony Ericsson Mobile Communications India Pvt. Ltd., which held BLT as judicial legislation beyond Chapter X of the Act and invalid. The assessee further challenged the selection of functionally dissimilar comparables and the contradictory stance of treating AMP as both a function of distribution and a separate international transaction.

The Revenue defended the adjustments by asserting that AMP expenses enhanced the brand value of the AE and were incurred at AE's behest, supported by the Transfer Pricing Study Report (TPSR) indicating AE's control over AMP policies. It also noted that the Sony Ericsson decision is under challenge before the Supreme Court.

The Court extensively analyzed the legal framework and precedents, particularly the High Court's rulings in Sony Ericsson and Whirlpool of India Ltd. The Court emphasized that Chapter X of the Income Tax Act contemplates substitution of transaction price with ALP where an international transaction exists, but the existence of such a transaction involving AMP expenses must be established first. The BLT method to determine existence and ALP of AMP transactions was held invalid. The Court further noted the absence of any statutory machinery provision to tax AMP expenses as international transactions without clear evidence of such transactions. It observed that incidental benefit to AEs does not transform AMP expenses into international transactions. The Court also highlighted the distinction between Section 37 (business expenditure) and Chapter X (transfer pricing), noting that mere expenditure for business does not imply an international transaction for transfer pricing adjustments.

Consequently, the Court held that AMP expenses are not international transactions and deleted the transfer pricing adjustments made on both substantive and protective bases, disallowing the application of BLT and Intensity methods. It also disapproved the selection of dissimilar comparables and the contradictory approach of the AO/TPO/DRP.

Concerning the CCDs, the AO/TPO/DRP re-characterized the CCDs as equity, disallowing interest deductions and making an upward adjustment of Rs. 6 crores. The assessee contended that CCDs issued for 20 years with fixed interest and no voting rights before conversion are debt instruments until conversion, relying on company law definitions and several judicial precedents including Praxair India, WeWork India, and Kirloskar Pneumatic Co. Ltd. The assessee argued that the ALP of interest paid could not be benchmarked as nil without valid comparison and that the AO/TPO erred in disregarding the commercial substance of the transaction.

The Revenue argued that the option to convert CCDs into equity at any time before maturity and the loss-making status of the assessee indicated equity characteristics, justifying re-characterization under the substance-over-form principle and OECD guidelines.

The Court examined the definitions under the Companies Act and SEBI guidelines, noting that debentures evidence debt and are distinct from shares. It considered the contractual terms, fixed repayment schedule, interest obligations, absence of voting rights, and subordinated status of CCDs, concluding that CCDs retain the character of debt until conversion. The Court relied on the Bangalore Tribunal's decision in Embassy One Developers and the Bombay High Court's ruling in Kirloskar Pneumatic to affirm that interest on CCDs is allowable and the re-characterization as equity was incorrect. The adjustment disallowing interest was thus deleted.

Regarding interest on outstanding receivables, the AO/TPO/DRP treated delayed payments as separate international transactions and made upward adjustments by imputing interest benchmarked at LIBOR plus a spread. The assessee argued that receivables were ancillary to primary business transactions, only one invoice was delayed, and working capital adjustments had already been factored in. It relied on the jurisdictional High Court's decision in Kusum Healthcare Pvt. Ltd., which held that further adjustment for receivables would distort pricing.

The Revenue maintained that delay warranted adjustment. The Court found that the adjustment was not in accordance with law, noting that the transaction was part of the primary international transaction and the delay was minor and already accounted for in working capital. It deleted the adjustment.

On the issue of reselling designated UC Singapore services, the TPO rejected the assessee's comparables summarily, and the DRP directed reconsideration. The assessee challenged the DRP's direction as beyond its powers under section 144C(8), which allows the DRP to confirm, reduce, or enhance variations but not to set aside and decide de novo. The Court held that the DRP's direction to reconsider comparables was beyond its jurisdiction and set aside the DRP's findings, directing the DRP to decide objections in accordance with law. This ground was partly allowed, and related issues became academic.

Lastly, the assessee challenged the levy of interest under sections 234A, 234B, and 234C, but these were not elaborated upon in the judgment.

Significant holdings include the following verbatim excerpts illustrating the Court's reasoning on AMP expenses:

"The very existence of an international transaction cannot be presumed by assigning some price to it and then deducing that since it is not an ALP, an 'adjustment' has to be made. The burden is on the Revenue to first show the existence of an international transaction."

"In the absence of any clear statutory provision giving guidance as to how the existence of an international transaction involving AMP expense, in the absence of an express agreement in that behalf, should be ascertained and further how the ALP of such a transaction should be ascertained, it cannot be left entirely to surmises and conjectures of the TPO."

"The BLT as a determinative tool has been expressly invalidated by the Court in Sony Ericsson. Therefore, it is not possible to view this as a machinery provision."

"Merely because there is an incidental benefit to Whirlpool USA, it cannot be said that the AMP expenses incurred by WOIL was for promoting the brand of Whirlpool USA."

Regarding CCDs, the Court established the principle that CCDs retain the character of debt until conversion, and interest paid thereon is allowable, rejecting re-characterization as equity for transfer pricing adjustments.

On procedural powers, the Court clarified that the DRP under section 144C(8) does not have the authority to set aside issues and decide them afresh but can only confirm, reduce, or enhance variations proposed by the AO.

In conclusion, the Court dismissed the limitation plea regarding the reference to TPO, deleted transfer pricing adjustments on AMP expenses based on invalid methods and lack of evidence of international transactions, upheld the debt characterization of CCDs and allowed interest deductions, deleted adjustments on interest on outstanding receivables, and set aside the DRP's direction on comparables for reselling services to be decided afresh in accordance with law. The appeal was partly allowed accordingly.

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