2025 (8) TMI 1177 - AT - Income Tax

AMP benchmarking via Bright Line or intensity disallowed; AMP and royalty TP adjustments deleted; CUP applied s.37(1) royalties allowed

Sony India Pvt. Ltd. Versus ACIT, Circle-24 (1) /22 (2), Delhi

Sony India Pvt. Ltd. Versus ACIT, Circle-24 (1) /22 (2), Delhi - TMI ISSUES PRESENTED AND CONSIDERED 1. Whether adjustments to Advertisement, Marketing and Promotion (AMP) expenditure and related transfer pricing adjustments made by the Transfer Pricing Officer (TPO) using the Bright Line Test (BLT) or the mirror-image 'intensity adjustment' are permissible under Chapter X (sections 92-92F) and Rules (including Rule 10B/10TA) of the Income Tax Act. 2. Whether the TPO was justified in treating royalty payments as having arm's length price (ALP) of nil by rejecting the assessee's combined-transaction TNMM approach and applying the Comparable Uncontrolled Price (CUP) method without comparable data. 3. Whether the TPO's selection and rejection of comparables for benchmarking provision of advisory/business-support services (TNMM) - in particular inclusion of Fcbulka Advertising Pvt. Ltd. - was permissible and whether a fresh direction was required. 4. Whether interest on outstanding receivables for transfer-pricing purposes can be computed beyond the assessment year under consideration (i.e., up to date of TPO order) when determining adjustments for delayed receivables. 5. Whether difference between cost and Net Realisable Value (NRV) of certain closing stock, determined under Accounting Standard-2 (lower of cost and NRV), can be treated as disallowable notional loss for income-tax and book-profit (section 115JB) purposes. 6. Whether Corporate Social Responsibility (CSR) expenditure, charged to profit & loss, is to be disallowed under section 37(1)/treated as appropriation of profits for computation of total income and book profit under section 115JB. 7. Whether provision for warranty (created as per accounting practice and based on past experience/scientific method) is disallowable as contingent/unascertained liability or must be allowed (or not added back) for income-tax and book-profit purposes. 8. Whether reversal in the current year of a Mark-to-Market (MTM) loss previously disallowed in an earlier year gives entitlement to reduce current year taxable income/book profit (avoid double taxation), and whether such claim requires restoration to AO for verification. 9. Whether request to apply treaty provisions or beneficial treaty rates instead of domestic dividend distribution tax (DDT / section 115-O) can be entertained in the appeal. ISSUE-WISE DETAILED ANALYSIS Issue 1 - AMP adjustments: legal framework Legal framework: Chapter X (sections 92-92F) and Transfer Pricing Rules govern adjustment of prices of international transactions; ALP must be determined by recognized methods (e.g., TNMM, CUP, PSM) and by application of statutory machinery. There is no statutory provision expressly recognising BLT or quantitative re-characterisation of AMP as a separate international transaction outside Chapter X machinery. Precedent treatment: Coordinate benches and relevant High Court decisions have disapproved BLT and have held that quantitative adjustments treating excessive AMP spend as a separate international transaction are not permissible under Chapter X; intensity-type adjustments have been treated as mirror images of BLT and similarly invalidated by Tribunals and High Court observations relied upon by the Court. Interpretation and reasoning: The TPO's AMP adjustment proceeded by (a) treating DEMPE/marketing contribution as an international transaction without first establishing an actual international transaction and a disclosed price; (b) applying an arithmetic BLT or reversing BLT on comparables ('intensity adjustment') to create a notional AMP cost and then marking it up using margins of advertising firms; and (c) inferring a payment obligation by the AE. The Court reasoned that Chapter X requires Revenue to first identify an international transaction and its disclosed price and then determine ALP under recognized methods; creating an assumed price (via BLT/intensity) to infer an international transaction and then adjusting is contrary to the statutory scheme. The Court relied on High Court pronouncements that quantitative AMP benchmarking is not within Chapter X and that BLT/intensity adjustments lack statutory or machinery foundation. Ratio vs. Obiter: Ratio - BLT and intensity adjustments (including protective adjustments based on same arithmetic) are not permissible bases for TP adjustments under Chapter X; such adjustments must be deleted. Obiter - observations about policy and comparative foreign law noting that some jurisdictions have provisions for AMP adjustments. Conclusions: Both substantive and protective AMP adjustments based on BLT or intensity approach are invalid and deleted. (Cross-reference: grounds on comparability and computation affected by this outcome.) Issue 2 - Royalty transaction: legal framework Legal framework: ALP must be determined by appropriate TP method with requisite comparability analysis and recorded data; CUP requires identification of comparable uncontrolled transactions and supporting data; TNMM combined-transaction approach may be appropriate where transactions are closely linked. Precedent treatment: Coordinate bench earlier considered similar facts and rejected the TPO's approach of declaring royalty ALP as nil without comparable data; High Court/Tribunal authorities emphasise that TPO must use comparable data and cannot arbitrarily re-characterise parties (e.g., treating OEMs as ultimate royalty payers) contrary to agreements/licences. Interpretation and reasoning: The TPO rejected combined TNMM and applied CUP without recording comparable transactions/data, and asserted that OEM/manufacturers should have paid the royalty to ultimate owner; Tribunal examined the manufacturing/license agreement showing license to the tested party and agreed commercial necessity for the tested party to pay royalty. The Court held that TPO's conclusion that ALP is nil was arbitrary, unsupported by comparable data or contractual realities, and beyond TPO's remit to question commercial arrangements or benefits. Ratio vs. Obiter: Ratio - TP adjustment setting royalty ALP at nil without comparable data and contrary to contract/license terms is unsustainable; adjustment to be deleted. Obiter - emphasis that TPO cannot substitute its view of commercial necessity for factual contractual arrangements. Conclusions: Royalty adjustment (ALP nil) set aside; corresponding grounds allowed. Issue 3 - Advisory services comparables (inclusion of Fcbulka) Legal framework: Selection of comparables must be functionally similar and supported by publicly available complete financial statements; comparability adjustments must be reasoned and documented. Precedent treatment: Tribunal practice requires proper functional similarity and availability of complete financial statements; materially different/functionally dissimilar entities should be excluded. Interpretation and reasoning: The TPO included Fcbulka Advertising Pvt. Ltd., a functionally different entity lacking complete financial statements; exclusion of one comparable (Fcbulka) materially affects median margins and the TP outcome. Earlier coordinate-bench direction in related year restored comparable selection for fresh consideration. Ratio vs. Obiter: Ratio - Inclusion of functionally dissimilar/completely undocumented comparable is improper; TPO directed to exclude Fcbulka and rework benchmarking. Obiter - procedural need to afford reasonable opportunity to assessee if restoration ordered. Conclusions: Direction to TPO to exclude Fcbulka and make fresh adjustment in accordance with law; corresponding grounds allowed for statistical purposes. Issue 4 - Interest on receivables beyond assessment year Legal framework: Adjustments for delayed receivables should be based on transaction-specific facts and restricted to assessment year unless proper basis shown for extension; computation must be invoice-wise and verifiable. Precedent treatment: Tribunal has required that interest computation be confined to appropriate period and supported by invoice-wise data; where discrepancy exists, matter may be restored for verification. Interpretation and reasoning: TPO computed interest up to date of his order rather than confining to the assessment year; assessee produced invoice-wise details. Court found it appropriate to restore the issue to TPO to verify discrepancies and recompute interest limited to proper period. Ratio vs. Obiter: Ratio - Interest computation beyond assessed year without proper basis is not acceptable; restoration to TPO for verification is warranted. Obiter - none significant. Conclusions: Issue restored to TPO for verification and recomputation; grounds allowed for statistical purposes. Issue 5 - Inventory valuation (NRV lower than cost) Legal framework: Accounting Standard-2 permits valuation of inventories at lower of cost and NRV; tax computation generally follows accounting treatment unless there is misapplication or inconsistency warranting disallowance under tax law. Precedent treatment: Coordinate-bench decisions have upheld assessee's consistent application of accounting standard and rejected AO's additions where valuation method consistently followed and not shown to be incorrect. Interpretation and reasoning: AO questioned application of AS-2 and treated NRV differences as notional loss; Court followed coordinate decision in earlier year holding AO's observations without merit where method was consistently followed and supported by records. Ratio vs. Obiter: Ratio - NRV-based valuation under AS-2 consistently applied is acceptable and not a basis for disallowance; corresponding additions deleted. Obiter - emphasis on consistency and documentary support. Conclusions: Addition deleted; issue decided in favour of assessee. Issue 6 - CSR expenditure Legal framework: Explanation to section 37(1) and judicial interpretation govern deductibility of CSR expenditure; book-profit computation under section 115JB treats CSR in a specific manner per law and precedents. Precedent treatment: Coordinate-bench decisions (and authority relied) have found CSR expenditure charged to P&L to be not necessarily an appropriation disallowable in computation of income/book profit where precedents support allowability. Interpretation and reasoning: DRP/AO disallowed CSR as appropriation under explanation(2) to section 37; Tribunal followed coordinate-bench holdings in related year and decisions holding that CSR charged in P&L need not be treated as appropriation for tax/book-profit computation in these facts. Ratio vs. Obiter: Ratio - CSR expenditure in facts of the case not to be treated as disallowance/appropriation; allowed in computation. Obiter - reliance on analogous coordinate-bench rulings. Conclusions: CSR disallowance deleted; grounds allowed in favour of assessee. Issue 7 - Provision for warranty Legal framework: Provisions for warranty treated as a liability/expense if reliably estimated and based on past experience; tax treatment depends on whether liability is contingent/unascertained or ascertained and computed scientifically. Precedent treatment: Tribunal and High Court decisions have recognized warranty provisions as allowable where supported by scientific method and historical experience; Revenue required to show disproportionality or unreasonableness to disallow. Interpretation and reasoning: AO observed large unused balances in warranty provision and disallowed; Tribunal relied on earlier coordinate-bench and High Court findings that Revenue failed to establish unreasonableness and that warranty provision constituted an ascertained liability calculated by scientific method; therefore disallowance unsustainable. Ratio vs. Obiter: Ratio - Warranty provision allowed where computed on scientific/empirical basis and not shown to be excessive; disallowance and add-back for book profit deleted. Obiter - where actual warranty expenditure in the year can be separately claimed, restoration to AO for verification may be appropriate (though not necessary here). Conclusions: Warranty provision disallowance set aside; corresponding grounds allowed. Issue 8 - Reversal of MTM loss previously disallowed Legal framework: Tax treatment of MTM losses and reversals requires year-wise correct application of ICDS/accounting and avoidance of double taxation; AO may require computations showing earlier disallowance and present reversal. Precedent treatment: Tribunal has permitted restoration to AO to verify computations and to eliminate double taxation where prior year disallowance and current year reversal occur. Interpretation and reasoning: Assessee claimed reversal of earlier disallowed unrealised MTM loss; Tribunal directed restoration to AO to verify computation of double taxation with invoice-level/ledger-level proof and on verification to delete the addition if double taxation established. Ratio vs. Obiter: Ratio - Reversal of an item previously disallowed may be entitled to relief subject to verification; matter to be examined by AO with computations. Obiter - procedural direction to file computation and verify. Conclusions: Issue restored to AO for verification; corresponding grounds allowed for statistical purposes. Issue 9 - Dividend distribution tax / treaty relief Legal framework: Claims for treaty relief on dividend tax implicate treaty-override and statutory scheme; remedies available but depend on facts, treaty applicability and timing of claims in assessment process. Precedent treatment: Special-bench and higher authority rulings have settled certain aspects against such claims where law settled. Interpretation and reasoning: Additional grounds seeking treaty-based restriction of dividend distribution tax raise legal issues but are settled against the assessee by higher authority precedents. Ratio vs. Obiter: Ratio - Claim for relief from DDT in the assessment context is not allowable on the facts given the prevailing authoritative ruling. Obiter - none. Conclusions: Ground on DDT/treaty relief is decided against the assessee. OVERALL DISPOSITION Several transfer-pricing additions based on BLT/intensity (AMP) and royalty (ALP nil) are set aside; certain comparability issues restored to TPO for fresh consideration (advisory services comparable), interest-on-receivables and MTM reversal matters restored for verification; inventory valuation, CSR, warranty provisions decided in favour of the assessee; DDT issue decided against the assessee. Consequential adjustments to assessment to follow as per findings and directions above.