TaxTMI 
TaxTMI 
2015 (3) TMI 580
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....ceeding the 'bright line' is a separate and independent international transaction undertaken by the resident Indian assessee towards brand building for the brand owner, i.e. the foreign Associated Enterprise ('AE', for short). Other core issues pertain to aspects of arm's length pricing of international transactions. 2. The details of appeals and cross-appeals by the assessees and the Revenue and the assessment years involved are as under: Assessment year ITA No. Assessee Cross Appeal by Revenue 2008-09 16/2014 Sony Ericsson Mobile Communications India Pvt. Ltd / Sony Mobile Communication India Pvt. Ltd. Now known as, Sony India Ltd. 155/2014 2008-09 70/2014 Discovery Communications India 218/2014 2006-07 521/2013 Canon India Pvt. Ltd 132/2014 2008-09 92/2014 Daikin Air Conditioning (India) Pvt. Ltd 214/2014 2007-08 93/2014 Daikin Air Conditioning (India) Pvt. Ltd 215/2014 2008-09 99/2014 Haier Appliances Pvt. Ltd 642/2014 2006-07 100/2014 Haier Appliances Pvt. Ltd 621/2014 2007-08 101/2014 Haier Appliances Pvt. Ltd 622/2014 2008-09 109/2014 Reebok India Company ....
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....es ('MNE', for short). During the relevant period, the assessed were engaged in distribution and marketing of imported and branded products, manufactured and sold to them by the foreign AEs resident abroad. Intangible rights in the brand-name/ trademark/ trade-name were owned by the foreign AEs. There is no dispute or lis that the assessed are AEs who had entered into controlled transactions with the foreign AEs. It is also uncontested that the controlled international transactions can be made subject matter of the transfer pricing adjustment in terms of Chapter X of the Income Tax Act, 1961 ('Act', for short). 4. In order to appreciate the controversy, we are reproducing in brief the findings of the Assessing Officer/TPO and the Income Tax Appellate Tribunal ('Tribunal', for short) in the case of Sony Mobile Communication Ltd, i.e. the assessee/appellant in ITA No.16/2014 and the assessee/respondent in ITA No.155/2014 filed by the Revenue pertaining to assessment year 2008-09; Reebok India Company Ltd., i.e. the assessee/appellant in ITA No.109/2014 and the assessee/respondent in ITA No.213/2014 filed by the Revenue relating to assessing year 2008-09; and, Canon India Pvt. Ltd.....
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....e TNM Method for computing the arm's length price and the Profit Level Indicator ('PLI', for short) adopted was total turnover, in proportion to the net profit rate. While computing the net profit, the assessee had included credit notes worth Rs. 73,83,70,409/- received from the overseas/foreign AEs in December, 2007 and March, 2008. 7. The TPO held that Rs. 73,83,70,409/- represented excess price charged by the AE and were issued to achieve the arm's length return in accordance with the business model of the assessee. He observed that the total AMP expenditure of Rs. 115,72,15,159/- on gross sales of Rs. 1,638,68,08,123/- gave AMP to sales ratio of 7.06%. Business promotion and selling expenses of Rs. 49,66,58,381/- were included and added to arrive at the figure of AMP expenses of Rs. 115,72,15,159/-. Out of the 18 comparables suggested by the assessee, the TPO accepted 12 and rejected 6 for they were involved in brand promotion activities being the owners of the brand-name or the intangibles. The mean AMP to sales ratio of the 12 comparables was 3.35%. This figure of 3.35% was treated as the 'bright line' and accordingly the AMP expenditure, exceeding the said ratio was treat....
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....e United States of America. 11. The assessed Reebok India Co. Ltd. was incorporated in 1995 as a joint venture between Reebok Mauritius and Focus Energy Ltd., India. As per the details furnished by the assessee, they had entered into the following international transactions: " S. No. Nature of Transaction Method used by assessee Amount 1. Import of apparels and footwear for resale RPM 34,75,63,922 2. Royalty CUP 15,28,77,527 3. Identification of factories in India for sourcing/exporting the goods TNMM 73,87,878 The aforesaid table also gives details of method adopted by the assessee. The assessee had received reimbursement of advertisement and other expenses to the tune of Rs. 44,67,273/- from the AE. 12. In the appeals, we are concerned with the international transaction at Sl. No.1, i.e. import of apparels and footwear for resale in India. Transaction No.2 also arises for consideration, but has been examined separately. The assessee had adopted RP Method for arm's length determination of transaction No.1. The gross margin earned and declared by the assessed from controlled transactions was 42.95%, compared to 42.5....
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....lume discount scheme. These expenses were not linked with advertisement functions, but they had worked to enhance the brand value by popularizing the use of the product through discount and attractive offers, creating familiarity and market for the products. Thus, the said expenditure should be added to AMP expenses. Accordingly, Rs. 16,61,12,065/- on account of selling and distribution was added to the advertisement and publicity expenditure of Rs. 39,01,24,915/- to reach a figure of Rs. 55,62,36,980/-, which gave the ratio of AMP to sales of 12.33%. 15. On the question of 'bright line' comparables, the TPO rejected companies like Colgate India Ltd., Dabur India Ltd., GlaxoSmithKline Consumer Healthcare Ltd., Hindustan Unilever Ltd., Marico Ltd., Trent Ltd., and Emami Ltd., with the ratio of AMP to sales of Rs. 12.52%, observing that these companies were engaged in promotion of their own name and the AMP expenses incurred by them were non-routine. Another list of five comparables was rejected on different grounds. This list included Khadim India Ltd. and Liberty Retail Revolutions Ltd. engaged in similar business of footwear. 16. The TPO adopted the following comparables for....
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....se running and maintenance expenses 28,795,393 20 IITTF trade fair stall expenses 1,810,963 21 Store general Merchandising 8,400,943 Total 166,12,066 21. Referring to the judgment in LG Electronics India Pvt Ltd. (supra), the following directions stand passed: " 11. Accordingly, we remit the issue of AMP expenses to the files of the TPO with the following directions:- i) Expenditure in connection with the sales as mentioned above cannot b e brought within the ambit of advertisement, marketing and promotions expense for determining the cost / value of the international transactions. However, the TPO shall examine the veracity of description and quantification of the amount of selling expenses and accordingly, allow the assessee's claim. ii) After deducting the selling price from the AMP expenses as mentioned above, the TPO shall decide the issue of AMP expenses by applying the proper comparables after hearing the assessee and keeping in view the Special Bench directions in this behalf. CANON INDIA PVT. LTD. ITA No.521/2013 (by the assessee) and ITA No.132/2014 (by the Revenue) Assessment Year 2006-07 22. The assesse....
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....tributor was simply given set transfer price and the development of the US market was at risk and economic cost of the US distributor. (b) The foreign parent indirectly subsidized the development of the US market through a reduced transfer price. (c) The foreign parent provided the distributor with a rebate of a portion of the distributor's AMP expenditure based on sales volumes. Following the theories in the above Tax Court case, the cheese examples could require a return for the distributor investment in the marketing intangibles either in the form of a service fee arrangement with an appropriate profit margin or more robust operating margins to reflect the return for the developed marketing intangible. For the tax authorities sought to disallow a portion of the AMP expenditure under the notion that it was incurred on behalf of foreign trademark owner." 24. Reference was made to the decisions in DHL Inc. and subsidiaries and GlaxoSmithKline Holding (America's) Inc., and Australian Tax Office Guidelines to hold that the AMP expenses should be separately benchmarked. 25. The TPO held that the assessee had incurred AMP expenses totalling Rs. 37,88,97,359/-, or 12.08%....
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....37 Si printer - retail Partners support 28,33,888 Ill printer - market development support 14,56,455 Projector promotions 4,46,067 Digital cameras - road show POS and promo material 18,01,200 LV X5 DGS&D 20 sets 1,21,581 Against Nikon Exchange programme - advertisements and mailers 6,91,526 Market development support for copiers 89,93,987 Market development support for copiers 98,72,372 market development support for faxes 27,10,972 market development support for faxes 13,57,566 Fabrication and display of neon signs 20,40,011 Advertisement and sales promotion support for scanners 12,86,044 LFP Advertisement and promotion 5,43,149 Major account support for market development and deliverables 9,10,000 Trade-in (buy back) for DC channel sales 14,62,000 Advertisement and promotion -LBP schemes 25,39,980 Advertisement and promotion - LBP support for GIL project through SI Acer 19,59,300 Advertisement and Promotion for DV -To implant promoters in stores for 6 months 2,86,250 Advertisement and promotion for DC -1 GB CF card for promo 7,80,000 Advertisement and promotion for....
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....d in routine distribution business and are not carrying out of non routine activities like trade mark promotion and development of marketing intangible are selected. Step 3: to determine AMP expenditure of the comparables finally selected for benchmarking of international transaction of subsidy. Step 4: the ratios of AMP. expenditure to the sales of uncontrolled comparables (routine distributors) were taken as comparable uncontrolled price which were compared with the ratio of AMP expenditure to the sales in the case of the assessee to determine bright line limit as discussed in paragraph 7.5 and 7.6 of this order. Step 5: the AMP expenditure of the assessee which was in excess of bright line limit determined on the basis of comparable uncontrolled AMP prices was held as arm's length price of-the subsidy." 29. Accordingly, the TPO observed that the total AMP expenditure of Rs. 37,88,97,359/-, inclusive of discount and volume rebate of Rs. 16,07,59,162/- gave a percentage of AMP expenditure to total turnover, of 12.08%. For the purpose of comparables, TPO rejected the comparables adopted by the assessee to benchmark the international transaction for purpose of non-ro....
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....e Rs.4,49,46,654 Expenditure incurred by the assessee on AMP Rs.37,88,97,359 Expenditure incurred for developing the intangibles Rs. 37,88,97,359- Rs. 4,49,46,654 Rs. 33,39,50,705 Arm's length value of the Subsidy Rs. 33,39,50,705 Amount of Subsidy received by the Assessee Rs. 12,10,48,124 Difference Rs. 21,29,02,581 % of Difference with Value at which international transaction has taken place 175.88%" 32. Arm's length price for non-routine AMP expenses was computed at Rs. 21,29,02,581/-, recording the arm's length difference of 175.88%. 33. The DRP upheld the suggested transfer pricing adjustment. 34. The Tribunal in the impugned order has observed that following the majority judgment in L.G. Electronics India Pvt Ltd. (supra), the legal grounds should be decided against the assessee. On the question of nature and scope of AMP expenditure, as elucidated by the majority judgment in L.G. Electronics India Pvt Ltd. (supra), it was held that the sale related expenses, i.e. trade discount, volume rebate, cash discount, commission etc. should be excluded. To this extent, the appeal filed by the assessee was allowed for statistical ....
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....jority judgment in L.G. Electronics India Pvt Ltd. (supra) had reached the following findings:- (i) In terms of the Sub-Section 2B to Section 92CA, a TPO could have examined and applied transfer pricing provisions to a transaction, which comes to his notice, in respect of which the assessee has not furnished a report under Section 92E of the Act. Amendment by the Finance Act, 2012 incorporating Sub-Section 2B to Section 92CA was retrospective and applicable with effect from 1st June, 2002. Thus, the TPO could have examined the unreported international transaction relating to the AMP expenses. (ii) AMP was an international transaction, given the contours and ambit of the term 'transaction' and 'international transaction' as defined in the Act. (iii) The said character as an international transaction cannot be denied or negated because AMP expenditure was incurred in India and was paid by the assessed to independent parties in India. (iv) The contention that there was no express agreement apropos brand building for incurring AMP expenses was rejected, holding that such agreement or understanding could be inferred and could also be oral. Reference was made to the definitio....
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....alysis of comparable uncontrolled cases which should be really comparable, i.e. the comparable must deal with the same genus of products; have comparable market share; and the assets employed; the functions performed and the risks assumed should be similar. Paragraph 17.2 reads: "17.2. We find that the first step in making comparability analysis, is to find out some comparable uncontrolled cases. It goes without saying that a comparison can be made with the cases which are really comparable. A case is said to be comparable when it is from the same genus of products and also other relevant factors, such as, type of products, market share, assets employed, functions performed and risks assumed, are also similar. Once proper comparable cases are chosen, then the next step is to neutralize the effect of the differences in relevant facts of the case to be compared and the assessee's case, by making suitable plus or minus adjustments." (xi) The Tribunal enumerated 14 criteria/parameters for selection of comparables for applying the 'bright line test' and determination of the cost/value of the international transaction of brand/logo promotion by incurring AMP expenses by an Indi....
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....n entity for the promotion of its brand in any form, such as subsidy on the goods sold to the Indian associated enterprise? 10. Where such subsidy is allowed by the foreign associated enterprise, whether the amount of subsidy is commensurate with the expenses incurred by the Indian entity on the promotion of brand for the foreign associated enterprise? 11. Whether, the foreign associated enterprise has its presence in India only in one field or different fields ? Where it is involved in different fields, then is there only one Indian entity looking after all the fields or there are different Indian associated enterprises for different fields ? If there are different entities in India, then what is the pattern of advertising, marketing and promotion expenses in the other Indian entities? 12. Whether the year under consideration is the entry level of the foreign associated enterprise in India or is it a case of established brand in India? 13. Whether any new products are launched in India during the relevant period or is it continuation of the business with the existing range of products? 14. How the brand will be dealt with after the termination of agreement between a....
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....od. (b) Scrutiny of Chapter X of the Act and language of Section 92(3) mandates and sanctions that TNM Method would be applied only on a transactional level and not at the entity level. (c) Bunching of international transactions was not permissible and each international transaction has to be separately valued and accordingly arm's length price computed. Each transaction should be taken as an independent transaction, for computing arm's length price. (d) Profit of an entity would depend upon several factors which contribute in earning of profits. Thus, costs of AMP expenses were independent of cost of raw material/products. (e) The factum that the assessed had declared an overall higher profit rate in comparison with the comparables was insufficient and sparse. It was certainly not a licence to the assessed to not record the AMP expenses as an international transaction. Benefit, service or facility furnished and provided to the AE resident abroad required compensation at arm's length price. (xiv) The argument that expenditure incurred on AMP was subsumed and included in the value of the international transaction already disclosed and paid for by the foreign AE,....
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....iples enrolled, were binding. What had been set aside by the Supreme Court were the observations on merits relating to facts, and not law. The legal principles enunciated by the High Court in Maruti Suzuki (supra) were not expressly or impliedly overruled. (xxi) AMP expenses would not include direct selling costs like trade or volume discounts, incentives etc. Direct marketing and sale related expenses or discounts/concessions would not form part of the AMP expenses. (xxii) Section 37(1) of the Act and the arm's length proceedings under Chapter X of the Act, operate independently. The AMP expenses, allowable as expenditure under Section 37(1) of the Act, would not affect determination of the arm's length price of an international transaction or income of the Indian assessee who has to pay tax in India. Accordingly, the TPO was entitled to make adjustment and compute the arm's length price, notwithstanding the legal position that AMP expenses were deductible under Section 37(1) of the Act. Determination and, if required, adjustment of the arm's length price is the mandate under Chapter X of the Act. 39. We are not at this stage referring to the minority decision, though we ....
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....l apply as if such transaction is an international transaction referred to him under sub-section (1). ###(2C) Nothing contained in sub-section (2B) shall empower the Assessing Officer either to assess or reassess under section 147 or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154, for any assessment year, proceedings for which have been completed before the 1st day of July, 2012. *Inserted by the Finance Act, 2002, w.e.f. 1-6-2002. *** Inserted by the Finance Act 2011, w.e.f. 1-6-2011. # Substituted by the Finance Act 2012, w.e.f. 1-4-2013. ## Inserted by the Finance Act 2012, w.r.e.f. 1-6-2002. ### Inserted by the Finance Act 2012, w.e.f. 1-7-2012." 42. Section 92CA(1) deals with reference to a TPO by an Assessing Officer, for computation of arm's length price in relation to an international transaction or a specified domestic transaction. It requires and mandates prior approval of the Commissioner. It is undisputed that the Assessing Officer had taken approval of the Commissioner under sub-section (1) to Section 92CA of the Act. The controversy raised is that ....
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....e said conditions to evaluate transfer price of an undeclared and unreported international transaction. The TPO must justify and establish that there was an international transaction. Satisfaction of the conditions can be also inferred from the findings recorded by the TPO. Only when these conditions are satisfied, the TPO would exercise his jurisdiction. Whether or not the said conditions are satisfied in a given case, would first depend upon the factual matrix and also possibly on the appropriate and applicable legal principles. Wrong assumption of jurisdiction by recording an erroneous finding, deciding whether there was a hidden or unknown international transaction or whether a report in respect of the said international transaction under Section 92E was not furnished, are matters that can be argued and adjudicated in appeal. 46. After insertion of sub-section (2B) to Section 92CA of the Act, w.e.f. 1st June, 2002, we have to give full effect to the said provision and not negate or curtail the retrospective effect. A retrospective amendment has a deeming effect and also consequences. The said effect cannot be unwritten or erased. The argument of the assessee that sub-section....
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.... erroneous. The said pre-requisite was missing, on the date when the order under Section 263 of the Act was passed. 49. There is an additional reason why the assessee's contentions must fail. In the present case, the claim of the assessee is that they had disclosed the international transaction in their report under Section 92E which included AMP expenses incurred by them. This aspect relates to merits, i.e. whether or not there was one composite, bundled or a packaged international transaction, but once for the said transaction a report in Form 92E was submitted, separate reference/approval was not required. Reference of the bundled transaction under sub-section (1) to Section 92CA is sufficient. Section 92CA has to be interpreted pragmatically. Therefore, once reference of a composite/bundled or packaged international transaction is made, it will be difficult for the assessee to contest applicability of sub-section (1) in cases of segregation or when the TPO invokes sub-section (2B) to Section 92CA of the Act. This flaw as it existed stands corrected with insertion of Sub-Section (2B) to Section 92CA with retrospective effect. It clarifies and 'cures' the deficiency and shortc....
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....ransaction included the said element or function of AMP expenses, for which they stand duly compensated in their margins or the arm's length price as computed. 53. We also fail to understand the contention or argument that there is no international transaction, for the AMP expenses were incurred by the assessed in India. The question is not whether the assessed had incurred the AMP expenses in India. This is an undisputed position. The arm's length determination pertains to adequate compensation to the Indian AE for incurring and performing the functions by the domestic AE. The dispute pertains to adequacy of compensation for incurring and performing marketing and 'non-routine' AMP expenses in India by the AE. The expenses incurred or the quantum of expenditure paid by the Indian assessee to third parties in India, for incurring the AMP expenses is not in dispute or under challenge. This is not a subject matter of arm's length pricing or determination. 54. The fact that this expenditure was incurred and has to be allowed as deduction under Section 37(1) of the Act has not been challenged by the Revenue. Revenue in their written submission accepts and has rightly stated that t....
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.... applicable has to be given full application. Impact of Chapter X of the Act cannot be controlled or curtailed by reference to the allowability of expenditure under Section 37(1) of the Act. As noticed above and subsequently, provisions of Chapter X are applicable to international transactions between two related enterprises. The purpose of determination of arm's length price is to find out the fair and true market value of the transaction and accordingly the adjustment, if required, is made. The said exercise has its own object and purpose. 57. In terms of the aforesaid discussion, question No.2 has to be answered against the assessed and in favour of the Revenue. 58. There are other aspects on which we also agree with the majority judgment of the Tribunal but would not like to deal with them at this stage but would refer to the same when we examine these aspects on merits. D. Transfer Pricing of International Transactions 59. A significant volume of global trade consists of international transfer of goods, services, capital and intangibles. As per the United Nations Practical Manual on Transfer Pricing, 2013, international transfers within MNE group entities which are....
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....ach country can formulate detailed domestic legislation to implement and check controlled pricing. Thus, the transfer pricing regulations may differ from country to country. In practice, this is partly true. Growing importance of international trade, globalization and rapid rise in the number of MNEs has resulted in exhaustive and meticulous research and studies in this complex area. The transfer pricing methods have seen a measure of standardization, universal recognition and acceptability. Indian transfer pricing regulations have adopted and benefited, from the international framework. The OECD Transfer Pricing guidelines for multinational enterprises and tax administration and United Nations' Practical Manual on Transfer Pricing do reflect the international understanding on several aspects relating to transfer pricing. We have taken note and liberally referred to the two guidelines as it is found to be conducive and helpful in deciding the issues. Their relevance has been examined in some detail below. E. Domestic Law, i.e. the Statutory Provisions of the Act. 61. Sections 92(1), 92(2) and 92C of the Act, are reproduced herein for the sake of convenience, " Comput....
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....he Central Government in the Official Gazette in this behalf, the price at which the international transaction or specified domestic transaction has actually been undertaken shall be deemed to be the arm's length price. The following third proviso shall be inserted after the second proviso to sub-section (2) of section 92C by the Finance (No.2) Act, 2014, w.e.f. 1-4-2015: Provided also that where more than one price is determined by the most appropriate method, the arm's length price in relation to an international transaction or specified domestic transaction undertaken on or after the 1st day of April, 2014, shall be computed in such manner as may be prescribed and accordingly the first and second proviso shall not apply. Explanation.-For the removal of doubts, it is hereby clarified that the provisions of the second proviso shall also be applicable to all assessment or reassessment proceedings pending before an Assessing Officer as on the 1st day of October, 2009. (2A) Where the first proviso to sub-section (2) as it stood before its amendment by the Finance (No. 2) Act, 2009 (33 of 2009), is applicable in respect of an international transaction for an as....
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.... Officer may compute the total income of the assessee having regard to the arm's length price so determined: Provided that no deduction under section 10A [or section 10AA] or section 10B or under Chapter VI-A shall be allowed in respect of the amount of income by which the total income of the assessee is enhanced after computation of income under this sub-section : Provided further that where the total income of an associated enterprise is computed under this sub-section on determination of the arm's length price paid to another associated enterprise from which tax has been deducted 2[or was deductible] under the provisions of Chapter XVIIB, the income of the other associated enterprise shall not be recomputed by reason of such determination of arm's length price in the case of the first mentioned enterprise." 62. We are not elaborately exacerbating the said provisions to avoid prolixity and would only refer to specifics relevant to decide the present appeals. 63. Sub-section (1) to Section 92 states that any income arising from an international transaction shall be computed having regard to arm's length price. It includes expense or interest arising f....
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....cordance with Section 92C(1) and (2) on the basis of material, information or documents in his possession, if any of the circumstances mentioned in clauses (a) to (d) are satisfied. The circumstances being: the price paid or charged for an international transaction has not been determined in accordance with sub-sections (1) and (2); information or documents relating to an international transaction has not been kept or maintained in accordance with the provisions of Section 92D(1) or the Rules; information or data used in computation or arm's length price is not reliable or correct; or the assessed has failed to furnish, within stipulated time, information or document required to be furnished as per notice under sub-section (3) to Section 92D. (See judgment dated 16th December, 2013 in ITA No. 306/2012 titled Li & Fung India Pvt. Ltd. vs. Commissioner of Income Tax of the Delhi High Court). Five Methods 65. Comparable Uncontrolled Price Method ('CUP Method', for short) compares price charged for the property or service in a controlled transaction with the price charged for comparable property or service in an uncontrolled transaction in comparable circumstances. In RP Me....
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.... are set out and articulated step-wise in detail in Rule 10B of the Rules. Be it any of the five methods, the first step to be exercised is to identify the international transaction and the transfer price paid for the same by two AEs. The second step is to carry out functional analysis i.e. the functions to be performed by the two AEs taking into account the assets used, risk assumed, the contractual terms, the economic circumstances of the parties and the business strategy pursued by the parties. On the question of comparability analysis United Nations' Practical Manual on Transfer Pricing in paragraph 5.1.1 states that the analysis is used to designate two distinct but related analytical steps. First being to understand the economic significant characteristic of the controlled transaction between the two AEs and the respective roles of the parties thereto. This has reference to the 5 characteristics i.e. (a) characteristic of property or services transferred; (b) functions performed by the parties taking into account assets employed and risk assumed i.e. functional analysis; (c) contractual terms; (d) economic circumstances and (e) business strategies pursued. The second analytic....
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....egree of features which can be usefully compared for determination of the arm's length price. The characters would include in cases of transfer of tangible property, the physical features of the property, its quality, reliability, availability, volume or supply and in cases of service, the nature and extent of service and in cases of intangible property, the form of transaction, licensing or sale, the type of property, i.e. trademark, patent, know-how, the duration and degree of patent and anticipated benefits. The function analysis test in selection of the comparables seeks to identify and compare economically significant activities and the responsibilities undertaken, the asset used and the risk assumed by the parties to the transaction. The functions, which an assessee may perform, would include design, manufacturing, assembling, research and development servicing, purchasing, distribution, marketing, advertising, transportation, etc. The principal function performed by the party under examination should be identified. Adjustments should be made for any material differences from the functions undertaken by the independent comparable enterprise and the tested party. While examini....
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....the specified domestic transaction and the uncontrolled transaction and between the enterprises entering into such transactions; (e) the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction or the specified domestic transaction and the comparable uncontrolled transaction or between the enterprises entering into such transactions; (f) the nature, extent and reliability of assumptions required to be made in application of a method." 72. Sub-rule (1) requires ascertainment of facts and circumstances of a particular international transaction and the method, which would provide the most reliable measure of the arm's length price. Sub-rule (2) stipulates that while selecting the most appropriate method, clauses (a) to (f) should be taken into account. Therefore, it would be appropriate and proper for the assessed to indicate why and for what reason the method applied is the most appropriate. Similarly, if the Assessing Officer/TPO disagree, they should stipulate and elucidate the reason for selecting or applying a particular method. Clauses (a) to (f) of sub-rule (2) are wide and presc....
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....esponsibilities, risk and benefits divided between the respective parties to the transactions. Clause (d) refers to the conditions prevailing in the markets of the respective parties to the transactions, overall economic development and level of competition and whether or not the markets are wholesale or retail. 75. Equally significant is sub-rule (3) to Rule 10B, which reads:- " 10B. (3) An uncontrolled transaction shall be comparable to an international transaction or a specified domestic transaction if- (i) none of the differences, if any, between the transactions being compared, or between the enterprises entering into such transactions are likely to materially affect the price or cost charged or paid in, or the profit arising from, such transactions in the open market; or (ii) reasonably accurate adjustments can be made to eliminate the material effects of such differences." To understand sub-rule (3), one must account for the definition of the term, "uncontrolled transaction". Rule 10A in clause (a) defines the term, "Uncontrolled transaction" for Rules 10B to 10E, as transactions between enterprises other than AEs, whether resident or non-res....
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....es that where more than one price is determined by most appropriate method, the arm's length price shall be taken to be the arithmetical mean of such prices. 77. As a concept and principle Chapter X does not artificially broaden, expand or deviate from the concept of "real income". "Real income", as held by the Supreme Court in Poona Electricity Supply Company Limited versus CIT, [1965] 57 ITR 521 (SC), means profits arrived at on commercial principles, subject to the provisions of the Act. Profits and gains should be true and correct profits and gains, neither under nor over stated. Arm's length price seeks to correct distortion and shifting of profits to tax the actual income earned by a resident/domestic AE. The profit which would have accrued had arm's length conditions prevailed is brought to tax. Misreporting, if any, on account of non-arm's length conditions resulting in lower profits, is corrected. 78. The aforesaid methods are systematic and methodical and in spite of prescription, there is an element of discretion and flexibility involved in selection of appropriate method, selection of comparable, functional analysis or adjustments. This play in the joints and latitud....
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....Inspector of Taxes) (1979) 2 All ER 677, Sin Poh Amalgamated (H.K.) Ltd versus Attorney-General (1965) 1 All ER 225 (PC)) 80. The use of expression 'class of transaction', 'functions performed by the parties' in Section 92C(1) illustrates to the contrary, that the word 'transaction' can never include and would exclude bundle or group of connected transactions. More important would be reference to meaning of the term 'transaction' in Section 92F, clause (v), which as per the said definition includes an arrangement or understanding or action in concert whether or not the same is formal or in writing, whether or not it is intended to be enforceable by legal proceedings. Rule 10A in clause (d) states that "for the purpose of this Rule and Rules 10AB and 10E", the term 'transaction' would "include a number of closely linked transactions". This Rule in positive terms declares that the legislative intent is not to deviate from the generic rule that singular includes plural. The meaning or definition of the expression 'transaction' in clause (d) to Rule 10A read with sub-section (1) to Section 92C, therefore, does not bar or prohibit clubbing of closely connected or intertwined or conti....
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....lause (e) to Rule 10B(1) of the Rules. We are reproducing the said Rule as it has been applied by the assessees in several cases and the TPO has also accepted application of the said method, but treated the AMP expenses as an independent transaction, a finding upheld by the majority judgment in L.G. Electronics India Pvt Ltd. (supra) and in the present cases. Clause (e) to Rule 10B(1) reads: "10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction or a specified domestic transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- Xxx (e) transactional net margin method, by which,- (i) the net profit margin realised by the enterprise from an international transaction or a specified domestic transaction entered into with an associated enterprise is computed in relation to costs incurred or sales effected or assets employed or to be employed by the enterprise or having regard to any other relevant base; (ii) the net profit margin realised by the enterprise or by an unrelated enterprise from a compa....
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....uncontrolled transaction, which would materially affect the net profit margin in the open market. 88. Under sub-clause (v), net profit margin thus established, is taken to arrive at an arm's length price in relation to the international transaction. 89. The TNM Method has seen a transition from a disfavoured comparable method, to possibly the most appropriate Transfer Pricing method due to ease and flexibility of applying the compatibility criteria and enhanced availability of comparables. Net profit record/data is assessable and within reach. It is readily and easily available, entity-wise in the form of audited accounts. The TNM Method is a preferred transfer pricing arm's length principle for its proficiency, convenience and reliability. Ideally, in TNM Method preference should be given to internal or in-house comparables. In absence of internal comparables, the taxpayer can and would need to rely upon external comparables, i.e. comparable transactions by independent enterprises. For several reasons, database providers, it is apparent, have the requisite information and data of external comparables to enable comparability analysis of the controlled and uncontrolled transactio....
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.... adequately on separate basis. Segmentation may be mandated when controlled bundled transactions cannot be adequately compared on an aggregate basis. Thus, taxpayer can aggregate the controlled transactions if the transactions meet the specified common portfolio or package parameters. For complex entities or where one of the entities is not 'plain vanilla distributor', it should be applied when necessary and applicable comparables on functional analysis, with or without adjustments are available. Otherwise, the TNM Method should not be adopted or applied on account of being an inappropriate method. 92. The majority judgment refers to an example where the Indian AE may have earned actual profit of Rs. 140/-, but returned reduced net profit of Rs. 120/- as the Indian AE had incurred brand building expenses to the tune of Rs. 20/- for the foreign AE, whereas the net profit on sales declared by comparable uncontrolled transactions was Rs. 100/- only. Thus, it was observed that the costs including AMP expenses are independent of cost of imported raw material/finished products having some correlation with overall profit. The example highlights the weakness of the TNM Method. The reaso....
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....es 300 Marketing expenses 50 Net profit 150 (15%) It is obvious that this would not be the correct way and method to compute the arm's length price. The purchase price adjustments/set off would be mandated to arrive at the arm's length price, if the AMP expenses are segregated as an independent international transaction. The position may be worse for the assessed, in case the Assessing Officer makes an addition of Rs. 100/- and adds 15% thereto by applying CP Method, i.e. Cost Plus Method. Consequently, the addition made would be of Rs. 115/-. When Rs. 115/- is added to the TNM Method computation of Rs. 150/-, it would result in the total income of Rs. 265/- or a net profit of 26.5%. Even if the Assessing Officer does not reduce the AMP expenses from Rs. 150/- to Rs. 50/-, while computing the arm's length price by applying the TNM Method, it would yet result in unacceptable anomaly for the net profit margin would be Rs. 50/- plus Rs. 115/- or 16.15% instead of 5%. Besides, the said approach would be illogical and unacceptable for AMP expenses when segregated as an independent international transaction, must be treated s....
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....ired, after making adjustments, then there should be no difficulty in accepting the international transfer price. In case of discrepancy, addition may be justified where the net profit margin declared in the case of the tested party is lower than the comparable. A comparable should be accepted if it deals with the same or identical or similar property under the same or substantially the same circumstances as the controlled transaction so as to give reliable and more certain measure of arm's length result. All methods including the TNM Method acknowledge that there could be difference between tested part and the comparable on functional analysis, but this would not be material where it is possible to reasonably ascertain the effect on account of the differences for which appropriate adjustments can be made. Thus, selection of the comparable depends upon the functional analysis, similarity as to the several factors and whether or not it is possible to make adjustments to account for the material differences in such circumstances to accept or reject a comparable. Selection of the appropriate comparable ensures similar profit potential and accordingly taxation of the subsidiary AE in t....
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....sis and when examining the reliability of comparables. See paragraphs 1.59-1.63 on business strategies. However, as discussed in, paragraphs 1.70-1.72, these considerations will not explain continued overall losses or poor performance over time. Moreover, in order to be acceptable, portfolio approaches must be reasonably targeted as they should not be used, to apply a. transfer pricing method at the taxpayer's company-wide level in those cases where different transaction's. have different economic logic and should be segmented. See paragraphs 2.78 - 2.79. Finally, the above comments. should not be misread as implying that it would be acceptable for one entity within an - MNE group to have a below arm's length return in order to provide benefits to another entity of the MNE group, see in particular paragraph 1.71. 3.11 While some separately contracted transactions between associated enterprises may need to be evaluated together in order to determine whether the conditions are arm's length, other transactions contracted between such enterprises as a package may need to be evaluated separately. An MNE may package as a single transaction and establish a single ....
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....so refers to allocation of price elements of a package or bundle of transactions. It recommends that segregation should be done in a way that the tax administration must be able to analyse similar deals between independent enterprises. This aspect of segregation has been examined separately. 100. The TPO/Assessing Officer can overrule the assessee as to the method adopted and select the most appropriate method. The reasons for selecting or adopting a particular method would depend upon functional analysis, comparison, which requires availability of data of comparables performing of similar or suitable functional tasks in a comparable business. When suitable comparables relating to a particular method are not available and functional analysis or adjustments is not possible, it would be advisable to adopt and apply another method. This would mean in the example given above, if the Assessing Officer/TPO notices that operating expenses in the case of the tested party are substantially lower than the comparable or indicative of greater and better efficiency, he can make suitable adjustments and then compute the operating profit. In case it is not possible to make adjustment, he may r....
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....user perceives relevant, unique, sustainable added values which match their needs most closely." The words of the Supreme Court in Civil Appeal No.1201/1966 decided on 12th February, 1970 in Khushal Khenger Shah versus Mrs. Khorshedbanu Dabida Boatwala, to describe 'goodwill', can be adopted to describe a brand as an intangible asset being the whole advantage of the reputation and connections formed with the customer together with circumstances which make the connection durable. The definition given by Lord MacNaghten in Commissioner of Inland Revenue versus Muller & Co's Margarine Ltd., 1901 AC 217 (223) can also be applied with marginal changes to understand the concept of brand. In the context of 'goodwill' it was observed: "It is very difficult, as it seems to me, to say that goodwill is not property. Goodwill is bought and sold every day. It may be acquired. I think, in any of the different ways in which property is usually acquired. When a man has got it he may keep it as his own. He may vindicate his exclusive right to it if necessary by process of law. He may dispose of it if he will - of course, under the conditions attaching to property of that nature..............What....
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....nically viewed as "a seed sprouting" or an "acorn growing into the mighty Oak of goodwill". ... It has been historically explained as growing and crystallising traditions in the business. It has been described in terms of a magnet as the "attracting force". In terms of comparative dynamics, goodwill has been described as the "differential return of profit." Philosophically it has been held to be intangible, Though immaterial, it is materially valued. Physically and psychologically, it is a "habit" and sociologically it is a "custom". Biologically, it has been described by Lord Macnaghten in Trego v. Hunt, 1896 AC 7 as the "sap and life" of the business. It has been horticulturally and botanically viewed as "a seed sprouting" or an "acorn growing into the mighty Oak of goodwill". It has been geographically described by locality. It has been historically explained as growing and crystallising traditions in the business. It has been described in terms of a magnet as the "attracting force". In terms of comparative dynamics, goodwill has been described as the "differential return of profit." Philosophically it has been held to be intangible, Though immaterial, it is materially valued. P....
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....as reference to brand goodwill, compared to a baseline of an unknown brand. It is in this manner that value of the brand or brand equity is calculated. Such calculations would be relevant when there is an attempt to sell or transfer the brand name. Reputed brands do not go in for advertisement with the intention to increase the brand value, but to increase the sales and thereby earn larger and greater profits. It is not the case of the Revenue that the foreign AEs are in the business of sale/transfer of brands. 107. Accounting Standard 26 exemplifies distinction between expenditure incurred to develop or acquire an intangible asset and internally generated goodwill. An intangible asset should be recognised as an asset, if and only if, it is probable that future economic benefits attributable to the said asset will flow to the enterprise and the cost of the asset can be measured reliably. The estimate would represent the set off of economic conditions that will exist over the useful life of the intangible asset. At the initial stage, intangible asset should be measured at cost. The above proposition would not apply to internally generated goodwill or brand. Paragraph 35 specifica....
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....s producing it and it is impossible to predicate the moment of its birth for it comes silently into the world unheralded and unproclaimed. Its benefit and impact need not be visibly felt for some time. Imperceptible at birth, it exits unwrapped in a concept, growing or fluctuating with numerous imponderables pouring into and affecting the business. Thus, the date of acquisition or the date on which it comes into existence is not possible to determine and it is impossible to say what was the cost of acquisition. The aforesaid observations are relevant and are equally applicable to the present controversy. 110. It has been repeatedly held by Delhi High Court that advertisement expenditure generally is not and should not be treated as capital expenditure incurred or made for creating an intangible capital asset. Appropriate in this regard would be to reproduce the observations in CIT versus Monto Motors Ltd, [2012] 206 Taxman 43 (Del), which read:- "4. ... Advertisement expenses when incurred to increase sales of products are usually treated as a revenue expenditure, since the memory of purchasers or customers is short. Advertisement are issued from time to time and ....
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....alistic and impracticable, if not delusive and misleading. (Aforesaid reputed Indian companies, it is patent, are not to be treated as comparables with the assessed, i.e. the tested parties in these appeals, for the latter are not legal owners of the brand name/trademark.) 112. Branded products and brand image is a result of consumerism and a commercial reality, as branded products 'own' and have a reputation of intrinsic believability and acceptance which results in higher price and margins. Trans-border brand reputation is recognized judicially and in the commercial world. Well known and renowned brands had extensive goodwill and image, even before they became freely and readily available in India through the subsidiary AEs, who are assessees before us. It cannot be denied that the reputed and established brands had value and goodwill. But a new brand/ trade-mark/ trade-name would be relatively unknown. We have referred to the said position not to make a comparison between different brands but to highlight that these are relevant factors and could affect the function undertaken which must be duly taken into consideration in selection of the comparables or when making subjectiv....
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....n India along with the assessee's own name. If it is so, the matter ends. The AO will have to allow deduction for the entire AMP expenses whether or not these are proportionately higher. But if it is found that apart from advertising the products and the assessee's name, it has also simultaneously or independently advertised the brand or logo of the foreign AE, then the initial doubt gets converted into a direct inference about some tacit understanding between the assessee and the foreign AE on this score. As in the case of an express agreement, the incurring of AMP expenses for brand building draws strength from such express agreement; in the like manner, the incurring of proportionately more AMP expenses coupled with the advertisement of brand or logo of the foreign AE, gives strength to the inference of some informal or implied agreement in this regard. 9.11. Adverting to the facts of the instant case, it is noticed that the ld. DR has amply shown that the assessee not only promoted its name and products through advertisements, but also the foreign brand simultaneously, which has remained uncontroverted on behalf of the assessee. This factor together with the fact that the asses....
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....enterprises behaving in a commercially rational manner, which unearths the covert act of treating the AMP expenses incurred for the brand building for and on behalf of the foreign AE, as also its own. What is relevant to consider is as to whether an independent enterprise behaving in a commercially rational manner would incur the expenses to the extent the assessee has incurred. If the answer to this question is in affirmative, then the transaction cannot be recharacterized. If, however, the answer is in negative, then the transaction needs to be probed further for determining as to whether its recharacterization is required. Such recharacterization can be done with the help of the ratio decidendi of this judgment itself, being, making a comparison with what `independent enterprises behaving in a commercially rational manner' would do, tied with the fact of the assessee also simultaneously advertising the brand of its foreign AE. Reverting to the context of AMP expenses, one needs to find out as to how much AMP expenses would independent enterprises behaving in a commercially rational manner, incur. Once by making such a comparison, the result follows that the Indian AE, prominentl....
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....mpany, who is legal owner of the brand, sells its brand to a third party for a particular consideration, can it be said that the Indian assessee or for that purpose the wholesalers or retailers should also get share in the total consideration towards the sale of brand because they were also economic owners of such brand to some extent? The answer is obviously in negative. It is only the foreign enterprise who will recover the entire sale consideration for the sale of brand and will be subjected to tax as per the relevant taxing provisions. There can be no tax liability in the hands of the Indian AE or the wholesalers or the retailers for parting with the economic ownership of such brand under the Act. In that view of the matter we are of the considered opinion that the concept of economic ownership of a brand, albeit relevant in commercial sense, is not recognized for the purposes of the Act. The above discussion leads us to irresistible conclusion that the advertisement done by the assessee also carrying the brand/logo of its foreign AE coupled with the fact that it spent proportionately higher amount on AMP expenses, gives clear inference of a `transaction' between the assessee a....
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....ax law. xxx 15.6. There can be an international transaction between the assessee and its AE under which the assessee incurs some expenses on behalf of its AE. There arises no difficulty when despite there being no formal agreement, the Indian AE incurs such expenses and keeps them in a separate account. The difficulty arises only when such expenses are either clubbed with certain other expenses incurred for the foreign AE or combined with certain similar expenses incurred by the Indian AE for its own business purpose. It is in such a later situation that the task of separating the costs incurred for the foreign AE and those for the business of the Indian AE, assumes significance. If such expenses in two classes are identifiable, one can separate them with ease. But, when both the expenses are intermingled and otherwise inseparable, then some mechanism needs to be devised for ascertaining the cost of the international transaction, being the amount of expenses incurred for the foreign AE. 15.7. As in the present case the assessee did not declare any cost/value of the international transaction of brand building, it became imperative for the TPO to find out such co....
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....lue of the international transaction, in the instant case is Rs. 161.21 crore. The TPO impliedly considered the same figure as both representing the cost/value of international transaction and also its ALP. However, the DRP came to hold that mark-up of 13% should also have been applied. In a way, the DRP adopted the cost/value of international transaction at Rs. 161.21 crore and computed the ALP of such transaction at Rs. 182.71 crore. It is this final figure of Rs. 182.71 crore which was eventually considered by the AO for making adjustment, against which the assessee has come up in appeal before the tribunal. 15.10. The fact of the matter is that it is the cost/value of the international transaction at Rs. 161.21 crore which has been determined by applying the bright line test. Position would have been different if the ALP of the international transaction would have been determined by invoking bright line test. What is appropriate is the substance of the matter and not the nomenclature given to a transaction. In our considered opinion the name given to the method of computing the cost/value of international transaction, whether bright line test or otherwise, has no signi....
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....s). In these models, the foreign companies invariably remunerate the Indian subsidiary with the cost together with some additional fee for such market support activities." 116. It was urged by the Revenue that development of markets for the products is the core function of the entrepreneur, which in this case is the foreign company, an AE. Implementation depends upon the business models of MNEs and how they want this core function to be exercised. Performance of this function clearly benefits the brands and market intangibles owned by the parent company. The test to determine whether the Indian subsidiary was/is incurring the AMP expenses for itself or at the instance of the AE was/is to find out whether an independent party would have undertaken the same level of AMP expenses. An independent party with short-term agreement with an MNE would not incur costs which give long-term benefits of brand and market development advantage to another entity. It is fallacious to contend that brand promotion would benefit an independent entity, for increase in volume of sales largely benefits the manufacturer both in terms of the profit with increased sales and enhanced value to the brand. Be....
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....uitous approach in the contention that increased turnover would not benefit the Indian AE. The argument is sceptical and conjectural. Moreover, transfer pricing can always correct profit shifting, albeit, by reducing/increasing price/consideration payable to the Indian AE. 118. The Indian subsidiaries in the present case are engaged in distribution and marketing functions of the products manufactured by foreign AEs and in some cases, products are also manufactured by them under license in India. Figure 2.1 refers to the value chain analysis, and treats 'marketing' and 'distribution' as two headings, but this does not mean that marketing and distribution functions cannot be combined and treated as one package or a bundle. The functions performed could be both marketing and distribution. Marketing in the form of sale promotion, advertisements, etc. would necessarily involve expenditure both in terms of third party expenditure which the Indian assessee would liable to incur, as also towards the office maintenance and other overhead expenses. Even as one package or a bundle, the Indian subsidiary, i.e. an assessee, must be adequately compensated by adhering to the arm's length pr....
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.... 'bright line test' on the basis of comparables mentioned in paragraph 17.4. Any excess expenditure beyond the bright line should be regarded as a separate international transaction of brand building. Such a broad-brush universal approach is unwarranted and would amount to judicial legislation. During the course of arguments, it was accepted by the Revenue that the TPOs/Assessing Officers have universally applied 'bright line test' to decipher and compute value of international transaction and thereafter applied 'Cost Plus Method' or 'Cost Method' to compute the arm's length price. The said approach is not mandated and stipulated in the Act or the Rules. The list of parameters for ascertaining the comparables for applying bright line test in paragraph 17.4 and, thereafter, the assertion in paragraph 17.6 that comparison can be only made by choosing comparable of domestic cases not using any foreign brand, is contrary to the Rules. It amounts to writing and prescribing a mandatory procedure or test which is not stipulated in the Act or the Rules. This is beyond what the statute in Chapter X postulates. Rules also do not so stipulate. The argument and reasoning in paragraph 17.6 in a....
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.... as per the general principles of international taxation accepted and applied universally. There is nothing in the Act or the Rules to hold that it is obligatory that the AMP expenses must and necessarily should be subjected to 'bright line test' and the non-routine AMP expenses as a separate transaction to be computed in the manner as stipulated. 122. During the course of hearing, our attention was drawn to United States ISR Regulations, 4.1.2004 Edition, section 1.482-4, Methods to determine taxable income in connection with a transfer of intangible property and also the final regulations 26 CPR Parts 1 and 31 and 602 effective from 31st July, 2009. These are specific regulations framed and applicable in the United States. Care and caution has to be used when we make reference or apply these regulations or interpretation placed by the IRS, in United States of America. 1.482-4 of 2009 Regulations, relating to methods to determine taxable income in connection with transfer of intangible property, elucidates that arm's length consideration for contribution by one controlled taxpayers that develops or enhances the value or may be reasonably anticipated to develop or enhance the va....
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....ethods in their application to actual conditions, the circumstances including functions performed, assets used and risk borne by the entities, availability of reliable information required to apply a particular method and degree of comparability between actual circumstances and comparable circumstances, including reliability of adjustments to eliminate the effect of material differences. In identifying comparable circumstances, functions, assets and risk analysis, characteristics of property or services transferred, terms of the relevant contract, economic circumstances and the business strategies of the entities assume importance. Circumstances are comparable to actual circumstances, if and to the extent that the circumstances differ from actual circumstances, when the said difference does not materially affect a condition that is relevant to the method or reasonably adequate adjustment can be made to eliminate the effect of the difference on the condition that is relevant to the method. Illustrations, six in number, draw distinction between long-term distribution or distribution-cum-marketing agreements and short-term contractual arrangements. The resident AEs must be compensated....
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....pendent distributor and a distributor with marketing rights. An independent distributor with a full marketing right is a person or an entity legally independent of the manufacturer, who purchases goods from the manufacturer for re-sale on its own accounts. The transaction between the two is a straightforward sale in which the distributor takes all economic risk of product distribution and ultimately gains or makes loss depending upon market and other conditions. The manufacturer is not concerned. In case of a low or no risk distributor and he virtually acts as an agent for the loss and gain is that of the manufacturer. There is no economic risk on distribution of profits. He is, therefore, entitled to fixed remuneration for the self efforts, i.e., relating to the task or function of distribution. Similar will be the position of a low risk distributor with marketing functions, except that the said distributor should be compensated for the marketing, including AMP function. A distributor with marketing function can be normal or a high risk distributor. Such distributors should be compensated but the quantum of compensation would be higher. Such cases have to be distinguished from cas....
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....d to multifarious challenges on several account. However, it stands recorded in sub-paragraph No.18 that the important issue in determination of arm's length price is to examine the benefits of the AMP expenditure and whether Indian entities do not receive share of excess profits related to local marketing intangible. Accordingly, the claim of the Revenue is that extraordinary AMP expenditure does not result in appropriate enhancement of profitability of Indian subsidiary or related party. The question, therefore, when a subsidiary entity engaged in distribution and marketing incurs AMP expenses, is to ascertain whether the subsidiary AE entity has been adequately and properly compensated for undertaking the said expenditure. Such compensation may be in the form of lower purchase price, non or reduced payment of royalty or by way of direct payments to ensure adequate profit margin. This ensures proper payment of taxes and curtails avoidance or lower taxes of the Indian subsidiary as a separate juristic entity. 127. We agree and accept the position in the portion reproduced above in bold and italics. The object and purpose of Transfer Pricing adjustment is to ensure that the cont....
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....pped their claim for refund. Noticeably, this was after about 14 years. 129. The dispute in the case of DHL Corporation, U.S.A. in appeal, was decided in favour of the assessed. DHL Corporation, U.S.A. was the registered owner of the trademark and had exclusive right to use and sub-licence DHL trademark in the United States. U.S. Corporation had entered into a long-term agreement with a group company, namely Document Handling Limited International, Hong Kong ('DHLI', for short) which was responsible for operations outside the U.S. No royalty was payable to DHL, U.S. 130. In 1992, a third party consortium in terms of an agreement, exercised their option to purchase majority stake in DHLI and another group company, DHLI Middleton, N.V. which owned most of the overseas operating companies. The said consortium, through a new entity created by them, exercised option to purchase DHL trademark rights for US$ 20 million. Several questions arose in the said case including valuation of the trademark rights. One of the contentious issues related to attribution of the sale consideration paid for the trademark between DHL, U.S. and DHLI, Hong Kong. 131. On the question of o....
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....ne and would not be entitled to share in any return attributable to the marketing intangible. 6.38 Where the distributor actually bears the cost of its marketing activities (i.e. there is no arrangement for the owner to reimburse the expenditures), the issue is the extent to which the distributor is able to share in the potential benefits from those activities. In general, in arm's length transactions the ability of a party that is not the legal owner of a marketing intangible to obtain the future benefits of marketing activities that increase the value of that intangible will depend principally on the substance of the rights of that party. For example, a distributor may have the ability to obtain benefits from its investments in developing the value of a trademark from its turnover and market share where it has a long-term contract of sole distribution rights for the trademarked product. In such cases, the distributor's share of benefits should be determined based on what an independent distributor would obtain in comparable circumstances. In some cases, a distributor may bear extraordinary marketing expenditures beyond what an independent distributor with similar rights ....
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....nefit. In some cases, where the distributor bears extraordinary marketing expenses, he would be entitled to additional or higher return, through decreased price or reduction of royalty rate. The difficulty in attributing advertisement and other promotional expenditures towards trademark valuation or towards marketing activities, i.e. contributing to manufacture and current income and the impracticability of division in the case of such attribution is highlighted in paragraph 6.39. 135. It is, therefore, incorrect to suggest or observe that international tax jurisprudence or commentaries recognise "bright line test" for bifurcation of routine and non-routine AMP expenditure, and non-routine AMP expenses is an independent international transaction which should be separately subjected to arm's length pricing. K. Aggregation or Disaggregation of Transactions and Set Off in Segregation of Bundled Transactions; whether Section 92(3) prohibits segregation. 136. This leads us to the question of set off when bundled transactions are segregated. Conceptually, this is justified and equitable, as tax is payable on the total income after transfer pricing computation in resp....
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.... two transactions. (such as a favourable selling price for manufactured goods in. return for a favourable purchase price for the raw material used in producing the goods). To an arrangement for a general settlement balancing all benefits accruing to both parties over a period. Independent enterprises would be very unlikely to consider the latter type of arrangement unless the benefits could be sufficiently accurately quantified and the contract is created in advance. Otherwise, independent enterprises normally would prefer to allow their receipts .and disbursements to flow independently of each other, taking any profit or loss resulting from normal trading. 3.15 Recognition of intentional set-offs does not change the fundamental requirement that for tax purposes the transfer prices for controlled transactions must be consistent with the arm's length principle. It would be a good practice for taxpayers to disclose the existence of set-offs intentionally built into two or more transactions between associated enterprises and demonstrate (or acknowledge that they have relevant supporting information and have undertaken sufficient analysis to be able to show) that, after ta....
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....s set offs or adjustments. It states that Section 92, which refers to computation of income from international transaction with reference to arm's length price under sub-section (2) or (2A), would not have the effect of reducing income chargeable to tax or increase the loss, as the as may be, computed by the assessee on the basis of entries in the books of account. Income chargeable to tax or loss as computed in the books is with reference to the previous year. The effect of sub-section is that the profit or loss declared, i.e. computed by the assessee on the basis of entries in the books of account shall not be enhanced or reduced because of transfer pricing adjustments under sub-section (2) or (2A) to Section 92. It states the obvious and apparent. In case the assessed has declared better and more favourable results as per the entries in the books of account, then the income chargeable to tax or loss shall not be decreased or increased by reason of Transfer Pricing computation. Thus, transfer pricing adjustments do not enure to the benefit or advantage the assessed, thereby reducing the income declared or enhancing the declared loss. Pertinently, the Sub-Section makes reference t....
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....t otherwise appear to be." 142. The Legislature, therefore, if it wanted to provide and stipulate that set off would not be available or should be denied, would have appropriately expressed their intention in specific and express words. The intention on the other hand of the Legislature is not what is propounded by the Revenue. Consistent, the stand of the Revenue, it is apparent is divergent from the internationally accepted practice relating to Transfer Pricing determinations. The Legislature when it wanted to deviate, has adopted such recourse as with the year data and use of inter-quartile range. We do not read any repugnancy on this aspect in Section 92(3) of the Act. Thus, where the Act, i.e. the Income Tax Act, 1961 or the Rules do not devise or enact a contrary provision, we should not discard or ignore, without adequate justification, the OECD Transfer Pricing Guidelines or the U.N. Transfer Pricing Manual. Otherwise we deny ourselves benefit and advantage of the study and the dexterous and deliberated elucidations made in the extant OECD Transfer Pricing Guidelines or the U.N. Transfer Pricing Manual, as if they are redundant and superfluous. The Act, i.e. the Income T....
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....reated the international transactions as a package or a single one and contribution is attributed to the aggregate package. It is noticeable that sub-section (3) to Section 92 does not make reference to the computation of the form 92E but makes reference to the books of account and computation on the basis of the entries in the books of account. It stipulates that the computation made under sub-section (2) or (2A) shall not have effect of reducing the income or increasing the losses as declared on the basis of the said entries. Income or loss is the net figure which is computed after taking into account the business activities undertaken by the assessed AE which will have reference to the declared bundled/packaged international transaction. 145. In the impugned decision, the majority decision has observed that there is no basis for a presumption that the international arm's length price of one transaction was lower and this position has to be proved de hors the overall net profit rate. It should be proved by the assessed by comparison with what was charged for similar goods supplied by other independent enterprises dealing with India. We with respect have reservation and do not ....
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....the transaction are the same, but the arrangements made in relation to the transaction, when viewed in their totality, differ from those which would have been adopted by the independent enterprise behaving in a commercially rational manner. The second exception also mandates that actual structure should practically impede the tax authorities from determining an appropriate transfer price. The majority judgment does not record the second condition and holds that in their considered opinion, the second exception governs the instant situation as per which, the form and substance of the transaction were the same but the arrangements made in relation to a transaction, when viewed in their totality, differ from those which would have been adopted by an independent enterprise behaving in a commercially rational manner. The aforesaid observations were recorded in the light of the fact in the case of L.G. Electronics (supra). Commenting on the factual matrix of L.G. Electronics case (supra) would be beyond our domain; however, we do not find any factual finding to this effect by the TPO or the Tribunal in any of the present cases. However, in L.G. Electronics decision (supra), it is observe....
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....operty may be affected by the value of intangible property, such as trademark affixed on the tangible property. Transfer of tangible property with embedded intangible property normally is not considered a transfer of such intangible particularly when the controlled purchasers do not acquire any right to exploit the intangible property other than the right to re-sell the tangible property with embedded or affixed intangible rights. However, while computing the arm's length price, the cost or value of the embedded intangible would be relevant when the comparability test is adopted and applied between the controlled transaction with the uncontrolled transactions. 151. Economic ownership of a trade name or trade mark is accepted in international taxation as one of the components or aspects for determining transfer pricing. Economic ownership would only arise in cases of long-term contracts and where there is no negative stipulation denying economic ownership. Economic ownership when pleaded can be accepted if it is proved by the assessed. The burden is on the assessed. It cannot be assumed. It would affect and have consequences, when there is transfer or termination of economi....
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....ted party in India for having promoted the sale of the products in India. Income-tax Act recognises this and therefore allows it as a revenue expense wholly and exclusively expended for the purposes of the business, the said issue has also been upheld by this court in the case of Agra beverages Corporation (P) Ltd vs. CIT [2011] 11 taxmann.com 350 (Refer Page no. 284 of the paperbook)." M. Decision in the case of Maruti Suzuki and the order of the Supreme Court 155. With respect, the majority judgment of the Tribunal has not appreciated the effect of the order passed by the Supreme Court on appeal in the case of Maruti Suzuki. The order passed by the Supreme Court a short one, reads: "Leave granted. By consent, the matter is taken up for hearing. In this case, the High Court has remitted the matter to the Transfer Pricing Officer ['TPO', for short] with liberty to issue fresh show-cause notice. The High Court has further directed the TPO to decide the matter in accordance with law. Further, on going through the impugned judgement of the High Court dated 1st July, 2010, we find that the High Court has not merely set aside the original sho....
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.... as binding ratio, in respect of third parties. Therefore, we have not treated the decision of the Delhi High Court in the case of Maruti Suzuki Ltd. (supra) as a binding precedent. Importantly, the Revenue has relied upon the final conclusions as recorded and the assessed have relied upon the earlier portions of the judgment. We have considered the reasoning given in the aforesaid decision and have reached our own conclusion. N. Resale Price Method 157. We begin by reproducing Rule 10B(1)(b) of the Rules:- "Determination of arm's length price under section 92C. 10B. (1) For the purposes of sub-section (2) of section 92C, the arm's length price in relation to an international transaction or a specified domestic transaction shall be determined by any of the following methods, being the most appropriate method, in the following manner, namely :- (a) xxx (b) Resale Price Method, by which,- (i) the price at which property purchased or services obtained by the enterprise from an associated enterprise is resold or are provided to an unrelated enterprise, is identified; (ii) such resale price is reduced by the amount of a normal gross prof....
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....ses incurred by the AE in connection with the purchase of property or obtaining of services are further subtracted. At the fourth stage, adjustments are made taking into account the functional and other differences, including the accountancy practices, if any, between the tested international transaction and the comparable uncontrolled transactions to the extent they would materially affect the gross profit margins in the open market. The price computed after the two reductions and after the adjustment on account of the functional and other differences, determines the arm's length price of the purchased property or services obtained by the assessed from the AE. 160. RP Method postulates reverse calculation, as it first requires identification and ascertainment of resale price, then reductions and adjustment. It hypothesises ascertainment of normal gross profit margins of comparables including, if required, adjustment on account of functional and other differences with comparables. Uncontrolled transaction is comparable with the controlled transaction for the purpose of RP Method, only if two conditions are satisfied: that there is no difference between the functions, which would....
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....level of activities can range widely from the case where the reseller performs only minimal services as a forwarding agent to the case where the reseller takes on the full risk of ownership together with the full responsibility for and the risks involved in advertising, marketing, distributing and guaranteeing the goods, financing stocks, and other connected services. If the reseller in the controlled transaction does not carry on a substantial commercial activity, but only transfers the goods to a third party, the resale price margin could, in light of the functions performed, be a small one. The resale price margin could be higher where it can be demonstrated that the reseller has some special expertise in the marketing of such goods, in effect bears special risks, or contributes substantially to the creation or maintenance of intangible property associated with the product. However, the level of activity performed by the reseller, whether minimal or substantial, would need to be well supported by relevant evidence. This would include justification for marketing expenditures that might be considered unreasonably high; for example, when part or most of the promotional expenditure ....
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....or other intangible properties and affiliated sales companies which purchase and resell the products to unrelated customers, the Resale Price Method is an appropriate method to use if: > The CUP Method is not applicable; > The sales companies do not own valuable intangible properties; and > Reliable comparisons can be made on COGS (cost of goods sold)." 162. In the case of Reebok India Co. Ltd., the assessee has applied RS Method using internal comparable. Contrary to the general rule, the internal comparable possibly may not be appropriate when the assessed has incurred considerable (not necessarily extra-ordinary or non-routine) AMP expenses. The reason is obvious; there is no comparability analysis possible. In such cases, it is not possible to examine and compare the functional comparability between the controlled tested transaction and uncontrolled internal party transaction on account of AMP expenses. Internal comparable would not account for the credible gross profit rate, which an AE should be ensured when it incurs AMP expenses. Functionally the comparable is merely a manufacturer and thus, the said function is compared. AMP expenses do ....
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....i.e. at stage (iii), from the price ascertained at stage (ii), expenses incurred by the enterprise in connection with the purchase of property or obtaining of services is reduced. Under clause (iv), adjustments have to be made on account of functional difference which would include assets used and risk assumed. It is at stage (iv) of the RP Method that the Assessing Officer/TPO can make adjustments if he finds that an assessee has incurred substantial AMP expenses in comparison to the comparables. Once adjustments are made, then the appropriate arm's length price can be determined. In case, it is not possible to make adjustments, then RP Method may not be the most appropriate and best method to be adopted. 167. Before us, the Revenue has not pleaded or submitted that the RP Method should not have been adopted. The TPO and the Assessing Officer did not reject the RP Method adopted by the assessee. The assessed submit that the Revenue accepts functional parity and in fact, without adjustment. Contra, Revenue would argue that the Assessing Officer/TPO and the Tribunal have adopted and applied the CUP Method for determining arm's length price of AMP expenses. We do not pronoun....
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.... 170. United Nations' Manual in arithmetic terms has elucidated CP Method in the following manner: "The formula for the transfer price in inter-company transactions of products is as follows: TP = COGS x (1 + cost plus markup), where: > TP = the Transfer Price of a product sold between a manufacturing company and a related company; > COGS = the Cost of Goods Sold to the manufacturing company; and > Cost plus mark-up = gross profit mark-up defined as the ratio of gross profit to cost of goods sold. Gross profit is defined as sales minus cost of goods sold." The said method is strictly applied to manufacturing or assembling activities or relatively simple service providers. Like RP Method, CP Method is a gross margin method as it attempts to derive the arm's length price on a mark-up of cost of goods or services provided. 171. Determination of cost or expense can cause difficulties in applying CP Method. Careful consideration should be given, what would constitute cost i.e. what should be included or excluded from cost. A studied scrutiny of CP Method would indicate that when the said Method is applied by treating AMP expenses as an i....
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....ust be undertaken in a fair, objective and reasonable manner. 174. Costs or expenses incurred for services provided or in respect of property transferred, when made subject matter of arm's length price by applying CP Method, cannot be again factored or included as a part of inter-connected international transaction and subjected to arm's length pricing. This situation would possibly result in over, if not double taxation, contrary to the object and purpose of arm's length pricing, which is to tax the real income after correcting the negative impact, if any, of the controlled conditions. Therefore, if entire marketing and distribution expenses, or marketing or AMP expenses are bench marked under CP Method, then it would be injudicious and irrational to apply any other method to compute the arm's length price of a larger composite international transaction, of which the said costs and expenses form only a part. Logically, if the costs or expenses as a function are excluded or included in the cost while computing the arm's length price under the CP Method, the gross profit as a result of such transaction would be lower or higher. This situation would be different from subjecting th....
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....n including distribution and marketing function, is flawed and has to be rejected. The respondent-assessees are engaged in distribution and marketing of consumer goods. Distribution and marketing exercise in case of tangibles requires transfer/sale of goods to third parties, be it sub-distributors or retailers. The said transaction is in the nature of sale of goods for consideration. The marketing or selling expenses like trade discounts, volume discounts, etc. offered to sub-distributors or retailers are not in the nature and character of "brand promotion". They are not directly or immediately related to "brand building" exercise, but have a live link and direct connect with marketing and increased volume of sales or turnover. The brand building connect is too remote and faint. To include and treat the direct marketing expenses like trade or volume discount or incentive as "brand building" exercise would be contrary to common sense and would be highly exaggerated. These reduce the net profit margin. It would lead to abnormal financial results defying accountancy practices and commercial and business sense. The expenses being in the nature of selling expenses have an immediate conn....
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.... Enterprises Pvt. Ltd. to Nike International Ltd. USA @ 5% was taken as a valid comparable. In addition, the assessed relied upon Foreign Exchange Management (Current Account Transactions) Rules, 2000 authorising remission of royalty of upto 5% on domestic sales and upto 8% on exports under the automatic route to foreign technical collaborators. The TPO rejecting the claim, observed that the assessed had not established cost-benefit analysis for payment of royalty. No such exercise had been carried out. The TPO referred to technology licence agreement dated 1st October, 2002 between the assessee and Reebok International Ltd., U.K. for providing data, documentation, drawings and specifications relating to inventions, designs, formulae, processes and similar properties, referred to as know-how and the non-exclusive, non-transferable right granted to utilize the technology to manufacture and distribute Reebok products in India. He referred to the profitability data of the assessed and observed that the technology and payment of royalty was not reflected in the profit margins or commensurate benefit. He, therefore, came to the conclusion that no independent enterprise would make paymen....
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....bstantial profit increase, has been rightly rejected as totally unsustainable. Profitability of the assessed could have been lower or varied due to various reasons and lower profitability in one or more years cannot lead to the conclusion that no benefits were derived or technology was unproductive. The justification given by the assessee for lower profits on account of bad debts, high rent, increase in legal cost stand highlighted and accepted by the Tribunal. 184. Transfer pricing provisions, as noted above, recognise separate entity principle. Therefore, as a sequitur, it follows that the AE is a separate entity and when it avails and secures advantage of technical know-how, it should pay arm's length price for the right to use. The arm's length price would be the fair market price of the technical know-how, which is licensed. 185. Royalty payable for availing the right to use would depend upon corresponding price, which would have been paid by an independent or unrelated enterprise. This is judged by applying comparables. TPO has not rejected the quantum of royalty on the said principle. The reasoning given by the TPO is not only erroneous for the reasons stat....
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....das International Marketing BV for payment of royalty @ 12%." 189. The Tribunal has noted with disapproval the observation of the TPO that comparable instances were not given, observing that this was factually incorrect. 190. However, do not agree with the finding recorded by the Tribunal that as the Government of India had permitted remission of royalty through automatic route, the royalty paid can be per se or conclusively treated as the arm's length price. Applicable rules authorise remission of royalty upto a particular percentage under automatic route to the foreign collaborators. Authorising remission through automatic route upto a particular percentage, does not reflect examination of arm's length principle. It would be incorrect to read into the general authorisation under the Foreign Exchange Management Act and Rules, an implied adjudication order on the question of quantum or arm's length price. When specific permission is granted, the issue may acquire a different dimension. We do not express any opinion, when specific permission is relied upon. 191. The fact that royalty has been paid would be a relevant consideration and factum, when we consider ar....
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....and flexibility to reach a fair and just conclusion on the arm's length price. Answers to Substantial Questions of Law 194. In view of the aforesaid discussion, substantial questions of law in the appeals filed by the assessee are answered as under: "Q.1. Whether the additions suggested by the Transfer Pricing Officer on account of Advertising/Marketing and Promotion Expenses ('AMP Expenses' for short) was beyond jurisdiction and bad in law as no specific reference was made by the Assessing Officer, having regard to retrospective amendment to Section 92CA of the Income Tax Act, 1961 by Finance Act, 2012." In terms of and subject to discussion under the heading C, paragraph Nos.41 to 50, the substantial question of law No.1 is answered in favour of the Revenue and against the assessee. "Q.2. Whether AMP Expenses incurred by the assessee in India can be treated and categorized as an international transaction under Section 92B of the Income Tax Act, 1961." In terms of and subject to discussion under the heading C, paragraph Nos.51 to 57, the substantial question of law No.2 is answered in favour of the Revenue and against the assessee. ....
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....ffect of such differences on the price or margin. Thus, identification of the potential comparables is the key to the transfer pricing analysis. As a sequitur, it follows that the choice of the most appropriate method would be dependent upon availability of potential comparable keeping in mind the comparability analysis including befitting adjustments which may be required. As the degree of the comparability increases, extent of potential differences which would render the analysis inaccurate necessarily decreases. (iv) The assessed, i.e. the domestic AE must be compensated for the AMP expenses by the foreign AE. Such compensation may be included or subsumed in low purchase price or by not charging or charging lower royalty. Direct compensation can also be paid. The method selected and comparability analysis should be appropriated and reliable so as to include the AMP functions and costs. (v) Where the Assessing Officer/TPO accepts the comparables adopted by the assessed, with or without making adjustments, as a bundled transaction, it would be illogical and improper to treat AMP expenses as a separate international transaction, for the simple reason that if the functio....
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.... has no statutory mandate and a broad-brush approach is not mandated or prescribed. We disagree with the Revenue and do not accept the overbearing and orotund submission that the exercise to separate 'routine' and 'non-routine' AMP or brand building exercise by applying 'bright line test' of non-comparables should be sanctioned and in all cases, costs or compensation paid for AMP expenses would be 'NIL', or at best would mean the amount or compensation expressly paid for AMP expenses. It would be conspicuously wrong and incorrect to treat the segregated transactional value as 'NIL' when in fact the two AEs had treated the international transactions as a package or a single one and contribution is attributed to the aggregate package. Unhesitatingly, we add that in a specific case this criteria and even zero attribution could be possible, but facts should so reveal and require. To this extent, we would disagree with the majority decision in L.G. Electronics India Pvt. Ltd. (supra). This would be necessary when the arm's length price of the controlled transaction cannot be adequately or reliably determined without segmentation of AMP expenses. (xi) The Assessing Officer/TPO for goo....