AI Drafter 
TaxTMI 
TaxTMI 
2019 (8) TMI 1534
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....e Act') [hereinafter referred to as 'the learned AO] in pursuance of the directions issued by the Hon'ble Dispute Resolution Panel - 1, (hereinafter referred to as the 'Hon'ble DRP') on the following grounds, each of which are without prejudice to one another. On the facts and in the circumstances of the case and in law, learned AO/ Joint Commissioner of Income- tax, Transfer Pricing-3(1), Mumbai ('learned TPO') /Hon'ble DRP on fact and in law has: Following grounds are without prejudice to each other: General 1. Erred in assessing the total income at Rs. 401.38 crores as against Rs. 46.65 crores computed by the Appellant. A. Adjustment on account of Advertisement, Marketing and Promotion ('AMP') expenses Presumption of fictitious transaction in the nature of 'provision of brand promotion services' 2. erred in making an adjustment in respect of AMP expenses of Rs. 354.73 (Rs. 254.58 crore for the manufacturing segment and Rs. 100.05 crore for the distribution segment) alleging that the AMP expense incurred by the Appellant is an international transaction under Section 92B; 3.....
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....ithout requesting for such data/ information from the Appellant; 13. without prejudice to the above, erred in computing the BLT of the comparables as 10.41% instead of 11.28%; 14. without prejudice to the above, erred in rejecting the analysis submitted by the Appellant and not adopting a scientific search process to identify companies comparable to the Appellant's manufacturing segment for benchmarking of the AMP expenses and considering inappropriate comparables, not having similar product/ brand profile as the Appellant; Distribution segment - comparable set 15. without prejudice to the above, erred in assuming that the alleged AMP expenses incurred by the Appellant in its distribution segment was in proportion to the net sales earned in respective segment, without requesting for such data/ information from the Appellant; 16. without prejudice to the above, erred in computing the BLT of the comparables as 8.78% instead of 10.52%; Sales related expenses 17. without prejudice to the above, erred in holding that items of selling expenditure such as rent cost for window display, point of sales materials etc. amountin....
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....for use of technical know-how at an adhoc rate of 2.3% as against 5% paid by the Appellant: 25. erred in resorting to cherry picking of comparable agreements (out of 12 comparable agreements identified by the Appellant through a royalty benchmarking search undertaken) while allegedly determining the alleged arm's length comparable rate for payments made by the Appellant to its AE. for use of technical know-how; Payments made to AEs for use of trademark 26. erred in holding that the Appellant has carried out significant AMP expenses and thereby assuming Appellant being economic owner, no trademark royalty is payable by the Appellant. In holding the same, the learned AO/ TPO erred in determining the arm's length price for payment of trademark royalty as Nil vis-a-vis the actual payment of Rs. 22.17 crores made by the Appellant; 27. failed to appreciate that in absence of payment of trademark royalty as stipulated in the license agreement, the Appellant would not have the legal right to use the 'L'Oreal' Trademark; 28. erred in not using any of the method prescribed under section 920 of the Act for benchmarking the said internationa....
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....e Act, while determining the arm's length price; 37. without prejudice to the above, erred in not following Learned TPO's own approach in Appellant's own case for AY 2012-13 using which the alternate adjustment value would have been Rs. 33.89 crore as against Rs. 60.03 crore; 38. without prejudice to the above, erred in not considering the profit level indicator of 'AMP adjusted gross profit' under RPM: C. Levy of interest and initiation of penalty proceedings 39. erred in charging interest under section 234B, 2340, 234D of the Act; 40. erred in initiating penalty proceedings under section 271(1)(C). The appellant craves the leave to amend or alter any ground or add a new ground which may be necessary.' 2. Briefly stated, the assessee viz. L'Oreal India Pvt. ltd. (hereinafter referred to as 'L'Oreal India') is a wholly owned subsidiary of L'Oreal S.A. France (hereinafter referred to as 'L'Oreal France'). The assessee had entered into a license agreement dated 02.01.2012 with L'Oreal France, which was effective from 01.01.2012. As per the 'agreement', the assessee was awarded the exclusive right to import, ....
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....e: International Transactions Amount disallowed (INR) (In Crores) Observations/reason of adjustment (as per TPO) AMP expenses incurred in manufacturing segment (allegedly treated as international transaction by the learned TPO) 254.68 Primary Adjustment- The TPO held that the assessee incurred AMP expenses with a view to enhance the brand image of L'Oreal and hence provided 'brand building services' to the AEs, for which it should be compensated. Payment of royalty for use of technical knowhow and trademarks 56.37 (primary adjustment is INR 254.68 crores) Alternate Adjustment on the manufacturing segment- If the above does not sustain in appellate stage, an alternate adjustment has been proposed by the TPO by treating arm's length price of payment of royalty for use of technical know-how @ 2.3% as against 5% paid by the assessee and also by cherry picking the comparable agreements. Further, the TPO completely disallowed payments for trademark stating that assessee was engaged in developing L'Oreal trademarks in India by incurring AMP expenses. Hence royalty payment for use trademark was not mandated. AMP expenses incurred in Distribution Segment (alleg....
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....ss of the assessee, also did not find favour with the DRP. It was observed by the DRP that as the TPO had selected all companies which alike the assessee were into FMCG industry, therefore, no infirmity did emerge from the selection of comparables by the TPO. Further, it was observed by the DRP that in the case before them the international transaction being considered was not the AMP expenditure incurred per se, but the benefit that was conferred on the AEs in the form of brand-value augmentation through incurring of excessive AMP by the assessee. Accordingly, the DRP was in agreement with the A.O/TPO regarding the determining of the non-routine AMP expenses which could be recovered from the AE. It was observed by the DRP that in A.Y. 2011-12 the issue was decided by the DRP in favour of the assessee by relying on certain decisions of the Hon'ble High Court of Delhi in the case of (i). Maruti Suzuki India Ltd. Vs. Addl. CIT/TPO (2010) 328 ITR 210 (Del); (ii). Whirlpool of India Vs. CIT [ITA No. 228/2015 & CM No. 5751/2015]; (iii). Bausch & Lomb Eyecare (India) Pvt. Ltd. Vs. Addl. CIT & Ors (2016) 381 ITR 227 (Del); and (iv).Honda Siel Power Products Ltd. Vs. DCIT (2016) 237 Taxman....
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....y for trademark was unwarranted. The DRP concurred with the view taken by the TPO and upheld the disallowance of the entire claim of royalty paid by the assessee to its AE for trademarks. As regards the royalty for technical knowhow, it was observed by the DRP that the TPO had done a detailed working and had arrived at an arms length percentage of the same. The DRP holding a conviction that the working of the royalty for technical knowhow by the TPO was fair and reasonable, therefore, concurred with his view and rejected the objection of the assessee. To sum up, the payment of royalty @ 4.45% viz. (i) royalty for trademark:1.75%; and (ii) royalty for technical knowhow: 2.7% [5% (- )2.3%] was held by the DRP to be excessive in nature. 7. The A.O after receiving the order passed by the DRP under Sec.144C(5), dated 22.09.2017, therein passed the final assessment order under Sec.143(3) r.w.Sec.144C(13), dated 15.11.2017. The A.O while framing the assessment carried out adjustment of Rs. 354,73,00,000/- to the ALP of the international transactions of the assessee and assessed its income at Rs. 401,38,64,620/-. 8. The assessee being aggrieved with the assessment framed by the A.O u....
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....MP expenses for and on their behalf, therefore, the lower authorities had erred in attributing the AMP expenses incurred by the assessee toward brand promotion of its AE. On the contrary, it is the claim of the revenue, that the assessee by incurring heavy AMP expenditure had carried out intensive market functions which had led to creation of valuable marketing intangibles for the AE, for which no compensation was received by it either in the form of direct compensation or by way of discount in its price. It is submitted by the ld. D.R, that the assessee had rendered DEMPE services which included market development, value addition, creation of marketing intangibles etc. The ld. D.R rebutted the claim of the assessee that there was no explicit arrangement whatsoever between the assessee and its AE for promotion of the brand of the AE by incurring AMP expenses on their behalf. It was submitted by the ld. D.R, that a perusal of the facts and circumstances of the case and also the material available on record clearly revealed that there was an arrangement, understanding and action in concert between the assessee and its AE for incurring AMP expenses in order to facilitate rendering of ....
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....17.65%, whereas the average PLI of the comparables is arrived at 98.44%. As the price charged in the international transaction was greater than the arithmetic mean price, therefore, the same had been treated by the assessee as being at arm's length. In the 'distribution segment', the PLI of the assessee company as per the TP study report had been worked out at 58.20% on sales, whereas the average PLI of the comparables is arrived at 36.02%. As the price charged in the international transactions in the 'distribution segment' was greater than the arithmetic mean price, therefore, the assessee had contended that the price charged in the international transactions were found to be at arms length. Also, the assessee company had during the year paid 'royalty' for the exclusive right to manufacture and distribute the licensed products using the technology and trademark of its overseas associated enterprise in accordance with the terms envisaged in the 'agreement' entered into with its AE. As the international transactions had taken into account both the segments i.e 'manufacturing segment' and 'distribution segment', therefore, the transfer pricing analysis was also undertaken by the asse....
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.... is in the nature of promotional activity. After verification of the submission of the assessee, the contention of the assessee is accepted and the expenditure is held to be in the nature of selling expenditure. 2. Marketing Promotions 3,02,41,161 Costs relating to promotions run at malls and key retail outlets on occasion of specific days like valentine's day, Father's day etc. Costs include promoters' fees, site rentals, stage/podium, gifts and prizes. Aimed at increasing retail sales. As per the explanation given by the assessee, these are the expenses on promotions at malls and key retail outlets. Obviously these expense are for DEMPE functions and hence cannot be categorised as selling expenses. Hence, the same are considered to be in nature of advertisement expenses. 3. Public Relations 11,86,81,081 Customer Relation Maintenance expenses like photoshoot, BSP (Beauty Sales Promoter) salary etc. As per the explanation given by the assessee, these are the expenses on customer relation maintenance, Obviously these expenses are for DEMPE functions and hence cannot be categorised as selling expenses. Hence, the same are considered to be in nature of....
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....st value of scheme is reimbursed to distributors. Note: Primary Trade Schemes are those which are given from company to distributor which is negligible. After verification of the submission of the assessee, the contention of the assessee is accepted and the expenditure is held to be in the nature of selling expenditure. 10. Cost of Goods Sold - Free Issues (including cost centre) 11,16,80,983 Finished goods used as Testers by retailers and cost reimbursed. Quantity replaced instead of value reimbursed for secondary Trade schemes After verification of the submission of the assessee, the contention of the assessee is accepted and the expenditure is held to be in the nature of selling expenditure. 12. Marketing fees (DMI fees paid to Overseas AE) 34,14,04,193 Availing international marketing services from overseas AE. The centralized international marketing management structure (DMI) providing common marketing services for the development of international marketing material and tools for the benefit of the L'Oreal affiliates. Services received are in connection with communication development, launch information and international marketing studies, packagi....
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.... the appellate authorities, then the entire AMP expenditure (without excluding selling expenses) of the assessee will have to be compared to the entire AMP expenditure of the comparables. 13. We find that the TPO on the basis of his aforesaid deliberations had carried out the benchmarking of the AMP expenses in respect of both the segments of the assessee company viz. (i) manufacturing segment; and (ii) distribution segment, as under: (A) Manufacturing Segment: The comparables selected by the assessee were rejected by the TPO for the following reasons: Sr. No. Name of the comparables Findings of the TPO 1. Gillette India Ltd. One common feature, in respect of these comparables is that the intangibles in all these cases are owned by the foreign AE. Hence the AMP transaction in all these cases is controlled transactions. It is a basic tenet of the transfer pricing regulations that a controlled transaction has to be compared with an uncontrolled transaction. A controlled transaction cannot be compared with another controlled transaction. Hence these comparables cannot be taken into account for determination of the AMP adjustment. It is no where the contentio....
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....) at Rs. 254.68 crores, as under: Net Sales of the taxpayer = Rs. 1214.09cr. Arm's Length % of AMP Expenditure = 10.41% Arm's Length AMP (10.41 % * Rs. 1214.09 cr) = 126.39 cr. Expenditure incurred by the taxpayer on AMP (Manufacturing sector) = Rs. 344.25 Expenditure incurred for developing the intangibles [Rs. 344.17 (-) Rs. 126.26 cr.] = Rs. 217.86 cr. Add Mark up @ 16.90% (16.90% * Rs. 232.23 Cr) = Rs. 36.82 cr. Arm's Length value for AMP activity = Rs. 254.68 cr. Value received by the taxpayer = Nil Difference = Rs. 254.68 cr. On the basis of his aforesaid calculations, it was observed by the TPO, that an adjustment of Rs. 254.68 crore towards AMP expenditure incurred by the assessee (manufacturing segment) for services rendered towards DEMPE functions for the intangibles owned by the AE was required to be carried out. (B) Distribution Segment: The TPO accepted the comparables which were selected by the assessee in its TP study report. Accordingly, the AMP expenditure incurred by the assessee (distribution segment) for serv....
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.... Expenditure incurred by the taxpayer on AMP = Rs. 123.98 cr Expenditure incurred for developing the intangible [Rs. 123.98 (-) 38.40 cr.] = Rs. 85.58 cr Add Mark up @ 16.90% (16.90% *Rs. 85.58cr) = Rs. 14.46 cr Arm's Length value for AMP activity = Rs. 100.05 cr Value received by the taxpayer = Nil Difference = Rs. 100.05 cr" Accordingly, on the basis of his aforesaid deliberations, it was concluded by the TPO that the total adjustment in respect of the AMP expenditure incurred by the assessee in respect of DEMPE functions for the intangibles owned by its AE for both the segments worked out at 354.73 crores viz. (i) manufacturing segment : Rs. 254.68 crores; and (ii) distribution segment : Rs. 100.05 crore. 14. We find that on the basis of his aforesaid observations, the TPO was of the view, that the assessee had not only rendered its services as a 'distributor' but had also incurred huge AMP expenses (28.35% of its 'sales') towards rendering of DEMPE functions for the brand owned by its AE, viz. L'Oreal S.A., France. It was observed by the TPO that for benchmarking the international transactions of its 'di....
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....alty : It was observed by the TPO that the assessee had benchmarked the royalty @5% of sales towards 'technical knowhow' by relying on the royalty study carried out by NERA Economic Consulting in November, 2013. The TPO observed that as per the said study the comparables considered were mainly the companies making payments for trademark royalties. It was observed by him that out of 12 comparables selected by the assessee only 4 comparables were having the payment for both marketing & processing royalty and the remaining 8 comparables were related to payment of exclusive marketing royalty. Further, it was observed by him that the average royalty paid for the marketing intangible by the 8 comparables was 6.1% and the average payment of royalty for both marketing & processing royalty by the remaining 4 comparables was 8.4%. On the basis of his aforesaid observations, it was concluded by the TPO that the average payment of processing/technical knowhow royalty worked out at 2.3% [8.4% (average payment of royalty for both marketing & processing royalty) - 6.1% (average payment of royalty for marketing intangible)]. Accordingly, it was observed by the TPO, that the ALP of the payment o....
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....ts AE viz. L'Oreal S.A., France, which obligated the assessee to incur AMP expenses for and on behalf of the AE. In fact, as per the 'agreement' the assessee was awarded by its AE viz. L'Oreal S.A., France the exclusive right to import, manufacture (or have manufactured by another L'Oreal affiliate), market, distribute and sell branded products of L'Oreal Group within its territory. As against granting of the said exclusive rights, the assessee was obligated to pay royalties in proportion with its net sales viz. (i). royalty for the use of technology: 5%; and (ii). royalty for the right to use the licensed trademarks: 1.75%.We are unable to persuade ourselves to subscribe to the view of the TPO/DRP, that as the assessee had agreed to allocate each year for such advertising an annual budget which would provide for smooth running of the business, therefore, the same was to be construed as an 'understanding' or an 'arrangement' or 'action in concert' as per which the assessee had agreed for incurring AMP expenses for brand building of its AE, viz. L'Oreal S.A., France. In our considered view, the aforesaid condition in the 'agreement' only obligated the assesse....
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....: 5%; and (ii). royalty for the right to use the licensed trademarks: 1.75%. To sum up, there is neither anything discernible from the 'agreement' between the assessee and its AE, viz. L'Oreal S.A., France, nor any thing has been placed on our record which could persuade us to conclude that there was any arrangement, understanding or action in concert between the assessee and its AE viz. L'Oreal S.A., France for incurring the AMP expenses to carry out the DEMPE functions for the intangibles owned by the AE. 17. We shall now in the backdrop of the aforesaid factual matrix, herein deliberate as regards the sustainability of the orders of the lower authorities, which we find had worked out the TP adjustments as regards the ALP of the AMP expenses incurred by the assessee in respect of both of its business segments, viz. (i) manufacturing segment; and (ii). distribution segment. As observed by us hereinabove, 'onus' is cast upon the revenue to show the existence of any arrangement or agreement on the basis of which it could be inferred that the AMP expenses incurred by the assessee was not for its own benefit but was for the benefit of its AE. The mere fact that the assessee was per....
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.... and make the TP adjustment by substituting the ALP for the contract price. Further, it was observed by the High Court that the TP adjustment is not expected to be made by deducing from the difference between the 'excessive' AMP expenditure incurred by the assessee and the AMP expenditure of a comparable entity that an international transaction exists and then proceed to make the adjustment of the difference in order to determine the value of such AMP expenditure incurred for the AE. Now, in the case before us, we are afraid that the TPO had failed to place on record any 'material' which would establish there was an international transaction involving AMP expenses between the assessee and its AE. Rather, the TPO had referred to the average AMP expenses of certain comparables and by comparing the same as against those incurred by the assessee company, had therein held that the excess of such AMP expenses were incurred towards DEMPE functions for brand building of its AE viz. L'Oreal S.A., France. The ld. D.R had tried to impress upon us that the method of benchmarking the AMP expenses incurred by the assessee for the year under consideration viz. A.Y 2013-14, as observed by ....
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....417/Mum/2017; dated 30.01.2019], had followed the view earlier taken in the preceding years and had vacated the adjustment of 304.69 crores that was made by the TPO by alleging that the AMP expenses incurred by the assessee was an international transaction under Sec. 92B of the Act. The Tribunal while so concluding had observed as under: "12. We have also perused the agreement of assessee with its AE dated 4th January 2011 executed between assessee and its AE. Clause 7 of the agreement descries about right of distribution of licensed product in the territory. As per Clause 8 of the said agreement the assessee is responsible for the advertising the licensed product in the territory. The 'territory' is defined under clause 1.5 of the agreement, which means the territory of Nepal, Bhutan, Bangladesh, Maldives, Mauritius, India and Sri Lanka. However, it excludes any free trade zone, which may exist or may be created. Further it excludes duty free shops located in the duty free or travel retail area which is specialized in sales against foreign currency to foreigner or diplomatic corps, ship chlanders, airlines companies or shipping companies. Though the AE has reserves its ri....
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....ed RPM benchmarked the international transactions of the 'distribution segment' of the assessee company. On the basis of his aforesaid adjustments, the TPO had proposed a TP adjustment of Rs. 60.03 crores to be made while determining the ALP of the purchases made by the assessee from its AEs. 20. We have given a thoughtful consideration to the aforesaid TP adjustment of Rs. 60.03 crores made by the TPO on the basis of adjusted RPM on account of alleged differences in intensity of AMP functions performed by the assessee vis a vis the comparable companies. As observed by us hereinabove, the aforesaid adjustment was carried out by the TPO as per the adjusted RPM in order to align the functions, assets and risks profile of the assessee with that of the comparable companies. As the revenue had failed to establish the existence of any 'understanding' or an 'arrangement' or 'action in concert' as per which the assessee had agreed for incurring of AMP expenses for brand building of its AE, viz. L'Oreal S.A., France, therefore, the AMP expenses incurred by the assessee had been held by us as not having been incurred by the assessee for brand building of its AE. Ac....
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....e TPO, for the reason, that as per him as the assessee had incurred significant AMP expenses for rendering of DEMPE functions for the brands of its AE, therefore, it was not required to make any payment towards royalty on trademarks. The TPO while concluding as hereinabove, had relied on the BEPS report. We have given a thoughtful consideration and are unable to persuade ourselves to subscribe to the adhoc disallowance of the royalty on trademarks by the TPO. In our considered view, the disallowance by the TPO is backed by a conviction held by him that the assessee in the backdrop of significant AMP expenses incurred towards DEMPE functions as regards brand building of its AE was thus under no obligation to make any payment towards royalty on trademarks. We are of a strong conviction that the TPO had exceeded his jurisdiction while making an adhoc disallowance of royalty on trademarks. In our considered view, in the course of transfer proceedings the TPO has to examine whether or not the method adopted by the assessee to determine the ALP is the most appropriate method and also whether the comparables selected are appropriate or not. In fact, it is not part of the TPO's jurisdictio....
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.... NERA Economic Consulting in November, 2013. The TPO observed that as per the said study the comparables considered were mainly the companies making payments for trademark royalties. It was observed by him that out of 12 comparables selected by the assessee only 4 comparables were having the payment for both marketing & processing royalty and the remaining 8 comparables were related to payment of exclusive marketing royalty. Further, it was observed by him that the average royalty paid for the marketing intangible by the 8 comparables was 6.1% and the average payment of royalty for both marketing & processing royalty by the remaining 4 comparables was 8.4%. On the basis of his aforesaid observations, it was concluded by the TPO that the average payment of processing/technical knowhow royalty worked out at 2.3% [i.e. 8.4% (average payment of royalty for both marketing & processing royalty) (minus) 6.1% (average payment of royalty for marketing intangible)]. Accordingly, it was observed by the TPO, that the ALP of the payment of royalty for technical knowhow was to be taken at 2.3%. In the backdrop of his aforesaid deliberations, it was observed by the TPO, that payment of royalty of....