, ,
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI SPECIAL BENCH, NEW DELHI
.. , , .. ,
, ,
Before Shri G.D.Agarwal, VP, Shri R.S.Syal, AM and
Shri Hari Om Maratha, JM
./ITA No.5140/Del/2011
( / Assessment Year : 2007-2008)
M/s.L.G.Electronics India Private Limited The Asstt.Commissioner of Income-tax
/
Plot No.51, Udyog Vihar Circle - 3
Surajpur Kasna Road, Greater Noida Noida.
Gautam Budh Nagar (U.P.) Vs.
PAN :
( /Appellant) (/Respondent)
/Appellant by : Shri Ajay Vohra, Advocate,
Shri Neeraj Jain, CA,
Shri Ramit Katyal, CA &
Shri Abhishek Aggarwal, CA
/Respondent by : Shri K.G.C.Srivastava, Special Counsel,
Shri Peeyush Jain, CIT-DR &
Ms.Preeti Bhardwaj
/
/
Date of Hearing : 08.11.2012 Date of Pronouncement : .01.2013
INTERVENERS
Sl. ITA no. & Asstt. Yr. Name of the party Represented by
No.
1. 5638/D/2011 2007-08 M/s Haier Telecom Sh. Ashwani Taneja Adv.
Pvt. Ltd.
2. 4022/D/2010 2003-04 M/s LVMH Watch & Sh. Vikas Srivastava Adv.
Jewellery India P. L
3 to 3571/D/2010- 2005-06 M/s Haier Applianeds Sh. Ajay Vohra Adv.
6. 4680/D/2010-2006-07 India P. Ltd. With Sh. Neeraj Jain
5235/D/2011 2007-08 Sh. Ramit Katyal &
4404/D/2012 2008-09 Sh. AbhishekAggarwal CAs.
7. 5650/D/2011- 2007-08 M/s Goodyear India P. -do-
Ltd.
8. 1148/Chd/2011-2007-08 M/s Glaxo Smithkline -do-
Consumer H. Ltd.
9. 5237/D/2011-2005-06 M/s Maruti Suzuki Sh. S. Ganesh Sr. Adv. with
India Ltd. Sh. Neeraj Jain CA
2 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
10. 4978/D/2011-2007-08 M/s Sony India P. Ltd. Sh. N. Venkatraman Sr. Adv.
with Sh. Manonnet Dalal
11 & 3861/D/2011-2006-07 M/s Bausch & Lomb Sh.Mukesh Butani Adv. with
12 4924/D/2011-2007-08 Eyecare P. Ltd. Sh. Rahul Yadav & Sh. Vishal
Kalra
13. 5826/D/2011-2007-08 M/s Fujifilm -do-
Corporation
14 5593/D/2011-2007-08 M/s Cannon India P. -do-
Ltd.
15 5090/D/2010-2006-07 M/s Daikin -do-
&16 5685/D/2011-2007-08 Airconditioning India.
P. Ltd.
17. 4602/D/2010-2006-07 M/s Cannon India P. Sh. M.S. Syali Sr. Adv. with
Ltd. Sh. Tarandeep Singh
18. 4584/D/2011-2007-08 M/s Amadeus India P. -do-
Ltd.
19 to 1370/Mum/09-2004-05 M/s Star India Pvt. Sh. S. Ganesh Sr. Adv. with
21 6030/Mum/09-2005-06 Ltd. Sh. Sunil Agrawal Adv.
4675/Mum/09-2006-07
22. 1334/Ch/2010-2006-07 Pepsi Foods Pvt. Ltd. Sh. M.S. Syali Sr. Adv. with
Sh. Tarandeep Singh
/ O R D E R
Per R.S.Syal (AM) :
The Hon`ble President has constituted this Special Bench to
adjudicate the following two questions:
"1. Whether, on the facts and in circumstances of the
case, the Assessing Officer was justified in making
transfer pricing adjustment in relation to advertisement,
marketing and sales promotion expenses incurred by the
assessee?
2. Whether the Assessing Officer was justified in holding
that the assessee should have earned a mark up from the
Associated Enterprise in respect of AMP expenses alleged
to have been incurred for and on behalf of the AE?"
3 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
2. The factual matrix of the case is that L.G. Electronics Inc.
(hereinafter called as LGK), is a Korean based company, engaged
in the business of manufacture, sale and distribution of electronic
products and electrical appliances such as television, audio/video
equipments, washing machines, refrigerators and air-conditioners etc.
Pursuant to the approval of the Govt. of India, conveyed vide letter
dated 29-1-1997, LGK was permitted to establish a wholly owned
subsidiary in India. L.G. Electronics India Pvt. Ltd. (hereinafter
called as LGI), that is the assessee in question, was incorporated in
1997 as a wholly owned subsidiary of LGK. An agreement was
entered between LGK and LGI on 10th March 1997, as per which
both entered into a mutual foreign collaboration agreement.
Thereafter a Technical assistance and royalty agreement was entered
into between these two entities on 1-7-2001 by which LGI, in the
capacity of a licensee, obtained a right to use the technical
information, designs, drawings and industrial property rights for the
manufacture, marketing, sale and services of the agreed products
from the LGK i.e. the licensor. As per the agreement, the assessee
agreed to pay royalty to LGK at the rate of 1% as a consideration for
the use of industrial property rights, designs and technical knowhow,
for the manufacture and sale of the greed products. The licensor
allowed the licensee to use its brand name and trade marks to
products manufactured in India during the validity period of the
agreement, which in the instant case is without any restriction.
Article 7 of this agreement with caption `Use of `LG` Brand name &
trade marks` provides that : `The Licensor hereby allows the Licensee
4 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
for the use of its Brand Name and Trade Marks for the licensed
products manufactured in India during the validity period of the
Agreement`. Second para of this article further states that : In case
at any stage in future the Licensor demands any royalty payment on
this account, the Licensee will take steps to get the Government of
India`s approval for payment of such royalty payment. It is not the
case of the Revenue that the licensor demanded any royalty payment
for use of LG brand name and trade marks during the year in
question. The Assessing Officer (hereinafter also called `the AO`)
referred the international transactions reported by the assessee to the
Transfer Pricing Officer (hereinafter called `the TPO`). One of such
transactions included in the assessee`s audit report was Contribution
towards Global Cricket Sponsorship. The TPO observed that the
assessee had received contribution from its Associated Enterprise
(hereinafter called the `AE`) for the expenditure incurred on
sponsorship of Global Cricket events. The quantum of contribution
received was considered as a part contribution for the brand
promotion carried out by the assessee on behalf of its foreign AE.
The TPO observed that the assessee`s expenses on advertisement,
marketing and promotion including trade discount and volume
rebate, described by him as Advertising, Marketing and Promotion
(hereinafter called `the AMP expenses`) were 3.85% of its sales at
`6553.36 crore. He computed similar percentage in the case of
Videocon Appliances Ltd. (0.12%) and Whirlpool of India Ltd
(2.66%) with their arithmetic mean at 1.39%. It was opined that the
assessee was promoting LG brand owned by its foreign AE and hence
5 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
should have been adequately compensated by the foreign AE.
Applying the Bright Line Test, the TPO held that the expenses up to
1.39% of the sales should be considered as having been incurred for
the assessee`s own business and the remaining part which is in excess
of such percentage, at 2.46% (3.85% - 1.39%) on brand promotion of
the foreign AE. Such excess at `161,21,99,499/- was proposed as a
transfer pricing adjustment on account of AMP expenses for brand
building.
3. Before the Dispute Resolution Panel (hereinafter called `the
DRP`), it was contended on behalf of the assessee that the total AMP
expenses so incurred helped in increasing its sales activity and hence
no part of the same could be considered as unrelated to its business,
being in the nature of brand building for the foreign AE. It was also
put forth that the LG brand was in existence globally even before the
assessee started its operations in India. Thus it was pleaded that the
assessee did not have any occasion to create this brand in India. The
assessee also claimed that brand name was available to it without
paying any brand royalty, which was an important factor to be kept in
mind. Even if such expenses resulted in creation of a brand in India,
the assessee contended that no further amount was attributable to
such brand creation on account of its higher profitability and non-
payment of brand royalty.
4. The DRP found that the assessee incurred extraordinary AMP
expenses for the promotion and development of LG brand in India.
The assessee`s contention that the incurring of such expenses did not
6 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
lead to the promotion of brand in India, was found to be not tenable.
The DRP concurred with the view taken by the AO in the draft order
prepared by the AO u/s 144C in making adjustment of `161.21 crore.
It was further observed by the DRP that TPO had not charged mark-
up on such AMP expenses. The same was found warranted as the
assessee`s activity required not only the deployment of its funds but
also entrepreneur`s efforts including the use of its infrastructure.
Opportunity cost was finalized at 10.50%, being the interest rate
charged by the banks; and compensation for the assessee`s
entrepreneurial efforts was taken at 2.5% . Thus, the DRP came to
hold that the mark-up of 13% should have been applied on the
amount proposed for adjustment. At the same time, the DRP agreed
with the assessee`s contention that no opportunity cost of 10.5%
should be charged on the expenses for which reimbursement was
received immediately after the same were incurred. Pursuant to
directions given by the DRP, the ld. AO passed order u/s 143(3) read
with sec. 144C on 31.10.2011 making additions, inter alia, of
`182.71 crore (inclusive of mark-up @ 13%) towards AMP expenses
on brand building incurred for and on behalf of its AE. The assessee
is aggrieved against such addition of `182.71 crore made by the AO.
5. We have heard Shri Ajay Vohra, Shri Ramit Katyal & Shri
Abhishek Aggarwal, the learned counsel representing the assessee
(hereinafter called the ld. counsel for the assessee /appellant) and Shri
G.C. Srivastava, Shri Peeyush Jain, the CIT-DR & Ms. Preeti
Bhardwaj (hereinafter called the ld. counsel for the
Revenue/Department). We have also heard several learned counsel
7 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
for the interveners, namely, Shri M.S.Syali & Shri Tarandeep Singh
for M/s. Cannon India P. Ltd., M/s. Amadeus India P. Ltd. and M/s.
Pepsi Foods P. Ltd., Shri S.Ganesh & Shri Neeraj Jain for M/s.
Maruti Suzuki India Limited, Shri S.Ganesh & Shri Sunil Agrawal
for M/s. Star India P. Ltd., Shri N.Venkataraman & Shri Manoneet
Dalal for M/s. Sony India P. Ltd., Shri Ajay Vohra, Shri Neeraj Jain,
Shri Ramit Katyal & Shri Abhishek Aggrawal for M/s. Haier
Appliances India P. Ltd., M/s. Goodyear India P. Ltd. and M/s. Glaxo
Smithkline Consumer H. Ltd., Shri Mukesh Butani, Shri Rahul
Yadav & Shri Vishal Kalra for M/s. Bausch & Lomb Eyecare P. Ltd.,
M/s. Fujifilm Corporation, M/s. Canan I.P. Ltd. and M/s. Daikin
Airconditioner I. P. Ltd., Shri Ashwani Taneja, for M/s.Haier
Telecom Private Limited and Shri Vikas Srivastava, for M/s. LVMH
Watch and Jewellery I. P. Ltd. (all collectively referred to as the ld.
counsel for the interveners).
6. Though both the questions referred to this special bench are
inter-linked, still we are taking up question no. 1 first. The ld.
counsel for the assessee has assailed the impugned order on various
legal and factual issues. In so far as the first question is concerned,
we have divided such submissions into seven broader parts for the
sake of convenience, which will be dealt with one by one.
I. JURISDICTION OF TPO
II. RULE 29
III. TRANSACTION
IV. INTERNATIONAL TRANSACTION
8 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
V. COST/VALUE OF TRANSACTION
VI. METHODS FOR DETERMINATION OF ALP OF
INTERNATIONAL TRANSACTION
VII. MARUTI SUZUKI`S CASE
I. JURISDICTION OF TPO
7.1. Without prejudice to the main argument that there is no
transaction much less an international transaction of brand building
for the foreign Associated enterprise in the facts and circumstances of
the present case, the ld. counsel for the appellant strongly contended
that the TPO was not justified in assuming jurisdiction to process the
such international transaction in the absence of any reference made to
him by the AO. It was stated that the jurisdiction over a subject
matter can be acquired only after the concerned authority first
discharges the onus of proof about the satisfaction of all the pre-
requisite conditions for the assumption of such jurisdiction. Coming
to the present context, the learned counsel for the assessee contended
that the AO did not refer the international transaction of marketing
intangibles to the TPO and as such the latter was precluded from
determining the arm`s length price (hereinafter also called `the ALP`)
in respect of such transaction. Our attention was invited towards the
judgment in the case of CIT Vs. Amadeus (India) (P) Ltd. [(2012) 246
CTR (Del.) 338] in which it has been held that it is not within the
domain of the TPO to determine whether a particular transaction is or
is not an international transaction and then to determine the ALP
9 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
thereof, which was not referred to him but comes to his notice during
the course of proceedings.
7.2. The ld. counsel submitted that section 92CA of the Income-
tax Act, 1961 (hereinafter also called `the Act`) has undergone certain
changes. He referred to sub-section (2A) of section 92CA, inserted
by the Finance Act 2011 w.e.f. 1-6-2011, as per which, where any
other international transaction, apart from those referred to under sub-
sec. (1), comes to the notice of the TPO during the course of
proceedings before him, the provisions of this Chapter shall apply as
if such international transaction is an international transaction
referred to him under sub-sec. (1). The ld. AR submitted that the
newly inserted provision is applicable only w.e.f. 1-6-2011. As the
TPO passed order on 29-10-2010, the deficiency in jurisdiction
which was missing under sub-section (2), remained lacking even
with the help of sub-section (2A). Referring to sub-sec. (2B) of sec.
92CA, the ld. AR contended that this provision has been inserted by
the Finance Act 2012 with retrospective effective from 1-6-2002.
Such provision with retrospective effect cannot come to the rescue of
the Revenue to cure the defect in the jurisdiction of the TPO in
determining ALP of the international transaction because it was not
there at the time of his passing the order. In support of this
contention, he referred to the judgment of the Hon`ble Supreme Court
in the case of CIT Vs. Max India Ltd. [(2007) 295 ITR 282 (SC)] . In
that judgment it has been held that the position of law is to be
considered as it stands on the date when the order is passed. He also
referred to the judgment of the Hon`ble Supreme Court in the case of
10 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
Sagir Ahamad Vs. State of U.P. & others 1954 AIR 728. The ld. AR
contended that it has been held in this later case that the subsequent
amendment of Constitution of India cannot validate a prior
unconstitutional Act. He also invited our attention towards the
judgment of the Hon`ble Gujarat High Court in the case of Avani
Export & others Vs. CIT & Others dated 2nd July, 2012, to shore up
his submission for reading down the retrospective operation of sub-
section (2B) of sec. 92CA. The ld. counsel emphasized on giving
prospective operation to sub-section (2B) of sec. 92CA by contending
that if sub-sec. (2B) is held to be retrospective from 1-6-2002, then
all other sub-sections of sec. 92CA will become otiose.
7.3. This point was also underscored by another ld. counsel
appearing for some of the interveners. It was contended that sub-sec.
(2A) of section 92CA considers all the circumstances under which an
international transaction, other than that referred to by the AO, comes
to notice of the TPO during the course of proceedings before him. He
submitted that this sub-section unconditionally empowers the TPO to
consider any transaction which comes to his notice during the course
of proceedings before him. On the contrary sub-section (2B) has been
made applicable only in respect of an international transaction for
which the assessee failed to furnish the report u/s 92E, which is a
restricted provision. It was claimed that the mandate of sub-sec. (2B)
can apply only in respect of a transaction which is an international
transaction as per assessee`s understanding but has not been reported.
But where a transaction is not an international transaction as per the
assessee`s version, the same cannot be brought within the ambit of
11 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
sub-sec. (2B). It was submitted that if we analyze the position after
1-6-2011, being the date from which sub-sec. (2A) has been inserted,
in a way that an international transaction for which the assessee did
not furnish audit report u/s 92E as covered under sub-section (2B),
then the mandate of sub-sec. (2A) to that extent shall fail. Both the
sub-sections (2A) and (2B) of section 92CA should be interpreted as
different in content from each other. He relied on the judgment of
Hon`ble Supreme Court in the case of Sultana Begum Vs. Prem
Chand Jain (1997) 1 SCC 373 to contend that the statute has to be
read as a whole to find out the real intention of the legislature. He
argued that if the interpretation is given to sub-sec. (2B) as
encompassing all international transactions in respect of which
assessee did not furnish report u/s 92E, then sub-sec. (2A) to that
extent shall be rendered inoperative because the contents of sub-
section (2B) in such a situation would also stand covered in sub-sec.
(2A). In his opinion, the only possible way to harmoniously interpret
sub-sections (2A) and (2B) of section 92CA is to imprison the scope
of sub-sec. (2B) with such transactions which the assessee perceives
as international transaction but fails to report.
7.4. The ld. counsel for the appellant invited our attention towards
the requirement enshrined in sub-sec. (1) of section 92CA, being the
taking of a previous approval of the Commissioner before making
reference by the AO. It was submitted that since in the instant case
the TPO himself assumed jurisdiction in determining ALP of the
international transaction, the requirement of seeking a prior approval
of the Commissioner failed. In that view of the matter also, the ld.
12 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
AR submitted that the action of the TPO in determining ALP in
respect of the transaction be declared as a nullity.
7.5. The ld. DR vehemently opposed the above contention by
stating that there is no irregularity or invalidity in assuming
jurisdiction by the TPO because of the insertion of sub-section (2B)
of section 92CA with retrospective effective, covering the period
under consideration.
7.6. We have heard the rival submissions and perused the related
material on record. In order to evaluate the rival contentions in this
regard, it will be apposite to consider the relevant parts of section
92CA, as under:
*92CA. Reference to Transfer Pricing Officer.--(1)
Where any person, being the assessee, has entered into an
#international transaction or specified domestic
transaction in any previous year, and the Assessing
Officer considers it necessary or expedient so to do, he
may, with the previous approval of the Commissioner,
refer the computation of the arm`s length price in relation
to the said #international transaction or specified domestic
transaction under section 92C to the Transfer Pricing
Officer.
(2) Where a reference is made under sub-section (1), the
Transfer Pricing Officer shall serve a notice on the
assessee requiring him to produce or cause to be produced
on a date to be specified therein, any evidence on which
the assessee may rely in support of the computation made
by him of the arm's length price in relation to the
#international transaction or specified domestic
transaction referred to in sub-section (1).
13 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
***(2A) Where any other #international transaction or
specified domestic transaction other than an #international
transaction or specified domestic transaction referred
under sub-section (1), comes to the notice of the Transfer
Pricing Officer during the course of the proceedings
before him, the provisions of this Chapter shall apply as if
such other #international transaction or specified domestic
transaction is an #international transaction or specified
domestic transaction referred to him under sub-section (1).
##(2B) Where in respect of an international transaction,
the assessee has not furnished the report under section 92E
and such transaction comes to the notice of the Transfer
Pricing Officer during the course of the proceeding before
him, the provisions of this Chapter shall 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.
7.7. Sub-section (1) of section 92CA provides that where the
assessee has entered into an international transaction and the AO
considers it necessary so to do, he may, with the previous approval of
the Commissioner, refer the computation of the ALP in relation to the
14 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
said transaction to the TPO. Thus, there is an intrinsic requirement of
seeking the approval of the Commissioner before making a reference
to the TPO u/s 92CA. As per sub-sec. (2), the TPO shall determine
the arm`s length price of the transaction which has been referred to
him by the AO as per sub-sec. (1). A conjoint reading of sub-secs.
(1) & (2) of section 92CA makes it manifest that the TPO can
determine ALP of an international transaction only when a valid
reference is made to him by the AO and not otherwise. The judgment
of the Hon`ble jurisdictional High Court in Amadeus (India) (P) Ltd.
(supra), has laid down that in the absence of a valid reference by the
AO, the TPO cannot determine ALP of an international transaction.
This judgment has been rendered on consideration the provisions of
sub-section (2) of section 92CA.
7.8. It is interesting to note that the Finance Act 2011 inserted sub-
sec. (2A) of sec. 92CA w.e.f. 1-6-2011. As per this provision the
TPO shall determine ALP of any international transaction, other than
that referred to him by the AO under sub-section (1), which comes to
his notice during the course of proceedings before him. This
provision has thus enlarged the jurisdiction of the TPO by
empowering him to compute ALP in respect of any transaction, other
than those referred to him by the AO, which comes to his notice
during the course of determining ALP of the referred transactions.
Consequently, the sub-section (2A) has changed the legal position as
settled by the Hon`ble jurisdictional High Court in the case of
Amadeus (India) (P) Ltd. (supra). It is worthwhile to mention here
that the Hon`ble jurisdictional High Court in Amadeus (India) (P)
15 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
Ltd. (supra), has decided the controversy in the light of sub-sec. (2)
of sec. 92CA. Their Lordships made it unequivocal at least at two
places in the judgment that their view is on the basis of provision of
sec. 92CA as applicable to the assessment year 2006-07, that is, prior
to introduction of sub-section (2A) of sec. 92CA. It thus becomes
apparent that with the insertion of sub-sec. (2A), the TPO can
compute ALP in respect of any transaction other than those referred
to him by the AO. However, it is pertinent to note that sub-sec. (2A)
has been inserted w.e.f. 1-6-2011. Thus, the mandate of sub-sec. (2A)
cannot apply to a period anterior to this cut-off date. As the TPO
passed the order in the instant case on 29-10-2010 which is obviously
prior to 1-6-2011, sub-section (2A) can not be of any help to save his
action.
7.9. Then comes the insertion of sub-sec. (2B) of section 92CA
by the Finance Act 2012 with retrospective effect from 1-6-2002. It is
significant to note that the date giving retrospective effect to this
provision coincides with the insertion of sec. 92CA itself in the
statute. As per sub-sec. (2B), where an assessee has not furnished
report u/s 92E in respect of an international transaction and such
transaction comes to the notice of the TPO during the course of
proceedings before him, it shall be considered as an international
transaction referred to the TPO under sub-sec. (1). Admittedly, the
assessee did not report the international transaction under
consideration in its report u/s 92E. Going by the prescription of sub-
sec. (2B), it becomes visible that such transaction is to be considered
as an international transaction referred by the AO to the TPO under
16 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
sub-sec. (1) of sec. 92CA because it came to his notice during the
course of proceedings, after 1.6.2002.
7.10. The ld. counsel for the appellant has seriously objected to
giving retrospective effect to sub-sec. (2B). His submission has been
recorded above as per which it was tried to make out that the
subsequent amendment by way of insertion of sub-section (2B)
cannot cure the defect in the otherwise invalid jurisdiction at the time
of its original exercise. The ld. AR submitted that jurisdiction has to
be tested on the basis of the law existing at the time of assuming
jurisdiction. In this regard he heavily relied on the judgment in the
case of Max India Ltd. (supra). Let us examine the factual matrix and
the legal proposition emerging out of that case and then its
applicability to the facts of the present case. It can be noticed that the
question before the Hon`ble Supreme Court was to examine the
validity of action of the Commissioner u/s 263. The Hon`ble Apex
Court has held that if an issue is debatable, that goes outside the
purview of sec. 263. In this judgment, the Hon`ble Su mmit Court
observed that sec. 80-HHC came to be amended eleven times and
obviously there were two views in respect of the words losses or
profits, which aspect was clarified by the 2005 amendment with
retrospective effect. The entire case has proceeded on the existence of
two views on the point, thereby debarring the Commissioner from
exercising revisional power u/s 263. Further, the Hon`ble Supreme
Court observed that subsequent amendment in 2005, even though
retrospective, will not attract the provisions of sec. 263 as the position
17 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
of law standing on the date of the passing of the order by the
Commissioner is to be considered.
7.11. In our considered opinion, the judgment does not support
the contention of the ld. AR. Obviously that case has advanced on the
question of two views existing on the point. There are umpteen
number of judgments to support the proposition that an action u/s 263
is barred on a debatable issue. An issue is said to be debatable when
two possible views exist on it. If the AO followed one of such
possible views, the Commissioner cannot intervene to impose the
other view by invoking jurisdiction u/s 263. It is of further
significance to note that Hon`ble Supreme Court in that case started
with the remarks we express no opinion on the scope of the said
amendment of 2005. It is patent from these observations that the
Hon`ble Apex Court did not go into the interpretation of the word
profit as encompassing the word loss as well, which was the
subject matter of the 2005 amendment under consideration. It simply
decided the point in assessee`s favour by holding that since there
were two views existing on the point, the CIT could not have
embarked upon section 263.
7.12. Presently we are concerned with the framing of assessment
and determining the question of ALP by the TPO. There is a
phenomenal distinction between the requirements for taking action
u/s 263 and framing an assessment u/s 143(3) or the other related
proceedings. Unlike sec. 263, there is no requirement that the AO/
TPO cannot decide a debatable issue. There is not and cannot be any
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law, prohibiting the AO from deciding a debatable issue in favour of
the Revenue until the dispute is finally set to rest by some legislative
amendment or by some judgment of the Hon`ble Supreme Court or
that of the Hon`ble jurisdictional High Court. The observations made
in the case of Max India (supra) need to be viewed in the
surroundings of the facts of that case and the legal position governing
the issue. Whereas section 80HHC was subjected to eleven
amendments and its interpretation was not free from doubt and even
the Hon`ble Summit Court dealt with the question of validity of
action u/s 263 without expressing any opinion on the scope of the
said amendment of 2005, sub-sec. (2B) of sec. 92CA is a provision
having no shred of doubt on its construction. Its ambit is not eclipsed
by any uncertainty. There is no question of keeping its interpretation
in the arena of any debate. Even a layman will read this provision as
extending the power of TPO to such international transactions in
respect of which the assessee did not furnish audit report. In view of
the above discussion, it becomes apparent that the ratio decidendi in
the case of Max India (supra) can have no application to the facts of
the instant case.
7.13. We now consider the judgment of the Hon`ble Gujarat High
Court in the case of Avani Exports (supra). Here also the controversy
rotates around the interpretation of third and fourth provisos to sec.
80HHC(3). Various writ petitions were filed before the Hon`ble
Supreme Court on the constitutional validity of insertion of the third
and fourth provisos to sec. 80HHC(3) of the Act by amendment of
the Tax Laws (Amendment) Act, 2005 with retrospective effect. The
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Hon`ble Supreme Court transferred these matters pending before
various High Courts to the Hon`ble Gujarat High Court for
considering whether the severable parts of the third and fourth
provisos to sec. 80HHC(3) of the I.T. Act, 1961, were ultra virus to
Articles 14 & 19(1)(g) of the Constitution of India. After considering
elaborate arguments from both the sides, the Hon`ble Gujarat High
Court has held the amendment to be prospective, thereby holding its
retrospective operation to be infringing the Constitution. From the
above judgment, it is clear that the Hon`ble Gujarat High Court has
read down the retrospective effect to the amendment of sec. 80-HHC
by deciding that it shall operate prospectively.
7.14. At this juncture, it is relevant to note difference between
powers of the Hon`ble Supreme Court and the Hon`ble High Courts
on one hand and the Tribunal on the other on the question of deciding
the constitutional validity of a provision. It hardly needs to be
emphasized that the Tribunal is a creature of the Act and hence has
no power to declare any provision of the Act as unconstitutional,
either fully or partly. Every single provision of the Act has to be
presumed by the tribunal as a constitutionally valid piece of
legislation. The power to declare any provision as unconstitutional
lies in the exclusive domain of the Hon`ble Supreme Court and the
Hon`ble High Courts. Not only a provision per se but even the
retrospective effect given by the legislature to a particular provision
can also be tested by these Hon`ble higher Courts on the touchstone
of the provisions of the Constitution of India. The tribunal can
examine the nature of amendment along with other relevant
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circumstances for ascertaining whether it is intended to be
prospective or retrospective, only where no retrospective effect has
been given by the Parliament to any provision. But where the
legislature has specifically given retrospective effect to a provision,
the tribunal has no power to declare the retrospective effect of such
amendment as unconstitutional, without there being any such direct
enunciation by the higher courts.
7.15. From the above judgment, it can be seen that Hon`ble Gujarat
High Court has held the retrospective operation of the amendment to
be null and void being in contravention of Articles 14 & 19 of the
Constitution of India. It is not a case that by upholding the
constitutional validity of the retrospective amendment, the Hon`ble
High Court has held that it can`t apply to the cases before it. There is
a marked difference in a situation where an amendment itself is held
to be in violation of the Constitution of India and hence declared as
void and a situation in which the amendment is valid but is
interpreted as not applicable to a particular case. Whereas the
Hon`ble Supreme Court and Hon`ble High Courts can declare an
amendment to be unconstitutional and hence invalid, the Tribunal
cannot do so. In view of the above discussion, we are of the
considered opinion that the judgment in the case of Avani Exports
(supra) cannot be applied to the facts of the instant case to declare the
retrospective operation of sub-section (2B) of section 92CA as
unconstitutional and hence inoperative.
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7.16. Now we take up the judgment in the case of Sagir Ahamad
(supra), relied on by the ld. AR for bolstering his submission that the
subsequent insertion of sub-section (2B) of section 92CA cannot
validate the jurisdiction of the TPO which was earlier lacking. In this
case the U.P. Road Transport Act, 1951 was enacted, which was
violative of Article 19(1)(g) of the Constitution of India. Thereafter,
an amendment was carried out to Article 19(1) of the Constitution
which validated the position stated in the U.P. Transport Act. The
question arose as to whether the amendment of the Constitution,
which came later, can validate an earlier legislation which was
unconstitutional when it was passed. The Hon`ble Supreme Court
held that the subsequent amendment of the Constitution cannot
validate or remove the unconstitutionality of an Act. It is beyond our
comprehension as to how this judgment supports the contention of
the ld. AR. We are dealing with a situation in which there is insertion
of sub-sec. (2B) of sec. 92CA with retrospective effect from 1-6-
2002. The effect of insertion with retrospective effect is that the
amendment is construed as existing from the date from which the
retrospective effect is given. It is not as if the amendment is to be
considered as effective from the date of its insertion only. If the force
of a provision is considered from the date of its insertion, then
obviously the retrospective effect given to such provision would
become meaningless. In Sagir Ahamad's case the amendment to the
Constitution was done prospectively. That is the reason for which the
Hon`ble Supreme Court held that the unconstitutional Act passed
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anterior to such amendment cannot be validated by a subsequent
amendment.
7.17. At this stage it is appropriate to note that sub-sec. (2B) has
been inserted by the Finance Act, 2012, whereas sub-sec. (2A) by the
Finance Act, 2011. We have noticed above that by means of insertion
of sub-sec. (2A), the TPO gets power to determine ALP in respect of
transaction not referred to him by the AO but coming to his notice
during the course of proceedings before him. Due to insertion of this
provision w.e.f. 1-6-2011, the earlier action taken by the TPO in
several cases in determining ALP of the transactions not referred to
him by the AO, remained to be saved. Thus the position of the
judgment in the case of Sagir Ahamad (supra) is akin to prevalence
of sub-sec. (2A) of sec. 92CA alone. In that case also U.P. Road
Transport Act 1951 was held to be unconstitutional despite
amendment to Article 19, which if present at the time of enactment of
U.P. Transport Act, would have made the Act constitutional.
Similarly, sub-sec. (2A) of sec. 92CA validates the determination of
ALP by TPO in respect of international transactions not referred to
him only w.e.f. 1-6-2011 and not prior to that.
7.18. Realizing that sub-sec. (2A) did not serve the purpose in
entirety to validate the action of the TPO in determining ALP in
respect of transactions not referred to by the AO, the legislature came
out with sub-sec. (2B) with retrospective effect from 1-6-2002. As
per this sub-section, any international transaction in respect of which
the assessee has not furnished report u/s 92E can be considered by the
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TPO for determining ALP. Thus, sub-sec. (2B) has the effect of
validating the action of the TPO with effect from 1.6.2002, thereby
covering even the period prior to 1-6-2011, being the date of insertion
of sub-sec. (2A) of sec. 92CA. The contention that sub-sec. (2B) of
sec. 92CA cannot be invoked to regularize the otherwise invalid
action of the TPO, in our considered opinion, is farfetched. When the
legislature in its wisdom has given retrospective effect to sub-sec.
(2B) from 1-6-2002, it is impermissible for us to hold that the
retrospectivity of this provision should be ignored and only
prospective effect be given to it. If the contention raised by the ld. AR
is accepted then the very insertion of sub-section (2B) shall become
redundant.
7.19. Here it is relevant to note that the Finance Act, 2012
introduced sub-sec. (2C) along with sub-sec. (2B) of section 92CA.
Whereas sub-section (2B) has been made retrospectively applicable
from 1.6.2002, sub-section (2C) has been given effect from 1-7-
2012. The reason is obvious when we see the contents of both the
provisions. Under sub-section (2C), the power of the AO to make
assessment or reassessment u/s 147 or pass order u/s 154 to enhance
the assessment completed before 1-7-2012, has been curtailed to the
extent the subject matter is covered by sub-section (2B). It shows that
abundant caution has been taken by the legislature in not disturbing
the finality of the assessment due to retrospective operation of sub-
section (2B) in cases set out in sub-section (2C). The acceptance of
the contention of the ld. AR to consider sub-section (2B) as
prospective, would not only make sub-section (2B) but sub-section
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(2C) also as dormant and non-existent. Obviously an interpretation
which makes a valid piece of legislation as redundant, does not merit
acceptance. The purpose intended to be achieved in validating the
jurisdiction of the TPO on the earlier transactions not referred to him
by the AO on one hand and also not disturbing the finality of
assessments already completed on the other, has been properly
achieved by the respective dates from which sub-sections (2A), (2B)
and (2C) have been given effect to.
7.20. The ld. counsel for the appellant also contended that if sub-
section (2B) is considered as retrospective in operation, then all other
sub-sections of sec. 92CA will loose the worth of their existence.
This argument was developed to contend that if the TPO is to be
permitted to determine ALP in respect of any transaction, then sub-
sec. (1) requiring reference to him by the AO, will be rendered
useless. In our considered opinion, this contention misses the wood
from the tree. The jurisdiction of the TPO is activate only when the
AO makes reference to him under sub-section (1) for determining
ALP in respect of certain transactions. Sub-secs. (2A) and (2B) come
into play only when sub-sec. (1) has already been set into motion.
Thus, it is only when the AO makes a reference to the TPO in terms
of sub-sec. (1) for determination of ALP in respect of the referred
international transactions, that the TPO gets power under sub-
sections (2A) and (2B) to determine ALP in respect of non-referred
international transactions as well. In the absence of any such
reference under sub-section (1), the TPO cannot suo motu undertake
the determination of ALP in respect of other international
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transactions not referred to him. It is a different matter that the
reference by the AO may be for one international transaction and the
TPO while determining ALP in respect of that one international
transaction, also comes across certain other international transactions
requiring determination of ALP. Thus, reference by the AO to the
TPO for at least one international transaction is a necessary
stipulation to assume power for determining ALP in respect of other
transactions.
7.21. Another point urged by the ld. counsel for the appellant was
that sub-sec. (1) requires making a reference by the AO with the
previous approval of the Commissioner. It was contended that insofar
as suo motu exercise of power by the TPO on other international
transactions is concerned, the requirement of seeking approval from
the CIT will be lacking, rendering the assumption of jurisdiction by
the TPO over such other international transactions as invalid. Here
again we find ourselves in respectful disagreement with the
submission. What sub-sec. (1) requires is that the AO should seek
previous approval of the Commissioner in respect of the transactions
for which he is making reference to the TPO. There is no
requirement of previous approval of the Commissioner in respect of
the international transactions which come to the notice of the TPO
during the course of proceedings before him. The prerequisite of
seeking approval of the Commissioner is incorporated in sub-sec. (1)
alone and the same cannot be read into sub-secs. (2A) and (2B) by
the doctrine of incorporation. Our view is fortified by the judgment of
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the Hon`ble Supreme Court in the case of CIT Vs. Pawan Kumar
Laddha [(2010) 324 ITR 324 (SC)] .
7.22. Now we take up the contention raised by the ld. counsel for
some of the interveners on harmoniously interpreting sub-section
(2B) by limiting its scope only to such transactions which the
assessee perceives as international transactions but fails to report. We
are not convinced with such interpretation. A line of distinction
sought to be drawn by the ld. counsel between two types of
international transactions for which the assessee has not furnished
audit report, viz., which is an international transaction as per
assessee`s version and which is not so, has no statutory sanction.
There is no such cue, even remotely, in the language of sub-sec. (2B).
The reference to international transaction in sub-sec. (2B), for which
the assessee has not furnished report u/s 92E, is unqualified. If we
interpret sub-sec. (2B) in the way suggested by the ld. AR, it would
amount to doing violence to the unambiguous language of the
provision by importing certain words in it, which is obviously
impermissible. The primary rule is that of strict or literal
interpretation, as per which a provision should be read as it is unless
manifestly absurd results follow from such interpretation.
7.23. We are equally conscious of the rule of harmonious
construction as reiterated in Sultana Begum (supra). Principle 3 in
para 15 of the judgment is that it is to be borne in mind by all the
courts all the times that when there are two conflicting provisions in
an Act which cannot be reconciled with each other, it should be
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interpreted as if possible, effect should be given to both. In our
considered opinion, the rule of harmonious construction can be
applied instantly by excluding the cases in which the assessee has not
furnished report in respect of international transactions, whether or
not it is an international transaction as per the assessee`s view p oint,
from the ambit of sub-sec. (2A) and including them in sub-section
(2B) of section 92CA. It is relevant to note that sub-sec. (2A) is a
general provision on the issue of the TPO suo motu taking up an
international transaction not referred by the AO, whereas sub-sec.
(2B) is a special provision limited in its scope only to such
international transactions in respect of which the assessee did not
furnish report u/s 92E. We have thoroughly discussed elsewhere in
this order that when there is special provision governing a particular
types of cases, then such cases stand excluded from the general
provision governing all the cases. As such we are of the considered
opinion that the scope of sub-sec. (2B) covers all types of
international transactions in respect of which the assessee has not
furnished report, whether or not these are international transactions as
per the assessee`s version. The contention of the ld. counsel in this
regard is thus sans merits and is hereby rejected. We want to clarify
that the above discussion has been made only to deal with the
contention raised on behalf of some of the interveners. But for that, it
is only academic in so far as we are concerned with the present
appeal involving the A.Y. 2007-08, which is a period anterior to A.Y.
2012-13. The extant case is fully and directly covered under sub-
section (2B) of section 92CA. In that view of the matter, it becomes
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evident that no fault can be found with the jurisdiction of the TPO to
process the transaction under reference.
II. RULE 29
8.1. Before we take up various legal and factual issues raised on
behalf of the assessee, it is appropriate to mention that the ld. DR
filed two separate applications at different stages of the proceedings
before this Special bench seeking leave of the tribunal for admission
of additional evidence under rule 29 of the ITAT Rules, 1963. First
application was filed before the commencement of his arguments as
respondent, that is, after the completion of arguments by the ld. AR;
and the second was filed, at the fag end of the proceedings of the
case, that is, after the completion of rejoinder by the ld. AR.
8.2. We will deal with both the applications one by one. Through
such first application, the ld. DR sought permission to file copies of
the order passed by TPO in assessee`s own case for A.Y. 2008 -09
along with written submissions filed by the assessee before the TPO
for the said assessment year and also statements dated 10-3-2011 of
Shri Laxmi Kant Gupta, Chief Marketing Officer and Shri Arim M.
Kooliyl AGM Products Planning, both employees of the assessee. It
was contended that these documents have bearing on the issue under
consideration as they go to the root of the matter. It was also stated
that there was indeed nothing new in these documents as these were
already in the knowledge of the assessee.
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8.3. The ld. counsel for the assessee seriously objected to the filing
of such additional evidence before the Tribunal. It was submitted that
Rule 29 does not confer any right on the parties before the tribunal to
file additional evidence in the circumstances which are presently
prevailing. The ld. AR relied on CIT Vs. Rao Raja Hanut Singh
[(2001) 252 ITR 528 (Raj.)]; A.K. Babu Khan Vs. CWT [(1976) 102
ITR 757(AP)]; and CIT Vs. Babu Lal Nim [(1963) 47 ITR 864 (MP)]
to oppose the admission of additional evidence. He contended that the
Revenue should have filed such application before commencement of
the arguments by the assessee appellant, so that he could get
opportunity of replying to such documents. It was also submitted that
the Department seeks to file some new material through such
application, which material is germane to the proceedings for the
A.Y. 2008-09 and hence the same cannot be considered as significant
for the year under consideration.
8.4. We have heard the rival submissions in this regard. In order
to put this controversy to rest, it would be apposite to note down the
prescription of Rule 29 of the ITAT Rules, 1963 which is as under :-
"29. The parties to the appeal shall not be entitled to
produce additional evidence either oral or documentary
before the Tribunal, but if the Tribunal requires any
documents to be produced or any witness to be examined
or any affidavit to be filed to enable it to pass orders or for
any other substantial cause, or, if the income-tax
authorities have decided the case without giving sufficient
opportunity to the assessee to adduce evidence either on
points specified by them or not specified by them, the
Tribunal, for reasons to be recorded, may allow such
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document to be produced or witness to be examined or
affidavit to be filed or may allow such evidence to be
adduced."
8.5. A bare perusal of the Rule reveals that the parties are not entitled
to produce additional evidence before the Tribunal. The same can be
filed inter alia, if the Tribunal requires to enable it to pass orders or
for any other substantial cause. We are not concerned with the
other part of the Rule 29. The contention raised by the ld. AR that the
Department has no right to file additional evidence under Rule 29 is
partly correct in the sense that no right vests with any party to press
for the admission of additional evidence before the Tribunal. It is the
prerogative of the Tribunal to entertain additional evidence for
enabling it to pass order or for any other substantial cause.
8.6. We find that the Revenue has invoked Rule 29 for filing
certain material which is already in the knowledge of the assessee.
Technically speaking, it is not additional evidence as it comprises of
the order passed by the TPO in assessee`s own case for A.Y. 2008 -
09; submissions made by the assessee itself and statements of the
employees of the assessee recorded by the Revenue. As will be seen
infra that the so called additional evidence is nothing but
corroboration of the material existing otherwise on which the ld. DR
has relied to bolster his submissions.
8.7. Be that as it may, it is pertinent to note that presently we are
dealing with the issue of determination of ALP in relation to
international transaction of brand building by the assessee for its
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foreign AE in this Special Bench. More than twenty parties, who
sought permission to intervene, have been permitted. Arguments
have been advanced on behalf of all of them through various ld.
counsel. The decision presently given by the Special Bench will have
binding effect over other Division Benches of the Tribunal across the
country. Through this Special Bench order certain broader principles
are going to be laid down, which will have impact over several other
cases. Since there are going to be much larger ramifications of this
order over several other cases, in our considered opinion the ends of
justice greatly demand the consideration of such additional evidence
having a direct bearing on the issue. The above enumerated factors
are sufficient to highlight the importance of the issue under
consideration and to bring it within the ambit of the expressions for
any other substantial cause and to enable it to pass orders as
employed in rule 29.
8.8. The Hon`ble Delhi High Court in CIT VS. Text Hundred India
P.Ltd. [(2011)239 CTR (Del.) 263] has held that the `discretion lies
with the tribunal to admit additional evidence in the interest of justice
once the tribunal affirms the opinion that doing so would be
necessary for proper adjudication of the matter. This can be done
even when application is filed by one of the parties to the appeal and
it need not to be a suo motto action of the Tribunal.` It further
observed that the true test in this behalf is whether the Appellate
Court is able to pronounce judgment on the material before it without
taking into consideration the additional evidence sought to be
adduced. The legitimate occasion, therefore, for exercise of discretion
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under this rule is not before the Appellate Court hears and examines
the case before it, but arises when on examining the evidence as it
stands, some inherent lacuna or defect becomes apparent to the
Appellate court coming in its way to pronounce judgment. From the
above judgment it is vivid that the additional evidence can not only
be admitted on an application by the parties, but also at the suo motu
discretion of the tribunal, if it considers necessary to entertain the
additional evidence for enabling it to pass orders or for any other
substantial cause.
8.9. Insofar as the judgment in the case of Rao Raja Hanut Singh
(supra) is concerned, it is seen that the Hon`ble Rajasthan High Court
has laid down that the admission of additional evidence at the
appellate stage is absolutely within the discretion of the Tribunal and
cannot be claimed as a matter of right. It has further been held that
the parties cannot set up an altogether new case through the
additional evidence. It will be seen on the appreciation of such
material at a later stage in this order that the additional evidence
sought to be relied by the ld. DR is not to set up a new case, but is
only in support of the reply to be given by the ld. DR on the
propositions argued by the ld. counsel for the assessee as well as the
interveners. The judgment in the case of A.K. Babu Khan (supra)
again talks of the discretion of the Tribunal in allowing or refusing to
admit the additional evidence. The case of Babulal Nim (supra), is
based on its own facts in which the assessee filed certain additional
evidence before the Tribunal at the Tribunal`s behest. Such additional
evidence was towards setting up of an overall new case. It was in
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such circumstances that the Hon`ble High Court directed to exclude
the additional evidence. In so far as the facts of the present case are
concerned, the additional evidence is not towards setting up of an
altogether new case.
8.10. Under the present circumstances, we are of the considered
opinion that the additional evidence sought to be field by the Revenue
through the first application has significant bearing on the issue
raised in this case. As there is overwhelming importance of this order,
we hereby admit such evidence for the reasons discussed
hereinabove. An announcement to this effect was made during the
course of hearing, so that both the parties may proceed accordingly.
8.11. As regards the contention of the ld. AR that the Department
should have filed such additional evidence before the commencement
of the arguments on behalf of the appellant-assessee, we note that
logic behind this contention is the adherence to the principles of
natural justice. It is axiomatic that no affected party can be denied the
opportunity to put forth his stand on the adverse material filed by the
opposite party. We indeed gave ample opportunity to the ld. AR to
controvert the additional evidence. He took one day in his rejoinder,
both the forenoon and afternoon sessions, inter alia making
submissions on such evidence, which have been duly recorded and
considered in this order at the appropriate place.
8.12. Now we take up the second application which, unlike the
first application, came to be filed by the ld. DR on the conclusion of
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the hearing of the assessee`s case. Relying on Text Hundred India
P.Ltd.(supra), the ld. DR contended that since the power of the
tribunal extends to accepting additional evidence even after the
conclusion of hearing, there can be no embargo on his filing
additional evidence at this stage.
8.13. We are not inclined to entertain this application for admission
of the additional evidence. A line of distinction needs to be drawn
between the additional evidence proposed to be filed by the either
party and that suo motu required by the tribunal. In so far as the
additional evidence proposed to be filed by the either party is
concerned, that can be possibly requested for admission at any stage
of proceedings provided there is a scope for the other side to rebut it.
Any stage can never embrace the conclusion of hearing, that is when
the appellant as well as respondent have made submissions and
further the appellant has also concluded his rejoinder. No party can
be allowed to come up with a request for filing additional evidence at
that juncture. If such a request is acceded to, it would create an
anomalous situation in which the other party will never get chance to
refute it. It is an elementary principle of law that no one can be
condemned unheard.
8.14. In contradistinction to the right of the parties to apply for
the admission of additional evidence at the appropriate stage of
proceedings, the power of the tribunal in suo motu requiring
additional evidence cannot be curtailed even after the conclusion of
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hearing. If in the given facts and circumstances of the case it is felt
by the tribunal that consideration of some fresh evidence is essential
for the proper and effective disposal of the appeal, it can very well
require the production of additional evidence. But in that case also it
will be essential for the tribunal to refix the matter for seeking
additional evidence and getting comments of both the sides on such
evidence.
8.15. As presently we are confronted with a situation in which the
hearing of the assessee`s case is effectively over not only by the reply
of the Revenue to the assessee`s contentions but also by the
completion of rejoinder on behalf of the assessee to the Revenue`s
reply, in our considered opinion the ld. DR cannot be allowed to file
additional evidence through its second application at this belated
stage. We fail to see any reason for the ld. DR in not filing such
additional evidence along with his first application which was filed at
the outset of the commencement of his arguments. We, therefore,
refuse to entertain the second application.
8.16. To sum up, out of the two applications filed by the ld. DR
under rule 29, first is allowed and the second is rejected.
III. TRANSACTION
9.1. The ld. counsel for the assessee contended that there is no
such alleged transaction of creating marketing intangible in the nature
of brand building by the assessee for its foreign AE, much less an
international transaction. It was stated that the assessee did not arrive
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at any understanding, oral or written, with its AE for promoting their
brand. All the AMP expenses were incurred in India for advertising
its products and there was no interference of the foreign AE in any
manner in this regard. He argued that it was the assessee who was
taking final decision on the question of when, where, and how the
advertisement was to be done. All the payments towards such
expenses incurred were made to the third parties and the foreign AE
was no where involved in this entire exercise. The ld. AR opposed
the view point of the Revenue in bifurcating the total advertisement
expenses into two parts, viz., first part towards the business carried
on by the assessee deductible in full in the hands of the assessee by
equating it with the proportionate amount of such expenses incurred
by the independent comparable parties; and the second part towards
the brand building for the foreign AE as not deductible. Whole of the
AMP expenses were incurred by the assessee for its own business
purpose and there was no question of spending anything exclusively
towards brand building for its foreign AE. There can be no brand
without product, which shows that all the advertisement expenses,
even though exhibiting the foreign brand, were liable to be attributed
only to the advertisement of products. He contended that when the
assessee incurred AMP expenses for its business purpose, which were
recorded as such, the Revenue was not entitled to recharacterize this
transaction by splitting it into two parts first towards advertisement
expenses for the assessee`s business and second towards the brand
building for the foreign AE. In support of this contention he relied on
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the judgment of the Hon`ble jurisdictional High Court in CIT Vs.
EKL Appliances Ltd. [(2012) 345 ITR 241 (Del)] .
9.2. It was stated that in order to reach any conclusion about the
assessee incurring AMP expenses towards brand building for the
foreign AE, there should be some agreement between the two for
incurring of such expenses. In the absence of any such agreement, the
existence of such an agreement cannot be inferred. He referred to sec.
92F(v) which defines the term `transaction` to elucidate that it talks
of agreement, understanding or action in concert. As there was no
such agreement etc. between the assessee and the foreign AE, the ld.
AR contended that it was wrong to infer it without any basis. He
relied on the judgment of the Hon`ble Supreme Court in the case of
Daiichi Sankyo Co. Ltd. Vs. Jayaram Chigurupati & others [(2010)
157 Company Cases 380 (SC)] to contend that there can be no
presumption about the acting of two parties in concert. Even if both
the parties are related to each other, the action in concert needs to be
specifically proved. In the radiance of this judgment, it was
contended that the Revenue was wrong in drawing an inference as to
any transaction of brand building between the assessee and the
foreign AE.
9.3. The ld. counsel further argued that primarily there was no
incurring of expenses for the brand building and even if it was
presumed that some part of the assessee`s advertisement expenses
incidentally led to the brand building for the foreign AE, then also it
cannot be considered as a `transaction` because there is no evidence
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of any prior understanding between the assessee and the foreign AE
in this regard. It was, therefore, stated that the vital ingredient of
`transaction`, being the agreement or understanding or action in
concert between the parties, was miserably lacking in this case.
9.4. The ld. DR countered the submissions advanced on behalf of
the assessee by stating that the existence of oral agreement in the
facts and circumstances of the present case is absolutely visible. He
argued that the incurring of AMP expenses of a magnitude which
have been incurred by the assessee but which no businessman in a
commercially rational manner incurs, goes to show that there was a
tacit understanding between the assessee and the foreign AE for
creating/improving the marketing intangible of the foreign AE in
India by incurring such excess AMP expenses, which is a transaction.
In view of the above arguments it was stated that the transaction of
brand building for the foreign AE can be very well inferred from the
facts and circumstances of the present case because the assessee is a
hundred percent subsidiary of its foreign AE working at the
command of its parent company.
9.5. The ld. DR invited our attention towards certain ads given
by the assessee in newspapers showing that the brand name and the
slogan of the foreign AE were demonstrated absolutely promptly,
which proved that the assessee was acting on the instructions of its
principal company for the creation/enhancement of the brand value
also. He also opposed the argument of the ld. AR that there can be no
advertisement of brand independent of product. In this regard some
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ad films of LG were shown in the open court to reveal that there can
be advertisement only for brand de hors products. One such video
was shown, by which only LG brand is advertised and there is no
reference to any LG products in that video. By placing on record an
extract from www. persuasive.com on page 173 of the paper book,
the ld. DR also quoted example of brand Tommy Hilfiger, which
does not manufacture anything at its own but sells the goods under its
brand. The ld. DR submitted that there can be advertisement only for
brand and not for product or it can also be for a product coupled with
brand or only for product and not for brand. It was, therefore,
submitted that the assessee entered into agreement with its foreign
AE for advertising the brand of the later, which is nothing but an
implied transaction.
9.6. He argued that the United Nations Transfer Pricing Manual
provides for the allocation of such cost of market penetration,
marketing expansion and market maintenance strategies between a
MNE and its subsidiaries under the Transfer Pricing Regulations.
The ld. DR referred to page 74 of the paper book, being extracts from
United Nations Transfer Pricing Manuals. Para 5.3.2.5 provides that
the allocation of the cost of these strategies between a MNE and its
subsidiaries is an important issue in transfer pricing and will depend
on the facts and circumstances of each case. It is important to
examine various factors in order to address this issue of cost
allocation between parties to the transactions. He invited ou r
attention towards certain relevant factors relevant in this regard
mentioned in such Manual including whether unusual intense
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advertising marketing and sales promotion efforts have taken place.
In the light of the above Transfer Pricing Manual of United nations,
the ld. DR contended that the incurring of unusual AMP expense
requires allocation of AMP cost between the MNE and its
subsidiaries. In so far as such allocation to the MNE is concerned, the
same is nothing but a transaction.
9.7. After considering the rival submissions and the perusing the
relevant material on record, an elementary question which falls for
our consideration is to decide as to whether there is any `transaction`
between the assessee and the foreign AE for the brand building in
India, the legal ownership of which vests with the principal abroad. It
would be apposite to consider the definition of `transaction` given i n
clause (v) of sec. 92F, which reads as under : -
"(v) "transaction" includes an arrangement,
understanding or action in concert, -
(A) Whether or not such arrangement, understanding or
action is formal or in writing; or
(B) Whether or not such arrangement, understanding or
action is intended to be enforceable by legal proceeding".
9.8. From the above definition it is apparent that a transaction is
an arrangement, understanding or action in concert, whether formal
or in writing or whether enforceable or not by legal proceedings. The
case of the Revenue is that brand building by the assessee for its
foreign AE via incurring AMP expenses to the extent of more than
what other independent entities proportionately incur for
advertisement of their products in a similar situation, has resulted into
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a transaction. On the other hand, it has been argued by the ld. AR that
there is a lack of agreement or unison between the assessee and its
foreign AE on the question of incurring AMP expenses for brand
building on behalf of the foreign entity. The contention has been
made by the ld. AR that in the absence of any mutual agreement
between the assessee and its foreign AE, it cannot result into a
transaction.
9.9. We do not find any force in this contention made on behalf
of the assessee. If the unison or mutual agreement between two
parties was to be deduced only from the terms of some formal
agreement, then there was no need for the legislature to define
transaction u/s 92F inter alia to mean an arrangement or
understanding - (A) whether or not such arrangement, understanding
or action is formal or in writing. The incorporation of the words
whether or not before the words such arrangement, understanding
or action is formal or in writing, is a clear pointer to the fact that the
agreement between the two AEs can be formal or in writing on one
hand or informal or oral on the other. When there is a formal or
written agreement between two AEs, the answer to the question as to
the existence of transaction becomes patent. If, however, there is an
informal or an oral understanding, the existence of such agreement
cannot be specifically found out because of it being not express.
However, such an informal or oral agreement, which is latent, can be
inferred from the attending facts and circumstances to make it patent.
Such inference can be drawn from the conduct of the parties. It
follows that a `transaction` can be both express as well as oral. So
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long as there exists some sort of understanding between two AEs on a
particular point, the same shall have to be considered as a transaction,
whether or not it has been reduced to writing. The ld. AR relied on
the judgment of the Hon`ble Supreme Court in the case of Daiichi
Sankyo Co. Ltd. Vs. Jayaram Chigurupati & others [(2010) 157
Company Cases 380 (SC)] to bring home the point that that there can
be no presumption about the acting of two parties in concert. Nobody
can deny that there can be no such presumption. Action in concert
can only be by the meeting of minds between two or more persons
leading to the shared objective. The Hon`ble Supreme Court observed
in this case that : it is another matter that the common objective or
purpose may be in pursuance of an agreement or an understanding,
formal or informal. In the case of an informal or oral concert, there
has necessarily to be something to indicate the concert indirectly. The
Hon`ble Summit Court has observed in this very judgment that : it
is the conduct of the parties that determines their identity. Thus it
cannot be said that in the absence of any express agreement between
the assessee and its foreign AE for incurring AMP expenses for the
brand promotion, whose legal ownership vests with the foreign entity,
there can be no transaction. The natural upshot is that if there is no
express agreement between the assessee and its foreign AE and still
the facts and circumstances indicate that the Indian entity incurred
some AMP expenses towards brand promotion of the foreign entity,
the same shall be considered as an implied or oral transaction.
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9.10. We do not find any force in the contention of the ld. DR
that the mere fact of the assessee having spent proportionately higher
amount on advertisement in comparison with similarly placed
independent entities be considered as conclusive to infer that some
part of the advertisement expenses were incurred towards brand
promotion for the foreign AE. Every businessman knows his interest
best. It is for the assessee to decide that how much is to be incurred to
carry on his business smoothly. There can be no impediment on the
power of the assessee to spend as much as he likes on advertisement.
The fact that the assessee has spent proportionately more on
advertisement can, at best be a cause of doubt for the AO to trigger
examination and satisfy himself that no benefit etc. in the shape of
brand building has been provided to the foreign AE. There can be no
scope for inferring any brand building without there being any
advertisement for the brand or logo of the foreign AE, either
separately or with the products and name of the assessee. The
AO/TPO can satisfy himself by verifying if the advertisement
expenses are confined to advertising the products to be sold in 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,
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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 assessee`s AMP
expenses are proportionately much higher than those incurred by
other comparable cases, lends due credence to the inference of the
transaction between the assessee and the foreign AE for creating
marketing intangible on behalf of the latter.
9.12. The ld. AR has vehemently argued that when the assessee
incurred AMP expenses for its business purpose and recorded them
as such, the Revenue went wrong in recharacterizing this transaction
by splitting it into two parts, viz., one towards advertisement
expenses for the assessee`s business and second towards the brand
building for the foreign AE. He fortified this contention by relying
on the judgment of EKL Appliances Ltd. (supra). There is absolutely
no doubt that para 17 of the judgment unambiguously lays down that
the tax administration should not disregard the actual transaction and
substitute other transactions for it. However, it is imperative to note
that the proposition laid down in para 17 is not infallible or is not an
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unexceptionable rule. Caveat has been included in the immediately
next para no. 18. Two exceptions have been carved out of the general
rule against recharacterization of any transaction as set out in para 17,
viz. (i) where the economic substance of a transaction differs from
its form; and (ii) where the form and substance of the transaction are
the same but the arrangements made in relation to the transaction,
viewed in their totality differ from those which would have been
adopted by the individual enterprise behaving in a commercially
rational manner. In our considered opinion, the second exception
governs the extant situation, as per which, where the form and
substance of the transaction are the same, but arrangements made in
relation to transaction viewed in totality differ from those which
would have been adopted by independent enterprises behaving in a
commercially rational manner. The assessee incurred AMP expenses
and explicitly showed them as such. Thus the form of showing the
AMP expenses coincides with the substance of the AMP expenses.
But the arrangement made in such transaction, viewed in totality,
differs from that which would have been adopted by independent
enterprises behaving in a commercially rational manner. Though the
AMP expenses were shown as such but the overt act of showing such
expenses as its own is different from what is incurred by independent
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
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the expenses to the extent the assessee has incurred. If the answer to
this question is in affirmative, then the transaction cannot be re-
characterized. 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,
prominently displaying brand of its Foreign AE in its advertisements,
has incurred expenses proportionately more than that incurred by
independent enterprises behaving in a commercial rational manner,
then it becomes eminent to recharacterize the transaction of total
AMP expenses with a view to separate the transaction of brand
building for the foreign AE. Even the United Nations Transfer
Pricing Manual, which has only a persuasive value, provides for the
allocation of such cost between the MNE and its subsidiaries. We,
therefore, hold that in the facts and circumstances of the present case,
there is a transaction between the assessee and the foreign AE under
which the assessee incurred AMP expenses towards promotion of
brand which is legally owned by the foreign entity.
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Economic vis-Ã -vis legal ownership of brand
10.1. The ld. counsel for some of the interveners contended that
there are two types of ownerships of a brand, viz., legal ownership
and economic ownership. In their opinion, part of the AMP expenses
incurred in India can be construed as leading only to the building of
the economic ownership of a foreign brand, which vests solely with
the Indian assessee, thus making full AMP expenses eligible for
deduction in its hands. They submitted that the total AMP expenses
should be segregated into routine and non-routine. Whereas routine
advertisement expenses are deductible in full u/s 37(1), non-routine
expenses on advertisement should be attributed to the economic
ownership of the brand. As it is the Indian entity which acquires the
economic ownership of brand and then exploits it for making more
and more sales in India, those should also be allowed in its hands. It
was claimed that no part of AMP expenses can be allocated to the
legal ownership of brand vesting with the foreign AE, so as to call for
any disallowance in the hands of the assessee.
10.2. We do not find any weight in the contention put forth about
the economic ownership and legal ownership of a brand. It is not
denied that there can be no economic ownership of a brand, but that
exists only in a commercial sense. When it comes in the context of
the Act, it is only the legal ownership of the brand that is recognized.
If we accept the contention of the ld. AR that it be held as an
economic owner of the brand or logo of its foreign AE for the
purposes of the Act and hence expenses incurred for brand building,
which is legally owned by the foreign AE, should be allowed as
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deduction in its hands, then incongruous results will follow. It is
patent that a manufacturer does not ordinarily sells its goods directly
to the ultimate customers. There is normally a chain of middlemen
ending with retailer. Going by that logic and descending in the line,
the distributors or wholesalers to whom the assessee sells its goods,
also become economic owners of the brand on the parity of reasoning
that they also exploit the brand for the purpose of selling the goods to
retailers. Similarly the retailers also become the economic owners of
the brand on the premise that on the basis of such brand they are
selling the goods to the ultimate customers. All these middlemen and
the assessee can be considered as economic owners of the brand only
in a commercial sense for the limited purpose of exploiting it for the
business purpose, which is otherwise legally owned by the foreign
AE. Such economic ownership is nothing more than that. Suppose
the foreign company, 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
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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 and its AE of
building and promoting the foreign brand.
Repercussions of parent AE's influence
11.1. The ld. DR contended that the inference of transaction of
brand building can also be drawn from the fact that the assessee and
its parent company are associated enterprises. The foreign AE
exercises complete control and influence over the economic behavior
of the assessee because of it being hundred percent subsidiary. If the
foreign entity chooses to direct the assessee to incur expenses on its
brand promotion without explicitly recording this fact in its account
books, the later cannot afford to say no. He argued that all the
arguments advanced by the ld. AR to the effect that it is solely for the
assessee to decide on the question of incurring of AMP expenses, are
based on the presumption of separate entity concept of the assessee
vis-a-vis the foreign AE, which is really not applicable in the present
case because of the relation between the two. Even though the
assessee and foreign AE are separate legal entities in two different tax
jurisdictions, the ld. DR contended that the assessee cannot be
regarded as distinct from its foreign AE. He invited our attention
towards the Foreign collaboration agreement dated 10-3-1997 which
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provides through clause 5 that the L.G. Electronics shall at all times
have the right to nominate all or majority of the directors on the board
of LGEIL. Clause 6 provides that L.G. Electronics shall have the
right to nominate the Chairman and the Managing Director of LGEIL
at all times. These clauses read in conjunction with other relevant
clauses amply prove that it is L.G. Korea which exercises complete
control over the assessee not only in nominating the Chairman and
Managing Director but also all the directors of the assessee company.
He also took us through Article 4 dealing with royalty payment under
the Technical assistance and royalty agreement dated 1-7-2001,
whose Clause 1(b) stipulates that the `licensor will advise the licensee
the rate of royalty and payment thereof on Agreed Products other
than TVs as and when the concerned division of licensor demands the
royalty payment. The licensee then will take necessary steps to take
Govt. of India`s approval if it so required.` It was argued that a
perusal of the above clauses indicates that it is only LGK which
decides the rate of royalty to be paid by the assessee over the period.
On such decision taken by LGK, the assessee is supposed to take
necessary steps for obtaining the Govt. of India`s approval, if any,
required for payment of royalty. This clause was claimed to be
proving that there is only one way traffic and there is no question of
any mutual negotiations taking place to finalise any business
decisions as happens between two independent entities. Under this
arrangement, it is only LGK which takes the final call and that has
binding effect on the assessee. He also referred to the Article 7 of
this agreement, which allows the use of LG brand name and
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trademark. This clause provides in second para that in case at any
stage in future the licensor demands any royalty payment on this
account, the licensee will take steps to get the Govt. of India`s
approval for payment of such royalty payment. It was stated that from
this Article it was evident that the amount of royalty to be paid by
LGI to LGK for use of its brand name falls in the exclusive domain
of LGK. The assessee has no role at all to play in such decision,
except following the dictate of LGK. The sum and substance of his
contention was that since LGK exercises complete control over the
economic decisions of LGI, the separate legal character of the
assessee should be overlooked notwithstanding the fact that LGI is a
legally separate entity.
11.2. Per contra, the learned Counsel for the assessee submitted in
rejoinder that the contention of the learned Departmental
Representative about disregarding the separate legal character of the
assessee due to the influence of the foreign AE on its economic
policies, was utterly erroneous. He relied on the judgment of the
Hon`ble Supreme Court in the case of Vodafone International
Holdings B.V. Vs. Union of India & Anr.s [(2012) 341 ITR 1 (SC)]
in which it has been held that if there are two separate but related
legal entities, their separate legal character cannot be ordinarily
disregarded. It was submitted that the legal character can be ignored
only where the Revenue positively proves the factum of the existence
of influence of the foreign AE over the affairs of the Indian AE in
general or in respect of specific transactions. He argued that such
burden has not been discharged in the present case by the Revenue in
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proving that there was any influence of the foreign AE in the decision
taken by the Indian AE towards incurring of the AMP expenses in
India.
11.3. We are convinced with the submissions advanced on behalf of
the assessee in this regard but only to the extent of not ignoring the
legal character of the Indian AE simply because of the close
relationship between the two enterprises. If we proceed with the
presumption that since the foreign enterprise has influence over the
economic behavior of the assessee and hence the separate legal
character of the Indian enterprise should be overlooked, then it would
mean that the such separate legal character of the assessee will be
lost not for one transaction but for all practical purposes. In that case
only the foreign entity will survive as a taxable unit even under the
Act. Probably it is not the case of the Revenue also as it is the Indian
entity which has been subjected to the present assessment.
11.4. However, we are not agreeable with the remaining part of
the contention of the ld. AR that the legal character of one enterprise
can be altered only where the Revenue positively proves the factum
of the existence of influence of the foreign AE over the affairs of the
Indian AE in general or in respect of specific transactions. In fact, it
is due to this close relation between AEs of MNC that Chapter-X has
been enshrined in the Act as an anti-tax avoidance measure. No doubt
AEs in India and abroad are two separate legal entities subject to tax
in different tax jurisdictions, but the fact that the economic behaviour
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of one depends on the wish of the other, can never be totally lost
sight of. Due to this factor, it becomes significant to verify as to
whether the decisions taken by the Indian AE are influenced by its
foreign AE. If any decision taken by the Indian AE is found to be
uninfluenced, then the transaction is accepted as such by the Revenue
at its face value. If however it turns out that the behavior of the Indian
AE has been influenced by the foreign AE, then there arises a need
for adjustment to that extent by removing the effect of such influence.
In fact, the transfer pricing provisions (hereinafter also called `the TP
provisions`) are aimed at discovering, in the first instance, if there is
any influence of the foreign AE over transactions between it and its
Indian counterpart ; and if the answer is in affirmative, then by
unloading the effect of such influence on the transaction. This entire
exercise is executed by firstly visualizing the value of an international
transaction between the two AEs; then ascertaining the ALP of such
transaction; and then eventually computing the total income of the
Indian AE having regard to the ALP of the international transaction.
Initial burden is always on the assessee to prove that the international
transaction with the foreign AE is at arm`s length price.
11.5. In our considered opinion the rival parties have occupied the
position akin to north pole and south pole on this score. In the context
of the TP provisions, the correct position lies somewhere between
these two extreme ends. Whereas the separate legal character of both
the entities remains intact under Chapter-X, at the same time there is
a simultaneous mandate for removing the effect of influence of one
entity over the economic dealings with the other on a transactional
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level by computing the income having regard to the ALP of each
international transaction.
Whether any express agreement in this case ?
12.1. The ld. DR submitted that it is a case in which, apart from
drawing an inference as to the transaction, there was an express
agreement between the assessee and the foreign AE for incurring of
AMP expenses for branding building. He referred to certain material
indicating the Blue Ocean Strategy (BOS in short) adopted by L.G.
group. He explained the concept of BOS as not to out-perform the
competition in the existing industry, but to create new market space
or a blue ocean, thereby making the competition irrelevant. It was
stated that this creation of new markets is obviously achieved inter
alia through the vigorous campaign for the awareness of brand and
products. Our attention was drawn towards pages 102 and 106 of the
paper book containing details of BOS of the LG Electronics, which
provides that In January 2006, the company launched `Blue Ocean
Management` campaign to be one among the top three EIT firms in
the world by 2010. From this material, it was shown that the BOS
was implemented in January 2006, to be carried on for four five years
with a view to bring L.G. Electronics within the three top firms of the
world by 2010. It was explained that the period relevant to the
assessment year under consideration is covered under the currency of
the BOS as adopted by the LGK on a global level including India
through the assessee. A reference was made to page 132 of the paper
book as per which the assessee, that is, LGI announced to follow the
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footsteps of LGK in adopting the BOS. Then he referred to interview
of Mr. M.B. Shin, the Managing Director of the assessee company, a
copy of which is available on page 133 of the paper book. In response
to question as to what is the rationale behind LGI adopting the BOS
in India, Mr. Shin replied that the concept of BOS as adopted by LG
Electronics world wide, is for strengthening business capabilities and
streamlining business structure thus being able to achieve the global
top three by 2010. Mr. Gabor George Burt, in response to same
question said that LG is adopting the Blue Ocean Strategy (BOS) in
India as part of its global strategy. The ld. DR also took us through
some other material to indicate that the task of finalizing the scheme
of advertisement under BOS and its implementation on global level
was assigned by LG Korea to LG Singapore and it was only in the
domain of LG Singapore to chalk out the advertisement strategy for
all the AEs of LGK uniformly on a global level. The ld. DR referred
to additional evidence admitted under rule 29 through his first
application to exhibit that the brand building for the foreign AE was
an important part of BOS, which the assessee admitted to have done
in India. The ld. DR energetically referred to Article 20 of Addendum
no. 1 dated 1-1-2002 to agreement dated 1-7-2001 between LGK and
LGI, a copy of which has been placed on page 58 of the paper book,
to show that it was the obligation of the Indian entity to incur all the
advertisement expenses in India.
12.2. The learned AR contended that the reliance of the learned
Departmental Representative on the BOS for making out a case that
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the assessee incurred AMP expenses at the dictate of the foreign AE,
was wrong. It was stated that the BOS is not a new strategy devised
by LG Korea, but was an already existing one. He reiterated his
earlier arguments that the entire advertisement in India was planned
and executed by the assessee alone. With the help of some papers, it
was shown by him that the foreign AE simply prescribed the size and
manner of placement of the brand and logo LG in the advertisements
to be done by the assessee in India.
12.3. After considering the rival arguments in this regard and
going through the relevant records it is clear that the LGK adopted
BOS on a global level with an aim to create new markets, which
primarily includes marketing strategy for the awareness of brand and
products. It is further evident from the interview of Mr. M.B. Shin,
the Managing Director of the assessee company that it adopted the
BOS in India as part of its global strategy. The details as referred to
by the ld. DR reveal that the entire marketing strategy of LG group
through advertising and promotion was decided globally. The
assessee and other AEs of LGK in other countries were supposed to
follow the overall strategy made by LGK. When the assessee
subscribed to BOS of its foreign AE, it cannot be contended that all
the decisions about the timing, areas and quantum of advertisement
were taken by the assessee, as was contended by the ld. AR. In fact
all such decisions are derivatives of the overall BOS formulated by
LGK. Though the ld. AR repeatedly asserted empty handedly that
advertisement in India was planned and executed by the assessee
alone, but he not only failed to support his contention but also could
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not place on record any contrary evidence to indicate that either the
BOS was not a strategy inter alia for advertising and marketing on a
global level or the assessee did not adopt it.
12.4. At this stage we need to consider the additional evidence
filed by the ld. DR through the first application. The assessee in
response to notice u/s 92CA for the A.Y. 2008-09 submitted before
the TPO that LG Electronics Singapore Pte. Ltd.`s (LGESL)
Marketing division is responsible for developing a range of marketing
and sale strategy. Marketing functions are provided by LGESL to
LGEA for establishing consistent and effective marketing and
promotion strategies in the respective countries. The assessee also
submitted that the corporate marketing functions included corporate
brand management relating to LGK on a regional level. The assessee
further stated before TPO, through the above referred written
submissions, that LGESL`s corporate Marketing division performs
the specific functions which include, Brand management including
Brand Health Index enhancement, customer insight enhancement,
new brand image deployment and brand campaign initiatives and
review. It is further relevant to consider the statement of Shri Laxmi
Kant Gupta, the Chief Marketing Officer of the assessee company
recorded on 10-3-2011. In answer to question about the building of
brand LG in India and how LGK controls this brand in India, he
replied that They give us set of guidelines on how to depict the
brand in various places like advertising, shops etc. In response to the
next question about the names of the expatriates employed in the
marketing department and their role and responsibilities, he gave the
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name of Mr. Gilbert Ahn, Vice President Marketing, by stating his
role to coordinate marketing inputs between India and Korea for
smooth implementation. He also named four persons with the names
Mr. D.S. Shin (Appliances) ; Mr. Joy Seo (TV); Mr. M.J. Jeon (AC.);
Mr. G.B. Kim (DAV); and Mr. Jaesung Choi (GSM mobiles) as
assisting in the strategy and coordination of marketing development
with Korea. From the statement of Shri L.K. Gupta, it is apparent that
his assertion was on the advertising policy of the LG as a whole and
not specific to the particular year of the recording of such statement.
It cannot be said that Shri L.K. Gupta, the Chief Marketing Officer of
the assessee was oblivious of the global BOS adopted by LGK in
vogue. Not only the assessee was directly helping in brand building
for the foreign AE, but also some of its executives were actively
engaged in coordinating with LGK in the marketing development. It
can be easily noticed that the entire additional evidence sought to be
relied by the ld. DR is nothing but corroboration of the material
already existing about the BOS implemented by the assessee in India
during the period relevant to the assessment year under consideration.
In view of the above discussion, it becomes manifest that all the
arguments advanced by ld. AR about the assessee taking suo motu
decision about the advertisement have become unsustainable. The
position which emerges is that the advertisement expenses were
incurred by the assessee in furtherance of BOS adopted by its
principal on a global level. Nothing turns out of the contention of the
ld. AR that the BOS is not a strategy devised by the assessee. Even if
it is not a strategy devised by LG Korea but still the fact remains that
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LG Korea adopted this strategy, acting under which it decided the
incurring of AMP expenses under a global scheme inter alia for
promotion of the brand and logo LG in India through the assessee.
When we consider these facts in totality about the assessee adopting
the BOS framed by LGK on global level, which also inter alia, aims
at Brand management including .....new brand image deployment
and brand campaign initiatives and review, the inference as to an
informal arrangement or understanding between the assessee and its
AE for the brand building gets reinforced. Such inference is
otherwise lucidly deducible from the fact that the assessee incurred
AMP expenses more than a commercially rational person incurs for
his business coupled with the fact that it also simultaneously or
separately advertised brand/logo of its AE.
12.5. The ld. DR has placed a lot of emphasis on Addendum no. 1
dated 1-1-2002 to agreement dated 1-7-2001 between LGK and LGI,
a copy of which has been placed on page 58 of the paper book, to
contend that there was express agreement between the assessee and
the foreign AE in this regard. Article 20 of this addendum is
reproduced as under:
Article 20 Advertising, Marketing and Sales Promotion.
The licensee agrees to provide and make arrangements for
advertising, marketing and sales promotion in the licensed
territory for LG Products manufactured by the Licensor and
those by the Licensee at their cost.
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12.6. From the above Article it can be seen that it is the assessee
who agreed to make arrangements for advertising, marketing and sale
promotion in India for the LG products manufactured by it as well as
LGK. The cost of such advertising, marketing and sale promotion in
India was also agreed to be exclusively borne by the assessee. It is
not only the products manufactured by LGI for which the assessee
has undertaken to incur AMP expenses but even for the products
manufactured by LGK as well. When we view this Article, it is
found that although there are sufficient hints but it falls short of
decisively saying that there exists an express agreement for incurring
of the AMP expenses in India by the assessee for creating marketing
intangibles for and on behalf of the foreign AE.
13. Ex consequenti we hold that there is a `transaction` between
the assessee and the foreign AE for the promotion of brand LG in
India, which is legally owned by the latter.
IV. INTERNATIONAL TRANSACTION
14.1. Having seen that there was a transaction between the assessee
and the foreign AE, now let us examine as to whether such
transaction can be called as international transaction. It was submitted
by the ld. counsel for the assessee and some of the interveners that
even if it is treated as a transaction, but still it does not falls within
the definition of `international transaction` as per section 92B of the
Act. It was argued that sec. 92B refers to a transaction between two
or more associated enterprises in the nature of purchase, sale or
lease of tangible or intangible property etc. It was submitted that the
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expression in the nature of has been clarified by way of insertio n of
Explanation to section 92B by the Finance Act, 2012 with
retrospective effect from 1-4-2002, but the case under consideration
does not fall in any of the sub-clauses of clause (i) of the Explanation
to section 92B so as to be called as an international transaction.
14.2. Coming a step ahead of actual international transaction as per
section 92B(1), the ld. counsel submitted that the legislature also
deems certain transactions as international transactions as per sub-
sec. (2) of sec. 92B. Elaborating sub-sec. (2) of sec. 92B, it was put
forth that a transaction with a third party is deemed as an
international transaction if there is a prior agreement in relation to the
relevant transaction between the third person and the associated
enterprise or the terms of relevant transaction are determined in
substance between such third person and the associated enterprise. It
was stated that the case of the assessee cannot be brought even within
the purview of sub-sec. (2) because there is no allegation by the
Revenue that the third parties who were paid by the assessee for
defraying advertisement expenses had any understanding with the
foreign AE so as to determine the terms of their agreements for
advertisement with the assessee. Once a transaction is not covered
under sub-sec. (1) of section 92B, the ld. AR stated that the same can
be deemed as an international transaction only when it falls under
sub-sec. (2) of sec. 92B. If a transaction does not satisfy the pre-
requisites for inclusion either in sub-sec. (1) or sub-section (2) of
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section 92B, it cannot be reckoned as an international transaction so
as to be eligible for processing under Chapter X of the Act.
14.3. The ld. AR argued that there is always some consideration for
doing any thing, without which there can be no valid agreement. It
was pointed out that no consideration moved between the assessee
and the foreign AE on account of the alleged brand building. The
assessee incurred advertisement expenses for which the payments
were made to third parties unrelated to it. Such transactions got
concluded on the incurring of advertisement expenses without any
direct or indirect involvement of the assessee`s foreign AE. It was
stated that a transaction with a third party or a part of such transaction
cannot be called as transaction with the AE. As the entire
advertisement expenses were incurred in India vis a vis third parties,
the requirement of sec. 92B was claimed to be lacking. The ld. AR
argued that there should be a first degree nexus between the incurring
of advertisement expenses and the brand promotion for the foreign
AE so as to regard it as an international transaction. Any incidental
benefit resulting to the foreign AE, out of the expenses incurred by
the assessee in India, cannot be termed as international transaction.
As there was no transaction between the assessee and its foreign AE
insofar as incurring of AMP expenses is concerned, the ld AR argued
that the same ceased to be an international transaction. It was argued
that the present so-called transaction of brand building for the foreign
AE by the assessee is neither covered under sub-section (1) nor (2) of
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section 92B and hence the same cannot be recognized as an
international transaction.
14.4. The ld. DR contended that a careful look at sub-section (1) of
section 92B would indicate that the term `international transaction`
has been defined in widest possible manner. Normally a provision is
either exhaustive or inclusive. Section 92B was claimed as a classic
example of a combination of both. It was explained that the
provision can be seen into three parts. First part is exhaustive as
opening with : `international transaction means a transaction ....in
the nature of purchase, sale or lease of tangible or intangible property,
or provision of services.....`. Second part further advances the scope
of the exhaustive character by roping in `any other transaction having
a bearing on the profits, income, losses or assets of such enterprises`.
Third part is inclusive which provides that it `shall include a mutual
agreement or arrangement between two or more associated
enterprises for the allocation or apportionment of...any cost or
expense ...in connection with a benefit, service or facility provided or
to be provided to any one or more of such enterprises.`
14.5. The ld. DR argued that the instant transaction can be viewed
as international transaction not on one but on three different counts.
The first being, the earlier part of sub-section (1), which is in the
nature of the exhaustive part of the definition referring to `...in the
nature of ....provision of services`. It was stated that the authorities
below have primarily viewed this transaction as in the nature of
provision of a service of creating, improving or maintaining
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marketing intangible for the foreign AE, in lieu of which the foreign
AE ought to have reimbursed the assessee.
14.6. The ld. DR contended that it can also be considered as an
international transaction having a `bearing on the profits, income,
losses or assets` of the assessee. Bearing on the profits of an
enterprise was explained as a transaction having been recorded in
such a way that the profits of the enterprise get needlessly deflated. In
the present context, there can be deflation of profits of an enterprise,
when the expenses pertaining to the foreign AE are also claimed as
deduction by the Indian enterprise. If it amply turns out that the
Indian entity has booked certain amount incurred for its AE as its
own expense, this would have the effect of reducing the profit
without reason, thereby depriving Indian exchequer from its rightful
share of taxes. It was stated on behalf of the Revenue that the
assessee incurred AMP expenses with a tacit understanding of
creating the marketing intangible for its foreign AE. The assessee not
only claimed deduction for the AMP expenses incurred for its own
business purpose but also for the expenses towards creating or
improving the marketing intangibles of the foreign entity. This
excess claim of deduction was stated to have a direct bearing on the
profits of the assessee, thereby bringing it within the ambit of an
international transaction.
14.7. The third way of looking at this as an international
transaction was its inclusion under the relevant part of section
92B(1), which runs as under : `and shall include a mutual agreement
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or arrangement (there is an oral understanding) between two or more
associated enterprises (between the assessee and foreign AE) for the
allocation or apportionment of..... any cost or expense incurred or to
be incurred (brand promotion expenses) in connection with a benefit,
service or facility provided or to be provided to any one or more of
such enterprises (benefit, service or facility of which shall be
available to the foreign AE). It was stated that there is an agreement
between the assessee and its foreign AE under which only the
assessee was to incur all AMP expenses in India in connection with a
benefit, service or facility to be provided to itself as well as its
foreign AE. He argued that the excess of the AMP expenses incurred
by the Indian entity over what other comparable independent entities
incur in similarly placed situation, means the exclusive benefit,
service or facility to the foreign AE so as to constitute the value of
international transaction of brand building for it. That is how he
contended that the present transaction is an international transaction
from three different angles.
14.8. The ld. DR argued that the payment to third parties for
advertising is not an international transaction. It has never been the
case of the Revenue that the payment made to the third parties
towards advertisement expenses be treated as an international
transaction. He stated that rather the international transaction is
restricted to the activity done by the Indian AE in relation to foreign
AE for adding value to a brand (being an intangible property of the
foreign AE), the payment for which made by the Indian assessee is
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included in the overall AMP expenses claimed as deduction by the
assessee.
14.9. Replying to the ld. DR`s contention that section 92B has
been worded very widely to include each and every transaction
between the two AEs within the pale of international transaction, the
ld. counsel for some of the interveners relied on the judgment in
Addtl. CIT Vs. Income Tax Appellate Tribunal & Anr. [(1975) 100
ITR 483 (AP)] to contend that simultaneous use of the words `means`
and `includes` in a definition make it exhaustive and not inclusive. It
was highlighted that only the transactions set out in section 92B can
be considered as international transactions and nothing beyond that.
As the instant transaction is not covered by section 92B, it was
claimed that the same cannot be considered as an international
transaction.
14.10. After considering the rival submissions in this regard, we
have no doubt in our mind that only international transactions can be
considered within the purview of the Chapter X of the Act. Unless a
transaction is an international transaction within the meaning of sec.
92B, the same cannot be subjected to the TP provisions. The
expression `international transaction` has been defined under section
92B, which has two sub-sections. The first sub-section talks of actual
international transaction and the second sub-section refers to a
deemed international transaction.
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14.11. The case of the revenue is that it is an international
transaction in terms of sub-sec. (1) of sec. 92B. Let us see the
prescription of this provision, which is as under :-
"92B. Meaning of international transaction.--(1) For
the purposes of this section and sections 92, 92C, 92D
and 92E, "international transaction" means a
transaction between two or more associated
enterprises, either or both of whom are non-residents,
in the nature of purchase, sale or lease of tangible or
intangible property, or provision of services, or lending
or borrowing money, or any other transaction having a
bearing on the profits, income, losses or assets of such
enterprises and shall include a mutual agreement or
arrangement between two or more associated
enterprises for the allocation or apportionment of, or
any contribution to, any cost or expense incurred or to
be incurred in connection with a benefit, service or
facility provided or to be provided to any one or more
of such enterprises."
14.12. After sub-section (1), there is sub-section (2) followed by
the Explanation with two clauses, inserted by the Finance Act, 2012
w.r.e.f. 1.4.2002 starting with the expression : ` For the removal of
doubts`. Clause (i) of the Explanation provides that the expression
`international transaction` shall include - . Then there are five sub-
clauses from (a) to (e). Clause (ii) of the Explanation provides that
the expressions `intangible property` shall include -. Then there are
twelve sub-clauses from (a) to (l).
14.13.1. Firstly we shall evaluate the rival contentions about the
definition of `international transaction` u/s 92B, being exhaustive or
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inclusive. It is noticed that such definition as per sub-section (1) uses
both the words `means` and `includes` at two different places. A
definition is exhaustive when it incorporates the word `means` in its
opening part and thereafter lists out certain items, say A and B. In
that case it will mean that only A and B form the content of the thing
defined. A definition is inclusive when it uses the word `includes` in
its opening part and thereafter lists out certain items, say A and B. In
that case it will mean that not only A and B but also other items not
listed, say C or D, can also form the content of the thing defined, if
these are otherwise of the same nature. If however a definition
includes both the words `means` and `includes`, that is, it says that it
means `A` and includes `B`, then it will again mean that it is an
exhaustive definition to include both A and B and not C or D etc. A
definition despite being exhaustive can still be inclusive, if one or
more of its components are again defined in an inclusive manner.
Suppose in the definition of the third category discussed above,
having both A and B by use of the words `means` and `includes`, the
contents of either A or B are both are further defined in an inclusive
manner, this definition will again become inclusive to the extent of
the definition of either A or B or both having been defined in an
inclusive manner.
14.13.2. Turning to the definition of international transaction as per
sub-section (1) of sec. 92B it is noticed that it uses both the words
`means` and `includes`. When we examine the Explanation to this
section clarifying the meaning of the expression `international
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transaction` and `intangible property`, then it becomes clear that both
have again been defined in inclusive manner. Even though sub-
clauses (a) to (c) and (e) of clause (i) of the Explanation defining
`international transaction` are exhaustive, but sub-clause (d) being the
`provision of services` is again inclusive as `including` provision of
market research, market development, marketing management,...`. It
is of critical importance to observe that the expression `international
transaction` itself has been defined in this Explanation only in an
inclusive manner. As a result of insertion of the Explanation with
retrospective effect, the otherwise exhaustive definition of
`international transaction` given in sub-section (1) has been converted
into an inclusive one. Clause (ii) of the Explanation also defines the
expression `intangible property` in an inclusive manner. Sub -clause
(a) of clause (ii) embraces `marketing related intangible assets` in the
ambit of intangible property, which is again not exhaustive because
of the use of the expression `such as` before `trademarks, trade
names, brand names, logos`. From the above examination of section
92B in entirety, it can be easily noticed that the legislature has given
very extensive and inclusive meaning to the expressions
`international transaction` and `intangible property`.
14.14. When we read sec. 92B(1) it comes to fore that in order to
be characterized as an international transaction, the following salient
features must be present : -
(1) There should be a `transaction`
(2) Such `transaction` should be between two or more
AEs and either or both of whom should be non-residents.
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(3) Such transaction should be of the nature as referred
to in section 92B.
14.15. In the earlier part of this order, we have held that the brand
building by the assessee for its foreign AE constitutes a `transaction`.
So far as the second requisite is concerned, there is no dispute on the
fact that LG Korea is an associated enterprise of the assessee. Thus,
there are two AEs in the present case and one of them, namely, LGK
is a non-resident. This condition also stands satisfied.
14.16. The third requisite is that the `transaction` as per the first
requisite must be of the nature as referred to in section 92B. All the
three requisites must be cumulatively satisfied so as to make a
`transaction` an `international transaction`. If there is a transaction
between two AEs and one or both of whom are non-residents, it will
not become an international transaction so as to fall within the
domain of Chapter-X, unless it is of the nature as defined in section
92B.
14.17. It has been vigorously argued by the ld. counsel for the
assessee and some of the interveners that clause (i) of Explanation to
section 92B gives meaning to the expression `in the nature of
international transaction` and since sub-clauses (a) to (e) of clause (i)
do not refer to transaction of brand building, it cannot be considered
as an international transaction. We are not persuaded by this
submission. It is pertinent to note that the expression `international
transaction` as per clause (i) of the Explanation has been `clarified` to
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`include' five sub-clauses. Thus the meaning assigned to
`international transaction` as per clause (i) of the Explanation is
simply inclusive and not exhaustive. There is hardly any need to
burden this order with the ratio decidendi emanating from a plethora
of judgments that the scope of an inclusive definition always extends
beyond the specified inclusions.
14.18.1. Now we will examine as to whether this transaction falls
within any of the sub-clauses of clause (i) of Explanation to section
92B. The learned counsel for the assessee contended that the view
point of the ld. DR that the transaction of brand building is in the
nature of `provision of service`, is not tenable. He submitted that
Indian entity is engaged in the business of manufacturing and selling
of electronic goods etc. and not in rendering services of
advertisement and promotion of a brand to its customers. His
contention was that in order to bring any transaction within the scope
of `provision of services`, it is sine qua non that the main business
activity of the Indian enterprise and the nature of service provided to
the foreign AE must be same. As it is not so in the present case, the
ld. AR contended that the transaction cannot be held as a `provision
of service`.
14.18.2. We do not find any force in this submission advanced on
behalf of the assessee for the reason that the language of section 92B
simply mandates the provision of services` by one AE to another. It
is not qualified by any words to restrict its scope only to such services
as are provided by the assessee in its regular course of business. What
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is significant in this regard is the factum of rendition of service,
which is an international transaction. Source of service is
inconsequential. It can be produced by the AE as primarily engaged
in the business of rendering such service or it can be produced by the
Indian AE otherwise than by being primarily engaged in such
business or it can be outsourced. The fact that the Indian entity is
rendering any service to the foreign AE, which is not its main
business, would not convert the otherwise international transaction
into a non-international transaction.
14.18.3. Ordinarily a service may be professional, public or a
business service. Even in common parlance provision of service
means the act of performing a task for a person which that person
requires it in exchange for some consideration. Cl. (i) of Explanation
to section 92B defining `international transaction` includes through
sub-clause (d) : `provision of services, including provision of market
research, market development, marketing management.....`. Clause
(ii) of the Explanation defining `intangible property` includes
through sub-clause (a) : `marketing related intangible assets, such as,
trademarks, trade names, brand names, logos`. When we consider
both these provisions together, it becomes clear that provision of
services defined in an inclusive manner encompassing all the market
related services including those specifically covered like market
development, research and administration and the further fact that
brand name and logos have been specifically considered as marketing
intangibles, there remains no doubt about the brand building being a
provision of service in the present context. In the light of the above
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discussion we are of the considered opinion that the transaction of
brand building by the assessee for the foreign AE is in the nature of
`provision of service`. Having held such transaction to be an
international transaction in the nature of `provision of service`, we do
not consider it expedient to deal with the contention of the ld. DR
that it is also an international transaction having a `bearing on the
profits, income, losses or assets` of the assessee on one hand and/or
towards allocation or apportionment of any cost or expense incurred
or to be incurred in connection with a benefit, service or facility
provided or to be provided to any one or more of such enterprises, on
the other.
14.19. Now we take up the contention of the ld. AR that there was
no transaction between the assessee and its foreign AE insofar as
incurring of AMP expenses is concerned and further the assessee
entered into transactions with the third parties who are advertising
agencies and it is not the case of the Revenue that the terms of
transactions with such third parties were determined in substance by
the foreign AE. Insofar as the part of the contention of the ld. AR
about the deemed international transaction u/s 92B is concerned, we
find that it is nobody`s case that the transaction in question is a
deemed international transaction. In order to be covered under sub-
sec. (2) of Sec. 92B for making a transaction with a third party as
deemed international transaction, it is essential that the AE of the
assessee should have influence over the third party in terms of
determining the terms and conditions of such transaction. It is only in
such a situation that the transaction with such third party is deemed to
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be an international transaction. Further it is not the case of the
Revenue that the transaction of payments of AMP expenses to the
third parties is an international transaction. Rather the international
transaction has been taken as the value addition made by the assessee
to the brand by making payment which are included in the overall
AMP expenses paid to the third parties.
14.20. The further contention that there was no consideration by
the foreign AE in the present case, is again of no avail. The mere fact
that no consideration moved between the AEs for a transaction is not
a decisive factor to have influence over its nature. Payment of
consideration has not been made as a condition precedent for
inclusion of any transaction within the ambit of section 92B. The
transfer pricing provisions should be seen in the backdrop of the fact
that these are special provisions for avoidance of tax on the
transactions structured between two associated enterprises. The
simple fact that the foreign AE did not pay any consideration to the
Indian AE will not take the transaction out of the purview of the
transfer pricing provisions, if it is otherwise an international
transaction.
14.21. Thus it is palpable that all the three necessary ingredients
as culled out from a bare reading of section 92B are fully satisfied in
the present case. There is a transaction of creating and improving
marketing intangibles by the assessee for and on behalf of its foreign
AE ; the foreign AE is non-resident ; such transaction is in the nature
of provision of service. Resultantly, we hold that the Revenue
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authorities were fully justified in treating the transaction of brand
building as an international transaction in the facts and circumstances
of the present case.
V. COST/VALUE OF TRANSACTION
15.1. At this stage, we feel it productive to have a macro view of
the transfer pricing provisions. Section 92 provides that the income
from an international transaction shall be computed having regard to
ALP. What is an international transaction and who is an associated
enterprise has been defined in sections 92B and 92A respectively.
Then arrives section 92C. Sub-section (1) of this section provides that
: The arm`s length price in relation to an international transaction
shall be determined by any of the following methods, being the most
appropriate method, having regard to the nature of transaction or
class of transaction......... A conjoint reading of sections 92 and 92C
divulges that the first step in the computation of income from
international transaction is to identify the international transaction
and its cost/value. In one case it may be the cost and in other it may
be the value of international transaction relevant for the purpose. For
example if AE X with cost of goods at`90 makes sales to AE Y at
`100, it will be `100, being the value of international transaction of
sale in the hands of AE X. However it will be `100, being the cost of
international transaction of purchase in the hands of AE Y. The
second step in such computation is to determine the arm`s length
price in relation to such international transaction as per section 92C.
The last step as per section 92 is to compute the total income of an
assessee from an international transaction having regard to the arm`s
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length price. It can be explained by way of a simple example.
Suppose the value of purchase of goods from AE is `100. This
amount constitutes the value of international transaction of purchase.
Second step is to determine arm`s length price of such purchases u/s.
92C. Suppose the arm`s length price of such purchase is `80. Then is
the final step of computing income u/s 92 in relation to the
international transaction having regard to the arm`s length price.
Other things being neutral, the value of international transaction in
the present case at `100 shall be substituted with the ALP of the
international transaction at `80, thereby leading to the computation of
total income by making upward adjustment of `20. The ALP of a
transaction can also be computed by finding out the rate of profit
margin of a comparable uncontrolled transaction. Again section 92C
will require the computation of ALP by considering the margin in a
similar uncontrolled transaction and then comparing it with that
shown by the assessee from its international transaction. Suppose the
assessee has entered into an international transaction of sale to AE at
`100 thereby giving profit margin at say 5%. Further suppose the
profit margin in a comparable uncontrolled transaction u/s 92C by
any of the recognized methods comes to 12%. In this case the total
income of the assessee shall be computed by considering the profit
margin at 12% thereby suitably increasing the ALP from sale
transaction of `100. From the above discussion it is vivid that before
applying the provisions of Chapter X, one needs to have the
cost/value of international transaction on one hand and the ALP in
relation to such international transaction as determined u/s 92C on the
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other. Thereafter starts the process of computing total income of the
assessee u/s 92 by making adjustment, if required, on comparing the
value of the international transaction with its ALP as determined u/s
92C. Thus it is evident that basically two variables are involved in the
transfer pricing exercise viz., firstly the cost/value of international
transaction and secondly, the ALP of such international transaction.
15.2. The ld. counsel for the assessee contended that the Revenue
has invoked the Bright Line Test for making the transfer pricing
adjustment by determining ALP in respect of the AMP expenses
towards the transaction of creating marketing intangibles. He stated
that the Bright Line Test is a part of U.S. legislation. By inviting our
attention towards sec. 1.482 -4 of US IRC, copy placed at page 399
of the paper book, the ld. AR contended that the US regulations
incorporate the Bright Line Test within its legislation. In the absence
of any such incorporation under the relevant provisions of the
Income-tax Act, 1961, the ld. AR contended that taking cognizance
of this test for denial of deduction of AMP expenses was
unwarranted. It was further submitted that the Revenue authorities
have relied on case of United States Tax Court in DHL Corporation
& Subsidiaries Vs. Commissioner of Internal Revenue, in which the
brand promotion expenses have been held to be not fully deductible
and part of the same has been held to be attributable to the enterprise
holding brand. By inviting our attention towards the judgment of the
United States Court of Appeals in DHL Corporation & Subsidiary Vs.
Commissioner of Internal Revenue, a copy of which has been placed
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at pages 364 onwards of the paper book, the ld. AR submitted that the
decision of the United States Tax Court in DHL Corporation &
Subsidiaries has been reversed by the United States Court of Appeals.
In that view of the matter it was stated that no reliance can be placed
on the decision of lower authority of U.S. which has been set aside by
a superior authority of US.
15.3. The ld. DR countered the submissions put forth for the
assessee. It was stated that the bright line test is simply a tool to
ascertain the cost of the international transaction and it is wrong to
contend that the ALP has been determined by applying the bright line
test, which is not a part of the Indian tax law.
15.4. We have heard the rival submissions in this regard and gone
through the necessary material. There is absolutely no doubt that a
provision from the legislation of a foreign country cannot be
imported into the Indian legislation. Similar is the position regarding
the judgments of the foreign courts. These have only a persuasive
value and cannot have a binding effect over the Indian authorities. As
such, we are abstaining from examining the case in the light of the
US Regulations or the decision of the United States Tax Court or
United States Court of Appeals in DHL Corporation & Subsidiaries
Vs. Commissioner of Internal Revenue.
15.5. Much emphasis has been laid by the learned Counsel for
the assessee and those for the interveners that the Revenue authorities
invoked the bright line test in order to determine ALP of the
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international transaction, which is not one of the recognized methods
u/s 92C. In our considered opinion there is an inherent fallacy in this
contention urged before us.
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 cost/value by
applying some mechanism. In fact, the bright line test in our case is a
way of finding out the cost/value of international transaction, which
is the first variable under the TP provisions and not the second
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variable, being the ALP of the international transaction. Bright line is
a line drawn within the overall amount of AMP expense. The amount
on one side of the bright line is the amount of AMP expense incurred
for normal business of the assessee and the remaining amount on the
other side is the cost/value of the international transaction
representing the amount of AMP expense incurred for and on behalf
of the foreign AE towards creating or maintaining its marketing
intangible. Now the pertinent question is where to draw such line. If
the assessee fails to give any basis for drawing this line by not
supplying the cost/value of the international transaction, and further
by not showing any other more cogent way of determining the
cost/value of such international transaction, then the onus comes
upon the TPO to find out the cost/value of such international
transaction in some rational manner.
15.8. In the present case, the assessee did not declare any
cost/value of the international transaction in the nature of brand
building. As such, it fell upon the TPO to find out such amount out of
the total AMP expenses incurred by the assessee. In the absence of
any assistance from the assessee in determining such cost/value,
logically it could have been by first identifying comparable
independent domestic cases ; ascertaining the amount of
advertisement, marketing and promotion expenses incurred by them
and percentage of such AMP expenses to their respective sales ;
noting the total AMP expenses incurred by the assessee ; discovering
the amount of AMP expenses incurred by the Indian entity for its
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business purpose, by applying the above percentage of comparable
cases to assessee`s sales. The excess of total AMP expenses over
such amount as determined as per the immediately preceding step
ought to have been and has been rightly taken as a measure to
determine the amount of AMP expenses incurred by the assessee for
the brand promotion of foreign AE. In other words, the amount
coming up as per the last step is the cost/value of such international
transaction.
15.9. The figure so deduced, by applying the above approach,
representing the cost/value of the international transaction, in the
instant case is `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 `161.21 crore
and computed the ALP of such transaction at `182.71 crore. It is this
final figure of `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 `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
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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 significance. Since in the present case it is the
cost/value of the international transaction which has been determined
by applying the bright line test, the contention raised by the learned
counsel in this regard has been rendered without merit.
15.11. As the adjustment made by the AO on account of this
international transaction with cost/value at `161.21 crore and ALP at
`182.71 crore is not in the nature of the assessee`s expense, naturally
no deduction was permissible to this extent. Proceeding, for the time
being, with the presumption as to correctness of both these figures,
the assessee was required to either exclude the total AMP expenses
by `161.21 crore and then show the upward adjustment to the total
income by `21.50 crore (`182.71 crore minus `161.21 crore) or if
the total AMP expenses were not to be reduced, then by showing
income of `182.71 crore, which would have had the effect of
reducing the AMP expenses by `161.21 crore coupled with the
showing separate income of `21.50 crore. The assessee in the present
case has not chosen any of these two permissible courses and allowed
the AMP expenses to swell by `161.21 crore. The case of the
Revenue is that the assessee should have been reimbursed by the
foreign AE with the ALP of the international transaction at `182.71
crore. From the above discussion there is absolutely no doubt in our
mind that the figure of `161.21 crore, determined by applying the
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bright line test, is the cost/value of the international transaction of
brand building for the foreign AE.
Interplay amongst sections 37(1), 40A(2) & 92
16.1. The ld. AR argued that the AMP expenses incurred by the
assessee are fully deductible u/s 37(1) and there is no question of
finding any ALP of the international transaction in this regard. The
conditions for deductibility of such expenses, being wholly and
exclusively incurred for the purpose of business, as set out in sec.
37(1), stand duly satisfied. He submitted that the word wholly
refers to the quantum of the expenditure and the word exclusively
refers to the assessee getting sole benefit out of such expenditure. It
was claimed that the AMP expenses were incurred by the assessee for
the promotion of its business. Even if some other person or for that
matter the foreign AE of the assessee got some benefit out of such
expenses, there can be no reason to restrict the allowance of such
expenses. Reliance was placed on the judgment of Hon`ble Supreme
Court in the case of Sassoon J. David & Co. P. Ltd. Vs. CIT [(1979)
118 ITR 261 (SC)], wherein it has been held that the assessee can
claim deduction for expenses incurred for its business purpose. The
fact that somebody other than the assessee was also benefited by the
expenditure, should not come in the way of expenditure being
allowed by way of deduction if it satisfies the otherwise test of
deductibility. It was submitted that the entire expenditure on AMP
was incurred by the assesssee for its business purpose which resulted
in substantial upswing in its turnover. Primarily, no benefit was
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availed by the foreign AE and even if some benefit did percolate to it
incidentally, that could not have been considered as a reason to mar
the deductibility of whole of such expenses in the hands of the
assessee u/s 37(1) of the Act.
16.2. The ld. AR also argued that the advertisement expense are
deductible in full as revenue expenditure in the year of incurring itself
notwithstanding the fact that the benefit of such expense is obtained
beyond the year. Apart from relying on certain decisions in this
regard, he also referred to the Accounting Standard 26 of the Institute
of Chartered Accountants of India prescribing the accounting
treatment to be given to marketing intangibles by writing it off in
entirety in the year of incurring. In the light of the above submissions
it was claimed that the entire amount of the AMP expenses incurred
by the assessee is eligible for deduction in the year itself and the
Revenue cannot make a disallowance of a part of such expense. He
argued that that the effect of the action by the authorities below has
been to reduce the amount of deduction which is otherwise fully
allowable u/s 37(1).
16.3. The ld. counsel for the assessee referred to certain
decisions governing deductibility of advertisement expenses
notwithstanding the foreign enterprise also getting some benefit by
way of the so called brand building. Firstly he relied on the decision
of the Delhi Bench of the tribunal in the case of Nestle India Ltd. Vs.
DCIT [(2007) 111 TTJ (Del.) 498]. The assessee in that case
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incurred certain advertisement expenses. As the assessee was using
the license of its foreign collaborator, the AO invoked the provisions
of sec. 92 and held that the incurring of the advertisement expenses
was for the benefit of the non-resident company also. Disallowance at
the rate of 50% of the total expenses incurred on advertisement and
sales promotion was made by treating them as not wholly and
exclusively for the assessee`s business. When the matter came up
before the Tribunal, it was held that there could be no disallowance of
such advertisement expenses. It was stated by the ld. AR that the
Department`s appeal against such order was not admitted on the
question of deletion of disallowance of advertisement expenses u/s 92
and further the SLP filed before the Hon`ble Supreme Court against
the judgment of the Hon`ble jurisdictional High Court in not
admitting substantial question of law, also came to be dismissed. The
ld. AR placed reliance on certain other cases in which almost similar
question was raised and also replied accordingly by holding that if the
foreign collaborator got some benefit out of advertisement expenses,
that would not mitigate against the deductibility of expenditure u/s
37(1) of the Act. However, on a specific query, the ld. AR was fair
enough to concede that the decision in the case of Nestle and such
other cases were decided in the context of sec. 92 as it existed before
its substitution by sec. 92 to 92F by the Finance Act, 2001, being the
transfer pricing provisions under consideration. It was however,
maintained that the ratio decidendi of these decisions still holds good
and is even applicable in the context of the transfer pricing
provisions.
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16.4. The learned Counsel also placed a great deal of emphasis
on the judgment of the Hon`ble jurisdictional High Court in the case
of CIT v. Nestle India Limited [(2011) 337 ITR 103 (Bom.)] , which
considered the interplay between sections 40A(2) and 37 and
thereafter came to hold that the payment in the form of
royalty/consideration to the related party cannot be treated as
excessive or unreasonable. On the strength of this judgment it was
contended that same logic should apply when considering the
deductibility of an expense under Chapter X of the Act.
16.5. In the oppugnation, the ld. DR argued that it was wrong to
say that the amount of deduction has been restricted by making
disallowance for some part of the otherwise deductible AMP
expenses. It was stated that due to inclusion of brand promotion
expenses in the total AMP expenses, which are otherwise not
deductible in the hands of the assessee as not incurred for its
business, section 92 has come to play for taking away a part of the
AMP expenses towards brand building out of the ambit of section
37(1) together with the mark-up.
16.6. We have heard the rival submissions in the light of material
placed before us and precedents relied on. A lot of emphasis has been
placed by the ld. counsel for the appellant and other interveners on
the point that the deductibility of AMP expenses should be viewed in
the light of section 37(1) alone. Once the entire amount is found to be
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deductible under this provision, then, no part of it can be attributed to
the brand building for the foreign AE notwithstanding the fact that
the foreign AE also got benefitted out of such expense. We do not
find such submission as correct under the present legal and factual
scenario. There is no doubt about the general proposition as laid
down in the decisions pressed into service by the ld. AR that if an
expenditure is deductible u/s 37(1), being incurred wholly and
exclusively for business purpose, the same has to be allowed in
entirety notwithstanding the fact that some third party was also
benefitted by such expenditure. However, in case of an international
transaction, this general proposition undergoes change because of
Chapter X of the Act containing the transfer pricing provisions, with
the marginal note: `Special provisions relating to avoidance of tax`.
This Chapter requires the computation of income from international
transactions having regard to arm`s length price. The hitherto section
92 as existing on the statute up to the A.Y. 2001-02 was substituted
by the Finance Act, 2001 with sections 92 to 92F. Through such TP
provisions it has been mandated that any income arising from an
international transaction shall be computed having regard to arm`s
length price. It has further been provided through section 92 that the
cost or expenses allocated or apportioned between two or more
associated enterprises shall be at arm`s length price. Memorandum
explaining the provisions of the Finance Bill has included such
provision under the main category of `Measures to Curb Tax
Avoidance`. This set of sections has been described as a : `New
Legislation to curb tax avoidance by abuse of transfer pricing`. It is
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significant to note the following excerpt from the Memorandum
explaining the provisions of the Finance Bill : The increasing
participation of multinational groups in economic activities in the
country has given rise to new and complex issues emerging from
transactions entered into between two or more enterprises belonging
to the same multinational group. The profits derived by such
enterprises carrying on business in India can be controlled by the
multinational group, by manipulating the prices charged and paid in
such intra-group transactions, thereby, leading to erosion of tax
revenues. The Memorandum explaining the provisions of the
Finance Bill 2001 further provides as under : -
"With a view to provide a statutory framework which can
lead to computation of reasonable, fair and equitable
profits and tax in India, in the case of such multinational
enterprises, new provisions are proposed to be introduced
in the Income-tax Act.
..............
It is proposed to substitute section 92 with a new section
to provide that any income arising from an international
transaction shall be computed having regard to the arm's
length price. It further provides that the costs or expenses
allocated or apportioned between two or more associated
enterprises shall be at arm's length prices."
16.7. From the above, it follows that the TP provisions have been
inserted in the Act as a measure to `curb tax avoidance`. In that view
of the matter these provisions acquire status of special provisions as
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have been rightly given in the heading of the Chapter itself. We are
reminded of the legal maxim `Generalia specialibus non derogant`
which means that the general things do not derogate from special. It
implies that the special provision overrides the general provision. If a
special provision is made on a certain subject, such matter is
excluded from the general provision. The Hon`ble Supreme Court in
the case of Britania Industries Ltd.Vs. CIT & Anr. [(2005) 278 ITR
546 (SC)] has held that the expenditure towards rent, repairs,
maintenance of guest house used in connection with the business is to
be disallowed u/s. 37(4) because this is a special provision overriding
the general provision. The Hon`ble Bombay High Court has quoted
the above maxim of `Generalia specialibus non derogant` with
approval in the case of Forbes Forbes Campbell And Co. Ltd. Vs. CIT
[(1994) 206 ITR 495 (Bom.)]. The same has also been applied by the
Hon`ble Madras High Court in the case of CIT Vs. Copes Vulcen Inc.
[(1987) 167 ITR 884 (Mad.)] . Turning to the facts of the instant case,
we find that the TP provisions have been inserted as special
provisions to curb the avoidance of tax. Once there is an international
transaction, then the TP provisions shall prevail over the other regular
provisions governing the deductibility or taxability of an amount
from such transaction.
16.8. Moreover, the decisive test is to consider the deductibility of
any expense in the hands of the assessee on its own account and not
otherwise. It is obvious that if some amount is spent by the assessee
for its AE, which may be deductible in the hands of such AE, cannot
by any stretch of imagination be claimed as deduction by the
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assessee. The TP provisions aim at streamlining the effect of shifting
of such excess expenses in the hands of the Indian assessee. It shows
that the amount spent on an international transaction, if combined by
the assessee with its own business expenses, is required to be taken
out for processing under the TP provisions to find out the extent of its
taxability in the hands of the Indian assessee. The remaining amount
incurred towards its own business expenses shall be considered for
deductibility as per the regular provisions of the Act. It is wholly
illogical to contend that the deductibility of such total expense, also
consisting of the amount spent on the international transaction,
should be viewed as per the general provisions of the Act. If the
contention advanced on behalf of the assesses is accepted and the
deductibility of the entire amount of AMP expenses, including that
incurred on account of international transaction, is considered under
the general provisions of Chapter IV-D, then it would render the TP
provisions as a redundant piece of legislation. Obviously this can
never be a correct position. When the legislature has inserted a
special provision in the Act and that too, which is for the avoidance
of tax, the taxability of the amount spent towards the international
transaction, included in the total amount of expense, is required to be
examined as per the TP provisions. The exercise of separating the
amount spent by the assessee in relation to international transaction
of building brand for its foreign AE for separately processing as per
section 92 of the Act cannot be considered as a case of disallowance
of AMP expenses u/s 37(1). In fact, both the sections i.e. 37(1) and
sec. 92 operate in different fields.
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16.9. The further contention that the advertisement expenses are
always revenue in nature and hence deductible in entirety in the year
of incurring, in our considered opinion is not disputed. It is not the
case of the Revenue that the AMP expenses incurred by the assessee
are capital in nature or of a deferred revenue nature and hence should
be disallowed or partly allowed. Rather the case is about not
allowing deduction to the extent these have been spent by the assessee
on the international transaction without receiving any corresponding
credit from the AE, which ought to have been received. Similarly, the
reliance of the ld. AR on the Accounting standard 26 prescribing the
writing off of the entire AMP expenses in the year of incurring, is
again of no avail for the same reasons.
16.10.1. We do not find much weight in the submission advanced
by the learned AR comparing section 40A(2) and section 92 on the
question of deductibility of advertisement expenses by relying on the
judgment of the Hon`ble jurisdictional High Court in Nestle India
Limited (supra) rendered in the context of the former provision.
Section 40A(2)(a) provides that : Where the assessee incurs any
expenditure in respect of which payment has been or is to be made to
any person referred to in clause (b) of this sub-section, and the
Assessing Officer is of opinion that such expenditure is excessive or
unreasonable having regard to the fair market value of the goods,
services or facilities for which the payment is made or the legitimate
needs of the business or profession of the assessee or the benefit
derived by or accruing to him there from, so much of the expenditure
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as is so considered by him to be excessive or unreasonable shall not
be allowed as a deduction. A cursory look at this provision indicates
that what is sought to be disallowed is the excessive expenditure
incurred by the assessee in respect of which payment has been made
to related parties as referred to in clause (b) of section 40A(2). The
application of section 40A(2) presupposes the expense having
otherwise passed through the deductibility test under the relevant
provision. If an expenditure is not deductible in full or in part as per
the concerned section granting deductions under Chapter IV-D, then
that expenditure or the part thereof as is otherwise not allowable,
does not come up for consideration for the application of the
provisions of section 40A(2). It is only when the expenditure is
otherwise deductible under the relevant provisions that the quantum
of excessiveness, due to payment made to the related parties, is
considered u/s 40A(2). The nutshell of section 40A(2) is that it
restricts the deduction to the extent it is reasonable with the
presumption of the otherwise deductibility in full of an expenditure
under the regular provisions.
16.10.2. On the other hand u/s 92 of the TP provisions has much
wider amplitude. This section provides that any income arising from
an international transaction shall be computed having regard to the
arm`s length price. Explanation to section 92(1) further clarifies that
the allowance for any expense or interest from an international
transaction shall also be determined having regard to the arm`s length
price. Sub-section (2) talks of a situation where two or more
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enterprises enter into a mutual agreement for the allocation or any
contribution to any cost or expense incurred in connection with a
benefit, service or facility provided or to be provided. Such
transaction as per sub-section (2) is also required to be determined
having regard to the arm`s length price of such benefit, service or
facility as the case may be. Further when we read section 92B in
juxtaposition to the word `income` as used in section 92(1), it come s
out that the term income does not restrict itself only to the items of
income earned from sale or lease of any tangible or intangible
property or provision of any service etc., but also to the expenses
incurred on purchase or provision of service etc. or lending or
borrowing of any money or any other transaction having a bearing on
profits, income, losses or assets of such enterprise. Thus, it is evident
that section 92 requires the benchmarking of all the international
transactions whether they relate to the expenses incurred by the
Indian AE vis-Ã -vis its foreign AE or income earned from such
foreign AE or any other transaction having any effect over the
income, losses or assets of the Indian AE. In contrast to section 92,
the scope of section 40A(2) is restricted only to the expenses incurred
by the assessee. Section 40A(2) does not embark upon measuring the
reasonableness of income earned by the assessee from its related
parties. At the same time it also does not operate when a transaction
concerns only the assets of the assessee. On a larger canvas, we can
say that the ambit of section 92 is much wider than section 40A(2) as
it extends beyond the item of expenses, which constitute the only
scope of section 40A(2).
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16.10.3. It is of utmost importance to note that the role of section
40A(2) is only to determine as to whether the quantum of a particular
expenditure is reasonable or not. It does not decide the otherwise
question of the very deductibility of expenditure claimed by the
assessee in the first instance. Section 92 of the TP provisions, when
applied to considering the allowance for any expense arising from an
international transaction, tests as to whether the claim of expenditure
is at arm`s length or not. Suppose the Indian enterprise has p aid
interest to the foreign AE, section 92 will determine as to whether the
payment of such interest by the Indian AE is at arm`s length or not or
whether it is excessive or unreasonable. To this limited extent, the
role of section 92 equates with that of section 40A(2). We have noted
earlier that section 92 covers not only the expenses but also items of
income of the assessee or transactions having bearing on profits,
losses or assets of the Indian AE. Suppose the Indian AE has
rendered any service to its foreign AE and has charged less than what
an independent comparable entity would have charged, section 92
will intervene to bring the income from such service at arm`s length
price. It may also be possible that the Indian enterprise does not at all
charge from the foreign AE for any service rendered by it. In such a
situation also, even though there is no item of income in the profit
and loss account of the Indian assessee, still section 92 will apply to
dictate that the income should be included in the total income of the
Indian AE for rendering such services as an independent comparable
entity would have charged. It is so for reason that the non-charging
or under-charging by the Indian AE from its foreign AE has bearing
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on its profits. Coming back to the interplay between section 37(1) and
40A(2) on one hand and section 37(1) and 92 on the other, we have
seen that there is a lot of difference between the scope of section
40A(2) and section 92 of the TP provisions. It is impermissible to
draw a blind support from the decisions rendered on the deductibility
of expenses u/s 37(1) read with section 40A(2) in the context of
section 92.
16.11.1. Now we take up the set of cases relied on by the ld. AR
including the Delhi Bench of the tribunal in Nestle India (supra), in
which it has been held that advertisement and sales promotion
expenses incurred by the assessee for promoting sales in India in
respect of products manufactured by it under various brands of a
foreign company are allowable in entirety even though it might have
benefitted the non-resident company who owned the brands of such
products and hence there was no question of invoking section 92 for
making any disallowance. At the outset, we want to make it clear, as
was also admitted by the ld. AR that these decisions were rendered
under section 92 which was there on the statute prior to its
substitution by the TP provisions. The hitherto section 92 provided as
under :-
92. Income from transactions with non-residents, how
computed in certain cases.-- Where a business is carried
on between a resident and a non-resident and it appears
to the Assessing Officer that, owing to the close
connection between them, the course of business is so
arranged that the business transacted between them
produces to the resident either no profits or less than the
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ordinary profits which might be expected to arise in that
business, the Assessing Officer shall determine the
amount of profits which may reasonably be deemed to
have been derived there from and include such amount
in the total income of the resident.
(emphasis supplied by us)
16.11.2. It can be observed from the prescription of this section
that it extended only to a situation where a business was carried on
between a resident and a non-resident and when it appeared to the
AO that owing to the close connection between them, the course of
business was so arranged that the business transacted between them
produced to the resident either no profits or less than the ordinary
profits, which might be expected to arise in that business. Obviously
the advertisement and sales promotion expenses incurred by the
assesses in such cases for promoting their sales in India could not
have been said to be part of business transacted between such
residents and non-residents, so as to suffer hit from section 92.
Presently, we are concerned with the post insertion era of the TP
provisions. Now the requirement is to subject all the international
transactions to the TP provisions for finding out if these have been
recorded at arm`s length price. Since the provisions of the then
existing section 92 were found to be insufficient to tackle the tax
evasion in a proper manner, the present anti tax avoidance TP
provisions were introduced with a larger and specific scope. There is
another significant distinguishing feature between the old and new
section 92. Whereas burden of proving that the course of business
was arranged in such a way so as to produce less profit in India was
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on the AO under the old section 92, now this burden has been shifted
on the assessee to prove that each and every international transaction
has been recorded at arm`s length price. The expression if it appears
to the assessing officer, as used in the hitherto sec. 92 clearly
demonstrates that the burden was on the Assessing Officer to show as
to how it appeared to him that the transactions were arranged between
Indian entity and foreign entity with a view to reduce taxable profit in
India. New sec. 92 of Chapter X has changed the entire scenario by
placing initial burden of proof on the assessee to show that the
international transactions with AEs are at arm`s length price.
Circular no. 214 of 2001 clearly provides in para 15.12 that under
the new provisions the primary onus is on the tax payer to determine
arm`s length price in accordance with rules and to substantiate the
same with the prescribed documentation. Where such onus is
discharged by the assessee and the data used for determining the
arm`s length price is reliable and correct, there can be no intervention
by the assessing officer. .... If any such circumstance exists, the
assessing officer may reject the price adopted by the assessee and
determine the arm`s length price in accordance with the same rules.
It is further relevant to observe that the Special Bench in Aztec
Software & Technology Services Ltd. Vs. ACIT [(2007) 107 ITD 141
(Bang.) (SB)] , has clearly held that the burden to establish that
international transaction was carried at arm`s length price is on the
tax payer. In view of the above discussion it is amply clear that sec.
92 of Chapter X as brought out on the statute by the Finance Act,
2001, has shifted the burden of proof on the assessee to establish that
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the international transaction has been recorded at arm`s length price.
As there is a vast difference between the scope of the earlier and
present section 92, the decisions rendered in the context of the former
section 92 per se can`t be validly applied.
16.12. Under such circumstances it is not possible to accept the
contention that the Revenue has subjected the AMP expenses
incurred by the assessee to the TP provisions, which are otherwise
deductible u/s 37(1). The correct position is that the Revenue by this
exercise has only ascertained the cost/value of the service rendered
by the assessee to the foreign AE towards creation and improvement
marketing intangibles. We, therefore, hold that there is no merit in
the contention of the ld. AR that the AO/TPO has made any
disallowance out of advertisement expenses, which are otherwise
deductible in full u/s 37(1).
Relevant factors for determining cost/value of international
transaction of AMP expenses :
17.1. Without prejudice to the above submissions, the ld. counsel
for the assessee submitted that DRP/AO were not justified in
computing the figures of `182.71 crore `161.21 crore . It was stated
that the TPO considered incomparable cases for the purpose of
making comparison of the percentage of assessee`s AMP expenses
and further failed to give effect to the other relevant factors having
bearing on the determination of such figures. The TPO chose certain
such companies which were not comparable in terms of nature of
products, size of share in the market etc. The ld. AR contended that
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that the TPO finally selected only two cases for the purposes of
comparison, viz., Videocon Appliances and Whirlpool of India Ltd.
Both these cases were claimed to be not comparable due to one
reason or the other. If some comparison was to be made, the ld. AR
stated that it should have been made with the cases also using a
foreign brand, such as Samsung. He also submitted that the TPO has
simply gone by the comparable cases and failed to give any weight to
other relevant factors such as the tenure of agreement with the foreign
AE, payment of royalty and subsidy allowed by the foreign AE on the
goods imported etc.
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.
17.3. From the arguments of the ld. counsel for some of the
interveners it transpires that the nature and terms of the agreements
between the Indian AEs and foreign AEs differ from case to case. In
some cases there is payment of royalty for the brand use, while in
others it is not. In some cases, the tenure of agreement is less, while
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in others it is more, while still in some others there is no reference to
the termination date of the agreement. In some cases, the Indian
entity has paid a consolidated payment towards fees for the use of
technical know-how and royalty. In some cases, the payment is only
for technical know-how, still in some others the payment is only for
royalty. In some cases the Indian enterprise is engaged in
manufacturing of the products having foreign brand, while in others,
the Indian entity is only a distributor. In some cases, the Indian entity
has got subsidy on the purchases made from the foreign AE, while in
others, there is no such subsidy. In some cases, the foreign entity has
presence in Indian only in one field through one Indian enterprise,
while in others it has presence in different fields represented by
different Indian entities. In this way we can see that there are also
certain other factors distinguishing one case from the other.
17.4. In our considered opinion, following are some of the
relevant questions, whose answers have considerable bearing on the
question of determination of the cost/value of the international
transaction of brand/logo promotion through AMP expenses incurred
by the Indian AE for its foreign entity :-
1. Whether the Indian AE is simply a distributor or is a holding a
manufacturing licence from its foreign AE ?
2. Where the Indian AE is not a full fledged manufacturer, is it
selling the goods purchased from the foreign AE as such or is it
making some value addition to the goods purchased from its
foreign AE before selling it to customers ?
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3. Whether the goods sold by the Indian AE bear the same brand
name or logo which is that of its foreign AE ?
4. Whether the goods sold bear logo only of foreign AE or a logo
which is only of the Indian AE or is it a joint logo of both the
Indian entity and its foreign counterpart ?
5. Whether Indian AE, a manufacturer, is paying any royalty or
any similar amount by whatever name called to its foreign AE
as a consideration for the use of the brand/logo of its foreign
AE?
6. Whether the payment made as royalty to the foreign AE is
comparable with what other domestic entities pay to
independent foreign parties in a similar situation.
7. Where the Indian AE has got a manufacturing licence from the
foreign AE, is it also using any technology or technical input or
technical knowhow acquired from its foreign AE for the
purposes of manufacturing such goods ?
8. Where the Indian AE is using technical know-how received
from the foreign AE and is paying any amount to the foreign
AE, whether the payment is only towards fees for technical
services or includes royalty part for the use of brand name or
brand logo also ?
9. Whether the foreign AE is compensating the Indian entity for
the promotion of its brand in any form, such as subsidy on the
goods sold to the Indian AE ?
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10 . Where such subsidy is allowed by the foreign AE , whether
the amount of subsidy is commensurate with the expenses
incurred by the Indian entity on the promotion of brand for the
foreign AE ?
11. Whether the foreign AE 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 AEs for different fields ? If
there are different entities in India, then what is the pattern of
AMP expenses in the other Indian entities ?
12. Whether the year under consideration is the entry level of the
foreign AE 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 AEs ?
17.5. In fact, it is the collective effect of the above factors in the
comparable case and the case to be compared with, which needs to be
kept in view before determining the cost/value of the international
transaction. There can be no straitjacket formula for giving weight to
each of these factors. What is result of each of such factors in
determining the cost/value of international transaction depends on the
facts of each case. It is the duty of the TPO to give due regard to such
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factors by making suitable plus or minus adjustments before finally
determining the cost/value of the international transaction.
17.6. In principle, we accept the contention of the ld. AR about the
necessity of choosing properly comparable cases in the first instance
before starting the exercise of making comparison of the AMP
expenses incurred by them for finding out the amount spent by the
assessee for its own business purpose. However the way in which
such comparable cases should be chosen, as advocated by the ld. AR,
is not acceptable. He submitted that only such comparable cases
should be chosen as are using the foreign brand. We find that
choosing cases using the foreign brand ex facie cannot be accepted.
It is but natural that the AMP expenses of such cases will also include
contribution towards brand building of their respective foreign AEs.
In such a situation the comparison would become meaningless as
their total AMP expenses will stand on the same footing as that of the
assessee before the exclusion of expenses in relation to brand
building for the foreign AE. The correct way to make a meaningful
comparison is to choose comparable domestic cases not using any
foreign brand. Of course when effect will be given to the relevant
factors as discussed above, it will correctly reflect the cost/value of
international transaction.
Scope of AMP Expenses:
18.1. The ld. counsel for the assessee and some of the interveners
contended that the TPO has included selling expenses in the total
AMP expenses for the purposes of determining the ALP. It was
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submitted that selling expenses cannot constitute part of AMP
expenses. Our attention was drawn towards the erstwhile sections
37(3A) and 37(3B), in which disallowance u/s 37(3A) was prescribed
in respect of expenses referred to in sub-sec. (3A), which, inter alia,
included advertisement, publicity and sales promotion. It was
submitted that various courts have held that the selling expenses
cannot be included within the scope of sec. 37(3B).
18.2. The learned Departmental Representative opposed this
contention by stating that there is no logic in the contention of the
learned AR that the expenses causing sales should be taken out of the
total AMP expenses for consideration. All the AMP expenses
including the expenses in connection with the sales should be
considered as one basket of expenses, out of which the AMP
expenses for the creation or promotion of marketing intangibles on
behalf of the foreign enterprise are to be segregated. It was contended
that since by their very nature most of the AMP expenses are
common having been incurred for own business and brand building
for the foreign AE, the reduction of expenses in connection with
sales would prejudice the computation of the AMP expenses for the
brand building.
18.3. Having heard the rival submissions on this issue, we find that
the AMP expenses refer only to advertisement, marketing and
publicity expenses. A divider needs to be placed between the
expenses for the promotion of sales on one hand and expenses in
connection with the sales on the other. Both these expenses are
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required to be kept in different compartments. While expenses for the
promotion of sales directly lead to brand building, the expenses
directly in connection with sales are only sales specific.
18.4. Sub-section (3A) of sec. 37, before its omission, provided that
where the expenses incurred by the assessee on any one or more of
the items specified in sec. 37(3B) exceed one lac of rupees, then
twenty percent of such excess shall not be allowed as deduction in
computing the income chargeable under the head `Profits and gains
of business or profession`. Clause (i) of sub-sec. (3B) referred to
advertisement, publicity and sales promotion. The Hon`ble
jurisdictional High Court in the case of CIT Vs. Khetu Ram
Bishambar Dass [(2008) 166 Taxman 273 (Del.)], has held that
bonus paid to dealers is not in the nature of sales promotion expenses
and hence the provisions of sec. 37(3A) cannot be applied to it. The
Hon`ble Calcutta High Court in CIT Vs. The Statesman Ltd. [(1992)
198 ITR 582 (Cal.)] has enunciated that the expenses incurred by way
of commission paid to sales agent do not attract disallowance under
sub-sections (3A) & (3B) of sec. 37. The Hon`ble M.P. High Court
in the case of CIT Vs. Mohd. Ishaque Gulam [(1998) 232 ITR 869
(MP)] has held that the dealer`s commission and sales agent
commission etc. cannot be brought within the purview of
advertisement, publicity and sales promotion expenses, as referred to
in sec. 37.
18.5. We do not find any force in the contention of the learned DR
made in this regard. The logic in the exercise of finding out the AMP
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expenses towards creation of marketing intangibles for the foreign
AE starts with the expenses which are otherwise in the nature of
advertisement, marketing and promotion. If an expenditure itself is
not in the nature of advertising, marketing or promotion, that ought to
be excluded at the very outset. We, therefore, reject this contention
raised by the learned DR.
18.6. As we are presently considering the term `advertisement
marketing and promotion expenses`, which is analogous to, if not
lesser in scope than the term `advertisement, publicity and sales
promotion` as employed in the erstwhile sub-sec. (3B) of sec. 37, all
the judgments rendered in the context of sub-sec. (3A) & (3B) of sec.
37 will squarely apply to the interpretation of the scope of AMP
expenses. We, therefore, hold that the expenses in connection with
the sales which do not lead to brand promotion cannot be brought
within the ambit of advertisement, marketing and promotion
expenses for determining the cost/value of the international
transaction.
19. In the facts and circumstances of the present case, it is found
that the TPO restricted the comparable cases to only two without
discussing as to how other cases cited by the assessee were not
comparable. Further it can be seen that the TPO has not considered
the effect of any of the relevant factors as discussed above. A bald
comparison with the ratio of AMP expenses to sales of the
comparable cases without giving effect to the relevant factors as
discussed above, cannot produce correct result. It can be illustrated
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by a simple example. If there is no subsidy in a comparable case but
the assessee has received some amount of subsidy from its foreign
AE on imports or in any other manner, which fact otherwise needs to
be specifically established by the assessee, then the initial amount so
computed would require reduction to the extent of such subsidy or
vice versa. As the TPO has neither properly considered the request of
the assessee for inclusion of some other comparable cases nor
examined the effect of the above discussed relevant factors on the
question of determination of the cost/value of international
transaction, in our considered opinion the ends of justice will meet
adequately if the order of the TPO and that of the AO giving effect to
such order is set aside and the matter is restored to the file of the TPO
for determining the cost/value of the international transaction and the
consequent ALP afresh as per law after allowing a reasonable
opportunity of being heard to the assessee.
VI. METHODS FOR DETERMINING ALP OF INTERNATIONAL
TRANSACTION
20.1. We have noticed above that the TP provisions require two
variables. Having seen the first variable, being the cost/value of
international transaction above, now we shall find the second
variable, being the arm`s length price of the international transaction.
TNMM applied on one transaction Whether ALP of other
transactions permissible ?
21.1. The ld. Counsel for the appellant started his contentions on
this point by urging in the very beginning that no disallowance can be
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made out of AMP expenses by benchmarking them separately when
the overall net profit rate declared by the assessee is higher than other
comparable cases. It was submitted that the assessee made imports
from its foreign AE which were subjected to the TP provisions under
the transactional net margin method (hereinafter called the TNMM)
and hence there was no warrant for making any further addition on
the transaction of brand building expenses incurred by the assessee
for the foreign AE. The ld. counsel stated that the overall higher net
profit rate implies that, firstly, there was no advertisement by the
assessee for the brand of the foreign AE and secondly, if at all it was
there, the same stood compensated by the foreign AE in terms of sale
of goods to the assessee at lower rates. The sale of goods at lower
prices to the assessee by the foreign AE should be considered as a
quid pro quo for the foreign brand building. For ascertaining as to
whether or not the foreign enterprise sold goods to the assessee at a
lower price, the ld. AR urged that the overall net profit rate of the
assessee should be considered, which will naturally absorb the effect
of incurring such brand building expenses. If the overall profit rate is
higher, it will mean that the expenses incurred by the assessee on
brand building were compensated by the foreign AE in terms of
lower price of goods charged from the Indian AE, necessitating no
separate further addition on the alleged presumption of the assessee
having incurred any AMP expenses towards brand building. The ld.
AR relied on the case of the Hon`ble Supreme Court in CIT Vs.
Calcutta Discount Co. Ltd. [(1973) 91 ITR 8 (SC)] , to canvass the
view that the assessee cannot be expected to earn maximum profit. It
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was submitted that the action of the Revenue in firstly taxing higher
rate of net profit on sales and thereafter further increasing the income
by making addition on account of AMP expenses, runs contrary to
the cardinal principle laid down in that case. He explained that in that
case the Revenue opined that the assessee should have transferred its
goods at a higher price than that declared. Rejecting this contention,
the Hon`ble Supreme Court came to hold that that once a transaction
is bona fide, the profit cannot be computed by taking market price,
ignoring the real price fetched. In the light of this judgment it was
contended that the action of the Revenue in firstly benchmarking the
net profit by applying TNMM on the international transaction of
imports and then making separate addition for AMP expenses is akin
to the stand of the Revenue in that case, being the maximization of
profit in all possible ways, which cannot be sustained. With
reference to certain material from the paper book, the ld. AR
submitted that the assessee`s net profit rate was better than certain
other comparable cases. Since the overall net profit of the assessee
was relatively higher, it was pleaded that no addition was called for
by separately processing any item of expense including the AMP
under the TP provision. Similar arguments were advanced by the ld.
counsel for some of the interveners.
21.2. Per contra, the ld. DR strongly opposed this contention by
submitting that there is no requirement under law that if one
transaction has been subjected to the transfer pricing provisions by
applying the TNMM then no other international transaction can be
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separately considered. It was accentuated that all the international
transactions are required to be viewed independent of each other.
21.3. We have heard the rival submissions on this issue in the light
of material placed before us and precedent relied. The crux of the ld.
AR`s submission in this regard is that when the international
transaction of import of raw material was scrutinized by the TPO
under TNMM and the overall net profit of the assessee was found to
be higher than other comparables, then no other international
transaction could have been processed under the TP provisions. There
are two sub-arguments in this main argument of the ld. AR. First,
that the international transaction of import of raw material has been
processed under the TNMM on entity level and second that when on
doing this exercise, the overall net profit was found to be better than
other comparables, then the no addition was called for by subjecting
the AMP expenses to the TP provisions.
21.4. There is a basic fallacy in the first sub-argument, which lies
in not properly appreciating the modus operandi of applying the
TNMM. This method provides for benchmarking of `an` internationa l
transaction by considering the operating profit from the concerned
international transaction vis-Ã -vis certain basis as given in Rule
10B(1)(e), being total cost, sales, capital employed etc. Here it is
significant to note the meaning of the term `transaction` as given in
rule 10A(d). It provides that : `transaction includes a number of
closely linked transactions`. Plural of transactions becomes singular
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when the transactions are closely linked to each other or are identical.
These closely linked transactions can be processed as one transaction
under any of the prescribed methods. If an Indian enterprise has made
sale of similar goods to its foreign AE through several invoices and
has also incurred some expenses or paid interest to it, it would mean
that all the transactions of sales are closely linked and these can be
processed as one unit. However the transactions of payment of
interest or incurring of any other expense would be required to be
separately scrutinized under Chapter-X because these are of a
different nature vis-a-vis the transactions of sales.
21.5. It is undisputed that under the TNMM, it is always the
operating profit from the concerned international transaction that is
viewed in relation to the total cost, sales or capital employed etc. of
that international transaction. It is not as if the percentage of the
margin is to be determined by considering the net profit of the entity
in relation to the total sales of the entity. When we consider operating
profit to total costs of an international transaction, all the items of
non-operating expenses and non-operating income qua such
international transaction are liable to be excluded. The correct
approach under the TNMM is to consider the operating profit from
each international transaction in relation to the total cost or sales or
capital employed etc. of such international transaction and not the net
profit, total costs, sales, capital employed of the assessee as a whole
on entity level. Section 92C unequivocally provides that the ALP in
relation to `an` international transaction shall be determined by any of
the prescribed methods. In turn, rule 10B(1)(e) also talks of the net
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profit margin realized by the enterprise from `an` international
transaction. When the mandate of the section and the relevant rule is
unambiguous so as to apply on each transaction, as is apparent from
the use of the article `an`, then the computation of the ALP of `an`
international transaction on the entity level is inappropriate. Our
conclusion that each international transaction is required to be
separately scrutinized under Chapter-X also becomes apparent from
the language of section 92(3) as discussed infra. Thus it is clear that
the sanction is for applying the TNMM only on a transactional level
and not on entity level. Of course, the TNMM can be correctly
applied on entity level if all the international transactions are of sale
by the assessee to its foreign AE and there is no other transaction of
sale to any outsider and also there is no other international
transaction. But if there are several unrelated international
transactions, as is the case before us and the assessee or the TPO has
applied the TNMM in a wrong manner on entity level for testing any
of such transactions, then the remedy lies in correcting such mistake
rather than drawing legally unsustainable conclusions by taking such
mistake as a correct legal position.
21.6. Now we espouse the second sub-argument that when on
applying the TNMM on entity level for the transaction of import of
raw material the overall net profit is better than other comparables,
then no addition is called for by subjecting the AMP expenses to the
TP provisions. We have held in an earlier para that when there are
different unrelated international transactions, the application of
TNMM on entity level for examining one of such transactions, is
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itself an incorrect approach. Notwithstanding that, we deem it
expedient to deal with the argument of the ld. AR that if rate of net
profit of the assessee is better than other comparables, then no
adjustment can be done under Chapter-X.
21.7. On a specific query from the Bench, it was admitted by the
ld. AR that no addition was made by the TPO on account of
application of the TNMM on the imports made by the assessee from
its foreign AE. In our considered opinion, there is a noteworthy
difference between two situations, viz., one where the TNMM is
wrongly applied on entity level and some addition is made to the
overall net profit of the Indian AE while testing the international
transaction of imports of raw material and also some further addition
is made by applying the TP provision on AMP expenses; and the
situation in which no addition is made to the overall profit on
account of application of the TNMM but an addition is made by
applying the TP provisions on the transaction of AMP expenses
incurred towards brand building for the foreign AE.
21.8. We find no bar on the power of the TPO in processing all
international transactions under the TP provisions when the overall
net profit earned by the assessee is better than others. Earning an
overall higher profit rate in comparison with other comparable cases
cannot be considered as a licence to the assessee to record other
expenses in international transactions without considering the benefit,
service or facility out of such expenses at arm`s length. All the
transactions are to be separately viewed. This position can be seen
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with a simple illustration. Suppose an Indian entity is engaged in
manufacturing of some products and all the sales are to its foreign
AE. In such international transaction, it earns actual profit of, say,
`120/-. Further suppose the arm`s length profit on total sales earned
in comparable uncontrolled transactions is `100. In such a case, there
can be no question of making any addition on account of arm`s length
profit from such international transaction of sale to foreign AE
because the actual overall profit is more than the arm`s length profit.
It may also be possible that the actual profit of the Indian AE was
`140/- but the AMP expenses have been so claimed as deduction so
as to include a part representing branding building for the foreign AE
to the tune of `20/-. In such a case, notwithstanding the fact that the
assessee`s overall profit at `120/- is more than the arm`s length profit
earned by comparable cases at `100/-, still there will be a
requirement for making adjustment of `20/- on account of
advertisement expenses incurred by the assessee towards the brand
building on behalf of the foreign AE. If we accept the assessee`s
contention that since `120/-, being the profit declared by the assessee
from the international transaction is more than the arm`s length profit
of `100/- and hence no further adjustment on account of AMP
expenses should be made, then the assessee`s income would stand
reduced to `120/- as against the actual income of `140/-. We fail to
appreciate as to how the judgment in the case of Calcutta Discount
Co. Ltd. (supra) advances the case of the assessee. There cannot be
any quarrel on the proposition that the assessee cannot be compelled
to earn maximum profit. As it is the real profit which is to be taxed
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and the assessee cannot be expected to earn maximum profit, in the
same way, the assessee cannot be allowed to reduce its real profit by
including certain expenses which are for the benefit of the foreign
AE.
21.9. It is pertinent to note that presently we are dealing with a
case in which the majority of the assessee`s sales is to Indian
customers. Naturally the TP provisions cannot be applied in respect
of sales to Indian customers because these are not international
transactions. In such a case, there can be no benchmarking of the
profits realized from such Indian customers so as to form a platform
for contending that the TNMM has been applied on the overall profits
and hence the AMP expenses should not be subjected to the TP
provisions. In fact, the assessee is a manufacturer and only raw
materials are imported from its foreign AE. The transaction of import
of raw-material is a separate international transaction liable to be
subjected to the TP provisions. Apart from such purchase of raw-
material, the assessee, as a manufacturer is also required to incur
several other expenses on manufacturing, financing and selling which
constitute part of the total cost of product along with the cost of raw
materials. Subjecting the international transaction of purchase of raw
material to the TP provisions would only show that purchase price of
raw-material is not unnecessarily inflated. It is self evident that net
profit is not dependent only on the purchase cost. A host of other
factors contribute to the earning of profit. It may be possible that a
manufacturer succeeds in making economical purchases but suffers
setback in incurring other expenses thereby resulting into a
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comparatively low profit. Similarly there can be a converse situation
in which the purchases are made costly but the economies in other
areas are achieved thereby leading to higher profit. The crux is that
purchase cost is only one of several other important factors having a
bearing on the overall profit. All other costs, including the AMP
expenses are independent of such cost of import of raw material,
having some correlation with the overall profit. In our considered
opinion there is no logic in not applying the TP provisions on AMP
expenses, if the international transaction of import of raw-material
from the foreign AE has been subjected to the TP provisions. As the
transactions of import of raw-material and AMP expenses are distinct
from each other, having independent effect on the overall net profit of
the Indian AE, both are required to be separately processed as per the
TP provisions.
21.10. It was also contended on behalf of the assessee that if the
overall profit of the Indian entity is more than the comparable cases
then it should be presumed that the foreign enterprise supplied goods
at relatively low price to make up for the AMP expenses incurred in
India towards brand promotion. In our considered opinion there are
no roots for such a presumption. In order to take benefit of such a
contention the assessee is required to directly prove the fact of cheap
purchases de hors the overall higher net profit rate. This fact can be
established by demonstrating that the foreign AE charged a specially
low price from the assessee in comparison with that charged for the
similar goods supplied to other independent entities dealing with it in
India or in case there is no other independent entity in India, then the
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price charged for similar goods from other foreign parties. It can also
be proved by showing that goods with identical features are available
in the Indian market at a higher price. The fact that the assessee has a
better net profit rate in comparison with other comparable entities is
not decisive in itself of the assessee having purchased the goods at a
concessional rate from its foreign AE as a compensation for its
incurring AMP expenses towards the promotion of their brand.
21.11. At this stage, it is relevant to note sub-section (1) of section
92, which provides that : `Any income arising from an international
transaction shall be computed having regard to the arm`s length
price.` Similarly it is pertinent to take stock of sub-section (3) of
section 92, which provides that : `The provisions of this section shall
not apply in a case where the computation of income under sub-
section (1) or the determination of the allowance for any expense or
interest under that sub-section, or the determination of any cost or
expense allocated or apportioned, or, as the case may be, contributed
under sub-section (2), has the effect of reducing the income
chargeable to tax or increasing the loss, as the case may be, computed
on the basis of entries made in the books of account in respect of the
previous year in which the international transaction was entered into`.
On a careful perusal of sub-section (3) in combination with sub-
section (1), it transpires that if the computation of income having
regard to ALP of an international transaction has the effect of
reducing the income chargeable to tax computed on the basis of
entries made in the books of account, then the provisions of section
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92 will be ignored. It can be understood by way of a simple example.
If the arm`s length price of an international transaction in the nature
of expense is `100 and the amount of actual expense recorded in the
books of account is `80/-, then the arm`s length price of such expense
at `100 will be ignored, because acting upon such ALP will lead to
lowering of the total income by `20, which isn`t permissible as per
sub-section (3). If however the ALP of such expense turns out to be
lower at `60, then sub-section (1) of section 92 will apply and the
total income of the assessee will be computed by considering the
ALP of expense at `60, making a northwards sojourn to the total
income by `20.
21.12. We have noticed above that sub-section (1) of section 92
read with rule 10B requires computation of income from `an`
international transaction having regard to its arm`s length price. It
means that each international transaction is required to be subjected
to the TP provisions distinctly. What is relevant to note on a conjoint
reading of sub-section (1) and sub-section (3) of section 92 is that if
there are two distinct international transactions and the determination
of ALP in respect of the first transaction leads to an increase in total
income as per sub-section (1) but no adjustment is called for in
respect of the second transaction as per sub-section (3) because of
the ALP on the negative side, then the ALP in respect of the first
transaction shall be considered in computing the total income, but the
ALP of the second transaction shall be ignored. There is no provision
which permits set off of negative adjustment with the positive
adjustment to the income on account of different international
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transactions. The outcome of both the transactions has to be given
effect distinctly. It, therefore, divulges that two or more international
transactions are required to be separately processed under the TP
provisions. The contention that if TNMM has been applied on one
international transaction, then it would oust the jurisdiction of the
TPO to process other international transactions under Chapter-X,
really does not stand in the scheme of the provisions. Further, it this
contention is taken to logical conclusion, then sub-section (3) of sec.
92 will become redundant to some extent.
21.13. There is one more way of fortifying our above conclusion.
TNMM is one of the five recognized methods for determining the
ALP of an international transaction. Such ALP can be determined
inter alia by comparable uncontrolled price (CUP) method or Cost
Plus method or even by the TNMM. All the five methods, as
prescribed under section 92(1) and rule 10B, aim at determining the
ALP of an international transaction in one way or the other. First is
the CUP method, by which the price charged or paid for property
transferred etc. in a comparable uncontrolled transaction is identified.
Such price is adjusted to account for differences, if any, between the
international transaction and the comparable uncontrolled transaction.
The adjusted price arrived at is taken as ALP in respect of the
property transferred etc. in the international transaction. In the like
manner all the methods including TNMM provide for determining the
ALP of an international transaction. The main focus of the ld. AR
was on restricting the application of the provisions of Chapter-X to
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other international transactions when one transaction has been
processed under the TNMM. It has been argued so on the ground
that under the TNMM, the net profit of the entity is considered which
includes the effect of all other transactions also. The natural
consequence of the ld. AR`s argument on this issue is that if the ALP
of an international transaction is determined by the TNMM then no
other international transaction can be subjected to the TP provisions.
From here it follows that if any other method, such as CUP or Resale
price method etc., is applied for determining the ALP of an
international transaction, then the processing of the other
international transactions is permissible. The irrationality of the
contention can be measured from this factor alone. As all the five
methods are aimed towards one end, being the determination of ALP
of an international transaction, it is but natural that the consequences
of application of each such method qua the other international
transactions cannot be varying. It is not possible to hold that if one
method is employed for determining the ALP of an international
transaction then it is open to the TPO to process other international
transactions through the TP provisions, but if some other method is
so used, then all other international transactions are immune from
such processing. The ld. AR could not draw our attention towards
any such provision in the Act. At best, the application of any method
including TNMM shows that the said transaction is at ALP. In our
considered opinion, the requirement of benchmarking all other
international transactions of expenses including AMP, also needs to
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be scrupulously done, apart from testing one international transaction
under the TNMM.
22.1. Notwithstanding his argument that the when the TNMM is
applied to international transaction of imports, no addition can be
made by processing any other international transaction, the ld. AR
then contended that the addition by way of adjustment made is not
sustainable because the determination of ALP in this case is not based
on any of the methods prescribed under the transfer pricing
regulations. Referring to sec. 92C, the ld. AR submitted that five
methods have been listed in specific and there is a general clause i.e.
(f), which states such other methods as maybe prescribed by the
Board. It was stated that such other method as per clause (f) of sec.
92C(1), has been brought into existence by means of Notification
dated 23-5-2012 through Income-tax sixth Amendment Rules 2012
coming into force on first day of April 2012, applicable from the
A.Y. 2012-13. Relying on the judgment of the Hon`ble jurisdictional
High Court in the case of Maxopp Investment Ltd. & Ors. Vs. CIT
[(2012) 247 CTR (Del.) 162] , the ld. AR contended that Rule 10AB,
specifying the sixth method, cannot have retrospective operation
when it has been made applicable from A.Y. 2012-13.
22.2. Coming back to his point, it was argued that the TPO/DRP
have determined ALP in respect of AMP expenses by applying the
bright line test, which is not one of the five recognized methods under
the Indian legislation. As determination of ALP has not been done as
per any of the methods u/s 92C, the ld. AR contended that the same
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should be set aside. He relied on an order passed by the Mumbai
Bench of the Tribunal in CA Computer Associates Pvt. Ltd. Vs. DCIT
dated 28-1-2010, in which the assessee paid royalty to its parent
company. The TPO rejected the ALP of royalty payment as shown by
the assessee on the ground that some of the sales did not materialize
for various reasons and the same were written off by the assessee in
the same financial year. It was opined that there was no question of
paying royalty on such sales merely on the basis of raising invoices.
The Tribunal rejected the Departmental stand by holding that the
ALP was not determined by the TPO as per any of the methods
prescribed in Rule 10B. To this extent the action of TPO was set
aside. The said order passed by the Tribunal has been upheld by the
Hon`ble Bombay High Court in the case of CIT Vs. CA Computers
Pvt. Ltd. vide its judgment dated 3-7-2012. In view of this legal
position, the ld. AR contended that since the bright line method
adopted by the authorities below is not a recognized method, the
determination so made should be set aside and the matter need not be
restored for a fresh determination. It was also contended that the
Revenue cannot be allowed to have second innings for its own fault.
The ld. AR further submitted that the TPO did not confront the
assessee with the computation of the ALP by applying the bright line
test, which goes against the principles of natural justice.
22.3. The learned Counsel for one of the interveners submitted
that any contract for purchase/service involves two elements viz.
quantity and price. Chapter-X of the Act only touches price aspect
and not quantity aspect. By adopting the bright line method, the
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learned counsel contended that the TPO has impinged on the
quantum aspect of the advertisement expenses which cannot fall
within the purview of Chapter-X. He submitted that by applying the
bright line method, the TPO/AO have taken a view that the assessee
should not have incurred so much expenses on AMP. He also
contended that Chapter-X of the Act is a complete code in itself
inasmuch as it includes not only the substantive but also the
machinery provisions. If machinery provision cannot be applied then
the subject matter goes out of the tax net. In support of this
contention, he relied on the judgment of the Hon`ble Supreme Court
in the case of CIT v. B.C.Srinivasa Setty [(1981) 128 ITR 294 (SC)]
and another judgment of the Hon`ble Supreme Court in the case of
PNB Finance Limited v. CIT [(2008) 307 ITR 75 (SC)] . In the light of
these judgments it was submitted that the Hon`ble Supreme Court has
clearly held that where machinery provision fails, the charge cannot
be attracted under the substantive provision. Since the Revenue`s
case hinges on the computation of ALP of AMP expenses on the
basis of a bright line method which is not prescribed u/s 92C, the ld.
AR contended that the entire exercise must fail.
22.4. Per contra, the ld. DR emphasized on the word any as
used in sub-section (1) of section 92C(1). His contention was that the
word any in sub-section (1) cannot be read as restricting itself to
any one of the five methods but it may also be a combination of two
or more of such methods. He relied on certain tribunal orders to
buttress his point that the ALP can be determined be any method
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even though it is not specifically one of such five methods. He invited
our attention towards an order passed by the Bangalore Bench of the
Tribunal in which it has been held that Excess Earning Method
(EEM) should be applied for determination of ALP which is nothing
but enlargement of the CUP method. He also referred to another
order passed by the Bangalore Bench of the Tribunal in which scope
of the CUP method has been enlarged. In this case the Tribunal
directed the determination of ALP by computing written down value
of the asset as against the value as per the Registered Valuer`s report,
which was adopted by the TPO. The learned DR contended that the
main thrust of the TP provision is on the determination of ALP and
methods are only means to achieve this end result. He argued that if
there is an international transaction and the ALP cannot be
determined by any of the prescribed methods, then there can be no
fetters on the powers of the TPO to adopt any other method for
determining ALP.
22.5. Without prejudice to his above submission, the learned DR
contended that the action of the DRP in enhancing the cost/value of
the international transaction of `161.21 crore by a mark-up of 13%
led to the implicit application of the `cost plus method`. It was
submitted that merely because there is no express mention of the use
of cost plus method, the reality and the substance of the application
of such method cannot be denied.
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22.6. Replying to the contention raised on behalf of the assessee
for cancelling the assessment itself for the reason of application of a
non-prescribed method, the learned Departmental Representative
contended that the DRP applied cost plus method. Even if in any case
there is a wrong application of method by the authorities, the right
course is to send the matter back to the AO/TPO for correcting the
deficiency instead of taking away the jurisdiction itself.
22.7. In rejoinder, the learned AR found fault with the argument
of the ld. DR on the application of the cost plus method by
contending that this method cannot be applied as the transaction is
not in the nature of rendering of service. His contention was that
unless an assessee itself is regularly engaged in the provision of
service which is provided to the AE, the cost plus method u/s
10B(1)(c) cannot apply.
22.8. We have considered the rival submissions. Before
proceeding further it is imperative to note that we have dealt with the
contention of the ld. AR about the application of bright line test by
the authorities below by holding that such method has been employed
to determine the cost/value of international transaction and not its
ALP. Another contention has been raised by the ld. AR that unless an
assessee itself is regularly engaged in the business of providing
services, there can be no provision of service to the other AE. This
contention has also been dealt with and rejected by holding that the
present international transaction is in the nature of `provision of
service`. Now we will proceed to see if it has to be any of the
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prescribed methods or it can even be a combination thereof and
further if an inappropriate method is applied by the authorities below
then what are the consequences.
22.9. Section 92(1) of the Act provides that any income arising
from an international transaction shall be computed having regard to
the arm`s length price. Computation of arm`s length price has been
set out in section 92C. Sub-section (1) provides that the ALP of an
international transaction shall be be determined by any of the
following methods, being the most appropriate method. Five methods
are distinctly prescribed u/s 92C(1) and then there is clause (f) which
talks of any other method as may be prescribed. Since sixth method
has been prescribed under rule 10AB through the Income-tax (6th
Amendment) Rules, 2012 which has been made applicable from the
A.Y. 2012-13, the same cannot apply to the assessment year under
consideration in view of the judgment of the Hon`ble jurisdictional
High Court in Maxopp Investment Ltd. (supra). Rule 10B provides
the modus operandi for the computation of ALP under these five
methods. Sub-section (1) of section 92C starts with : The arm`s
length price in relation to an international transaction shall be
determined by any of the following methods, being most appropriate
method ................ In our considered opinion, the contention of
the ld. DR laying emphasis on the word `any` for propelling his point
of view that the method for determining the ALP can also be a
combination of the prescribed methods, is devoid of force. There is
no doubt that the word any has been used u/s 92C(1) which would
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have ordinarily implied that any specific or non-specific method or
even a combination of one or more prescribed methods is sufficient.
However it is relevant to note that the scope of the word any is
circumscribed by the succeeding words of the following methods
being the most appropriate method. The ambit of the word any in
sub-section (1) has been restricted by the `following` five specific
methods given in the later part of the provision. Rule 10B also
provides in the same manner that .... the arm`s length price in
relation to an international transaction shall be determined by any of
the following methods, being the most appropriate method........
Here also the word `any` is succeeded by the word `following`, which
implies that it can be any of the five methods prescribed in the
following part of the rule. When we read sub-section (1) of section
92C in entirety along with Rule 10B(1), there remains no doubt that
the arm`s length price is required to be determined by any single
method out of the five prescribed methods. It is further pertinent to
note the prescription of Rule 10C which deals with the determination
of most appropriate method to be applied for determining ALP. Sub-
rule (1) provides that the most appropriate method for the purpose of
section 92C(1) shall be the method which is best suitable to the facts
and circumstances of each case. Sub-rule (2) which assumes
significance in the present context provides that : In selecting the
most appropriate method as specified in sub-rule (1), the following
factors shall be taken into account........... Use of the definite article
the in sub-rule (2) along with the most appropriate method, makes
it abundantly clear that it can be any of the methods given in sub-rule
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(1), that, in turn, draws strength from section 92C(1), which refers to
the five methods. In our considered opinion the general and a non-
case specific argument advanced by the ld. DR that there can also be
a combination of the one or more of the five methods for determining
the ALP, is not correct.
22.10. As regards the contention that methods are tools for
determining the ALP, we find that there is no dispute that the main
purpose of Chapter X is to determine the ALP of an international
transaction, but such determination can be done only by way of the
methods specified by the statute. When the legislature has
specifically enshrined a provision u/s 92C requiring the computation
of ALP by any of the prescribed methods, it does not fall in the realm
of the TPO or for that matter any other authority to breach such
mandate and apply or direct to apply any other method. Going by the
dictate of the provision as subsists under sub-section (1) of section
92C, there can be absolutely no doubt on adoption of any single
method out of those set out in section.
22.11. Rule10B has specified a set procedure to be followed for
determining the ALP distinctly under the five methods. It is equally
not permissible to invent a new procedure and try to fit such
procedure within any of the existing procedures prescribed as per
these methods. No one is authorized to add one or more new steps in
the prescribed procedure or to substitute any other mechanism with
the one prescribed under the rule. It is neither possible to invent a
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new method nor to substitute a new methodology in place of the one
prescribed in the rule.
23.1. We have noticed from the orders of the authorities below
that there is no express reference to any method employed for
determining the ALP of the international transaction. This factor in
itself, cannot be considered as detrimental to the computation of the
ALP, if in substance it has actually been computed by any of the
prescribed methods. In our considered opinion the DRP as well as
AO in passing the impugned order were right in applying the spirit of
the `cost plus method` to the facts of the instant case by firstly
identifying the cost/value of service provided to the assessee and
thereafter adding mark-up. The mere fact that DRP did not
specifically mention it in so many words, will not ipso facto mean
that it did not apply the cost plus method, when the essence of the
working matches with the methodology provided in that method.
23.2. At this stage it will be apt to note the directive of `cost plus
method` as per rule 10B(1) (c), which is as under :-
"(c) cost plus method, by which,--
(i) the direct and indirect costs of production incurred by
the enterprise in respect of property transferred or
services provided to an associated enterprise, are
determined ;
(ii) the amount of a normal gross profit mark-up to such
costs (computed according to the same accounting norms)
arising from the transfer or provision of the same or
similar property or services by the enterprise, or by an
unrelated enterprise, in a comparable uncontrolled
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transaction, or a number of such transactions, is
determined ;
(iii) the normal gross profit mark-up referred to in sub-
clause (ii) is adjusted to take into account the functional
and other differences, if any, between the international
transaction and the comparable uncontrolled
transactions, or between the enterprises entering into
such transactions, which could materially affect such
profit mark-up in the open market ;
(iv) the costs referred to in sub-clause (i) are increased by
the adjusted profit mark-up arrived at under sub-clause
(iii) ;
(v) the sum so arrived at is taken to be an arm's length
price in relation to the supply of the property or provision
of services by the enterprise ;"
23.3. Going by the cost plus method as per rule 10B(1)(c), we
find that the first step is to determine the cost of services provided by
an enterprise to its associated enterprise. We have noticed above that
the authorities below have computed the cost/value of the service
provided to the foreign AE at `161.21 crore. It is this amount which
constitutes the first step under the cost plus method. The second step
is to determine the amount of normal gross profit mark-up to such
costs arising from the provision of similar service by an unrelated
enterprise in an uncontrolled comparable transaction. The third step
under the cost plus method is to adjust the gross profit mark-up as
determined under the second step to take into account the functional
or other differences between the comparable uncontrolled transaction
and the international transaction. The DRP determined 13% profit
mark-up. The adoption of 13% constitutes steps 2 and 3 of the cost
plus method. Step 4 talks of increasing the cost as determined under
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step 1 by such adjusted profit mark-up. In this case, the DRP
increased cost of `161.21 crore under step 1 with 13% as determined
under steps 2 and 3 to find out the amount as per 4 th step at `182.71
crore. Step 5 declares that the figure computed under step 4 should be
taken as an arm`s length price for the provision of services by the
enterprise. Thus it is vivid that the DRP determined a sum of `182.71
crore as the ALP under the cost plus method of the international
transaction in the nature of provision of service with its cost/value at
`161.21 crore.
23.4. It is relevant to note that under second and third steps
what is required to be determined is the rate of normal gross profit
mark-up as arising to the enterprise from an uncontrolled transaction
or to an unrelated enterprise in a similar situation. Here it is
significant to note that a comparable uncontrolled transaction to be
considered for benchmarking the normal gross profit mark-up has to
be similar to the international transaction under consideration.
Consequently, the profit mark-up under steps 2 and 3 should in the
present case be the rate which an independent third party earns for
creating marketing intangible for and on behalf of the foreign
enterprise. In the present case, the DRP suggested 13% mark-up. The
DRP went wrong in applying steps 2 and 3 by arbitrarily determining
the rate of mark-up at 13% without showing as to how much an
independent comparable entity has earned from an international
transaction similar to one which is under consideration.
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23.5. At this juncture we consider it expedient to refer clause (ii)
of section 92F which defines arm`s length price to mean a price
which is applied or proposed to be applied in a transaction between
persons other than associated enterprises, in uncontrolled conditions.
Rule 10A of the Income-tax Rules, 1962 gives meaning to
uncontrolled transaction under clause (a) as a transaction between
enterprises other than associated enterprises, whether resident or non-
resident. It is this expression uncontrolled transaction which has
been used in Rule10B(1) inter alia in clause (c) i.e. cost plus method.
A reading of section 92F(ii) with Rule 10A(a) and 10B(1)(c) in
unison clearly points out that the arm`s length price is a price which
is applied in a transaction between non-AEs in uncontrolled
conditions. Steps 2 and 3 of rule 10B(1)(c) contemplate the
determination of normal gross profit mark-up of a comparable
uncontrolled transaction, which would mean a transaction between
non-AEs. One has to necessarily pass through these steps for
determining ALP under the cost plus method. When these steps
unequivocally provide for determining normal gross profit mark-up
from the provision of similar services by an unrelated enterprise in a
comparable uncontrolled situation, what is required to be done is to
first find out some comparable uncontrolled transaction; then
ascertain the profit mark-up of such comparable uncontrolled
transaction; and then adjust it to bring it at par with the international
transaction under consideration by removing the effect of factors of
non-comparability. The cost plus method under Rule 10B(1)(c) does
not provide for assuming a hypothetical profit mark-up under steps 2
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and 3 for determining ALP. It has to be a profit mark-up of a
comparable uncontrolled transaction. The DRP suggested 13% mark-
up without showing such mark-up in a comparable uncontrolled
transaction. This course of action cannot be sanctioned. When the
rule prescribes a particular method to be followed and the steps so
given are unambiguous, it is impermissible to substitute such steps
with any other mode. Accordingly we do not approve the action taken
by the A.O. in implementing the direction of the DRP to mark-up
13% on the cost/value of international transaction.
23.6. We have held earlier in this order that the TPO was not
justified in restricting himself only to the two comparable cases as
against certain other comparable cases cited by the assessee without
verifying or discussing the comparability or otherwise of such cases
cited by the assessee. These observations have been made in the
context of determining the cost/value of international transaction
which was worked out by the authorities below at `161.21 crore.
Certain relevant factors have also been discussed by us in that part of
the order which should be taken into consideration before
determining the cost/value of the transaction. Resultantly, we have
set aside the cost/value of international transaction at `161.21 crore
and restored the matter to the file of AO/TPO for determining such
value afresh after allowing a reasonable opportunity of being heard to
the assessee. This determination would provide the figure of first
step as per the cost plus method, being the cost/value of the
international transaction. As the DRP also did not correctly proceed
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to compute the correct rate of mark-up as per law, in our considered
opinion the ends of justice would adequately meet if the process of
determining normal profit mark-up as per steps 2 and 3 of Rule
10B(1)(c) as against 13% applied by the DRP/AO, is also restored to
the file of the AO/TPO so that he may determine the cost/value of
international transaction in the first instance and then the ALP of this
international transaction.
24.1. We do not find any substance in the contention of the
learned AR that since the authorities below did not apply any of the
recognized methods, their orders be declared as void ab initio without
requiring any restoration for fresh determination. The obvious reason
is that, even if it is presumed that the contention of the ld. AR is
correct, which is otherwise not because of the application of the
essence of the cost plus method by the DRP/AO in the present case, it
would at the most be a case of defect in application of the procedural
provision in the sense that the ALP has not been computed strictly as
per the force of the prescribed methods. It would not be a case that
the authorities lacked jurisdiction to determine ALP or their action
was barred by the limitation period. In that sense it would be a case of
irregularity. Once an irregularity intervenes at a particular stage of the
proceedings, the requirement is to take the hands of clock back to
such stage and then make the necessary correction. Any proceedings
become nullity when these are taken without any jurisdiction or
beyond the limitation period. The test to determine as to whether the
order passed is invalid or irregular is to see whether there is a lack of
jurisdiction or a procedural default. Coming back to our context, we
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find that the lapse came in applying the procedure of determining
ALP correctly. Such a lapse coupled with the fact that there was
otherwise valid jurisdiction and the action was well within the time
limit, cannot in our considered opinion lead to the declaration of the
order as a nullity. There occurred an irregularity due to such lapse
which can very well be cured by correcting it from the stage at which
such lapse occured. In view of the foregoing discussion, we are of the
considered opinion that there is no merit in the contention of the
learned AR that the entire proceedings be declared as null and void
simply because of some procedural lapse in determining the ALP of
the international transaction.
24.2. There can be no dispute on the legal proposition raised by
the ld. counsel for the assessee and some of the interveners that if the
computation provision is not capable of application, then the charge
shall cease under the substantive provision. In our considered
opinion there is even no failure of any procedural provision in that
sense of the matter. It is not as if the ALP of the transaction is not
capable of ascertainment. The same has actually been ascertained in
the order appealed against and we have held above that the `cost plus
method` is correctly applicable for determination of the ALP. The
raising of this argument by the ld. AR seems to have been prompted
because of incorrectly proceeding with the presumption that the
bright line test was applied to determine the ALP of the international
transaction, whereas the correct position is that the resultant figure is
the cost/value of the international transaction.
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25. Once the assessee has disclosed the ALP of a transaction, it
is for the TPO to satisfy himself as to the correctness of such ALP. If
the TPO is not satisfied with such correctness or where the assessee
has failed to compute such ALP, as is the case under consideration, it
is always the duty of the TPO to find out the ALP of international
transaction. If similar transaction is not there, it is not that the TP
provision would become redundant or the TPO will become functus
officio. In that case it will again be on the TPO to find out a case,
which is comparable to some extent and then make suitable
adjustments to the price in such a case so as to bring it at a level with
the international transaction of the assessee which is sought to be
compared. Rule 10B(3) provides to this extent by providing that an
uncontrolled transaction shall be comparable to an international
transaction if 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 transaction in the open market
or reasonably accurate adjustments can be made to eliminate the
material effects of such differences. Thus it is evident that the T PO
is required to eliminate the material effects of difference between a
partly comparable uncontrolled transaction and the transaction under
consideration by making suitable adjustments, so as to bring both the
transactions to the level of comparability.
26. Insofar as the contention of one of the interveners that the
Department cannot process the quantity aspect under the TP
provisions is concerned, we find that the Revenue has not proceeded
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to determine the quantity aspect of the international transaction but
only the price aspect. The case of the Revenue is that out of say `100
advertisement expenses incurred by the assessee, only , say, `30
pertain to the assessee for its business purpose and remaining `70 are
towards creating or promoting marketing intangible for and on behalf
of the foreign AE. The Department is not making out a case that the
assessee should have incurred `90 or `80 or any other lower amount
and not `100. Their point of view is that the incurring of `100 is fine
but the bifurcation is required to be made for determining that which
part of it was incurred for the assessee`s own business in India and
which part was incurred towards the creation of marketing intangible
for the foreign AE. By doing this exercise, the Revenue has simply
tried to ascertain the AMP expenses incurred by the assessee for its
business and AMP expenses incurred by the assessee towards
creating marketing intangible for the foreign AE thereby determining
the cost/value of international transaction at `161.21 crore.
27. Now we take up the contention that the TPO did not confront
the assessee with the determination of the ALP. Having regard to the
prevailing legal position in this regard and the facts of the instant case
we find that it is the primary duty of the assessee to declare the ALP
in respect of an international transaction. Where such duty has been
discharged then the burden shifts on the Revenue to show that how
the ALP computed by the assessee is not correct. In a case, where the
assessee does not show an international transaction and further fails
to compute the ALP in respect of such international transaction, then
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the TPO gets full power to determine the ALP of the international
transaction at his own. Sub-section (3) of section 92C provides that
where during the course of any proceedings for the assessment of
income, the A.O. is, on the basis of material or information or
document in his possession of the opinion that : (d) the assessee has
failed to furnish, within the specified time, any information or
document which he was required to furnish by a notice issued under
sub-section (3) of section 92D, the Assessing Officer may proceed to
determine the arm`s length price in relation to the said international
transaction in accordance with sub-sections (1) and (2), on the basis
of such material or information or document available with him.
Section 92D(1) enjoins duty on every person entering into
international transaction to keep and maintain the necessary
information and document in respect thereof. Sub-section (3) of
section 92D provides that the AO may in the course of proceedings
under this Act, require any person to furnish any information or
document in respect thereof, as may be prescribed under sub-section
(1) within the stipulated period. When we read section 92D along
with section 92C(3), it becomes apparent that if the assessee does not
consider a particular transaction as international and further fails to
maintain relevant records in this regard, the Assessing Officer is free
to determine the ALP on the basis of such material or information or
document as are available with him. It goes without saying that
despite the fact that the ALP in such circumstances is determined by
the TPO, yet the assessee has to be confronted with it. If certain
objections are raised by the assessee, these are also required to be
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addressed. Here is a case in which the assessee did not maintain any
document, information or evidence about the international transaction
in question. In such a situation, it became incumbent upon the
authorities to determine arm`s length price as per section 92C(1) and
(2). Similar is the position about section 92CA(3) which empowers
the TPO to determine ALP after considering the relevant evidence as
produced by the assessee and the relevant material as gathered by
him. It has been discussed above that the assessee contended about
the TPO not considering some of the comparable cases put forth by
it. The detail of such cases has been placed in the paper book, which
is admittedly not additional evidence. It is beyond our comprehension
as to how the assessee came to place such details without the TPO
confronting it with the entire issue. It is further evident from the order
of the DRP that there is no discussion on any such plea raised by the
assessee. Rather it can be seen that the assessee assailed the order of
the AO/TPO tooth and nail before the DRP on merits. Be that as it
may, we have set aside the computation of the ALP by the authorities
below for the reasons given above with a direction to do it afresh as
per law after allowing a reasonable opportunity of being heard to the
assessee. Now the assessee will get full opportunity to put forth its
case against any part of the computation of ALP of the international
transaction by the TPO.
28. In view of the above discussion we are of the considered
opinion that there is no merit in the contention of the ld. AR that the
ALP has been determined by applying the bright line test, which is
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not one of the recognized methods in India and hence the provisions
of Chapter-X will not apply.
VIII. MARUTI SUZUKI'S CASE
29.1. The judgment of the Hon`ble jurisdictional High Court in the
case of Maruti Suzuki India Ltd. vs. Addtl. CIT/TPO (2010) 328 ITR
210 (Del) has been deliberated upon during the course of the
arguments. The learned AR put up his position in this regard by
contending that it was a case of writ petition before the Hon`ble Delhi
High Court and while passing the order, the Hon`ble High Court also
went on to give directions on the question of allocation of expenses.
It was submitted that this judgment was challenged before the
Hon`ble Supreme Court and the judgment of the Hon`ble
jurisdictional High Court has been rendered non est as having been
overruled in Maruti Suzuki India Ltd. VS. Addl. CIT [(2011) 335 ITR
121 (SC)] . It was stated that the judgment of the Hon`ble High Court
has merged with the judgment of the Hon`ble Supreme Court and
hence cannot be considered as independently existing or having any
binding force. In that view of the matter, it was stated that the
reliance by the Revenue on the judgment of the Hon`ble jurisdictional
High Court is misplaced and unfounded as it is no more a good law
as having been directly overruled by the Hon`ble Supreme Court in
Maruti`s own case.
29.2. On the other hand the learned Departmental Representative
submitted that there is no change in the status of the judgment of the
Hon`ble Delhi High Court. He relied on the ratio of the judgment of
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the Hon`ble jurisdictional High Court in the case of Maruti Suzuki
(Del)(supra) to drive home the point that the instant transaction is an
international transaction; and the modus operandi adopted by the
authorities for determining the ALP of the transaction of brand
building for the foreign AE in making the addition of `182.71 crore
is correct. He also stated that the Hon`ble Supreme Court simply
directed the TPO to pass fresh order uninfluenced by the observations
of the Hon`ble Delhi High Court on the merits of the case and as s uch
the legal principles as found in the said judgment cannot be said to
have lost their value.
29.3. In order to appreciate the rival contentions in this regard, it
will be apt to go through these judgments of the Hon`ble Courts.
Firstly, we take up the case of the Hon`ble Delhi High Court. The
assessee company in that case (Maruti), was engaged in the
business of manufacture and sale of automobiles, with its registered
trade mark/logo M`. On 4-12-1992 Maruti entered into a License
Agreement with Suzuki for manufacture of cars with the brand
Maruti Suzuki. From 1993 onwards it started using the logo S,
the logo of Suzuki and also continued to use the mark M along with
the word S on the rear side of the vehicles manufactured and sold
by it. Reference was made by the AO u/s 92CA(1) to the TPO for
determination of ALP of international transaction. A notice dated
27-8-2008 was issued by the TPO to the assessee on the premise that
it amounted to sale of the brand Maruti to Suzuki. Since Suzuki
had taken substantial amount of royalty from Maruti without
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contributing anything towards brand development in Indian market
and Maruti had incurred expenditure amounting to `4092 crores on
advertisement, marketing and publicity etc., the TPO prima facie
opined that such advertisement expenses with 8% mark-up
amounting in total to `4420 crores was the value of the brand. The
assessee was called upon to explain as to why the international
transaction be not adjusted on the basis of its deemed sale of the
brand Maruti to Suzuki. The assessee submitted that it had not
charged any additional consideration for the use of its logo on the
vehicles manufactured. The jurisdiction of the TPO was disputed by
the assessee by way of writ petition seeking stay of the proceedings.
The Hon`ble Court allowed the proceedings to continue but directed
the TPO not to give effect to order, if any, passed by him.
Subsequently, during the course of proceedings before the TPO, he
abandoned his earlier stand and propounded a new view that Suzuki
had piggybacked on the Maruti brand and all the expenses on
branding building were incurred by the Indian company. Maruti was
found to have paid royalty to Suzuki, without Suzuki paying any
compensation to the Maruti for such brand building. As Maruti had
paid certain royalty to Suzuki in the relevant year and since no
bifurcation of the royalty paid to Suzuki was furnished towards
license for manufacture and use of trade mark, the TPO apportioned
50% of the royalty paid to the use of the trade mark. He also held that
Maruti had developed marketing intangibles for Suzuki in India at its
cost and it had not been compensated for building those marketing
intangibles for Suzuki. Non-routine advertisement expenses
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amounting to `107.22 crores were held to be liable for adjustment. In
the mean time, the assessee amended its writ petition so as to
challenge the final order passed by the TPO. It was contended that the
TPO had completely given up the grounds set out in the notice issued
by him on 27-8-2008 for initiating transfer pricing proceedings. It
was stated that the only ground given in such notice was that change
of the brand logo M` of Maruti to Suzuki amounted to sale of the
brand of Maruti to Suzuki and there was no allegation in the show
cause notice that the trade mark S had piggybacked on the trade
mark M.
29.4. On perusal of the terms and conditions contained in the
agreement between Maruti and Suzuki, the Hon`ble High Court
observed that Maruti had not transferred its brand or logo to Suzuki.
Rather it was only Maruti which was given the right to use the brand
name and logo of Suzuki on its products. As the brand name/ logo
had not been transferred to Suzuki nor had the same been used by
Suzuki, either in India or in other country, the Hon`ble High Court
held that TPO failed to make out any case of sale of a brand name
Maruti or logo M by the assessee to Suzuki. Further, since the case
set up in the show cause notice was abandoned by the TPO himself,
the Hon`ble High Court laid down certain principles for the
determination of the ALP in respect of the international transaction of
brand building for the foreign AE. It also heard the parties on the
merits of the case, examined the facts and finally directed the TPO to
decide the new issue of brand building afresh in accordance with its
view point.
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29.5. As we are presently concerned only with the question of
AMP expenses leading to the brand building for the foreign AE, the
relevant parts of the judgment of the Hon`ble High Court can be
noted as under : -
I.
(1). Page 236 of ITR Vol. 328: `The transaction in question is
definitely covered in the above referred definition, since not
only does it include sale of tangible properties such as parts
and components and licensing of trade mark by Suzuki to
Maruti, it also had a bearing on the profits and losses of both
the entities. If there was a mutual arrangement between Maruti
and Suzuki relating to their respective costs and expenses in
connection with the services provided by Suzuki to Maruti or
by both the entities mutually to each other, that also would
come within this definition.`
From the above it is clear that the Hon`ble High Court has held the
transaction of brand promotion for the foreign AE as an international
transaction. It is also self evident because the further part of the
judgment is based on the mode of determination of ALP in respect of
this international transaction.
II.
(1). Page 266 of the report : (vii) The expenditure incurred by
an independent domestic entity on advertising, promotion and
marketing of its products using a foreign trade mark/logo does
not require any payment or compensation by the owner of the
foreign trade mark/logo to the domestic entity on account of
use of the foreign trade mark/logo in the promotion,
advertising and marketing undertaken by it, unless agreed by
the domestic entity.
(2). Page 267 of the report : (ix) If the expenses incurred by a
domestic entity which is the associated enterprise of foreign
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entity, using a foreign brand trade mark and/or logo while
advertising, marketing and promoting its products, are more
than what a similarly situated and comparable independent
domestic entity would have incurred, the foreign entity needs
to suitable compensate the domestic entity in respect of the
advantage obtained by it in the form of brand building and
increased awareness of its brand in the domestic market.
(3). Page 267 of the report - (x) In case the foreign entity is
liable to compensate in terms of (ix) above, the Transfer
Pricing Officer needs to determine the arm's length price in
respect of the international transaction made by the domestic
entity, with the foreign entity, which is its associated enterprise
within the meaning of section 92A of the Act, taking into
consideration all the rights obtained and obligations incurred
by the two entities, including the advantage obtained by the
foreign entity.
(4). P. 258 of the report : -`In our opinion, if the agreement
between two entities which are not independent entities,
carries an obligation to use a joint trade mark, either some
appropriate payment needs to be made or appropriate rebate in
the charges payable to it needs to be given by the foreign entity
to the Indian entity, for being obliged to carry the name of the
foreign entity on all its products even if it does not see any
advantage from carrying that name on its products. Of course,
the Department cannot insist upon such a payment in case the
parties entering into the contract are independent parties.`
III.
(1). P. 258 of the report : `We are unable to agree that there
can be no possible benefit to "Suzuki" on account of
compulsory use of the joint trade mark "Maruti Suzuki" on all
the parts and products manufactured and sold by Maruti in
India. Once the name "Suzuki" becomes widely known in the
domestic market, nothing prevents Suzuki from refusing to
extend its agreement with Maruti or to independently enter the
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Indian market for manufacture and/or sale of similar products
under its own brand name.`
(2). P. 252 of the report : - `The TPO has not tried to find out
what royalty, if any, a comparable independent Indian entity
would have paid for the benefits derived by Maruti from
Suzuki under the agreement dated December 12, 1992. The
case of Maruti before the TPO was that in fact, it had got a
subsidy from Suzuki in payment of royalty...... The TPO,
however, rejected the contention without trying to make an
effort to find out how much royalty, fixed and running, would
a comparable independent domestic entity have paid in
consideration of an agreement of this nature. This becomes
important since, according to the petitioner, even if some
benefit on account of promotion and brand building of the
brand "Suzuki" accrued to Suzuki in the form of marketing
intangibles, that was more than offset by the subsidy which
Suzuki granted to Maruti by accepting a lesser royalty.`
(3). Pages 253 and 254 of the report : `We do not know
whether the price being charged by Suzuki from Maruti for
those components and parts is a fair price or not. ... If Suzuki
has been charging less than the amount, which a comparable
independent entity would have paid to it for those parts and
components, that would be considered as a subsidy by Suzuki
to Maruti and will be taken into consideration while
determining the arm's length price under the composite
agreement dated December 12, 1992.
.......
We hasten to add here that the TPO would not be justified in
determining the fair price in respect of components and parts
being supplied by Suzuki to Maruti solely on the basis of the
price charged by domestic auto part manufacturers from
Maruti, since the case of Maruti has been that Suzuki owns
intellectual property rights in respect of the parts and
components supplied by it to Maruti, whereas Indian vendors
did not have any such rights which are essential for the
manufacture and supply of those parts.
.........
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The correct approach to determine the fair price of such parts
and components would be either to ascertain the price at
which such components and parts were being exported by
Suzuki outside Japan or the price at which they were being
sold in Suzuki`s domestic market. The other alternative can be
to ascertain the price which a comparable independent
domestic entity would have paid for importing such parts from
Suzuki or from some other comparable foreign manufacturer
of repute.
...........
Of course, necessary adjustments will have to be made by the
TPO wherever required in this regard. Unless the TPO
determines the price which an independent Indian entity would
have paid for the benefits derived from Suzuki in the form of
marketing intangibles, it may not be possible to determine a
fair arm's length price, that should have been paid under the
agreement between Suzuki and Maruti.`
(4). P. 248 of the report : `The comparables chosen by the TPO
were Hindustan Motors Limited, Mahindra and Mahindra
Limited and Tata Motors Limited. ...In order to compare the
advertisement, marketing and promotion expenses incurred by
the petitioner, with similar expenditure incurred by other
automobile companies, the TPO compared the advertisement
costs of three other companies Hindustan Motors Limited,
Mahindra and Mahindra Limited and Tata Motors Limited. He
noticed that there was no advertisement costs of Hindustan
Motors and TATA Motors Limited whereas it was 0.876 per
cent. of net sales in the case of Mahindra and Mahindra
Limited. He found that the advertisement/net sales ratio in the
case of Maruti was 1.843 per cent. as against 0.876 per cent. of
Mahindra and Mahindra Limited........the TPO found no
justification for the expenditure incurred by "Maruti" in this
regard and was of the view that half of these expenses should
be payable by "Suzuki" to "Maruti". In our view, the
comparables chosen and the method adopted by the TPO in
this regard was faulty and unjustified. .....For this reason
alone, the expenses incurred by Mahindra and Mahindra on
advertising, promotion and marketing, etc., cannot be
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compared with the expenses incurred by "Maruti" under these
heads.
...........
We find from a perusal of the order of the TPO that Maruti had
suggested the name of Honda SIEL and Hyundai Motors for
this purpose. ........In any case, if the TPO did not find Honda
Siel and Hyundai Motors to be appropriate comparables, he
ought to have looked for other entities which could be really
compared with Maruti...The appropriate method for the TPO
would have been to take all automobile companies
manufacturing and selling vehicles in the domestic market,
eliminate those which were incomparable, adopting a
methodological approach, and then carry out comparison with
those which were really comparable independent entities.
Adjustments wherever needed could then be made, considering
individual profiles of those entities.`
29.6. Decision part of any judgment or an order chiefly comprises
of, firstly, noting the principle of law, if already settled, on the
interpretation of the relevant provisions germane to the issue under
consideration. Then the facts of the case are evaluated on such
principle. The case is decided accordingly by seeing if the facts of
the case pass or fail such principle. If the principle of law already
settled, requires passing through a set procedure for testing the merits
of the case ; and the court finds that some part(s) of the procedure
have either been skipped or not properly examined, then the matter is
restored to the lower authority to check the merits of the case on the
bedrock of such principle. In such a case, where there already exists
a principle of law on the point, the decision part of the judgment will
involve a simple evaluation of facts on the touchstone of such
principle. In another case, where there does not exist an already
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settled principle of law, it becomes the duty of the court to first
evolve the principle of law on the interpretation of the relevant
provisions and then decide the merits of the case on the strength of
such principle. If all the relevant facts for applying such evolved
principle are available, then there arises no difficulty in taking
appropriate decision on the merits of the case accordingly. If,
however, the lower authorities had proceeded on a line of action,
which is not fully or partly in consonance with the procedure required
for the application of the principle of law so deduced by the court,
then a redo is directed as per the correct procedure emanating from
the principle so propounded. It may be possible that the Court, while
restoring the matter to the lower authority, apart from asking it to
apply the principle of law so laid down by it, also prescribes the case-
specific ways of applying such principle of law. In that case it will
mean that the court has not only laid down the principle of law to be
applied but has also given certain directions on the merits of the case
before it.
29.7. The judgment of the Hon`ble jurisdictional High Court in
Maruti Suzuki (supra) is a perfect depiction of the last situation as
discussed above. From the relevant extracts of the judgment and the
summary of its conclusions as reproduced above, it can be noticed
that its decision part can be conveniently divided into three parts. Ist
part upholds the character of brand promotion expenses for the
foreign AE as an international transaction. IInd part comprising of
four sub-points, outlines the principle of law in two parts. First, the
incurring of AMP expenses by an independent domestic entity does
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not require compensation by the foreign AE to the Indian enterprise.
Second, if the AMP expenses are incurred by a domestic entity
which is an associated enterprise of foreign entity, then there is a
requirement on the part of the foreign entity to compensate the
domestic entity in respect of the advantage obtained by it in the form
of brand building to the extent the expenses are more than what a
similarly placed comparable independent domestic entity would have
incurred. When the foreign AE is required to compensate, then the
TPO needs to determine the ALP in respect of such international
transaction. IIIrd part comprising of four sub-points, deals with the
merits of the case in pointing out that where the TPO went wrong and
how he should go ahead in the fresh proceedings restored to him for
determining the ALP of the AMP expenses incurred by the assessee
towards the brand building for the foreign AE.
29.8. Both the sides have heavily banked upon the judgment of
the Hon`ble Supreme Court in Maruti Suzuki Limited (supra) in
support of their respective stands. Whereas the ld. AR has contended
that this judgment of the Hon`ble Summit Court has overruled the
judgment of the Hon`ble Delhi High Court, the ld. DR has stressed
that there is no such overruling of the principle of law laid down by
the Hon`ble High Court.
29.9. The judgment of the Hon`ble Apex Court is a short one,
which is reproduced in entirety, as under: -
`Order
Leave granted.
By consent, the matter is taken up for hearing.
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In this case, the High Court has remitted the matter to the
Transfer Pricing Officer ("the TPO" for short) with liberty
to issue fresh show-cause notice. The High Court has
further directed the Transfer Pricing Officer to decide the
matter in accordance with law. Further, on going through
the impugned judgment of the High Court dated July 1,
2010, we find that the High Court has not merely set aside
the original show-cause notice but it has made certain
observations on the merits of the case and has given
directions to the Transfer Pricing Officer, which virtually
conclude the matter. In the circumstances, on that limited
issue, we hereby direct the Transfer Pricing Officer, who,
in the meantime, has already issued a show cause notice on
September 16, 2010, to proceed with the matter in
accordance with law uninfluenced by the
observations/directions given by the High Court in the
impugned judgment dated July 1, 2010.
The Transfer Pricing Officer will decide this matter on or
before December 31, 2010.
The civil appeal is, accordingly, disposed of with no order
as to costs.`
(emphasis supplied by us)
29.10. From the above judgment of the Hon`ble Supreme Court it
is evident that firstly, there is a reference to the observations made by
the Hon`ble High Court on the merits of the case, and secondly, the
TPO has been advised to proceed with the matter in accordance with
law uninfluenced by the observations/directions given by the High
Court. The decision of the Hon`ble Supreme Court is on that limited
issue. The word `that` in the term `that limited issue` refers to the
observations of the Hon`ble High Court on `the merits of the case`.
152 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
29.11. Two things emerge from the judgment of the Hon`ble
Supreme Court. First, that the afore discussed Part I (comprising of
one sub-point) and Part II (comprising of four sub-points) of the
judgment of the Hon`ble jurisdictional High Court, being the decision
on AMP expenses towards brand building of the foreign AE as an
international transaction and the principle of law laid down about
the procedure for determining the ALP of such AMP expenses, have
neither been considered nor commented upon by the Hon`ble
Supreme Court. Second, only the afore discussed Part III (comprising
of four sub-points), being the merits of the case, has been summarily
touched upon by laying down that the TPO should decide the
quantum of determination of ALP in respect of AMP expenses
uninfluenced by the observations/directions given by the High Court.
29.12. Here it is of paramount importance to note that the
decision of the Hon`ble jurisdictional High Court on the merits of the
case has not been overruled, either impliedly or expressly. The
argument of the ld. counsel for the assessee that the judgment of the
Hon`ble jurisdictional High Court in the case of Maruti Suzuki
(supra) has been overruled by the Hon`ble Supreme Court is wholly
devoid of merits. There is a marked difference in a situation where
the judgment of a lower court is considered and overturned by a
superior court and a situation where it is considered but not
commented upon. Such difference in the two situations can be better
understood with the help of an example. Suppose an authority
intends to complete some proceedings. First can be a case where such
153 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
authority is directed to exercise option A and not options B or C for
completing the proceedings. In the second case, the higher authority
directs the lower authority to complete the proceedings by exercising
any of the options at his command. In such a case the lower authority
gets choice to exercise any of the options A, B or C. It cannot be
said by such later direction of the higher authority, exercising option
A has been debarred. The change is only to the extent that the
otherwise mandatory option A in the first situation has been
substituted with the discretion of the authority to choose any option.
If the authority still chooses A option, his action will not become void
for this reason alone.
29.13. Applying the same logic to the facts of the instant case, it
is noticed that with the advent of the judgment of the Hon`ble
Supreme Court, the directions given by the Hon`ble High Court to the
TPO for determining ALP as per the afore discussed Part IIIrd has
lost the tag of binding force. Now the TPO is free to determine the
ALP in any of the ways open before him. Thus the contention of the
ld. AR that the judgment of the Hon`ble jurisdictional High Court has
been reversed, is jettisoned.
29.14. Now we take up the next contention of the ld. AR about
the merger of the judgment of the Hon`ble jurisdictional High Co urt
with that of the judgment of the Hon`ble Supreme Court.
Judgment/order of a lower authority merges with that of the higher
authority when it is considered and decided by such higher authority
either way. It is a trite law that merger can be full or in part. If an
154 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
issue as decided by the Hon`ble High Court has not received
attention and consideration of the Hon`ble Supreme Court, then the
Hon`ble High Court`s decision cannot be said to have merged to that
extent. The reasoning and conclusion of the Hon`ble High Court on
such issue stand on its own force.
29.15. We have noticed above that merger can be full or in part.
Whether the merger is on wholesome manner or is issue based is a
question to be decided by considering all the relevant facts and
circumstances and also going through the orders of the both the lower
and higher authorities. It is observed that the concept of partial
merger is not alien to the Act. Clause (c) of Explanation to sub-
section (1) of Section 263 is an example of a provision encompassing
both full and partial merger of the assessment order with that of the
CIT(A) so as to permit the CIT to exercise the revisional power on
that part of the assessment order which has not been considered and
decided by the first appellate authority. To bring a decision of some
lower authority within the meaning of merger with that of some
higher authority, it is quite natural that there must exist decisions of
both the authorities on such point. If there is only a decision of the
lower authority on an issue, without there being any decision on that
issue by the higher authority, obviously the theory of merger will fail.
In fact, the partial merger pre-supposes that with the decision of the
higher authority on a particular point, the decision of the lower
authority ceases to exist independently. Unless there are decisions by
both the authorities, the question of such merger cannot arise.
155 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
29.16. Coming back to the Maruti`s case it is crystal clear that the
above discussed Ist and IInd Parts of the judgment of the Hon`ble
jurisdictional High Court laying down the principles of law have not
at all been considered and decided by the Hon`ble Supreme Court. As
such it cannot be said that there is a merger of the judgment. In our
considered opinion it is absolutely erroneous to argue on behalf of the
assessee that the judgment of the Hon`ble jurisdictional High Court
has become non-existent as having been overruled or fully merging
with that of the Hon`ble Supreme Court. If, for a moment, the
contention of the ld. AR that the judgment of the Hon`ble Delhi High
Court has completely merged with that of the Hon`ble Supreme Court
is presumed to be correct, which we really do not accept as correct, it
would mean that only the judgment of the Hon`ble Supreme Court in
the case of Maruti Suzuki (supra) is existing. The relevant part of
this judgment is that : In the circumstances, ..., we hereby direct the
Transfer Pricing Officer, who, in the meantime, has already issued a
show cause notice on .... to proceed with the matter in accordance
with law ..... We have noticed above that there was no express
agreement for brand building between Maruti and Suzuki. It shows
that as per this judgment, the Hon`ble Supreme Court has directed
the TPO to make a de novo determination of the ALP of the
transaction of brand building for the foreign AE in such
circumstances. The direction for such determination inherently
recognizes that there is a transaction of brand building between the
assessee and the foreign AE, which is an international transaction as
156 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
per section 92B and the TPO has the jurisdiction to determine the
ALP of such transaction.
WHETHER MARK-UP IS PERMISSIBLE?
30.1. Now we take up the second question as to whether a mark-
up is permitted in respect of AMP expenses incurred for and on
behalf of the AE. We have observed above that the AO in the
impugned order has computed the ALP of the transaction at `182.71
crore, by adding mark-up of 13% to the cost/value of international
transaction at `161.21 crore, in conformity with the DRP`s direction.
It has been noticed that the DRP applied the essence of `cost plus
method` in determining the ALP of the transaction. Such addition of
mark-up to the costs has the sanction of law as can be seen from sub-
clause (iv) of clause (c) to rule 10B(1). Albeit we have restored the
matter of determining the correct mark-up in the facts and
circumstances of the present case to the file of the TPO, yet we do not
see any hitch in holding that mark-up can be validly imposed.
30.2. Thus, on principle, we answer both the questions posted
before this special bench in positive by holding that firstly, the
transfer pricing adjustment in relation to advertisement, marketing
and sales promotion expenses incurred by the assessee for creating or
improving the marketing intangible for and on behalf of the foreign
AE is permissible and secondly, earning a mark-up from the
Associated Enterprise in respect of AMP expenses incurred for and
on behalf of the AE is also allowable. However in so far as answering
157 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
these two questions on the facts and circumstances of the present case
is concerned, we have restored the matter to the file of the TPO for de
novo adjudication in the light of certain guidelines outlined above.
31. Before parting with this matter we wish to place on record our
deep appreciation for the illuminating arguments advanced by both
the sides, which greatly assisted us in the disposal of the issues raised
in this appeal. We also want to make it clear that all the cases relied
on by both the sides have been duly taken into consideration while
deciding the matter. The omission of reference to some of such cases
in the order is either due to their irrelevance or to ease the order from
the burden of the repetitive ratio decidendi laid down in such
decisions.
32. Now the instant appeal is directed to be placed before the
Division Bench for disposal as per law having regard to the decision
of the special bench on the questions raised before it.
Order pronounced on this day of December, 2012.
- sd - As per separate order - sd -
(G.D.Agarwal) (Hari Om Maratha) (R.S.Syal)
Vice-President Judicial Member Accountant Member
New Delhi : January, 2013.
Varma/Devdas*
158 ITA No.5140/Del/2011.
M/s.L.G.Electronics India Private Limited.
Copy to :
1. The Appellant.
2. The Respondent.
3. The CIT concerned
4. The CIT(A)- , Delhi.
5. The DR/ITAT, Delhi.
6. Guard File.
TRUE COPY.
By Order
Assistant Registrar, ITAT, Delhi.
Date
1. Draft dictated on Different Sr.PS
dates.
2. Draft placed before author 26.11.2012 Sr.PS
3. Draft proposed and send to the Hon`ble 26.11.2012
V.P. (through
email)
13.12.2012
(hard copy
after
discussion)
4. Draft proposed and placed before the 26.11.2012
Hon`ble J.M. (through
email).
5. Draft discussed/approved by Hon`ble VP 13.12.2012
6. Draft discussed/approved by Hon`ble JM JM/AM
7. Approved Draft comes to the Sr.PS/PS Sr.PS/PS
8. Kept for pronouncement on Sr.PS
9. File sent to the Bench Clerk Sr.PS
10. Date on which file goes to the AR
11. Date on which file goes to the Head
Clerk.
12. Date of dispatch of Order.
*
1
IN THE INCOME TAX APPELLATE TRIBUNAL
DELHI BENCHES : NEW DELHI.
ITA No. 5140/Del/2011
[A.Y. 2007-08]
M/s L.G. Electronics India P Ltd Vs. ACIT, Circle 3
Noida Noida
PER HARI OM MARATHA, JM:
Invariably, the constitution of a Special Bench is triggered either
when there is a need to decide a maiden issue which is likely to recur
in numerous cases or with a view to resolve a conflicting view taken or
is likely to be taken on any issue by different benches. The Special
Bench so constituted u/s 255(3) of the Act has a designated
responsibility to decide a momentous issue. That is why wider hearing
is given to professionals (referred to as Interveners) representing cases
in which similar or near to similar issues are involved. After cogitating
the submissions advanced for and against the referred issue(s) and
after circumspecting entire relevant facts, law, precedents and even
literature on the subject, finally a decision is taken to resolve that
issue to the extent it is possible. The issue before this Special Bench is
2
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
very dicey, subtle and tenuous in nature; the decision thereof is likely
to have a far-reaching effect on the decision-making in similar cases. I
have perused the order proposed by ld. A.M. and have carefully
treaded through it umpteen times with the intention to toe the line of
reasoning undertaken therein to arrive at the conclusion that the AMP
expenses to the extent these are treated as non-routine is an
`international-transaction', in itself, between the assessee and its AE,
requiring TP adjustment by the TPO no matter it was not even referred
to him by the A.O. Despite making fastidious circumspection of the
record vis-a-vis the oral submissions of the parties in the light of
voluminous other records, paper books, etc produced before the
bench, I could not convince myself to fall in line therewith. I could not
convince myself to agree with the proposed answer supplied to
question No. (i) itself due to reasons discussed in my separate
dissenting order which I am proceeding to write. It would be
appropriate to mention that in the confabulations, discussions and
deliberations undertaken amongst us during and after the hearing, I
had agreed to differ when I failed to bring home to other ld. Members
my point of view on the disputed issues.
3
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
2. The main issue, referred to in Q. No. (1) to the Special Bench is
not only convoluted but its impending solution also seems intractable
for which we don't have a beaten path and, therefore, we have to
carve out our own way. I do not agree with the view taken in the given
facts and the circumstances of L.G. Electronics India Private Limited
that the advertisement marketing and sales-promotion, expenses [in
short `AMP', expenses], to the extent these have been christened as
`non-routine' and attributed to brand building / brand promotion /
brand maintenance, with whatever name it is referred to, have to be
`compensated' by assessee's foreign AE and hence, this is an
`international transaction' for which TP adjustment is required to be
done by the TPO/A.O. These expenses, admittedly, were incurred in
India and paid to an Indian tax-payer entity or entities who have
undeniably paid their tax in the Indian jurisdiction. I don't agree with
the proposition that the alleged non-routine expenditure has to be
treated as a `transaction' between the assessee and its foreign AE
fitting in the definition of an `international transaction' given in the
Act, for which T.P. adjustment having regard to Arm's Length price
4
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
(ALP) is required to be made u/s 92 of the Act. In my humble view in
the given facts and circumstances of this case as per the provisions of
the law as applicable to an `international transaction' especially in
relation to A.Y. 2007-08, the so-called `non-routine' expenses
segregated out of the AMP expenses, alleged to have been incurred
towards brand-promotion, cannot tantamount to `an international
transaction', for which T.P. adjustment is necessitated.
3. The first question referred to the Special Bench reads as under :-
"Whether, on the facts and in circumstances of the case, the
Assessing Officer was justified in making transfer pricing
adjustment in relation to advertisement, marketing and sales
promotion expenses incurred by the assessee?"
4. At the very outset, let me make it abundantly clear that we are
not required to decide the appeal of the case of L.G. Electronics India
Private Ltd., the appellant, in which case this Special Bench has been
constituted. This position was made clear by the Bench, in the very
beginning, in the open court, that it was going to answer only the two
5
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
questions referred to it u/s 255(3) of the Act, and is not going to
decide the appeal.
5. Albeit the facts of the case have been extensively narrated by ld.
A.M. yet I will not hesitate in repeating certain very relevant facts for
the sake of coherence, congruence and ready-reference. I would like
to narrate very basal facts which are ad rem to the questions under
adjudication as most of the facts have been narrated in Para 2 of the
proposed order and not required to be repeated. I think it is
quintessential to incorporate all the facts which led the TPO/A.O., to
tax the impugned AMP expenses. These facts are contained in the
`Transfer Pricing Officer's [TPO's] order dated 29.10.2010, passed u/s
92CA(3) of the Act, in its internal pages 29 and 30, and are being
extracted, verbatim, as under:
"4.3 Advertisement, Publicity and Sales Promotion and GCC
Contribution Received:
The assessee has received contribution from its AE, for the
expenditure incurred on sponsorship of cricket events. The
6
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
quantum of contribution received is considered as a part
contribution for the brand promotion carried out by the assessee
on behalf of the AE. The reasonableness of the quantum needs
to be examined.
The following is an analysis of the quantum of contribution to
the made by AE for brand promotion by the assessee.
The basic objective of making comparability analysis is to
determine bright line limit i.e., routine, Advertisement,
Marketing and Promotional expenditure including trade discount
and volume rebate (AMP Expenditure) which a no risk entity
(which is not the owner of brand name or intangible) is expected
to spend, to exploit the items of intangible property to which it
is provided. Indian Transfer Pricing provisions stipulate of
(Supreme Court) determination of arm's length price of each
transaction. Accordingly arm's length price of reimbursement
for expenditure should be determined separately using TNMM.
In order to benchmark the transactions, I had proposed to
compare AMP expenditure of the tested party with AMP
expenditure of other comparables engaged in similar business
using Advertisement, Marketing and Promotional expenditure
(including trade discount and volume rebate) to the sales ratio
for comparability analysis. For the purpose of comparability, I
7
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
had proposed to use the current year's data (March, 2007) of
the comparables.
Sl. Company Name AMP Sales AMP/Sales Remarks
No.
1 Applicomp (India) Relevant data for
Ltd. carrying out Amp
analysis not
available Relevant
data for
2 Penguln Electronics
Ltd.
3 Videocon Appliances 1.63 1339.3 0.12 Accepted
4 Videocon Relevant data for
Communication Ltd. carrying out Amp
analysis.
5 Whirlpool of India 42.46 1591.8 2.66 Accepted
Ltd.
Arthmetic Mean 1.39
Following companies were selected for the purpose of
determining the bright line :
Sl. Company Name AMP/Sales
No.
1 Videocon Appliances 0.12
2 Whirlpool of India Ltd. 2.66
Arithmetic Mean 1.39
The mean of the `expenditure incurred on AMP/sales" of such
comparable companies is the "bright line". Any expenditure in
excess of the bright line is for the promotion of brand/trade
name (which is owned by the AE) that needs to be suitably
compensated by the AE.
8
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
On the basis of above it can be seen that the expenditure on
AMP incurred by LG India exceeds the bright line limit. Such
excess expenditure of should have been compensated by the AE.
I, therefore, proposed (sic. Propose) to make TP adjustment
accordingly.
6. The TPO show-caused the assessee for making above proposed
adjustment. The assessee gave a detailed reply which has been
incorporated by the TPO at pages 30 to 56 of his order. Being not
satisfied, the TPO has given his finding in following words:
"The Assessee promotes the brand `LG' in India. The assessee
was asked to give copies of advertisements and sponsorships and
payment details pertaining to brand ambassadors. The terms
brand ambassador clarifies that the payment by the assessee is
for promotion of brand. The brand `LG' is owned by LG
Electronics Korea (LGE Korea) and not by the assessee and
hence, any expenditure incurred on brand promotion should be
funded by LGE Korea.
It is the Indian company which has promoted the brand name of
LG in India over the last 14 years. It has spent aggressively on
9
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
marketing activities through media, electronic and print. The
advertisements only promote LG bran din India.
It is obvious that any form of advertisement would create brand
awareness apart from creating awareness about the products.
The endeavour is to quantify the value of brand related
advertising cost out of the total advertising cost. The brightline
approach is recognized as an appropriate mechanism to quantify
the excess expenditure of the assessee which would not have
been incurred by an uncontrolled used of the license. Therefore,
an adjustment based on the brightline approach is made.
Following the principles of allocation employed by the Transfer
Pricing Officer in the previous years, the cost of the sponsorship
should be shared by LG Electronics, Korea and assessee based on
the percentage of profit of assessee-company and its parent
company LG, Korea.
12 Months Ending 31-Dec., 2006.
Gross Profit (Million Won) 5,443,316.00
LGEK (in Rs.) 251,680.20
LGEIL (in Rs.) 14,483.80
Percentage of profit 5.75%
The total contribution towards ICC agreements by LG India (40%)
is Rs. 257,314,212. The share of LG India based on the ratio of
10
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
profit is 5.75% comes to Rs. 37,020,071. However, since the
brightline approach has been employed to determine the
quantum of expenditure pertaining to brand promotion out of
the total advertising expenses of the assessee, the contribution
towards the ICC agreement by LGE Korea is a part of the overall
adjustment pertaining to advertising and promotion expenses.
Adjustment
Assessee's AMP / Sales 3.85%
Comparable's AMP/ Sales 1.39%
Difference 2.46%
Sales 65,536,565,000
Adjustment 1,612,199,499.00
7. The TPO has compared the AMP:sales ratio of the assessee with
that of Videocon Appliances and Whirlpool of India by treating only
them as `comparables' and has ignored the Carrier Aircon, Hitachi
Home and Life Solutions, Bajaj Electronics, Blue Star Ltd, Usha
International, Voltas Ltd, Mirc Electronics, Timex and Titan. He has
taken the mean of the two comparables and `treating' it as a
benchmark, has made the impugned TP adjustment of Rs.
1,612,199,499/. Thereafter, draft assessment order was passed u/s
11
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
144C/143(3) on 27.12.2010 and was served on the assessee. The
assessee chose to file objections before the Dispute Resolution panel
[DRP], who issued the necessary directions u/s 144C(5) on 27.9.2011.
As per DRP the approach regarding creation of a marketing intangible
and application of the `brightline test' for its benchmarking is not a
new phenomenon. They have observed that in the countries like USA,
Canada, U.K., Australia, China, France, etc., this aspect is being
considered not only by tax-authorities but also by the tax-courts. They
have further observed that in the case of Maruti Suzuki, the Hon'ble
Delhi High Court has approved this approach. Since the taxpayer has
incurred extra-ordinary expenses for the promotion and development
of LG brand and has helped in creation of a marketing-intangible in
India, they have approved the finding of the TPO that the assessee
must be compensated suitably on that account by its foreign AE. They
have even observed that a good quality product also needs an
active and sustained effort for the promotion of the brand and the
quality alone may not necessarily retain the customers or enhance
the sales [emphasis supplied]. They have further directed to charge
mark-up because no independent person would carry out such
12
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
marketing activity involving promotion of brand name owned by other
party without recovering the opportunity cost. They have directed that
a markup of 13% should be applied on the total amount of
reimbursement [amount shown by the taxpayer in the books and the
excess amount worked out by the TPO; but they have not directed that
opportunity cost [10.50%] should be charged on the expenses for which
the reimbursement was received immediately after the same were
incurred. Thereafter, the A.O. has passed the assessment order dated
31.10.2011 u/s 143 r.w.s 144C of the Act, after considering the
directions of the DRP and upholding the adjustment of Rs.
1,61,21,99,499/- in respect of AMP expenses.
8. Thus, it becomes evident from the ratiocination of TPO in taking
arithmetical mean of ratios of their "Sales to AMP Expenditure"
disclosed by the two Comparable Companies, which comes to 1.39%,
for benchmarking the AMP expenses into routine and non-routine by
using `Bright Line Test'. He has opined that it is the Indian Company
who has promoted the brand name LG in India over the past 14 years.
He has noted that the assessee has spent aggressively on
13
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
advertisement and marketing activities through electronic and print
media. According to the TPO, only these advertisements have
promoted the LG-brand in India. The `brightline' approach employed
to determine the quantum of expenditure pertaining to brand
promotion out of the total advertisement expenses, the contribution
towards ICC agreement by LGE Korea has been treated as a part of
overall adjustment pertaining to advertisement and promotion
expenses. Accordingly, the TPO/AO has made impugned adjustment by
applying differential ratio of AMP: Sales [3.85% - 1.39% = 2.46%] at
2.46% to total sales of Rs. 65,536,565,000/- resulting into total
adjustment of Rs. 1,612,199,499/-. In doing so, the TPO has rejected
the objections of the assessee-company made through its written-
submission filed against the proposed ALP adjustment. The gist of
assessee's objections against TPO's proposed adjustment, which were
again repeated before us by the ld. A.R. Shri Vohra, can be
summarized as under: [Note : LGEIL = LGI & LGEK = LGK]
(i)That the assessee has undertaken an appropriate analysis to
benchmark its international transactions as per chapter X of the Act.
14
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
(ii)That the net-profit margin reached by employing TNMM method,
from international transaction entered into with its AE has been
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.
(iii) That A.O. has no jurisdiction to come to a conclusion that there
is such an international transaction unless it is proved by him that a
international transaction for which TP adjustment is to be done having
regard to ALP, exist between the Assessee and its AE.
(iv) That the bright-line test is not a prescribed method under the
Act.
(v) That the advertisement expenses may not necessarily result in
the increase in sales, so the ratio of AMP-expenditure with its sales
may not be a correct approach.
15
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
(vi) That the comparison would be meaningful only if companies
engaged in trading of similar products under similar market conditions
are used for comparison.
(vii) That there may be a difference in classification of AMP
expenditure in the books of accounts in different business models.
(vii) That, LGEIL is the sole beneficiary of advertising and sales
promotion expenditures. These expenses were incurred wholly and
solely for the purpose of LGEIL's business and accordingly should be
borne entirely by LGEIL. The LGEK is not directly involved in the
business of manufacture/trading of electronic goods in India either of
its own or through any on its other subsidiaries.
(viii) That, the assessee is an independent risk bearing entity and any
cost incurred towards advertising, promotion and publicity would be
for the sole benefit of LGEIL, since it earns profits from the increased
sale of products as result of such marketing activities. That
advertisement, publicity and business promotion are planned and
16
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
carried out by the management of LGEIL based keeping in mind the
market condition.
(ix) That, the assessee is operating in the hyper competitive market,
featured by diversified range of product portfolio, in order to attract
customers, product specific advertising is critical and clearly the
increment to the value of the brand in India as a result of the
advertising is beneficial to LGEIL only since it is the sole company
dealing with LG products in India.
(x) That, payments for these expenses have been made to third
parties in India, who are not in any way related to the parent entity.
(xi) That, increase in the demand for the finished product due to the
excessive advertisement and marketing activities results in the
increase of purchase / import of the raw materials and finished goods.
All decisions relating to the purchase of raw material indigenously or
through import from its AEs etc. lies with the management of LGEIL,
which are taken based on the market conditions prevailing at that time
17
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
and, therefore, any derived demand for finished goods, raw material,
components and spaces as a result of demand for LGEIL's products
cannot be construed to be the benefit derived by LGEK due to
advertising done by LGEIL in India.
(xi) That, any benefit to LGEK is incidental in nature only; although
expenditure has been incurred on advertisement to attract attention
of the customers in the market, full of numerous brands, and
expenditure on advertisement is a ongoing and continuous process.
(xiii) That, no brand royalty was paid by LGEIL and that without
prejudice to all the above contention, the AMP expenses incurred by
LGEIL are within the brightline limits.
9. The undeniable and undisputed facts of this case, which emerge
and which I could cull out from the available record, are as under:
18
M/s L.G. Electronics P. Ltd
ITA No. 5140/Del/2012
(a) The LGI was incorporated in the year 1997 and is a wholly owned
subsidiary of LGK, legally approved as such, by the Government
of India;
(b) As per the "Technical Assistance and Royalty Agreement'
executed between LGK and LGEIL on 01.07.2001, vide which
LGEIL is given a right to use the LG brand-name and trader-
mark is owned by LGK [foreign AE].
(c) The LGK has not demanded any brand-royalty during the period
relevant to A.Y. under consideration, despite there being such a
clause (para second of Article 7) in this agreement.
(d) The A.O. has not, verily, referred alleged transaction to the TPO
to be treated as an `int. transaction' for which ALP adjustment
was contemplated.
(e) The A.O. has referred, according to assessee's audit report, the
transaction regarding `contribution towards Global Cricket
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Sponsorship, for which LGK has contributed towards the
expenditure incurred on the sponsorship of this events, by
treating it as part contribution towards brand-promotion to have
been undertaken on behalf of the foreign AE.
10. Now it becomes evident that, concomitantly, the TPO by taking a
clue from the above part-contribution expenses has inferred that other
AMP expenses may also have been utilized for LG brand. Therefore,
he has compared AMP expenses incurred by the LGEIL and found them
on higher side when seen through the reference of ratio between the
AMP expenses incurred and its sales, by comparing it with Videocon
Appliances Ltd. and Whirlpool of India Ltd. and by taking their
arithmetical means at 1.39% as against 3.85% disclosed by the
assessee. The differential amount has been treated as expenses
incurred towards brand-promotion, which according to the Revenue
`should have been' compensated by LGK, by applying the `bright-line-
test' and the TPO has treated this compensation valued at Rs.
161,21,99,499/- which, according to him required T.P. Adjustment on
account of AMP expenses for brand-building. The DRP has moved a step
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farther and has treated them as extra-ordinary expenses for the
"promotion and development" of LG brand in India.
11. It would be appropriate to mention here that the other
companies/comparables on which assessee had relied, were ignored
and have not been compared as per the convenience of the authority.
Now, the million dollar question arises as to can these AMP expenses,
allegedly incurred towards building / promoting LG Brand in India, be
treated as an `international transaction' on the premise that there
exists a discreet or tacit understanding between the AEs, even if no
iota of proof evidencing it is found or brought on record in black and
white to give an inkling of existence of such an understanding and the
Revenue `discerns' its existence on the basis of `surrounding
circumstances', especially, referring to the general policy of LGK to
fiercely penetrate into viable markets aiming at its major market
share, obviously, through extensive advertisement of its brand.
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12. The evidence sought to be placed for our consideration as
`additional evidence', which was allowed to be produced as such,
were not available before either the A.O. or the TPO, or the DRP, as
the case may be. None of these authorities had the benefit of these
`evidence' to come to their impugned epilogue. Moreover, there is no
provision either in the Act or in the Rules to bring on record of a
Special Bench any `evidence' in the name of `additional evidence'
especially, when the Special Bench is dealing with a specific legal
issue. It is open to the Division Bench who has to decide the appeal to
decide the question of admission of any `additional evidence'. Before
a Special Bench any document can be submitted when that evidence is
treated as helpful in adjudicating any question of law referred to it.
In so far as the issue of admission of additional evidence is concerned,
the Revenue was allowed to produce those evidence / documents to
consider the same not for the purpose of deciding the grounds raised
in the appeal of the assessee but to understand the moot issue before
the Bench in its correct perspective and thereafter, to reach to a
logical conclusion. The correct forum to entertain and admit the
additional evidence is the concerned Bench who would hear and
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decide the grounds raised in the appeal of the assessee. There are no
such provisions in the Act or Rules for admission of additional evidence
by a Special Bench, when it is not going to decide the appeal. The
admission of this so-called `additional evidence' was for a limited
purpose. Any Special Bench which is not going to decide the appeal
and is required to answer specific legal question(s), cannot and should
not admit any additional evidence u/r 29 of I.T.A.T. Rules, 1962.
13. During hearing of the appeal of L.G. India P. Ltd by the Division
Bench and on the request of the parties, it was treated necessary to
refer this issue to Hon'ble President of ITAT to constitute a Special
Bench to decide whether the AMP expenses incurred by a Indian MNE
being a hundred percent subsidiary of its Principal-AE operating in the
foreign jurisdiction can be considered to that extent towards brand-
building (owned by its foreign AE) despite the fact that there is not
even a whit of proof evidencing any written or oral agreement,
understanding or concert of mind between them. The TPO has re-
characterized advertisement expenses despite there being no
supporting tangible-evidence on record; and if it can be `presumed'
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that some tacit understanding is discernible between AEs for brand-
promotion/building, can the AMP expenses apportioned between them
under the provisions contained in the Act, and that too, specifically
relevant for the A.Y. 2007-08. The ld. Authorized representatives even
representing the Interveners, advanced their erudite and well-
informed submissions against the controversial issue, which is very
maiden as no binding or referable decision is available to provide its
straight-jacket answer and that is why it was referred to the special
bench. The issue is so entwined and labyrinth that it has acquired a
status of economic or financial malaise. That is why while hearing the
parties on the `two questions' referred to the Special Bench, on the
other allied issues, nomenclatured as `propositions' the parties were
allowed to make submissions qua them with a view only to understand
and adjudicate the main issues. The representatives from both sides
were allowed to make their respective submissions on wide spectrum
of the issues even at the cost of extending the tentatively fixed days
of hearing.
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14. There can be no two opinions about the fact that the issue(s)
under reference has to be decided with reference to the provisions of
our Indian Tax Law. In our Act, chapter X is the relevant chapter which
prescribes a special provision to check avoidance of tax. In my humble
opinion, once `a transaction' falls under section 92B, only then income
arising therefrom can be computed under Chapter X of the Act.
Thereafter, if required, help can be sought from the globally accepted
OECD, U.N. or USA guidelines. But, before making any reference to
such guidelines, the `international transaction' must satisfy the
conditions of Section 92B of the Act.
15. While analyzing the scheme of the Act pertaining to transfer
pricing, contained in sections 92 to 92F of the Act, it is noticed that
these provisions cover inter-group cross-border transactions w.e.f.
1.4.2001. These provisions prescribe that income arising from
international transactions between associated enterprises [the AEs]
should be computed having regard to the arm's length price [ALP].
The allowance for any expense or interest arising from an international
transaction has also to be determined having regard to ALP. The Act
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defines an `international transactions', `associated enterprises' and
`arm's length price'. The Indian tax-authorities, generally, do not
believe that domestic transactions will erode Indian tax base because
any shifted income is ultimately subjected to tax in India. The
Chapter X talks about and aim at checking `avoidance of tax', which is
not considered in the case of domestic transactions.
16. The relationship of AEs is defined by Sec. 92A to cover
direct/indirect participation in the management, control or capital of
an enterprise by another enterprise. It also covers situations in which
the same person directly/indirectly participates in the management,
control or capital of both the enterprises. Apart from the above, other
specific parameters have been laid down based on which two
enterprises would be deemed as AEs. Furthermore, in certain cases, a
transaction between an enterprise and a third party may be deemed to
be a transaction between AEs if there exists a prior agreement in
relation to such transactions between the third party and an AE or if
the terms of such transaction are determined in substance between
the third party and an AE or if the terms of such transactions are
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determined in substance between the third party and an AE. This rule
aims at countering any move by taxpayers so as to avoid the transfer
pricing regulations by interposing third parties between group entities.
The code is complete in this regard. Once the provisions of the Act
are found applicable to an international transaction, other global rules
or guidelines, be it U.S; OECD or U.N. guidelines, may be looked into
for further clarifications, etc.
17. The Hon'ble Supreme Court of Canada, has reiterated this view
while deciding the case of Her Majesty The Queen vs. Glaxo Smith
kline Inc. indexed as Canada v. Glaxo Smith kline. Inc. Cited as 2012
SCC 52, with docket No. 33874 and judgment dated 18.10.2012 a copy
of which was produced before us during hearing, holding that
`transfer-pricing issue are to be decided by the law of the land and not
with reference to any other law or guidelines. It is a well known fact
that Canada is one of the pioneer promoters of and signatories to the
OEEC and OECD and is also instrumental in the creation of these
Guidelines. For quick reference, we would like to extract the relevant
held portion of the above judgment, which is as under:
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"In the courts below and in this Court, there has been reference
to the 1979 Guidelines and the 1995 Guidelines ("the
Guidelines"). The Guidelines contain commentary and
methodology pertaining to the issue of transfer pricing.
However, the Guidelines are not controlling as if they were a
Canadian statute and the test of any set of transactions or
prices ultimately must be determined according to s. 69(2)
rather than any particular methodology or commentary set out
in the Guidelines."
18. Chapter X of our Act not only defines a `transaction' but also
defines `international transaction'. Thus, we are not required initially
to resort to the internationally accepted `guidelines' or the provisions
of U.S. Tax laws for that purpose. First of all we have to determine if,
there exists any such `transaction' between the AEs. Thereafter, it is
to be seen if it is also an `international transaction'. Only thereafter,
the question of TP adjustment would arise. Hence for `transfer-price
adjustments' it is a pre-condition that there must exist `international
transaction' between the assessee and its foreign AE. [between two
AEs], as per the provisions of the Act.
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19. Let us now analyze the facts of the given case. The assessee-
company (MNE) did not verily reported such an `international
transaction' in respect of AMP expenses as per its voluminous
documents maintained as per the Rules. The A.O. has also not referred
such a question to TPO. The TPO himself has re-characterized the AMP
expenses and has `presumed' that an `international transaction' is
discernible in the alleged non-routine AMP expenses which are
incurred on product-plus-brand-promotion advertisement, even if
these have been paid to an Indian entity, who is admittedly a non-
related third party. According to the TPO, a part of these expenses
have to be treated towards building of the LG Brand exclusively owned
by and belonging to Assessee's foreign AE who has been so benefited,
and to that extent the assessee must be compensated by its AE. The
TPO has arrived at the conclusion that the assessee has incurred non-
routine AMP expenses with reference to and after making comparison
of AMP expenses and sales ratio of Comparables which are to be
treated by him as independent/uncontrolled comparable entities.
However, this fact has been disproved by the assessee by establishing
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that these `entities' are, in fact, not comparable entities. But the core
question to be decided by this Bench is whether, in the given facts and
the circumstances of this case, an abstract international-transaction
can be presumed between the assessee and its AE or not?
20. In my considered opinion no such liberty has been or can be
given to the taxman to treat, his any or every `subjective conclusion',
in the absence of any deeming provision in the Act which may crop up
in his mind purely on the basis of his `presumption'. Such a
presumption cannot be taken as proof of the existence of a
`transaction'. A presumption is after all a presumption which cannot
take a place of a `proof' unless it is consciously so deemed to exist by
the Act in particular circumstances of a case. It is nobody's case that a
`transaction' cannot be an arrangement, understanding or action in
concert, whether formal or informal; whether oral or in writing. True,
it is not even required to be enforceable in law. The legislators have
consciously referred to a situation where even non-enforceable
transactions have been included in the definition of a transaction
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contrast to such a condition. Under the Contract Act, its
enforceability in law is a condition precedent for a contract.
21. Undeniably, no such written agreement has been found to exist
between the AEs. There is no evidence on record to suggest, even
remotely that there is any oral agreement between the parties. The
question of its enforceability in law is irrelevant under this section.
The contention of the Revenue is that AMP expenses, to the extent
these are more than what other similar independent entities
proportionately incur for advertisement of their products under
identical conditions, has resulted into an `transaction'. And that this
presumed transaction between Indian assessee and its foreign AE, has
to be treated as a `international transaction'. As per revenue, there
being a brand-building/brand promotion, even if it is incidental, it has
to be presumed that there exists a unison or concert of mind between
them. According to the revenue, even if this transaction is not
disclosed by the assessee, or even if it is not referred by the A.O. to
TPO, `presumption' of existence of a transaction qua differential AMP
expenses between the assessee and its AE, by way of tacit
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understanding or unison or concert between them, especially when the
assessee is a 100% subsidiary of its foreign AE, becomes visible. Thus,
the existence of a `transaction' between AEs can be gathered from the
conduct of the parties if it is exhibited being so `obvious' that one can
easily `presume' the existence of such a transaction with the help of
attending circumstances of a given case.
22. First of all let us understand as to what exactly a `brand' is all
about and what is the meaning of its building, promotion or
development? Brand is the name, term, design, symbol or any other
feature that identifies one seller's goods or services as distinct from
those of other sellers. The word "Brand" has been derived from the
word `brandr' used in the old Scandinavian language (Norwegian
language) meaning "to burn", burning their mark (or brand) onto their
products. The oldest generic `Brand', which is in continuous use in
India since the Vedic period is known as "Chyawanprash" an herbal
paste consumed for its purported health benefits and is attributed to a
revered Rishi (Seer) named Chayawan. The Italians were among the
first to use `Brand' in the form of watermarks on paper in the year
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1200. The Bars and Company, the British Brevery, claims that their red
triangle brand is the world's first trademark. Factories established
during the Industrial Revolution introduced mass-produced goods and
needed to sell their products to a wider market, to customers
previously familiar only with locally produced goods. The products
needed to convince the market that the public could trust that the
new packaged product is useful, durable and as good as the locally
made one. Around 1900, Fames Walter Thompson published a `house
ad' explaining trade-mark advertising. This was an early commercial
explanation of what we now know as a `brand'. The companies
adopted slogans, mascots, and Jingles that began to appear on radio
and early television. Later, (by 1940s) the manufacturers recognized
the way as to how the consumers get socially, psychologically and
anthropologically related with their "Brands". This journey has
reached a stage when the customers now buy the "Brand" and not
exactly the product. They go by the brand-name. But came 1993, the
brand-names experienced nose-dive, which questioned the power of
"brand-value". What I am trying to suggest is that proper branding
can result in higher sales of not only one product but also other
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products associated with the brand. The brand is the personality that
identifies a product, or service, of a company. Brand experience is a
brand's action perceived by a person and brand-image is a symbolic
construct created within the minds of people consisting of all
informations and expectations associated with a product, service or
the company(ies) providing them. A branding seeks to develop or align
the expectations behind the brand-experience, creating the impression
that a brand associated with a product or service has certain specific
qualities or characteristics that makes it unique. The brand is the most
valuable element in the advertising theme, as it demonstrates what
the brand-owner is able to offer in market place. The art of creating
and maintaining a brand is called `brand-management'. The brand
orientation is developed in "responsiveness" to market intelligence.
The brand represents the sum of all valuable qualities of a product
to the consumers. A brand which is widely known in the market place
acquires brand-recognition what it builds up to a point where brand
enjoys a positive sentiment in the market place. Then it is said to have
achieved a `brand-franchise'. Brand recognition is most successful
when people can state a brand without being explicitly exposed to the
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company's name but rather through visual signifiers such as logos,
slogans and colours. Consumers may look branding as an aspect of
product or service, as it often servers to denote a certain attractive
quality or characteristic, which even commands higher price. From the
perspective of brand owners brand products or services also command
higher prices. People often select the more expensive branded product
on the basis of the `quality' of the brand or `reputation' of the brand-
owner. The brands as stated above are made up of various elements,
such as, the `name', logo, Tagline or Catchprase, graphics, shapes,
colours, sounds, scents, tastes, et al. Thus a brand-trust is the intrinsic
`believability' that any entity evokes.
23. This `brand' is built only and only by the `product-satisfaction'
which a brand-name inspires in the minds of the customers. Once a
brand is built-up, the next step is to `maintain' it. Again, even at this
stage, the maintenance of the `brand' depends on its product-
satisfaction. Thus, in my considered opinion, after a brand is built, any
expenditure is done on the brand-alone, it is going to increase the sale
of assessee's products. The brand-built is not a permanent asset or
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permanent `marketable intangible' as it is subject to a day-to-day test
with reference to its `product satisfaction'. A product satisfaction
depends on the utility of the product, durability of the product and its
after sales-service, amongst others. Therefore, one can safely state
that it is the `product' which defines a brand ultimately but so long as
the product is satisfactory, any and every advertisement of the
"brand" would promote the sales thereof of the products of that brand
and of course, even the brand is also promoted by such advertisement.
Thus, `Brand-promotion' and `product promotion' go hand-in-hand as
they are tagged together', each having its bad or good impact on the
other. Both of them cannot be quietly segregated. A brand depends on
its products and the `product' (product-satisfaction) depends on the
brand as its products are supervised by the brand owner to keep intact
the reputation of its brand. So, whenever, a product is advertised the
brand is also advertised. Undoubtedly, when products are advertised
with its brand (logo, etc.) the product-sales improves, the brand-
image also gets enhanced. The owner of the brand is definitely
benefited. But, in case the sales of the brand products are reduced,
the brand-owner also suffers, as the brand-value is reduced. The other
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important factor which has to be considered is the life of an
advertisement. The life of an advertisement is not very long. What is,
in fact, the object of advertisement is to make the customers aware
about every detail of the product and nature of the after sales-service,
before they exercise their option to purchase that brand-product.
Thus, one can safely conclude, that in the totality of the above facts
and circumstances and the reality of life, the entire expenditure
incurred towards AMP (expenses) has to be treated only as `product-
centric'. No expenditure can be said to have been incurred towards
brand-building. Even in case a brand is incidentally promoted, the
assessee cannot ask for any compensation from its AE, in this regard.
Intangible-assets, including brand, goodwill, intellectual property etc.
contribute to a company's intrinsic value and are `internecine' in
nature. Let us think in a different way, when by advertisement a brand
is demoted/devalued, can its foreign AE ask for any compensation on
the same parity. In my opinion, this is a wrong conclusion and
incorrect presumption. A marketable intangible can serve as an
additional protection of investment.
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24. Let us now examine the issue in hand as to whether the so-called
extra ordinary expenses incurred on AMP, can be or should be treated
as an `international transaction' between the AEs? Before moving
further, I reiterate that only and only if a `transaction' is found to
exist between the Indian Company and its foreign AE, can to be
treated as an `international transaction', and in case its price is found
to be not at arm's length, it can be adjusted to bring it at arm's
length, with reference to and under the Chapter X of the Income Tax
Act, 1961, and not otherwise.
25. The Finance Act, 2001, has substituted the existing section 92 by
new section 92 and 92A to 92F. According to the above provisions,
income arising from an international transaction between associated
enterprises shall be computed having regard to the arm's length price.
The term AE has been defined in S. 92A. Section 92B defines an
`international transaction' between two or more AFs. Section 92C
provides for the methods to determine the ALP in relation to an
international transaction, and the most appropriate method to be
followed out of the specified methods. While the primary
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responsibility of determining and applying an arm's length price is on
the assessee, sub section (3) of Section 92C empowers A.O. to
determine ALP and compute the total income of the assessee, subject
to the conditions provided therein. Section 92 D provides for certain
information and documents, required to be maintained by persons
entering into `international transactions' and section 92E provides for
a report of an accountant to be furnished along with the return of
income. The Board has prescribed Rules 10A to 10E in the Income Tax
Rules, 1962, giving the manner and the circumstances in which
different methods would be applied in determining ALP and the factors
governing the selection of the most appropriate method. The form of
the report of the accountant and the documents and information
required to be maintained by the assessee have also been prescribed.
The aforesaid provisions have been enacted with a view to provide a
statutory frame work which can lead to computation of reasonable,
fair and equitable profits and tax in India so that the profits
chargeable to tax in India do not get diverted elsewhere by altering
the prices charged and paid in intra-group transaction leading to
erosion of our tax reserve. However, this is a new legislation. In the
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initial years, there may be room for different interpretations leading
to uncertainties with regards to determination of ALP of an
international transaction. While it would be necessary to protect our
tax base, there is a need to ensure that tax-payers are not put to
hardship in the implementation of these regulations. That is why the
Board have decided and issued the following instructions:
(i) the A.O. shall not make any adjustment to the ALP
determined by the tax-payer, if such price is upto 5% less or
upto 5% cent more than the Alp determined by A.O. In such
cases the price declared by the taxpayer may be accepted.
(ii) The provisions of Section 92 and 92A to 92 F came into force
w.e.f. 01-04-2002, and are accordingly applicable to the
Assessment year 2002-03 and subsequent years.
26. A `transaction' as per clause (v) of section 92F `includes' an
arrangement, understanding or action in concert; it may be formal or
in writing; or it may or may not be intended to be enforceable by legal
40
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proceedings. This definition of `transaction' supplied by the Act seems
to be guided by the definition of an `agreement' provided under the
Indian Contract Act, 1872 wherein when a offeror [promisor] makes an
offer to other person [offeree/promisee] to do or to abstain from
doing any act, for a consideration and the promise accept that offer an
agreement or a promise is complete. When this agreement/promise is
made enforceable in law, it is called a `contract'. But the law-makers
were conscious of these provisions that is why they have defined
`transaction' especially, by including an arrangement, understand or
action in concert as stated above, and have also excluded the
condition of its enforceability.
27. In the given case, the contention of revenue is that brand-
building by the assessee for its foreign AE by way of incurring
uncomparable AMP expenses, and to the extent they are more than
what other independent entities incur in similar circumstances would
incur for advertising of their products, is nothing but a `transaction',
for which, albeit, there is no mutual agreement or concert or meeting
of minds, but it is an `international transaction'. The very foundation
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on which the revenue has built its castle of `brand-building'
transaction between the assessee and its foreign AE would fall after
the Tribunal has reached to a conclusion that the comparable
companies, which are the touch-stones to conclude that extra-ordinary
AMP expenses have been incurred by the assessee, are not actually its
comparables, and on which the TPO/A.O. has relied are not actually
comparables and that the TPO has restricted the comparable cases
only to two without discussing as to how other cases cited by the
assessee are not comparable [para 19 of the Proposed Order]. In the
proposed order a finding of fact has been reached that the
`comparables' are not really `comparable-companies' with reference
to FAR analysis. When we have struck down the very basis of
`comparison', which gave impetus to the TPO to conclude that there
exists an `international transaction' between the AEs, then how a
finding that the assessee has incurred more AMP expenses as compared
to the `comparables' can survive? The finding regarding the alleged
non-routine expenses would not survive then how it would amount to a
`transaction', much less any `international transaction'. Accordingly,
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there cannot exist any `international transaction' between the AEs and
then where is the question of ALP adjustment.
28. Be that as it may, even otherwise, it is an admitted fact that no
`tangible transaction' exists between the AEs but an `intangible-
transaction' has been inferred by TPO/AO having regard to the so
called "more than routine" AMP-expenses-incurred with reference to
the `conduct' of the parties (the assessee and its foreign AE). What is
that covert `common objective' of the parties"? It is the brand-
building or brand promotion as per the revenue for which the assessee
has incurred huge AMP expenses. Fine, but it is an undeniable fact
that the assessee has not paid any `brand-royalty' in this year. What
even if the assessee is a wholly owned entity of its foreign AE but in
law it has to pay or can pay or can be asked to pay, a `brand-royalty'
for the use of the `brand-name' by its foreign AE. It cannot be denied
that the LG brand is already built internationally and is being used by
the assessee who also incurs AMP expenses. It is a fact that there is
such a provision of demand of `royalty' by the AE subject to certain
conditions, in their agreement, already discussed by the ld. AM, but I
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am on a different angle. Can any entity incur AMP expenses without
having even a single `product' or without offering any such product for
sale, or say refuse to sell any such product. Can in that eventuality any
brand is bolstered? Would any brand then survive? The answer is an
emphatic `no'. The `brand' will have a nose-dive and will be reduced
to a `nil' value. In this case the assessee is incurring AMP expenses
and is making huge sales. The assessee has offered its income for
taxation in our jurisdiction. The AMP expenses have been paid to an
unrelated entity in Indian jurisdiction and that third-party has also
suffered tax in Indian jurisdiction, only. The Chapter X of the Act
prescribes `Special Provisions Relating to Avoidance of Tax". These
transfer pricing provisions aim at checking shifting of income by
inflating or deflating `price' of a transaction, and section 92 prescribes
the tools and techniques to `transfer' that price to Indian jurisdiction
having regard to arm's length price. The ALP is arrived at by various
methods prescribed under the Rules. According to me, the `brightline'
approach is not applicable in such like cases.
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29. The issue of arm's length price of AMP expenses, incurred by an
enterprise in India, by way of exploiting the trademarks/brand name
or logo owned by the overseas AE has been frequently cropping up
while making T.P. assessments. In such cases, the contention of the
revenue, invariably, is that AMP expenses results in creation of a
marketing intangibles owned by the foreign AE, who in turn, should
compensate the Indian entity for such advertisement and brand
promotions expenses to that extent. The TPO by applying the
Developer-Assister Rule adopting from T.P. Regulation of USA and the
`Brightline Test' laid down by the U.S. Tax Court holding that the AMP
expenditure on advertisement and brand-promotion expenses which is
found excess average of AMP expenses incurred by comparable
companies of the AE is required to be reimbursed by the overseas AE.
As I have already touched the issue, the guidelines, be it that of OECD
or that U.N., they come into play, only if India has no reservations
towards them, and that too, only after a transaction is brought under
Chapter X of the Act. So, to rely on these guideline when the
`transaction' has not been brought under Chapter X is of no moment,
and does not subserve any fruitful purpose. Likewise, how the
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assessee can be supposed to seek compensation for AMP expenditure
which is not consistent with the character of business of the assessee.
It may be easy to say that the parent company cannot completely
disassociate itself from AMP expenses either in the manner of planning
strategy and budgeting of such expenditure and it may also enjoy the
benefits arising therefrom, but it is very difficult to translate this
philosophy into action to the hilt, to establish that verily some
`marketable intangible' has taken birth and at the cost of the assessee
it has flourished although it is owned by its foreign AE. I am not in
agreement with the assertion of the Revenue that there is no concept
of `commercial ownership' of a brand which is legally owned by
someone else. A commercial ownership is a reality in the modern
global business realm and it is as good as a legal ownership in so far as
its effects on sale of products in India is concerned. The brand name
and its products have a very piquant relationship; when a `brand' has a
high name, its products have higher sales, and if brand earns a bad
name, the sale of its products would be adversely effected. A bad-
name comes to a `brand', only because of its products when they don't
satisfy customers. So, the brand may be directly and even `inversely'
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proportional to sale of its products; but converse is not true. In case,
the product of a brand has a higher name, its brand will be
emboldened but if the products have bad name the name of that
brand in the `foreign countries' may not be affected. Therefore, any
advertisement which is product-centric, and for that matter of even
entirely brand-centric, it will only enhance the sales of the products
of that brand in India. In no way, the brand owner will be benefited.
It is more the reason in case of a wholly owned entity because any
benefit derived by the foreign company will directly and
proportionately benefit the Indian company. Therefore, this is not a
case of brand-building/promotion. Hence, no such `covert
transaction' between the Indian entity and its foreign AE, can be been
culled out and presumed or inferred by the TPO/AO in the given facts
and the circumstances of this case. Thus, the department has not not
been able to discharge its burden which is cast upon it by the precincts
of the provisions contained in Chapter X of the Act. The assessee has
only incurred expenditure towards advertisement to sell its products.
No proof regarding rendering of any service towards brand-building, is
brought on record by the Revenue. Therefore, only presumption or
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assumption at all stages cannot be and should not be approved to
replace an `evidence'.
30. It is the assessee who is the master of its affairs. It has to
ascertain as to what is the level of advertisement expenditure which is
required in its commercial exigencies. The commercial realities of the
transaction, costs incurred by the assessee cannot be los sight of, by
the Revenue. The Revenue has no power to re-characterize as routine
and non-routine expenditure out of total AMP expenditure incurred by
any assessee. Therefore, it not only illegal but also absurd to
mechanically and arithmetically assume that such and such cost has
been incurred by way of service towards brand-building, because we
have found as that comparable, entity are not actually comparable
and rejected the comparable in the proposed order.
31. Once a transaction is to be checked whether it is at arms' length
or not then such comparables are brought into service. It looks some
what strange that for `arriving at a conclusion' that there is an `int.
transaction' between AEs, first the comparables are tested. This seems
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to be not as correct approach. The Act prescribes a diagonically
opposite procedure. First a price of an international transaction is
compared and then a suitable adjustment is made. During the year
under consideration, there is no such law, whereunder, the existence
of an international transaction can be inferred, deduced or deemed.
Therefore, in my considered opinion, the very approach of the
concerned authority[ies] is incorrect, illegal and unjustified.
32. A query was thrown by the Bench to both parties to seek a
suggestion as to what is the impact of the judgement of Hon'ble Delhi
High Court in the case of Maruti Suziki India Ltd Vs. Addl. CIT / TPO
[2010] 328 ITR 210 [Del], especially after the decision of the Hon'ble
Apex Court rendered in that very case, reported in [2011] 335 ITR 121
[SC]. In fact, revenue has not relied on this decision of the Hon'ble
Jurisdictional High Court, and rightly so. Had it been the case that the
main issue [raised vide question No. 1] is covered by the decision of
the Hon'ble Jurisdictional High Court, it being a binding decision, how
can a Special Bench be constituted in that very issue. When a Special
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Bench is constituted it is so done only when there are either
contradictory decisions of different Benches of ITAT or some legal
issue has a wider effect but that particular upto the level of the
Tribunal. No Special Bench can be constituted, in my humble opinion,
to supply interpretation of any judgment of a superior forum. If it is
so done, it would amount to cocking a snook on the prudence and
wisdom of Hon'ble judges of that High Court terminating into dire
consequences. Therefore, we can hold that the issue stands before us
is covered, therefore, there is no need to decide the very same issue
by a Special Bench. We cannot hold that the issue before Special
Bench stands covered by Maruti Suzuki's judgments, and at the same
time we go one taking our own decision, only referring to the binding
judgment. More so when a issue is covered under the judgment of
Hon'ble Jurisdictional High Court and still we go on deciding that issue
independently it will be against all canons of law. Thus, I am moving
with a notion that whatever has been observed by the Hon'ble Delhi
High Court does not survive after the decision of the Hon'ble Apex
Court. The Divisional Bench comprised of Shri G.D. Agarwal [Hon'ble
Vice President] and Shri I.C. Sudhir, Hon'ble J.M., have passed order,
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dated 9.7.2012, in ITA No. 5140/Del/2011, in the matter of L.G.
Electronics Pvt. Ltd Vs. ACIT for A.Y. 2007-08, for the constitution of a
Special Bench on two questions, u/s 255(3) of the Act, to Hon'ble
President of the ITAT. The judgment in the case of Maruti Suzuki Ltd
[supra] of Hon'ble Delhi High Court is dated 01.7.2010; and that of the
Hon'ble Apex Court is dated 1.10.2010, and both the above judgments
were available on 9.7.201, when reference us/ 255(3) was made by the
Division Bench order passed u/s 255(3) of the Act. Advanced either
from Revenue's side or from assessee's side. Be that as it may,
whatever has been observed by Hon'ble High Court has been set at
naught by the Hon'ble Apex Court when it has held in 335 ITR 121 [SC]
as under:
"On going through the impugned judgment of the High Court
dated July 1, 2010, we find that he High Court has not merely
set aside the original show-cause notice but it had made certain
observations on the merits of the case and has given directions
to the Transfer Pricing Officer, which virtually conclude the
matter. In the circumstances, on that limited issue, we hereby
direct the Transfer Pricing Officer, who, in the meantime, has
already issued a show-cause notice on September 16,2010 to
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proceed with the matter uninfluenced by the observations/
directions given by the High Court"
33. Thus, by barely going through the above judgment, whatever I
have stated above becomes evident. It would be not apposite to rely
on those very observations and direction by this Bench as the Hon'ble
Apex Court's judgment is staring at us. It ill-beholves an inferior
judicial forum in a judicial hierarchy to show jural arrogance in
challenging the wisdom of the Highest court of the country, by giving
twists and turns to their judgment. Moreover, the facts of Maruti
Suzuki's case are on different footing and are distinguishable.
Therefore, we cannot reply on the decision of Maruti, in view of my
above discussion.
34. The concern of the law relating to TP is only with the `price' of a
`transaction', and it is not otherwise. The `transaction' precedes a
`price' which cannot be used to `construct' a `transaction'. Some price
is assigned to transaction and if this price is not found to be within
arm's length, only then T.P. adjustment can be made.
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35. In my considered opinion, the issue of `jurisdiction' is not
referred to us. In any case, in view of my above finding, this issue
would not arise for adjudication. This issue can be raised before and
can be considered by the regular Division bench when the appeal of
the assessee is fixed before that for hearing and decision of grounds
raised, therein.
36. Thus, in my firm view, the situs of this `intangible-asset', is in
India, even if its legal ownership vests in the parent company in Korea.
The sale or transfer of `brand' can be considered under Indian law at
that juncture, in view of the amended provisions of the law which are
incorporated as a sequel to Vodafone's decision by the Hon'ble Apex
Court. I am in agreement with ld. Counsel Vohra's submissions that
the expatriates may have come to India as employee of the foreign
entity, but they have to work under the supervision and control of the
Indian entity. Likewise, economic-ownership is a reality and it resides
with the entity bearing the economic burden of creation of a
marketing intangible and, therefore, that entity is entitled to the
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economic returns of economic exploitation of that marketing
intangible. Whatever value of the marketing intangible is created, it is
created in India and to that extent Indian entity is the economic owner
of that `marketing intangible'. Thus, the AMP expenditure, in the
given facts and circumstances of the case, cannot be treated as
`service rendered' to its AE. The economic ownership and service
cannot co-exist. Therefore, with the foregoing reasoning,
cumulatively, I am of the considered opinion that the idea of
`compensation' to that extent by the foreign AE to assessee is a
`myth' and illogical. After all, the primary beneficiary of the AMP
activities is the Indian company but in case its foreign AE derives or
may derive some or any benefit, that is only and purely incidental
being an unavoidable byproduct of advertisement activities undertaken
aggressively by the Indian Company. Even as per OECD guidelines on
intra-group service no compensation is required to be paid in such
cases of incidental benefits. The transfer pricing of intra-group
services is a high risk area for the Indian transfer pricing
administration. Accordingly, I answer the first question referred to us
in favour of the assessee and against the revenue. Having decided the
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first question, as above, the second question becomes, simply of
academic interest and would not require any answers.
37. In my humble opinion, when we are not required to decide the
appeal, we cannot restore any issue for that matter, to the file of the
TPO for de novo adjudication. We have only to answer the two
questions referred to us u/s 255(3) of the Act. The main appeal has to
be decided by the Division Bench. In the given facts and circumstances
of the case, an apt argument was advanced from the side of the
assessee's that to make any such T.P. adjustment, even in a case an
`international transaction' is found to exist which was not disclosed
and not referred to by the A.O.; the TPO cannot assume a valid
jurisdiction u/s 92CA falling back from the retrospective amendment
made in this section, because a subsequent amendment cannot vest a
jurisdiction in nay authority which it did not possess at that relevant
point of time. The reasons for the above contention are given as that
a law effecting substantial justice will not and cannot have a
retrospective effect, and that any defect in the jurisdiction cannot be
cured by any subsequent amendment in the law. Support was drawn
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from various judicial pronouncements. On the other hand, the
argument that the Tribunal has to follow the provisions of the Act and
it has got no authority to touch its validity was put forth from the
revenue's side. Although the Bench allowed the parties to advance
arguments on this allied legal issue, yet in my humble opinion, we are
not required to decide it because no such question has been referred
to this Special Bench and this issue is to be and cannot be decided by
the Division Bench, who will decide the `appeal' of the L.G. India, in
case such a ground is raised therein. The answer to this legal issue is
not at all necessary to answer questions before us. This issue is a case
specific.
38. The Benchmarking of AMP expenses has to be done, if it is
required, within the precincts of Chapter X only. It has been
consistent view of the courts in India, including that of the Hon'ble
Apex Court that in cases where the assessee derives direct advantage
of benefit from AMP expenses incurred by it on advertisement and
promotion, no adverse inference is to be drawn even if some indirect
or even direct benefit reaches to its foreign AE, i.e. the parent
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company owning that trademark/brand/logo, etc. The Hon'ble Delhi
Court in the case of Sony India [P] Ltd Vs. Dy. CIT reported in 114 ITD
448 [Delhi] has held as under:
"there was no illegality or arbitration in the order of the
Assessing Officer in making a reference to the TPO or in
adopting the computation of `ALP' determined by the TPO."
The Hon'ble Supreme Court in the case of Sassoon J. Davit & Co. Pvt.
Ltd. Vs. CIT 118 ITR 261 [SC] has held as under:
"The expression `wholly and exclusively' used in section
10(2)(xv) of the Income-tax Act, 1922 does not mean
`necessarily'. Ordinarily, it is for the assessee to decide
whether any expenditure should be incurred in the course of his
or its business. Such expenditure may be incurred voluntarily
and without any necessity and if it is incurred for promoting the
business and to earn profits, the assessee can claim deduction
u/s 10(2)(xv) of the Act even though there was no compelling
necessity to incur such expenditure . The fact that somebody
other than the assessee is also benefitted by the expenditure
should not come in the way of an expenditure being allowed by
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way of deduction u/s 10(2)(xv) of the Act if its satisfies
otherwise the tests laid down by law."
39. When AMP expenses are incurred by a domestic enterprise in the
business transaction by the assessee in India and these expenses inures
to the domestic enterprise in the form of higher sales and resultant
higher profits, but also incidentally benefits its overseas AE, can it be
justified to treat this as a marketing service performed for or on
behalf of foreign AE, to bolster the foreign brand. In U.S T.P
Regulations, as contained in section 482 of the Internal revenue Code
[1.482-4] specifically provides for methods to determine taxable
income in connection with the transfer of `intangible property'
providing for the Developer Assister Rules, dealing with the economic
relationship of the relevant parties for the purpose of evaluating the
development of intangibles and assigned profits.
40. During and after the hearing in deliberations amongst us, a naive
idea surfaced that while taxing an Indian MNC which is 100% subsidiary
of its foreign AE it should be presumed that its every action aims at
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shifting its `income' as far as possible, and even if it is not possible, its
Principal entity residing in a foreign jurisdiction would like to benefit
itself anyhow or somehow. It was suggested that while dealing with
such cases, this possible angle must always be kept in mind. When this
idea was investigated into, hibernated and analyzed by me it was
found with certitude that this is simply an unrealistic phenomenon
which is in contrast not only to the economic policy of our country but
also against the provisions of the Company Law. Why, because any
and every MNC is to be incorporated in India under the Company Law
of our country. The law permits registration and pursuing its business
independently to even an entity which is 100% subsidiary of a foreign
entity. The law-makers in their wisdom, aiming at generation of
taxable income, establishment of infra-structure facilities, provision
of best quality goods and services to its people at a competitive price,
and for generation of more employment, inter-alia, have permitted
such MNEs to operate from Indian soil. Indian Income Tax Act takes
care of all such situations which are created through deliberate
transactions to decrease the incidence of tax in India by transferring
the same to a foreign jurisdiction. In this regard chapter X of the Act
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has been enacted which comprehends all possible situations and
provides all sorts of tools and techniques to check avoidance of tax
payment in India. But one cannot and should not be carried away by
any such subjective idea which does not fit in the parameters of this
Act. In case we try and approve this `idea' the very basis of
incorporation of such entities under the Companies Act will be
negatived. Our Act is capable of dealing with any possible situation
where income of an `international transaction' is involved. Let us
assume for a moment that entire AMP expenditure has been incurred
towards advertisement for promoting `LG Brand' alone, and since all
these expenses have been paid in India to unrelated Indian-entities,
who have also paid tax on their receipt in India, still in that case, in
any opinion, this payment in question cannot be treated as an
`international transaction' between the MNE and its AE. This is a
transaction simplicitor between MNE and the payee in India,
particularly when payment is made to an `Indian Entity' which is
undeniably taxable in India, and is not related to the foreign AE. How
can it be said then that the payment of tax has been avoided and its
price has been transferred to the foreign parent entity because its
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brand has been promoted. A `Payment' made to an Indian entity
towards [100 per cent] brand-building of a `foreign-brand' by an Indian
Company who manufacturers/trades in products of that Brand cannot
be treated on presumption basis, as an international transaction,
between the AEs. Such a conclusion is likely to defeat the very basic
purpose of Chapter X of the Act and would result in its negation and
would amount to enlarging the scope of the Act, by adding a new
unwritten provision or by reading a provision in the way it is not so
written and enacted. We, as a judicial body, cannot approve
`subjective ideas' of any authority based on pure presumptions and
assumptions. The `objective' of an enactment can never be lost-sight-
of, and we are required to satisfy its intent. The `subjectivity' of a
quasi judicial or even a judicial authority has got no place in the tax-
jurisprudence when it comes to adjudication of a tax-dispute.
41. Let us now examine as to what exactly is the `objectivity' of
Chapter X which deals with the Transfer Pricing aspect of an
international transaction. I have made a very detailed and in depth
analysis of the subject while deciding the case of Iljin Automative Pvt.
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Ltd Vs. ACIT order dated 30th November, 2011 in SP No. 67/Mds/2011
and ITA No. 2182/Mds/2010 for A.Y. 2006-07, the relevant portion of
which is held as under:
"10. The principle of Transfer Pricing is stated in Article 9 of the
OECD or the UN Model Double Taxation Convention. It, however, does
not specify the methodology, which is done under the domestic laws.
The Indian law on the subject is contained in sections 92 to 92F. The
concept of Transfer Pricing is applied in the computation of income
from international transaction between the AEs having regard to ALP.
Thus, the important aspects of the subject are
i) Arm's Length Price (ALP)
ii) International transactions (I.Ts)
iii) Associated Enterprises (AEs)
11. An `international transaction' is a transaction between two or more
AEs, either or both of whom are non-residents, in the nature of
purchase, sale or lease of tangible or intangible property; or provision
of services; or lending or borrowing money; and any other transaction
having a bearing on the profits, income, losses or assets of such
enterprises. A transaction is the transfer of goods or services, involving
a physical product or knowledge or a right to use or exploit an
intangible asset. The definition of the word `transaction' is an inclusive
one. It includes an arrangement, understanding or action in concert,
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irrespective whether it is formal or in writing; or whether or not it is
intended to be enforceable by legal proceedings.
12. `Transfer Price' may mean manipulation of prices in relation to
international transactions between the parties which are controlled by
the same interest, involving two or more countries with differing tax
rates and legislation a realizing profits in the country with the most
favourable tax regime so that total tax liability is reduced.
13. Such manipulations are difficult to be established because of the
problems of off-shore investigations. For that matter, States have,
through Legislation, resorted to a hypothesis of ALP i.e what would
have been the price if the transactions were between two unrelated
parties similarly placed as the related parties. As regards nature of
product and conditions and terms of the transactions. Methodology for
the purpose of comparability has been formulated, under the respective
domestic laws of the countries. The hypothesis presumes that the tax
payer's income is incorrectly reported on the ALP standard and permits
the Revenue authorities to make a determination of true taxable
income. This is apart from incorrect reporting because of fraudulent,
colourable or sham transactions. The general theory of transfer pricing
is that the Legislation is to treat each of the individual price of
commonly controlled group as a separate entity, transactions between
which are taxable events to be formed to the economic realities that
would obtain between independent entities conducting identical
transactions at Arm's Length. To transfer a tangible property, CUP
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method, or resale price method or cost plus method are applied. If
none of them is applicable, the fourth method known as `appropriate
method' i.e., comparable profit method or profit split method or
unspecified method is applied. It is to be seen if the amount charged is
arm's length by reference to gross profit margin in comparable
transaction. The comparability depends on similarity of the product
under CUP method.
14. Before deciding the impugned issue let us try to understand the
need, the necessity and methodology utilized in international taxation.
In the year 1991, the Indian economy started opening up. Foreign
investment pouring in as a result of economic reform measures was
taken by the Government. Industrial licensing policy was considerably
liberalized; tax structure simplified and made internationally compatible.
In order to have smooth flow of investment and trade, India has made
its economic climate conducive to investment and for that purpose, it
has entered into agreements with almost all the capital and technology
exporting countries with a view to avoid double taxation of income
arising in India by virtue of the business connection. Double taxation
agreements are established the way for the States to agree at
International Level for resolution of the problems arising from the
cross-border trading and investments. The Tax Treaty facilitates
investments and trade flow by preventing discrimination between
taxpayers, adds fiscal certainty to cross-border operation, prevents
evasion and avoidance of tax at international level. Apart from
facilitating collection of taxes and attainment of national development
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goal, the treaty warrants the stability of tax burden, so that its
provisions may not be abused by Multi-national Enterprises (MNEs) by
fixing prices, terms and conditions of transactions between their
controlled enterprises located in different jurisdictions. The treaty
requires that such transactions be dealt with as if they are between
unrelated parties and even account be re-written if required, so that
real profit would be taxed, which is sought to be manipulated. The
relevant provisions of the Act are patterned on the OECD
Guidelines1995. These provisions are erosion of Indian tax base by
multi-nationals through a mechanism of what is known as "transfer
pricing" . In a modern democratic set up, the Governments Local,
State or Central are modified version of `service corporations' of
which all the people in the community are the members and the
principle object of the Government is to serve the people, so that we
can achieve the goal of establishing egalitarian society as envisaged in
the Constitution of India. In India, there is no crown and there is no
subject. `We, the people of India', are the real sovereign and it is the
people, who decide to tax the community for the benefit and welfare of
the society. The Government collects most of the money it needs from
its citizens and the companies by taxing their income according to their
capacity to pay, to spend on behalf of the citizen in maintaining law and
order, defending from outside attack and providing education, health
care, social security etc. So taxation is a means of apportioning the
cost of Government amongst those, who benefits from it. Non-
payment of tax by any person when it is due increases the burden of
those who pay. That is why Government takes measures to curb
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evasion of tax resorting to penalty and prosecution. No Government
can afford multinational companies to dictate transactions amongst
their affiliates and avoid payments of tax in the `State' where it is due,
causing substantial loss of much needed public revenue in a welfare
state. There are two ways of preventing this: (1) -Global Formulary
Apportionment and (2) -Arm's Length Principle for transfer pricing
adjustment. Where tax rates are different between countries, there is a
strong incentive to shift income to a lower tax and deductions to a
higher tax country, so that the overall tax effect is minimized. There
are two different approaches to deal with shifting of the profits from
one jurisdiction to another; either to ignore the independent status of
the corporations within the group and consequently also the
transactions between them or to treat them independent and make
adjustments to their income. The former is know as the Global
Formulary Apportionment method and the latter is know as transfer
pricing adjustment approach. In first, corporate group is taxed as a
whole and the global profits allocated amongst the associated
enterprises in different countries on the basis of pre-determined
formula. In the other, associated enterprises are taxed as separate
entities. The latter is mostly adopted, because corporate laws recognize
independent status. To illustrate this, suppose an American
manufacturing company `A' sells goods to its associated enterprises in a
low tax rate country `B' for say $ 100 that enterprise sells it to an
unrelated entity in India for $400. Global Formulary Method approach
is the transaction between A & B is ignored and the sale between B
and the Indian company is treated as if A made it direct and the entire
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sale proceeds of $400 belongs to A and not just $100. In other words,
the income of associated enterprise B ( $ 300) is attributed to the
American company. The Arm's Length transaction adjustment requires
that sales price up and consequently, the profit of B increased by $300.
In both the case, the conclusion is the same,
however, the route is different. Under the transfer pricing approach
relationship between the corporations and transactions between them
are recognized while under consolidation approach they are ignored.
The consolidation approach has many advantages. It prevents transfer
pricing by the residents; does away with treaty shopping, which
involves re-characterization as well as diversion of income; eliminates
the vice of thin capitalization.
15. The League of Nations to international associations of countries
created to maintain peace among the nations of the world in the year
1920 and had its headquarters in Geneva, Switzerland. But this
association ceased to function after the Second World war and was
finally dissolved in April, 1946, and its place was taken by the United
Nations. The League played a pioneering role in developing Model Tax
Treaties during the period between 1930s and 1940s, its work being
taken over in 1960s by the Organization for European Economic Co-
operation (in short OEEC). This OEEC subsequently was substituted by
the Organizations for Economic Co-operation and Development (OECD).
The OECD is a multilateral organization comprised of mostly Western
European countries, the United States, Canada, Japan, Australia and
New Zealand. Its headquarters are in Paris (France) and it was
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founded in the year 1961 by replacing OEEC. It was established in the
year 1948 in connection with the Marshall Plan, and it provides a forum
for representatives of industrialized countries to discuss and attempt to
co-ordinate economic and social policies. Its primary objectives are: (i)
to maintain and stimulate economic growth and (ii) to increase co-
operation and promote economic development within and outside of
the territories of the Member countries and assist development and
growth of world trade. The OECC and OECD played an important and
pioneering role in the development of model tax treaties during 1960s
to the present day. The OECD's work on taxation is managed by Tax
Center for Tax Policy and Administration.
16. Separate taxation and not the consolidation approach is generally
favoured because under the Arm's Length standard, each nation's tax
system operates under its own domestic tax rules subject to relatively
minor qualifications of arm's length prices in certain international
transactions. It facilitates sharing of revenue between two States,
unlike under the Consolidation Approach. The Consolidation Approach
is based on a `formulatory apportionment system', which has its own
difficulty of operations. The reasons for the above are that one - it
relates to defining `relationship' among corporations as to bring their
profits within the formulae, two - to the formulae to be used in the
allocation of profits among the jurisdictions and three - to defining
world wide tax base used in identifying group of profits. These
difficulties are not addressed to in tax treaties. Most of them favoured
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separate taxation of associated enterprises and the transfer pricing
approach. The OECD Transfer Pricing Guidelines are as follows:
1) There are several reasons OECD Member countries and other countries
have opted Arm's Length Principle. The major reason for the same is
that the Arm's Length principle provides broad parity of tax treatment
for MNEs and independent enterprises. Because the Arm's Length
Principle puts associated and independent enterprises on a very equal
footing for tax purposes and avoids the creation of tax advantageous
or dis-advantageous that would otherwise distort the relative
competition purposes.
2) The Arm's Length Principle has also been found to work effectively in
the vast majority of the cases like there are many cases which involve
the purchase and sale of commodities and the lending of money,
where Arm's Length price may readily be found in the comparable
transaction undertaken by the comparable enterprises under
comparable circumstances. One of the major flaws in the system is
that the Arm's Length Principle dis-regard integral and functional unity
of a MNE, which is responsible for greater efficiencies and
advantageous competition edge. The function of all its subsidiaries
located in various tax jurisdictions cannot be analyzed in isolation of
each other; and dealings and transactions within MNEs are treated at
par with the dealings and transactions between unrelated parties at
Arm's Length Principle. Transfer Pricing Guidelines as contained in the
OECD guidelines are largely followed by various countries, but their
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implementation by the tax authorities differ. The focus of tax
authorities is on increasing national tax base. In an attempt to achieve
that objective they lose the international perspective. The same issues
are treated in different ways in different jurisdictions, for example,
such as allocation of capital risk, entrepreneur function, local market
penetration risks and rewards. There are practical difficulties in
applying Arm's Length Principle. The concept of separate taxation is
not only confined to the recognition of a corporation as an entity
independent of the parent, but also extended to treating a branch of
the parent as separate and independent. The Arm's Length Principle is
applied both in the context of transfer pricing and attribution of profits
to the Permanent Establishment (PE). Commercial transactions
between different parts of the multinational groups may not be subject
to the same market forces shaping relations between two independent
firms. Open market considerations need not necessarily govern
transactions between two enterprises under the same or common
control. The prices paid for transaction between members of a
multinational enterprise may be fixed in order to meet the convenience
of the multinational enterprise or a group as a whole and done in a
variety of ways. Such fixing would not have been possible. if the
parties to the transaction were independent acting at arm's length. A
transfer price is defined as a price paid for goods transferred from one
economic unit to another, assuming that two units involved are
situated in different countries, but belong to the same multinational
firm. Transfer price is the price charged in a transaction, which means
an actual price charged between the associated enterprises in an
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international transaction. Transfer pricing is widely used in
multinational organization, which typically involve a parent company
domiciled in one country and a number of subsidiary companies
operating in other countries. When multinational firms conduct
business within their group, the concept of market pricing or arm's
length pricing has no relevance. Income or deduction is arbitrarily
shifted. Supposing A purchases goods worth Rs.100 and sells them to
its associated Company B in another country for Rs.200/-, who in turn
sells in the open market for Rs.400/-. If A would have sold it directly,
itwould have made a profit of Rs.300/- which has been restricted to
Rs.100/- by something it through B. The transaction between A & B is
arranged and is not subject to market forces. The profit of Rs.200/-
has been, thus, shifted to Country of B. The goods have been
transferred on a price (transfer-price) which is arbitrary or dictated
being Rs.200/- and not being Rs.400/- which is its market price.
Transfer between enterprises under the same control and
management, of goods, commodities, merchandise, raw-material,
stock or services is made on a price, which is not dictated by the
market but controlled by such considerations. Transfer of goods or
services as aforesaid is as dictated by the market but it is controlled by
the consideration of shifting taxable profits or duties or of arranging
the direction of cash flow. The developing countries lay heavy
restrictions in regard to remittance of profits, but in their engineers to
secure access to foreign technology, expertise technical know-how,
capital goods and components for their industrial development. The
MNCs have changed their investment and technical collaborations,
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policies and the developing countries unpredictability about political
and economic stability of a country may necessitate flight of capital
and profit there from. This flight is achieved through the device of
transfer pricing.
17. The reason for fixing a price, which is not an Arm's Length price,
whatever be the motive, is the avoidance of the profit from a country
where it would have accrued, had the transactions been at Arm's
Length. The avoidance or evasion of tax cannot be the purpose or
there could be honest difference of opinion about what should be the
Arm's Length price, the tax authorities are aware that tax is avoided.
Therefore, the question of the tax treatment of the transfer pricing is
always considered in association with avoidance or evasion of tax. The
net effect of transfer pricing abused is that profits properly attributable
to one jurisdiction are shifted to another jurisdiction. In controlled
transaction if it is not found at arms length shifting of profit and
consequently avoidance of tax is heavily presumed even if it is done
inadvertently or with purpose. The arms length principle cannot be
applied, if income could not be legally received. MNE group to
companies seek to achieve the best tax results not only by
manipulating export and import prices, but also by manipulating
category of income. World over, different categories of income are
dealt with differently and so also the treaties on tax are structured.
Income is separate into separate categories and each category has its
own role for computation as well as tax rate. Business income is taxed
at the normal rates in a given country on a net basis whereas royalty,
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interest and dividend are taxed at reduced rates on gross basis.
Therefore, a non-resident tax payer being permanent organization of
the subsidiary company incorporated in the source country would be
encouraged to categorize business income as royalty or technical fee.
Because the parent organization and its subsidiary company are treated
as independent entities for tax purposes and treaty purposes, the
characterisation of income changes the same result as for unrelated tax
payers, for example, the non-resident conferring patent right on a
resident may transfer a patent in exchange of shares (producing
dividend income) or can leave purchase particulars outstanding as a
loan ( producing interest income) or may license patent in exchange for
royalties. Thus, the tax manipulation among the related corporations
not only involves the use of arbitrary prices, but also conversion of
returns on equity, investment to royalty and interest. Transfer pricing
may mean manipulation of prices in relation to international transaction
between the parties, which are controlled by the same interest,
involving two or more countries with different countries having different
tax rates and realising profits in the country, which has the payable tax
regime resulting into reduction of payable tax liability. Such
manipulations are difficult to be caught and established because the
taxman is handicapped to make off-shore investigations. With a view
to deal such a situation, so that a legitimate tax to which a State is
entitled to, a combined effort has been made through legislation.
According to which on hypothetical manner such evasion of tax can be
controlled, a term known as an `arm's length' has been coined. What
would have been the price if the transactions were between two
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unrelated parties, similarly placed as the related parties in so far as
nature of product, conditions and terms and conditions of the
transactions are concerned? For that purpose methodology and
modalities to compare the results under perspective domestic laws of a
given country have been formulated. According to this hypothesis, it is
presumed that tax payer's income has been incorrectly reported on the
arms length standard which permits the revenue authorities to
determine a correct taxable income. This methodology is different from
incorrect reporting by way of fraudulent, colorful or sham transactions.
The basic thesis is that transfer pricing legislation is to treat each of
the individual members of a commonly controlled group as a separate
entity, the transactions between whom are taxable events to be
conformed to the economic realities obtaining between independent
entities entering into similar and identical transactions, at arm's length.
Thus, a transfer pricing is a device to control avoidance of tax in a
jurisdiction where it is otherwise due. The right to do business in a
most beneficial manner given to a businessman is thus abused causing
loss to ex-chequer of a country where the profit is drawn and it is
shifted to another country. The law does not permit or sanction abuse
of such a right. This abuse can be curbed in the following ways:
(1) By establishing an arms length transfer price which requires
enquiry/investigation as to what unrelated parties, which are
not under common control, would do in similar
circumstances. So it is an attempt to establish the prices that
would prevail in the market place; or apportioning of over all
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profit of the enterprises those establishing a fair or proper
division of global profits.
(2) By non-deducting of intra firm payment, unless such
payments are consistent with normal commercial practices.
Therefore, with a view to provide a statutory framework
which can lead to computation reasonable, fair and equitable
profits and taxing the same in India, in relation to
international transactions between two or more associated
enterprises, new provisions have been introduced in the
Income Tax Act effective from 01.04.2002. These provisions
are more or less based on traditional rules outlined in the
work of the OECD. For that matter strict conditions have
been imposed on the tax payer to maintain and provide
documentation of transfer pricing, methodology, non-
compliance thereof attracts heavy penalties.
Controlled tax payer means one of the two or more tax payers
owned or controlled directly or indirectly by the same interests, and
includes the tax payer who owns or controls the other tax payers.
Uncontrolled tax payers mean any one of the two or more tax
payers not owned or controlled directly or indirectly by the same
interest. Likewise control means any kind of control directly or
indirectly whether legally or not and however, exerciseable or
exercised, including control resulting from the actions of two or
more tax payers acting in concert or with a common goal or
purpose. Thus, it is the exercise of real control, which is decisive but
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in its forum or more of its exercise. A presumption of control arises
if income or deductions have been arbitrarily shifted. A `transaction'
means same assignment, lease, loan, advance, contribution or any
other transfer of interest in or right to use any property whether
tangible or intangible or money. However, such transaction is
effected and whether or not the terms of such transaction are
formally documented. Such a transaction also includes performance
of any services for the benefit of or taxes, other tax payers. In
determining the true taxable income of a controlled taxpayer, the
standard to be applied in several case is that of a taxpayer dealing
at arm's length with an uncontrolled tax payer. Whether a
transaction results an arm's length result will to be determined with
reference to the results of a comparable under comparable
circumstances. Transactions are not ordinarily considered
comparable if they are not made in the ordinary course of business
or one of the principal purposes of the uncontrolled transaction was
to establish an arm's length result with respect to the controlled
transaction. Specific methods for that purpose have been provided
for determining arm's length results, if the transaction's do not
satisfy that standard. Transactions may involve different kinds of
transfer such as transfer of property, services, loan or advances and
therefore, may require selection of appropriate method for the
calculation of arm's length results. No shift method of priority is
recommended The best suitable method for determining a most
reliable measure of arm's length result has to be given priority. In
selecting the best method, two factors to be taken into account
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are:- (i) the degree of comparability and (ii) Completeness and
accuracy of the data. Degree of comparability depends on the
following factors: (i) Functions identifying and comparing the
economical significant activities; (ii) comparing significant
contractual terms, (iii) comparing significant reasons (iv) comparing
significant economic conditions (v) comparing of property or services
and (vi) market strategies, location, savings, etc.
18. The methods to determine arms length price of tangible
property are (i) comparable controlled price (CUP) method (ii) Result
Price Method (3) CUP plus method (4) ( if none of the above applied)
appropriate method is comparable profits method; profits supplied
method; unspecified method.
The CUP method is one comparable uncontrolled price method, which is
defined as transfer price method that compares the price for property
or services transferred in a controlled transaction to the prices charged
for property or services transferred in a comparable uncontrolled
transaction in comparable circumstances. Thus, CUP method is the
most direct and reliable method.
The resale price method measures the value of functions performed
and is ordinarily used in cases of purchase and resale of tangible
property in which the reseller has not added substantial value to the
tangible goods by physically altering the goods before resale
(packaging, re-packaging, labeling or minor assemble do not constitute
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physical alteration). This method is not an ordinarily used where the
controlled taxpayer uses in its tangible property to add substantial
value to the tangible goods.
Cost Plus Method is ordinarily used in cases involving the manufacture,
assembly, or other production of goods, that are sold to related parties.
Comparability under this method is dependent on similarity of functions
performed, risks borne and contractual terms, and adjustments to
account for the effects of any such differences.
With respect to intangible property, the methods which apply are
(i) Comparable uncontrolled transaction method which evaluates
whether amount charged for controlled transfer of an intangible
property was at arm's length by reference to the amount charged in
comparable uncontrolled transactions. This method requires that
controlled or the uncontrolled transactions involve either the same
intangible property or comparable intangible property. The burden of
proof is always on the taxpayer .
Transactional Net Margin Method (TNMM) is applied in a case where
the sale its products to its subsidiary and makes no uncontrolled sales
in geographic market, but there are other players, who sell similar
product to other distributors in that market. The uncontrolled
distributors purchase the product from unrelated parties, but there is a
difference in that they do not have the brand names. Because reliable
assessments cannot be made for the brand name, the CUP method
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cannot be used. But when there is a close functional similarity between
controlled and uncontrolled function in terms of market in which they
occur the volume of the transactions, the marketing activities
undertaken by the distributor, inventory levels, fluctuation of currency
risks and other relevant functions and risks and reliable adjustments
can be made for similar difference in payment terms and inventory
levels for same differences in payment term and inventory level, re-sale
particulars method just a higher degree of comparability and thus
provides a reliable measures on arms length result. It is preferred over
TNMM. TNMM is preferred to costly price method but costless method
is preferred to TNMM.
TNMM is another method which provides a practical solution to
otherwise insolvable transfer pricing problem. This method is used
where net margins are determined from the uncontrolled transaction of
the same taxpayer in comparable circumstances, or comparable
transactions of two independent enterprises with the material
differences affecting price between the associated and independent
enterprises having been adjusted. If not adjusted, the method is not to
be used. This method requires comparison between income derived
from the operations of the uncontrolled parties and income derived by
an associated enterprise from similar operations. The TNMM is a
modified, cost +/- resale price method. Price guidelines defined it as
the method, which examined the net profit margin relating to an
appropriate base ( for e.g. costs, sales, assets ) that taxpayer realizes
from a controlled transaction. This method is used where CUP or resale
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or cost plus method cannot be applied. In this method focus is on
transactions rather than business line or the operating income of the
company. As regards comparability, the focus is on comparability in
the transaction and enterprises rather than on the same level of
comparability in product and function has required in traditional
method. This is based on net profit margin relative to anappropriate
base costs, sales, assets- which the taxpayer makes from a controlled
transaction. This method has been aptly described in Rule-10(B)(1)(e)
of the Income Tax Rule as under:-
(e) transactional net margin method, by which,--
(i) the net profit margin realised by the enterprise from an international
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 comparable uncontrolled transaction or a number of
such transactions is computed having regard to the same base;
(iii) the net profit margin referred to in sub-clause (ii) arising in comparable
uncontrolled transactions is adjusted to take into account the
differences, if any, between the international transaction and the
comparable uncontrolled transactions, or between the enterprises
entering into such transactions, which could materially affect the
amount of net profit margin in the open market;
(iv) the net profit margin realised by the enterprise and referred to in sub-
clause (i) is established to be the same as the net profit margin referred
to in sub-clause (iii);
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(v) the net profit margin thus established is then taken into account to
arrive at an arm's length price in relation to the international
transaction.
And I think that my above observations still holds good, even in the
given facts and circumstances of the case.
42. So, by now it has become clear that, under the Act what is
required to be `adjusted' is the `price' of an International Transaction.
One cannot first presume that there exists an international transaction
and then by assigning some price to it and by arriving at a conclusion
that its price is not at arm's length make adjustment under Section 92
of the Act. This Idea is against the very `spirit' of international-
taxation. The objective of the Chapter X or for that matter is to `make
adjustments' to the price of an international transaction, which the
entities may have shifted from one jurisdiction to another jurisdiction.
When no `price' is shifted to a different jurisdiction, how can it be
dealt with under Chapter X and how an `assumed price' can be taken
for ALP adjustments. It is not permissible under the Act. What
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transfer pricing adjustment can be made in India are circumscribed by
Section 92 of the Act.
43. The Act does not speak about intangible and abstract
transaction. What the department is trying to bring home to us is that
there exists an `intangible-transaction' between the parties as
canvassed, inferring unwritten agreement via unwritten understanding
between the wholly owned assessee and its foreign parent AE to create
an `intangible asset' (marketing intangible). Chapter X is a complete
and self-contained code which contains all relevant provisions of
transfer pricing provisions apart from those set out in the Rules. A
transfer pricing adjustment is to be made within the four-corners of
Chapter X. This chapter provides for substitution of an arm's length
price for a contract-price in an international transaction. This is the
only TP adjustment which is authorized and permitted under the Act.
Chapter X deals with the price part of a contract and does not deal
with the `quantity part of goods or services.
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44. "The assessee should have been compensated to the extent non-
routine AMP expenses" is the main plank of the revenue which cannot
be equated with an `international transaction' much more than a
`transaction'. This phrase `should have been compensated' refers only
to a subjective approach of the taxman in the given facts and the
circumstances of a case.
45. Let us think in a different way by treating `the entire expenses
incurred on AMP towards `brand-building, maintaining, brand -
promoting and brand-strengthening, and the conclusion that `product-
promotion' is only incidental. This can be impressive argument in the
given facts of the case particularly when the assessee is 100%
subsidiary of its foreign AE. When `product-promotion' is incidental
then by applying the same analogy as is being applied, incidental
benefit arising to it would not require incurring of any AMP
expenditure and therefore, entire expenses are to be treated as
`brand-promotion' expenses. Fine, this is another way of drawing
inference from the given facts of a case. In case of LG as it was
demonstrated with the help of slide-show that the whole
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advertisement is for brand-building. Then the entire expenses must be
compensated by the AE, or else entire expenses can be treated as
MNE's income, if one further enlarges one's presumption. According
to me, the stand taken by the Revenue is not staid and firm, it is only
dilly-dallying. They are treating the "should have been compensated"
statement as an "International transaction" with reference to the
alleged non-routine expenditure incurred towards AMP expenses, as
found, after comparing with similar, not-so similar or not similar
entities who are also incurring such expenses. But would it be a
correct method to arrive at the existence of an international
transaction in this way as has been done by the revenue. According to
me, no, not at all. This procedure is not laid down in our law.
46. In my view what revenue could have done in such a case is that
`such and such portion' of AMP expenditure should be treated towards
`brand royalty', as it is so accepted in such like or alike cases. In that
view of the matter, it could be presumed that an unwritten
understanding exists between the parties because for user of brand
something is required to be paid to its owner. But, a question would
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then arise that the `Brand-royalty' is paid to its legal owner only when
they allow the use of its brand by any third party. When one thinks
that whatever is earned by a MNE who is 100% subsidiary of its AE,
then by enlarging this theory, it can be safely said that even the
existence of the assessee benefits its AE. Thus, whatever is earned as
income by it pertains to its AE, then why it is being taxed in India. In
that case, the entire income needs to be taxed in foreign jurisdiction.
In this way, we would reach at a ridiculous conclusion. The MNE exist
in India under the authority of law and treated as separate legal
entities. Whatever is permitted by law cannot be allowed to be
treated illegal. The assessee is doing business in India and is also
paying taxes on its income. The assessee has a right to derive as
much is legally possible. It is the duty of the `tax-man' to check any
illegal pilferage of tax but such shifting of benefit but by remaining
within the four-corners of the law of the land, otherwise the policy of
the Government, who wants foreign investment in India towards
establishment of infrastructure creation of more jobs for its youths
and strengthen economy, would utterly be defeated.
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47. The Revenue has taken the stand that the T.P. Regulations
proceed on the assumption that separate legal entity in a
multinational group does not have economic independence to take
vital policy decisions. That AMP expenses are incurred as part of global
strategy to promote the brand and/or capture markets or to sustain
the market share. That AMP expenditure is an `international
transaction' within the meaning of Section 92B. That under the
amended provisions, TPO has the necessary powers to examine under
certain circumstances an international transaction even if there is no
specific reference of such a transaction from the A.O. that the burden
to demonstrate that the price of an international transaction is at
arm's length is on the tax-payer under the India TP Regulations. That
AMP expenses go to build the brand owned by the parent company.
That Indian entity incurs the expenditure for building the brand for
and on behalf of AE. That the provisions of Section 37(1) and those of
Chapter X operate in different fields and one does not militate
(hinder) against the other. That the parent company cannot
completely disassociate itself from AMP expenses either in the manner
of planning, strategy and budgeting of such expenditure nor can it
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assets that it does not enjoy the fruits of such expenditure. That the
`Brightline' has been adopted by the TPO only as a tool to arrive at the
direct cost of expenses attributable to the brand promotion. That
adjustments have been made as per the method prescribed under the
Act. That that TP regulation stipulate arm's length price of a
transaction and application of TNMM to benchmark one set of
transactions by itself cannot be a sanction for non-determination of
ALP of a different transaction. That it would be unwarranted and
impractical for the Revenue to define the manner or mode for
incurring the expenditure and to characterize or re-charactage them
into one or the other kind. That the degree and extent of risk borne by
the Indian entity may be factor of comparability but the arm's length
price for the cost of service provided to the Associated Enterprises and
fee for services would still need to be determined.
48. The oppugned submissions on behalf of the taxpayers are that
the issue of `AMP' expenses incurred in relation to unrelated third
parties in India, does not tantamount to a `transaction' much less an
`international transaction' and is not governed by Section 92 and 92B,
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as there is no written / oral, agreement, understanding or concert
between the AE and the Indian Company, so it is not a `international
transaction'. The AMP expenses depended on local needs, capacity
etc. That there is no such direction from the Parent Company, to
incurred expenditure. That neither the assessee referred such a
transaction nor such reference was made by the A.O. or TPO . That the
AMP expenses incurred by the assessee have not resulted into any
benefit and has not created any intangible for its foreign AE. That
expenses on AMP is an allowable revenue deduction even if it results in
some indirect benefit to a third party i.e., the AE. That adjustment
not made based on any of the methods prescribed in Transfer Price
Regulations is not sustainable. That when the assessee is using royalty
free trade mark it would not be a case of TP adjustment. That if the
AMP expenditure created economic ownership for the Indian entity, it
cannot be regarded as service to AE as an expenditure cannot create
ownership in favour of one entity and at the same time also be
regarded as service to another entity. That economic ownership and
service are mutually exclusive. That when AMP expenses are
subserving assessee's objective and if any benefit to overseas entity
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has occurred it can be only incidental. That the classification of
routine and non-routine may vary from assessee to assessee; from
market to market; from time to time; depending upon the product
cycle. That due attention needs to be given to assessee's business
profile, competitive landscape and broader industry trends. Because
the AMP for Pharma, auto, consumer goods, consumer electronics and
luxury goods are going to be governed by different consideration. That
determination of provision of services should be subject to a vigorous
FAR analysis and benchmarking of the same for determination of ALP
should be subject to the standard comparability criteria. Such like host
of arguments were advanced for and against this issue by both sides.
49. The word `transaction' takes its legal colour from the definition
of the term "agreement" given is section 2 of the Indian Contact Act.
Accordingly to which there must be `promisor' and `promisee', and at
the desire of the promisor, the promisee either does or abstains from
doing it. Thus a transaction cannot be a unilateral act and it involves
more than one person (or entity).The definition of `transaction' has
been provided in clause (v) of Sec. 92F, which is inclusive one. This
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definition opens with `transaction' includes, meaning thereby,
whatever definition is assigned to an agreement it is further enlarged
and under this Act any arrangement, understanding or action in
concert, are also included, apart from what is ordinarily and genuinely
it is understood to mean. This `inclusion' is further qualified by
assertions that the above these' inclusives may be `formal' / informal
or may be in writing / or oral. These may be intended to be
enforceable in law or may not be so enforceable' so the definition of
`transaction' ordinarily `understood' has been further enlarged.
50. In my considered opinion, the burden to prove "that incurring of
AMP expenses to the extent of more than what other independent
entities proportionately incur towards advertisement of their
products, in a similar situation, has resulted into a transaction and
that these expenses are incurred for brand building on behalf of the
foreign parent entity which is so manifestly inferred from the conduct
of the parties that there exists an arrangement /understanding /
action between the assessee and its foreign AE, which has resulted
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into an international transaction for which ALP, adjustment is required
under the Act", is on the Revenue.
51. It was argued from assessee's side that the burden to establish
this alleged international transaction is on the Revenue. In the opinion
of the department this `AMP expenditure' tantamount to an
international transaction, within the meaning of Section 92B of the
Act. That under the amended provision, TPO has the necessary powers
to examine, under certain circumstances, any international transaction
even if there is no specific reference of such a transaction to him from
the A.O, and that the burden to demonstrate that a particular
international transaction is at arm's length is on the tax payer under
Indian TP regulations. That when AMP expenses go to build the brand
owned by the parent company, the Indian entity has incurred this
expenditure for building brand for and on behalf of the AE, which
should be compensated to that extent, can be inferred from the facts
/ circumstances of a given case and the conduct of the parties.
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52. It cannot be denied, rather it is the law of the land that under
the transfer pricing regulations the burden to prove that, `a
transaction is not at arm's length' always remains on the Revenue. As
per Rule 10D the onus to maintain the requisite records and documents
is on the assessee. Thus, in terms of Section 92C, the burden to prove
that the computation of ALP by the assessee in relation to an int.
transaction is not appropriate and requires adjustment is always on
the Revenue. Section 92 (2), 92B(1) r.w.s. 92(F)(v), when read
conjointly, clearly suggest that an allocation or apportionment or
adjustment is contemplated only under expressly defined conditions as
specified there-under. Undeniably, there is no deeming fiction in
Chapter X and the corresponding Rules to assume/presume that every
transaction or action done by the Indian entity which is wholly owned
company of its foreign AE, is influenced by its foreign master or
principal, and whatever is whispered even clandestinely by the Indian
Company would translate into an int. transaction. There is no such
presumption in law, or even under chapter X of the Act. The Revenue
cannot deduce whatever it wants to from the given facts and the
circumstances of a case. The inference which is permitted, even under
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Section 92F(v), has to be based on some material; it cannot be entirely
`subjective' in any case. The subjective inference based on objective
material like any candid arrangement / understanding etc., has to be
established and objectively demonstrated, wherefrom, it can be safely
deducted that there exists an int. transaction between the AEs. The
AMP expenses vis-a-vis its impact on brand if is not found palpable it
cannot be treated as an international transaction. The intention of the
law is not to treat every international transaction as not at arm's
length. And similarly, it would be over-reaching and blowing out of
proportion if every 100% subsidiary entity of a foreign AE in India, is
treated as a creation for manipulation for the benefit of its foreign AE.
No one can deny that any foreign entity a multinational entity come
here to do business for a profit and not for charity. They want to make
profit to the fullest possible and at the same time it is not only the
right but even duty of a `taxman' to ferret out such a transaction to
bring under Chapter X of the Act. But it cannot be illogical and purely
based on guess work and sheer assumption and presumption derived
from one action which is not found as `avoidance of tax'.
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53. By no stretch of imagination a philosophy of `Blue Ocean
Strategy' [BOS], which may have been adopted by L.G. Group, globally
to create new market space or a blue ocean, thereby making the
competition irrelevant, can help the revenue to infer any such
international transaction, as they have done. The reason for my above
epilogue is that the LG brand is already well established in the context
of India. The vigorous campaign throughout the length and breadth of
our country, of LG Brand will only help the sale of LG Brand products
and in no way it can be treated as an effort to bolster the `brand'.
The brand in vacuum has zilch value. When the Brand `LG' is heard and
seen on TV or read in print media, anybody and everybody would make
out a picture in their minds of one or the other `product' of LG brand.
Nobody cares and remembers as to how the brand `LG' looks; what
colours are used therein etc. The simple glimpse of the `brand-name'
is bound to create a `picture' of its products only.
54. As per section 101 of the Indian Evidence Act, 1872, whosoever
desires any court to give judgment as to any legal right or liability
dependent on the existence of facts which he asserts must prove that
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these facts exist. In this case therefore, the burden to prove, that the
alleged AMP expenses are a result of a tacit understanding between
the Indian companies and its foreign AE to built/promote LG brand, is
on the revenue. The revenue has not been able to discharge this
burden, in my opinion. When it has been held in the proposed order
that actual comparables have not been considered then in that
eventuality, how one can arrive at proportionately higher AMP
expenses having been incurred in this case. That so-called non-routine
or more that required expenses theory, has to tumble down and thus,
the very basis of presumption of `Revenue' vanishes, resulting into
absence of any such international transaction between the AEs.
55. I would go to the extent in saying that after products of LG have
been amply advertised and thereafter only the brand name is
advertised, which is admittedly India specific, it will only and only
enhance the sale of LG products, in India, and it cannot be treated
even partly towards brand-building.
56. It is true and cannot be denied that when the brand LG is
promoted and its value stays put, it can be sold or otherwise used and
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its benefits can be taken by its owner only. Fine, but when the Indian
entity is its foreign owner's wholly owned entity, in that case, benefit
will definitely accrue or arise to it also, may be indirectly, and that
`indirect-benefit' when transferred then it can be taxed in India, in
view of the amended provisions of the Act. So, where is the question
of `avoidance of tax'. The assessee has made huge-profits which has
been subjected tax in India. Other items which are treated as
international transaction have been dealt with by the `taxman' by
making requisite adjustments under Chapter X of the Act. The entire
AMP expenses, were paid to third party in India, to which we are
concerned have also suffered tax in Indian jurisdiction, which is
admittedly not related to the assessee or its AE. So, where the
question of applying provisions of Chapter X of the Act, in the way it
has been done arises in this case. When the department alleges that
`brand' promotion of foreign AE's brand has taken place, it has to be
proved and simply by inference, no such conclusion can be drawn
under the Act. Therefore, before invoking transfer price provisions,
the TPO has to first prove that there exists an international
transaction in this regard, and thereafter by showing that its price is
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not within Arm's Length he can make necessary adjustments as per
law.
57. There should be some proof of creation of marketable intangible,
before any further step can be taken in that direction. Admittedly,
the advertisement expenses are of Revenue in nature. The expenditure
incurred in one year on advertisement may not travel to even next
year as the memory of consumers is very short. The following decisions
support my above conclusion :-
1. In CIT Vs. Berger Paints [India] Ltd 254 ITR 503 (206)
wherein it has been held that advertisement expenditure is
generally of revenue in nature since the memory of purchasing
market is short and the advertisement is required to be done
from year to year.
2. In CIT Vs. Jai Parabolic Springs Ltd. 306 ITR 42 (Del) it has
been held that there was no prohibition on the powers of the
Tribunal to entertain an additional ground which according to
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the Tribunal arose in the matter and for the just decision of the
case. There was no infirmity in the order of the Tribunal.
3. In CIT Vs. Brilliant Tutorials P. Ltd 292 ITR 399 (Mad) it has
been held that as regards advertisement it was not denied that
the expenditure incurred was for the purpose of business and the
possible benefit in future did not militate against the claim for
expenditure in the present. Hence, considering the scope of
section 37, the Tribunal correctly held that the assessee was
entitled to the deduction sought for.
58. As I have already touched the issue, the guidelines, be it that of
OECD or that U.N., they come into play, only if India has no
reservations towards them, and that too, only after a transaction is
brought under Chapter X of the Act. So, to rely on these guideline
when the `transaction' has not been brought under Chapter X is of no
moment, and does not subserve any fruitful purpose. Likewise, how
the assessee can be supposed to seek compensation for AMP
expenditure which is not consistent with the character of business of
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the assessee. It may be easy to say that the parent company cannot
completely disassociate itself from AMP expenses either in the manner
of planning strategy and budgeting of such expenditure and it may also
enjoy the benefits arising therefrom, but it is very difficult to translate
this philosophy into action to the hilt, to establish that verily some
`marketable intangible' has taken birth and at the cost of the assessee
it has flourished although it is owned by its foreign AE. I am not in
agreement with the assertion of the Revenue that there is no concept
of `commercial ownership' of a brand which is legally owned by
someone else. A commercial ownership is a reality in the modern
global business realm and it is as good as a legal ownership in so far as
its effects on sale of products in India is concerned. The brand name
and its products have a very piquant relationship; when a `brand' has a
high name, its products have higher sales, and if brand earns a bad
name, the sale of its products would be adversely effected. A bad-
name comes to a `brand', only because of its products when they don't
satisfy customers. So, the brand may be directly and even `inversely'
proportional to sale of its products; but converse is not true. In case,
the product of a brand has a higher name, its brand will be
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emboldened but if the products have bad name the name of that brand
in the `foreign countries' may not be affected. Therefore, any
advertisement which is product-centric, and for that matter of even
entirely brand-centric, it will only enhance the sales of the products of
that brand in India. In no way, the brand owner will be benefited. It
is more the reason in case of a wholly owned entity because any
benefit derived by the foreign company will directly and
proportionately benefit the Indian company. Therefore, this is not a
case of brand-building/promotion. Hence, no such `covert
transaction' between the Indian entity and its foreign AE, can be been
culled out and presumed or inferred by the TPO/AO in the given facts
and the circumstances of this case. Thus, the department has not been
able to discharge its burden which is cast upon it by the precincts of
the provisions contained in Chapter X of the Act. The assessee has
only incurred expenditure towards advertisement to sell its products.
No proof regarding rendering of any service towards brand-building, is
brought on record by the Revenue. Therefore, only presumption or
assumption at all stages cannot be and should not be approved to
replace an `evidence'.
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59. For the purposes of section 92, 92B, 92C, 92D and 92E,
`international transaction' means a transaction between two or more
AEs [one of whom should be a non-resident]. What is the nature of
this transaction? It is either
(i) a purchase, sale; or
(ii) lease of intangible or intangible property; or
(iii) provision of services; or
(iv) lending/borrowing of money; or
(v) any other transaction having a bearing on the profits,
income, losses or assets of such enterprises
It also includes :- [`It' refers to a `transaction']
(i) a mutual agreement or arrangement between them for the
allocation or apportionment of, or any contribution to
Any cost or
expense,
incurred or to be incurred in connection with such service,
benefit or facility provided or to be provided to any one or more
such enterprises
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60. Sub-section (3) of section 92 envisages a situation wherein
computation of income arising from an international transaction having
regard to the arm's length price [or allowance for any expenses or
interest arising from an international transaction] has the effect of
reducing the income chargeable to tax or increasing the loss when
computed on the basis of the entries made in the books of account in
respect of the previous year in which the international transaction was
entered into. In that eventuality, provisions of section 92 shall not
apply. What this provision signifies and resembles a situation when
the computation of income of a particular assessment year, on the
basis of books of account of previous year, goes below disclosed
income. The declared income has to be accepted and the
computation taking the income below the declared one has to be
ignored. To further simplify, the purport of 92 (3) is that the
computation of income from an international transaction having
regard to ALP should not be allowed to fall below the income
disclosed from this `international transaction' by the in its books of
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account. The term `international transaction' is singular and not
plural. It is not `international transactions'.
61. In no way it signifies that section 92 prescribes different
methods of computation of income from different `international
transactions' provided under the Act and Rules. In my opinion,
these provisions don't speak of fixing higher ALP, in whatever
manner and b applying any of the methods provided under Rule
10B. Rule 10B. These provisions don't speak about any set-off and
nobody can infer such a course from Section 92(1) + 92(3) or
otherwise. No forum or authority or court has a vested right or duty to
compute income from an international transaction by applying any
Method not prescribed in the Act or the Rules, at least in the
assessment year 2007-08. For one international transaction for the
purposes of sub-section (1) of section 92C, the most appropriate
method (of the methods provided under Rule 10B) which is best
suited to the facts and the circumstances of that particular
international transaction, which is most reliable one, shall be applied.
And, if the application of that most appropriate method reduces
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income or increases loss arising from that international transaction
which can be computed as per the books of accounts, that
computation has to be ignored and the book result has to be
accepted.
62. The definition of any word or term, expression or phrase, which
is in the form of a noun, is its denotation or signification of a term
[word etc.] may be made specific by either including something in or
by excluding something from it. It does not mean that the definition
can either be `inclusive or `exclusive'. It can add [include] something
to, or / and exclude [substract] something from the general definition
provided when an expression `means and includes' is used to define a
word, it is only enlargement of its normal meaning by adding such
`inclusive[s]", to make it comprehensive. The definition of a word
etc., is always exhaustive; even if it is included in or extracted from
it, specifically. Thus, a definition of a term etc, is its exhaustive
definition with or without there being `inclusives' or `exclusives'. So,
in my opinion, the definition of an `international transaction' as per
section 92B is not classic as has been canvassed by the ld. D.R. Sub-
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section (2) of section 92B deems a transaction between `other person'
and the AE as an international transaction.
63. In my considered view, the impugned transaction does not fit in
any part of the definition of an `international transaction'. It is not at
all a `provision of service'. The assessee has not provided any such
service - directly or indirectly to its AE, as has been alleged. The
assessee has been pursuing its business activities in the manner which
in its opinion increases or would increase its turnover of the year. The
assessee in my opinion has not created, improved or maintained the
marketing intangible for its foreign AE. So, no question of any sort of
compensation arises in this case. The ld. D.R., and for that matter,
the ld. TPO/A.O. is reading too much between the lines. If one goes
by the canvassed definition of an `international transaction', as has
been done in this case, anything and everything can be brought under
the definition of the term `bearing on the profits, income, losses or
assets' of the assessee or its AE. If this contention is accepted, then
anything and everything done or not done by the assessee can be
brought to tax as an income from an `international transaction'. For
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example, if the assessee reduces sale-price to compete in the market
which increases volume of income but it may have a bearing on the
profit as the net-profit is bound to decrease, or the net profit rate is
bound to fall, then, in that case, particularly in the case of this
assessee who is a hundred per cent subsidiary of its AE, who is
benefitted with increase in income, the `reduced-sale-price'
cumulatively, has to be treated as an `international transaction'. In my
view, it would amount to far fetching the meaning of the term
`international transaction'. This is not at all the case where the
assessee has claimed expenses relating to its AE. The ld. D.R. has
been fair enough to accept that the payment to third-party or parties
[who are Indian assessees], has not been treated as an `international
transaction'. The payment made to third-party for advertisement in
the Indian territory, for the purpose of enhancing its sale, and by
drawing benefit of the foreign trade-mark/brand/logo, also cannot and
should not be read in a different manner.
64. The explanation appended to section 92B, which was inserted
vide the Finance Act, 2012, w.r.e.f 1.4.2002 [i.e. from the very
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inception of section 92B] does not enlarge the scope of section 92B
and does not, in fact, widen the `exhaustive' definition of the term
`international transaction'. This explanation only `explains' the
words, terms, etc. used in the main section, as enumerated above.
Explanation (i)(a) clarifies as to what is the `tangible-property', used
in section 92B(1) and to be very specific, building .....etc. have to be
named. By (i)(b), this Explanation clarifies by naming specific
`intangible properties'. Likewise, other sub-clauses (c) to (e) have
clarified capital financing; provision of services and a transaction of
business. Through Explanation (ii), it has further clarified the
expression "intangible property' to include :
(a) marketing related intangible assets, such as, trademarks, trade names, brand
names, logos;
(b) technology related intangible assets, such as, process patents, patent
applications, technical documentation such as laboratory notebooks, technical
know-how;
(c) artistic related intangible assets, such as, literary works and copyrights, musical
compositions, copyrights, maps, engravings;
(d) data processing related intangible assets, such as, proprietary computer
software, software copyrights, automated databases, and integrated circuit
masks and masters;
(e) engineering related intangible assets, such as, industrial design, product
patents, trade secrets, engineering drawing and schema-tics, blueprints,
proprietary documentation;
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(f) customer related intangible assets, such as, customer lists, customer contracts,
customer relationship, open purchase orders;
(g) contract related intangible assets, such as, favourable supplier, contracts,
licence agreements, franchise agreements, non-compete agreements;
(h) human capital related intangible assets, such as, trained and organised work
force, employment agreements, union contracts;
(i) location related intangible assets, such as, leasehold interest, mineral
exploitation rights, easements, air rights, water rights;
(j) goodwill related intangible assets, such as, institutional goodwill, professional
practice goodwill, personal goodwill of professional, celebrity goodwill, general
business going concern value;
(k) methods, programmes, systems, procedures, campaigns, surveys, studies,
forecasts, estimates, customer lists, or technical data;
(l) any other similar item that derives its value from its intellectual content rather
than its physical attributes.]
65. This explanation has tried and clarified the `terms' used in
section 92B(1). The `provision of services' as per clause (d) of
Explanation (i) include provision of market research, market
development, marketing management, administration, technical
service, repairs, designs, consultation, agency scientific research,
legal or accounting service. Admittedly, the assessee is engaged in the
business of manufacturing and selling of electronic goods etc. and not
in rendering services of advertisement or brand-promotion. As per
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section 92B with its explanation, only if the assessee is consciously
involved in providing services as its business, only then it can fall
under the definition. The `provision of service' refers to Explanation
(i)(d) and includes provision of market research, market
development, marketing management, administration, technical
service, repairs, design, consultation, agency, scientific research, legal
or accounting service . If one looks towards the tenor of the above
`services' all of them refer to specific `provision of these services'.
Whereas, in the given case, no such service has been provided by the
assessee to its AE. The `factum' of rendition of any one of such
services is not existent in the case in hand. The service should
consciously emanate from the act and conduct of the assessee.
Therefore, the source of service is also a relevant factor. By incurring
AMP expenses for the benefit of increasing its sale of `products' would
in case amount to `provision of service' even if it is concluded that
the LG brand is also promoted, may be incidental. The definition of
provision of service is given entirely in different and distinct meaning
which cannot be in a `presumptive' manner at all.
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66. Explanation (ii) further clarifies the meaning of the expression
`intangible property'. We are not concerned with this portion of the
explanation because in section 92B(1) the definition of `international
transaction' is given as meaning of `purchase, sale or lease of
intangible property. This is not the case wherein any such sale,
purchase or lease of an `intangible property' is involved. The inclusive
definition of the term `provision of services' does not speak about any
`intangible or tangible property" [emphasis supplied]. As stated above
qua tangible and intangible property, their purchase, sale or lease are
only relevant and not `provision of services'. Therefore, there is no
point in reading section 92B Explanation (i)(d) and 92B Explanation
(ii)(a). Nobody has denied that a `trademark, a trade-name, brand-
name or logos are `intangible property'. But, in case of such property
only sale/purchase or lease is relevant and if that exists that will
amount to an `international transaction'.
67. In view of the above position of law, Section 92CA of the Act
cannot be treated as verbose bombastic, turgid or flowery. This
section alongwith all its sub-sections viz., 1, 2, 2A, 2B, 2C, 3, 3A, 4, 5,
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6, and 7 has to be read harmoniously. None of its sub-sections can be
treated as irrelevant, overlapping the other or in contravention of the
other sub-section. All sub-sections of section 92CA are to be read in
continuation, in furtherance and in achieving its main objective and
intent. Section 92CA deals with the requirement of reference to TPO
of an international transaction entered into, in any previous year,
when the A.O. considers it necessary and expedient to do so, and after
obtaining previous approval of the Commissioner, for the computation
of the ALP in relation to that international transaction. Thus, it
becomes manifest that it is in the domain of the concerned A.O. to
make reference of any an international transaction which has been
entered into by the assessee. Meaning thereby, that whatever
international transaction has been reported by the assessee in the
terms of the relevant provisions of the Act and of Rules, the A.O., if
desires to do, may refer it to the TPO for the computation of its ALP
but after taking previous approval of the Commissioner. Thus, u/s
92CA, three conditions are laid down before such a reference can be
made, and these pre-conditions are:
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(1) There should be accepted and reported international
transaction which has been entered into by the assessee during
the previous year.
(2) The A.O. must find it necessary or expedient so to do. This
is A.O.'s sole discretion.
(3) The A.O. must obtain previous approval of the
Commissioner, before making this reference.
(4) The sub-section (2) of this section 92CA prescribes the
procedure to be adopted by the TPO, once he receives such valid
reference. He has to serve a notice to the assessee to require
him to prove that the `price' computed by it in relation to that
international transaction is within arm's length.
68. Sub-section (2A) of section 92CA(2) enlarges the scope of its sub-
section (1) and (2) which talks about reported international
transaction. According to this sub-section, which is brought on the
statute vide the Finance Act, 2011 w.e.f. 1.6.2011, if other
international transaction, other than reported [covered u/s 92CA(1)],
the TPO can still proceed to compute its ALP, as if it was referred to
him under sub-section (1) of section 92CA. What does it imply? It
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implies that the conditions of (i) that the A.O. considers it necessary
or expedient to refer an international transaction to TPO and (ii) prior
approval of the Commissioner, are foregone, in that eventuality. The
only requisite is that during the course of proceedings before him,
other international transactions, other than referred to him u/ss (1) of
section 92CA, comes to his notice. Hence, in such an eventuality, the
preconditions laid, for making reference to the TPO, on the A.O. have
been relaxed.
69. The sub-section 2B, which was inserted by the Finance Act, 2012,
w.r.e.f 1.6.2002 and is given retrospective effect, is in controversy.
According to the assessee, it will not apply to cases before 1.6.2012 in
so far as jurisdictional issue is concerned. In my opinion, this sub-
section is entirely different and distinct from the provision operates,
as it exists as on today, only in cases of international transaction which
has not been reported u/s 92E but it comes to the notice of the TPO.
70. This sub-section applies in cases other than covered by sub-
section 2A and sub-section (1). There may be cases where no report
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u/s 92E is furnished but the transactions comes to the notice of the
TPO.
71. What is that report which is required to be furnished u/s 92E, it
is the report from an Accountant which is to be furnished by persons
entering into international transaction or specified domestic
transaction. If these all sub-sections are conjointly construed, it will
become manifest that all these operate in different spheres and for
different objectives. u/ss (1) it is discretion of the A.O. subject to
few conditions to refer to the international transaction to the TPO, in
respect of international transactions which are entered into and
reported to him by the assessee. Then, comes in the role of the TPO
who can examine other international transaction, as per rule, which
comes to his notice from the records available before him. Sub-
section 2B talks about international transaction regarding which
accountants report, which is mandatory as per the provisions of
section 92E, has not been furnished by the assessee to the A.O.
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72. In my anxious opinion, this provision applies to such cases, in
which the assessee has disclosed and reported an international
transaction entered into by the assessee during the previous year but
for that requisite accountant's report [u/s 92E has not been furnished,
yet the A.O. has not considered it necessary or expedient to refer it to
the TPO u/ss (1) of section 92CA. In that case, the TPO has power to
deal with it in the similar manner as he can deal with u/ss 2A. Sub-
section 2A has not been `reported' by the assessee and consequentially
not referred by the A.O. to the TPO. But sub-section 2B deals with
such situations in which the assessee has `reported' an international
transaction but has not furnished accountant's report in respect
thereof but still the A.O. has not found it necessary to refer the same
to the TPO and at that stage, the TPO notices that requisite report of
the accountant has not been furnished, and in that eventuality, the
TPO can proceed further, as prescribed in sub-section 2B. Had the
legislators intended to give section 2B an overriding effect, even to
bulldoze sub-section 2A, they could have deleted sub-section 2A, but it
is not the case. Hence, to that extent, I have found the contentions of
the ld. Authorized representative to be correct as per the Act. The
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case of LGI is not covered u/ss 2B, in that view of the matter because
the assessee has not treated this impugned alleged transaction as an
international transaction and has not reported the same and has not
obtained and furnished accountant's report. The remaining sub-
sections of section 92CA are not relevant for our instant purpose.
Accordingly, I have to answer question No. (1) against the revenue, in
the given facts and circumstances of this case. [LGI] obtaining in A.Y.
2007-08. But I would like to add here that the aspect of assumption of
jurisdiction to charge an income is substantive in nature and the law
obtaining at that particular point of time is only relevant and it cannot
be altered by any retrospective amendment or insertion of any
provision. It is the ratio-decidendi of a judgment which matters and
not the provisions under which it is rendered. Anyway, my above
answer to Question No. 1, also supplies answer to Question No. (2)
relating to charging of mark-up. In view of my above finding the
answer to Question No. (2) is also against the revenue.
Sd/-
[HARI OM MARATHA]
th
Dated : 15 January 2012. JUDICIAL MEMBER
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