The Central Board for Direct Taxes ("CBDT"), the apex body of direct taxes in India, have notified vide notification no. 57/2016/F.No.500/1/2014-APA-II dated 14th July 2015, the tolerance range for the difference in the arm's length price as computed under section 92C of the Income Tax Act, 1961 and the prices at which the international transaction and/or specified domestic transaction have been undertaken during Assessment Year 2016-17, as 1 per cent in case of wholesale trading business and 3 per cent for all other transactions.
In this regards, 'wholesale trading' shall be construed where:
i. purchase cost of finished goods is eighty per cent or more of the total cost pertaining to such trading activity; and
ii. average monthly closing inventory of such goods is ten per cent or less of sales pertaining to such trading activity.
Further Reading
On June 29, 2016, the Organization for Economic Cooperation and Development (OECD), issued guidance on the implementation of the Country-by-Country (CbC) Reporting as set out in the 2015 Base Erosion and Profit Shifting (BEPS) report under Action 13 “Transfer Pricing Report and Country-by-Country Reporting”. Under the CbC Reporting, the multinational entities (MNEs) are required to provide aggregate information annually, for each jurisdiction where the MNE operates, which shall include, inter alia, global allocation of income and taxes paid, intangibles and other economic activities within the group.
The guidance covers the following issues:
Ø Transitional filing options for MNEs (“parent surrogate filing”);
Ø The application of CbC reporting in investment funds;
Ø The application of CbC reporting in partnerships; and
Ø The impact of currency fluctuation on the agreed EUR 750 million filling threshold.
The above issues are discussed in detail as under:
1. For jurisdictions that have set an implementation date other than January 1, 2016, the MNE operating in those jurisdictions shall voluntarily file the CbC report for the fiscal year commencing on or from January 1, 2016 in their resident tax jurisdiction. This is known as the “parent surrogate filing”, and as such does not alter the timelines or the minimum standard, and thus ensures the integrity of the agreement reached in the Action 13 report. For example, in India, the CbC Reporting shall be effective from financial year beginning on or after April 1, 2016 i.e. the first CbC report shall be filed only on March 31, 2017. In such case, MNEs that are tax resident of India, shall voluntarily file the CbC report for the period commencing January 1, 2016 (Please note, India has not confirmed surrogate filing requirement);
2. The CbC reporting in case of investment funds shall be based on the accounting consolidation rules. As such, if the accounting rules instruct investment entities to not constitute with the investee company, then the investee company should not form part of the MNE group (whether or not the investment entity has a controlling interest in the investee company). Thus, shall not form part of the CbC report. However, if the accounting rules allows for such consolidation, then the investee company shall form part of the MNE group and shall be required to file CbC report, if the MNE group exceeds the revenue threshold;
3. Similar to the above, the rules of accounting shall be followed to determine the inclusion of a partnership firm, being a tax transparent entity, in a MNE group. However, if the partnership is not tax resident of any jurisdiction, then the partnership’s items, to the extent not attributable to a permanent establishment, shall be included under for stateless entities (i.e. where the partnership does not have a tax jurisdiction in any country). The share of the partners shall also be included in their respective jurisdiction. Also, if a stateless partnership is the ultimate parent of the MNE group, then the CbC report shall be filed in the jurisdiction in which the partnership is registered;
4. In case where the ultimate parent or the surrogate parent is tax resident of a country which uses the domestic currency equivalent of EUR 750 million to determine the filing threshold, shall not be exposed to the filing requirement in another jurisdiction based on the local currency filing requirement in that jurisdiction. For example, in India the revenue requirement for filing CbC report is set at INR 5395 crores (local equivalent to EUR 750 million). Therefore, for MNEs, whose ultimate parent is a tax resident of India shall be required to file the CbC repot only if it meets the revenue threshold of INR 5395 crores as on April 1, 2016. However, if the local equivalent in another jurisdiction, where the MNE operates, is higher than in India (due of currency fluctuations), then the MNE shall not be exposed to filing requirement in such other jurisdiction.
The appropriateness of the EUR 750 Million threshold (and the local currency equivalent) may be included in the review of the CbC reporting minimum standards to occur in 2020.
In addition, the OECD will provide information on country specific aspects of CbC implementation, including the effective dates of CbC legal framework, local filing and surrogate filing mechanisms, and identifying the agreements for exchange of CbC reports that are in effect. The guidance further states that given that the CbC Reporting is none of BEPS minimum standards, a peer review of the implementation of CbC reporting will be conducted to ensure that the implementation of jurisdictions’ domestic legal frameworks is timely and in accordance with the BEPS Action 13.
The Delhi Tribunal ruled that where the assessee has engaged in several transactions with its AEs and the transactions are not interrelated to each other, the TPO was justified in segregating those transactions and determining the ALP separately.
Facts of the case
The assessee[1] [2] is an Indian subsidiary of Gruner AG, Germany and engages in the manufacture of Latching Relays, Solenoids and Actuators. The assessee was sourcing raw material, spares and other consumables by making purchase from its AEs. Also, during the year, the assessee has made certain export to the AEs. During the year, the assessee entered into two agreements with its AE for licence permitting use of technology and technical know-how in the field of electro mechanical components and also the brand name of its foreign AE. As result the assessee was required to pay its AEs royalty and fee for technical service, at the rate of 8 per cent, in lieu of the above agreement.
In the transfer pricing proceedings, the assessee aggregated all transactions and applied the transactional net margin method (TNMM) as the most appropriate method to compute the arm’s length price (ALP) of the transactions. The transfer pricing officer (TPO) however, opined that the international transaction for ‘royalty’ and ‘fee for technical service’ cannot be aggregated as these are separate from the other transactions entered by the assessee. Accordingly, the TPO selected two companies form the list of comparables submitted by the assessee to determine the ALP of these transactions.
ITAT’s observations
The key question before the tribunal was whether the segregation of the two transactions for payment of royalty and fee for technical service from the other international transactions, is justified?
The ITAT, citing the decision of the jurisdictional High Court in the case of Sony Ericson[3] held that, it is a well settled that the although closely related transactions can be aggregated, but, unrelated transactions cannot be clubbed for determining ALP on a combined basis. The relevant criteria to determine whether certain transactions be considered as one international transaction or not is to see if such transactions were entered into a package deal or were intended to be simultaneously accepted or these are so closely linked that one cannot at all stand without the other.
In the instant case, the assessee had entered into two separate agreements dated 6-3-2009 and 25-6-2009 with its AE for inter alia, licence permitting use of technology & brand name and availing certain management services.
The tribunal observed that the assessee has paid the royalty and fee for technical service for value additions made and is not correlated with the import of raw materials. Thereby, confirming the actions of the TPO that the said transactions cannot be aggregated with the other international transactions for the computation of the ALP. In this regards, the tribunal held as under.
“When one considers more than one separate transaction under the combined umbrella of TNMM on an entity level, it is quite possible that a probable addition on account of transfer pricing adjustment arising from one international transaction may be usurped by the income from the other international transaction giving higher income on transacted value. That is the reason for which the legislature has provided for determining the ALP of each international transaction separately from the others. As the international transactions of payment of royalty and fees for technical services are separate transactions and not closely linked with the other transactions with which the assessee has merged them, one cannot permit such merger or aggregation for the purpose of the determining their ALP on entity level under TNMM. Therefore, this contention raised by the assessee is rejected. [Para 5.7]”
Further, in regards to the selection of the most appropriate method, the ITAT ruled that in the instant case comparable uncontrolled price (CUP) method is the most appropriate method for determining the ALP of the royalty and fee for technical service and that the TPO was right is applying CUP as the most appropriate method in the instant case. However, the ITAT rejected the approach followed the TPO for determining the ALP for royalty and fee for technical services by applying the ratio of royalty expense to sales.
“In such circumstances, even the comparison of the ratio of royalty expenses to sales of comparables with the ratio of aforesaid expenses to the sales of the assessee was totally unwarranted, because these expenses have been paid by the assessee as a percentage of 'value addition' made by it and not on the sale price. Thus it is patent that the TPO not only applied CUP method in a wrong manner but also went wrong in determining ALP in such wrong application. [Para 7.4]”
Further, the assessee submitted that, the royalty and fee for technical service were paid by the assessee to its AEs as per the rates approved by the RBI under the automatic route and the same per se be considered as ALP. However, the revenue such rate are approved the government to regulate the movement of funds and are not binding on the TPO. On this, the ITAT observed that the RBI provides for maximum permissible rate of royalty etc. which can be paid. Such rate of royalty etc. as permitted is applicable to all the manufacturing activities across the board with a few exceptions. Further, these rates may vary from zero to the maximum rate specified by the RBI, hence, these rates may not be useful while determining the ALP under transfer pricing. The ITAT opined that, “at best, the rate of royalty approved by the RBI has a persuasive value in the process of determination of ALP but it cannot be considered as conclusive”. Thus, the matter for determination for ALP of the royalty and fee for technical service is remitted to the file of the assessing officer.
The controversy surrounding the treatment of the advertisement, marketing and promotion (‘AMP’) expense as an international transaction has been a part of discussion in many a matters across tax courts in India. The issue was first discussed by the special bench of the Delhi tribunal in the case of LG Electronics wherein the bright line test (‘BLT’) was envisaged to ascertain the quantum of AMP expense as routine and non-routine. Though the use of BLT was subsequently overruled by the Delhi High Court in the case of Sony Ericsson, however, no clarity was accorded for whether the said expenses constituted as international transaction. This issue was put to rest in yet another decision of the Delhi High Court in the case of Maruti Suzuki, wherein the High Court observed that in absence of machinery provisions in the Income Tax Act (‘Act’) and with application of BLT being overruled, AMP expense cannot automatically be construed to be a deemed international transaction.
Recently, the Mumbai tribunal in the case of Thomas Cook reiterated the decisions taken by various courts on the subject and held that AMP expense is not an international transaction in view of the following:
- In accordance to the judgments of the Delhi High Court, the legal position on AMP is crystal clear that in absence of any agreement for sharing expense, AMP expense cannot be held as an international transaction;
- Mere incidental benefit to the foreign associated enterprise would not tantamount an AMP as international transaction;
- The fact that AMP expense has been incurred on third party and for promotion of own business takes away the alleged “internationality” of the transaction;
- Further, in absence of any evidencing material on benefit accruing to the associate enterprise, the disputed transaction shall not be taken as an international transaction;
- Also, once a transaction falls outside the ambit of being an international transaction, FAR analysis of comparables or any other adjustment does not arise;
In view the above, the tribunal opined that the matter shall not be remanded back to the file of the assessing officer/transfer pricing officer thus putting a rest to the issue of treatment of the AMP expense.
The judgment is likely to decrease the transfer pricing dispute in the country as earlier the department, as a hawk, scanned the financials of the taxpayer for any AMP expense and proceed to determine the quantum of expense attributable to the foreign parent and ultimately inflate the profits of the taxpayer by such amount. This approach by the department had resulted in additional compliance burden and litigation for the taxpayer.
Facts of the case
Adobe Systems Incorporated (‘the assessee’) is incorporated under the laws of Delaware, USA and engages in the business of providing software solutions for network publishing including web, print, video, wireless and broadband applications. The assessee has a wholly owned subsidiary in India ‘Adobe India’ engaged in providing research & development (‘R&D’) services to the assessee. These R&D services are billed by Adobe India on a cost plus basis under the terms of the intercompany agreement.
It is contented by the assessee that Adobe India has deducted tax on payments made to the assessee and therefore the assessee is not obliged to file return under section 115A(3) of the Act. Further that the R&D services carried out by Adobe India are on assignment basis and does not entail end to end software development. Also the cost plus methodology adopted by Adobe India has been upheld by the transfer pricing officer (‘TPO’) in AY 2004-05 and 2005-06. However, the TPO rejected the transfer pricing study for AY 2006-07 and applied profit split method (‘PSM’) instead of the transactional net margin method (‘TNMM’) to determine the arm’s length price (‘ALP’). Accordingly, reasoned that the assessee’s income has escaped assessment. The observations of the TPO was over ruled by the dispute resolution panel stating that the ALP of the transaction shall be determined using the TNMM method.
Reasons to believe that the income has escaped assessment
The assessing officer (‘AO’) concluded that the activities carried on by Abode India formed a business connection of the assesse in India and accordingly constituted a permanent establishment (‘PE’) in India under Article 5(1) of the India US DTAA (‘the treaty’). Further, under the terms of the agreement the assessee was obliged to provide assistance, specifications and supervision and was further entitled to audit the facilities of Adobe India for maintenance of requisite standards, thus constituting a service PE under Article 5(2)(1) of the treaty. The AO also believed that Adobe India was a dependent agent PE of the assessee under Article 5(5) of the treaty. In light of the above, the AO reasoned that part of the profits of the assessee was to be attributed to the PE in India. Further as per the AO the cost plus model is not a suitable method for intangibles such as software services and PSM should be applied in terms of Rule 10B of the Act. Further, the apportionment of profit shall be made in the ratio of R&D expense incurred. The AO, in support of his observations, cited the ruling of the divisional bench of the Delhi High Court in the case Sony Ericsson Mobile Communications India Pvt. Ltd. and Ors. v. Commissioner of Income Tax-III and Ors. (2015) 374 ITR 118 (Del).
Observations of the High Court
The High Court observed that the only so much of profits is attributable to the PE which is attributable in accordance with the principle of Force of Attraction under Article 7(1) of the treaty. Further, in accordance with Article 7(2), the attribution cannot exceed what an unrelated entity would have earned in a similar scenario. Also, even if Abode India is said to constitute the PE of the assessee in India under Article 5(1), 5(2)(1) and 5(5), no profits of the assessee can be assessed in India, as Adobe India has been independently assessed on income from R&D services and the dealings have been assessed at arm’s length. Further, there is no material that would remotely suggest that the assessee has undertaken any activity in India other than which has already been subject to ALP scrutiny in the hands of Adobe India. Further, there is no dispute that Adobe India, which is alleged to be a PE of the assessee, has been independently taxed on income from R&D services and that the same has been accepted to be in adherence of the arm's length requirement. Therefore, no further income can be brought to tax in India even if Adobe India is said to constitute a PE. Accordingly, the AO’s contention that the assessee’s income has escaped tax is not tenable. The High Court cited the judgment of the hon’ble Supreme Court in the case of DIT (International Taxation) v. Morgan Stanley & Company Inc. (2007) 292 ITR 416 (SC) in support of its analysis.
Whether Adobe India constituted a PE in India
In accordance with Article 5(6) of the treaty, an independent entity cannot by virtue of being a subsidiary of a foreign company be construed as the PE of its parent company. This principle is also supported in the Klaus Vogel on Double Taxation Conventions, Third Edition as under:
“40. [Principle] It is generally accepted that the existence of a subsidiary company does not, of itself, constitute that subsidiary company a permanent establishment of its parent company. This follows from the principle that, for the purpose of taxation, such a subsidiary company constitutes an independent legal entity. Even the fact that the trade or business carried on by the subsidiary company is managed by the parent company does not constitute the subsidiary company a permanent establishment of the parent company.”
However, in case where the subsidiary acts as an agent of its holding company, the income from the activities conducted by the subsidiary for and on behalf of its principal would be assessed in the hands of the principal i.e., the holding company and not in the hands of the subsidiary company.
In light of the above, the fact that whether Adobe India constitutes the PE of the assessee under Article 5(1), 5(2)(1) and 5(5) of the treaty can be analysed as under:
Article 5(1) defines a PE to mean a fixed place of business through which the business of the enterprise has been carried on. The fixed place must be at the disposal of an enterprise through which it carries on its business wholly or partly. Although, the word 'through' has been interpreted liberally but the very least, it indicates that the particular location should be at the disposal of an Assessee for it to carry on its business through it. These attributes of a PE under Article 5(1) of the treaty were elucidated by the Supreme Court in Morgan Stanley (supra). In a recent decision, a Division Bench of this Court in Director of Income Tax v. E-Funds IT Solution: [2014] 364 ITR 256 (Delhi) reiterated the above-stated attributes; after quoting from various authors, this Court held that "The term 'through' postulates that the taxpayer should have the power or liberty to control the place and, hence, the right to determine the conditions according to its needs". In the instant case, there is no allegation that the assessee has a branch office or any other office or establishment through which it is carrying on its business. The AO has concluded Adobe India to be a PE on the assumption of it rendering R&D services to the assessee. Since, the right to use or disposal test was not satisfied by the AO, Adobe India cannot be assumed to be a PE in terms of Article 5(1) of the treaty. The fact is supported by the decision of the jurisdictional High Court in the case of E-Funds IT Solutions.
Further, the AO’s contention that Adobe India constituted the PE of the assessee in terms of Article 5(2)(1) on the grounds that the assessee has the right to audit Adobe India and that according to the agreement the assessee would provide specifications, assistance and supervision for the R&D services. The said terms of the agreement do not in any manner indicate that the Assessee has been providing services in India. Clause 5.5 of the agreement referred to by the AO indicates that the Assessee is authorized to audit the Indian subsidiary (Adobe India), so as to ensure that Adobe India adheres to the standards required by the Assessee. The same cannot possibly lead to the inference that the Assessee has been rendering services to Adobe India. The stipulation for provision of supervision and further assistance in the agreement cannot lead to an inference that the assessee has a PE in India. This principle has been held by the hon’ble Supreme Court in Morgan Stanley. Also, the AO whilst computing the income that is alleged to have escaped assessment has not attributed any income to the services alleged to be rendered by the assessee.
Further, the AO’s contention that Adobe India constitutes a PE in terms of Article 5(5) is not sustainable as there is not material fact evidencing the fact that Adobe India has acted as an agent for and on behalf of the assessee and that there is no allegation that the clauses (a), (b) or (c) of Article 5(4) of the treaty is applicable to Adobe India. One of the necessary conditions for holding that an agent constitutes a PE of an enterprise is that the agent must have an authority to conclude contracts or should have been found to be habitually entering into or concluding contracts on behalf of the enterprise. In the present case, there is no allegation that Adobe India is authorised to conclude contracts on behalf of the Assessee or has been habitually doing so.
Therefore, in light of the above, Adobe India cannot be assumed to constitute a PE of the assessee in India.
Conclusion
The judgment of the High Court is likely to put a rest to the ongoing dispute on the quantum of profit to be attributed to a permanent establishment. Further, it has been made amply clear that, where the profits of the Indian company has been assessed to be at arm’s length (whether or not constituting a PE), the reassessment of profits of the foreign associated enterprise is not required.
Facts of the case
Gillete Diversified Operations Pvt. Ltd (“The Assessee”), a subsidiary of Gillette Group India Private Limited, is engaged in the business of manufacturing and trading of personal care products such as oral care products, hair epilating devices, electric shavers and other appliances. During the impugned year (AY 2005-06), the assessee entered into certain international transactions with its associated enterprise (“AE”) benchmarking the same by using the transaction net margin method (“TNMM”) as the most appropriate method (“MAM”) and concluding the transactions to be at arm’s length under the Indian law. The assessing officer (“AO”) referred the case to the transfer pricing officer (“TPO”) for determining the ALP of the international transactions. The assessee had selected five comparables as functionally similar to its business. However, the TPO rejected two comparables, as selected by the assessee, one for being unavailable in the database and other for having negative net worth in the year 2005. Accordingly, proposing an adjustment of INR 28,202,588 for the difference in the operating profit margin of the assessee company and the remaining comparables.
Appeal with CIT(A)
Aggrieved by the order of the AO, the assessee preferred an appeal with the commissioner of income tax (appeal) (“CIT(A)”). The CIT(A) though upheld the rejection reasons for the two excluded comparables. The ld CIT(A) held that Corporate Support services income of INR 2,187,030 and other sales of INR 1,214,675 was forming part of the total revenue for the purpose of calculation of PLI which has been excluded by TPO. Further he held that liabilities written back of provisions no longer required amounting to INR 5,566,871 cannot be part of the operating revenue for the purpose of business activities of the assessee for the year under consideration. Further while calculating PLI TPO had excluded lease rental income from operational income but has not excluded corresponding expenses of lease while working out PLI. For this the ld CIT(A) held that depreciation amounting to INR 9,877,580 pertaining to leased out asset should be excluded from the operating expenses. He further held that an amount of INR 6,496,093 being repairs and maintenance expenses pertaining to leases asset should also be excluded from operating cost. The ld CIT(A) further held that loss on sale of fixed assets of INR 1,037,445 which is in the nature of non-operating expenses should also be excluded from the operating cost of the company. Accordingly, the ld. CIT(A) partly allowed the assessee’s appeal and reduced the total transfer pricing addition to INR 7,199,984.
ITAT’s observation
Aggrieved by the order of the CIR(A), both the assessee and the department preferred an appeal with the Delhi bench of the Income Tax Appellate Tribunal (“ITAT” or “the tribunal”). On the perusal of the rejection reasons accorded by the TPO, the ITAT observed as under:
Argus Cosmetic Ltd.
Though the company is functionally similar to the business of the assessee, however, since the assessee has not been able to provide with the relevant financials of the comparable company, the TPO and the CIT(A) was right in excluding the same from the comparable list.
Muller & Phipps India Ltd.
The Tribunal pointed out that according to rule 10(B)(a), the comparability of an international transaction with an uncontrolled transaction shall be judged with respect to the functions performed, the asset employed or to be employed and the risk assumed. Further rule 10B(3) states that an international transaction shall be comparable to an uncontrolled transaction, if there exist no material difference in the prices charged or to be charged between the said transactions. The ITAT further observed that the Income Tax Rules, does not provide for any other exception for inclusion or exclusion of comparables. Therefore, the ITAT observed that the TPO/CIT(A) was not able to substantiate how the negative net worth affects the pricing policy adopted by the company. Further, the tribunal observed that, merely because the company is having negative net worth but when the FAR is comparable, it cannot be said to be non-comparable unless it is shown that how the negative net worth of the company has impacted the profitability of the comparable company. The ITAT disregarded the observations of the special bench in the case of DCIT V Quark Systems Limited[1] wherein it was held that business reorganization and negative net worth cannot be treated at par with the normal business activities, noting that in the instant case the comparables selected by the assessee were functionally not comparable. The tribunal also noted that the special bench did not expressed its opinion on comparables having similar FAR but with negative net worth is required to be excluded without showing the impact of negative net worth on the profitability of the company. Therefore, in view of the above, the tribunal ruled that M/s Muller & Phipps India Ltd. is a comparable company for the purpose of determining the arm’s length price.
Conclusion
In view of the above decision by the Delhi bench of the ITAT, it can be observed that a company with similar FAR analysis of the assessee cannot be excluded for the reason of the same having a negative net woth.
Facts of the case
Heinz India Private Limited (“the assessee”) is engaged in the business of food processing. During the impugned year, the assessee has incurred several international transactions with its AEs, namely Hienz US and Hienz Italy, towards import and export of finished goods, royalty payment, payment for support services and reimbursement paid and received. The assessee adopted the Transactional Net Margin Method (“TNMM”) as the most appropriate method (“MAM”) to benchmark the said international transactions. The benchmarking analysis adopted by the assessee was upheld by the Transfer Pricing Officer (“TPO”) during the course of assessment. However, the TPO deemed, the advertisement, marketing and promotion (“ALP”) expenses incurred by the assessee, as international transaction, being expenses incurred by the assessee to promote the brand of the AEs. Also, the TPO suo motto applied Profit Split Method (“PSM”) as the MAM to determine the arm’s length price of the AMP transactions. Alternatively, the TPO used the Bright Line Method to bifurcate the AMP expenses of the assessee as routine and non-routine. Further the TPO rejected the comparables selected by the assessee and carried out an individual search in justification of the Bright Line method.
Appeal to the DRP
Aggrieved by the draft order of the TPO, the assessee preferred an appeal with the Dispute Resolution Panel (“DRP”), stating that the AMP expenses incurred by the assessee were not an international transaction and that the assessee had incurred the AMP expenses for carrying out its own business and not to benefit the AEs. Further the assessee submitted that there was no arrangement between the assessee and the AEs to substantiate the TPO’s views that the AMP expenses incurred were indeed at the behest of the AEs.
Having considered the submissions made by the assessee, the DRP held that the assessee’s contention that the AMP expenses incurred were not international transaction, is misconceived. Further, the DRP noted that it was not the actual payment of advertising charges to third parties that had been considered by the TPO as an international transaction, that the relevant transaction was the benefit conferred by the assessee on its AEs and that section 92B of the Act included any transaction having a bearing on the profits and income of the concerned enterprises and included an arrangement between the AEs for allocation of costs incurred in connection with a benefit, service/facility provided to one or more such enterprises.
The DRP referred to the judgment of the Hon’ble Delhi High Court in the case of Maruti Suzuki India Ltd.[1] and held that even in the case of manufacturing AMP expenditure incurred in excess of what a comparable independent entity placed in the same position would have incurred would deserve some compensation from the brand owner unless it was shown that the assessee had obtained some other concession or subsidy from the AE in some form or the other which could offset the extra AMP expenses of the assessee. Finally, the DRP concluded that a portion of AMP expenses were actually conferring a benefit to the AEs which constituted an international transaction for which the assessee was entitled to compensation.
in regards to the selection of PSM as the MAM, the DRP held that, the assessee had not considered the transaction in the TP study report and that the TPO was justified in attempting to find a better methodology. The DRP, agreeing with the approach followed by the TPO, held that the method selection by the TPO was in accordance with the law laid down in Rule 10(B)(1)(d). The DRP further declined the assessee’s contention that the Bright Line was not a prescribed method under the Act, holding that the Bright Line is just a standard which is used to just the reasonable level of expenditure that would be required to be incurred by an enterprise for its own risk bearing activities.
ITAT’s observation
The ITAT observed that the assessee has incurred royalty expense towards the licences granted by the AEs to the assessee. Also, the fact that the license agreement between the assessee and the AEs were on principal-to-principal basis for the payment of royalty was not challenged by the TPO. The ITAT, accordingly, opined royalty payment is one of the criterions to hold that the assessee is an independent unit. Further, the ITAT held that assessee is having a fully operational manufacturing, marketing and distribution system in India. Further, the manufacturing unit of the assessee had shown a huge turnover (Rs.631.24 crores). Therefore, the ITAT did not find force in the arguments of the TPO /DRP that AMP expenses incurred by the assessee were primarily or secondarily aimed to benefit the AEs and that it was entitled to a reasonable compensation for such AMP expenses. Thus concluding that the expenses were incurred by the assessee to promote its own business interests. Further, the ITAT noted that the TPO has failed to prove that the real intention of the assessee in incurring AMP expenses were to benefit the AEs and not to promote its own business. The tribunal noted that the turnover of the assessee proves that during the year under consideration the assessee had done a reasonably good business. Also, the resultant profit was offered for taxation in India. Therefore, transferring of profit from India, the basic ingredient to invoke the provisions of section 92 of the Act, remains unproved.
To this affect, the ITAT cited various judgments pronounced by the Hon’ble Delhi High Court such as Maruti Suzuki, Whirlpool of India Ltd[2], Bausch & Lomb Eyecare (India) Pvt. Ltd[3] and Yum Restaurants (India) Pvt. Ltd[4]. Accordingly, the ITAT observed that, the Hon'ble Delhi High Court had categorically held that in the absence of agreement between Indian entity and foreign AE whereby the Indian entity was obliged to incur AMP expenditure of a certain level for foreign entity for the purpose of promoting the brand value of the products of the AEs, no international transaction can be presumed. It was further held that the fact that there was an incidental benefit to the foreign AE, it could not be concluded that AMP expenditure incurred by an Indian assessee was for promoting brand of foreign AE. The Hon’ble Court further held that in the absence of machinery provisions, bringing an imagined transaction to tax was not possible. While coming to this conclusion, the Hon'ble High Court had placed reliance on the decisions of B.C. Srinivasa Setty[5] and PNB Finance Ltd[6].
Considering the facts-like absence of an agreement between the assessee and the AEs for sharing AMP expenses and failure of the TPO prove that expenses were not for the business carried out by the assessee in India and following the judgments of the Hon’ble Delhi High Court delivered in the case of Bausch and Lomb (India) Pvt. Ltd (supra), the ITAT opined that the impugned AMP transactions was not an international transaction and that the TPO had wrongly invoked the provisions of Chapter X of the Act for the said transaction.
Background
The assessee’s international transactions were referred to the ld. Transfer Pricing Officer (‘TPO’) for the determination of arm’s length pricing (‘ALP’). The ld. TPO in its order found no adverse inference on the pricing of the international transactions and accordingly were accepted to be in compliance with the ALP standards. However, ld. TPO noted that assessee has not filed TP study report (documents prescribed under Rule 10D of the Income Tax Rules, 1962) in time and there were repeated non-compliances in that regard. Therefore, ld AO initiated penalty proceedings u/s 271G of the Act.
In response to the penalty notice, the assessee submitted that it has submitted the requisite documents within the prescribed time limit of 30 days and the remaining documents within the extended time period of 60 days. Thus, the assessee contented that no penalty was leviable in this scenario. The assessing officer disregarded the assessee’s submission and the same was further upheld by the CIT (A). In confirming the penalty the CIT (A) held that the collective information required under Rule 10D is called the TP Study Report and since the assessee has failed to comply with the provisions of Section 92D read with Rule 10D by failing to furnish the TP Study Report during the course of assessment. The CIT (A) further noted that though the international transactions were at arm’s length, the purpose of penalty is to ensure timely compliance of the substantive provisions of the law in which assessee has failed.
ITAT’s observations
The ITAT observed that the order of the TPO specifically mentioned that transfer pricing documentation containing functional and economic analysis prescribed under Rule 10D of the Income Tax Rules was submitted by the assessee. However, in para No.6 of the same order it is mentioned that it has been pointed already to the assessee on 03.10.2012 that tax payer did not file the TP study report (documentation prescribed under Rule 10D) in time. Provisions of Rule 10D(1) prescribes information from Sl. No.(a) to (m) required to be kept and maintained by the assessee with respect to its international transactions. During the course of assessment proceedings assessee also submitted a TP study report prepared by its Chartered Accountant The ITAT observed that the assessee did furnish all the required documents with the ld. TPO before completion of order u/s 92CA(3). Further the tribunal observed that the order of the ld. TPO did not mention any specific document on which the ld. TPO is proposing penalty u/s 271G of the Act.
It is also pertinent to note that after examination of all details the international entered into by the assessee are found to be at Arm?s length by ld. TPO. But the penalty is being levied on the assessee on account of non-furnishing of “TP Study Report” in time. On reading of Rule 10D we do not find any such nomenclature of information contained in that Rule. However, it is also a matter of common knowledge that combined information mentioned in Rule 10D is generally called “TP Study Report” which is prepared by assessee containing all the details.
The reliance was placed on the judgment of the Hon’ble Delhi High Courts in the case of Jonson Mathey[1] wherein the court noted that the TPO did not interfere and make adjustment to the international transaction therefore it can be inferred that as per documentation filed no addition was required. Further, reliance was placed on the judgment of the Delhi High Court in case of Bumi Hiway[2] wherein the High Court noted, as under, that in order to levy penalty under Section 271G
“A specific finding should be recorded on the date by which the assessee was required to furnish documents and whether documents were furnished, if not which documents were not furnished and whether any extension of time was granted by the Transfer Pricing Officer and if the required documents were then actually filed. The penalty order is bereft and devoid of the said details and, therefore, shows lack of application of mind. Transfer Pricing Officer had indicated that the Assessing Officer might initiate proceedings under Section 271G but he also did not refer to date of notice, date of furnishing of information/documents etc. There was no mandate or affirmative direction that penalty shall be imposed by the Assessing Officer, as has been observed in the first part at the penalty order.”
Similarly Hon?ble Delhi High court in case of Leroy Somer[3] has held that where there is general and substantive compliance of the provisions of Rule 10D it is sufficient.
Thus, the tribunal held that, since the Assessee has made substantial compliance before the order of the Ld. TPO and failure of the revenue to point out specifically which information was not provided by Assessee in time and most importantly based on the documentation provided by the Assessee no adjustment is proposed by the TPO and further the penalty is levied for non-furnishing “TP Study Report? which is not a specified document under Rule 10D. Therefore, no penalty is imposable in the instant case.
Facts
Toshiba India Pvt. Ltd. (“the assessee”) is engaged in the trading of consumer durable etc. and also providing representative and marketing support services to Toshiba Group Companies Worldwide (“AE”). During the impugned year, the assessee has entered into certain international transactions with its AEs. However, the expenses towards advertisement, marketing and promotion incurred by the assessee, has been analysed as a deemed international transaction by the TPO and accordingly proposed an adjustment of Rs. 71.23 crores by applying the Bright Line Test (“BLT”).
Appeal to the DRP
The assessee filed its objection with the DRP which vide its directions dated 15.12.2015 directed the TPO to exclude certain comparables and recomputed the amount of adjustment at Rs. 21.73 crores.
Assessee’s contention
The ld. counsel of the assessee at the very outset submitted that the issue under consideration needs to be set aside as the same has been decided in the case of Sony Ericsson[1] and Maruti Suzuki[2] by the Hon’ble jurisdictional High Court, wherein the Hon’ble High Court disregarded the use of BLT as a measure to appropriate the arm’s length value in case of AMP transactions.
ITAT’s Observations
The ITAT observed that the addition made by the TPO by applying the BLT approach is not sustainable and the same has been decided in the case of Sony Ericsson. Also, the tribunal disregarded the DRP’s view that the decision in case of Maruti Suzuki is not applicable in the assessee’s case as the same was rendered in context of a manufacturer.
In the Maruti Suzuki case, the assesee questioned on the eligibility of the AMP expense as an International Transaction, which earlier in the case of LG special bench[3] or Sony Ericsson were assumed as international transactions with or without the use of BLT. The high court held that, since the BLT has been negated in the case of Sony Ericsson, there is no basis on which it can be said that in the instant case of Maruti Suzuki, that there is an international transaction as a result of the AMP expense incurred. Thus, remanding the case back to the AO/TPO to decide the case based on the ratio of the Sony Ericsson case as applicable to a manufacturer.
The ITAT observed that in the case of Maruti Suzuki, though the Hon’ble High Court has decided the principle in case of a manufacturer however, the same is applicable in case of a distributor also. The observation of the ITAT is supported by the decision of the jurisdictional High Court in the case of Bausch & Lomb Eyecare[4] and Whirlpool of India[5].
In case of Whirlpool of India, the Delhi High Court observed that the Revenue is unable to demonstrate with tangible material that there is an international transaction involving AMP expenses between Whirlpool India and Whirlpool USA, thus the question of determining ALP does not arise. Further, the High Court observed that the provisions under Chapter X do envisage a ‘separate entity concept’ and merely the fact that Whirlpool USA has a financial interest in Whirlpool of India, it cannot be assumed that the AMP expenses incurred by Whirlpool of India are at the behest of its AEs.
In Bausch & Lomb case, the High Court accepted the assessee’s contention that distinction is required to be drawn between a 'function' and a 'transaction' and that every expenditure forming part of the function cannot be construed as a 'transaction'. The High Court further held that mere fact that Bausch & Lomb USA through Bausch & Lomb South Asia Inc holds 99.9% of the share of the Assessee would not lead to conclusion that mere increasing of AMP expenditure by the Assessee would involve international transaction with Bausch & Lomb USA. Thus the High Court concluded that “where the existence of an international transaction involving AMP expense with an ascertainable price is unable to be shown to exist, even if such price is nil, Chapter X provisions cannot be invoked to undertake a TP adjustment exercise” and deleted TP adjustments on account of AMP expenses.
Accordingly the ITAT considering the totality of the facts and the ratio of the case laid down by the Hon’ble High Court set aside the issue relating to the AMP expenses to the file of the AO to be considered in view of the judicial pronouncements and after providing due and reasonable opportunity of being heard to the assessee.
Conclusion
The application of the BLT to determine the quantum of adjustment on account of routine and non-routine expense has been set aside by the Hon’ble High Court in the case of Sony Ericsson. Also it is evident from the numerous pronouncements by the High Court and the ITAT, that the ALP of an international transaction shall be ascertained only by the methods prescribed under section 92C. Further, the application of BLT cannot be taken to decide the eligibility of AMP as a deemed international transaction in absence of any material document, oral or in writing, available with the revenue authorities to prove that the AMP expense so incurred by the assessee has been at the behest of its foreign AEs. Further the judgments by the High Courts also provides that since BLT is not recognized concept and in absence of any machinery provisions in Chapter X, the excessive AMP expense incurred by the assessee cannot tantamount to an international transaction.
[1] Sony Ericsson Mobile Communications India Pvt. Ltd vs. CIT [374 ITR 118 (Del)]
[2] Maruti Suzuki India Ltd. Vs CIT [ITA 110/2014 and 710/2015}
[3] L.G. Electronics India Pvt. Ltd vs. ACIT [140 ITD 41 (Del)]
[4] Bausch & Lomb Eyecare (India) Pvt. Ltd. vs. A.C.I.T. in I.T.A. No. 643 & 675/14
[5] Whirlpool of India vs. DCOT in I.T.A. 228/2015 & C.M.No. 5751/2015
The assessee objected the order of the CIT(A) of characterizing the income receivable on the rendering of marketing services by the assessee to its AE. The assessee clarified that though the marketing services were rendered during the impugned year i.e. AY 2004-05, the consideration was crystalized only in AY 2005-06 and that the interest charged by characterizing the delay in the receipt of income as loan is not tenable.
The assessee had signed a transfer pricing agreement with its Singapore branch for the marketing services provided by the Indian branch in respect of the External Commercial Borrowings. The AO noted that even though the agreement was signed on 28th March, 2005, it was retrospective in effect in as much as the services rendered from 1st August, 2003 were covered by this agreement. It was also noted that, in terms of the agreement, the assessee was entitled to “one third of interest margin, commitment fees etc.” It was also noted that even though the amount has been paid to the assessee after such a long time after the end of financial year ended 31st March, 2004, but no interest has been charged on the overdue amount. It was in this backdrop that the Assessing Office made an addition of Rs.1,46,61,695/- being remuneration for marketing services rendered during the relevant previous year, plus of Rs.9,89,176 being interest @ 7.36% on the delayed payment of this amount by the AE based in Singapore.
The CIT(A) upheld the AO’s stand and held as under:
“I have gone through the issue. It is an admitted fact that Indian Branch provided the services to Singapore Branch during the accounting period relevant to this assessment year i.e. Assessment year 2004-05. The income accrues as and when the services are provided. There is no other contingencies available to show that the income has not accrued. The appellant is following the mercantile system of accounting and hence the income is taxable in this assessment year. The TPO and the AO has very elaborately discussed the issue and come to the correct decision. I completely concur with the decision. Further Transfer Pricing Regulations are in force for this assessment year. Even if the assessee has not raised and accounted the receipts for the services rendered, the AO is empowered to determine the Arms Length Price (ALP) and determine the income. The AO has properly determined the income as per the Transfer Pricing Regulations. In view of this addition made is in order and I uphold the AO’s action.”
On subsequent appeal the tribunal noted that, the CIT(A) has erred in proceeding on the basis that the income income accrues when the services are rendered even in situation in which consideration for services so rendered is not finalised. The tribunal further noted that “It is an undisputed position that the arrangements, which include the consideration for which services were rendered, were finalised only on 28th March, 2005. Such being the undisputed position, income could not have been quantified or accrued earlier. The very foundation of impugned addition is thus devoid of legally sustainable foundation.”
In respect of levy of interest, the tribunal held that, the interest cannot be levied unless there is an unreasonable delay in realisation of the debt. However, in case where the consideration itself has not been finalized, the interest on non-receipt cannot be levied in such a case. Accordingly the tribunal held that, “The liability of interest on account of delay in payment will arise only when there is a liability to pay, and the liability to pay will arise, only when the liability has crystallized.”
Therefore, the tribunal dismissed the addition made in respect of levy of interest for non-realisation of remuneration for marketing services rendered by the assessee.