Delhi Tribunal rules on aggregation of closely-linked transactions and characterisation of reimbursement of advertisement expenses
Court elhi bench of the Income-tax Appellate Tribunal
Citation : M/s Panasonic India Pvt Ltd Vs. Income Tax Officer (2010-TII-47-ITAT-DEL-TP)
Brief :Recently, the Delhi bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of M/s Panasonic India Pvt Ltd Vs. Income Tax Officer (2010-TII-47-ITAT-DEL-TP), has upheld the aggregation of transactions where the Functions, Assets & Risks underlying those transactions are similar. The Tribunal also concluded that reimbursement of advertisement expenses received by a Distributor from its Associated Enterprise (AE) must be treated as operating income for computing profitability of the taxpayer under the Transactional Net Margin Method (TNMM) method.
Further, the Tribunal accepted the taxpayer’s claim of relying upon multiple year financial data, both in the case of the taxpayer and the comparable companies, as the taxpayer was able to demonstrate that a fall in its profitability in the year under examination was attributable to business dynamics.
Facts of the case
- · The taxpayer is an Indian company engaged in the business of trading of household appliances, consumer electronics, office automation and telecommunication products and provision of agency services. During Financial year (FY) 200 1-02, the taxpayer operated in three segments:
o Consumer Product Division (CPD);
o System Products Division (SPD); and
o Industrial Sales Division (ISD).
- ·In respect of CPD and SPD Division, the taxpayer was characterised as a typical distributor while in relation to the ISD segment, it acted as an agency service provider. In the Transfer Pricing documentation, the taxpayer aggregated the CPD and SPD segments and benchmarked them under the TNMM with Net Profit Margin (NPM) as the profit level indicator (PLI). The ISD segment was also benchmarked under TNMM, though with Net Cost Plus mark-up (NCP) as the PLI.
- ·During the course of Transfer Pricing assessment proceedings, the Transfer Pricing Officer (TPO) proposed Transfer Pricing adjustment based on the following observations:
o The TPO rejected the aggregation of CPD and SPD divisions owing to differences in products and target customer group of the two divisions. He further segregated the CPD division into CPD (Local) and CPD (Imported Goods);
o The TPO characterised the reimbursement of advertisement expenditure received by the taxpayer from its AE as non-operating income; and
o In respect of the ISD segment, the TPO disregarded the rationale provided by the taxpayer that the losses in this segment were attributable to low volumes owing to specific industry dynamics.
- Aggrieved by the order of the Assessing Officer (AO), the taxpayer filed an appeal with the Commissioner of Income Tax (Appeals) [CIT(A)] which affirmed the adjustment proposed by the AO.
The Tribunal, after considering rival submissions and perusing the material on record, rejected the order of the CIT(A) and ruled in favour of the taxpayer. The key aspects of Tribunal’s order are summarized below:
- The Tribunal affirmed the aggregation of the CPD (Imported Goods) and the SPD divisions primarily based on the following assertions:
o The Functions, Assets & Risks analysis underlying the two divisions were similar; and
o The TPO had relied on the same set of comparables for benchmarking the disaggregated segment
- Secondly, it was held that as the taxpayer has been receiving reimbursement of advertisement expenditure for the past few years, the taxpayer was in reasonable expectation of receiving such reimbursement even in FY2001-02, even though there were no written contractual terms in this regard. Therefore, such reimbursement was directly linked to the business of the taxpayer and could not be disregarded while calculating taxpayer’s income under the TNMM method.
- In respect of the ISD division (agency business), the Tribunal accepted the use of multiple year data for both the taxpayer and the comparable companies. The Tribunal observed that the losses incurred by the taxpayer in the current year on account of low volumes satisfy the provisio to Rule 10B(4) which provides for use of two years data prior to the relevant financial year where a taxpayer can demonstrate that such data reveals facts which have an influence on the determination of transfer prices for the year in question.
- The Tribunal rejected the taxpayer’s contention for relying upon the valuation done by the Special Valuation Bench (SVB) of the Custom Department to justify arm’s length character under the Income Tax Act observing that where specific rules of law exist in the statute on a particular subject, they would hold the field.
The Ruling re-affirms the view that transactions, with contiguous Functions, Assets & Risks Analysis, can be aggregated. Further, the Tribunal has ruled that SVB’s valuation cannot be relied upon for ascertaining compliance with the arm’s length price under the Transfer Pricing Regulations.