In absence of International Transaction ALP Determination not necessary

DCIT Vs Ferrero India Pvt. Ltd (ITAT Pune)

The main contention that was advanced by the assessee in this case before the Tribunal was that the existence of international transaction cannot be inferred by the T.P.O in the absence of any actual transaction and the presumption by the lower authorities that the benefit had endured to its foreign AE is merely based on the conjectures. In the absence of any agreement between the assessee and its foreign AE to incur any A & M expenses to the benefit of its foreign AE, the presumption of existence of international transaction is incorrect.

Reverting to the facts of the present case before us, the Revenue was unable to prove existence of any agreement between the assessee and the foreign AE for incurring advertisement and marketing expenses for the benefit of such foreign AE. That, no interference can be drawn as to the existence of international transaction on mere incurring excess expenditure on those items as compared to expenditure incurred by comparables as chosen by the T.P.O. The Revenue also could not demonstrate the presence of any machinery provision to compute Arm’s Length Price nor could demonstrate existence of any agreement between the assessee and its AE that the expenses on AMP was incurred for enhancing the brand value of the AE. That, even the bright line method cannot be used either to determine the existence of international transaction or ALP of international transaction. Merely because on account of expenditure incurred by the assessee the third party also benefits thereby, the expenditure cannot be disallowed. We are of the considered view in this case, there does not exist any international transaction and therefore, the question of determination of ALP of such transaction does not arise. Furthermore as we have examined from the case-law cited above, the onus is on the Revenue for establishing that there is an international transaction has not been discharged in this case. Consequently, the relief provided by the learned CIT(A) to the assessee is sustained and furthermore since there is no international transaction at all, the question of determining ALP does not exist.

FULL TEXT OF THE ORDER OF ITAT PUNE

This Appeal preferred by the Revenue and corresponding Cross Objection preferred by the assessee emanates from the order of the learned CIT(A) Pune-13, dated 28-10-2020 for the A.Y. 2011-12 as per the following grounds of appeal.

I.T.A No. 07/PUN/2021 : (Revenue’s appeal)

“1. Whether on the facts and circumstances of the case, the ld. CIT(A) is correct in holding that certain portion(90.42%) of AMP expenditure cannot constitute on international transaction?

2. Whether in the facts and circumstances of the case, the ld. CIT(A) is correct in holding that the AMP expenditure incurred in India is wholly and exclusively for the purpose of appellant‟s business, ignoring the facts that all the marketing intangibles are owned by the foreign AE and India subsidiary company is merely promoting the marketing intangibles of the overseas AEs?

C.O. No. 06/PUN/2021 filed by the assessee arising out of ITA No. 07/PUN/2021 for A.Y 2011-12

“Based on the facts and circumstances of the case, Ferrero India Private Limited (‘the Respondent’) respectfully submits its cross objections against the appeal preferred by DCIT Circle-I (I), Pune, which are without prejudice to each other:

1.1 Alleged excessive AMP expenses is not an international transaction

The learned AO, based on the order of the learned TPO, erred in law and on the facts and circumstances of the case in alleging that excessive AMP expenses incurred by the Respondent were an international transaction between the associated enterprise (‘AE’) and the Respondent.

1.2 No control exercised by AE in determining the extent or nature of AMP expenditure (no understanding or arrangement between respondent and AE to incur AMP expenditure)

The learned AO, based on the order of the learned TPO, erred in law and on the facts and circumstances of the case in not appreciating that in the absence of any understanding I arrangement between the Respondent and the AE, the AE was under no obligation to reimburse the AMP expenses incurred by the Respondent for sale of its products.

1.3 Methodology not followed as per Chapter X of the Act

The learned AO, based on the order of the learned TPO, erred in law and on the facts and circumstances of the case in applying the bright line limit as a statistical tool for determining routine and non-routine expenditure in respect of alleged AMP expenses, contravening the provisions of Chapter X of the Act.

1.4 AMP expenses incurred by the Respondent cannot be compared with well-established players

The learned AO, based on the order of the learned TPO, erred in law and on the facts and circumstances of the case in considering well-established companies as comparable companies for benchmarking AMP expenses

1.5 AMP expenses promote the products of Respondent and not ‘Ferrero ‘ brand

The learned AO, based on the order of the learned TPO, erred in law and on the facts and circumstances of the case in holding that the AMP expenses incurred by the Respondent resulted in promotion of brand owned by the AE, thereby creating marketing intangibles whose ultimate benefit inured to the AE.

1.6 No royalty charged by the AE for use of the brand name Ferrero

The learned AO, based on the order of the learned TPO, erred in law and on the facts and circumstances of the case in not considering that the Respondent has not incurred any expenses on royalty for use of the brand of the AE as compared to the comparable companies selected by the learned TPO.

1.7 AMP expenses incurred wholly and exclusively for the purpose of business of the Respondent

The learned AO, based on the order of the learned TPO, erred in law and on the facts and circumstances of the case in not appreciating that the AMP expenses were purely in respect of the Respondent’s own business requirements and that all rewards as well as risks of incurring such expenses were entirely reaped/ borne by it.

1.8 Erroneously imputing mark-up on AMP expenses

The learned AO, based on the order of the learned TPO, erred in imputing a mark-up of 18.25% on the alleged AMP expenses.

1.9 Comparable companies selected by the learned TPO for the purpose of calculating mark-up on AMP expenses are functionally different

The learned AO, based on the order of the learned TPO, erred in law and on the facts and circumstances of the case in selecting the comparables which are engaged into provision of marketing services and thus, functionally different from the Respondent, for the purpose of calculating mark-up on AMP expenses.

1.10 Incorrect margin calculations of com parables selected by learned TPO

The learned AO, based on the order of the learned TPO, erred in calculating the margins of comparable companies selected by the learned TPO for the purpose of calculating the mark-up

1.11 Separate entity of Group undertaking marketing function

On the facts and the circumstances of the case, the learned AO / learned TPO has erred in alleging the Respondent undertakes marketing activity for the Ferrero Group in spite of being clearly mentioned the Group TP policy that the said services are undertaken by a separate entity in the Ferrero Group; i.e. Ferrero Pubbligeria Sr1.

1.12 No DEMPE functions performed by Respondent

On the facts and the circumstances of the case, the learned AO / learned TPO has erred in alleging that the Respondent has undertaken provision of marketing services and hence is into provision of DEMPE functions for creation of marketing intangibles for its AEs. The learned AO and TPO has further alleged that, owning to such alleged functions the Respondent is eligible for compensation from its AEs.

1.13 Initiation of penalty proceedings

The ld. A.O erred in law and on the facts and circumstances of the case in proposing to initiate penalty proceedings section 271(1)(c) of the Act without considering the facts of the case and legal provisions of the Act.

Each one of the above grounds of appeal are independent of and without prejudice to one another.

The respondent craves leave to add, to or alter, by deletion, substitution, modification or otherwise or amend or withdraw the cross objections herein and to submit such statements, documents and papers as may be considered necessary either before or during the hearing of the appeal.”

2. At the time of hearing both the parties agreed that the facts and circumstances of the issues involved are similar and identical and therefore, the appeal and the cross objection are heard together and are disposed of by this consolidated order.

3. The brief facts of this case are as follows:

Ferrero India Private Limited (‘Assessee’) is a subsidiary of, Ferrero International S.A., Luxembourg, which is the holding company of the Ferrero Group. It was incorporated in 2 June 2004 under the Companies Act, 1956. The Company is engaged in distribution of finished goods in the Indian market. In this regard, the Company purchases finished goods, i.e., chocolates and confectionery from Associated Enterprises (‘AEs’) for distribution to agents who subsequently sell to retailers and the final consumers. During the year under consideration, the assessee filed its return of income declaring the total loss of Rs. 562,721,541/-. The return was processed for scrutiny and notice under section 143(2) of the Income-tax Act, 1961 (lithe Act”) was served on the Appellant by the AO. The AO referred the case of the assessee to the Additional Commissioner of Income Tax, Transfer Pricing Officer – 1 (2) (TPO) for determination of arm’s length price of international transactions entered into by the Assessee with its Associated Enterprises (“AEs”).

4. During AY 2011-12, the following international transactions were entered into by Assessee and its AEs:

Purchase of finished goods;

Purchase of fixed assets; and

Reimbursement of expenses paid

The above transactions were reported by the Assessee in Form 3CEB, which was filed along with the return of income for the AY 2011-12. The assessee adopted Resale Price Method (AMP) for benchmarking the major international transactions of purchase of finished goods. The gross profit on revenue earned by comparable companies from trading activity range from -0.04% to 25.89% with the arithmetic mean of 9.66%. For the year ended 31st March 2011, the Assessee earned gross margin (GP/Net sales) of 24.84% from its trading activities. Accordingly, as per the assessee, the transactions entered into with its AEs are at arm’s length price from an Indian Transfer Pricing perspective. The TPO in the order passed uls 92CA(3) treated advertising, marketing and promotions (,AMP’) expenditure paid to the third parties as service provided to its AE in the nature of promotion of the brand ‘Ferrero’. The TPO applied bright line test for the difference in ratio of AMP expenses incurred by the Assessee (18.14%) vis-a-vis the comparable companies (13.79%) and further added a mark-up of 18.25% on excess AMP expenditure incurred by the Assessee.

5. Hence, the TPO determined the arm’s length price of the above AMP expenditure as Rs. 9,82,82,571/- and made the transfer pricing adjustment. The AO in the assessment order passed uls 143(3) added the amount of transfer pricing adjustment to the assessee’s total income determining the total loss of the assessee at Rs. 46,44,38,9701- as against the returned loss of Rs. 56,27,21,541/-. The AO has also proposed to initiate penalty proceedings under section 271 (1 )(c) of the Act.

6. The AO passed the assessment order uls 143(3) r.w.s. 144C of the Act on 17.04.2015 (Received by assessee on 07.05.2015). Aggrieved by the assessment order passed by the AO, the Assessee has filed the appeal before the CIT(A) on 03.06.2015.

7. In respect of transfer pricing adjustment for AMP expenses of Rs. 9,82,82,571/-.

During the year under consideration, the A.O has observed that the assessee had entered into international transactions with ‘Associated Enterprises’. As the Value of international transaction with A.E. exceeded Rs. 15 crores, the case has been referred to the TPO after obtaining prior approval of the CIT-I, Bangalore. During the transfer pricing proceedings, the TPO observed that the assessee had entered into the following international transactions with its AEs:

The above transactions were reported by the assessee in Form 3CEB, which was filed along with the return of income for the A.Y. 2011-12.

8. The Assessee adopted Resale Price Method for benchmarking the trading activity of purchase of finished goods. The gross profit on revenue earned by comparable companies from trading activity range from -0.04% to 25.89% with the arithmetic mean of 9.66%. For the year ended 31^st March 2011, the Assessee earned gross margin (GP/Net sales) of 24.84% from its trading activities. Accordingly, as per the Assessee, the transactions entered into with its AEs are at arm’s length price from an Indian Transfer Pricing perspective.

9. The TPO in the order passed u/s 92CA(3) treated advertising, marketing and promotions (AMP) expenditure paid to the third parties as service provided to its AE in the nature of promotion of the brand ‘Ferrero’. The TPO applied bright line test for the difference in ratio of AMP expenses incurred by the Assessee (18.14%) vis-a-vis the comparable companies (13.79%) and further added a mark-up of 18.25%, on excess AMP expenditure incurred by the Assessee.

10. Hence, the TPO determined the arm’s length price of the above AMP expenditure as Rs. 9,82,82,571/- and made the transfer pricing adjustment. The AO in the assessment order passed u/s 143(3) added the amount of transfer pricing adjustment to the assessee’s total income declaring the total loss of the assessee at Rs. 46,44,38,970/- as against the returned loss of Rs. 56,27,21,541/- .

11. Broadly, before the revenue authorities, the submissions of the assessee can be summarized as follows:

12. Contention of the assessee that adjustment on account of higher AMP expenditure cannot be made in the case of the tax-payer-assessee due to the following reasons.

Advertisement, marketing and promotion (AMP) expenditure has been incurred for the benefit of the assessee.

Initial year of operation: It has been submitted that, the taxpayer started its operations recently in 2020 in India. Being in the initial stage of operation it was imperative to advertise its main products i.e. Kinder Joy and Tic Tc.

The company is operating in the hyper competitive market features by diversified range of product portfolio and established players in the FMCG Sector lime Cadbury India Limited, Hindustan Unilever Ltd. and Procter and Gamble Hygiene and health Care Ltd. These companies are established in the market and operate in the same line of business as FIPL.

The expenditure has been incurred wholly and exclusively for the purpose of business. The responsibility for achieving sales targets and contracting with vendors lies locally with FIPL. The AMP expenses were incurred by the company for expansion of its own business and to widen the market spread in India. The company is an independent risk bearing entity and any cost incurred towards advertising promotion and publicity would be for the sole benefit of FIPL. It will earn profits in the long run from the increased sales of products as a result of such marketing activities. Further, the benefits from incurring AMP expenses are evidenced from the increased sales of FIPL from year to year.

No control exercised by AE in determining the extent or nature of AMP expenditure: It has been submitted by the taxpayer that the AMP expenditure were incurred for the advertisement in India only and primarily contained local content/created for the Indian customers and that advertisement, publicity and business promotion are planned and carried out by the management of FIPL keeping in mind the local market conditions and the AMP expenditure is solely decided in India and there were no strategic or other controls or inputs of Ferrero Group on such expenditure.

AMP expenses promote the products of FIPL and not the ^„Ferrero‘ Brand.

There is no direct or indirect evidence that the AEs were benefited in any manner from the AMP expenses incurred by the Company. Benefit if any arising to the overseas AEs is nothing more than in direct/incidental.

The assessee‘s international transactions are at ALP: It has been submitted that the assessee‘s international transactions with its AEs for purchase of finished goods for resale//distribution has been benchmarked by using Resale Price Method 9RMP) as the most appropriate method and Gross Profit Marin as the profit level indicator and the international transaction of FIPL is considered to be at arm‘s length from India Transfer Pricing perspective.

No Royalty has been charged by AE for use of the Brand name: It has been submitted that generally the companies operating in this industry pays royalty for the use of brand name. Further, the rate of royalty is usually in the range of 3-4%. It is submitted that the taxpayer company has not paid any Royalty to its AE.

Alleged excessive AMP expenditure is not an international transaction. Bright Line Test cannot be applied to compute the Arm‘s Length Price.

Appropriate comparables for the comparison of AMP expenditure: It is submitted by the taxpayer that, for comparison of AMP expenses the appropriate comparables would be the distributors of MNC Brands in the same geographies and having same tenure of distribution license and further should be like assessee in the initial year of operations. It is also submitted by the taxpayer that, the assessee is in the initial year of its operations wherein the assessee has incurred higher AMP expenses to generate the Indian market and that, the companies proposed by the TPO for determining AMP expenditure are not in the initial year.

No mark-upto be charged on the alleged AMP expenses: It is has been submitted that the AMP expenditure incurred by the assessee is wholly and exclusively for its own business and neither benefit the assessee nor result in the creation of marketing intangible belonging to the AE.

Assessee is not engaged in the business of provision of marketing services.”

13. The ld. TPO opined on the basis of the decision by the Co-ordinate ITAT Special Bench, Delhi in the case of L.G. Electronics India Pvt. Ltd. Vs. ACIT Cir. 3, Noida 9ITA No. 5140/Del/2011) that incurrence of high AMP and use of foreign brand in advertisements etc. entails “understanding” for the purposes of section 92F(v) of the Act and thus constitutes a transaction. Therefore, the excess expenditure incurred by the taxpayer for Brand Promotion of its AE constitutes an international transaction. The TPO observed that though taxpayer has sold the products the ultimate beneficiary is the manufacturer whose products have been sold and therefore, the brand name of the manufacturer has been benefited. Thus, it cannot be said that the taxpayer has only been befitted out of the AMP expenses. The TPO also did not agree with the submissions of the assessee i.e. huge AMP expenses have been incurred since it was in the initial years of operation and it was also operating in the hyper competitive market with established players like Cadbury India Ltd., Hindustan Unilever Ltd. and Procter and Gamble Hygiene and health Care Ltd. Consequently, the T.P.O selected two comparable companies i.e. Cadbury India Ltd. and Hindustan Unilever Ltd., and arrived at percentage of AMP/Sales at 13.79%. The T.P.O therefore, observed that the assessee’s AMP/sales ratio is 18.14% s against average of 13.79% of the comparable companies as selected above. Therefore, the excess AMP expenditure incurred by the assessee over its comparable was 4.35% of sales amounting to Rs. 8,31,14,225/- . The TPO was of the view that this excess AMP expenditure of Rs. 8,31,14,225/- which was incurred by the assessee as against its comparables should have been actually incurred by the AE since actually the assessee spent this amount for the brand development of its AE. The TPO made total adjustment as under:

Excess AMP expenditure: Rs. 8,31,14,225/-

Mark UP  : Rs. 1,51,68,346/-

Total: Rs. 9,82,82,571/-

Thus, the TPO had made final TP adjustment of Rs. 9,82,82,571/-.

14. When the matter travelled before the CIT(A) the assessee had filed detailed written submissions which are on record and need not be repeated here again for the sake of brevity. The ld. CIT(A) after considering thesubmissions of the assessee, T.P.O/A.O’s order observed and held as follows:

3.3 I have gone through the learned TPO’s order and the elaborate submission of the appellant. It is seen from the TP order that the learned TPO has examined the Profit and Loss Account of the appellant for the relevant financial year and came to the conclusion that the expenditure of Rs 346,627,795 on account of “Advertisement and Marketing Expenses” is the main reason of the net loss of Rs 600,687.,555. However, it is also seen from his analysis that there are 2 other major expenditures, “Selling and distribution expenses of Rs 255,051,198 and salary expenditure of Rs 161,346,147, which also contributed to the loss. It is also seen that the TP order was passed before the landmark Delhi High Court decision in the case of Sony Ericsson Mobile communication India Pvt. Ltd vs CIT (ITA.No 16/2014) dtd 16.03.2015. Couple of other judicial decisions after this has also been reported by the appellant in the above paragraphs. Honourable High Court of Delhi has confirmed the revenue’s stand that AMP expenses constitute an international transaction and the TPO has jurisdiction over this. However the Court also held that application of bright line test and concept of segregation of non-routine AMP expenses lack statutory backing.

3.3.1 Before discussing any other judicial precedent, following facts emerge from the TPO’s order, then and online submission by the appellant and the audited financials.

A. The company is in its initial years of operation. Its business is in the highly competitive market of chocolates and confectionaries. As it’s the initial phase of marketing, the need for market penetration against the established players like Cadbury’s and Nestle is naturally more and thus the appellant has spent substantial proportion (18.14%) of its sales revenue during the financial year on advertising and marketing expenses.

B. The appellant has taken the argument that the AMP expenses resulted in promotion of the products like “KINDER JOY”, “TIC TAC”, NUTELLA rather than the brand “FERRERO”. To augment this, the appellant furnished the product wise AMP expenses as follows:

The above table shows that major amount of the expenditure is for the Kinder Joy and Tic Tac (90.42%), wherein the products do not exhibit the brand “Ferrero”. These products do not exhibit the brand “Ferrero” and their advertisement do not demonstrate these as part of Ferrero group. The consumers in the Indian market purchase these products because of the name of “Kinder Joy” and “Tic Tac” without knowing that these are part of the Ferrero group.

*(The cost of packing material amounting to Rs 4,957,101 was inadvertently grouped by the Appellant under total ‘advertisement and promotion expenses of Rs 346,627,795. Hence, the Appellant requested to give due consideration for the above and exclude the cost of packing material while determining the excess AMP expenses. This stand was accepted by the TPO in AY 2012-13 and AY 2013-14.

Accordingly, this amount is kept out of discussion here).

C. The advertisement campaigns were also perused and it was seen that the emphasis was on the product Kinder Joy rather than Ferrero. The primary focus of the campaign is Kinder Joy and Tic Tac rather than Ferrero. So factually, there is no AMP efforts for the brand Ferrero, rather it is on the products like Kinder Joy and Tic Tac.

D. If at a”, any AMP expenses for brand “Ferrero” is to be considered, it is for an amount of Rs 32,710,689 spent on Ferreo Rocher and Nutella. This is less than 1 0% of total AMP expenses of Rs 341,670,694.

E. It is also seen that generally the companies operating in this industry pay royalty for the use of brand name. Further, the rate of royalty is usually in the range of 3-5%. However, Appellant has not paid any royalty to its AE for the use of brand name in India. Accordingly, the Appellant has saved on the expenditure of payment of royalty to the AE. In line with the findings of Honourable Delhi ITAT in the case of BMW India Private Limited vs ACIT 126 ITD 165(2014), the honourable Delhi High Court in the case of Sony Ericsson case held that separate remuneration for the AMP activities may not be required if such compensation is already provided by way of lower purchase price or reduced payment of Royalty. It is seen that the comparables taken by the learned TPO for application of “Bright line test” have paid average royalty at the rate of 3.43% of the sales during the year in contrast with nil payment by the appellant.

F. FAR analysis (Functions performed, assets employed and risks assumed) of the appellant and its AEs submitted by the appellant in above paragraphs show that appellant did not undertake DEMPE functions (Development, Enhancement, Maintenance, Protection and exploitation of Intangibles), rather there is a separate entity of FERRERO group called Pubbligeria which is engaged in enhancement, Maintenance and protection functions. The appellant’s risk is limited to the products sold in India, it is involved in the design and control of research and marketing programs for local sales in India and local advertisements or products sold in India.

G. As the appellant has incurred heavy losses in the initial years of its operations in India, the AEs have given adequate capital support by way of infusion of share capital amounting to Rs 630,305,000 during the financial year. The continued support is again manifested in further receipt of share application money amounting to Rs 640,600,000, subsequent to the year end, on 6.7.2011 as per the “Notes to the accounts” to the audited financials.

3.3.2 Thus, the findings can be summarized as follows:

The major part of the AMP expenditure worth Rs 308,960,005 out of total of Rs 341,670,694 promote the products and not the brand “FERRERO”. Therefore as per the above discussions and judicial precedents, this portion (90.42%) can not constitute an international transaction. The learned TPO has failed to establish the existence of any “understanding” or an “arrangement” or “action in concert”between the appellant and the AEs for incurring of AMP expenses for brand building. It can be safely concluded that the AMP expenditure incurred in India is wholly and exclusively for the purpose of appellant’s business. All the rewards as well as risks of incurring such expenses were entirely reaped by the appellant and any benefit to the AEs was incidental. However these are based on the factual matrix concerned with the relevant year only. As transfer pricing exercise is highly fact sensitive, the conclusions pertain to this year only.

As the basic appeal has been allowed, the grounds no. 2.8 to 2.10 become academic and not commented upon. Transfer pricing adjustment of Rs.98,282,571 is deleted.

Accordingly, the appeal of the appellant is allowed.”

15. It was examined by the ld. CIT(A) that whatever AMP was incurred by the assessee was for promotion of its products and not the brand of its AE. It was also examined and held by the ld. CIT(A) that such AMP expenditure in India was wholly and exclusively for the purposes of assessee’s business. All the rewards as well as risks of incurring such expenses were entirely reaped by the assessee and any benefit to the AEs was incidental. Therefore, the ld. CIT(A) held that 90.42% of the AMP expenditure does not constitute of international transaction. The entire T.P adjustment of Rs. 9,82,82,571/- was also deleted. The learned CIT(A) held that even the application of bright line test and concept of segregation of non-routine AMP expenses lack statutory backing. However, the very fact that only 90.42% of the AMP expenses does not constitute international transaction in fact on a corollary means that the remaining percentage constitutes international transaction in respect of excessive AMP expenditure and the appeal was partly allowed. It is in this background that the assessee had filed Cross Objection submitting that in its case there is no question of international transaction at all since prima facie the revenue was unable to discharge its onus of establishing international transaction in respect of the assessee. Rather, there was no machinery nor any specific agreement through which the revenue could establish that there was an international transaction. The assessee in this regard placed heavy reliance on the decision of Hon’ble Delhi High Court in the case of Maruti Suzuki India Ltd. Vs. CIT 381 ITR 117 (Del).

16. We find that the Co-ordinate Bench Pune in the case of Kimberly Clark Lever P. Ltd. Vs. ACIT in ITA No. 2481/PUN/2012 for A.Y. 2008-09, order dated 22-02-2021 relied on the decision of Hon’ble Delhi High Court in the case of Maruti Suzuki India Ltd. (supra) wherein the Tribunal was faced with an identical issue. There was an addition on account of T.P adjustment of Rs. 32,63,66,267/- in respect of AMP expenses incurred by the assessee. The T.P.O as well as D.R.P inferred the existence of international transaction on noticing that the assessee had incurred excess expenditure on A & M expenses as compared to the expenses incurred by the comparables which is chosen by the T.P.O and then proceeded to make adjustment of difference in order to determine the value of such A & M expenses incurred by the A.E In the process the T.P.O as well as D.R.P presumed that both of these expenses had endured to its foreign AE. The main contention that was advanced by the assessee in this case before the Tribunal was that the existence of international transaction cannot be inferred by the T.P.O in the absence of any actual transaction and the presumption by the lower authorities that the benefit had endured to its foreign AE is merely based on the conjectures. In the absence of any agreement between the assessee and its foreign AE to incur any A & M expenses to the benefit of its foreign AE, the presumption of existence of international transaction is incorrect. The Tribunal thereafter referred to the decision of co-ordinate Bench of Bangalore in the case of Essilor India Ltd. Vs. DCIT, (supra) wherein they have referred to the decision of Hon’ble Delhi High Court in the case of Maruti Suzuki India Ltd. (supra) and held as follows:

“19. In the present case, the assessee-company imports the lens from its foreign AE and after some processing, sells the products on its own. However, the amount of value addition on account of processing in terms of total revenue is not clear from the material on record. That apart, the assessee-company has been throughout contesting before all the authorities the very existence of international transaction on account of incurring AMP expenditure between assessee-company and its AE and therefore, the contentions that the law laid down by the Hon‘ble Delhi High Court in Sony Ericsson Mobile Communication India (P) Ltd. (supra) should be applied to the case on hand, is not correct. Therefore, the submission of the learned Departmental Representative that the matter be remanded to the file of TPOD for fresh decision in the light of law laid down by the Hon‘ble Delhi High Court in the case of Sony Ericsson Mobile Communication India (P) Ltd.(supra), cannot be acceded to.

20. Subsequent to the decision in the case of Sony Ericsson Mobile Communication India (P) Ltd. (supra), the Hon’ble Delhi High Court had rendered five decisions on the same issue. Those decisions are:

(i) Maruti Suzuki India Ltd. Vs. CIT (282 CTR 1),

(ii) CIT vs. Whirlpool of India Ltd. (129 DTR (169),

(iii) Bausch & Lomb Eyecare (India) (P) Ltd. Vs. Addl. CIT (129 DTR 201) and

(iv) Yum Restaurants (India) Pvt. Ltd. Vs. ITO (ITA No.349/2015 dated 13/01/2016) and

(v) Honda SeilProducts

In the above-mentioned decisions, the issue of the very existence of international transaction on incurring AMP expenditure and the method of determination of ALP was the subject matter of appeal before the Hon‟ble Delhi High Court. 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 foreign entity, no international transaction can be presumed. It was further held that the fact that there was an incidental benefit to the foreign AE, it cannot be said that AMP expenditure incurred by an Indian entity was for promoting brand of foreign AE. One more aspect highlighted by the Hon‟ble High Court is 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 the Hon‟ble Apex Court in the cases of CIT vs. B.C.Srinivasa Setty (128 ITR 294) and PNB Finance Ltd. Vs. CIT (307 ITR 75). The Hon‟ble Delhi High Court after referring to its earlier decision in the case of Maruti Suzuki India Ltd (supra) and Whirlpool of India (P) Ltd.,(supra) had considered the question of existence of the international transaction and computation of ALP thereon in the case of Bausch & Lomb Eyecare (India) (P) Ltd.(supra) vide para 51 to 65 as under:

“51. The central issue concerning the existence of an international transaction regarding AMP expenses requires the interpretation of provisions of Chapter X of the Act, and to determine whether the Revenue has been able to show prima facie the existence of international transaction involving AMP between the Assessee and its AE.

52. At the outset, it must be pointed out that these cases were heard together with another batch of cases, two of which have already been decided by this Court. The two decisions are the judgement dated 11th December 2015 in ITA No. 110/2014 (Maruti Suzuki India Ltd. v. Commissioner of Income Tax) and the judgment dated 22nd December 2015 in ITA No. 610 of 2014 (The Commissioner of Income Tax-LTU v. Whirlpool of India Ltd.) and many of the points urged by the counsel in these appeals have been considered in these two judgments.

53. A reading of the heading of Chapter X [“Computation of income from international transactions having regard to arm’s length price”] and Section 92 (1) which states that any income arising from an international transaction shall be computed having regard to the ALP and Section 92C (1) which sets out the different methods of determining the ALP, makes it clear that the transfer pricing adjustment is made by substituting the ALP for the price of the transaction. To begin with there has to be an international transaction with a certain disclosed price. The transfer pricing adjustment envisages the substitution of the price of such international transaction with the ALP.

54. Under Sections 92B to 92F, the pre-requisite for commencing the TP exercise is to show the existence of an international transaction. The next step is to determine the price of such transaction. The third step would be to determine the ALP by applying one of the five price discovery methods specified in Section 92C. The fourth step would be to compare the price of the transaction that is shown to exist with that of the ALP and make the TP adjustment by substituting the ALP for the contract price.

55. Section 92B defines ^„international transaction‟ as under: “Meaning of international transaction. 92B.(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. (2) A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes of sub-section (1), be deemed to be a transaction entered into between two associated enterprises, if there exists a prior agreement in relation to the relevant transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise.”

56. Thus, under Section 92B(1) an ‘international transaction’ means- (a) a transaction between two or more AEs, either or both of whom are non­resident (b) the transaction is in the nature of purchase, sale or lease of tangible or intangible property or provision of service or lending or borrowing money or any other transaction having a bearing on the profits, incomes or losses of such enterprises, and (c) shall include a mutual agreement or arrangement between two or more AEs for allocation or apportionment or contribution to the any cost or expenses incurred or to be incurred in connection with the benefit, service or facility provided or to be provided to one or more of such enterprises.

57. Clauses (b) and (c) above cannot be read disjunctively. Even if resort is had to the residuary part of clause (b) to contend that the AMP spend of BLI is “any other transaction having a bearing” on its “profits, incomes or losses”, for a ‘transaction’ there has to be two parties. Therefore for the purposes of the ‘means’ part of clause (b) and the ‘includes’ part of clause (c), the Revenue has to show that there exists an ‘agreement’ or ‘arrangement’ or ‘understanding’ between BLI and B&L, USA whereby BLI is obliged to spend excessively on AMP in order to promote the brand of B&L, USA. As far as the legislative intent is concerned, it is seen that certain transactions listed in the Explanation under clauses (i) (a) to (e) to Section 92B are described as an ‘international transaction’. This might be only an illustrative list, but significantly it does not list AMP spending as one such transaction.

58. In Maruti Suzuki India Ltd. (supra) one of the submissions of the Revenue was: “The mere fact that the service or benefit has been provided by one party to the other would by itself constitute a transaction irrespective of whether the consideration for the same has been paid or remains payable or there is a mutual agreement to not charge any compensation for the service or benefit.” This was negatived by the Court by pointing out: “Even if the word ‘transaction’ is given its widest connotation, and need not involve any transfer of money or a written agreement as suggested by the Revenue, and even if resort is had to Section 92F (v) which defines ‘transaction’ to include ‘arrangement’, ‘understanding’ or ‘action in concert’, ‘whether formal or in writing’, it is still incumbent on the Revenue to show the existence of an ‘understanding’ or an ‘arrangement’ or ‘action in concert’ between MSIL and SMC as regards AMP spend for brand promotion. In other words, for both the ‘means’ part and the ‘includes’ part of Section 92B (1) what has to be definitely shown is the existence of transaction whereby MSIL has been obliged to incur AMP of a certain level for SMC for the purposes of promoting the brand of SMC.”

59. In Whirlpool of India Ltd. (supra), the Court interpreted the expression “acted in concert” and in that context referred to the decision of the Supreme Court in Daiichi Sankyo Company Ltd. v. Jayaram Chigurupati 2010(6) MANU/SC/0454/2010, which arose in the context of acquisition of shares of Zenotech Laboratory Ltd. by the Ranbaxy Group. The question that was examined was whether at the relevant time the Appellant, i.e., Daiichi Sankyo Company and Ranbaxy were “acting in concert” within the meaning of Regulation 20(4) (b) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997. In para 44, it was observed as under:

“The other limb of the concept requires two or more persons joining together with the shared common objective and purpose of substantial acquisition of shares etc. of a certain target company. There can be no “persons acting in concert” unless there is a shared common objective or purpose between two or more persons of substantial acquisition of shares etc. of the target company. For, de hors the element of the shared common objective or purpose the idea of “person acting in concert” is as meaningless as criminal conspiracy without any agreement to commit a criminal offence. The idea of “persons acting in concert” is not about a fortuitous relationship coming into existence by accident or chance. The relationship can come into being only by design, by meeting of minds between two or more persons leading to the shared common objective or purpose of acquisition of substantial acquisition of shares etc. of the target company. It is another matter that the common objective or purpose may be in pursuance of an agreement or an understanding, formal or informal; the acquisition of shares etc. may be direct or indirect or the persons acting in concert may cooperate in actual acquisition of shares etc. or they may agree to cooperate in such acquisition. Nonetheless, the element of the shared common objective or purpose is the sine qua non for the relationship of “persons acting in concert” to come into being.”

60. The transfer pricing adjustment is not expected to be made by deducing from the difference between the ‘excessive’ AMP expenditure incurred by the Assessee and the AMP expenditure of a comparable entity that an international transaction exists and then proceeding to make the adjustment of the difference in order to determine the value of such AMP expenditure incurred for the AE. In any event, after the decision in Sony Ericsson (supra), the question of applying the BLT to determine the existence of an international transaction involving AMP expenditure does not arise.

61. There is merit in the contention of the Assessee that a 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’. Further, the Revenue’s attempt at re- characterising the AMP expenditure incurred as a transaction by itself when it has neither been identified as such by the Assessee or legislatively recognised in the Explanation to Section 92 B runs counter to legal position explained in CIT v. EKL Appliances Ltd. (supra) which required a TPO “to examine the ^„international transaction‟ as he actually finds the same.”

62. In the present case, the mere fact that B&L, USA through B&L, South Asia, Inc holds 99.9% of the share of the Assessee will not ipso facto lead to the conclusion that the mere increasing of AMP expenditure by the Assessee involves an international transaction in that regard, with B&L, USA. A similar contention by the Revenue, namely, that even if there is no explicit arrangement, the fact that the benefit of such AMP expenses would also enure to the AE is itself sufficient to infer the existence of an international transaction has been negatived by the Court in Maruti Suzuki India Ltd. (supra) as under: “

68. The above submissions proceed purely on surmises and conjectures and if accepted as such will lead to sending the tax authorities themselves on a wild-goose chase of what can at best be described as a ‘mirage’. First of all, there has to be a clear statutory mandate for such an exercise. The Court is unable to find one. To the question whether there is any ‘machinery’ provision for determining the existence of an international transaction involving AMP expenses, Mr. Srivastava only referred to Section 92F (ii) which defines ALP to mean a price “which is applied or proposed to be applied in a transaction between persons other than AEs in uncontrolled conditions”. Since the reference is to ^„price‟ and to ^„uncontrolled conditions‟ it implicitly brings into play the BLT. In other words, it emphasises that where the price is something other than what would be paid or charged by one entity from another in uncontrolled situations then that would be the ALP. The Court does not see this as a machinery provision particularly in light of the fact that the BLT has been expressly negatived by the Court in Sony Ericsson. Therefore, the existence of an international transaction will have to be established de hors the BLT………..

70. What is clear is that it is the ‘price’ of an international transaction which is required to be adjusted. The very existence of an international transaction cannot be presumed by assigning some price to it and then deducing that since it is not an ALP, an ‘adjustment’ has to be made. The burden is on the Revenue to first show the existence of an international transaction. Next, to ascertain the disclosed ‘price’ of such transaction and thereafter ask whether it is an ALP. If the answer to that is in the negative the TP adjustment should follow. The objective of Chapter X is to make adjustments to the price of an international transaction which the AEs involved may seek to shift from one jurisdiction to another. An ‘assumed’ price cannot form the reason for making an ALP adjustment.”

71. Since a quantitative adjustment is not permissible for the purposes of a TP adjustment under Chapter X, equally it cannot be permitted in respect of AMP expenses either. As already noticed hereinbefore, what the Revenue has sought to do in the present case is to resort to a quantitative adjustment by first determining whether the AMP spend of the Assessee on application of the BLT, is excessive, thereby evidencing the existence of an international transaction involving the AE. The quantitative determination forms the very basis for the entire TP exercise in the present case. …….  

72. The problem with the Revenue’s approach is that it wants every instance of an AMP spend by an Indian entity which happens to use the brand of a foreign AE to be presumed to involve an international transaction. And this, notwithstanding that this is not one of the deemed international transactions listed under the Explanation to Section 92B of the Act. The problem does not stop here. Even if a transaction involving an AMP spend for a foreign AE is able to be located in some agreement, written (for e.g., the sample agreements produced before the Court by the Revenue) or otherwise, how should a TPO proceed to benchmark the portion of such AMP spend that the Indian entity should be compensated for?

63. Further, in Maruti Suzuki India Ltd. (supra) the Court further explained the absence of a ‘machinery provision qua AMP expenses by the following analogy:

75. As an analogy, and for no other purpose, in the context of a domestic transaction involving two or more related parties, reference may be made to Section 40 A (2) (a) under which certain types of expenditure incurred by way of payment to related parties is not deductible where the AO “is of the opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods.” In such event, “so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction.” The AO in such an instance deploys the ‘best judgment’ assessment as a device to disallow what he considers to be an excessive expenditure. There is no corresponding ‘machinery’ provision in Chapter X which enables an AO to determine what should be the fair ‘compensation’ an Indian entity would be entitled to if it is found that there is an international transaction in that regard. In practical terms, absent a clear statutory guidance, this may encounter further difficulties. The strength of a brand, which could be product specific, may be impacted by numerous other imponderables not limited to the nature of the industry, the geographical peculiarities, economic trends both international and domestic, the consumption patterns, market behaviour and so on. A simplistic approach using one of the modes similar to the ones contemplated by Section 92C may not only be legally impermissible but will lend itself to arbitrariness. What is then needed is a clear statutory scheme encapsulating the legislative policy and mandate which provides the necessary checks against arbitrariness while at the same time addressing the apprehension of tax avoidance.”

64. In the absence of any machinery provision, bringing an imagined transaction to tax is not possible. The decisions in CIT v. B.C. Srinivasa Setty (1981) 128 ITR 294 (SC) and PNB Finance Ltd. v. CIT (2008) 307 ITR 75 (SC) make this position explicit. Therefore, 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.

65. As already mentioned, merely because there is an incidental benefit to the foreign AE, it cannot be said that the AMP expenses incurred by the Indian entity was for promoting the brand of the foreign AE. As mentioned in Sassoon J David (supra) “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 way of a deduction under Section 10 (2) (xv) of the Act (Indian Income Tax Act, 1922) if it satisfies otherwise the tests laid down by the law”.

21. Respectfully following the ratio of the decision of the Hon‘ble Delhi High Court in the above cases, we hold that no TP adjustment can be made by deducing from the difference between AMP expenditure incurred by assessee company and AMP expenditure of comparable entity, if there is no explicit arrangement between the assessee-company and its foreign AE for incurring such expenditure. The fact that the benefit of such AMP expenditure would also enure to its foreign AE is not sufficient to infer existence of international transaction. The onus lies on the revenue to prove the existence of international transaction involving AMP expenditure between the assessee- company and its foreign AE. We also hold that that in the absence of machinery provisions to ascertain the price incurred by the assessee-company to promote the brand values of the products of the foreign entity, no TP adjustment can be made by invoking the provisions of Chapter X of the Act.

22. Applying the above legal position to the facts of the present case, it is not a case of revenue that there existed an arrangement and agreement between the assessee-company and its foreign AE to incur AMP expenditure to promote brand value of its products on behalf of the foreign AE, merely because the assessee-company incurred more expenditure on AMP compared to the expenditure incurred by comparable companies, it cannot be inferred that there existed international transaction between assessee-company and its foreign AE. Therefore, the question of determination of ALP on such transaction does not arise. However, the transaction of expenditure on AMP should be treated as a part of aggregate of bundle of transactions on which TNMM should be applied in order to determine the ALP of its transactions with its AE. In other words, the transaction of expenditure on AMP cannot be treated as a separate transaction. In the present case, we find from the TP study that the operating profit cost to the total operating cost was adopted as Profit Level Indicator which means that the AMP expenditure was not considered as a part of the operating cost. This goes to show that the AMP expenditure was not subsumed in the operating profitability of the assessee-company. Therefore, in order to determine the ALP of international transaction with its AE, it is sine qua non that the AMP expenditure should be considered as a part of the operating cost. Therefore, we restore the issue of determination of ALP, on the above lines, to the file of the AO/TPO. The grounds of appeal raised by the assessee-company on this issue are partly allowed.”

34. Thus, the ratio laid down by the Hon‘ble Delhi High Court in the case of Maruti Suzuki India Ltd. (supra) is reiterated in series of decisions like Bausch and Lomb Eyecare (India) Pvt. Ltd., 381 ITR 227 and the Hon‘ble Rajasthan High Court followed the decision in the case CIT vs. Gillette India Ltd. (2019) 411 ITR 459 and the Hon‘ble High Court had categorically ruled out the applicability of bright line test on advertising and marketing promotion expenditure. The ratio that can be culled out in all the decisions cited above is that (1) In the absence of any agreement between the assessee and its foreign AE to incur the advertising and marketing expenses to the benefit of foreign AE, no inference can be drawn as to existence of international transaction on mere incurring excess expenditure on those items as compared to expenditure incurred by comparables. (2) Furthermore, in the absence of any machinery provisions to compute the arm‘s length provision, the provision of Chapter X cannot be invoked. (3) The initial burden lies upon the revenue to show the evidence of international transaction with reference to material on record. (4) The bright line test method cannot be used either to determine the existence of international transaction or arm‘s length price of international transaction. (5) Merely because, on account of expenditure incurred by an assessee, third party also benefits thereby, expenditure cannot be disallowed.”

17. Reverting to the facts of the present case before us, the Revenue was unable to prove existence of any agreement between the assessee and the foreign AE for incurring advertisement and marketing expenses for the benefit of such foreign AE. That, no interference can be drawn as to the existence of international transaction on mere incurring excess expenditure on those items as compared to expenditure incurred by comparables as chosen by the T.P.O. The Revenue also could not demonstrate the presence of any machinery provision to compute Arm’s Length Price nor could demonstrate existence of any agreement between the assessee and its AE that the expenses on AMP was incurred for enhancing the brand value of the AE. That, even the bright line method cannot be used either to determine the existence of international transaction or ALP of international transaction. Merely because on account of expenditure incurred by the assessee the third party also benefits thereby, the expenditure cannot be disallowed. We are of the considered view in this case, there does not exist any international transaction and therefore, the question of determination of ALP of such transaction does not arise. Furthermore as we have examined from the case-law cited above, the onus is on the Revenue for establishing that there is an international transaction has not been discharged in this case. Consequently, the relief provided by the learned CIT(A) to the assessee is sustained and furthermore since there is no international transaction at all, the question of determining ALP does not exist.

18. In view thereof, the appeal filed by the Revenue in ITA No. 07/PUN/2021 is dismissed and the C.O filed by the assessee in C.O. 06/PUN/2021 is allowed.

Order pronounced on this 06^th day of July 2022.