Brief of the Case
Delhi High Court held In the case of Honda Siel Power Products Ltd. vs. DCIT that the Court is satisfied that in the present case, the Assesses is carrying on business as an independent enterprise and is incurring AMP expenses for its own benefit and not at the behest of the AE. The benefit of creation of marketing intangibles for the foreign AE on account of AMP expenses can at best said to be incidental. There is nothing to indicate that the AMP expenses incurred by the Assesses are at the instance of foreign AE and that the Assesses has to be compensated by the foreign AE in that behalf. The Revenue has not been able to demonstrate that there exists an international transaction involving the Assesses and a foreign AE on the question of AMP expenses.
Facts of the Case
The Assesses, Honda Siel Power Products Ltd. (HSPP), is engaged both in the manufacture of licensed products as well as the distribution of goods manufactured by its associated enterprises. The Assesses is engaged in the business of manufacturing of portable generating sets, IC engines, water pumping sets and manufacturing and processing of pressure die casting parts. The HONDA trademark is owned by Overseas Associated Enterprise (AE), i.e. Honda Motor Company, Japan (‘Honda Japan’). During the AY in question, the Assesses entered into the various international transactions with its AE.
The Assesses filed its return of income for the AY in question on 30th September, 2008, declaring a total income of Rs. 37,15,72,026. The return was picked up for scrutiny and notices under Sections 143(2) and 142(1) of the Income Tax Act, 1961 (‘Act’) were issued. During the course of the assessment proceedings, the Assessing Officer invoked Section 92CA (1). The total advertisement, marketing and sales promotion (‘AMP’) expenses of the Assesses was Rs. 12,39,19,327/-, which was 4.46 per cent of its sales.
The TPO benchmarked the AMP expenses incurred by the Appellant, by applying the Bright Line Test, and compared the percentage of such expenses incurred to total sales of the Appellant with that of comparable companies. It was found that the AMP expenses of the Assesses as a percentage of sales at 4.46 per cent was higher than 1.87 per cent incurred by the comparable companies. The TPO concluded that the AMP expenses incurred by the Appellant, in excess of the Bright Line must be regarded as having been incurred for promoting the brand name HONDA and further that this was for creating marketing intangibles owned by the AE and for which the Appellant was required to be suitably compensated by the AE. The TPO passed an order dated 28th October, 2011 determining the ALP of the Assessee’s international transactions with respect to AMP expenses. The TPO further charged a mark-up of 15% and accordingly made a Transfer Pricing (TP) adjustment inter alia of Rs. 8,27,61,669/- on account of AMP expenses. The TPO also passed a rectification order dated 12th January, 2012 wherein it restricted the dis allowance of royalty paid to Rs. 53.34 lakhs instead of the inadvertent figure of Rs. 1.53 Crore, as stated in the order.
The Dispute Resolution Panel (‘DRP’) by an order dated 24th September, 2012 negated the objections to the draft assessment order by the Assesses and sustained the TP adjustment in respect of AMP expenses proposed by the TPO. The AO then completed the adjustment and passed the final assessment order on 31st October, 2012 inter alia making an addition of the said sum of Rs. 8,27,61,669/- on account of TP adjustment in respect of the AMP expenses.
Contention of the Assesses
The ld counsel of the assesses submitted that the payment of royalty fee for the HONDA trademark are separately benchmarked by the Assesses. That is not the subject matter of the dispute in the present case. It is further pointed out that the agreement where under license has been granted to the Assesses, does not contain any stipulation concerning the promotion of the brand name HONDA or for incurring AMP expenses for that purpose. There is, according to the Assesses, no tangible material to show that any arrangement or understanding, even an informal one, exists between the Assesses and its foreign AE in relation to AMP expenses.
Contention of Revenue
The ld counsel of the revenue submitted that there is no dispute that the Assesses is engaged in developing and maintenance of brand/trade name in India. A reference is made by the Revenue to the Export Agreement where under the Assesses has been granted rights to export products to certain ‘permitted countries’ for payment of royalty of 8 per cent of the export price, which was subsequently raised to 12.25 per cent from 1st February 2008. Honda, Japan reserved the right to change the permitted countries at any time. According to the Revenue this indicates that the Assesses has not been an independent manufacturer and is only functioning as a contract manufacturer for the AE. It is also pointed out that the list of countries to which export is permitted by Honda, Japan included the countries falling in the same geographical location as India. It is stated that the terms of the agreement with such distributors in other countries “could have worked as a sound comparable” but that the Assesses had not chosen to make any such attempt in its TP documentation.
Held by ITAT
The ITAT followed the decision of the special bench in LG Electronics India Pvt. Ltd. v. ACIT (2013) 140 ITD 41 (Del) and referred the matter back to the assessing authority for fresh consideration. In this case it was held that (i) A TP adjustment in relation to AMP expenses incurred by the Assesses for creating and improving the marketing intangibles for its foreign AE was permissible. (ii) Earning the mark up from the AE in respect of AMP expenses incurred by the foreign AE was also allowed. The majority of the ITAT adopted the BLT for determining the existence of an international transaction involving AMP expenses as well as for determining its ALP. If the expense incurred by the Assesses on AMP was higher than what was incurred by an independent entity behaving in a commercially rational manner, then the TPO would determine whether the said transaction required re-characterization. If the Assesses failed to supply the details of the value of such international transaction, the onus was on the TPO to determine its ALP it on some rational basis by identifying the comparable domestic cases. It was further held that the initial burden to show that the international transaction with the AE was at ALP was on the Assesses.
Held by High Court
Existence of an international transaction
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.
To begin with there has to be an international transaction with a certain disclosed price. The TP adjustment envisages the substitution of the price of such international transaction with the ALP. The TP adjustment is not expected to be made by deducing from the difference between the ‘excessive’ AMP expenditure incurred by the Assesses and the AMP expenditure of a comparable entity that an international transaction exists and then proceed to make the adjustment of the difference in order to determine the value of such AMP expenditure incurred for the AE. It is for the above reason that the BLT has been rejected as a valid method for either determining the existence of international transaction or for the determination of ALP of such transaction. Although, under Section 92B read with Section 92F (v), an international transaction could include an arrangement, understanding or action in concert, this cannot be a matter of inference. There has to be some tangible evidence on record to show that two parties have “acted in concert”.
In the present case, in the absence of there being an international transaction involving AMP spend with an ascertainable price, even if such price were to be nil, neither the substantive nor the machinery provision of Chapter X are applicable to the transfer pricing adjustment exercise. The Court is satisfied that in the present case, the Assesses is carrying on business as an independent enterprise and is incurring AMP expenses for its own benefit and not at the behest of the AE. The benefit of creation of marketing intangibles for the foreign AE on account of AMP expenses can at best said to be incidental. The decision in Sony Ericsson (2015) 374 ITR 118 (Del) acknowledges that an expenditure cannot be disallowed wholly or partly because it incidentally benefits the third party. This was in context of Section 37(1).
Also the OECD Transfer Pricing Guidelines, para 7.13 emphasises that there should not be any automatic inference about an AE receiving an entity group service only because it gets an incidental benefit for being part of a larger concern and not to any specific activity performed. Even paras 133 and 134 of the Sony Ericsson judgment makes it clear that AMP adjustment cannot be made in respect of a full-risk manufacturer. In that view of the matter, the question of a benchmarking analysis by evaluating the AMP expenses incurred by the Assesses in relation to its total sales vis-à-vis its comparables is not called for. There is nothing to indicate that the AMP expenses incurred by the Assesses are at the instance of foreign AE and that the Assesses has to be compensated by the foreign AE in that behalf.
Accordingly appeal of the assessee allowed.