Philips India Ltd. vs ACIT (ITAT Kolkata)
In many cases, licensed manufacturers operate as risk-bearing entrepreneurs, and there is no existence of an ‘agreement’ or ‘arrangement’ or ‘understanding’ with the AE regarding AMP expenditure, the initial onus is on the revenue to show that there is an international transaction for AMP spend.
The mere fact that the Indian entity is engaged in the activity of creation, promotion or maintenance of certain brands of its foreign AE or for the creation/promotion of new/existing markets for the AE, cannot by itself be enough to demonstrate that there is an arrangement with the parent company for this activity. The Revenue has to show that there exists an ‘agreement’ or ‘arrangement’ or ‘understanding’ between the AEs whereby the assessee is obliged to spend on AMP in order to promote the brand of the AE. As held by the Supreme Court in CIT v. B.C. Srinivasa Setty (1979) 128 ITR 294 (SC) and PNB Finance Ltd. vs. CIT (2008) 307 ITR 75 (SC), in the absence of any machinery provision, bringing an imagined international transaction to tax is fraught with the danger of invalidation.
This would be notwithstanding the fact that –
1. The assessee company outsources its entire production requirements to toll manufacturers/contract manufacturers on a licence basis.
2. The assessee procures the raw materials and gets it converted from the third party toll manufacturers.
3. The usage of the foreign brand of the AE as the name of the manufactured product, for eg. Savlon.
It cannot be construed that the assessee is not a manufacturer at all and only a distributor simplicitor.
The same was held in the case of Philips India Ltd. vs. ACIT in ITA No.2489/Kol/2017 dated 4th April, 2018. The same was also reiterated in the case of PRINCIPAL COMMISSIONER OF INCOME TAX-4, KOLKATA Vs M/s ORGANON (INDIA) PVT LTD [2023-VIL-43-CAL-DT]. The landmark decision though shall always remain the Maruti Decision of 2015.
However, this apart, it is advised for taxpayers in such cases to have the following safeguards1. They should have clear intercompany arrangements by which the transaction is clear.
2. The TP documentation and day-to-day business conduct of the taxpayers have to be such to clearly demonstrate that there is no agreement or tacit understanding with the AE for AMP spends.
3. It must be depicted by the Cost Sheet or any other means or MIS that the AMP expenses are inbuilt in the pricing and duly factored in.
4. It must be depicted that the selling expenses do not construe an AMP spend.
5. Incase there is an understanding then it must be demonstrated by intercompany arrangements, TP documentation and day-to-day business conduct that the decision pertaining to AMP spends has been taken independent of the manufacturing business.
FULL TEXT OF THE ORDER OF ITAT KOLKATA
1. This appeal filed by the assessee against the assessment order of the ACIT Circle-12(2), Kolkata, dt. 25.10.2017 for the A.Y. 2013-14 passed u/s 143(3) r.w.s. 144C(5) of the Income Tax Act, 1961 (hereinafter the ‘Act”) in pursuance to the order of the DRP-2, New Delhi, dt. 18.9.2017.
2. The Ground No. 1 raised by the assessee is general in nature and does not require any adjudication.
3. Determination of Arm’s Length Price (ALP) for Management Support Services
The brief facts of this issue is that the assessee is a part of the Royal Philips Organisation, Headquartered in Netherlands. The ultimate parent company of the group is Koninklijke Philips Electronics NV (KPENV). Royal Philips Electronics of the Netherlands is a diversified health and well being company. Royal Philips is organized into the following product divisions:-
(i) Philips Consumer Electronics: This division develops, manufactures and markets a wide range of television, audit, video, communications and interactive media systems.
(ii) Philips Domestic Appliance and Personal Care : This division makes a wide range of electrical products for personal care and household convenience.
(iii) Philips Lighting: This division is the global leader in lamps, luminaries, lighting electronics, automotive lighting, special lighting, UHP & LCD backlighting and lumileds.
(iv) Philips Medical Systems : This division is one of the world leaders in diagnostic imaging systems and related services.
(v) Philips Semiconductors : This division supplies silicon system solutions for mobile communications, consumer electronics, digital displays, contactless payments and connectivity and in-car entertainment and networking.
(iv) Other Activities : relates to Corporate Technology, Corporate Investments etc.
The assessee had made international transaction with its associated enterprises (AEs) during the year and the same was referred to the Transfer Pricing Officer (TPO) u/s 92CA of the Act for determination of ALP. The assessee submitted sector wise transfer pricing study report along with functional analysis and information required u/s 92D(1) of the Act before the ld TPO. The assessee has undertaken international transactions during the year under considerations as under:-
3.1 The assessee submitted before the ld TPO that some of the transactions pertain to services which are commonly described in international tax and transfer pricing context as ‘intra-group services’ (in short IGS). The assessee benchmarked the Intra Group Services transactions by using the Transactional Net Margin Method (TNMM) as the Most Appropriate Method (MAM).
3.2 The intra-group services (IGS) received by the assessee are covered under what has been described as a General Services Agreement (GSA). Under the overall umbrella package of this GSA, the assessee has entered into a ‘Management Support Services Agreement (MSSA)’ and a ‘Research and Development Cooperation Agreement (RDCA)’ with KPENV. Among these two agreements under the GSA, only the IGS provided under the MSSA are discussed herein. The preamble to this MSSA are as under :-
An AGREEMENT made this day 22nd October, 2004 by and between
Koninklijke Philips Electronics NV (KPENV) and Philips India Ltd (assessee herein).
WHEREAS, Philips has substantial resources in commercial , financial, accounting and other matters which would be beneficial to successfully conducting a business;
WHEREAS, these resources would be employed for the benefit of the individual member companies of the Philips concern ;
WHEREAS, the Company wishes to ensure continuity in its business operations and for that reason is interested to take advantage of and secure access to the aforementioned resources and acknowledges the necessity of paying an appropriate consideration for that purpose ;
WHEREAS, it is recognized between the parties that a system requiring separate payments for resources on each separate occasion poses great problems in view of the fact that for certain Concern services (as hereinafter defined) no market price can reasonably be established with reference to comparable situations in the market place ;
WHEREAS, it is further recognized that in view of the continuous flow of information such a system of separate payments would in any event be very difficult, if not impossible, to administer and would involve very costly and burdensome accounting procedures ; and
WHEREAS, it is finally recognized that such a system of separate payments does no justice to the continuous efforts of Philips to generate and obtain new resources for the benefit of the Company and other member companies of the Philips concern and , accordingly, the parties have agreed on a remuneration system which is based on the relation existing from year between the activities of the Company and the activities of Philips and its Associated Companies.
NOW, THEREFORE, IT IS HEREBY AGREED AS FOLLOWS
ARTICLE 1 – DEFINITIONS
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“Concern Services” : Any and all activities performed by Philips in respect of the matters specified in Article 2 hereto.
ARTICLE 2 – Services in commercial, accounting, auditing, financial, fiscal, social and legal matters and in all other fields in which Philips has resources
These services for which resources are available with KPENV were sought to be rendered to PEIL (assessee herein). The assessee explained Article 2 before the ld TPO elaborately as under:-
i. In case of commercial matters, the services are described in general as pertaining to distribution and trading of products, and particularly with respect to
a) advertising,
b) sales promotion,
c) public relations,
d) market research (including information and trends on the world market),
e) labelling, packaging, shipping and forwarding,
f) long-term export business and
g) international tendering and purchasing from third parties.h)
ii. In case of accounting. auditing and financial matters, the services are described as
a) Accounting and auditing principles and methods
b) Budgeting methods
c) Capital structure, loans, exchange risks, financial research, warranties and guarantees, credit management, the establishment and management of finance and lease companies and all further banking activities, including long-term finance plans
d) Developments of data processing
iii. In case of fiscal and legal matters, special mention is made of patents, trademarks and customs duties, particularly in international transactions
iv. In case of personnel matters, special mention is made of
a) Selection and training of personnel
b) An adequate personnel policy
v. Insurances
vi. Admittance at PEIL’s specific request at mutually agreed times of reasonable number of employees of PEIL to KPENV’s premises to acquaint elves with commercial and other knowledge as specified above, familiarise themselves with the organisation of the whole Group and with working methods used by it or receive advice on specific matters in the fields described above.
vii. Any other similar matters which PEIL may reasonably refer to KPENV or which KPENV may itself deem appropriate.
ARTICLE 4 – REMUNERATION
In consideration of the Concern Services rendered by Philips under this Agreement the Company agrees to pay to Philips remuneration by aggregating amounts calculated as follows:
a) that part of the Concern Services costs which corresponds to the ratio between the Relevant local turnover and the Relevant world turnover; and
b) a surcharge of 10% on the amounts as calculated according to a) above.
The amount calculated at a) above would exclude any costs in respect of Concern Services rendered inside the Country.
3.3 The assessee stated that the reason of entering into the MSSA has been described in the preamble to the Agreement. It mentions that KPENV (acting at the same time for its Associate Companies, and referred to as ‘Philips’ jointly and severally in the MSSA) has substantial resources in commercial, financial, accounting and other matters which would be beneficial to successfully conducting a business. These resources ‘would be employed for the benefit of individual member companies of the Philips concern’ (i.e KPENV and its Associated Companies). Thus, it would appear that KPENV, on the basis of the resources available at its disposal, has decided to employ those resources for the benefit of its Associated Companies. The assessee also stated that it is mentioned in the Preamble that it is PEIL (assessee) which, wishing to ensure the continuity in its business operations, is interested to take advantage of and secure access to the aforementioned resources. Further , it is PEIL which has acknowledged the necessity of ‘paying an appropriate consideration for that purpose’ . It was further stated that the Preamble also asserts that it is recognized by each party to the Agreement that a system requiring payments for resources on each separate occasion poses great problems in view of the fact that for certain Concern Services (activities described in Article 2 of the MSSA) ‘no market price can reasonably be established with reference to comparable situations in the market place’. This statement is of great importance with regard to arm’s length pricing of the transactions covered under the MSSA. The Preamble also mentions that it is further recognized by the Parties to the Agreement that in view of the continuous flow of information, such a system of separate payments would in any event be very difficult, if not impossible, to administer and would involve very costly and burdensome accounting procedures. In the end, the Preamble goes on to mention that such a system of separate payments does no justice to the continuous efforts of Philips to generate and obtain new resources for the benefit of the Company and other member companies of the Philips concern and , accordingly, the parties have agreed on a remuneration system which is based on the relation existing from year to year between the activities of the Company and the activities of Philips and its Associated Companies.
3.4. The assessee submitted a separate Transfer Pricing Study Report with regard to the ‘Philips General Service Agreement’. This Report of September 2006 is subtitled ‘For certain Internal General Services between various Philips Group Companies in Asia Pacific Region with Koninklijke Electronics NV (KPENV). The assessee stated that the group had placed reliance on OECD guidelines and had accordingly used indirect method of charging the costs , wherein, when an indirect method of charging is used, the relationship between the costs and the services provided is obscured and it may become difficult to assess the value of the benefit provided. Indeed, it may mean that the contributing enterprise is less aware than in the case of the direct- charge method that it is incurring costs for certain facilities and, in consequence, is less aware of whether or not it is benefitting from them. The most appropriate indirect method is generally recognized to be one which is based on sharing among the beneficiaries, in proportion to the benefits received or expected, the actual costs incurred in providing the services. It was stated that KPENV has applied the indirect method for allocating the costs to the assessee under the MSSA and then added a margin of 10% on the costs while making the charge. So far as the margins are concerned, they have been benchmarked through a separate benchmarking study which has relied on data from Pan-Asia comparables. It needs to be mentioned that this selection of the comparables is not appropriate as the recipient of services, with its specific functional profile of a low-risk distributor for consumer life style sector and speciality lighting sector and a near zero-risk distributor in case of health care sector and a general manufacturer for domestic consumption in case of lighting sector, is based in India with its specific economic and market conditions. If the margins are at all to be compared, then the comparables need to be selected from India.
3.5. The ld TPO applied the Comparable Uncontrolled Price (CUP) Method as the MAM for determination of Arm’s Length Price (ALP) in respect of this transaction. In this regard, the ld TPO observed as under:-
(a) The application of the arm’s length principle would be to see whether the charges paid by the taxpayer for intra group services reflect the same charges for the services that would have been, or would reasonably be expected to be, levied between independent parties dealing at arm’s length for comparable services under comparable circumstances. It is crucial to determine how much a comparable independent service recipient, under comparable circumstances, would be wiling to pay for that service.
(b) An arm’s length entity would be willing to pay for an activity only to the extent that the activity confers on it a benefit of economic or commercial value. Thus, whether as a result of payment of management service fees and head quarter to its AE the taxpayer, got any economic or commercial value to enhance its commercial position is also to be seen. The expected benefit must be sufficiently direct and substantial so that an independent recipient, in similar circumstances, would be prepared to pay for it. If no benefit has been provided (or was expected to be provided), the service cannot be charged for.
(c ) It is for the taxpayer to prove that the services are rendered. The other aspect of intra group services is the quantification of such services in terms of actual expenditure incurred and commensurate benefits derived therefrom. To confirm to the arm’s length principle, the costs of intra-group services can only be charged for, where the recipient of the services derived a benefit from those services and that the benefit has been sufficiently direct and substantial so that an independent recipient, in similar circumstances, would be prepared to pay for it.
(d) Another aspect to be seen is, would the entity for whom the activity is being performed either have been willing to pay for the activity if performed by an arm’s length entity or would have performed the activity itself?
(e) Whether expenses incurred by one entity should be apportioned and allocated to other members of the group or whether a charge should be levied by the service provider that reflects the value of the services supplied. Because, the arm’s length charge is not only a function of the price at which a supplier is prepared to perform the service (or the cost of providing the service), but also a function of the value to the recipient of the service (or the willingness of the recipient to pay for such services). Therefore, the determination of an arm’s length charge must take into consideration the amount that an arm’s length entity is prepared to pay for such a service in comparable circumstances.
(f) Mere description of the various services will not suffice to justify the price charged in intra group services. The taxpayer has to prove with proper documentation and evidence that the services are actually rendered and payment is commensurate with the benefit derived therefrom.
(g) Understandably, when expenditure is incurred for the benefit of the group as a whole, no charging of such expenditure is required as such expenditure is not incurred in connection with any individual member of the group and the benefit of such expenditure would be available to all the members of the group. Similarly, if no benefit is received or the benefit is remote or for the benefit of entire group, the same should not be charged.
Therefore, unless it is shown that tangible and direct benefit has been derived by such payment and that the payment made is commensurate to the benefit derived or expected to be derived when parties deal with each other at arm’s length, the arm’s length price of such payment for intra group services is to be treated either as Rs. Nil or to the extent of the benefit actually derived from such payment. Thus, payment for intra group services to be treated at arm’s length only when it is proved substantially by the taxpayer that such services were actually received and further proving that the taxpayer has benefitted from the receipt of such services.
3.6 During the course of proceedings before the ld TPO, the assessee submitted that the services to be rendered as per the MSSA by the AE are essential to the assessee to operate in consistent and cost effective manner. In present business environment, operational synergies between the peer companies are imperative for any company to thrive in the current market scenario. The services under MSSA were in the nature of technical, commercial, financial, administrative and general areas. The Philips group globally has access to extensive knowledge and expertise in such areas. These arrangements helped Philips group in effective application of these services which resulted in substantial savings in total costs compared to the cost, the group would have incurred, if these were borne by the respective companies in different countries in an inconsistent manner without adhering to the global best practices within the group. The MSSA lays down that KPENV has expertise and resources in commercial, accounting, auditing, financial, fiscal , social and legal matters. The General Service Agreement framework leads to global arrangement made by Philips whereby the group service centers are relentlessly carrying out research studies in technical, commercial, accounting, financial, human resource, legal and administrative matters. The outcome of the activities carried out by the group service centers are shared across the Philips group. The arrangement under MSSA is an exclusive arrangement to be used within the Philips group and is not made available to any third parties. It is important to mention that the objective of the Group is to centralize certain activities so that an overall standardization is achieved by the service delivery and quality. However, in few cases, technical assistance and licenses are granted to third parties in return of royalty. The royalty proceeds are deducted from concern costs before allocating the cost to respective companies. As the services provided by AE under MSSA are vast and on continuous basis, the relative share (in %) of services provided to third parties as compared to Philips is negligible and hence not comparable. The assessee submitted that the intra group services from AE have been accounted under different segments as follows:-
