Michelin India Pvt. Ltd. Vs DCIT (ITAT Delhi)
Conclusion: Outward freight in India except the freight for import of material distributed be not considered for adjustment as it is not operating from transaction perspective.
Held: Assessee-company was into import and resale (or trading) of tyres for passenger cars, trucks and buses under the brand name ‘Michelin’. During the year under assessment, the taxpayer entered into International Transaction with its Associate Enterprises (AE). TPO noticed that the taxpayer had incurred huge Advertisement, Marketing and Promotional (AMP) expenses to expand the reach of the AE’s brand in India. TPO reached the conclusion that assessee being a distributor had undertaken the marketing activities on behalf of its AE to create intangible in its favour and had not paid any royalty and after applying the Resale Price Method (RPM) on the trading activities treated the incurring of AMP expenses and the resultant creation of marketing intangibles as a separate international transaction and benchmarked the same separately. TPO selected three companies in A.Y. 2009-10 as comparables namely ; Dunlop India Ltd.; T V S Srichakra Ltd. ; Krypton Industries Ltd having AMP/ Sales ratio of 4.79% as against 11.30% in case of the taxpayer which was into similar activities. TPO applied bright line test and computed the arm’s length of AMP i.e. the bright line at 4.79% of sales. The taxpayer spent AMP expenses to the tune of Rs. 25,08,53,510/- and TPO computed the amount in excess of the arm’s length amount of AMP at Rs. 144,586,263/-. TPO had also applied the mark-up of 13% on the cost of CPM (15% assured markup on all costs minus 2% = 13%) and computed arm’s length price of AMP expenses. It was held that CIT(A) had passed order following the decision rendered by Hon’ble Delhi High Court in case of Soni Ericssion Mobile Pvt. Ltd. wherein it was held that gross profit margin should be computed after including AMP expenditure and RPM was considered as the most appropriate method for import segment for resale and “brightline test” had no statutory mandate for benchmarking AMP expenses. Thus, there was no scope to interfere in the finding returned by CIT(A) by following the decision rendered by Jurisdictional High Court in case of Soni Ericsson Moble Pvt. Ltd.. However, outward freight in India except the freight for import of material distributed be not considered for adjustment as it was not operating from transaction perspective.
FULL TEXT OF THE ITAT JUDGEMENT
Since common question of facts and law is involved in all the aforesaid cross appeals, the same are taken up together for disposal by way of composite order to avoid repetition of discussion.
2. Appellant, M/s. Michelin India Pvt. Ltd. (hereinafter referred to as ‘taxpayer’) and Appellant, Dy. Commissioner of Income Tax, Circle 6(1) (herein after referred to as ‘revenue’) by filing the present cross appeals sought to set aside the impugned order dated 04.08.2014 and 07.11.2016 for A.Y. 2009-10 and 2010-11 respectively passed by Ld. CIT(A) challenging the order passed by AO in consonance with the orders passed by the ld. TPO under section 143 (3) read with section 144C of the Income-tax Act, 1961 (for short ‘the Act’) on the grounds inter alia that :-
ITA No. 5774/Del/2014, A.Y.2009-10– Assessee’s appeal
The following grounds of appeal are mutually exclusive and without prejudice to each another.
1. That on the facts and in law, the Learned Commissioner of Income Tax (Appeals)-XX, New Delhi (hereinafter referred to as “the Hon’ble CIT(A)”/ Learned Assessing Officer (hereinafter referred to as “Ld. AO”) erred in assessing the income of the Appellant for the relevant assessment year at Rs. 15,33,85,193 as against the returned income of Rs. 1,47,91,724.
2. Grounds pertaining to Corporate Tax
2.1 That the Hon’ble CIT(A) / Ld. AO have erred on facts and in law in disallowing the management fee amounting to Rs. 54,698,578 paid by the Appellant and questioning the need for availing such services from its associated enterprise, thereby challenging the commercial expediency of the services availed. The Hon’ble CIT(A) / Ld. AO have failed to give due cognizance to the detailed submissions filed by the Appellant which clearly demonstrate the nature services availed, need of the Appellant and the benefit reaped therefrom, and have instead subjectively disallowed the expenditure purely based on presumed disposition.
2.2 That the Hon’ble CIT(A) / Ld. AO erred in mindlessly disallowing management fee paid by the Appellant without appreciating the prime facts applicable to the Appellant’s business operations and thereby causing double taxation in the hands of Appellant.
2.3 Without prejudice, the Hon’ble CIT(A) / Ld. AO has erred in disallowing management fees paid by the Appellant to its AE without appreciating that the expenditure is an international transaction and has already been subjected to detailed scrutiny by the Ld. Transfer Pricing Officer pursuant to a reference made by the Ld. AO under section 92CA(1) of the Act.
2.4 That the Hon’ble CIT(A) / Ld. AO erred in facts and law in disallowing the Appellant’s claim of brought forward losses amounting to Rs. 6,50,98,677 collectively for the AY 2005-06 and AY 2006-07, thereby ignoring the fact that the matter is pending before the Hon’ble Tribunal for disposal.
2.5 That the Ld. AO erred in levying interest under section 234C of the Act.
2.6 That the Ld. AO has erred in facts and circumstances of the case by initiating penalty proceedings under section 271(1)(c) of the Act, which is bad in law.
Grounds pertaining to Transfer Pricing Matters
3.1 That the Hon’ble CIT(A) / Ld. TPO erred in law and on facts in inappropriately applying Transfer Pricing provisions to benchmark specific domestic expenses incurred to fulfill Appellant’s own business interests, and without appreciating that such unilateral action of the Appellant (to incur such expense) cannot be regarded as an “international transaction” as per the provision of Section 92B of the Act.
3.2 That the Hon’ble CIT(A) / Ld. TPO erred in law and on facts while benchmarking the impugned transaction of the Appellant without conclusively determining a “method” prescribed under the Act and used the ‘Brightline’ approach, which is not a method under the Act.
3.3 That the Hon’ble CIT(A) / Ld. TPO erred in adopting a myopic view of the expense trends of the Appellant, and has instead deliberately not given any credence to the fact that the Appellant (being the sole distributor of Michelin products in India) is the primary and only direct beneficiary of the Advertisement, Marketing and Promotion (‘AMP’) expenses incurred locally, and any benefit what-so-ever which may have been derived by the AEs is purely incidental.
3.4 Without prejudice, the Hon’ble CIT(A) / Ld. TPO failed to apply the international guidance as espoused in the case of M/s DHL Incorporated and in the decision of the Hon’ble Special Bench of Delhi Tribunal in the case of M/s L.G. Electronics India Private Limited providing specific guidelines on the manner in which ‘Brightline’ approach may be applied.
3.5 That the Hon’ble CIT(A) / Ld. TPO erred on facts and in circumstances of the instant case by conveniently ignoring that the Appellant (which operates as a limited risk distributor) is reimbursed / remunerated for all its costs (including personnel cost, AMP expenses, finance cost etc.) along with an appropriate / arm’s length mark-up.
3.6 Without prejudice, the Hon’ble CIT(A) / Ld. TPO erred on facts in holding that dealer’s incentive, commission and discounts/rebates leads to creation of “marketing intangibles”. Ld. TPO/ Hon’ble CIT(A) erred in including such expenses for the purpose of determining the AMP expense of the Appellant, thereby erroneously assuming such expense leads to creation of market network through dealers and customers.
3.7 Without prejudice, the Hon’ble CIT(A) erred confirming the Ld. TPO’s approach of drawing a subjective comparison of the Appellant’s AMP/ sales ratio with the AMP/sales ratio which are inexact and highly inappropriate comparable companies . Ld. TPO/ Hon’ble CIT(A) has chosen to completely ignore the guidance on the issue of choice of appropriate comparable companies for a ‘Brightline’ analysis, as has been laid out in the decision of Hon’ble Special Bench of the Delhi Tribunal in the case of M/s L.G. Electronics India Private Limited.
3.8 Without prejudice to the above grounds, Ld. TPO/Hon’ble CIT(A) erred in facts and circumstances in concluding that the Appellant has effectively provided a brand building services/creation of marketing intangible to its AEs, without giving any specific finding / reason to support such erroneous claim and have committed another absurdity by applying a mark-up 15% using highly inappropriate data points.
ITA No.6128/Del./2014, A.Y. 2009-10- Revenue’s appeal
1. Whether on the facts and circumstances of the facts & in law, the Ld. CIT(A) has erred in deleting the addition of Rs. 5,31,75,3291- on account of advertising and publicity expenses stating that these expenses are revenue in nature by completely ignoring the detailed reasons given by AO and without appreciating that the facts that above expenditure was not uncured wholly and exclusively for the purpose for the purpose of business and was also capital in nature?
2. Whether on the facts and circumstances of the facts & in law, the Ld. CIT(A) has erred in deleting the addition of Rs. 12,83,663/- on account of impairment of stock ignoring the facts that AO has established that assessee has tried to claim a provision, which is neither ascertained not is in fact, liability of assessee?
3. That the order of the Ld. CIT(A) is erroneous and is not tenable on facts and in law.
4. That the grounds of appeal are without prejudice to each other.
5. That the appellant craves leave to add, alter, amend or forego any ground(s) of the appeal raised above at the time of the hearing.”
ITA No.3167/Del./2017, A.Y. 2010-11-Assessee’s appeal
“The following grounds of appeal are mutually exclusive and without prejudice to each another.
1. Impugned order dated 07 November 2016 passed by Ld. Commissioner of Income Tax (Appeals)-44, New Delhi (hereinafter referred to as “the Ld. CIT(A)” is bad in law.
2. Grounds pertaining to Corporate Tax Matter
2.1 That the Ld. CIT(A) / AO erred on facts and in law by making the adjustment amounting to Rs. 8,17,64,429 in relation to management fee paid by the Appellant to its Associated Enterprise (AE).
2.1.1. That the Ld. CIT(A) / AO failed to give due cognizance to the detailed submissions and evidences filed by the Appellant which clearly demonstrate the nature of services availed, need of the Appellant of availing such services and the benefit reaped therefrom, and instead subjectively disallowed the expenditure purely based on presumed disposition.
2.1.2. That the Ld. CIT(A) / AO grossly erred by making the adjustment in relation to management fee paid by the Appellant to the AE without appreciating that the Learned Transfer Pricing Officer (“Ld. TPO”) has already accepted that the management services rendered by the Appellant are at arm’s length price.
2.1.3. at the Ld. CIT(A) / AO grossly erred by making the adjustment in relation to management fee paid by the Appellant to the AEs in violation of provisions of section 92C(4) of the Act without appreciating that such transaction has already been analysed by the Ld. TPO and no adverse inference has been drawn therefrom.
2.1.4. 2.1.4 That the Ld. CIT(A) / AO grossly erred by not appreciating that the Appellant indeed operates under a ‘Market – Minus’ pricing model, wherein the Appellant is assured of a guaranteed return on its entire cost of doing business (including personnel cost, advertising expenses, management fee, finance cost etc.) by way of reduction in purchase price of goods imported from the AEs.
2.1.5. That the Ld. CIT(A) / AO grossly erred in not applying relevant decisions of the Hon’ble jurisdictional Tribunal and making a disallowance leading to double taxation which is contrary to the basic principles of taxation, thus bad in law.
2.2 That the Ld. CIT(A) / AO erred in facts and law by considering the license fees paid towards purchase of computer software (to facilitate inventory, sales order and sub-contract management etc.) as an intangible asset i.e. acquisition of “right to use” the application, thereby allowing depreciation at the rate of 25% as against the Appellant’s claim of 60% in the return of income.
2.3 That the Ld. CIT(A) / AO grossly erred by disallowing the Appellant’s claim of brought forward losses amounting to Rs. 26,85,56,128 collectively for AY 2006-07 and AY 2007-08, thereby ignoring the fact that the matter is pending before the Hon’ble Tribunal for disposal.
2.4 That the Ld. AO grossly erred in not giving the full credit for tax withheld at source and self- assessment tax deposited by the Appellant while computing the tax demand due from the Appellant.
2.5 That the Ld. AO erred on facts and in law by levying interest under section 234B and section 234C of the Act.
2.6 That the Ld. AO erred on facts and in law by initiating penalty proceedings under section 271(1)(c) of the Act, which is bad in law.
3. Grounds pertaining to Transfer Pricing Matters
3.1 That the Ld. CIT(A) / TPO erred in not following the Central Board of Direct Taxes (CBDT) Instruction 3/2016 and making a transfer pricing adjustment under Chapter X of the Act in respect of specific domestic expenses relating to advertising, marketing and promotion (“AMP”)
3.1.1. That the Ld. CIT(A) / AO erred in ignoring the fact that the Appellant (being the sole distributor of Michelin products in India) is the primary and only direct beneficiary of the AMP expenses incurred by it and any benefit what-so-ever which may have been derived by the AEs is purely incidental.
3.1.2. That the Ld. CIT(A) / TPO erred on facts and in law by conveniently ignoring that the Appellant (which operates as a limited risk distributor) operates under a ‘Market – Minus’ pricing model, wherein it is reimbursed / remunerated for all its costs (including personnel cost, AMP expenses, finance cost etc.) along with an appropriate / arm’s length mark-up.
3.1.3. That the Ld. CIT(A) grossly erred in not applying relevant decisions of Hon’ble High Court and further in applying the decision of Hon’ble Delhi High Court in the case of Sony Ericsson Mobile Private Limited (ITA No. 16/2014) and issuing directions to re-compute the arm’s length adjustment in respect of import of finished goods for resale from the AEs after including the AMP expenditure locally incurred by the Appellant, without appreciating that the transaction relating to import of finished goods has already been analyzed by the Ld. TPO and no adverse inference has been drawn therefrom.
3.1.4. That the Ld. CIT(A) grossly erred by directing the Ld. AO / TPO to adjust the freight expenses debited in profit and loss account of the Appellant, to compute the adjusted gross profit margin in relation to the transaction of import of finished goods for resale, ignoring the provisions of Accounting Standard (“AS”) – 2.
The above grounds are independent and without prejudice to each other.
The Appellant craves leave to add, amend, vary, omit or substitute any of the aforesaid grounds of appeal at any time before or at the time of hearing of the appeal.”
ITA No.3125/Del./2017, A.Y. 2010-11-Revenue’s appeal
1. Whether on facts and in circumstances of the case, Ld. CIT(A) is legally justified in holding that Resale Price Method (RPM) was most appropriate method without appreciating a fact that gross profit as disclosed in the Annual Report of the companies including assessee and comparables were computed without considering advertisement, marketing and business promotion expenditure (AMP expenditure) and application of RPM would require multiple comparability adjustments leading to unreliable arm’s length price?
2. Whether on facts and in circumstances of the case, Ld. CIT(A) is legally justified in holding RPM as most appropriate method to compute the arm’s length price of AMP expenditure without taking into account that AMP expenditure adds value to the product by enhancing its saleabil ty accordingly, RPM was not most appropriate method to determine arm’s length price (ALP) of AMP expenditure i.e. marketing intangibles?
3. Whether on facts and in circumstances of the case, Ld. CIT(A) is legally justified in holding RPM as most appropriate method to determine ALP of AMP expenditure even when the AMP expenditure effects net profit instead of gross profit?
4. Whether on facts and in circumstances of the case, Ld. CIT(A) is legally justified in holding RPM as most appropriate method without considering the amended provisions of section 92 of the Income Tax Act, 1961 (the Act) which makes a departure from profit determination to price determination and that AMP services rendered by the AE needs to be benchmarked separately?
5. Whether on facts and in circumstances of the case, Ld. C1T(A) is legally justified in rejecting the Bright Line Test (BLT) in benchmarking the AMP expenditure without considering a fact that BLT was not used as method to determine arm’s length price but was used as economic tool to compute the cost of services rendered by the assessee requiring arm’s length remuneration?
6. Whether on facts and in circumstances of the case, Ld. CIT(A) is legally justified in observing that benefit to the AE due to AMP expenditure is only incidental and not intentional?
7. Whether on facts and in circumstances of the case, Ld. CIT(A) is legally justified in holding that if mi comparison, the gross profit are found to be comparable then no adjustment is warranted on account of AMP expenditure by ignoring a legal position that separate benchmarking of each international transaction is stipulated under the transfer pricing provision as well as under international guidance?
8. Whether on facts and in circumstances of the case, Ld. CIT(A) is legally justified in ignoring a iega position that provisions of services of market development (services of carrying out advertisement, marketing and business promotion) are international transactions under subclause (d) of clause (i) of explanation to section 92B(2) of the Act are intended to promote t ie brand as well as sale of product requiring determination of arm’s length price of provision of these services separately?
9. Whether on facts and in circumstances of the case, Ld. C1T(A) is legally justified in holding that su e discount/ trade discount are not covered under sub-clause (d) of clause (i) of explanation to section 92B(2) of the Act by ignoring a fact that sale discount/ trade discount were intended to promote the brand of product as well as its sale by creating distributor’s loyalty accordingly these expenditures were squarely covered under the provisions of market development services leading to generation of marketing intangibles under Explanation below section 9213(2) of the Act?
10. Whether on facts and in circumstances of the case, Ld. CIT(A) is legally justified in deleting disallowance of Rs. 4,78,89,110/- u/s 37(1) of the Act on account of advertising and publicity expenses even when the assessee had not discharged its initial onus u/s 37(1) of the Act that expenditure was not capital in nature?
11.Whether on facts and in circumstances of the case, Ld. C1T(A) is legally justified in deleting disallowance of Rs. 4,78,89,110/- u/s 37(1) of the Act on account of advertising and publicity expenses ignoring the fact that the expenses incurred by the assessee have created marketing intangibles the capital asset as defined under Explanation below section 92B(2) of the Act?
12.Whether on facts and in circumstances of the case, Ld. CIT(A) is legally justified in deleting disallowance of Rs. 9,90,383/- on account of provision for impairment of stocks’ ignoring the fact that the expenses claimed in profit & loss account were in nature of uncertain liability and hence, was not allowable u/s 37(1) of the Act?
13. That the appellant craves leave to add, amend, alter or forgo any ground/s of appeal either before or at the time of hearing to appeal.”
BRIEF FACTS
ITA No. 5774/DEL/2014 OF A.Y. 2009-10- Taxpayer’s appeal
AND
ITA No. 6128/DEL/2014 OF A.Y. 2009-10- Revenue’s appeal
3. Briefly stated the facts necessary for adjudication of the controversy at hand are : M/s. Michelin India Pvt. Ltd. is into import and resale (or trading) of tyres for passenger cars, trucks and buses under the brand name ‘Michelin’. During the year under assessment, the taxpayer entered into International Transaction with its Associate Enterprises (AE) as under :-
