Brief of the Case
Delhi High Court held In the case of Bausch & Lomb Eye care (India) Pvt. Ltd. that 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 clears. 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. 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.
Facts of the Case
The Assessee, Bausch & Lomb (India) Pvt. Ltd. (‘BLI’), formerly known as Bausch & Lomb Eyecare (India) Pvt. Ltd., was incorporated on 30th May 2000 under the Companies Act, 1956. It is engaged in the business of manufacturing and trading of soft contact lenses, eye care solutions and protein removing enzyme tablets (vision-care segment) and distribution of imported products such as Excimer Laser System, cataract machines and intra-ocular lenses (surgical segment). The immediate parent company of the Assessee is B&L South Asia Inc., which holds 99.9% of its equity share capital. The balance 0.01% is held by B&L Opticare Inc., USA (‘B&L, USA’). The Assessee used the trademarks, brand name, logo, brands, processes, technical data and operative quality standard owned by the B&L Group worldwide without making any payment of royalty. B&L, USA did not charge the Assessee for the use of the logo. The Assessee also gets the global research report of the B&L Group free of cost.
The Assessee filed its return for AY 2006-07, declaring income of Rs. 16,85,26 ,980. The return was picked up for scrutiny and notice dated 4th July 2008 was issued to the Assessee by the AO under Section 143(2). The AO referred the matter to the Transfer to TPO for determination of the arm’s length price of the international transactions. The TPO concluded that the Assessee had developed marketing intangibles for its AE and was in the process of making the intangible even more valuable by incurring huge AMP expenses, bearing risks and using both its tangible assets and skilled, trained man power. The Assessee was described as a limited risk distributor. The TPO held that the AMP expenses did not benefit the Assessee as it had incurred a loss in AY 2006-07. The TPO noted that the Assessee did not receive any reimbursement from its AE for the AP expenses. Further the TPO applied a mark-up of 10% and determined the ALP of the AMP expenses at Rs. 19,59,90,441. This was to be added to the income of the Assessee for the AY in question, i.e., 2006-07. Similarly, additions of Rs. 25.86 crores, Rs. 13.53 crores, Rs. 9.90 crores and Rs. 6.24 crores were made in AYs 2007-08, 2008-09, 2009-10 and 2010-11 respectively including different mark-up percentages determined by the TPO. The DRP, inter alia, found that the TPO had relied on the function analysis and concluded that the Assessee had developed marketing intangibles for the sale in India of the products manufactured by its AE by “incurring huge AMP expenditure”.
On the basis of the order of the DRP, the AO passed a final order dated 14th June 2010, making additions on the basis of the AMP. Accordingly, the total taxable income determined for AY 2006-07 was Rs.36,45,53,644 as against the disclosed income of Rs.16,85,26,980.
Contention of the Assessee
The ld counsel of the assessee submitted that the Revenue had not been able to discharge its primary onus of showing that there was an international transaction with regard to AMP expenditure between the Assessee and its AE. He submits that unlike the decision in Sony Ericsson (supra), where the Assessees were only distributing the products manufactured by the foreign AE and the facts brought on record clearly showed that each of them were receiving some subsidy/subvention from their foreign AEs, in the present case the Assessee received no such subsidy/subvention from B&L, USA. Also, in this Assessee’s case, the operations involved both manufacturing and distribution. Therefore, the parameters for determining the existence of an international transaction cannot be governed by what has been stated in Sony Ericsson (supra).
He further submitted that in Sony Ericsson (supra) the three Assessees had virtually conceded the position that there existed an international transaction whereas in the present case, the Assessee has throughout been contesting the existence of such transaction. It is further submitted by Mr. Rao that the figures of AMP expenses incurred by the Assessee includes huge trade discounts, sampling, marketing research and points of sales expenditure. Even according to the decision in Sony Ericsson (supra) such expenditure has to be excluded from the calculation of AMP expense. He pointed out that for the AYs 2006-07 to 2009-2010, the TPO not only treated the entire expenses as recoverable from B&L, USA but has further applied a mark-up of 10%, 14.93%, 15% and 15.27% for the aforementioned AYs respectively. There was no basis for such a mark-up.
There is no basis for concluding that the AMP expenses incurred did not result in any benefit to the Assessee only because it incurred a loss in AY 2006-07, although, the reasons for such loss were clearly explained by the Assessee. In any event, in both the surgical and vision-care segments, the earnings and profitability of the Assessee were much higher than that of the comparables. This was the case even if the AMP activity was to be considered a benchmarked ‘function’ without prejudice to the Assessee’s contention that it could not. Reliance was placed on the decision of the Supreme Court in Commissioner of Central Excise v. Detergents India Ltd. (2015) 7 SCC 198.
Mr. Rao further submitted that since the Assessee had in its TP study already declared the transactions of import, export and warranty etc., the alleged incidental benefit to the AE due to the Assessee’s AMP expenditure could at best be one of the several functions of such ‘arrangement’. In the TP study, the Assessee had already benchmarked AMP as a function. The comparables chosen by the Assessee for that purpose had been accepted by the TPO. Therefore, there was no justification for separately benchmarking the AMP expenses as that would amount to duplication. It was submitted that re-characterization of the transaction in order to bring it within the inclusive part of Section 92B(1) was impermissible in view of the decision of this Court in CIT v. EKL Appliances Ltd. (supra).
Therefore, once the BLT was held to be an invalid basis for determining the existence of an international transaction, there would be no basis “even for a suspicion that any extraordinary expenditure is incurred beyond necessity of Indian business of Assessee”. Mr. Rao submitted that since no objections were raised under Section 37(1) of the Act to the effect that the AMP expenses incurred were not wholly or exclusively for the benefit of the Assessee and since no AMP adjustment was made under Chapter X in the earlier AYs, there was no justification for the TPO to treat the AMP expenses as a separate international transaction for the AYs in question. Since higher margin had been earned by the Assessee vis-a-vis the comparables under all segments, it was clear that the Assessee’s relationship with its AE had not affected the business dealings between the parties.
In last he submitted that he submitted that no TP adjustment would be justified in the Assessee’s case on the principles of mutual benefit and reciprocity. The question of the Assessee being compensated by the AE for the AMP expenditure did not arise since B&L was an established brand for over 150 years and the Assessee was reaping the benefits of an established brand.
As regards the intra group support services received by the Assessee for the AYs 2007-08 and 2008-09, it is submitted that in the TP study, the said intra group services were benchmarked by the Assessee and shown to be at ALP. The TPO had benchmarked the said transaction by applying the ‘benefit test’ and concluded that the services were not essentially for its business operation. The TPO then applied the Comparable Uncontrollable Price (‘CUP’) method and determined the ALP of the intra group services as ‘nil’. However, for the AY 2009-10, the expenditure towards some intra group services have been allowed to the Assessee without adjustment. There was no occasion for the ITAT to have granted one more opportunity to the Revenue in this regard by remanding the matter to the TPO.
Contention of Revenue
The ld counsel of the revenue relied on the TP study itself to show that the inference drawn about the existence of international transaction involving AMP expenses was justified. He reiterated that the Assessee was only a limited risk distributor and was unlikely to incur such huge expenses on AMP without being compensated. He pointed out that the import of finished goods constitutes a major portion of the Assessee’s business and that the manufacturing activity is relatively small. Since the comparables chosen were only of Indian companies involved in distribution of the products of foreign AEs, there was justification in seeking remand of the matter to the TPO for a fresh determination. It is submitted that the question of whether the AMP expenses is to be treated as ‘function’ or ‘separate transaction’ should also be sent back to the TPO.
He further submitted that merely because there was no explicit agreement between the Assessee and its AE with regard to AMP expenses did not mean that from the overall facts and circumstances an inference could not be drawn regarding the Assessee and its AE ‘acting in concert”. He reiterated that the creation of brand building/marketing intangibles for the AE amounted to the provision of a service to the AE and therefore the mark up of the AMP expenses was called for.
It is further submitted that the BLT was used by the Revenue only as an arithmetical tool to arrive at the cost base of the AMP expenditure. The determination of the cost base is a necessary step for arriving at the ALP of the transaction under different methods including the TNMM. It is submitted that although the decision in Sony Ericsson (supra) rejects the use of the BLT for determining the existence of an international transaction for determining ALP, and although the Revenue had filed an appeal in the Supreme Court against the said finding, as far as the present appeals are concerned, the Revenue seeks to establish the existence of an international transaction de hors the BLT.
On the question of onus on the Revenue to show the existence of international transaction, he submitted that once it is shown that the AMP expenses were incurred by the Assessee, the onus should be on the Assessee to justify the extent of the expenses. He referred to the availing of intra group services by the assessee and the payments characterised as ‘receivables’ in its hands which was a further indication that the AMP expenses could be treated as ‘transactions’ within the ambit of Section 92B.
Held by ITAT
The Special Bench of the ITAT considered the issue of TP adjustment in relation to AMP expenses incurred by Indian entities for improving the market intangibles for their respective AEs. By a majority of 2:1, the Special Bench of the ITAT in LG Electronics India Pvt. Ltd. v. ACIT (2013) 140 ITD 41 (Del) adopted the ‘Bright Line Test’ (‘BLT’) for determining the existence of an international transaction involving AMP expenses as well as for determining the ALP. It was held that if the expense incurred by the Assessee 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-characterisation. If the Assessee 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 Assessee.
Based on above decision, in the current case ITAT held that the approach of the TPO and the DRP has been fundamentally changed by the Special Bench of ITAT in LG Electronics and therefore, it was desirable that the relevant expenses are verified by the AO. Accordingly, the ITAT set aside the assessment order and remanded the matter to the file of TPO to decide it afresh after giving the Assessee adequate opportunity of hearing.
As far as AY 2010-11 is concerned, in the Assessee’s appeal, i.e., 471/Del/2015, the IT noted that since this Court in Sony Ericsson (2015) 374 ITR 118 (Del). had rejected the applicability of the BLT, it would be appropriate to restore the entire issue to the file of the TPO for benchmarking the AMP functions. It was clarified that while computing the AMP expenditure, direct selling and distribution had to be excluded. As regards selection of comparables, the ITAT was of the opinion that the whole exercise is to be carried out de novo.
Held by High Court
Existence of an international transaction
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.
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. 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 (2015) 374 ITR 118 (Del), the question of applying the BLT to determine the existence of an international transaction involving AMP expenditure does not arise.
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.  345 ITR 241 (Del) which required a TPO “to examine the ‘international transaction’ as he actually finds the same.”
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. 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.
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”.
On the issue of the intra group services, the Assessee is justified in contending that the re-characterization of its transaction involving its AE for the two years which have been fully disclosed in the TP Study on the basis of it not being for commercial expediency of the Assessee is clearly beyond the powers of the TPO and contrary to the legal position explained in EKL Appliances  345 ITR 241 (Del).
Accordingly appeal of the assessee allowed.