Delhi Tribunal Ruling –- the Transfer Pricing Officer (TPO) cannot determine the arm’s length price of an international transaction, which has not been referred to him by the Assessing Officer. When brand name is owned by the Associated Enterprise (AE) and the assessee incurs more than normal expenses on advertisement, marketing and promotion (AMP), the TPO cannot make adjustments considering that the AE did not reimburse the assessee for excess AMP expenses. [Amadeus India Pvt Ltd Vs. ACIT (2011-TII-22-ITAT¬DEL-TP)]
Amadeus India Pvt Ltd (the assessee) was engaged in the business of providing data processing and related services to its Associated Enterprises (AEs). The assessee was responsible for proving software access to the subscribers of the Amadeus products and computer database within the Indian sub-continent i.e. in India, Nepal and Bangladesh.
During the previous year under consideration, the assessee applied Transactional Net Margin Method (TNMM) to justify the arm’s length price (ALP) of international transactions with its AEs. As the operating margin i.e. net operating profit / total cost (OP/TC) of the assessee was much higher than the arithmetic mean of operating margin of the com parables companies, it was concluded by the assessee that the transaction is at arm’s length basis.
The case was referred to the Transfer Pricing Officer (TPO) as per provisions of section 92CA(1) of the Income tax Act (Act) .The TPO did not raise any objection to the method adopted or to the computation of ALP of the services rendered to the AEs. However, the TPO in the impugned order alleged that the assessee had incurred more than normal sales and marketing expenses to build “aMaDEUS” brand in India, which is legally owned by Amadeus Spain. The TPO asserted that the assessee should have been reimbursed with an appropriate mark up on such additional marketing expenses. The TPO computed more than normal marketing expenses by comparing the advertisement, marketing and promotion (AMP) expenses as a percentage to sales of the assessee with the average AMP% of three companies, viz., Galileo India Private Ltd., Aztec soft Ltd and Geometric Limited. The TPO computed the average AMP% of three companies at 12.16% and concluded that any expenditure over and above 12.16% would be considered as more than routine marketing expenses. The TPO computed AMP% of the assessee at 40.87% and imputed the income by adding a mark-up of 10% on more than normal marketing expenses. Based on this order, the Assessing Officer (AO) passed a draft order.
The Dispute Resolution Panel (DRP) also confirmed the action of the TPO and therefore, the assessee preferred an appeal before the Income tax Appellate Tribunal (Tribunal) against the order passed by the AO in pursuant to the direction given by the DRP.
Contentions of Revenue before the Tribunal
• The assessee had incurred the cost of AMP for the benefits of its AE. The assessee had incurred the cost in connection with a benefit and services provided to the AE under a mutual agreement, which was not in writing; but such arrangements are proved from the conduct of the assessee.
• The transfer pricing regulations (TPR) does not require the ‘form’ but also the overall arrangement/substance of the transactions before determining the ALP of an international transaction and that TPR are to be applied keeping in mind the overall scheme of the taxpayer’s business arrangement.
• The theory of substance over form given by statutory TPR and which was upheld by Bombay High court in the case of Vodafone International Holdings B.V (WP 1325 Of 2010) and also advocated by Organization of Economic Development, empowers the revenue authorities to disregard the ‘form’ of a transaction and look into its ‘substance’ to ensure that the tax base of the country does not suffer unjust erosion.
• A reliance was also placed on the decision of Bangalore Tribunal in the case of Logix Micro Systems Ltd. (2010-TII-50-ITAT-BANG-TP) for the proposition that when a file is referred to the TPO for the purpose of examining the matters relating to ALP, the AO is referring the entire gamut of international transactions for the consideration of the TPO. The purpose of an ALP analysis itself is in the larger context of anti-evasion measure.
• In the view of the above, it was submitted that the AMP expenditure incurred by the assessee should be considered to be an “International Transaction” within meaning of section 92B(1) of the Act.
Contentions of the assessee before the Tribunal
• The AMP expenses were third party expenses and the same were not recognized by the assessee as an international transaction in an Accountant’s Report in Form 3CEB, which was submitted with the return of income. The AO referred the Accountant’s Report for adjudication of the TPO. As per section 92CA (1) of the Act, the TPO is required to analyze the arm’s length basis of the international transactions referred to him for examination by the AO. Hence, TPO has the authority to determine the ALP in respect of only those international transactions, which have been referred to him by the AO. Further, the AO did not refer the said transaction to the TPO, this clearly shows the AO’s acceptance, that, this transaction was at arm’s length.
• The AMP expenses were not disallowed by AO under section 37(1) of the Act. Hence the fact that AMP expenses were incurred by the assessee wholly and exclusively for the purpose of its business was accepted by the Revenue Authorities. Thus it rules out the contention that the expenditure either in whole or in part was incurred on behalf of someone else and hence, it called for reimbursement plus a margin addition. Further, it was stated that avoidance of tax was not condition precedent for invoking TPR and that there is no requirement of establishment of ‘tax evasion’ before initiation of proceedings for determination of ALP.
• International transactions reported by the assessee in Form No. 3CEB were acknowledged by the TPO in his order. TPO did not conclude that AMP expenditure incurred by asses see is an ‘international transaction’ before adjudicating thereon and his order did not propose any adjustment to the income of assessee in respect of international transactions disclosed in the Accountant’s Report.
• Under the Act, there is no concept of creation of marketing intangibles or recognizing such an asset which may have resulted by virtue of extra ordinary AMP expenses unilaterally incurred by domestic enterprise in course of carrying on its business in India. Under the TNMM, the Profit Level Indicator of the assessee, i.e., OP/Cost has not been disputed by the TPO, while the ‘Bright Line Test’ done by the TPO by applying AMP Expense/Sales as a base for benchmarking is not one of the five methods prescribed under the TPR in India.
Observations and decision of the Tribunal:
• As per section 92CA(1) of the Act, the AO may consider it necessary and expedient to verify the ALP of the international transactions and for that purpose, he is required to take previous approval from the Commissioner of Income tax for referring the computation of the ALP in relation to the said international transaction to the TPO. The role of the TPO is restricted to that transaction, which has been referred to him by the AO for computation of the ALP. The plain reading of this section nowhere reveals that the TPO can take any transaction suo moto for verification and then suggest necessary adjustment.
• The decision of Bangalore Tribunal in case of Logix (supra) is correctly distinguished by the assessee.
• No adjustment is required in respect of the transaction relating to incurrence of AMP expenses and order of the AO is set aside as the adjustment was done without any jurisdiction.
This is an important ruling of the Tribunal which emphasizes on the strict procedure to be followed by the TPO while making adjustment to the international transaction. The Tribunal has correctly ruled that the TPO cannot determine the ALP of an international transaction, which has not been referred to him by the AO.