Income Tax Appellate Tribunal - Hyderabad
Dq Entertainment (International) ... vs Assessee on 22 June, 2016
IN THE INCOME TAX APPELLATE TRIBUNAL
HYDERABAD BENCH "A", HYDERABAD
BEFORE SHRI D. MANMOHAN, VICE PRESIDENT
AND SHRI S. RIFAUR RAHMAN, ACCOUNTANT MEMBER
ITA No. 151/Hyd/2015
Assessment Year: 2010-11
DQ (International) Ltd., vs. Asst. Commissioner of
Hyderabad Income-tax, Circle - 17(1),
Hyderabad.
PAN - AACCD
(Appellant) (Respondent)
Assessee by : Shri P.V.S.S. Murthy
Revenue by : Shri M. Sitaram
Date of hearing 22-04-2016
Date of pronouncement 22-06-2016
O RDE R
PER S. RIFAUR RAHMAN, A.M.:
This appeal by the assessee is directed against the assessment order passed u/s 143(3) read with section 144C of the Income-tax Act in pursuance to the directions of the Dispute Resolution Panel (DRP in short), Hyderabad pertaining to the assessment year 2010-11.
2. Briefly the facts of the case are that the assessee, DQ Entertainment (International) Ltd. is one of the leading producers of animation visual effects, game art and entertainment content for the Indian as well as global media and entertainment industry. The company has produced/co-produced and distributed cartoon TV series, direct-to-home videos and feature films, created real time game animation for online mobile and next-gen console games and now diversified into production and distribution of 3D stereoscopic animated feature films. The assessee-company filed its return of 2 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
Income on 12.10.2010 and the same was processed u/s 143(1) of the Act. The case was selected for scrutiny under CASS and Notice u/s 143(2) dated 07.09.2011 was issued and served on the assessee. Subsequently notices u/s 143(2) & 142(1) calling for information were issued.
Profile of the AE:
2.1 The company, DQE Plc., Isle of Mann, is the holding company of DQE (Mauritius) Ltd., Mauritius. The DQE (Mauritius) Ltd. is the holding company of DQE (International) Ltd., (assessee). The DQE (International) Ltd., is the holding company of DQE (Ireland) Ltd.
2.2 As per the audited statement of accounts, the financials of the assessee are as under:
Description Amount (In Rs.)
Operating Revenue 1,48,52,58,323
Operating Cost 1,17,85,17,865
Operating Profit 30,67,40,458
OP/OR (%) 20.65
OP/OC (%) 26.03
2.3 After verifying the information submitted/available and after
taking into consideration the order of the TPO, the assessment was completed as under:
2.4 Since the international transaction with Associate Enterprises exceeds the limits fixed by the CBDT, in accordance with provisions u/s. 92CA of IT Act, 1961, the case was referred to the Transfer Pricing Officer (TPO), Hyderabad with the prior approval of Commissioner of Income tax, Hyderabad-I. The Transfer Pricing Officer passed an order u/s, 92CA(3) of IT Act, 1961 on 27.01.2014.
The TPO in his order has recommended following adjustments u/s.92CA of the Act.
S.No. International transaction Adjustment 1 Sale of intangible asset 6,98,98,271 2 Profit Attributable 6,74,17,416 3 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
3 Payment of management 3,70,53,448
charges
4 Reimbursement of expenses 7,73,699
received
Total adjustment 17,51,42,834
2.5 In accordance with the order of the TPO dated 27.01.2014, the adjustments of Rs.17,51,42,834/- as proposed was added to the income of the assessee for the year under consideration.
3. Aggrieved, the assessee preferred an appeal and raised objections before the DRP. The DRP rejected the objections of the assessee.
4. Aggrieved, the assessee is in appeal before us and has raised the following grounds of appeal:
1. The Learned Dispute Resolution Panel (DRP) / Assessing Officer (AO) are erroneous in law and on the facts of the case.
2. The Ld DRP/AO are legally not justified in law in arriving at the price of Rs 12,35,18,271/- towards sale of intangible asset as against the price of Rs 5,36,20,000/- determined by the appellant thereby making an adjustment of Rs. 6,98,98,271/-.
3. The Ld DRP/AO ought to have accepted the fact that the sale of intangible asset of Rs 5,36,20,000/- arrived at by the appellant was at arms length when the same had been valued by 2 independent valuers.
4. The ld DRP/AO ought not to have substituted the projections made as per DCF on which the valuation reports were based with the actual figures and use of latest information available .
5. The Ld. DRP/AO are not legally justified in making an additional adjustment of Rs 6,74,17,416/- as profit attributable to the appellant company under the Profit Split Method in connection with the absolute sale of intangible asset to AE when such revenue is generated by AE of the appellant company i.e., DQ Ireland as absolute owner of such intangible asset.
6. Without prejudice to ground Nos. the Ld. DRP/AO are erroneous in allocating 80 percent of the total profits of DQ Ireland to DQ India, when the profits of DQ Ireland include 4 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
revenue generated from several intangible assets while the appellant has sold only one Intangible asset i.e., Jungle Book.
7. Without prejudice to ground no.5 the Ld. DRP/AO is erroneous in allocating 80% of profit on sale of IP to DQ India when the tax on sale of such capital asset was already paid in India by DQ India.
8. The Ld. DRP/AO are not justified in questioning the commercial wisdom of the appellant' decision to incur the expenditure towards management consultancy fees of Rs 3,70,53,448/-.The Ld DRP/AO ought to have considered the tangible and direct benefit derived by the appellant by incurring the management consultancy fees and ought to have allowed the same as complying with arms length principle.
9. The Ld. DRP/AO legally erred in making an adjustment of Rs 7,73,699/- on reimbursement of expenses received of Rs 77,36,985/- which was arrived at by applying the mark up @ 10 percent. The Ld DRP/AO ought to have appreciated the fact that expense incurred on behalf of DQ Entertainment Ireland our Associated Enterprise towards expenses were purely at cost and is not a service.
10. The Ld DRP erred in not adjudicating the ground of objection which is as under:
"The Ld AO/TPO is legally and factually incorrect in making an adjustment of Rs 751,83,46,202/- in respect of bonus shares issued by the appellant to its AE. The Ld AO/TPO erred in by holding that there was excess benefit in the hands of the AE and the same was dividend when in fact share premium account is utilised for issuing bonus shares as per company law provisions."
11. The Ld ORP erred in not adjudicating the ground of objection which is as under:
"The Ld AO/TPO erred in making a reference to the jurisdictional AO of International Taxation for taking up proceedings u/s 195 of the IT Act when the issue of bonus shares by the assessee was at arm's length and cannot legally be treated as dividend or otherwise."
5. As regards ground Nos. 2 to 4, it is observed that during the year, DQE India sold the Intellectual Property ("IP") rights of the Jungle Book Animation series to DQE Ireland, for an amount of Rs. 5,36,20,000/- which was based on average of the value's arrived at by 2 independent valuers. The detailed valuation conducted by independent valuer, Grant Thornton using Relief from Royalty Method 5 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
is part of the paper book in pages,170 to 187 and the valuation carried out by independent valuer, American Appraisal using Discounted Cash flow Analysis is part of the paper book in pg.188 to
216. The consideration for purchase of Jungle Book Animation was arrived at the average values determined by independent valuers at Rs. 536.20 Lakhs. In order to arrive at the ALP, the Ld. TPO has replaced the projected cash flows with the actual total revenues of DQE Ireland for the year 2009-10 and 2010-11 and arrived at value of Rs.12,35,18,271/- as compared to Rs. 5,36,20,000 as determined by the assessee and proposed the ALP adjustment to the AO. AO had accepted the ALP adjustment and added the same to the total income of the assessee.
6. Before the DRP, the assessee submitted that the valuation by applying DCF method or any other method is always applied by considering projections of revenues (Which were based on the detailed market expectation on that particular date) which cannot be tinkered at a later point of time by substituting with actuals. Nowhere such an approach is technically accepted. Actual revenues may be higher or lower and the same cannot be substituted for changing valuation. Valuation should always be appreciated and accepted as a reasonable exercise at the time when it was made. It is not supposed to be analyzed 3 to 4 years down the line. If actual revenues are higher by substituting the same, the valuation will go up. In the converse if actuals are lower, the valuation will go down. According to assessee, this sort of valuation of substituting actual values against projected values is nowhere accepted in the world. Assessee submitted that it is well aware about the huge fluctuation in the global market place. The projection is based on the assumptions based on normal market scenario and it is based on which any valuation exercise is completed and accepted world-Wide. The situation would have had been same even if the transaction was done with a third party (as against related party), Global market scenario has always been volatile and will always be volatile in the future, This was the 6 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
reason for which projections of 15 years has been considered, which perhaps enables ups and downs over a period of time, it will be normalized. The assessee relied on the decision of the Jurisdictional Tribunal in the case of Social Media India Ltd. Vs. ACIT Circle 3(2) Hyderabad ITA No.1711/Hyd/2012 wherein it was held that the assessee's valuation has to be accepted as it was supported by an independent valuer.
7. After considering the submissions of the assessee and the order of TPO, the DRP held that there is no merit in the submissions of the assessee and there is no infirmity in the action of the TPO in determining the Arm's length price. DRP accordingly rejected the objection raised by the assessee on this issue.
8. Ld. AR submitted before us that during the year, DQE India sold the Intellectual Property ("IP") rights of the Jungle Book Animation series to DQE Ireland. The Intangible asset was sold when the Intellectual property right was under development phase. It is submitted that the assessee company sold IP Rights to its AE DQ Ireland for an amount of Rs. 5,36,20,000/- which was based on average of the value's arrived at by 2 independent valuers. The detailed valuation conducted by independent valuer American Appraisal using Discounted Cash flow Analysis is given in pg. to 207 to 235 of the paper book and the valuation carried out by independent valuer Grant Thornton using Relief from Royalty Method is given in pg.236 to 253 of paper book. It is submitted that the consideration for purchase of Jungle Book Animation was arrived at the average values determined by independent valuer 536.20 Lakhs ((510+562.3)/2) 8.1. The Ld. AR submitted that the TPO has replaced the projected cash flows with the actual total revenues of DQE Ireland for the year 2009-10 and 2010-11 and arrived at value of Rs.12,35,18,271/- instead of Rs. 5,36,20,000 as determined by tax payer and made an adjustment of Rs.6,98,98,271/-and added the same to the total income of the assessee. Further the Ld. TPO while replacing 7 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
projections with actuals have considered the total revenue generated by DQ Ireland whereas the Intangible asset sold by DQ India to DQ Ireland was Jungle Book only.
8.2 The ld. AR contended that the Ld. TPO ought to have considered the fact that the appellant company made an outright sale to DQE Ireland. The cost incurred on Jungle Book by the appellant company is Rs. 4,94,03,810 (Breakup at pg. 362 of Paper Book) and the appellant company has sold the said Intangible asset for Rs. 5,36,20,000 based on valuation by 2 Independent valuers. The balance amount of Rs. 42,16,190/- was offered as short term capital gains. Further the Ld. TPO/AO erred in allocating 80% of capital gains to DQ India when tax on sale of such capital asset was already paid by DQ India.
8.3 The ld. AR submitted that the valuation by applying DCF method or any other method is always applied by considering projections of revenues (which were based on the detailed market expectation on that particular date) which cannot be tinkered at a later point of time by substituting actuals. Nowhere such an approach is technically accepted..
8.4 Ld. AR referred to the decision of the ITAT, Bangalore in the case of In Tally Solutions (P.) Ltd. v. DCIT [2011} 14 taxmann.com 19 (Bang.) wherein the Hon'ble Bangalore Tribunal held as under:
"The excess earning method is the method that is adopted by the TPO. We see no infirmity in adoption of this method for the simple reason that the relevant data is available with reasonable accuracy, closing in on real valuation of a software product. This valuation is upheld by the US courts while arriving at the sale value of a software product. Further, the valuation under the method mainly revolves around discounted cash flow DCF analysis which is known to economists for the times immemorial. Thus, the TPO used a reasonable well accepted method of valuation of in tangibles including software products and accepted by courts in the countries like in USA, where the TP regime is well developed.8 ITA No. 151 /Hyd/2015
D.Q. Entertainment (International) Ltd.
Further, the assessee's contention to adopt the actual revenues for the future years which are available now cannot be accepted now for a simple reason that the ALP was calculated on the date of sale which was in January, 2006 itself and also under EEM future revenues will be projected based on the previous year data keeping the current year's data as the base which has got no relevance on the actual revenues during the future years. We also make it clear that the actual CAGR shall be adopted by the TPO without any discount."
8.5 Finally ld. AR submitted that TPO's contentions of replacing the projections with actuals are legally unsustainable and technically incorrect.
9. Ld. DR submitted that the TPO with a view to determine the fair price replaced the projected figures in the DCF with the actual figures from the audited financial statements. In this regard, the TPO observed that there was a wide difference in the valuation of the intangible and therefore the TPO is well within his powers to examine and analyze the transaction and arrived at the Arm's Length Price with the information available.
9.1 Ld. DR submitted that the TPO requested the taxpayer company to provide justification for the revenues projected as he found from the valuation report that the projections have been provided by the management themselves. The TPO obtained that financial statement of DQ Ireland and replaced projected figures in valuation report by Grant Thornton and retained all other values and margins provided by the valuer. The result of such exercise resulted in the value of IP of Jungle Book at a relatively higher amount. The TPO could not arrive at the figures of "Value till patent IP expiry" of RS.2.70 lakhs and "TAB" of RS.1.21 crores as adopted by the valuer. If such figures are known then the value of the IP will further increase. Since the difference in the valuation was so fundamental, that in an uncontrolled circumstances independent parties' would have entered into a renegotiation or an adjustment to the negotiated price. Ld. DR submitted that in such a case of wide variation in the price, the TPO 9 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
is justified in concluding that the transaction is not at arm's length. The TPO is well within his powers as provided in para 9.87 & 9.88 of QECD Transfer Pricing Guidelines and substituted his own prices for the actual transaction undertaken as the difference in valuation was substantial.
10. Considered the submissions of both the parties and perused the material facts on record as well as the orders of revenue authorities. The assessee had sold 'IP' to its "AE" after considering the independent valuation from two valuers and arrived at the sale consideration. No doubt the projections were submitted by assessee for such valuation. Now, the revenue has no problem with the valuation but they are replacing the projected values with actual values. The question arises, whether the action of the revenue was justified for replacing the projection with actuals after three years down the line ? Ld. AR submitted two case laws before us. The first being the valuation submitted by the independent valuers has to be adopted without any modification as held in Social Media India Ltd. Vs. ACIT (ITA No. 1711/Hyd/2012). The coordinate bench of this Tribunal held that "the assessee's valuation has to be accepted as it was supported by an independent valuer." We are in agreement with the above decision. But now the question before us is, whether the actual result can be adopted in the valuation of "IP". The ld. AR has also brought to our knowledge the decision of ITAT, Bangalore in the case of Tally Solutions (P) Ltd. Vs. DCIT (supra). In the above case, the assessee attempted to adopt the actual revenues for the future years which were available then, which was rightly declined by the Bangalore Bench. We are in agreement with the above findings of the Bangalore Bench that the valuation method adopted for determining the future years cannot be replaced with actuals down the line, the valuation will go either way. When it goes to north, the revenue may adopt the same time, when it goes to south, the assessee may adopt, there won't be any consistency. What is important is the value 10 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
available at the time of making business decision. It should be left to the wisdom of the businessman, he knows what is good for the organization. No doubt, 'IP" was sold to "AE". The method adopted should be consistent and should be documented to review in the future. The review does not mean replacing the projection with actuals. It is the rational of adopting the values for making decision at the point of time of making decision. When the values are replaced subsequently, it is not valuation but evaluation i.e. moving the post of result determined out of projections. The revenue is doubting the valuation because the actual revenues were favourable. In rational decision making, the actual results are irrelevant. In the present case, the valuation was done by two independent valuers not by the assessee. The other issue with this are that the revenue adopted the actuals of AE without considering whether they are revenues generated out of the "IP" or not. They simply adopted the revenues of AE without giving proper findings that the revenues of AE are all generated only out of this "IP" (Jungle Book). The assessee submitted that these revenues are generated by "AE" out of other properties(IPs) as well. We are of the view that the revenue cannot adopt such values without proper verification. In our considered view, for valuation of an intangible asset, only the future projections alone can be adopted and such valuation cannot be reviewed with actuals after 3 or 4 years down the line. Accordingly, the grounds raised by assessee are allowed.
11. As regards ground Nos. 5 to 7, the TPO has apportioned the profit of the AE based on the ownership arising out of exploitation of intangibles. The findings of TPO are extracted below:
"7.3.1 Before carrying out the economic analysis the following issues have jointly and severally impacted the international transactions undertaken by the taxpayer.
Economic Substance:
The OECD in its Draft Handbook on Transfer Pricing Risk Assessment in Chapter 3 on Assessing When Transfer Pricing 11 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
Risk Exists And When it Does Not in para 3.2.1.7 under Transfer or Use of intangibles to/for Related parties stated that an intangible may be of great significance because the economic return on the intangible can be substantial. When income- producing intangibles are transferred, determining their arm's length value Is crucial.
There are various reports which suggest that importance of IPRs (including trademarks, patents, copy rights) to business has increased. These are usually the 'key value drivers' within international groups. 30% of world trade relates goods and services are associated with IPRs and that the intangible assets account for 50-70% of the market value of the public company. IPRs are highly mobile and provide an excellence opportunity for tax planning. For transfer pricing profit potential can more easily reallocated in the case intangibles than production facilities. The legal ownership or bearing of costs alone is not sufficient to be entitled to all the returns related to the intangibles.
The OECD TPG has also provided guidelines on recognition of actual transactions undertaken in para 1.64 to 1.68. The guidelines provide that there are two particular circumstances in which it may, exceptionally, be appropriate and legitimate for a tax administration to consider disregarding the structure adopted by a taxpayer in entering into a controlled transaction. The first circumstance arises when the economic substance of a transaction differs from its firm. In such a case the tax administration may disregard the parties' characterization of the transaction and re-characterize it in accordance with its substance. The second circumstance arises where, while the form and substance of the transaction are the same, the arrangements made in relation to the transactions, viewed in their totality, differ from those which would have been adopted by independent enterprise behaving in a commercially rationale manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price. In both sets of circumstances described above the character of the transaction may derive from the relationship between the parties rather than be determined by normal commercial conditions and may have been structured by the tax payer to avoid or minimize tax.
Legal registrations and contractual arrangements tend to be the starting point for determining the party entitled to the intangibles related returns. Where no written agreement exists, the OECD states that the conduct of the parties involved should be examined to determine their tacit agreement: it is the 'best evidence concerning the true allocation of entitlement to 12 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
intangible related returns'. The OECD further states that the party claiming entitlement to intangible related returns will physically perform, through its own employees, the most important functions related to the development, enhancement, "'maintenance and protection of intangibles'. Of the multinationals surveyed, over half indicated that such intangibles have been recognized in the books and records where development cost is borne which suggest that the location of the people performing the key .functions (development, enhancement, maintenance and protection) have not been used to determine where to allocate the intangible related returns. The UN TP Manual also recommends establishing the economic and legal ownership of the intangible. It suggests that in some cases an enterprise which does not have legal ownership 0' an intangible may nevertheless be entitled to a share of the returns from its exploitation. Some countries refer to this notion as "economic ownership".
Substance over Form:
The issue of substance-over-form is a much debated subject the world over. Revenue authorities in several jurisdictions have struck down tax avoidance or planning that lacks commercial substance. The legislation that has been formulated to disregard these transactions is collectively referred to as General Anti- Avoidance Rules (GAAR). Some countries, including UK and USA, have vigorous judicial anti-avoidance doctrines and no statuary GAAR, while other countries, such as Australia, Canada, Germany, Spain, New Zealand etc. have enacted statuary GAAR. Although India does not have wide ranging anti-avoidance rules under the domestic law, the principle of 'substance-aver-form' has been invoked by Indian Judiciary in various cases. There are various case laws where the Indian Judicial authorities have lifted the corporate veil and looked through the transactions thus highlighting the substance over form. In the case of Super Poly Fabriks Ltd, the Hon'ble Supreme Court has specifically laid down the ratio as under:
"8. There cannot be any doubt whatsoever that a document has to be read as a whole. The purport and object with which the parties thereto entered into a contract ought to be ascertained only from the terms and conditions thereof: Neither the nomenclature of the documents nor any particular activity undertaken by the parties to the contract would be decisive. "
In the case of Nilkantha Narayan Singh v. CIT 20 ITR 8 at page
14), the Court held that if the terms used in the agreements are not conclusive and one has to look at the substance rather than the form. In addition, it is equally well settled that a name given 13 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
to a transaction by the parties does not necessarily decide the nature of the transaction.
In the case of Bhopal Sugar Industries Limited V S. T.O. (1977) 3 SCC 147, the court held as follows:
"It is well settled that while interpreting the terms of the agreement, the Court has to look to the substance rather than the form of it. The mere fact that the word "agent" or "agency" is used or the words "buyer" and "seller" are used to describe the status of the parties concerned is not sufficient to lead to the irresistible inference that the parties did in fact intend that the said status would be conferred. Thus the mere formal description of a person as an agent or buyer is not conclusive, unless the context shows that the parties clearly intended to treat a buyer as a buyer and not as an agent"
In the case of Moped India Ltd. V Assistant Collector Central Excise 1985 - TMI - 41634 - (SC) the Hon'ble Supreme Court held that while interpreting the terms of an agreement, court has to look to the substance rather than the form and observed as follows:
"Now it is true that this amount allowed to the dealers has been referred to in the agreement as commission but the label given by the parties cannot be determinative because it is, for the court to decide whether the amount is trade discount or not, whatever be the name given to it.
Even more important in this context is to refer to the Accounting Standard- 1 issued by the Institute of Chartered Accountants of India and Central Government, wherein it is mentioned that the primary consideration in presentation of financial statements and selection of accounting policies by a business enterprise is that it should represent a true and fair view of the state of affairs and profit and loss account of the enterprise. The major considerations governing the selection and application are prudence, substance over form and materiality. Accordingly, the accounting treatment and presentation in financial statements of transactions and events should be governed by their substance and not merely by the legal form. Thus, substance should take precedence over its legal form. In any commercial transaction, substance must be recognized rather than its form. The decision of State of Andhra Pradesh v. Kane Elevators India Ltd. (2005) 181 ELT 156 (Supreme Court) can also be relied upon where apex court held that the substance of the contract is determinative and not its form. Thus, the essence of the contract is crucial and is to be seen, keeping in mind the intention of the parties.14 ITA No. 151 /Hyd/2015
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In Sundaram Finance Ltd. v State of Kerala AIR 1966 SC 1178 the Supreme Court has held that true effect of transaction must be determined from the terms of the agreement considered in the light of surrounding circumstance. In each case, the court can, unless prohibited by statute, go behind the documents and determine the nature of transaction whatever may be form of documents.
To ensure non-discriminatory enforcement of laws and regulation, choosing a formal approach is very logical. In other words, the form of a situation a transaction, determines the legal consequences. In tax law particularly, choosing a form to suit a particular tax benefit is not warranted but what matters is the actual substance.
In the case of Rolls Royce Plc Vs DCIT (2007), greater emphasis was laid on the facts than the contractual arrangement. Rolls Royce Plc (RRP) was incorporated in UK and supplied aeronautical engines and spare parts to certain defense establishments in India. It had a wholly owned subsidiary in India, Rolls Royce India Ltd (RRIL). In this case, the Delhi ITAT found that the premises in the name of RRIL were being occupied by RRP's employees while visiting India frequently for the purposes of its business operations in India. RRP reimbursed RRIL the expenses for the operation and maintenance of the office in India and also compensated RRIL for the support services it rendered. The ITAT stated that RRP had a permanent establishment (PE) in India and held that 35% of its profits were attributable to marketing activity that was carried out in India and was therefore taxable in India.
Business Restructuring:
With the recently inserted explanation w.r.e.f. 1.4.2002, which is clarificatory in nature, international transactions include a transaction of business restructuring.
"Explanation. - For the removal of doubts, it is hereby clarified that-
(i) the expression "international transaction" shall include -
(a) .
(b) .
(e) .
(d) .15 ITA No. 151 /Hyd/2015
D.Q. Entertainment (International) Ltd.
(e) a transaction of business restructuring or reorganization, entered into by an enterprise with an associated enterprise, irrespective of the fact that it has bearing on the profit, income, losses or assets of such enterprises at the time of the transaction or at any future date."
The OECD in its Draft Handbook on Transfer Pricing Risk Assessment in Chapter 3 on Assessing When Transfer Pricing Risk Exists And when It Does Not in para 3.2.1.9 under Business Restructurings has stated that the business structures and transactions flows adopted in connection with restructuring an MNE's business need careful consideration. There are two aspects of such transactions to be considered. The first is the restructuring transaction itself. The transfer of assets, including intangibles, in connection with such transactions can give rise to difficult valuation and other transfer pricing issues. Often these transactions involve efforts to move valuable assets into more tax favoured environments. Risk assessment should seek to identify such transactions and evaluate the potential exposures. OECD TPG in Chapter 9 has dealt with the issue of business restructuring. Business restructuring is defined as cross border redeployment by a MNE of functions, assets and / or risks and may involve cross border transfer of valuable intangibles. Business restructuring typically accompanied by reallocation of profits among the members of the MNE group, either immediately after the restructuring or over a few years and the Chapter thus discusses the extent to which such a reallocation of profits is consistent with the arm's length principle and more generally how the arm's length principle applies to the business restructuring. The UN TP Manual in chapter 8 on Audits and Risk Assessment, in para 8.3.2.3 proposed "8.3.2.3. The following describes some of the more complex categories of risk that are not always readily identifiable. It is by no means exhaustive and it is acknowledged that additional classes and categories of risk may exist:
Category 1: Intentional profit shifting through new structures; Category 2: Intentional profit shifting through restructuring; Category 3: Intentional profit shifting through incorrect functional classification, the use of incorrect methods, allocation keys, etc; Category 4: Thin capitalization; and Category 5: Unintentional profit shifting.
Re-characterization:
Rule 10B(2)(c) of the IT Rules provide the TPO with necessary powers to re-characterize the transactions taking into account 16 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
the contractual terms whether or not such terms are formal or in writing. The GECD TPG in para 1.64 to 1.69 has provided guidance on recognition of the actual transactions undertaken. Two circumstances have been enumerated where it is appropriate to consider disregarding the structure adopted by a taxpayer in entering into a controlled transaction. "The first circumstance arises where the economic substance of a transaction differs from its form. In such a case the tax administration may disregard the parties characterization of the transaction and re-characterize it in accordance with its substance." "The second circumstance arises where while the form and substance of the transaction are the same, the arrangements made in relation to the transaction, viewed in their totality, differ from those which would have been adopted by independent enterprises behaving in a commercially rational manner and the actual structure practically impedes the tax administration from determining an appropriate transfer price." In para 1.66 the manual stated that "In both sets of circumstances described above, the character of the transaction may derive foam the relationship between the parties rather than determined by normal commercial conditions and may have been structured by the taxpayer to avoid or minimize tax. In such cases, the totality of its terms would be the result of a condition that would not have been made if the parties had been engaged in arm's length transactions. Article 9 would thus allow an adjustment of conditions to reflect those which the parties would have attained had the transaction been structured in accordance with the economic and commercial reality of parties transacting at arm's length."
Further in para 1.67 commenting that AEs may and frequently do conclude arrangements of a specific nature that are not or are very rarely reencountered between independent parties and that in such circumstances the tax administration would have to determine what underlying reality is behind a contractual arrangement in applying the arm's length principle. BEPS:
Intangibles have been highlighted as a particular area of concern in the 2013 OECD publication addressing Base Erosion and Profit Shifting (BEPS), which states that the "current rules produce undesirable results from a policy perspective". The OECD draft guidance is expected to be finalized in 2014. The OECD's work on intangibles is a specific action area listed in the OECD's Base Erosion and Profit Shifting (BEPS) Action Plan and is closely related to other action areas on transfer pricing, including work on allocation of risks and capital for transfer pricing purposes, work on re-characterization of transactions that 17 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
might not occur between unrelated parties, and work on transfer pricing methods including profit splits in the context of the global value chains of multinational enterprises. Some of the text and examples contained in the revised Discussion Draft raise issues that the OECD expects to address further through the various actions contained in the Action Plan. Accordingly, portions of the revised Discussion Draft can be expected to be further revised during the course of the work on BEPS.
New OECD guidance -
1. The definition of intangibles subject to the guidance has been clarified, and is a fairly comprehensive definition, not limited by requirements of legal registration or protection.
2. The concept of entitlement to intangible related returns is the guiding principle that determines which entity should receive the compensation arising from the intangible. Legal ownership and funding the development of the asset are now only a 'starting point'. The performance of key functions with respect to the development,. enhancement, maintenance and protection of the intangibles and, in particular, controlling the risks related to these functions is the primary determinant.
3. The requirement that all participants in a restructure consider the 'options realistically available' to them to validate whether the transaction makes commercial sense.
4. The economic analysis methods used to determine the arm's length price of intangibles now includes valuation techniques, such as a discounted cash flow analysis.
This guidance cannot be viewed as business as usual. The OECD in its publication addressing "Base Erosion & Profit Shifting" in Chapter 1 on introduction observed that there is a growing perception that Government's use substantial corporate tax revenue because of planning aimed at shifting profits in ways that erode the taxable base to locations where they are subject to more favourable tax treatment. Business leaders often argued that they have a responsibility towards their shareholders to legally reduce the taxes their companies pay. Some of them might consider most of the acquisitions unjustified, In some cases deeming Governments responsible for incoherent tax policies and for designing tax systems that provide incentives for BEPS.
In Chapter 4, the report has further highlighted the need for the determination of the relevant share of profits which will be subjected to taxation. The issue of jurisdiction to tax is closely linked with the one of measurement of profit: once it has been established that a share of an enterprise's profits can be 18 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
considered to originate from a country and that the country should be allowed to tax it. In the same chapter the report states that one of the underline assumptions of the arm's length principle is that the more extensive the functions/assets/ risks of one party to the transaction, the greater its expected remuneration will be and vice-versa. This therefore, creates an incentive to shift functions/assets/ risks to where there returns are taxed more favorably. While it may be difficult to shift underline functions, the risks and ownership of tangible and intangible assets may, by their very nature, be easier to shift. Many corporate tax structures focus on allocating significant risks and hard-to-value intangibles to low-tax jurisdictions, where their returns may benefit from a favourable tax regime. Such arrangements may result in or contribute to the BEPS. OECD Action Points on Transfer Pricing The Report notes that a major concern is the ability of corporates to misapply income allocation rules by separating income from economic activities that produce income and shift the same to low tax jurisdictions. In this regard, the Report states:
"This most often results from transfers of intangibles and other mobile assets for less than full value, the over-capitalization of lowly taxed group companies and from contractual allocations of risk to low-tax environments in transactions that would be unlikely to occur between unrelated parties."
Thus, following are the key areas of concern:
- Intangible Transfers
- Over capitalization
- Contractual allocation of risk to low tax jurisdictions OECD plans to tackle above issues through action points 8-10 listed in the Report. Overall, the underlying theme of Action Points 8-10 is according an overriding importance to 'substance' over form in the context of Transfer Pricing. This is not an entirely novel direction as OECD has always accorded precedence to conduct over contractual agreements to the extent there is inconsistency between the two (refer para 1.48 to 1.49 of OECD Transfer Pricing Guidelines, 2010).
Action Point 8 - 'Intangibles' Develop rules to prevent HEPS by moving intangibles among group members. This will involve: (i) adopting a broad and clearly delineated definition of intangibles; (ii) ensuring that profits associated with the transfer and use of intangibles are appropriately allocated in accordance with (rather than divorced 19 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
from) value creation; (iii) developing transfer pricing rules or special measures for transfers of hard-to-value intangibles; and
(iv) updating the guidance on cost contribution arrangements.
Action Point 9 - 'Risk' and 'Capital' Develop rules to prevent BEPS by transferring risks among, or allocating excessive capital to, group members. This will involve adopting transfer pricing rules or special measures to ensure that inappropriate returns will not accrue to an entity solely because it has contractually assumed risks or has provided capital. The rules to be developed will also require alignment of returns with value creation. This work will be co-ordinated with the work on interest expense deductions and other financial payments:
Action Point 10 - Other high risk transactions Develop rules to prevent BEPS by engaging in transactions which would not, or would only very rarely, occur between third parties. This will involve adopting transfer pricing rules or special measures to: (i) clarify the circumstances in which transactions can be recharacterised; (ii) clarify the application of transfer pricing methods, in particular profit splits, in the context of global value chains; and (iii) provide protection against common types of base eroding payments, such as management fees and head office expenses.
7.3.2 Therefore in view of the above discussion which has an impact over the profits arising from the exploitation of the intangible consequent to the legal transfer of the IP and also taking guidance from para 9.190 of the OECD TPG, under the example "Example (B): Transfer of valuable intangibles to a shell company", it was felt that the taxpayer also needs to get its rightful share in the profit. This will be clear after the following discussion.
As per the TP document, the taxpayer did not carry out any FAR analysis for the transaction relating to the sale of IP. However from the subsequent information gathered during the course of hearing it is seen that the cost of development of the IP is Rs.4,94,03,810/-. DQE India started working on the concept of Jungle Book since April, 2008 and sold it to DQE Ireland for Rs.5,36,20,000/- in April, 2009. It is stated that the IPR was sold in the development phase, As per the details submitted regarding DQE Ireland, it is seen that the company is a WOS of DQE India which was incorporated in Ireland on November, 12 2008. The company is stated to be engaged in the business of content development including all production activities for animation and live action for TV series, home video and various other media. As regards the purpose of establishment, it is stated -
20 ITA No. 151 /Hyd/2015D.Q. Entertainment (International) Ltd.
"One of the key business strategies of DQE India is to strengthen the IP content creation and global lP portfolio. However, the talent for creation of global IPs in India is still nascent when compared to the European and other Western markets. Accordingly, DQE Ireland being located in Europe, enables to expand the DQE group's European footprint and pursues growth opportunities in pre-production and post-production services of various IPs. DQE Ireland, being a European company avails the benefits provided by the Government of Ireland to the Animation Industry,"
DQE Ireland has two directors and one employee -
Shri Sanjay Choudhary, Director Shri Dominic Poole, Director Laurent Amar working as Marketing Manager As per the submission made on 23.12.2013 DQE Ireland hires various identified talents across Europe & US for script writing, music. mixing & composing, development & design, voice, music etc., on freelance basis. Most of these artists have had many years of experience working with the biggest animation studios as a result of which they understand what the audience expects from the cartoons. DQE Ireland produces content predominantly for Europe & North America and hence hiring international artists becomes necessary to cater to global audiences needs as also as per the demand of co-producers, broadcasters & partners. DQE hires foreign artists even their experience, command over the English language & technical expertise when it comes to writing for animation as against a stark contrast to India artists who mostly have experience writing for live action feature films and, therefore, do not have the know-how to adopt their writing to animation. Foreign artists also have the technical expertise of animation writing, which includes understanding the structure of episodes, development of characters, understanding the current market for animation, quick turn around on an episode to episode basis and development of stories from a logline to beat outline to the final script. Alongwith this write-up, the taxpayer provided the profiles of few artists such as Jimmy Hibbert, Chris Trengrove and James Mason.
However, the facts of the case as understood by the TPO appear different. As per the financial statement of DQE Ireland, in the notes to the accounts it is mentioned that there are no employees during the year apart from the directors. The company is thus functioning with only two or three persons (if the marketing manager is also an employee) and has been able to 21 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
generate revenue of 4 million Euros in its first year of operations. The only activity carried out by the company is hiring of artists. The copyrights valued at Euro 812,182 were purchased by the company from DQE India on 16-04-2009. The cost of sales of Euro 2,798,190 is paid to outsiders as there are no employees other than directors. Distribution cost is marketing expenses of 42,172 Euro, which constitutes 1% of the revenue. Administrative expenses include Professional charges paid to outsiders of 8,000 Euros, Directors fees of 5,398 Euros, travelling expenses 5,000 Euros, legal and professional 446 Euros, audit 20,000 Euros and bank charges 1,235 Euros. All the administrative expenses put together at Euros 40,079 constitutes another 1% of the revenue. A further finance cost of Euros 46,699 constitutes 1.15% of revenue. Thus the balance of 96.85% of the expenditure is to freelancers. From the expenses it is seen that there are no expenses towards rent and from the FA schedule it is seen that there is no owned building; Assets include only intangible asset worth Euro 1,740,049. Thus the company appears to be working from some place other than Ireland. In this digital age there is also no need for a person to be stationed at a place to work but almost all the work such as hiring of persons, execution of contracts, payments, receipt of services are being done online and which is more so prevalent in the developed countries such as Europe.
As per the profile of the taxpayer contained in the TP document, the DQE Group is a leading animation production company engaged in the production of 20, 3D and flash animation, with a substantial workforce and a global client base. The Group currently produces animation for films, television series and console based games for a number of international production houses. The group is equipped with manpower strength of close to 3,000 who operate out of seven facilities in India. DQE Group operates through three major business divisions viz. Animation Division, Gaming Division and the Distribution Division. DQ Entertainment (International) Limited (DQE India") was formerly known as Animations and Multimedia Private limited ("AMPL"). AMPL was incorporated on 13th April 2007 and the name was subsequently changed to the current name DO Entertainment (International) Private Limited on 17 th January 2008 by a fresh certificate of incorporation issued by Registrar of Companies, Andhra Pradesh, India. DOE India is a subsidiary of DOE Mauritius.
The annual report is flush with the achievements of the company and the details of vast library of IPs. The annual report starts with the note on 'Celebrating a decade of excellence' and goes on to list the achievement and awards won over a period of time. In the Chairman's statement, Shri Tapaas Chakravarti, Chairman, MD and CEO of the company states that-
22 ITA No. 151 /Hyd/2015D.Q. Entertainment (International) Ltd.
"GLOBAL FOOTPRINT I am proud to report that the credibility of your company has been established amongst the elite entertainment fraternity worldwide as recognized by the achievement of the highest international quality standards and timely deliveries by its professional, creative and highly motivated workforce. DQE's reach and networking is truly global partnering with the best in India, Europe, North America, Australia and New Zealand, Asia, the Middle East and Africa as well as CIS countries. Licensing of Jungle Book TV rights in over 160 countries is fine proof of DOE's global sales, distribution and licensing reach. The Company has a strong presence for high quality development in the US, the UK, France, the Philippines with a large work force of over 3000+ in India alone. I believe that one of the most important differentiators of the Company has been the extraordinary talent and commitment of our associates. DOE is leveraging on the best talents available for procreative work such as primary designing, script writing, voice, music and some other preproduction from its subsidiaries in Europe and offices in Ireland, France, the UK and the Philippines to support the main production in Indio."
There are ample other references about the company which shows that it is one of the globally premium producer of animation and visual effects for global TV series, feature films, DTH videos including online, mobile and next generation console game art and in-game animation. The company was able to place IPs like Twisted Whiskers, Sandra and Rat Man with Disney, Casper with Nickelodeon and Balkend & Ravan with Turner Group among others. Thus the company is a multi faceted company with a very large trained and skilled work force capable of taking of any challenge. The taxpayer, however, is trying to project DQE India as incapable as compared to DOE Ireland, which is only into first year of its operations. It may again be pointed out that the Director Sanjay Chaudhary is a product of the Indian entity. The revenues of DOE India over a period of three years are as under:
FY Sales (in crores)
2007-08 92.21
2008-09 149.81
2009-10 148.12
2010-11 161.70
It is, therefore, improbable to imagine that such an established company would sell an IP at a relatively low price which would be 23 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
earning substantial revenue in the coming years. The revenue of DQE Ireland has increased from Euros 4 million to Euros 7.8 million within a span of 1 year of acquiring the IP. It is possible that the taxpayer has purposefully shifted the revenue earning potential IP to a low tax regime jurisdiction where within a year of its incorporation, it has earned substantial revenue, which has further increased substantial, 10 the subsequent years. The tax rate for corporate is 12.50% in Ireland as against the tax rate in India at 33.99%. Apparently the company is a shell company. It is also noticed that in t'l2 following years a few more IPRs have been shifted to Ireland AE, but the production work is again assigned back to the taxpayer. Thus both the AE and the taxpayer are involved at sore stages in the exploitation of the IP even after the legal ownership of the IP is transferred. Taking into account the above facts, it appears appropriate that the profit earned by DQE Ireland ought to be rightfully attributed to DQE India. Also realizing that the taxpayer has earned a meager profit of Rs.42,17,810/- on the sale of IP, it was, therefore, proposed to apply Profit Split Method (PSM) to bring the appropriate profit earned from the use of IP to India. A show cause notice was issued to the taxpayer on 09.01.2014 and the compliance was requested by 20.01.2014. The taxpayer sought a short adjournment upto 24.01.2014 which was granted. The PSM may be applicable when the various entities, involved in controlled transactions in which the associated enterprises are engaged, have significant intangible assets and/or operations of the entities are highly integrated, sharing more or less proportionately in the risks associated with the design, production and sale of applicable product that cannot be evaluated on a separate basis. The ICAI TPG notes illustrates the situation where PSM may be useful-
"6.20 Typical transactions where the profit-split method may be used are transactions involving:
(a) integrated services provided by more than one enterprise for e.g. in case of financial service sector. where the activities performed by Indian company and foreign AEs in relation of a merger and acquisition transaction are so interrelated that it may not possible to segregate them:
(b) transfer of unique intangibles. for e.g. two associated enterprises contribute their respective intangibles to develop a new product or process and earn income from such product or process. "
The case of the taxpayer falls in category (b) above. The profit is to be divided such as is expected in a joint venture relationship. In the present case the creation of an IP is a significant process 24 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
and is the life of the movie / animated series. One without the other does not exist. The UN practical manual on TP provides the method to allocate or split the profits Para 6.3.14.1 to 5 are extracted hereunder:
"6.3.14. Methods to Allocate or Split the Profits 6.3.14.1. There are generally considered to be two specific methods to allocate the profits between the associated enterprises: contribution analysis and residual analysis. 6.3.14.2. Under the contribution analysis the combined profits from the controlled transactions are allocated between the associated enterprises on the basis of the relative value of functions performed by those associated enterprises engaged in the controlled transactions, External market data that reflect how independent enterprises allocate the profits in similar circumstances should complement the analysis to the extent possible.
6.3.14.3. If the relative value of the contributions can be calculated directly, then determining the actual value of the contribution of each enterprise may not be required. The combined profits from the controlled transactions should normally be determined on the basis of operating profits. However in some cases it might be proper to divide gross profits first and subsequently subtract the expenses attributable w each enterprise.
6.3.14.4. Under the residual analysis the combined profits from the controlled transactions are allocated between the associated enterprises based on a two-step approach:
Step 1: allocation of sufficient profit to each enterprise to provide basic arm's length compensation for routine contributions. This basic compensation does not include a return for possible valuable intangible assets owned by the associated enterprises. The basic compensation is determined based on the returns earned by comparable independent enterprises for comparable transactions or, more frequently, functions. In practice TNMM is used to determine the appropriate return in Step 1 of the residual analysis; and Step 2: allocation of residual profit (i.e. profit remaining after Step 1) between the associated enterprises based on the facts and circumstances. If the residual profit is attributable to intangible property then the allocation of this profit should be based on the relative value of each enterprise's contributions of intangible property.25 ITA No. 151 /Hyd/2015
D.Q. Entertainment (International) Ltd.
6.3.14.5. The residual analysis is typically applied to cases where both sides of the controlled transaction contribute valuable intangible property to the transaction. For example Company X manufactures components using valuable intangible property and sells these components to a related Company Y which uses the components and also uses valuable intangible property to manufacture final products and sells them to customers. The first step of a residual analysis would allocate 0 basic (arm's length) return to Company X for its manufacturing function and a basic (arm's length) return to Company Y for its manufacturing and distribution functions. The residual profit remaining after this step is attributable to the intangible properties owned by the two companies. The allocation of the residual profit is based on the relative value of each company's contributions of intangible property. The OECD Guidelines do not refer to specific allocation keys to be used in this respect. Step 2 may not, and typically does not, depend on the use of comparables."
In response to the show cause notice the taxpayer filed its reply on 24.01.2014. It is stated that "PSM is applicable only when the intangibles is jointly owned by both Associated Enterprises under cost contribution arrangement whereas in our case it is the absolute sale from DO India to DO Ireland which is supported by independent valuation reports. Hence application of PSM for revenues generated by DQ Ireland is legally unsustainable and factually incorrect. Hence it is not correct to attribute 80% of profits to DQ India."
The submission has been considered. The question here is not who the legal owner of the IP is but who the economic owner of the IP is. The case of taxpayer encompasses business restructuring involving economic substance of the trans action. As discussed above the legal ownership is not in dispute. But as shown above, DQE Ireland is only a shell company located in low tax jurisdiction and being run by only 2 persons, therefore the economic benefits do not lie there. The AE in turn is also offloading production work to the taxpayer for ±= development of the IP. The profits arising by exploiting the intangibles rightly lie with DQE India. Para of the OECD TPG succulently answers the question.
"9.67 In the context of business restructurings, profit potential should not be interpreted as simply the profits/losses that would occur if the pre-restructuring arrangement were to continue indefinitely. On the one hand, if an entity has no discernible rights and/or other assets at the time of the restructuring, then it has no compensable profit potential. On the other hand, an entity with considerable rights and/or other assets at the time of the 26 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
restructuring may have considerable profit potential, which must ultimately be appropriately remunerated in order to justify the sacrifice of such profit potential."
In an arm's length situation, no independent enterprise would allow its valuable IP to be sold at a low value which has the potential of earning huge revenues unless it is a distress sale Having said so, no independent enterprise would allow its rightful share of profit to be retained by another enterprise. Accordingly the computation is as under-
Particulars DQE India DQE Ireland Total Total (INR @
(Euro) Rs. 70 per
Euro)
Operating 0 Marketing 128,950 90,26,500
Cost Expenses-
42,172
Admn.
Expenses -
40,079
Total -
128,950
Step 1 : Allocation of profit on routine contributions Profit 0 10% of OC, 12,895 9,02,650 Allocation being routine marketing and administrative functions -
12,895
Balance 0 1,156,523- 1,143,628 8,00,53,960
profit 12,896 =
1,143,628
Step 2 : Allocation of profit on IP contribution Profit on 42,17,810 0 - 8,42,71,770 sale of IP Further 80% of 20% - 8,42,71,770 allocation 8,42,71,770 8,42,71,770 = based on = 1,68,54,340 FAR 6,74,17,416 Justification for 80:20 split:
As made out above, DQE India is headed by leading persons in Animation Industry having as many as 8 directors with a trained and skilled combined work force of 3000+, as compared to DQE Ireland which has no other set up other than the presence of 2 directors. DQE India is in existence for more than 10 years with tie ups with various studios over the world, whereas DQE Ireland which is only 1 year old can only get so much of business only with the association with DQE India. The taxpayer has the presence and a brand value of itself which has been capitalized by the AE to tap the right contacts in the industry. The hired staff 27 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
in Ireland, if they are renowned, would like to associate with some established entity rather than a start-up company. Therefore it is only due to the identity and standing of DOE India in Global arena, the persons got hired. In this scenario it is only appropriate to share the profits in the ratio of 80:20 between DQE India and DQE Ireland.
Thus the ALP of the profit attributable to DQE India is Rs.6,74,17,416/- and the profit attributable to DQE Ireland is Rs.1,68,54,340/-. Accordingly the income of the taxpayer shall be enhanced by Rs.6,74,17,416 u/s 92CA(3) of the IT Act." Based on the above, the TPO decided that even though the legal ownership IPs of Jungle Book sold, has been transferred to DQ Ireland, but the economic ownership lies with DQ India. The TPO, therefore, proceeded to apply Profit Split Method to apportion the appropriate profit to DQ India which otherwise is lying with DQ Ireland, in the ratio of 80:20 and accordingly determined the profit of Rs.6,74,16,416/- being attributable to DQ India and the balance portion of Rs. 1,68,54,340/· attributable to DQ Ireland.
12. When the assessee raised objection before the DRP, the DRP extracted the TPO's order on this issue in their order and confirmed the action of the TPO on this issue rejecting the objection of the assessee. Hence, assessee is in appeal before us.
13. Ld. AR submitted that the Intangible asset "Jungle Book" was sold to DQ Ireland on 30 th September, 2009.(Pg.264 of the paper book). He submitted that the Ld TPO allocated 80% of profit on IP contribution to the appellant company and adopted the Profit Split Method (PSM) for this purpose. It is submitted that PSM is applicable only when the intangibles are jointly owned by both the assessee and AE under cost contribution arrangement and whereas in our case it is an absolute sale on so" September, 2009 itself. It is submitted that when the Intangible asset is sold and is at arms length, there arises no question of joint ownership.
13.1 Ld. AR submitted that Ld TPO had made an adjustment of Rs. 6,74,17,416/- towards profit attributable to appellant company in 28 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
connection with sale of Intangible asset. This addition was based on the overall revenue generated by the Associated Enterprise DQ Ireland which included other Intangible assets. He submitted that the Intangible asset is sold in September, 2009 and no revenue is generated between April 2009 to September 2009 either in the hands of DQ India or in the hands of DQ Ireland, hence apportioning revenue to DQ India is factually incorrect and legally unsustainable. It is submitted that the revenue from the IP 'Jungle Book' was started generating from last quarter of FY 2009-10, i.e. during January 2010 to March 2010 when the ownership of the intangible asset was with DQ Ireland and therefore revenue generated from the intangible asset wholly belongs to DQ Ireland.
13.2 Ld. AR submitted that TPO considering the financials of DQ Ireland apportioned revenue to DQ India, the basis of allocation is as under:
Particulars Amount Amount
P.B.T. of DQ Ireland for year
ending 31 st March, 2010 (pg. 91
of paper book) (I) 11,56,523
Euros
Distribution cost (pg. 91 of 42,172
paper book) Euros
Administrative expenses (pg. 91 40,079
of paper book) Euros
Finance costs (pg. 91 of paper 46,699
book) Euros
Total 1,28,950
Euros
12,895
10% Routine expenses (II) Euros
P.B.T. after deduction of routine
expenses (A) = (I-II) 11,43,628
Amount in INR(A*70) (1 Euro =
Rs. 70 approximately) E(B) 8,00,53,960
Profit on Intellectual property
(Capital Gains)
29
ITA No. 151 /Hyd/2015
D.Q. Entertainment (International) Ltd.
Sale of Intellectual property 5,36,20,000
Less: Cost of intellectual
property (pg. 77 & 362 of paper
book) 4,94,03,810
Capital Gains (pg. 6 of paper
book) (C) 42,16,190
Profit on mutual funds (pg. 6 of
paper book) It is only Rs. 1090 (D) 1,620
(E = C+D) 42,17,810
F = (B+E) 8,42,71,770
80% of profits allocated to DQ
India F* 80% 6,74,17,416
13.3 Referring to the above table, ld. AR submitted that it is clearly
evident that the Ld TPO has taken the overall profits being generated by DQ Ireland. It is also evident that the Ld TPO has also considered Rs.42,16,190/- capital gains in his calculation ignoring the fact that the same was already offered to tax by appellant company. (Pg.3 & 6 of paper book). He submitted that revenue generated by DQ Ireland includes revenue from various projects like Jungle Book, Maryoku Yummy & Peterpan (Pg. 265 & 286 of paper book). Since the projects Maryoku Yummy and peterpan are no way related to DQ India and further revenue from project Jungle Book started only from January 2010 when DQ Ireland was absolute owner there arises no question of any profits belonging to DQ India.
13.4 Ld. AR, therefore, submitted that it is not legally & factually tenable to attribute 80% of profits of DQ (Ireland) to DQ (India) when such profits solely belong to DQ Ireland who is the absolute owner of the intangible asset. Hence the above mentioned calculation of attribution of income to assessee company is totally against the facts and has no legal sanctity. Accordingly, he prayed the Bench to grant relief as per the grounds of appeal and submissions made as above.
14. Ld. DR submitted that it is the submission of the taxpayer that PSM is only applicable when the intangible is jointly owned by both 30 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
the AEs and the taxpayer. In this regard, the TPO observed that the sale of the intangible asset to AE is in the nature of business restructuring. Under this particular restructuring there is a transfer of asset including intangible. Often these transactions involved efforts to move valuable assets into the tax favoured nation like Ireland and therefore, there was incentive to transfer the intangible asset in the development stage itself. The TPO also highlighted the issue of BEPS examining the substance, substance over form and re- characterization to conclude that the arrangements of the specific nature such as transfer of intangibles are not reencountered between the Indian entity and in such circumstances the tax administration would have to determine all the underlying reality is behind the contractual arrangement in applying the ALP principle. The TPO .observed that the DQ Ireland has only two directors and one employee. The only activity carried out by the company is hiring of artists. The copyrights valued at Euro 812,182 were purchased by the company from DQE India on 16-04-2009. The cost of sales of Euro 2,798,190 is paid to outsiders as there are no employees other than directors. Distribution cost is marketing expenses of 42,172 Euro, which constitutes 1% of the revenue. Administrative expenses include Professional charges paid to outsiders of 8,000 Euros, Directors fees of 5,398 Euros, travelling expenses 5,000 Euros, legal and professional 446 Euros, audit 20,000 Euros and bank charges 1,235 Euros. All the administrative expenses put together at Euros 40,079 constitutes another 1% of the revenue. A further finance cost of Euros 46,699 constitutes 1.15% of revenue. Thus the balance of 96.85% of the expenditure is to freelancers. From the expenses, it is seen that there are no expenses towards rent and from the FA schedule it is seen that there is no owned building. Assets include only intangible asset worth Euro 1,740,049. Thus the company appears to be working from some place other than Ireland. In this digital age there is also no need for a person to be stationed at a place to work but almost all the work such as hiring of persons, execution of contracts, payments, 31 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
receipt of services are being done online and which is more so prevalent in the developed countries such as Europe.
14.1 Ld. DR submitted that as per the profile of the taxpayer contained in the TP document, the DQE Group is a leading animation production company engaged in the production of 2D, 3D and flash animation, with a substantial workforce and a global client base. The Group currently produces animation for films, television series and console based games for a number of international production houses. The group is equipped with manpower strength of close to 3,000 who operate out of seven facilities in India. DQE Group operates through three major business divisions viz. Animation Division, Gaming Division and the Distribution Division. DQ Entertainment (International) Limited ("DQE India") was formerly known as Animations and Multimedia Private Limited ("AMPL"). AMPL was incorporated on 13th April 2007 and the name was subsequently changed to the current name DQ Entertainment (International) Private Limited on 17 th January 2008 by a fresh certificate of incorporation issued by Registrar of Companies, Andhra Pradesh, India. DQE India is a subsidiary of DQE Mauritius.
14.2 Ld. DR submitted that the TPO further observed that it is therefore, improbable to imagine that such an established company would sell an IP at a relatively low price which would be earning substantial revenue in the coming years. The revenue of DQE Ireland has increased from Euros 4 million to Euros 7.8 million within a span of 1 year of acquiring the IP. It is possible that the taxpayer has purposefully shifted the revenue earning potential IP to a low tax regime jurisdiction where within a year of its incorporation, it has earned substantial revenue, which has further increased substantially in the subsequent years. The tax rate for corporate is 12.50% in Ireland as against the tax rate in India at 33.99%. Apparently the company is a shell company. It is also noticed that in the following years a few more IPRs have been shifted to Ireland AE, but the 32 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
production work is again assigned back to the taxpayer. Thus both the AE and the taxpayer are involved at some stages in the exploitation of the IP even after the legal ownership of the IP is transferred. The TPO therefore rightly applied PSM.
14.3 As regards the profit sharing ratio of 80:20, ld. DR submitted that the reasons thereof are that DQE India is headed by leading persons in Animation Industry having as many as 8 directors with a trained and skilled combined work force of 3000+, as compared to DQE Ireland which has no other set up other than the presence of 2 directors. DQE India is in existence for more than 10 years with tie ups with various studios over the world, whereas DQE Ireland which is only 1 year old can only get so much of business only with the association with DQE India. The taxpayer has the presence and a brand value of itself which has been capitalized by the AE to tap the right contacts in the industry. The hired staff in Ireland, if they are renowned, would like to associate with some established entity rather than a start-up company. Therefore it is only due to the identity and standing of DQE India in Global arena, the persons got hired. In this scenario it is only appropriate to share the profits in the ratio of 80:20 between DQE India and DQE Ireland.
15. Considered the submissions of both the parties and perused the material facts on record as well as the orders of revenue authorities. The facts are, the assessee had sold "IP" (Jungle Book) to its "AE" on 30/09/2009 at the development stage. It was not fully developed to generate revenue immediately. As per ld. AR, "AE" was in a position to generate revenue in the last quarter of 2009-10 i.e. Jan-March, 2010. But TPO adopted the whole revenue generated by "AE" in the whole year to arrive the profit arithmetically to the Indian Entity. The main issue before us is, whether the TPO justified to determine the profit attributable to Indian entity (assessee) when he himself determined the sale consideration of IP (Jungle Book). When the TPO 33 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
agreed that there is a outright sale, there ends the international transaction. Now, TPO is trying to go beyond sales and making TP adjustments. We are asking ourselves, whether there is any international transaction exists. In our considered view, there is no international transaction after outright sale. There is no international transaction exists as per section 92B of the Act as there is no transaction exists between assessee and with it's AE. We are inclined to reject the stand of the TPO.
15.1 Moreover, after the completion of the sale process, the "AE" has done transaction with the outsiders or outside the jurisdiction of the Indian territorybut there is no transaction done with the assessee involving the above IP (jungle book) to consider that there exists a international transaction. Once, the IP is sold and Arm's length price is determined, the "IP" becomes the property of "AE". The assessee has no locus standi to claim any benefit neither the revenue.
15.2 The revenue has grievances on the arrangement and existences of group companies. There is no doubt, there exists tax planning. There can be tax planning within the four corners of the taxation laws. There is enough mechanism in the existing Act and also there is DTAA - arrangement with Ireland, which will take care of the situations of tax avoidance. The revenue has not brought any cogent evidence to prove that there exists any tax avoidance. In our considered view, the action of the TPO is not justified and accordingly, the grounds raised by assessee are allowed.
16. As regards ground No. 8 regarding payment towards management consultancy service fee of Rs. 3,70,53,448/-, it is observed that the assessee has paid management consultancy charges of Rs.3,70,53,448/- to its AE, DQ Mauritius for availing management consultancy services. In view of the assessee's failure to substantiate with supporting evidences showing the tangible benefit has been received, the TPO computed the Arm's Length Price at NIL. Following the decision of the earlier DRP for the preceding 34 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
assessment years and ground of objections raised by the assessee were rejected by the TPO.
17. DQE India availed management consultancy services from DQE Mauritius, as per the terms and conditions in DQ Memorandum of Understanding ("MoU") entered into between both the companies. The services provided by DQE Mauritius to DQE India as per this arrangement from time to time, are in the nature of administrative, general management and professional services. During the assessment year 2010-11 the assessee paid an amount of Rs. 3,70,53,448/- to M/s DQ Entertainment (Mauritius) Ltd, Mauritius towards management consultancy services received. The assessee company submitted to the TPO that the payment of management fee was made to the Board of Directors of the associated Enterprise (DQ Plc) as they were rendering invaluable advice and guidance to the assessee company. These Board of Directors included persons from the animation field, and having experience in children's entertainment and who had been rendering invaluable inputs to the assessee company. The assessee also submitted that Board of DQ Plc has been instrumental in bringing in a number of projects with important customers. These projects are valued at approx. Rs. 198 crores which have been executed by DQ India over the period 2009-10 to 2012-13. Board of DQ Plc's strategic decisions have helped assessee in getting majority revenue of Rs.124 Crores from Method Animation, France. Further the business of DQ India is growing with the support of BOD of DQ PIc. It is also stated that DQ India with the strategic & management support of DQ Plc were able to complete public issue in Indio in FY 2009-10 and listing with BSE, NSE where the issue was oversubscribed 86 times. Their experience and critical actions have enabled DQ India to exploit business opportunities which enabled growth in the company. All such guidance and advice was being rendered by the Board of Directors and hence the payment of management consultancy fees was made.
35 ITA No. 151 /Hyd/2015D.Q. Entertainment (International) Ltd.
18. The Learned TPO has observed that the tax payer failed to furnish any evidence in support of receipt of the tangible benefits for which the payment was made to its AE and hence treated the arms length price as NIL.
19. When the assessee raised objection before the DRP, the DRP following its decision in AY 2008-09 and 2009-10, rejected ground of objection of the assessee. In AY 2008-09 and 2009-10, the DRP held as follows:
"Thus, it is seen that DQE Mauritius will identify those costs of its officers and consultants who are chiefly involved in providing management and supporting services to DQE India. Their costs will be allocated across DQE Mauritius and DQE India based on shares of agreed budgeted sales. DQE Mauritius will pass through at cost any major items of third party expenses to which it has not added value. All costs will be marked up with a profit element of 5%.
Thus, detailed budgeting and documentation needs to be maintained for the services being rendered by the AE. These records, if produced before the TPO would throw more clarity and proof for the actual rendering of services. Therefore, this panel directs that the TPO shall call for those appropriate records for which the assessee shall extend full cooperation and then come to a determination whether the sum paid of Rs.3,19,23,085/- to its holding company, DQ Mauritius on account of management consultancy services is at arm's length or it should be less."
20. Aggrieved with the above decision, assessee is in appeal before us and Ld. AR submitted that DQE India availed management consultancy services from DQE Mauritius, as per the terms and conditions in a Memorandum of Understanding ("MoU") entered into between both the companies. The services provided by DQE Mauritius to DQE India as per this arrangement from time to time, are in the nature of administrative, general management and professional services.
20.1 Ld. AR submitted that during the assessment year 2010-11 the assessee paid an amount of Rs. 3,70,53,448/- to M/s DQ Entertainment (Mauritius) Ltd, Mauritius towards management 36 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
consultancy services received. The assessee company submitted to the TPO that the payment of management fee was made to the Board of Directors of the associated Enterprise (DQ Pic) as they were rendering invaluable advice and guidance to the assessee company. These Board of Directors included persons from the animation field, and having experience in children's entertainment and who had been rendering invaluable inputs to the assessee company.
20.2 Ld. AR submitted that Board of DQ Plc has been instrumental in bringing in a number of projects with important customers. These projects are valued at approx. Rs. 198 crores which have been executed by DQ India over the period 2009-10 to 2012-13. Board of DQ Plc's strategic decisions have helped the assessee in getting majority revenue of Rs.124 Crores from Method Animation, France. Further the business of DQ India is growing with the support of BOD of DQ Plc. It is also submitted that DQ India with the strategic & management support of DQ Plc., were able to complete public issue in India in FY 2009-10 and listing with BSE, NSE where the issue was oversubscribed 86 times. AE experience and critical actions have enabled DQ India to exploit business opportunities which enabled growth in the company. All such guidance and advice was being rendered by the Board of Directors and hence the payment of management consultancy fees was made by the assessee.
20.3 Ld. AR submitted that despite the submissions made, the Learned TPO has observed that the tax payer failed to furnish any evidence in support of receipt of the tangible benefits for which the payment was made to its AE and hence treated the arms length price as NIL.
20.4 Ld. AR submitted that the assessee has provided the detailed breakup of expenditure along with the invoices by DQ Mauritius for the AY 2010-11 as asked for by the TPO (Pg.202 to 206 of Paper Book) The Breakup of Management Consultancy Fees is as under:
37 ITA No. 151 /Hyd/2015D.Q. Entertainment (International) Ltd.
Particulars Amount (in USD)
Administration charges 12,900
Audit Fee 4,600
Consultancy charges 7,32,570
Total 7,50,070
Add 5% 37,504
Grand Total 7,87,574
20.5 Ld. AR submitted that the Ld TPO determined the ALP at Nil without considering the details of expenditure provided by the assessee.
20.6 Ld. AR submitted that test of commercial expediency for determining whether the expenditure was necessary and reasonable has to be adjudged from the point of view of the businessman and not of the revenue. Expenditure can never be linked to the income earnings ability or the value addition the expenditure has bought into the business as the same cannot be quantified. Hence, the legitimacy of expenditure cannot be questioned. For this proposition he relied on the following decisions:
1. Dresser-Rand India (P) Ltd. Vs. Addl.CIT (2011) 47 SOT 423 (Mum).
2. Ericsson India Pvt. Ltd. vs. DCIT (TS-319-ITAT-2012-(Del)
3. CIT Vs. EKL Appliances (ITA Nos 1068/2011 & 1070/2011) 20.7 Ld. AR submitted that whether or not to enter into the transaction is for the taxpayer to decide. The quantum of expenditure can be examined by the TPO as per law but he has no authority to disallow the expenditure. He relied on the following decisions:
1. CIT vs Walchand & Co Pvt Ltd (65 ITR 381),
2. J.K. Woolen Manufacturers vs CIT (72 ITR 612)
3. Aluminium Corporation (86 ITR 11).
4. Sasson J David & Co Pvt Ltd (1181TR 261)
5. CIT vs. Kirloskar Tractors Limited (231 ITR 849 Mum) 38 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
20.8 Ld. AR submitted that the TPO cannot determine the ALP of a transaction at Rs. NIL. In this connection, ld. AR relied on the following case laws:
1. Social Media India Ltd vs ACIT ITA No.1711/Hyd/2012
2. Thyssen Krupp Industries India (P) Ltd Vs. ACIT Mumbai (2012) 27 taxmann.com 334 (Mum)
3. Castrollndia Ltd v Asst CIT (2013) 29 Taxmann.com 62 (Mum)
4. SC Enviro Agro India Ltd Vs. DCIT Mumbai (2013) 34 taxmann.com 127.
5.Festo Controls (P) Ltd. Vs. DCIT Bangalore (2013) 30 taxmann.com 16
6. LG polymers (P) Ltd. Vs. Addl. CIT (2011) 48 SOT 269/15 taxmann.com 79.
7. Quintiles Research (India) Private Ltd Vs. The Deputy Commissioner of Income Tax 1605/Bang/2012
8. Atotech India Limited Vs ACIT ITA No 104/Del/2012
9. AWB India Pvt. Ltd Vs. ACIT ITA No. 4454/Del/2011
10. TNS India Pvt. Ltd. Vs. ACIT ITA. No. 944/Hyd/2007 20.9 Ld. AR submitted that the Hon'ble Tribunal in assessee's own case for AY 2008-09 DQ Entertainment (International) Ltd. v, ACIT (2015J 64 taxmann.com 360 (Hyderabad - Trib.) held that services in fact have been rendered by assessee's holding company and the TPO cannot take the amount of ALP as NIL and allowed the Management consultancy fees paid to the holding company. The operative portion of the order of the Hon'ble Tribunal is given below:
" 6.2 As can be seen from the above, the TPO analysed the accounts of DQ Entertainment PIc and DQE Mauritius in analyzing the nature of payment. Out of the total amount of US$ 39 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
7,99,000 paid, the actual Management Consultation Charges were only US$ 4,27,000 along with administrative and audit fee of US$ 14,000. As per the agreement, there is a markup of 5%. This expenditure only can be considered, in our view, as the Management Consultancy Service Fee, whereas the foreign exchange loss of US$ 3,21,000 cannot be considered as intra group service. We notice from the documents placed on record that instead of quarterly bills being raised as per the agreement, DQE Mauritius has raised only one bill for the whole of the year, which was placed at page 170 of the Paper Book. As can be seen from the details of payments made, placed at page 171 of the Paper Book, the amount of US$ 799,174 charged on 31-03- 08 was paid in three installments of US$ 3,00,000 on 14-09- 2010, US $ 1,99,174 on 25-10-2010 and US$ 3,00,000 on 04-01- 2011. It is noticed that even though invoice was raised on 31-03- 2008 for whole year instead of quarterly billing, the payments were made from September, 2010 to January, 2011 with substantial delay. The reasons for such delayed payments were not explained. Therefore, we are of the view, that in the given circumstances, the foreign exchanges losses or gains in the hands of DQE Mauritius cannot be considered as services rendered by the DQE Mauritius to assessee which should be on it's own account. To the extent of the above amount, we are in agreement with the observation of the TPO in para 8.3 of his letter dt. 08-11-2012, that foreign exchange loss does not pertain to any management and consultancy services. To that extent his order has to be approved.
6.3 What the TPO has missed is with reference the amounts other than foreign exchange loss. In the absence of any comparable figures and in the absence of any further enquiry and having the fact that services have been rendered to assessee as accepted by DRP also, TPO cannot take the amount of ALP at NIL, ignoring the payment by assessee of US$ 4,27,000. As per the agreement, all the costs incurred by the DQE Mauritius with 5% markup had to be charged to assessee. Therefore, as per the details furnished by assessee before the TPO, the actual management fee of US$ 4,27,000 with administration charges of US$ 14000 and markup of 5%, at the exchange value as on the date of 31-03-2008, can be considered as 'service charges' for the intra group services rendered. This can be taken as ALP. Therefore, modifying the order of TPO, we determine the Management Consultancy Fee as detailed above and AO is directed to modify the order accordingly.
7. In arriving at the above, we have considered the OECD Transfer Pricing guidelines 2010, Chapter-VII pertaining to 'special considerations for intra group services'. Considering the assessee's agreement with DQE Mauritius which in turn has an agreement with DQ Entertainment PIc, and the reimbursement of 40 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
cost from one company to another, we agree with the TPO's observation that foreign exchange loss in financial transactions cannot be considered as 'service charge' for the intra group and therefore, we after considering the facts of the case, restrict the amount to the actual management fees charged by the DQE Mauritius along with other cost of administration and audit and mark up at 5%.
20.10 Since the same issue arises for the AY 2010-11 also, ld. AR prayed the Hon'ble Tribunal to treat the Management Consultancy Services of Rs. 3,70,53,448/- to be at Arm's Length and allow the same as a deductible expenditure.
21. Ld. DR submitted that the payment of management fee was made to the Board of Directors (BOD) of the AE (DQ Plc.), the ultimate holding company, as they were rendering invaluable advice and guidance to the assessee company. The Board of Directors of DQ Plc., have been instrumental in bringing in a number of projects with important customers. These projects have been executed by DQ India over the period. Further the business of DQ India is growing with the support of BOD of DQ Plc. However, the BOD of DQ Plc., includes members from the animation field, children entertainment field and those from the financial and legal background. Their experience and critical actions have enabled DQ India to exploit business opportunities which enabled growth in the company. The details of BOD from whom it had received advice and guidance -
- Tapaas Chakravarti - Chairman & CEO
- K Balasubramanian - Non Executive Director
- Theresa Plummer Andrews - Non Executive Direc
- Anthony BM Good - Non Executive Director
- Sanjay Saxena - Non Executive Director It is seen from the submission that DOE Mauritius has the following key management personal -
1. Tapaas Chakravarti - Director
2. Marc Yan Fook Cheong - Director
3. Li Fap Kien Kam Young - Director 41 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
As per the Annual Report of the taxpayer following are the directors -
1. Tapaas Chakravarti - CMD & CEO
2. Akula Ramakrishan - Additional Director
3. Lakshminarayan Nagu - Additional Director
4. Rashmi Chakravarti - Additional Director
5. K. Balasubramanian - Additional Director
6. Theresa Plummer Andrews - Additional Director
7. Girish Kulkarni - Additional Director
8. Sanjay Kulkarni - Additional Director (later resigned) The ownership profile of the group is as under -
DQE Plc., DQE (Mauritius) Ltd., Mauritius DQE (International), India DQE, Ireland
21.1 Ld. DR submitted that as can be seen that the persons to whom management services fees were paid were also on the Board of Directors of the taxpayer company. It is mentioned in the TP document that the services provided related to day-to-day operations. Therefore the services provided by the BoD of DQ Plc., are nothing but a part of shareholder activity and for duplication of services. It is but natural that any holding company and its directors will provide advice and guidance to its step down subsidiary. Such services do not form part of the 'intra group services' as per the OECD guidelines. Shareholder activities, duplicate services and incidental services from group services do not give rise to intra-group services requiring arm's length remuneration.
21.2 Ld. DR submitted further that, in this case the Hon'ble DRP has directed to pass through at cost any major item of third party expenses, to which it has not added value. All other costs will be marked up with a profit element of 5%. Accordingly, the TPO observed that the following are the costs:
42 ITA No. 151 /Hyd/2015D.Q. Entertainment (International) Ltd.
Particulars Amount (in USD)
Administration charges 12,900
Audit fees 4,600
Consultancy charges 732,570
Total 750,070
Add 5% 37,504
Grand Total 787,574
Ld. DR submitted that just like the last year the major item of cost is Consultancy Charges of 732,570 USD. These are the charges paid to the DQE Plc., which are the expenditures made by it and which in turn have been providing management consultancy to the taxpayer. There is no value addition made by the taxpayer company and as such were required to be passed through at cost. Other items of expenditure have no bearing on the provision of the management consultancy service fee. Hence, the TPO relying on the directions of the DRP has rightly treated the management consultancy fee as Nil.
22. Considered the submissions of both the parties and perused the material facts on record as well as the orders of revenue authorities and case laws submitted. After analyzing the case laws and assessee's own case in the earlier year, the coordinate bench of this Tribunal has adjudicated that management consultancy charges have to be allowed as per the MoU and OECD guidelines. Respectfully following the earlier decision, we are inclined to allow the grounds raised by the assessee. Accordingly, ground No. 8 is allowed.
23. As regards ground No. 9 pertaining to mark up on travel and other expenses reimbursed by the AE of Rs. 77,36,985/-, it is observed that DQE India had incurred expenses on behalf of DQE Ireland in the nature of travel & other expenses. DQE India recovered the same from DQE Ireland on the basis of actual costs incurred. It was explained by assessee to the Ld. TPO that, reimbursement of travel and other expenses were incurred solely on behalf of DQE 43 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
Ireland, This transaction did not impact the P&L of DQ India and that it was at cost and did not amount to any service rendered. The assessee raised bills against DQE (Ireland) at cost, and explained to Ld. TPO that it is in general practice among group companies to incur expenses on behalf of group companies and to recover the same at cost, and that these transactions have no impact on profit & loss account.
24. Ld. TPO applied mark -up on reimbursement of travel and other expenses @ 10%, stating that the same was reasonable which any independent party would be willing to pay. Assessee submitted that it is only reimbursement of expenses incurred by the company on behalf of its AE and there is no services rendered. This resulted in an adjustment of Rs 7,73,699/- to the profit of the assessee company.
25. When the assessee raised objection before the DRP, the DRP observed that the receipt of reimbursement has not been routed through books of account. No independent party would render such services without any mark up. Even other wise, recovery of expenses always forms part of operating cost in the case of independent comparable companies. Thus these expenses incurred by the taxpayer and subsequently reimbursed by AEs need to be suitably marked up. The TPO held a mark-up of 10% for rendering services. The DRP, therefore, hold that the TPO was justified and accordingly, declined to interfere with the order of the TPO and the ground of objection was rejected.
26. Ld. AR submitted that DQE India had incurred expenses on behalf of DQE Ireland in the nature of travel & other expenses. DQE India recovered the same from DQE Ireland on the basis of actual costs incurred. During the assessment year 2010-11 the assessee incurred amount of Rs.77, 36, 985/- on behalf of its AE DQE (Ireland) towards travel expenses and other expenses. It was submitted that, Reimbursement of travel and other expenses were incurred solely on behalf of DQE Ireland, This transaction did not impact the P&L of DQ 44 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
India and that it was at cost and did not amount to any service rendered. It is submitted that the assessee raised bills against DQE (Ireland) at cost, and submitted that it is in general practice among group companies to incur expenses on behalf of group companies and to recover the same at cost, and that these transactions have no impact on profit & loss account.
26.1 Ld. AR submitted that despite the submissions made Ld TPO applied mark -up on reimbursement of travel and other expenses @ 10%, stating that the same was reasonable which any independent party would be willing to pay. It is submitted that it is only reimbursement of expenses incurred by assessee on behalf of AE and there is no services rendered This resulted in an adjustment of Rs 7,73,699/- to the profit of the assessee company.
26.2 Ld. AR submitted that according to Black's Law "reimburse means to pay back, to make restoration, to repay that expended, to indemnify or make whole". As per Concise Oxford Dictionary the term reimburse means "repay (a person who has expended money) or repay( a person's expenses)" In view of the above definition being reimbursement of actual cost there is no income element in embedded in such payment and is merely in the nature of reimbursement. Hence to apply a markup of 10% based on the profit earned by the assessee is factually and legally incorrect.
26.3 Ld. AR submitted that in M/s. Cognizant Technology Solutions India Pvt. Ltd v, ACIT ITA Nos.114 & 2100(Mds)/2011 the Bench held that "The next issue raised by the assessee is against the addition made by the Transfer Pricing Officer on the ground of reimbursement of expenses. The Transfer Pricing Officer has made a mark up of 5 per cent on certain travel cost incurred by the assessee and reimbursed by its associate enterprise and treated as additional income to be taxed as part of transfer pricing adjustment. But the fact is that the reimbursement was made on cost to cost basis and there is no rendering of any service and it does not involve service element.
45 ITA No. 151 /Hyd/2015D.Q. Entertainment (International) Ltd.
What is incurred is reimbursed. So, therefore, there is no profit element in the reimbursement. In such situation there is no justification in making a mark up of 5 per cent. This addition is accordingly deleted. This issue is decided in favour of the assessee."
27. Ld. DR submitted that the TPO considered markup of 10% on these reimbursements and accordingly computed the ALP and adjustment of Rs. 7,73,699/- was computed. He submitted that the assessee submitted that the markup adopted by the TPO of 10% is incorrect and the reimbursements received are at arm's length. Ld. DR submitted that the TPO has considered 10% markup as no independent party would render such services without any markup. Hence, the mark up made is correct and accordingly, the ALP on reimbursements and the adjustment thereon is correct.
28. Considered the submissions of both the parties and perused the material facts on record as well as the orders of revenue authorities. The assessee as a group company, incurred travelling and other expenditure on behalf of DQE, Mauritius. Assessee had raised the bill for reimbursement on cost to cost basis, it is normal in the case of group companies. There is no element of service in these transactions. These transactions are not in any way connected to the nature of business of assessee. These are the services rendered by outsiders for the AE's and only payment was made by assessee and got reimbursement from "AE". Since there is no element of service by the assessee, adding markup on these kind of transactions are not justified. As held in the case of M/s Cognizant Technologies Solution (spra), the additions made were deleted by Chennai Bench of ITAT. Accordingly, the grounds raised by the assessee are allowed.
29. As regards ground Nos. 10 & 11, the DRP observed that they find that there is no grievance arising out of this issue of bonus shares since neither the TPO nor AO made any addition to the total income of the assessee. The TPO made a suggestion in the order to refer the matter to the Jurisdictional AO for appropriate action under 46 ITA No. 151 /Hyd/2015 D.Q. Entertainment (International) Ltd.
the law for failure to deduct dividend distribution tax. The DRP, therefore, held that these grounds became infructuous and do not deserve adjudication, hence, rejected.
30. Ld. AR submitted that the AO/TPO is legally and factually incorrect in making an adjustment of Rs 751,83,46,202/- in respect of bonus shares issued by the assessee to its AE. He submitted that the AO/TPO erred in by holding that there was excess benefit in the hands of the AE and the same was dividend when in fact share premium account is utilized for issuing bonus shares as per company law provisions. Further, ld. AR submitted that AO/TPO erred in making a reference to the jurisdictional AO of International Taxation for taking up proceedings u/s 195 of the IT Act when the issue of bonus shares by the assessee was at arm's length and cannot legally be treated as dividend or otherwise.
31. Ld. DR, on the other hand, relied on the order of DRP.
32. Considered the submissions of both the parties and perused the material facts on record as well as the orders of revenue authorities. The TPO made a general observation in his report on the issue of bonus shares but the TPO or the AO had not made any addition. Since there is no demand raised, the ground raised by the assessee on this issue becomes infructuous. Hence, need no adjudication. Accordingly, the ground Nos. 10 & 11 are dismissed.
33. In the result, appeal of the assessee is partly allowed.
Pronounced in the open court on 22 nd June, 2016.
Sd/- Sd/-
(D. MANMOHAN) (S. RIFAUR RAHMAN)
VICE PRESIDENT ACCOUNTANT MEMBER
Hyderabad, Dated: 22 nd June, 2016
47
ITA No. 151 /Hyd/2015
D.Q. Entertainment (International) Ltd.
kv
Copy to:-
1) D.Q Entertainment (International) Ltd.), C/o Prasad & Prasad, CAs., Flat No. 301, MJ Towers, 8-2-698, Road No. 12, Banjara Hills, Hyderabad - 500 034.
2) ACIT, Circle - 17(1), Hyd.
3) DRP, Hyderabad
4. CIT, International Taxation, Income Tax Towers, 10-2-3, AC Guards, Hyd - 500 004
5) The Departmental Representative, I.T.A.T., Hyderabad.