Income Tax Appellate Tribunal - Mumbai
Loreal India P.Ltd, Mumbai vs Asst Cit Cir 7(1)(2), Mumbai on 30 January, 2019
IN THE INCOME-TAX APPELLATE TRIBUNAL "K" BENCH MUMBAI
BEFORE SHRI PAWAN SINGH, JUDICIAL MEMBER AND
SHRI RAJESH KUMAR, ACCOUNTANT MEMBER
ITA No. 1417/Mum/2017 (Assessment Year 2012-13)
M/s L'Oreal India Pvt. Ltd. ACIT-7(1)(2)
A-Wing, 8th Floor, Marathon Room No. 130, Ground Floor,
Futurex, N.M. Joshi Marg, Aayakar Bhavan, M.K. Road,
Lower Parel,
Vs. Mumbai-400020.
Mumbai-400013.
PAN: AAACL0738K
Appellant Respondent
Appellant by : Shri Percy J. Pardiwala Sr. Advocate
With Shri Hiten Chande Advocate
Respondent by : Shri Anand Mohan (CIT-DR)
Date of Hearing : 19.12.2018
Date of Pronouncement : 30.01.2019
ORDER UNDER SECTION 254(1)OF INCOME TAX ACT
PER PAWAN SINGH, JUDICIAL MEMBER;
1. This appeal by assessee is directed against the order assessment order passed under section 143(3) read with section 144C (13) of the I.T. Act (the Act) dated 31.03.2016. The assessing officer passed the order in pursuance of direction of Dispute Resolution Panel (DRP) under section 144C (5) dated 26.12.2016. The assessee has raised the following grounds of appeal:
Following grounds are without prejudice to each other:
General
1. erred in assessing the total income at Rs 384.99 crores as against Rs 81.74 crores computed by the Appellant.1
ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
A. Adjustment on account of Advertisement, Marketing and Promotion ('AMP') expenses Presumption of fictitious transaction in the nature of 'provision of brand promotion services'
2. erred in making an adjustment in respect of AMP expenses of Rs 304.69 crores alleging that the AMP expense incurred by the Appellant is an international transaction under Section 92B;
3. erred in ignoring that the alleged AMP expenses incurred by the Appellant represents only domestic transactions undertaken with third parties and hence in absence of a valid international transaction, the adjustment is outside the purview of the jurisdiction of learned TPO;
4. erred in not appreciating that there is no arrangement whatsoever between the Appellant and its Associated Enterprises ('AEs') for promotion of AEs brand by incurring AMP expenses on behalf of the AEs;
Expenses on marketing support services
5. erred in alleging that the payments made by the Appellant to its AEs for availing marketing support services (DMI services) were in the nature of AMP expenses;
Business and commercial expediency
6. erred in holding that the Appellant incurred AMP expenses for promoting the brands owned by overseas AE, instead of appreciating that the Appellant was only carrying out its business by using the well-established brands and any benefit derived by the AE is purely incidental;
Most appropriate method
7. erred in applying bright line test CBDT) to determine the arm's length price of the AMP expenses incurred by the Appellant without appreciating that no such method has been prescribed under the Act and the Income Tax Rules, 1962;
8. without prejudice to the above, erred in not considering the profit level indicator of AMP adjusted gross profit' for benchmarking AMP transaction; Manufacturing segment - comparable set
9. without prejudice to the above, erred in rejecting the analysis submitted by the Appellant and not adopting a scientific search process to identify companies comparable to the Appellant's manufacturing segment for benchmarking of the 2 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
AMP expenses and considering inappropriate com parables, not having similar product/ brand profile as the Appellant;
Distribution segment - comparable set
10. without prejudice to the above, erred in rejecting the analysis submitted by the Appellant and not adopting a scientific search process to identify companies comparable to the Appellant's distribution segment for benchmarking of the AMP expenses;
Sales related expenses
11. without prejudice to the above, erred in holding that items of selling expenditure such as rent cost for window display, point of sales materials etc. should be considered for making an adjustment without appreciating the fact that none of these expenses can in any way be considered as incurred for brand promotion but were for effecting sales for the Appellant;
12. without prejudice to the above, erred in artificially bifurcating the advertisement and sales promotion expense of comparable companies in the ratio of Appellant's alleged advertisement and sales promotion expense (ie 83:
17), in case of comparable companies;
Mark-up on AMP expenses
13. without prejudice to the above, erred in holding that the Appellant should have earned a mark-up of 9.40% on the alleged excessive AMP expenses to be reimbursed to the Appellant;
14. without prejudice to the above, erred in not adopting a scientific search process to identify companies comparable to the Appellant, for computing the mark-up to be applied to the alleged excessive AMP expenses and considering inappropriate comparables;
15. without prejudice to the above, erred in computing mark-up over alleged excessive AMP expenses incurred without appreciating that an addition if any, shall be commensurate with agency function, if any, undertaken by the Appellant;
Alternate adjustment - International transaction of import finished goods from AEs for resale
16. erred in making an arbitrary adjustment amounting to Rs 26.40 crores to the distribution segment of the Appellant on account of alleged differences in intensity of AMP functions performed by the Appellant vis a vis the comparable 3 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
companies to align the functions, assets and risks ('FAR') profile of the Appellant with that of the comparable companies;
17. erred in rejecting the economic analysis undertaken by the Appellant by use of resale price method ('RPM') to benchmark the aforesaid transaction without giving an opportunity with regard to the proposed adjustment;
18. erred in using 'adjusted RPM' as the most appropriate method by recalculating sales to benchmark the said international transaction;
19. without prejudice to the above, in an attempt to account for difference in intensity of AMP functions, erred in inadvertently making an adjustment based on the total 'General and Administrative Expenses' incurred by the comparable companies, instead of AMP expenses itself, as stated in the TP order;
20. without prejudice to the above, erred in applying an adhoc mark-up of 18.17% (without providing any backup) to arrive at the adjusted sales for computation of margins of the comparable companies;
21. without prejudice to the above, erred in not considering the profit level indicator of 'AMP adjusted gross profit' under RPM.
B. Adjustment on account of payment of royalty for use of technical know- how and trademark
22. erred in making an adjustment of Rs 47.91 crores (Rs 29.48 crores for technical know-how and Rs 18.43 crores for trademark) in respect of payment of royalty to the AEs by the Appellant for use technical know-how and trademark;
23. erred in not accepting the benchmarking analysis undertaken by the Assessee using the Comparable Uncontrolled Price Method (,CUP'), wherein reliance was placed on a royalty benchmarking study undertaken by independent consultant - NERA Economic Consulting;
Payments made to AEs for use of technical know-how
24. erred in refuting / placing partial/selective reliance on the royalty benchmarking study submitted by the Appellant and on that basis wrongly determining the arm's length price of technical know-how royalty;
25. erred in treating arm's length price of payment of royalty for use of technical know-how at a rate of 2.3% as against 5% paid by the Appellant; Payments made to AEs for use of trademark 4 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
26. erred in holding that the Appellant has developed the L'Oreal trademark by carrying out significant AMP expenses in India and thereby assuming Appellant being economic owner, no royalty payment to the AE was warranted;
27. erred in not using any of the method prescribed under section 92C of the Act for benchmarking the said international transaction of payment of trademark royalty and determining the arm's length price of royalty as nil; C. Levy of interest and initiation of penalty proceedings
28. erred in charging interest under section 234B, 234C, 234D of the Act;
29. erred in initiating penalty proceedings under section 271(1)(c).
2. Brief facts of the case are that the assessee company is subsidiary of L'Oreal SA, France. The assessee is engaged in the business of manufacturing, marketing and selling of cosmetic and beauty products imported from its overseas Associate Enterprises (AE). The assessee filed its return of income for Assessment Year 2012-13 on 29.12.2012 declaring total income of Rs. 81,75,72,077/-. In the return of income, the assessee reported international transaction with its Associate Enterprises (AE's) in Form-3CEB. Consequent upon the reporting of international transaction during the relevant financial year, the Assessing Officer made a reference under section 92CA(3) for computation of Arms Length Price (ALP). As per report in Form 3CEB, manufacturing segment and distribution segment was determined by applying Cost Plus Method (CPM) and Resale Price Method (RPM) respectively. In the manufacturing segment, the Profit Label Indicator (PLI) of assessee as per Transfer Pricing Study report was 223.44% on input cost whereas average PLI of comparable was reported at 113.08%. In distribution 5 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
segment, the PLI of assessee as per the Transfer Pricing Study was 57.93% on the sale whereas average PLI for comparable was 49.70% based on the same, the assessee claimed that international transaction related to manufacturing and distribution segment are at ALP for the bench marking royalty with regard to Trademark and technical knowhow, the assessee bench marked the transaction by applying CUP Method on the basis of bench marking analysis carried by independent consultant NERA. The study considered similar Royalty segment based on which the ALP was determined at 6.95 (arithmetical means) and the assessee had paid royalty at 6.50%/6.75% from 1st July 2011. Thus, claimed international transaction of Royalty at ALP. The Transfer Pricing Officer (TPO) made the adjustment of Rs. 303.24 Crore on account of Advertisement Marketing and Brand Promotion Expenses on his taking view that there is international transaction between the assessee and its AE's as is rendering services of brand building by incurring the AMP expenses. Clause-8 of the license agreement provides that assessee must incur for AMP expenses, therefore, there is understanding between the assessee and AE to incur AMP expenses. The alleged incurrence of alleged AMP expenses lead to increase in sale of the assessee, which in turn increased the payment of Royalty to the AE, therefore, the AMP expenses have benefited the AE's in term of higher Royalty payment. The TPO applied Bright Line Test (BLT) and arrived 6 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
at a Bright Line of 9.15% for manufacturing segment and 9.10% for distribution segment. According to TPO brand building services was rendered by assessee to its AE's and made adjustment of Rs. 303.24 Crore. In alternative to BLT, the TPO also proposed to apply adjusted Resale Price Segment (RPM) to distribution segment, therefore, determined the alternative by adjustment of Rs. 26.40 Crore vide its order dated 07.01.2016. The TPO passed the order on 29.01.2016. The TPO rectified its order on 07.12.2016, rectifying the certain mistake with regard to AMP to sales ratio of comparable companies for distribution segment; accordingly adjustment value of AMP of Rs. 304.69 Crore was made against initial order of adjustment of Rs. 303.24 Crore.
3. For adjustment of Trademark Royalty, the TPO determined the ALP at Nil and made the entire amount of Trademark Royalty of Rs. 18.43 Crore on the basis that assessee should not have paid royalty for the use of Trademark as brand name of L'Oreal was not known in the Indian market and the value of Trademark is generated by assessee by incurring AMP expenses. The TPO held that assessee should not have paid royalty for the use of Trademark and thus, made adjustment of Rs. 18.43 Crore.
4. The TPO also made the adjustment on account of technical knowhow Royalty of Rs. 29.48 Crore. The TPO determined the ALP by considering the difference between average rate royalty in term of agreement (6.1%) where only use of Trademark was provided and 7 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
average rate of royalty in term of agreement 8.4%), whereas uses of both Trademark and technical knowhow was provided. The TPO determined the ALP at 2.3% on account of difference in ALP of technical knowhow royalty. On receipt of report of TPO, the AO served the draft assessment order passed under section 143(3) r.w.s. 144C(1) dated 31.03.2016. The assessee filed its objection before the DRP on 03.05.2016. The objection of the assessee was decided by DRP by after granting opportunity to the assessee on 26.12.2016. The DRP while deciding the objection of assessee with regard to adjustment on account of AMP concluded that this issue is covered in favour of assessee by the order of Tribunal in assessee's own case for AY 2008-09 to AY 2010-11, however, the department have no right to file appeal against the order of DRP, the DRP uphold the addition to keep the issue alive, therefore, the issue of adjustment of AMP expenses was held against the assessee. For adjustment on account of royalty on Trademark and technical knowhow. The DRP upheld the action of TPO. After receipt of direction of DRP dated 26.12.2016, the AO passed the final assessment order dated 31.03.2017 under section 143(3) r.w.s. 144C(13) of the Act. Aggrieved by the order passed in pursuance of direction of DRP as referred above, the assessee has filed the present appeal before us.
5. We have heard the submission of ld. Senior Counsel for assessee/Authorized Representative (AR) and ld. Departmental 8 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
Representative (DR) for the Revenue and perused the material available on record.
6. Ground No.1 is general in nature and needs no specific adjudication; therefore, the same is dismissed.
7. Ground No. 2 to 21 relates to adjustment on account of AMP expenses. The ld. AR of the assessee submits that AMP expenses were incurred by assessee in the course of its business in India and there is no mutual understanding or arrangement between the assessee and its AE to incur alleged AMP expenses. The ld. AR of the assessee further submits that Clause-8 of the agreement with AE does not in any manner obliged the assessee to incur the AMP expenses so far as to promote the brands owned by the AE's and render a service of brand building. The ld. AR of the assessee further submit that Clause-8 only provides for expenses to be incurred by assessee in normal course of its business which is required smooth running of its business. Thus, the TPO erred in relying on agreement to hold that assessee is rendering services of brand owned by AE. The ld. AR of the assessee further submits that identical issue has been decided by Tribunal in AY 2008-04 to 2010-11 vide order dated 04.05.2016. Thus, the grounds of appeal are covered in favour of assessee. The aforesaid decision of Tribunal was followed in department's appeal for A.Y. 2011-12 by dismissing the appeal. In alternative submission, the ld. AR of the assessee submits that in A.Y. 2011-12, the Tribunal by 9 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
following the order of earlier years for A.Y. 2008-09 to 2010-11 held that there is no international transaction on account of AMP expenses.
8. On the other hand, the ld. DR for the Revenue submits that there exist international transaction between the assessee and its AE. It was further submitted that while passing the order for A.Y. 2008-09 to 2010-11 & 2011-12, the Tribunal has not considered the facts of Clause-8 of the agreement between the assessee and its AE. The ld. DR for the Revenue further submits that department has filed appeal before the Hon'ble Bombay High Court against the order of Tribunal for A.Y. 2008-09 to 2010-11 and accordingly prayed that adjustment on account of AMP should be upheld. The TPO passed the order after analyzing international transaction. The ld. DR further submits that various terms and conditions regarding marketing advertisement between the assessee and AE. Further as per Clause-7, the assessee is mandated to mark the license product under Trademark as per Clause-8 under the head "Advertisement". The assessee is responsible for advertising the license product in the territory. The assessee is also mandated to allocate annual budget for each year for such advertising. The entire AMP expenses of assessee in India are effectively controlled by AE outside India, who is the owner of brand and other marketing intangible.
9. In rebuttal submission, the ld. AR of the assessee submits that Clause-8 of the agreement between the assessee and AE's cannot be considered to be 10 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
an agreement or arrangement for incurring AMP expenses by the assessee. The said Clause-7 & 8 of the agreement not obligates the assessee to inter in marketing expenses on behalf of its AE, or incur any excessive AMP expenses to enhance the brand value. In absence of any obligation to incur AMP expenses either in a particular manner or other way on brand owned by the AE or any price of the alleged international transaction, there is no amount or any particular extent of expenditure agreed to be incurred as AMP. There is no international transaction involved in the assessee's case with regard to alleged AMP. In support of his submission, the ld. AR of the assessee relied upon the decision of Hon'ble Delhi High Court in CIT vs. Whirpool of India Ltd. (381 ITR 154 and in Bouch & Lomb Eyecure India Pvt. Ltd. vs. ACIT (381 ITR 227).
10. We have considered the rival submission of the parties and have gone through the orders of authorities below. We have also deliberated on the various documents placed by assessee. We have noted that the similar adjustment was made by TPO for A.Y. 2008-09, 2009-10 & 2010-11 and on the objection before the DRP, the adjustment was upheld, however, on appeal before the Tribunal, the entire adjustment was deleted vide ITA No. 7714/Mum/2012 for A.Y. 2008-09 in ITA No. 1119/Mum/2014 for A.Y. 2009-10 and ITA No. 518/Mum/2015 for A.Y. 2010-11 vide order dated 04.05.2016 holding as under:
11
ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
2.4.We have heard the rival submissions and perused the material before us.We find that the assessee had bench marked the International transactions in two different segments i.e.Manufacturing Segment(MS) and Distribution Segment (DS),that the financial of MS had net sales of Rs.447.84 crores and the DS had net sales of Rs.113.33 crores,that for the MS the assessee had adopted Cost Plus Method(CPM) as the most appropriate method,that gross margin of the assessee was bench marked against the gross margins of comparable manufacturing companies,that the arithmetic mean of the comparables was taken @83.69% on input-cost, as against 146.71% on input-cost of the assessee, that the it had claimed that transaction in the MS were at arm's-length, that for DS it had adopted RPM, that the gross margin in the DS was bench marked against the gross margin of the comparable distribution companies, that the arithmetic mean of the comparables was 33.37% on sales as against 61.01% on sales of the comparables, that it had also bench marked the transactions using TNMM,that the operating expenses(other than the direct expenses) were allocated between the two segments on the basis of turnover, that the operating margin in MS was 7.46% on sales as against that of the comparables of 9.12%, that the assessee has used the latest available year's data, that the operating margin of the assessee in DS was 8.37% on sales as against the 8.03% of the comparables, that the TPO had held that none of the above methodologies had given reliable results, that the assessee had incurred an expenditure of Rs. 186 crores on AMP on net sales of Rs.561 crores, that the expenditure was 33.15% of the net sales, that he further observed that the assessee was developing and promoting the brands that were not owned by it though same were manufactured and distributed by it,that he had also held that the assessee had incurred huge expenses for promoting the brands owned by its AEs and that it was a deemed international transaction, that he further observed that the transactions involved significant intangibles and that the PSM was the most appropriate method. We find that he had relied upon the decision of the ITAT, Delhi Bench in the case of Rolls Royce Plc(1310/Del/2015; A.Y 2010-11 dt.03/ 12/2015)and had computed 35% of Global profit of the group at Rs. 55308. 91 crores for arriving at the figure of Rs.333.43 crores as the compensation receivable by the assessee for promoting and enhancing the brands owned by the AEs. Alternatively, he made the computation of compensation receivable on account of AMP expenditure, using 12 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
the Bright Line Standard (BLS).In the MS, he had rejected five out of the six comparables selected by the assessee and identified five other companies that were engaged in manufacturing cosmetics and were of similar size. The arithmetic mean of the AMP expenditure of the six comparables (on Net sales) was computed @12.53%. Considering the fact that the companies would be incurring AMP expenses for the purpose of brand owned by them, the TPO held that BLS for the routine AMP expenditure should be taken at 8% of the net sales.It is found that the assessee had objected to the figure of 8% and that the TPO rejected the five other comparables suggested by the assessee. It is also observed that he had rejected two of the four comparables selected by the assessee in DS and had determined the excess AMP of Rs.40.25 crores for the year under appeal,that after applying mark-up of 8.92%,he determined an adjustment of Rs.43.84 crores in the second segment.
We also find that the sales of the assessee had increased 19 time since the year 1999,that the average annual growth of the cosmetic industry in India was reported to be about 15-20%, that the TPO had not compared the market share of the assessee for the year under consideration. Now, if the expenditure incurred by the assessee is considered in the back ground of the growth achieved by it one has to agree with the argument of the assessee that it made rapid progress in the Indian market and AMP played an important role in it. The assessee was manufacturer and distributor of cosmetic products. The very nature of the business carried out by the assessee was such that to establish its product it had to spend huge expenses.The TPO had ignored the fact that expenditure was incurred for products launched especially for the Indian market and that the brand of the AEs was not promoted.The manufacturing unit of the assessee had shown a huge turnover.Thus,we do not find force in the arguments of the TPO / DRP that AMP expenses incurred by the assessee were primarily or secondarily aimed to benefit the AE.s.and that it was entitled to a reasonable compensation for such AMP expenses.Secondly,the important issue raised by the assessee that it had huge amount on account of sales promotion had not been dealt with by the TPO/DRP.In our opinion,it is an important factor for determining the ALP. We further find that the TPO has not brought on record any evidence to prove that the assessee had rendered any services to its AE.s 13 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
under the head AMP.On the contrary,payment on account of advertisements etc.was made to unrelated domestic third parties.In our opinion,these basic facts compelled the TPO to hold that in the case under consideration the international transaction was not the actual AMP expenditure,but the real issue was the benefit conferred by it to its AE.s in form of promotion and brand value augmentation of the brands owned by them.
In these circumstances,in our opinion,the fundamental question to be answered is to decide as to whether in absence of any agreement for payment of AMP expenses by the AE.s can it be held that there was an international transaction only on the basis that AMP expenditure,incurred by the assessee,would have benefitted the AE.s.,who owned the brands used by the assessee.In our opinion, the arguments suffers from the very basic flaw that it presumes that the assessees would incur AMP not to promote its own business.In other words,the TPO has failed to prove that the real intention of the assessee in incurring advertisement and marketing expenses were to benefit the AE.s.and not to promote its own business.The turnover of the assessee proves that during the year under consideration the assessee had done a reasonably good business,as state earlier.The resultant profit was offered for taxation in India.Therefore, transferring of profit from India,the basic ingredient to invoke the provisions of section 92 of the Act,remains unproved.
We find that in the cases of Maruti Suzuki(supra)Whirlpool India(supra), Bausch & Lomb Eyecare(India) Pvt.Ltd(ITA 643 of 2014 of Hon'ble Delhi HC),the issue of AMP expenses had been deliberated upon extensively and each and every argument raised by the TPO/DRP have been analysed thread bare.We would like to reproduce relevant portion of the judgment of Bausch & Lomb Eyecare (India) Pvt.Ltd.(supra) and same reads as under:
"53.A reading of the heading of Chapter X['Computation of income from international transactions having regard to arm's length price"]and Section 92 (1) which states that any income arising from an international transaction shall be computed having regard to the ALP and Section 92C (1) which sets out the different methods of determining the ALP, makes it clear that the transfer pricing adjustment is made by substituting the ALP for the price of 14 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
the transaction. To begin with there has to be an international transaction with a certain disclosed price.The transfer pricing adjustment envisages the substitution of the price of such international transaction with the ALP.
54. Under Sections 92B to 92F, the pre-requisite for commencing the TP exercise is to show the existence of an international transaction. The next step is to determine the price of such transaction. The third step would be to determine the ALP by applying one of the five price discovery methods specified in Section 92C. The fourth step would be to compare the price of the transaction that is shown to exist with that of the ALP and make the TP adjustment by substituting the ALP for the contract price.
55. Section 928 defines 'international transaction' as under:
"Meaning of international transaction. 928.(1) For the purposes of this section and sections 92,92C,92D and 92E ,"international transaction" means a transaction between two or more associated enterprises, either or both of whom are non- residents; in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to anyone or more of such enterprises. (2) A transaction entered into by an enterprise with a person other than an associated enterprise shall, for the purposes 'of sub-section (1), be deemed to be a transaction entered into between two associated enterprises, if there exists a prior agreement in relation to' the relevant transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined in substance between such other person and the associated enterprise."
56.Thus, under Section 92B(1) an 'international transaction' means- (a) a transaction between two or more AEs, either or both of whom are non- resident (b) the transaction is in the nature of purchase, sale or lease of tangible or intangible property or provision of service or lending or borrowing 15 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
money or any other transaction having a bearing on the profits, incomes or losses of such enterprises, and (c) shall include a mutual agreement or arrangement between two or more AEs for allocation or apportionment or contribution to the any cost or expenses incurred or to be incurred in connection- with the - benefit, service or facility provided or to be provided to one or more of such enterprises.
57. Clauses (b) and (c) above cannot be read disjunctively. Even if resort is had to the residuary part of clause (b) to contend that the AMP spend of BLI is "any other transaction having a bearing" on its "profits, incomes or losses", for a 'transaction' there has to be two parties. Therefore for the purposes of the 'means' part of clause (b) and the 'includes' part. of clause (c), the Revenue has to show that there exists an 'agreement' or 'arrangement' or' 'understanding' between BLI -and B&L, USA whereby BLI is obliged to spend excessively on AMP in order to promote the brand of B&L, USA. As far as the legislative intent is concerned, it is seen that certain transactions listed in the Explanation under clauses (i) (a) to (e) to Section 92B are described as an 'International transaction'. This might be only an illustrative list, but significantly' it does not list AMP spending as one such transaction.
58. In Maruti Suzuki India Ltd. (supra), one of the submissions of the Revenue was: "The mere fact that the service or benefit has been provided by one party to the other would by itself constitute a transaction irrespective of whether the consideration for the same has been paid or remains payable or there is a mutual agreement to not charge any compensation for the service or benefit. "This was negatived by the Court by pointing out; "Even if the word 'transaction' is given its widest connotation, and need not involve any transfer of money or a written agreement as suggested by the Revenue, and even if resort is had to Section 92F (v), which defines 'transaction' to include 'arrangement', 'understanding' or 'action in concert', 'whether formal or in writing', it is still incumbent on the Revenue to show the existence of an 'understanding' or an 'arrangement' or 'action in concert' between MSIL and SMC as regards AMP spend for brand promotion. In other words, for both the 'means', part and the 'includes' part of Section 928 (1) what has to be definitely shown is the existence of transaction whereby MSIL has been 16 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
obliged to incur AMP of a certain level for SMC for the purposes of promoting the brand of SMC."
59. In Whirlpool of India Ltd. (supra), the Court interpreted the expression "acted in concert" and in that context referred to the decision of the Supreme Court in Daiichi Sankyo Company Ltd. vs. Jayaram Chigurupati 2010(6)MANU/SC/0454/2010, which arose in the context of acquisition of shares of Zenotech Laboratory Ltd. by the Ranbaxy Group. The question that was examined was whether at the relevant time the Appellant, i.e., 'Daiichi Sankyo Company and Ranbaxy were "acting in concert" within the meaning of Regulation 20(4) (b) of the Securities and Exchange Board of India (Substantial Acquisition of Shares and Takeovers) Regulations, 1997. In. para 44, it was observed as under:
"The other limb of the concept requires two or more persons joining together with the shared common objective and purpose of substantial acquisition of shares etc. of a- certain target company, There can be no "persons acting in concert" unless there is a shared common objective or purpose between two or more persons of substantial acquisition of shares etc. of the target company, For, de hors the element of the shared common Objective' or purpose the idea of "person acting in concert" is as meaningless as criminal conspiracy without any agreement to commit a criminal offence. The idea of "persons acting in concert" is not about a fortuitous relationship coming into existence by accident or chance. The relationship' can come into being only by design, by meeting of minds between two or more persons leading to the shared common objective or purpose of acquisition of substantial acquisition of shares etc. of the target company. It is another matter that the common objective or purpose may be in pursuance of an agreement' or an understanding, formal or informal; 'the acquisition of shares etc. may be direct or indirect or the persons acting in concert may cooperate in actual acquisition of shares etc. or they may agree to, cooperate in such acquisition. Nonetheless, the element of the shared common objective or purpose is the sine qua non for the relationship of "persons acting in concert" to come into being. "17
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60. The transfer pricing adjustment is not expected to be made by deducing from the difference between the 'excessive' AMP expenditure incurred by the Assessee and the AMP expenditure of a comparable entity that an international transaction exists and then proceeding to make the adjustment of the difference in order to determine the value of such AMP expenditure incurred, for the AE. In any event, after the decision in Sony Ericsson (supra), -- the question of applying the BLT to determine the existence-of an-international transaction involving AMP expenditure does not arise.
61. There is merit in the contention of the Assessee that a distinction is required to be drawn between a 'function' and a 'transaction' and that every expenditure forming part of the function, cannot be construed as a 'transaction'. Further, the- Revenue's attempt at re-characterising the AMP expenditure incurred as a transaction by itself when it has neither been identified as such by the Assessee or legislatively recognised in the Explanation to Section 92 B runs counter to legal position explained in CIT vs. EKL Appliances Ltd. (supra) which required a TPO "to examine the 'international transaction' as he actually finds the same."
62. In the present case, the mere fact that B&L, USA through B&L, South Asia, Inc holds 99.9% of the share of the Assessee will not ipso facto lead to the conclusion that the mere increasing of AMP expenditure by the Assessee involves an international transaction in that regard with B&L, USA. A similar contention by the Revenue, namely the fact that even if there is no explicit arrangement, the fact that the benefit of such AMP expenses would also encure to the AE is itself self sufficient to infer the existence of an international transaction has been negatived by the Court in Maruti Suzuki India Ltd. (supra) as under:
"68. The above submissions proceed purely on surmises and conjectures and if accepted as such will lead to sending the tax authorities themselves on a wild-goose chase of what can at best be described as a 'mirage'. First of all, there has to be a clear statutory mandate for such an· exercise. The Court is unable to find one. To the question whether there is any 'machinery' provision for determining the existence of an international transaction 18 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
involving AMP expenses, Mr. Srivastava only referred to Section 92F (ii) which defines ALP to mean a price "which is applied or proposed to be applied in a transaction between persons other than AEs in uncontrolled conditions", Since the reference is to 'price' and to 'uncontrolled conditions' it implicitly brings into play the BLT. In other words, it emphasises that where the price is something other than what would be paid or charged by one entity from another in uncontrolled situations then that would be the ALP. The Court does not see this as a machinery provision particularly -in-light of the fact that the-BLT has been expressly negatived by the Court in Sony Ericsson. Therefore, the existence of an international transaction will have to be established de hors the BLT,
70. What is clear is that it. is the 'price' of an international transaction which is required to be adjusted: The very existence of an international transaction cannot be presumed by assigning some price to it and then deducing that since it is not an ALP, an adjustment had to be made. The -burden is on the Revenue to first show the existence of an international transaction. Next, to ascertain the disclosed 'price' of such transaction and thereafter ask whether it is an ALP. If the answer to that is in the negative the TP adjustment should follow. The objective of Chapter X is to make adjustments to the price of an international transaction which the AEs involved may seek to shift from one jurisdiction to another. An 'assumed' price cannot form the reason for making an ALP adjustment. "
71- Since a quantitative adjustment is not permissible for the purposes of a TP adjustment under Chapter X, equally it cannot be permitted in respect of AMP expenses either. As already noticed hereinbetore, what the Revenue has sought to do in the present. case is to resort to a quantitative adjustment by first determining whether the AMP spend of the Assessee on- application of the. BLT, is excessive, thereby evidencing the existence of an international transaction involving the AE. The quantitative determination forms the very basis for the entire TP exercise in the present case.
74. The problem with the Revenue's approach is that it wants every instance of an AMP spend by an Indian entity which happens to use the brand of a 19 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
foreign AE to be presumed to involve an international transaction. And this, notwithstanding that this is not one of the deemed international transactions listed under the Explanation to Section 92B of the Act. The problem does not stop here. Even if a transaction involving an AMP spend for a foreign AE is able to be located in some agreement, written (for e.g., the sample agreements produced before the Court by the Revenue) or otherwise, how should a TPO proceed to benchmark the portion of such AMP spend that the Indian entity should be compensated for?
63. Further, in Maruti Suzuki India Ltd. '(supra) the Court further explained the absence of a 'machinery provision qua AMP expenses by the following analogy:
"75. As an analogy; and for-no other purpose; in the- context of a domestic transaction involving two or more related parties, reference may' be made to Section 40 A (2) (a) under which certain types of expenditure incurred by way of payment to related parties is not deductible where the AO is of the opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods." In such event, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction." The AO in such an instance deploys the 'best judgment' assessment as a device to disallow what he considers to be an excessive expenditure. There is no corresponding 'machinery' provision in Chapter X which enables' an AO to determine what should be the fair 'compensation' an Indian entity would be entitled to if it is found' that there is an International transaction in that regard. In practical terms, absent a clear statutory guidance, this may encounter further difficulties. The strength of a brand, which could be product specific, may be "impacted by numerous other imponderables not limited to the nature of the industry, the geographical peculiarities, economic trends both international and domestic, the consumption patterns, market behaviour and so on. A simplistic approach using one of the modes similar to the ones contemplated by Section 92Cmay not only be legally impermissible but will lend itself to arbitrariness. What is then needed is a clear statutory scheme encapsulating the legislative policy 20 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
and mandate which provides the necessary checks against arbitrariness while at the same time addressing the apprehension of tax avoidance."
64. In the absence of any machinery provision, bringing an imagined transaction to tax is not possible. The decisions in CIT v. B.C. Srinivasa Setty (1981) 128 ITR 294 (SC) and PNB Finance Ltd. v, CIT (2008) 307 ITR 75 (SC) make this position explicit. Therefore, where the existence of an international transaction involving AMP expense with an ascertainable price is- unable to be shown to exist, even if such price is nil, Chapter X provisions cannot be invoked to undertake a TP adjustment exercise.
65. As already mentioned, merely because there is an incidental benefit to the foreign AE, it cannot be said that the AMP expenses incurred by the Indian entity was for promoting the brand of the foreign AE. As mentioned- in- Sassoon -J David-(supra)- "the--fact that- somebody other than the Assessee is also benefitted by the expenditure should not come in the way of an expenditure being 'allowed by way of a deduction under Section 10 (2)
(xv) of the Act (Indian Income Tax Act, 1922) if it satisfies otherwise the tests laid down by the law".
Considering the facts-like absence of an agreement between the assessee and the AE's. for sharing AMP expenses ,payment made by the assessee under the head AMP to the domestic parties, failure of the TPO prove that expenses were not for the business carried out by the assessee in India-and following the judgments of the Hon'ble Delhi High Court delivered in the case of Bausch and Lomb(India) Pvt. Ltd (supra),we are of the opinion that the transaction in question was not an international transaction and that the TPO had wrongly invoked the provisions of Chapter X of the Act for the said transaction. With regard to the submissions of the AR that the issue of AMP should be restored back to the file of the AO, we want to mention that law as a concept is supposed to evolve with passage of time-it cannot be static always. Non- availability of a particular decision of the higher forum cannot justify the restoration of issue/cases to the file of AO in each and every case. Unnecessary litigation has to be avoided and issues have to be settled for once and all.We are 21 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
of the opinion that after the judgments of Maruti Suzuki and Bausch & Lomb (supra) there is no scope of any other interpretation about the AMP expenditure. In the case under consideration, the AO/TPO has not brought anything on record that there existed and agreement, formal or informal, between the assessee and the AE to share/reimburse the AMP expenditure incurred by the assessee in India. In absence of such an agreement the first and primary precondition of treating the transaction in question an international transaction remains un- fulfilled. Conducting FAR analysis or adopting an appropriate method is the second stage of transfer pricing adjustments.The first thing is to find out whether the disputed transaction in is international transaction or not. Without crossing the first threshold second cannot be approached. In the case under consideration, we are of the opinion that AMP expenditure is not an international transaction and therefore we are not inclined to restore back the issue to the file of the AO. Considering the peculiar facts and circumstances of the case, first effective ground of appeal is decided in favour of the assessee and the additions made by the AO, including the mark-up adjustments, are directed to be deleted.
11. We have further noted that similar adjustment on account of AMP was made by TPO for AY 2011-12, however, the DRP accepted the objection of assessee holding that there was no international transaction of AMP expenses and on appeal before the Tribunal, the appeal of revenue was dismissed vide ITA No. 663/Mum/2016 vide order dated 11.09.2018 holding as under:
"16. Upon hearing both the counsel and perusing the records. We find in Revenue's appeal, the issue raised pertains to the deletion of international transaction addition consisting of Amp transaction by the Transfer Pricing Officer following the decision by ITAT in assessee's own case and also decision of Hon'ble Delhi High Court in the case of Sony Eriscon Mobile Communication (India) Pvt. Ltd. (now known as Sony India Ltd.) v. CIT[2015] 374 ITR 118 (Delhi), Maruti Suzuki India Ltd. vs. ACIT [2016] 381 ITR 117 (Del) and Whirlpol of India Ltd (supra). Since 22 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
the DRP's direction is supported by the Hon'ble High Court's decision, we do not find any infirmity in the same. Hence, the Revenue's appeal is dismissed."
12. We have also perused the agreement of assessee with its AE dated 4th January 2011 executed between assessee and its AE. Clause 7 of the agreement descries about right of distribution of licensed product in the territory. As per clause 8 of the said agreement the assessee is responsible for the advertising the licensed product in the territory. The 'territory' is defined under clause 1.5 of the agreement, which means the territory of Nepal, Bhutan, Bangladesh, Maldives, Mauritius, India and Sri Lanka. However, it excludes any free trade zone, which may exist or may be created. Further it excludes duty free shops located in the duty free or travel retail area which is the specialized in sales against foreign currency to foreigner or diplomatic corps, shipchlanders, airlines companies or shipping companies. Though the AE has reserves its right for the zones of excluded areas. The contentions of the ld. AR for the assessee is that clause 8 of the agreement does not obligates the assessee to incur expenses on AMP so as to promote the brand owned by its AE's. And that the expenses are incurred by assessee in the normal course of its business. The perusal of the clause 7 and 8 reveals that there is no agreement between the assessee and the AE's for sharing the expenses and the payments made by the assessee for the expenses of AMP. The TPO has also not brought any fact on record that there exist any agreement 23 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
between the assessee and its AE to share or reimburse the AMP expenses. Moreover, we have seen that there is no material change in the facts for the year under consideration. Therefore, considering the above factual discussions and the decision of the coordinate bench of Tribunal for AY 2008-09 to 2010-11, on the identical issue the ground No.2 to 21 of the appeal is allowed.
13. Ground No.22 to 27 relates to adjustment on account of payment of Royalty and technical knowhow. The ld AR of the assessee submits that the adjustment for royalty paid by the assessee for the use of trademark on the basis that there was no impact of the trademark used by the assessee in the initial years of its operation and the value of trademark is generated by the assessee by incurring AMP expenses and therefore, there was no need to pay royalty for the trademark used by the assessing for the purpose of business. The licensed trademarks used by the assessee is in existence since 1909, the assessee acquired Garnier in 1965 and Metrix in 2000, which are well-known brands and are known even before the assessee was set up in India. Since the Indian market was dominated by FMCG giants like HUL and P&G, the assessee would not have been able to survive in the market and attains growth in sales, profits and market share without the licensed use of the trademark owned by the AE's. This fact was explained to the transfer pricing officer vide submissions dated 22 January 2016 copy of which is filed on record at page no1756 of paper 24 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
book. The transfer pricing officer and DRP have not disputed the trademark and benefit by the assessee from such use; therefore, it is not open to them to disallow the entire expenditure on account of commercial expediency. The ld. AR further submits that in the expenses were incurred by the assessee for the purpose of selling the products manufactured and distributed by the assessee in India. Therefore, incurrence of AMP expenses has no connection with the payment of royalty on trademark. The Tribunal in its order dated 4th May 2016 for assessment year 2008- 09 to AY 2010-11 have expressly held that alleged AMP expenses are incurred by assessee has grown up the sale of its product.
14. In alternative submissions the ld. AR for assessee further submits that transfer pricing officer determined the arm's-length price at Nill without applying any of the prescribed method under section 92C of the Act. Since the TPO made the adjustment without following any of the prescribed methods and without bringing any comparable on record, purely on the basis of lack of commercial expediency is unjustified. The transfer pricing officer has no jurisdiction to see whether the expenditure incurred by the assessee meets the test of section 37(1) of the Act. In support of his submission, the ld. AR of the assessing relied upon the decision of honorable Bombay High Court in case of CIT vs. Lever India Exports Ltd. (78 taxmann.com 88). The Ld. AR further submits that similar agreement was in force for assessment year 2015-16 and the 25 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
transfer pricing officer has accepted the payment of royalty on use of license trademark at 1.75% without making any adjustments in this regard. Therefore, it was submitted that having accepted the method and the benchmarking of the transaction in the subsequent year on the same set of facts, it is not open for the department contend to the contrary for the year under consideration. It was canvassed that the department cannot dispute a transaction when the same transaction has been accepted in a subsequent year as it cannot be allowed to blow hot and cold at the same time. Therefore, it is submitted that the adjustment made by TPO deserves to be deleted as the department has accepted the same transaction in assessment year: 2015-16.
15. On adjustment on account of technical knowhow, the ld. AR submits that royalty formula trademark and technical knowhow could not be looked in isolation as both these are combined and bundled. The trademark royalty was paid to its AE as consideration for the right to affix the licensed trademark on products manufactured/sold by the assessee. The royalty for technology paid to AE is a consideration for the right to use technology and other formulations developed and improvised by the AE which enables the assessee to manufacture the high-quality products. As both the transaction are inter related and connected with each other, the assessee benchmarked both the transactions together by considering the royalty agreements where trademark was licensed and also considering the 26 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
royalty agreements where trademark and technical know-how both are licensed out. Based on the comparables royalty agreements, Arm's Length Price was determined at 6.95% (arithmetic means). The benchmarking carried out by assessee was explained to the TPO vide assessee's submission dated 22.01.2016, copy of which is filed on record at page no. 1757 of Paper Book. TPO erred in determining ALP at 2.3% by taking the difference between average rate 8.5% of agreements the trademark and technical know-how vis a vis the average rate at. 6.1% of the agreements with only trademark by purporting to apply the CUP Method. The ld. AR submits that when no separate rate was found for use of technical know- how in the comparable agreements selected by the TPO, it was not open for him to estimate a rate for use of technical know-how. In support of his submission, the ld. AR of the assessee relied upon the decision of Mumbai Tribunal in case of Maruti Suzuki India Ltd. vs. Addl. CIT(supra).
16. On the other hand, the ld. DR for the Revenue submits that clauses 2 and 11 of the license agreement dated 4th January 2011 are relevant in respect of payment of royalty. By clause 2 of the agreement, the assessee is given exclusive right to manufacture the licensed product of L'OREAL and therefore, to use the technology as well as licensed trademark and exclusive right to import and distribute and sale the licensed product in the territory. Further, as per clause 11 of the agreement the assessee paid royalty @ 6.75% upto June 2011. The clause 11 specifies bifurcation of 27 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
royalty into two components i.e. 5% for technical knowhow and 1.5% for trademark. Thus, the contention of assessee that TPO wrongly bifurcated royalty into two components are not correct as the clause of the agreement itself specify the bifurcation. The reliance on the decision of Delhi Tribunal in Maruti Suzuki India (supra) is misconceived as facts of the case are entirely different. For technical knowhow, the ld. DR submits that TPO was correctly brought on record that out of 12 comparables selected by the assessee, only 4 comparable were having payment for both marketing and processing and remaining 8 comparable were related to payment of exclusive marketing royalty, which facts are not disputed by assessee. Therefore, all the comparable selected by assessee need to be rejected. And the TPO should have come out with appropriate comparable where payments are made either for processing royalty or technical knowhow royalty. The TPO computed the average payment of processing/technical knowhow royalty at 2.3% by reducing the average payment of royalty for both marketing and processing intangible with average payment of royalty for market intangible only. The ld. DR submits that the matter may be set-aside to the file of AO/TPO for selecting appropriate comparable where payments are exclusively made for processing/technical knowhow royalty.
17. In rejoinder submission, the ld. AR of the assessee submits that the assessee only manufactures products under the trademarks licensed by the 28 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
AEs and the rate of royalty for all the products manufactured and sold under all trademark (L'Oreal, Garnier and Matrix) is same. The assessee does not paid royalty at different rate for different traders. Therefore, the submission of ld. DR that assessee did not furnish product-wise royalty is relevant and justified. For non-applicability of decision of Maruti Suzuki (supra), the ld. AR submits that the principle laid down by tribunal is applicable in so far as the TPO has estimated the rate of royalty while selecting comparable for bench marking for technical knowhow royalty. The matter cannot be remanded that for the failure of TPO to apply one of the prescribed method to provide him a second inning and for taking advantage of his own wrong. The ld.AR submits that a similar contention was rejected by Tribunal in assessee's own case for A.Y. 2008-09 to 2010-11.
18. We have considered the rival submission of the parties and have gone through the orders of authorities below. We have also deliberated on various case law relied by lower authorities and the ld. representative of the parties before us. Both the parties have made their exhaustive submission on the issues under consideration, however, on careful perusal of the order of Tribunal for Assessment Year 2011-12 in ITA No. 693/Mum/2016 dated 11.09.2018, we find that the identical issue has been restored to the file of DRP. Therefore, in all fairness we deem it appropriate to restore these grounds to the file of ld. DRP to decide the 29 ITA No. 1417 Mum 2017 - M/s L'oreal India Pvt. Ltd.
issue afresh. Needless to say that before deciding the issue afresh in accordance with law, the assessee shall be granted sufficient opportunity of hearing. The assessee is given liberty to raise all their submission before the DRP, including the argument that for assessment year 2015-16 the transfer pricing officer has accepted the payment of royalty on use of license trademark at 1.75% without making any adjustments. In the result, ground no. 22 to 27 is allowed for statistical purpose.
19. Ground No. 28 & 29 are consequential, therefore, needs no specific adjudication.
20. In the result, the appeal of the assessee is partly allowed.
Order pronounced in the open court on 30/01/2019.
Sd/ Sd/-
RAJESH KUMAR PAWAN SINGH
ACCOUNTANT MEMBER JUDICIAL MEMBER
Mumbai, Date: 30.01.2019
SK
Copy of the Order forwarded to :
1. Assessee
2. Respondent
3. The concerned CIT(A)
4. The concerned CIT
5. DR "K" Bench, ITAT, Mumbai
6. Guard File
BY ORDER,
Dy./Asst. Registrar
ITAT, Mumbai
30