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Judgment
PER S.RIFAURRAHMAN,AM:
This appeal filed by the assessee is directed against the assessment order dated 29.04.2021passed by the DCIT, Circle 8 (1), New Delhi under section 143(3) read with section 144(C)(13)r.w.s. 144Bof the Income-tax Act, 1961 (for short ‘the Act”) for Assessment Year 2016-17pursuant to the directions of the Dispute Resolution Panel u/s 144C (5) of the Act raising following grounds of appeal :-
“Based on the facts and in the circumstances of the case and in law, the learned AO/ TPO has:
General
1.Erred in determining the Appellant's income from business at Rs.12,95,10,035 as against Rs.1,43,27,495 disclosed in the return of income, thereby making additions/ disallowances aggregating to Rs 11,51,82,540.
Transfer Pricing Adjustments
2.Erred in making an adjustment of Rs 5,02.84,262 to the total income of the Appellant under section 92CA(3) of the Act on account of adjustment in the arm's length price of the international transaction of payment of royalty.
Rejection of economic analysis undertaken by the Appellant
3.Erred in not accepting the economic analysis undertaken by the Appellant using the Resale Price Method (,RPM'), in accordance with the provisions of the Act read with the Income-tax Rules, 1962 ('the Rules'), for the determination of the arm's length price of the international transaction of payment of royalty.
4.Erred in rejecting the aggregation approach adopted by the Appellant using RPM to benchmark the said international transaction and not appreciating that payment of royalty is closely connected with the distribution business of the Appellant.
Inappropriately considering Comparable Uncontrolled Price as the most appropriate method
5.Erred in comparing the agreement between the Appellant and its AE with non-comparable third party arrangements/ templates (identified from the RoyaltyStat database) for franchise models.
6.Without prejudice to the above, erred in ignoring the differences in these said arrangements/ templates selected.
Ignored evidences submitted for use of trademarks and marketing know-how and benefits derived therefrom
7.Erred in not appreciating the evidences submitted in order to substantiate the benefits derived from the use of trademark and marketing know-how provided by the AE and disregarding the same without giving any cogent reasons.
Inappropriate determination of ALP of the international transaction
8.Without prejudice to the above, the Appellant pays higher royalty vis-a-vis the brands held by third parties as against group companies and the same should be used to benchmark the royalty payment.
Ignored that ALP determined has been accepted in the hands of AE
9.Without prejudice to the above, the international transaction of payment of royalty by Appellant to its AE has been accepted to be at arm's length in the hands of AE during the transfer pricing assessment proceedings for the year under consideration and hence the payment by the Appellant should also be accepted to meet the arm's length test.
Corporate tax additions/ disallowances
Disallowance of Employee Stock Option Plans expenses
10.Erred in disallowing expenditure of Rs.35,84,521 paid by the Appellant to its overseas group company, towards Restricted Stock Units ('RSU') provided to certain employees, under section 37(1) of the Act.
Disallowance of information technology ('IT) support charges
11.Erred in disallowing expenditure of Rs 48,02,126 being amount paid to Estee Lauder International Inc. for availing IT support services, under section 37(1) of the Act.
Disallowance of advertisement and sales promotional expenditure
12.Erred in disallowing advertisement and sales promotional expenditure of Rs 5,65,11,631.
Not allowing claim for reversal of provision for sales return
13.Erred in not allowing the claim made on account of reversal of provision for sales return of Rs 36,04,725 during AY 2016-17, out of provision created during AY 2015-16, without prejudice to the appeal filed by the Assessee against addition made during AY 2015-16 on account of provision for sales return
Set-off of brought forward business losses and unabsorbed depreciation
14.Without prejudice to the above grounds of appeal, erred in not allowing the set-off of brought forward business losses and unabsorbed depreciation against the assessed income of the Appellant for the captioned year, despite specific directions of the Dispute Resolution Panel.
The above grounds of appeal are independent and without prejudice to each other.”
Ground No.1 is general in nature and does not require separate adjudication.
With regard to Grounds No.2 to 9, brief facts of the case are, the business of the assessee is that of distribution of various products purchased from its group entities, i.e. the assessee is engaged in wholesale purchase of products of its group entities [associated enterprises (AEs)] and selling them to retailers (such as Shoppers Stop Ltd., Select City Walk Mall (GLB Bodycare Pvt. Ltd.), Promenade Mall (Cian Builders & Developers Pvt. Ltd., etc.) for eventual sale by retailers to consumers in India. To be precise, the assessee purchases various branded products from its AEs such as MAC, Clinique, Bobbi Brown etc. in bulk (as a wholesaler) and then sells them to retailers (such as those aforementioned) at a discount on maximum retail price.
The assessee has entered a Trademark License Agreement dated 1stApril 2012(Trademark Agreement) whereunder it has agreed to pay royalty @3% of the Net Sales for receiving a right to use and to sub-license the trademark of the various brands. Similarly, the assessee has also entered a Marketing Knowhow License Agreement dated 1stApril 2010 (Marketing Knowhow Agreement) whereunder it has agreed to pay royalty @3% of the Net Sales for receiving the marketing knowhow, to facilitate the sales of the branded products in a manner consistent with and maintaining the global brand image and standards of customer experience.While selling the above referred products to the retailers, the assessee also provides the right to use the trademark and marketing knowhow it receives from ELII for no separate consideration.
It was submitted before the authorities below that the licensing of trademark and marketing knowhow is essential as it enables the retailers to sell the products purchased under the brand through dedicated spaces within their retail outlets/space and also sell them in a manner consistent with and maintaining the global brand image and standards of experience. For e.g. the malls like Shoppers Stop will have a dedicated space for selling MAC products which bares the trademark “MAC” and the look and experience of shopping by consumers at these dedicates spaces commensurate with the global standards. The pictures of the dedicated space bearing “MAC” logo/trademark and the layout of the space (marketing knowhow). Further picture demonstrating use of the trademark “Clinique” of the store design was also submitted.It was submitted that these pictures establish that it is necessary for the assessee to have a right to use this logo/trademark (MAC, Clinique, etc.) and marketing knowhow (space designs, etc.) so as to inturn pass it to the retailers in order to enable the retailers to use them for selling the products purchased by them from the Assessee. To sum up, the assessee procures from its AEs products alongwith a license to the associated trademarks and related marketing knowhow and sells to retailers those products alongwith a right to use the associated trademarks and related marketing knowhow. Based on the above, the assessee had bench marked the international transactions by aggregating the royalty payments on purchase of products on the basis that both the activities are inextricably connected with each other and benchmarked the same using RPM, it came to conclude that the payment of royalty is within arm’s length price. The AO/TPO had rejected the above study and TPO had selected the CUP as the most appropriate method in this case and after selecting 4 agreements of comparables, determined the average royalty rate of 2.65% and arrived at Rs. 380,71,002 as ALP of royalty and made adjustment of Rs. 502,84,262/- to the total income.
Further, the AO had made further corporate tax additions relates to ESOP, advertisement and promotional expenditures, provisions for sales return and rejection of claim of set off of brought forward losses and depreciation.
Aggrieved with the above order, filed objections before Ld DRP and Ld DRP had sustained the adjustments proposed. Aggrieved with the above order, the assessee is in appeal before us.
At the time of hearing, ld. AR submitted as under:-
5.The royalty paid by the Appellant to ELII is a factor of the price at which the Appellant sells the products to its retailers computed in a manner setoutin the said trademark and marketing knowhow agreement. In the Trademark Agreement the relevant clause reads as under (Pg. 913 to 914 of Volume 2 of paperbook):
“2.1.SUBLICENSEE shall pay to LICENSEE periodic royalties equal to three percent (3%) of the aggregate “Net Sales” (as hereinafter defined) of all PRODUCTS sold by SUBLICENSEE or its sub-licensees in the TERRITORY during the term of this Agreement. As used throughout this Agreement, “Net Sales” shall mean the gross volume of sales of the Products in the Territory by LICENSEE or its sub-licensees under the Trademarks, less Discounts and Returns. “Discounts” shall mean reductions in the invoice price for goods if payment is made within a stipulated time period. “Returns” shall mean product returns based on authorization from the seller. Sales of Products between SUBLICENSEE and its Affiliates (as hereinafter defined) or between one such Affiliate of SUBLICENSEE and another Affiliate of SUBLICENSEE are not to be included in computing royalties hereunder. Royalties shall become due to the LICENSEE (subject to paragraph 2.2 herein below) on the basis of the Net Sales made by the SUBLICENSEE.” Similar clause in the Marketing Knowhow Agreement reads as under (Pg.932 to 933 of Volume 2 of paperbook):
“7.1In full payment for the rights to use the Know How and Technical Expertise and Copyrights granted under Articles 2 and 3, beginning July 1, 2010, Licensee shall pay Licensor a royalty equal to three percent (3%) of Licensee’s Net Sales (as hereinafter defined). As used throughout this Agreement, “Net Sales” shall mean the gross volume of sales of the Products in the Territory by Licensee, less Discounts and Returns. “Discounts” shall mean reductions in the invoice price for goods if payment is made within a stipulated time period. “Returns” shall mean product returns based on authorization from the seller. Sales of Products between Licensee and its AFFILIATED COMPANIES are not to be included in computing royalties hereunder. Royalties shall become due to the Licensor (subject to paragraph 7.2 herein below) on the basis of the Net Sales made by the Licensee, whether through cash or credit and shall not be subjected to the actual realization of the Net Sales proceeds by the Licensee.”
6.The Appellant has in its transfer pricing study (TP Study) aggregated the royalty with the international transaction of purchase of products as the two are inextricably connected with each other and benchmarked using the Resale Price Method (RPM). The Appellant from its business of distribution earned a gross profit of Rs. 55,06,79,414 which translates to a gross-profit margin of 37.97% (Pg. 1637 of PB,Volume 3). The average gross-profit margin of comparables chosen by the Appellant in its TP Study is 32.28% (Pg.1556 of PB, Volume 3). Accordingly, the Appellant submitted that the amount paid by it as royalty is at arm’s length.
7.It is further pertinent to note that the receipt of royalty for this very assessment year was a subject matter of scrutiny in the hands of ELII. ELII has in its TP Study taken the Appellant as a tested party and benchmarked the transaction using the Resale Price Method (RPM). The Transfer Pricing Officer of ELII in his order dated 25 March 2019 (Pg.1276 to 1277 of PB, Volume) has recorded as under:
“2…In response to said notices, Ms. Neha Malhotra, C.A., AR from SRBC & Associates, Authorized Representatives of the Assessee company appeared from time to time and filed written submissions and copies of documents from time to time. The details and documents furnished in relation to the transactions with AEs vis-à-vis computation of ALP were discussed and examined.
3.Considering the facts and circumstances of the case and documents furnished by the assessee, the value of the assessee's transactions with regards to the arm’s length price is not being disturbed.” The Appellant submits that the transfer pricing order in the hands of ELII accepting RPM as the most appropriate method for benchmarking royalty has been accepted by the Revenue and the same has attained finality.
8.The Transfer Pricing officer in his order dated 31 October 2019 at internal Page 2 set out the various international transactions. The revenue has finally disputed only one of the several international transactions, viz. the payment of royalty of Rs. 8,83,55,264 to ELII. As stated earlier, it is the Revenue’s case that royalty cannot be aggregated with the international transaction of purchase of products and benchmarked using the Resale Price Method (RPM). As per the Revenue the most appropriate method is the Comparable Uncontrolled Price (CUP) Method. Accordingly, the Revenue has chosen 4 franchise agreements from the RoyaltyStat Database and used them as CUP; and, based on the royalty rates under the said 4 agreements computed average royalty rate of 2.65% and arrived at Rs. 3,80,71,002 as the arm’s length royalty. Consequently, the transfer pricing offer directed a disallowance of Rs.5,02,84,262.
Submissions:
9. Aggregation of the transaction of purchase of products from its AEs and payment of royalty
a. During the course of the hearing, the Appellant explained the facts as narrated above. The Appellant highlighted that the distribution business model of the Appellant is a composite one, in that it purchases from its AEs products alongwith a license to the associated trademarks and related marketing knowhow and sells to retailers those products alongwith a right to use the associated trademarks and related marketing knowhow for no separate consideration. The Appellant submitted that it would be unable to sell the products purchased by it from its AEs without the requisite trademarks and marketing knowhow. The Appellant therefore submitted that the international transaction of purchase of products and payment of royalty for the associated trademarks and related marketing knowhow is one composite transaction and has been rightly aggregated.
b. The Appellant further highlighted that the price at which it is in a position to sell the branded products it acquires, is directly influenced by the fact that the products are branded and are sold in manner commensurate with the global standards. The Appellant submitted that this is another reason why the transaction of purchase of products from its AEs and payment of royalty cannot be separately considered, but ought to be aggregated.
c. It is pertinent to note that while benchmarking the transaction of Purchase (import) of Products from AEs for resale, the Revenue has accepted RPM as the most appropriate method and the computation of Gross Profit Margin as the Profit level Indicator (PLI)(Gross Profit / Net Sales)of37.97% for the purposes of comparability. It is further pertinent to note that in computing the Gross Profit Margin of 37.97% the expenditure of royalty paid to its AEs (the transaction in dispute in the present appeal) has been debited, in other words bundled with the amount paid for Purchase (import) of Products from AEs for resale. This computation insofar as benchmarking of the transaction of Purchase (import) of Products from AEs for resale has been accepted by the Revenue. It is therefore not open for the Revenue to contend that the payment of royalty is not inextricably connected to the international transaction of purchase of products from AEs for resale and unbundle the two transactions to then subject one element, i.e. payment of royalty, to an entirely different method.
d. The Appellant places reliance on the following decisions in this regard to support its plea for aggregation:
i.Magneti Marelli (75 taxmann.com 213) (Del.)and in particular the following observations therein: (Para 17)
“17.As far as the second question is concerned, the TPO accepted TNMM applied by the assessee, as the most appropriate method in respect of all the international transactions including payment of royalty. The TPO, however, disputed application of TNMM as the most appropriate method for the payment of technical assistance fee of Rs. 38,58,80,000 only for which Comparable Uncontrolled Price ("CUP") method was sought to be applied. Here, this court concurs with the assessee that having accepted the TNMM as the most appropriate, it was not open to the TPO to subject only one element, i.e payment of technical assistance fee, to an entirely different (CUP) method. The adoption of a method as the most appropriate one assures the applicability of one standard or criteria to judge an international transaction by. Each method is a package in itself, as it were, containing the necessary elements that are to be used as filters to judge the soundness of the international transaction in an ALP fixing exercise. If this were to be disturbed, the end result would be distorted and within one ALP determination for a year, two or even five methods can be adopted. This would spell chaos and be detrimental to the interests of both the assessee and the revenue. The second question is, therefore, answered in favour of the assessee; the TNMM had to be applied by the TPO/AO in respect of the technical fee payment too.”
ii.Cummins India (153 taxmann.com 223) (Bom.)and in particular the following observations therein: (Para 11)
“11.Therefore, the TPO having accepted that TNMM method applied by Assessee was the most appropriate method in respect of all the international transactions including payment of royalty cannot dispute application of TNMM method as the most appropriate method for the payment of royalty only for which CUP method was sought to be applied. We would concur with Mr. Mistri that having accepted the TNMM method as the most appropriate, it was not open to the TPO to subject only one element, i.e, payment of royalty, to an entirely different CUP method……”
10.Without prejudice to the foregoing, the Appellant submitted that the 4 comparables selected by the Revenue are ex facie not comparable, and on that count alone the CUP method as applied by the Revenue is liable to be rejected.
a. During the course of the hearing, the Appellant pointed out that none of the 4 agreements selected by the Revenue are executed transactions. All of them are only template agreements, in fact none of the agreements even have the name of the other parties. Attention of the Hon’ble Bench was invited to the following pages of the Paperbook:
i.Desert Sun Franchising Inc.: Page 944 and 991 (Volume 2 of the PB)
ii.Cobe Nails Franchise System Inc. - Page 1168 and 1223 (Volume 2 of the PB)
iii.V's Barbershop Franchise LLC - Page 1122 and 1158 (Volume 2 of the PB)
iv.Just a Buck Licensing Inc. - Page 1025 and 1068 (Volume 2 of the PB)
b. Templates/unexecuted transactions cannot be used as CUP, reliance is placed on the following decisions to urge that:
i.Redington India (34 taxmann.com 279) (Chennai) and in particular the following observations therein: (Para 11)
“11.We have perused the orders and heard the rival submissions. There is no dispute that in the transfer pricing document submitted by the assessee before the TPO, assessee itself had considered CUP method to be the appropriate one. However, in the audit report in Form No.3CEB, it was mentioned that TNMM was being followed. Reason given by the assessee was that list price, based on which CUP method could be adopted, was only indicative and was not in public domain. Assessee itself had submitted the list price of various items purchased by it, as available in the website of M/s Intel Semiconductor Limited, and the TPO had gone ahead with comparative study based on such list. ……. … … ……However, the contention of the assessee that such list price was only indicative, in our opinion, carries considerable strength. We cannot say that M/s Intel Semiconductor Limited would have entered into sale transactions with its customers at the very same price as given in the list price. Prices are always a measure of market exigencies and economic rules of demand and supply. Prices are negotiated between parties according to quantity, value and other aspects which are determinant of market forces. For making a comparative study under CUP method also, what is required is a comparison with actual sale and purchase with unassociated enterprise or transaction between unassociated enterprises. It cannot solely be based on list prices, which at the best can be considered only as a reference point.
12……We are, therefore, of the opinion that the adjustment carried out by the lower authorities, based on list price, on the purchase of 1250 Pentium IV processors from Associate Enterprise was not called for. Such adjustment, therefore, stands deleted.”
ii.Bumi Highway (94 taxmann.com 655) (Del.) and in particular the following observations therein: (Para 12)
“12.The Court finds that DRP proceeded on the basis that clause in the sanctioned letter issued by BNS envisaged charging of 18.5% as penalty interest in the event of default in repayment for failure to make timely payment of the loan. What was perhaps was not noticed that the said clause itself gives a discretion to BNS as regards charging of penal interest @ 18.5%. It would be purely hypothetical to presume, without there being an actual instance of default in repayment of the loan by the Assessee to BNS, that in the event of such default BNS would charge interest at 18.5%. The possibility of the BNS, in its discretion, rolling over the loan or not charging a higher rate of interest in a given set of circumstances where the repayment of the loan was not timely could not be ruled out and in any event could not be surmised. As rightly pointed in the application of CUP method, the DRP had necessarily to go by what was actually charged in the comparable uncontrolled transaction and not a hypothetical transaction…...”
c. Further, a chart highlighting the differences between the nature of business of the Appellant and that of each of the 4 comparables was handed over during the course of the hearing. The same is enclosed herewith for ready reference. At the outset and without prejudice to the detailed distinctions setout in the chart handed over, it was highlighted that all the 4 agreements were Franchise Agreements, which without anything further would render all of them incomparable. Attention of the Hon’ble Bench was invited to the following pages of the Paperbook:
i.Desert Sun Franchising Inc. - Page 941 (Volume 2 of the PB)
ii.Cobe Nails Franchise System Inc. - Page 1168 (Volume 2 of the PB)
iii.V's Barbershop Franchise LLC - Page 1122 (Volume 2 of the PB)
iv.Just a Buck Licensing Inc. - Page 1025 (Volume 2 of the PB)
d. Even if there is a minor difference in the properties of products, circumstances of trade, etc. the comparable would be rendered incomparable, reliance is placed on the following decisions:
i.Principal Commissioner of Income-tax v. DCM Shriram Ltd. [2025] 170 taxmann.com 631 (Delhi) and in particular the following observations therein (Para 39):
“39.It is relevant to refer to Law & Practice of Transfer Pricing in India - A Compendium3, the relevant extract is set out below:-"While applying CUP method product comparability should be examined rather than business functions. The CUP method is used in cases where an independent enterprise buys or sells products that are identical or very similar to those purchase/ sold by one AE to another AE or in situations where services are rendered that are identical or very similar to those rendered in the controlled transaction. While product comparability is the most important factor under the CUP method, the following other comparability factor also play a vital role: 1. Contractual terms; and 2. Economic circumstance Where there are difference between controlled transaction and transaction with/ between unrelated parties due to other comparability factors, adjustments should be made to enhance reliability."
ii.Amphenol Interconnect (91 taxmann.com 441) (Bom.)
11.The Appellant submits that RPM is the most appropriate method to benchmark a distribution business and the same is held in the following cases:
a. Matrix Cellular (90 taxmann.com 54) (Del.).
b. Fujitsu India (156 taxmann.com 310) (Del.), the Delhi high court in the said case followed the judgement in case of Matrix Cellular International Services (P.) Ltd. [2018] 90 taxmann.com 54 (Delhi).
On the other hand, ld. DR of the Revenue submitted that aggregation of royalty with purchase of products is improper. He further relied on the order of the TPO. The Ld.CIT DR also submitted that if it is found that the comparables chosen are incorrect, the matter should be remanded back to the Revenue for selection of fresh comparables.
In rejoinder, ld. AR of the assessee submitted as under :-
12.In response the Ld. CIT DR during the course of the hearing submitted that aggregation of royalty with purchase of products is improper. He further relied on the order of the TPO. The Ld.CIT DR also submitted that if it is found that the comparables chosen are incorrect, the matter should be remanded back to the Revenue for selection of fresh comparables.
13.In rejoinder, the Appellant submitted that:
a. Once the Ld. CIT DR could not dislodge the inextricable connection / composite nature of the distribution business demonstrated by the Appellant, aggregation, as held by the Hon’ble Delhi High Court in Sony Ericsson Pvt. Ltd. vs CIT (374 ITR 118) is desirable, reliance is placed on Para 137 thereof:
“137… Aggregation of transactions is desirable and not merely permissible, if the nature of transaction(s) taken as a whole is so inter-related that it will be more reliable means of determining the arm‘s length consideration for the controlled transactions. There are often situations where separate transactions are intertwined and linked or are continuous that they cannot be evaluated adequately on separate basis.…….”
b. Once it is found that the comparables selected by the Revenue deserve to be rejected and it is the categorical stand of the Appellant that there is no reliable third-party comparable data available, the CUP method must fail.
c. In view of the above, it is not permissible for the Tribunal to remand the matter back to the TPO for a second inning. In this regard, the Appellant relies on the judgment of Delhi High Court in case of Bumi Highway (supra) wherein similar argument made was made by the Department before the High Court, when the it was found that CUP method selected for benchmarking is not appropriate. The High Court rejected the request of remand, holding as under:
“10.…… Mr. Sahni urged that ITAT should have remanded the matter to AO for a fresh determination after using an appropriate comparable transaction. .. ..
12.….. With the TPO, the DRP and the ITAT approaching the question of determination of the ALP by using the CUP method with reference to the above clause in the sanction letter of BNS, the question of the Court remanding the matter at this stage to the TPO at this stage to examine if there could be a determination of the ALP using a method different from the CUP method or using a different comparable transaction does not arise.”
The matter cannot be remanded back for fresh benchmarking in the present case for the following additional reasons:
i.In benchmarking the international transaction of purchase of products from AEs for resale, the Revenue has accepted the royalty paid to its AEs (the transaction in dispute in the present appeal) as a component for the purposes of arriving at the PLI (Gross Profit / Net Sales), it is therefore accepted by the Revenue that the payment of royalty is inextricably connected to the international transaction of purchase of products from AEs for resale and therefore there the Revenue’s plea that matter should be remanded deserves to be rejected.
ii.In the hands of ELII, RPM has been accepted as the most appropriate method for benchmarking royalty by the Revenue and the same has attained finality therefore it is not open for the Revenue to ask for fresh benchmarking of the said transaction in the case of the Appellant (Refer para 7 above); and for this reason also the Revenue’s plea that matter should be remanded deserves to be rejected.
14.In view of the above, it is submitted that the adjustment made by the TPO to the international transaction of Royalty is unsustainable and deserves to be deleted.
Considered the rival submissions and material placed on record. We observed that the assessee had paid 6% combined on trade mark usage and marketing knowhow usage by the assessee as a licensee and usage by the sub-licensees towards sale of the branded goods purchased by the assessee from ELII based on the trademark agreement and marketing agreements on the net invoice price. The assessee has bench marked the same by aggregating both the royalty payments and purchase transaction as the same are inextricably interconnected and followed RPM as the most appropriate method for both type of transactions. However, the TPO had rejected the same and proceeded to bench mark the royalty transaction by adopting CUP method. The TPO further proceeded to select 4 comparables and while bench marking the same, he obtained franchise agreements from RoyaltyStatDatebase and used them as CUP. Accordingly, he benchmarked by determining the royalty by adopting the rate of 2.65%. At the time of hearing Ld AR brought to our notice the relevant franchise agreements selected by Ld TPO which is placed on record. We observed that all the above agreements are non-executed and are only templates, it cannot be treated as proper comparable to bench mark the transaction under consideration for the reason that TPO cannot bring on record certain template which are not executed, also the templatesadopted by the TPO are unsigned and details contained indicate that it is collected merely to bench mark the transactions, the above said templates which were not actually executed, has no substance to adopt. This kind of collection of data to undermine the TP adjustments of activities of the assessee are not desirable. Since the TPO adopted the CUP method without there being proper comparables available, the same deserves to be rejected and accordingly, the adjustment made by utilising such unconventional method of collecting information to bench mark the international transactions are deleted.
Coming to the main issue, can the assessee be allowed to aggregate the two royalty payments, which are paid on the basis of net sales achieved by the resellers. It was submitted before us that the distribution business model of the assessee is a composite one, in that it purchases from its AEs products alongwith a license to the associated trademarks and related marketing knowhow and sells to retailers those products alongwith a right to use the associated trademarks and related marketing knowhow for no separate consideration. The assessee submitted that it would be unable to sell the products purchased by it from its AEs without the requisite trademarks and marketing knowhow. The assessee therefore submitted that the international transaction of purchase of products and payment of royalty for the associated trademarks and related marketing knowhow is one composite transaction and has been rightly aggregated. After careful consideration, the nature of business of the assessee demands that the assessee had to sell the high-end branded products along with the trade mark and in support of the marketing knowhow, it looks like the products are sold exclusively on the strength of brands which are sold by the reseller. If that being the case, the products are sold along with the connected brand and its value. The result reflects in the Gross Profit earned by the product. The ultimate utilisation of brand and its connected knowhow, as submitted it cannot be separated. If that being the case, why the AE intended to encash the brand value and marketing knowhow separately, on top of basic selling price. The product costs are separate, either comes along with the purchase price or comes separately. If the trademark and marketing know-how must be recovered separately, the same has to be bench marked separately as separate cost even though it is part and parcel of final selling prices. It cannot be bench marked on the basis of aggregation.We observed that coordinate bench held in the case of (Gruner India (P.) Ltd. [2016] 70 taxmann.com 240 (Delhi – Trib.)), where assessee-company entered into international transactions of import of raw materials and export of finished goods alongwith royalty payment for use of technical know-how and brand name of AE, since said transactions had no link with each other, TPO was justified in segregating those transactions and determining ALP of royalty payments by applying CUP method.
It is fact that the assessee purchases products from its AEs for resale. The transaction of purchase price of products for resale has been accepted by the revenue and the resale price is the method to determine the gross profit earned in the controlled transaction and compared with the uncontrolled transaction after making certain adjustments. The GP so determined consist of purchase price, other selling expenses but the royalty for trademark and marketing knowhow is not part of above cost structure in the uncontrolled transaction, it is case specific. In the given case, and the above said royalties, which are part and parcel of the cost of sales, however, recovered by the AE as separately from the selling price.Before us, it was submitted that the transactions carried on by the assessee are composite and they have rightly aggregated by adopting RPM method. However, in order to stress the above point, they have relied on the two decisions of Hon’ble High Court of Delhi and Bombay in the case of Magneti Marelli (supra) and Cummins India (supra). We noticed that in the decisions relied onhave adopted and accepted by the TPO are TNMM. The Hon’ble Courts have concurred with the views of the assessee with the observation that when the revenue accepted the TNMM as most appropriate method, it was not open to the TPO so subject only one elementie, payment of royalty, to an entirely different CUP method. However, the above decisions are distinguishable to the facts in the present case. Here the method adopted by the assessee is RPM and TPO rejected the above method and proceeded to bench mark the payment of royalty by adopting CUP, it is fact that the TPO had adopted wrong comparables to benchmark, which we have already rejected. However, we are dealing presently with the different issue of segregation. In our view, the method of TNMM and RPM are different to each other as below:
a. RPM focuses on the gross margin, whereas TNMM looks at net operating profit (PLI like operating margin or return on total costs).
b. RPM requires high similarity in products and functions because gross margins vary heavily with product type. TNMM is less sensitive to minor product differences and can tolerate wider variations in goods.
c. RPM does not account for differences in operating expenses below the trading/gross level, meaning diverse indirect overhead costs can distort the comparison. TNMM naturally absorbs operating expense variations since it measures the final net profit result.
d. TNMM is widely used as a default practical method due to accessible net profit data. RPM is preferred strictly when goods are resold without substantial value addition or physical alteration.
In our view, RPM does not absorb the operating expenses, and the payment of royalty is part of operating expenses below the line, even though the benchmarkon the transaction of purchase of products from the AEs for resale was accepted by the TPO, does not factor the payment of royalty. Therefore, above said two transactions cannot be bundled as composite even though the final objective is to sell the same branded products. Hence, we are inclined to reject the above submissions of the assessee.
Coming to the issue under considerationand alsothe year under consideration is AY 2016-17, in our view resending the issue back to the lower authorities to benchmark afresh does not serve any fruitful purpose. No doubt we have to bench the royalty transaction separately, but TPO had missed the bus by adopting the wrong approach of bench marking, it is against the concept of ease of doing business in India. In order to address the issue to resolve, we proceeded to adopt the best possible option/view based on the information available on record. We noticed that the assessee had declared very healthy gross profit of 37.97% as compared to the comparables selected by the assessee in their TP study at 32.28%. It is also fact on record that the assessee is dealing with the high fashion, niche market product having very few comparables in the international market even then the assessee had bench marked the comparables at 32.28% and achieved the GP @ 37.97% without absorbing the royalty payments. We do not have any data on the finalisation of purchase transactions for bench marking the TP and relevant details of comparables selected. The assessee had achieved the GP without absorbing the royalty payments of 6% and other operating expenses. In case, the same is adjusted, the adjusted GP will be31.97% which matches with the margin of comparables selected by the assessee at 32.28%, it is within the range of plus or minus 3%. Since it is within the range of 3% variation, in our view, the benefit of the ALP may be granted to the assessee based on the result available on record for the year under consideration. Therefore, we are inclined to delete the ALP adjustment proposed by the TPO in the year under consideration only in order to resolve the unresolved dispute which was pending over the years. The above method of bench marking cannot be applied for other years or any other assessee. In the result, ground raised by the assessee is partly allowed.
With regard to Ground No.10 i.e. disallowance of expenses with respect to employee’s stock options (“esop”), ld. AR of the assessee brought the relevant facts and his submissions as under. During the year under consideration, the assessee paid Rs.35,84,521 to its Associated Enterprise (“AE”) Estee lauder International Inc. for allotment of Restricted Stock Units (“RSU”) to certain employees of the assessee. The aforesaid amount paid by the assessee was claimed as a deduction under section 37(1) of the Act. During the course of the assessment proceeding, vide letter dated 16 December 2019 (Pg. 494 of Volume 1 of Paper book), the assessee submitted (a) agreement dated 23 February 2012 under which the RSUs are allotted (Pg.511-515of Volume 1 of Paper book), (b) the list of employees to whom RSUs were allotted also giving the details of number of units allotted, value of units and tax deducted at source (Pg.516of Volume 1 of Paper book) (c) debit note raised by the AE for the aforesaid allotment of RSUs (Pg.517of Volume 1 of Paper book).
He submitted that the Assessing Officer disallowed the aforesaid amount relying on the order of the Tribunal in case of Ranbaxy Laboratories Ltd. vs ADIT [2009] 124 TTJ 771 (Delhi). He further held that the order of the Tribunal in case of Accenture Services Pvt. Ltd. (ITA No. 4540/M/2008) cannot be followed as the issue has not attained finality and accordingly, made the disallowance under section 37(1) of the Act. The DRP approves the order of the AO on the ground that since the issue has not attained finality, the disallowance under section 37(1) of the Act deserves to be upheld.
It is submitted that this issue has been decided by the Tribunal in Assessee’s own case for A.Y. 2015-16 wherein it has been held that the amount paid by the assessee for allotment of RSUs to its employees is allowed as deduction under section 37(1) of the Act as the same is incurred wholly and exclusively for the purpose of business. The relevant part of the order for A.Y. 2015-16 is extracted as under:
“8.From examination of record in light of aforesaid submissions, it is crystal clear that stock of ELII were granted to the employees of the assessee via a relevant agreement and cost of such shares issued to the employee are recovered by ELII from ELCA India. RSU agreement at Page 1-5 of Appendix is annexed. RSO Cost is an actual cash outflow and hence not notional or contingent in nature. The shares of ELII are not regulated in India hence, regulatory authorities, guidelines were inapplicable. The assessee had provided list of employees to the AO. Page 12 of Appendix is annexed.
8.1As per ratio of judgment in case of Caterpillar India Pvt. Ltd. (supra) and in view of above material facts and respectfully following the judicial precedents, the compensation paid in form of expenditure incurred on Employee’s Stock Option Plan (ESOP) is held allowable deduction as an expenditure incurred wholly and exclusively for the purpose of business. Accordingly, the Ground No.2 of appeal raised by assessee is allowed.”
For completeness, it is submitted that the order of the Tribunal in case of Ranbaxy forA.Y. 2002-03 relied upon by the AO has been overruled by the Special Bench in case of Biocon [2014] [144 ITD 21] (Bangalore-Trib) (SB) and, following the order of the Special Bench, the Tribunal in Ranbaxy’s case for A.Y. 2008-09 (2016) (68 taxmann.com 322) (Delhi – Trib) has decided this issue in favour of the assessee. Therefore, the reliance placed by the AO on the order of the Tribunal for A.Y.2002-03 in case of Ranbaxy is unsustainable in law.
On the other hand, ld. DR of the Revenue relied on the orders of lower authorities.
Considered the rival submissions and material placed on record. We observed that the above issue of ESOP is covered in favour of the assessee by the various courts, particularly in assessee’s own case, the coordinate bench had decided the issue under consideration in its favour. The facts are exactly similar, we are inclined to allow the grounds raised by the assessee in this regard.
Regarding Ground No.11 which is against the disallowance of Information Technology (IT) Support Charges, ld. AR of the assessee brought before us the relevant facts and his submissions as under. During the year under consideration, the assessee has claimed a deduction of Rs.48,02,128 incurred with respect to IT support charges paid to its Associated Enterprise for (a) developing/maintaining websites for each of the brands like MAC, Clinique, Bobbi Brown, etc. and (b) provision of global information services under shared services agreement dated 1 July 2011 under which costs are allocated to the assessee based on appropriate allocation keys. During the course of the assessment proceeding, vide letter dated 17 December 2019 (Pg. 315of Volume 1 of Paper book), the Appellant submitted (a) GIS agreement dated 1 July 2011 (Pg.348-356of Volume 1 of Paper book), (b) Screenshots of India specific websites for which maintenance charges have been paid (Pg.357-368of Volume 1 of Paper book), (c) Global Information Services Catalog giving complete details services provided by the AE under the agreement (Pg.370-461of Volume 1 of Paper book), (d) e-mail communications between the Appellant and the AE to substantiate the receipt of services (Pg.462-480of Volume 1 of Paper book).
He submitted that the AO without considering the documents submitted by the assessee held that the assessee has failed to submit necessary evidence and has failed to establish the nexus between the IT services and business of the assessee. Accordingly, made a disallowance under section 37(1) of the Act.
He submitted that before the DRP, the assessee submitted additional evidence (a) Screenshots of showing back-up and restoration of Appellant’s data on global servers (Pg.2873-2878of Volume 1 of Paper book), (b) Copy of logs maintained for tracking of IT related requirements and resolutions for issues faced by the Appellant (Pg.2879-2887of Volume 1 of Paper book) (c) e-mail correspondences for resolution of IT related issues, communication and changes in software (Pg.2879-2887of Volume 1 of Paper book). The DRP without considering the aforesaid evidence, upheld that the addition made by the AO that the assessee has failed to prove the benefit and documentation in support of the services received for the payments made.
It is submitted that this issue has been decided by the Tribunal in Appellant’s own case for A.Y. 2015-16 wherein it has been held that the amount paid by the assessee towards IT support charges is allowable as a deduction under section 37(1) of the Act. The relevant portion of the order of the Tribunal is reproduced as under:
“11.From examination of record in light of aforesaid rival submissions, it is crystal clear that learned CIT(A) upheld the disallowance of IT support services of Rs. 35,41,072/-. Appellant/assessee had paid charges for developing country specific websites and periodic maintenance of the websites, provisions of centrally sourced IT services, which helps the assessee in execution of its IT requirement across all functional areas. The global IT Shares Services Agreement had been submitted on record with the AO. Details of TDS deducted were also submitted at Page 446 of paperbook. Basis of allocation for GIS cost at page 39-45, acknowledgment of income ELII at page 46-55, GIS guide and catalogue at page 56 and Email correspondence showing receipt of services at pages 149-165 of appendix is annexed.
11.1As per ratio of judgment of S.A. Builders Ltd. vs. CIT (supra) and in view of above material facts, the appellant/assessee deserves the disallowance of expenditure of Rs. 35,41,072 of IT support services. Accordingly, Ground No.3 of appeal is allowed.”
In view of the above, it is submitted that the disallowance made by the AO in respect of IT support charges deserves to be deleted.
On the other hand, ld. DR of the Revenue relied on the orders of lower authorities.
Considered the rival submissions and material placed on record. The issue under consideration is payment towards IT support services to its AE during the year. The issue is squarely covered in favour of the assessee by the coordinate bench in its own case AY 2015-16. Since the facts in the present case are exactly similar, we are inclined to follow the same and delete the additions made by the AO. In the result, the relevant ground raised by the assessee is allowed.
With regard to Ground No.12 regarding disallowance of advertisement and sales promotion expenditure, ld. AR of the assessee brought before us the relevant facts and submitted his submissions as under. During the year under consideration, the assessee has incurred expenditure of Rs.22,87,23,731 on testers and promotions which was claimed as a deduction under section 37(1) of the Act. During the course of assessment proceeding, the AO raised a query vide notice dated 16 December 2019 requiring the assessment to submit the details of the aforesaid expenses and justify the allowability of the expenses whether the same is incurred wholly and exclusively for the purpose of business.
Ld. AR submitted that the assessee vide letter dated 17thDecember 2019 explained as under (Pg. 319 of Paper book):
“During the year under consideration, the assessee has incurred a total expenditure of Rs 22,87,23,731 towards advertisement and sales promotion expenses.
ELCA is in business of trading of cosmetic products. The assessee’s marketing efforts focus principally on promoting the quality and benefits of the products it sells. Each of the products is distinctively positioned, has a single global image, and is promoted with consistent logos, packaging and advertising designed to enhance its image and differentiate it from other products.
In this regard, we wish to highlight that ELCA is in the business of trading of cosmetic products such as lipsticks, perfumes, etc and hence it is imperative that testers of products and related collaterals are kept at stores which help in demonstrating the quality of the products of the Estee Lauder group to prospective customers. This in turn assists in generation of revenues to ELCA India.
Thus, expenditure on advertisement and sales promotion is essential for effectively marketing its products and achieving higher sales. Further, as per market practice of the cosmetic/ make-up industry, ELCA India is required to provide products to its retailers/ distributors to be kept as testing samples at their stores.
Further, it is humbly submitted that the cosmetics market is highly volatile with newer products being launched continuously and at regular intervals. Hence, it is essential for ELCA to incur expenditure on advertisement and sales promotion including testers in order to promote new products launched (to demonstrate the products and their quality to prospective customers and to enable them to test the features/ quality of the products), enter new geographical markets within India and explore newer distribution channels for existing products as well as to market the existing products to new customers.
It is also humbly submitted that the market of the goods sold by the assessee has increased over the years and accordingly the expenditure incurred on advertisement and sales promotion has increased. The increase in expenditure is supported by the corresponding increase in sales.
Further, marketing of products are also required to protect the market share against the new entrants and well-established players of each industry, especially the cosmetic industry, where all companies aggressively market their products.”
He submitted that in the draft assessment order, the AO accepted that the expenditure is incurred justifiable considering the nature of business, however, makes an ad-hoc disallowance of Rs. 5,65,11,631/- on the basis that the expenditure incurred by the assessee on tester and promotions is very high considering as assessee has incurred substantial amount of expenditure on promotion and advertisement of the products. Thereafter, the DRP approved the ad-hoc disallowance made by the AO.
It is submitted that this issue has been decided by the Tribunal in assessee’s own case for A.Y. 2006-07, 2007-08 and 2015-16 wherein it has been held that it is an industry practice to incur expenditure on testers and promotions, since the market for the cosmetic and beauty products is very volatile; such expenditure allows assessee to retain its market share. The relevant portions of the order of the ITAT for A.Y. 2015-16 is reproduced as under:
“13.From examination of record in light of aforesaid rival submission, it is crystal clear that the assessee had submitted year-on-year expenses on testers and promotion vis-à-vis sales submitted to justify expenses are not abnormally high and in fact have decreased over the years. Industry practice to spend on testers and promotion. Such expense is required to maintain ELCAs market share. The market for such products is also highly volatile, further showing the need for such expenditure. Tribunal in A.Ys. 2006-07 & 2007-08 held in favour of ELCA India. This matter also relates to the business expediency of the assessee and should be left to the businessman concerned or the board of directors. Bill of entry along with relevant invoices submitted to CIT(A) showing that testers and samples were shipped by foreign AE to Shoppers Stop and corresponding no-charge of invoice of ELVA.
13.1In assessee’s own case the issued raised in Ground No.4 is covered by decisions for A.Y. 2006-07 & 2007-08. Accordingly, the disallowance of Testers and Promotional Expenses to the tune of Rs. 4,00,00,000 cannot be sustained and is deserves to be deleted. Therefore, Ground No.4 is allowed.”
Considered the rival submissions and material placed on record. The issue under consideration is disallowance of Testers and Promotional Expenses during the year. The issue is recurring and squarely covered in favour of the assessee by the decision of the coordinate bench in its own case AY 2015-16. Since the facts in the present case are exactly similar, we are inclined to follow the same and delete the additions made by the AO. In the result, the relevant ground raised by the assessee is allowed.
With regard to Ground No.13 regarding reversal of sales return, ld. AR of the assessee submitted that the assessee has been allowed deduction for the sales return of Rs.36,04,725 in A.Y. 2015-16 and the same has been upheld by the Tribunal vide order dated 19 August 2025. Accordingly, this ground has been rendered academic.Since this issue is raised by the assessee on the basis of without prejudice, also there is no impact in the year under consideration, the same is dismissed.
With regard to ground no.14 regarding set-off of brought forward business losses and unabsorbed depreciation, ld. AR submitted that the assessee has brought forward losses and unabsorbed depreciation from earlier years, however, the AO has not granted the set off for the same in the assessment order. He further submitted that the ld. DRP vide order dated 30 March 2021 had directed the AO to verify the contention of the Appellant and allow the same in accordance with law. He submitted that the AO has failed to comply with the directions of the DRP and has not considered the loss and depreciation brought forward from earlier years. Accordingly, it is submitted that the AO may be directed verify the losses and depreciation and grant the set off of the same in accordance with law.
On the other hand, ld. DR of the Revenue has not objection to give direction to the AO in this regard.
Considered the rival submissions and material placed on record. We observed that the Ld DRP has given specific direction to the AO and AO had not dealt with the same in his final order. We direct the AO to consider the above issue after giving proper opportunity of being heard to the assessee and allow the same as per law. We direct the AO strictly follow the specific directions of Ld DRP. In the result, the above ground raised is allowed for statistical purposes.
In the result, the appeal filed by the assessee is partly allowed.