M/s. Callaway Golf India Private Limited vs Income Tax Officer, Ward 5(3), New Delhi

“As discussed Issue wise above the TPO has given valid reasons for his decision. The various issues raised by the assessee in its Grounds of objections have been discussed in the above paras. The assessee has failed to controvert the findings of the TPO. The Assessee objection to it being an International Transaction has been discussed in great detail and on the basis of adequate support from Judicial Decisions it has been successfully held to be an International Transaction.

The Far Analysis and Justification for Compensation has been discussed in Para 6 which is adequately supported by the BEPs report as discussed in para 7. This takes care of most of the Assessee's objections. As discussed, the assessee has also failed to demonstrate that the AMP expenditure done by the assessee was compensated by the AE through a set off in any other transaction. After discussion on why the transaction needs to be separately benchmarked the use of Cost plus method has been justified and is upheld. In view of the SLP filed against the decision of Sony Ericsson the TPO has been directed not to exclude selling and distribution expenses.

The Protective adjustment made using the bright line method has been justified in Para 14 and is upheld.

A Without Prejudice Method of Intensity Adjustment using TNMM has been given in Para 15 for TPO to compute and add on protective basis. The order of the TPO is thus upheld. The grounds raised by the assessee are dismissed.”

“(a)

Bright Line Test; in the Transfer Pricing (TP) order as well as DRP vide its directions upheld the application of BLT to compute the ALP of the AMP expenses. The only difference being in the quantum of the addition made originally in the TP order and the effect order passed in pursuant to DRP directions Le. original TP adjustment of Rs. INR 2,39,76,137 being enhanced to Rs. 3.70.51.737 (refer para 7 of the Final Assessment Order at page 136 of appeal set). It is pertinent to add that the above addition based on BLT has been deleted by the Hon'ble ITAT vide its order dated August 23, 2017 (refer para 8 of the Hon'ble ITAT Order at page 142 of the Case Law Compendium)

(b)

Cost Plus Method: The TPO in its order applied the above method by holding that the AMP Expenses incurred by the appellant is an International Transaction under section 92B of the Act. Thereafter, the TPO proceeded with substantive adjustment by using the Cost-Plus Method. While doing so, the TPO considered the entire business promotion expenses amounting to Rs. 2,39,24,629/-being AMP expenses and applied the gross margin of the appellant being 80.71% as markup which resulted into total adjustment of Rs. 4.32.34,167 on substantive basis. (refer para 8.1.3 of the TP Order at 15 of appeal set). The DRP also upheld the above action of the TPO in its order (refer para 16.2 of the DRP Order at page 94 to 95 of the appeal set). Here it is pertinent to add that the above method is merely an extension of the BLT to the extent that benefit of the adjustment of the expenses incurred by the comparable being denied all together and the AMP being treated as 'separate international transaction in the nature of services given by the appellant to its AE for brand building.

(c)

Adjusted TNMM Method (Intensity Adjustment): The Ld. TPO in its order had not carried any adjustment based upon Adjusted TNMM method. However, the DRP has specifically directed the TPO to make adjustment based upon Adjusted TNMM (Intensity Adjustment) by driving the strength from the decision in the case of Sony Ericsson Mobile Communications India (P.) Ltd. (refer para 18.5 of the DRP Order at pages 121 to 124 of appeal set). The Ld. TPO, following the directions of the Hon'ble DRP, computed NIL adjustment by applying the Adjusted TNMM (Intensity Adjustment) (refer para 2 of the Final Assessment order at page 135 of the Appeal Set).”

“1.

That on the facts and circumstances of the case and in law, the order passed by the Ld. Assessing Officer ("Ld. AO") under section 143(3) read with section 144C (13) of the Act is bad in law to the extent of adjustment of INR 8,02,85,904 made in the impugned assessment order.

2.

That on the facts and circumstances of the case and in law, the Ld. AO/ Ld. Transfer Pricing Officer (Ld. TPO) (following the directions of Hon'ble Dispute Resolution Panel ("Hon'ble DRP")] erred in assessing the returned income of the Appellant of INR 16,33,420 at INR 8,19,19,324.

3.

That on the facts and circumstances of the case and in law, the Ld. TPO/Ld. AO/ Hon'ble DRP failed to establish that there is an arrangement between the Appellant and the Associated Enterprises ("AEs") for the development of marketing intangibles and proceeded to make an adjustment by disregarding various rulings pronounced by the Honourable Jurisdictional High Court, thereby not following the judicial discipline as mandated by law.

4.

That on the facts and circumstances of the case and in law, the Ld. TPO/ Ld. AO/ Hon'ble DRP disregarded the nature of Advertising, Marketing and Promotion ("AMP") expenses incurred by the Appellant and incorrectly held that such expenses resulted in an intra group service rendered by the Appellant of developing marketing intangibles for its AEs which needs to be reimbursed by the AF along with the mark-up.

5.

That on the facts and circumstances of the case and in law, the Ld. TPO/Ld. AO/ Hon'ble DRP failed to appreciate the functional profile of the Appellant and the revenue model with its AE wherein it receives an assured net return on sales.

6.

That on the facts and circumstances of the case and in law, the Ld. AO/Ld. TPO/ Hon'ble DRP erred in incorrectly benchmarking the AMP expenses incurred by the Appellant by applying "bright line method".

7.

That on the facts and circumstances of the case and in law, the Id. AO/ Ld. TPO/ Hon'ble DRP grossly erred in rejecting comparable companies selected by the Appellant in the Transfer pricing documentation.

8.

That on the facts and circumstances of the case and in law, the Ld. AO/ Ld. TPO erred in interpreting the directions of the Hon'ble DRP and proceeded to add protective as well as substantive adjustment amount to the income of the Appellant.

9.

That on the facts and circumstances of the case and in law, the Ld. AO erred in initiating penalty proceedings under section 271(1)(c) of the Act.

10.

That on the facts and in the circumstances of the case and in law, the Ld. AO erred in proposing to levy interest under section 234B of the Act.”

“8.

It is submitted that the decision of Sony Ericsson (supra) dealt with assumption that AMP function/expenditure can be subject to transfer pricing provisions without examining the issue of whether or not the AMP function/expenditure per se is an international transaction which was subsequently dealt by Hon'ble Delhi High Court in the case of Maruti Suzuki India Limited, [2015] 64 taxmann.com 150 (Delhi), dated December 11, 2015.

9.

Be that as it may, the final conclusion of the decision of Sony Ericsson is that it has prescribed a standard guidance for considering the cases of a distributor and marketing AE which incurs AMP function/expenditure (refer Para 194 on Page 75 and 76 of the decision) and this marks as a guideline for making any adjustment in the case of distribution company which incurs AMP function/expenditure. Relevant extracts of the judgement are reproduced hereunder for the sake of ready reference;

194.

For the purpose of clarity, we would like to enlist our findings-

(i)

In case of a distributor and marketing AE, the first step in transfer pricing is to ascertain and conduct detailed functional analysis, which would include AMP function/expenses.

(ii)

The second step mandates ascertainment of comparables or comparable analysis. This would have reference to the method adopted which matches the functions und obligations performed by the tested party including AMP expenses.

(ii)

A comparable is acceptable, if based upon comparison of conditions a controlled transaction is similar with the conditions in the transactions between independent enterprises. In other words, the economically relevant characteristics of the two transactions being compared must be sufficiently comparable. This entails and implies that difference, if any, between controlled and uncontrolled transaction, should not materially affect the conditions being examined given the methodology being adopted for determining the price or the margin. When this is not possible, it should be ascertained whether reasonably accurate adjustments can be made to eliminate the effect of such differences on the price or margin. Thus, identification of the potential comparables is the key to the transfer pricing analysis. As a sequitur, it follows that the choice of the mast appropriate method would be dependent upon availability of potential comparable keeping in mind the comparability analysis including befitting adjustments which may be required. As the degree of the comparability increases, extent of potential differences which would render the analysis inaccurate necessarily decreases.

(iv)

The assessed, i.e, the domestic AE must be compensated for the AMP expenses by the foreign AE. Such compensation may be included or subsumed in low purchase price or by not charging or charging lower royalty. Direct compensation can also be paid. The method selected and comparability analysis should be appropriated and reliable so as to include the AMP functions and costs.

iv) The assessee, ie, the domestic AE must be compensated for the AMP expenses by the foreign AE. Such compensation may be included or subsumed in low purchase price or by not charging or charging lower royalty. Direct compensation can also be paid. The method selected and comparability analysis should be appropriated and reliable so as to include the AMP functions and costs

(v)

Where the Assessing Officer/TPO accepts the comparables adopted by the assessed, with or without making adjustments, as a bundled transaction, it would be illogical and improper to treat AMP expenses as a separate international transaction, for the simple reason that if the functions performed by the tested parties and the comparables match, with or without adjustments, AMP expenses are duly accounted for. It would be incongruous to accept the comparables and determine or accept the transfer price and still segregate AMP expenses as an international transaction.

(vi)

The Assessing Officer/TPO can reject a method selected by the assessee for several reasons including want of reliability in the factual matrix or lack/non-availability of comparables. (see Section 92C(3) of the Act).

(vii)

When the Assessing Officer/TPO rejects the method adopted by the assessee, he is entitled to select the most appropriate method, and undertake comparability analysis. Selection of the method and comparables should be as per the command and directive of the Act and Rules and justified by giving reasons.

(viii)

Distribution and marketing are inter-connected and intertwined functions. Bunching of inter-connected and continuous transactions is permissible, provided the said transactions can be evaluated and adequately compared on aggregate basis. This would depend on the method adopted and comparability analysis and the most reliable means of determining arm's length price.

(ix)

To assert and profess that brand building is equivalent or substantial attribute of advertisement and sale promotion would be largely incorrect. It represents a coordinated synergetic impact created by assortment largely representing reputation and quality. "Brand" has reference to a name, trademark or trade name and like 'goodwill' is a value of attraction to customers arising from name and a reputation for skill, integrity, efficient business management or efficient service. Brand creation and value, therefore, depends upon a great number of facts relevant for a particular business. It reflects the reputation which the proprietor of the brand has gathered over a passage or period of time in the form of widespread popularity and universal approval and acceptance in the eyes of the customer. Brand value depends upon the nature and quality of goods and services sold or dealt with. Quality control being the most important element, which can mar or enhance the value.

(x)

Parameters specified in paragraph 17.4 of the order dated 23rd January, 2013 in the case of LG Electronics India (P.) Ltd. (supra) are not binding on the assessee or the Revenue. The 'bright line test' has no statutory mandate and a broad-brush approach is not mandated or prescribed. We disagree with the Revenue and do not accept the overbearing and orotund submission that the exercise to separate 'routine' and 'non-routine AMP or brand building exercise by applying bright line test of non-comparables should be sanctioned and in all cases, costs or compensation paid for AMP expenses would be NIL, or at best would mean the amount or compensation expressly paid for AMP expenses. It would be conspicuously wrong and incorrect to treat the segregated transactional value as 'NII' when in fact the two AEs had treated the international transactions as a package or a single one and contribution is attributed to the aggregate package. Unhesitatingly, we add that in a specific case this criteria and even zero attribution could be possible, but facts should so reveal and require. To this extent, we would disagree with the majority decision in L.G. Electronics India (P.) Ltd. (supra). This would be necessary when the arm's length price of the controlled transaction cannot be adequately or reliably determined without segmentation of AMP expenses.

(xi)

The Assessing Officer/TPO for good and sufficient reasons can de-bundle interconnected transactions, i.e. segregate distribution, marketing or AMP transactions. This may be necessary when bundled transactions cannot be adequately compared on aggregate basis.

(xii)

When segmentation or segregation of a bundled transaction is required, the question of set off and apportionment must be examined realistically and with a pragmatic approach. Transfer pricing is an income allocating exercise to prevent artificial shifting of net incomes of controlled taxpayers and to place them on parity with uncontrolled, unrelated taxpayers. The exercise undertaken should not result in over or double taxation. Thus, the Assessing Officer/TPO can segregate AMP expenses as an independent international transaction, but only after elucidating grounds and reasons for not accepting the bunching adopted by the assessed, and examining and giving benefit of set off. Section 92(3) does not bar or prohibit set off.

(xiii)

CP Method is a recognised and accepted method under Indian transfer pricing regulation. It can be applied by the Assessing Officer/TPO in case AMP expenses are treated as a separate international transaction, provided CP Method is the most appropriate and reliable method. Adoption of CP Method and computation of cost and gross profit margin comparable must be justified.

(xiv)

The object and purpose of Transfer Pricing adjustment is to ensure that the controlled taxpayers are given tax parity with uncontrolled taxpayers by determining their true taxable income. Costs or expenses incurred for services provided or in respect of property transferred, when made subject matter of arm's length price by applying CP Method, cannot be again factored or included as a part of inter-connected international transaction and subjected to arm's length pricing."

10.

A combined reading of the aforesaid paras concludes that in the case of distribution companies the AMP function/expenditure cannot be benchmarked on a standalone basis and therefore aggregate approach is to be applied by either applying unadjusted or adjusted margins of companies having similar activities and the Hon'ble DRP in para 18 on page 108 to 124 of the appeal set has elaborately dealt with the decision of Sony Ericsson (supra) while proposing the adjusted TNNM/intensity method, which methodology is similar to what has been proposed by Hon'ble Delhi High Court in the case of Sony Ericsson (supra) (para 194 .on P9ge 25 and 76 of the decision).

11.

Pursuant to the directions of DRP, Ld. TPO carried out and sought information from the Ld. AO to calculate adjusted TNMM/intensity. The Appellant also, vide its submission dated December 14, 2016 (Copy enclosed at page 329 to 334 of the paper book), filed the calculation of adjusted TNMM with the Ld. AO, pursuant to DRP directions. Such calculation has been also been accepted by the Ld. TPO, with minor variations, in its effect order reproduced at page 135 of the appeal set wherein a NIL adjustment has been proposed. Accordingly, in the present case of Appellant, no adjustment on account of AMP function/expenditure is warranted which is also in line with the decision of the Hon'ble Delhi High Court in the case of Sony Ericsson (supra).

12.

It is also relevant to highlight that this position is accepted by undertaking Advanced Pricing Agreement (APA) dated 16 March 2021 under section 92CC of the Act, in subsequent years wherein after examining the detailed Functions, Assets and Risks (FAR) of the Appellant, TNMM method has been approved by applying aggregate approach (refer page 15 and 16 of the case law compendium). Accordingly, the Appellant humbly prays, without prejudice to the main contention that AMP doesn't constitute international transaction, that no adjustment is warranted.

13.

Coming to the substantive adjustment of INR 4,32,34,167 made in the final assessment order dated December 29, 2016, it is evident that the same is nothing but application of bright line test wherein entire expenditure is being treated as service to AE in the nature of intra group services (refer page 10 and 11 of the appeal set) by applying the gross margin of appellant at 80.70% (refer page 15 of the appeal set).

14.

In this regard the appellant draws kind attention of Your Honours to para 169 to 174 on page 69 and 70 and para 194 clause xi and xii on page 76 of the decision of Sony Ericsson (supra) wherein the contention of the revenue regarding application of cost plus method was deliberated upon in detail. Relevant extracts are being reproduced hereunder for the sake of ready reference:

170.

United Nations' Manual in arithmetic terms has elucidated CP Method in the following manner: The said method is strictly applied to manufacturing or assembling activities or relatively simple service providers. Like RP Method, CP Method is a gross margin method as it attempts to derive the arm's length price on a mark-up of cost of goods or services provided.

171.

Determination of cost or expense can cause difficulties in applying CP Method. Careful consideration should be given, what would constitute cost i.e what should be included or excluded from cost. A studied scrutiny of CP Method would indicate that when independent the said Method is applied by treating AMP expenses as transaction, it would not make any difference whether the same are routine or non-routine, once functional comparability with or without adjustment is accepted. The gross profit of the comparable is applied and accepted, when there is no difference between the AMP and other functions being compared that would materially affect the gross profit mark up or when reasonably accurate adjustments can be performed. Thus, CP Method requires functional comparability. This comparability analysis would necessarily imply that the comparable must and should be performing similar functions, including the nature of costs and expenses incurred. If the discounts/incentives and for that matter entire distribution and marketing expenses ure treated as costs, functional and comparable analysis comparison should be similar. Thus, the entire cost, i.e. marketing expense or distribution and marketing expense, can be made subject matter and included in 'cost', for determining arm's length price by applying CP Method. ……..

173.

This task of arm's length pricing in the case of tested party may become difficult when a number of transactions are interconnected and compensated but a transaction is bifurcated and segregated. Allocation of price or compensation paid would be a contentious question and apportionment must be justified and fair. CP Method, when applied to the segregated transaction, must pass the criteria of most appropriate method. If and when such determination of gross profit with reference to AMP transaction is required, it must be undertaken in a fair, objective and reasonable manner. ……..

194.

For the purpose of clarity, we would like to enlist our findings: -……..

(xi)

The Assessing Officer/TPO for good and sufficient reasons can de-bundle interconnected transactions, i.e. segregate distribution, marketing or AMP transactions. This may be necessary when bundled transactions cannot be adequately compared on aggregate basis.

(xii)

When segmentation or segregation of a bundled transaction is required, the question of set off and apportionment must be examined realistically and with a pragmatic approach. Transfer pricing is an income allocating exercise to prevent artificial shifting of net incomes of controlled taxpayers and to place them on parity with uncontrolled, unrelated taxpayers. The exercise undertaken should not result in over or double taxation. Thus, the Assessing Officer/TPO can segregate AMP expenses as an independent international transaction, but only after elucidating grounds and reasons for not accepting the bunching adopted by the assessed, and examining and giving benefit of set off. Section 92(3) does not bar or prohibit set off.

15.

From a co-joint reading of the above findings of the Hon'ble Delhi High Court given in the case of Sony Ericsson(supra), it is observed that segmentation and segregation of a bundled transaction could be done only if sufficient reasons exist for de-bundling the interconnected transactions.

16.

It is submitted that the facts of the case and the order of the APA in appellant's own case clearly suggest that AMP function/expenditure is inextricably linked with the trading operations/activities and hence the same cannot be 'de-bundled' or 'segregated as done by the TPO in its order. Hence, the approach followed by the TPO/AO is bad and liable to be dropped.

17.

Thus, in light of the above, it can be inferred that the decision of Sony Ericsson(supra) has dealt with de bundling of interconnected transactions in case of manufacturing companies where cost plus method is more appropriate. Accordingly, the substantive adjustment of INR 4.32.34.167 is liable to be deleted on following counts:

a. Firstly, it is a derivative of bright line test and

b. Secondly, only if treated as a separate international transaction which would need to be adjudicated in light of the decision of Delhi High Court in the case Maruti Suzuki(supra) and subsequent decisions wherein the onus is on Revenue to show the existence of an 'understanding' or an 'arrangement or 'action in concert' between the appellant and its AE

18.

In light of the above, it is prayed that the substantive addition of INR 4.32.34.167 may kindly be deleted.”