The Mumbai Tribunal deletes addition on export related advertisement reimbursement

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Published on February 25, 2014

Author: kpmgindia

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The Mumbai Bench of the Income-tax Appellate Tribunal in the case of Lever India Exports Limited (the Company or the taxpayer) has confirmed the Commissioner of Income-tax (Appeals) order, in deleting Transfer Pricing Adjustment on advertisement expenditure reimbursed to Associated Enterprise, as the same was related to export activity of the taxpayer, and the Transfer Pricing Officer had accepted the export activity to be at Arm’s Length Price.

KPMG FLASH NEWS KPMG IN INDIA The Mumbai Tribunal deletes addition on export related advertisement reimbursement 24 February 2014 Background The Mumbai Bench of the Income-tax Appellate Tribunal (the Tribunal) in the case of Lever India 1 Exports Limited (the Company or the taxpayer) has confirmed the Commissioner of Income-tax (Appeals) [CIT(A)] order, in deleting Transfer Pricing (TP) Adjustment on advertisement expenditure reimbursed to Associated Enterprise (AE), as the same was related to export activity of the taxpayer, and the Transfer Pricing Officer (TPO) had accepted the export activity to be at Arm’s Length Price (ALP).  The taxpayer in its TP study adopted Transactional Net Margin Method (TNMM) as the most appropriate method for determining the ALP at an entity level and identified six comparable companies.  The arithmetic mean of the comparable companies was 8.08 per cent while the taxpayer had an entity level operating margin of 47.17 per cent.  During the course of TP assessment proceedings, the TPO accepted the taxpayer’s transactions, other than payment of advertising expenses, to be at ALP. The TPO noted that the taxpayer reimbursed advertisement expenditure for its products to its AEs, to the extent of 20 per cent of the advertisement expenses incurred by them.  In response, the taxpayer contended that its export business was highly profitable, largely due to the equity and market position enjoyed by its brand. These expenses were paid by the taxpayer so that the products were promoted and did not loose out in the market place, in view of the severe competitive pressure and interest of the business. Facts of the case  The taxpayer is engaged in the business of exporting home and personal care products to its Associated Enterprises.  During the Assessment year (AY) 2003-04, the taxpayer has entered into international transactions, with its AEs, such as export of home and personal care products, advertising expenses paid to AEs and others. ____________________ 1 Lever India Exports Limited v. ACIT (ITA No. 7089/MUM/2010) – Taxsutra.com © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

These expenses were also incurred from time to time in order to promote new products in foreign markets. Therefore, the taxpayer collaborated with the AEs, who were operating in foreign markets and provided support in their marketing efforts.   However, the TPO rejected the contentions of the taxpayer stating that the taxpayer had failed to provide fixed basis on which the advertisement expenditure were to be reimbursed. Further, the TPO stated that the advertisement expenditure incurred by the taxpayer were on principal to principal basis and the AEs were responsible for their own business. Accordingly, the TPO made a TP Adjustment of INR 13.9 million. Against the aforesaid addition, the preferred an appeal before the CIT(A). Contentions before the Tribunal Before the Tribunal, the tax department raised the contentions that the transaction between the AE and the taxpayer was on principal to principal basis and the taxpayer was not required to incur any advertisement expenditure. Accordingly, the tax department pleaded that the TPO was right in taking ALP of the transaction at nil. In response, the taxpayer’s contentions were as follows:  The transaction cannot be seen in isolation as such expense was related to the export business of the taxpayer. Even if the advertisement expenditure was reduced from the operating margin of export, then also the operating margin was much more than the operating margin of the comparables and the operating margin of the taxpayer was held to be at ALP.  Further, the taxpayer submitted that the TPO did not have any jurisdiction to decide whether or not the taxpayer was right in incurring such expenditure. Reliance was placed on the decision of the Delhi High Court in the case of EKL 2 Appliances Ltd wherein it was held that it is not necessary for the taxpayer to show that any legitimate expenditure incurred by the taxpayer was incurred out of necessity. It is also not necessary for the taxpayer to show that any expenditure incurred by taxpayer for the purpose of business has actually resulted in profit or income either in the same year or in the subsequent years. The only condition is that the expenditure should have been incurred wholly and exclusively for the purpose of business.  The ALP of the transaction is required to be determined as per the method prescribed in the statute and if not so done, then the adjustment was required to be struck down. Reliance was placed on the decision of Mumbai Tribunal in the 3 case of Kotak India Pvt. Ltd. and CA Computers Associates Pvt. Ltd. taxpayer Taxpayers contentions before the CIT(A) Before the CIT(A), the taxpayer raised the following contentions in respect of the ALP determined for its international transactions:  Reimbursement of advertisement expense was an integral part of Export transaction.  Reimbursement cost was solely incurred to maximise the overall profit from export market and to sustain export in future.  The Export business was highly profitable and it had earned an operating margin of 47.17 per cent as against the operating margin of 8.08 per cent of the comparable companies, and the same was accepted by the TPO at arms length.  Also, the contentions put forth before the TPO were reiterated. Observations and rulings of the CIT(A) Considering the contentions of the taxpayer, the CIT(A) held the issue in favour of the taxpayer on the following grounds:   The TPO made the additions in an adhoc manner without adopting any of the prescribed methods to determine the ALP of the transaction. The huge advertisement expense incurred by the taxpayer for the launch of two new products was the strategy to develop the business. Hence, sharing of the said advertisement expenses cannot be isolated or seen as an incidental phenomenon. The addition should therefore be deleted. Observations Tribunal ruling of the The Tribunal dismissed the plea of the department on the following grounds:  The advertisement expense reimbursed by the taxpayer relates to the export activities, even though it may be an independent transaction. _______________ 2 3 Aggrieved by the CIT(A) order, the tax department filed an appeal before the Tribunal. and 4 CIT v. EKL Appliances Ltd., [2012] 345 ITR 241 (Del) Kotak India Pvt. Ltd. v. ACIT 88 DTR 242 (Mum) C.A.Computer Associates Pvt. Ltd. v. DCIT [2011] 8 ITR(T) 142 (Mum) © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

 Huge export sales were made to the AEs to whom such expenses were reimbursed.  The Tribunal also seconded the view of the taxpayer that even after removing the advertisement expenditure from the operating margin of export, the operating margin was much more than the operating margin of the comparables. In view of the above, the Tribunal confirmed the CIT(A) order in deleting the TP adjustment on advertisement expenses reimbursed to AE. Our comments This decision of the Mumbai Tribunal endorses the principle of aggregating inter-linked transactions for the purpose of benchmarking, unlike the Delhi Special Bench decision of 23 Jan 2013, in case of LG 5 Electronics where transaction-by-transaction benchmarking approach was advocated and it was held that robust profit margin of a taxpayer would not by itself justify a higher AMP (advertisement, marketing and promotion) spend. The Tribunal has held that expenditure if incurred wholly and exclusively for the purpose of the business, then the TPO has no jurisdiction to determine whether the Assessee’s expenditure is legitimate or not. The Tribunal has reinforced the earlier decisions that it is obligatory on the TPO to determine ALP of any transaction as per the methods prescribed in the statute. _______________ 5 LG Electronics India Private Limited v ACIT [2013] 22 ITR (T) 1 (Del) (SB) © 2014 KPMG, an Indian Registered Partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity. All rights reserved.

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