Diageo India (P.) Ltd. v. Deputy Commissioner of Incometax

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The Tax PublishersIT Appeal No. 8602 (Mum.) Of 2010 2012 TaxPub(DT) 0546 (Kol-Trib) : (2011) 142 TTJ 0287 : (2011) 047 SOT 0252 : (2011) 063 DTR 0033 INCOME TAX ACT, 1961 Transfer pricing- 5 per cent variation from the arithmetic mean of ALP-Applicability of amendment w.e.f. 1-10-2009 Assessee was engaged in business of procuring, either by way of getting it manufactured from vendor`s facilities in India or by way of imports from its associated enterprises abroad, and marketing alcoholic beverages in India. As far importing and marketing imported alcoholic beverages was concerned, this operation was confined to importing the bottled drinks from associated enterprise from abroad and marketing in India. He also provided sales agency services to one of its AEs for direct sales to Indian Tourism Development Corporation, Airlines such as Air India and Indian Airlines, certain duty free shops and licensed bonders and distributors. As regards the manufacturing of alcoholic beverages in India, the entire operation was done through contract bottling units (CBUs). Assessee followed two distinct approaches in two distinct segments in this business-namely whiskey segment, and OTW (i.e., alcoholic beverages other than whiskey, such as rum, vodka etc.) segment. In whiskey segment of this business, assessee was importing concentrate or flavours and, with help of imported concentrate or flavours, bottled beverages in India, while in OTS segment, assessee was getting beverages manufactured in India with the help of inputs available locally, i.e., local purchases. While in both segments, manufacturing was done through CBUs, while there were no imported inputs of flavours in manufacturing OTW segment, flavour or the concentrate used in manufacturing beverages in whiskey segment was imported from associated enterprises abroad. However, in respect of manufacturing done by CBUs under both of these segments, manufacturers were to meet all costs themselves and realize all sale proceeds on their own, but any difference, over their costs and agreed margin of profit, was to credit of assessee. It was in this background that assessee reported all international transactions with AEs, including in respect of purchases of concentrate and other inputs by CBUs, in Form No. 3CEB. In the course of the assessment proceedings, the assessing officer made reference to the TPO for determination of arm`s length price with respect to `all the transactions reported in Form No. 3CEB filed by assessee`. In course of ensuing proceedings before TPO, it was noticed that while assessee had incurred a loss (OP/TC) of 4.93 per cent in business segment involving no AE transactions ,assessee had made a profit (OP/TC) of 1.16 per cent in the business segment involving AE transactions (whiskey segment). Overall, TPO noticed that assessee had made a loss (OP/TC) of 3.07 per cent. TPO was of opinion that since computation of gross profit margins was not required to be shown under company law and same might not be in public domain, right course would be to compare operating profit to total sales. Assessee was also asked to furnish OP/TC and OP/TS margins with respect to the comparable cases. SO, assessee submitted figures of NPM (net profit margins) and NCP (Net Cost Plus markup) of the comparable cases and arithmetic mean of these figures worked out to 5.25 per cent and 7.07 per cent respectively. TPO made ALP adjustment in respect of purchases from AEs, in respect of profitability of whiskey segment, by applying 5.25 per cent as OP/TS. TPO further noticed that difference between ALP determined by him vis-A-vis transaction value taken by assessee was more than 5 per cent and, accordingly, adjustment contemplated in proviso to section 92C(2) was not admissible. TPO further noticed that assessee had incurred an expenditure on account of sales promotion and advertising, which worked out to 40.64 per cent of entire turnover. TPO was held that assessee had spent huge amounts on advertisement and sales promotion which pertained to brands owned by AEs and assessee had not received any compensation from its AEs for brand promotion. TPO proceeded to compute how much advertisement expenses assessee ought to have incurred and he relied upon highest advertisement expenses incurred by comparable cases selected by assessee for purpose of computing ALP of purchases from AE. He noticed that highest advertisement expenditure incurred, which was 6.2 per cent of sales and amount spent by assessee in excess of this ratio was considered to be for purposes of associated enterprise owning related brands. Accordingly, TPO concluded that out of advertisement and sales promotion expenses incurred to, only amount could be said to be for the purposes of business of assessee and balance amount should have been reimbursed by associated enterprises to assessee. SO, he disallowed and held it to be `Transfer pricing adjustment with reference to contribution by assessee towards strengthening the brands owned by AE`. On the basis of report of TPO, AO proceeded to disallow impugned claim and objections raised by assessee were rejected by the DRP. *Held:* As per terms of provisions of section 92 A(1)(a ), the expression `associated enterprises`referred to an enterprises `which participated, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise`. The scope of `associated enterprises`was expanded further by section 92A(1)(b ), taking into account group concerns, and it was provided that `associated enterprises`covered an enterprise `in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, were same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.`Thus, when same persons participated, directly or indirectly or through an intermediary, in management or control or capital of two or more enterprises, such enterprises were required to be treated as `associated enterprise`. This expression had been used in article 9(1) of OECD and UN model conventions, but no assistance could be found from OECD and UN commentaries either. All that OECD commentary said on scope of this expression was that it referred to `parent and subsidiary companies and companies under common control`. True test of associated enterprise, thus, was control by one enterprise over other, or control of two or more associated enterprises by a common interests, and such a control was essentially an effective control in decision making process. [Para 10] SUBSCRIBE FOR FULL CONTENT

The Tax PublishersIT Appeal No. 8602 (Mum.) Of 2010
2012 TaxPub(DT) 0546 (Kol-Trib) : (2011) 142 TTJ 0287 : (2011) 047 SOT 0252 : (2011) 063 DTR 0033

INCOME TAX ACT, 1961

Transfer pricing- 5 per cent variation from the arithmetic mean of ALP-Applicability of amendment w.e.f. 1-10-2009

Assessee was engaged in business of procuring, either by way of getting it manufactured from vendor`s facilities in India or by way of imports from its associated enterprises abroad, and marketing alcoholic beverages in India. As far importing and marketing imported alcoholic beverages was concerned, this operation was confined to importing the bottled drinks from associated enterprise from abroad and marketing in India. He also provided sales agency services to one of its AEs for direct sales to Indian Tourism Development Corporation, Airlines such as Air India and Indian Airlines, certain duty free shops and licensed bonders and distributors. As regards the manufacturing of alcoholic beverages in India, the entire operation was done through contract bottling units (CBUs). Assessee followed two distinct approaches in two distinct segments in this business-namely whiskey segment, and OTW (i.e., alcoholic beverages other than whiskey, such as rum, vodka etc.) segment. In whiskey segment of this business, assessee was importing concentrate or flavours and, with help of imported concentrate or flavours, bottled beverages in India, while in OTS segment, assessee was getting beverages manufactured in India with the help of inputs available locally, i.e., local purchases. While in both segments, manufacturing was done through CBUs, while there were no imported inputs of flavours in manufacturing OTW segment, flavour or the concentrate used in manufacturing beverages in whiskey segment was imported from associated enterprises abroad. However, in respect of manufacturing done by CBUs under both of these segments, manufacturers were to meet all costs themselves and realize all sale proceeds on their own, but any difference, over their costs and agreed margin of profit, was to credit of assessee. It was in this background that assessee reported all international transactions with AEs, including in respect of purchases of concentrate and other inputs by CBUs, in Form No. 3CEB. In the course of the assessment proceedings, the assessing officer made reference to the TPO for determination of arm`s length price with respect to `all the transactions reported in Form No. 3CEB filed by assessee`. In course of ensuing proceedings before TPO, it was noticed that while assessee had incurred a loss (OP/TC) of 4.93 per cent in business segment involving no AE transactions ,assessee had made a profit (OP/TC) of 1.16 per cent in the business segment involving AE transactions (whiskey segment). Overall, TPO noticed that assessee had made a loss (OP/TC) of 3.07 per cent. TPO was of opinion that since computation of gross profit margins was not required to be shown under company law and same might not be in public domain, right course would be to compare operating profit to total sales. Assessee was also asked to furnish OP/TC and OP/TS margins with respect to the comparable cases. SO, assessee submitted figures of NPM (net profit margins) and NCP (Net Cost Plus markup) of the comparable cases and arithmetic mean of these figures worked out to 5.25 per cent and 7.07 per cent respectively. TPO made ALP adjustment in respect of purchases from AEs, in respect of profitability of whiskey segment, by applying 5.25 per cent as OP/TS. TPO further noticed that difference between ALP determined by him vis-A-vis transaction value taken by assessee was more than 5 per cent and, accordingly, adjustment contemplated in proviso to section 92C(2) was not admissible. TPO further noticed that assessee had incurred an expenditure on account of sales promotion and advertising, which worked out to 40.64 per cent of entire turnover. TPO was held that assessee had spent huge amounts on advertisement and sales promotion which pertained to brands owned by AEs and assessee had not received any compensation from its AEs for brand promotion. TPO proceeded to compute how much advertisement expenses assessee ought to have incurred and he relied upon highest advertisement expenses incurred by comparable cases selected by assessee for purpose of computing ALP of purchases from AE. He noticed that highest advertisement expenditure incurred, which was 6.2 per cent of sales and amount spent by assessee in excess of this ratio was considered to be for purposes of associated enterprise owning related brands. Accordingly, TPO concluded that out of advertisement and sales promotion expenses incurred to, only amount could be said to be for the purposes of business of assessee and balance amount should have been reimbursed by associated enterprises to assessee. SO, he disallowed and held it to be `Transfer pricing adjustment with reference to contribution by assessee towards strengthening the brands owned by AE`. On the basis of report of TPO, AO proceeded to disallow impugned claim and objections raised by assessee were rejected by the DRP. Held: As per terms of provisions of section 92 A(1)(a ), the expression `associated enterprises`referred to an enterprises `which participated, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise`. The scope of `associated enterprises`was expanded further by section 92A(1)(b ), taking into account group concerns, and it was provided that `associated enterprises`covered an enterprise `in respect of which one or more persons who participate, directly or indirectly, or through one or more intermediaries, in its management or control or capital, were same persons who participate, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise.`Thus, when same persons participated, directly or indirectly or through an intermediary, in management or control or capital of two or more enterprises, such enterprises were required to be treated as `associated enterprise`. This expression had been used in article 9(1) of OECD and UN model conventions, but no assistance could be found from OECD and UN commentaries either. All that OECD commentary said on scope of this expression was that it referred to `parent and subsidiary companies and companies under common control`. True test of associated enterprise, thus, was control by one enterprise over other, or control of two or more associated enterprises by a common interests, and such a control was essentially an effective control in decision making process. [Para 10]