Income Tax Appellate Tribunal – Delhi
Samsung India Electronics Pvt. … vs Acit, New Delhi on 4 October, 2019 IN THE INCOME TAX APPELLATE TRIBUNAL DELHI BENCH “I-2” NEW DELHI BEFORE SHRI AMIT SHUKLA, JUDICIAL MEMBER AND SHRI PRASHANT MAHARISHI, ACCOUNTANT MEMBER I.T.As. No.3248, 3410/DEL/2012, 5856/Del/2010,
5315/Del/2011,52/Del/2013, 1567/Del/2014, 6741/Del/2014, 868/Del/2016 & 2511/Del/2018 Assessment Years: 2005-06, 2006-07, 2007-08, 2008-09, 2009-10, 2010-11, 2011-12 Samsung India Electronics vs. Addl.CIT, Range-7
Pvt. Ltd., New Delhi.
3rd Floor, Tower-C, Vipul
Tech Square,
Sector-43, Golf Course
Road, Gurgaon.
TAN/PAN: AAACS 5123K
(Appellant) (Respondent) Appellant by: S/Shri Himanshu Sinha, Shri Bhuwan Dhooper, Adv. & Ms. Vrinda Tulsan, Adv.
Respondent by: Shri H.K. Choudhary, CIT-D.R.
Date of hearing: 27 09 2019
Date of pronouncement: 04 10 2019 ORDER
PER BENCH:

The appeals in ITA Nos. 3248/Del/2012, 5856/Del/10,
5315/Del/11, 52/Del/13, 1567/Del/2014, 6741/Del/2014,
868/Del/2016 & 2511/Del/2018 have been filed by the assessee
in respect of the assessment years 2005-06 to 2011-12
respectively. Whereas, the appeal in ITA No. 3410/Del/2012 is a
cross appeal filed by the Revenue for the AY 2005-06. Since the
issues involved in all these appeals are common therefore, we
2 deem it fit and convenient to dispose-off these appeals by way of
this consolidated order. We will take first the appeals for the A.Y.
2005-06.
2. The appellant assessee, Samsung India Electronics Pvt. Ltd.
(SIEL), is a company incorporated in India under the Companies
Act, 1956 and is primarily engaged in the business of manufacture
and sale of consumer electronics and home appliances goods such
as colour televisions, refrigerators, air conditioners, washing
machines, microwave ovens, computer peripherals etc. The
appellant company is a part of the Samsung group of companies.
It is 100% subsidiary of Samsung Electronics Co. Ltd. Korea
(‘SEC’). One common ground permeating in all the years except for
the appeal for AY 2006-07 is the ground pertaining to transfer
pricing adjustment made on account of advertising and marketing
promotion (AMP) expenditure incurred by the appellant, which
shall be dealt firstly and subsequently, all other grounds shall be
taken up.

AY 2005-06
3. Facts in brief for the AY 2005-06 are that, the appellant had
filed its return of income on 31 October 2005, declaring a loss of
Rs. 6,35,44,316. The assessing officer referred the case to the
Transfer Pricing Officer – II (2), New Delhi (TPO) for determination
of the arm’s length price (ALP) of the international transactions
entered into by the appellant with its associated enterprises.
During the relevant assessment year, appellant had entered into
new numerous international transactions with various associated
enterprises (AEs). These international transactions were grouped
under various segments and based on a transfer pricing study,
3 their arm’s length price were determined. A summary of the
international transactions and the appellant’s approach in
determining their ALP is summarised in the table below: – Nature of International Most Profit Level SIEL’s Compar
Transactions Appropriate Indicator Profit ables Method Level Profit Indicator Level Indicato r
Class I – Cost Plus Gross 33.60% 23.78%
Manufacturing Method Profit /
(Consumer (CPM) Input Cost
Electronics, Home
Appliances & Colour
Monitors)
Import of raw
materials
Import of spare parts
Export of finished
goods
Purchase of samples
Purchase of sales
promotion material
Class II – Distribution Resale Price Gross 14.48% 6.45%
(Consumer Method Profit/Sale
Electronics, Home (‘RPM’) s
Appliances, Monitors
and other IT &
Telecom Products)
Import of finished
goods
Import of spare parts
Export of spare parts
Purchase of samples
Export of samples
Payment for packing &
R&D expenses
Purchase of sales
promotion material
Class III – Sales and Transactional Operating 20.43% 6.12%
Post-sales support Net Margin Profit /
Service Income Method Total Cost
4 (‘TNMM’)
Class IV – Contract Transactional Operating 15% 13%
Software Development Net Margin Profit /
Software development Method Total Cost
services (‘TNMM’)
Class V Comparable NA NA NA
Reimbursement of Uncontrolled
expenses Price Method (‘CUP’)
Class VI Comparable NA NA NA
Payment of royalty Uncontrolled Price Method (‘CUP’)
Class VII – Comparable NA NA NA
Miscellaneous Uncontrolled
expenses/transactions Price Method
Import of capital goods (‘CUP’)
and spare parts
Payment of IT related
fees
Payment of service
expenses
Payment of technical
assistance fees
Payment for service
fee, training fees etc 4. The dispute in the appeals for the A.Y. 2005-06 filed by the
appellant and the cross appeal filed by the Revenue pertains to the
international transactions grouped under Class-I (manufacturing)
segment and Class-II (distribution) segment. There is no dispute in
respect of the ALP of the international transactions in Classes III,
IV, V, VI and VII, which are in respect of segments pertaining to
post sale support services, software development service and other
miscellaneous transactions, i.e., payment on royalty and
reimbursement of expenditure.
5 5. In respect of Class -I (manufacturing) segment, following
transactions have been grouped together by the appellant in its
transfer pricing study prepared under rule 10B of the Income Tax
Rules 1962 (Rules);
i) Import of raw-materials;
ii) Import of spare parts’
iii) Export of financial goods;
iv) Purchase of goods on sample basis;
v) Purchase of sales promotion material;

As stated above, assessee is engaged in the manufacturing of
consumer electronic goods, home appliances and colour monitors.
Cost Plus Method (CPM) was chosen qua this segment as the most
appropriate method in its transfer pricing study. The profit level
indicator taken was taken as gross profit/input costs. For the
benchmarking exercise, an economic analysis was carried out in
the TP study leading to identification of 11 uncontrolled
comparable companies. Since appellant had earned gross profit
margin of 36.6% which was much higher than the gross profit
earned by the comparable companies, hence it was reported that
the international transactions in which Class-I (manufacturing)
segment were at arm’s length price.
6. In Class-II (distribution) segment, assessee was engaged in
the distribution of consumer electronic goods, home appliances,
monitors, IT products and telecom products. For this segment,
Resale Price Method (RPM) was chosen by the assessee as the
most appropriate method to determine the ALP with Gross Profit
margin (gross profit /sales) as the profit level indicator. The
economic analysis carried out on the database showed 5
uncontrolled independent comparable companies whose mean
6 gross profit margin arrived at 6.45%. Since the gross profit margin
of the appellant in the distribution segment was higher at 14.48%,
hence it was concluded that the international transactions in
Class-II segment were at arm’s length.
7. The transfer pricing officer (TPO) rejected the most
appropriate method adopted by the assessee and discarded the
CPM for Class-I (manufacturing) segment; and RPM for the Class-
II (distribution) segment. As per the TPO for both the segments,
Transactional Net Margin Method (TNMM) was the most suitable
method for determining of arm’s length price. Under the TNMM, he
selected operating profit margin on revenues (OP/OR; OP =
operating profit/ OR = operating revenue) as the profit level
indicator for both the segments. Further, the TPO while computing
the PLI of the assessee for manufacturing and distribution
segments increased the quantum of operating expenditure for
computing the operating profit by Rs. 142.39 crores. The aforesaid
amount of Rs. 142.39 crores had been received by the assessee
during the relevant financial year from its parent company as a
reimbursement under an assistance agreement referred to as
Marketing Development Fund (MDF) Agreement. In terms of MDF
agreement, the assessee had received the assistance from its
parent company to conduct certain marketing activities. This
amount has been shown as reimbursement in the Form 3CEB and
in the transfer pricing study report and was reduced from the
expenditure shown under the head “advertisement”. Accordingly,
in the profit and loss account of the financial statement under
head “advertisement” expenditure only the net amount was shown,
though the gross amount expended for advertisement was Rs
306.38 crores, on account of reimbursement received was Rs.
7 142.39 crores, the net amount of Rs. 306.38 (-) Rs.142.39 crores =
163.99 crores was shown as the net advertisement expenditure.
The TPO concluded that this was an erroneous approach and was
of the view that the entire amount of Rs. 306.38 crores incurred
under the head “advertisement” should be taken into account to
compute operating profit and the operating profit margin. This
approach and calculation of the TPO was based on a similar
approach adopted in the prior assessment years. Accordingly,
while the operating expenditure under the head advertisement was
increased from Rs. 163.99 crores to Rs. 306.38 crores leading to
fall in operating profit and margin, the corresponding
reimbursement of Rs. 142.39 crores received from the appellant’s
parent company was not included as part of the revenue. Based on
this approach, the operating profit margin (OP/OR) of the
manufacturing segment was determined at (-) 4.34% and the
distribution segment at (-) 3.5%. The TPO further proceeded to
undertake a fresh benchmarking analysis of the uncontrolled
comparable companies and arrived at a set of 12 comparable
companies for the Class-I manufacturing segment and set of 13
comparables for the Class-II distribution segment. The arithmetic
mean of the operating profit margin (OP/OR) of these comparables
for the manufacturing segment was computed at 1.25%. Similarly,
the profit margin of the comparables in the distribution segment
was carried out at (-) 0.447%. To compute profit level indicators of
the comparable companies, the TPO used multiple years’ data
(current and two previous years to the extent of availability of
data). The margins computed by the TPO are after making
adjustments on account of working capital differences. Based on
the above approach, the TPO worked out an adjustment to the
arm’s length price of the international transactions pertaining to
8 manufacturing segment at Rs.112,642,9851/- which was
subsequently reduced to Rs.110,586,5807/- vide an order under
section 154 dated 19/01/2009. In respect of distribution
segment, the adjustment to the arm’s length was worked out to be
at Rs. 592,809,324/- which was subsequently reduced to Rs.
572,545,869/- vide aforesaid order dated 19/01/2009.
8. The TPO also carried out a secondary analysis, with respect
to the Advertisement, Marketing and Promotion (“AMP”) expenses
incurred by the assessee company as he was of the view that the
assessee has provided certain services in respect of creation of
marketing intangibles, to its AE. The TPO was of the view that any
AMP expenditure incurred by the assessee over and above the
average AMP spentby the comparable companies was
extraordinary in nature and incurred for the benefit of the AE
which owned the “Samsung” brand. The TPO worked out the
average AMP spend by the comparables at 1.05% of the Sales,
whereas the assessee was at 7.71% of the Sales and treated the
difference as the value for the brand promotion service which the
assessee had provided to its AE. He accordingly proposed that,
this amount should have been recovered by the assessee from its
AE. The approach followed by the TPO in respect of this
adjustment was as under:

Particulars Amount (Rs.)
Total Income (A) 39,741,026,611
Advertisement and sales promotion expenses incurred 3,063,811,643
(B)
AMP / Total Income of SIEL (C) = (B)/(A) 7.7094%
Bright Line (AMP/total income of comparables) (D) 1.05%
AMP as per bright line (‘E) = (A)*(D) 417,280,779
9 Excess Amount Spent on Advertisement as compared 2,646,530,864
to the comparables (F) = (B)-(E)
Less: Reimbursement received from its parent SEC 1,423,950,954
Adjustment proposed as per secondary analysis 1,222,579,910
(Rs.) on protective basis However, no addition was made by the TPO/AO in this respect and
this analysis was meant to the used if the additions made under
TNMM for Class I and II were deleted in appeal. This was an
alternate and without prejudice analysis given by the TPO.
10. The AO incorporated the adjustment to the ALP made by the
TPO and further made the following additions to total income:-
(a) Recruitment and training expenses of Rs. 1,72,98,334 was treated as capital expenditure and not allowable as a revenue expenditure u/s 37 of the Act;
(b) Loss arising on account of fluctuation of foreign exchange currency amounting to Rs. 7,79,52,000 was disallowed as being notional and contingent in nature. Subsequently, the Ld. AO passed an order (u/s 154) dated July 24, 2009 deleting the addition made on this account;
(c) Depreciation on UPS, printers and servers was restricted to 15% as against 60% claimed by the appellant leading to a disallowance of Rs. 3,21,617.
11. The assessee being aggrieved by the orders of the TPO and
AO preferred an appeal before the Commission of Income Tax
(Appeals)-XXIX, New Delhi (CIT(A)) contesting the aforesaid
additions made to the total income of the assessee on various
grounds.
10 12. The CIT (A) disposed off the appeal filed by the assessee vide
his order dated 27th April 2012, partly allowing the appeal on
following lines:

(a) CIT (A) held that the reference made by the AO to the TPO for determination of ALP of the international transactions did not suffer from any illegality and was a valid one;

(b) The CIT(A) held that TNMM should be adopted as the most suitable method for Class I and II Manufacturing and Distribution segments;

(c) Videocon International Ltd., being functionally different, cannot be taken as a comparable for Class I Manufacturing segment because this company is engaged in backward integration and indigenous manufacturing of components. The CIT(A) in this regard relied on the order of the prior assessment year 2004-05 whereby his predecessor while examining the suitability of this company as a comparable had rejected the same for the above reason. Since there was no change of facts and circumstances, the CIT(A) has followed the prior year’s order;
(d) The CIT(A) ordered the exclusion of four companies, namely, Khaitan Electricals Ltd, Hotline Teletube& Components Ltd, Samtel India Ltd and Samtel Colour Ltd. from the list of comparables for the Class I Manufacturing segment as these companies had substantial related party transactions. The value of transactions as a percentage of sales was in excess of the generally accepted limit of 15%.;

(e) In the Class II segment, the CIT(A) ordered the exclusion of Control Print (India) Ltd. from the list of comparable companies
11 as in the prior assessment year 2004-05 on identical facts it
had been held by his predecessor that this company is
functionally dissimilar to the appellant’s distribution business;

(f) Similarly, another company Gemini Communication Ltd. was
also held to be incomparable to the appellant’s Class II
distribution business on account of functionally dissimilarity.
This company was found to be engaged in end to end IT
solutions and provision of services;

(g) The CIT(A) held that the TPO’s approach of relying on three
years’ average data to determine the average profit margin of
the comparables was not in accordance with law and it should
be restricted to only current year data. While holding so, he
once again relied on his predecessor’s order of A.Y. 2004-05;

(h) As regards the issue of re-computation of profit margin of
the appellant by treating the reimbursement received from its
AE as operating expenditure while not treating the same as
operating income, the CIT(A) held the same to be unjustified. He
held that this approach of the TPO had been adopted in prior
assessment years as well but the same had been negated by his
predecessors in A.Yrs. 2002-03 to 2004-05. By relying on these
prior years’ orders, he held that the reimbursement of Rs.
142.39 crores was to be treated as operating income and profit
as well.

(i) The CIT(A), however, approved the secondary analysis carried
out by the TPO in respect of the AMP expenditure whereby he
had made a protective assessment on account of “excessive”
AMP expenditure incurred by the appellant to promote the “Samsung” brand. As per the TPO, since the appellant’s
combined AMP expenditure for this year at 7.7% of sales was
12 much higher than 1.05% of sales (the three years average AMP
spend by the comparables in the manufacturing and trading
segments), the excess of 6.65% (corresponding to Rs. 264.65
crores) represented a brand promotion service rendered by the
appellant company to its parent which ought to have been
received as reimbursement under the arm’s length principle.
However, the TPO had not proposed any separate addition on
this account as he had taken a view that the reimbursement of
marketing expenditure of Rs. 142.39 crores received by the
appellant did not form part of the operating income while being
part of the operating expenditure. On this basis an addition of
Rs. 167.84 crores wasmade by the TPO which was incorporated
by the AO in the assessment year. No further addition based on
the secondary AMP analysis was made by the TPO and the AO.
It was stated that this was only a protective assessment which
would come into effect if on appeal the primary approach was
deleted. Since the CIT(A) had negated the primary approach of
treating the reimbursement of marketing expenses as
expenditure but not as income, he examined the alternative
approach based on which protective assessment had been made
and held that the alternative approach was an acceptable
method of determining the ALP of the excess AMP expenditure.
He held as below:
“Now, since the ground of appeal regarding upward adjustment of TP has been allowed by taking a view that he reimbursement of marketing expenses shall form part of operating profits, the issue of excess of advertisement expenses has to be decided separately. The AO has not made separate addition on this account because this addition already stands included in upward adjustment of TP and therefore this addition was in effect eclipsed by the addition
13 made on account of TP. Now since the eclipse caused by the TP addition has been removed, the addition on account of excess advertisement expenses becomes apparent. As it is not a new addition made by the AO on account of TP, no notice of enhancement is required to be given to the appellant. The appellant has not submitted any substantial argument on this issue and has simply argued that since the products that were advertised in India were not dealt with anyone else in India therefore benefit of such expenditure enures to no one else. TPO has already taken care of this argument. TPO has worked out excess advertisement expenses by making proper comparative analysis. I therefore hold that addition on account of excess marketing expenses stands confirmed to the tune of Rs. 122,25,79,910.” (Page 31 of the impugned order).

(j) The CIT(A) held that the benefit of 5% provided in the Proviso
to Section 92C(2) is not a standard deduction and if the
difference between the transfer price and ALP exceeds 5%, the
whole of such difference shall be treated as an adjustment.
(k) The CIT(A) computed the profit margin of the appellant at (-
) 0.64% as against the comparables mean profit margin at (-)
7.37% using current year data for the Class I manufacturing
segment leading to the deletion of the TP adjustment made in
this segment. Further, the margin of the Class II Distribution
segment of the appellant was worked out to be 0.21% as against
the mean margin of the comparables at 0.38% leading to
adjustment of Rs. 3,30,33,800 in this segment. The margins
were computed after giving effect to the CIT(A)’s findings on
treatment of reimbursement, exclusion of certain comparables
and use of current year data for the comparables.
(l) As regards the disallowance pertaining to treatment of
recruitment and training expenses as capital expenditure and
not revenue expenditure, the CIT(A) deleted the disallowance by
14 relying on the decision of its predecessor in AY 2004-05, as well as the ITAT on this issue in appellant’s case for A.Y. 1998-99. The CIT(A) observed that an appeal filed against the order of the ITAT has been dismissed by the Delhi High Court on 11/01/2010. Facts being same as in earlier years, he held that these expenses are fully deductible.
(m) The CIT(A) while examining the issue of depreciation on UPS, printers and servers, observed that this issue has been decided by the Delhi High Court in favour of the assessee in the case of CIT v. BSES Rajdhani Powers Ltd. (ITA No. 1266/Del/2010). While following the same, he held that depreciation is to be allowed @60% on these items.
(n) The ground relating to disallowance on account of loss arising from fluctuation of foreign currency was not pressed by the appellant as the AO had amended the assessment order dated July 24, 2009 u/s 154 to allow the claim of this loss.

13. Aggrieved by the order of the CIT (A), the assessee and
Revenue have preferred the present appeals for AY 2005-06. The
issues involved in all the appeals from AYs 2005-06 to 2011-12 are
though several, however, one common issue permeating in all the
appeals (i.e. AY 2005-06, 2007-08 to 2011-12), except for AY
2006-07, pertains to the transfer pricing adjustment on account of
AMP expenditure which we will deal firstly, as it is one of the core
issues contested by the parties before us. The remainder of the
issues shall be dealt with appeal wise subsequently in this order.
Adjustment made in respect ofAdvertising and Marketing Promotion (AMP) Expenditure involved in Assessee’s appeals for AY 2005-06 (Ground No. 3.1 to
3.6); 2007-08 (Ground No. 1.1 to 1.3); 2008-09 (Ground
15 No. 2.1 to 2.12); 2009-10 (Ground No. 1 to 12); 2010-11
(Ground No. 1 to 11); and 2011-12 (Ground No. 2 to 12) 14. Grounds 3.1 to 3.6 taken by the appellant in its appeal for
AY 2005-06 are as below:
GROUND NO. 3.1: The AO/CIT(A) has erred by not providing reasons for rejecting the analysis undertaken by the appellant for benchmarking the international transaction pertaining to reimbursement of advertisement expenses.

GROUND NO. 3.2:The CIT(A) has erred in not providing an opportunity of being heard to the appellant and mechanically accepting the secondary analysis (of determining the arm’s length price of marketing intangibles) undertaken by TPO in respect of reimbursement of advertisement expenses, thereby failing to pass a speaking order.

GROUND NO. 3.3: The AO/CIT(A) has acted in excess of jurisdiction assigned under the Indian transfer pricing regulations by analyzing the advertisement expenditure of the appellant, in plain disregard of the fact of the same, being a domestic transaction undertaken by the parties, does not fall under the purview of Section 92 of the Act.

GROUND NO. 3.4: The AO/CIT (A) has erred in concluding that the appellant has incurred excess advertising expenditure vis-à- vis comparable companies and should have accordingly, been reimbursed for the same.

GROUND NO. 3.5: The AO/CIT (A) has erred in not appreciating that the advertisement expenditure was incurred exclusively for promotion of products of the appellant in India and was in the nature of business expenditure allowable as deduction.

Ground NO. 3.6: The CIT(A) has erred in upholding the secondary analysis undertaken by the TPO when the arm’s length price of the appellant’s transactions with the AEs have already been tested under the transactional net margin method.

The grounds and issues pertaining to AMP taken up by the
appellant in other AYs are similar and are not being reproduced
herein for the sake of brevity.
16 15. From AY 2005-06 to AY 2011-12 (except for AY 2006-07),
the TPO has made similar adjustments on account of AMP
expenses incurred by the assessee as he was of the view that the
assessee had provided certain services in respect of creation of
marketing intangibles to its AE. The TPO held that any AMP
expenditure incurred by the assessee over and above the average
AMP spend of the comparable companies (referred to as the “Bright Line” Test) was extraordinary in nature and incurred for
the benefit of the AE which owned the “Samsung” brand. In AY
2005-06 (as in other years), the Ld. TPO applied the Bright Line
Test (BLT) and worked out the average AMP spend of the
comparables at 1.05% of Sales and that of the Appellant at 7.71%
of Sales and treated the difference as the value of the service which
the Appellant had provided to its AE. He accordingly held that the
excess amount should have been recovered by the appellant from
its AE and made an addition of Rs. 122,25,79,910/-.
16. Similar additions were made by the TPO for AY 2007-08 to
AY 2011-12, wherein the TPO applied the BLT to benchmark the
AMP expenditure.In AY 2007-08, the TPO made an addition on
account of excess AMP expenditure of Rs. 131,13,25,080/- after
applying a mark-up of 12%. In AY 2008-09, the TPO proposed an
adjustment of Rs.454,94,35,445/- which was revised to Rs.
48,40,26,768/- by the Dispute Resolution Panel (DRP). In AY
2009-10, the TPO worked out the average AMP/Sales of the
comparables at 3.66% as against 9.19% in the case of the
Appellant (rectified to 9.03% of sales vide rectification order dated
06 March 2013) and considered this difference as the value of the
service which the Appellant had provided to its AE and he
proposed an adjustment of Rs. 455,53,39,101/-. In AY 2010-11,
17 the TPO proposed an adjustment of Rs.740,15,52,834/- (Rs.
102,15,61,275/- under the IT business and Rs. 637,99,91,559/-
under the Non-IT business) with respect to AMP expenses. In AY
2011-12, the TPO proposed an adjustment of Rs.1188,41,38,456/-
(Rs. 122,22,38,922/- under the IT business and Rs.
1066,18,99,534/- under the Non-IT business) which was reduced
to Rs. 39,43,68,561/- (i.e. Rs. 31,31,05,771/- under the non-IT
segment and Rs. 8,12,62,790/- under the IT segment) by the Ld.
DRP.
17. On this issue, the Ld. Counsel for the appellant assessee
right at the onset submitted that the approach adopted by the TPO
and the CIT(A) in respect of the AMP expenditure has come to be
known as the “Bright line test” which has been subject matter of
extensive litigation before the ITAT and the High Courts. The
Special Bench of this Tribunal in the case of L.G. Electronics
[2013] 140 ITD 41 had approved this approach and had held that
excessive expenditure could be treated as a separate international
transaction that could be subjected to arm’s length exercise on its
own. While holding so, the Special Bench had laid down extensive
guidelines to determine the value of the international transaction
and the ALP of the same. Subsequently, the Hon’ble Jurisdictional
Delhi High Court in the case of Sony Ericsson [2015] 374 ITR
118has held that the “Bright line test” was not a valid test of
determining the ALP of the AMP transaction as it was not
statutorily mandated. The High Court further laid down numerous
guidelines and principles to determine the ALP of AMP transaction.
Subsequent to this the Hon’ble Delhi High Court expanded the
jurisprudence in this regard in the cases of Maruti Suzuki [2016]
381 ITR 117, Whirlpool [2016] 381 ITR 154 and Bausch &
18 Lomb [2016] 381 ITR 227 by holding that existence of an
international transaction merely on the ground of excess AMP
expenditure cannot be presumed. It has to be shown to be existing
based on mutual understanding or arrangement between the
assessee and its associated enterprise. The Court further held AMP
was a function and not a transaction.
18. It was also pointed out by the Ld. Counsel that Sony
Ericsson’s case (supra) was a batch of appeals dealing with
assessees who were distributors; and the subsequent decisions of
Maruti Suzuki and Whirlpool (supra) dealt with manufacturers
and the two categories of assessee’s stand on a different footing.
The licensed manufacturers who operate as risk bearing entities
cannot be examined under the so-called AMP framework as their
investments in manufacturing and marketing are fully reflected in
their profit margins and there cannot be a segregation of returns
on manufacturing and returns on marketing as both go hand in
hand and are inextricably linked. When goods are manufactured
and marketed by the same Indian entity, it would be illogical for
the Revenue to contend that such an entity should be treated in
the same manner as an Indian distributor which distributes goods
imported from a foreign manufacturer under a brand owned by an
AE on the ground that by incurring “excessive” AMP expenditure,
the brand-owner AE stands to gain at the expense of the Indian
entity.
19. He submitted that Samsung is a globally well-known name
in consumer goods industry and the strength of the brand
enhances the sale of consumer goods by it in India, while
competing with other domestic and global brands operating in the
19 Indian market. It is the assessee, an Indian Company, who is
actually benefitted by being able to exploit the license for the use
of brands granted by the licensor. Had the taxpayer sold these
goods under an unknown brand name, products could not have
stood in competition against other reputed brands in the market.
The primary benefit is of the assessee who is selling the goods in
India and the benefit obtained by the licensor is only incidental. As
per the Ld. Counsel, after the decisions of Maruti Suzuki,
Whirlpool and Bausch & Lomb (supra), there is no room for any
confusion regarding the treatment of AMP expenditure as a
separate international transaction. The Hon’ble Delhi High Court
in these decisions has categorically held that for an international
transaction to exist within the meaning of Section 92B, the
Revenue has to show that there existed an agreement or
understanding or arrangement, that the Indian entity would incur
AMP expenditure for or on behalf of the AE which owns the brand.
In the absence of such “action in concert”, no international
transaction can be said to exist. If the existence of international
transaction cannot be established with any degree of certainty, the
question of determining the ALP of the same would not arise.
20. The same principle has been upheld in numerous other
judgments of the Delhi High Court as cited below:- • Goodyear India Limited (ITA 77/2017 & CM Nos. 3072-
73/2017, ITA 78/2017 & CM Nos. 3074-75/2017, ITA 79/2017 & CM No. 3076/2017) • Amadeus India Pvt. Ltd. (ITA 154/2017) • Casio India Company Private Limited (ITA 309/2016) • Maruti Suzuki India Ltd (ITA No. 110/2014)
20 • Whirlpool of India Ltd. (ITA No. 610/2014) • Honda Siel Power Products Ltd.(ITA No. 127/2017 & CM Nos. 4906-4907/2017 & 346/ 2015) • Bausch & Lomb Eyecare India Pvt. Ltd. (ITA No. 643/2014).
21. The Ld. Counsel vociferously argued by applying the
aforesaid principles in the instant case, where there was a
marketing assistance agreement between the assessee and its
parent under which it had received an assistance to the tune of
Rs. 142.39 crores (in A.Y. 2005-06 and varying amounts in other
years under appeal) for the marketing activities it had conducted,
this reimbursement received under the MDF agreement was duly
disclosed by the appellant in the list of international transactions
in Form 3CEB and further its arm’s length price (ALP) was also
justified using Comparable Uncontrolled Price (CUP) method. The
same has not been disputed by the TPO in any manner. These
reimbursements are in respect of specific third party costs
incurred for advertising and marketing undertaken by the
appellant after obtaining the approval of the AE under a pre-
agreed budget. He drew our attention to the relevant clauses of the
MDF agreement under which the reimbursements were received.
Accordingly, he submitted that as per the relevant terms of the
MDF agreement, the assessee obtains prior approval under a
capped budget set by the AE. It is a pure assistance or subsidy
received by the appellant and does not arise from a service
rendered by the appellant. The appellant as a matter of right
cannot demand this assistance. The AE in its own discretion
determines the annual budget and approves specific marketing
activities for the appellant. Therefore, the only international
21 transaction with an ascertainable price is limited to the
reimbursement received by the appellant under the MDF
agreement. Not even a single rupee beyond the amount received as
reimbursement can be treated as an international transaction.
22. The Ld. CIT (DR) Mr. Chaudhary, on the other hand, argued
that the existence of the MDF agreement between the appellant
and the AE clearly demonstrated that there existed an
understanding between the two parties that AMP expenditure
would be incurred by the appellant on behalf of the AE for the
promotion of the brand owned by the AE. He further argued that
on account of this agreement, the value of this international
transaction cannot be limited to the amount of reimbursement
received (Rs. 142.39 crores for AY 2005-06) but extended to the
entire quantum of AMP expenditure incurred by the appellant
during the year (Rs. 306.39 crores for AY 2005-06). He referred to
the terms of the MDF agreement which provided for assistance in
respect of marketing activities pertaining to the “Samsung” brand
in print and electronic media. These obligations, in his view,
showed that the appellant was acting in concert with its AE in
respect of the brand promotion in India.
23. In rejoinder, the Ld. Counsel, Mr. Sinha submitted that it is
an admitted position of the assessee that there is an
understanding or arrangement under the MDF agreement in
respect of AMP expenditure. However, such a transaction or
arrangement is strictly limited to the value of reimbursement (Rs.
142.39 crore) received by the appellant under the agreement.
These reimbursements have been received against pre-approved
invoices under a budget/cap stipulated by the AE at the beginning
22 of the year. There is no tangible material or evidence to show that
even a rupee beyond this amount was spent under an
understanding or arrangement or action in concert with the parent
AE. As per the ratio of Maruti Suzuki, Whirlpool (supra) and other
decisions, no presumption can be made about the existence of an
international transaction. It was also pointed out that the
appellant has no right to demand any assistance or subsidy
beyond the amount agreed under the MDF. In the absence of any
such right, the value of the international transaction cannot be
extended beyond the reimbursement amount which has already
been disclosed in the list of international transactions in Form
3CEB. The Ld. Counsel then strongly relied upon the Sony
Ericsson (supra) decision of the Hon’ble Delhi High Court where
Bright line test has been categorically rejected by the Court as a
method of determining the ALP of the AMP transaction. He drew
the attention of the Bench towards Paras 127 and 135 of this
decision to contend that it was not open for the Revenue to make a
comparison of the average AMP expenditure of the comparable
companies to arrive at a bright line of AMP expenditure beyond
which it is presumed that the expenditure is for a service rendered
to the brand-owing AE.
24. The Ld. Counsel also pointed out that even the official
position of the Govt. of India in respect of the bright line test has
changed as is evident from the India Chapter of the UN Transfer
Pricing Guidelines. In the said chapter which contains the official
position of the Indian Govt. on marketing intangibles, it has been
clearly stated that instead of applying the bright line test, it would
be better to focus on the marketing function of the Indian entity
vis-a-vis the comparables chosen for benchmarking. He further
23 contended that the Hon’ble Delhi High Court in the decisions of
Maruti Suzuki, Whirlpool (supra) and others has recognised the
fact that AMP expenditure are incurred in respect to third party
costs insofar as these represent amounts paid or payable to
unrelated parties (media houses, advertising agencies, marketing
bodies etc.) and cannot be treated as related party transactions
merely because some incidental benefit is said to accrue to the
AEs.
24. The Ld. Counsel also made a without prejudice argument
regarding the quantum and composition of AMP expenditure taken
by the TPO. The TPO while determining the value of international
transaction of AMP and its ALP has taken into account
expenditure which is purely selling and operational expenses and
have no nexus with brand promotion or advertising in any
manner. These expenses include purely operational expenses
incurred in connection with dealers and sales promotion. The
Hon’ble Delhi High Court in Sony Ericsson (supra) has held that
selling costs cannot form part of the AMP transaction. Only those
expenses which related to promotion of brand and advertising of
brand can be taken. Sales related costs like dealer commission,
discounts, sales promotions and trade event expenditures cannot
be taken as part of the advertising costs. In this case, the TPO and
the CIT (A) have erred in not distinguishing between the sales and
brand promotion costs leading to a distorted picture. It was
accordingly submitted that if at all the AMP expenditure was to be
permitted to be taken as a separate international transaction, the
value and ALP of the same has to be limited to the brand
promotion related expenses and should exclude selling costs.The
Ld. Counsel also submitted that for AYs 2007-08 to 2010-11, the
24 TPO has also erroneously considered rebates & discounts, in
addition to sales promotion and selling expenditure, as a part of
AMP. Further, the TPO himself for AY 2005-06 & 2011-12 did not
include rebates and discounts as part of AMP. In this respect, the
he contended that ‘Rebates and discounts’ and expenses in
connection with sales do not lead to brand promotion and cannot
be attributed to brand promotion as they represent ‘point of sale’
expenses.
25. The Ld. CIT(DR) in his reply contended that even selling
costs should be included within the ambit of AMP expenditure as
even these costs lead to creation of “marketing intangibles”. In his
view, the concept of marketing intangibles is wider than that of
brand promotion and includes within its ambit marketing network,
dealer and customer relationship and therefore all kinds of selling
expenses should also form part of the AMP expenses.
26. By way of rejoinder, Ld. Counsel submitted that this issue is
no longer res integra as the Hon’ble Delhi High Court in Sony
Ericsson and the Special Bench in LG Electronics (supra) have
decided this issue in a categorical manner in favour of the
assessee by holding that it would not be fair and logical to include
selling costs within the ambit of the AMP expenditure. A break-up
of the total AMP expenses (operational and promotional expenses)
for AY 2005-06, 2007-08 to 2011-12 was also submitted.
27. On the issue of application of Transaction Net Margin
Method, the Ld. Counsel submitted that the Hon’ble Delhi High
Court in Sony Ericsson (supra) has held that, once the profit
margin of the manufacturing and distribution segments are tested
25 under TNMM, all the international transactions which are clubbed
in the segment stand fully covered by the TNMM analysis. In such
a situation, it would be illogical and incongruous to treat AMP
expenditure as a separate transaction and subject the same to a
Bright line test on a stand-alone basis. Under TNMM, the net
margin of the segment is tested and since the net margin is
computed after taking into account the entire AMP expenditure,
the impact of AMP is fully captured in the TNMM analysis.
Furthermore, he argued that the TPO has changed the
comparables used in the TNMM benchmarking analysis which
implies that he has applied his mind on the comparability of the
companies chosen for the comparison under TNMM. The TPO not
only had changed the comparables but had also changed the
method of computation of the profit level indicator. The CIT (A)
further had an occasion to examine both the aspects and has
given his clear findings on both these aspects. Once the TNMM
analysis has been subject matter of analysis at the hands of TPO
and the CIT (A), it would serve no purpose in segregating the AMP
expenditure as a separate transaction at this stage of second
appeal.
28. The Ld. CIT (DR) submitted that despite having examined all
the international transactions in a bundled manner under TNMM,
the Ld. TPO and Ld. CIT (A) are justified in subjecting the AMP
transaction to a Cost Plus Method on a standalone basis, because
this expenditure has been incurred to benefit the brand “Samsung” which is owned by the Appellant’s parent company and
no remuneration for this brand promotion service has been
received.
26 29. The Ld. Counsel then submitted that the Revenue has
grossly erred in equating AMP expenditure with brand building
and in alleging that “excessive” AMP expenditure beyond the bright
line is a brand promotion service. He submitted that brand is a
capital asset and it would be fallacious to treat any and all AMP
expenditure as leading to brand building. Brand-building leads to
enhancement of value of the brand and benefits the brand owner
as much as it helps the brand-exploiter like a licensed
manufacturer or a distributor. Brand-building is in the realm of
capital and brand-promotion targeted towards sale of goods or
services is in the realm of revenue transactions. Therefore, any
distributor or licensed manufacturer like the assessee which
incurs AMP expenditure for promoting the sales of its goods is not
guided by the motive of enhancing brand value but purely by
enhancing its sales. Increase in brand value happens slowly over a
long period of time and there is no correlation between AMP
expenditure and brand value. This is because brand value
depends on numerous factors, most of which are not linked with
AMP expenditure. The most important component of a brand is its
reliability and quality and the reliability and quality of goods are
not linked with AMP expenditure but on other expenses like R&D,
quality control, after-sales services, customer services etc. AMP
expenditure incurred by SIEL being revenue expenditure cannot be
treated as contributing towards enhancement of value of the brand
owned by the AE. There can be situations where AMP expenditure
incurred by an Indian affiliate leads to enhancement of value of
brand owned by an AE over a long period of time, but such a
relationship cannot be presumed to exist for every assessee and
for every year. It has to be specifically demonstrated that brand
value has gone up over a long period of time and a portion of this
27 enhancement is attributable to successful AMP campaigns
conducted by the Indian affiliate. Even in these situations, the
benefit to the brand owner AE has to be treated as incidental and
not a guiding force for the AMP expenditure incurred by the Indian
assessee. The Ld. Counsel further submitted that if an assessee
exercises long-term distribution and long-term licensing
manufacturing rights, it is implicit that any investment in AMP
whether high or low is towards its own sales. The return on
investment is expected to be reaped over a period of time as SIEL
as an exclusive distributor/licensed manufacturer in India is alone
entitled to benefit from this investment.
30. The Ld. Counsel submitted that empirical and scholarly
studies have shown that within a sector or industry there is huge
variation of AMP expenditure among competitors. Various
competitors place differing levels of importance on advertising and
brand promotion depending upon their understanding and belief
regarding the impact of advertising on sales. Empirical studies
have shown that there is no positive correlation between
advertising and increase in sales and no specific return on
investment (ROI) can be inferred in respect of expenditure incurred
on advertisement. To support this proposition he referred to a
scholarly article authored by Justin M. Rao of Microsoft and
Randall A. Lewis of Google titled “The Unfavourable Economics of
Measuring the Returns to Advertising” published in The Quarterly
Journal of Economics (2015) 1941-1973, Oxford University Press
which contains a rigorous analysis of correlation between
advertising spend and increase in sales. The conclusion drawn in
this article is that it is not possible to quantify the extra sales that
can be generated based on incremental AMP spend. It also
28 contains empirical data showing wide variation of AMP spend
among competitors in the same sector or industry. Based on the
above, it has been submitted that it is not possible to determine
the impact of increased intensity of advertising function on profit
margin, because the impact of advertising on sales cannot be
determined and quantified. In the absence of a quantifiable
measurement, it is not possible to make a “reasonably accurate”
adjustment to the profit margins of the comparable companies as
mandated under law.In view of the above, it was submitted that it
would be erroneous to treat AMP as a separate international
transaction and any attempt to benchmark such an imaginary
transaction in any manner (whether as bundled transaction or on
a stand-alone basis) would be an exercise in futility.
31. In his reply, the Ld. CIT (DR) fairly conceded that “bright
line” test is no longer a valid and legal way of determining the
existence of an international transaction pertaining to “excessive”
AMP expenditure. However, he emphasised that in terms of the
principles laid down by the Hon’ble Delhi High Court, existence of
an international transaction in respect of AMP expenditure can be
shown to exist if there is an arrangement between the assessee
and its brand-owning AE to carry out brand promotion activities in
India. He submitted that in the present case, the facts show that
such an arrangement exists by way of an agreement (MDF
agreement) between the Appellant and its AE. In this respect, he
relied upon the ruling of this Tribunal in the case of BMW India
(P.) Ltd. v. DCIT [2017] 190 TTJ 717 (Delhi – Trib.), wherein the
question of AMP being an international transaction has been
decided against the assessee and the determination of the ALP of
the same has been remanded to the TPO in view of the principles
29 laid down in Sony Ericsson decision of the High Court (supra). In
this case, in an agreement between BMW India and its AE BMW
Germany, it was found that the BMW India represented the
interests of BMW Germany. It was found that BMW India was
responsible for the sale promotion and full utilization of the
market potential for the Contract Goods in India. Further, it was
found that BMW India undertook the performance of adequate
advertisement and sales promotion as well as public and media
relations activities for BMW Germany and not on its own volition.
Under these circumstances, it was held that there is an Agreement
between BMW India and BMW Germany for promoting BMW brand
in India which constituted an international transaction. He further
submitted that even in the present case there is an agreement
between the assessee and its AE whereby the assessee is
undertaking marketing and advertising activity at an extensive
level and this activity is being carried out at the behest of the AE
and the brand development benefit is solely derived by the AE
itself. Such an arrangement, in his view, can be inferred from the
terms of the agreement and the conduct of the assessee.
32. The Ld. Counsel for the Appellant in his rejoinder submitted
that in the present case, there is no clause in the MDF agreement
between the assessee and its foreign AE which shows that the
assessee represented interests of the foreign AE in India. Further,
the assessee has already disclosed the reimbursement of Rs.
142.39 crores in its Form 3CEB as an international transaction
and has justified its ALP in the TP report using CUP method for AY
2005-06. Similar disclosures have been made in other years as
well. The amount reimbursed is in the nature of assistance
received against specific pre-approved invoices under a capped
30 budget specified in advance. The value of this international
transaction cannot be extended or stretched beyond the amount
reimbursed because the understanding between the appellant and
its AE is limited to Rs. 142.39 under the terms of the MDF
agreement itself. Accordingly, it was not possible to rely on this
agreement to argue that the entire AMP expenditure (or the
amount beyond the so-called bright line) be treated as a separate
international transaction. It was also submitted that the Hon’ble
Delhi High Court in the case of Whirlpool (supra) has held that a
mere agreement providing for the involvement of the AE in the
AMP function of an Indian assessee cannot be treated as a reason
for presuming the existence of an international transaction. There
has to be a clear common understanding or action in concert in
respect of the AMP expenditure in India as being incurred at the
behest or instance of the foreign AE.
33. The Ld. Counsel further relied on the following decisions of
the Tribunal where existence of an international transaction of
AMP expenditure has been negated:
– Nippon Paint India (P) Ltd v ACIT: [2017] 79 taxmann.com 8 (Chennai-Trib)
– Widex India (P)Ltd v ACIT: [2017] 78 taxman.com 348 (Chandigarh-Trib)
– MSD Pharmaceuticals(P) Ltd v ACIT: 2017] 88 taxmann.com 54 (Del-Trib)
– Philips India Ltd v ACIT: [2018] 90 taxmann.com 357 (Kolkata-Trib)
– CIT v Johnson & Johnson Ltd: [2017] 80 taxmann.com 269 (Bombay HC)
31 – ACIT v Colgate Palmolive (India) Ltd: ITA No. 6073/Mum/2014 (Mum-Trib).
34. The Ld. Counsel on a without prejudice basis, submitted
that the Ld. TPO in AYs 2007-08 to 2011-12 has added a mark-up
on the excess AMP expenses. He submitted that no mark-up must
be charged on the same as the consumer electronics and IT
hardware industry is highly competitive in nature, featured by
aggressive marketing strategies undertaken by various players in
the industry due to various factors such as price sensitivities,
different preferences in urban and rural markets etc. to
create/retain the customer base. It is extremely important for the
players in this industry to undertake such strategies to
create/maintain their market position. He contended that
payments made to third parties such as advertisement agencies,
printing press etc. should be excluded from the cost base while
computing a mark-up and the same does not reflect the value
addition/ efforts of the assessee and are merely third-party costs.
In this regard, he has placed his reliance on ITAT decision in the
case of Cheil Communications India Private Limited (2011) 46
SOT 60.
Protective Assessment in AY 2005-06 35. As regards the approach of the TPO to make a “protective
assessment”, the ld. Counsel submitted that such an approach is
impermissible in law. Protective assessment cannot be made in the
hands of the same assessee on an alternative basis. It has a
limited application to cases where a single item of income is
assessed in the hands of two distinct persons as the identity of the
32 real owner of income is not known or is not clear. In this regard he
relied on the decision of the ITAT in the case of MSD
Pharmaceuticals (P.) Ltd. v. ACIT [2018] 191 TTJ 702 (Delhi –
Trib.).The Ld. Counselalso placed reliance on the decision of
Hon’ble Supreme Court in the case of Lalji Haridas v Income
Tax Officer: [1961] 43 ITR 387 wherein it was held that
protective assessment can only be made in respect of two separate
entities to ensure that income does not escape taxation. Ld.
CIT(DR) relied on the order of the lower authorities.
DECISION
36. We have heard the rival submissions, perused the relevant
findings given in the impugned orders as well as material referred
to before us in respect of transfer pricing issue pertaining to AMP
adjustment made by the TPO. We have already discussed in detail,
the brief facts and background of the cases in the light of the
material on record and as captured in the arguments placed by the
parties. From the discussion made above, we will deal with various
issues relating to AMP adjustment. The first issue for our
consideration is:-

Whether AMP expenditure incurred by the assessee during the year is an international transaction? In the present context can the value of the AMP transaction be extended or expanded beyond the amount received as reimbursement under the MDF agreement?
37. First of all, if assessee is a full fledged risk bearing
manufacturer and is carrying out sales through the territory of
India on its own with all the risks and rewards, then in our
opinion, AMP expenditure incurred by an assessee is
33 demonstrative of its marketing and advertising function. This
function is carried out by the assessee with the intention of driving
its sales in India and resultant profit and loss. AMP expenditure
incurred is meant to aid and facilitate the main sales function. The
question before us is that, whether this function can be
characterized as a transaction which falls under the ambit of an “international transaction” u/s 92B of the Act. Ordinarily, AMP
expenditure is manifested in the form of third-party transactions
by way of payments for advertisement and brand promotion
activities. These transactions cannot per se partake the character
of an “international transaction” within the meaning of Section
92B unless the conditions laid down in the provision are met.
Section 92B covers transactions between AEs having cross-border
element (i.e., involving a non-resident). Section 92B also
contemplates existence of international transactions where the
parties are not related to each other and don’t qualify as AEs
under Section 92A of the Act. These situations are those where
though in form the transaction is entered into between unrelated
parties the substance of the same is governed by an
understanding or arrangement between AE of one party with
another enterprise.Therefore, for any transaction of AMP entered
into between the assessee and another enterprise which is not an
AE u/s 92A of the Act, this understanding or arrangement has to
be shown to exist. If the assessee denies having any such
arrangement or understanding with its AE or when there is no
apparent material on record to show that there exists any
agreement, arrangement or action in concert between the two
related parties, the onus rests on the Revenue to demonstrate the
same before it can apply the provisions of Chapter X on the AMP
expenditure. In the present case, the only ground on which the Ld.
34 TPO and the Ld. DRP have concluded that the AMP expenditure
constitutes an “international transaction” is the “excessive”
quantum of expenditure which is stated to be much above the “bright line” of the average AMP spend of the comparable
companies. This approach, to our mind, is contrary to law and
untenable.
38. Our view is bolstered by the various decisions of the Hon’ble
Delhi High Court and coordinate benches of this Tribunal in this
regard. In Whirlpool of India Ltd. v. DCIT (2016) 381 ITR 154
(Del), the following relevant principles have been laid down by the
Court which have been reiterated/followed in other decisions as
well:
(a) Sections 92B to 92F contemplate the existence of an international transaction as a pre-requisite for commencing the TP exercise. The Court observed that “to begin with there has to be an international transaction with a certain disclosed price. The TP adjustment envisages the substitution of the price of such international transaction with the ALP”. (Para
33).
(b) The Court went to hold that, “the TP adjustment is not expected to be made by deducing the difference between the excessive AMP expenditure incurred by the Assessee and the AMP expenditure of a comparable entity that an international transaction exists and then proceed to make the adjustment of the difference in order to determine the value of such AMP expenditure incurred for the AE. It is for this reason that the Bright line test has been rejected as a valid method for either determining the existence of international transaction or for the determination of ALP of such transaction. Although, under
35 Section 92B read with Section 92F(v), an international transaction could include an arrangement, understanding or action in concert, this cannot be a matter of inference. There has to be some tangible evidence on record to show that the two parties have “acted in concert””. (Paras 34-35).
(c) The Court cited the Supreme Court decision of Daichi Sankyo v. J. Chiguripati (Civil Appeal No. 7148 of 2009) to emphasize that “action in concert” would necessarily entail a “shared common objective or purpose” between two or more persons. In the absence of such shared objective or purpose, no presumption of a transaction can be made.
(d) As regards the onus to show the application of TP provisions, the Court held that “initial onus is on the Revenue to demonstrate through some tangible material that the two parties acted in concert and further there was an agreement to enter into an international transaction concerning AMP expenses”. (Para 37).
(e) As regards the presumption for imposing a transfer pricing adjustment in relation to AMP, the Court held that “37. The provisions under Chapter X do envisage a ‘separate entity concept’. In other words, there cannot be a presumption that in the present case since WOIL is a subsidiary of Whirlpool USA, all the activities of WOIL are in fact dictated by Whirlpool USA. Merely because Whirlpool USA has a financial interest, it cannot be presumed that AMP expense incurred by the WOIL are at the instance or on behalf of Whirlpool USA.” (Para 37)
(f) There is no machinery provision in the Act to bring an international transaction involving AMP expense under the ambit of transfer pricing provision if it cannot be shown that such an international transaction was entered into by the
36 assessee. In Court’s words, “It is in this context that it is submitted and rightly by the Assessee that there must be a machinery provision in the Act to bring an international transaction involving AMP expense under the tax radar. In the absence of clear statutory provision giving guidance as to how the existence of an international transaction involving AMP expense, in the absence of an express agreement in that behalf, should be ascertained and further how the ALP of such a transaction could be ascertained, it cannot be left entirely to surmises and conjectures of the TPO.” (Para 39). The Court further held that after the invalidation of the Bright line test by the Delhi High Court in Sony Ericsson (supra), existence of an international transaction of AMP expenditure has to be established de hors the Bright line test.
39. It is also pertinent that the Hon’ble Court further held that
as per the principles laid down by the Apex Court in CIT v. B.C.
Srinivasa Setty [1981] 128 ITR 294 (SC) and PNB Finance Ltd.
v. CIT [2008] 307 ITR 75 (SC), in the absence of a machinery
provision, bringing an imagined transaction to tax is not possible.
If such a transaction with an ascertainable price is not shown to
exist, Chapter X cannot be invoked. The aforementioned principles
have also been applied by the Hon’ble Delhi High Court in the case
of Valvoline Cummins Private Ltd. (ITA 158/2016) wherein the
Court observed as below:
“17……. The mere fact that the Assessee was permitted to use the brand name ‘Valvoline’ will not automatically lead to an inference that any expense that the Assessee incurred towards AMP was only to enhance the brand ‘Valvoline’. The onus was on the Revenue to show the existence of any arrangement or
37 agreement on the basis of which it could be inferred that the AMP expense incurred by the Assessee was not for its own benefit but for the benefit of its AE. That factual foundation has been unable to be laid by the Revenue in the present case. On the basis of the existing record, the TPO has found no basis other than by applying the BLT, to discern the existence of international transaction. Therefore, no purpose will be served if the matter is remanded to the TPO, or even the ITAT, for this purpose.”
40. Therefore, the argument advanced by the Ld. CIT (DR) that
the MDF Agreement should be viewed as an evidence to
demonstrate the existence of an understanding and arrangement
to carry out AMP in India at the behest of the AE needs to be
examined in light of the above principles laid down by the Delhi
High Court. In the present facts, we find that this transaction of
having received assistance /reimbursement has already been
shown by the assessee in its Form 3CEB as an international
transaction. It has been contended by the Revenue that by virtue
of this agreement, the entire AMP expenditure incurred by the
assessee should be treated as an international transaction and
subject to the provisions of Chapter X of the Act.
41. We find that the Appellant-assessee has entered into an
understanding with its AE in respect of a portion of the AMP
expenditure by way of the MDF agreement. Under this agreement,
the AE of the assessee gives assistance to the assessee for carrying
out certain advertising and marketing activities in India. Varying
amounts have been received by the assessee from its AE under
this agreement as reimbursements in all the assessment years
impugned before us. The amounts received as assistance under
this agreement in all these years have also been indisputably
38 disclosed and explained in the Form 3CEB and in the TP study.
The question that requires our adjudication is whether by virtue of
this agreement, the so-called “excessive” AMP expenditure of the
assessee (which is much higher than the assistance received
under the MDF agreement) can be treated as an international
transaction u/s 92B. For this we need to advert to the terms of the
MDF agreement. Relevant clauses of the MDF agreement
applicable for A.Y. 2005-06 (the agreements pertaining to other
years are materially similar) are extracted as below:

“Marketing Fund Agreement THIS AGREEMENT made and entered into this 1st day of January, 2004 by and between Samsung Electronics Co., Ltd., a corporation duly organized and existing under the laws of the Republic of Korea, having its head office at Samsung Main Bldg, 250-2Ka Taepyung-Ro, Chung-Gu, Seoul, Korea (hereinafter referred to as “SEC”) and Samsung India Electronics a corporation duly organized and existing under the laws of INDIA, having its principal office at 3rd, IFCI Tower, Nehru Place, New Delhi, INDIA (hereinafter referred to as “DISTRIBUTOR”) Article 1. Purpose 1.1 The objectives of this Agreement are to provide for terms and conditions of the Marketing Fund activities as set forth in Article 4.3 which shall be carried out by DISTRIBUTOR on behalf of SEC in the territory to further enhance Samsung corporate and brand images therein. 1.2 The Marketing Fund shall mean a strategic fund specifically reserved by SEC to support activities for upgrading corporate and brand images in the target markets and developing new opportunities to promote the sales of the target products therein.

Article 4. Scope of Reimbursement 4.1 The amount of reimbursement shall be the actual Marketing Fund related expenses DISTRIBUTOR incurs to carry out the pertinent activities as specified in Article 3 and 4.3 for the term of this Agreement and the yearly total amount of such reimbursement shall be limited to USD 30,000,000 assigned by SEC.
39 4.2 DISTRIBUTOR shall submit to SEC a detailed implementation plan pursuant to the annual Marketing fund schedule in writing at least two weeks in advance of the proposed implementation date for approval of said activities. DISTRIBUTOR shall be entitled to claim a reimbursement for the expenses hereof only when execution of such activities are pre-approved by SEC in a manner stated herein.
4.3 The extent of the Marketing Fund related activities to be reimbursed shall be limited to the following:
Category ACTIVITIES Advertising Broadcast media, print media, outdoor ad. Sponsor, intent ad PR Marketing Market research, consulting, market data infrastructure subscription database
Other marketing infrastructure activities Promotion Sales promotion activities Dealer support activities (dealer convention, product training, incentive tour) Exhibition, trade, roadshow Sales kit and POP materials Shop display Samsung shop corner Rack & shop light box Other store display activities A perusal of the aforesaid terms of the MDF agreement shows that
the reimbursement of a portion of the advertising and marketing
expenditure incurred by the assessee by its AE is on a pre-
approval basis and under an annual budget decided solely by the
AE. The nature of reimbursement received is a form of assistance
or subsidy and does not arise on account of any service rendered
by the assessee. There is no obligation on the AE to approve any
particular item of expenditure. It is solely on its own volition that
the AE determines the activity it wants to
finance/reimburse/assist. Therefore, it is not possible to infer the
40 existence of an international transaction beyond what has been
reimbursed.
42. In a similar situation, coordinate Bench of this Tribunal has
examined the issue of existence of an “international transaction” in
the case of PepsiCo India Holdings Pvt. Ltd. v. Addl. CIT (I.T.As.
No. 1334/CHANDI/2010, 1203/ CHANDI /2011,
2511/DEL/2013, 1044/DEL/2014 & 4516/DEL/2016) where the
assessee, an Indian company had reimbursed a portion of the
sponsorship expenditure (for international cricket events) incurred
by the AE for the benefit of certain group companies including the
assessee. The Revenue had contended that by virtue of this
reimbursement the entire AMP expenditure of the assessee should
be treated as an international transaction and subject to
determination of arm’s length price under Chapter X of the Act.
This view was categorically repelled by the Coordinate Bench by
observing as below:
“52……. In any case, if at all, ALP was to be determined then it should have been strictly circumscribed to the reimbursement of the cost aggregating to Rs.33,60,15,501/-. Further, the transaction of reimbursement of expenditure of Rs.33,60,15,501/- cannot be expanded to the entire expenditure of AMP of Rs.202.34 crores. The reason being, the amount of Rs.202.34 crores have been incurred by the assessee on its own volition and business requirement to be in competition with other big players in the field of aerated and non-aerated beverages and food products. It is acclaimed fact that industry in which assessee company is operating has to face stiff competition not only from the Indian companies but also from many multinational
41 companies; and to remain in the competition as a lead brand it
has to aggressively promote its product under the brand to
remain in the competition and to augment its sale. All the
necessary functions of strategizing, advertising and marketing
activities, its implementation for market penetration in India is
solely carried out by the assessee and there is no material on
record to infer that there is any arrangement or agreement with
the AE at any point of time that assessee is required to spent on
AMP or it has been done at the behest of the AE. The reason
adopted by the Revenue to conclude that the incurrence of AMP
expenditure by the assessee for promoting the brands which is
owned by its AE constituting a separate international transaction
for the purpose of Section 92B which requires separate bench
marking, does not has any legs to stand, because the Revenue
has failed to show the existence of any agreement,
understanding or arrangement between the assessee company
and AE regarding the quantum of AMP spent or it was spent on
behest of AE. The TPO has not recorded or identified any such
separate arrangement or agreement that AMP expenses incurred
by the assessee company are in pursuance of any agreement or
arrangement. It is also not the case of the Department that the
expenses which has been incurred by the assessee company
during the course of its business have any bearing whatsoever
on any other international transaction with the AE, other than
reimbursement of expenditure of Rs.33.60 crores as discussed
above.
53. Section 92B defines the international transaction in the
following manner: – “(1) For the purposes of this section and
sections 92, 92C, 92D and 92E, “international transaction”
42 means a transaction between two or more associated
enterprises, either or both of whom are non-residents, in the
nature of purchase, sale or lease of tangible or intangible
property, or provision of services, or lending or borrowing money,
or any other transaction having a bearing on the profits, income,
losses or assets of such enterprises and shall include a mutual
agreement or arrangement between two or more associated
enterprises for the allocation or apportionment of, or any
contribution to, any cost or expense incurred or to be incurred in
connection with a benefit, service or facility provided or to be
provided to anyone or more of such enterprises.
From the plain reading of the aforesaid Section, it is quite clear
that: (i) the transaction has to be between two or more associated
enterprises either or both of whom are non-resident; (ii) the
transaction is in the nature of purchase, sale or lease of tangible
or intangible property or provision of services or lending or
borrowing money; (iii) or any other transaction having bearing on
the profits, income, loss or assets of such enterprises; (iv) all such
nature of transaction described in the section will also include
mutual agreement and the arrangement between the parties for
allocation or apportionment or any contribution to any cost or
expenses incurred or to be incurred in connection with benefit,
services and facility provided to any of such parties. Relevant
Explanation to Section 92B as inserted by the Finance Act, 2012
reads as under: – “i. the expression “international transaction”
shall include– ………………………… (b) the purchase, sale,
transfer, lease or use of intangible property, including the
transfer of ownership or the provision of use of rights regarding
land use, copyrights, patents, trademarks, licences, franchises,
43 customer list, marketing channel, brand, commercial secret,
know-how, industrial property right, exterior design or practical
and new design or any other business or commercial rights of
similar nature;
Clause (ii) of the said explanation reads as followsii. the
expression “intangible property” shall include– (a) marketing
related intangible assets, such as, trademarks, trade names,
brand names, logos;………………..”
Thus, under the expanded definition of the term ‘international
transaction’ intangible property has been defined to include
marketing related intangible assets such as trademark, trade
name, brand name and logos, etc. This inter alia means that
where two AEs engaged in the transaction which involved,
purchase, sale, transfer, lease or use of intangibles rights then
the same shall be classified as international transaction. From
the above, definition, apart from transaction relating to purchase,
sale or lease of tangible or intangible property, services lending
or borrowing money, etc. functions having bearing on the profits,
income, losses or assets is reckoned as international transaction.
Besides this, if such a transaction is based on any mutual
agreement or arrangement between the AEs for allocation or any
contribution to any cost or expenditure incurred or to be incurred
for the benefit, service or facility, then also such an agreement or
arrangement is treated as international transaction.
Clause (v) of Section 92F reads as under: “92F (v). “transaction’
includes an arrangement, understanding or action in concert, – (A)
Whether or not such arrangement, understanding or action is
formal or in writing; or (B) Whether or not such arrangement,
44 understanding or action is intended to be enforceable by legal
proceedings.” This definition of transaction has to be read in
conjunction with the definition given in section 92B, which means
that the transaction has to be first in the nature given in Section
92B (1); and then when such transaction includes any kind of
arrangement, understanding or action in concert amongst the
parties, whether in writing or formal, then too it is treated as
international transaction. Here the conjoint reading of both the
sections lead to an inference that in order to characterized as
international transaction, it has to be demonstrated that
transaction arose in pursuant to an arrangement, understanding
or action in concert. Such an arrangement has to be between the
two parties and not any unilateral action by one of the parties
without any binding obligation on the other or without any
mutual understanding or contract. If one of the party by its own
volition is entering any expenditure for its own business
purpose, then without there being any corresponding binding
obligation on the other or any such kind of an arrangement
actually existing in wring or oral or otherwise, it cannot be
characterized as international transaction within the scope and
definition of Section 92B (1).
Here, in this case, it has been vehemently argued from the side of
the assessee that assessee-company had incurred expenditure
on AMP to cater to the needs of the customers in the local market
and such an expenditure was neither incurred at the instance or
behest of overseas AE nor there was any mutual understanding
or arrangement or allocation or contribution by the AE towards
reimbursement of any part of AMP expenditure incurred by it for
the purpose of its business. If no such understanding or
45 arrangement exists, then no transaction or international
transaction could be said to be involved between the AE and the
assessee which can be reckoned to be covered within the
provision of Transfer Pricing Regulation. The incurring of
expenditure by the assessee is in fact purely a domestic
transaction by a domestic enterprise with a third party in India
for its own business purpose. Even the reimbursement, as
discussed above, by the assessee to its AE was in lieu of
sponsorship fee paid to ICC which again was wholly and
exclusively for the assessee’s own business and was not at the
behest or mandate of AE. This contention of the learned counsel
on the face of record is liable to be accepted and in absence of
any material or any kind of arrangement discovered or brought
on record by the Revenue, remains unrebutted. The onus is on
the Revenue to show that the twin requirement of Section 92B
exists, that is, firstly, the transaction involved was between the
AE, one of which is resident and other a non-resident was
involved; and secondly, the transaction of AMP expenses has
taken place between the two AEs (except for reimbursement of
Rs.33.60 crore). Now it has been well settled by the Hon’ble
Jurisdictional High Court in the case of Maruti Suzuki India Pvt.
Ltd. (supra) that onus is upon the Revenue to demonstrate that
there existed an arrangement between the assessee and its AE
under which assessee was obliged to incur excess amount of
AMP expenses to promote the brands owned by the AE. The
relevant observation and the finding of the Hon’ble High Court in
paragraph 60 reads as under:
“60……Even if the resort is had to the residuary part of clause (b)
to contend that the AMP spend of MSIL is “any other transaction
46 having a bearing” on its “profits, income or losses” for a ‘transaction’ there has to be two parties. Therefore, for the purposes of the ‘means’ part of clause (b) and the ‘includes’ part of clause (c,) the revenue has to show that there exists an ‘agreement’ or ‘arrangement’ or ‘understanding’ between MSIL and SMC whereby MSIL is obliged to spend excessively on AMP in order to promote the brand SMC……
61……Even if the word ‘transaction’ to include ‘arrangement’, ‘understanding’ or ‘action in concert’, ‘whether formal or in writing’, it still incumbent on the revenue to show the existence of an ‘understanding’ or an ‘arrangement’ or ‘action in concert’ between MSIL and SMC as regards AMP spend for brand promotion. In other words, for both the ‘means’ part and the ‘includes’ part of Section 92B (1) what has to be definitely shown is the existence of transaction whereby MSIL has been obliged to incur AMP of a certain level for SMC for the purposes of promoting the brand of SMC.” Same proposition has been upheld by the Hon’ble Jurisdictional High Court in the case of Whirlpool of India Ltd. vs. DCIT, Bausch & Lomb Eyecare India Pvt. Ltd. vs. ACIT (supra) and Honda Siel Power Products Ltd. vs. DCIT (supra)”
43. In the present case we find that the Revenue has not been
able to place any material to record to show or suggest that the
Appellant’s AMP activity was carried out at the behest of its AE,
beyond what was approved and reimbursed under the MDF
Agreement. No understanding or arrangement or “action in
concert” can be inferred from the terms of the MDF agreement or
the conduct of the assessee to show that “excessive” AMP
expenditure has been incurred at the behest of the brand-owning
47 AE. The appellant being one of the major players in the Indian
market has carried out its AMP activity and function based on its
own judgement and commercial realities. Revenue has not placed
any material or evidence to show that there existed an
understanding to incur “excessive” AMP expenditure. The
arrangement and understanding were limited to the amounts
agreed to be paid as assistance under the MDF Agreement. The
amounts incurred as AMP expenditure by the appellant under the
MDF Agreement have already been received as
reimbursement/assistance and have indisputably been disclosed
as an international transaction in Form 3CEB and form part of the
transfer pricing study conducted under Rule 10D. The AMP
expenditure which is outside the ambit of reimbursement received
under the MDF Agreement, has been incurred by the appellant on
its own volition as per its own requirements and without any
interference of the AE and have been paid to third parties.
44. In view of the above, we hold that the scope and value of
international transaction cannot be expanded beyond the
reimbursements received under MDF agreement to cover the entire
gamut of AMP expenditure incurred by the assessee during the
year.
45. Now the second issue before us is, whether:
“Bright Line Test” a valid test that can be used by the TPO to determine the existence of an international transaction and also for the determination of its arm’s length value?
In all the years under appeal, the TPO has applied the “Bright
Line” Test to determine the “excessive” AMP expenditure incurred
48 by the Appellant. This “excessive” amount has been treated as a
separate international transaction and subject to transfer pricing
adjustment. The “bright line” test which was first approved by a
Special Bench of this Tribunal in LG Electronics now stands
rejected by the Delhi High Court decision in Sony Ericsson. In
Sony Ericsson, the Hon’ble High Court examined the concept of “bright line” in the context of domestic law and international
jurisprudence and arrived at a conclusion that such an approach
is untenable and contrary to law and not sanctioned by
international jurisprudence. The concluding remarks of the
Hon’ble High Court are as below:
“127. We agree and accept the position in the portion reproduced above in bold and italics. 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. There should be adequate and proper compensation for the functions performed including AMP expenses. Thus, 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 and in all case, costs or compensation paid for AMP expenses would be ‘NIL’, or at best would mean the amount or compensation expressly paid for AMP expenses. 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).
135. It is, therefore, incorrect to suggest or observe that international tax jurisprudence or commentaries recognise “bright
49 line test” for bifurcation of routine and non-routine AMP expenditure, and non-routine AMP expenses is an independent international transaction which should be separately subjected to arm’s length pricing.”

45. In view of the above, we hold that the “bright line” approach
is untenable in law either as a way to determine the existence of
an international transaction or as a method to determine the ALP
of an international transaction pertaining to AMP. No international
transaction can be presumed to exist merely on the basis of “bright line” of expenditure incurred by comparable companies.
46. The third issue for our consideration is, If TNMM has been adopted at segmental/entity level, then can individual component of AMP be segregated?
TNMM analysis entails comparison of net level profit margins of
the assessee with that of the comparables. Net level margins are
determined after reducing the entire operating expenses incurred
by the business entity which necessarily includes AMP
expenditure. Therefore, once a TNMM exercise is undertaken at
entity level by subsuming the entire AMP expenditure as part of
the operating expenditure, the arm’s length nature of all the
transactions that are accounted for within the net profit margin
stand fully accounted for. In the present case, the reimbursement
received by the Appellant from its AE under the MDF Agreement
for a part of the AMP expenditure forms part of the operating
income as well as expenditure which goes into the computation of
the net profit margin (which is profit level indicator). Once a group
of transactions pertaining to operating income and expenditure are
50 being tested under TNMM, it would not be open for the Revenue to
segregate one item of expenditure/income for a separate
benchmarking unless for cogent reasons it is of the view that a
TNMM is not the most appropriate method to test all the
international transactions together. In such a situation the
Revenue would have to test each of the transactions separately
and not leave any of the transactions untested leading to an
incongruous situation. We are fortified in our view by the decision
of the Hon’ble Delhi High Court in the case of Sony Ericsson
(supra) wherein the Court observed as below:
“101. However, once the Assessing Officer/TPO accepts and adopts TNM Method, but then chooses to treat a particular expenditure like AMP as a separate international transaction without bifurcation/segregation, it would as noticed above, lead to unusual and incongruous results as AMP expenses is the cost or expense and is not diverse. It is factored in the net profit of the inter-linked transaction. This would be also in consonance with Rule 10B(1)(e), which mandates only arriving at the net profit margin by comparing the profits and loss account of the tested party with the comparable. The TNM Method proceeds on the assumption that functions, assets and risk being broadly similar and once suitable adjustments have been made, all things get taken into account and stand reconciled when computing the net profit margin. Once the comparables pass the functional analysis test and adjustments have been made, then the profit margin as declared when matches with the comparables would result in affirmation of the transfer price as the arm’s length price. Then to make a comparison of a horizontal item without segregation would be impermissible.”
51 In the present facts, we find that the TPO has subjected various
international transactions of the assessee to TNMM analyses
under various segments and made transfer pricing adjustments on
the basis of external comparables chosen by him. Several of these
comparable companies included/excluded by him form subject
matter of the present appeals. It implies that the TPO has applied
his mind on the suitability of TNMM and made adjustments.
Having adopted TNMM in a considered manner, it is not open for
him to take up AMP as a separate transaction and subject to the
same to a Cost Plus type of benchmarking because the entire AMP
expenditure forms part of the operating expenditure that has been
taken into account while computing the profit level indicator (net
profit margin).
47. Next issue is, Brand building exercise equivalent to incurring
AMP expenditure?
In our view, it would be erroneous to treat any and all AMP
expenditure as being a brand building exercise. There is no basis
to presume that there is a positive correlation between AMP
expenditure and brand-value. Brand value is a far more complex
concept than mere AMP expenditure. Brand is an intangible asset
that encapsulates the reputation of an entity and a reputation is
built over a long period of time primarily on the basis of trust it
invokes. Year to year AMP expenditure may vary due to market
conditions, but the brand value does not get altered in proportion
to expenditure. AMP function itself is a complex activity involves
several nuanced aspects of marketing management targeted
towards increasing sales. Such an exercise is sometimes premised
on product promotion and sometimes brand messaging and
occasionally for brand familiarization. But the core of brand value
52 is not determined by the quantum of expenditure incurred but the
overall level of trust inspired in the minds of the consumers. The
Hon’ble Delhi High Court in the case of Sony Ericsson (supra) has
examined this aspect in detail. The relevant observations are
extracted below:
“103. Brand has been described as a cluster of functional and emotional values. It is a matter of perception and reputation as it reflects customers’ experience and faith. Brand value is not generated overnight, but is created over a period of time, when there is recognition that the logo or the name guarantees a consistent level of quality and expertise. Leslie de Chernatony and McDonald have described “a successful brand is an identifiable product, service, person or place, augmented in such a way that the buyer or user perceives relevant, unique, sustainable added values which match their needs most closely.” The words of the Supreme Court in Civil Appeal No.1201 of 1966 decided on 12th February, 1970 in Khushal Khenger Shah v. Mrs. Khorshedbanu, DabridaBoatwala, to describe ‘goodwill’, can be adopted to describe a brand as an intangible asset being the whole advantage of the reputation and connections formed with the customer together with circumstances which make the connection durable. The definition given by Lord MacNaghten in Commissioner of Inland Revenue v. Muller & Co’ & Margarine Ltd. [1901] 217 AC 223 can also be applied with marginal changes to understand the concept of brand. In the context of ‘goodwill’ it was observed:
“It is very difficult, as it seems to me, to say that goodwill is not property. Goodwill is bought and sold every day. It may be acquired. I think, in any of the different ways in which property is usually acquired. When a man has got it he may keep it as his own. He may vindicate his exclusive right to it if necessary by process of law. He may dispose of it if he will – of course, under the conditions attaching to property of that nature…..What is good-will? It is a thing very easy to describe very difficult to define. It is the benefit and advantage of the good name, reputation, and connection of a business. It is the attractive force which brings in custom. It is the one thing which distinguishes an old established business from a new business at its first start. The goodwill of a business must emanate from a particular centre or source. However, widely extended or diffused its
53 influence may be, goodwill is worth nothing unless it has power of attraction sufficient to bring customers home to the source from which it emanates. Goodwill is composed of a variety of elements. It differs in its composition in different trades and in different businesses in the same trade. One element may preponderate here and another element there. To analyse goodwill and split it up into its component parts, to pare it down as the Commissioners desire to do until nothing is left but a dry residuum ingrained in the actual place where the business is carried on while everything else is in the air, seems to me to be as useful for practical purposes as it would be to resolve the human body into the various substances of which it is said to be composed. The goodwill of a business is one whole, and in a case like this it must be dealt with as such. For my part, I think that if there is one attribute common to all cases of goodwill it is the attribute of locality. For goodwill has no independent existence. It cannot subsist by itself. It must be attached to a business. Destroy the business, and the goodwill perishes with it, though elements remain which may perhaps be gathered up and be revived again………. ”
104. “Brand” has reference to a name, trademark or trade name.
A brand like ‘goodwill’, therefore, 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. To use
words from CIT v. Chunilal Prabhudas& Co. AIR 1971 Cal 70, it
would mean:
‘… It has been horticulturally and botanically viewed as “a seed
sprouting” or an “acorn growing into the mighty Oak of goodwill”.
… It has been historically explained as growing and crystallising
traditions in the business. It has been described in terms of a
magnet as the “attracting force”. In terms of comparative
dynamics, goodwill has been described as the “differential
return of profit.” Philosophically it has been held to be intangible,
Though immaterial, it is materially valued. Physically and
psychologically, it is a “habit” and sociologically it is a “custom”.
Biologically, it has been described by Lord Macnaghten in Trego
v. Hunt, 1896 AC 7 as the “sap and life” of the business. It has
been horticulturally and botanically viewed as “a seed
sprouting” or an “acorn growing into the mighty Oak of goodwill”.
54 It has been geographically described by locality. It has been historically explained as growing and crystallising traditions in the business. It has been described in terms of a magnet as the “attracting force”. In terms of comparative dynamics, goodwill has been described as the “differential return of profit.” Philosophically it has been held to be intangible, Though immaterial, it is materially valued. Physically and psychologically, it is a “habit” and sociologically it is a “custom”. Biologically, it has been described by Lord Macnaghten in Trego v. Hunt, 1896 AC 7 as the “sap and life” of the business.’
105. There is a line of demarcation between development and
exploitation. Development of a trademark or goodwill takes place
over a passage of time and is a slow ongoing process. In cases of
well recognised or known trademarks, the said trademark is
already recognised. Expenditures incurred for promoting
product(s) with a trademark is for exploitation of the trademark
rather than development of its value. A trademark is a market
place device by which the consumers identify the goods and
services and their source. In the context of trademark, the said
mark symbolises the goodwill or the likelihood that the
consumers will make future purchases of the same goods or
services. Value of the brand also would depend upon and is
attributable to intangibles other than trademark. It refers to
infrastructure, know-how, ability to compete with the established
market leaders. Brand value, therefore, does not represent
trademark as a standalone asset and is difficult and complex to
determine and segregate its value. 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.

106. Therefore, to assert and profess that brand building
as 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. There are a good number of
examples where brands have been built without incurring
substantial advertisement or promotion expenses and also cases
where in spite of extensive and large scale advertisements,
brand values have not been created. Therefore, it would be
erroneous and fallacious to treat brand building as counterpart or
to commensurate brand with advertisement expenses. Brand
building or creation is a vexed and complexed issue, surely not
just related to advertisement. Advertisements may be the
55 quickest and effective way to tell a brand story to a large
audience, but just that is not enough to create or build a brand.
Market value of a brand would depend upon how many
customers you have, which has reference to brand goodwill,
compared to a baseline of an unknown brand. It is in this manner
that value of the brand or brand equity is calculated. Such
calculations would be relevant when there is an attempt to sell or
transfer the brand name. Reputed brands do not go in for
advertisement with the intention to increase the brand value, but
to increase the sales and thereby earn larger and greater profits.
It is not the case of the Revenue that the foreign AEs are in the
business of sale/transfer of brands.

107. Accounting Standard 26 exemplifies distinction between
expenditure incurred to develop or acquire an intangible asset
and internally generated goodwill. An intangible asset should be
recognised as an asset, if and only if, it is probable that future
economic benefits attributable to the said asset will flow to the
enterprise and the cost of the asset can be measured reliably.
The estimate would represent the set off of economic conditions
that will exist over the useful life of the intangible asset. At the
initial stage, intangible asset should be measured at cost. The
above proposition would not apply to internally generated
goodwill or brand. Paragraph 35 specifically elucidates that
internally generated goodwill should not be recognised as an
asset. In some cases expenditure is incurred to generate future
economic benefits, but it may not result in creation of an
intangible asset in form of goodwill or brand, which meets the
recognition criteria under AS-26. Internally generated goodwill or
brand is not treated as an asset in AS-26 because it is not an
identifiable resource controlled by an enterprise, which can be
reliably measured at cost. Its value can change due to a range of
factors. Such uncertain and unpredictable differences, which
would occur in future, are indeterminate. In subsequent
paragraphs, AS-26 records that expenditure on materials and
services used or consumed, salary, wages and employment
related costs, overheads, etc. contribute in generating internal
intangible asset. Thus, it is possible to compute goodwill or brand
equity/value at a point of time, but its future valuation would be
perilous and an iffy exercise.

108. In paragraph 44 of AS-26, it is stated that intangible asset
arising from development will be recognised only and only if
amongst several factors, it can demonstrate a technical feasibility
56 of completing the intangible asset so that it will be available for
use or sale and the intention is to complete the intangible asset
for use or sale is shown or how the intangible asset will generate
probable future benefits, etc. 109. The aforesaid position finds recognition and was accepted
in CIT v. B.C. Srinivasa Setty [1981] 2 SCC 460, a decision
relating transfer to goodwill. Goodwill, it was held, was a capital
asset and denotes benefits arising from connection and
reputation. A variety of elements go into its making and the
composition varies in different trades, different businesses in the
same trade, as one element may pre-dominate one business,
another element may dominate in another business. It remains
substantial in form and nebulous in character. In progressing
business, brand value or goodwill will show progressive
increase, but in falling business, it may vain. Thus, its value
fluctuates from one moment to another, depending upon
reputation and everything else relating to business, personality,
business rectitude of the owners, impact of contemporary market
reputation, etc. Importantly, there can be no account in value of
the factors producing it and it is impossible to predicate the
moment of its birth for it comes silently into the world unheralded
and unproclaimed. Its benefit and impact need not be visibly felt
for some time. Imperceptible at birth, it exits unwrapped in a
concept, growing or fluctuating with numerous imponderables
pouring into and affecting the business. Thus, the date of
acquisition or the date on which it comes into existence is not
possible to determine and it is impossible to say what was the
cost of acquisition. The aforesaid observations are relevant and
are equally applicable to the present controversy.

110. It has been repeatedly held by Delhi High Court that
advertisement expenditure generally is not and should not be
treated as capital expenditure incurred or made for creating an
intangible capital asset. Appropriate in this regard would be to
reproduce the observations in CIT v. Monto Motors Ltd. [2012]
206 Taxman 43/19 taxmann.com 57 (Delhi), which read:– “4. … Advertisement expenses when incurred to increase sales
of products are usually treated as a revenue expenditure, since
the memory of purchasers or customers is short. Advertisement
are issued from time to time and the expenditure is incurred
periodically, so that the customers remain attracted and do not
forget the product and its qualities. The advertisements
published/displayed may not be of relevance or significance
57 after lapse of time in a highly competitive market, wherein the products of different companies compete and are available in abundance. Advertisements and sales promotion are conducted to increase sale and their impact is limited and felt for a short duration. No permanent character or advantage is achieved and is palpable, unless special or specific factors are brought on record. Expenses for advertising consumer products generally are a part of the process of profit earning and not in the nature of capital outlay. The expenses in the present case were not incurred once and for all, but were a periodical expenses which had to be incurred continuously in view of the nature of the business. It was an on-going expense. Given the factual matrix, it is difficult to hold that the expenses were incurred for setting the profit earning machinery in motion or not for earning profits.”
(Also see, CIT v. Spice Distribution Ltd. [2015] 229 Taxman
400/54 taxmann.com 325 (Delhi) by the Delhi High Court on 19th
September, 2014; and CIT v. Salora International Ltd. [2009] 308
ITR 199 111. Accepting the parameters of the ‘bright line test’ and if the
said parameters and tests are applied to Indian companies with
reputed brands and substantial AMP expenses, would lead to
difficulty and unforeseen tax implications and complications.
Tata, Hero, Mahindra, TVS, Bajaj, Godrej, Videocon group and
several others are both manufacturers and owners of intangible
property in the form of brand names. They incur substantial AMP
expenditure. If we apply the ‘bright line test’ with reference to
indicators mentioned in paragraph 17.4 as well as the ratio
expounded by the majority judgment in L.G. Electronics India (P)
Ltd case (supra) in paragraph 17.6 to bifurcate and segregate
AMP expenses towards brand building and creation, the results
would be startling and unacceptable. The same is the situation in
case we apply the parameters and the ‘bright line test’ in terms of
paragraph 17.4 or as per the contention of the Revenue, i.e. AMP
expenses incurred by a distributor who does not have any right
in the intangible brand value and the product being marketed by
him. This would be unrealistic and impracticable, if not delusive
and misleading. (Aforesaid reputed Indian companies, it is
patent, are not to be treated as comparables with the assessed,
i.e. the tested parties in these appeals, for the latter are not legal
owners of the brand name/trademark.).”
58 48. Placing reliance on the above extracts of the Sony Ericsson
decision (supra), a coordinate bench of this Tribunal in PepsiCo
(supra) held as below:
“60. Thus, the Hon’ble High Court after describing the concept of the “brand” had made a clear cut demarcation between development and exploitation of brand which is either in the form of trademark or goodwill which takes place over a passage of time by which its value depends upon and is attributable to intangibles other than trademark like, infrastructure, knowhow, ability to compete in the established market, lease, etc. Brand value does not represent trademark as asset and it is quite difficult to determine and segregate its value. Brand value largely depends upon the nature of goods and services sold, after sales services, robust distributorship, quality control, customer satisfaction and catena of other factors. The advertisement is more telling about the brand story, penetrating the mind of the customers and constantly reminding about the brand, but it is not enough to create brand, because market value of a brand would depend upon how many customers you have, which has reference to a brand goodwill. There are instances where reputed brand does not go for advertisement with the intention to increase the brand value but to only increase the sale and thereby earning greater profits. It is also not the case here that foreign AE is in the business of sale/transfer of brands. Their Lordships have also referred to Accounting Standard 26 which provides for computation of goodwill and brand equal value at a point of time but not its future valuation or how such an intangible asset will generate probable future benefit. Because, the value fluctuates from one moment to other depending upon reputation and other factors. Reputation of a brand only enhances the sale and profitability and here in this case is only benefitting the assessee company when 86 marketing its products using the trade mark and the brand of AE. Even otherwise also, the value of the brand which has been created in India by the assessee company will only be relevant when at some point of time the foreign AE decides to sell the brand, then perhaps that would be the time when brand value will have some significance and relevance. But to make any transfer pricing adjustment simply on the ground that assessee has spent advertisement, marketing expenditure which is benefitting the brand/trademark of the AE would not be
59 correct approach. Thus, this line of reasoning given by the TPO is rejected.”

49. In PepsiCo (supra), this Tribunal, while examining the AMP
issue examined the implications of the recent developments in
transfer pricing spearheaded by OECD in its Base Erosion and
Profit Shifting (BEPS) project and observed as below:

“61. Further in the final report of Action 8-10 of Base Erosion and Profit Shifting Project (BEPS) of OECD titled as “Aligning Transfer Pricing Outcomes with Value Creation’. It has been suggested that no adjustment is required on AMP expenditure incurred by full-fledged manufacturers. The report contains various examples pertaining to manufacturer. The following passage from the report is quite relevant which for the sake of ready reference is quoted hereinbelow:
“6.40 The legal owner will be considered to be the owner of the intangible for transfer pricing purposes. If no legal owner of the intangible is identified under applicable law or governing contracts, then the member of the MNE group that, based on the facts and circumstances, controls decisions concerning the exploitation of the intangible and has the practical capacity to restrict others from using the intangible will be considered the legal owner of the intangible for transfer pricing purposes.
6.41 In identifying the legal owner of intangibles, an intangible and any licence relating to that intangible are considered to be 87 different intangibles for transfer pricing purposes, each having a different owner. See paragraph 6.26. For example, Company A, the legal owner of a trademark, may provide an exclusive licence to Company B to manufacture, market, and sell goods using the trademark. One intangible, the trademark, is legally owned by Company A. Another intangible, the licence to use the trademark in connection with manufacturing, marketing and distribution of trademarked products, is legally owned by Company B. Depending on the facts and circumstances, marketing activities undertaken by Company B pursuant to its licence may potentially affect the value of the underlying intangible legally owned by Company A, the value of Company B’s licence, or both.
60 6.42 While determining legal ownership and contractual arrangements is an important first step in the analysis, these determinations are separate and distinct from the question of remuneration under the arm’s length principle. For transfer pricing purposes, legal ownership of intangibles, by itself, does not confer any right ultimately to retain returns derived by the MNE group from exploiting the intangible, even though such returns may initially accrue to the legal owner as a result of its legal or contractual right to exploit the intangible. The return ultimately retained by or attributed to the legal owner depends upon the functions it performs, the assets it uses, and the risks it assumes, and upon the contributions made by other MNE group members through their functions performed, assets used, and risks assumed. For example, in the case of an internally developed intangible, if the legal owner performs no relevant 88 functions, uses no relevant assets, and assumes no relevant risks, but acts solely as a title holding entity, the legal owner will not ultimately be entitled to any portion of the return derived by the MNE group from the exploitation of the intangible other than arm’s length compensation, if any, for holding title.”
From the above quoted passage, it can be seen that the guidelines clearly envisage that legal ownership of intangibles, by itself, does not confer any right ultimately to retain returns derived by MNE group from exploiting the intangibles, even though such returns is initially accruing to the legal owner as a result of its legal/contractual right to exploit the intangible. The return depends upon the functions performed by the legal owner, assets it uses, and the risks assumed; and if the legal owner does not perform any relevant function, uses no relevant assets, and assumes no relevant risks, but acts solely as a title holding entity, then the legal owner of the intangible will not be entitled to any portion of the return derived by the MNE group from the exploitation of the intangible other than the Arm’s Length compensation if any for holding the title.”

50. In view of the above, we hold that in case of licensed
manufacturers like the appellant who bear the full risks and
rewards of manufacturing and selling their goods in the Indian
market, the concept of brand promotion being for the benefit of the
AE has no application at all. As regards brand building expenses
61 incurred by a distributor who does not own the brand, the same
needs to be examined from a long-term perspective whereby the
ability of the distributor to recover the advertising costs by way of
increased sales for a reasonable period of time is to be judged.
Once a distributor arrangement in place for a fairly long period of
time (as in the present situation where the assessee is the
distributor of “Samsung” products in India), expenses on
advertising cannot be subjected to a stand-alone analysis as a “service” to its AE on a year to year basis. This question of
compensating an Indian distributor would arise only if the parties
prematurely terminate the distributorarrangement. In such an
event, if the Indian distributor has been deprived of the
opportunity of recovering its investment in AMP, it could be a valid
reason for a transfer pricing adjustment because third parties
would not agree to a premature termination of this kind without
demanding compensation. Therefore, the question of compensating
the taxpayer for any loss suffered due to excess AMP spend would
arise only at the time of such premature termination and not
during the pendency of the distributorship arrangement. Thus, in
case of a routine distributor, disallowance/adjustment on account
of AMP spend on the mere assumption that the supplier may
terminate the agreement in the future is not sustainable. A
taxpayer cannot be penalized on the presumption of a future event
(which may not even occur) while ignoring the present facts and
circumstances. It is also worthwhile to note that in the present
case, the assessee has not paid any trade-mark or brand royalty to
its AE for having used its brand.
51. Next issue before us is:
62 Whether it is permissible for the TPO to make a substantive and protective assessment on the same issue using two alternative approaches?
It is settled law that protective addition along with substantive
addition of an item of income can be made only when the identity
of the real owner of the income is unclear. The following
observations made by the coordinate bench in MSD
Pharmaceuticals Pvt. Ltd. (supra) make this amply clear: “The very concept of protective addition is relevant only when an income is to be added in the hands of more than one taxpayer, in a situation in which there is an element of ambiguity as to in whose hands the said income can be rightly brought to tax. That’s not the case before us. In our humble understanding, therefore, the concept of ‘protective assessment’, as is known to the income tax law, has no application in the cases like the one before us.”
52. The last issue before us is:
If AMP expenditure incurred by the Appellant is held to be an international transaction, can it include selling costs within its ambit? Further, would the Appellant be eligible to receive a mark-up on the AMP expenditure to capture the arm’s return on the cost?
Since we have held that there is no international transaction in the
nature of AMP expenditure which needs to be subjected to Chapter
X analysis, these issues are rendered infructuous and academic.
53. Thus, in view of our finding given above we hold that, no
adjustment can be made in the case of the appellant on account of
AMP expenses and same is directed to be deleted.
OTHER GROUNDS IN ITA No. 3248/DEL/2012)AY 2005-06
63 GROUND NO. 4: The CIT has erred in not appreciating that no adjustment is warranted in respect of transactions undertaken by the appellant with its AEs in Class II segment since the underlying difference between the transfer price and arm’s length price does not exceed 5% of the latter and thus, the case is squarely covered by the proviso to section 92C (2) of the Act.

54. In respect of Class II (Distribution of consumer electronics,
home appliances and other IT and Telecom Products) segment, the
Appellant had adopted Resale Price Method (RPM) and had chosen
5 comparables in its transfer pricing documentation with a mean
margin of 6.45%. The Ld. TPO rejected RPM and chose TNMM as
the most appropriate method. Further, the TPO also altered the set
of comparables and adopted a set 13 comparables with a mean net
profit margin of (-) 0.447%. The TPO also computed the net profit
margin of the Appellant after giving effect to the MDF expenditure
treatment to -3.50%. On appeal, the Ld. CIT (A) rejected 2 of TPOs
comparables namely Control Print Ltd. and Gemini
Communication Ltd. and applied current year data on the
remaining comparables. The mean margin of the remaining
comparables came to 0.38% as against 0.21% of the Appellant
(after treating reimbursement for advertisement expenses as
operating expense). The Ld. CIT (A) accordingly concluded that an
adjustment of Rs. 3.3 crores is required to be done because the
difference between ALP and the transfer price exceeds 5% of the
ALP. The Ld. Counsel for the appellant submitted that the Ld. CIT
(A) erred in making an incorrect calculation in this regard. The
difference between the ALP and transfer price is within the
permissible 5% range as shown in the computation below:

Particulars Reference Amount (in Rs.) Sales A 19,431,647,242 AE costs B 9,205,413,953
64 Third Party costs C 10,184,978,943 Total costs D= B+C 19,390,392,896 Operating profit E= A-D 41,254,346 Appellant’s OP/Sales F= E/A 0.21% Arm’s length OP/Sales G 0.38% Arm’s Length OP H=A*G 73,840,260 Shortfall in Appellant’s I=H-E 32,585,913 OP Arm’s length AE costs J=B-I 9,172,828,040 105% of Arm’s length K=J*1.05 9,631,469,442 AE costs TP adjustment (if any) L=B-K Nil 55. The Ld. Counsel submitted that no adjustment to the ALP
could be made as under the Proviso to Section 92C(3), if the
difference between the price recorded in the books and the ALP
determined was less than 5%, no adjustment could be made. The
Ld. CIT (DR) relied on the orders of the TPO and the CIT(A).
55. In view of the details submitted by the assessee which have
not been disputed or controverted by the Ld. CIT(DR), it is
apparent that by applying the permissible 5% margin under the
second Proviso to Section 92C(2), no adjustment is warranted.
Accordingly, this ground is allowed and the adjustment made by
the Ld. CIT (A) is directed to be deleted.

56. GROUND NO. 5: This Ground has not been pressed by the
assessee and is accordingly dismissed.
GROUNDS IN DEPARTMENT’S APPEAL (ITA No. 3410/Del/12) FOR AY 2005-06 GROUND NO. 1: The Ld. CIT (A) has erred in excluding certain comparables while benchmarking international transactions
65 under Class I – Manufacturing and Class II – Distribution Segment.
57. The Assessee is engaged in manufacturing of consumer
electronics, home appliances &colour monitors (known as Class I-
Manufacturing segment) which includes the import of raw
materials, import of spare parts, export of finished goods,
purchase of samples and purchase of sales promotion material. In
the TP Study, the Assessee selected 11 comparables. The TPO
proceeded to undertake a fresh analysis and arrived at a fresh set
of comparables by accepting certain comparables of the Assessee
and introducing certain new comparables. The comparables which
were introduced by the TPO and thereafter rejected by the CIT (A)
are under challenge by the Department in its appeal. The
Department’s appeal is in respect of two comparables, namely,
Videocon Industries Ltd. and Samtel Colour Ltd.
58. Videocon Industries Ltd (Class I- Manufacturing): The
company was included by the Ld. TPO in the final list of
comparables by merely relying on its predecessor’s order for AY
2004-05. On appeal by the Assessee, the Ld. CIT(A) excluded this
comparable by relying on its predecessor’s order for AY 2004-05
wherein it was held that the company is engaged in backward
integration and indigenous manufacturing of components, hence it
cannot be treated as an appropriate comparable.
59. Being aggrieved by the CIT (A)’s order, the Department is in
appeal asking for inclusion of this comparable. The Ld. CIT (DR)
argued that under TNMM broad level of function and product
similarity is mandated and this company is engaged in
manufacturing which is also the function of the tested party. He
66 vehemently argued that product similarity may not be exact and
as long as there is a broad level of similarity, comparables should
be accepted. In this case, he submitted that components of colour
TVs are being manufactured by this comparable, which falls under
the broad category of consumer goods. He also argued that prior
years precedents should not be applied to questions of fact.
60. The Ld. counsel for the Assessee while supporting the order
of the CIT (A) submitted that the company should not be taken as
a comparable due to following reasons:
(a) Videocon did not form a part of SIEL’s TP Study and the same was included by the TPO by merely relying on its own order for AY 2004-05 without conducting any functional analysis.
(b) It may be noted that Videocon was excluded as a comparable by CIT (A) in AYs 2003-04 and 2004-05 as well. Also, the Department did not file an appeal on this issue against the order of the CIT (A) for AY 2004-05. There is no change in the facts and circumstances of the case from AY 2004-05 and AY 2005-06. The functional description of this company and that of the appellant has remained the same and hence the decision of the prior year should be followed.
(c) The company is engaged in backward integration and indigenous manufacturing of components (glass shells) and derives sizeable portion of income from manufacture of glass shells, funnels and panels which are used in manufacturing of colour TV. Videocon enjoys cost benefits due to captive manufacturing of CTV shells. The Ld. Counsel relied on the decision of this Tribunal in the case of Sony India P. LTD V DCIT [2008] 114 ITD 448 (Del) in this regard where on similar facts Videocon was held to be incomparable to Sony
67 India, a company that was engaged in the manufacture of TVs and other consumer goods, on the ground that it undertakes manufacturing of components for CTV units which renders it functionally incomparable to companies which import the same parts.
61. We have analyzed the functional and product profile of
Videocon and find that it is a component manufacturer, whereas
the assessee’s manufactured goods are in the category of finished
goods. Though the components like glass shells and funnels are
components of TV sets which are manufactured by the assessee, it
would be wholly inappropriate to treat the two as comparables
under TNMM as they operate in entirely different sectors. While
components are sold to OEMs, finished goods are sold to end-
customers and face entirely diverse market risks and dynamics.
Furthermore, in the prior years this comparable has been rejected
in first appeal by the CIT (A) and no appeal was preferred against
the same. It is important to maintain consistency if there is no
change in facts. We also note that the coordinate Bench has,
under similar facts, examined the appropriateness of this
comparable in Sony India (supra) and held it to be inappropriate.
In view of the above, we dismiss this ground of appeal and hold
that Videocon has been rightly excluded by the CIT (A) from the
list of comparables.
62. Samtel Colour Limited (Class I- Manufacturing): Samtel
was introduced by the Ld. TPO in the final list of comparables by
merely relying on its predecessor’s order for AY 2004-05. The
company operates in only one segment i.e. manufacture of colour
68 picture tubes and electron gun. It has a Related Party Transaction
(RPT) as a percentage of sales of 23.85%.
63. On appeal by the Assessee, the Ld. CIT (A) relied on the
decisions of Sony India (supra) and Avaya India Pvt. Ltd (ITA No.
5150/Del/2010) wherein it was held that companies having more
than 15% RPT should not be taken as comparable. Even for AY
2004-05, in Assessee’s own case, Khaitan Electricals Ltd was
excluded as it had RPT in excess of 15%. Based on above, Ld. CIT
(A) excluded Samtel as a comparable.
64. Being aggrieved by the CIT (A)’s order, the Department is in
appeal before this Tribunal for inclusion of this comparable. It is
the Department’s contention that RPT filter should be 25% instead
of 15% as it is a reasonable threshold for comparability. The Ld.
CIT (DR), further submitted that the Tribunal in numerous
decisions has approved a 25% threshold and the same should be
followed in this case as well.
65. The Ld. Counsel for the Assessee submitted that the
company should not be taken as a comparable on the ground of
consistency as the TPO in subsequent year i.e. AY 2006-07 has
himself excluded companies having RPT in excess of 15%. Further,
even after applying RPT filter of 15%, if sufficient number of
comparable companies are available for determination of arm’s
length price, then such tolerance limit is proper.The Ld. Counsel
for the Assessee placed reliance on LSI Technologies India
Private Limited vs. ITO (IT (TP)A Nos.1380 & 1381/Bang/
2010) and Textron India Pvt. Ltd. v. DCIT
(IT(TP)ANo.1228/Bang/2010, etc).
69 66. We have heard the parties and also perused the relevant
finding and the material referred to before us. The exercise of
determination of arm’s length price u/s 92 of the Act entails
finding comparable uncontrolled transactions/entities for the
purpose of comparison. If the levels of related party transactions
are higher the “uncontrolled” nature of the comparable transaction
or entity is diluted and the comparability is compromised.
Therefore, in principle, lower the level of RPT, more accurate the
result is likely to be. However, if sufficient number of comparables
is not available due to paucity of data or comparables, the RPT
threshold may have to be relaxed upwards for reasons of
practicality. However, in situations where sufficient numbers of
comparables are available by applying a lower threshold, the same
should be preferred as the results are likely to be more accurate.
The same view has been expressed by the coordinate Bench in the
case of Motorola Solutions India Pvt. Ltd.[2014] 35 ITR(T) 546
(Delhi – Trib.) We accordingly hold that since in the given situation
sufficient numbers of comparables are available even by following
the lower level of threshold of 15%, the same should be followed.
This ground is accordingly dismissed and the order of the Ld. CIT
(A) is upheld.
67. Now we come to Class II-, which is DISTRIBUTION
SEGMENT: The Assessee is engaged in distribution of consumer
electronics, home appliances, colour monitors and other IT &
Telecom products (known as Class II- Distribution segment) which
includes import of finished goods, import of spare parts, export of
spare parts, purchase of samples, export of samples, payment for
packing & R&D expenses, purchase of sales promotion material. In
70 the TP Study, the Assessee selected 5 comparables. The TPO
proceeded to undertake a fresh analysis and arrived at a fresh set
of comparables. He accepted some of the comparables of the
Assessee but also introduced 8 new comparables. Some of the
comparables which were introduced by the TPO were thereafter
rejected by the CIT (A) and the same are under challenge by the
Department in its appeal as under. Ld. CIT (DR) submitted that
the Revenue is aggrieved in respect of two comparables, namely
Control Print (India) Ltd. and Gemini Communications Ltd.
68. Control Print (India) Limited (Class II- Distribution): This
comparable was introduced by the Ld. TPO in the final list of
comparables by merely relying on his predecessor’s order for AY
2004-05. The company operates in only one segment and is
engaged in coding, marking systems and development of digital
printing systems for various markets & applications including
packaging applications, specialty industrial applications, textile
printing and security printing.
69. On appeal by the Assessee, the Ld. CIT (A) excluded this
comparable by relying on his predecessor’s order for AY 2004-05
wherein it was held that the company’s functional/business profile
of the company vis-à-vis the Assessee is dissimilar.
70. The Ld. CIT (DR) submits that the company has been taken
as a comparable after conducting a detailed functional analysis
and is functionally similar to the appellant. He emphasized that
under TNMM broad level of product similarity is required and
some degree of divergence is acceptable both in respect of product
difference and functional difference.
71 71. The Ld. Counsel for the Assessee submitted that the
company should not be taken as a comparable due to following
reasons:
(a) ________________________________ The same was included by the TPO by merely relying on his own order for AY 2004- 05 without conducting any functional analysis. This was excluded as a comparable by CIT(A) in AY 2004-05 as well. And the Department did not file an appeal on this issue against the order of the CIT(A) for AY 2004-05.
(b) ________________________________ The company is not a trader but a manufacturer cum assembler of solvents, ink- rolls, coding machines. It has a completely different functional profile as it is engaged manufacturing of marking and coding machines. Not only the activity is different, the products are also completely dissimilar.
72. We have perused the Annual Report of this company and we
find that this company is engaged in manufacturing activity. The
products are also very dissimilar to those traded by the assessee in
its Class II segment. The financials of this company state that it
has a single segment comprising of, “Coding and Marking
Machines and Consumables thereof”. It is quite obvious that this
comparable is wholly unfit to be chosen as a comparable to the
trading segment of the assessee as it is functionally dissimilar. In
A.Y 2004-05, this comparable was ordered to be removed by the
CIT (A) and no appeal was filed against his order. In these
circumstances, we hold that the Ld. CIT (A)’s order in this regard
is correct and justified and does not warrant any interference.
72 73. Gemini Communications Limited (Class II- Distribution):
The Ld. TPO included this comparable by merely relying on its
predecessor’s order for AY 2004-05. The Ld. CIT (A) excluded this
comparable by relying on his predecessor’s order for AY 2004-05
wherein it was held that the functional/business profile of the
company vis-à-vis the Assessee is dissimilar. It is a full-fledged
and end-to-end IT solutions and service provider unlike the
Assessee which is engaged in distribution operations only.
74. Before us, the CIT (DR) submits that the company has been
taken as a comparable after conducting a detailed functional
analysis and is similar to the appellant in several material
respects.
75. The Ld. Counsel for the Assessee while supporting the order
of the CIT (A) submitted that the company should not be taken as
a comparable due to following reasons:
(a) ________________________________ Gemini is engaged in the business of providing solutions on networking and communications with products of companies like Cisco, Nortel, Avaya, etc.
(b) ________________________________ The same was excluded by the CIT (A) for AY 2004-05 but the Department did not file an appeal on this issue. Since, Department has accepted it as a comparable in one year, it cannot change its stand and challenge it in the subsequent year, if there is no change in the facts and circumstances of the case.
(c) ________________________________ Further, the major products dealt by it are ‘communication equipment’ and its major source of revenue is sale of network products as well
73 as network service solutions. It is a leading networking solutions and technical service provider.
76. We have perused the orders of the lower authorities and the
Annual Report of this company. We find that this company is a
leading networking solutions service provider. As part of the
networking solutions it provides to its clients, it sells
communication equipment as well. The solutions comprise of LAN
and WAN designs, ITeS consulting solutions, data center design
solutions, security consulting solutions etc. Entire revenue has
been reported under a single segment of network products and
services. These facts show that the CIT (A) has rightly ordered its
exclusion on account of functional dissimilarity. The assessee in
its Class II segment is engaged in pure trading/distribution of
consumer electronics, home appliances, monitors and other
products. The factors of comparability provided in Rule 10B (2) are
not satisfied at all and accordingly we hold that the Ld. CIT (A) has
rightly ordered its exclusion.

GROUND NO. 2: DISALLOWANCE OF EXPENDITURE ON RECRUITMENT AND TRAINING
77. The Ld. Counsel submitted that the said issue is covered by
decision of Hon’ble Delhi High Court in Assessee’s own case for AY
1999-2000, 2002-03 and AY 2003-04 wherein the Delhi High
Court affirmed the decision of this ITAT of allowing the deduction
of expenditure incurred on recruitment and training of employees.
The Ld. AO erred in treating it as a deferred revenue expenditure
on the assumption that recruitment expenses will result in long
term benefit. He failed to appreciate that such expenditure was
revenue in nature, incurred for the purpose of business and
74 therefore allowable under section 37(1) of the Act. Ld. CIT (DR) relied on the order of the CIT (A).
78. It has now been settled that recruitment and training expenses have to be treated as revenue expenditure and cannot be seen as leading to enduring benefit warranting any disallowance. We observe that similar disallowances were made in the prior years as well which have been deleted in appeal. The issue travelled up to the High Court and the Hon’ble Delhi High Court has affirmed the view taken by this Tribunal that these expenses are allowable in full in the year in which it is incurred. Orders dated 9.06.2013 and 15.05.2017 in the appeals for A.Yrs 1999- 2000 and 2003-04 respectively of the Delhi High Court have been placed before us. Respectfully following the decision of the Delhi High Court we dismiss this ground of appeal.

AY 2006-07 (ITA No. 5856/DEL/10)
79. The facts and business model in the present Assessment Year i.e. 2006-07 are similar to the facts already stated for AY 2005-06. The appellant had filed its return of income on November 29, 2006, declaring an income of Rs. 36,26,44,434. A summary of the international transactions and the appellant’s approach in determining their ALP is given in the table below: Particulars Most Profit Margin No. of Arm’s Appropriate Level earned by compar Length Method as Indicat the ables Margin per TP or (PLI) Appellant as consid as per TP study as per per TP ered as study TP study per TP study study
Class I – Transactional OP/OR 2.22% 6 2.52%
Manufacturing Net Margin
(Consumer Method
75 Particulars Most Profit Margin No. of Arm’s Appropriate Level earned by compar Length Method as Indicat the ables Margin
per TP or (PLI) Appellant as consid as per TP study as per per TP ered as study TP study per TP study study
Electronics, and (“TNMM”)
Home
Appliances)
Import of raw
materials, Import
of stores and
service parts,
export of finished
goods, payment of
royalty, import of
fixed assets
Class II – Trading Resale Price Gross 24.78% 12 23.16%
(Consumer Margin Profit
Electronics, and (“RPM”) Margin
Home (“GPM”)
Appliances)
Import of finished
goods, import of
stores and service
parts, export of
finished goods,
payment of
royalty, import of
fixed Assets
Class III – TNMM OP/OR 6.80 5 2.29%
Manufacturing
(Color Monitors)
Import of raw
materials, import
of stores and
service parts,
export of finished
goods, import of
fixed Assets
Class IV – RPM GPM 10.15% 9 8.69%
Trading
(Color Monitors
and other IT
products)
import of finished
goods, import of
76 Particulars Most Profit Margin No. of Arm’s Appropriate Level earned by compar Length Method as Indicat the ables Margin per TP or (PLI) Appellant as consid as per TP study as per per TP ered as study TP study per TP study study
stores and service
spares, service
income from hand
held phones
80. The dispute in the present appeal (ITA No. 5856/DEL/2010) filed by the appellant pertains to the international transactions grouped under Class-I and Class-III (manufacturing) segment and Class-II and Class-IV (trading) segments. There is no dispute with respect to Class V (contract software development and reimbursement of expenses) transactions.
81. In Class-I (manufacturing segment) the appellant was engaged in the manufacturing of consumer electronic goods and home appliances and in Class-III (manufacturing segment), the appellant was engaged in the manufacturing of colour monitors. Transactional Net Margin Method was chosen as the most appropriate method in its transfer pricing study for both these segments. The profit level indicator taken was operating profit/operating revenue. For the benchmarking exercise in Class-I and Class-III segments, an economic analysis was carried out in the TP study leading to identification of 6 and 5 uncontrolled comparable companies respectively. Since the appellant had earned profit margin of 2.22% and 6.8% in the Class-I and Class- III segments respectively which was within the ± 5% range of the profit margin earned by the comparables, it was concluded that the international transactions were at arm’s length.
77 82. In Class-II (trading segment), the appellant was engaged in
the trading of consumer electronic goods and home appliances and
in Class-IV (trading segment), the appellant was engaged in the
trading of colour monitors and other IT products. For Class-II and
Class-IV segments, Resale Price Method (RPM) was chosen as the
most appropriate method to determine the ALP with Gross Profit
margin (gross profit /sales) as the profit level indicator. The
economic analysis carried out in the TP Study for Class-II and
Class-IV segments resulted in identification of 12 and 9
uncontrolled independent comparable companies respectively.
Since the appellant had earned gross profit margin of 24.78% and
10.15% in the Class-II and Class-IV segments respectively which
was higher than the profit margin earned by the comparables, it
was concluded that the international transactions were at arm’s
length.
83. The TPO rejected the most appropriate method adopted by
the assessee. He discarded the Resale Price Method for Class-II
(trading) and Class-IV (trading) segment. As per the TPO, for both
the segments Transactional Net Margin Method (TNMM) was the
most suitable method for determining of arm’s length price. Under
TNMM he selected operating profit margin on revenues (OP/OR;
OP = operating profit/ OR = operating revenue) as the profit level
indicator for both the segments. Further, the TPO while computing
the profit level indicator of the appellant for manufacturing and
trading segments increased the quantum of operating expenditure
taken into account to increase the operating profit by Rs.
86.22crores. The aforesaid amount of Rs. 86.22 crores had been
received by the appellant during the relevant financial year from
its parent company as a reimbursement under an assistance
78 agreement referred to as Marketing Development Fund (MDF)
agreement. In terms of MDF agreement, as in prior years, the
appellant had received the assistance from its parent company to
conduct certain predefined marketing activities. This amount has
been shown as reimbursement in the Form 3CEB and the transfer
pricing study and was reduced from the expenditure shown under
the head “advertisement”. Accordingly, in the profit and loss
account of the financial statement under head “advertisement”
expenditure only the net amount was shown. Though the gross
amount expended for advertisement was Rs 229.84 crores, on
account of reimbursement received of Rs. 86.22crores, the net
amount of Rs. 229.84-Rs.86.22 crores = 143.61 crores was shown
as the net advertisement expenditure. The TPO concluded that this
was an erroneous approach and was of the view that the entire
amount of Rs. 229.84 crores incurred under the head “advertisement” should be taken into account to compute
operating profit and the operating profit margin. This approach
and calculation of the TPO was based on a similar approach
adopted in the prior assessment years. Accordingly, while the
operating expenditure under the head advertisement was
increased from Rs. 143.61 crores to Rs. 229.84 crores leading to
fall in operating profit and margin, the corresponding
reimbursement of Rs. 86.22 crores received from the appellant’s
parent company was not included as part of the revenue. Based
on this approach, the operating profit margin (OP/OR) of Class-I
and Class-III manufacturing segments was determined at (-) 0.16%
and 4.42% respectively. Further, the operating profit margin
(OP/OR) of Class-II and Class-IV trading segments was determined
at (-) 1.94% and (-) 3.36% respectively.
79 84. The TPO further proceeded to undertake a fresh
benchmarking analysis of the uncontrolled comparable companies
and arrived at a set of 5 comparable companies for the Class-I
manufacturing segment, 3 comparables for the Class-II trading
segment and 11 comparables for Class-IV trading segments. The
arithmetic mean of the operating profit margin (OP/OR) of these
comparables for the Class-I manufacturing segment was computed
at 2.74%. Similarly, the profit margin of the comparables in the
Class-II and Class-IV trading segments were carried out at 2.45%
and 1.61% respectively. To compute profit level indicators of the
comparable companies, the TPO used multiple years’ data (current
and two previous years to the extent of availability of data). The
margins computed by the TPO are after making adjustments on
account of working capital differences 85. Based on the above approach, the TPO worked out an
adjustment to the arm’s length price of the international
transactions pertaining to Class-I manufacturing segment at Rs.
439,163,419/-. In respect of Class-II and Class-IV trading
segments, the adjustment to the arm’s length was worked out to
be at Rs. 509,049,110 and Rs. 300,466,885 respectively. There
was no adjustment made to the Class III and Class V segments.
86. The AO incorporated the adjustment to the ALP made by the
TPO and also made the following additions to total income:
(a) ________________________________ Recruitment and training expense of Rs. 1,03,07,792 was treated as capital expenditure and not allowable as a revenue expenditure u/s 37 of the Act;
80 (b) ________________________________ Depreciation on UPS, printers and servers was restricted to 15% as against 60% claimed by the appellant leading to a disallowance of Rs. 7,72,086.
87. The assessee being aggrieved by the orders of the TPO and
AO filed objections before the DRP, New Delhi contesting the
aforesaid additions made to the total income of the assessee on
various grounds. The Ld. DRP disposed off the objections filed by
the assessee vide its directions under section 144C of the Income
Tax Act, 1961 30th September 2010 and upheld the order of the
TPO/AO.
88. In pursuance to the DRP Directions, the AO passed the final
assessment order dated 19th October 2010. Aggrieved by the order
of the AO (impugned order), the assessee has preferred the present
appeal and has prayed for adjudication of the following grounds of
appeal.
GROUNDS IN APPELLANT’S APPEAL (ITA No. 5856/DEL/10) FOR AY 2006-07
GROUND NO. 1 & 2: These are general in nature.
GROUND NO. 3 & 4.1: These Grounds have not been pressed by
the assessee. These grounds are accordingly dismissed as not
being pressed.
GROUND NO. 4.2: That on facts and in law, the TPO/AO has erred
in rejecting Voltas Limited as a comparable company for
benchmarking the international transactions under Class II (trading
of consumer electronics and home appliances segment)
81 89. The Ld. TPO has rejected Voltas Ltd. on the sole ground that
the company is persistently making losses with declining net
margins and the Ld. DRP has upheld the Ld. TPO’s reasoning. The
Ld. Counsel for the Appellant submitted that this comparable has
been accepted by the Ld. TPO in AYs. 2004-05 and 2008-09. The
Ld. Counsel submitted that Voltas has 4 segments i.e. Electro-
mechanical Projects and Services, Engineering Products and
Services, Unitary Cooling Products for Comfort and Commercial
Use and Others. Voltas is not a loss-making company on an entity
level, rather, losses are suffered only in one segment. However, the
same segment is earning profits in future years and the loss is
only in the current financial year and immediately preceding
financial year. It has recorded a profit in the financial year 2003-
04 and therefore it is factually incorrect to treat this company as a
persistently loss-making company. Under Rule 10B(4) data of
current year and two immediately prior years can be considered if
the same has a bearing on the profitability of the company. This
Tribunal in numerous cases held that to check whether a
persistently loss company should be excluded, data of at least
three years (current plus two prior years) have to be seen.
90. The Ld. Counsel argued that Voltas cannot be said to be
categorized as a persistently loss-making entity because persistent
loss-making entities imply that losses are suffered year after year
leading to erosion of net worth. In the present case, a company
suffering losses only in two years cannot be said to be persistent
loss-making company. Further, it has been pointed out that
turnover of the company has increased over the years, and it had
no intention to close down its business and is in the market for
the long run. The Ld. Counsel contended that the courts have
82 consistently held that if a company is functionally comparable,
then it cannot be rejected merely on the basis that it is making
losses. In this regard, the Ld. Counsel places reliance on the case
laws below:
(a) ________________________________ In the cases of DCIT vs. Exxon Mobil Company India Pvt. Ltd. (ITA No. 4389/Mum/2010)(Para 7) and Bobst India (P.) Ltd. v. DCIT (ITA No. 1380 (PN) of 2010), it has been observed that exclusion of a comparable merely on the ground that the comparable is incurring abnormal profit margin or persistent losses without considering the applicable law under Rule 10B of the Income Tax Rule, 1962 (Rules) is untenable under law;
(b) ________________________________ The Special Bench of Hon’ble Chandigarh ITAT held in the case of DCIT vs. Quark Systems (P.) Ltd [2010] 38 SOT 307 (CHD.) (SB) that if a company is functionally comparable and the turnover does not show declining trend, then merely on the basis that the comparable company is incurring losses, the comparable cannot be excluded. The Hon’ble Ahmedabad ITAT reiterated the above position by relying on Quark Systems supra in the case of Erhardt+Leimer (India) Private Limited vs ACIT (ITA Nos. 3298/Ahd/2011 & 2880/Ahd/2012;
(c) ________________________________ In the case of Chryscapital Investment Advisors (India) Pvt. Ltd. Vs. DCITDelhi)/[2015] 376 ITR 183 (Delhi), the Hon’ble jurisdictional High Court reiterated the same position supra that it is a settled law that comparables cannot be excluded
83 merely on the ground that it is making abnormally high profits or losses.
91. The Ld. Counsel further relying on 24/7 Customer.Com (P.)
Ltd. v. DCIT [2013] 21 ITR (Trib) 514 (Bangalore) submitted
that when in a particular assessment year, if Arithmetic Mean
Method has been applied, comparables with abnormal
profits/losses cannot be excluded. This is for the reason that up
until April 1, 2014, Indian transfer pricing regulations followed the
Arithmetic Mean Method which took into account all comparables
irrespective of their margin variance and calculates the average of
all comparables for calculating the ALP. In contrast to this, post
April 1, 2014, Indian transfer pricing regulations now employ the
Quartile Method wherein, the companies that fall in the extreme
quartiles (i.e. abnormally high profits/losses) get excluded and
only those that fall in the middle quartile are retained for
comparability. For the AY under consideration, Arithmetic Mean
Method has been applied and thus, comparables with higher
profits/losses cannot be excluded.
92. Further, the Ld. Counsel submitted that the exclusion of
persistent loss-making companies has been in the context of IT
companies which is a booming sector where the industry trend has
been of growth and persistent losses is not normal. However, this
approach cannot be ipso facto extended to other industries such as
consumer electronics etc. which are very competitive industries as
is evident from the low margins of the comparable companies.
93. The Ld. CIT (DR) relied vehemently on the orders of the Ld.
TPO and DRP and submitted that two years of continuous losses
84 demonstrated that the company was in a downward trend and was
experiencing a situation that was different from that of the
appellant. On account of the extraordinary situation, this company
cannot be taken as a comparable. The Ld. CIT (DR) further
submitted that the Tribunal in various decisions has upheld the
application of persistent loss making as a filter.
94. We have perused the orders of the lower authorities and
examined the Annual Report of this company and seen the
profitability trend as well. This company is indisputably a
functionally comparable company and therefore the question that
requires our consideration is whether it has shown persistent
losses and whether persistent losses can be a ground for excluding
a comparable. It is now settled that a mere loss-making or
abnormally high loss/profit making company cannot be excluded
unless it can be shown that extraordinary economic factors are
present. It is also now settled that if a company has been
exhibiting persistent losses for a long period leading to erosion of
its net worth, it would be considered as facing an extraordinary
economic situation and as not being representative of the
economy/sector in which it operates. In the present facts we find
that this comparable (Voltas) has shown an operating loss only in
the current year and one prior year (F.Y. 04-05). In the financial
year 2003-04, it is stated to have earned a positive profit margin of
4% in the relevant segment. It has also been contended that its net
worth has not been rendered negative and has shown consistent
increase in turnover from F.Y. 2003-04 onwards for five years in a
row. In our view while examining whether a company can be
excluded on the ground of persistent losses, a long term trend has
to be seen and at least a period of 3 years (current year and two
85 prior years) is mandatory under Rule 10B(4). This is an exercise
which has not been carried out by the TPO. We accordingly set
aside this matter to the file of the TPO to determine whether Voltas
had shown losses in the three years covered under Rule 10B (4)
and whether its net worth had been rendered negative. If both the
conditions are found to have been met, i.e., three years continuous
losses leading to erosion of net worth, Voltas would have to be
excluded. If it is found to have failed either or both of the
conditions, it shall be retained as a comparable. While
determining this, the TPO shall take into account only that
segment of Voltas which is comparable to that of the assessee, i.e.,
cooling products. This ground is therefore disposed off in terms of
the above directions.
GROUND NO. 4.3: That on facts and in law, the TPO/AO has erred in considering Bajaj Electricals Limited as a comparable company while applying the transactional net margin method to benchmark the international transactions under Class II (trading of consumer electronics and home appliances segment)
95. The Ld. TPO has included this comparable on ground that it
is functionally similar and has been accepted as comparable by
the Appellant in FY 2004-05. The Ld. DRP has upheld the Ld.
TPO’s reasoning. The Ld. Counsel for the Appellant submitted that
Bajaj is engaged in manufacturing and distribution of various
lighting, consumer durables, galvanized structures and other
products. It has four segments as below:
• ‘Lighting’ includes Lamps, Tubes and Luminaries; • ‘Consumer Durables’ includes Appliances & Fans;
86 • ‘Engineering & Projects’ includes Transmission Line Towers, Telecommunications Towers, Highmast, Poles and Special Projects;
• ‘Others’ includes Die-casting and Wind Energy.
96. The Ld. Counsel pointed out that the gross-profit margin of
Appliance products were computed from the product schedule and
used for Resale Price Method (RPM) computation in the TP report.
However, when RPM was discarded in favour of TNMM by the TPO,
the net profit margin of the entire consumer durables segment was
selected for computation of net profit margin. It was also pointed
out by the Ld. Counsel that the assessee applied RPM for this
segment and computed the gross profit margin of the products
appearing under the head ‘Appliances’ in the product schedule of
the Annual Report. In the product schedule, there were two
categories, appliances and fans in this segment of consumer
durable. The Ld. TPO has rejected RPM and has adopted TNMM
and used the net margin of the consumer durable segment which
includes fans.
97. The Ld. Counsel contended that the Ld. TPO has committed a
gross error in including the net profit margin derived from the
manufacturing of fans as a part of the segmental profit margin
taken for benchmarking the assessee’s class II trading
transaction.The Ld. Counsel has placed his reliance in this respect
on Adidas Technical Services (P.) Ltd. v. DCIT [2016] 69
taxmann.com 401 (Delhi – Trib.), wherein it was held that, where
segmental data is not available, the comparable is liable to be
rejected.
87 98. The Ld. CIT (DR) relied vehemently on the orders of the Ld.
TPO and DRP and submitted that the company was functionally
comparable to the appellant and was rightly included in the list of
comparables by the Ld. TPO. He further submitted that Bajaj
Electricals was chosen by the assessee itself as a comparable and
it cannot now ask for its exclusion. The Ld. CIT (DR) further
submitted that fans as a product falls under the category of home
appliances and though the assessee is not trading in fans, it is
engaged in trading of other home appliances and under TNMM
broad level of product similarity is required.
99. We have perused the order of the Ld. TPO and the DRP in
this regard as well as examined the Annual Report of Bajaj
Electricals. While it is correct that the assessee itself had selected
Bajaj Electricals as a comparable, the same was done under
Resale Price Method which requires comparison at gross profit
level. Further, the assessee in its TP report had taken only the “Appliances” category as a comparable category and had excluded
the gross profit margin earned from manufacturing of fans.
Whereas, the TPO has discarded RPM and has adopted TNMM
which is a comparison of net profit margins and the TPO has
taken the net profit margin of the entire “consumer durable”
segment of Bajaj Electricals which includes both Appliances and
Fans. Most significantly the function in relation to fans in this
segment is of manufacturing and not trading. From the Annual
Report, it emerges that during the year, Bajaj Electricals had
manufactured 537,000 pieces of fans. While the consolidated sales
quantity of fans has been given at 1,784,000, the segmental break-
up of manufactured fans and traded fans is not provided. In these
88 circumstances it is not possible to determine the net profit margin
derived from the sale of traded fans. We also note that the range of
traded products of the assessee does not include fans and is
limited to consumer products like Colour TVs, Air conditioners,
Washing Machines, Microwave ovens and refrigerators. We
therefore order the exclusion of this comparable for determination
of ALP of the international transactions of the segment pertaining
to trading of consumer products of the assessee. This ground is
accordingly allowed.

GROUND NO. 4.4: That on facts and in law, the TPO/AO has erred in additionally identifying Control Print Limited and Gemini Communications Limited as a comparable company for benchmarking the international transactions under Class IV (trading of colour monitors and other IT products)
100. The Ld. Counsel pointed out that this issue has already
been decided in favour of the assessee by CIT (A) in prior years i.e.
AY 2004-05 and 2005-06. He pointed out that no appeal has been
filed by the Department before the ITAT on this issue in AY 2004-
05. However, in AY 2005-06, the Department has filed an appeal
on the same issues and the same has been covered in the
submissions for AY 2005-06. The Ld. CIT (DR) relied on the orders
of the Ld. TPO and DRP.
101. While adjudicating the appeal filed by the Dept. for A.Y.
2005-06, we have held that the Ld. CIT (A) was right in excluding
these two comparables. In this assessment year as well, we find
that the facts and circumstances relating to these two companies
(Control Print and Gemini Communications) remain the same. A
perusal of their Annual Reports shows that their functional and
89 product profile is unchanged. Control Print is a manufacturer of
coding and marking machines and Gemini Communications is
engaged in providing network solutions and as part of this exercise
sells communication equipment. In order to maintain consistency
with the approach approved by us in the prior year, in the absence
of change of facts, we order the exclusion of these two companies.
GROUND NO. 5:That on facts and in law, the TPO/AO has erred in law and facts by grossing up the advertisement and sales promotion expenses and not including the advertising reimbursements as part of income received by the appellant from its associated enterprises while computing the operating margins of the respective segments
102. The Ld. Counsel for the Appellant contends that the Ld.
DRP has merely stated that the reasons given by the TPO in his
order are correct and has failed to take into account the decision
rendered by Hon’ble ITAT in the case of Sony India Private
Limited 114 ITD 448 on this issue. The Ld. Counsel pointed out
that after the Ld. DRP issued its directions, the Hon’ble ITAT
rendered a decision on this issue in favour of the assessee in its
own case for AY 2002-03 to 2004-05 wherein it was held that the
assessee has a prior agreement for reimbursement of specific AMP
expenses and genuineness or bona fide of the said agreement
cannot be disputed. Further, it was held that based on evidence on
record, the recoveries directly correspond to actual expenses
incurred by the assessee and such expenditure was incurred in
line with terms of aforesaid agreement.
103 Further, the CIT(A), in AY 2005-06 (as well as in the earlier
years), based on merits of the case and placing reliance on ITAT
90 judgment in case of Sony India (P) Ltd supra decided the matter in
favour of the assessee by treating AMP recovery as operating
income at para no. 105.4 of the said order. It has been submitted
that it has clearly been held that the prior agreement provided for
reimbursement of specific AMP expenses and genuineness or bona
fide of the agreement cannot be questioned. Also, there are
evidences on record to prove that the expenses directly correspond
to actual expenses incurred. The Ld. Counsel contends that the
issue stands squarely covered in favour of the Appellant in its own
case for three prior years by this Hon’ble ITAT.
104. Ld. DR argued that the Marketing Development Fund
entered into by the appellant with its AE was for promotion of
brand of the AE in India. Thus, action of the Ld. TPO of making an
addition by treating AMP recovery as non-operating income and
including the same as part of the operating expenses was correct.
He also placed reliance on the DRP order wherein the DRP has
upheld the action taken by the Ld. TPO on the same reasoning.
105. We have perused the orders of the TPO and the DRP as
well as the appellate orders passed by this Tribunal on this issue
in the prior years. We observe that a coordinate Bench of this
Tribunal while deciding the appeals of the Appellant-assessee in
A.Yrs 2002-03, 2003-04, 2004-05 has examined this issue in
detail and has concluded that the approach of the TPO to treat the
reimbursement received under the MDF agreement as non-
operating income while treating the same as operating expenditure
for computing the net profit margin is unjustified and contrary to
law and principles of transfer pricing. In A.Y. 2005-06 as well, the
TPO had adopted a similar approach which was held to be
91 impermissible by the CIT (A). No appeal was preferred by the
Revenue before the Tribunal in respect of this issue. Respectfully
following the orders of the Coordinate Bench on this issue, we hold
that reimbursements received by the Appellant from its AE under
the MDF agreement has to be taken into account both as operating
income as well as operating expenditure while computing the net
profit margin under TNMM analysis. This ground is therefore
allowed.
GROUND NO. 6:That on facts and in law, the TPO/AO has erred in not restricting the transfer pricing adjustment in proportion to the value of impugned international transactions with the associated enterprise vis-à-vis the total cost base of the various business segments which included the cost of uncontrolled transactions with independent third parties also.
106. The Ld. Counsel argued that the Ld. TPO erred in not
granting the proportionate adjustment to the Appellant. It is
settled law that the adjustment is to be made only on international
transactions and not on other unrelated transactions. He placed
reliance on the following case laws for grant of proportionate
adjustment:
(a) ________________________________ IL Jin Electronics (I) (P.) Ltd. v. ACIT ITA NO. 438/DEL/2008, [2010] 36 SOT 227 DELHI) (para 15)
(b) ________________________________ CIT v. Keihin Panalfa Ltd. ITA No. 11 and 12/2015 (Del HC) (para 12)
(c) ________________________________ CIT v. Thyssen Krupp Industries India (P.) Ltd. ITA No. 2201 OF 2013, [2016] 381 ITR 413 (Bombay) (paras 3 and 4)
92 (d) ________________________________ Tasty Bite Eatables Ltd.
v. ACIT ITA NO. 1682/PN/2011 (para 37) 107. Ld. CIT (DR) relied on the order of Ld. TPO and DRP and
contended that proportionate adjustment should not be given to
the Appellant. Ld. TPO has allowed proportionate adjustment in
AY 2014-15 & AY 2015-16.
108. It is now well settled that the transfer pricing exercise is
strictly limited to the transactions with AEs and transactions with
unrelated parties do not come within its ambit. It has also been
brought to our notice that in A.Y. 2013-14 the DRP itself has
issued directions to the TPO to confine the adjustments to the
proportionate value of the international transactions with AEs.
Accordingly, the TPO is directed to restrict the amount of
adjustment, if any, made under Chapter X of the Act limited and
proportionate to the value of the international transactions with
AEs.
GROUND NO. 7: As this Ground has not been pressed by the
assessee, it is dismissed.
GROUND NO. 7.1:That on facts and in law, the AO has erred in
holding that the benefit of expenditure on recruitment and training of
employees is not restricted to one year and accordingly has to be
apportioned over 6 years, accordingly, the AO has erred in
disallowing expenditure of Rs. 1,03,07,792.
GROUND 7.2: That on facts and in law, the AO has erred in not
allowing in the year under assessment, 1/6th of the expenditure on
recruitment and training that was similarly disallowed in the
preceding five assessment years
93 109. The Ld. Counsel submitted that the said issue is covered by
decision of Hon’ble Delhi High Court in Assessee’s own case for AY
1999-2000, 2002-03 and AY 2003-04 wherein the Delhi High
Court affirmed the decision of this Hon’ble Tribunal allowing the
deduction of expenditure incurred on recruitment and training of
employees. The Ld. Counsel submitted that the Ld. AO erred in
treating it as a deferred revenue expenditure on the assumption
that recruitment expenses will result in long term benefit. He failed
to appreciate that such expenditure was revenue in nature,
incurred for the purpose of business and therefore allowable under
section 37(1) of the Act. Ld. CIT (DR) relied on order of the Ld. TPO
and DRP.
110. We have already decided this issue under Ground no. 2 in
the Dept’s appeal for A.Y. 2005-06 (ITA No. 3410/Del/12) in
assessee’s favour relying on the orders of the Hon’ble Delhi High
Court on this issue. Orders dated 9.06.2013 and 15.05.2017 in
the appeals for A.Yrs 1999-2000 and 2003-04 respectively of the
Delhi High Court have been placed before us. Respectfully
following the decision of the Delhi High Court we allow this ground
of appeal.
GROUND NO. 8.1: That on facts and in law, the AO has erred in
disallowing deduction in respect of depreciation on UPS amount to
Rs. 7,72,086 by classifying them to be plant and machinery instead
of computers
GROUND 8.2: That on facts and in law, the AO has erred in
computing the amount of the depreciation disallowance.
111. The AO allowed 15% depreciation on UPS stating that it is
covered under the head ‘plant and machinery’. Thus, 60%
94 depreciation claimed by the assessee was disallowed. In this
aspect, the Ld. Counsel submits that this issue is no longer res
integra as there are numerous decisions of the High Courts and
Tribunal where it has been held that depreciation on UPS is to be
allowed at 60% and not 15%. The Ld. Counsel contends that UPS
were purchased for the purpose of running the computer
uninterruptedly during power cuts and to prevent the loss of data
in the computer due to sudden, frequent power cuts. He stated
that UPS also controls voltage fluctuation and prevents the
damage of computer system and its parts such as hard disk,
memory etc. These UPS were connected to LAN, PCs, servers,
routers, V Sats, etc. and these would not have functioned properly
without support from the UPS. Thus, UPS form a vital component
of the computer system and therefore, the applicable rate of
depreciation on such UPS systems should be considered as 60
percent (same as that of computers) under the category of ‘Computers’. The Ld. Counsel pointed out that 60% depreciation
on UPS was allowed by the CIT (A) in assessee’s own case for AY
2005-06. Ld. CIT (DR) relies on the order of the AO and the DRP.
112. We are in agreement with the Ld. Counsel of the Appellant
that this issue is no longer res integra as this Tribunal has already
taken a view that for depreciation purposes, UPS falls under the
category of Computers being a computer peripheral. The law in
this regard has been settled by various decisions, particularly the
decision of the Hon’ble Jurisdictional High Court in the case of
CIT v. BSES Rajdhani ITA No. 1266/2010. This ground is
therefore allowed.
95 AY 2007-08 (ITA No. 5315/DEL/11) 113. The facts and business model in the present Assessment Year i.e. 2007-08 are similar to the facts already stated for AY 2005-06 and 2006-07. For the relevant assessment year, the appellant had filed its return of income on 31 October 2005 declaring an income of Rs. 104,57,52,771/- A summary of the international transactions in dispute and the appellant’s approach in determining their ALP for these disputed transactions is given in the table below: Particulars Most Profit Margin No. of Arm’s Appropri Level earned comparabl Length ate Indicato by the es Margin Method r (PLI) as Appell considere as per as per TP per TP ant as d as per TP study study per TP TP study study study
Class II -Trading – Resale Gross 24.15 10 23.08%
(Consumer Price Profit/Sa %
Electronics and Method les
Home Appliances) (“RPM”) Import of finished
goods, Import of
stores and service
spares, Export of
service spares, Service
income from hand
held phones Class III – Transacti OP/OR 0.17% 6 1.82%
Manufacturing – onal Net
(Colour Monitor) Margin
Import of raw material Method
Import of stores and (“TNMM”)
service spares, Export
of raw materials and
service spares, Import
of fixed assets, Service
96 Particulars Most Profit Margin No. of Arm’s Appropri Level earned comparabl Length ate Indicato by the es Margin Method r (PLI) as Appell considere as per as per TP per TP ant as d as per TP study study per TP TP study study study
income from hand
held phones 114. The other international transactions pertain to Classes I (Manufacturing of Consumer Electronics and Home Appliances), Class IV (Trading of Colour monitors) and class V (Contract software development). There is no dispute in respect of these transactions. The dispute in the present AY (ITA No. 5315/DEL/2011) filed by the appellant pertains to the international transactions grouped under Class-II (Trading of Consumer Electronics and Home Appliances) segment and Class- III (Manufacturing of Colour monitors) segment.
115. In respect of Class -II (Trading of Consumer Electronics and Home Appliances) segment, the following transactions have been grouped together by the appellant in its transfer pricing study prepared under rule 10B of the Income Tax Rules 1962 (Rules);
i) Import of finished goods;
ii) Import of stores and service spares;
iii) Export of service spares;
iv) Service income from hand held phones.
The appellant is engaged in the trading of consumer electronic goods and home appliances. Resale Price Method was chosen as the most appropriate method in its transfer pricing study. The profit level indicator taken was gross profit/ sales. For the benchmarking exercise, an economic analysis was carried out in
97 the TP study leading to identification of 10 uncontrolled
comparable companies. Since appellant had earned gross profit
margin of 24.15% which was higher than the gross profit of
23.08% earned by the comparable companies chosen in the TP
study, it was concluded that the international transactions in
Class-II (Trading of consumer electronic goods and home
appliances) segment was at arm’s length price.
116. In Class-III (manufacturing of colour monitor) segment,
Transactional Net Margin Method (TNMM) was chosen as the most
appropriate method to determine the ALP with operating profit/
operating revenue as the profit level indicator. The economic
analysis carried out in the TP study resulted in identification of 6
uncontrolled independent comparable companies. Since the
appellant had earned profit margin of 0.17% which was within the
± 5% range of the profit margin earned by the comparables, it was
concluded that the international transaction was at arm’s length.
117. The transfer pricing officer rejected the most appropriate
method adopted by the assessee. He discarded the Resale Price
Method for Class-II (Trading of consumer electronic goods and
home appliances) segment and adopted Transactional Net Margin
Method (TNMM) as the most suitable method for determining of
arm’s length price. Under TNMM, he selected operating profit
margin on revenues (OP/OR; OP = operating profit/ OR =
operating revenue) as the profit level indicator. The TPO further
proceeded to undertake a fresh benchmarking analysis of the
uncontrolled comparable companies and arrived at a set of 3
comparable companies for the Class-II (Trading of consumer
electronic goods and home appliances) segment and 2
98 comparables for the Class-III (Manufacturing of colour monitors)
segment. The arithmetic mean of the operating profit margin
(OP/OR) of these comparables for the Class-II (Trading of
consumer electronic goods and home appliances) segment was
computed at 4.59% and for Class-III (Manufacturing of colour
monitors) segment was computed at 5.64%. Based on the above
approach, the TPO worked out an adjustment to the arm’s length
price of the international transactions pertaining to Class-II
segment at Rs. 310,027,372/-. In respect of Class-III segment, the
adjustment to the arm’s length was worked out to be at Rs.
291,019,708/-. The TPO also carried out an adjustment with
respect to the Advertisement, Marketing and Promotion (“AMP”)
expenses incurred by the appellant company as he was of the view
that the appellant has provided certain services in respect of
creation of marketing intangibles, to its AE. The TPO was of the
view that any AMP expenditure incurred by the Appellant over and
above the average AMP spend of the comparable companies was
extraordinary in nature and incurred for the benefit of the AE
which owned the “Samsung” brand. The TPO worked out the
average AMP spend of the comparables at 6.55% of Sales and that
of the Appellant at 10.44% of Sales and treated the difference as
the value of the brand promotion service which the Appellant had
provided to its AE. He accordingly held that this amount should
have been recovered by the Appellant from its AE. The approach
followed by the TPO in respect of this adjustment is as follows:

Particulars Amount (Rs.) Total Income (A) 44,89,80,86,000
Advertisement and sales promotion expenses 469,10,06,942 incurred (B) AMP / Total Income of SIEL (C) = (B)/(A) 10.44% Bright Line (AMP/total income of 6.55%
99 comparables) (D) AMP as per bright line (‘E) = (A)*(D) 294,08,24,633 Excess Amount Spent on Advertisement as 175,01,82,309 compared to the comparables (F) = (B)-(E) Less: Reimbursement received from its 57,93,56,345/- parent SEC AMP reimbursement that should have been 117,08,25,964/- made Mark-up at 12% 14,04,99,115
Adjustment proposed on account of AMP 131,13,25,080 (including mark-up) 118. The AO incorporated the adjustment to the ALP made by
the TPO and also made the following additions to total income:
(a) Recruitment and training expenses of Rs. 1,20,69,362/- was treated as capital expenditure and not allowable as a revenue expenditure u/s 37 of the Act;
(b) Loss arising on account of fluctuation of foreign exchange currency amounting to Rs. 206,77,205/- was disallowed as being notional and contingent in nature;
(c) Depreciation on UPS, printers and servers was restricted to 15% as against 60% claimed by the appellant leading to a disallowance of Rs. 7,12,027/-.
119. The assessee being aggrieved by the orders of the TPO and
AO filed objections before the DRP, New Delhi contesting the
aforesaid additions made to the total income of the assessee on
various grounds. The Ld. DRP disposed of the objections filed by
the assessee vide its directions under section 144C of the Income
Tax Act, 1961 30th August 2011 and upheld the order of the
TPO/AO. In pursuance to the DRP Directions, the AO passed the
final assessment order dated 19th September 2011. Aggrieved by
the order of the AO (impugned order), the assessee has preferred
100 the present appeal and has prayed for adjudication of the following
grounds of appeal.
GROUNDS IN APPELLANT’S APPEAL (ITA NO. 5315/DEL/11) FOR AY 2007-08
GROUND NOs. 1 and 2: These grounds are general in nature.

GROUND NOs. 1.1 to 1.3: These grounds pertain to the AMP
issue and are identical to those already adjudicated by us in ITA
No. 3248/Del/2012 for A.Yr. 2005-06. These grounds are
therefore allowed in line with our findings and observations given
in respect of Grounds 3.1 to 3.6 of ITA no. 3248/Del/2012.
GROUND NOs. 1.4, 1.8 and 3: These Grounds are dismissed as
not being pressed.
GROUND NO. 3.1: That, on facts and in law, the Ld. TPO/ AO has
erred in rejecting Voltas Limited as a comparable company for
benchmarking the international transactions under Class II segment
(trading of consumer electronics and home appliances segment)-
120. The inclusion of this comparable came up for our
consideration in the appeal no. ITA No. 5856/Del/2010 under
Ground no. 4.2 (and has been discussed at length above). As the
facts and circumstances of this year remain the same (and the
arguments of the two parties remain the same), we hold that the
direction given by us in the prior year would apply for this year as
well. The examination of this comparable company is, therefore,
remanded to the file of the TPO with a direction to determine
whether the twin conditions of persistent loss for three years and
erosion of net worth are met. If a clear three years’ trend of
persistent loss coupled with negative net worth is found, it can be
101 excluded from the list of comparables. This ground is therefore allowed in terms of the above directions.

GROUND NO. 3.2:That, on facts and in law, the ld. TPO/ AO has erred in considering Bajaj Electricals Limited as a comparable company while applying the transactional net margin method to benchmark the international transactions under Class II segment (trading of consumer electronics and home appliances segment)
121. An identical ground in respect of this comparable (Bajaj Electricals) came up for consideration in the appeal for A.Y. 2006- 07 (ITA No. 5856/Del/2010) where we have already given our finding under Ground no. 4.3. The facts for this year are identical and the arguments advanced by the two sides are also identical. Therefore, our decision in this regard in ITA no. 5856/Del/2010 is to be followed. While deciding this ground in favour of the assessee we had directed the exclusion of this comparable as the segmental result taken into consideration includes manufacturing of fans and the assessee’s activity is limited to trading of consumer products (but not fans). A perusal of this year’s Annual Report shows that a similar situation exists in this year as Bajaj Electricals had manufactured 379,000 fans out of total of 21,78,000 fans sold by them. A bifurcation of profit margin of fans manufactured fans and traded fans are not provided. We accordingly allow this ground by following the earlier year’s position in this respect.

GROUND NO. 4:That, on facts and in law, the ld. TPO/AO has erred
in rejecting PCS Technology Limited, Spice Limited and VXL
Instruments as comparable companies for benchmarking the
international transactions under Class III segment (manufacturing of
color monitors)
102 VXL Instruments
122. The Ld. Counsel contends that the TPO committed an error
by rejecting VXL Instruments on the sole ground that it is a
persistent loss-making company with declining net margins. The
Ld. DRP upheld the order and reasoning of the TPO. The Ld.
Counsel submits that it is factually incorrect that the said
comparable is incurring persistent losses. As per the second
proviso to Rule 10B (4), we should be checking losses in the
current year and two prior years.
123. The Ld. Counsel pointed out that in subsequent years,
turnover of VXL Instruments has increased and it continues to
have operations. He contends that de-facto rejection of a negative
margin company is not correct. He further contended that if a
company is functionally comparable, then it cannot be rejected
merely on the basis of suffering losses. In this regard, he has
placed reliance on the following judicial decisions:
(a) DCIT vs. Exxon Mobil Company India Pvt. Ltd. (ITA No. 4389/Mum/2010) (Para 7) and Bobst India (P.) Ltd. v. DCIT (ITA No. 1380 (PN) of 2010): In both these cases, it was held that exclusion of a comparable merely on the ground that the comparable is incurring abnormal profit margin or persistent losses without considering the applicable law under Rule 10B of the Income Tax Rule, 1962 (Rules) is untenable under law;
(b) DCIT vs. Quark Systems (P.) Ltd [2010] 38 SOT 307 (CHD.) (SB): In this case, it was held that if the company is functionally comparable and the turnover does not show declining trend then, merely on the basis that the comparable company is incurring losses, the comparable cannot be excluded;
103 (c) Erhardt+Leimer (India) Private Limited vs. ACIT (ITA Nos. 3298/Ahd/2011 & 2880/Ahd/2012): Relying on the special bench decision in the case of Quark Systems (supra) the Hon’ble Tribunal has held as below:
“…consistent loss-making entities cannot be per se excluded merely in view of the negative income figures thereof.”

(d) Chryscapital Investment Advisors (India) Pvt. Ltd. Vs. DCIT (ITA 417/2014): [2015] 376 ITR 183 (Delhi), the Hon’ble jurisdictional High Court reiterated the same position supra that it is a settled law that comparables cannot be excluded merely on the ground that it is making abnormally high profits or losses.
124. The Ld. Counsel pointed out that in the present case, no
extraordinary economic factor leading to persistent losses are
evident from the annual report of VXL Instruments. The company
is showing a steady increase of turnover on year-on-year basis
except for a small dip in the F.Y. 2005-06 followed by a quick
recovery in FY 2006-07 where there was a sharp increase in
turnover. The trend analysis of the profit margin and the turnover
as given below clearly shows that this company was passing
through a temporary phase of losses from which it has recovered.
Such losses are normal incident in the market and the purpose of
providing for a computation of average under section 92C (2) of the
Act, has been provided to account for profit as well as loss making
companies. He submitted the Turnover and Net margin trend for
different years:

Assessment Segmental NPM Year Turnover (INR in
104 crores) AY 2004-05 49.48 0.96% AY 2005-06 52.38 0.24% AY 2006-07 40.26 -11.09% AY 2007-08 72.81 -1.92% AY 2008-09 93.43 -7.53% AY 2009-10 80.38 2.14% AY 2010-11 76.60 1.26% 125. Thus, he submitted that it can be seen from the trend
analysis that there is no trend of persistent losses on a long-term
basis. Further, the trend of sales on year-on-year basis shows that
the company clearly has an upward trend. Therefore, it cannot be
branded as a persistent loss maker.
126. The Ld. CIT (DR) vehemently argued that since VXL
Instruments was persistently making losses, it was rightly rejected
as a comparable by the Ld. TPO and the said rejection was rightly
upheld by the DRP. He pointed out that this company has
experienced losses in the current year, prior year and the
subsequent year and on account of this trend it is evident that this
company is a persistently loss-making company. He further
submitted that this Hon’ble Tribunal has held in various
judgments that a persistently loss-making company cannot be
taken as a comparable.
127. While examining the suitability of another comparable, viz.,
Voltas Industries Ltd. in this appeal as well in the prior year’s
appeal, we have examined the issue of persistent loss making
entities that are sought to be used as functionally comparable
companies under TNMM. We have already held that a persistent
loss trend has to be carefully gleaned from the facts of the case to
105 check whether this trend persists over a period of at least three
years (current year and two prior years as specified in Rule 10B
(4)). Furthermore, as loss and profit cycles are normal incident of
the market, in order to check whether the persistent loss situation
has arisen from an extraordinary economic situation which is not
representative of the sector in which it operates, one has to see
whether the net worth of the company has been eroded. If the twin
conditions are fulfilled, the comparable can be excluded. In this
case, though a chart of trend analysis has been furnished, it has
not been examined by the TPO. The details of net worth are not
placed before us. We accordingly remit this issue to the file of the
TPO with a direction to apply the aforesaid principles to determine
the suitability of this comparable. This ground is therefore
disposed off in terms of the above observations.

PCS Technology Ltd.
128. Ld. Counsel contends that the TPO and the DRP committed
an error in rejecting PCS Technology on the ground that it has a
different financial year ending. He contends that different financial
year is not a criterion to reject a comparable company. He
contends that this company was accepted in AY 2006-07 by the
TPO in which year too, the financial year of the company ended in
June. The Ld. Counsel also submitted that the company’s net
profit margin for April-March can be extrapolated from the figures
of the two overlapping years. He placed reliance on DCIT vs.
McKinsey knowledge Centre India private limited (ITA No.
195/del/2011), affirmed by the Hon’ble High Court of Delhi
[TS-672-HC-2015(DEL)-TP] to contend that extrapolated figures
for the financial year has been approved by the Court.
106 129. Ld. CIT (DR) relied on the reasoning given by Ld. TPO and
DRP and argued that since PCS Technology has a different
financial year ending, it cannot be included in the list of
comparables for the Appellant.
130. We have perused the reasoning given by the TPO and the
Annual Report of this company (PCS Technology Ltd.). As per Rule
10B (4) current year data is to be primarily used for comparison
under any of the specified methods. If the time period of
comparison does not converge, the accuracy of comparison gets
compromised. We do not agree with the contention of the Ld.
Counsel that financial year ending is an irrelevant factor for the
purpose of comparison under TNMM. In our view the law clearly
stipulates the time period for which the data can be used for
determination of ALP. It is only in certain situations where the
company maintains and publishes quarterly results, the results
for April-March period can be accurately extrapolated. In other
situations where quarterly results are not available, any effort to
derive at April-March results by extrapolating the figures on a
proportionate basis would be fraught with the risk of inducing
inaccuracy in the comparability process. The Hon’ble High Court’s
decision in Mckinsey Knowledge Centre (supra) was also rendered
in the context of availability of quarterly results. In the present
case, the extrapolated results submitted by the Ld. Counsel have
not been drawn from published quarterly results but derived on a
proportionate basis from the two overlapping years’ financials.
This approach is not tenable and is accordingly rejected. This
ground in respect of PCS Technology Ltd. is, accordingly,
dismissed.
107 Spice Mobile Ltd.
131. Ld. Counsel pointed out that the TPO erred in rejecting
Spice Mobile Ltd. from the list of comparables on the ground that
it is not clear from the financials if the company is performing
manufacturing operations. The Ld. DRP upheld order of the TPO
on the same reasoning. Ld. Counsel submitted that the company
has 2 segments – IT segment and mobile segment. In the IT
segment, the company is engaged in the business of
manufacturing of computer systems and printers. Sales from
computer systems and printers amount to Rs. 37.01 crore out of
total sales of Rs. 52.1 crore in the IT segment. This works out to be
71% of the total revenue. The balance 29% is derived from trading,
installation and networking. The calculated as submitted by the
Ld. Counsel from the Annual Report is as below:
Particulars Amount in INR – thousands Turnover of IT segment 521,912 Passbook printers 234,423 (manufactured) Computer Systems 135,728 (manufactured) Sale from manufactured goods 370,151 Ratio of sales from 71% manufacturing goods to turnover of IT segment 132. The Ld. CIT (DR) submitted that Spice Mobile was rightly
excluded from the list of comparables because it was not
functionally comparable. Further, he contended that from the
financials of the relevant segment, it was not clear if Spice Mobile
was manufacturing comparable products.
108 133. We have perused the orders of the TPO and the Annual
Report of Spice Mobile Ltd. This company has reported two
segments – mobiles and Information Technology. In the IT segment
it has significant operations in manufacturing of computer
systems and peripherals which are comparable to the assessee’s
Class III segment wherein computer peripherals like monitors are
being manufactured. However, the IT segment also has trading
and installation revenues. The split between the manufacturing
sales and other sales is 70:30 whereas break-up of operating costs
between manufacturing and trading is not discernible from the
report. In these circumstances, it is not possible to accept the
inclusion of this company as a comparable. It is now well settled
that if accurate segmental results are not available, the same
cannot be used for TNMM benchmarking. We accordingly dismiss
this ground pertaining to inclusion of Spice Mobiles Ltd.
GROUND NO. 5: That, on facts and in law, the Ld. TPO/AO has
failed to make appropriate adjustments to account for the
differences in working capital employed by the appellant vis-à-vis
the comparables, thereby disregarding the provisions of the Indian
transfer pricing regulations and several judicial pronouncements on
this subject
134. The Ld. Counsel contends that appropriate adjustment to
account for differences in working capital employed by the
appellant vis-à-vis comparables ought to be allowed. He submitted
that the TPO erred in not granting the working capital adjustment
to the appellant to account for differences in working capital
employed by the appellant vis-à-vis comparables. He argued that
the TPO himself has allowed the working capital adjustments in
109 two preceding years, i.e., AY 2005-06 & 2006-07. He further
submitted that working capital adjustments usually include
adjustments for accounts payable, accounts receivable and
inventory. These adjustments ensure that the absolute levels of
the relevant balance sheet items are normalized by measuring
them against the total cost. In respect of grant of working capital
adjustment, the Ld. Counsel placed reliance on the following
judicial decisions:
(a) ________________________________ Capgemini India Private Limited ITA No. 786/MUM/2011), [2013] 27 ITR(T) 74 (Mumbai – Trib.) (para 6)
(b) ________________________________ Demag Cranes & Components India Private Limited v. DCIT ITA No. 120/PN/2011, [2012] 144 TTJ 320 (Pune) (para 31)
(c) ________________________________ M/s Nevis Network (India) Pvt. Ltd v. ITO ITA No.338/PN/2012, [2015] 55 taxmann.com 519 (Pune – Trib.) (paras 11 and 13)
(d) ________________________________ Nortel Networks India Private Limited v. ACIT ____________ ITA No. 4765/DEL/2011, [2015] 40 ITR(T) 102 (Delhi – Trib.) (para 11.8)
(e) ________________________________ M/s Motorola Solutions India Private Limited v. ACIT Circle-2 ITA No. 5637/Del/2011, [2014] 35 ITR(T) 546 (Delhi – Trib.) (para 162.1)
(f) _________________________________ Qualcomm India Pvt. Ltd. v. ACIT Circle 14(1) ITA No.5239/DEL/ 2010, [2014] 147 ITD 17 (Delhi – Trib.) (para 41)
(g) ________________________________ Mentor Graphics (Noida) (P) Ltd. (109 ITD 101)
110 135. The Ld. CIT (DR) relied on the orders of the lower
authorities.
136. The issue of grant of adjustment for difference in levels of
working capitals between the assessee and the comparable
companies is now well recognized by this Tribunal and is no longer
res-integra. Differences in inventory levels, credit period allowed by
the suppliers and credit period given to its customers lead to
capital being locked in circulation. The net profit margins do not
reflect this difference. An entity which permits a longer credit
period of realizing its sale proceeds would want to receive
compensatory interest which is often inbuilt in the price of
goods/services sold. Similarly, a customer who is paying the full
price upfront would want a discount to account for the prompt
payment that is made. Therefore, working capital adjustment is
nothing but accounting for time value of money. The necessity and
desirability of an adjustment for the same is advocated by the
OECD and the UN guidelines on Transfer Pricing as well.
Economic adjustment of this nature is also mandated by Rule
10B(3) and Rule 10B(1)(e)(iii). In light of this discussion, we allow
this ground and hold that TPO should, while determining the net
profit margins of the comparables should compute and allow
suitable adjustments for differences in working capital. We also
note that this is justified from the angle of consistency as well
because the TPO himself had made working capital adjustments to
the margins of the comparables in the two prior assessment years.
GROUND NO. 6: That, on facts and in law, the Ld. TPO / Ld. DRP
has erred in not restricting the transfer pricing adjustment in
111 proportion to the value of impugned international transactions with
the associated enterprise vis-à-vis the total cost base of the various
business segments which included the cost of uncontrolled
transactions with independent third parties also
GROUND NO. 6.1: Without prejudice, the ld. AO / Ld. DRP has
erred in holding that the value of international transactions is
approximately 50% of the total cost and therefore the international
transactions have significant effect on the total profitability which is
not true for Class II transactions for which adjustment may be
restricted in proportion to the value of international transactions
137. This ground is identical to Ground no. 6 of ITA No.
5856/DEL/2010 for A.Y. 2006-07 which has been adjudicated in
favour of the Appellant. Accordingly, following our own approach
in prior year this ground is allowed.
GROUND NO. 8 & 8.1: That, on facts and in law, the Ld. AO has
erred in holding that expenditure on recruitment and training of
employees’ leads to enduring benefit to the appellant and in holding
to allow only 1/6th of the total expenditure in the current year and
deferring the balance to be allowed in next five years
Without prejudice to the above, the Ld. AO has erred in not allowing
in the year under assessment, 1/6th of the expenditure on this
account that was similarly disallowed in the preceding five
assessment years.
138. These grounds are identical to Ground no. 2 in ITA
No.3410/Del/2012 for A.Y. 2005-06 and Ground nos. 7.1 and 7.2
in ITA no. 5856/Del/2010 for A.Yr.2006-07 and we have allowed
these grounds in the two years by following the orders of the
Hon’ble Delhi High Court in prior years. Following the same, these
grounds are therefore allowed.
112 GROUND NO. 9: That, on facts and in law, the Ld. AO has erred in
not treating UPS connected to computers as ‘computers’ and instead
regarding it as an item of general ‘plant and machinery’ for the
purpose of allowing deprecation
GROUND NO. 9.1: Without prejudice to the above ground, the Ld.
AO has also erred in not regarding said ups as ‘electrical equipment
being automatic voltage controllers’, eligible for depreciation @80%
under Item III(8)(ix)(e)(c) of Part A of Appendix I to the Income Tax
Rules, 1962 (‘the Rules’)
139. While deciding the appeal for A.Y. 2006-07 (ITA No.
5856/Del/2010), we have already allowed the ground no. 8.1 and
8.2 by holding that depreciation on UPS is to be allowed at 60%
under the category of computers. Following the same, we allow
this ground.
GROUND NO. 10: That, on facts and in law, the Ld. AO has erred
in holding that loss on exchange fluctuation amounting to Rs.
2,06,77,205 debited to P&L account is a notional loss and is not
allowable as a deduction under the provisions of the Act
140. The assessee in order to hedge itself against forex
fluctuations which impacts its export proceeds and import price it
has to pay in the course of business enters into forward foreign
exchange contracts from time to time. These contracts which
remain open and unexpired on March 31st are marked to the
market as per generally accepted accounting principles. If there is
loss on the open contract the same is debited to the P&L account
and claimed as a deduction u/s 37 of the Act. The AO in his
assessment order has held that the provisions of Act do not allow
deduction of any such notional loss for which the liability has not
113 crystallized. Therefore, Marked to Market (MTM) losses on account
of revaluation of forex forward contracts are only notional and are
deductible as business losses under income tax provisions. For the
purpose of taxation, MTM Losses should be considered as just
notional losses which do not involve any actual outgo as the
assessee is not liable to pay such losses. This view of the AO has
been upheld by the Ld. DRP.
141. The Ld. Counsel for the appellant-assessee submits that
the Ld. AO has erred in holding that loss on exchange fluctuation
debited to P&L account on account of revaluation of open forward
forex contracts is a notional loss for which liability is not
crystallized or is contingent upon the actual settlement of forward
contracts and is not allowable as a deduction under the provisions
of the Act. The foreign exchange loss was incurred on the
restatement of value of forward contracts which are executed in
respect of underlying transactions of revenue nature i.e. trade
payables/receivables and not for purchase of capital asset or any
speculative purposes and, hence, the loss was claimed as
deductible expense. It was explained that in a foreign exchange
contract, there is a binding obligation to buy or sell a certain
amount of foreign currency at a pre-agreed rate of exchange, on a
certain future date. Due to binding nature of agreement, the
liability of the Appellant accrued the moment it entered into
forward contract. It was mandatory for the Appellant to measure
the MTM losses on the unexpired forward contracts at the end of
the year in accordance with the method of accounting consistently
followed by it with respect to the effects of changes in foreign
exchange rates. The Ld. Counsel stated that this issue is now well
settled in view of the Hon’ble Supreme Court decisions of CIT v.
114 Woodward Governor India Private Ltd. 312 ITR 254 (SC) and
Bharat Earth Movers v CIT: [2000] 245 ITR 428(SC). He further
submitted that in the assessee’s own case in ITA no.
6508/Del/2012 this Tribunal has examined this issue and given a
finding that such MTM losses are allowable u/s 37 of the Act.
142. We have heard both the sides and examined the orders of
the lower authorities. We observe that the losses have been
recognized in accordance with applicable accounting
standards/consistent accounting policy. The Hon’ble SC judgment
of CIT v. Woodward Governor India Private Ltd. 312 ITR 254
(SC) has settled the issue of allowability of forex losses recognised
on the last date of Balance sheet u/s 37 of the Act arising on
account of trading transactions. The Hon’ble Apex Court has
categorically held that loss on account of exchange difference or
mark to market losses as on the date of Balance sheet is not a
notional or contingent loss and has to be allowed as ordinary
principles of commercial accounting should be applied while
deciding deductibility under the Act so long as they do not conflict
with any express provisions of the Act. Further, in the case of
Bharat Earth Movers v CIT: [2000] 245 ITR 428(SC), the
Hon’ble Apex Court had held that if a liability has definitely arisen
in accounting year, deduction should be allowed although liability
may have to be quantified and discharged at a future date but
what should be definite is incurring of liability. The Ld. Counsel for
the appellant has placed before us a copy of an order passed u/s
154 of the Act where similar forex losses in A.Yr.2005-06 has been
allowed by relying on the Hon’ble SC judgement of Woodward
Governor (supra). Further, this Tribunal has examined and
adjudicated this issue in favour of the assessee in ITA No.
115 6508/Del/2012 in the case of Samsung Technology India Pvt. Ltd which had subsequently merged with the assessee. In view of the above discussion and respectfully following the authority laid down by the Hon’ble Supreme Court, this ground is allowed.

AY 2008-09 (ITA No. 52/DEL/13)
143. The facts and business model in the present Assessment Year i.e. 2008-09 are similar to the facts already stated for AY 2005-06, 2006-07 & 2007-08. The appellant had filed its return of income on November 30, 2008, declaring an income of Rs. 173,84,64,490/-. A summary of the international transactions of the appellant and the appellant’s approach in determining their ALP is given in the table below: Particulars Most Profit Level Margin No. of Arm’s Appropria Indicator earned by comparables Length te Method (PLI) as per the considered as Margin as per TP TP study Appellant per TP study as per study as per TP TP study study
Class I – Transactio Operating 4.43% 7 2.77%
Manufacturing nal Net Profit /
(Consumer Margin Operating
electronics and Method Revenue
home appliances) (‘TNMM’)
Import of raw
material, Import of
stores and services
spares, Export of
raw material and
services spares,
Export of finished
goods, Payment of
Royalty, Import of
fixed assets,
Import of spares
for repair and
maintenance,
Availing of
technical services,
116 Particulars Most Profit Level Margin No. of Arm’s Appropria Indicator earned by comparables Length te Method (PLI) as per the considered as Margin as per TP TP study Appellant per TP study as per study as per TP TP study study
Reimbursement of
marketing
expenditure by
AEs
Class II – Trading TNMM Operating 2.22% 7 1.78%
(Consumer Profit /
electronics, home Operating
appliances and Revenue
mobile phones)
Import of finished
goods, Import of
stores and service
spares, Service
income,
Reimbursement of
marketing
expenses by AEs Class III – TNMM Operating -1.55% 5 -2.50%
Manufacturing Profit /
(Colour monitors) Operating
Import of raw Revenue
material, Import
of stores and
service spares,
Export of raw
material and
service spares,
Import of fixed
assets,
Reimbursement of
marketing
expenses by AEs
Class IV – TNMM Operating 3.37% 9 -0.52%
Trading Profit /
(Colour monitors Operating
and other IT Revenue
products)
Import of finished
goods, Import of
stores and services
spares,
117 Particulars Most Profit Level Margin No. of Arm’s Appropria Indicator earned by comparables Length te Method (PLI) as per the considered as Margin as per TP TP study Appellant per TP study as per study as per TP TP study study
Reimbursement of
marketing
expenses by AE
Class V – TNMM Operating 17.60% 23 14.65%
Contract Profit /
Software Operating
Development Cost
Services
(Provision of
contract software
development
services) 144. The dispute in the present appeal (ITA No. 52/DEL/2013) filed by the appellant pertains to the international transactions grouped under Class-II (Trading of Consumer Electronics, Home Appliances and Mobile Phones) and Class-III (Manufacturing of Colour Monitors) segment. The other international transactions pertain to Classes I (Manufacturing of Consumer Electronics and Home Appliances), Class IV (Trading of Colour monitors and other IT products) and Class V (Contract software development services). There is no dispute in respect of these transactions.
145. In Class-II (Trading of Consumer electronics, Home Appliances and Mobile Phones) segment, the appellant was engaged in the trading of consumer electronics, home appliances and mobile phones and in Class-III (Manufacturing of Colour Monitors) segment, the appellant was engaged in the manufacturing of colour monitors. Transactional Net Margin Method was chosen as the most appropriate method in its transfer
118 pricing study for both these segments. The profit level indicator
taken was operating profit/operating revenue. For the
benchmarking exercise in Class-II and Class-III segments, an
economic analysis was carried out in the TP study leading to
identification of 7 and 5 uncontrolled comparable companies
respectively. Since the appellant had earned profit margin of
2.22% and -1.55% in the Class-II and Class-III segments
respectively which was higher than the profit margin earned by the
comparables, it was concluded that the international transactions
were at arm’s length.
146. The TPO rejected the economic analysis undertaken by the
appellant and proceeded to undertake a fresh benchmarking
analysis by accepting certain comparables of the appellant and
introducing certain new comparables. The TPO arrived at a set of 7
comparable companies for the Class-II trading segment and 2
comparables for the Class-III manufacturing segment. The
arithmetic mean of the operating profit margin (OP/OR) of these
comparables for the Class-II trading segment was computed at
5.21%. Similarly, the profit margin of the comparables in the
Class-III manufacturing segment was carried out at 2.94%. vide
Order dated 14 October 2011, the TPO proposed an adjustment of
Rs. 50,24,84,061/- pertaining to Class-II (trading segment) and
Rs. 18,99,32,764/- pertaining to Class-III (manufacturing
segment). Further, he proposed an adjustment of Rs.
454,94,35,445/- with respect to AMP expenses incurred by the
appellant because he was of the view that the appellant has
provided certain services in respect of creation of marketing
intangibles, to its AE.
119 Computation of TP adjustment (In Rs.)
Value of gross sales 55,784,998,000/-
AMP/Sales of the comparables 2.07%
Amount that represents bright line 1,154,749,458/-
Expenditure on AMP by assessee 5,542,768,817/-
Expenditure in excess of bright line 4,338,019,359/-
Mark-up at 15% 658,202,903/-
Reimbursement that assessee should have 5,046,222,262/-
received
Reimbursement actually received 496,786,817/-
Adjustment to assessee’s income 4,549,435,445/-

147. The assessee being aggrieved by the orders of the TPO and
AO filed objections before the DRP, New Delhi contesting the
aforesaid transfer pricing adjustments. The DRP disposed of the
objections filed by the assessee vide its directions under section
144C of the Income Tax Act, 1961 dated 27 September 2012 and
directed as follows:
(a) ________________________________ The DRP directed the exclusion of Spice Mobiles Ltd. as a comparable for Class II segment and arrived at a final list of 6 comparables. The arithmetic mean of the Net Profit Margin of these 6 comparables was calculated at 5.10% vis-à-vis 2.22% of the appellant. Thus, the adjustment for Classs-II segment was reduced to Rs. 48,40,26,768;
(b) ________________________________ The DRP also directed the TPO to exclude three companies i.e. Compuage Infocom Ltd., Redington India Ltd. and Computer Point Ltd. as comparables for determining the bright line of AMP expenditure. These companies were directed to be excluded because the amount incurred by these companies on marketing and selling was ‘nil’. The DRP directed to exclude VXL Instruments Ltd. because it was a persistently loss-
120 making company. Further, to fix the Bright Line, the Ld. DRP directed to exclude cash discount for calculating AMP expenditure of the appellant as well as the comparables. Further, it directed to include other discounts and commission payments reflected in P&L account of comparables in the AMP expenditure to fix the Bright Line. A final set of 7 comparables was directed to be used for determining the bright line. The computation of AMP adjustment was revised as under:

Particulars Amount (Rs.) Value of Gross Sales 55,784,998,000 AMP/ Sales of the Comparables 2.95% Amount that represents Bright Line 1,645,657,441 Amount actually spend on AMP 5,54,27,68,817 Expenditure
Amount spent in excess of ‘bright line’ and 3,89,71,11,376 on creation of marketing intangibles Mark-up @15% 58,45,66,706 The amount by which Samsung India 4,48,16,78,082 should have been reimbursed Amount reimbursed 49,67,86,817 Adjustment (Rs.) 3,98,48,91,265 148. Based on the above directions, the TPO vide his rectified
order dated 31 October 2012 made a final adjustment of Rs.
4,65,88,50,797 which comprised of (i) adjustment on account of
AMP expenditure at Rs. 398,48,91,265/-, (ii) adjustment in respect
of Class-II (trading segment) at Rs. 48,40,26,768/- and (iii)
adjustment in respect of Class-III (manufacturing segments) at Rs.
18,99,32,764/-.
149. The AO incorporated the adjustment to the ALP made by the
TPO and also made the following additions to total income:
121 (a) Recruitment and training expense of Rs. 2,07,83,696 was treated as capital expenditure and not allowable as a revenue expenditure u/s 37 of the Act;
(b) Foreign exchange fluctuation loss of Rs. 1,74,38,690 was not allowed as a deduction;
(c) Depreciation on UPS, printers and servers was restricted to 15% as against 60% claimed by the appellant leading to a disallowance of Rs. 7,24,741.
150. Aggrieved by the order of the AO, the assessee has preferred
the present appeal and has prayed for adjudication of the following
grounds of appeal.
GROUNDS IN APPELLANT’S APPEAL (ITA NO. 52/DEL/13) FOR AY 2008-09
GROUND NO. 1 & 2: These grounds are general in nature.

151. GROUND NO. 2.1 to 2.12: These grounds pertain to the
issue of AMP expenditure being treated as an international
transaction and adjustment being made on the basis of the “bright
line” test. We have already decided this issue in favour of the
appellant in ITA no. 3248/Del/2012 for the A.Y. 2005-06 by
examining this issue in detail. These grounds for this year are
accordingly allowed and disposed-off on the lines of our findings
and observations made while deciding Grounds no. 3.1 to 3.6 of
ITA no. 3248/Del/2012.

GROUND NO. 3: That on facts and in law, the Ld. AO/TPO erred in
rejecting Shyam Telecom Limited as a comparable company for
determining the ALP of international transactions under Class II
122 segment (trading of consumer electronics, home appliances and
mobile phones)
152. The Ld. TPO rejected Shyam Telecom for the sole reason
that it was a persistently loss-making company. The Ld. DRP was
of the view that the company was functionally different since the
company has significant export income from trading and relevant
segment considered by the appellant is not purely a trading
segment but engaged in turnkey projects and trading.
153. The Ld. Counsel argued that Shyam Telecom is not a
persistent loss-maker because on an entity basis, the company
has shown positive operating profit year on year even though
relevant segment incurred losses. He submitted that this
comparable has been accepted by the Ld. TPO in subsequent 2
years and thus, the principle of consistency should be followed. He
pointed out that the principle of consistency has been upheld in
Brintons Carpets Asia P. Ltd. v. DCIT (ITA 1296/PN/2010). The
Ld. Counsel submitted that Shyam Telecom operates under three
business segments as stated in the table below:

Segment Name Segment Description Telecom Products & Services The Telecom products & Services segment comprise of manufacturing and services in the related area. Turnkey Projects and Trading Turnkey Projects and trading services segment includes the turnkey projects and trading in telecom products.
Investments (including Dividend) Investments are primarily in the subsidiaries which are dealing in telecommunication
123 sectors.
He pointed out that over 99% income under Turnkey Projects and
Trading Segment are attributable to trading income from sale of
GSM handsets, accessories, communication systems and
components. Revenue from GSM handsets & accessories is Rs.
157.08 crores which is 99% of total revenue from the Turnkey
Projects and trading segment as is evident from the table below:

Particulars Amount (In INR) (In Lakhs) Total revenue from Turnkey projects and trading 15,893 segment Total revenue from traded goods 15,708 Ratio of traded goods to segmental revenue 99% 154. Ld. Counsel argued that in this case, no extraordinary
economic factor leading to persistent losses are evident from the
annual report of the company. Such losses are normal incident in
the market and the purpose of providing for a computation of
average under section 92C (2) of the Act, has been provided to
account for profit as well as loss making companies.
155. The Ld. CIT (DR) vehemently relied on the order of the TPO
and argued that Shyam Telecom was correctly excluded. He
argued that since Shyam Telecom is a persistently loss-making
company and it has a different functional profile, it cannot be
included in the list of comparables to determine arm’s length price.
The Ld. CIT (DR) pointed out that the quantum of revenue derived
124 from turnkey project was INR 1.85 crores out of total segment
revenue of INR 158.93 crores which was a material amount and
cannot be ignored.
156. We have examined and perused the orders of the lower
authorities and also the Annual Report of Shyam Telecom Ltd.
While the basis of the claim that this company is a persistent loss-
making one is not very clear, it is manifest that the product profile
of this entity is very dissimilar to that of the assessee’s. The
relevant segment which is being sought to be taken for comparison
is called the “Turnkey” segment. In this segment, predominant
part of the revenues is derived from trading of GSM sets and
communication network. Only a very small portion of revenue is
derived from turnkey projects. However, the breakup of sales and
profit margins of GSM phones and other equipment is not
available in the Annual Report. In such a situation it would be an
error to allow the inclusion of this comparable. This ground is
accordingly dismissed.
GROUND NO. 4: That, on facts and in law, the Ld. AO/TPO has
erred in considering Bajaj Electricals Limited as a comparable
company for determining the ALP of international transactions under
Class II segment (trading of consumer electronics, home appliance
and mobile phones).
GROUND NO. 5: That, on facts and in law, the Ld. AO/TPO has
erred in rejecting PCS Technology Limited and VXL Instruments
Limited as comparable companies for determining the ALP of
international transactions under Class III segment (manufacturing of
colour monitors).
125 157. Ground no. 4 pertaining to Bajaj Electricals Ltd. is identical
to the Ground no. 4.3 in ITA no. 5856/Del/2010 for A.Y. 2006-07
and Ground no. 3.2 in ITA no. 5315/Del/2011 for A.Y. 2007-08.
As the material facts and circumstances and the arguments taken
by both sides remain the same, this ground is decided on the
findings and observations made in these two years. As in prior
years, the material fact that needs to be seen is whether the
segment of consumer products taken by the TPO includes
manufacturing of fans. The Annual Report of Bajaj Electricals for
the F.Y. 2007-08 reveals that in this year as well the company had
manufactured 2,87,000 fans out of a consolidated sales quantity
of 27,07,000 fans and the net profit margins of the manufactured
and traded fans are not provided. In the absence of these details
Bajaj Electricals Ltd cannot be taken as a comparable.
158. Ground no. 5 pertains to two companies which have been
sought to be included as comparables – these are PCS Technology
Ltd. and VXL Instruments Ltd. The suitability of these two
companies as comparables for the Manufacturing Segment has
already been examined by us in the appeal for A.Y. 2007-08, where
identical questions and arguments had been raised by the two
sides. In the said appeal (ITA No. 5315/Del/2011) while
adjudicating Ground no.4 pertaining to these comparables, we
have held that PCS Technology Ltd. is not a suitable comparable in
the absence of accurate financials and for VXL Instruments, we
have ordered a remand to the file of the TPO to determine whether
the twin conditions of persistent loss (for current and two prior
years) coupled with erosion of net worth are present. These
directions would be equally applicable to these comparables for
this year as well as the facts and circumstances remain the same.
126 Accordingly, Ground nos. 4 and 5 are partly allowed.
GROUND NO. 6: That, on facts and in law, the Ld. AO/TPO has
erred by not making appropriate adjustments to account for
differences in working capital employed by the appellant vis-à-vis
the comparables-
GROUND NO. 7: That, on facts and in law, the Ld. AO/TPO has
erred in not restricting the TP adjustment in proportion to the value
of international transactions with the associated enterprises vis-à-
vis the total cost base of the various business segments which
included cost of uncontrolled transactions with independent third
parties as well
159. Ground no. 6 pertains to the issue of allowability of
economic adjustment to account for differences in working capital
between the assessee and the comparables chosen for TNMM
analysis and the same has already been adjudicated by us under
Ground no. 5 for the appeal for A.Y. 2007-08 (ITA No.
5315/Del/2011). We have held that this issue of working capital
adjustment is now no longer res integra and has to be allowed.
This would be equally applicable for this year as well and this
ground is accordingly allowed. The TPO is directed to compute the
adjustment while determining the arm’s length price under TNMM.
160. Similarly, Ground no. 7 pertaining to restricting the
transfer pricing adjustment to the proportionate value of the
international transactions has been decided by us under Ground
no. 6 of ITA No. 5856/DEL/2010 for A.Y. 2006-07 and Ground no.
6 of ITA no. 5315/Del/2011for A.Y. 2007-08 by allowing the same.
Our observations and order in this respect would apply to this
Ground as well.
127 These two grounds 6 and 7 are accordingly disposed off in terms of
the above observations.
GROUND NO. 8: This ground is dismissed as not being pressed.
GROUND NO. 9: That, on facts and in law, the Ld. AO has erred in
holding that expenditure on recruitment and training of employees
leads to enduring benefit to the appellant and in allowing only 1/6th
of the total expenditure in the current year and deferring the
balance to be allowed in next five years and in doing so disallowing
expense of Rs. 2,07,83,696
GROUND 9.1: Without prejudice to above, the Ld. AO has erred in
not allowing in the year under assessment, 1/6th of the expenditure
on this account that was similarly disallowed in the preceding five
assessment years
161. We have already adjudicated this issue in the appeals for
prior years (A.Y. 2005-06, 2006-07 and 2007-08) and allowed the
same. We have held that training and recruitment expenditure is
fully allowable as revenue expenditure in the year in which it is
incurred. There being no enduring benefit it cannot be treated as
capital expenditure or deferred revenue expenditure. Ground no. 9
is therefore allowed and Ground no. 9.1 is dismissed as being
infructuous.

GROUND NO. 10: That, on facts and in law, the Ld. AO has erred
in not treating UPS connected to computers as ‘computer’ and
instead regarding it as an item of general ‘plant and machinery’ for
the purpose of allowing depreciation and in doing so disallowed
depreciation of Rs. 7,24,741
162. We have already adjudicated this issue in the appeals for
prior years (A.Yrs. 2006-07 and 2007-08) and allowed the same.
We have held that it is now settled that depreciation on UPS
128 systems is allowable at the rate of 60% under the category of ‘computer’ and not at 15% under the category of ‘plant and
machinery’. Following the same, this ground is allowed.

GROUND NO. 11: That, on facts and in law, the Ld. AO has erred
in holding that loss on exchange fluctuation amounting to Rs.
1,74,38,690 debited to P&L account is a notional loss and in not
allowable as a deduction under the provisions of the Act
GROUND 11.1: Without prejudice to the above ground, the Ld. AO
has erred in not excluding Rs. 2,06,77,205 from the taxable income
of current year being marked to market losses incurred in respect of
foreign exchange contracts which were outstanding as on 31st
March 2007 and written back during the year as same was not
allowed as deduction in the assessment proceedings for AY 2007-08
163. This ground pertains to allowability of loss arising from
revaluation of forward forex contracts on the last date of the
balance sheet on account of restatement of amounts payable and
receivable in foreign exchange. This issue has already been
decided by us in ITA No. 5315/Del/2011 for A.Y. 2007-08 under
Ground no. 10 wherein we have allowed the ground in view of the
law being settled by the Hon’ble Supreme Court in CIT v.
Woodward Governor India Pvt. Ltd. 312 ITR 254 (SC) in this
regard. Following the same, this Ground is allowed.
AY 2009-10 (ITA No. 1567/DEL/14) 164. The facts and business model in the present Assessment
Year i.e. 2009-10 are similar to the facts already stated for AY
2005-06 to AY 2008-09. The appellant had filed its return of
income on November 30, 2009, declaring an income of Rs.
129 143,10,59,696/-. A summary of the international transactions entered into by the appellant and the appellant’s approach in determining their ALP is given in the table below: Particulars Most Profit Margin No. of Arm’s Appropriate Level earned by comparables Lengt Method as Indicator the considered h per TP study (PLI) as Appellant as per TP Margi per TP as per TP study n as study study per TP study
Class I – Transactional OP/OR 4.13% 6 1.91%
Manufacturing Net Margin
(Consumer Method
Electronics, (“TNMM”)
Home
Appliances and
Mobile Phones)
Import of stores
and service
spares, Import of
raw material,
Export of raw
material and
service spares,
Export of finished
goods, Payment
of royalty, Import
of fixed Assets,
Import of spares
for repair and
maintenance,
Availing of
services,
Reimbursement
of marketing
expenses by AEs
Class II – TNMM OP/ OR 1.38% 8 2.14%
Trading
(Consumer
Electronics,
Home
Appliances and
Mobile phones)
Import of finished
goods, Import of
130 Particulars Most Profit Margin No. of Arm’s Appropriate Level earned by comparables Lengt Method as Indicator the considered h per TP study (PLI) as Appellant as per TP Margi per TP as per TP study n as study study per TP study
stores and service
parts, Export of
finished goods,
Services income,
Reimbursement
of marketing
expenses by AEs
Class III – TNMM OP/OR 1.42% 9 -0.41%
Trading
(Colour Monitors
and other IT
products)
Import of finished
goods, Import of
stores and
services spares,
Reimbursement
of marketing
expenditure by
AE
Class IV – TNMM OP/ OC 15% 21 14.33
Contract %
Software
Development
Services
Provision of
contract software
development
services 165. The dispute in the present appeal filed by the appellant pertains to the international transactions grouped under Class-IV (Contract software development) segment. The other international transactions pertain to Classes I (Manufacturing of Consumer Electronics, Home Appliances and Mobile Phones), Class II (Trading of Consumer Electronics, Home Appliances and Mobile
131 Phones) and Class III (Trading of Colour monitors and other IT
products). There is no dispute in respect of these transactions.
166. In Class-IV (Contract software development) segment, the
appellant was engaged in the provision of contract software
development services. Transactional Net Margin Method was
chosen as the most appropriate method in its transfer pricing
study. The profit level indicator taken was operating
profit/operating cost. For the benchmarking exercise, an economic
analysis was carried out in the TP study leading to identification
21 uncontrolled comparable companies having margin of 14.33%.
Since the appellant had earned profit margin of 15% which was
higher than the profit margin earned by the comparables, it was
concluded that the international transactions were at arm’s length.
167. The dispute in the present appeal filed by the appellant
primarily pertains to the transfer pricing adjustments made by the
TPO vide order dated 30 January 2013 on account of: (a) alleged
international transaction of Advertising, Marketing and Promotion
(AMP) expenses; and (b) software development segment.
168. The first adjustment relates to adjustment made on
account of AMP expenses: The TPO was of the view that the
Appellant has provided certain services in respect of creation of
marketing intangibles to its AE by spending huge AMP expenses
and worked out the average AMP/Sales of the comparables at
3.66% as against 9.19% in the case of the Appellant (rectified to
9.03% of sales vide rectification order dated 06 March 2013) and
considered this difference as the value of the service which the
Appellant had provided to its AE. He accordingly held that this
132 excess amount should have been recovered by the Appellant from
its AE or should have been compensated by its AE. The approach
followed by the TPO in respect of this adjustment is as follows:
Amount as per Amount as per
Particulars original TP original rectified Order TP Order Advertisement and Sales A 2,341,766,583 2,341,766,583
Promotion Rebates and discounts B 5,100,380,243 5,100,380,243 Reimbursement of C 271,038,677 271,038,677
marketing expenditure –
Class I transactions Reimbursement of D 97,935,129 97,935,129
marketing expenditure –
Class II transactions Reimbursement of E 39,419,164 39,419,164
marketing expenditure –
Class III transactions Total Expenditure on AMP F= 7,850,539,796 7,850,539,796 A+ B+ C+ D +E Less: Cash Discounts* G (489,586,765) (620,056,638) AMP for this analysis H= 7,360,935,031 7,230,438,158 F -G
*While computing the total amount of AMP spent, cash discounts
were accepted to be excluded from the computation Particulars TP adjustment TP Adjustment as per original as per original
133 TP Order rectified TP Order Value of Gross Sales A 80,092,644,000 80,092,644,000 AMP/ Sales of the B 9.19% 9.03%
Assessee (%) Arm’s length level of AMP C 2,931,390,770 2,931,390,770
(3.66% of sale) Amount actually spent on D 7,850,539,796 7,230,438,158
AMP Amount spent in excess E= 4,919,149,026 4,299,092,388
of the ‘bright line’ D-
C Mark up @ 15.46% F 760,500,439 664,639,683 Amount to be reimbursed G = 5,679,649,465 4,963,732,071
by the AE E+F Amount already H 408,392,970 408,392,970
reimbursed by the AE Amount of TP I=G 5,271,256,495 4,555,339,101
adjustment -H
169. Subsequently, the Appellant filed a rectification application
under section 154 dated 19 February 2013 with the TPO. This
application was for correct consideration of the cash discount at
Rs. 620,056,638 as against Rs. 489,586,765. Accordingly, the TPO
passed a rectified order dated 06 March 2013 and computed the
AMP adjustment at Rs. 455,53,39,101 as against Rs.
527,12,56,496 in his original order.
170. For computation of the Bright Line, the TPO selected a list
of 10 comparables which is as under:
S. No Name of the company AMP/ Sales (%)
134 1. Home Solutions Retail (India) Ltd. 4.77% 2. Vivek Ltd. 3.59% 3. Infiniti Retail Ltd. 4.64% 4. CCS Infotech Ltd. 0.72% 5. Iris Computers Ltd. 0.44% 6. Cellucom Retail India Pvt. Ltd. 8.16% 7. General Sales Ltd. 10.18% 8. Allied Photographics India Ltd. 0.49% 9. VXL Instruments Ltd. 2.83% 10. ACI Infocom Ltd. 0.79% Arithmetic Mean 3.66% Further, for computation of the mark-up for computing the TP
adjustment on AMP, the TPO selected two comparables as under:
S.No Name of the company NCP (%) 1. Crystal Hues Ltd. 8.03% 2. Cyber Media Research Ltd. 10.89% Arithmetic Mean 9.46%
This mean of NCP 9.46% has been increased by an ad-hoc 6% (i.e.
half of 12%, being the nominal rate of interest to cover the return
on the funds that has been blocked), thereby, arriving at a mark-
up of 15.46%.
171. In so far as adjustments in the software development
segment, the Appellant in its Transfer Pricing Report computed its
margins at 15% NCP as against an ALP of 14.33% (arithmetic
mean earned by 21 comparables companies). The TPO after
making certain alterations to the quantitative filters adopted by
the Appellant in its Transfer Pricing Report and further, adding a
135 few new quantitative filters, accepted 11 comparables forming part
of the Appellant’s Transfer Pricing Report, included 1 additional
company, namely Blue Star Infotech at the behest of the Appellant
and 6 additional companies from the accept/ reject matrix forming
part of the Transfer Pricing Report. There by computing the ALP at
25%, being the arithmetic mean of 18 comparable companies. A
representation of the final comparable set adopted by the TPO is
tabulated below:
S.No Comparables NCP (%) 1. Akshay Software Technologies Ltd. 7.99% 2. Aztecsoft Ltd. (Consolidated) 27.37% 3. Blue Star Infotech Ltd. (Consolidated) 17.64% 4. Bodhtree Consulting Ltd. 69.80% 5. Cat Technologies Ltd. 34.43% 6. CG Vak Software & Exports Ltd. 2.7% 7. Goldstone Technologies Ltd. (Seg) 10.28% 8. Infosys Technologies Ltd. 40.74% 9. Larsen & Toubro Infotech Ltd. 21.56% 10. LGS Global Ltd. 17.55% 11. Mindtree Ltd. 27.36% 12. Persistent Systems Ltd. 37.77% 13. R S Software (I) Ltd. 10.15% 14. Sasken Communication Technologies 22.67% Ltd. 15. Tata Consultancy Services Ltd. 31.44% 16. Tata Elxsi Ltd. 16.89% 17. Thinksoft Global Ltd. 16.56% 18. Thirdware Solutions Ltd. 37.37% Arithmetic Mean 25.00%
136 Based on the above set of comparables, the TPO computed the
adjustment as under:

Particulars Amount (Rs.) Operating Cost A 1,071,382,122 Arm’s Length Margin @ 25% B = A*25% 267,845,531 Arm’s Length Price C=A+B 1,339,227,653 Price charged by the D 1,232,080,000 Assessee Adjustment proposed E=C-D 107,147,653 172. The Ld. DRP passed its directions under section 144C of
the Act dated 30 December 2013. Vide its directions, the Ld. DRP
upheld the action of TPO with respect to the adjustment made on
account of AMP expenses. However, for the adjustment made on
account of software development segment, the Ld. DRP accepted
arguments of the Appellant that the comparable ‘Bodhtree
Consulting Ltd.’ had an exponential growth in revenue in the
relevant assessment year and deleted the said comparable from
the final list of comparables. Accordingly, the transfer pricing
adjustment was reduced to Rs. 7,30,77,701 as the ALP of the 17
comparables was recomputed at 21.82%.
173. Pursuant to the directions of Ld. DRP, the AO passed the
final assessment order dated 28 January 2014 incorporating the
transfer pricing adjustment on account of AMP expenses of Rs.
455,53,39,101 and on account of software development segment of
Rs. 7,30,77,701. The AO also made the following additions to total
income:
137 (a) Recruitment and training expense of Rs. 4,61,16,829/- was treated as capital expenditure and not allowable as a revenue expenditure u/s 37 of the Act;
(b) Foreign exchange fluctuation loss of Rs. 2,99,52,597/- was not allowed as a deduction;
(c) Depreciation on UPS, printers and servers was restricted to 15% as against 60% claimed by the appellant leading to a disallowance of Rs. 2,87,820/-
(d) Denied deduction claimed under section 10A of the Act amounting to Rs. 27,74,04,907/-.

Aggrieved by the order of the AO (impugned order), the assessee
has preferred the present appeal and has prayed for adjudication
of the following grounds of appeal.
GROUNDS IN APPELLANT’S APPEAL(ITA NO. 1567/DEL/14) FOR AY 2009-10
174. GROUND NO. 1 to 12: These grounds pertain to the issue of
AMP expenditure being treated as an international transaction and
adjustment being made on the basis of the “bright line” test. We
have already decided this issue in ITA no. 3248/Del/2012 for A.Y.
2005-06 by examining the same in detail. These grounds for this
year are allowed and disposed-off in favour of the appellant on the
lines of our findings and observations made while deciding
Grounds no. 3.1 to 3.6 of ITA no. 3248/Del/2012.
GROUNDS PERTAINING TO ADJUSTMENT ON ACCOUNT OF
SOFTWARE DEVELOPMENT (13-23)
GROUND NO. 13: The Ld. TPO/AO/DRP have erred in not
accepting the economic analysis undertaken by the appellant in
respect of international transaction pertaining to provision of
138 contract software development services by the appellant to its AEs
and computing adjustment of INR 7,30,77,701 to the total income of
the appellant
GROUND NO. 14: The Ld. TPO/AO/DRP have erred in rejecting
certain comparable companies identified by the appellant using ‘turnover less than INR 5 crores’ as a comparability criterion
GROUND NO. 15: The Ld. TPO/AO/DRP have erred, in rejecting
certain comparable companies identified by the appellant on
account of showing diminishing revenues trend
GROUND NO. 16: The Ld. TPO/AO/DRP have erred in rejecting
certain comparable companies identified by the appellant for having
different accounting year (i.e. having accounting year other than
March 31 or companies whose financial statements were for a
period other than 12 months)
GROUND NO. 17: The Ld. TPO/AO/DRP have erred in rejecting
certain comparable companies identified by the appellant using ’employee cost greater than 25 percent of total cost’ as a
comparability section
GROUND NO. 18:The Ld. TPO/AO/DRP have erred in rejecting
certain comparable companies identified by the appellant using ‘export earnings less than 75 percent of operating revenues’ as a
comparability criterion
GROUND NO. 19:The Ld. TPO/AO/DRP have erred in wrongly
rejecting certain companies from and adding certain companies to
the final set of comparables for the said transaction on an ad-hoc
basis, thereby resorting to cherry picking of comparable for
benchmarking
GROUND NO. 20: The Ld. TPO/AO/DRP have erred in selecting
certain companies (which are earning supernormal profits) as
comparable to the appellant to benchmarking the said transaction.
139 GROUND NO. 21: The Ld. TPO/AO/DRP have erred in treating
gain arising from foreign exchange fluctuation as non-operating in
nature while computing the profit margin of the appellant.
GROUND NO. 22: The Ld. TPO/AO/DRP have erred in not making
appropriate adjustments to account for differences in working
capital employed by the appellant vis-à-vis the comparable
companies.
GROUND NO. 23: The Ld. TPO/AO/DRP have erred in not allowing
appropriate adjustments to account for differences in risk profile of
the appellant vis-à-vis the comparables.

175. The Ld. Counsel submitted that in this segment, out of
final set of 17 comparables, the appellant is aggrieved by 5
comparables (namely Cat Technologies Ltd., Infosys Tecnhologies
Ltd, Thirdware Solutions Ltd, Tata Elxi Ltd, Tata Consultancy
Services Ltd.). Further, the appellant is also aggrieved by the
erroneous exclusion of 9 comparable companies (namely Ancent
Software International Ltd, Helios and Matheson IT Ltd, Indium
Software (India) Ltd, KPIT Cummins Info Ltd, Maars Software
International Limited, Qunitegra Solutions Ltd, SIP Technologies
and Exports Ltd, Softsol India Limited, Zylog Systems Limited).
Further, the appellant has also raised grounds of appeal in respect
of denial of adjustment for risk, denial of working capital
adjustment, erroneous treatment of foreign exchange loss as non-
operating in nature, erroneous use of filters while selecting
comparables (export filter, employee cost filter, diminishing
revenue filter, turnover filter), erroneous rejection of companies
having different financial year and erroneous inclusion of
comparables having super normal profits.
140 176. However, it has been submitted by the Ld. Counsel of the Appellant that if only two comparables (Infosys Technologies Ltd and Tata Consultancy Services Ltd) selected by the TPO and DRP held to be inappropriate and are excluded and working capital adjustment is allowed, the appellant’s transaction value will be at arm’s length and the rest of the grounds will not be required to be adjudicated and would be rendered academic in nature. Accordingly, we examine the validity of these two comparables and the claim of working capital adjustment. The Ld. Counsel made the following submissions and pleaded for exclusion of Infosys Technology Ltd and Tata Consultancy Services Ltd.

i) Infosys Technologies Limited
(a) The Ld. Counsel pointed out that there is a huge disparity in turnover between Infosys and the Appellant’s software segment- INR 20,000 Cr approx. for Infosys vis-à-vis INR 125 Cr (approx.) for the Appellant. The Ld. Counsel also submitted the company was engaged in diversified and non-comparable services i.e. design development, re-engineering, infrastructure management services and it commands a huge brand value of approximately Rs. 31,900 Cr and, hence, could not be compared to the Appellant who is a captive service provider. He further submitted that the company has significant onsite revenue i.e. 51% of revenue is from on-site jobs whereas the comparables ‘Maars Software International Ltd.’ and ‘Zylog Systems Ltd.’ have been excluded by the TPO on the ground that they had onsite revenue of approximately 42%.
(b) The Ld. Counsel argued that since the company has significant R & D activities (i.e. 1.3% of revenue earned), has significant
141 intangible assets (patents filed by its R & D labs by the name of ‘SET Labs’ & brands) and has significantly large scale of
operations i.e. it is an industry giant, this cannot be included
in the list of comparables. He vehemently contended that there
is a catena of judgments in which Infosys has been held to be
an inappropriate comparable company. He listed out the
judgments as follows:

• CIT vs. Agnity India Technologies Pvt. Ltd. (ITA 1204/2011 dated July 10, 2013) • UT Starcom Inc. (India Branch) (ITA No.5848/Del./2011) • Toluna India Pvt.Ltd. (ITA 393/2016 & ITA 394/2016) • Sumtotal Systems India Pvt. Ltd. (I.T.T.A. NO.660 OF 2014) • Adaptec India Limited (I.T.T.A. No.638 of 2014) • Virtusa (India) Private Limited [ITA No. 1962/Hyd/2011] • Telcordia Tech nologies India Pvt. Ltd [ITA No.7821 /Mum/2011] • Agnity India Technologies Pvt. Ltd. v. DCIT TS-265-
ITAT-2013(DEL)-TP • Mercedes Benz Research & Development India Pvt. Ltd.
[IT(TP)A No. 1222/Bang/2011] • Transwitch India Pvt. Ltd. [IT(TP)A No. 948/Bang/2011] • Yodlee Infotech Private Limited [ITA No. 1397/Bang/2010] • Meritor LVS India (P) Ltd. [ITA No. 405/Bang/2011] • Patni Telecom Solutions Pvt.Ltd.[ITA No. 1846/Hyd/2011]
142 • Sonata Software Ltd. [ITA No. 3514/Mum/2010]
• Agilent Technologies International Pvt. Ltd. [ITA No. 6047/Del/2012]
• Cincom Systems India P.Ltd. [ITA no. 761/Del/2012]
• Insilica Semiconductors India P. Ltd Vs. ITO [ITA No.1399/Bang/2010]
• Frost &Suvilian (I) Pvt. Ltd. [ITA No. 2073/Mum/2010]
• Adaptec (India) Pvt. Ltd. [ITA 1801/Hyd/2009]
• Genesys Integrating Systems (India) Pvt. Ltd. Vs. DCIT [ITA No. 1231/Bang/2010]
• Trilogy-E-Business Software India Pvt Ltd [TS-748-
ITAT-2012-Bang]
• Bearing Point Business Consulting P. Ltd TS-758-ITAT-
2012(Bang)-TP (AY:2007-2008)
• CSR PVT LTD Vs. ITO TS-68-ITAT-2013(Bang)-TP AY 2007-2008
• DCIT Vs. M/s Hellosoft India P. Ltd.TS-59-ITAT-
2013(HYD)-TP 2005-06
• LG Soft India Private Ltd Vs. DCIT TS-64-ITAT-
2013(BANG)-TP AY 2007-2008
• Autodesk India Pvt Ltd Vs DCIT TS-62-ITAT-
2013(Bang)-TP 2006-2007
• HCL EAI Services Ltd V DCIT TS-133-ITAT –
2013(Bang)-TP 2006-2007
• NDS Services Pay-TV Technology Private Limited v ACIT TS-127-ITAT-2013-Bang-TP 2007-2008
• Logica Private Ltd v ACIT TS-131-ITAT-2013(Bang)-TP 2007-2008
143 • NTT Data India Enterprise Application Servico5es Pvt. Ltd. vs. ACIT [TS-293-ITAT-2013(HYD)-TP] (AY 2005-
06) • 3DPLM Software Solutions Ltd. (TS-359-ITAT-
2013(Bang)-TP) (AY 2008-09) • Hyundai Motors India Engineering Pvt. Ltd.
[ITA.No.1850/Hyd/2012] • App Labs Technologies Pvt. Vs DCIT [TS-316-ITAT-
2013(HYD)-TP] (c) The Ld. CIT (DR) submitted that the Ld. TPO retained this comparable for the reason that major revenue of this company was from software development and the revenue from software product was extremely low and that R&D of 1.3% of revenue was not significant. The Ld. DRP upheld action of the TPO for the reason that FAR profile of this company was akin to the Appellant.
ii) Tata Consultancy Services Ltd
(a) This company was introduced by the Ld. TPO and his action was upheld by the Ld. DRP for the reason that this company is functionally similar to the Appellant.
(b) The Ld. Counsel contended that this company fails the Related Party Transaction (RPT) filter applied by the TPO. He pointed out that the value of RPT (only revenues derived from related parties) is Rs. 12619.79 crore and the total revenue is Rs. 22,404 crores. Accordingly, the Ld. Counsel contended that the percentage of RPT as a ratio of total sales is 56.32% and fails the RPT filter of 25% applied by the Ld. TPO himself.
144 (c) The Ld. Counsel pointed out that the company has 42 patents registered and over 150 applications pending registration. Further, the company has huge employee base which gives it an access to variety of talent. It has significant R & D activities and has significantly higher assets of Rs. 2669.08 crores (Net book value as on 31 March 2009) as against Rs. 44.90 crores of the appellant.
(d) The Ld. Counsel also submitted that Tata has a significantly higher turnover of Rs. 21535.75 cras against Rs. 123.20 Cr. in the case of the Appellant i.e. 175 times more than the latter.

e) The Ld. Counsel contended that this company has to be rejected as a comparables also because it has on-site revenue of 51.19% of the total revenue. He submitted that the comparables ‘Maars Software International Ltd.’ and ‘Zylog Systems Ltd.’ have been excluded by the Ld. TPO in AY 2008- 09 on the ground that they had on-site revenue of 42%.

f) The Ld. CIT (DR) vehemently opposed the exclusion of the said comparables. The Ld. CIT (DR) submitted that there is no correlation between branding and profit margin. Similarly, he contended that for service companies the turnover does not have a material bearing on the profit margin as long as the company is functionally similar, it should be retained as a comparable under TNMM because size, scale and brand name do not impact the profit margin though these aspects may affect the profit. He specifically pointed out that many companies without brands and operating at low turnover have high profit margins and companies with brands and high
145 turnover can have low margins. Therefore, these factors are
not relevant for determination of ALP under TNMM.
g) The Ld. Counsel in his rejoinder submitted that the
contentions raised by the CIT(DR) do not have any merit
because application of TNMM does not mandate a positive
correlation between a relevant economic factor (brand / scale/
turnover) and net profit margin. He pointed out that Rule
10B(1)(e) read with Rule 10B(2) mandate the following key
aspects need to be taken into account while selecting
comparables:
h) Apart from similarity of function, similarity of asset level
and risks undertaken by the company sought to be taken as
comparable has to be similar to that of the tested party. A
company which is much bigger in size and has greater
number of employees requires much different level of assets
and undertakes much higher levels of risk as compared to a
company which is smaller in size and lesser number of
employees.
i) A company with a significant brand and other valuable trade
intangibles has a distinct advantage in the market place over
unbranded companies. It is also important to emphasize that
branded and unbranded companies operate at different levels
of the market and compete in different market segments. This
is a relevant factor under Rule 10B(2).
j) In the real world, there can never be a positive correlation
between two economic factors / indicators, specially while
measuring the impact on profit margins it is not possible to
judge the exact quantum of impact of any one factor on the
profit margin because profit margin is impacted by numerous
factors and reasons all of which cannot be documented and
146 quantified. It is for this reason that Rule 10B(1)(e)(iii) contains the words “could materially affect the amount of net profit margin in the open market”. Therefore, the statute does not mandate that an economic factor is relevant only if it is positively correlated with net profit margin but as long as there is a likelihood of impact, the conditions are fulfilled.
177. We have heard the two sides and perused the orders and
material on record. We are examining the suitability of both these
companies (Infosys Technology and Tata Consultancy Services)
together as these two are similar in many respects. As per their
profile, function and volume of scale, they are reckoned as the
leaders of the Indian IT sector and are often considered to be the
most prestigious brands in this space. The process of selection of
appropriate comparables under TNMM is to be guided by Rule 10B
(2) which lays down the factors of comparability. These factors are
functions, assets and risks, nature of the services, contractual
terms, level of the market and other relevant economic parameters
which have a material effect on profitability. The ‘OECD Transfer
Pricing Manual 2017’ in Para 3.43 and the ‘UN Transfer Pricing
Manual 2017’ in Para B.2.3.4.40 also provide guidance in this
respect, which for sake of ready reference are extracted below:

“3.43. In practice, both quantitative and qualitative criteria are used to include or reject potential comparables. Examples of qualitative criteria are found in product portfolios and business strategies. The most commonly observed quantitative criteria are:
• Size criteria in terms of Sales, Assets or Number of Employees. The size of the transaction in absolute value or in proportion to the activities of the parties might affect the relative competitive
147 positions of the buyer and seller and therefore comparability.

• Intangible-related criteria such as ratio of Net Value of Intangibles/ Total Net Assets Value, or ratio of Research and Development (R&D)/Sales where available: they may be used for instance to exclude companies with valuable intangibles or significant R&D activities when the tested party does not use valuable intangible assets nor participate in significant R&D activities.

• Criteria related to the importance of export sales (Foreign Sales/ Total Sales), where relevant.

• Other criteria to exclude third parties that are in particular special situations such as start-up companies, bankrupted companies, etc. when such peculiar situations are obviously not appropriate comparisons.

• The choice and application of selection criteria depends on the facts and circumstances of each particular case and the above list is neither limitative nor prescriptive.”

“B.2.3.4.40. Criteria commonly used for initial screening
may include the following list. The relevance of the
screening criteria below depends on the facts and
circumstances of each particular case and the list here is
purely indicative:
 Geographic restrictions with respect to a country or region;
 A specific industry classification;
 Certain keywords;
 Elimination of those enterprises which may have substantial transfer pricing issues themselves and fail an independence screening;
 Inclusion or expulsion of specific functions such as research and development, production, distribution or holding of shares;
 Exclusion of companies which were only recently set up;
 Consideration of diagnostic ratios such as turnover per employee, ratio of net value of
148 intangibles/total net assets value or ratio of research and development/sales etc.; and  A focus on sales volume, fixed assets or numbers of employees.”

A perusal of the above principles along with the factors stipulated
in Rule 10B(2) makes it amply clear that functions, assets and
risks manifested in terms of scale, size, head-count, presence of
valuable intangibles are very relevant considerations to be taken
into account.
178. The exclusion/inclusion of Infosys Technology Ltd. as a
comparable for captive software entities is an issue that has arisen
in large number of cases (some of which have been cited above by
the Ld. Counsel also). Infosys Technology Ltd. is one of India’s
leading IT companies have presence worldwide. Its turnover is in
excess of Rs. 20,000 crore (as against Rs. 125 crore of the
appellant) and its functions are highly diversified. One of the
important attributes that sets Infosys apart from small captive IT
companies is the presence of highly valuable IPRs by way of brand
and software products which generate licensing revenues. It
invests significant amounts in R&D and advertising every year. Its
head count is significantly larger than that of the appellant
company. The diversified nature of its business has been stated on
Page 78 of the Annual Report – “.end to end business solutions.. the
solutions span the entire software life cycle encompassing technical
consulting, design development, re-engineering, maintenance,
systems integration, package evaluation and implementation, and
testing and infrastructure management services. In addition, the
Company offers software products for the banking industry”. A
perusal of the Annual Report further reveals that it owns a well-
149 known proprietary product used by the banks called “Finnacle”.
The Company generates licensing revenue from products like
Finnacle. The Annual Report also states that its brand has been
valued by the company at a staggering Rs. 31,900 crore. For these
reasons, the functional, assets and risk profile of Infosys
Technology Ltd. is very dissimilar to that of the assessee’s software
development segment which operates as a risk mitigated captive
entity. In large number of decisions of this Tribunal Infosys
Technology Ltd. has been held to be incomparable to captive
software developers who lack scale, size and heft of Infosys
Technology Ltd. The Hon’ble Delhi High Court in the case of CIT
vs. Agnity India Technologies Pvt. Ltd. (supra) has upheld the
order of the Tribunal ordering its exclusion on the above grounds
(vast difference in scale, size, functions, intangible assets and risk
levels). In view of the above, we hold that Infosys Technology Ltd.
should be excluded from the list of comparables.
179. The factual matrix pertaining to Tata Consultancy Services
is quite similar. We have perused the Annual Report of this
company and we find that its turnover is in excess of Rs. 20,000
crores. Furthermore, on Page 58 of the Annual Report it has been
stated that the company has 42 registered patents and another
150 are pending registration. The head-count given on Page 23 of
the Report indicates that it has more than 100,000 employees. Its
asset base is in excess of Rs. 2500 crore (as against Rs. 45 crores
of the Appellant). In these circumstances, it is vastly dissimilar
and different that the software segment of the appellant, which is
operating at a much smaller level and sans any ownership of IPRs.
Furthermore, the details given on Page 144 of the Annual Report
demonstrate that more than 50% of its revenues are derived from
150 related parties. It, accordingly, fails the RPT filter of 25% applied
by the TPO. The reasons for excluding Infosys Technology are
equally applicable to Tata Consultancy Services as well. We,
therefore, hold that Tata Consultancy Services Ltd. is a wholly
inappropriate comparable for the software development segment of
the appellant.
Working Capital Adjustment
180. The Ld. TPO rejected the request for working capital (WC)
adjustment to the margin of the comparables by stating that out of
the 3 components of WC adjustment, only one component is
affected by the subject transaction i.e. receivables. On this basis,
he stated that it is not justified to allow WC on 3 components. The
Ld. DRP upholding the action of the Ld. TPO directed that the
working capital adjustment is difficult to make due to lack of
accurate and reliable data. It held that the Appellant has failed to
demonstrate that difference in working capital deployed is making
difference in the margin earned by the taxpayer and the
comparables.
181. The Ld. Counsel pointed out that detailed submissions and
calculations have been submitted by the Appellant before the Ld.
DRP. He argued that WC adjustment has been granted by the Ld.
TPO in subsequent years i.e. AYs 2010-11 and 2011-12. He
submitted that the difference in working capital position has a
bearing on the ALP. Further, he drew our attention to rule
10B(1)(e) and rule 10B (3) which allows for making reasonably
accurate adjustment to arrive at the ALP. The Ld. Counsel also
placed reliance on the OECD Guidelines 2017, UNTP Manual 2017
and ICAI Guidelines in this regard.
151 182. Further the Ld. Counsel relied on the following judicial
decisions where working capital adjustment has been held to be a
permissible and desirable adjustment to improve comparability:
(a) ___________________________________ TNT India Private Limited vs. Asst. Commissioner of Income tax, ITA No. 1442 (BNG)/ 08
(b)___________________________________ The Income-tax Officer vs. M/s Nextlinx India Pvt. Ltd., ITA No. 454/Bang/2011
(c) ___________________________________ Bearing Point Business Consulting Private limited vs. The DCIT, ITA No. 1124/Bang/2011
(d)___________________________________ Nortel Network Vs ACIT [TS-65-ITAT-2014(DEL)]
(e) ___________________________________ Cengage Learning Pvt.
Ltd v ITO: [ITA No. 5926/Del/2010]
(f) ___________________________________ AMD India (P) Ltd v DCIT: ITA No. 204 & 242/Bang/2015
(g) ___________________________________ DCIT v M/s Kyocera Asia Pacific India Pvt Ltd ITA No. 1029/Del/2016
(h) __________________________________ M/s NCS Pearson India Pvt Ltd v DCIT: ITA No. 5561/Del/2014
(i) ___________________________________ DCIT v Whirlpool of India Ltd: ITA No. 1609/Del/2013
(j) ___________________________________ United Health Group Information Services Pvt Ltd v DCIT: ITA No. 419/Del/2014
(k)___________________________________ ITO v M/s H&S Software Development & Knowledge Management Centre Pvt Ltd: ITA No. 6662/Del/2014
152 (l) ___________________________________ Transcend MT Services Pvt Ltd
(m) __________________________________ Accenture Services (P) Ltd v ACIT: ITA No. 7686/Mum/2012 183. The Ld. CIT (DR) relied on the orders of the lower authorities
and reiterated that the appellant had failed to show the differences
between the working capital levels.
184. We have perused the orders of the lower authorities and the
material on record. We find that the WC adjustment figures were
furnished by the appellant which were disregarded by the TPO. On
the issue of allowability of this adjustment we find that this issued
has been settled by this Tribunal in numerous decisions (some of
which have been cited by the Appellant) in favour of the assessees.
The desirability of making the WC adjustment has also been
endorsed by the OECD and UN Guidelines. The relevant extracts
are as below:
OECD Guidelines 2017 “2.87 In those cases where there is a correlation between the credit terms and the sales prices, it could be appropriate to reflect interest income in respect of short-term working capital within the calculation of the net profit indicator and/or to proceed with a working capital adjustment.”

UN TP Manual 2017 “…5.3.2.14. …x..x..Adjustment might be required to ensure consistency of accounting standards between the controlled transaction and the comparable. Differences in the use of assets can be eliminated or reduced to a significant extent by making comparability adjustments on account of working capital or capacity utilization.”
153 185. Further, the issue of allowability of economic adjustment
to account for differences in working capital between the assessee
and the comparables chosen for TNMM analysis has already been
adjudicated by us under Ground no. 5 for the appeal for A.Y.
2007-08 (ITA No. 5315/Del/2011); and Ground no. 6 for the
appeal for A.Y. 2008-09 (ITA No. 52/DEL/13). We have held that
this issue of working capital adjustment is now well settled
proposition and has to be allowed. This would be equally
applicable for this year as well and this ground is accordingly
allowed. The TPO is directed to allow the WC adjustment while
determining the arm’s length price of the international
transactions in the software segment under TNMM. It would,
however, be open to the TPO to verify the figures given by the
assessee.
186. Since we have held that Infosys Technology Ltd. and Tata
Consultancy Services Ltd are to be excluded from the list of
comparables and working capital adjustment is to be allowed to
the profit margin of the remaining comparables, the other grounds
are rendered academic in nature as the value of international
transaction in the software segment would fall within the arm’s
length range.

GROUND NO. 24:The Learned AO/DRP has erred in holding that
expenditure on recruitment and training of employees leads to
enduring benefit to the appellant and in holding to allow only
1/6thof the total expenditure in the current year and deferring the
balance to be allowed in next five years.
154 GROUND NO. 25: Without prejudice to the above, Learned AO/DRP
has erred in not allowing in the year under assessment, 1/6th of the
expenditure on this account that was similarly disallowed in the
preceding five assessment years
187. We have already adjudicated this issue in the appeals for
prior years (A.Yrs. 2005-06, 2006-07, 2007-08 and 2008-09) and
allowed the same. We have held that training and recruitment
expenditure is fully allowable as revenue expenditure in the year in
which it is incurred. There being no enduring benefit it cannot be
treated as capital expenditure or deferred revenue expenditure.
Ground no. 24 is therefore allowed and Ground no. 25 is
dismissed as being infructuous.
GROUND NO. 26:The Learned AO/DRP has erred in reducing the
claim of depreciation on UPS without mentioning anything in the
final assessment order and without assigning any reasons which is
against the principle of natural justice
GROUND NO. 27: Without prejudice to the above ground, the
Learned AO/DRP has erred in not treating UPS connected to
computers as ‘computer’ and instead regarding it as an item of
general ‘plant and machinery’ for the purpose of allowing
depreciation.
188. We have already adjudicated this issue in the appeals for
prior years (A.Yrs. 2006-07, 2007-08 and 2008-09) and allowed
the same. We have held that it is now settled that depreciation on
UPS systems is allowable at the rate of 60% under the category of ‘computer’ and not at 15% under the category of ‘plant and
machinery’. Following the same, this ground is allowed.
155 GROUND NO. 29: The Learned AO/DRP has erred in holding that
loss on exchange fluctuation amounting to Rs. 2,99,52,597 debited
to P&L account is a notional loss and is not allowable as a
deduction under the provisions of the Act.
GROUND NO. 30: Without prejudice to the above ground, the
Learned AO/DRP has erred in not excluding Rs 1,74,38,690 from
the taxable income of current year being marked to market losses
incurred in respect of foreign exchange contracts which were
outstanding as on 31st March 2008 and written back during the
year as same was not allowed as deduction in the assessment
proceedings for AY 2008-09.
GROUND NO. 31: Without prejudice to the above ground, the
Learned AO/DRP erred in not excluding Rs. 7,559,120 from the
taxable income of current year being marked to market losses
incurred by Samsung Telecommunications India Private Limited
(now amalgamated with the appellant) in respect of foreign
exchange contracts which were outstanding as on 31st March 2008
and written back during the year by the appellant as same was not
allowed as deduction in the assessment proceedings for AY 2008-
09.
189. This ground pertains to allowability of loss arising from
revaluation of open forward forex contracts on the last date of the
balance sheet on account of restatement of amounts payable and
receivable in foreign exchange under the marked to market (MTM)
policy mandated under accounting norms. This issue has already
been decided by us in ITA No. 5315/Del/2011 for A.Y. 2007-08
under Ground no. 10 and ITA No. 52/Del/2013 for A.Y. 2008-09
under Ground no. 11 and 11.1, wherein we have allowed the
ground in view of the law being settled by the Hon’ble Supreme
156 Court in CIT v. Woodward Governor India Pvt. Ltd. 312 ITR 254
(SC) in this regard. Following the same, this Ground is allowed.

GROUND NO. 32:The learned AO has erred in law and on fact in
withdrawing a deduction of Rs 27,74,04,907 claimed by the
appellant under Section 10A of the Act on the wrong pretext that
mere shifting of undertaking from one location to another
tantamount to non-fulfilment of conditions laid down in section
10A(2)(II)/(III) of the Act
190. The Ld. Counsel submitted that this issue is covered in its
favour by the order of this Tribunal in ITA No. 6508/Del/2012 in
the case of Samsung Telecommunications India Pvt. Ltd. for AY
2008-09, which merged with the Appellant w.e.f. 1 April 2008. A
copy of the order of this Tribunal in ITA No. 6508/Del/2012 dated
23/05/2017 has been placed before us. Our attention has been
drawn towards Paragraphs 19-30 of this order where the Tribunal
has examined this issue in detail and has concluded that re-
location of an unit from one place to another in order to meet
shortage of space and to effect expansion of business does not
amount to splitting or reconstruction of an existing business and
would not disentitle the assessee from claiming the benefit of
Section 10A of the Act. This order of the Tribunal was
subsequently confirmed by the Hon’ble Delhi High Court on this
issue. Respectfully following the decision of the Tribunal and the
Hon’ble Delhi High Court we allow this ground of appeal.

AY 2010-11 (ITA No. 6741/DEL/14)
191. The facts and business model in the present Assessment
Year i.e. 2010-11 are similar to the facts already stated for AY
2005-06 to 2009-10. The appellant had filed its return of income
on September 30, 2010, declaring an income of Rs.
157 7,52,20,73,240/-. A summary of international transactions entered into by the appellant and the appellant’s approach in determining their ALP is given in the table below: Particulars Most Profit Margin No. of Arm’s Appropri Level earned comparab Length ate Indicator by the les Margin Method (PLI) as Appella considere as per as per TP per TP nt as d as per TP study study study per TP TP study study
Class I – Transacti Operating 8.14% 10 1.26%
Manufacturing onal Net Profit/
(Consumer Margin Operating
electronics, Home Method Revenue
Appliances, Mobile (“TNMM”) (“OP/ OR”)
Phones and Colour
Monitors)
Import of raw
material, Import of
stores and service
spares, Export of
raw material, service
spares and finished
goods, Payment of
royalty, Import of
fixed assets, Import
of spares for repair
and maintenance,
Availing of services,
Provision of intra-
group services,
Reimbursement of
marketing expenses
by AEs
Class II – Trading TNMM OP/ OR -0.05% 17 0.43%
(Consumer
electronics, Home
Appliances, Mobile
Phones, Colour
Monitors and other
IT products)
Import of finished
goods, Import of
stores and service
spares, Export of
158 Particulars Most Profit Margin No. of Arm’s Appropri Level earned comparab Length ate Indicator by the les Margin Method (PLI) as Appella considere as per as per TP per TP nt as d as per TP study study study per TP TP study study
raw material, service
spares and finished
goods, Service
income,
Reimbursement of
marketing expenses
by AEs
Class III – TNMM Operating 14.84% 4 15.78%
(Contract software Profit /
development Operating
services) Cost
Provision of contract (OP/OC)
software
development
services,
Reimbursement of
expenses by AEs,
Rental income 192. The dispute in the present appeal filed by the appellant pertains to the international transactions grouped under Class-III (Contract software development) segment. The other international transactions pertain to Classes I (Manufacturing – Consumer electronics, home appliances, mobile phones and colour monitors) and Class II (Trading – Consumer electronics, home appliances, mobile phones, colour monitors and other IT products). There is no dispute in respect of these transactions.
193. In Class-III (Contract software development) segment, the appellant was engaged in the provision of contract software development services. Transactional Net Margin Method was chosen as the most appropriate method in its transfer pricing
159 study. The profit level indicator taken was operating
profit/operating cost. For the benchmarking exercise, an economic
analysis was carried out in the TP study leading to identification 4
uncontrolled comparable companies. Since the appellant had
earned profit margin of 14.84% which was within +/-5% of the
profit margin earned by the comparables, it was concluded that
the international transactions were at arm’s length.
194. The dispute in the present appeal filed by the appellant
pertains to the adjustments made by the TPO vide order dated 30
January 2014 on account of: (a) alleged international transaction
of Advertising, Marketing and Promotion (AMP) expenses and (b)
software development segment.
195. Adjustments made on account of AMP expenses: The
Ld. TPO proposed an adjustment of Rs. 7,401,552,834 (Rs.
1,021,561,275 under the IT business and Rs. 6,379,991,559
under the Non-IT business) with respect to AMP expenses incurred
by the Appellant. He was of the view that the Appellant has
provided certain services in respect of creation of marketing
intangibles to its AE.
196. ALP determination for Provision of Contract software
development services (Class III): In Class III (Contract software
development services segment), the Ld. TPO proceeded to
undertake a fresh benchmarking analysis of the uncontrolled
comparable companies and arrived at a set of 17 comparables
(rejected 2 out of 4 comparables of the Appellant and introduced
15 other comparables). The Appellant offered new comparables
during the transfer pricing proceedings which were not accepted
160 by the TPO. Final set of comparable for benchmarking of
international transaction are reproduced in the table below:

S.No. Name of Comparable Working capital adjusted NPM for AY 2010-11 (%) 1 Akshay Software Technologies Ltd. -2.93% 2 e-Infochips 63.63% 3 Evoke Technologies Pvt Ltd 17.16% 4 E-Zest Solutions 12.30% 5 Infinite Data Systems Pvt. Ltd 82.23% 6 Infosys Ltd. 43.89% 7 Larsen & Toubro Infotech Ltd. 18.47% 8 LGS Global Limited 5.95% 9 Mindtree Ltd. 12.98% 10 R S Software (India) Ltd 8.66% 11 Sasken Communication Technologies Ltd 16.35% 12 Tata Elxsi Ltd. 15.52% 13 Thinksoft Global Services Limited 12.11% 14 Thirdware Solutions Ltd. 36.54% 15 Cat Technologies Limited 2.13% 16 Maveric Systems Limited 13.19% 17 Persistent Systems and Solutions Ltd. 10.33% Arithmetic Mean (Page 61 of TP Order) 21.68% NPM of Samsung India (Page 5 of TP Order) 14.84% Adjustment (Rs.) 109,395,995
197. The Ld. DRP vide order dated 21 October 2014 upheld the
action of TPO with respect to the adjustment made on account of
AMP expenses. However, for the adjustment made on account of
software development segment, the Ld. DRP directed the Ld. TPO
to rectify arithmetical errors in margin computation of comparable
companies. As a consequence, the Ld. TPO rectified the margin
computation of one comparable namely Maveric Systems Limited
from 13.19% to 12.75%, thereby reducing the arm’s length margin
from 21.68% to 21.65%. Consequently, the adjustment was
reduced to INR 10,89,09,254/-.
161 198. Pursuant to the directions of Ld. DRP, the AO passed the
final assessment order dated 5 November 2014. The AO while
incorporating the transfer pricing adjustments made by the Ld.
TPO on account of AMP expenses of Rs. 7,40,15,52,834 and on
account of software development segment of Rs. 10,89,09,254,
made further additions of:

(i) Rs. 3,01,54,176/- on account of recruitment and training expenses;
(ii) Rs. 4,86,59,085/- on account of forward exchange contracts classified under forex loss;
(iii) Rs. 2,18,19,987/- on account of deduction claimed under section 10A of the Act.
199. Aggrieved by the order of the AO, the assessee has
preferred the present appeal and has prayed for adjudication of
the following grounds of appeal.

GROUNDS IN APPELLANT’S APPEAL(ITA NO. 6741/DEL/14) FOR AY 2010-11
200. GROUND NO. 1 to 11: These grounds pertain to the issue
of AMP expenditure being treated as an international transaction
and adjustment being made on the basis of the “bright line” test.
We have already decided this issue in ITA no. 3248/Del/2012 for
A.Y. 2005-06 by examining the same in detail. These grounds for
this year are allowed and disposed-off on the lines of our findings
and observations made while deciding Grounds no. 3.1 to 3.6 of
ITA no. 3248/Del/2012.

ADJUSTMENT ON ACCOUNT OF SOFTWARE DEVELOPMENT
162 GROUND NO. 12: The Learned TPO/AO/DRP have erred in not
accepting the economic analysis undertaken by the appellant in
respect of international transaction pertaining to provision of
contract software development services by the appellant to its AEs
and computing adjustment of INR 10,93,95,995 to the total income
of the appellant
GROUND NO. 13: The Learned TPO/AO/DRP have erred, in
rejecting certain comparable companies identified by the appellant
for having different accounting year (i.e. having accounting year
other than March 31 or companies whose financial statements were
for a period other than 12 months)
GROUND NO. 14: The Learned TPO/AO/DRP have erred in
rejecting certain comparable companies identified by the appellant
using turnover less than INR 5 crores’ as a comparability criterion.
GROUND NO. 15: The Learned TPO/AO/DRP have erred in
rejecting certain comparable companies identified by the appellant
using ‘export earnings less than 75 percent of operating revenues’
as a comparability criterion.
GROUND NO. 16: The Learned TPO/AO/DRP have erred, in
rejecting certain comparable companies identified by the appellant
on account of showing diminishing revenues trend
GROUND NO. 17: The Learned TPO/AO/DRP have erred in
rejecting certain comparable companies identified by the appellant
using ’employee cost greater than 25 percent of total cost’ as a
comparability criterion
GROUND NO. 18: The Learned TPO/AO/DRP have erred in
wrongly rejecting certain companies from and adding certain
companies to the final set of comparables for the said transaction on
an ad-hoc basis, thereby resorting to cherry picking of comparable
for benchmarking
163 GROUND NO. 19: The Learned TPO/AO/DRP have erred in
selecting certain companies (which are earning supernormal profits)
as comparable to the appellant to benchmark the said transaction.

201. At the outset, the Ld. Counsel submitted that out of 17
comparables retained by the TPO after the DRP directions, the
assessee is aggrieved by the erroneous inclusion of 3 comparables
(e-Infochips, Infosys, Infinite). Furthermore, the assessee is also
aggrieved by the erroneous rejection of 10 comparables whose
inclusion is being sought. These comparables are Caliber Point
Business Solutions Ltd, CG-VAK software & Exports Ltd, Cigniti
Technologies Ltd, Goldstone Technologies Ltd, Helios & Matheson
Information and Technology Ltd, Quintegra Solutions Ltd, R
systems International Ltd, Saven Technologies Ltd, Silver Line
Technologies Ltd, Zylog Systems Ltd. However, it has been
submitted by the Ld. Counsel that if only 3 comparables are
excluded namely Infosys Technologies Ltd, E-infochips Bangalore
Ltd and Infinite Data systems Ltd, then the assessee’s
international transaction would be at arm’s length and the rest of
the grounds will be rendered academic in nature. We therefore
proceed to examine the validity of this claim.
202. The Ld. Counsel made following submissions with respect to
rejection of the three comparable companies:

E-Infochips Bangalore Limited (“E-Infochips”)
(a) The Ld. Counsel argued that E-Infochips is functionally dissimilar as the company is engaged in both software development and IT enabled services. He pointed out that in the Annual Report, segmental information is not available and he drew the attention of the Bench to Page No. 63 of the
164 Annual Report where this fact has been clearly stated and the segmental information in respect of software development and ITES has not been given.
(b) The Ld. Counsel submitted that the Ld. TPO included the said comparable by merely stating that this company cannot be said to be providing IT enabled services since its communication costs are very low and that merely having supernormal profits is not a criterion for rejection. The Ld. Counsel argued that that the Ld. TPO’s conclusions are based on surmises and are contrary to the facts on record as evident from the Annual Report of the company. He further submitted that the exclusion of this company was sought not on the basis of super normal profits but on the basis of functional dissimilarity and absence of segmental information.
(c) The Ld. Counsel placed reliance on the judgment delivered by the coordinate Bench in the case of Steria India Ltd. (ITA No.107/Del/2016) wherein it has been held that the company is not functionally comparable as it is engaged in both software development and IT enabled services for which no bifurcation is available (as segmental information is not available). This judgment has also been upheld by the Hon’ble Delhi High Court (ITA 762/2017).
(d) The Ld. Counsel also placed reliance on the coordinate Bench ruling in the case of Headstrong Services (India) Pvt. Ltd. (ITA No. 714/Del/2015).
(e) The Ld. Counsel further placed reliance on the following judgments wherein E-Infochips has been held to be functionally dissimilar and non-comparable to a software development company:
165 • Pegasystems worldwide India Pvt Ltd. (ITA No. 1758/Hyd/2014) • Intoto Software India Pvt. Ltd. (1921/Hyd/2014 & 25/Hyd/2015) • Allscripts India Pvt. Ltd. (ITA No. 771/Ahd/2014) • Freescale Semiconductor India Pvt Ltd (ITA No1263 /Del/2015) • Headstrong Services (India) Pvt. Ltd. (ITA No.714/Del/2015) • Stryker Global Technology Center Pvt Ltd v DCIT (ITA No. 6866/Del/2014) 204. The Ld. CIT (DR) emphasized the fact that the
communication expenses of this company are at a very low level
and accordingly, it is highly probable that this is not an ITES
company because ITES companies typically incur substantial
amount of communication expenses to deliver their services.
205. We have heard both the sides and perused the Annual
Report of E-Infochips Bangalore. From the perusal of Page 63 of
the Annual Report it is evident that this company has reported its
results under a single segment which has been stated to be
including Software as well as ITeS activities without any
bifurcation being provided. It is a fundamental principle of transfer
pricing that, functionally different spheres like software and ITeS
segments are not to be treated as comparable functions. A
company operating in one sector cannot be taken as comparable to
another company in the other sector. Only if segmental profit
margins for software and ITeS segments are separately provided in
166 the audited results, the results of the software segment can be
taken for comparison with the software segment of the assessee. It
is now well settled that in the absence of segmental margins,
combined entity level results cannot be used for a TNMM analysis.
In Headstrong Services (supra), this Tribunal while examining the
comparability of E-Infochips Bangalore to a software company held
as under:
12.2. After considering the rival submission and perused the relevant material on record, we find from the Annual Report of this company available on page 352 of the paper book that its P & L Account shows `Income from software services’ as one unit at Rs. 43,04,66,481/-. Schedules 7 gives break up of this income with “Income from Software Services” at Rs. 37.13 crore and “Consultancy Charges” at Rs. 5.90 crore. Segmental information of this company is available on page 66 of its Annual Report which states that: “The Company is primarily engaged in Software Development and I.T. enabled services which is considered the only reportable business segment”. This indicates that the revenue from Software Development and ITES has been clubbed by this company which also includes consultancy charges. No doubt Consultancy charges in relation to Software Development are part of overall Software Development, but the inclusion of ITES in the overall segment frustrates the comparability. We are currently dealing with the international transaction of `Provision of Software Development services’ and the international transaction of ITES is separate which has also been benchmarked distinctly. In our considered opinion, e- Infochips Bangalore Ltd. having a pool of both software developments and ITES segments into the overall segment
167 designated as `Software development’, cannot be considered as comparable on entity level with the international transaction of `Software development’ of the assesse. We, therefore, order for the exclusion of this company from the list of comparables.”
206. We also do not find merit in the contention raised by the
Revenue that since the communication expenses shown in the P&L
account is at a low level, the Company should be presumed to be
not be engaged in ITeS. Such a conclusion is not based on
evidence but is a mere speculation. In the face of a clear disclosure
in the Annual Report, a speculative approach is to be discarded.
We, accordingly, hold that E-Infochips Bangalore is to be excluded
from the list of comparables for the software segment.

Infosys Technologies Limited-
207. The Ld. Counsel submitted that the facts pertaining to this
comparable and the Appellant remain the same as in the prior
year i.e. A. Yr. 2009-10:
(a) As per the Annual Report, the Company provides end-to-end business solutions that leverage cutting-edge technology, thereby enabling clients to enhance business performance. The Company provides solutions that span the entire software lifecycle encompassing technical consulting, design, development, re-engineering, maintenance, systems integration, package evaluation and implementation, testing and infrastructure management services. In addition, the Company offers software products for the banking industry.
(b) The Ld. TPO/ AO included this company as a comparable for the reason that it is engaged in software development services. The Ld. DRP upheld order of the Ld. TPO/ AO.
168 (c) The Ld. Counsel pointed out that there are significant intangible assets and R & D activities leading to creation of IP for this company. R&D is conducted at the various Software Engineering & technology Labs (SET Labs) at Infosys. The SET Labs are engaged in R&D in various technologies, which inter alia includes:
• Next generation of software engineering • Convergence of services, network and applications • Text analysis, machinelearning, symbolic and quantitative approaches to Reasoning and Decision Making, and Task Oriented Knowledge Management Systems • Virtualization, grid models for computing efficiencies and cloud computing.
• Application security requirements, etc. The efforts of the SET Labs have led to creation of R&D and filing of patents
(d) The Ld. Counsel pointed out that Infosys has an established brand presence which is one of the most important intangible assets. The company itself accepts this in its Annual Report. He further pointed out that from a perusal of Infosys’ Annual Report, it has claimed that it is the most reputed and admired company in India.
(e) The Ld. Counsel argued that Infosys was engaged in diversified services apart from software services income. Revenues is also derived from sale of software products & on- site services. As per the Annual Report, the Company provides end-to-end business solutions that leverage cutting-edge
169 technology, thereby enabling clients to enhance business performance. The Company provides solutions that span the entire software lifecycle encompassing technical consulting, design, development, re-engineering, maintenance, systems integration, package evaluation and implementation, testing and infrastructure management services. In addition, the Company offers software products for the banking industry.
208. The Ld. CIT(DR) relied on the orders of the Ld. TPO and
DRP and contended that scale, size, brand may impact profits but
not profit margins. He reiterated that there is no positive
correlation between turnover and profit margin.
209. We have heard both the parties, perused the orders of the
TPO and the DRP and analysed the Annual Report of Infosys
Technologies Ltd. The facts pertaining to the assessee’s software
segment and the business results of Infosys remain the same as in
prior year. In appeal of the prior A.Y. 2009-10 (ITA
No.1567/Del/2014) we have analyzed the suitability of this
company as a comparable to the appellant’s software segment and
held that it has to be excluded from the set of comparables.
Following the same, we hold that Infosys Technologies Ltd is to be
excluded.

Infinite Data Systems Private Limited
210. The Ld. Counsel argued that this company is functionally
dissimilar to the Appellant. He pointed out that as per the Annual
Report, the company is a full-fledged IT consulting organization
and provides services in the nature of technical consulting, design
and development of software, maintenance, systems integration,
170 implementation, testing and infrastructure management services.
Further, revenue is primarily derived from technical support and
infrastructure management services. The Ld. Counsel submitted
that the Ld. TPO has accepted this company as a comparable
merely on the basis that services provided by this company were in
the nature of software development services. The Ld. DRP upheld
the order of the Ld. TPO disregarding the disclosures made in the
Annual Report of this company wherein it has been clearly
mentioned that this is a highly diversified company. The Ld.
Counsel also pointed out that there was exceptional growth in
operations, revenue and profits. He submitted a year-on-year
analysis for the period FY 2007-08 to 2009-10 which is as under: Particulars FY 2007- FY 2008- FY 2009-10 FY 2010-11 08 09 Sales revenue NIL 47,407,301 383,160,901 527,524,561 Year-on-year – 708.23% 37.67% increase (%) Employee NIL 18,725,836 109,151,595 143,902,273 remuneration Year-on-year – 482.29% 31.83% increase (%)
Profit before (49,999) 9,851,316 157,310,476 337,737,471 tax Year-on-year – 1496.85% 114.495% increase (%) Debtors NIL 50,097,205 131,326,992 225,170,269 Year-on-year – 162.14% 71.46% increase (%) The Ld. Counsel submitted that the fact that this company has
witnessed widely fluctuating growth rates (as depicted above) is
171 indicative of the fact that the company was facing exceptional or
peculiar circumstances and risks and cannot be said to be
representative of the Indian software industry. In this regard, the
Ld. Counsel placed reliance on the jurisdictional ITAT ruling in the
case of M/s. Stryker Global Technology Center Private Limited
vs. DCIT, (ITA No.6866/Del./2014) wherein the ITAT has
examined the functional profile of Infinite Data Systems for AY
2011-12 and excluded it as a comparable. He also placed reliance
on the jurisdictional ITAT ruling in the case of M/s Freescale
Semiconductor India Pvt Ltd (ITA No1263 /Del/2015).
211. The Ld. CIT (DR) vehemently opposed the exclusion of the
abovementioned comparable and supported the order of the TPO
and the DRP. He submitted that though the nature of services is
diversified many of the services rendered by this company fall
under the broad category of software development.
212. We have heard the two sides and perused the orders of the
TPO and the DRP. We have also perused the Annual Report of
Infinite Data Systems Ltd. The business activity of the Company
has been provided at Page 13 of the Annual Report as: full-fledged
IT consulting organization and provides services in the nature of
technical consulting, design and development of software,
maintenance, systems integration, implementation, testing and
infrastructure management services. The Annual Report further
states that, “Revenue is primarily derived from technical
support and infrastructure management services. The
company has entered into contracts with customers where the
pricing is on time and material basis. Revenues from these
contracts are recognized as and when the related services are
172 rendered and related costs are incurred. Revenue from the end of
the last billing to the Balance Sheet Date is recognized as unbilled
revenues.” The fact that this company is deriving most of its
revenue from technical support and infra management services
make it clear that software development activity is a minor and
subsidiary activity of this company. Further, the Annual Report
does not contain segmental bifurcation of profitability between
technical support segment and the software segment. Both the
activities are clubbed together. In the decision cited by the
Appellant in the case of Stryker Global Technology Center Pvt. Ltd.
(supra), a coordinate Bench of this Tribunal has examined the
validity of Infinite Data Systems Pvt. Ltd. as a comparable to a
software company. The Tribunal ordered the rejection of this
company on the ground of functional dissimilarity by observing as
under:
“24. The comparability of Infinite was also examined in Sun Life India Service Centre (P.) Ltd. (supra) with Sun Life India Service Centre (P.) Ltd. which is a routine software development and service provider and held to be not a suitable comparable as it is a full-fledged IT consulting organisation and provides services in the nature of technical consulting, design and development of software, maintenance, system irrigation, implementation, testing and infrastructure management services. So, in view of the matter, we are of the considered view that Infinite is not a suitable comparable vis-à-vis assessee company, hence ordered to be excluded.”

In light of the aforesaid we order the exclusion of this company
from the list of comparables.
213. The other grounds of the software segment are not being
adjudicated as being academic in nature in view of the submission
made by the Ld. Counsel regarding the international transaction of
173 software segment being at arm’s length on the basis of deletion of
the three aforesaid comparables, viz., Infosys Technologies, E-
Infochips Bangalore and Infinite Data Systems.

GROUND NO. 25: The Learned AO/DRP has erred in holding that
expenditure on recruitment and training of employees leads to
enduring benefit to the appellant and in holding to allow only 1/6th
of the total expenditure in the current year and deferring the
balance to be allowed in next five years
GROUND NO. 26: Without prejudice to the above, Learned AO/DRP
has erred in not allowing in the year under assessment, 1/6th of the
expenditure on this account that was similarly disallowed in the
preceding five assessment years.
214. We have already adjudicated this issue in the appeals for
prior years (A.Yrs. 2005-06, 2006-07 and 2007-08, 2008-09 and
2009-10) and allowed the same. We have held that training and
recruitment expenditure is fully allowable as revenue expenditure
in the year in which it is incurred. There being no enduring benefit
it cannot be treated as capital expenditure or deferred revenue
expenditure. Ground no. 25 is, therefore, allowed and Ground no.
26 is dismissed as being infructuous.
GROUND NO. 27:The Learned AO/DRP has erred in holding that
loss on exchange fluctuation amounting to Rs. 4,86,59,085 debited
to P&L account is a notional loss and is not allowable as a
deduction under the provisions of the Act.
GROUND NO. 28: Without prejudice to the above ground, the
Learned AO/DRP has erred in not excluding INR 29,952,597 from
the taxable income of current year being marked to market losses
incurred in respect of foreign exchange contracts which were
174 outstanding as on 31st March 2009 and written back during the
year as same was not allowed as deduction in the assessment
proceedings for AY 2009-10.
215. This ground pertains to allowability of loss arising from revaluation of open forward forex contracts the last date of the balance sheet on account of restatement of amounts payable and receivable in foreign exchange under the marked to market (MTM) policy mandated under accounting norms. This issue has already been decided by us in ITA No. 5315/Del/2011 for A.Yr. 2007-08 under Ground no. 10, ITA No. 52/Del/2013 for A. Yr. 2008-09 under Ground no. 11 and 11.1 and ITA No. 1567/DEL/14 for A. Yr. 2009-10 under Ground no. 29-31 wherein we have allowed the ground in view of the law being settled by the Hon’ble Supreme Court in CIT v. Woodward Governor India Pvt. Ltd. 312 ITR 254 (SC) in this regard. Following the same, this Ground is allowed. Ground no. 28 being infructuous is dismissed.

GROUND NO. 29:The Learned AO has erred in law and on fact in
withdrawing a deduction of INR 21,819,987 claimed by the
appellant under section 10A of the Act on the wrong pretext that
mere shifting of undertaking from one location to another
tantamount to non-fulfilment of conditions laid down in section
10A(2)(ii)/(iii) of the Act
216. This issue has already been decided by us in ITA No.
1567/DEL/14 for A. Yr. 2009-10 under Ground no. 32 wherein we
have allowed the ground. Following the same, this Ground is
allowed.
AY 2011-12 (ITA No. 868/DEL/2016 and ITA No. 2511/DEL/2018 arising out of order passed u/s 154)
175 217. The facts and business model in the present Assessment
Year i.e., 2011-12 are similar to the facts already stated for AY
2005-06 to 2010-11. The appellant had filed its return of income
on November 29, 2011, declaring an income of Rs.
1,73,33,95,170/-. A summary of international transactions
entered into by the appellant and the appellant’s approach in
determining their ALP is given in the table below:
Particulars Most Profit Margin No. of Arm’s Appropr Level earned compara Length iate Indicat by the bles Margin Method or Appell consider as per as per (PLI) ant as ed as per TP study TP as per per TP TP study study TP study study
Class I – Transac Operati 1.77 9 1.43%
Manufacturing tional ng
(Consumer Net Profit/
Electronics, Home Margin Operati
Appliances, Mobile Method ng
Phones and Colour (‘TNMM’) Revenu
monitors) e (OP/
Import of raw material, OR)
Import of stores and
service spares, Export of
raw material, Export of
stores, spares and semi-
finished goods, Payment
of royalty, Import of
fixed assets, Import of
spares for repair and
maintenance, Provision
of intra-group services,
Availing of services,
Reimbursement of
marketing expenses by
AEs
176 Particulars Most Profit Margin No. of Arm’s Appropr Level earned compara Length iate Indicat by the bles Margin Method or Appell consider as per as per (PLI) ant as ed as per TP study TP as per per TP TP study study TP study study
Class II – Trading TNMM OP/ 1.39% 19 0.67%
(Consumer electronics, OR
Home Appliances,
Mobile Phones, Colour
Monitors and other IT
products)
Import of finished
goods, Import of stores
and service spares,
Service income,
Reimbursement of
marketing expenses by
AEs
Class III – Provision of TNMM Operati 15.01% 22 8.97%
contract software ng
development services Profit / Operati ng Cost (OP/O C) 218. The dispute in the present appeal filed by the appellant
pertains to the international transactions grouped under Class-III
(Contract software development) segment. The other international
transactions pertain to Classes I (Manufacturing – Consumer
electronics, home appliances, mobile phones and colour monitors)
and Class II (Trading – Consumer electronics, home appliances,
mobile phones, colour monitors and other IT products). There is no
dispute in respect of these transactions. In Class-III (Contract
177 software development) segment, the appellant was engaged in the
provision of contract software development services. Transactional
Net Margin Method was chosen as the most appropriate method in
its transfer pricing study. The profit level indicator taken was
operating profit/operating cost. For the benchmarking exercise, an
economic analysis was carried out in the TP study leading to
identification 22 uncontrolled comparable companies. Since the
appellant had earned profit margin of 15.01% which was higher
than the profit margin earned by the comparables, it was
concluded that the international transactions were at arm’s length.

219. The dispute in the present appeal filed by the appellant
pertains to the adjustments made by the TPO vide order dated 29
January 2015 on account of (a) alleged international transaction of
Advertising, Marketing and Promotion (AMP) expenses and (b)
software development segment.
220. Adjustments made on account of AMP expenses: The Ld.
TPO was of the view that the Appellant has provided certain
services in respect of creation of marketing intangibles to its AE.
Therefore, he proposed an adjustment of Rs. 11,884,138,456 (Rs.
1,222,238,922 under the IT business and Rs. 10,661,899,534
under the Non-IT business) with respect to AMP expenses incurred
by the appellant. The Ld. TPO applied the bright line test (“BLT”) to
compare the AMP/sales ratio of the appellant with that of the
comparable companies and application of a mark-up equivalent to
SBI’s PLR.
221. ALP determination for Provision of contract software
development services (Class III): In Class III (software
178 development services) segment, the Ld. TPO proceeded to
undertake a fresh benchmarking analysis of the uncontrolled
comparable companies by modifying the filters and arrived at a
fresh set of comparables. He selected 11 out of the 26 comparables
provided by the appellant (i.e. 22 comparables identified as per TP
Study and 4 comparables identified by the assessee during the
course of TP assessment proceedings) and introduced 8 additional
comparables. The final sets of comparables for benchmarking
international transaction are reproduced in the table below:
S.No. Name of Comparable Working capital adjusted NCP for AY 2011-12 (%) 1 Akshay Software Technologies Ltd. 3.63% 2 E-Infochips Limited 56.42% 3 Evoke Technologies Pvt Ltd 10.23% 4 E-Zest Solutions 38.19% 5 Infosys Technologies Ltd. 45.11% 6 Larsen & Toubro Infotech Ltd. 21.22% 7 LGS Global Limited 13.58% 8 Persistent Systems and Solutions Ltd 22.80% (Merged) 9 Persistent Systems Ltd. 24.10% 10 R S Software (India) Ltd 18.07% 11 Sasken Communication Technologies Ltd 26.68% 12 Wipro Technologies Services Ltd. (Merged) 55.37% 13 Celstream Technologies Pvt. Ltd. 15.27% 14 Acropetal Technologies Ltd. (Seg) 21.34% 15 Mindtree Ltd.(Seg) 11.22%
179 S.No. Name of Comparable Working capital adjusted NCP for AY 2011-12 (%) 16 Sankhya Infotech Limited(Seg) 24.13% 17 Tata ElxsiLtd(Seg) 13.34% 18 Thirdware Sol (Seg) 19.54% 19 Zylog Systems Limited 27.56%
Arithmetic Mean (Page 84 of TP Order) 24.62%
NCP of Samsung India (Page 5 of TP Order) 15.01%
Adjustment (Rs.) 216,107,588 220. The Ld. DRP vide order dated 23 December 2015 upheld
adjustments made by the Ld. TPO and stated that incurring AMP
expenses constitutes an international transaction. The Ld. DRP
directed for exclusion of routine selling and distribution expenses
while computing the AMP adjustment of comparables. The Ld.
DRP also directed for imputing the said adjustment using AMP to
gross profit (‘GP’) ratio and the mark-up on excessive AMP expense
to be as per sub-clause (ii) to Rule 10(1)(c) i.e. the GP/Sales of
comparable companies, thus selected. As a consequence, the Ld.
TPO passed an order dated 28 January 2016, giving effect to the
directions of the Ld. DRP, wherein the adjustment was reduced to
Rs. 394,368,561 (i.e. Rs. 313,105,771 under the non-IT segment
and Rs. 81,262,790 under the IT segment).
221. ALP determination for Provision of contract software
development services (Class III): The Ld. DRP directed to exclude
Infosys Ltd. and Sankhya Infotech Ltd. as a comparable for Class
III segment. Accordingly, the Ld. TPO passed an order dated 28
180 January 2016, giving effect to the directions of DRP, wherein the
adjustment was revised to Rs. 189,797,464, with a revised arm’s
length NCP of 23.45% as against 24.62% determined by the Ld.
TPO earlier.
Accordingly, the total adjustments pursuant to Ld. DRP’s
directions are tabulated as under:

Particulars Amounts as per TP Amounts pursuant order (In Rs.) to DRP directions (In Rs.)
Adjustments made on account 11,884,138,456 394,368,561
of AMP expenses
Adjustment on account of 216,107,588 189,797,464
provision of contract software
development services
Total 12,100,246,044 584,166,025 222. Pursuant to the directions of Ld. DRP, the AO passed the
final assessment order dated 28 January 2015. The AO while
incorporating the transfer pricing adjustments made by the TPO,
made further additions of:

i) Rs. 143,127,352 on account of disallowance in respect of foreign exchange contracts classified under forex loss
ii) Rs. 889,984,961 on account of disallowance of deduction claimed under section 40(a)(i) of the Act.
223. The Ld. TPO initiated rectification proceedings suo-moto
vide notices dated 6 April 2016 and 12 March 2018. In response to
these notices, the Appellant filed submissions contesting the
rectifications so proposed by the Ld. TPO dated 28 April 2016, 19
May 2016 and 22 March 2018. A rectification order dated 27
181 March 2018 was passed by the Ld. TPO ignoring the Appellant’s
contentions and enhanced the total adjustment amount as below:
224. Adjustments made on account of AMP expenses: The Ld.
TPO enhanced the AMP adjustment from Rs. 394,368,561 (i.e. Rs.
313,105,771 under the non-IT segment and Rs. 81,262,790 under
the IT segment) to Rs. 1,936,311,967 (i.e. Rs. 1,936,311,967 under
the non-IT segment and ‘nil’ under the IT segment) on account of:

– Revision in the AMP/ Gross Profit (‘GP’) ratio of comparable companies to 13.14% from 22.47% [on account of revision in the AMP/ GP margins of two comparables namely Dynalog (India) Ltd. and Wep Peripherals Ltd. from (427.78%) and 21.36% to 3.65% and 7.48% respectively.] – Revision in the AMP/ GP ratio of SIEL to 22.82% from 27.55%.

225. ALP determination for Provision of contract software
development services (Class III): The Ld. TPO re-computed the
operating margin of SIEL by treating foreign exchange gain as
operating income instead of adjusting the same against operating
expenses. In the re-computation of operating margins of
comparable companies, he further treated foreign exchange gain
and amounts written back as operating. Accordingly, the
adjustment under this segment was enhanced from Rs.
189,797,464 to Rs. 220,348,249.
226. The AO passed an order dated 30 March 2018
incorporating the above revised adjustments made by the Ld. TPO
vide his rectified order and enhanced the assessed income to Rs.
182 500,44,30,490. Aggrieved by the order passed by the AO, the Assessee has preferred the present appeal and has prayed for adjudication of the following grounds of appeal.

GROUNDS IN APPELLANT’S APPEAL (ITA NO. /DEL/16) FOR AY 2011-12
227. GROUND NO. 1 to 12 and all the Grounds in ITA No.
2511/DEL/2018 arising out of order passed u/s 154): These
grounds pertain to the issue of AMP expenditure being treated as
an international transaction and adjustment being made on the
basis of the “bright line” test. During this year as well the “bright
line” test has been used albeit in a slightly different manner.
Instead of AMP/Sales ratio, the TPO has used AMP/GP ratio to
overcome the hurdle posed by the Hon’ble Delhi High Court
decision of Sony Ericsson (supra) where the “bright line” test has
been held to be contrary to law and impermissible. In our view the
approach by the TPO in treating the AMP expenditure as a separate
international transaction based on a claim that “excessive”
expenditure has been incurred remains the same as in prior years.
Only the bright-line has varied from AMP/Sales to AMP/GP. We
have already decided this issue in ITA no. 3248/Del/2012 for A.Y.
2005-06 by examining the same in detail. These grounds for this
year are allowed and disposed-off on the lines of our findings and
observations made while deciding Grounds no. 3.1 to 3.6 of ITA no.
3248/Del/2012.

ADJUSTMENT ON ACCOUNT OF SOFTWARE DEVELOPMENT GROUND NO. 13: The Learned TPO/AO/DRP have erred in computing adjustment of INR 18,97,97,464 to the total income of the appellant on account of adjustment in ALP of the international
183 transaction pertaining to provision of software development services
entered into by the appellant with its AE
GROUND NO. 14: The Learned TPO/AO/DRP have erred in
rejecting certain comparable companies identified by the appellant
using ‘export earnings less than 75 percent of operating revenues’
as a comparability criterion
GROUND NO. 15: The Learned TPO/AO/DRP have erred, in law
and on facts and circumstances of the case, by rejecting certain
comparable companies identified by the appellant on account of
showing diminishing revenues trend
GROUND NO. 16: The Learned TPO/AO/DRP have erred in
rejecting certain comparable companies identified by the appellant
using ‘related party filter less than 25 percent of total cost’ as a
comparability criterion even though they satisfy the same on a
consolidated basis
GROUND NO. 17: The Learned TPO/AO/DRP have erred, in
rejecting certain comparable companies identified by the appellant
for having different accounting year (i.e. having accounting year
other than March 31 or companies whose financial statements were
for a period other than 12 months)
GROUND NO. 18:The Learned TPO/AO/DRP have erred in
selecting certain companies (which are functionally dissimilar or
which are earning super normal profits) as comparable to the
appellant to benchmark the said transaction
GROUND NO. 19: The Learned TPO/AO/DRP have erred in
wrongly rejecting certain companies from and adding certain
companies to the final set of comparables for the said transaction on
an adhoc basis (including functional comparability), thereby
resorting to cherry picking of comparable for benchmarking
184 228. At the outset, the Ld. Counsel submitted that despite there
being numerous grounds against the adjustment made in the
software segment, the appellant was primarily aggrieved by the
inclusion and exclusion of certain comparables by the TPO.
However, if only 2 comparables are excluded namely E-Infochips
Ltd and Wipro Technologies Services Ltd and 2 comparables are
included namely, R Systems International Ltd and Caliber Point
Business Solutions Limited, then the assessee’s international
transaction would be at arm’s length and the rest of the grounds
will be rendered academic. Accordingly, we proceed to examine the
validity of these four comparables.

229. The Ld. Counsel made his submissions with respect to the
following comparable companies:
E-Infochips Limited (“E-Infochips)
(a) The Ld. Counsel contended that E-Infochips should be excluded because the company fails TPO’s filter of software service income to total income filter of at least 75% since the revenues from software development service accounts for 73.38% as evident from the below table:

Particulars Amounts (In Reference INR)
Income from software 192,109,661 Page no. 64 of annual development (A) report for AY 2011-12 (FY 2010-11) Income from 260,384,251 Page no. 33 of annual operations (B) report for AY 2011-12 (FY 2010-11) Revenue from 73% comparable
185 segment (A/B) (b) The Ld. Counsel further submitted that the company fails TPO’s filter of export income to total income filter of at least 75% – Revenues from export of software development service accounts for 62.77% as is evident from the table below:

Particulars Amounts Reference (In INR)
Income from export 163,443,751 Page no. 68 of annual of software services report for AY 2011-12 (A) Income from 260,384,251 Page no. 33 of annual operations (B) report for AY 2011-12 Revenue from 62.77% comparable segment (A/B) (c) The Ld. Counsel argued that E-Infochips incurred significant R & D expenses of 4.15% of the total cost during the year whereas the Appellant has not incurred any amount towards R&D in this segment. He further contended that the company is functionally dissimilar to the Appellant on account of undertaking diversified business operations since it has derived income from hardware and such income accounts for 15% of the total revenue. It is evident from the table below:

Particulars Amounts (In Reference INR) Income from 39,248,562 Page no. 62 of annual computer report for AY 2011-12 hardware(A) Income from 260,384,251 Page no. 33 of annual operations (B) report for AY 2011-12 Revenue from 15%
186 comparable segment (A/B) (d) He further pointed out that the company has reported only one segment despite undertaking diversified operations. He placed reliance on various judgments wherein it has been held that E-Infochips ought to be excluded as it is involved in products and no segmental data is available. The list of decisions are as below:
i) Saxo India (P.) Ltd. v. ACIT, Circle 22(2), also upheld by Hon’ble Delhi High Court in Pr. CIT v. Saxo India (P.) Ltd. (ITA No. 682/2016); ii) Intoto Software India Pvt. Ltd. (ITA No. 1196/HYD/2010); iii) Conexant Systems India Pvt. Ltd. (ITA No. 1429/HYD/2010 and 1978/HYD/2011); iv) Virtusa India Private Limited (ITA No. 1962/HYD/2011; v) EMC Software and Services (India) Private Limited (IT(TP)A No. 273/Bang/2016); vi)Philips India Ltd (ITA No.863 & 539/Kol/2016) wherein it was held that the company is not functionally comparable as it is engaged in diversified business (software development, hardware maintenance, IT consultancy), does not have segmental information (to carve out its ITeS), was involved in R&D, and had an exceptional year (grew at rate 5 times more than industry average).
230. Ld. CIT (DR) submitted that E-Infochips was included by
the Ld. TPO for the reason that it is engaged in software
development. The Ld. TPO was of the view that revenue from IT
consultancy and software development taken together satisfy the
service income filter. The Ld. CIT (DR) vehemently defended the
187 order of Ld. TPO/DRP and contended that E-Infochips was rightly
included for the reasons mentioned in their orders.

231. We have heard both the sides and perused the material on
record. We find that this company (E-Infochips) fails the filters
applied by the TPO himself. The TPO has eliminated companies
from his list of comparables whose service income constitutes less
than 75% of its total revenues. Similarly, the export filter of 75% is
also not met. The details extracted from the Annual Report have
been examined by us and we agree that these filters are not met.
We also note that this company derives a material part of its
revenues from computer hardware which is commingled with the
revenues from software and the Annual Report does not provide
bifurcation of profitability between hardware and software
development. In such a situation this company is not suitable to
be taken up for a TNMM comparison.

232. We also draw strength from various decisions of the
Tribunal in this respect where this comparable was held to be
incomparable to a software service company for the reasons
discussed above. These aspects have been discussed in detail in
the decision of a coordinate bench of this Tribunal in Saxo India
Pvt. Ltd. (supra) and Intoto India Pvt. Ltd. (supra). In view of the
above factual aspects and the numerous decisions of this
Tribunal, we hold that E-Infochips is not a suitable comparable
and is directed to be excluded from the list of comparables.
Wipro Technologies Limited (“Wipro Technology”)
233. The Ld. Counsel pointed out that, as per the Annual
Report (Page No. 38) of Wipro Technology for AY 2011-12, Wipro
Technology is engaged in providing IT software solutions /
188 maintenance and technology infrastructure support services to Citi
Group entities globally. He contended that Wipro Technology is
functionally dissimilar on account of undertaking diversified
business operations comprising software related support services,
primarily information technology software solutions / maintenance
and technology infrastructure support services unlike the
Appellant who is engaged in software development support
services only. Reliance was placed by the Ld. Counsel on the
following judgments that hold that in absence of segmental details,
a company cannot be taken into account for comparability
analysis:

• LG Soft India (P.) Ltd. Vs. DCIT (2014) 48 taxmann.com 237 (Bangalore-Trib.) • M/s British Marine PLC-India Branch vs. DCIT(IT)-
1(3)(2) (ITA No.1908/MUM/2016) The Ld. Counsel further contended that Wipro has significant
related party transactions. As per the annual report of the Wipro
Technologies Ltd. of FY 2009-10, Wipro Limited, the holding
company of the Wipro Technologies Ltd., has acquired all the
interest held by Citigroup Inc. in Citi Technology Services Limited
(Subsequently renamed as Wipro Technology Services Limited)
with effect from 21 January 2009. On the same date, Wipro
Limited entered a master service agreement with Citigroup Inc.,
erstwhile holding company of Wipro Technology for providing
technology infrastructure services and application development
and maintenance services for a period of six years. Therefore, all
the transactions between Wipro Technologies Ltd and Citigroup
Inc. would qualify as an international transaction within the
189 meaning of Section 92B(2) of the Act. The Ld. Counsel placed
reliance on Saxo India Pvt. Ltd. (ITA No. 6148/Del/2015) which
has further been upheld by the Hon’ble jurisdictional High Court
vide order dated 28.09.2016 in ITA No. 682/2016 (Pr.CIT, Delhi-8
v. Saxo India Pvt. Ltd.): In this case, the relevant para is
reproduced below for ready reference:

“16.5. Adverting to the facts of the instant case, we find that Wipro Technology Services Ltd. earned a revenue from Master services agreement with Citigroup Inc. for the delivery of technology infrastructure services. This agreement was, in fact, executed between the assessee’s AE, Wipro Ltd., and Citigroup Inc., a third person. This unfolds that the transaction of earning revenue from software development support and maintenance services by Wipro Technology Services Ltd., is an international transaction because of the application of section 92B(2) i.e., there exists a prior agreement in relation to such transaction between Citigroup Inc. (third person) and Wipro Ltd. (associated enterprise). In the light of this structure of transaction, it ceases to be uncontrolled transaction and, hence, Wipro Technology Services Ltd., disqualifies to become a comparable uncontrolled transaction for the purposes of inclusion in the final list of comparables under Rule 10B(1)(e)(ii). We, therefore, direct removal of this company from the list of comparables.”
The Ld. Counsel also relied on the following decisions of the coordinate Bench of this Tribunal wherein exclusion of this comparable has been upheld in the case of a software development company:
190 • Intoto Software India Private Ltd. [2013] 35 taxmann.com 421 (Hyderabad – Trib.) • M/s. FCG Software Services (India) Pvt. Ltd. Vs. ITO, I.T(T.P) A.No. l242/Bang/2012 • Vodafone India Services Vs. DCIT, ITA No.7140 /Mum/2012 • Xander Advisors India Pvt. Ltd., Vs. ACIT, ITA No.5840/Del/2012 • NEC Technologies India P Ltd. (ITA No. 6283/Del/2015) 234. Ld. CIT (DR) has contended that the TPO included Wipro
Technology as a comparable for the reason that it is providing
specialized services within software development and is not selling
products and thus, it is comparable to the Appellant. The Ld. CIT
(DR) contended that the order of Ld. TPO was correct, and Wipro
Technology was rightly included for the reasons mentioned in his
order.
235. We have examined the facts relating to Wipro Technology
Services and the contention raised by the two sides. We find that
this company has been consistently held to be incomparable on
account of the peculiar facts surrounding its history. This
company was earlier a subsidiary of Wipro Ltd. and had a long
term service contract with Citi group. Subsequently, it was
acquired by Citi group and the long term service contract
continued post acquisition. On these facts, the revenues earned by
Wipro Technology Services from Citigroup acquire the dimension
of “controlled” transactions between related parties within the
191 meaning of Section 92B(2) of the Act. This issue was first
examined and adjudicated by a coordinate bench of this Tribunal
in Saxo India Pvt. Ltd. wherein the Tribunal observed as below:

“16.5. Adverting to the facts of the instant case, we find that Wipro Technology Services Ltd. earned a revenue from Master services agreement with Citigroup Inc. for the delivery of technology infrastructure services. This agreement was, in fact, executed between the assessee’s AE, Wipro Ltd., and Citigroup Inc., a third person. This unfolds that the transaction of earning revenue from software development support and maintenance services by Wipro Technology Services Ltd., is an international transaction because of the application of section 92B(2) i.e., there exists a prior agreement in relation to such transaction between Citigroup Inc. (third person) and Wipro Ltd. (associated enterprise). In the light of this structure of transaction, it ceases to be uncontrolled transaction and, hence, Wipro Technology Services Ltd., disqualifies to become a comparable uncontrolled transaction for the purposes of inclusion in the final list of comparables under Rule 10B(1)(e)(ii). We, therefore, direct removal of this company from the list of comparables.”
The view taken by the coordinate bench in Saxo India (supra) was
subsequently approved by the Hon’ble High Court and followed in
numerous other cases (listed above). In light of the peculiar facts
which permeate during the year under consideration and
respectfully following these precedents we hold that Wipro
Technology Services Ltd. cannot be taken as a comparable as it is
not an uncontrolled entity and accordingly fails the essential
requirement of transfer pricing analysis.
236. Caliber Point Business Solutions Limited (“Caliber”) and
R System International Ltd. (R System): The Ld. TPO excluded
Caliber and R System as comparables for the reason that these
two companies adopt financial year ending in December and not in
March. The Ld. DRP upheld order of the Ld. TPO.
192 237. The Ld. Counsel submits that different financial year ending
is not a criterion to reject a comparable company. He pointed out
that no adverse inference was made by the TPO in AY 2012-13
wherein Caliber was accepted as a comparable by the Appellant in
its TP Study even though in that year too, the financial year of the
company was December as in this year. The Ld. Counsel argued
that a functionally comparable company cannot be rejected merely
on the grounds of having different financial year if the data can be
reasonably extrapolated. Reliance was placed by him on:

• DCIT vs. McKinsey knowledge Centre India private limited (ITA No. 195/DEL/2011), affirmed by the Hon’ble High Court of Delhi [TS-672-HC-2015(DEL)-TP] • Mercer Consulting (India) Pvt Ltd [TS-664-HC-2016(P & H) • Exevo India Pvt. Ltd. vs. ITO (I.T.A. No.907/Del/2016) • SSL TTK (TS-887-ITAT-2016) • Aegis Limited (ITA No. 7694/Mum/2014)
238. The Ld. Counsel submitted that extrapolated annual
profitability of the comparable segment depicting March ending
results for AY 2011-12 have been computed at 4.25% from annual
reports for period December 2010 and December 2011. He placed
reliance on the judgment delivered in the case of Maersk Global
Services Centre (I) Pvt Ltd (I.T.A. No.944/Mum/2016)
pertaining to inclusion of Caliber Point Solutions Ltd. as a
comparable for AY 2011-12. As regards R Systems, the Ld.
Counsel submitted that the extrapolated annual profit margin for
the period ending March 2011 has been computed at 6.55% for
the software development and customization service segment from
193 the quarterly statements filed by this company with the stock
exchanges.

239. The Ld. CIT (DR) vehemently defended the order of Ld. TPO
and contended that Caliber and R System were rightly rejected for
the reasons mentioned in his order. He further submitted that the
extrapolated annual figures are not reliable because these have
been computed based on weighted average basis and not on actual
quarterly results which are not available in the public domain.
240. The issue of different financial year ending in the context of
rejection of comparables has been examined by us in ITA no.
5315/Del/2011 (appeal for A.Yr 2007-08) while determining the
suitability of PCS Technology Ltd. as a comparable under Ground
no.4. We have already held that it is mandatory under Rule 10B
(4) to use current year data for purpose of comparison under
TNMM. Use of data from different financial years would result in
an inaccurate comparison and may erode the credibility of the
benchmarking exercise. We had also taken note of the Tribunal
decision in the case of McKinsey Knowledge Centre (supra) which
was affirmed by the High Court wherein extrapolation of figures
from quarterly statements was permitted. In the present situation,
it has been submitted that the quarterly results of R System is
available in public domain as it is a listed company and is required
to file quarterly statements with the stock exchanges and
regulators. However, the same has not been verified by the TPO.
As regards Caliber it is not clear whether the quarterly statement
of this company is available in the public domain. The
extrapolated figures given by the appellant appear to be a weighted
average mean. In our view this is not permissible. We accordingly
194 remand the determination of these facts to the file of the TPO who
is directed to examine whether quarterly results of R System and
Caliber is available in public domain so that their annual profit
margin can be determined in an accurate way. If such information
is available, the comparable can be included. If such information
is not available, the comparable cannot be included merely on the
basis of extrapolated figures derived from weighted average basis.
This ground is disposed off in terms of our above directions.
GROUND NO. 23: The Ld. AO/DRP has erred in law and in fact, in
holding that loss on exchange fluctuation amounting to Rs.
143,127,352 debited to P&L account is a notional loss and is not
allowable as a deduction under the provisions of the Act GROUND NO. 24: Without prejudice to the above ground, the Ld.
AO/DRP erred in not excluding Rs. 48,659,085 from the taxable
income on the current year being marked to market losses incurred
in respect of foreign exchange contracts which were outstanding as
on 31st March 2010 and written back during the year as same was
also not allowed as deduction in the assessment proceedings for AY
2010-11 241. This ground pertains to allowability of loss recognized under
accounting standards under marked to market (MTM) guidelines
in respect of forward forex contract which are open and unexpired
on the last date of the balance sheet on account of restatement of
amounts payable and receivable in foreign exchange. This issue
has already been decided by us in ITA No. 5315/Del/2011 for A.Y.
2007-08 under Ground no. 10, ITA No. 52/Del/2013 for A. Yr.
2008-09 under Ground no. 11 and 11.1, ITA No. 1567/DEL/14 for
195 A.Y. 2009-10 under Ground no. 29-31 and ITA No.
6741/DEL/2014 for A.Y. 2010-11 under Ground no. 27 & 28
wherein we have allowed the ground in view of the law being
settled by the Hon’ble Supreme Court in CIT v. Woodward
Governor India Pvt. Ltd. 312 ITR 254 (SC) in this regard. Following
the same, this Ground is allowed.

GROUND NO. 25: In the facts and circumstances of the case and in
law, the Ld. AO/DRP has erred in making a disallowance/addition
of Rs. 88,99,84,961 in terms of section 40(a)(i)/(ia) of the Act GROUND NO. 26: The Ld. AO/DRP erred in disallowing Rs.
88,99,84,961 being the reversal of excess provision which was
already disallowed in AY 2010-11 GROUND NO. 27: The Ld. DRP failed to acknowledge the facts that
appellant had clearly submitted that reversal was of excess
provision and accordingly, it erred in observing that the provisions
have been reversed without clarifying whether payments were
made or not and if made, the status of TDS on such payments GROUND NO. 28: The Ld. AO/DRP has factually erred in stating
that the appellant has not credited the profit and loss account in the
current year with the amount of expenses of the previous years
which have been so reversed, without appreciating that the reversal
of provisions was made in the profit and loss account, by crediting
the amount in respective heads of expenses and thereby increasing
the income GROUND NO. 29: The Ld. AO/DRP has erred in not appreciating
that the said amount of Rs. 889,984,961 has already been
disallowed in the preceding year, i.e., AY 2010-11 when it was
196 debited to the P&L account, accordingly, the same has to be reduced
in computing the total income when it is credited to the P&L account
at the time of reversal in the current year, otherwise it would lead to
double disallowance/taxation of the same amount GROUND NO. 30: The Ld. AO has erred on facts in observing that
the reversal of expenses of Rs. 889,984,961 establishes the said
expenses as prior period expenses which cannot be claimed in the
current year, as he failed to understand that during the year under
consideration the appellant had only reversed the said amount of
Rs. 80,99,04,961 by crediting the P&L account 242. Ground nos. 25 to 30 pertain to the issue of disallowance
made by the AO u/s 40(a)(i)/(ia). The relevant facts in this respect
are that, the assessee had created a year end provision of INR
3,396,650,580 for the year ending 31 March 2010. Out of this
provision, INR 889,984,971 was in respect of vendors who could
not be identified, and no TDS could be made. Accordingly, the
assessee in its computation of income and in income tax return
for A.Y. 2010-11 disallowed this amount of INR 889,984,971.
During this year i.e. FY 2010-11 (AY 2011-12), the assessee
reversed such provision in the books of accounts and credited the
same in respect heads of expenses thereby reducing the expenses.
This led to an increase of the total income to the extent of INR
889,984,971.The Ld. AO held that the assessee company has not
deducted and deposited the tax deduction at source (TDS) and on
a failure to deposit withholding taxes on this amount disallowed
the same under section 40(a)(i)/(ia) of the Act. He further held that
creation of provision is nothing but a strategy / tool for decreasing
the income and taxes. The AO was of the view that the
submission of the assessee that the expense was reversed in the
197 current year establishes that the prior period expense cannot be
claimed in the current year especially when the assessee is
following mercantile system of accounting. The AO observed that
the legal fiction of section 40(a)(i)/(ia) is not available as the
assessee has merely reversed the entries of expenses and has not
actually deducted the tax and deposited the same. The Ld. DRP
upheld the reasoning and action of the Ld. AO.
243. The Ld. Counsel for the appellant submitted that the
reversal of the provision in the books of accounts of Rs.
889,984,971 was claimed as a deduction in computing the total
income of AY 2011-12 because the same had already been taxed
in the prior AY 2010-11. He further submitted that the action of
the AO amounts of double taxation of the same amount. The Ld.
Counsel pointed out that the deduction on account of reversal of
the provision was mistakenly described as a deduction under
section 40(a)(i) of the Act in the computation of income. This
deduction was merely on the account of a reversal of a provision
which had already been subject to tax in the prior year. The
relevant details of reversal had been placed before the Ld. AO and
have also been placed before us. The Ld. Counsel placed reliance
on Johnson Matthey India Pvt. Ltd. [I.T.A. No.
4397/Del/2011] where in similar circumstances the Tribunal
had deleted the disallowance made by the AO. It has been
submitted by the Ld. Counsel of the appellant that as the said
amount has already been disallowed in the preceding year i.e. AY
2010-11 when it was debited in the P&L account, the same is to
be reduced in the computing the total income when it is credited
to the P&L account at the time reversal in the current year i.e. AY
2011-12.
198 244. Ld. CIT(DR) relied on the orders of the AO and the DRP and contended that since no TDS had been deducted and deposited in this year, the disallowance made by the AO was justified because the same is mandated by Section 40(a)(i)/(ia).It has also been submitted that the reversal of provision made by the assessee in its books is in conformity with the generally accepted accounting principles consistently followed by the assessee to represent a true and fair view of the state of affairs of the financial statements and the same has been certified by the statutory auditors of the company as well.
245. We have heard both sides and examined the material on
record. The computation of income for the prior year shows that
the appellant on its own volition had added back an amount of Rs.
889,984,971to its income on account of a provision being created
without any TDS being made. We find that during the relevant
financial year, this provision was reversed and the corresponding
heads of expenses to which the provision pertained were reduced
correspondingly. This led to increase of income in the books of
account. Since this amount had already been voluntarily
disallowed in A.Y. 2010-11 and offered to tax, the impact of write-
back in the books for the current year had to be reversed. The
assessee claimed this as a deduction in its computation of income.
We are in agreement with the submission of the assessee that this
approach is consistent with the generally acceptable accounting
practices.
246. In our view, Section 40(a)(i)(ia) of the Act comes into play
only when an assessee claims any expense as a deduction without
199 deducting TDS on the same. However, in the present case, as the
assessee has reversed the provision created in the previous year,
the same has accordingly be reduced from the total income as it
was already added back while computing the income of previous
year. In this situation Section 40(a)(i) or (ia) has no application as
there is no expense which has been incurred. The allowability of
the reversal of the provision is a deduction that is claimed on the
basis of alignment of the books of accounts with the taxable
income. Therefore, the reasoning of the Ld. AO that as no tax has
been deducted and deposited the said reversal of provision should
not be allowed to be reduced from taxable income is on completely
wrong footing because claim of the assessee pertains to reversal of
excess provision created in preceding year for which vendors were
not identifiable, and thus the question of deducting tax on the
same does not arise.
247. Accordingly, we hold that the Ld. AO and the DRP have
erred in not appreciating that in the preceding year at the time of
creation of the said provision, the same was already suo-moto
added back to the income under the head “Profits and Gains of
business or Profession,” for the reason that it is not allowable
under the Act. Therefore, in the current year, on the reversal of
the said amount, the same should be allowed to be reduced in
computing the total income else it would lead to double taxation of
the same. The decision of the coordinate Bench in the case of
Johnson Matthey India Pvt. Ltd. [I.T.A. No. 4397/Del/2011]
cited by the appellant is applicable to the present facts. In this
case, the issue before the Tribunal was whether the reversal of
provision (created in preceding years), which was disallowed in
200 those years, should be taxed in the year of reversal. The Tribunal
while holding in favour of the assessee held as below: “14. Each year the assessee has been making a provision for inventory in the books of account maintained by the company. While filing its return of income, this provision for inventory made in the books of account, is added back to the income under the head “Profits and Gains of business or Profession,” for the reason that it is not allowable under the IT Act. In other words the provision for slow moving/obsolete inventory, which is created each year in the profits & loss account and balance sheet prepared in accordance with the Companies Act, 1956, has been specifically added back while computing taxable income under the IT Act, while filing the return of income of the respective year i.e. the assessee has not claimed deduction on the ‘Provision’ created in its accounts, in its income tax computation in the earlier years.
15. During the year under consideration the provision in question, in respect of slow moving/obsolete inventory was written back in the accounts of the company, on the ground that the said provision to the extent written back is no longer required. The assessee had sold the slow moving stock and disclosed the sale proceeds, in its sales account. The provision was written back as no longer required in the accounts and as the provision was not claimed as an expense in its income tax computation in the year in which it was created, the same need not be added back once again. The action of the AO is a double addition. A figure which was never claimed or allowed as a deduction in the earlier year was added back.”
248. In another case involving a similar situation, this Tribunal has held that such reversal has to be allowed as a deduction. In
201 SPX India (P) Ltd. Vs. CIT (A) [(2014) 147 ITD 120 (Delhi)] wherein it was held that:

“…As far as quantification of the amount is concern, we find that assessee has made the provision for a sum of Rs. 2,61,540/-. The excess provision has been written back and a sum of rs. 1,05,989/- was offered for tax in the next year. Thus the exact amount paid without deducting the TDS is Rs. 1,55,551/-. The assessee has raised the plea before the AO but ld. AO has not assign any reason for not accepting this plea. If we confirmed the disallowance of the total amount then amount of Rs.1,05,989/- would suffer tax twice i.e. by way of disallowance in this year and in the next year when assessee has written back the provision. Therefore, we direct the AO to exclude this amount from the disallowance after verification that it was offered for tax in the next year.”

In view of the foregoing discussion and the authorities cited above, we allow this ground and direct the AO to allow this deduction.

249. In view of our discussion and our finding given above qua each year, all the appeals are treated as partly allowed.

Order pronounced in the open Court on 4th October, 2019.
Sd/- Sd/- [PRASHANT MAHARISHI] [AMIT SHUKLA] [ACCOUNTANT MEMBER] JUDICIAL MEMBER
DATED: 4th October, 2019
PKK:

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