Judgment summary
This is a common order of the Income Tax Appellate Tribunal, Delhi, disposing of two appeals filed by Samsung India Electronics Pvt. Ltd. (SIEL) against final assessment orders passed pursuant to Dispute Resolution Panel (DRP) directions under section 144C for Assessment Years 2016-17 and 2017-18 (paras 1-2).
The appeals concerned transfer pricing adjustments made by the Transfer Pricing Officer (TPO) and confirmed or modified by the DRP in relation to advertising, marketing and promotion (AMP) expenditure, the manufacturing segment, the networking segment, royalty payments to the parent company, and disallowance of salary paid to expatriate employees.
The Tribunal, following its own prior decisions in the Assessee's case spanning eleven earlier assessment years (AY 2005-06 to AY 2015-16), several of which were upheld by the Hon'ble Delhi High Court, allowed the appeals substantially, directing deletion of the AMP and royalty adjustments, deletion of the expatriate salary disallowance, and recomputation of the manufacturing and networking segment adjustments after adjusting the set of comparables.
Background
SIEL is a wholly owned subsidiary of Samsung Electronics Co. Ltd., Korea (SEC), engaged in manufacturing and trading of consumer electronics, home appliances, mobile phones and IT products, as well as contract software development and networking (buy-sell of telecommunication equipment) (para 3).
For AY 2016-17, SIEL filed its return declaring income of Rs. 4864,43,19,590/-, later revised and then restored to the original figure (para 3). The TPO passed an order under section 92CA(3) proposing transfer pricing adjustments, following which the AO passed a draft assessment order under section 143(3) read with section 144C. After DRP directions dated 22.10.2020, the final assessment order dated 30.03.2021 determined a total addition of Rs. 4858,91,08,884/-, comprising adjustments in the manufacturing segment (Rs. 817,29,76,086/-), networking segment (Rs. 436,80,85,062/-), trading segment/BLT (Rs. 339,23,89,070/-), AMP expenditure (Rs. 1338,82,19,250/-) and royalty (Rs. 1732,93,94,316/-) (paras 4-5).
The DRP had also directed deletion of a proposed disallowance of Rs. 193,80,45,100/- for salary paid to expatriate employees, but the AO nonetheless included this disallowance in the final order, resulting in total assessed income of Rs. 9723,34,28,470/- (para 5).
For AY 2017-18 (ITA No. 1955/Del/2021), similar issues arose, save that the Assessee adopted a segregated benchmarking approach for the networking segment, separately benchmarking import of telecommunication equipment (using the 'Other Method' with Berry Ratio as the Profit Level Indicator) and availing of network support services (using TNMM with OP/OC), which the TPO rejected in favour of an aggregated TNMM approach, resulting in an adjustment of Rs. 177,72,26,294/- (paras 61-65).
Core dispute
The central disputes were: (i) whether AMP expenditure incurred by SIEL constituted a separate 'international transaction' with its AE, and if so, whether the Bright Line Test (BLT) or Intensity Based Approach (IBA)/TNMM could validly be used to benchmark it; (ii) whether the comparables selected by the TPO for the manufacturing and networking segments were functionally comparable to SIEL; (iii) whether royalty payments to SEC Korea should be benchmarked separately under the Comparable Uncontrolled Price (CUP) method using three agricultural-industry licence agreements, or aggregated with other manufacturing segment transactions under TNMM; (iv) whether salary paid to expatriate employees seconded to SIEL was allowable under section 37(1), given DRP directions to delete the disallowance; and (v), specifically for AY 2017-18, whether SIEL could adopt a segregated benchmarking approach (Berry Ratio for goods, TNMM for services) for the networking segment departing from the aggregated approach used in the immediately preceding year.
Court findings
On AMP expenditure, the Tribunal held that this issue was covered in the Assessee's favour by orders of the Tribunal for eleven prior assessment years (AY 2005-06 to 2015-16), some of which were upheld by the Hon'ble Delhi High Court, and that AMP expenditure could not be treated as an international transaction beyond amounts actually agreed to be reimbursed under an MDF-type arrangement, in the absence of evidence of an understanding, arrangement or action in concert with the AE. The Tribunal held the Bright Line Test and Intensity Based Approach both untenable in law for this purpose and deleted the substantive and protective AMP adjustments (paras 13-14).
On the manufacturing segment, the Tribunal partly allowed the ground regarding comparables: it directed inclusion of Value Industries, Videocon Industries, IFB Industries and Penguin Electronics, remanded Trend Electronics Ltd. for verification of financial year-end, upheld exclusion of Amber Enterprises (India) Pvt. Ltd. due to product dissimilarity, and directed exclusion of Frog Cellsat Ltd. as functionally dissimilar, following the preceding year's Tribunal order (paras 15-28).
On the networking segment for AY 2016-17, the Tribunal directed exclusion of seven service-oriented comparables (PCS Technologies, Hughes Communication India, Planetcast Media Services, Altruist Technologies, Avantel, AT&T Global Network Services, and Bharti Airtel) and also Verizon Communications Pvt. Ltd., holding these companies to be service providers not comparable to SIEL's predominantly trading-based networking segment (paras 29-37).
The Tribunal remanded the issue of incorrect margin computation for both segments, directed inclusion of foreign exchange gain as operating income (following the Assessee's own case for AY 2011-12 as upheld by the jurisdictional High Court), directed grant of working capital adjustment consistent with binding DRP directions under section 144C(10), and remanded the computation of proportionate adjustment (paras 38-44).
On royalty, the Tribunal held that the three third-party royalty agreements relied upon by the TPO under CUP (involving agricultural biotechnology companies) had no meaningful comparability with SIEL's royalty transaction for consumer electronics manufacturing technology. Following its decision for AY 2015-16, the Tribunal held that TNMM, applied on an aggregated basis together with other manufacturing segment transactions, was appropriate, and that separate CUP benchmarking of royalty resulted in an impermissible double adjustment. The royalty adjustment was deleted (paras 45-52).
On expatriate salary, the Tribunal found that the DRP itself had directed deletion of the disallowance for AY 2016-17 (as it had for AY 2014-15, following the Tribunal decision in SEC Korea's own case), but that the AO had wrongly reproduced earlier years' directions and made the disallowance regardless. As the AY 2014-15 Tribunal order deleting the disallowance had attained finality (no substantial ground raised on this issue in the Revenue's High Court appeal), the Tribunal directed deletion of the disallowance (paras 53-59).
For AY 2017-18, on the networking segment segregated approach, the Tribunal accepted that SIEL functioned as a limited-risk distributor for imported telecommunication equipment (obtaining only 'flash title' on high sea sales, bearing no inventory risk and no warehousing), making Berry Ratio (GP/VAE) an appropriate Profit Level Indicator for that transaction, while network support services availed from SEC's Project Office were properly benchmarked separately under TNMM. The Tribunal held there is 'no estoppel against law' and that the Assessee was not bound to follow the aggregated approach used in the preceding year, since a more scientifically appropriate segregated methodology was now available given developments in the case law on Berry Ratio (paras 76-85).
Outcome
Both appeals filed by Samsung India Electronics Pvt. Ltd. for AY 2016-17 and AY 2017-18 were allowed, with the Tribunal directing deletion of the AMP expenditure adjustments (both substantive and protective, under BLT and intensity-based approaches), deletion of the royalty adjustment, deletion of the expatriate salary disallowance, and recomputation of the arm's length price for the manufacturing and networking segments by the AO/TPO in line with the Tribunal's directions on comparables, margin computation, foreign exchange treatment, working capital adjustment and proportionate adjustment. For AY 2017-18, the segregated benchmarking approach adopted by the Assessee for the networking segment, using Berry Ratio for the distribution transaction and TNMM for the services transaction, was upheld. The connected stay applications were dismissed as infructuous (para 86).
Tp method highlighted
Multiple transfer pricing methods were in issue. For AMP expenditure, the Revenue had applied the Bright Line Test (comparing AMP spend against a notional 'bright line' derived from comparable companies) on a protective basis, and an Intensity Based Approach using TNMM, on a substantive basis; both were rejected by the Tribunal for lack of a demonstrated international transaction.
For the manufacturing and networking segments, TNMM was applied by both parties, with disputes confined to the selection of comparable companies, treatment of foreign exchange gains, working capital adjustment, and computation of proportionate adjustments.
For royalty payments, the TPO applied the Comparable Uncontrolled Price (CUP) method using three third-party licence agreements from the agricultural sector, which the Tribunal rejected as lacking comparability, holding that TNMM applied on an aggregated basis with other manufacturing segment transactions was the most appropriate method.
For the AY 2017-18 networking segment, the Assessee adopted a segregated approach: the 'Other Method' with Berry Ratio (Gross Profit/Value Added Expenses) as the Profit Level Indicator for the import/distribution of telecommunication equipment (treating SIEL as a limited-risk distributor with 'flash title' only), and TNMM with OP/OC as PLI for network support services availed from SEC Korea's Project Office in India, as against the TPO's aggregated TNMM approach using service-sector comparables. The Tribunal upheld the segregated Berry Ratio approach.
Major issues / areas of contention
- Whether AMP expenditure incurred by the Assessee constitutes a separate international transaction with its AE in the absence of an agreement or arrangement
- Whether the Bright Line Test or Intensity Based Approach (TNMM) can be validly used to benchmark AMP expenditure
- Whether specific comparables should be included or excluded in the manufacturing segment under TNMM
- Whether service-oriented companies can be treated as valid comparables for the networking segment, which is predominantly a trading segment
- Whether foreign exchange gains should be treated as operating income for computing margins
- Whether working capital adjustment must be granted following binding DRP directions under section 144C(10)
- Whether royalty payments should be benchmarked separately under CUP using unrelated agricultural-industry agreements, or aggregated with the manufacturing segment under TNMM
- Whether salary paid to expatriate employees is disallowable under section 37(1) where the DRP had directed deletion of the disallowance
- Whether the Assessee could adopt a segregated benchmarking approach (Berry Ratio and TNMM) for the networking segment in AY 2017-18 departing from the aggregated approach used in the preceding year
- Whether Berry Ratio (GP/VAE) is an appropriate Profit Level Indicator where the Assessee acts as a limited-risk distributor bearing no inventory or substantive goods-related risk