Calculation of Deduction under section 80HHC

IN THE INCOME TAX APPELLATE TRIBUNAL

DELHI BENCH “I”, NEW DELHI

BEFORE SHRI R.P. TOLANI, JUDICIAL MEMBER

AND

SHRI SHAMIM YAHYA, ACCOUNTANT MEMBER

I.T.A. No. 3823/Del/2009

A.Y.: 2003-04

Asstt. Commissioner of Income

Tax, Circle, Noida,

G-Block Commercial Complex,

Sector-20, Noida

(Appellant)

Vs.

M/s LG Electronics India Pvt.

Ltd.,

Plot NO. 51, Udyog Vihar,

Surajpur- Kasna Road,

Greater Noida – 201 306 (UP)

(PAN/GIR NO.: AAACL 1745Q)

(Respondent)

AND

I.T.A. NO. 3729/DEL/2009

A.Y. 2003-04

M/s LG Electronics India Pvt. Ltd.,

Plot NO. 51, Udyog Vihar,

Surajpur- Kasna Road,

Greater Noida – 201 306 (UP)

(PAN/GIR NO. : AAACL 1745Q)

(Appellant)

Asstt. Commissioner of Income

Tax, Circle, Noida,

G-Block Commercial Complex,

Sector-20, Noida

 (Respondent)

Assessee by:- S/Sh. Ajay Vohra, Adv., Neeraj

Jain,Adv. Sh. Ramit Katyal, CA

Revenue by:- Sh. Peeyush Jain, Ld.

C.I.T.(D.R.)(TP)

ORDER

PER SHAMIM YAHYA: AM

These cross appeals by the Revenue and Assessee emanate out of orders of the Ld. Commissioner of Income Tax (A) dated 29.6.2009 and pertain to assessment year 2003-04.

REVENUE’S APPEAL

2. The grounds raised read as under:

“1. That the Ld. Commissioner of Income Tax (A) has erred in law and on the facts by allowing relief of Rs. 13,58,98,217/- by holding that the Transfer Pricing Officer’s (TPO) action of apportionment of Global Cricket Council contribution in the ratio of 5.40:94.60 between LG Electronics India Pvt. Ltd. and L.G. Electronics Korea is incorrect without appreciating the facts mentioned by the TPO.

2. That the Ld. Commissioner of Income Tax (A) has erred in law and on the facts by allowing relief of Rs. 6,57,19,516/- being provision of warranty expenses without appreciating the facts mentioned by the Assessing Officer that the expenses were mere estimations and had not matured and it was a contingent liability rather than a ascertained liability.

3. Hence order of the Ld. Commissioner of Income Tax (A) may be set aside and the order of the Assessing Officer be restored.

3. Apropos ground no. 1 :- Transfer Pricing Issue :-

3.1 LG Electronics India Pvt. Ltd. (LGEIL) is a 100% subsidiary of LG Electronics Korea (LGEK). Its major international transactions undertaken by the assessee are as under:-

3.2 An economic analysis was undertaken by the assessee, in accordance with the Act and Rules for the determination of arms’ length price of the international transactions and based on the economic analysis so conducted by the assessee, it was concluded that the pricing in respect of the above transactions are at arms length, as per section 92(1) of the Act.

3.3 A reference was made by the Assessing Officer u/s. 92CA(1) of the Act to the TPO for computation of arms’ length price of above mentioned international transaction. The TPO agreed with the ALP (Arms Length Price) determined by the assessee for all of its transactions except for the ALP of contribution towards global sponsorship of ICC World Cup Tournament.

3.4 As per the Transfer Pricing Report the LGEIL alongwith LGEK and LD AD Inc. Korea entered into an agreement with Global Cricket Corporation PTE Limited, Singapore (GCC) and World Sport Nimbus PTE Ltd. Singapore on 28.6.2002 to sponsor Cricket World Cup 2003 and 2007 and ICC Championship Trophy 2004, 2005 and 2006 to promote sale of LG product. The cost of sponsorship was shared between the assessee LGEIL and its parent company LGEK in the ratio of 40:60. The breakup of the contribution for the present assessment year i.e. 2003- 04 is as follows:-

Hence, the value of international transactions, i.e. the contribution made by LGEIL during the year was Rs. 16,29,59,302/-. This sharing ratio, as explained in the TP report for the relevant years, was arrived at by the LG group, keeping in mind the following factors:

a) Sales Growth: Cricket is a very important game for India and has a lot of promotional value attached to it. Every International Cricket tournament where India is participating gives a boost to the Sales of all Consumer durables, more particularly Colour Televisions. Therefore, LGEIL expected that during Cricket World Cup 2003, the sales of LG products would grow due to greater visibility achieved by sponsoring the Cricket World Cup 2003.

b) Brand Awareness growth:- LGEIL anticipated that the media coverage of the event would lead to greater brand awareness in India (expected to grow from 17.50% to 35.00%.

c) Viewership:- There are 14 nations playing in 2003 World Cup of which three nations are new. The population table of these Countries is as given below:-

Total   158.73 100%

World Population  636.36

Based on LGEIL’s assessment, the level of enthusiasm regarding the game is definitely much higher in the South Asian sub-continent than in most other parts of the world and the larger market for televisions and other appliance and media devises is in India, amongst all cricket playing (and watching) countries. Hence, the percentage of the population watching cricket is much higher than the other thirteen countries where sports such as soccer, golf, motor racing etc. are more popular. Based on the above data, LGEIL perceived that at least 65% of viewers of the Cricket World Cup telecast belong to India. Considering the co-relation between population and sales, atleast 65% of the cost should have been allocated to LGEIL, as the higher viewership ratio results in a potentially larger market size for consumer durable products and a higher sale. However, in view of the fact that LGEIL was already receiving support form LGEK for its advertising efforts, it requested LGEK to pick up a higher percentage than its share. Taking into consideration the above facts, LGEIL and LGEK decided that LGEIL should contribute of 40% towards the total sponsorship.

3.5 However, the TPO did not agree with the above cost contribution ratio. He observed that LGEK and LGEIL have to demonstrate respective benefits in proportion of their share in cost contribution. Both these parties would be at arm’s length price if they are able to demonstrate that they receive benefit in the ratio of 60:40 from this cost contributory agreement.

3.6 The TPO rejected the analysis adopted by the appellant and held that cricket is not the only dominant game in India. He has also stated that in England, Soccer is most popular game whereas Australia has proved its supremacy in Hockey as well along with Cricket. In Western Countries Tennis has a high popularity which is evident from Wimbledon matches and Australian open matches. Even in Asian subcontinent, cricket is not the only game but Hockey and Athletics is equally popular.

3.7 The TPO held that it has been assumed by the appellant that there is a higher level of enthusiasm about cricket in South Asian subcontinent and thus it will get translated in higher sale benefit for appellant. However, in reality, level of enthusiasm is not the only factor for buying consumer which drives his first decision to buy or not to buy a consumer product. The appellant company has not considered that purchasing power of South Asian Sub-continent is

comparatively very poor as compared to Western Continents. In fact media appliances and other consumer durables are considered as luxurious items in this part of the world whereas in developed nations these items have greater penetration. It is also demonstrated from the fact that consumer companies keep on adding new models and versions of products in more advanced countries to begin with having better per capita income and then these versions are brought to Asian Continent market. Therefore, while arriving at a conclusion that impact of level of enthusiasm only will bear fruits for appellant is not a correct assumption.

3.8 The TPO further commented that that cricketing events involving Indian team would benefit LGEIL also but if there is an additional sale of Rs. 100 of LG product in India it will add a profit of Rs. 5.85 to LGEIL (since as per transfer pricing documentation submitted by the appellant operating margin of LGEIL over sale is 5.85%.) However at the same time it will mean additional profit of Rs. 3 for LGEK on account of Royalty payment @ 3% on domestic sale and also a profit on account of technical know how, design fee and profit element in sale of raw material or finished goods which LGEIL has to buy from parent company for effecting additional sale. It means LGEK is also rewarded with almost equal to LGEIL for any additional sale in India. Apart from direct benefits, it further strengthens Brand awareness of LG in India providing more bargain power to Korea company worldwide.

Please check the full judgment in the attached file.