The question whether advertising, marketing and promotion (AMP) is an international transaction or not for a risk-bearing manufacturer has been put to rest by the Delhi High Court in the Maruti Suzuki India Ltd (MSIL) case.
MSIL started operations in 1982 as a government-owned company, with Suzuki Motor Corp (SMC) as business partner. The co-branded trademark ‘Maruti Suzuki’ was used by way of a licence agreement since the inception of MSIL. During 2004-05, AMP expenses incurred by MSIL for Rs 204.4 crore (advertisement expenses Rs 162.3 crore; sales promotion Rs 42.1 crore) worked to 1.87% of sales when compared to similar companies’ AMP cost of 0.62% by applying the bright-line test (BLT). Royalty payments and payments for copyrights and patents have been separately assessed for transfer pricing purposes.
It was concluded by the transfer pricing officer (TPO) that MSIL, apart from promoting its name and products through advertisement, also promoted the foreign brand simultaneously, coupled with its expenses being “proportionately much higher” than those incurred by comparable companies. Accordingly, the excess of AMP expenditure towards promoting the ‘Suzuki’ brand was worked out and an addition of Rs 154.12 crore for FY05 and Rs 158.64 crore for FY06 were made, respectively. The Dispute Resolution Panel (DRP) upheld TPO’s decision.
In line with the special bench decision in LG Electronics India Pvt Ltd vs ACIT, it was held by the Delhi tribunal that AMP expenses incurred by MSIL created brand value and marketing intangibles to SMC in respect of brands/trademarks belonging to MSIL. The Delhi High Court, in the case of Sony Ericsson Mobile Communications India P Ltd vs CIT, held AMP as an international transaction, upholding the special bench decision in the LG Electronics case. In the LG case, the Income Tax Appellate Tribunal (ITAT) held that while excess AMP expenditure incurred itself shall not constitute a ‘transaction’, but that the taxpayer promoted its products and brand owned by the foreign associated enterprise (AE) coupled with such excessive expenditure implied an agreement between the taxpayer and its AE.
Before the Delhi High Court, a specific question—whether AMP expenses incurred by MSIL in India can be treated and categorised as an international transaction under Sec 92B of the Income-Tax Act, 1961?—was framed. Sec 92B to Sec 92F provide for existence of an international transaction; determining the price of such transaction; and determining the arm’s length price by application of any of the methods prescribed in Sec 92C.
Sec 92B(1) states there should be a mutual agreement or arrangement for the allocation or apportionment of, or any contribution to, any cost or expenses incurred or to be incurred between AEs to be called an international transaction. Since there is no agreement or an arrangement or an understanding between MSIL and SMC prior to incurring the AMP expenditure, the same will not fall within the ambit of international transaction. Merely AMP expenditure incurred may not be considered as international transaction. Sec 92F(v) cannot be regarded as a machinery provision for treating excessive AMP expenses as an international transaction when an arrangement, understanding or action-in-concert could not be established for the AMP expenditure incurred by MSIL.
It was elaborated that BLT (routine vs non-routine expenditure) was used to infer the existence of an international transaction and then TP adjustment was made to that effect. In other words, the very existence of an international transaction cannot be a matter for inference or surmise. In the Sony Ericsson case, this Court has clarified that the Act does not prescribe for BLT to be applied to determine ALP of an international transaction. There is nothing in the Act which indicates how, in the absence of the BLT, one can discuss the existence of an international transaction.
The exercise of separating the amount spent by the assessee in relation to the international transaction of brand building for its foreign AE out of the AMP expenses can be considered only when the transaction is an international transaction. A distinction should be made between expenses incurred for sales promotion and expenses in connection with sales. While sales promotion lead to brand building, expenses in connection with sales were only sales specific. If advertisement or selling expenses have a live link and direct connect with marketing and increased volume of sales, then it ought to be excluded from the notion of brand promotion at the outset. Calling AMP expenses incurred exclusively for the sale of goods manufactured by a full-fledged entrepreneur-manufacturer as a brand-building exercise would be exaggerated.
MSIL has a market share of 45% and a year-on-year growth of about 21%. This clearly shows that AMP expenses incurred substantially benefited MSIL only. Also, when we look at the AMP spend worldwide by SMC, it is 7.5% of the sales when compared to 1.87% on sales by MSIL. By the time SMC became a 54% holding company in 2002, brand ‘Maruti Suzuki’ was well established and was selling products under that brand. These products carried the co-branded mark ‘Maruti Suzuki’ which had a high degree of name and recognition which cannot be used by SMC anywhere else in the world. For Sec 92B(1) to apply, there should be an obligation to incur AMP expenses by MSIL of a certain level for SMC towards brand promotion.
The government in its India chapter in the UN TP Manual has mentioned that marketing intangibles shall be subject to TP adjustment only when the Indian subsidiary does huge expenditure on advertisement for a limited risk-bearing distributorship when compared to a similar independent enterprise. When a risk-bearing manufacturer incurs AMP expenses for the sale of goods, how can the same be construed as an international transaction and subject to BLT adjustment based on comparable companies? How can that lead to brand-building for the foreign AE and benefit them to call for a compensation under TP regulations?
The Delhi High Court stated that AMP expenditure is not an international transaction as there is no substantive or machinery provision under Chapter X to do an adjustment to the transaction. The objective of Chapter X is to make adjustments to the price of an international transaction which the AEs involved may seek to shift from one jurisdiction to another. An ‘assumed’ price cannot form the reason for making an ALP adjustment under Chapter X.
The Court mentioned that only when there is a corresponding ‘machinery’ provision in Chapter X , the TPO/AO can determine what should be the fair ‘compensation’ to the Indian entity. The Court made an impressive remark on what is needed to bring a transaction under TP enactment. A clear statutory scheme encapsulating the legislative policy and mandate which provides the necessary checks against arbitrariness while at the same time addresses the apprehension of tax avoidance be in place to avoid proceedings on surmises or conjectures.
The author is executive partner, Lakshmikumaran & Sridharan