No transfer pricing on promotional expenses incurred by domestic manufacturer of international brand: High Court distinguishes Sony Ericsson
Recently, the Delhi High Court in the case of Maruti Suzuki India Ltd. vs. Commissioner of Income Tax1 held that excessive advertisement, sales and promotion (“AMP”) expenditure incurred by domestic manufacturer using co-branded trademark of its foreign Associated Enterprise (“AE”) does not constitute as an international transaction warranting a transfer pricing adjustment. The court distinguished the decision of Delhi High Court in Sony Ericsson Mobile Communications India P. Ltd. v. CIT2 and held that it was in respect of distributors selling products produced by foreign manufacturers and not those taxpayers who were manufacturers themselves.
The High Court held that in the absence of substantive and machinery provisions in Chapter X of the Income Tax Act, 1961 (“ITA”), excessive AMP expenditure could not be used as a basis for inferring existence of an international transaction. Relying on the Sony Ericsson case, the court rejected Bright Line Test (“BLT”) as a legitimate method for determining existence of international transaction.
Maruti Suziki India Limited (“MSIL”/ “Taxpayer”), a subsidiary of Suzuki Motor Corporation, Japan (“SMC”) is an Indian company which manufactures passenger cars in India. MSIL has entered into various licence agreements with SMC under which SMC grants license to MSIL to manufacture SMC’s car models, provides technical know-how and right to use SMC’s patents and technical information, and also gives right to use the co-branded trademark ‘Maruti-Suzuki’ on the car models manufactured by MSIL. In return, MSIL pays SMC a bundled royalty.
The Assessing Officer (“AO”) referred the Taxpayer’s international transactions to the Transfer Pricing Officer (“TPO”) for determination of arm’s length price (“ALP”). The international transactions referred by the AO included purchase of components, consumables and spare parts, sale of vehicles, purchase of capital item, payment of royalty etc. The TPO undertook benchmarking analysis and compared the Advertisement, Sales and Promotion (“AMP”) expenses incurred by MSIL by applying the BLT. The TPO observed that the AMP expenses incurred were 1.87% of its turnover, with the mean of 0.60% being incurred by comparable companies. Thereafter, the TPO concluded that the excess was incurred for promoting the brand ‘Suzuki’ owned by SMC and hence warranted a transfer pricing adjustment on the basis of which the AO issued a draft assessment order. The Dispute Resolution Panel (“DRP”) concurred with the AO’s disallowance. On appeal for AY 2005-06 and 2006-07, the Income Tax Appellate Tribunal (“Tribunal”) through separate orders relied on the ruling of the Special Bench in LG Electronics India Pvt. Ltd. v. ACIT3 and upheld the transfer pricing adjustment. MSIL appealed against the Tribunal’s orders before the Delhi High Court.
Whether AMP Expenses incurred by MSIL in India can be characterised as an international transaction under section 92B of the ITA?
The High Court held that the AMP expenses incurred by MSIL did not classify as international transaction under Section 92B4 of ITA and in the absence of there being an international transaction involving AMP spend with an ascertainable price, neither the machinery nor the substantive provisions relating to avoidance of tax under the ITA can be made applicable to the transfer pricing adjustment exercise. Further, the Revenue had failed to show an ‘arrangement’ or ‘understanding’ between the two AE’s under which MSIL was obliged to incur AMP expenses for SMC. The Court made the following observations in reaching to this conclusion:
This is a welcome judgment which has settled the controversial decisions of LG Electronics and Sony Ericsson in favour of the taxpayers. The court has rightly held that excessive AMP expenditure does not constitute an international transaction in the absence of specific statutory provisions for the same. The provisions of the ITA deal with avoidance of tax and do not contemplate a quantitative adjustment in respect of AMP expenses unlike taxing statutes of certain countries such as USA, Australia and New Zealand which have specific provisions which permit such adjustment. The court has effectively nullified the Delhi High Court’s decision in Sony Ericsson even though it purports to distinguish the same on facts. Additionally, the court has also invalidated the judgment of Delhi High Court in MSIL v. ACIT/TPO6 on an earlier writ petition filed by MSIL, which in principle had upheld characterisation of excessive AMP expenses as international transaction. The court has held that the High Court’s decision in no more binding since, in response to a Special Leave Petition field by MSIL, the Supreme Court7 directed the TPO to proceed with the matter in accordance with law uninfluenced by the observations of the High Court.
After the decision of Special Bench of Delhi Tribunal in LG Electronics, there was a growing trend in India of deeming AMP spend by domestic AEs as international transaction between the domestic and foreign AE. The court has rightly held that mere incidental benefit to the foreign brand is not reason enough to presume an “arrangement” or an “understanding” between the two AEs. The objective of transfer pricing is to make adjustments to the price of an international transaction in order to check shifting of profits from one jurisdiction to another. Hence, an assumed price cannot form the basis for making ALP adjustment. The court has recognised that quantum of AMP expenses is a business decision and the Revenue cannot decide on the propriety of AMP expenses incurred by every entity having a foreign AE.
1 ITA Nos. 110/2014 and 710/2015
2 (2015) 374 ITR 118
3 (2013) 24 ITR (Trib) 634 (Delhi)
4 Meaning of International Transaction
5 (2012) 345 ITR 241
6 (2010) 328 ITR 210
7 MSIL v. ACIT (2011) 335 ITR 121