In the case of Maruti Suzuki India Ltd. vs. Commissioner of Income Tax, the Delhi High Court has pronounced a landmark ruling that Transfer Pricing Adjustment cannot be made on Advertising, Marketing and Promotion (“AMP”) expenses incurred by a domestic manufacturer who has a license to use the brand of a foreign entity and that excessive AMP expenditure cannot be a basis for discerning the existence of an international transaction.

The taxpayer was an Indian company and a subsidiary of Suzuki Motor Corporation, Japan. The taxpayer had entered into license agreements with the parent company under which the latter granted license to the taxpayer to manufacture car models, provide technical know-how and right to use Suzuki's patents, trademarks, etc. The taxpayer paid the parent a bundled royalty as the consideration.

Upon reference by the Assessing Officer for determination of arm’s length price, the Transfer Pricing Officer (“TPO”) benchmarked the AMP expenses by applying the Bright Line Test, wherein the proportion of such expenses of the domestic entities are compared with that of comparable companies.

The TPO observed that the AMP expenses incurred were 1.87% of its turnover, whereas the average was 0.60% that was being incurred by comparable companies. The Transfer Pricing Officer concluded that transfer pricing adjustment would be required, as excess expenditure must be regarded as being incurred for promoting the brand “Suzuki” owned by SMC, the foreign parent. The DRP upheld the addition made by the TPO. The Assessing Officer thus passed the final order making an addition of AMP expenses.

On further appeal, the Income Tax Appellate Tribunal relied on the ruling of the Special Bench in LG Electronics India Pvt. Ltd. v. ACIT and upheld the transfer pricing adjustment of the revenue department. Thereafter the taxpayer filed an appeal before the Delhi High Court.

The Court held that the very basis of the Bright Line Test was negated by this very Court in an earlier case of Sony Ericsson Mobile Communications India (P.) Ltd. both for determining if there is an international transaction and secondly for the purpose of determining the ALP. The Court opined that the revenue department must establish the existence of international transaction without use of the Bright Line Test. The Court held in this case that existence of international transaction was deduced by the revenue department merely from the fact that the taxpayer had excess AMP spend after applying Bright Line Test. However, upon analysis of Sections 92B to 92F of the Income Tax Act, the Court held that since there is no machinery provided in the Act to determine the existence of international transaction involving AMP expenses, excessive AMP expenditure could not be used as a basis for pointing to the existence of an international transaction.

The Court also observed that under the Income Tax Act, ‘international transaction’ means, inter alia, a transaction “having a bearing on the profits, incomes or losses of such enterprises” and includes “a mutual agreement or arrangement” for allocation of any costs or expenses. Thus an ‘agreement’ or ‘arrangement’ or ‘understanding’ between the two entities must exist whereby one entity is obliged to incur AMP expenses to promote the brand of the other. Such an agreement is a necessary condition but the Revenue had failed to show any such ‘arrangement’ or ‘understanding’ between the two AEs. The Court noted that the taxpayer’s AMP spending was only 1.87% of its sale whereas the parent’s AMP expense worldwide was 7.5% of sales and therefore this belies the possibility of any ‘arrangement’ or ‘understanding’ between the taxpayer and the foreign parent.

The Court further placed reliance on the decision of Sony Ericsson (supra) and Rule 10B to hold that if the Indian entity had satisfied the Transaction Net Margin method i.e. the operating margins of the Indian enterprise are much higher than the operating margins of the comparable companies, no further separate adjustment for AMP expenditure is warranted. Source: High Court of Delhi, ITA Nos. 110/2014 and 710/2015

VA View

This judgment is a significant development on the dispute relating to benchmarking of marketing intangibles resulting from AMP expenses incurred by multinational corporations who operate as a licensed manufacturer. The ruling lays down important principles on the creation of marketing intangibles through services rendered by domestic manufacturers. The Delhi High Court had earlier ruled upon the issue of marketing intangible adjustment in case of Sony Ericsson Mobile Communications India Pvt. Ltd and others who were all distributors of products manufactured by foreign associated entities.

The Delhi High Court has also subsequently held in cases relating to those taxpayers, namely, Whirlpool of India Ltd, Honda Siel Power Products Limited, Bausch & Lomb Eyecare India P Ltd, who are either manufacturers or engaged in manufacturing as well as distribution activity that where the existence of an international transaction involving AMP expense with an ascertainable price is unable to be shown to exist, even if such price is nil, the transfer pricing provisions under Chapter X of the Act cannot be invoked to undertake a TP adjustment exercise.