Income earned from intangible property is one of the most challenging
issues in Transfer Pricing (TP), more so in the context of India and its
growing economy. More often than not, the transactions pertaining to intangible
property are between Associated Enterprises (AEs) and hence the challenges to
ensure that such transactions reflect arm’s length dealings.
Marketing
intangibles have become a hotly debated topic within the transfer pricing
community in different countries. Generally, the term marketing intangibles and
its value is derived from the company's levels of AMP expenses. These are
created by the enterprise that invests to give market recognition or value to
the brand. While the increased brand value at a local level may benefit the
local entity only, it may not have the right to future perpetual intangible
benefits arising from it. Hence, the tax authorities seek to identify and
differentiate these spends that develop the intangible and provide enduring
benefit over that of routine advertising costs. The revenue authority's
contention is that the entity that has incurred significant spends to generate
these non-routine intangible needs to be compensated by its affiliates in other
jurisdictions, if the benefit from such intangibles is flowing to the foreign
affiliates which own the intangibles.
The US
regulations have tried to draw a line to separate the provision of marketing
services and the development of intangible property. An important theory
propounded in IRS regulations relates to 'Developer – Assister rule' and it
finds application where there is no legal ownership to intangible property and
one of the controlled taxpayers is considered as the developer (who bears the
largest portion of direct/indirect costs of developing the intangible) and the
other participating member is regarded as the assister. Allocation may be made
to reflect an arm's-length consideration for assistance provided, however it
does not include expenditure of a routine nature that an unrelated party
dealing at arm's length would be expected to incur.
In an
early interesting decision, the US courts, in the DHL case, held that no
royalty would be due to DHL US from its associated entity DHL International,
standing for the proposition that for items of intangible property, the party
which bore the economic burden of the investment should bear the economic
rewards. Here, the trial judge espoused the 'bright-line' test which
notes that, while every licensee or distributor is expected to expend a certain
amount of cost to exploit the items of intangible property to which it is
provided, it is when the investment crosses the bright line of routine
expenditures into the realm of non-routine that economic ownership, probably in
the form of a marketing intangible, is created.
While the
guidelines and court precedents fundamentally revolve around dividing AMP
spends into routine and non-routine or applying the bright-line test, it is not
possible to apply this uniformly because companies within the same industry
have different marketing philosophies, business realities/features, product
launches, product dependence or interdependence and may account for their marketing
spends under different accounting heads, which would create different levels of
AMP and different bright lines for each entity.
However,
to date the bright-line approach has been considered as more realistic to
resolve the issue at hand though it is often used by tax authorities to their
advantage. It would also be pertinent to note that recently the Committee on
Fiscal Affairs of the OECD announced that Working Party No 6 is considering a
new consultation project on the transfer pricing aspects of intangibles.
In the
Indian context, the decision of the Delhi High Court in the case of Maruti Suzuki India Ltd vs. ACIT (2010-TII-01-HC-DEL-TP) has highlighted the complex
issue pertaining to marketing intangibles. The High Court held that:
·
If the AMP
expenses incurred by the domestic entity are more than what a similarly
situated and comparable independent domestic entity would have incurred
(bright-line test), the foreign AE needs to suitably compensate the domestic
entity in respect of the advantage obtained by it in the form of marketing
intangible development;
·
In case
the domestic entity uses a foreign trademark or logo on its product
manufactured or sold in India, no payment to the foreign entity on account of
such use, is necessary, in case the use of the foreign trademark or logo is
discretionary. However, the consideration for usage needs to be determined at
arm’s length.
The Indian
Revenue/TP authorities are implementing the ratio of the High Court decision
and are scrutinizing existing as well as past cases (under Section 148 of the
Indian Income-tax Act, 1961) where similar issues exist / arise. There are
various approached being followed by the TPO’s in quantifying the benefit from
the AMP spend. One approach relates to using the Profit Split Method alleging
that the foreign AE as well as the Indian AE are both involved in enhancing the
value of the IPR and hence there should be an apportionment of global profits
to the Indian AE. The other alternate method is to treat the AMP expenses which
exceed the bright-line test, to be a service by the Indian AE and adding a
mark-up in the range of 10-15%. In either of the approach, the resultant
adjustment in the hands of the Indian AE, more often than not, is huge. Also
the recent amendment enabling the TPO to bring into scrutiny any international
transactions which he deems fit is a step to empower the TPO to bring into
ambit transactions like AMP spends.
Marketing
intangibles are assets that may have considerable value even though they may
have no book value in the enterprise’s balance sheet. However, it is important
to understand that not all marketing activities result in creation of marketing
intangibles. There also may be considerable risks associated with such
intangibles including contract or product liability risks.
Given the
emerging focus of the TP authorities on AMP spends, it is imperative for tax payers
responding to tax-authority challenges and proactively:
·
Evaluate
existing arrangements and the nature of rights obtained, functions, costs and
risks relating to marketing activities;
·
Segregate
AMP expenditure between routine and non-routine;
·
Evaluate
whether the level of marketing activities performed by the Indian affiliate is
more than that performed by comparable companies / competitors having regard to
various factors;
·
Analyse
whether the Indian affiliate requires any compensation for its marketing
activities.
Further,
Indian transfer pricing regulations do not have specific guidance dealing with
the transfer pricing of marketing intangibles. Accordingly, in line with
international practice and OECD principles, guidance should be issued to
recognise certain methodologies/approaches for evaluating the arm's- length
character of transactions involving marketing intangibles.
In this
context, let us analyse few more recent court rulings.
·
In the
case of L.G. Electronics India Pvt. Ltd v. .ACIT, 140 ITD 41/ 22 ITR 1/83 DTR
1/152 TTJ 273(SB)(Delhi)(Trib.) , it was held that the “Bright Line test” can
be applied to determine whether AMP expenses incurred by assessee are excessive
and for the benefit of the brand owner- Adjustment in relation to advertisement,
marketing, and sale promotion expenses incurred by assessee for creating or
improving, marketing intangible for and on behalf of foreign AE is permissible.
Expenses in connection with sales which do not lead to brand promotion cannot
be brought within ambit of ‘advertisement, marketing and promotion expenses’.
Correct approach under TNMM is to consider operating profit from each
international transaction in relation to total cost or sales or capital
employed ,etc of such international transaction and not net profit , total
costs sales , capital employed of assessee as a whole on entity level. (S. 92B
, Rule 10A, 10B ).
·
In A.Y.
2008-09, the assessee entered into two transactions: (i) it sold its call
center business to Hutchison Whampoa and (ii) it assigned its call options to
Vodafone International Holdings B.V. The said two transactions were not
reported in Form 3CBEB. The AO made a reference on 25.01.2010 u/s 92CA(1) to
the TPO to determine the ALP of certain other transactions entered into by the
assessee with the AEs. The said two transactions were not a part of the
reference. The TPO took suo motu cognizance of the said two transactions and
held that though the sale of the center business was between two domestic
companies, it was pursuant to the share sale agreement with Vodafone
International and so was hit by s. 92-B(2). He also held that the assignment of
the call options was the transfer of a capital asset giving rise to capital
gains. He made an adjustment of Rs. 8,590 crore. The assessee did not raise any
objection on the jurisdiction of the TPO to consider the said two un-referred
transactions though it filed objections on the merits before the DRP. During
the pendency of the DRP proceedings, the assessee filed a Writ Petition
contending that (a) under the law laid down in CIT v. Amadeus India (P) Ltd.
(2011) 203 TM 602 (Del) the TPO has no jurisdiction to go beyond the reference
made by the AO, (b) s. 92CA(2A) which was inserted on 1.6.2011 to provide that
the TPO can suo motu take cognizance of an un-referred international
transaction is a substantive provision and cannot apply retrospectively to a
reference made on 25.01.2010, (c) the rewriting of the call options was not an
international transaction in view of the law laid down in Vodafone
International Holdings B.V. v. UOI ( 2012) 341 ITR 1(SC). It was urged that as
there was inherent lack of jurisdiction in the TPO and as the DRP did not have
jurisdiction u/s 144C(8) to quash the TPO’s order, the Writ Petition was
maintainable. HELD by the High Court dismissing the Petition:
(i)
Though s.
92CA(2A) inserted w.e.f 1.6.2011 is a substantive provision and not a
procedural one and confers fresh jurisdiction on the TPO, it applies to all
proceedings that are pending as of 1.6.2011. Consequently, the TPO has
jurisdiction to consider unreported and un-referred international transactions
in proceedings that were pending before him on 1.6.2011;
(ii)
(ii) The
assessee’s contention that s. 92CA (2B) inserted by FA 2012 w.r.e.f. 1.6.2002
operates only where an assessee has not furnished a report u/s 92E in Form 3CEB
and thereafter an international transaction comes to the notice of the TPO is
not correct. S. 92CA(2B) applies also where the assessee has filed Form 3CEB
but not included certain transactions. There is no cogent reason why the Legislature
would have conferred jurisdiction upon the TPO to consider an unreported
international transaction in cases where a report has not been furnished at all
but not in cases where a report has been furnished u/s 92E, but the report does
not include a particular international transaction;
(iii)
The
department’s contention that the AO is entitled to revisit and, in effect, sit
in appeal over the TPO’s report in all respects is not correct. It is not that
the TPO is a valuer who merely facilitates the AO in the computation of the
arm’s length price. U/s 92CA(4) the AO is bound to pass an order “in
conformity” with the TPO’s order and so he is bound by the TPO’s determination
and cannot sit in judgment over the same in any respect;
(iv)
The
assessee’s contention that it has no alternate remedy because the DRP is not
entitled u/s 144C to consider whether or not the transactions are international
transactions is not correct. Though s. 144C(8) refers to the DRP’s powers to
only “confirm, reduce or enhance”, its powers are wider and it can consider the
question as to whether the unreported transactions are international
transactions or not or even whether what the TPO considered was a transaction
at all. S. 144C is an alternate to an appeal to the CIT(A) and the legislature
cannot be intended to curtail the assessee’s rights;
(v)
While in
principle a Writ Petition can be entertained if the TPO lacks inherent
jurisdiction to proceed in the matter u/s 92CA(2A)/(2B), that should be done
only if it is invoked at the appropriate time viz. at the outset or soon
thereafter. There would be no question of exercising jurisdiction after the TPO
has made the order or has proceeded to a considerable extent in the
determination of the arm’s length price. On facts, as the TPO has already passed his
order and as the assessee has an alternate remedy before the DRP/ ITAT, the
writ petition cannot be entertained;
(vi)
On merits,
the contention that the sale of the call center business was between two
domestic companies and that it could not
be regarded to be pursuant to the share sale agreement for purposes of s.
92-B(2) cannot prima facie be accepted because the sale of the call center
business appears to be foreshadowed by
the shares sale agreement. The assessee does not have an ‘open and shut’ case. Likewise, the argument that there was no
transfer of the call options and that the findings of the TPO are contrary to
Vodafone International Holdings B.V. v. UOI (2012) 341 ITR 1(SC) would have to
be urged before the DRP especially in view of the subsequent amendment to s.
2(47)
Refer, Vodafone
India Service Pvt. Ltd v. UOI, WP No. 488 of 2012, dt. 06/09/2013)
·
The
Assessing Officer made disallowance by 10% of the expenditure on advertisement
& sales promotion relatable to promotion of ‘samsung’ brand. CIT(A) deleted
the addition. Tribunal held that no part of the advertisement and sales
promotion expenditure can be treated as relatable to promotion expenditure of
foreign brand in India. There was no allegation by the TPO that the assessee
had spent proportionately higher amount of AMP expenses to draw an inference of
a transaction between the assessee and its AE of promoting the foreign brand. Refer,
ACIT v. Samsung India Electronics (P.) Ltd., 156 TTJ 44.
·
The focus under the TNMM is on transactions
rather than operating income of the enterprise as a whole. Once in a given
case, there are similar nature of transactions and functions between controlled
transactions with the related party and uncontrolled transactions with
unrelated party, then internal comparability will result into more appropriate
result of ALP, as it will require least amount of adjustments. Since product
similarity has to be seen while applying CUP method and not TNM method,
rejection of internal TNM method, simply on basis of distinction between
alcoholic beverages, holding whisky and non-whisky as two different products,
is wholly undesirable and not sustainable. Advertisement, marketing and sales
promotion expenses incurred by assessee, resulting in brand promotion of
foreign AE, is an international transaction as per section 92B, triggering
transfer pricing mechanism. However, sales expenses not related to brand
promotion, should be excluded while determining cost of international
transactions in respect of AMP expenses. Refer, Diageo India (P) Ltd. .v. DCIT,
59 SOT 150.
·
After TPO
determines the AMP expenditure incurred for benefit of AE, balance is deemed to
be incurred for assessee’s business & is automatically allowable u/s 37(1).
[S.37(1)] The avowed object of the TP adjustment on
account of AMP expenses is to first find out and attribute the amount spent by
the assessee towards promotion of its foreign AE’s brand/logo etc and then make
addition for such amount with appropriate mark-up. By this exercise, the total
AMP expenses get segregated into two classes, viz., one benefiting the
assessee’s business and two, benefiting the foreign AE by way of promotion of
the brand. Whereas the first amount is deductible in full subject to the
regular provisions, the second amount is added to the total income with
suitable mark-up by way of the TP adjustment. Once the total amount of AMP
expenses is processed through the provisions of Chapter X of the Act with the
aim of making TP adjustment towards AMP expenses incurred for the foreign AE,
or in other words such expenses as are not incurred for the assessee’s
business, there can be no scope for again reverting to s. 37(1) qua such amount
to make addition by considering the same expenditure as having not been
incurred `wholly and exclusively’ for the purposes of assessee’s business. If
the amount of AMP expenses is disallowed by processing under both the sections,
that is 37 and 92, it will result in double addition to the extent of the
original amount incurred for the promotion of the brand of the foreign AE de
hors the mark-up Refer, Whirlpool
of India Ltd. .v. DCIT, Delhi ITAT.
·
In an important ruling in the case of Canon India Private Limited (“Canon India”), the Delhi
Divisional Bench of the Income Tax Appellate Tribunal (“Tribunal”) has laid
down important principles in relation to Transfer Pricing adjustments relating
to the issue of creation of marketing intangibles. In this case, the Tribunal
remanded back the matter to the Transfer Pricing Officer (“TPO”) with specific
instructions that Advertisement, Marketing and Promotion (‘AMP') expenditure
should be benchmarked in light of guidelines laid down by the Special Bench
(“SB”) in the case of LG Electronics India Limited vs. ACIT[1] (“LG India”) and Chandigarh
Bench in the case of Glaxo Smithkline Consumer Healthcare Limited vs. ACIT[2] (“GSK India”). While doing so, the
Tribunal has directed the TPO to exclude subsidy [received from associated
enterprise (“AE”)], trade discount & volume rebates, commission and cash
discount from AMP. This serves as a significant relief to majority of taxpayers
facing this issue.
Brief background
For the past few years, Indian Tax Authorities have been alleging
that the non-routine marketing efforts of a subsidiary company should be
categorized as ‘service’ rendered to their AE and accordingly, should be
compensated for the same. Such adjustments have increased tremendously over the
years and no jurisprudence existed to deal with this vexed issue. Thus, SB was
constituted in the case of LG India that dealt with this issue. Canon India
also participated as one of the interveners in addition to several other
taxpayers facing similar issue. The SB in its ruling has ruled in favor of Tax
Authorities in relation to the legal concept of marketing intangible by stating
that excessive AMP expenditure constitutes an international transaction.
Simultaneously, SB defined the scope of AMP expenditure by providing specific
guidelines to benchmark AMP expenditure.
In view of the aforesaid, Delhi Divisional Bench construed the
guidance provided by SB in case of LG India and ruled in favor of Canon India
by adjudicating that the amount of subsidy (received from AEs), trade discount
& volume rebates, commission and cash discount should be reduced from AMP
expenditure while computing the bright line. Further, in context of legal
issues the Tribunal has ruled in favor of Tax Authorities, thereby
acknowledging the concept of marketing intangibles.
Brief facts of Canon India
· Canon India is primarily
engaged in distribution of digital imaging products that include photocopiers,
multifunctional peripherals, fax-machines, printers, scanners, digital cameras
and multimedia projectors.
· Canon India also receives
subsidy from its AE in relation to certain AMP related costs.
· Canon India had benchmarked
its international transactions by using Resale Price Method as the most
appropriate method with gross profit to sales as profit level indicator.
· During the Transfer Pricing
assessment proceedings, the TPO made an adjustment questioning the adequacy of
AMP expenditure incurred by Canon India and alleging that it resulted in
creation of marketing intangibles. Accordingly, an adjustment was made by the
TPO stating that Canon India should have been compensated for provision of
services. TPO further added a mark-up.
· Transfer Pricing adjustment
made by the TPO was upheld by the Dispute Resolution Panel.
· Aggrieved by the order of
Assessing Officer, Canon India filed an appeal with the Tribunal.
Taxpayer’s contentions
Contentions of Canon India are summarized below:
· Canon India pressed upon
the legal issues before the Divisional Bench of Tribunal. These issues
primarily included arguments relating to the validity of TPO’s jurisdiction,
qualification as transaction/ international transaction, use of bright line
approach, etc.
· With respect to the
composition of AMP expenditure, Canon India argued that expenses directly
related to sales such as trade discount & volume rebates, commission/ cash
discount and receipt of subsidy from the AE should be excluded while computing
AMP expenditure to determine the bright line.
· Further, Canon India while
seeking specific directions from the Tribunal argued that the thirteen
criteria’s as laid down in the case of LG India by SB should be considered by
the TPO while benchmarking the AMP expenditure in light of Canon India’s facts.
These criterion include
analysis of contractual arrangements, business model, product life cycles,
choice of comparables, payment of royalty, etc.
Revenue’s contentions
· Revenue contended that the
issue of Transfer Pricing adjustments made on account of AMP expenditure stands
covered against Canon India by the decision of SB in the case of LG India and
GSK India and the same should be followed.
· Nature of trade discount
& volume rebates, commission and cash discount may be set aside and
restored back to AO / TPO to verify the nature of such expenditure.
· If subsidy is reduced from
the amount of AMP expenditure, Canon India may get double deduction as some
part of the subsidy may have been received in respect of trade discounts and
incentives provided to dealers, which has to be reduced from AMP expenditure.
Decision of the Tribunal
In view of SB decision in the case of LG India and Chandigarh
Bench decision in the case of GSK India, the Delhi Divisional Bench of Tribunal
adjudicated as follows:
· The Tribunal decision
reaffirms the principles laid down by the majority view of the SB in the case
of LG India. While reiterating the principles articulated by the SB, the
Tribunal has unequivocally held that TP adjustments in relation to AMP
expenditure incurred by the taxpayer for creating the marketing intangible for
and on behalf of the foreign AE is permissible.
· Tribunal has allowed
exclusion of trade discount & volume rebates, commission and cash discount
form AMP expenditure and restricted the scope of AMP expenditure.
· Moreover, exclusion of
subsidy (received from its AE) from AMP expenditure has resulted in a move that
will benefit large number of subsidiaries functioning in India and receiving
special subsidies from their AEs. This will significantly reduce the quantum of
expenditure classified as non-routine AMP expenditure.
· Tribunal has restored the
matter back to the TPO for computation/ benchmarking of AMP expenditure, after
affording a reasonable opportunity.
In an important ruling in the case of Glaxo SmithKline Consumer Healthcare (“GSK India”), the Chandigarh Bench of the
Income Tax Appellate Tribunal (‘Tribunal’) has laid out important principles in
relation to transfer pricing adjustments on
marketing intangibles following the guidelines laid down by the SB in the case
of LG India.
Brief background
Indian Revenue Authorities have been alleging
Advertisement, Marketing and Promotion (‘AMP') expenses incurred by the Indian
subsidiaries of MNC’s to be services rendered to their associated enterprises
(‘AE’). The Revenue Authorities have held that the Indian subsidiary be
compensated for such services in relation to creation of marketing intangibles.
The Special Bench of the Income Tax Appellate Tribunal (‘SB’) was constituted
in the case of LG Electronics India Pvt. Ltd., (‘LG India’) and had delivered its
decision on the vexed issue of Transfer Pricing (‘TP’) of marketing
intangibles.
The SB held, on the facts of LG India’s case,
that AMP expenditure incurred by the Indian subsidiary resulted in creation or
improvement of marketing intangibles of the foreign brands, which constituted
an ‘international transaction’ and, accordingly, the TP adjustments were
permissible. The SB also held that such compensation should not only be at cost
but with a mark-up. However, the SB has restored the matter to the Transfer
Pricing Officer (‘TPO’). The SB, has, provided relief to the taxpayers while holding
that the amount of subsidy received from its AE should be reduced for computing
ALP and expenditure inextricably linked to sales, such as trade discount,
dealer commission, etc. should not be considered for determining the cost/
value of international transaction. There were several interveners before the
SB, including, GSK India.
Brief facts of GSK India
· GSK India was incorporated under the laws of
India and was owned 40% by Horlicks Ltd, UK, which is part of GSK Group.
· GSK India, inter alia,
was engaged in manufacturing and selling of nutritional products i.e. malted
milk food products and drinks under the brands ‘Horlicks’, ‘Boost’, ‘Maltova’
and ‘Viva’. In addition, GSK India also provided certain administrative support
services such as marketing, sales inputs, IT support, training and accounting,
etc. to its group companies.
· GSK India had benchmarked its international
transactions by adopting transactional net margin method (‘TNMM’) with
operating profit/ total cost ratio as profit level indicator for AY 2007-08.
· The TPO made an adjustment on account of AMP
expenditure incurred by GSK India. The TPO took the view that GSK India had
created marketing intangibles for the benefit of its AE by incurring excessive
AMP expenditure and, accordingly, should have been compensated at arm’s length
by the AE. The TPO, further, added a mark-up of 13.04% to the excess AMP
Expenditure incurred by GSK India.
· The TP Adjustment was confirmed by the DRP but
directed the Assessing Officer to allow expenditure incurred on R&D by GSK
India as the same did not form part of the AMP expenditure.
· Aggrieved GSK India filed an appeal with the
Tribunal.
Taxpayer’s contentions
· There was no international transaction as per
Section 92B of the Act.
· AMP Expenditure was neither incurred at the
instance or direction of the AE and nor the AE is expected to benefit from such
expenditure.
· In line with the ratio laid down by the SB,
AMP Expenditure needs to be re-looked by the TPO after giving an opportunity to
GSK India.
· AMP Expenditure incurred by GSK India also
included certain expenses not in the nature of advertising and marketing expenses
such as
i) service charges paid to the selling agent,
ii) sales promotion,
iii) discount on sales,
iv) market research expenses and
v) selling and distribution expenses.
· Such expenses were in the nature of selling
expenses and not brand promotion and, accordingly, the same ought to
be excluded from AMP Expenditure.
· Expenses incurred for the promotion of Indian
brands such as Viva, Maltova and Boost, should be excluded.
Revenue’s contentions
· The issue of TP Adjustments made on account of
AMP expenditure
stands covered against GSK India by the decision of SB in LG India. In view of
the directions of the SB, the matter has to be restored to the file of the TPO
for computation/ benchmarking purposes.
Decision of the Tribunal
· Following the SB ruling, the Tribunal held
that excessive AMP expenditure incurred by GSK India does constitute an
international transaction.
· In view of the directions of the SB, the
matter has been restored to the TPO for computation/ benchmarking the AMP expenditure, after affording a reasonable opportunity. GSK
India will have the liberty to furnish fresh set of comparables for
benchmarking and computing the ALP.
· The Tribunal has also directed the TPO to consider
the relative spends made on foreign brands and domestic brands while
determining the ALP.
· Placing reliance on the SB ruling, the
expenses inextricably incurred in connection with sales and not related to
brand promotion were excluded from AMP Expenditure.
· Further, the amounts attributable to the
promotion of domestic brands owned by GSK India were also excluded.
In a recent order in the case of BMW India Private Limited (the “Taxpayer” or “BMW India”), the Income Tax Appellate
Tribunal (“Tribunal”) has laid down an important principle on the concept of
marketing intangibles holding that the premium profits earned by the Indian
subsidiary of a foreign parent represents an arm’s length compensation for
excessive marketing activities undertaken by the Taxpayer, and hence, no
further adjustment was required.
Facts of the case
· BMW India was incorporated in 1997 as a private limited company
and is a wholly owned subsidiary of BMW Holding B.V, Netherlands. The relevant
year in question was the first full year of operations for BMW India.
· Taxpayer demonstrated its international transactions to be at
arm’s length after application of Resale Price Method (“RPM”) corroborated by
Transactional Net Margin Method (“TNMM”) as the most appropriate method.
Taxpayer had earned a Gross Profit Margin (“GPM”) of 27.36 percent as compared
to 13.65 percent earned by comparable companies and a Net Profit Margin (“NPM”)
of 13.52 percent as compared to 2.11 percent earned by comparable companies
thereby complying with the arm’s length principle as envisaged in the Indian
Transfer Pricing (“TP”) legislations.
Assessment Proceedings
· The case was picked up for scrutiny by the Transfer Pricing
Officer (“TPO”) post receiving reference from the Assessing Officer (“AO”).
During the course of proceedings, the TPO adjudicated the primary international
transactions of purchase of completely built units (“CBU”), completely knocked
down (“CKD”) kits and parts & components to be at arm’s length. However,
the TPO observed that BMW India had incurred advertisement, marketing and
promotion (“AMP”) expenses in excess to that of comparable companies and that
the same had not been compensated by its associated enterprises (“AEs”) for the
brand promotion activities which resulted in creation of marketing intangibles
for its AE.
· Accordingly, the TPO after excluding certain comparables of the
Taxpayer came to an average AMP sales ratio representing the bright line of
0.52 percent.
· However, the Taxpayer, submitted a fresh set of comparables to
the TPO which had similar “intensity of functions” performed as that of BMW
India. The TPO, post adding few comparables taken by the Taxpayer in its TP
documentation to this fresh comparable set, recomputed the bright line at 1.99
percent as against Taxpayers’ AMP to sales ratio of 7.09 percent. Further, the
TPO added a mark-up of 15 percent to propose addition to the total income of
the Taxpayer.
Dispute Resolution Panel (“DRP”) Proceedings
· Aggrieved by this, the Taxpayer filed its objections before the
DRP. The DRP concurring with the findings of the TPO, nonetheless, directed the
TPO to exclude amounts inextricably incurred in relation to sales from the AMP
expenditure. However, the AO erroneously did not incorporate the same in the
final assessment order.
Taxpayer’s Contentions before the Tribunal
· International Power House (“IPH”) is the organizational unit of
BMW and as such it is responsible for marketing and development, consequently,
the Taxpayer had no role to develop campaigns etc.
· AMP expenses calculation included expenditure like after-sales
support costs etc. which needed to be rectified in accordance with the
directions of the DRP.
· Further, the Taxpayer while trying to distinguish its case from
that of LG Electronics India Private Limited (“LG India”), it was argued that
since it had withdrawn its application for intervention before the Special
Bench, the principles as laid down by the Special Bench are not applicable to
its factual matrix.
· Taxpayer also contended that it is a routine/ entrepreneurial
distributor engaged in the import and resale of CBUs. In addition to the
distribution activity, the Taxpayer also carried out low
value-added assembling of CKD kits from its assembly facility in Chennai.
value-added assembling of CKD kits from its assembly facility in Chennai.
· Taxpayer being a routine/ entrepreneurial distributor was solely
responsible for enhancing its market by undertaking sales promotion and
marketing activities. Therefore, the AMP expenditure incurred resulted into a
benefit to the Taxpayer by way of enhanced sales and benefit, if any accruing
to the overseas AEs, was purely incidental.
· It was the first full year of operations of BMW India and given
the position of automobile industry in India which faces intense competition
and rising costs thereby lowering the margins, the Taxpayer necessarily had
aggressively undertake sales promotion and advertisement in order to enhance
its market share while performing the functions of a distributor..
· Placing reliance on the ‘Importation Agreement’ entered between
Taxpayer and its AE, it was highlighted to the Tribunal that the pricing is
done in such a manner that the price charged for the contract goods is adequate
to ensure recovery of total cost of the contract goods supplied plus
representative profits.
· Taxpayer also strongly argued that it had earned premium profits
which were substantiated by the fact that the Taxpayer had earned a gross
profit/ sales margin of 27.36 percent as compared to 13.65 percent of
comparables. Alternatively, under the TNMM, the Taxpayer demonstrated that its
net margin was 13.52 percent as compared to 2.11 percent of comparables.
· Based on the above, the Taxpayer demonstrated that even after
considering the comparables accepted by the TPO, BMW India’s earning was much
higher than the arms’ length return, both at gross profit and net profit level.
Accordingly, placing reliance on various international commentaries including
Organization for Economic Co-operation and Development (“OECD”) Transfer
Pricing Guidelines, US TP Regulations (“US Regs”) and Australian Tax Office
(“ATO”) Guidelines, it was submitted that the bright line test had no
application in the face of high profit/ premium margin shown in RPM/ TNMM.
· It was further argued that, post incorporating the DRP
directions and removing after-sales support costs and salesman bonus, the
excess AMP ratio would be 3.62 percent as opposed to 7.09 calculated by the
TPO. The difference between bright line considered by the TPO (1.99 percent)
and the Taxpayer’s AMP remained at 1.63 percent (3.62- 1.99). The Taxpayer,
thus, , as compared to its comparables has earned, 13.71 percent higher gross
margin (27.36 - 13.65) and 11.41 percent higher net margin (13.52 - 2.11) whereas
the actual excess AMP spend was only 1.63 percent. In absolute terms, the
Taxpayer claimed that it has already been compensated to the tune of INR 106.85
crore (11.41 percent being the difference between BMW India OP/sales and Arm’s
Length OP/sales) which is greater than AMP spend of INR 33.93 crore from which
routine expenses are to be allowed.
· Based on the above, the Taxpayer contended that BMW India has
already received the payment for the services rendered to the foreign AE and no
further compensation was required to be made by the AEs as the same has already
been received.
· During the course of proceedings, it was also emphasized that
for exploiting the brand logo etc, no royalty has been paid by the Taxpayer to
its foreign AE. Further, the Taxpayer argued that the AE has provided the
Taxpayer with a loan at a rate better than the external benchmark, the average
PLR as per the Taxpayer’s TP study is 13.30 percent and the BMW India’s
effective Rupee cost on the loan is 7.43 percent.
Tribunal Ruling
· On the key legal grounds, the Tribunal followed the Special
Bench decision in the case of LG India and held that the excess spend of AMP is
an international transaction and, further, upheld the application of the bright
line .
· The Tribunal agreed with the primary argument of the Taxpayer
that, since it has earned premium profits vis-Ã -vis comparable companies, the
AEs had actually more than compensated BMW India for development of marketing
intangibles. The Tribunal, while placing reliance on the “Importation
Agreement” wherein it was stated that the Taxpayer shall charge such a price
that would ensure adequate recovery of total costs of the contract goods plus
representative profits, agreed with the Taxpayer that no further compensation was
required to be made by the AE as the same has already been received which is
represented by premium profits earned by the Taxpayer.
· The Tribunal, further, stated that the revenue department cannot
insist, in the absence of any provision under the Income-tax Act, 1961 (the
“Act”), that the mode of compensation to the Taxpayer by the foreign AE
necessarily has to be direct compensation and pricing adjustment should not be
accepted. In the absence of any such rule or provision in the Act, the Taxpayer
is free to adjust and apply any method which it finds most suitable to manage
its affairs. The Tribunal also observed that had it been specifically required
by the Act and the Rules that the remuneration/ compensation for the
performance of non-routine functions of a distributor has to necessarily be
remitted/ reimbursed separately with a cost plus, the occasion to refer and
rely on the terms of the “Importation Agreement” would have not arisen.
· It was further held that the above proposition is also supported
by contemporaneous international jurisprudence and even the Special Bench
ruling in LG India’s case leaves the issue open while giving voice to the
diverse nature of facts, business models and peculiar terms and conditions of
different assessee by observing that there cannot be any ‘straight-jacket’
formula.
DCIT vs. Motorola
Solutions India Pvt. Ltd (ITAT Delhi)
The AO made a transfer pricing
adjustment for the AMP expenditure incurred by the assessee and raised a demand
of Rs. 210 crore. The assessee filed an appeal before the Tribunal and a stay
application. The Tribunal granted a stay on recovery of the demand on the
condition that the assessee would not seek an adjournment of the hearing. When
the matter came up for hearing, the assessee pointed out that a similar issue
was pending before the Special Bench (now decided as L. G. Electronics 152 TTJ 273) and so the Bench
adjourned the appeal to await the
judgement of the Special Bench. The AO took the view that the assessee had
sought an adjournment and violated the stay order and so he attached the bank
account u/s 226(3) and recovered some part of the demand. The assessee filed an
application before the Tribunal and claimed that it had not sought an
adjournment and that the AO had acted in defiance of the stay order and should
be directed to vacate the attachment and refund the moneys recovered. The
Tribunal accepted the plea that the assessee had not sought an adjournment and
directed the AO to refund the sums collected (order attached). The AO
filed a MA against the order and also a Writ Petition before the High Court. In
the Writ Petition, the AO did not disclose the fact that the MA had been filed.
The High Court granted an interim stay (now finally decided)
against the Tribunal’s order directing refund. During the pendency of the Writ
petition, the AO argued in the MA that the recovery of the demand was justified
and that as the appeal was “in the process of final hearing”,“judicial
propriety demanded that the interim order directing a refund should not have
been passed”. HELD by the Tribunal dismissing the MA:
(i) “It alarms us that
unfortunately with complete impunity and disregard of the factual position, the
AO repeatedly makes apparently naive misplaced, mis-guiding and factually
incorrect assertions that the Tribunal was in the process of final hearing of
the appeal”. These assertions indicate either a gross ignorance or
ineptitude of the Department or a deliberately calculated belief that even
misstatement of facts before the Tribunal could be accepted as gospel truth on
a mere assertions of the government officers. Both or either of these
situations are equally dangerous and fraught of dangers as vast powers have
been given by the Act to the AO in order to exercise its powers and discharge
the functions under the Income Tax Act;
(ii) An AO cannot claim to be in
constant and perpetual ignorance nor can the officers under whom she was
functioning themselves feign ignorance of this actual factual position on the issue
where on the grounds of judicial propriety the Department was constantly
seeking adjournments in almost all stay granted appeals on the said issue over
the years;
(iii) Being ignorant of relevant facts
shows a pattern which needs to be considered before such laxity becomes endemic
and plays havoc with “the interest of the revenue” which the AO most
vociferously seeks to uphold;
(iv) The actions of the AO, which
earlier appeared to be wrongful acts of misfeasance by a public official were
actually serious acts of malfeasance. In our adversarial system, one or the
other side will probably be lying, if only to exaggerate their position and
hence perjury is likely to be far more common place then we would choose to
admit. In either case and especially in the case of the Revenue, apparently
when swearing falsely or referring to wrong facts, the concerned officers may
be under the belief that he or she is doing so in a good cause that is “protecting
the interest of revenue.” Judges and judicial authorities are not so
unrealistic that they do not recognize that a substantive portion of the
population displays a lack of respect for or otherwise merely pays lip service
on oath to tell the truth. But unlike in the Courts having “lay litigants”,
the litigants in tax matters are invariably of a class which recognize the
solemnity of the occasion and understand the consequences of swearing to an
affidavit or affirmation as a serious act outside the course of their everyday
lives and it is hoped that the deponents understand the sanction for breach of
such oath and the seriousness with which such a breach will be normally
regarded by adjudicating authorities. In the present case, the acts of
malfeasance by pleading apparent ignorance or acting in a subterfuge and underhand
manner in apparently trying to achieve their objectives and targets of higher
tax collection are required to be understood and addressed by the appropriate
authorities;
(v) The CBDT is requested to ensure
that proper legal knowledge and training is imparted to the officers addressing
the appropriate interpretation of orders of higher forums and instead of
resorting to underhand manner in achieving the targets set. Such an exercise
will go a long way in addressing identical situations where the AO may be tempted
to take matters in his or her own hands with complete impunity and disregard
for the laws of the land
Cadbury India Ltd vs. ACIT (ITAT Mumbai)
Transfer Pricing: ALP of royalty for trademark usage and
technical know-how fee can be determined as per TNMM. Approval of RBI &
Govt. means payment is as at arms length
The assessee entered into an agreement with its parent company,
Cadbury Schweppes, pursuant to which it agreed to pay royalty for the use of
trademarks and royalty for the use of technical know-how at 1.25% each of the
net sales. This was approved by the RBI and the SIA (Government). The assessee
adopted the Transaction Net Margin Method (“TNMM”) for computing the ALP of the
international transactions by comparing the net margin of the company at entity
level with that of companies engaged in food products, beverages and tobacco
business. The TPO held that the transactions pertaining to payment of royalty
for trademarks and technical know-how fee had to be separately and
independently bench-marked using the Comparable Uncontrolled Prices (“CUP”)
method. He held that the ALP of royalty and technical know-how fee should be
computed at 1% of sales the instead of at 1.25% of the sales. This was reversed
by the CIT(A) who held that the royalty and technical know-how fee paid by the
assessee were at ALP. On appeal by the department to the Tribunal HELD
dismissing the appeal:
The assessee has been paying royalty on technical know-how to
its parent AE since 1993. Other group companies across the Globe are also
paying the same royalty. Also, the payment is as per the approval given by the
RBI and the SIA. Hence there cannot be any scope of doubt that the royalty
payment on technical know-how is at arms length. As regards the royalty on
trademark usage, the assessee is in fact paying a lesser amount if the payment
is compared with the payment towards trademark usage by other group companies
using the brand “Cadbury” in other parts of the world. Accordingly, the royalty
payment on trademark usage is also within the arms’ length and does not call
for any adjustment (Lumax Industries (ITAT
Del) (attached) followed). The Department’s request for a remand to the
TPO to examine the AMP expenses in the light of Maruti Suzuki 328 ITR 210 (Del) (and L. G. Electronics140
ITD 41 (Del)(SB)) rejected
Hope
the above small summary on AMP will help you in getting some relief from the
hardship from the ITD. In case you have any further clarification please mail
me at taxbymanish@yahoo.com.
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