Delhi High Court upholds bundling approach for benchmarking AMP expenses in a landmark transfer pricing judgement

 

This Tax Alert summarizes a recent ruling of the Delhi High Court (DHC) involving a group of taxpayers, with the lead case being that of Sony Ericsson Mobile Communications India Pvt. Ltd. (now known as Sony India Ltd.) (Taxpayer) v. Commissioner of Income-tax on the issue of a transfer pricing (TP) adjustment for “excessive” advertising, marketing and promotional (AMP) expenditure incurred by the Taxpayers during the Assessment Year (AY) 2008-09.  

 

The transfer pricing issue before the DHC was whether an affiliate needs to be compensated under arm’s length conditions for its promotional efforts that allegedly enhance the value of a trademark or brand name legally owned by another affiliate. The promotional efforts typically result in the marketing affiliate incurring AMP expenses. The marketing affiliate may be a trademark licensee or a distributor of trademark products, while the legal owner of the trademark is the licensor or the supplier of the trademark products.  

 

Earlier, in the case of LG Electronics, Special Bench (SB) of Delhi Income Tax Appellate Tribunal held that there is a transaction between the taxpayer and its Associated Enterprise (AE) under which the taxpayer incurred AMP expenses towards promotion of the brand which is legally owned by the AE.  The SB held that transaction of brand building by the taxpayer for the AE is in the nature of “provision of service” requiring a mark-up.  Further, the SB also upheld the use of bright line test (BLT) in order to determine the transaction value of AMP.  The SB also laid down fourteen factors which need to be considered while determining the value of the international transaction of brand/logo promotion through AMP expenses such as determining whether the Indian affiliate has received any subsidy from the foreign AE, whether the Indian AE has paid any royalty, whether the brand is an established brand etc.

 

The DHC while holding that AMP spend may be considered an international transaction, has concluded that the compensation for AMP expenses may be included or subsumed in the purchase  price of goods imported from overseas AE or lower charge of royalty paid. The DHC held that arm’s length nature of the arrangement may be tested by way of an aggregated/bundled analysis with other transactions relating to the distribution activity. In case the Tax Authority seeks to unbundle the transactions, the Tax Authority should elucidate reasons for doing so. The DHCt emphasized that transfer pricing is an income allocating exercise and should not result in over or double taxation.  The “fourteen factor test” as espoused by the SB of Delhi Tribunal earlier in the case of LG Electronics India would now have limited precedential value as the matters have been restored to the Tribunal for application of the ruling in light of the facts of  each case.