Delhi High Court rekindles the controversy surrounding the benchmarking of Brand Promotion

Expenditure

- Thangadurai VP, Advocate

MPC Legal

May 02, 2015

Introduction:

The recent decision of the Hon’ble High Court of Delhi in the case of Sony Ericsson Mobile

Communications India (P) Ltd. Vs CIT [ITA Nos. 16, 70, 92, 93, 99 & 100 of 2014 dated March 16,

2015]has once again set the ball rolling in terms of the controversy surrounding the benchmarking of

the Advertising, Marketing and Promotional ( ‘AMP’) Expenditure.

It is important to highlight that the Hon’ble Delhi court was the first to take cognizance of the AMP

expenditure incurred by the subsidiaries of the foreign entitieslocated in India in the case of M/s.

Maruti Suzuki India Ltd. Vs ACIT [(2010) 328 ITR 210], by insisting on independent benchmarking of the

AMP Expenditure to find outwhether the associated enterprise of a foreign entity (i.e., tax payer)has

spent more on AMP than what a similarly situated and comparable independent entity would have

spent on its AMP Expenditure. The Apex Courtcreated further confusion, while entertaining the Special

Leave Petition filed against the decision of Maruti Suzuki India Ltd. (Supra),by inexplicitly remanded the

matter back to the file of Transfer Pricing Officer without expressly denying or acknowledging the

aforesaid decision.

Subsequently, the Hon’ble Income Tax Appellate Tribunal (‘ITAT’) Delhi Special Bench had sought to put

the controversy to rest in the case of L.G. Electronics (P.) Ltd. Vs ACIT (2013) 152 TTJ 273 (Delhi Trib.)

(SB)by categorically holding that AMP expenditure is an international transaction and that its arm’s

length price had to be determined independently in accordance with theBright Line Test (‘BLT’)by

making a demarcation between routine and non-routine expenditure.

The Hon’ble Appellate Tribunal (the final fact finding authority) held that the non-routine expenditure

had to be reimbursed by the foreign associated enterprises (‘AE’) of the tax payer. The other benches of

the Hon’ble Appellate Tribunal across India in substantial number of cases had plainly adopted the

principles propounded by the Delhi Special Bench to adjudicate the matters concerning AMP

expenditure worth several thousand of crores.

Now, the Hon’ble High Court has once again stirred the controversy by partly reversing the decision of

the Hon’ble Special bench of the ITAT by holding that the Bright Line Test (BLT) is not a statutory

mandate(It may be noted that the Delhi High Court did not disturb the Special Bench’s proposition that

AMP expenditure is an international transaction) and hence, the exercise of computing routine and non-

routine AMP expenses separately by applying the Bright Line Test should not be sanctioned.

Most importantly, it has also held that it is illogical and improper to treat the AMP expenses as a

separate international transactionthough the same is an international transaction. Therefore,

independently benchmarking the marketing intangibles is an unwarranted exercise.

All in all, this decision of Delhi High Court is a welcome respite for the tax payers.

Highlights:

Significance of the decision:

This decision of the Delhi High Court gives a much awaited breather to the Indian tax payers and

the foreign MNCs alike as it not only holds that independent benchmarking of the AMP

expenditure is an unwarranted exercise but also holds that no reimbursements from the foreign

AE are called for when this factor (AMP expenditure) was already accounted, in arriving at the

arm’s length price of the international transaction of the tax payer with its foreign AE.

Thus, this Delhi High Court’s decision has certainly gone a long way in promoting the brand of

the transfer pricing jurisprudence of India which augurs well for resorting the confidence of

foreign MNCs to increase their footprints in India.

Was it expected or does it come as a surprise?

Our Response: I think the tax practitioners and communities across India were hopeful that

atleast on occasion were to happen where analysis ought to have been undertaken so as to be

able to adjudicate thoroughly upon this intricate aspect of transfer pricing.

Working of BLT

BLT computes the AMP expenditure to sales ratio of the tax payer and compares the same with

the AMP expenditure to sales ratio of the tax payer’s comparable entities.

The percentage of AMP which the tax payer has spent over and above the percentage of the

comparables’ AMP is treated as non-routine expenditure of the taxpayer which went on to build

the brand of the foreign AE and hence, the same has to be reimbursed by the foreign AE.

Distinction between brand development and brand exploitation

The reported judgement identifies the distinction between brand development and brand

exploitation. The Hon’ble Court has asserted that equating brand building with the AMP

expenditure would largely be incorrect and fallacious since the AMP expenditures aims to

commercially exploit the brand value to increase the sales of the entity and not the other way

around i.e., these AMP expenditures are not spent to build the brand value of the foreign AE but

only to boost the sales of the Indian subsidiary.

The court, while arriving at the aforesaid conclusion, also made a note on the unforeseen tax

implications and complications that could arise if the parameters of the BLT were applied to the

Indian companies with reputed brands which incurs substantial AMP expenses. The Hon’ble

Court went on to name few of the highly reputed brand owners of India who are both

manufacturers and owners of the intangible property in India such as Tata, Mahindra, Bajaj,

Godrej and Videocon and held that the application of BLT to bifurcate and segregate AMP

expenditure towards Brand building on these giant entities would make the results, in the view

of Hon’ble Court, startling and unacceptable.

Independent Benchmarking of AMP Expenditure: Resulting in double or over taxation

The Hon’ble Delhi High Court has reiterated its stance of benchmarking of the marketing

intangibles independently is an irrational exercise by holding thatthe expenses incurred in

respect of services provided or property transferred, which havealready been factored into

determine the arm’s length price of the international transactions of the tax payer, cannot be

factored again for the second time for the purpose of benchmarking AMP expenditure.

The Hon’ble High Court was indicating to the Functions, Assets and Risks (FAR) analysis

undertaken by the tax payer in its Transfer Pricing report wherein these indirect factors (AMP

expenditure, risks undertaken, etc.) could be accounted,for arriving at the arm’s length price of

the international transaction with its foreign AE.

According to the Hon’ble Court, it would be injudicious and irrational to independently

benchmark and apply the BLT for the expenditure which have already been considered to

determine the arm’s length price of the international transaction of the tax payers through

some other method.

(* Views are personal)