AMP Expenditure : A Treatise
CA. Rajat Powar
The author is a member of the Institute. He can be reached at rajatpowar00@gmail.com and eboard@icai.in.
One of the major issues in this arena being faced by almost all the major MNE is with respect to Transfer Pricing (TP) adjustment of AMP expenses. The issue of AMP expenditure incurred by the Indian Associated Enterprise (AE) has been a much debated issue and continues to be litigated at various forums and is currently pending before the Supreme Court of India. The Author tries to analyze various tests laid down by the judiciary with respect to the TP analysis of AMP expenditure.
I. Issue For Consideration
The foreign companies have been typically operating in India by setting up a subsidiary in India. The Indian subsidiaries depending on the business model adopted by the foreign parent are performing variety of functions. These functions include manufacturing of the product, marketing of the product, and distribution of the product. In many of the cases, the Intellectual Property Rights (IPR) such as the technical knowhow, Trade Marks, Patent are owned by the foreign parent Associated Enterprise (AE) and the Indian subsidiary pays royalty for the use of the IPR owned by Foreign AE. In case of manufacturing entities, the parent company also supplies the raw material along with the technical knowhow and other requirements. The Indian subsidiary may also act as distributor for selling the goods supplied by the foreign parent.
In order to increase their sales or as per the marketing strategy, the subsidiary often incurs expenses in the nature of Advertisement, Marketing and Promotion. The AMP controversy revolves around the issue whether the expense incurred by such AE are excessive, are of non-routine nature and are in fact being incurred for the purpose of promoting the brand which is owned by the foreign AE and in such a case the Indian subsidiary should be remunerated on Arm’s Length basis for such expenses.
“The AMP controversy revolves around the issue whether the expense incurred by such AE are excessive, are of non-routine nature and are in fact being incurred for the purpose of promoting the brand which is owned by the foreign AE and in such a case the Indian subsidiary should be remunerated on Arm’s Length basis for such expenses.”
II. Legislative History & Landmark Judgments
The TP adjustment in respect of AMP expenses has been a hotbed of perennial litigation. The issue has been considered by various Income Tax Appellate Tribunals (ITATs) and High Courts and is currently pending before the Honorable Supreme Court. Few important judgments in this respect are as follows:
1. Maruti Suzuki India Ltd. vs. Addtl. CIT/TPO (2010) 328 ITR 210 (Del)
The first Landmark judgment can be said to be the decision of Delhi High Court In the case of Maruti Suzuki. In this case it was held that the AMP expenses were an international transaction and the Indian AE was to be compensated for the excessive AMP incurred. The matter was remanded back to AO/TPO for fresh determination of the case. The said judgment was challenged before the Honorable Supreme Court, the Supreme Court while observing that the Hon HC not only remitted the case back to AO/TPO but also made certain observations on merits of the case which virtually concluded the matter. The Hon SC then directed the TPO to proceed with the matter without taking into consideration the observations made by Hon HC. Hence, the ratio of the earlier judgment of the Hon HC lost its precedential value.
2. LG Electronics India Pvt Ltd [TS-11-ITAT-2013(DEL)-TP]
The issue came up for consideration before the Special Bench of Delhi Income Tax Appellate Tribunal (ITAT) in the case of LG Electronics India Pvt Ltd. The tribunal in this case relied upon the ‘Bright Line Test’ to confirm the existence of international transaction in form of ALP. The tribunal also did not allow aggregation of transaction and held that AMP expenses to be benchmarked separately.
3. Maruti Suzuki India Limited vs CIT (2016) 381 ITR 117 (Delhi)
Maruti Suzuki India Limited was Indian subsidiary engaged in manufacturing of passenger cars in India. MSIL was co-owner of the brand in this case. The net Margin of MSIL was higher than other comparables. The Honorable Delhi High Court based on the above facts in this case held that the AMP expenses does not amount to international transaction.
4. Sony Ericsson Mobile Communications India Pvt. Ltd. v Commissioner of Income Tax [(2015) 374 ITR 118]
In this case the Indian subsidiaries were engaged in distribution and marketing of branded products, manufactured and sold by foreign AEs. The Honorable Del HC rejected the theory of Bright Line test but held the AMP expense incurred to be an international transaction. Moreover, in this case the Delhi High Court allowed aggregation of transactions of AMP expense and calculation of Net Margin from all the transactions using TNMM method.
5. Diageo India Pvt Ltd (ITA No 1228/Mum/2015)
In this case it was held by the Mumbai ITAT that there exists a mutual agreement between the assessee and the foreign AE to incur AMP expense, and agreement also provides for apportionment of cost between the AEs hence this qualifies as an international transaction.
6. NGC Network (India) (P) Ltd. v. Addl. CIT (ITA No. 6829/Mum/2012)1
NGC Network (India) was engaged in business of distribution of two satellite channels and had incurred AMP expenses. The ITAT after relying on the Third member judgment in the assessee’s own case which was later affirmed by the Honorable Bombay High Court, has held that, the AMP expenditure incurred by the assessee was to make the viewers aware about the programs and were for product promotion and not brand promotion, further there was no arrangement/agreement with foreign AE for incurring of AMP expenses. Hence, the amount of AMP expenses cannot be termed as international transaction.
1 Other Relevant Precedents Dealing with AMP Expenditure:
- Nivea India (P.) Ltd. v. ACIT (2018) 92 taxmann.com 165 (Mum.) : (Mum-Trib)
- L’Oreal India Pvt. Ltd. & Ors v. DCIT & Ors. (2016) 49 ITR (Trib.) 473 (Mum.)
- Mondelez India Foods Pvt. Ltd. v. ACIT (2016) 47 CCH 98 Mum
- Bausch & Lomb Eyecare (India) Pvt. Ltd. & Ors. v. Addl. CIT (2015) (2016) 381 ITR 227 (Del.)
- CIT v. Whirlpool of India Ltd. (2015) (2016) 381 ITR 154 (Del-HC)
- Honda Siel Power Products Ltd. v. Deputy CIT (2015) 94 CCH 170 (Del-HC)
- Johnson & Johnson Pvt. Ltd. v. ACIT [ITA No. 6142/Mum/2017, (Mum-Trib)]
III. Key Principles Culled Out from Judicial Precedents
Some of the important points which can be culled out from the judgments are as follows:
1. International Transaction
Sec 92 provides that income from any international transaction shall be computed having regard to the ALP. In the given case, it is required to be determined whether there is any ‘International Transaction’ between the Indian Company and the foreign AE. Hence, it must be first ascertained as to whether AMP is an international transaction. The term International transaction has been defined under section 92B. The ambit of the definition is very wide. Sec 92B inter alia specifically includes in its ambit a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises. In accordance with provisions of sec 92B, there must be some mutual agreement or arrangement between the AE’s or some obligation on the part of Indian AE to incur such an expense. The aspect of existence of International transaction in AMP expense is based on the peculiar facts of each case and the judiciary has laid down various tests which are relevant for this purpose.
2. The Bright Line Test
In order to prove the existence of International transaction Bright Line Test is often used by the Revenue. As per the test the total AMP expenditure is bifurcated into routine and non-routine expenses based on comparison with other companies. A Bright Line is deduced by calculating the average percentage of AMP expenses. The expenses over and above such bright line is considered to be incurred by the Indian entity for the Foreign AE and accordingly adjustment is made by charging a mark-up on the above cost of AMP applying Cost Plus Method (CPM).
“It is pertinent to note that the Bright Line Test does not have any statutory recognition under the Indian Income tax law.”
Existence of an international transaction is a sine qua non for provisions of Transfer pricing to apply. The bright line test cannot be used to ascertain the existence of international transaction. This view stands affirmed by the Hon Delhi HC in the case of Sony Ericsson Mobile Communications India Pvt. Ltd. v Commissioner of Income Tax, which has been followed in many cases subsequently.
3. Economic Ownership
Ownership of an asset can be divided into two parts – legal ownership and economical ownership. The legal owner refers to a person who is the registered owner of the property, while the economical owner is not the legal owner but is the entity which incurs the expenditure for developing the asset and subsequently may derive economic benefits from the assets. The legal owner of the Intangible Property Rights in almost all the cases is the foreign Parent Company. However, economic ownership of the asset may be with the Indian Counterpart. Economic ownership of brand can also be said to be an Intangible Asset just like a Legal ownership.
Consider an example of Entity having a long term contract of Sole distribution arrangement. In such a case, if sole distributor has incurred heavy expenditure on advertisement he may benefit by increased volume of sales and market share. In such a case the entity is said to be economic owner of the brand. In case of economic ownership there cannot be said to be any services provided by the Indian AE to the foreign parent in respect of AMP expense incurred and no compensation is required for the purpose of the excessive expenditure.
“Nevertheless, determination of economic ownership is a rigorous factual exercise and would depend on many factors such as the tenure of the contract, the functions being performed by the entities and the contractual arrangements between entities. The burden to prove economic ownership lies on the assessee.”
The OECD Transfer Pricing guideline in Para 6.36 to para 6.39 while dealing with marketing intangible also take into consideration the concept of economic ownership. The concept of Economic ownership of the marketing intangibles has also gained judicial recognition in India.
4. Aggregation of Transactions and Set Off of Bundled Transactions
Yet another issue which is for consideration is whether the AMP expense incurred should be analyzed separately or should it be aggregated with other transactions of the entity for benchmarking. As per the OECD Guidelines and the judgments of Maruti Suzuki India Limited vs. CIT as referred above If the transaction is aggregated then it would be adequate if the entity is earning adequate net margin on all its transactions combined and there would be no need to benchmark AMP expenses separately.
If the transactions are inter-linked and inter-related to such an extent that they cannot be reliably analyzed separately or if aggregating them increases the reliability of comparison then it is desirable to aggregate the transactions. However, when the bundled transactions cannot be adequately compared on aggregated basis, segmentation is essential.
The issue of segmentation gains importance especially in the case when the AE has adopted Transactional Net Margin Method (TNMM) and the Net Margin of the AE is higher than other comparable. In the case of Maruti Suzuki India Limited vs. CIT (Supra), the operating margin of the company was 11.19% whereas the margin of other comparables were 4.04%. The Honorable Delhi High Court after taking into consideration this fact and the provisions of Rule 10B, decided that no further TP adjustment is required as the Net margin of the AE is higher than the comparables.
5. Direct Selling / Marketing Expenses
The Indian AE while selling the product may allow various trade discounts, cash discounts, loyalty bonus, turnover incentives etc. These expenses are termed as direct/selling or marketing expenses. A question would arise as to whether they would be included in the AMP expenses. It is to be noted that these expenses essentially help in increasing the sales volume/collection and as such are not incurred for the purpose of brand building. Hence, they are not to be included in the AMP expenses. This view is now settled by various judicial decisions as mentioned above.
6. Existence of Prior Arrangement / Agreement
As per the Sec 92B, Existence of prior arrangement/agreement between the Indian subsidiary and foreign parent is essential to constitute an international transaction. Even in the absence of a formal written agreement inferences can be drawn from the facts of the case. The Indian AE should be mandated to incur certain amount of AMP expense as per the agreement/arrangement with the foreign AE or the group’s policy, in such a case the AMP expenses incurred can be termed to be international transaction and would require appropriate TP analysis. However, if the Indian AE determines the marketing policy and quantum of AMP expenses itself which are not dictated by foreign AE and there is no prior agreement/arrangement it cannot be termed as an international transaction.
7. Absence of Machinery Provision under the Act
As discussed earlier, the Bright Line Test has no statutory recognition in India. The only statutory provision which has application in this case is sec 92. Section 92 provides that in case of international transaction income shall be computed having regards to ALP. Sec 92C deals with Computation of ALP and lists down method for computation of ALP. Hence, it is evident that what is envisaged in the Statutory Provision is a price adjustment. Adjustment of quantum of AMP expense incurred is not envisaged in the Act.
Moreover, determination of existence of international transaction precedes determination of ALP. Hence, it can be inferred that under the Indian Tax Regime there is absence of statutory and machinery provision for determination of existence of international transaction in respect of AMP expenditure incurred by the Indian AE. In absence of such a machinery and statutory provisions no TP adjustments can be made.
“Hence, it can be inferred that under the Indian Tax Regime there is absence of statutory and machinery provision for determination of existence of international transaction in respect of AMP expenditure incurred by the Indian AE. In absence of such a machinery and statutory provisions no TP adjustments can be made.”
The Hon SC in the case of CIT v. B.C. Srinivasa Setty (1979) 128 ITR 294 (SC) and PNB Finance Ltd. vs. CIT (2008) 307 ITR 75 (SC) has affirmed that in absence of the necessary machinery provisions to tax the income, no Income Tax can be levied on the same.
8. Difference Between Product Promotion and Brand Promotion
AMP expenditure incurred can be necessarily differentiated into expenditure incurred for product promotion and expenditure incurred for brand promotion. The benefit of product promotion accrues to the Indian AE and whereas in the case of brand promotion the benefit would accrue in the form of increase in the brand value to owner of the brand.
The presence of an international transaction cannot be inferred merely on the pretext of incidental benefit accrued to the Foreign AE due to the advertisement. Hence, merely because the AE has entered huge amount of expenditure on advertisement It cannot be concluded that the AMP is an international transaction.
“The presence of an international transaction cannot be inferred merely on the pretext of incidental benefit accrued to the Foreign AE due to the advertisement. Hence, merely because the AE has entered huge amount of expenditure on advertisement It cannot be concluded that the AMP is an international transaction.”
IV. Relevant OECD and UN Guidelines
Paragraphs 6.36 to 6.39 of the OECD Transfer Pricing Guidelines deal with the issue of marketing intangibles which have been reproduced for ready reference:
OECD Transfer Pricing Guidelines: Paragraph 6.36
“6.36 Difficult transfer pricing problems can arise when marketing activities are undertaken by enterprises that do not own the trademarks or tradenames that they are promoting (such as a distributor of branded goods). In such a case, it is necessary to determine how the marketer should be compensated for those activities. The issue is whether the marketer should be compensated as a service provider, i.e., for providing promotional services, or whether there are any cases in which the marketer should share in any additional return attributable to the marketing intangibles. A related question is how the return attributable to the marketing intangibles can be identified.”
OECD Transfer Pricing Guidelines: Paragraph 6.37
“6.37 As regards the first issue- whether the marketer is entitled to a return on the marketing intangibles above a normal return on marketing activities- the analysis requires an assessment of the obligations and rights implied by the agreement between the parties. It will often be the case that the return on marketing activities will be sufficient and appropriate. One relatively clear case is where a distributor acts merely as an agent, being reimbursed for its promotional expenditures by the owner of the marketing intangible. In that case, the distributor would be entitled to compensation appropriate to its agency activities alone and would not be entitled to share in any return attributable to the marketing intangible.”
OECD Transfer Pricing Guidelines: Paragraph 6.38
“6.38 Where the distributor actually bears the cost of its marketing activities (i.e. there is no arrangement for the owner to reimburse the expenditures), the issue is the extent to which the distributor is able to share in the potential benefits from those activities. In general, in arm’s length transactions the ability of a party that is not the legal owner of a marketing intangible to obtain the future benefits of marketing activities that increase the value of that intangible will depend principally on the substance of the rights of that party. For example, a distributor may have the ability to obtain benefits from its investments in developing the value of a trademark from its turnover and market share where it has a long-term contract of sole distribution rights for the trademarked product. In such cases, the distributor’s share of benefits should be determined based on what an independent distributor would obtain in comparable circumstances. In some cases, a distributor may bear extraordinary marketing expenditures beyond what an independent distributor with similar rights might incur for the benefit of its own distribution activities. An independent distributor in such a case might obtain an additional return from the owner of the trademark, perhaps through a decrease in the purchase price of the product or a reduction in royalty rate.”
United Nations TP Manual: Para 10.4.8.17 and Para 10.4.8.18 of the UN TP manual also deal with the issue of Marketing Intangibles.
V. Conclusion
The question whether the AMP expenditure incurred is an international transaction is a complex question and needs to be answered after undertaking rigorous factual analysis based on the factors mentioned above. Special emphasis should be laid on Functional, Asset and Risk analysis as well as the contractual terms between the entities in this regards. Caution should be exercised by the MNE group while drafting the advertising policy, agreements or arrangements so as to save itself from the TP disputes.