India: Transfer Pricing Of Marketing Intangibles - Benchmarking Of Advertisement, Marketing And Promotion Expenses – Special Bench Decision In The Case Of LG Electronics India Private Ltd*

Introduction:

The Revenue authorities in India have been seeking to benchmark  the increased Advertisement, Marketing and Promotion ('AMP') expenses incurred by the Indian subsidiaries of global multinationals ('MNEs'), contending it to be services rendered to the foreign AEs  by  creating marketing intangibles in India, which are legally owned by them. The Revenue have held that the Indian subsidiary should have received compensation from the overseas associated enterprise for creation of marketing intangible by incurring excessive AMP expenditure in promoting brand name of the AE in India. The Special Bench of the Income Tax Appellate Tribunal ('ITAT'), constituted in the case of LG Electronics India Pvt. Ltd., recently delivered its decision on the vexed issue of Transfer Pricing of marketing intangibles.

Facts of the case:

  • L.G. Electronics India Pvt. Ltd. ('the Taxpayer') is a subsidiary of L.G. Electronics Inc., Korea ('associated enterprise') and is engaged in the business of manufacture and sale of consumer electronics products in India under the brand name "LG".
  • During the relevant previous year, the Taxpayer incurred advertisement, marketing and sales promotion expenses ('AMP expenses'), amounting to 3.85% of sales.
  • As per the analysis of Transfer Pricing Officer ('TPO') applying Bright Line Test, the ratio of AMP expenses to sales of the Taxpayer was higher than the average of the similar ratio of two comparable companies namely Videocon Appliances Ltd – 0.12% and Whirlpool of India Ltd - 2.66%, average AMP expense of the two comparables being 1.39%.
  • The TPO held that the excess AMP expenditure incurred by the Taxpayer was towards creation of brand 'LG' in India which is legally owned by the associated enterprise, and therefore, the associated enterprise should have compensated the taxpayer for the excess AMP expenditure incurred by it.
  • The Dispute Resolution Panel ('DRP') upheld the order of the TPO and also directed that mark up of 13% be charged to account for the opportunity cost (10.50%) and entrepreneurial efforts (2.50%) undertaken by the Taxpayer.
  • Accordingly an addition of Rs 182.71 crores was made to the income of the taxpayer.

Issues before the Special Bench

i. Whether the TPO had jurisdiction to benchmark AMP expenses in absence of reference from the assessing officer ?

ii. Whether AMP expenses result in a 'transaction' or an 'international transaction'?

iii. Whether bright line test would be applied to deem existence of a transaction?

iv. Whether, any of the prescribed methods were applied for benchmarking AMP expenses?

v. Whether selection of comparables was appropriate?

vi. Whether the DRP was justified in directing the assessing officer to charge a mark up?

Taxpayer's contention:

Some of the significant contentions raised by the taxpayer in LG's case were as follows:

i. Section 92CA(2B) of the Act inserted by the Finance Act, 2012 empowered the TPO to assume jurisdiction to benchmark AMP expenses even though the same is not referred by the assessing office, cannot have retrospective operation.

ii. It was contended that unilateral incurring of AMP expenditure by the Taxpayer for its own business without any pre-existing agreement / understanding with the associated enterprise could not be characterized as an 'international transaction', so as to invoke the provisions of section 92 of the Act.

iii. Advertisement and marketing expenses incurred by the Taxpayer for its own benefit, any benefit to the associated enterprise being purely incidental.

iv. The expenditure incurred on AMP is not in the nature of capital expenditure nor results in creation of an intangible asset.

v. It was contended that the Revenue was deeming existence of an international transaction by applying bright line test, i.e., on the basis that the taxpayer has incurred AMP expenses exceeding bright line limit of such expenses incurred by comparable companies. Such deeming fiction similar to the developer-assister rule as it exists in US Transfer Pricing regulations, is alien to the Indian Transfer Pricing Regulations and the action of the Transfer Pricing Officer in embarking upon benchmarking of AMP expenses was not permissible.

vi. It was contended that the Bright Line Test sought to be applied by the Revenue for computing adjustment on account of excess advertisement and promotion expenses incurred by the Taxpayer was not one of the five methods provided under the Transfer Pricing Regulation in India and therefore, no adjustment could have been made by the TPO.

Decision of the Special Bench:

Our analysis of the Special Bench judgment is as under:

a. Jurisdiction of the TPO:

Majority view

In view of section 92CA(2B) of the Act inserted by the Finance Act 2012 with retrospective effect from 1-6-2002, the TPO had the jurisdiction to make TP adjustment qua AMP expenses even if the said issue was not referred to the TPO by the AO.  [paras 7.9, 7.18 and 7.23]

Minority view

Section 92CA(2B) would apply only where the taxpayer has reported international transaction, but has not furnished the report of the chartered accountant in respect thereof and further, the AO has not referred such transaction to the TPO.

Additionally, the assumption of jurisdiction has to be tested with reference to the law pertaining at that particular point of time; the same cannot be altered by any retrospective amendment or insertion or any provision. [para 72]

b. Existence of international transaction:

Majority view

Where the Indian company has incurred expenditure on product advertisements including the foreign brand and the AMP expenses incurred by the taxpayer are proportionately higher than those incurred by comparable cases, the same leads to the inference of "transaction" between the taxpayer and the foreign AE for creating marketing intangibles on behalf of the later.  [para 9.11]

As held by the Delhi High Court in the case of CIT Vs. EKL Appliances Ltd. [(2012) 345 ITR 241 (Del)] it is possible to re-characterize the transaction entered into between the parties, inter alia, in a situation where the arrangements made in relation to the transaction, viewed in their totality differ from those which would have been adopted by individual enterprises behaving in a commercially rational manner. [para 9.12]

If on making comparison of AMP expenses incurred by the taxpayer vis-à-vis AMP expenses incurred by independent AE behaving in a commercially rational manner, it appears that the Indian taxpayer prominently displaying brand of its foreign AE in its advertisements, has incurred expenses proportionately more than that incurred by independent enterprises behaving in a commercial rational manner, it is possible to recharacterize the transaction of total AMP expenses with a view to support the transaction of brand building for the foreign AE.

In view of the fact that the entire marketing strategy of LG Group through advertising and promotion was decided globally, in the absence of any evidence it could not be said that all decisions about the timing, area and quantum and advertisements was taken by the Indian taxpayer. [para 12.3]

The inference as to informal arrangement or understanding between the taxpayer and its AE for brand building is reinforced by the fact that LG Korea adopted a global strategy under which the AE decided incurring of AMP expenses under a global scheme. LG Korea adopted this strategy, acting under which LG Korea decided the incurring of AMP expenses under a global scheme, inter alia, for promotion of the brand and logo LG in India through the taxpayer. [para 12.4]

Notwithstanding the observation in para 12.6 that there is no evidence on record to come to the decisive finding that there exists an express agreement for incurring of the AMP expenses in India by the taxpayer for creating marketing intangibles for and on behalf of the foreign AE, it was held that there was a 'transaction' between the taxpayer and the foreign AE for promotion of brand LG in India, which is legally owned by the latter.  [paras 9.12, 12.6, 13]

Minority view

No written agreement has been found to exist between the AEs.  There is no evidence on record to suggest even remotely that there is any oral agreement between the parties. [para 21]

So-called 'non-routine' expenses segregated out of the AMP expenses, alleged to have been incurred towards brand-promotion, could not tantamount to 'an international transaction', for which T.P. adjustment was necessitated."  [para 2]

Once the majority had taken the view to set aside the matter to the file of the TPO to determine comparable cases, and thus determine whether there was any extra ordinary AMP expenses incurred by the Indian taxpayer, finding could not be reached that the taxpayer had allegedly incurred excess AMP expenses and consequently there would be any transaction, much less, an international transaction, between the parties.  [para 27]

It is the taxpayer who has to decide the level and extent of advertisement expenditure, dictated by commercial exigencies of business.  The Revenue has no power to recharacterize AMP expenditure as routine and non-routine.  [para 30]

The bright line test could not be used to reach the conclusion that there was any arrangement between the AEs with regard to incurring of expenditure for brand building.  The expenditure on AMP had been incurred by the Indian entity solely for purposes of its business and it was not a case of brand building / promotion, in the absence of any proof regarding rendering of service of brand building brought on record by the Revenue. [para 28]

The Revenue had erred in first carrying out the comparability analysis of AMP expenses as a percentage to sales, to determine whether there existed any international transaction.  The law does not mandate existence of international transaction to be inferred, deduced or deemed. [para 31]

The procedure adopted by the Revenue to arrive at the existence of an international transaction by comparing the AMP expenses as a percentage of sales is not mandated in law.

The Revenue had not discharged the burden of proving the existence of an international transaction.  The finding by the Revenue that the taxpayer should have been compensated with reference to alleged non-routine expenditure incurred towards AMP expenses as found incurred towards AMP expenses, as found, after comparing with similar, not-so similar or not similar entities who are also incurring such expenses was not as per procedure prescribed by law. [paras 29, 45]

The case would be covered within the ambit of section 92B of the Act only if the taxpayer was consciously involved in providing services as its business.

c. Nature of alleged international transaction:

Majority view

The transaction of brand building is a transaction of creating and improving marketing intangibles by the taxpayer for and on behalf of its foreign AE; such transaction is in the nature of provision of service. [para 14.21]

Economic ownership of the brand is not recognized under the provisions of the Act; it is only the legal owner who is so recognized. [para 10.1]

Minority view

The promotion of brand is only in relation to the product; there can be no promotion of brand de hors the product. [paras 22 and 23]

Advertisement which is product-centric / brand-centric only enhance the sales of the products of that brand in India.  The brand owner is no way benefitted.  [para 29]

The Indian entity is economic owner of the brand since the Indian entity bears the economic burden of creation of marketing intangible. Consequently, the Indian entity is entitled to economic rights of economic exploitation of that marketing intangible.  [para 29]

The concept of economic ownership and service cannot co-exist and thus AMP expenses cannot be treated as services rendered to the AE. The benefit of AMP expenses to the AE is only incidental.  Even as per OECD guidelines on intra group service, no compensation is required to be paid in case of such incidental benefits. [para 36]

In the very nature of advertisement expenses, no marketing intangible is created. The taxpayer is not in the business of rendering services for brand building; no such services have been provided by the taxpayer to its AE. The taxpayer has not created, improved or maintained the marketing intangibles for its foreign AE. [para 63, 65]

d. Application of bright line test:

Majority view

Since the expenses incurred by the Indian taxpayer for its own business purposes and for promotion of brand of the AE, are intermingled and otherwise inseparable, the bright line test is a way of finding out the cost / value of international transaction.  [paras 15.6, 15.7]

The bright line test is used to only ascertain the cost / value of service rendered by the taxpayer to foreign AE towards creation and improvement of marketing intangibles. [para 16.12]

Minority view

The bright line test could not be used to reach the conclusion that there was any arrangement between the AEs with regard to incurring of expenditure for brand building.  The expenditure on AMP had been incurred by the Indian entity solely for purposes of its business and it was not a case of brand building / promotion, in the absence of any proof regarding rendering of service of brand building brought on record by the Revenue. [para 50]

e. Choice of comparables:

Majority view

The question of determination of the cost/value of the international transaction of brand/logo promotion through AMP expenses incurred by the Indian AE for its foreign entity would be dependent on the 14 factors enumerated in para 17.4.  [para 17.4]

In choosing comparables the correct way to make a meaningful comparison is to choose comparable domestic cases not using any foreign brand. Where suitable adjustment is made for the factors enumerated in para 17.4, the same would correctly reflect the cost / value of the international transaction. [para 17.6]

Remarks:

Since the dissenting judgement holds that there is no international transaction to be benchmarked, no view has been expressed on the computation of ALP.

f. Nature of AMP expenses:

Majority view

Expenditure in the nature of selling expenses would not be covered within the ambit of advertising, marketing and promotional expenses, for determining the cost / value of the international transaction.   [para 18.6]

Remarks:

Since the dissenting judgement holds that there is no international transaction to be benchmarked, no view has been expressed on the computation of ALP.

g. Method applied by TPO / DRP:

Majority view

Although the assessing officer / TPO / DRP did not make reference to any specific method of determining ALP of international transaction, in a sense cost plus method was applied.    [paras 23.17 and 23.3]

Remarks:

Since the dissenting judgement holds that there is no international transaction to be benchmarked, no view has been expressed on the computation of ALP.

h. Application of TNMM:

Majority view

Merely because the net profit rate of the Indian taxpayer is better than the corresponding rate of comparable companies would not lead to the conclusion that incurring of AMP expenses for the AE is at arm's length. TNMM has to be applied on transaction to transaction basis and not on entity level basis.

Remarks:

Since the dissenting judgement holds that there is no international transaction to be benchmarked, no view has been expressed on the computation of ALP.

i. Application of Delhi High judgement in the case of Maruti Suzuki:

Majority view

The decision of the Delhi High Court in the case of Maruti Suzuki India was relied upon for the proposition that benchmarking of international transaction of incurring of AMP expenses was upheld therein.  The Special Bench did not accept the submission that the judgement of the Delhi High Court has been overruled by the decision of the Supreme Court.

The Special Bench as per majority view held that the adjustment in relation to AMP expenses and also earning a mark-up from associated enterprise is permissible. As per the majority view, the matter has been set aside to the TPO to readjudicate the entire issue in law / in accordance with the directions / guidelines given.[para 19] .In the dissenting order, the judicial member answered both the questions against the Revenue and in favour of the Taxpayer.

Our Comments:

I. The majority, while considering the question whether there was transaction for creating marketing intangibles in the nature of brand building for the AE by way of arrangement, understanding or action in concert, observed that "in the case of informal or oral concert, there has necessarily to be something to indicate concert indirectly". The finding of the majority that there exists a transaction and consequently an international transaction, is based on its conclusion that, "if there is no express agreement between the taxpayer and its foreign AE and still the facts and circumstances indicate that the Indian entity incurred some AMP expenses towards brand promotion of the foreign entity, the same shall be considered as an implied or oral transaction."

The majority has dealt with the primary contention of the taxpayer that in absence of a mutual agreement with the foreign AE , AMP expense cannot result into a transaction in para 9,9 of the order. The majority has concluded that agreement could also be informal or oral. It is further held that an informal  or oral agreement ,which is latent, could be inferred from the attending facts and circumstances to make it patent.

The majority observed that there could be no presumption about acting of two parties in concert which can only be by meeting of mind of  two or more parties leading to  shared objective. It is further held that in case of an informal or oral concert, there necessarily to be something to indicate the concert indirectly. The majority, relying upon the decision of the Supreme Court in the case of Daiichi - Sankyo Co. Ltd. vs. Jayaram Chigurupati & others [ (2010) 157 Company Cases 380 (SC)], concluded that such inference could be drawn from conduct of the parties.

The majority has further observed that there can be no impediment on the power of the taxpayer to spend as much as he likes on advertisement. The fact that the taxpayer has spent proportionately more on advertisement, can, at best, be a cause of doubt for the AO to trigger examination and satisfy himself that no benefit etc. in the shape of brand building has been provided to the foreign AE. At the same time, the majority has concluded that, "if it is found that apart from advertising the products and the taxpayer's name, it has also simultaneously or independently advertised the brand or logo of the foreign AE, then the initial doubt gets converted in a direct inference about some tacit understanding between the taxpayer and the foreign AE on this score......". 

In the case of Daiichi - Sankyo Co. Ltd. vs. Jayaram Chigurupati & others (supra), the Supreme Court was concerned with the Securities And Exchange Board of India (Substantial Acquisition Of Shares And Takeover) Regulations, 1997 (the Takeover code), which provides the regulatory mechanism for indirect acquisition of shares or voting right to acquire control over the target company. Sub-regulation (1) of Regulation 2(e) of the Takeover Code defines the term 'person acting in concert' and sub-regulation (2)(e) provides for a deeming fiction specifying relationships when the person pared with others shall be deemed to be acting in concert.

The Supreme Court held that the deeming provision under sub-regulation (2) operates only within the larger framework of sub-regulation (2) of regulation 2(e). It was held that, "............ persons who are deemed to be acting in concert must have the intention or the aim of acquisition of shares of a target company. It is the conduct of the parties that determines their identity. Whether a person is or is not acting in concert with the acquirer would depend upon the facts of each case. In order to hold that a person is acting in concert with the acquirer or with another person it must be established that the two share the common intention of acquisition of shares of some target company". The Supreme Court held that, whether in a given case an FII and his sub-account(s) have a common objective of making investment in India to earn profits in unit holders or whether they have a common objective of acquiring substantial stakes or control in some target company would depend on the facts of each case. On facts of that case, the Supreme Court concluded that since the earlier purchases of shares by the parties , when they were strangers and not acting in concert, were subsequently brought within the concept by an express agreement between them,  such earlier purchases too, would attract regulatory provision of the Takeover Code.

There is fundamental fallacy in the order passed by the majority in assuming that the incurring of AMP expenses results in an international transaction on the basis that part of the expenditure may be considered / non-routine, applying the bright line approach, even in the absence of any formal / informal understanding between the parties. The majority has further erred in holding, again, on presumption that the taxpayer has rendered service of brand building to the AE while accepting that the taxpayer is not in the business of brand building.

The majority, drawing inference from proportionately higher AMP expenditure incurred by the taxpayer, assumed existence of a transaction between the parties The majority is, in fact, seeking to place cart before the horse by first construing a 'transaction' or 'international transaction' based on benchmarking analysis instead of undertaking benchmarking of an existing international transaction.

The majority has interchangeably used the words 'informal' and 'implied'. The term 'informal' is an antonym of formal and refers to casual or unofficial. 'Implied' on the other hand means indirect, oblique disguised or obscure. The two terms, therefore, are not synonyms and have different import. Wharton's Law Lexicon explains 'implied contract' as "a contract which the law infers, from acts, circumstances, or relationships. The term 'implied' refers to something which is consequence of or is derived or inferred from an event and a presumption is implicit in everything which is implied. The majority is seeking to presume or draw an inferences that there is an action in concert or meeting of minds between the two parties on the basis of their conduct of incurring of proportionately more AMP expenses coupled with the advertisement of brand or logo of the foreign AE, which provide inference of some informal or implied agreement in this regard.

The term 'transaction' is defined in clause (v) of section 92F of the Income-tax Act, 1961 to include arrangement, understanding or action in concert, whether or not the same is formal or in writing. In other words, the arrangement, understanding or action in concert can also be informal and can result in a transaction. There can be no dispute that the arrangement, understanding or action in concert could be oral or informal and in case of such an informal or oral concert, there has to be something to indicate concert indirectly.  The law does not, however, provides to consider an implied agreement to infer a transaction. The informal or oral concert does not mean inferring or implying the concert or agreement. The conclusion of the majority, therefore, that incurring or proportionately more AMP expenses coupled with advertisement of brand or logo of the foreign AE, leads to inference of some informal or implied agreement for construing a transaction, appears to be farfetched.

There is a distinction between incurring of AMP expenditure for exploiting the brand name owned by the foreign AE for the benefit of the taxpayer itself and the conscious activity of brand promotion on behalf of the foreign AE. In order to construe a brand promotion services rendered by the taxpayer to the foreign AE, there needs to be an evidence of arrangement, understanding or action in concert for the purpose of incurring the AMP expenses, which cannot be implied or inferred on the basis of quantum of expenditure incurred by the taxpayer.

II. The majority held that benchmarking of AMP expenditure would be possible if the Indian taxpayer is prominently displaying brand of its foreign AE in its advertisement and has incurred proportionately more expense than independent enterprises. In such scenario, the Special Bench concluded the transaction of brand building is a transaction of creating and improving marketing intangibles by the taxpayer for and on behalf of its foreign AE; such transaction is in the nature of provision of service.

It has not been appreciated that the main purpose  of 'trademark' or 'brand name 'is to designate the source of goods and is  always associated with the product or goods being dealt in by the company. 'Trademark' is used as a distinctive mark to differentiate the goods or product from others. The term 'trademark' is defined in clause (zb) of section 2(1) of the Trade Marks Act, 1999, as under:

"(zb)    "trade mark" means a mark capable of being represented graphically  and which is capable of distinguishing the goods or services of one person from those of others and may include shape of goods, their packaging and combination of colours; and –

i.In relation to Chapter XII (other than section 107), a registered trade mark or a mark used in relation to goods or services for the purpose of indicating or so as to indicate a connection in the course of trade between the goods or services, as the case may be, and some person having the right as proprietor to use the mark; and

ii.In relation to other provisions of this Act, a mark used or proposed to be used in relation to goods or services for the purpose of indicating or so to indicate a connection in the course of trade between the goods or services, as the case may be, and some person having the right, either as proprietor or by way of permitted user, to use the mark whether with or without any indication of the identity of that person, and includes a certification trade mark or collective mark."

In Black's Law Dictionary, the term 'trademark' has been explained as follows:

"trademark, n. 1. A word, phrase, logo, or other graphic symbol used by a manufacturer or seller to distinguish its product or products from those of others.

The main purpose of a trademark is to designate the source of goods or services. In effect, the trademark is the commercial substitute for one's signature. To receive federal protection, a trademark must be (1) distinctive rather than merely descriptive or generic; (2) affixed to a product that is actually sold in the marketplace, and (3) registered with the U. S. Patent and Trademark Office. In its broadest sense, the term trademark includes a servicemark........."

In case of a taxpayer, having an exclusive license to use the trade mark in India on the products, such trade mark would feature in advertisements released in media for promotion of sale of products in India. Such trademark is entirely associated with the products manufactured / sold in India. The dissenting judgment, in our view, correctly records that the brand has no existence de hors the product and that brand building happens essentially based on product satisfaction. 

It has further been assumed by the majority that AMP expenses incurred for promotion / exploiting the brand name for the benefit of the foreign AE rather than taxpayer. Benefit of use of brand name in the advertisement resulted to the taxpayer, i.e., LG India, in the form of higher profit than the comparable companies. The majority has, in our opinion, wrongly assumed that there was a transaction of rendering of service by way of brand building by creating and improving marketing intangible on behalf of the foreign AE. 

The dissenting judgment correctly highlights that the existence of an international transaction must be established as a fact.  There is no scope for any assumption /deeming the existence of an international transaction, de hors any express or implied agreement between the parties, the burden of proving which is on the Revenue.

The approach followed by the majority of deeming an international transaction is completely faulty, more so in light of the fact that the majority has set aside the issue to the file of the TPO for de novo adjudication for choosing the correct comparables and taking into account the guiding principles enumerated in para 17.4 of the majority judgement, as rightly pointed out in the dissenting judgement.  It must first be established on facts that there exists an international transaction, which, then, has to be benchmarked taking into account comparables; the majority view has advocated the other way round, which is contrary to law.

The majority view has erred in using the bright line approach to determine existence of a transaction and then using the same approach, deeming the alleged excess / non-routine AMP expenses as the cost / value of the international transaction.  Such a procedure is clearly not mandated in law.

III. The fact that the benefit / advantage of advertisement expenditure incurred by the taxpayer in India through unrelated third parties enured directly to the taxpayer and benefit, if any, to the AE is only incidental, has not been accepted by the majority. In the opinion of the majority, the advertisement(s) released by the taxpayer, featuring the logo / trade mark of the AE, which the taxpayer was permitted to use, resulted in rendition of service of brand building by the taxpayer to the AE.

It is further held in the dissenting judgement, and rightly so, that the AMP expenses have been incurred by the taxpayer wholly and exclusively for purposes of its business, which is reflected in increased turnover and profitability.

The minority view also takes into account the OECD guidelines on intra group services which recommend that no cognizance be taken of any incidental benefit arising to an affiliate / AE, in absence of any mutual agreement / arrangement.  The dissenting judgement, therefore, correctly holds that there was no service of brand building provided by the taxpayer to the AE.

IV. On the scope and nature of the TP adjustments, the majority held that the exercise of separating the amount spent by the taxpayer in relation to international transaction of building brand for its foreign AE, for separately processing as per section 92 of the Act could not be considered as a case of disallowance of AMP expenses u/s 37(1) of the Act; the case is about not allowing deduction to the extent these have been spent by the taxpayer on the international transaction without receiving any corresponding credit from the AE, which ought to have been received.

It has not been appreciated by the majority that the expenses incurred by an taxpayer wholly and exclusively for purposes of its business are allowable deduction under section 37(1) of the Act.  Expenses incurred on behalf of the third party are not allowable deduction at the threshold. Where brand building expenses are regarded as incurred for the AE, the same would not pass the test of "commercial expediency".  It is only where the taxpayer is engaged in the business of providing services for brand building, that such expenditure would initially be allowable business deduction in terms of section 37(1) of the Act.  Such expenses would then have to be benchmarked in terms of section 92 of the Act where services are rendered to an AE.

The majority has contradicted itself in holding that there is no requirement for the taxpayer to be carrying on business of providing /rendering of services, in order to benchmark the "transaction" of incurring of AMP expenses. It is cardinal that there must first be a finding recorded that the taxpayer is engaged in the business of providing services for brand building before embarking upon any transfer pricing adjustment for such services provided to an AE. In the absence of such finding and assuming the expenses are incurred for the AE, the expenses would, at the threshold, be disallowable under section 37(1) of the Act itself and there would, therefore, be no requirement of benchmarking such "transaction".

In the minority view it has been held that the taxpayer must be in the business of providing service of brand building before any TP adjustment could be made, and that in the absence of such finding, the adjustment made was not sustainable.

V. The finding by the majority that for purposes of comparability domestic comparables not having use of a foreign brand, must be chosen. The comparability analysis must then take into account 14 factors enumerated in para 17.4 of the majority view.

It has not been appreciated by the majority that the comparables to be adopted must be comparable in terms of size, range of products, market positioning, etc. 

Further, since incurring of AMP expenses through unrelated third party, is not a related party transaction, a domestic entity having use of a foreign brand (of an unrelated party) should be used as benchmark to determine the excess / non-routine expenditure even if one were to adopt the approach advocated by the majority.  If there by a domestic entity, (having a domestic brand) which satisfies the aforesaid parameters, the same can definitely be adopted; however, it is not any and every domestic entity engaged in the same line of business which can be taken as comparable(s).

VI. The majority has not appreciated the import of the argument that once rate of profitability of the taxpayer is higher than the comparables taken by the TPO for benchmarking AMP expenses, no adjustment is required, considering that the benefit of AMP expenses is duly reflected in the revenues realized from sale of products and the profitability of the parties.  In other words, the benefit of AMP expenses is reflected in the increased profitability of the taxpayer, and, therefore, no part of it should be assumed to be for the benefit of the AE / rendition of service of brand building of the AE.

VII. The conclusion arrived at by the majority in the Special Bench does not appear to be workable from the business perspective. The AE has developed and created a brand name over the years and has allowed the Indian enterprise to use and exploit it's valuable IPR for the purpose of carrying on business in India. The AE does not sell products or goods on its own account in India and the entire benefit in the form of increased sale of the increased AMP expenditure on promoting / exploiting the brand name is reaped by the Indian enterprise and the income whereof is subjected to tax in India. There is also no tangible evidence of the AE asking for services for promotion of their brand name in India nor of their receiving benefit of AMP expenses incurred on promotion of the brand name in India.

It is inconceivable that in an arm's length situation, the foreign enterprise (the AE) would enter into an agreement with an Indian enterprise for allowing use of their valuable IPR and at the same time making compensation for AMP expenditure unilaterally incurred by such enterprise for exploiting that IPR for the purpose of its business and to earn higher income / profit on its own account. It is also a moot question that the AE would be desirous of availing brand promotion services from the Indian enterprise on payment of compensation and there is no evidence for such an agreement or arrangement.

The interpretation of Transfer Pricing Regulation, as placed by the majority of Special Bench, is contrary to the settled principal "ut res magis valeat quam pereat"  i.e., the Statute must be so construed as to make it effective and operative [CIT vs. S. Teja Singh : 35 ITR 408; Management of Advance Insurance Co. Ltd vs. Gurudasmal : 1 SCC 633; Commissioner of Income-tax vs. Hindustan Bulk Carriers : 3 SCC 57].

Conclusion:

Transfer Pricing continues to lead the list of international tax issues that MNEs wrestle with today and expect to grapple with in the coming years. The conclusion by the majority of the Special Bench of deeming a 'transaction' or 'international transaction' on the basis of conduct of the parties of incurring significant AMP expenses on promotion of brand of the foreign AE in India, is of far reaching implication for the MNEs, manufacturing or selling products bearing the prominent foreign brand name in India. The High Courts in the various jurisdictions would have to deal with this complex Transfer Pricing dispute in the current fiscal year.

Article by: Neeraj Jain, Vaish Associates Advocates. Author acknowledges guidance from Mr. Ajay Vohra, Managing Partner, Vaish Associates Advocates email: ajay@vaishlaw.com and contribution from Ramit Katyal, Senior Associate, Vaish Associates Advocates email: ramit@vaishlaw.com

© 2013, Vaish Associates, Advocates,
All rights reserved with Vaish Associates, Advocates, 10, Hailey Road, Flat No. 5-7, New Delhi-110001, India.

The content of this article is intended to provide a general guide to the subject matter. Specialist professional advice should be sought about your specific circumstances. The views expressed in this article are solely of the authors of this article.

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Neeraj Jain, Partner Vaish Associates Advocates
 
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Registration
Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:
  • To allow you to personalize the Mondaq websites you are visiting.
  • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our information providers who provide information free for your use.
  • Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.
    If you do not want us to provide your name and email address you may opt out by clicking here
    If you do not wish to receive any future announcements of products and services offered by Mondaq you may opt out by clicking here

    Terms & Conditions and Privacy Statement

    Mondaq.com (the Website) is owned and managed by Mondaq Ltd and as a user you are granted a non-exclusive, revocable license to access the Website under its terms and conditions of use. Your use of the Website constitutes your agreement to the following terms and conditions of use. Mondaq Ltd may terminate your use of the Website if you are in breach of these terms and conditions or if Mondaq Ltd decides to terminate your license of use for whatever reason.

    Use of www.mondaq.com

    You may use the Website but are required to register as a user if you wish to read the full text of the content and articles available (the Content). You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these terms & conditions or with the prior written consent of Mondaq Ltd. You may not use electronic or other means to extract details or information about Mondaq.com’s content, users or contributors in order to offer them any services or products which compete directly or indirectly with Mondaq Ltd’s services and products.

    Disclaimer

    Mondaq Ltd and/or its respective suppliers make no representations about the suitability of the information contained in the documents and related graphics published on this server for any purpose. All such documents and related graphics are provided "as is" without warranty of any kind. Mondaq Ltd and/or its respective suppliers hereby disclaim all warranties and conditions with regard to this information, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. In no event shall Mondaq Ltd and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use or performance of information available from this server.

    The documents and related graphics published on this server could include technical inaccuracies or typographical errors. Changes are periodically added to the information herein. Mondaq Ltd and/or its respective suppliers may make improvements and/or changes in the product(s) and/or the program(s) described herein at any time.

    Registration

    Mondaq Ltd requires you to register and provide information that personally identifies you, including what sort of information you are interested in, for three primary purposes:

    • To allow you to personalize the Mondaq websites you are visiting.
    • To enable features such as password reminder, newsletter alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
    • To produce demographic feedback for our information providers who provide information free for your use.

    Mondaq (and its affiliate sites) do not sell or provide your details to third parties other than information providers. The reason we provide our information providers with this information is so that they can measure the response their articles are receiving and provide you with information about their products and services.

    Information Collection and Use

    We require site users to register with Mondaq (and its affiliate sites) to view the free information on the site. We also collect information from our users at several different points on the websites: this is so that we can customise the sites according to individual usage, provide 'session-aware' functionality, and ensure that content is acquired and developed appropriately. This gives us an overall picture of our user profiles, which in turn shows to our Editorial Contributors the type of person they are reaching by posting articles on Mondaq (and its affiliate sites) – meaning more free content for registered users.

    We are only able to provide the material on the Mondaq (and its affiliate sites) site free to site visitors because we can pass on information about the pages that users are viewing and the personal information users provide to us (e.g. email addresses) to reputable contributing firms such as law firms who author those pages. We do not sell or rent information to anyone else other than the authors of those pages, who may change from time to time. Should you wish us not to disclose your details to any of these parties, please tick the box above or tick the box marked "Opt out of Registration Information Disclosure" on the Your Profile page. We and our author organisations may only contact you via email or other means if you allow us to do so. Users can opt out of contact when they register on the site, or send an email to unsubscribe@mondaq.com with “no disclosure” in the subject heading

    Mondaq News Alerts

    In order to receive Mondaq News Alerts, users have to complete a separate registration form. This is a personalised service where users choose regions and topics of interest and we send it only to those users who have requested it. Users can stop receiving these Alerts by going to the Mondaq News Alerts page and deselecting all interest areas. In the same way users can amend their personal preferences to add or remove subject areas.

    Cookies

    A cookie is a small text file written to a user’s hard drive that contains an identifying user number. The cookies do not contain any personal information about users. We use the cookie so users do not have to log in every time they use the service and the cookie will automatically expire if you do not visit the Mondaq website (or its affiliate sites) for 12 months. We also use the cookie to personalise a user's experience of the site (for example to show information specific to a user's region). As the Mondaq sites are fully personalised and cookies are essential to its core technology the site will function unpredictably with browsers that do not support cookies - or where cookies are disabled (in these circumstances we advise you to attempt to locate the information you require elsewhere on the web). However if you are concerned about the presence of a Mondaq cookie on your machine you can also choose to expire the cookie immediately (remove it) by selecting the 'Log Off' menu option as the last thing you do when you use the site.

    Some of our business partners may use cookies on our site (for example, advertisers). However, we have no access to or control over these cookies and we are not aware of any at present that do so.

    Log Files

    We use IP addresses to analyse trends, administer the site, track movement, and gather broad demographic information for aggregate use. IP addresses are not linked to personally identifiable information.

    Links

    This web site contains links to other sites. Please be aware that Mondaq (or its affiliate sites) are not responsible for the privacy practices of such other sites. We encourage our users to be aware when they leave our site and to read the privacy statements of these third party sites. This privacy statement applies solely to information collected by this Web site.

    Surveys & Contests

    From time-to-time our site requests information from users via surveys or contests. Participation in these surveys or contests is completely voluntary and the user therefore has a choice whether or not to disclose any information requested. Information requested may include contact information (such as name and delivery address), and demographic information (such as postcode, age level). Contact information will be used to notify the winners and award prizes. Survey information will be used for purposes of monitoring or improving the functionality of the site.

    Mail-A-Friend

    If a user elects to use our referral service for informing a friend about our site, we ask them for the friend’s name and email address. Mondaq stores this information and may contact the friend to invite them to register with Mondaq, but they will not be contacted more than once. The friend may contact Mondaq to request the removal of this information from our database.

    Emails

    From time to time Mondaq may send you emails promoting Mondaq services including new services. You may opt out of receiving such emails by clicking below.

    *** If you do not wish to receive any future announcements of services offered by Mondaq you may opt out by clicking here .

    Security

    This website takes every reasonable precaution to protect our users’ information. When users submit sensitive information via the website, your information is protected using firewalls and other security technology. If you have any questions about the security at our website, you can send an email to webmaster@mondaq.com.

    Correcting/Updating Personal Information

    If a user’s personally identifiable information changes (such as postcode), or if a user no longer desires our service, we will endeavour to provide a way to correct, update or remove that user’s personal data provided to us. This can usually be done at the “Your Profile” page or by sending an email to EditorialAdvisor@mondaq.com.

    Notification of Changes

    If we decide to change our Terms & Conditions or Privacy Policy, we will post those changes on our site so our users are always aware of what information we collect, how we use it, and under what circumstances, if any, we disclose it. If at any point we decide to use personally identifiable information in a manner different from that stated at the time it was collected, we will notify users by way of an email. Users will have a choice as to whether or not we use their information in this different manner. We will use information in accordance with the privacy policy under which the information was collected.

    How to contact Mondaq

    You can contact us with comments or queries at enquiries@mondaq.com.

    If for some reason you believe Mondaq Ltd. has not adhered to these principles, please notify us by e-mail at problems@mondaq.com and we will use commercially reasonable efforts to determine and correct the problem promptly.

    By clicking Register you state you have read and agree to our Terms and Conditions