India: Transfer Pricing Adjustment For Excessive Marketing Expenses Taking A Twist In India

Last Updated: 20 June 2017
Article by SKP  


The Delhi bench of the Income Tax Appellate Tribunal in a recent ruling in the case of Luxottica India Eyewear Pvt Ltd (ITA No. 344/Del/2017) has given a new dimension to the issue of excessive spend on Advertisement, Marketing, and Promotion expenses (AMP) in India. The Tribunal has scanned the relatively new approach adopted by the Tax Authorities of making an "AMP intensity adjustment" to factor in the "marketing function" and brand value creation done by the Indian distributors on behalf of its Associated Enterprises (AE) who is the brand owner, as an alternative to applying the bright line test.

The facts and observations of the case are discussed below:

Facts of the case

  • The taxpayer is a part of Luxottica group which is into design, manufacture and distribution of sunglasses and prescription frames in mid and premium price categories.  
  • The taxpayer is engaged in trading and distribution of the group products in India. 
  • For the Assessment Year (AY) 2012-13, with respect to the international transaction pertaining to its trading activity viz import of finished goods, the taxpayer has applied Resale Price Method (RPM) for benchmarking purposes. Notably, the taxpayer has incurred a significant AMP expenditure in proportion to its sales revenue.
  • The Transfer Pricing Officer (TPO) evaluated the significant AMP expenditure incurred by the taxpayer and opined that the excessive promotional efforts or expenditure incurred by the taxpayer was in essence 'marketing function' carried out by the taxpayer on behalf of its AE and it enhanced the value of 'Luxottica' brand owned by its AE. 
  • The TPO analysed the need to make an adjustment to the operating margins of comparable companies vis-à-vis the taxpayer to factor in the difference in the intensities of AMP expenditure of the comparable companies. Based on the same, the TPO carried out an 'AMP intensity adjustment' to operating margin of comparable companies by considering the difference in the percentage of AMP to sales (intensity of AMP) of the taxpayer and the comparable companies. While doing so the TPO considered the Transactional Net Margin Method (TNMM) as the most appropriate method for benchmarking the international transaction of import of finished goods. 
  • In effect, transfer pricing adjustment was proposed post comparing the profit margin of the taxpayer and the AMP intensity adjusted margins of comparable companies. 

The Tribunal's ruling

In response to the appeal filed by the taxpayer against the computation of transfer pricing adjustment, the Delhi Tribunal has decided the appeal principally in favour of the Revenue. The Key observations of the Tribunal's ruling are as below:

  • While the taxpayer did not challenge the 'AMP intensity adjustment' made by the TPO before the Tribunal, the Tribunal in its order reaffirmed the approach adopted by the TPO of treating AMP as a function in view of the similar observations of the jurisdictional Delhi High Court in case of Bausch & Lomb Eyecare India Pvt Ltd and Ors vs Addl CIT and Ors and Sony Ericson Mobile Communications (India) Pvt Ltd vs CIT. 
  • In response to the taxpayer's contention that the TPO had rejected RPM and applied TNMM as the most appropriate method, the Tribunal, in the light of the facts presented, observed that the TPO had not considered the excessive AMP expenditure as a 'separate international transaction' and adopted an alternative approach of considering the AMP expenses to be embedded in the primary international transaction i.e. import of finished goods. The Tribunal acknowledged the fact that "If, however, it turns out that such an adjustment cannot be done due to one reason or the other, then the RPM should be discarded and another suitable method be adopted, which encompasses the effect of AMP intensity adjustment."  

SKP's comments

It is worthwhile to note that in this case the Indian Tax Authorities have resorted to the concept of 'AMP intensity adjustment' as an alternative to the bright line test approach which has been applied in a number of cases in the past to make transfer pricing adjustments for excessive AMP expenses incurred by the Indian counterparts of Multinational groups. The issue in respect of treating of excessive AMP expenses as a separate international transaction and appropriateness of the bright line test for benchmarking such transaction is still under litigation and has now reached the Supreme Court of India.

It appears that the debate around 'excessive AMP expenses' is going to continue in the Indian transfer pricing arena, till the time Government of India comes up with specific guidance on the treatment of such expenses for transfer pricing analysis purposes.

Lastly, it is crucial for taxpayers to evaluate their marketing functions and the intensity of AMP expenses incurred in relation to their Indian operations. In case the AMP expenses are on a higher scale, it makes sense to collate rational justifications for the same and document them appropriately.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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