Brief Facts of the case
Diageo India Private Limited (the taxpayer) is a wholly owned subsidiary of Selvic Netherlands BV, which is a part of Diageo group. The taxpayer is engaged in the business of manufacturing and distribution of alcoholic beverages.
During the year under consideration (i.e. AY 2010-11), the taxpayer has incurred Advertisement, Marketing and Promotion (AMP) expenses which comprises of advertisement as well as selling expenses. These include expenses incurred for the brand owned by Associated Enterprise (AE) as well as brand owned by the taxpayer.
Inter-company agreement between the taxpayer and the AE was amended (w.e.f. 1 April 2009) to include that the taxpayer shall incur AMP expenses on its own account for sale of products licensed by AE to taxpayer wherein the AE shall bear certain component of such AMP expenses by way of brand contribution to the taxpayer. Owing to such arrangement, the taxpayer has received compensation towards brand contribution from its AE during the year under consideration.
Outcome of Transfer Pricing assessment:
The Transfer Pricing Officer (TPO) has re-computed the AMP expenses of the taxpayer, by enhancing the total AMP expenses admitted by taxpayer with the following adjustments:
- Firstly, the TPO re-allocated the total AMP expenses admitted by taxpayer, in the ratio of segmental sales between Manufacturing segment, Distribution segment and other segment. Wherein, other segment represents AMP expenses incurred on brands owned by the taxpayer itself.
- Secondly, the TPO treated certain selling expenses (e.g. display, glow signs etc.) as AMP expenses.
- Lastly, the TPO alleged that with respect to the AMP expenses incurred towards other segment (viz own brands) the taxpayer was not able to submit adequate supporting documents/vouchers to support such claim. Accordingly, the TPO re-allocated these expenses (to the extent of no vouchers) to Manufacturing and Distribution segment to apply the Bright Line Test (BLT).
Further, the TPO, while re-computing the amount of AMP expenses (as above) refused to give credit towards the reimbursement received by the taxpayer from its AE.
Thereafter, the TPO compared the above re-computed AMP expenses of the taxpayer with the comparable companies by applying BLT. The TPO proposed an adjustment in relation to excessive AMP expenses incurred over and above the BLT and adding an arm's length mark-up. The arm's length mark-up for the said purpose was determined by selecting comparable companies engaged in marketing support/sales support services.
Outcome of Dispute Resolution Panel [DRP] proceedings:
DRP accepted the contentions of TPO (relying on previous year's DRP order) that AMP expenditure incurred by the taxpayer has benefitted brands on a global basis. Further, DRP also accepted the re-allocation of AMP expenses done by the TPO amongst both segments (viz Manufacturing and Distribution). Also, DRP directed that selling expenses and advertisement expenses incurred by the taxpayer on its own brand (for which no justification/vouchers provided by the taxpayer) shall form part of AMP expenses for the purpose of computing AMP adjustment.
Lastly, DRP provided relief to the taxpayer to reduce brand contribution received from AE from the adjustment made towards excessive AMP.
Judgement of Income Tax Appellate Tribunal (ITAT), Mumbai Bench:
Aggrieved by the directions of DRP, the taxpayer as well as revenue filed an appeal before the ITAT. We have briefly summarized the taxpayer's as well as revenue authority's arguments as below:
|Taxpayer's arguments||Revenue's arguments|
Based on aforesaid arguments placed by the taxpayer and revenue, ITAT rules as listed below:
AMP expenditure by taxpayer is an international transaction
In all judicial precedents relied upon by the taxpayer wherein AMP was held not to be an international transaction, no agreement/arrangement existed between the parties to incur AMP expenses. However, it is an established fact in the instant case that a mutual agreement exists between taxpayer and its AE for incurring AMP expenses.
Thus, AMP expenses is an international transaction requiring determination of arm's length price. The same is apparent from the brand contribution received from the AE. The taxpayer's contention that the same is towards enabling taxpayer to achieve arm's length rate of return is nowhere emanating from the agreement and hence not acceptable.
Determination of ALP for AMP expenditure
ITAT has remitted the matter back to the TPO's office to
determine ALP by relying on judicial precedent given in the case of
BMW India Ltd which has further relied upon the observations given
by Delhi High Court in case of Sony Ericson Mobile Communications
(India) Pvt Ltd. The steps prescribed in the said ruling (Sony
Ericson) is as follows:
|Step 1||Analyze and examine manufacturing/distribution and AMP functions of assessee and compare the same with comparable companies on an aggregated basis|
|Step 2||In a case where manufacturing/distribution and AMP functions of assessee are different from that of comparable companies, make a suitable adjustment|
|Step 3||If such adjustment cannot be made, reject these companies as comparable|
|Step 4||If no comparable exist after performing aforesaid step, segregate both transactions and find separate comparable for each function|
|Step 5||Compare AMP functions of assessee with selected comparable companies|
|Step 6||In a case when AMP functions of assessee are different from that of comparable companies, make a suitable adjustment|
|Step 7||Once comparable companies are finalized and ALP for AMP functions has been determined, adjustment available (if any) from manufacturing/distribution function be made.|
In the context of AMP related transfer pricing adjustments, the Indian Tax Courts and judiciary have in most cases favored taxpayer's position that in the absence of any arrangement/written agreement the AMP expenses do not qualify the definition of 'international transaction' to be covered under the Indian transfer pricing regulations. However, a few notable exceptions are:
In the instant case, one may say that what was seen by the taxpayer as a bonafide intention in getting the reimbursement of certain AMP expenses to recoup operating losses was on the other hand conceived by the tax authorities as evidence to conclude the existing of arrangement to promote the global brand.
Therefore, this judgment re-emphasizes the need to review the language of inter-co agreement/arrangement especially on the matters involving litigious issues such as marketing intangibles.
The takeaway from the above judgment could be that the Tribunal has answered quite a few questions of principle nature in this judgment regarding transfer pricing analysis, such as:
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.