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Transfer Pricing: The AMP Issue Keep Oscillating
August, 20th 2018

Multinational Enterprises ("MNEs") set up subsidiaries in India to cater to the Indian market and capitalize on their brands. Such subsidiaries/Indian entities are entrusted with various functions ranging from license manufacturing to selling and distributing the products. The intellectual property rights ("IPR") in products as well as the brands lies with the parent entities. The subsidiaries are generally engaged in marketing the products manufactured or imported by them and incur certain expenses, which are popularly known as Advertisement, marketing and sale promotion expenditure ("AMP expenses").

The revenue authorities, on several occasions in past, have contended that AMP gives rise to IPR of parent company in India for which it ought to be remunerated. Thus, being an international transaction, it needs to be tested for Arm's Length Price ("ALP"). To test that whether the transaction is at ALP or not, Revenue Authorities' have adopted Bright Line Test ("BLT"), as per which for the amount of AMP expenses incurred above the similar amount incurred by comparable is considered as non-routine AMP expense.

Since the very beginning, the issue of AMP has been mired in controversy. One of the primary issues has been that, whether such a transaction would at all qualify as an international transaction or not? It would also be apt to mention that so far this dispute has involved two types of MNEs: License Manufacturers and Distributors. However, this distinction may not be relevant in view of the recent judgments holding that incurring AMP expense is not even an international transaction.

The matter has been subject matter of numerous cases. One of the earliest decision on this issue was in the case reported as Maruti Suzuki India Ltd. (MSIL) v. Addl. CIT, TPO [2010] 328 ITR 210 (Delhi),(1st Maruti judgment) a case of license manufacture, wherein the AMP was held as international transaction under section 92B of the Income Tax Act, 1961("Act"). It was further held that the Indian Entities merely uses the brand of their foreign partners for its business. The matter was then remanded, however, this judgment was challenged before the Hon'ble Supreme Court and was overruled in Maruti Suzuki India Ltd. v. Addl. CIT [2011] 335 ITR 121 (SC). The Maruti matter again travelled to the ITAT and the Delhi Bench of ITAT in LG Electronics India (P.) Ltd. v. Asstt. CIT [2013] 140 ITD 41 (Delhi) (SB) held that the Assessing Officer ('AO') was entitled to make a transfer pricing adjustment under Chapter X of the Act on the basis of BLT in respect of the AMP expenditure incurred by Indian Entity as the same is an international transaction. The correctness of the decision of the Special Bench in LG Electronics India (P.) Ltd. (supra) came up for consideration in a batch of appeals including the cases of Sony, Reebok, Canon etc., who are distributor of foreign company, before the Hon'ble Delhi High Court, which came to be decided by a decision in Sony Ericsson Mobile Communications India (P.) Ltd. v. CIT [2015] 374 ITR 118 (Del).

The Hon'ble High Court partially overruled the LG Electronics India (P.) Ltd. (supra), the Hon'ble court disregarding the application of BLT held that the function of AMP may be treated as an international transaction and since distribution and marketing functions are inter-connected and intertwined functions, the same can be bundled for determination of ALP. The matter was remanded back for determination of ALP after doing the functional analysis and determination of valid comparable.It was further held that even if an expense is wholly and exclusively spend for the purpose of business and allowable under section 37 of the Act, still, the same can be a subject matter to transfer pricing adjustment under chapter X of the Act in so far as it is excessive.

In the meanwhile, the fact that the benefit of such AMP expenses would also enure to the AE is itself sufficient to infer the existence of an international transaction has been negatived by the Hon'ble Delhi High Court in Maruti Suzuki India Ltd. v. CIT [2015] 381 ITR 117 (Delhi) (2nd Maruti judgment). Further, there are various other decisions of the Hon'ble Delhi High Court including Bausch & Lomb Eyecare (India) (P.) Ltd. v. Addl. CIT [2016] 381 ITR 227 (Delhi) which has similarly held that AMP expense is not an international transaction and further there is no machinery provision for computation of AMP expense adjustment.

Recently, the Delhi Bench of Income tax Appellate Tribunal in the case of M/s Sony Mobile Communications [India] Pvt. Ltd v. The Addl. C.I.T (ITA No. 6410/Del/2012) has in remand proceedings (pursuant to Sony Ericsson (Supra) judgment) held that the AMP expense incurred by the assessee company could not have added any value to the brand Sony Ericsson owned by its Associated Enterprise and since this was the first year of business in India, the assessee had to advertise aggressively but could not be considered as expenditure incurred for brand building. At the most, the same can be considered as having been incurred for brand maintenance. Further, the assessee earned margin of 2.5% after considering AMP expenditure which is much higher than the mean margin of comparable companies, which is at 0.4%. Hence, any addition on account of ALP is uncalled for.

This decision is somewhat similar to the 1stMaruti judgment in so far as it held that the Indian Entities merely uses the brand of their foreign partners for its business. The judgment is contradictory in so far as it states that the AMP expense was not related to the business of foreign associate, yet, the same was benchmarked against the comparable to justify ALP. It is also important to point that the High Court decisions wherein it was held that the AMP expense is not an international transaction were not discussed in this judgment of the ITAT.

Although, all the aforesaid judgment of Delhi High Court including the Sony Ericsson (Supra) and 2ndMaruti judgment are pending before the Hon'ble Apex Court (Civil Appeal No. 132 of 2016), therefore, a final view on the issue may be taken once the same are disposed by the Apex Court.

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