13 January 2020
Excessive Advertising, Marketing and Promotion (AMP) expenses incurred pursuant to amended inter-co agreement qualifies the definition of international transaction

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:
  1. 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.
  2. Secondly, the TPO treated certain selling expenses (e.g. display, glow signs etc.) as AMP expenses.
  3. 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
  • AMP expenses incurred for increasing own sales, thus not an international transaction, even if an incidental benefit occurs to AE.
  • BLT is not a prescribed method as per the Income Tax Act and hence cannot be used to infer AMP as an international transaction.
  • There is no agreement/arrangement with AE to perform AMP related activities.
  • Existing agreement is merely a guidance towards marketing policy and not a contractual obligation to perform AMP activities.
  • Brand contribution received from AE is merely towards ensuring an arm’s length return for manufacturing and distribution activities.
  • Selling expenses and advertisement expenses incurred by the taxpayer on its own brand cannot be considered as advertisement expense for determining AMP adjustment.
  • Without prejudice, even if AMP is considered as an international transaction, arm’s length price should be determined using aggregated approach under TNMM. According to the taxpayer if this approach is followed, then, considering that the TPO has already accepted the arm’s length nature of all other transactions, the AMP expenses can also be said to meet the arm’s length standard.
  • A mutual agreement exists between the taxpayer and AE requiring the taxpayer to incur AMP expenses in relation to the sales of AE’s products.
  • All the parameters to cover AMP under the ambit of international transaction are fulfilled. 
  • Brand contribution received from AE indicates that AE remunerates the taxpayer for the benefits received by it from AMP expenses incurred by taxpayer.
  • For determination of ALP, matter should be set aside to follow the manner of computation illustrated by the High Court in case of Sony Ericsson Mobile Communications India Pvt Ltd. 
  • Determining selling expenses and advertisement expenses incurred by taxpayer on its own brand as AMP should be remitted for fresh consideration to TPO.

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.
SKP's Comments
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:
  • Bacardi India Pvt Ltd [TS-884-HC-2016(DEL)-TP], mere reimbursement of certain expenses (without having any formal agreement) was treated by the revenue as an arrangement qualifying the definition of international transaction.
  • LG Electronics India Pvt Ltd [TS-11-ITAT-2013(DEL)-TP], mere guidelines issued by the AE on the manner of incurring of AMP expenses by the Indian entity was considered as an arrangement qualifying the definition of international transaction.
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: 
  • Existence of arrangement between the taxpayer and AE towards incurring of AMP expenses is one of the conditions to trigger AMP as an international transaction.
  • Bright Line test cannot be used to determine ALP.
  • While transfer pricing is subjective in nature and especially the determination of arm’s length nature of AMP remains to be a very litigious issue due to its factual specific nature, this judgment provides clarity and persuasive value for other similar cases under dispute. 
  • Further, analysis of the inter-company agreement is critical while studying AMP functions performed, if any, by the Indian subsidiary of a multinational group. Therefore, it is advisable to review the terms of the inter-co agreement.
  • As the AMP is a contentious issue and the matter relating to AMP expenses is pending for adjudication before the Supreme Court, the taxpayers are advised to look at their inter-company transactions/arrangements in a manner that the risks on account of such transfer pricing adjustments are minimized.
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