SKP Tax Alert
26 December 2018
M/s PepsiCo India Holdings Pvt Ltd[1] - AMP expenditure, not an international transaction, absent any agreement, understanding or arrangement

Brief Background
The taxpayer is a subsidiary of US entity, PepsiCo Inc. and is mainly involved in the manufacturing of soft drink/juice-based concentrate and other agro products. The taxpayer has obtained non-transferrable, royalty free license from its US parent (Associated Enterprise (AE)) for the technology to manufacture the concentrate and to use and exploit the brands owned by the said AE in the regions designated to the taxpayer. Transactions with related parties were minimal.
The Transfer Pricing Officer (TPO) while accepting the related party transactions to be at arm’s length, made significant TP adjustment towards Advertisement, Marketing, and Promotion (AMP) expenditure of the Taxpayer in each of the years starting from Assessment Year (AY) 06-07 to AY 13-14. The TPOs used a different approach to compute TP adjustment Bright Line Test (AY 06-07 to AY 09-10), Profit Split Method (AY 10-11 to 12-13) and Other Method (AY 13-14)
We have briefly summarized key arguments of the taxpayer as well as tax authorities and the judgment of the Income Tax Appellate Tribunal (ITAT).
  1. Whether AMP expenses incurred by the taxpayer fall in the definition of ‘international transaction.’

    Key Contentions of the tax authorities
    TPO observed that the taxpayer had reimbursed an amount of INR 336 million in AY 2006-07 to its AE, Pepsi Cola Ireland, towards sponsorship rights of cricketing events worldwide. Basis this observation, the TPO alleged that AE recovering some part of the AMP expenditure from the taxpayer suggests that there was some arrangement between the taxpayer and the AE for incurring of total AMP expenditure viz INR 2023 million during AY 2006-07.

    TPO also highlighted clause in the Trademark License agreement between the taxpayer and its AE, which empowered AE to approve and review the advertisement proposed to be telecasted in India. Thus, the TPO concluded that AE is controlling the AMP activities of the taxpayer.

    Lastly, the TPO alleged that incurring of huge AMP expenses (2/3rd of total expenses) indicates that the expenses must have been incurred at the behest of AE for promoting the brand owned by the AE.
    Based on above observations, TPO contended that taxpayer was providing services to the AE by way of AMP spend, there was an “action in concert” between the taxpayer, and it’s AE which constituted an international transaction as per section 92F of the Income Tax Act, 1961.

    Key Contentions of the taxpayer
  • Taxpayer submitted that the approval and review of the advertisements to be telecasted in India by the AE were only to ensure that the applicable “Brand guardrails” are being followed and it is not at all directed to control the marketing function.
  • Taxpayer has a marketing team in India,  the taxpayer carries all the necessary function of strategizing, advertisement and marketing activities, its implementation for market penetration in India as per the ethos, culture, and aspiration of the local population.
  • Taxpayer is an ‘economic owner’ of the brand and was entitled to all the return in this regard.
  • AMP expenses are domestic transaction as it was undertaken with the third party in India, thus, not covered in the definition of ‘International Transaction’ as defined in Indian transfer pricing laws.
  • ‘International Transaction’ cannot be construed in the absence of any arrangement/understanding/ ‘action in concert,’ and the onus is on the TPO to demonstrate that there existed an arrangement between the taxpayer and AE with regard to AMP expenses
  • The taxpayer placed reliance on the Delhi High Court ruling in case of Maruti Suzuki India Ltd[2], Honda Siel Power Products[3], Whirlpool of India Ltd.[4], Bausch & Lomb Eyecare (India) Pvt. Ltd.[5] and contended that in the absence of an agreement/arrangement with the AE, AMP expenditure could not be treated as an international transaction.

    Judgment of the ITAT
  • The tribunal held that the transaction of reimbursement of expense by the taxpayer to the AE could not be expanded to the entire AMP expenditure as the taxpayer incurs the AMP expenses on its own volition and business requirement.
  • The tribunal held that the definition of ‘transaction’ has to be read in conjunction with the definition given in section 92B of the Income Tax Act, 1961 (the Act), which means that the transaction has to be first in the nature given in Section 92B and then when such transaction includes any kind of arrangement, understanding or action in concert amongst the parties, whether in writing or formal, then too it is treated as international transaction.
  • Here the conjoint reading of both the sections lead to an inference that in order to characterized as an international transaction, it has to be demonstrated that ‘transaction’ arose in pursuant to an ‘arrangement’, ‘understanding’ or ‘action in concert.’ Therefore, if one of the parties (taxpayer in the instant case) by its own volition is incurring any expenditure for its own business purpose, then without there being any corresponding binding obligation on the other (AE) or any such kind of an arrangement actually existing in wring or oral or otherwise, it cannot be characterized as ‘international transaction’ within the scope and definition of Section 92B of the Act.
  1. Whether huge AMP spends by the taxpayer benefit the AE and amounts to brand building activity for the AE requiring recovery from the AE
  • The TPO contended that the taxpayer did not own and develop its own brand and thus AMP expenses incurred by the taxpayer was purely towards building the brand owned by AE. Therefore, AE ought to have compensated the taxpayer towards the benefit received. Further, tax authorities also alleged that certain local brands such as ‘Kurkure’, ‘Aliva’ and ‘Nimbooz’ were conceptualized and developed in India but the trademark was owned by AE.
  • Further, the TPO opined that AMP expense was two third of the total expenses accordingly, AMP function dominated the manufacturing function hence taxpayer was providing services to AE by way of strengthening the brands and creation of brands for the AE
  • It was also submitted that the overseas AE was paying taxes in home jurisdiction on the imputed royalty that it ought to have received from the taxpayer for grant of the trademark license. Also, the taxpayer submitted that even if it is presumed that some benefit is derived by the overseas AE then such benefit is only ‘incidental’.

    Judgment of the ITAT
  • The tribunal held that all the rewards for AMP functions and the returns associated with the commercial exploitation of the brand is completely enjoyed by the taxpayer. Therefore, under FAR analysis also, no such benefit from the AMP expenditure having any kind of bearing on the profits, income, losses or assets has accrued to the AE or any kind of benefit has arisen to the AE
  • Further, with respect to the brands developed in India the tribunal considered that as the AE has not charged royalty for the use of trademark in India to allege that taxpayer should have been compensated for the brand developed and conceptualized by it, is too far fetched and also considering that the brand developed in India which is to be exclusively sold in India will only help in promotion of sales in India and not in the jurisdiction of the other AEs.
  1. Whether the use of Bright Line Test (“BLT”) / Profit Split Method (“PSM”) and Other methods for benchmarking the AMP expenses incurred by the taxpayer appropriate

    Judgment of the ITAT
  • The tribunal, considering the view of the Hon’ble jurisdictional High Court rejected the use of BLT, both, for determining the existence of international transaction, and, also for benchmarking the transaction of AMP.
  • The tribunal opined that TPO has neither applied PSM correctly nor has he analyzed the contribution made by both entities on the relative value of FAR of each of the entity accordingly, such an approach of the learned TPO at the threshold is wholly erroneous.
  • Further, the tribunal also rejected the application of Other Method by DRP terming it to be a distorted BLT.
Considering all the above factors, the tribunal ruled that in none of the years, the AMP adjustment made by the TPO can be sustained and accordingly, directed the same be deleted.
[1] ITA No. 1334/Chandi/2010, 1203/Chandi/2011, 2511/Del/2013, 1044/Del/2014, 4516, 4517 and 4518 / Del/ 2016, 6537/Del/2016 and 6582/Del/2017
[2] [2016] 381 ITR 117 (Delhi)
[3] [2016] 283 CTR 322
[4] [2016] 381 ITR 154
[5] [2016] 381 ITR 227
SKP Comments
So, quite understandably, the tax tribunals in India (including this case) are placing heavy reliance on two landmark judgments (i.e., Sony Ericsson and Maruti Suzuki) in the context of Marketing intangible. The Apex court is expected to give its ruling in these two cases before it. The fate of these two landmark judgments and perhaps many others which have got adjudged basis the principles laid down in these judgments, therefore, will be determined once the apex court in India provides its judgment.
It is well recognized that it is extremely challenging to decide on the complex issue of a marketing intangible especially considering that India is one of the largest consumption markets which has the potential to significantly enhancing the brand value of consumer goods manufacturers.
Having said this, it is essential to ascertain what is the appropriate barometer to determine the existence of ‘marketing intangible’ when analyzing AMP expenses. Since, BLT test stands rejected by the Indian courts, it would be helpful, if, either the tax authorities or the Apex court provides relevant guidelines on an alternative test methodology for determining the existence of Marketing Intangible.
Key takeaways for the taxpayers from this ruling 
  • The Tribunal in the given case has given due weightage to the factual aspects and data submitted by the taxpayer. Accordingly, It is critical to have adequate data/facts/figures such as sales growth, Function asset and risk profile of the taxpayer and the AE, etc. as proof to substantiate the benefits received by the taxpayer.
  • 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 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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