SKP Tax Alert
Volume 9 Issue 5 |
AMP expenditure incurred by a licensed manufacturer in India for its business is not an international transaction

Echoing the Delhi High Court’s verdict on advertisement, marketing and sales promotion (AMP) expenses, the Mumbai Tribunal, in case of Indian licensed manufacturers, has deleted the adjustment holding that AMP is not an international transaction and is out of the purview of Indian transfer pricing regulations. The Tribunal has given due weightage to the factual aspects and data submitted by the taxpayer, L’Oréal India Pvt Ltd. This case was for assessment years 2008-09[1], 2009-10[2] and 2010-11[3].

  • L’Oréal India Pvt Ltd (taxpayer) was engaged in the manufacture and distribution of cosmetic products.
  • During the transfer pricing assessment, the transfer pricing officer (TPO/Revenue/AO) accepted all the international transactions to be at arm’s length price, except advertisement, marketing and sales promotion (AMP) expenses.
  • The TPO held that by incurring AMP expenses, the taxpayer is creating/enhancing brands legally owned by an overseas associated enterprise (AE) for which it should be compensated by its AE. The TPO proposed adjustment on account of AMP expenses by adopting two alternative approaches:
    • Under the first approach, the TPO adopted the Profit Split Method (PSM). He proposed that the consolidated profits of L’Oréal Group could be attributed to three major activities: manufacturing – 50%, research and development – 15%, and AMP – 35% (taking his cue from the Delhi Tribunal ruling on Rolls Royce[4]). The AMP expenditure incurred by the taxpayer was 0.63% of the total AMP expenditure of L’Oréal Group. Thus, of the 35% of L’Oréal Group’s profits, 0.63% (i.e. INR 3.48 billion) was attributable to the taxpayer. The taxpayer had declared a profit of INR 429 million, hence the TPO allocated INR 150.1 million (35% of the INR 429 million) towards AMP and proposed an adjustment of INR 3.33 billion (INR 3.48 billion – INR 150.1 million).
    • Under the alternative approach, the TPO proposed a Bright Line Test (BLT) whereby he adopted two different sets of comparable companies for the manufacturing and distribution segment. The AMP expense of these comparable companies (separately for manufacturing and distribution) was worked out to determine the routine AMP expense. Any excess AMP expense by the taxpayer over such routine AMP expense was treated as recoverable from the AE with a mark-up. The TPO proposed a total adjustment of INR 1.42 billion for the manufacturing and distribution segment.
  • Against the adjustment proposed, the taxpayer preferred an appeal before the Dispute Resolution Panel (DRP) but no relief was granted by the DRP. Aggrieved, the taxpayer appealed before the Tribunal.
Taxpayer’s arguments
  • The primary argument by the taxpayer was that the AMP expenditure incurred by it was not an international transaction. To support this, the taxpayer relied on the following factual arguments:
    • There was no agreement between the taxpayer and the AE with respect to brand building/ AMP expenses;
    • AMP expenses were incurred under the normal course of business to promote its products and sales in India;
    • AMP expenses were not incurred at the insistence of the AE;
    • The TPO had not brought any evidence on record to prove that there was an arrangement between the taxpayer and the AE. In this context, the taxpayer had furnished a certificate from the AE showing that there was no arrangement between them for AMP expenses.
  • The taxpayer placed reliance on the Delhi High Court ruling in case of Maruti Suzuki India Ltd[5], Honda Siel Power Products[6], Whirlpool of India Ltd[7], and contended that in absence of an agreement with the AE, AMP expenditure could not be treated as an international transaction.
  • The taxpayer also argued that it was an independent, risk-bearing entity. All the benefits of AMP expenses were enjoyed by it in the form of increased sales of products, and benefit (if any) derived by the AE, was incidental and ancillary in nature.
  • The manner in which the PSM is proposed to be applied results in adopting a global formulary approach, which is not permissible. Also, the alternative approach of adopting BLT is not recognised by Indian transfer pricing regulations as observed by the Delhi High Court in case of Sony Ericsson Mobile Communication India Pvt Ltd[8].
Revenue’s contentions
  • The Revenue placed reliance on the Special Bench ruling in case of LG Electronics[9] wherein the Tribunal upheld AMP as an international transaction and also upheld BLT as an appropriate benchmarking approach.
  • Furthermore, the Delhi High Court ruling in case of Sony Ericsson upheld AMP as an international transaction but rejected the BLT approach. The court laid emphasis on conducting detailed functional analysis including AMP functions/expenses, selection of comparables and criteria to be matched with the functions and obligations performed by tested parties including AMP expenses and thereby recommended a bundled transaction approach as an alternative to BLT.
  • Furthermore, the Revenue proposed that the matter should be remanded to the file of the TPO for a fresh examination in light of the Sony Ericsson ruling (by placing reliance on various tribunal rulings).
Tribunal’s ruling
  • The Tribunal observed that the taxpayer’s sales had increased 19 times since its inception in 1999 as against annual growth of 15–20% for the cosmetic industry in India. The TPO had not compared the taxpayer’s market share for the year under consideration. In light of the rapid growth achieved by the taxpayer, it was observed that AMP expenses played a crucial role.
  • The Tribunal also appreciated the fact that considering the nature of the business and the cosmetic industry in which the taxpayer operates, it had to incur huge AMP expenses to establish its products.
  • AMP expenditure was incurred for products launched especially for the Indian market and the brand of the AE was not promoted.
  • The Revenue’s assumption that AMP expenditure incurred by the taxpayer would have benefitted the AE was flawed because it presumed the taxpayer would not incur AMP expenditure to promote its own business. The Revenue failed to prove that the taxpayer’s real intention of incurring AMP expenditure was to benefit the AE.
  • The Revenue failed to prove that AMP expenses incurred by the taxpayer were under an arrangement/agreement with the AE and hence following the Delhi High Court rulings in case of Maruti Suzuki and Bausch & Lomb, the Tribunal held that AMP expense incurred by the taxpayer was not an international transaction.
  • Furthermore, the Tribunal refrained from restoring the issue of AMP expenditure to the file of the TPO because the first step in doing so was determining “whether AMP is an international transaction”, which was concluded in the taxpayer’s so the question of computing the arm’s length price doesn’t arise.
  • Since the issue in the other two years was also the same/similar, the judgement applied to those as well.

[1] ITA No. 7714/Mum/2012
[2] ITA Nos. 1119 and 976/Mum/2014
[3] ITA Nos. 518 and 335/Mum/2015
[4] TIOL-408-ITAT-Delhi
[5] 64 150
[6] 64 328
[7] 64 324
[8] 231 Taxmann 113
[9] 140 ITD 41
SKP's comments
  • Transfer pricing issues related to marketing intangibles have been one of the most complex issues raised by the Revenue and have been an area of litigation in the past few years. The Tribunal has echoed the Delhi High Court’s verdict and has further acknowledged that the AMP expense incurred by the taxpayer who manufactures its products in India cannot be said to solely benefit the AE.
  • Analysis of the inter-company agreement is critical while studying AMP functions performed, if any, by the Indian subsidiary of a multinational group.
  • The Tribunal has given due weightage to the factual aspects and data submitted by the taxpayer. It is critical to have adequate data/facts/figures such as sales growth, comparison of market share data, etc. as proof to substantiate the benefits received by the taxpayer.
  • As the Revenue has already filed an appeal against the Delhi High Court rulings in the Supreme Court, the final verdict on this matter is yet to be heard. 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 minimised.
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