Issues before Tribunal:

The SB of Tribunal was constituted to adjudicate on the following two questions:

• Whether the TPO was justified in making TP adjustment in relation to AMP expenses incurred by the taxpayer?
• Whether the TPO was justified in holding that the taxpayer should have earned a mark-up from the AE in respect of AMP expenses alleged to have been incurred for and on behalf of the AE?

Tribunal’s Ruling:

The Special Bench of the Tribunal has segregated its ruling based on various important aspects / questions discussed as under:

1. Whether the TPO has jurisdiction to process an international transaction in the absence of any reference made to him by the Assessing Officer (hereinafter referred to as ‘AO’)?

Taxpayer’s Contentions:

• Since the AO did not refer the international transaction of marketing intangibles to the TPO, the TPO is precluded from determining the arm’s length price (hereinafter referred to as ‘ALP’) in respect of such transaction.

 Revenue’s Contentions:

• There is no irregularity or invalidity in assuming jurisdiction by the TPO because of the insertion of sub-section (2B) of section 92CA with retrospective effect, covering the period under consideration.

Tribunal’s Ruling:

• The retrospective amendment to Section 92CA(2B) inserted by the Finance Act 2012 effective from 1st June 2002, grants powers to the TPO to look into the transactions which are not reported by the taxpayer and which come to his notice during the course of assessment proceedings.

2. Whether in the absence of any verbal or written agreement between the taxpayer and AE for promoting the brand, can there be said to be a “transaction”?

Taxpayer’s Contentions:

• There is no understanding, oral or written, with its AE for promoting their brand.
• AMP expenses were incurred in India for advertising its products without any interference of the AE.
• Payment towards AMP expenses were made to the domestic third parties.

 Revenue’s Contentions:

• The existence of oral agreement in the present case is absolutely visible since the taxpayer is a wholly owned subsidiary of AE and is functioning at the command of its parent company.
• The advertisements given by the taxpayer in newspapers clearly showed the brand name and the slogan of the AE.
• Relying on the United Nations Transfer Pricing Manual, the Revenue contended that incurring of unusual AMP expense requires allocation of AMP cost between the MNC and its subsidiaries and the allocation of cost is nothing but a transaction.

Tribunal’s Ruling:

• Incurring proportionately higher AMP expenses coupled with the advertisement of brand or logo of the AE, gives inference of the existence of some informal or implied agreement. Also, the fact that the taxpayer’s marketing strategy was under the directions, guidance and control of the AE implies that the AE had full control over the AMP expenses of the taxpayer. The Tribunal thus held that there is a transaction between the taxpayer and the AE under which the taxpayer incurred AMP expenses towards promotion of brand which is legally owned by the AE.

3. Whether such a “transaction”, if any can be treated as an “international transaction”?

Taxpayer’s Contentions:

• Since the entire AMP expenses were incurred in India vis-a-vis third parties, and as there was no transaction between the taxpayer and its AE, it cannot be regarded as an international transaction.

 Revenue’s Contentions:

• The transaction is covered under the definition of international transaction as per Section 92B.
• The payment made to the third parties towards AMP expenses is never proposed to be treated as an international transaction. Rather, the international transaction is restricted to the activity done and AMP expenses incurred by the taxpayer for adding value to a brand owned by AE.

Tribunal’s Ruling:

• The AE being non-resident and such transaction being classified in the nature of provision of services for creating and improving marketing intangibles by the taxpayer for and on behalf of its AE; the Revenue authorities were fully justified in treating the transaction of brand building as an “international transaction”.

4. Whether the ‘BLT’ which is a part of U.S. legislation can be applied for making the transfer pricing adjustment?

Taxpayer’s Contentions:

• Since BLT does not find any mention in Indian context or statute, taking cognizance of this test was outside the provisions of law.

Revenue’s Contentions:

• The BLT is simply a tool to ascertain the cost of the international transaction and not the ALP of the transaction. The ALP has been determined by application of mark-up on the cost so determined using BLT. Further, the Revenue contended that a combination of one or more of the five prescribed methods can be adopted for determining the ALP.

Tribunal’s Ruling:

• Provisions of other countries / jurisdictions have only a persuasive value and cannot have a binding effect over the Indian authorities. When the expenses incurred for the taxpayer’s own business purpose and the expenses for development of brand are intermingled and otherwise inseparable then some mechanism needs to be devised for ascertaining the cost of the international transaction being the amount of expenses incurred for the AE. The BLT is a way of finding out the cost/value of international transaction and application of the same is upheld. Further, the DRP as well as AO were right in applying the spirit of the ‘Cost Plus Method’ (after determining cost/value of transaction using BLT). The Tribunal rejected Revenue’s contention of adopting combination of one or more of the five methods for determining ALP and held that only one of the most appropriate methods should be applied for TP benchmarking. 

5. Whether, if as per TNMM, the taxpayer’s profit is found to be as good as the comparables, a separate adjustment for AMP expenses can still be made?

Taxpayer’s Contentions:

• AMP expenses cannot be benchmarked separately when the overall net profit rate declared by the taxpayer is higher than other comparable cases. Further, since the commensurate net profit earned by the taxpayer takes care of AMP expenses, there is no need for separate benchmarking of AMP expenses.

  Revenue’s Contentions:

• There is no requirement under law that if one transaction has been benchmarked by applying the TNMM then no other international transaction can be separately benchmarked. All the international transactions are required to be viewed independent of each other.

Tribunal’s Ruling:

• Under the TNMM one should consider the operating profit from each international transaction in relation to the total cost or sales etc. of such international transaction and not the net profit, total costs, sales, etc of the taxpayer as a whole / entity level. Two or more international transactions are required to be separately benchmarked under the TP provisions. Further, the Tribunal has observed that non application of any of the prescribed methods in TPO / DRP’s orders does not make entire proceedings void.

6. Whether, the arbitrary mark-up added by the DRP on expenses incurred for development of brand of AE is permissible?

Taxpayer’s Contentions:

• There should not be any mark-up on the expenses incurred for development of brand of AE without showing such mark-up in a comparable uncontrolled transaction.

Revenue’s Contentions:

• Mark-up should be added i.e. opportunity cost at 10.5% being the interest rate charged by the banks and compensation for the taxpayer’s entrepreneurial efforts at 2.5% making it a total of 13%. 

Tribunal’s Ruling:

• Action of adding arbitrary mark-up by DRP is not correct. Therefore, this matter is restored back to the file of AO / TPO to determine the mark-up and then the ALP of this transaction. However, the tribunal upheld the principle that there ought to be a mark-up.

Other observations of Tribunal:

• Further, the Tribunal has observed that Supreme Court ruling in the case of Maruti Suzuki does not overrule the High Court ruling on merits and hence ratios can be drawn from it. It may be recalled that the HC had affirmed the use of BLT in case of Maruti Suzuki’s writ petition and the SC had stayed the order of HC and had asked the TPO to look at the matter afresh.
• TP provisions have been inserted as special provisions to curb the avoidance of tax. Once there is an international transaction, then the TP provisions shall prevail over the other regular provisions [such as Sections 37(1) and 40A(2)] governing the deductibility or taxability of an amount from such transaction.
• The tribunal has highlighted factors to be considered while choosing the comparable cases and determining the cost/value of the international transaction of AMP expenses.
•  The expenses in connection with the sales which do not lead to brand promotion cannot be brought within the ambit of AMP expenses for determining the cost/value of the international transaction. Thus, the Tribunal agreed principally that the sales promotion expenses are not to be considered as a part of AMP and remanded the matter back to TPO / AO to recompute the AMP expenses accordingly.

SKP’s Comments:

Transfer Pricing issues relating to marketing intangibles have been one of the most complex issue raised by Indian authorities and have been an area of focus in the past few years. This decision of SB is first step in the long drawn battle between the tax authorities and MNC tax payers.

On most of the legal issues raised, the SB has favoured the revenue. Some of the decisions such as whether it constitutes international transaction or not and on the jurisdiction of the TPO, are on expected lines especially in view of the retrospective amendments made in the last Union Budget. The SB observation on a transaction being a definition of wide amplitude and inclusive of oral arrangements would have far reaching consequences. Also acceptance of the BLT and presumption that the taxpayer is creating / enhancing brand value of the AE by incurring higher AMP expenses is a big blow to several MNCs operating in India. Unfortunately, the SB did not address this issue based on the fundamentals of economics and transfer pricing but looked at it purely from a legal perspective. The overall concept of BLT, its application in the Indian context, need to find closer comparables etc. would throw up new challenges.

Another major set back is that the ruling does not recognise the global best practices and principles developed by matured tax jurisdictions like Australia and United States. The Australian tax office has issued the guidelines (ATO guidelines) which deal with examples of marketing intangibles and these clearly state that in cases where the gross margin or net margin of the tax payer is commensurate with that of comparable companies, there is no reason for attribution of additional profit to the tax payer in India. The ATO guidelines further rule out any compensation to the distributor on the basis that the excess AMP expenses incurred by the distributor add value to its own intangible asset – viz. long term distribution rights / contract. The concept of “economic owner” though recognised by the “US cheese examples” failed to gain attention of the SB.

However, not all is lost for the taxpayer. The SB did mention that what constitutes AMP has to be decided on facts of each case and cannot include expenses in connection with sales promotion. It also held that there is a need to look at the right comparable for the application of BLT. While it laid down some criterion for selection of such comparable, it denied inclusion of MNCs which are themselves using / promoting foreign brand cannot be used as comparable.

Thus, though the legal issues seem to have been settled in favour of the revenue, one cannot disregard the factual matrix of the case and the same can be distinguished from any other case. It is only when facts are properly compiled and presented to the tax authorities, can the taxpayer hope for some relief. 

The judgment of the SB would have binding effect over other Division Benches of the Tribunal until such time as the High Court or Supreme Court adopts a different view. Affected taxpayers are thus advised, in light of this Ruling, to proactively review their current policies and assess the impact of the Ruling based on the facts and circumstances of their case. Additionally, when applying /defending the BLT it is important that taxpayers undertake an extensive exercise to better understand the products of the comparables, their life cycle, industry etc.