Trade in today's global era visualizes significant number of international transactions in form of transfer of goods, services, capital and intangibles. International transfers arise within the Multinational Enterprise group entities and are called intra-group transfer. What is actually paid by one entity to another entity in the intra-group transfer is called the transfer price. Such transactions are controlled transactions as they are between two associated enterprises. Transfer pricing adjustment enables the tax administration of a country to correct the transfer price and compute the same on arm's length price (ALP), to check, avoid and ensure correct payment of taxes. ALP simply means fair market price. The OECD Transfer Pricing guidelines for multinational enterprises and tax administration and United Nations' Practical Manual on Transfer Pricing outlines several international aspects relating to transfer pricing.
In India, Income Tax Act, 1961, provides transfer pricing regulations. Sub-section (1) to section 92 of the Act states that any income arising from an international transaction shall be computed having regard to arm's length price. It includes expense or interest arising from an international transaction.
There have recently arisen a number of controversies between the domestic entities ('the Assessed'), who are subsidiaries of the foreign Associated Enterprises (AEs), and the Income tax Authorities. The primary issue being that whether advertisement, marketing and sales promotion expenditure ('AMP' for short) undertaken by the resident Indian assessee, towards brand building for the brand owner, is a separate and independent international transaction and also whether the foreign AE should compensate the Indian subsidiary for such expenses or not. On March 16, 2015, a common Judgment has been passed by Delhi High Court to1 dispose of the appeals and cross-appeals by the number of assessees and the Revenue, at one go.
The term International Transaction has been defined in section 92B. The section also had retrospective amendment which was inserted by the Finance Act, 2012 w.e.p. April 1, 2002. Thus the contention of the Indian AEs that the AMP expenses are not international transactions has been rejected by the court. Therefore now the AMP expenses in form of Market Intangibles shall form part of international transaction u/s 92B. Expenditure and decision of the assessee , whether or not to incur the said expenditure; the quantum thereof, cannot be a subject matter of challenge or disallowance by the Assessing Officer, once it is accepted that the expenditure was wholly and exclusively for business purpose. The ALP is not concerned with disallowance of expenditure but its purpose is to find out the fair and true market value of the transaction and accordingly the adjustment, if required, is made.
There can be an international transaction between the assessee and its AE under which the assessee incurs some expenses on behalf of the AE, despite their being no formal agreement. The difficulty arises only when such expenses are either clubbed with certain other expenses incurred for the Foreign AE or combined with certain similar expenses incurred by the Indian AE for its own business purpose. In such case it becomes imperative for the TPO to find out such cost/value by applying some mechanism. TPO has considered Bright Line test as one such method. Bright Line is a line drawn within the overall amount of AMP expense. The amount on one side of the bright line is the amount of AMP expense incurred for normal business of the assessee and the remaining amount on the other side is the cost/value of the international transaction representing the amount of AMP expense incurred for and on behalf of the foreign AE towards creating and maintaining its marketing intangible. If the assessee fails to give the basis for drawing the line, then the onus comes upon the TPO to find out the cost/value of such international transaction in some rational manner.
The Revenue authorities in India have been seeking to benchmark the increased Advertisement, Marketing and Promotion ('AMP') expenses incurred by the Indian subsidiaries of global multinationals ('MNEs'), contending it to be services rendered to the foreign Associated Enterprises by creating marketing intangibles in India, which are legally owned by them.
It was held that well known and renowned brands had extensive goodwill and image, even before they became freely and readily available in India through the subsidiary AEs. Reputed brands do not go in for advertisement with the intension to increase the brand value, but to increase the sales and thereby earn larger and greater profits. So the contention of the Revenue was rejected. It is for the assessee to decide that how much is to be incurred to carry on his business smoothly.
The dispute was not whether the assessee had incurred the AMP expenses or not. The question, therefore, when a subsidiary entity is engaged in distribution and marketing incurs AMP expenses, is to ascertain whether the subsidiary AE entity has been adequately and properly compensated for undertaking the said expenditure. The court accepted the United Nations' Manual Transfer Pricing which provides that such compensation may be in form of lower purchase price, non or reduced payment of royalty or by way of direct payments to ensure adequate profit margin. This ensures proper payment of taxes and curtails avoidance or lower taxes of the Indian subsidiary as a separate juristic entity. The Delhi High Court also laid down internationally accepted norms for computation of such compensation which the parent companies should reimburse to their Indian subsidiaries.
The Judgment also answered to certain other substantial question of law. It clarified the additions suggested by the Transfer Pricing Officer on account of AMP expenses was within his jurisdiction as per the section 92CA of the Act. The assessees have also raised objections for the legal ratio accepted and applied by the Tribunal for calculating AMP expenses. The court passed an order of remand to the Tribunal to examine and ascertain facts and apply the ratio enunciated in its decision.
The judgment also clarified that the Transfer pricing provisions are to prevent anti-avoidance and should not lead to double-taxation. The Court order will now provide a base and clarification for the ongoing disputes.
Footnote
1.ITA 16/2014 and connected matters.
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