Jul 11, 2019

Advertising and Transfer Pricing – Unraveling the complexities


Who would have thought that engaging Indian cricketers or Bollywood celebrities to promote brands may trigger a transfer pricing issue involving ever-increasing stakes, currently valued beyond a few billions of dollars?

Over the past decade, one of the most litigious issue surrounding the transfer pricing (‘TP’) regime in India pertains to adjustments on account of advertisement, marketing and promotional (‘AMP’) expenses incurred in India by an Indian entity, which is a related party[1] of a foreign entity in relation to the business carried out by the Indian entity in India.  Typically, the Indian entity is set up to carry out either manufacturing activity or distribution activity of products sold by the foreign entity and is granted the necessary rights to use brands associated with such products by such foreign entity.  During the course of its business in India, such Indian entity incurs expenses on account of AMP activities, which as per the Indian Income Tax Department (‘Department’) increase the brand value of the foreign entity, which does not compensate commensurately the Indian entity for carrying out such AMP activities in India.  Such view of Department has resulted in transfer pricing adjustments in the hands of the Indian entity which, as per the Department, ought to have received compensation as well as a mark-up for carrying out the AMP activities in India that increase the value of the brand of the foreign entity.


The Indian tax regime allows, any expenditure, unless otherwise restricted, laid out or expended wholly and exclusively for the purposes of the business or profession as a deduction[2] while computing income in the nature of ‘Profits and gains of business or profession’ that is chargeable to tax in India.  As a sequitur, spending on marketing and advertising activities, wholly and exclusively for the purposes of the business is allowable business expenditure.  The TP provisions that run parallel provide that any income arising from an ‘international transaction’ shall be computed basis the arm’s length price[3]. The two parallels met when the Department started computing transfer pricing adjustments vis-à-vis excess amount of money spent by the Indian entity on AMP activities (and not selling and distribution activities) while operating under a license to use brands owned by the related foreign entity, thereby ushering a new era of litigation, which currently awaits final outcome before the Supreme Court of India.

Transfer Pricing

An ‘international transaction’ between two related parties (either or both of whom are non-residents) becomes subject matter of TP adjustment if the same is not at arm’s length (i.e., such transaction is evaluated as if the same was entered into between two unrelated parties).  While computing TP adjustment, evaluation of activities carried out by all the related parties vis-à-vis a particular ‘international transaction’ are evaluated, prior to comparing such related party situation with a comparable unrelated party situation.  After evaluating comparable unrelated party situation, arm’s length price (“ALP”) of the relevant ‘international transaction’ is determined and if the same does not match with the actual value of the ‘international transaction’, a TP adjustment is computed.

One relevant aspect of the TP provisions contained in the ITA is that they become inapplicable if the TP adjustment would lead to reduction of income chargeable to tax or increase in loss for the party in whose hands the TP adjustment is sought to be computed.  In simple words, if an Indian entity is making a payment to a related non-resident entity for goods or services, then the price that Indian entity pays will not invite a TP adjustment in its hands, if such price is equal to or less than the ALP.  This is for the reason, as an example, if the Indian entity pays nothing for such goods or services, where the ALP of the transaction is INR 100/-, then, by making an upward adjustment of INR 100/-, Department would actually be decreasing the profit of the Indian entity that would be chargeable to tax in India.  Therefore, the ITA makes TP provisions inapplicable if the TP adjustment would lead to reduction of income chargeable to tax or increase in loss for the party in whose hands the TP adjustment is sought to be computed.    For the same reason, if an Indian entity is receiving money from a related non-resident entity then the price that the Indian entity receives will not invite a TP adjustment, if such price is equal to or more than the ALP.  In essence, the TP provisions contained in the ITA seek to prevent shifting of taxable profits from India.

It is also noteworthy that while TP adjustment in the hands of one party vis-à-vis a particular ‘international transaction’ may be computed in accordance with the ALP, there is no corresponding effect of such adjustment granted to the other related party.  For example if the Indian entity in the above example pays INR 200/- to a related non-resident entity, where the ALP of the transaction is INR 100/-, then while the Department may compute a downward TP adjustment of INR 100/- in the hands of the Indian entity, thereby decreasing the expenditure if claimed by the Indian entity and hence increasing taxable profit of the Indian entity in India, there would be no corresponding effect of such TP adjustment for Indian tax purposes in the hands of the non-resident entity.  The same is again for the reason that such corresponding effect, if given to the non-resident entity, would lead to reduction of income chargeable to tax in India for the non-resident.

Transaction & Jurisprudence

In a typical scenario, there is a foreign brand owner that has a related Indian entity which carries out manufacturing of goods in India or distributes goods or services manufactured/ provided by such foreign brand owner.  Such foreign brand owner grants a license in favour of such Indian entity to carry out manufacturing/ distribution activities along with the right to use brand, trademark, technical know-how etc.  There may or may not be a ‘royalty’ pay-out as consideration for such license granted to the Indian entity.  However, what is relevant in a typical fact pattern is a direction to the said Indian entity to carry out AMP activities in India and the extent to which the Indian entity should spend on it.

In such a fact pattern, the Indian entity spends money on AMP activities, which amount is disbursed to local third parties in India, which on a bare reading of the provisions of Chapter X of the ITA, could not constitute an ‘international transaction’ between related parties.  To elaborate, the word ‘transaction’ has been defined in the ITA[4] to include an arrangement, understanding or action in concert irrespective of the fact whether the same is formal or in writing or is intended to be enforceable by legal proceeding.  Furthermore, the phrase ‘international transaction’, has been defined in the ITA[5] to mean a transaction[6] between two or more related parties, either or both of whom are non-residents for Indian tax purposes.  Therefore, for TP provisions to trigger the subject ‘transaction’ must be between a resident and a related non-resident or two related non-residents[7].

However, courts have interpreted the above provisions in an oscillating manner.  The first point in time when the AMP controversy reached courts was in 2010 in the case of Maruti Suzuki India Ltd. (MSIL) v. ACIT.[8]  In this case, the Delhi High Court set aside the order of the Transfer Pricing Officer (‘TPO’) and remanded back the issue to the TPO while observing that the expenditure incurred by a domestic entity, which is a related party of a foreign entity, on AMP activities using a foreign trademark/brand did not require any payment or compensation by the owner of the foreign trademark/brand, so long as the expenses incurred by the domestic entity did not exceed the expenses which a similarly situated and comparable independent domestic entity would have incurred.  As a sequitur it was held that if the expenses incurred by a domestic entity towards AMP activities were more that what a similarly situated and comparable independent domestic entity would have incurred, the foreign entity in such a case needed to suitably compensate the domestic entity with respect to the advantage obtained by it in the form of brand building and increased awareness of its brand in the domestic market.

Although the Supreme Court of India in 2011 in an SLP filed against the aforesaid order in Maruti Suzuki India Ltd. v. ACIT[9] directed the TPO to remain uninfluenced by the guidance given by the Delhi High Court in computing a TP adjustment on account of AMP activities, the decision of the Delhi High Court paved the path for what is called the bright line test (‘BLT’).  BLT as a concept for the purposes of computing a transfer pricing adjustment vis-à-vis AMP expenses means a line drawn with the overall amount of money spent on AMP, one side of which represents routine business expenses and the other side represents the amount spent on brand building.

In the beginning of 2013, a special bench of the Income Tax Appellate Tribunal (“Tribunal”) in the case of L.G. Electronics India (P.) Ltd. v. ACIT[10] interpreted the TP provisions in a fact pattern similar to the one elucidated above, and observed that the ratio of the advertisement expenditure incurred by the Indian entity while using the brand of a foreign related entity to the sales made by such Indian entity was proportionally higher than comparable situations between two non-related entities.  The ratio of comparable situations in this case was considered to be the bright line, expenditure on one side of which was considered to be advertisement expenditure and expenditure on the other side of which was considered to be expenditure towards brand building.  By resorting to such application of BLT, the Tribunal inferred the existence of an “international” transaction” between L.G. Electronics and its foreign related entity for brand building.  The Tribunal in this case also observed that it was immaterial that the payments towards AMP were made to third parties since the ‘international transaction’ in question was the value addition made by the Indian entity to the brand by making payments which were to be included in the overall AMP expenses paid to third parties.

The uproar created as a result of the aforesaid decision of the Tribunal, resulted in the decision of the Delhi High Court in Sony Ericsson Mobile Communications India (P.) Ltd. v. CIT[11], in March 2015.  In the said case, involving Indian entities[12] engaged in distribution and marketing of products manufactured and sold by their respective related non-resident entities, the High Court upheld the expenditure pertaining to AMP to be in the nature of ‘international transaction’, primarily pursuant to the concession given by the assessees therein that there existed an ‘international transaction’ for incurring cost vis-à-vis AMP activities.  However, while doing so, the High Court held various principles applied in the case of LG Electronics (supra) to be erroneous and unacceptable.  Amongst various guidelines issued by the High Court in this decision, the most important direction vis-à-vis the development of jurisprudence on the subject of AMP litigation was the rejection of BLT.  The High Court opined that application of BLT, by virtue of lacking statutory backing as a means to determine existence of an ‘international transaction’, would lead to judicial legislation.  In that manner, the High Court remanded back the AMP issue to the file of the TPO to re-ascertain the ALP of the international transaction in accordance with the recognized TP principles in India.   This decision of the Delhi High Court was limited in scope as far as it applied only in cases of a distributor who had accepted that there was an ‘international transaction’ vis-à-vis incurring of expenses on AMP activities.

However, the landscape of AMP litigation has been shaped differently for a full fledged manufacturing entity.  Subsequent to the Sony Ericsson (supra) decision, in December 2015, the Delhi High Court in the celebrated decision of Maruti Suzuki India Ltd. v. CIT[13] held that there was no ‘international transaction’ for the purposes of the TP provisions to apply in case of an Indian manufacturing entity, which had received no direction in the form of an agreement whether oral or written, from its foreign related entity who was the brand owner of the brand which was being used by such Indian entity in its AMP activities and the onus to prove the same lied on the Department and such onus was to be discharged without using BLT.  It was also held by the High Court that in the absence of any substantive or machinery provisions contained in the ITA to recognize existence of an ‘international transaction’ in the context of AMP expenses, a TP adjustment could not be made.  This decision, therefore, created two parallels as far as the AMP litigation is concerned, both of which parallels have reached the Supreme Court level and are currently awaiting final outcome.

Recently, in November 2018, the Delhi Tribunal in the case of PepsiCo India Holdings Pvt. Ltd. v. ACIT[14] deleted the transfer pricing adjustment to the tune of Rs 2,900 crores computed on account of AMP expenses incurred by Pepsi in its capacity as a full-fledged manufacturer in India.[15]  In fact, umpteen number of cases before various High Courts and the Tribunal involving a manufacturing entity have relied upon the Delhi High Court decision in the case of Maruti Suzuki India Ltd. v. CIT (supra) to hold that there was no ‘international transaction’ vis-à-vis incurring AMP expenses that could trigger the applicability of the TP provisions in India.

This decision of the Delhi Tribunal has been recently followed in number of decisions.  However, the same has been distinguished by the Delhi Tribunal[16] recently in March, 2019 in a case involving an Indian distributor.  On the contrary, a decision similar to the Delhi Tribunal decision in PepsiCo has been rendered by the Delhi Tribunal[17] again in April, 2019 in a case involving an Indian manufacturer.  Therefore, there is an apparent split on how the jurisprudence on this subject is being carried forward to Supreme Court between a case involving a manufacturer and other kind of business models.  However, the bottom line, as far as this controversy is concerned, is whether there is an ‘international transaction’ between the Indian entity and related non-resident entity for incurring a certain amount of expenditure on AMP activities.  Further, the Department is also before the Supreme Court in relation to the applicability of BLT[18].  Even at the international level, this controversy seems to not rest in peace.  Needless to add, it is important for cross border arrangements to be drafted carefully in order to avoid getting entangled in this controversy.

Ravi Prakash, Partner
Anmol Anand, Associate

End Notes:
[1] Under the Income-tax Act, 1961 (‘ITA’), the term ‘associated enterprises’ has been used instead of ‘related parties’.  Therefore, the term related party or related parties used in this article should be construed to mean ‘associated enterprise’ as defined in ITA.
[2] Section 37 of the ITA.
[3] Chapter X, Section 92 of the Act.
[4] Section 92F(v) of the ITA.
[5] Section 92B of the ITA.
[6] “in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises, and includes a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises.”.
[7] For the purposes of this article and the subject dealt herein, the concept of specified domestic transaction has been ignored.
[8] Maruti Suzuki India Ltd. (MSIL) v. ACIT, (2010) 328 ITR 210 (Delhi High Court).
[9]  Maruti Suzuki India Ltd. v. ACIT, (2011) 335 ITR 121 (Supreme Court of India).
[10] L.G. Electronics India (P.) Ltd. v. ACIT, (2013) 22 ITR(T) 1 (Delhi -Trib.) (SB).
[11]  Sony Ericsson Mobile Communications India (P.) Ltd. v. CIT, (2015) 374 ITR 118 (Delhi).
[12] Sony Ericsson Mobile Communications India (P.) Ltd., Discovery Communications India, Daikin Airconditioning India Pvt. Ltd., Haier Appliances (India) Pvt. Ltd., Reebok India Company Ltd. etc.
[13]    Maruti Suzuki India Ltd. v. CIT, (2016)381 ITR 117.
[14]   PepsiCo India Holdings Pvt. Ltd. v. ACIT, (2018) 100 taxmann.com 159 (Delhi – Tribunal).
[15] Pepsi was represented by the Tax Litigation Team at AZB & Partners before the Tribunal.
[16] M/s. Olympus Medical Systems India Pvt. Ltd. v. DCIT, ITA No. 7414/Del/2018, order dated 27.03.2019.
[17]  Casio India Co. Pvt. Ltd.. v. DCIT, ITA No. 1764/Del/2015, order dated 22.04.2019.
[18] Sony Ericsson Mobile Communications India Pvt. Ltd. (now merged with Sony India Pvt. Ltd.) v. CIT, CA No. 135/2016.  All other matters in relation to AMP expenses have been clubbed with this case and the entire AMP batch is likely to be listed during the second half of 2019.


  • Associates:

    Anmol Anand




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