Renault India case: Just because assessee mentioned that marketing expenditure incurred by it helped promotion of Renault brand in India, it cannot be presumed that such expenditure resulted in any international transaction
Recently, in Renault India P. Ltd. vs. DCIT [I.T.A. No. 1078/Mds/2017, A.Y.: 2012-2013, decided on 30.01.2018], one of the ground was assailing of the treatment of advertisement and market promotion activity as an international transaction. Authorised Representative submitted that, by virtue of judgment of Hon’ble Delhi High Court in the case of Maruti Suzuki India Ltd vs. CIT (381 ITR 117), AMP spends could not be considered so.
Departmental Representative strongly supported the orders of the lower authorities.
Learned Members of the ITAT, Chennai considered the rival contentions and perused the orders of the authorities below. TPO had found expenditure of F123.80 crores incurred by the assessee towards advertisement and sales promotion expenses as helping the promotion of ”Renault” brand in India. According to him, assessee had mentioned this in its own business plan. Though the assessee argued against any adjustment on brand promotion, relying on the judgment of Hon’ble Delhi High Court in the case of Maruti Suzuki India Ltd (supra), TPO did not accept it. According to him, in the case of the assessee there was an admission that it was promoting ”Renault” brand. The learned Members opined, just because assessee mentioned that marketing expenditure incurred by it helped promotion of Renault brand in India, it cannot be presumed that such expenditure resulted in any ”international transaction’’. What was observed by the TPO in its order on this issue is reproduced hereunder:-
” Here it is the assessee’s own admission that its business plan is ”distribution of Renault Cars in India and to promote the Renault brand in India and to create a market share for Renault cars in India. Therefore no further evidence is required to make out an international transactions either by going through BLT or otherwise”.
Expenditure was incurred by the assessee, to create market share for its cars and marginal benefits derived by its principal abroad, as an off shoot cannot in our opinion convert it to a international transaction.
Hon’ble Delhi High Court in the case of Maruti Suzuki India Ltd (supra), had held as under at paras 68 to 86 of its judgment:-
”68. The above submissions proceed purely on surmises and conjectures and if accepted as such will lead to sending the tax authorities themselves on a wild-goose chase of what can at best be described as a “mirage”. First of all, there has to be a clear statutory mandate for such an exercise. The court is unable to find one. To the question whether there is any “machinery” provision for determining the existence of an international transaction involving AMP expenses, Mr. Srivastava only referred to section 92F(ii) which defines arm’s length price to mean a price “which is applied or proposed to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions”. Since the reference is to “price” and to “uncontrolled conditions” it implicitly brings into play the bright line test. In other words, it emphasises that where the price is something other than what would be paid or charged by one entity from another in uncontrolled situations then that would be the arm’s length price. The court does not see this as a machinery provision particularly in light of the fact that the bright line test has been expressly negatived by the court in Sony Ericsson. Therefore, the existence of an international transaction will have to be established dehors the bright line test.
69. There is nothing in the Act which indicates how, in the absence of the bright line test, one can discern the existence of an international transaction as far as AMP expenditure is concerned. The court finds considerable merit in the contention of the assessee that the only transfer pricing adjustment authorised and permitted by Chapter X is the substitution of the arm’s length price for the transaction price or the contract price. It bears repetition that each of the methods specified in section 92C(1) is a price discovery method. Section 92C(1) thus is explicit that the only manner of effecting a transfer pricing adjustment is to substitute the transaction price with the arm’s length price so determined. The second proviso to section 92C(2) provides a “gateway” by stipulating that if the variation between the arm’s length price and the transaction price does not exceed the specified percentage, no transfer pricing adjustment can at all be made. Both section 92CA, which provides for making a reference to the Transfer Pricing Officer for computation of the arm’s length price and the manner of the determination of the arm’s length price by the Transfer Pricing Officer, andsection 92CB which provides for the “safe harbour” rules for determination of the arm’s length price, can be applied only if the transfer pricing adjustment involves substitution of the transaction price with the arm’s length price. Rules 10B, 10C and the new rule 10AB only deal with the determination of the arm’s length price. Thus for the purposes of Chapter X of the Act, what is envisaged is not a quantitative adjustment but only a substitution of the transaction price with the arm’s length price.
70. What is clear is that it is the “price” of an international transaction which is required to be adjusted. The very existence of an international transaction cannot be presumed by assigning some price to it and then deducing that since it is not an arm’s length price, an “adjustment” has to be made. The burden is on the Revenue to first show the existence of an international transaction. Next, to ascertain the disclosed “price” of such transaction and thereafter ask whether it is an arm’s length price. If the answer to that is in the negative the transfer pricing adjustment should follow. The objective of Chapter X is to make adjustments to the price of an international transaction which the associated enterprises involved may seek to shift from one jurisdiction to another. An “assumed” price cannot form the reason for making an arm’s length price adjustment.
71. Since a quantitative adjustment is not permissible for the purposes of a transfer pricing adjustment under Chapter X, equally it cannot be permitted in respect of AMP expenses either. As already noticed hereinbefore, what the Revenue has sought to do in the present case is to resort to a quantitative adjustment by first determining whether the AMP spent by the assessee on application of the bright line test, is excessive, thereby evidencing the existence of an international transaction involving the associated enterprise.
The quantitative determination forms the very basis for the entire transfer price exercise in the present case.
72. As rightly pointed out by the assessee, while such quantitative adjustment involved in respect of AMP expenses may be contemplated in the taxing statutes of certain foreign countries like U.S.A., Australia and New Zealand, no provision in Chapter X of the Act contemplates such an adjustment. An AMP transfer pricing adjustment to which none of the substantive or procedural provisions of Chapter X of the Act apply, cannot be held to be permitted by Chapter X. In other words, with neither the substantive nor the machinery provisions of Chapter X of the Act being applicable to an AMP transfer pricing adjustment, the inevitable conclusion is that Chapter X as a whole, does not permit such an adjustment.
73. It bears repetition that the subject matter of the attempted price adjustment is not the transaction involving the Indian entity and the agencies to whom it is making payments for the AMP expenses. The Revenue is not joining issue, the court was told, that the Indian entity would be entitled to claim such expenses as revenue expense in terms of section 37 of the Act. It is not for the Revenue to dictate to an entity how much it should spend on AMP. That would be a business decision of such entity keeping in view its exigencies and its perception of what is best needed to promote its products. The argument of the Revenue, however, is that while such AMP expense may be wholly and exclusively for the benefit of the Indian entity, it also enures to building the brand of the foreign associated enterprise for which the foreign associated enterprise is obliged to compensate the Indian entity. The burden of the Revenue’s song is this : an Indian entity, whose AMP expense is extraordinary (or “non-routine”) ought to be compensated by the foreign associated enterprise to whose benefit also such expense enures. The “non-routine” AMP spent is taken to have “subsumed” the portion constituting the “compensation” owed to the Indian entity by the foreign associated enterprise. In such a scenario what will be required to be benchmarked is not the AMP expense itself but to what extent the Indian entity must be compensated. That is not within the realm of the provisions of Chapter X.
74. The problem with the Revenue’s approach is that it wants every instance of an AMP spent by an Indian entity which happens to use the brand of a foreign associated enterprise to be presumed to involve an international transaction. and this, notwithstanding that this is not one of the deemed international transactions listed under the Explanation to section 92B of the Act. The problem does not stop here. Even if a transaction involving an AMP spend for a foreign associated enterprise is able to be located in some agreement, written (for e.g., the sample agreements produced before the court by the Revenue) or otherwise, how should a Transfer Pricing Officer proceed to benchmark the portion of such AMP spend that the Indian entity should be compensated for ?
75. As an analogy, and for no other purpose, in the context of a domestic transaction involving two or more related parties, reference may be made to section 40A(2)(a) under which certain types of expenditure incurred by way of payment to related parties is not deductible where the Assessing Officer “is of the opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods”. In such event, “so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction”. The Assessing Officer in such an instance deploys the “best judgment” assessment as a device to disallow what he considers to be an excessive expenditure. There is no corresponding “machinery” provision in Chapter X which enables an Assessing Officer to determine what should be the fair “compensation” an Indian entity would be entitled to if it is found that there is an international transaction in that regard. In practical terms, absent a clear statutory guidance, this may encounter further difficulties. The strength of a brand, which could be product specific, may be impacted by numerous other imponderables not limited to the nature of the industry, the geographical peculiarities, economic trends both international and domestic, the consumption patterns, market behaviour and so on. A simplistic approach using one of the modes similar to the ones contemplated by section 92C may not only be legally impermissible but will lend itself to arbitrariness. What is then needed is a clear statutory scheme encapsulating the legislative policy and mandate which provides the necessary checks against arbitrariness while at the same time addressing the apprehension of tax avoidance.
76. As explained by the Supreme Court in CIT v. B. C. Srinivasa Setty  128 ITR 294 (SC) and PNB Finance Ltd. v. CIT  307 ITR 75 (SC) in the absence of any machinery provision, bringing an imagined international transaction to tax is fraught with the danger of invalidation. In the present case, in the absence of there being an international transaction involving AMP spend with an ascertainable price, neither the substantive nor the machinery provision of Chapter X are applicable to the transfer pricing adjustment exercise.
Economic ownership of the brand
77. The next issue is concerning the economic ownership and legal ownership of the brand. According to the Revenue, viewing legal ownership as something distinct from economic ownership “may not be the right way of looking at things”.
78. It is necessary at this juncture to examine the history of the relationship between MSIL and SMC. When the licence agreements were originally entered in 1982, MSIL was known as Maruti Udyog Limited (“MUL”) and SMC did not hold a single share in Maruti Udyog Limited. In 2003 SMC acquired the controlling interest in MSIL. There are various models of Suzuki motor cars manufactured by MSIL and each model is covered by a separate licence agreement. Under these agreements SMC grants licence to MSIL to manufacture that particular car model ; provides technical know- how and information and right to use Suzuki’s patents and technical information. It also gives MSIL the right to use Suzuki’s trade mark and logo on the product. Pursuant to the above agreement, MSIL has been using the co-brand, i.e., Maruti-Suzuki trade mark and logo for more than 30 years. As already noted, this co-brand cannot be used by SMC and is not owned by it.
79. The clauses in the agreement between MSIL and SMC indicate that permission was granted by SMC to MSIL to use the co-brand “Maruti- Suzuki” name and logo. The mere fact that the cars manufactured by MSIL bear the symbol “S” is not decisive as the advertisements are of the particular model of the car with the logo “Maruti-Suzuki”. The Revenue has been unable to contradict the submission of MSIL that the co-brand mark “Maruti-Suzuki” in fact does not belong to SMC and cannot be used by SMC either in India or anywhere else. The decision in Sony Ericsson requires that the mark or brand should belong to the foreign associated enterprise. The Revenue also does not deny that as far as the brand “Suzuki” is concerned its legal ownership vests with the foreign associated enterprise, i.e., SMC. The Revenue proceeds on the basis that the benefit of the economic ownership also accrues to the foreign associated enterprise by way of increased royalty, increased raw material sales, increased brand value, etc.
80. The Revenue is proceeding on a presumption regarding the comparative benefits to MSIL and SMC as a result of the AMP expenditure incurred by MSIL. The Revenue is unable to deny that MSIL’s expenditure on AMP is only 1.87 per cent. of its total sales whereas SMC’s expenditure worldwide on AMP is 7.5 per cent. of its sales. In the circumstances, in the absence of some data, it cannot be simply asserted that the benefit of MSIL’s AMP spend to SMC is not merely incidental. The court is unable to accept the assertion of the Revenue that the mere fact of incurring AMP expenditure should lead to an inference of the existence of an international transaction.
81. It must be recalled here that the royalty paid to SMC for use of its logo on the product manufactured with its technical know-how is separately subject to transfer pricing. Likewise, payments for use of patents or copyrights are separately assessed. What the present appeals are concerned with is only the AMP expenditure incurred and nothing more. As pointed out by the Revenue the issue is not about the expenditure incurred by MSIL in engaging Indian third parties for AMP but the extent to which the AMP spend can be attributed to enure to the benefit of SMC’s brand. This can be a complex exercise and in the absence of clear guidance under the statute and the rules, can result in arbitrariness as a result of proceeding on surmises or conjectures. The Transfer Pricing Officer will need to access data as regards the strength of the foreign associated enterprise’s brand and what it commands in the international market and to what extent the presence of the brand in the advertisement actually adds to the benefit of the brand internationally.
82. Para. 6D of the OECD Guidelines deals with “Marketing activities undertaken by enterprises not owning trade marks or trade names”. It contains a discussion on promotion of trade marks by distributors of branded goods. It acknowledges the difficulties in determining the extent to which the expenses have contributed to the success of a product. It is stated :
“For instance, it can be difficult to determine what advertising and marketing expenditures have contributed to the production or revenue, and to what degree. It is also possible that a new trade mark or one newly introduced into a particular market may have no value or little impression on the market (or perhaps loses its impact). A dominant market share may to some extent be attributable to marketing efforts of a distributor. The value and any changes will depend to an extent on how effectively the trade mark is promoted in the particular market. More fundamentally, in many cases higher returns derived from the sale of trade marked products may be due as much to the unique char acteristics of the product or its high quality as to the success of adver tising and other promotional expenditures. The actual conduct of the parties over a period of years should be given significant weight in evaluating the return attributable to marketing activities.”
83. The Organisation for Economic Co-operation and Development Guidelines set out broad parameters for determining the existence of international transaction and for ascertaining the arm’s length price of such transaction. They may not ipso facto become applicable in situations where no studies have been conducted on a scientific basis on the behaviour of market and assessment of brand value.
Incidental benefit to SMC
84. The court next deals with the submission of the Revenue that the benefit to SMC as a result of the MSIL selling its products with the co-brand “Maruti-Suzuki” is not merely incidental. The decision in Sony Ericsson acknowledges that an expenditure cannot be disallowed wholly or partly because its incidentally benefits the third party. This was in context on section 57(1) of the Act. Reference was made to the decision in Sassoon J. David and Co. Pvt. Ltd. v. CIT  118 ITR 261 (SC). The Supreme Court in the said decision emphasised that the expression “wholly and exclusively” used in section 10(2)(xv) of the Act did not mean “necessarily”. It said : “The fact that somebody other than the assessee is also benefited by the expenditure should not come in the way of an expenditure being allowed by way of a deduction under section 10(2)(xv) of the Act if it satisfies otherwise the tests laid down by the law”.
85. The Organisation for Economic Co-operation and Development Transfer Pricing Guidelines, para 7.13 emphasises that there should not be any automatic inference about an associate enterprise group service only because it gets an incidental benefit for being part of a larger concern and not to any specific activity performed. Even paras. 133 and 134 of the Sony Ericsson judgment makes it clear that AMP adjustment cannot be made in respect of a full-risk manufacturer.
MSIL’s higher operating margins
86. In Sony Ericsson it was held that if an Indian entity has satisfied the transactional net margin method, i.e., the operating margins of the Indian enterprise are much higher than the operating margins of the comparable companies, no further separate adjustment for AMP expenditure was warranted. This is also in consonance with rule 10B which mandates only arriving at the net profit by comparing the profit and loss account of the tested party with the comparable. As far as MSIL is concerned, its operating profit margin is 11.19 per cent. which is higher than that of the comparable companies whose profit margin is 4.04 per cent. Therefore, applying the transactional net margin method it must be stated that there is no question of transfer pricing adjustment on account of AMP expenditure”.
The learned Members of ITAT, Chennai held that the transactions between assessee and Renault Nissan Automotive India Private Ltd as not international transactions, no Arms Length Price adjustment could have been carried out on the advertisement and marketing expenditure incurred by the assessee.