Case Law Details

Case Name : Maruti Suzuki India Ltd. (MSIL) Vs CIT (Delhi High Court)
Appeal Number : Income Tax (Appeal) nos. 110 of 2014 and 710 of 2015
Date of Judgement/Order : 11/12/2015
Related Assessment Year :
Courts : All High Courts (3799) Delhi High Court (1203)

Brief of the Case

Delhi High Court held In the case of Maruti Suzuki India Ltd. (MSIL) vs. CIT that the transfer pricing adjustment is not expected to be made by deducing from the difference between the ‘excessive’ advertisement, marketing and sales promotion (AMP) expenditure incurred by the Assessee and the AMP expenditure of a comparable entity that an international transaction exists and then proceed to make the adjustment of the difference in order to determine the value of such AMP expenditure incurred for the AE. In the present case, the first arrived at the ‘bright line’ by comparing the AMP expenses incurred by MSIL with the average percentage of the AMP expenses incurred by the comparable entities. Since on applying the ‘bright line test’ (BLT), the AMP spend of MSIL was found ‘excessive’ the Revenue deduced the existence of an international transaction. It then added back the excess expenditure as the transfer pricing ‘adjustment’. This runs counter to legal position explained in CIT v. EKL Appliances Ltd. (2012) 345 ITR 241 (Del), which required a TPO “to examine the ‘international transaction’ as he actually finds the same.” In other words the very existence of an international transaction cannot be a matter for inference or surmise.

Facts of the Case

The Maruti Suzuki India Ltd. (MSIL) is engaged in the manufacture of passenger cars in India. It is a subsidiary of Suzuki Motor Corporation, Japan (SMC).MSIL filed its return of income for the AY 2005-06 on 31st October 2005, declaring an income of Rs. 13,46,51,71,140/-. Its case was selected for scrutiny and notices under Sections 143(2) and 142(1) of the Act were issued. During the course of assessment proceedings, the AO invoked the provisions of Section 92CA (1) and referred the case to the transfer pricing officer for determination of ALP in relation to the international transactions undertaken by MSIL with its AE, SMC.

The TPO proposed an addition of Rs.252.26 crores to the returned income of MSIL. The TPO made an adjustment of Rs.98.14 crores as regards the royalty paid by MSIL attributing the same towards payment for use of foreign trademark of SMC on the ground that the brand had no value. The said adjustment was later deleted by the ITAT. The remaining adjustment of Rs.154.12 crores was towards the AMP expenses by imputing a notional/purported arm’s length compensation towards the AMP expenses incurred by MSIL for SMC.

The case of MSIL is that while undertaking the above exercise, the TPO, on his own, benchmarked the AMP expenses incurred by MSIL in India, although that international transaction was not specifically referred to the TPO. The TPO compared the AMP expenses incurred by MSIL i.e. 1.87% of its turnover with the mean of 0.620% incurred by the comparable companies i.e. Hindustan Motors, Tata Motors and Mahindra & Mahindra. Since the ratio of selling and distribution expenses as a percentage of sales of MSIL was higher than that incurred by the comparable companies, the TPO concluded that the excess must be regarded as having been incurred for promoting the brand ‘Suzuki’ owned by SMC. Accordingly, the adjustment on account of AMP expenses was computed at Rs.154.12 crores. Finally the AO completed the assessment in terms of the directions of the DRP and passed the final assessment order on 28th October 2011, assessing the total income of MSIL at Rs. 16,34,18,35,040 after making an addition of Rs.154.12 crores on account of the AMP expenses

Contention of the Assessee

Whether on account of the decision in Sony Ericsson, it would be open to MSIL to question the existence of an international transaction involving it and the AE i.e. SMC as far as AMP expenses are concerned?

The ld counsel of the assessee submitted that the contention of the Revenue that the question regarding existence of an international transaction on account of the incurring of AMP expenditures by the Assessee has been decided by the Sony Ericsson case is based on a patent misreading of that judgment. Reference is made to para 3 of the judgment which notes the admitted facts in those three cases. It is submitted that once the BLT has been rejected by the decision in Sony Ericsson, the question of there being an international transaction does not arise. It is submitted that the TPO’s order and the Assessee’s case makes it clear that the BLT has been used first to infer the existence of an international transaction and thereafter quantify the amount of the TP adjustment. After the judgment in Sony Ericsson, BLT cannot be used for either of the purposes.

Further submitted that the Revenue has to show the existence of an agreement or an arrangement or an understanding between MSIL and SMC prior to incurring of the AMP expenditure, in terms of which MSIL would incur AMP expenditure in excess of the bona fide requirements of its business in India and thereby may add to the value of the brand of the foreign AE, i.e. SMC. In other words, a mere incurring of the AMP expenditure may not be considered as an international transaction.

Effect of the earlier decision in the writ petition by MSIL

The ld counsel of the assessee submitted that the earlier decision in MSIL’s writ petition virtually set aside the order of the TPO and AO and required the TPO to proceed de novo. The Supreme Court in its turn did not express any view on the existence of an international transaction and, therefore, it was incorrect to contend that the judgment of the Supreme Court impliedly affirmed the finding of the High Court regarding the existence of an international transaction.

Contention of the Revenue

Whether on account of the decision in Sony Ericsson, it would be open to MSIL to question the existence of an international transaction involving it and the AE i.e. SMC as far as AMP expenses are concerned?

The ld counsel of the revenue submitted that after the decision in Sony Ericsson the existence of an international transaction between MSIL and SMC as far as AMP expenses is concerned is not in dispute. It is submitted that in paras 51 and 52 of the decision in Sony Ericsson, the Court answered the question “whether AMP expenses incurred by the Assessee in India can be treated and categorised as an international transaction under Section 92B” in the affirmative. It is further submitted that the Sony Ericsson case does not distinguish the cases of the manufacturers from those of the distributors except observing that TNMM may not be an appropriate method in the case of entities which are performing complex functions like manufacturing or making substantial value addition to the material imported from the AE.

It is further submitted that the Bright Line Test (‘BLT’) was used by the Revenue only as an arithmetical tool to arrive at the cost base of the AMP expenditure. The determination of the cost base is a necessary step for arriving at ALP of the transaction under different methods including the TNMM. It is submitted that although the decision in Sony Ericsson rejects the use of BLT for determining the existence of an international transaction for determining ALP, and although the Revenue had filed an appeal in the Supreme Court against the said finding,

Effect of the earlier decision in the writ petition by MSIL

The ld counsel of the revenue submitted that in light of the said judgment of this Court, the findings which have not been disturbed by the Supreme Court, it can no longer be contended by MSIL that there is no international transaction resulting from the incurring of AMP expenses.

Is there an international transaction concerning AMP expenses?

The ld counsel of the revenue submitted that the mere fact that the Indian entity is engaged in the activity of creation, promotion or maintenance of certain brands of its foreign AE or for the creation/promotion of new/existing markets for the AE, is by itself enough to demonstrate that there is an arrangement with the parent company for this activity. It is urged that merely because MSIL and SMC do not have an explicit arrangement/agreement on this aspect cannot lead to the inference that there is no such arrangement or the entire AMP activity of the Indian entity is unilateral and only for its own benefit.

According to the Revenue, “the only credible test in the context of TP provisions to determine whether the Indian subsidiary is incurring AMP expenses unilaterally on its own or at the instance of the AE is to find out whether an independent party would have also done the same.” It is asserted: “An independent party with a short term agreement with the MNC will not incur costs which give long term benefits of brand & market development to the other entity. An independent party will, in such circumstances, carry out the function of development of markets only when it is adequately remunerated for the same.”

Reference is made by Mr. Srivastava to some sample agreements between Reebok (UK) and Reebok (South Africa) and IC Issacs & Co and BHPC Marketing to urge that the level of AMP spend is a matter of negotiation between the parties together with the rate of royalty. It is further suggested that it might be necessary to examine whether in other jurisdictions the foreign AE i.e., SMC is engaged in AMP/brand promotion through independent entities or their subsidiaries without any compensation to them either directly or through an adjustment of royalty payments.

Held by DRP

The DRP upheld the addition made by the TPO on account of AMP expenses.

Held by ITAT

The ITAT by its order dated 24th August 2015 partly allowed MSIL’s appeals against both the orders dated 20th October 2010 and 12th April 2012 and sent the matter back to the file of TPO/AO for determination of the AMP in the light of the Sony Ericsson Mobile Communications India P. Ltd. v. Commissioner of Income Tax (2015) 374 ITR 118.

Held by High Courts

Whether on account of the decision in Sony Ericsson, it would be open to MSIL to question the existence of an international transaction involving it and the AE i.e. SMC as far as AMP expenses are concerned?

As already noticed, the judgment in Sony Ericsson does not seek to cover all the cases which may have been argued before the Division Bench. In particular, as far as the present appeal ITA No. 110 of 2014 is concerned, although it was heard along with the batch of appeals, including those disposed of by the Sony Ericsson judgment, at one stage of the proceedings on 30th October 2014 the appeal was delinked to be heard separately.

Secondly, the cases which were disposed of by the Sony Ericsson judgment, i.e. of the three Assessees Canon, Reebok and Sony Ericsson were all of distributors of products manufactured by foreign AEs. The said Assessees were themselves not manufacturers. In any event, none of them appeared to have questioned the existence of an international transaction involving the concerned foreign AE. It was also not disputed that the said international transaction of incurring of AMP expenses could be made subject matter of transfer pricing adjustment in terms of Section 92.

However, in the present appeals, the very existence of an international transaction is in issue. The specific case of MSIL is that the Revenue has failed to show the existence of any agreement, understanding or arrangement between MSIL and SMC regarding the AMP spend of MSIL. It is pointed out that the BLT has been applied to the AMP spend by MSIL to (a) deduce the existence of an international transaction involving SMC and (b) to make a quantitative ‘adjustment’ to the ALP to the extent that the expenditure exceeds the expenditure by comparable entities. It is submitted that with the decision in Sony Ericsson having disapproved of BLT as a legitimate means of determining the ALP of an international transaction involving AMP expenses, the very basis of the Revenue’s case is negated.

Since none of the above issues that arise in the present appeals were contested by the Assessees who appeals were decided in the Sony Ericsson case, it cannot be said that the decision in Sony Ericsson, to the extent it affirms the existence of an international transaction on account of the incurring of the AMP expenses, decided that issue in the appeals of MSIL as well.

As regards the submission regarding the BLT having been rejected in the decision in Sony Ericsson is concerned, the Court notes that the decision in Sony Ericsson expressly negatived the use of the BLT both as forming the base and determining if there is an international transaction and secondly for the purpose of determining the ALP. Once BLT is negatived, there is no basis on which it can be said in the present case that there is an international transaction as a result of the AMP expenses incurred by MSIL.

Although the Revenue seems to contend that the BLT was used only to arrive at the quantum of the TP adjustment, the order of the TPO in the present case proceeds on the basis that an international transaction can be inferred only because the AMP expenses incurred were significantly higher that what was being spent by comparable entities and it was also used for quantifying the amount of the TP adjustment. Consequently, the Court does not agree with the submission of the learned Special counsel for the Revenue that de hors the BLT, which has been rejected in the Sony Ericsson judgment, the existence of an international transaction on account of the incurring of the AMP expenses can be established.

The result of the above discussion is that in the considered view of the Court the Revenue has failed to demonstrate the existence of an international transaction only on account of the quantum of AMP expenditure by MSIL. Secondly, the Court is of the view that the decision in Sony Ericsson holding that there is an international transaction as a result of the AMP expenses cannot be held to have answered the issue as far as the present Assessee MSIL is concerned since finding in Sony Ericsson to the above effect is in the context of those Assessees whose cases have been disposed of by that judgment and who did not dispute the existence of an international transaction regarding AMP expenses.

Effect of the earlier decision in the writ petition by MSIL

This Court in Sony Ericsson proceeded on the basis that the decision of this Court in the writ petition by MSIL was not a binding precedent. Be that as it may, there are other reasons why the earlier decision in the writ petition filed by MSIL cannot be held to survive. A careful reading of the judgment of the Supreme Court reveals that the Supreme Court asked the TPO to proceed with the matter in accordance with law “uninfluenced by the observations/directions given by the judgment in the impugned order dated July 1, 2010.” That virtually nullifies the judgment of the High Court on all aspects. A further reason is that even this Court in disposing of the writ petition of MSIL proceeded on the basis of there being an international transaction only on account of the excessive AMP expenses incurred by MSIL. In other words, this Court disposing of MSIL’s writ petition also applied the BLT to determine the existence of an international transaction whereas throughout it has been MSIL’s case that the fact that its AMP spend is significantly higher cannot ipso facto lead to the conclusion regarding the existence of an international transaction in that regard between MSIL and SMC. With the decision in Sony Ericsson having jettisoned the BLT, the very basis of the judgment of this Court in the writ petition must be held to be no longer binding.

Is there an international transaction concerning AMP expenses?

Under Section 92B (1) an ‘international transaction’ means- (a) a transaction between two or more AEs, either or both of whom are non-resident (b) the transaction is in the nature of purchase, sale or lease of tangible or intangible property or provision of service or lending or borrowing money or any other transaction having a bearing on the profits, incomes or losses of such enterprises, and (c) shall include a mutual agreement or arrangement between two or more AEs for allocation or apportionment or contribution to the any cost or expenses incurred or to be incurred in connection with the benefit, service or facility provided or to be provided to one or more of such enterprises.

As far as clause (a) is concerned, SMC is a non-resident. It has, since 2002, a substantial share holding in MSIL and can, therefore, be construed to be a non-resident AE of MSIL. While it does have a number of ‘transactions’ with MSIL on the issue of licensing of IPRs, supply of raw materials, etc. the question remains whether it has any ‘transaction concerning the AMP expenditure. That brings us to clauses (b) and (c). They cannot be read disjunctively. Even if resort is had to the residuary part of clause (b) to contend that the AMP spend of MSIL is “any other transaction having a bearing” on its “profits, incomes or losses”, for a ‘transaction’ there has to be two parties. Therefore for the purposes of the ‘means’ part of clause (b) and the ‘includes’ part of clause (c), the Revenue has to show that there exists an ‘agreement’ or ‘arrangement’ or ‘understanding’ between MSIL and SMC whereby MSIL is obliged to spend excessively on AMP in order to promote the brand of SMC. As far as the legislative intent is concerned, it is seen that certain transactions listed in the Explanation under clauses (i) (a) to (e) to Section 92B are described as ‘international transaction’. This might be only an illustrative list, but significantly it does not list AMP spending as one such transaction.

The transfer pricing adjustment is not expected to be made by deducing from the difference between the ‘excessive’ AMP expenditure incurred by the Assessee and the AMP expenditure of a comparable entity that an international transaction exists and then proceed to make the adjustment of the difference in order to determine the value of such AMP expenditure incurred for the AE. And, yet, that is what appears to have been done by the Revenue in the present case. It first arrived at the ‘bright line’ by comparing the AMP expenses incurred by MSIL with the average percentage of the AMP expenses incurred by the comparable entities. Since on applying the BLT, the AMP spend of MSIL was found ‘excessive’ the Revenue deduced the existence of an international transaction. It then added back the excess expenditure as the transfer pricing ‘adjustment’. This runs counter to legal position explained in CIT v. EKL Appliances Ltd. (2012) 345 ITR 241 (Del), which required a TPO “to examine the ‘international transaction’ as he actually finds the same.” In other words the very existence of an international transaction cannot be a matter for inference or surmise.

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 ALP, 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 ALP. If the answer to that is in the negative the TP adjustment should follow. The objective of Chapter X is to make adjustments to the price of an international transaction which the AEs involved may seek to shift from one jurisdiction to another. An ‘assumed’ price cannot form the reason for making an ALP adjustment.

Since a quantitative adjustment is not permissible for the purposes of a TP 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 spend of the Assessee on application of the BLT, is excessive, thereby evidencing the existence of an international transaction involving the AE. The quantitative determination forms the very basis for the entire TP exercise in the present case.

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 TP 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 TP adjustment, the inevitable conclusion is that Chapter X as a whole, does not permit such an adjustment.

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 AE for which the foreign AE 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 AE to whose benefit also such expense enures. The ‘non-routine’ AMP spend is taken to have ‘subsumed’ the portion constituting the ‘compensation’ owed to the Indian entity by the foreign AE. 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.

As explained by the Supreme Court in CIT v. B.C. Srinivasa Setty (1979) 128 ITR 294 (SC) and PNB Finance Ltd. vs. CIT (2008) 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.

Hence, it is held that AMP expenses incurred by MSIL cannot be treated and categorised as an international transaction under Section 92B.

Accordingly appeal of the assessee allowed.

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