Analysing of the classification of AMP expenditure in Indian Tax jurisprudence, going beyond the bright-line test.
“Any product which makes money doesn’t sell itself… you’ve got to sell it and sell it hard, because if you don’t it won’t be sold, however good it is”
These words by Sir Paul Girolami, former chairman of GlaxoSmithKline plc – a well-known British Pharmaceutical Multinational Corporation (MNC), aptly describes the reality which permeates businesses across the globe. Due to increasingly tough competition in the market caused by technically superior products, businesses are flooding their books of accounts with promotional expenses. An offshoot of this phenomenon has been the quandary which has developed pertaining to the attribution of such Advertisement, Marketing and Promotional (AMP) expenses carried out by subsidiaries of MNC’s. Revenue authorities in India are insistent on bringing such expenses under the ambit of International Transaction (IT) within the framework of Transfer Pricing (TP) regime, thereby bringing additional elements of brand building within its fold.
In India, there hasn’t been a great deal of statutory reference for such AMP expenses incurred by Indian subsidiaries in their capacity of distributors/manufacturers. Lack of guidance in the statute books has led to a multitude of litigation on the subject with non-resident MNC’s, the legal owners of the trademarks exploited by the subsidiaries, being left in the dark with respect to their tax liabilities. Indian courts take differing stances time and again, which hasn’t helped the cause of taxpayers. The matter currently lies pending before the Honorable Supreme Court to provide much needed guidance and settle the dust on the matter for once and all.
AMP – An International Transaction?
The revenue authority’s argument for including AMP expenses within the fold of TP stems from the presumption that such advertising expenditure inevitably leads to enrichment of the brand value, owned by the foreign Associated Entity (AE). Revenue authorities seek to compensate Indian subsidiaries for the excess amount spent for the purported benefit received by the foreign entity. The major contention against this approach is that the revenue authorities don’t acknowledge the need to first establish the existence of an ‘international transaction’ before making TP adjustment of AMP expenses with the Arm’s Length Price (ALP).
The first step of the TP analysis remains to be the establishment of an ‘International Transaction’ between associated entities. Section 92B of the Income Tax Act, 1961 (The Act) elucidates the meaning of ‘International Transaction’. The definition envisages a presence of an ‘agreement’, an ‘arrangement’ or an ‘understanding’ between the parties. AMP expenditure is conspicuously missing from the list laid down under explanation to clause (i) of section 92B. Even if a wide-sweeping connotation is accepted for the term ‘transaction’ under Section 92F, statutorily it won’t enable the revenue authorities to cover AMP expenses within the realm of ‘International Transaction’, in the absence of some form of ‘arrangement’ or ‘understanding’ between the parties. The burden to show the existence of an International Transaction lies with the revenue authorities and not the assessee, and the same needs to be established with sufficient material and can’t be presumed as a matter of conjecture. The incidental or ancillary benefits received by the foreign AE cannot be sufficient enough reason to infer an existence of ‘tacit’ understanding or arrangement between the 2 entities.
Chapter X of the Act, which deals with TP arrangement, envisions the adjustment to prices of those transactions which intend to shift the base of profit from one country to another. Making the assumed price the basis of such ALP analysis, falls foul of the objective of TP law. This proposition has been reaffirmed in the Delhi High Court ruling of “CIT v. EKL Appliance Ltd.”, where the court directed the Transfer Pricing Officer (TPO) to “examine the International Transaction as he finds it and not to make its existence a matter of surmises.” Although the High Court of Delhi has acknowledged the lack of an arrangement or agreement for such AMP expenses, the revenue continues to regard the same as IT, thereby subjecting it to TP analysis. In such backdrop, it is incumbent upon the Supreme Court to take cognizance of the matter and lay down the parameters to deal with such AMP expenditure.
Brightline Test – a Viable Solution or a Knee Jerk Reaction?
The Test used by the TPO to scrutinize exorbitant AMP expenses is the “Brightline Test” (BLT). The US Tax Court promulgated this test in the case of “DHL Corporation & Subsidiaries v. Commissioner of Internal Revenue” . According to this test, when the subsidiary bears a certain cost towards exploiting the intangible brand name and when that expense crosses the bright-line of routine expenses, then an economic ownership is formulated for the subsidiary. The foreign AE is obligated under this rule to compensate the domestic enterprise for expenses incurred for non-routine expenditure towards the so-called brand building exercise. The Delhi High Court has categorically rejected the applicability of the BLT under the Indian taxation regime. The Court ruled that the test has no statutory mandate in “ChrysCapital Investment Advisors (India) Pvt. Ltd. vs. DCIT”, observing that “the Indian TP regime is exhaustive in itself and is not to be supplemented by […] other guidelines”.
Despite such unequivocal rulings, the TPO continues to apply the BLT to characterise AMP expenses as non-routine. Transfer Pricing analysis is undertaken in a phased manner by first proving the existence of IT and then adjusting the price of the transaction with the price of the other comparables. But the revenue authorities, while applying BLT, adopt a regressive analysis where they infer the existence of IT from the excessive AMP expenditure incurred by the assessee. First, they craft a bright-line by looking at the expenditure incurred by comparables and then, they surmise an IT to bring the assessee within the books of TP law. They don’t acknowledge that there is a different Function, Asset and Risk (FAR) analysis for each assesse. The bright line could vary from industry to industry, thereby making economic benchmarking much more difficult. Such an approach was not contemplated by Chapter X. This way, the revenue authority is only looking at the quantitative determination of expenses without laying down any objective criteria to label something as non-routine expenses. This is an overly broad approach and would lead to a slippery slope of arbitrary exercise of discretion by the authorities, vis-a-vis deeming any expense routine or non-routine.
Brand Building or Product Selling?
BLT prescribes that anything over the routine expenditure, is used for brand building for the overseas AE and thus entitles the local subsidiary to be compensated. This creates an artificial distinction between AMP expenditure leading to increased sales and the one leading to overall brand creation. It is presumed that enhanced AMP expenditure necessarily leads to increase in sales for the enterprise incurring it. Such a presumption overlooks other factors like market situation, lack of confidence in competitors etc. which may lead to increased sales. Another area where the revenue authorities seem ignorant is that some advertisements are specifically created to attract local audiences and capture the local market. In such kind of targeted AMP expenditure, any effect on brand value of foreign AE is merely incidental and hence applying TP on such transactions would be highly erroneous.
It needs to be considered that brand creation is dependent upon a variety of factors. Brand value is something which the proprietor of the brand earns over a long period of time. It is contingent on the quality and the nature of goods offered. Equating such brand building with advertising and presuming a positive correlation between the two, is surely an interpretation which goes against accepted business norms and practices.
The Supreme Court needs to acknowledge that the question of what is excessive or non-routine is best left to the commercial wisdom of the taxpayer and that the revenue authorities shouldn’t be allowed to step into the shoes of the taxpayer. Abolition of the Brightline Test could be a major step to ensure this. Another point that should be considered, is that when increased AMP expenditure boosts sales, the revenue/profit of the Indian entity grows proportionately. Authorities get to tax this increased revenue, thereby absorbing their share for permitting increased AMP expenses, instead of taxing the ‘excessive’ expenses themselves.
Various taxpayers including manufacturers, traders, distributors etc. are seeking a resolution of the concerned dispute. Considering that each group of such taxpayers comes with its own peculiar facts, it will be difficult for the SC to come up with a ruling which addresses each such category. Hence, the Supreme Court will have its task cut out when it sits to adjudicate this matter. In the opinion of the author, the SC should primarily decide the question of whether the AMP expenditure amounts to ‘International Transaction’ or not, and whether the Brightline test should be adopted in Indian TP practice.
As the advertising contract entered into by the assessee is with a third party and not the foreign AE, the Supreme Court should affirm the rulings of the Delhi HC and dismiss revenue authorities’ proposition of holding such AMP expenses as IT. With respect to the second question, the SC needs to give a stern direction to the revenue authorities to stop the usage of BLT, which has continued despite an express bar imposed by the Delhi HC in its ruling. Lastly, it would be appropriate for the government to consider India’s economic outlook, revenue implications and technical complexities to posit appropriate rules in the Act to deal with potential AMP issues that might arise in the future.
The author is a fifth-year B.A.LLB (Hons.) student at NALSAR University of Law, Hyderabad
 Glaxo SmithKline Holdings (America) vs. Inland Revenue Services Nos. 5750-04.
 DHL Corporation & Subsidiaries v. Commissioner of Internal Revenue, TC Memo 1998-46 I