PART I: Introduction To the Concept of Transfer Pricing in relation to AMP
The issue of Arm’s Length Pricing (ALP) was first discussed in 1936 in Art. 6 of the League of Nations Draft Convention on the Allocation of Profits and Property of International Enterprises. Later, Art. 9 of the UN Model Tax Treaties and Art. 9 of the OECD Draft Double Taxation Convention on Income and Capital (1963) which are identical, gained currency and they crystallised the international perspective in regulating tax matters. These instruments affirm the domestic right of a country to adjust the profits of an enterprise situated on its territory if the transaction that it holds with a foreign associated enterprise isn’t subject to the same stipulations as those which would govern any comparable normal transnational business relationships.
The Indian Transfer Pricing Regulations (TPR) are enshrined in S. 92 of the Income Tax Act which defines an ‘associated enterprise (AE)’  and ‘international transaction’,  apart from discussing the accepted methods of computing the ALP. The Finance Act 2012 has further expanded the definition of an international transaction to bring within its ambit the trans-border provision of any service related to the development of market intangibles. It should be noted that the brand name of a Trademarked enterprise which could influence buyers would count as a ‘market intangible.’
The term ‘market intangible’ is defined in the OECD Transfer Pricing Guidelines which elucidates firstly on the meaning of intangible property and goes on to characterise ‘marketing intangible’ as a qualification of a ‘commercial intangible.’
“Intangible property includes rights to use industrial assets such as patents, trademarks, trade names, designs or models. It also includes literary and artistic property rights, and intellectual property such as know-how and trade secrets.” 
“Commercial intangibles include patents, know-how, designs, and models that are used for the production of a good or the provision of a service, as well as intangible rights that are themselvesbusiness assets transferred to the customers or used in the operation of a business (e.g. computer software).” 
From here, Marketing intangibles are defined as:
“A special type of commercial intangibles which include trademarks and trade names that aid in thecommercial exploitation of a product or service, customer lists, distribution channels, and unique names, symbols, or pictures that have an important promotional value for the product concerned.”
So the benefits like brand name, customer lists, unique symbols, logos, and distribution/dealership network etc. which are not normally measured or recognised in the books of account and which are created over a period of time through brand building, large-scale marketing of product, distribution network would count as marketing intangibles. Also, they are said to be dependent on:
- The reputation and credibility of the trade name or the trademark,
- The quality of the goods and services provided under the name or the mark in the past,
- The degree of quality control and ongoing R&D,
- The availability of the goods or services being marketed,
- The extent and also the success of the promotional expenditures incurred for familiarising potential customers with the goods or services et al.
Thus, it can be seen that ‘marketing intangible’ isn’t an independent variable. Having settled the definition of the term, the important issue of contention regarding it, for the purpose of this article, is whether the advertising, marketing and sales promotion (AMP) expenditure would result in thecreation of market tangibles or they’d merely help in product promotion. Before attempting to answer this question, a before excursion into the concept of AMP is necessitated.
For the sake of clarity, better than a positive definition would be one which negatively defines advertising and promotion by differentiating one from the other. Advertising would involve a method of occupation of the potential consumer’s mind space by controlling the content and the graphic aspects of the message being conveyed. Ads are communicative and they’d include scripted commercials, magazine advertisements and radio announcements that inform the consumer about a product. Whereas, a promotional venture is one wherein general methods are employed to effect a two-way interaction between the brand name and new customers who wouldn’t show interest under normal circumstances and in the absence of such promotional campaigns. This could be done by taking a celebrity brand ambassador on the bandwagon, giving rebates, coupons, samples etc.
The question regarding the essential effect of AMP campaigns becomes especially relevant in the case of an Indian venture which deals in the products of a foreign associated enterprise (AE). Since these are branded goods, the advertisements given by the Indian AE would inevitably carry the brand name of the foreign AE and it’d also popularise it. So the money spent by the local company towards marketing the sales- both in terms of the intellectual capital which goes into the creation of a message and also the promotional measures like providing rebates and bringing in a celebrity brand ambassador- would unavoidably amount to appreciating the value of the brand name and thus result in intangible benefits in the market, to the Foreign associated enterprise. Since the Foreign AE is also advantaged, it becomes problematic when the Indian Co. is made solely liable to cover the AMP expenses. Hence, by following the landmark US case law in DHL Corporation & Subsidiaries v. Commissioner of Internal Revenue  reprieve could be provided to the local dealers.
This issue came up for judicial consideration after the US Regulations 1968, which propounded an important theory and elaborated on a certain, ‘Developer-assister Rules’. This theorisation, in the case of a local and a foreign AE, seeks to classify the creator of the marketing intangible in the domestic market as the economic owner and thus the ‘developer’ of the same vis-à-vis the AE which, as the mere legal owner, would solely remain as ‘assister’. In such a situation, the domestic enterprise won’t have to compensate the foreign AE for usage of the trademark. Therefore, the just principle of equitable ownership on the basis of respective economic expenditure, has been warranted in this case.
Further, in recognition of this principle, the US Tax Court devised the ‘Bright Line Test’ which states that ‘expenditure on advertisement and brand promotion expenses which exceed the average of AMP expenses incurred by the ‘comparable companies’ in India, is required to be reimbursed/ compensated by the overseas associated enterprise.’ It establishes a distinction between routine & non-routine expenditure and holds that remuneration shall be sought only (emphasis added) for the non-routine brand building expenses which wouldn’t normally be incurred. Hence the question is whether the AMP spend could have been the routine expense of a third party company in selling the product.
The India Transfer Pricing Officers (TPOs) have essentialised these above elements and in the absence of a statutory dicta, this legal principle from international jurisprudence would have a persuasive value: ‘excess AMP expenditure incurred by the Indian AE contributes towards the development and enhancement of the brand owned by the parent of the multinational group (the foreign AE) might have to be reimbursed.’ Such compensation could mean the recovery of expenses incurred and an appropriate mark-up over and above such expenses.
The ITAT (majority) opinion in LG India case has recognised the sanction provided by Rule 10B (1) C (iv) of the Income Tax Rules 1962 to the TPO for applying mark-up on the cost for determining the Arm’s Length Price of the International Transaction. The Special bench has also approved the Governmental intervention through the application of Bright Line Test by the A.O/ TPO when the ‘tested party’ fails to discharge the onus upon him to segregate the AMP expenses incurred on its own behalf vis-à-vis those incurred for the sake of the foreign AE. A new qualification has also been devised by the ITAT based on the Bright Line Test, to segregate the routine AMP expenses as thoseincurred in connection with sales from the disallowable AMP costs as those incurred for sales promotion which will lead to brand building for which the Indian Company is liable to be compensated by the AE on Arm’s Length basis. The case was set aside and the matter was restored to the file of the TPO for selection of appropriate comparable companies, examining the effect of various relevant factors laid down in the decision and for the determination of the correct mark-up.
This ‘comparable company’ standard is highly problematic and the selection process is equally debatable. In the Maruti India case, Tata Motors, Mahindra & Mahindra and Hindustan Motors were considered as ‘comparables’ by the Delhi HC. Since the SC didn’t overrule the HC judgment on merit, it could also be considered as good law. But the Chennai Bench of the ITAT in Ford India Pvt. Ltd. v. DCIT  despite following the Delhi Court, ruled that these entities weren’t comparable to the ‘tested party’ and that new selections have to be made by A.O/ TPO, or the figures in the same entities could be adjusted. Thus the standard is dicey.
It should be noted that:
“A tested party is the one to which a transfer pricing method can be applied in the most reliable manner i.e. with minimum adjustments and for which the most reliable comparable can be found, i.e. it will most often be the one that has the less complex functional analysis.” 
Usually the Transaction Net Margin Method (TNMM) is employed to compute the ALP when much data isn’t available since only the net margin is required to be known here. The operating margins of the comparable company in a ‘similar field’, but not the ‘same field’ is computed by keeping in mind the average business expenditure. The LG Indian case has even approved the selection of ‘domestic comparable companies’ not using any foreign brand for determining the cost/value of the international transaction by considering the other relevant factors. One disadvantage of such selection is that whendifferent operating models are employed in different industries the expenditure may differ; but TNMM adjusts the figures to compensate for these nuances. After corrections, if the expenses of the tested party exceed those of the comparable company, then the surplus amount would be termed as non-routine AMP expenses which must be TP adjusted (E.g. a promotion party commemorating an anniversary of the brand or the success of the Multi National Group in India may be regarded as non-routine expenditure). So, this additional amount would be disallowable and it is recoverable from the foreign AE since it contributes towards the enhancement of its brand image. This principle that the taxpayer should receive an arm’s length consideration based on the fair market value of the brand is deemed ‘transfer theory’.
But the usual AMP costs are tax deductible- and so are the price of raw materials, items such as payroll, leased commercial space and property taxes- since they’re considered to be expenses incurred in the course of doing business and the Department can’t interfere with reasonable business expenses u/s. 37 (1). Also payments which are ‘wholly’ and ‘exclusively’ for the purpose of business could not be disallowed under section 40A (2).11. But it is important to note here that the incurring of AMP expenses would lead to promotion of LG brand in India, which is legally owned by the foreign AE and hence it is a transaction. The said transaction can be characterised as an international transaction within the ambit of Section 92B (1) of the Act, since;
- There is a transaction of creating and improving marketing intangibles by the assessee for and on behalf of its AE;
- The AE is non-resident; and
- Such transaction is in the nature of provision of service.
Since the non-routine AMP expenditure would count as spending for a Foreign Enterprise, S.37 wouldn’t be applicable since its scope is restricted to taxpayers who spend for the purpose of their own business. Therefore, as held in the LG India case  when the spending in terms of brand promotion was clearly for the sake of the AE, it wouldn’t qualify u/s. 37. Furthermore, the ITAT Ruling concludes that section 40A (2) determines the reasonableness of expenditure while S.92 questions the very admissibility of the expenditure but as a special provision it would override the general provision u/s. 40A (2).
The issue ultimately boils down to a distinction between expenses which amount to brand promotion and those which will result in product promotion, a distinction which the IRA has been failing to make correctly. Product promotion primarily targets an increase in the demand for a particular product. Such product promotion expenditure may support brand building; however, such rub on effect would need to be analysed on a case to case basis and not by comparing the same with the other companies identified for the purpose of determining the remuneration that the Indian AE should have earned.
PART II: Judicial Precedents
The dispute had its origin in India with the Maruti Suzuki case.  In response to a writ petition filed in the High Court, certain guidelines were laid down to calculate the ALP in respect of the international transaction of brand building of the foreign AE. The Delhi High Court decreed that if:
- The AMP expenses incurred by the domestic company was ‘significantly higher’ than what comparable third party companies incurred for selling the product,
- The usage of the logo of the foreign AE was compulsory and not merely Here the usage of Suzuki logo was mandatory as per the licensing agreement
- The benefits accrued to the foreign AE weren’t incidental. Here, since there was a prior agreement to the effect that the trademark of SMC would be displayed by Maruti, it could be concluded that the intangible benefits derived by Suzuki weren’t incidental.
Therefore, if the SMC doesn’t compensate the Indian company, it could be seen as piggybacking on Maruti’s renown in India to build its own brand image. So Maruti is liable to be reimbursed for the perceived enhancement of the Suzuki brand name.’
Furthermore, the Court distinguished selling expenditure from non-routine AMP costs, as those which are concerned with creating awareness and communicating the strengths, features and price of the product to invoke the interest of potential customers. In these activities, it can be seen that the brand name as such doesn’t gain much leverage.
Moreover, in the opinion of the Court even ‘distribution expenses’ which are usually grouped with AMP costs should be analysed separately as a ‘product placement’ expenditure and not that of ‘product promotion’.
Next, the appropriateness of the margin of the Indian AE would demand attention. Herein, it is important to note that the local company would receive adequate remuneration, directly or indirectly, upon an FAR analysis to identify the:
- degree of control,
- the capacity for independent operational activity,
- relative costs involved and
- The location of the development activity, before arriving at a sum.
This TP adjustment becomes stark when the Indian Tax Authorities notice that the Company which has enormously spent on AMP has a profit margin commensurate with other companies performing similar functions. If the Tax Authorities insist that separate compensation should be provided for AMP expenses with a mark-up addition, it would be unreasonable and it would lead to Double Taxation. Hence, the concept of TP adjustments has to be recognised in such international transactions.
Though all of the principles propounded by the Delhi HC are accepted in law, it should be noted that through a SLP, the Apex Court granted leave to the A.O to carry on his duty in accordance with the law and in ignorance of the High Court’s ruling by declaring that ‘no such principles ought to be laid down while deciding a writ petition’.
The LGI case interpreted the Supreme Court’s direction to the A.O for de novo determination, to inherently affirm the nature of AMP expenses as an international transaction u/s. 92B and to reiterate the A.O’s jurisdiction in determining the ALP when the matter wasn’t referred to him. Thus the TPO can examine the arm’s length pricing of such international transactions as those which weren’t reported by the taxpayer in Form 3CEB  nor specifically referred to him by the A.O. but comes to his notice during the course of the proceedings. The above issues were disputed before the introduction of the Finance Act 2012, which has rendered the much needed clarity.
The Chennai Tribunal in Ford India case upheld the LG SB ruling and stated that the Bright Line Test is applicable to compute the TP adjustments subject to the exclusion of selling expenses. Further, thehypothetical brand promotion fee computed at 1% was deleted.
This was followed by the BMW India v. ACIT ruling in the Delhi ITAT  which distinguished the LG SB Ruling on the basis of the fact that it was related to distributors who don’t need separate compensation but they could be reimbursed by being given a higher gross margin at ALP. The Tribunal further reasoned that:
“A judgement or a decision considered as a binding precedent necessarily has to be read as a whole. To decide the applicability of any section, rule or principle underlying the decision or judgement which would be binding as a precedent in a case, an appraisal of the facts of the case in which the decision was rendered is necessary. The scope and authority of a precedent should not be expanded unnecessarily beyond the needs of a given situation.”
Hence the applicability of a judicial precedent when the fact scenario and the circumstances of the cited case weren’t pari materia was problematized. It was further acknowledged that Transfer Pricing is a subjective exercise which can’t be solved with a straightjacket formula. Hence, the assessee’s business model, contractual terms entered into with the AEs and a detailed FAR analysis, are necessitated to appropriately characterise the transactions before making ALP adjustments. Herein, the FAR profile of a distributor is distinguished from that of a licensed manufacturer to hold that one single equation can’t decide the TP matters in both of the cases. Further, it was held herein that excessive AMP expenses could be compensated by the higher premium earned through robust sales. This is in contravention to the SB finding in LG India:
“Entity level profits do not benchmark all the international transactions of LG India and that a robust profit margin at entity level would not rule out AMP expense adjustment.”
The Tribunal also held that in the absence of suitable aids or guidelines in the Indian tax laws or jurisprudence, there is no bar/prohibition to refer to international jurisprudence/guidelines. In consonance with this pronouncement the findings in this case show a greater conformity to the well accepted international practice incorporated in the OECD Transfer Pricing Guidelines, the Australian Tax Office (ATO) Guidelines related to Marketing Intangibles and the OECD Discussion Draft on Intangibles.
It’s important to note that a later decision in Casio India Pvt Ltd.,  dissented from the coordinate bench’s decision in the BMW India case to follow the SB Ruling in LGI. Since it was a bench of the same quorum dissent was possible.  Casio India were the distributers of watches, consumer information and other related products of Casio, Japan. The Tribunal expressly decreed that the SB decision in the case of L.G. Electronics is ‘applicable with full force on all the classes of the assessees, whether they are licensed manufacturers or distributors, whether bearing full or minimal risk’.
In Glaxo Smith Kline Consumer Healthcare Ltd.,  the Chandigarh Tribunal also held that the Consumer Market Research Expenses and AMP Expenses attributable to various other domestic brands owned by the assessee should be excluded from the ambit of AMP Expenses and no adjustment is required to be made in respect of the same with the foreign AE.
In Canon India vs. DCIT,  the Delhi Tribunal relying on Special Bench Ruling in case of L.G. Electronics and Glaxo’s case held that, ‘while computing TP Adjustment for marketing intangibles, expenses on Commission, Cash Discount, Volume Rebate, Trade Discount etc. and AMP Subsidy received by the assessee from the Parent Company should be excluded from the total AMP Expenses.’
Recently, in Sony Ericsson Mobile Communications India Pvt. Ltd. v. CIT  it was held that AMP expense is a TP Transaction since June 1st, 2002. The Delhi HC ruled against the bifurcation and AMP costs and it has disagreed with the use of the bright-line test and the OECD/UN Manual suggesting non-routine AMP as a separate transaction. It was stated that if the same does not figure in the Act and rules in India, then it cannot be applied.
But the High Court differentiated the concept of brand-building from that of the AMP spend. It stated that brand-building does not necessarily result out of the AMP spend. There are many reputed brands which do not go in for advertisement with the intention to build brand value, but to increase sales and earn more profits. Thus ruled that considering the notion of brand-building as an equivalent of or as a substantial attribute of advertisement and sales promotion campaigns would be largely incorrect.
Further, it was added that the use of aggregation method is strongly suggested when the transactions are closely linked or are continuous transactions. The High Court clearly stated that bundling of marketing and distribution functions is the right approach since they are interconnected. This is at contrast to the ruling in LGI which held that purchase of goods is a separate transaction from AMP and it failed to appreciate that AMP is in fact closely linked to the overall activities of sales and distribution.
Thus the Court has held that separate computation of AMP expenses would result in incongruous results. So, after zeroing in on a ‘comparable’, the net margin should be analysed against the corresponding constructed figures of the comparable company as per Transaction Net Margin Method to arrive at the ALP. Also, ‘when the company is only in a single line of business, then there is no prohibition in applying TNMM on an entity wide basis.’ But if a suitable comparable isn’t available, then the other methods should be resorted to.
Since in Sony Ericsson it is recognised that these are closely linked transactions, set off is also permitted unlike the SB decision wherein separate compensation was necessitated despite higher profitability in distribution function.
Moreover, this recent judgment is in consonance with the dissenting opinion in LGI in so far as the relevance of Economic ownership on intangibles is recognised to state that the creator of the market intangible through advertising functions i.e. the domestic enterprise has the right to economically exploit it to realise tangible benefits. Such a reasoning, rules out the question of the Indian venture rendering any ‘service’ to the foreign AE, which is liable to be compensated.
Therefore, in accordance with the majority ruling in LGI it was held that marketing, having a direct connection with increasing the volume of selling and distribution expenses, wouldn’t constitute AMP costs.
Further, the Court has identified various factors which would be relevant in computing the appropriate method to determine the Transfer Pricing. They are:
- Functions, assets & Risk (FAR)
- The terms of the contract (short term or long term),
- Economic circumstances under which the business would operate
- Geographical locations,
- Level of demand and supply,
- Government contracts,
- Market size,
- Extent of competition,
- Business strategy
- Market penetration et al.
The appropriate methods to calculate the ALP of an international transaction for different business models and arrangements are:
- Transactional Net Margin Method (TNMM) for licensed distributers. Here, the royalty is added to the import value itself and it’ll be taxable.
- Resale Price Method (RSP) for Limited Risk Distributers. The similarity in the intensity of the functions performed by the ‘tested party’ and the comparable is crucial to the applicability of this method.
- TNMM for Licensed Manufacturing, producing and selling goods. If value addition is made upon importing the product, then the royalty fee would be allowable.
Thus, in essence, the High Court has recognised that a different principle would apply if the ‘tested party’ is a dealer or a trader in contrast to a manufacturer.
PART III: Conclusion
Before we conclude, it is interesting to note that the tried & tested idea of a ‘comparable company’, the only concept which hasn’t been shaken through the long run of judicial pronouncements, would indeed be hostile to the competitive economy which pervades Market Capitalism across countries. When comparable companies are chosen on the presumption that companies should incur a similar level of expense and resultantly, they should achieve similar profit numbers, it defeats the notion of acompetitive economy; and pursuant to this, when the averages are compared, that particular company itself is lost in the numbers!
 S. 92A 1a-b, 2a-m.
 S. 92B.
 OECD TP Guidelines, Chapter VI, para. 6.2, 2010.
 [TCM 1998- 461]; similar idea was propounded by the Canada SC in Canada vs Glaxo Smithkline Inc.
 (ITA No. 2089/Mds./2011).
 OECD TP Guidelines, para 3.9, 2010; UN Practical Manual on Transfer Pricing, para 18.104.22.168.
 LG India Private Ltd. v. Assistant Commissioner of Income Tax ITA No. 5140/Del/2011, Assessment Year 2007– 2008.
 Maruti Suzuki India Ltd vs. ACIT (2010‐TII‐01‐HC‐DELTP).
 S. 92CA (2B) of the Finance Act 2012.
(ITA No. 5354/Del./2012).
 Central Board Of Dawoodi Bohra v. State Of Maharashtra & Anr on 17 December, 2004 Writ Petition (civil) 740 of 1986.
 [TS-72-ITAT-2013 (CHANDI)-TP /2013-TII-71-ITAT-CHD-TP].
 (ITA No. 16/2014- Taxsutra.com).
Lakshana Radhakrishnan is presently an undergraduate student at National Academy of Legal Studies and Research (NALSAR) University of Law, Hyderabad. She will be graduating in 2019. She can be contacted at firstname.lastname@example.org.