Judgment summary
These were two appeals by Maruti Suzuki India Ltd. ('MSIL') under Section 260A of the Income Tax Act, 1961, against orders of the Income Tax Appellate Tribunal ('ITAT') for Assessment Year 2005-06 (ITA 110/2014) and Assessment Year 2006-07 (ITA 710/2015) (1).
The appeals concerned determination of the arm's length price ('ALP') of advertisement, marketing and sales promotion ('AMP') expenses incurred by MSIL, and whether such expenditure could be treated as an international transaction with its associated enterprise ('AE'), Suzuki Motor Corporation, Japan ('SMC'), attracting transfer pricing adjustment under Chapter X of the Act (2, 3).
The Court examined the earlier Special Bench decision of the ITAT in LG Electronics India Pvt. Ltd. v. ACIT, its own prior decision in Sony Ericsson Mobile Communications India P. Ltd. v. Commissioner of Income Tax, the history of MSIL's own writ petition and the Supreme Court's order in that matter, before answering the questions of law framed.
The Court concluded that AMP expenses incurred by MSIL could not be treated and categorised as an international transaction under Section 92B, and accordingly no transfer pricing adjustment under Chapter X could be made in respect of such expenditure (89). The impugned ITAT orders for both assessment years, and the corresponding orders of the DRP, AO and TPO, were set aside, and the appeals allowed with no order as to costs (90).
Background
MSIL is engaged in manufacture of passenger cars in India and is a subsidiary of SMC, which held 54.21% of MSIL's shares as on 31st March 2006 (4). MSIL began as a Government of India owned company in 1982, and SMC was independently selected as its business partner; the co-branded trademark 'Maruti-Suzuki' had been used since MSIL's inception under a licence agreement dated October 1982 (5).
For AY 2005-06, MSIL filed its return declaring income of Rs. 13,46,51,71,140 (6). The AO referred the matter to the Transfer Pricing Officer ('TPO') under Section 92CA(1) for determination of ALP of international transactions with SMC, including purchase of components, sale of vehicles, technical services, royalty and other items (6). The TPO's order dated 21st December 2010 proposed an addition of Rs.252.26 crores, comprising Rs.98.14 crores on royalty (later deleted by the ITAT) and Rs.154.12 crores on AMP expenses (7).
The TPO applied the 'bright line test' ('BLT'), comparing MSIL's AMP spend of 1.87% of sales with a mean of 0.620% for comparable companies (Hindustan Motors, Tata Motors and Mahindra & Mahindra), and treated the excess as brand promotion for SMC (8). This formed the basis of the draft assessment order dated 31st December 2010, the DRP's order dated 23rd September 2011 upholding the addition, and the AO's final assessment order dated 28th October 2011 (9, 10, 11).
MSIL had earlier filed a writ petition (W.P.(C) 6876 of 2008) challenging the TPO's notice, which resulted in a Division Bench judgment reported as MSIL v. ACIT/TPO (2010) 328 ITR 210 (Del.), directing the TPO to re-determine the ALP (16-19). On appeal, the Supreme Court in MSIL v. ACIT (2011) 335 ITR 121 (SC) directed the TPO to proceed 'uninfluenced by the observations/directions' of the High Court's judgment (20).
For AY 2006-07, the TPO's order dated 26th October 2009 proposed an addition of Rs.124.24 crores on account of AMP expenses, later enhanced through subsequent orders to Rs.158.64 crores, with the AO's rectification order dated 12th April 2012 giving effect to the enhancement (33). The ITAT, by order dated 24th August 2015, remitted the matter to the TPO/AO in light of the Sony Ericsson decision (34).
Core dispute
The central issue was whether AMP expenses incurred by MSIL in India could be treated as an international transaction under Section 92B of the Income Tax Act, 1961, so as to permit a transfer pricing adjustment under Chapter X (31, 89).
Related questions concerned whether the Assessing Officer's reference to the TPO validly covered AMP expenses despite no specific reference having been made prior to the retrospective amendment to Section 92CA by the Finance Act, 2012; whether, if such a transaction existed, the ITAT was correct to direct that the adjustment be computed using the Cost Plus Method; and whether the ITAT was right to direct fresh benchmarking by the TPO applying the parameters in paragraph 17.4 of the Special Bench decision in LG Electronics (31).
The Revenue contended that MSIL's AMP spend, being 'proportionately higher' than comparable domestic entities, evidenced an implied arrangement or understanding with SMC to build the 'Suzuki' brand, and that economic ownership of the brand benefit accrued to SMC through increased royalty, raw material sales and brand value (8, 66, 77-81).
MSIL contended that the Revenue had failed to demonstrate any agreement, arrangement or understanding between MSIL and SMC regarding AMP expenditure, that the bright line test could not be used (following Sony Ericsson) either to infer the existence of an international transaction or to quantify any adjustment, and that MSIL's own operating margins were already higher than comparables under the transactional net margin method (39, 40, 86).
Court findings
The Court held that the decision in Sony Ericsson Mobile Communications India P. Ltd. v. Commissioner of Income Tax (2015) 374 ITR 118 did not conclusively determine the existence of an international transaction as far as MSIL was concerned, because the assessees whose appeals were decided in Sony Ericsson (Sony Ericsson, Reebok and Canon) were distributors, not manufacturers, and none of them had disputed the existence of an international transaction regarding AMP expenses (42-51).
The Court found that the earlier Division Bench judgment in MSIL's own writ petition, and the Supreme Court's order directing the TPO to proceed 'uninfluenced' by that judgment, did not preclude MSIL from contesting the existence of an international transaction, particularly since the writ petition judgment itself had relied on the bright line test, which Sony Ericsson had since rejected (52-56).
Analysing Section 92B(1) read with Section 92F(v), the Court held that for an international transaction to exist, the Revenue had to show an actual 'agreement', 'arrangement' or 'understanding' between MSIL and SMC obliging MSIL to incur AMP expenditure for SMC's benefit; the existence of such a transaction could not be inferred merely from the quantum of AMP spend being higher than that of comparable entities (60, 61, 64).
The Court held that Chapter X of the Act contains no machinery provision enabling determination of the existence of an international transaction involving AMP expenditure once the bright line test is excluded, and that a quantitative adjustment of this kind is not contemplated by Chapter X, which only permits substitution of the transaction price with the ALP (68-76).
The Court noted that MSIL's AMP expenditure was only 1.87% of its sales compared to SMC's worldwide AMP expenditure of 7.5% of sales, which undermined any inference of an arrangement obliging MSIL to incur AMP spend for SMC's benefit (50, 80). It also noted that the co-branded mark 'Maruti-Suzuki' did not belong to SMC and could not be used by SMC, and that any benefit to SMC was, on the material presented, incidental rather than the product of an arrangement (78-84).
The Court further observed that MSIL's operating profit margin of 11.19% exceeded the comparable companies' margin of 4.04%, so that under the transactional net margin method there was no basis for a separate AMP adjustment (86).
Outcome
The Court answered the framed questions as follows: Question 1 was answered by reference to Sony Ericsson, namely that the TPO could examine whether AMP expenses constituted an international transaction absent a specific reference by the AO. Question 2 was answered in the negative and in favour of the Assessee, holding that AMP expenses incurred by MSIL could not be treated as an international transaction under Section 92B. Question 3 was answered in the negative and in favour of the Assessee, since no transfer pricing adjustment could arise given the answer to Question 2. Question 4 did not arise for consideration. Question 5 was answered in the negative and in favour of the Assessee, holding that the ITAT was not right to direct fresh benchmarking by the TPO applying the LG Electronics parameters (89).
The impugned order dated 2nd August 2013 of the ITAT for AY 2005-06 and the order dated 24th August 2015 of the ITAT for AY 2006-07, together with the corresponding orders of the DRP, AO and TPO, were set aside. The appeals were allowed in these terms, with no order as to costs (90).
Tp method highlighted
The TPO had applied the 'bright line test' (BLT), comparing MSIL's AMP expenditure as a percentage of sales (1.87%) against a mean percentage (0.620%) incurred by comparable companies (Hindustan Motors, Tata Motors and Mahindra & Mahindra), treating the excess as expenditure incurred for brand promotion of SMC and applying a mark-up to compute the proposed adjustment of Rs.154.12 crores for AY 2005-06 (8, 18).
The Court held that the BLT, having been rejected in Sony Ericsson as a means of determining either the existence of an international transaction or the ALP of AMP expenses, could not be used, and that Chapter X contains no other machinery provision to determine the existence of an international transaction involving AMP expenditure or to quantify any adjustment in respect of it (65, 68, 72).
The Court also noted that under the transactional net margin method (TNMM), where an assessee's operating margins are already higher than those of comparable companies, no separate adjustment for AMP expenditure is warranted; MSIL's operating margin of 11.19% exceeded the comparables' 4.04% (86).
Major issues / areas of contention
- Whether AMP expenses incurred by MSIL in India could be treated and categorised as an international transaction under Section 92B of the Income Tax Act, 1961.
- Whether, if such a transaction existed, a transfer pricing adjustment could be made by the TPO/AO under Chapter X in respect of AMP expenditure.
- Whether the additions suggested by the TPO on account of AMP expenses were beyond jurisdiction given the absence of a specific reference by the AO, having regard to the retrospective amendment to Section 92CA by the Finance Act, 2012.
- Whether the earlier Division Bench judgment in MSIL's writ petition, and the Supreme Court's subsequent order, precluded MSIL from contesting the existence of an international transaction concerning AMP expenses.
- Whether the bright line test could be used to infer the existence of an international transaction or to quantify any transfer pricing adjustment, in light of the decision in Sony Ericsson.
- Whether the ITAT was right to direct that a transfer pricing adjustment in respect of AMP expenses should be computed by applying the Cost Plus Method.
- Whether the ITAT was right to direct fresh benchmarking/comparability analysis by the TPO applying the parameters specified in the Special Bench decision in LG Electronics India Pvt. Ltd.
- Whether the benefit derived by SMC from MSIL's AMP expenditure and use of the co-branded trademark 'Maruti-Suzuki' was merely incidental or the result of an arrangement between the parties.
- Whether MSIL's operating margins, being higher than those of comparable companies, obviated the need for any separate AMP adjustment under the transactional net margin method.