Delhi HC Ruling on AMP Expenses – Rejecting the Bright Line Test for PepsiCo India

AMP expenses (Advertisement, Marketing, and Promotion expenses) are costs incurred by a company to promote its products and build brand awareness. They include:

– Advertisement Costs | Media advertising (TV, radio, print, online).
– Marketing Costs | Market research, product launches, sponsorships.
– Promotion Costs | Sales promotions, discounts, special offers, events.

In transfer pricing, AMP expenses are analysed to see if they benefit a foreign parent company's brand, potentially requiring compensation for the local subsidiary.

By Nitin Narang | Partner [Transfer Pricing] – Nangia & Co LLP

Table of Contents

1. The Background
2. The Controversy
3. The Missing Pieces
4. Judiciary’s View
5. To Conclude

In the recent ruling of Hon’ble Delhi High Court (HC) in the case of Pr. CIT v. Pepsico India Holding Pvt. Ltd. involving the issue of marketing intangibles, it was held that the AMP computation (i.e. computation of advertisement, marketing and sales promotion expenses) which was based on the adoption of the Bright Line Test (BLT), would clearly not sustain in light of the judgement rendered by the Court in Sony Ericson v. CIT. Thus, the case did not find any merits and same was dismissed.

On opening a soda bottle, carbon dioxide dissolved in it suddenly comes out as a fizz. This is because, there is a sudden decrease in the pressure above the drink and thus the dissolved carbon dioxide becomes less soluble resulting in fast release of CO2 with a fizzing sound. Similar to this, is the marketing intangibles or the AMP expenses issue, where the pressure is created from the excess AMP expenses, incurred by the local Indian subsidiaries, tested by BLT and if excessive, resulting into a fizzing adjustment for marketing intangibles issue. However, as per the Hon’ble HC, the BLT cannot create any fizz.

1. The Background

The issue of marketing intangibles or the AMP expenses as is its commonly called, is vexed and has been in litigation from a long time. Its original shape and form was designed around the BLT and inspite of being struck down very explicitly by HC, it remains in its vintage form, in the Transfer Pricing (TP) orders.

Let us dwell further on the issue and what’s the history has been so far.

In many instances, the Tax Authorities in India have taken an aggressive stand by claiming that the AMP expenses or any expense incurred under the AMP account makes a valuable addition to the trademark/brand legally owned by the foreign-related party for brand building. This thereby concludes that the local Indian subsidiary must be compensated by the legal brand owner, i.e. the overseas related party/associated enterprise, for the benefit bestowed or the additional services rendered by the local Indian subsidiary, on an arm’s length basis.

As a background, even though intellectual property (IP) is part of the definition of an ‘international transaction’, however in addition to this, the Indian TP regulations do not offer clear guidance on intangibles. Furthermore, there is no specific inclusion of the expenses relating to AMP in the definition of the term ‘international transaction’. On the contrary, the BLT is used to state that if the AMP expenses are higher than comparables, then there is an international transaction, else not. Thus, the basic premise of being an international transaction is a non-starter to begin with. This leads to a discussion about the legitimacy of whether the AMP should be considered an international transaction in the first place. Besides, the question in this regard arises as to whether AMP expenses are allowed in the hands of the taxpayer based on the commercial justification or the legal ownership of the assets.

2. The Controversy

India as the new global market has its unique characteristic features that includes location advantages, market accessibility, customer necessity, etc. that have made its subsidiaries/related parties of Multi-National-Enterprises (MNEs) spearhead different and far more extensive and faster marketing techniques seeking to gain a competitive ground in India. This has resulted in the topic of marketing intangibles becoming one of the most widely discussed TP topics in India.

As mentioned earlier, the tax authorities indicate that the issues relating to legal ownership of intangibles are pertinent to the TP regulations. However, the taxpayers argue that since the Indian subsidiary is the economic owner of such intangibles, they cannot justify that the subsidiary must recover the AMP expenses from its related parties because the subsidiary would be the direct recipient of the benefits from the incurring of such expenses.

The information is further amplified by the use of what the tax department employs to determine the arm’s length price (ALP) of such other alleged international transaction: the ‘BLT.’ This is a concept derived from a US tax court case. As per this test, all such AMP expenses that are incurred by the taxpayer and are more than the amount of average AMP expenses, about foreign-related parties, incurred by comparable companies in India, then such fees are to be treated as non-routine expenses (expenses for creating brand value in India of the foreign related parties) and thus should be benchmarked as per the ALP.

3. The Missing Pieces

In this context, several pertinent questions arise:

• Whether the AMP expenses can be considered an international transaction?
• Must the Indian local subsidiary, seeing it is not a legal owner of the trademark but is an economic owner or developer of the brand/trademark, be exonerated from the necessity to cover AMP expenses?
• If construed to be an international transaction, then how can the ALP be determined, and what is the validity of the ‘BLT’?
• How much incremental value do the IP owner get from the brand, and what specifically relates to the AMP expenses of the Indian subsidiary that have been claimed?

4. Judiciary’s View

The matter is still an open issue in the Hon’ble Supreme Court (SC) as the taxpayers and the Indian Revenue Board have filed appeals against different decisions of the various HCs throughout India.

More importantly, the Delhi HC came out with important judgments in the cases of Sony Ericsson Mobile Communications India Pvt. Ltd.3 and Maruti Suzuki India Ltd. v. CIT
Brief synopses of the Hon’ble Delhi HC rulings are as follows:

• In the case of Sony Ericsson, the Hon’ble HC held that, since taxpayer distributors had argued that the rewards of their excessive AMP expenses were subsumed within the profit margins of distribution, the taxpayers could not contend that AMP expenses were not ‘international transactions’ at the same time. However, having held as above, the Hon’ble HC hastened to add that, while a taxpayer distributor who may perform additional functions on account of the AMP as compared to similar companies would generally require additional remuneration for such functions. Such additional rewards may be granted through pricing of products or distribution margins. If so received, the revenue officer cannot demand a separate remuneration through reimbursement of excess AMP expenses along with a mark-up, as such action would clearly result in double addition or taxation, which does not have any sanctity.
• In the case of Sony Ericsson, the AMP computation which was based on the adoption of the BLT, was struck down.
• In the case of Maruti Suzuki, optically being of the character of an entrepreneurial licensed manufacturer, the Hon’ble HC dismissed the attempt on the part of the revenue officer to impute TP adjustment of the above nature while adjudicating the case. The excess AMP spend of Maruti Suzuki India, as a percentage of its turnover was over the average of those of its comparable companies selected under Transactional Net Margin Method (TNMM). The main reasoning of the Hon’ble HC, while concurring with the arguments of the taxpayer, was that the AMP spend on a stand-alone basis could not be treated as an ‘international transaction’ under the provisions of the Indian TP regulations, in the context of licensed manufacturers of the type of Maruti Suzuki India. Thus, the TP adjustment with respect to any part thereof, in the manner proposed by the revenue officer, namely reimbursement of the ‘so-called’ excess amount of the AMP spend, by the foreign licensor of the brand, was clearly not sustainable.
• Appeals arising from both the said rulings of the Hon’ble HC along with the other rulings following the ratio of such rulings filed both by taxpayers and the Indian tax authorities are currently pending adjudication before the Hon’ble SC. It is worthwhile to note that the main ground, which is being contested by both the parties before the SC, is whether AMP expenses are an ‘international transaction’.
• Until any resolution is provided by the Hon’ble SC, the available antagonistic Hon’ble HC and Hon’ble Tribunal judgements at present do not provide clear direction to proceed on the matter.

5. To Conclude

The question that arises is, would the issue of the AMP expenses, which is a subset of the overall concept of marketing intangibles, be fully resolved only through the Hon’ble SC answering such a question, albeit in the backdrop of the facts of different types of taxpayers?

The Hon’ble SC may render justice only with respect to the limited issue before itself which is created by the manner in which TP adjustments have been made by the tax authorities in such cases wherein reimbursement of excess AMP expenses of a licensee with a mark-up has been proposed. Therefore, there is uncertainty as to how and to what extent would the larger issue around marketing intangibles be addressed by the Hon’ble SC. Additionally, doubts arise whether the SC would actually be laying down detailed guidance around the same in the context of different classes of taxpayers in the absence of the SC being seized of such matter. Only time will unfold the SC’s view.

However, on their part, it is imperative for the taxpayers to undertake a comprehensive and detailed analysis of the supply chain, functional profile of the transacting entities in terms of the development, enhancement, maintenance, protection, exploitation (‘DEMPE’) related to marketing intangibles, legal contracts, economic substances, etc., to substantiate the arm’s length nature of their business models.

(With excerpts from India Chapter in the book – “Fundamentals of Transfer Pricing, Industries, Regions, New Technologies, and Other Topics”, edited by Dr. Raffaele Petruzzi, Giammarco Cottani and Michael Lang, Institute of Austrian and International Tax Law, Vienna – WU Transfer Pricing Center, which he has Co-authored in 2022)