Delhi High Court Sets New Precedent on Transfer Pricing Adjustments for AMP Expenses: Rejection of Bright Line Test

Introduction

In the landmark case of The Commissioner Of Income Tax-Ltu v. Whirlpool Of India Ltd., adjudicated by the Delhi High Court on December 22, 2015, significant legal principles concerning Transfer Pricing (TP) adjustments were established. The case revolved around the determination of the arm's length price (ALP) for advertisement, marketing, and sales promotion (AMP) expenses incurred by the Indian subsidiary, Whirlpool of India Ltd. (WOIL), in its international transactions with its foreign associated enterprise (AE), Whirlpool Corporation, USA.

The crux of the matter was whether the AMP expenses incurred by WOIL, which by nature benefited both the subsidiary and the foreign AE, should be subject to TP adjustments. The Revenue argued for attributing a portion of these expenses to the foreign AE, necessitating compensation or reimbursement, while WOIL contended that these expenses were solely for its own business interests.

Summary of the Judgment

The Delhi High Court meticulously examined the issues pertaining to TP adjustments of AMP expenses under Section 92A of the Income Tax Act, 1961. The primary contention was whether the AMP expenses constituted an international transaction under Section 92B of the Act, thereby necessitating an ALP determination.

The court delved into the validity of the Bright Line Test (BLT) applied by the Income Tax Appellate Tribunal (ITAT) in previous decisions, notably the LG Electronics case. It held that the BLT, as a method for identifying and determining ALP for AMP expenses, was invalid, reaffirming the decision in the Sony Ericsson case. Consequently, the court concluded that the Revenue failed to demonstrate the existence of an international transaction involving AMP expenses, thereby dismissing the TP adjustments proposed by the assessing officer.

Analysis

Precedents Cited

The judgment extensively referenced prior cases to substantiate its stance:

• LG Electronics India Pvt. Ltd. v. ACIT (2013): The ITAT Special Bench introduced the BLT for determining ALP in TP adjustments concerning AMP expenses.
• Sony Ericsson Mobile Communications India P. Ltd. v. Commissioner of Income Tax (2015): The Delhi High Court overruled the BLT, emphasizing the necessity of tangible evidence over judicially created tests.
• Maruti Suzuki India Ltd. v. Commissioner of Income Tax (2014): Reinforced that TP adjustments require substitution of transaction prices with ALP, rejecting the notion of assuming transactions without clear evidence.
• Daiichi Sankyo Company Ltd. v. Jayaram Chigurupati (2010): Clarified the meaning of "acted in concert," emphasizing the necessity of a shared common objective.
• Sassoon J. David v. CIT (1979): Established that incidental benefits to third parties do not automatically disqualify expenses from being deductible under business purposes.

Legal Reasoning

The court's reasoning centered on the strict interpretation of the provisions under Chapter X of the Income Tax Act. It emphasized that:

• Existence of International Transaction: For any TP adjustment, there must be clear evidence of an international transaction as defined under Section 92B. Mere association or incidental benefits do not suffice.
• Rejection of BLT: The court invalidated the use of BLT for determining the ALP, asserting that TP adjustments should rely on established price discovery methods as outlined in Section 92C.
• Substitution Principle: Emphasized that TP adjustments should substitute the transaction price with the ALP, not derive adjustments from excess expenditures.
• Bifurcation of Expenses: Any attempt to segregate AMP expenses without a valid transactional basis was deemed incongruous and impermissible.

By rejecting the BLT and reiterating the necessity of tangible agreements or arrangements for TP adjustments, the court reinforced the principle that TP laws must be applied with precision and substantiated evidence.

Impact

This judgment has profound implications for both tax authorities and multinational enterprises:

• For Tax Authorities: It underscores the importance of concrete evidence in establishing international transactions for TP purposes, discouraging reliance on arbitrary tests like the BLT.
• For Multinational Enterprises: Reinforces the autonomy of subsidiaries in managing their business expenses, provided there is no explicit agreement linking those expenses to the foreign AE.
• Regulatory Framework: Highlights the need for clear statutory provisions governing TP adjustments, especially concerning complex expense allocations like AMP.
• Judicial Oversight: Encourages higher courts to revisit and rectify lower tribunal decisions that may deviate from established legal principles.

Complex Concepts Simplified

Transfer Pricing (TP)

TP refers to the rules and methods for pricing transactions between enterprises under common ownership or control. TP adjustments ensure that transactions are conducted at arm's length prices (ALP), preventing profit shifting and tax avoidance.

Arm's Length Price (ALP)

ALP is the price that would be charged between independent entities under similar circumstances. It serves as a benchmark to ensure fair pricing in inter-company transactions.

Bright Line Test (BLT)

A heuristic used to establish standards or determine clear-cut outcomes. In this context, it was an arbitrary test to identify and adjust AMP expenses, which the court subsequently invalidated.

Advertisement, Marketing, and Sales Promotion (AMP) Expenses

These are costs incurred by a company to promote its products and brand. The debate in this case was whether such expenses, benefiting both the subsidiary and the parent company, should be adjusted for TP purposes.

Conclusion