BRIGHT LINE TEST: CONTROVERSY AROUND
Bright Line test is used by the revenue authorities to benchmark the advertisement and brand promotion expenses (AMP expenses) incurred by an enterprise in India on the reasoning AMP expense is incurred for brand-building and predominantly benefits the foreign parent or associated enterprises (AEs). Hence, appropriate compensation for such AMP expenses is required to be made by the AE with a mark-up based on the bright-line test. Since the very beginning, the issue related to AMP expenses has been has been the subject matter of controversy. As there is no statutory provision dealing with the same, the issues is getting settled through judicial pronouncements.
Origin of the Concept
The Bright Line Test was laid down by the US Tax court in the case DHL Corporation & Subsidiaries v. Commissioner of Internal Revenue while applying the Developer-Assister rule which exists in the US Transfer Pricing Regulations. As per the Developer-Assister rule, the developer being the person incurring the AMP spends (though not being the legal owner of the brand) was treated as an economic owner of the brand and the assister (being the legal owner of the brand), would not be required to be compensated for the use or exploitation of the brand by the developer. To cater to the Indian market and exploit their brands, MNCs set up subsidiaries in India which are generally engaged in the distribution of imported and branded products, manufactured and sold to them by their foreign AE. The intellectual property rights in the products as well as the brand lies with the AE whereas the subsidiary is licensed to use such brand for selling the products in India. The subsidiary company incurs AMP expenses for the promotion of the products or services. Revenue authorities have time and again held that the Indian subsidiaries incur huge non-routine expenditure to promote the brand of AE and to develop marketing intangibles for the AE. As per the revenue authorities, for incurring non-routine AMP expenditure, the taxpayer should be reimbursed. It is contended that by promoting the brand in India, the Indian subsidiary is providing a service to the foreign AE, for which it should be compensated. In order to benchmark the AMP expenditure, the revenue authorities used Bright Line Test (BLT) thereby holding that any expenditure in excess of the BLT is for the development of marketing intangibles, owned by the AE, which needs to be suitably compensated by the AE. As per the revenue authorities, the excess AMP expenditure incurred by the Indian subsidiary contributes towards the development and enhancement of the brand owned by the foreign AE. This enhancement in the value of the brand is generally referred to as marketing intangibles.
Indian Transfer Pricing regulations
In India, there is no such provision for benchmarking of marketing intangibles allegedly created by incurring non-routine AMP expenses. Chapter X of the Income Tax Act deals with the provisions for avoidance of tax. Section 92 and the related provisions deal with computation of income arising from an international transaction having regard to the arm's length price. Transfer Pricing Provisions are not intended to override the charging provisions of section 4 of the Act. Section 92 is a machinery provision and it cannot enlarge the scope and ambit of the Act. Section 92 of the Act is not a charging provision and would not apply in the absence of liability to pay tax.
The term International transaction is defined in section 92B of the Act. To be covered within the scope of section 92B, there must be a transaction between two or more 'associated enterprises', either of whom is a non-resident. A transaction to be characterized as an 'international transaction', it should arise pursuant to an arrangement, understanding or action in concert. Arm's length price in relation to an international transaction shall be determined by applying any of the methods prescribed in section 92C. The role of the Transfer Pricing Officer is limited to the determination of arm's length price in relation to the international transaction(s) referred to him by the Assessing Officer. Thus, the benchmarking analysis of the AMP expenses has to be carried out with respect to income from an 'international transaction' by applying any of the prescribed methods. Prior to the amendments made by the Finance act, 2012, the Tribunals held that the international transaction of AMP expenses have not been referred to the TPO by the AO, hence, the assumption of the jurisdiction by the TPO in working out the ALP of the AMP transaction is not justified. But after the amendments made by Finance Act, 2012, the definition of the term international transaction has been widened to bring within its ambit provision of services related to the development of marketing intangibles and the TPO has been empowered to scrutinize any international transaction which he deems fit.
The primary issues surrounding AMP Expenses is whether AMP transaction is an international transaction and under what circumstances can transfer pricing adjustments be made for AMP expenses? Whether TPO can make an addition on account of royalty or brand development fee, computed on sales turnover and on excess AMP expenditure determined on the arms length principle? What is the process for benchmarking of AMP transactions, whether the revenue authorities are justified in applying the Bright Line Test for determination of ALP of AMP?
Application of Bright Line Test in India Legal Precedents
MARUTI SUZUKI INDIA LTD vs. ACIT
The issue of marketing intangibles was dealt by the Delhi High Court in the case of Maruti Suzuki India Ltd vs. ACIT wherein the assessee, Maruti Suzuki India Ltd. (MSI), entered into a license agreement, with Suzuki Motor Corporation (SMC) for the manufacture and sale of certain models of Suzuki automobiles. MSI was granted exclusive right to use trademark 'Suzuki' for a lump sum royalty payment as well as running royalty to be paid every year. As per the agreement, all products and parts assembled and sold by MSI pursuant to the agreement shall bear the trade mark of MARUTI-SUZUKI.
TPO held that the trademark Suzuki, which was owned by SMC, had piggybacked on the Maruti trademark, without payment of any compensation by Suzuki to Maruti. TPO held that on the basis of the terms and conditions of the agreement between Maruti and Suzuki that Maruti had developed marketing intangibles for Suzuki in India, at its cost, and it had not been compensated for developing those marketing intangibles for Suzuki. He also concluded that non-routine advertisement expenditure was also to be adjusted.
Delhi High Court while remanding the matter back to TPO to determine the appropriate ALP, clarified the procedure to be followed and approach to be adopted by authorities while processing such cases. Some of them are enumerated below:
(i) If an independent domestic entity uses a foreign trademark and/or logo on its products no payment to the foreign entity in this regard is necessary, unless agreed by it.
(ii) If a domestic entity, which is an AE of a foreign entity within the meaning of s. 92A of the Act, uses a foreign trademark and/or logo on its products no payment to the foreign entity on account of such user, is necessary, in case the use of the foreign trademark and/or logo is discretionary for the domestic entity.
(iii) If the domestic entity is mandatorily required to use the foreign trademark and/or logo on its products, appropriate payment in this regard should be made by the foreign entity to the domestic entity on account of the benefit it derives in the form of marketing intangibles, obtained by it from such mandatory use of its trademark and/or logo. Even in the cases where payment in such terms is to be made by the foreign entity, to the domestic entity, the ALP in respect of the income, from the international transaction between the two entities, needs to be determined.
(iii) The expenditure incurred by an independent domestic entity on advertising, promotion and marketing of its products using a foreign trademark/logo does not require any payment or compensation by the owner of the foreign trademark/logo on account of use of the foreign trademark/logo, unless agreed by the domestic entity.
(iv) Domestic entity is not entitled to compensation on advertising, promotion and marketing of its products using a foreign trademark/logo so long as the expenses incurred by the domestic entity do not exceed the expenses incurred by a similarly situated comparable independent domestic entity. If the expenses incurred by domestic entity are more then the foreign entity needs to suitably compensate the domestic entity in respect of the advantage obtained by it in the form of brand building and increased awareness of its brand in the domestic market.
(v) In case the foreign entity is liable to compensation, TPO needs to determine the ALP in respect of the international transaction made by the domestic entity, with the foreign entity taking into consideration all the rights obtained and obligations incurred by the two entities, including the advantage obtained by the foreign entity.
The judgment delivered by the Delhi High Court supported the Bright Line Test propounded by US Tax Court. It made a distinction between mandatory and discretionary use of brand name to decide whether the AMP expenditure incurred by the Indian AE increased brand value of foreign AE. While specifying some general guiding principles, it led to new set of issues altogether.
Supreme Court directed the TPO to examine the matter in accordance with law without being influenced by the observations or directions given by the Delhi High Court.
L.G. ELECTRONICS INDIA PRIVATE LIMITED vs. ASSISTANT COMMISSIONER OF INCOME TAX
A Special Bench of the Income Tax Appellate Tribunal, Delhi held that the AMP expenses incurred by assessee for creating or improving the marketing intangibles for and on behalf of the AE would constitute an international transaction. It held that AO is entitled to make a transfer pricing adjustment on the basis of Bright Line Test in respect of the AMP expenditure incurred by assessee. It was held that while expenses for the promotion of sales directly lead to brand building, the expenses directly in connection with sales are only sales specific and cannot be brought within the ambit of AMP expenses for determining the cost/value of the international transaction. It laid down a set 14 factors which needs to be kept in view before determining the cost/value of the international transaction. While holding that the transfer pricing adjustment in relation to advertisement, marketing and sales promotion expenses incurred by the assessee for creating or improving the marketing intangible for and on behalf of the foreign AE is permissible and secondly, earning a mark-up from the Associated Enterprise in respect of AMP expenses incurred for and on behalf of the AE is also allowable, TPO restored the matter to TPO for de novo adjudication in the light of guidelines issued by it.
MS FORD INDIA PVT. LTD. vs. DEPUTY COMMISSIONER OF INCOME TAX
In this case, the Chennai Tribunal following the Special Bench ruling in the case of LG Electronics India Pvt. Ltd. held that there was an international transaction for creating and improving the marketing intangible comprised in the logo "Ford" by the assessee for and on behalf of FMC. It was held that since, assessee did not declare any cost/value for the international transaction comprising of brand building, therefore, it was imperative for the TPO to apply Bright Line test for determining such value. Tribunal held that order of TPO in applying Bright Line Test did fall within the method prescribed under Section 92C and the only lacuna was only in not following the steps mentioned in the Rule 10B(1)(c) in the manner prescribed. Tribunal further held that the expenditure directly in connection with sales had to be excluded in computing the AMP adjustment.
MARUTI SUZUKI INDIA LTD. & ANR. vs. COMMISSIONER OF INCOME TAX & ANR.
In this case, Delhi High Court held that that AMP transaction did not fall within the ambit of Explanation I to Section 92B and that the onus of proving the existence of an international transaction was on the Department. It was held that in the absence of substantive machinery provisions in Income Tax Act, 1961, excessive AMP expenditure could not be used as a basis for inferring existence of an international transaction. The court rejected the Bright Line Test as a legitimate method for determining existence of international transaction by placing reliance on the judgment in the case of Sony Ericsson.
The decision of the Delhi High Court in Maruti Suzuki India Ltd. has subsequently been followed in a number of other cases. Further, in cases like Haier Appliances (India) Pvt Ltd vs. Deputy Commissioner of income Tax, Valvoline Cummins Ltd vs. Deputy Commissioner of income Tax  and Commissioner of income Tax vs. Whirlpool of India Ltd, Bausch & Lomb Eyecare (India) Pvt. Ltd. & Ors. vs. Additional Commissioner of Income Tax & Ors., it was held that mere increasing of AMP expenditure by the Assessee cannot lead to conclusion that it involves an international transaction in that regard. The authorities examined the circumstances that would be relevant in determining whether the AMP expenses/ activities constitute an international transaction requiring an arms length compensation.
Decision of the Delhi Tribunal gave a new dimension to the issues of AMP expenses in the case of Luxottica India Eyewear Pvt Ltd vs. Assistant Commissioner of Income Tax. In this case, for the first two years, TPO had applied the bright line test and treated excess advertising, marketing and promotion (AMP) expenses, as a separate international transaction. But for the third year, TPO made an adjustment on account of difference in intensity of marketing function undertaken by the taxpayer vis-à-vis its comparables. For the first two AYs, the matter was remanded back with a direction to the AO/ TPO to relook at the cases, in line with the decision of the Delhi High Court in the case of Sony Ericsson. For the third AY, Tribunal accepted the approach of the TPO by placing reliance on judgements of the Delhi High Court in the case of Bausch and Lomb and Sony Ericsson wherein the court had stated that the comparables chosen should be undertaking similar functions. In this case, TPO drifted from its previous approach and classified marketing activity as a function undertaken by a distributor. Since the intensity of the marketing function was higher than those of the comparables, the TPO attempted to make an economic adjustment on the margins of the comparables to account for differences in intensity of marketing function.
In some of the recent judgments, Pepsico India Holdings Pvt. Ltd. & Anr. vs. Additional commissioner of income tax & Anr., Valvoline Cummins Pvt. Ltd. vs. Deputy Commissioner of Income Tax, Whirlpool of India Ltd. vs. Deputy Commissioner of Income Tax, it has been held that when the BLT method adopted by the TPO incurring the AMP expenses has been held to be not legally sustainable, the entire exercise of determining AMP expenses as international transaction by the TPO is without any basis, hence not sustainable.
The transfer pricing aspects of marketing intangibles has been in controversy from the last few years. The AMP is a controversial issue and is highly factual depending upon qualitative examination of the business model and true functional profile of the taxpayer. It has to be determined as to whether the AMP expenses incurred by the Indian entity is in their capacity as a service provider or as entrepreneurs in their own capacity. The mode of remuneration would also play an important role. In the absence of any specific guidelines, the resolution to the controversy seems inevitable.
About the author
CA Maneet Pal, Partner, I.P. Pasricha & Co
Maneet Pal Singh is a member of the Institute of Chartered Accountants of India. He is a partner in I. P. Pasricha & Co., New Delhi. He has experience in the field of Direct Taxation. He has extensive experience in advising clients across a range of industries in assessments/ transfer pricing assessments, returns filings, drafting opinions, preparation of Transfer Pricing Study reports.
CA Deepak Suneja, Senior Manager, I.P. Pasricha & Co
Deepak Suneja is a member of the Institute of Chartered Accountants of India. He is working as Senior Manager in I.P. Pasricha & Co., New Delhi. He has experience in the field of Taxation and Regulatory services.
Disclaimer: Above expressed are the personal views of the author, and the publisher or the author disclaim all, and any liability and responsibility, to any person on any action taken on reliance of it.
 (2010) 78 CCH 0529 DelHC : (2010) 328 ITR 0210
 (2013) 35 CCH 0090 : (2013) 022 ITR 0001 (SB)
 (2013) 36 CCH 0184 ChenTrib : (2013) 25 ITR (Trib) 0456 (Chennai)
 (2015) 94 CCH 0121 DelHC : (2016) 381 ITR 0117 (Delhi)
 (2015) 45 CCH 0148 DelTrib
 (2017) 99 CCH 0307 DelHC
 (2015) 94 CCH 0156 DelHC : (2016) 381 ITR 0154 (Delhi)
 (2015) 94 CCH 0162 DelHC : (2016) 381 ITR 0227 (Delhi)
 (2017) 50 CCH 0055 DelTrib
 (2018) 54 CCH 0293 DelTrib
 (2018) 54 CCH 0268 DelTrib
 (2018) 54 CCH 0264 DelTrib
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