Section 92B of the Income Tax Act defines `international transaction’. So let’s start with a simplified reading of the section.
Simplifying Section 92B – International Transaction
The section primarily classifies the combination of party types and transactions that results in an international transaction.
- Transaction between two or more associated enterprises, either or both of whom are non-residents.
- Transaction between an enterprise and an individual based on a prior agreement, where either of the two parties are non-residents.
- Purchase, sale, transfer or lease of tangible or intangible property,
- Provision of services
- Lending or borrowing money
- Any other transaction having a bearing on the profits, income, losses or assets of such enterprises
A list of transactions qualifying as international transactions has been appended to Section 92B. An explanation defining intangible property has also been appended to Section 92B. Intangible property inter alia includes marketing related intangible assets such as trademarks, trade names etc.
Types of Intangibles Covered
What’s the Issue?
This gives rise to the question: If a domestic company is promoting the brand name of its foreign parent company, will the advertising and promotion expenses be subject to transfer pricing rules?
What do case laws say?
Every expenditure forming part of the function cannot be termed as a transaction. An incidental benefit cannot be construed to be brand promotion.
It is up to the revenue to show that the associated enterprises acted in concert and that there was an agreement to enter into a transaction involving AMP expenses.
Delhi High Court held that the AMP expense would be classified as an international transaction as it exceeded the expenses incurred by similarly situated comparable domestic entities.
Expenditure on AMP was deduced as an international transaction, owing to disproportionate AMP expenses. Brightline Test was expounded in the LG electronics decision.
What’s a Bright Line Test?
A `bright line’ test (expounded in the LG Electronics decision) is typically adopted to assess whether AMP expenses can be categorised as an international transaction. This bright line is the average AMP expenditure incurred by comparable entities. Limits exceeding the bright line are characterised as international transactions. However, the judiciary’s treatment to AMP expenses being subject to transfer pricing laws has been oscillatory at best.
Court rejected the bright line test and stated that no straight-jacket formula for determining the existence of international transaction involving AMP can be adopted. Stressed on the need to examine the facts of each case for the determination of existence of international transaction.
Licensing agreements permitted the Indian subsidiary to sell cars and use the brand of the parent company. The bright line test found the same to be excessive and hence, transfer pricing adjustment would be required. However, relying on the Sony Ericsson judgment, the Court negated the very basis of bright line test in this decision. For a transaction to qualify as an international transaction, an agreement should pre-exist whereby one party is obliged to incur AMP expenses to promote the brand of the other. Apart from this test, the revenue authorities do not have any other rationale to classify the given transaction as an international transaction. This is a significant departure from the Delhi High Court’s decision in 2010 involving the same company. Such negation has led to determination of AMP as an international transaction on a fact-to-fact basis.
Based on functional, asset and risk analysis (FAR) analysis Delhi ITAT came to the conclusion that the non-resident AE does not bear any risk in India in relation to its brand and therefore any expense by Pepsico India on account of brand promotion cannot be termed as being done on behalf of the AE.
With some of the key cases in appeal at a higher forum and no verdict at the Supreme Court yet, the jury is still out on this one. If you are facing an issue like this, you may want to track it closely.
Plugging in Telescope
Riverus Telescope for income tax has an issue docket for this, which includes ready research on it, with relevant cases and laws easily accessible from the docket.
You can also stay abreast on the latest happenings on this issue and many other such issues. We will leave you with an infographic that was created using the issue docket from Telescope.
Soumya Shekhar, legal writer @ Riverus.