Transfer Pricing: The “Bright Line test” can be applied to disallow the excessive AMP expenses incurred by the assessee for the benefit of the brand owner

L.G.Electronics India Pvt. Ltd vs. ACIT (ITAT Delhi Special Bench) 

L.G. Electronics Inc, a Korean company, set up a wholly owned subsidiary in India (the assessee) to which it provided technical assistance. The assessee agreed to pay royalty at the rate of 1% as consideration for the use of technical know how etc. The Korean company also permitted the assessee to use its brand name and trade marks to products manufactured in India on a royalty-free basis. The AO, TPO & DRP held that as the Advertising, Marketing and Promotion (“AMP expenses”) expenses incurred by the assessee were 3.85% of its sales and such percentage was higher than the expenses incurred by comparable companies (Videocon & Whirlpool), the assessee was promoting the LG brand owned by its foreign AE and hence should have been adequately compensated by the foreign AE. Applying the Bright Line Test, it was held that the expenses up to 1.39% of the sales should be considered as having been incurred for the assessee‘s own business and the remaining part which is in excess of such percentage on brand promotion of the foreign AE. The excess, after adding a markup of 13%, was computed at Rs. 182 crores. On appeal by the assessee, the Special Bench had to consider the following issues: (i) whether the TPO had jurisdiction to process an international transaction in the absence of any reference made to him by the AO? (ii) whether in the absence of any verbal or written agreement between the assessee and the AE for promoting the brand, there can be said to be a “transaction“? (iii) whether a distinction can be made between the “economic ownership” and “legal ownership” of a brand and the expenses for the former cannot be treated as being for the benefit of the owner? (iv) whether such a “transaction“, if any, can be treated as an “international transaction“? (v) whether the “Bright Line Test” which is a part of U. S. legislation can be applied for making the transfer pricing adjustment? (vi) whether as the entire AMP expenses were deductible u/s 37(1) despite benefit to the brand owner, a transfer pricing adjustment so as to disallow the said expenditure could be made? (vii) what are the factors to be considered while choosing the comparable cases & determining the cost/value of the international transaction of AMP expenses? (viii) whether, if as per TNMM, the assessee’s profit is found to be as good as the comparables, a separate adjustment for AMP expenses can still be made? (ix) whether the verdict in Maruti Suzuki 328 ITR 210 (Del) has been over-ruled/ merged into the order of the Supreme Court so as to cease to have binding effect?