(2016) 381 ITR 117 (Del)
Meaning of international transaction; determination of arm's length price
No. The existence of an international transaction must be established as a fact before any pricing exercise begins. It cannot be inferred merely because the Indian entity's marketing expenditure is high.
In the absence of any agreement or arrangement with the foreign associated enterprise regarding marketing spend, can an international transaction be inferred from the quantum of that spend alone?
The taxpayer, a well-known Indian automobile manufacturer with a foreign parent, incurred substantial advertisement, marketing and promotion expenditure in India in relation to vehicles it manufactured and sold on its own account. There was no agreement with the foreign associated enterprise requiring it to incur that expenditure, no reimbursement arrangement, and no provision obliging it to promote the foreign brand as such. The Transfer Pricing Officer nonetheless applied the bright line approach, treated the excess spend as a transaction with the associated enterprise, and made an adjustment with a mark-up for the brand-promotion service said to have been rendered.
The matter came before the Delhi High Court after Sony Ericsson, which had addressed the quantification of such adjustments in the context of distributors. Here the Court was concerned with a manufacturer and, more fundamentally, with the anterior question of whether a transaction existed at all.
For the assessee
Chapter X applies to an international transaction, which the statute defines as a transaction between associated enterprises. A transaction requires an arrangement, understanding or action in concert. None existed. The taxpayer spent its own money to sell its own products in its own market, and any benefit to the brand owner was incidental to that commercial activity.
For the Revenue
The disproportionate level of expenditure is itself evidence that the Indian company was acting in the interest of the foreign brand owner. Where spending so far exceeds that of comparables, an arrangement may be inferred, and the definition of international transaction is wide enough to cover it.
The Court addressed the question that logically precedes quantification: whether there is an international transaction at all. It held that the existence of such a transaction is a jurisdictional fact which the Revenue must establish, and cannot be assumed from the magnitude of expenditure. A transaction, even on the extended statutory definition, presupposes an arrangement, understanding or action in concert between the associated enterprises in relation to the expenditure in question. The Court held that no such arrangement could be inferred simply because the Indian company spent more than comparables; businesses spend what they judge necessary to sell their products, and the fact that a brand owner derives incidental benefit from successful marketing of its products in India does not convert the expenditure into a service rendered to it. It also observed that the machinery provisions offer no means of determining the price of a transaction whose very terms have never been identified, which itself indicates that no such transaction was contemplated. Absent a transaction, there was nothing to benchmark, and the adjustment was deleted.
Read with Sony Ericsson, this sets the two-stage analysis that still applies under Sections 163 and 165 — first whether an international transaction exists, and only then how it should be priced. It is the leading authority where an adjustment is proposed on marketing spend with no underlying agreement, and the jurisdictional-fact framing makes it a stronger defence than arguments directed only at quantification.