Income Tax

Maruti Suzuki India Ltd. vs Commissioner of Income Tax: Case Analysis

On 11.12.15, the Hon’ble Delhi High Court (HC) pronounced a landmark judgement in the case titled Maruti Suzuki India Limited Vs Commissioner of Income Tax, with respect to the transfer pricing (TP) adjustment on account of advertisement, marketing and sales promotion (AMP) expenditure incurred by Maruti Suzuki India Limited (MSIL). Certain TP adjustments were made by the tax authorities by alleging that there has been the creation of marketing intangible for its associated enterprise (AE) Suzuki Motors Corporation (SMC) through the excess AMP expenditure incurred by MSIL vis-à-vis the comparable companies for which it should have received arm’s length compensation from SMC.

It was held by the Hon’ble Delhi High Court (HC) that the alleged excess AMP expenditure incurred by MSIL cant be considered an international transaction in the absence of any agreement or arrangement among the company and its AE. The HC also held that the AMP expenditure incurred by MSIL benefited the enterprise itself in the way of increased market share in India and year-on-year growth of its turnover.

The HC further held that the quantitative approach that the tax authorities had adopted for the determination of the existence of an international transaction on the basis of the excess AMP expenditure wasn’t as per the Indian transfer pricing regulations. The receipt of any benefits by the SMC is only incidental. Further, the extent to which AMP spent on MSIL has given rise to the benefit of the “Suzuki” brand is a complex exercise and can’t be determined in the absence of clear guidelines by the statute.

Facts of the Case

The facts of the case titled Maruti Suzuki India Limited Vs Commissioner of Income Tax are discussed below –

• MSIL is engaged in the manufacture of passenger cars in India. The operations of the company commenced in 1982 as a Government of India-owned enterprise. Subsequently, SMC was selected as its business partner by the company, thereby becoming a subsidiary of SMC. MSIL entered into a license agreement with SMC for using the co-branded trade mark “Maruti Suzuki” on its cars.
• In the proceedings regarding transfer pricing, there was the issuance of a show cause notice by the Transfer Pricing Officer (TPO) to MSIL for making TP adjustments on account of alleged excess AMP expenses incurred by the company.
• MSIL challenged the notice issued by the TPO by filing a writ petition for a stay of TP proceedings before the HC. This led to the court passing an interim order for the continuance of the TPO proceedings, but the final order of the TPO could not be effectuated.
• Consequently, the TPO passed its order making TP adjustment on account of AMP expenditure wherein the TPO concluded that :

• The trademark “Suzuki” had piggybacked on the trademark “Maruti” without any compensation being paid to SMC to MSIL
• The trademark “Maruti” had acquired the status of “super brand”, whereas the trademark “Suzuki” was a relatively weak brand.
• Co-branding of “Maruti Suzuki” resulted in the promotion of the trademark of the AE and reinforcement of the trademark “Suzuki”, which was a relatively weak brand in India. This also resulted in the impairment of the value of the “Maruti” trademark due to the co-branding process.
• Accordingly, the TPO posed the allegation that there has been the incurrence of a huge AMP expense of 1.87% of its turnover by MSIL as compared to an average AMP expense of 0.62% incurred by its comparables, viz. Hindustan Motors, Tata Motors and Mahindra and Mahindra. Therefore through the application of the Bright-line test (BLT), it was held by the TPO that the excess AMP spent incurred by MSIL was for the promotion of the “Suzuki” brand of SMC and hence benefitted SMC.
• Accordingly, the TPO made the TP adjustment for excess AMP spent that should have been recovered by MSIL from SMC.
• An amendment was made in the writ petition to challenge the order of the TPO due to the order being passed by the TPO during the pendency of the writ petition (WP) before the HC.
• In July 2010, the HC passed the order in respect of the writ petition holding that the co-branding of “Maruti Suzuki” act as evidence of an attempt for the popularization of its name in India by Suzukiat the cost of the “Maruti” brand.
• It could not be accepted that there wasn’t any benefit to Suzuki from the compulsory use of a Joint trademark.
• Since the TPO may not be able to ascertain the monetary value of the benefit obtained by Suzuki in the form of intangible marketing, the TPO would have to ascertain the ALP by finding out the amount of compensation that would have been paid in similar uncontrolled situations.
• However, the HC held the procedure followed by the TPO, in this case, to be arbitrary and faulty; therefore, the court directed the TPO for the re-determination of the appropriate ALP for the AMP incurred by MSIL.
• After this, a writ petition was filed by the MSIL before the Supreme Court (Apex Court), wherein the Apex Court directed the TPO to proceed with the matter without considering the order of the HC.
• Accordingly, on 21^. 12.10  the TPO passed its final order, which was upheld by the Dispute Resolution Panel (DRP) and TP adjustment was finally included in the final assessment order (AO) of the Assessing Officer. Subsequently, the MSIL filed an appeal before the Income tax appellate tribunal (ITAT).
• The tax authorities made the TP adjustment on account of AMP expenses in the case of several assessees. Considering the importance of the issue, a Special Bench of ITAT was constituted in the case of LG Electronics LG Electronics India Pvt. Ltd. v. ACIT 2013 for the adjudication of the issue of TP adjustment for excess AMP expenses, along with the filing of an application as an intervener in the Special Bench proceedings by the MSIL. 
• The Special Bench of ITAT, in the case of LG Electronics, specifically dealt with the case of MSIL, holding that the direction given by the Apex Court to the TPO to ascertain the Arm Length Price (ALP) of AMP expenses inherently recognized the existence of an international transaction of the brand building between MSIL and SMC.
• As a consequence of the same, the ITAT issued the order in the case of MSIL in accordance with the Special Bench decision in the case of LG Electronics and made a TP adjustment on account of excess AMP spent by the company.
• Subsequently, several companies filed appeals (including MSIL) along with the tax authorities regarding the correctness of the LG case before the HC in the case of Sony Ericsson, ie Sony Ericsson Mobile Communications India P. Ltd. v. Commissioner of Income Tax (2015) or  (Sony Ruling).
• The HC, however, decided the case in Sony ruling only for those assessees being engaged in the distribution and marketing of imported branded products.
• Accordingly, several issues were framed by the High Court in the case of MSIL, which is a manufacturer of TP adjustment on account of AMP activity.

Issues before the High Court

The  issues raised in the case titled Maruti Suzuki India Limited Vs Commissioner of Income Tax are discussed below –

1. Whether the additions suggested on AMP expenses are beyond the jurisdiction of the TPO and bad in law due to the absence of any specific reference being made by the Assessing Officer (AO) to the TPO with regard to such transaction?
2. Whether AMP expenses which the assessee incurred in India be treated as an International transaction?
3. Whether TP adjustment can be made by TPO/AO regarding AMP expenditure, and if so, in which circumstances?
4. If the answer to questions 2 and 3 favours the revenue, whether the ITAT was right in holding that TP adjustment regarding AMP expenses should be calculated through the application of the cost plus method?
5. Whether the ITAT was right in giving the direction to the TPO for conducting a fresh benchmarking analysis through the application of the parameters specified in the Special bench ruling in the case of LG Electronics?

Observations & Ruling of the High Court

The observations and ruling of the High Court in the case titled Maruti Suzuki India Limited Vs Commissioner of Income Tax are discussed below –

• The High Court observed that despite the HC’s holding about the existence of an international transaction as far as AMP is concerned, in the Sony Ericsson ruling, such a verdict couldn’t be applied to MSIL due to its appeal being specifically de-linked by High Court from such judgement.
• The Sony Ruling was passed only in the case of distributors distributing products manufactured by their foreign AEs and didn’t manufacture the products by themselves. Further, the question of the existence of international transactions wasn’t disputed in Sony Ruling.
• In the case of MSIL, the court made the observation that the tax authorities failed to prove the existence of any agreement or arrangement between MSIL and SMC regarding the AMP spent by MSIL.
•  The tax authorities had used the BLT approach to prove the existence of an international transaction on account of AMP. They had contended that international transactions on account of AMP could be inferred as the AMP incurred by the assessees was significantly higher than the AMP incurred by the comparable entities.
• Since the BLT had been disregarded by Sony Ruling, there want any basis on which the tax authorities could conclude the existence of an international transaction on account of AMP.
• Regarding the benefit arising to SMC to strengthen its trademark “Suzuki” through the AMP expenses of MSIL, the HC held that MSIL had already built a huge reputation before the acquisition of a controlling stake by SMC in MSIL in 2002 and substantial AMP expense had already been incurred by MSIL by that time.
• MSIL has India’s highest market share and achieved an approximately 21% growth of its turnover, year on year. This was substantiated by the fact that MSIL had been enjoying the benefit of the AMP expenditure incurred by it over the period.
• The HC also acknowledged the fact regarding the incurrence of the AMP expense of around 7.5 % of its worldwide turnover by SMC, while only 1.87% of the turnover by MSIL.
•  This was further substantiated by the fact of the non-existence of any arrangement or agreement between MSIL and SMC whereby MSIL was obligated for the incurrence of AMP expenses on behalf of SMC.
• Accordingly, the HC held that as the tax authorities contested the existence of international transactions merely on account of the quantum of AMP, the HC overruled the existence of any international transaction with regard to the incurrence of AMP expenditure by MSIL.
• Further, regarding the contention of the revenue with regards to HC already holding about the existence of an international transaction on account of AMP expenses in the case of MSIL in its earlier ruling in the writ petition, the HC observed that the direction of the Apex Court to the TPO for conducting the TP proceedings according to the law without being influenced by order of the HC in the writ petition had led to the virtual nullification of the order of the HC. Accordingly, the conclusion of the earlier order of the HC in the writ petition can’t be relied upon for the existence of international transactions on account of AMP in the case of MSIL.
• There was an analysis of the provisions of TP regulations by the HC  wherein the court concluded that there is a requirement for an international transaction with a certain disclosed price. On the other hand, there was the determination of the bright line first by the revenue followed by arriving at a conclusion with regards to the existence of international transactions based on the excess of AMP expense incurred by MSIL vis-à-vis the bright line.
• Such an approach was disapproved by the High Court, followed by the holding that the very existence of international transactions can’t be a matter of inference or surmise. The existence of international transactions has to be established, do hours BLT.
• With regard to the economic ownership, the court observed and acknowledged that the cobrand mark “Maruti Suzuki” couldn’t be used by SMC either in India or in any other country. Therefore, the basic condition for TP adjustment on AMP that foreign AE must be the legal owner of the trademark doesn’t exist.
• The HC also held that if there is a receipt of any incidental benefit by the AE for being part of a larger concern, it can’t automatically be inferred that such AE receives any group service.
• In the end, the HC also acknowledged that the operating margin of MSIL was much higher than the average operating margin of the comparables. Accordingly, there want any question of any TP adjustment on account of AMP.

Conclusion

The ruling in the case titled Maruti Suzuki India Limited Vs. Commissioner of Income Tax is one of the landmark rulings of the HC, which provides relief to the Indian manufacturers from the TP adjustment on account of AMP expenditure incurred by them. Despite the Hon’ble Delhi High Court having jurisdiction just over the state of Delhi, considering the order was detailed, it shall have a persuasive value for other HCs as well.

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