Hyundai Motor India Limited vs. DCIT (ITAT Chennai)

DATE: April 27, 2017 (Date of pronouncement)
DATE: May 9, 2017 (Date of publication)
AY: 2009-10
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Transfer Pricing AMP Adjustment: Entire law on whether the advertisement expenditure incurred by the Indian AE towards brand of a foreign company can be treated as an “international transaction” and whether a notional adjustment can be made in the hands of the Indian AE towards compensation receivable from the foreign AE for “deemed brand development” explained

The Tribunal had to consider whether the TPO was justified in attributing a notional income of Rs 54,15,28,903 to the assessee on account of compensation for deemed brand development and as compensation for assessee’s depriving himself of the use of his own logo and brand name in the motor vehicles manufactured by the assessee. HELD by the Tribunal:

(i) The first question that we need to decide is whether the benefit accruing to the HMC Korea, as a result of increased brand value due to sale of Hyundai cars in India by the assessee company, constitutes an international transaction.

(ii) It is necessary to appreciate the fundamental fact that the issue in LG Electronics Pvt Ltd Vs ACIT [(2013) 22 ITR (Trib) 1 (Del)] before the Special Bench was materially different from the issue in the case before us inasmuch as LG’s case dealt with advertisement, marketing and promotion (AMP) expenses incurred by the assessee, which were in excess of similar expenses incurred by the comparables, and an inference was thus drawn that these excessive expenses were incurred for the benefit of the AE which was legal owner of the brand. That was a case in which the special bench had specifically noted that under Article 20 (Advertising, Marketing and Sales Promotion) of the agreement that the assessee company had with its AE, it was provided that “The licensee agrees to provide and make arrangements for advertising, marketing and sales promotion in the licensed territory for LG Products manufactured by the Licensor and those by the Licensee at their cost”

(iii) The Special Bench then took note of Hon’ble Delhi High Court decision in the case of Maruti Suzuki India Ltd Vs ADIT [(2010) 328 ITR 510 (Del)], wherein, according to the special bench, it was held that “if the AMP expenses are incurred by a domestic entity which is an associated enterprise of foreign entity, then there is a requirement on the part of the foreign entity to compensate the domestic entity in respect of the advantage obtained by it in the form of brand building to the extent the expenses are more than what a similarly placed comparable independent domestic entity would have incurred”. The Special Bench then also observed that this decision still holds good in law as it has not been “overruled, either impliedly or expressly”. It was on the basis of this analysis that the Special Bench concluded, to quote its own words of majority view, “the contention of the ld. AR that the judgment of the Hon’ble jurisdictional High Court has been reversed, is jettisoned.” What follows thus is that unless the expenses incurred by the assessee on its AMP are excessive vis-à-vis what similarly placed comparables would have incurred, according to the special bench, then, to that extent, the foreign AE had an obligation to compensate the assessee company for the AMP expenses.

(iv) In sharp contrast to this position in LG’s case, in the present case, it is an undisputed position that “the percentage of AMP expenses as a proportion of net sales is not an unreasonable high figure” and that “the arguments of the assessee that there is no excess over and above a market benchmark average in this financial year is accepted”. There were some reservations on the data submitted by the assessee in the assessment year 2009-10 for want of complete information, but then in the subsequent two assessment years, i.e. 2010-11 and 2011-12, the TPO has, upon examining requisite details, accepted the submission based on the same data on the same comparables.

(v) Clearly, therefore, the facts in the case of LG’s special bench decision are materially different and the TPO cannot thus derive any advantage from LG’s special bench decision. As a matter of fact, if the criterion laid down in LGs case is to be adopted, there cannot at all be any justification for making impugned ALP adjustment on account of brand promotion.

(vi) It is also important to bear in mind the fact that in the present case, the emphasis is all along on the benefit accruing to the parent company, on account of increased brand valuation, as a result of cars being sold by the assessee company in India, and not as a result of conscious brand promotion by the assessee company. The trigger for the impugned ALP adjustment is not the expense incurred by the assessee company, or any efforts made by the assessee company, for brand building for its principal, but the mere fact of the sale of cars made by the assessee company. No services are thus rendered by the company, unlike, for example, in LGs case where brand building was due to conscious and focused efforts of the Indian assessee company to do so. Yet, the case of the TPO is that the assessee should be compensated for the increase in brand valuation, proportionate to sale of cars by the assessee company vis-à-vis the global sale of cars of that brand, as this increase in the brand valuation is, to that extent, due to sale of cars by the assessee company.

(vii) A lot of emphasis is laid down by the learned counsel on the fact that even if bright line test, as laid down by the Special Bench decision in LG’s case (supra), is to be adopted, no AMP adjustment is required to be made in this case. However, as we have seen in the foregoing discussion, neither the ALP adjustment is made, strictly speaking, in respect of the AMP expenses, nor, for that purpose, bright line test holds good in law anyway- as was specifically held by Hon’ble Delhi High Court in the case of Sony Ericsson Mobile Communications India Pvt Ltd [(2015) 374 ITR 118 (Del)]. Nothing, therefore, turns on Special Bench’s decision in LG’s case (supra), which, in any event, is no longer good law in this respect.

(viii) As clarified by Hon’ble Delhi High Court, in Sony Ericsson’s case (supra), it’s earlier judgment in the case of Maruti Suzuki decision (supra), in view of subsequent legal developments, including the judicial observations of Hon’ble Supreme Court on the said judgment, does not hold good in law either. To this extent also, the stand of the Special Bench in LG’s case (supra) stands reversed now.

(ix) The legal arguments relied upon by the learned counsel on satisfying the bright line test, as also by the authorities below on the legal validity of foundational basis of the impugned addition, have thus no bearing on the decision on correctness of the impugned addition for brand promotion fees. To this extent, the legal analysis by both the parties does not meet our approval. There are, however, other issues raised by the learned representatives which, in our humble view, have merits worth being accepted. We will turn to those issues in a little while.

(x) Let us, for the time being, now come back to the question as to whether the benefit accruing to Hyundai Korea, as a result of increased brand value due to sale of Hyundai cars in India by the assessee company, is an international transaction. It has been contention of the assessee all along that it does not constitute an international transaction.

(xi) We must bear in mind the fact that the short case of the revenue is that simply because the cars are sold by the assessee, the brand gets more visibility, and this visibility results in greater brand value of the Hyundai Korea. It is not the case of the revenue that such an accretion to brand value is on account of any conscious efforts of the assessee to this end- such as, for example, in the case of advertising, marketing and sales promotion. A lot of emphasis is placed on the fact that if the assessee, instead of using ‘Ford’ name in the name of each of its brand of cars manufactured, was to use a name owned by the assessee, the advantage of adding value to a brand, as a result of sale of cars manufactured by the assessee, would have gone to the assessee, rather than going to the AE. It is this arrangement, for the benefit of the AE, which is stated to be international transaction.

(xii) The difference in these two kind of triggers to accretion in brand value is that while AMP is a conscious effort and an activity for achieving that goal, in case of brand building by increased market in India is by sales simplictor is a subliminal exercise and by-product of the economic activity of selling the products in the Indian market.

(xiii) There are two basic aspects of this arrangement being an international transaction- first, what is the true nature, and proximate cause, of this arrangement about the use of foreign brand name- is it a case of using foreign brand name to promote the brand name, or to benefit from the reputation that such a brand name; and- second, what is the scope of definition of ‘international transaction’ under the Indian transfer pricing legislation, and whether this arrangement fits into the same.

(xiv) To begin with, the question that we must ask ourselves is whether use of ‘Hyundai’ name on the vehicles manufactured by the assessee is primarily a privilege of the assesse, for the benefit of itself- as an effective tool of marketing the products., or is it, as is the case of the revenue, essentially an obligation of the assessee, triggered by the benefit of its AE.

(xv) It is an undisputed position that the foreign AE owns a valuable brand, i.e. Hyundai, and this brand has a certain degree of respect and credibility all over the globe- including, of course, in the Indian market. When assessee uses this brand name in the name of the models of vehicles manufactured by the assessee, it does indeed amount to an advantage to the assessee. Let us put it like this. If the assessee makes the same car and markets it in the Indian market, without any established brand name, the acceptability of the car by the Indian consumer will be little less vis-à-vis the situation in which the car is marketed with the foreign brand name. Any other view of the matter would mean that the foreign brand has no value which is admittedly not the case. The use of Hyundai brand name in the cars manufactured by the assessee thus does indeed amount to a benefit to the assessee. In that sense, the use of brand name owned by the foreign AE is a privilege, a marketing compulsion and of direct and substantial benefits to the assessee.

(xvi) The obligation of the assessee to use the brand name owned by the assessee is, therefore, not solely and proximately driven by the benefits to the AE, owning the brand name. The technology owned by the AE abroad is in the field of motor vehicles, and, with a view to ensure that the AE, owning this technology- which owns the brand name too, continues to be identified with the products manufactured with the use of its technology, it is a common commercial practice, and quite understandable a commercial practice too, that the use of AE’s brand name in the name of motor vehicle is made mandatory. Such a clause in the technology use agreement is essentially with a view to protect the intellectual property owned by the foreign AE, and, even in arm’s length transaction, fully justified. This business practice is fully justified on the grounds of commercial expediency, which inherently operates de hors the compulsions of intra AE relationship of the AEs- the impact of which is sought to be neutralized by the transfer pricing legislation.

(xvii) Ironically, however, there can never be a comparable controlled price input for this kind of a transaction, because, the moment use of an intangible like this is involved, the entities entering into the transactions will become AEs under section 92A(2)(g) and, being a transaction between the AEs, the transaction will cease to be a valid input. For the sake of completeness, we may mention that, for the purposes of sub-section (1), two enterprises shall be deemed to be associated enterprises if, at any time during the previous year, if, inter alia, “the manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on the use of know-how, patents, copyrights, trade-marks, licences, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of which the other enterprise has exclusive rights”.

(xviii) Having held so, however, we must recognize the fact that the use of brand name, owned by the AE, in the motor vehicles manufactured by the assessee does amount to a benefit to the AE of the assessee, an incidental benefit thought, in the sense that increased visibility to this trade name does contribute to increase in brand valuation of the brand name. The question really is whether such an incidental benefit to the AE, even if there be any, can be treated as an international transaction under the Indian transfer pricing legislation include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to anyone or more of such enterprises, but then this aspect of the matter is not really relevant because it is not a case of allocation of, apportionment of, or contribution to, any costs or expenses in connection with a benefit, service or facility. We need not, therefore, deal with this aspect of the matter in much detail. The same is the situation so far as the transactions in the nature of ‘lending or borrowing of money’, included in the definition under section 92B, are concerned. There is no dealing in money in the present case, and, therefore, this limb of the definition is not at all relevant either.

(xix) Coming back to the basic definition under section 92B, so far as intangibles are concerned, the relevant transaction, covered by the definition of international transactions, are only transactions of purchase, sale or lease of intangible properties. The brand name is an intangible but then all that definition deals with is sale, purchase or lease of intangibles, and there is no purchase, sale or lease of intangibles in this case at all. What is being claimed to be an international transaction does deal with an intangible, but it deals with increase in the value of the intangible as a by-product of the business model employed by the assessee and the AE and this increase in value is not on account of sale, purchase or lease of intangible. This part of the definition, by no stretch of logic, has any application on the facts of this case. Section i (b) to Section 92 B does add that the expression international transaction shall include “the purchase, sale, transfer, lease or use of intangible property, including the transfer of ownership or the provision of use of rights regarding land use, copyrights, patents, trademarks, licences, franchises, customer list, marketing channel, brand, commercial secret, know-how, industrial property right, exterior design or practical and new design or any other business or commercial rights of similar nature” but even under this, what appears to be, extended definition, the accretion to the value of intangibles is not covered. As we say, we must reiterate that so far as use of brand name under the technology agreement is concerned, the agreement has been examined by the TPO and it is not even the case of the TPO that the consideration paid for the transactions flowing from this agreement is not an arm’s length consideration. The arrangement under the technology use agreement, which permits the assessee and binds the assessee to use the brand name of the AE on the products manufactured by the assessee, has been specifically held to be an arm’s length transaction. An aspect covered by this agreement, therefore, cannot be subject matter of yet another benchmarking exercise. All that is to be seen is that an accretion to the value of brand name owned by the assessee, on the facts and in the circumstances of this case, amounts to an international transaction.

(xx) Undoubtedly, ‘provision for services’ is included in the definition of ‘international transaction’ under section 92B, but then accretion in brand value due to use of foreign AEs brand name in the name of assessee’s products cannot be treated as service either. It is not that the brand name owned by the AE is used in the name of the assessee’s products as a service to the AE; it is, as we have seen in our discussions earlier in this order, included as a “privilege, a marketing compulsion and of direct and substantial benefits to the assessee”. A privilege to the assessee cannot be a service by the assessee.

(xxi) In any event, a service has to be conscious activity and it cannot be a subliminal exercise- as is the impact on brand value in this case. A service, by definition, is an act of helping, or doing something on behalf of, someone. A passive exercise cannot be defined as a service. Every benefit accruing to an AE, as a result of dealing with another AE, is not on account of service by the other AE. What I benchmarked is not the accrual of ‘benefit’ but rendition of ‘service’. All benefits are not accounts or services by someone, just as all services do not result in benefits to the parties. The expressions ‘benefit’ and ‘service’ have different connotations, and what is truly relevant, for the purpose of definition of ‘international transaction’ in Indian context, is ‘service’- not the benefit. There is no rendition of service in the present context.

(xxii) Of course, from the point of view of determination of arm’s length price, mere rendition of service is also not sufficient; it should be intended to result in such a benefit as an independent enterprise would pay for. While on this aspect of the matter, we may usefully refer to discussions on “special consideration for intra group services”, in the ‘OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations’. These discussions note that there are two fundamental issues with respect to the intra group services- first, whether intra group services have indeed been provided, and, second- if the answer to the first question is in positive, that charge to these services should be at an arm’s length price.

(xxiii) In the present case, however, since no services are performed, the discussion about benefit of the services is academic. We have referred to the above discussions in the OECD Guidelines just to highlight the fact that even in situations in which benefit test is specifically set out in the definition of international transaction, the determination of arm’s length price of a service has two components- first, of rendition of service; and- second, of benefit accruing from such services. When the first condition is not satisfied, as in the present case, the matter rests there, and there is no question of benchmarking the benefit in isolation. In our considered view, an incidental benefit accruing to an AE, therefore, cannot be benchmarked unless it is result of a specific service by the assessee.

(xxiv) That takes us to last component of definition of ‘international transaction’ under section 92 B. This refers to a transaction in the nature of any other transaction having a bearing on the profits, income, losses or assets of such enterprises. An accretion in the brand valuation of a brand owned by the AE does not result in profit, losses, income or assets of the assessee company, and it cannot, therefore, result in an international transaction qua the assessee. Unless the transaction is such that it affects profits, losses, income or assets of both the enterprises, it cannot be an international transaction between these two enterprises. If the assets of one of the enterprises are increased unilaterally, without any active contribution thereto by the other enterprise, such an impact on assets cannot, in our humble understanding, amount to an international transaction. The accretion in brand value of the AE’s brand name is not on account of costs incurred by the assessee, or even by its conscious efforts, and it does not result in impact on income, expenditure, losses or assets of the assessee company. It is not, therefore, covered by the residuary component of definition of ‘international transaction’ either.

(xxv) As for the emphasis placed by the learned Departmental Representative, as also by the authorities below, on the exhaustive definition of ‘intangibles’ in Explanation to Section 92B, we may only reiterate that this definition would have been relevant only in the event of there being any transaction in the nature of sale, purchase of lease of intangible assets but then, it is not even the case of the revenue, that there was any sale, purchase or lease of intangibles. In view of these discussions, as also bearing in mind entirety of the case, we are of the considered view that the accretion of brand value, as a result of use of the brand name of foreign AE under the technology use agreement- which has been accepted to be an arrangement at an arm’s length price, does not result in a separate international transaction to be benchmarked. The impugned ALP adjustments of Rs 54,15,28,903, Rs 62,20,34,587 and Rs 253,44,00,000, for the assessment years 2009-10, 2010-11 and 2011-12 respectively, must, therefore, stand deleted. We hold so. Grievance of the assessee, with respect to ALP adjustments on account of accretion in brand value of the AE due to its use by the assessee, is thus upheld.

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