AUGUST 04, 2014

By Yudhvir Dalal

RECAP: IN the first Part of this article, I had discussed about Transfer Pricing and various methods of resolving Transfer Pricing disputes in India. I had also discussed about the 'arm's length principle' and different methods of computing 'arm's length price' of an international transaction in India. In this Part, I will discuss & evaluate the adoption of 'Bright Line Test' as a new mechanism for computing 'arm's length price' of an international transaction.

"Necessity is the mother of invention."

Transfer pricing disputes involving market intangibles and non-consensus on selection of comparables to ascertain arm's length price of an international transaction have become bone of contention. Revenue department was not able to ascertain the arm's length price of assessee's income from international transactions. So, in India, a new tool in the form of 'bright line test' (hereinafter 'BLT') was borrowed from foreign jurisdiction. Basically, BLT is a test to distinguish between the routine and non-routine expenditure incurred by a subsidiary of a foreign Parent Enterprise.

In order to separate the advertising, marketing and promoting (hereinafter 'AMP') expenditure incurred by the tax payer for its own business and for brand promotion of its parent enterprise, this test was propounded by the US Tax Court in DHL Incorporated and Subsidiaries case, T.C. Memo. 1998-461. The US Tax Court in that case laid down that AMP expenses, to the extent incurred by uncontrolled comparable distributors is to be regarded within the 'Bright Line limit' of the routine expenses and AMP expenses incurred by the distributors beyond such 'Bright Line limit' constituted non routine expenditure, resulting in creation of economic ownership in the form of market intangibles which belong to the owner of the brand. Every licensee or distributor is expected to spend a certain amount of cost to exploit the items of intangible property to which it is provided, it is when the investment crosses the 'bright line' of routine expenditure into the realm of non-routine that, economic ownership likely in form of a marketing intangible is created.

In India, this test was for the first time, applied by Delhi Special Bench in M/s. L.G. Electronics India Private Limited v. ACIT - 2013-TII-15-ITAT-DEL-SB-TP by justifying that when the tax payer has intermingled the expenses done in conducting its own business and expenses incurred in brand building of its foreign AE i.e., parent AE, it becomes imperative for the TPO to find out such cost/value by applying some mechanism. In the absence of any assistance from the assessee in determining such cost/value of international transaction, it is logical that TPO will first identify the comparable independent domestic enterprises dealing with similar products and in same market. Then he will ascertain the amount of advertisement, marketing and promotion expenses incurred by them and calculate the percentage of such AMP expenses to their respective sales. If applying this method it is found that the AE of foreign enterprise has incurred excessive AMP expenditure then it can be rightly considered as the excessive expenditure incurred for the brand promotion of foreign Parent Enterprise. In other words, the amount coming up as per the last step is the cost/value of such international transaction.

In L.G. case (supra), further justifying application of BLT, it was held that even when there was no express reference to any method employed while determining ALP of international transaction, it would not be detrimental to the computation of ALP, if in substance, and one of the prescribed methods was followed. An analysis based on Bright Line test was nothing but application of Cost Plus method, by first identifying the cost/value of services provided to the Appellant. Non-mentioning of the method in so many words, did not ipso facto mean that Cost Plus method was not applied. Essence of the method adopted by TPO was nothing but Cost Plus method. Later while relying on LG case, this test was applied and upheld in Ford India Pvt Ltd v. DCIT 2013-TII-118-ITAT-MAD-TP and Glaxo Smithkline Consumer Healthcare Ltd. v. Addl. CIT, 2012-TII-18-ITAT-CHD-TP.

So, the application of bright line test was tried to be justified by bringing it under the ambit of Cost Plus Method provided under section 92C (1). Although, in Maruti Suzuki India Ltd . v. ACIT - 2010-TII-01-HC-DEL-TP, it was not expressly referred to by the Hon'ble Delhi High Court in decision's conclusion it was inter alia held that, if the domestic entity which is an Associate Enterprise of the foreign entity within the meaning of Section 92A of the Act is mandatorily required to use the foreign trademark and/or logo on its products and/or their containers, packaging, etc., appropriate payment in this regard should be made by the foreign entity to the domestic entity, on account of the benefit it derives in the form of marketing intangibles, obtained by it from such mandatory use of its trademark and/or logo.

Critical Evaluation of Application of Bright Line Test in India

S. 92C (1) provides for five most appropriate methods, while computing an income of an international transaction at ALP. But, BLT is not one of them. In U.S.A, when decision in DHL case (supra) was delivered, BLT was a part of their legislation i.e. Sec. 1.482-4 of US–IRC, but, BLT is not a part of the Act. Determination of ALP based on non-prescribed methods can be set aside. In CIT v. CA Computers Pvt. Ltd., - 2012-TII-02-HC-MUM-TP, the Bombay High Court while upholding the Tribunal decision held that the ALP was not determined by the TPO as per any of the methods prescribed in Rule 10B. To that extent the action of TPO is set aside. In view of this legal position, since the BLT is not an authoritative mechanism, the determination so made cannot be relied much.

Chapter X of the Act is a complete code in itself. It includes not only the substantive but also the machinery provisions. On one side, it contains substantial provisions, which provide for ALP in cases of international transactions and on another side it contains procedural law like S. 92C (1), which provides for some specific methods for computing income at ALP. So, if a machinery provision cannot be applied then the subject matter goes out of the tax net. In PNB Finance Limited v. CIT - 2008-TIOL-206-SC-IT, and CIT v. B.C. Srinivasa Setty - 2002-TIOL-587-SC-IT-LB, Supreme Court has clearly held that where machinery provision fails, the charge cannot be attracted under the substantive provision. In such a scenario, question arises, when BLT is not explicitly prescribed under S.92C, can it be applied?

According to legal maxim 'Generaliaspecialibus non derogant', the general things do not derogate from special. The Supreme Court in Oracle India (P) Ltd. v. ACIT, IT Appeal No. 18 of 2007 (Delhi), has held that the special provision overrides the general provision and if a special provision is made on a certain subject, such matter is excluded from the general provision. While applying this legal principle, when some specific methods are given then they should be given preference to any other test. In Aztec Software & Technology Services Ltd. v. ACIT - 2007-TII-01-ITAT-BANG-SB-TP, also, it was held that any general provision within the framework of the Act cannot take precedence over the specific transfer pricing provisions (Chapter X). This position has been widely accepted by the Indian Courts in plethora of cases like Britannia Industries Ltd. v. CIT & Anr. - 2005-TIOL-125-SC-IT, Forbes Forbes Campbell & Co. Ltd. v. CIT, 2003-TIOL-193-HC-MUM-IT, CIT v. Copes Vulcen Inc. - 2003-TII-46-HC-MAD-INTL.

Furthermore, the scope of word "any" used in S. 92C (1) is restricted by the term 'any of the following'. Similarly, Rule 10B also provides in the same manner that "…. the arm's length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method…….". The use of word 'following' implies that computation method should be any of the five methods prescribed thereon. Therefore, when we read S. 92C (1) in entirety along with Rule 10B (1), there remains no doubt that the arm's length price is required to be determined by any single method out of the five prescribed methods.

The BLT is not a reliable and suitable method. In Commissioner of Income Tax v. M/S. DCM Shriram Consolidated Ltd., ITA 1289/2010, it has been held that Brightline tests  have, over the years not been considered to be decisive, or accurate in deciding if expenditure leads to an enduring capital advantage. In Empire Jute Co Ltd. v. CIT - 2002-TIOL-238-SC-IT-LB, it was held that BLT is not the certain or conclusive test and it cannot be applied blindly and mechanically without regard to the particular facts and circumstances of a given case.The Supreme Court itself in Alembic Chemical Works v CIT - 2002-TIOL-160-SC-IT, has held that, in the infinite variety of situational diversities in which the concept of what is capital expenditure and what is revenue arises, it is well-nigh impossible to formulate any general rule, even in the generality of cases, sufficiently accurate and reasonably comprehensive, to draw any clear line of demarcation.

Conclusion

As far as application of bright line test is concerned it should be applied very judiciously and only after selecting the appropriate and apt comparables. There is every possibility of FAR analysis of the comparable selected being different from associated enterprise (tax payer). Comparables should always be chosen after analysis FAR factors. Tax Authorities should be reluctant to apply BLT. BLT should be applied only when the assessee has intermingled with his routine and non-routine expenditures in such a way that it is not possible to separate them by using any of the five prescribed methods.

Also See - Changing Transfer Pricing Scenario in India – Part I

(The author is a fifth semester student at National University of Advanced Legal Studies, Kochi.)

(Two-Part series is Concluded)