Transfer pricing adjustments on AMP expenses require proof of international transaction before applying Bright line test

The ITAT Delhi held that transfer pricing adjustments on AMP expenses cannot be made without first establishing the existence of an international transaction. The TPO applied a Bright line test comparing the assessee's AMP/sales ratio of 57.44% against four comparables averaging 0.83%, but failed to demonstrate that higher AMP expenditure constituted an international transaction. Following the coordinate bench's decision in the assessee's own case for AY 2011-12, the tribunal ruled that ALP determination is premature without proving an international transaction exists. All grounds relating to transfer pricing adjustment were allowed in favor of the assessee.

---

---

Issues Involved:

1. Adjustment of Arm's Length Price (ALP) of Advertisement, Marketing, and Promotional (AMP) expenditure.
2. Classification of AMP expenditure as an international transaction.
3. Application of Bright Line Test and Transactional Net Margin Method (TNMM).
4. Economic adjustments for differences in risk.
5. Penalty proceedings under section 271(1)(c) of the Income Tax Act.

Detailed Analysis:

1. Adjustment of ALP of AMP Expenditure:

The primary issue in this appeal concerns the adjustment of Rs. 79,258,314 to the assessee's income, pertaining to AMP expenditure. The Transfer Pricing Officer (TPO) initially proposed an adjustment of Rs. 79,887,754 by using the Bright Line Test and the TNMM as alternative approaches. The Dispute Resolution Panel (DRP) subsequently directed a reduction in this adjustment to Rs. 79,258,314. The assessee contested this adjustment, arguing that the AMP expenses were not international transactions, and thus should not be subject to ALP determination.

2. Classification of AMP Expenditure as an International Transaction:

The assessee argued that the AMP expenditure should not be classified as an international transaction under Section 92B of the Income Tax Act, as these expenses were incurred for domestic transactions with unrelated parties. The assessee contended that there was no 'understanding', 'arrangement', or 'action in concert' with its Associated Enterprise (AE) regarding AMP expenditure for brand promotion. The tribunal found that the TPO failed to establish the existence of an international transaction, thereby negating the need for ALP determination.

3. Application of Bright Line Test and TNMM:

The TPO applied the Bright Line Test, selecting four comparables with an average AMP/sales ratio of 0.83%, compared to the assessee's 57.44%. The tribunal rejected the Bright Line Test, citing a previous decision in the assessee's case for the assessment year 2011-12, where it was held that AMP expenditure could not be considered an international transaction. The tribunal also noted that the TPO did not establish an international transaction before determining the ALP, rendering the application of both the Bright Line Test and TNMM inappropriate.

4. Economic Adjustments for Differences in Risk:

The assessee argued that the TPO failed to allow economic adjustments for differences in risk, such as working capital, import duty, capacity utilization, and penetration policy. The tribunal did not specifically address these adjustments, as the primary issue was the misclassification of AMP expenditure as an international transaction.

5. Penalty Proceedings under Section 271(1)(c):

The assessee challenged the initiation of penalty proceedings under section 271(1)(c) for allegedly furnishing inaccurate particulars of income. The tribunal deemed this issue premature and dismissed it without detailed consideration, as no arguments were advanced by the parties.

Conclusion:

The tribunal allowed the appeal in part, primarily in favor of the assessee, by dismissing the transfer pricing adjustments related to AMP expenditure. The tribunal upheld the assessee's position that the AMP expenses were not international transactions and rejected the application of the Bright Line Test and TNMM for ALP determination. The general ground of appeal was dismissed as it was generic, and the penalty-related ground was dismissed as premature.

---