Recent Indian TP court ruling suggests change of direction on AMP expenses

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The case of Luxottica India Eyewear Pvt. vs Acit was heard in New Delhi on 23 May 2017 and the decision on 25 May has created new uncertainty for multinationals operating in India.

Luxottica is the owner of premium brands such as Ray Ban and Oakley. Luxottica India Eyewear imports sunglasses and frames from associated enterprises and distributes them in India.

Luxottica had claimed that the Resale Price Method (RPM) was the most appropriate for the facts and circumstances of its Indian operation and used RPM to demonstrate the arm’s length nature of its imports from connected parties.

However, during a Transfer Pricing enquiry the Tax Authorities discovered that Luxottica India had incurred advertisement, marketing and promotional (AMP) expenses significantly in excess of  the comparable importers/distributors identified by Luxottica for its RPM comparability study, casting doubt on the methodology.

In previous cases, e.g. Sony, Suzuki and Whirlpool, the Tax Authorities attempted to disallow  excessive AMP expenditure, evaluated by a Bright Line Test, by arguing that the excessive expenditure served to develop the brand and was therefore for the benefit of the brand owner. However the Courts held that AMP expenses are not separate international transactions and therefore do not need to be separately benchmarked.

In the Luxottica case the Tax Authorities changed their approach by treating AMP activities as a distinct function of the taxpayer rather than a separate international transaction, the extent of which could be adjusted for in comparability studies. As this could not be achieved using the Resale price method they determined that the Transactional Net Margin Method (TNMM) was more appropriate.

The application of TNMM resulted in an addition to Luxottica’s profits and the Court deemed this an acceptable approach.

Luxottica disputed the use of TNMM and the resulting adjustment but the Tribunal agreed that if the extent of AMP activities cannot be adjusted for using RPM then RPM should be discarded and replaced by another, more suitable method. The Tribunal also determined that AMP expenses can be benchmarked and adjusted as required in order to determine the arm’s length nature of the main transaction, in this case being the importation of goods.

Many previous AMP cases were remitted back to the Tax Authorities to apply the principles that came out of the Sony judgement, i.e. was AMP an international transaction and, if so, what is the arm’s length price. This ruling sees an acceptance by the Tribunal that AMP expenses can effectively be integrated into the import costs and dispenses with the legal question regarding the existence of an international transaction.

As a result of this decision, multinationals in India will need to have a robust functional analysis of their marketing function and a credible comparability analysis.

Luxottica judgement here

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