Rules in favour of tax department in the matter of advertising, marketing expenses in brand building
In a severe blow to multinational corporations operating in India, a special bench of the Income tax appellate tribunal (ITAT) has ruled that a significant portion of advertising, marketing and promotional (AMP) expenses incurred by their Indian arms to promote the brand and trademarks of the multinational will be taxable in India.
In a majority decision, the SB ruled in favour of the tax department that the taxpayer incurring AMP expenses in excess of amounts spent by comparable companies ought to have been compensated for creation / enhancement of such brand by its associated enterprises (AE) which own the said brand. The decision will be binding on other division benches of the tribunal unless it is overruled in a high court. The tribunal invoked the retrospective amendment to Section 92CA(2B) inserted by the Finance Act 2012 effective from 1st June 2002, that grants powers to the transfer pricing officer to look into the transactions which are not reported by the taxpayer and which come to his notice during the course of assessment proceedings. It also upheld the usage of Bright line test, which uses the expenses incurred by comparable companies, to decide arms'length pricing.
The ruling came in an appeal by home appliances maker LG Electronics which faced transfer pricing adjustments of over Rs 162 crore for the assessment year 2007-08. However, fourteen other Indian arms of multinationals had also argued as ‘interveners’ against the decision of the transfer pricing officer, which was earlier upheld by a dispute resolution panel. Pepsi Foods, Maruti Suzuki, Glaxo Smithkline, Goodyear India, Ray Ban-maker Bausch & Lomb, Amadeus, Canon, FujiFilm, Star India, Sony, Haier Telecom, Haier Applinads, LVMH Watch and Jewellery and Daikin Airconditionin also faced transfer pricing adjustments on the excessive AMP.
Of these fifteen entities (Including LG), only three were listed, all of whom fell sharply following the decision on January 23. Maruti shares fell about 4% from Rs 1,590-levels on January 22 to Rs 1,530 on January 24. However, it recovered on Friday. Goodyear India shares fell nearly 4% from Rs 328 to Rs 316 between Jan 22 and Jan 25. Glaxo fell from Rs 3780 to Rs 3766. All others are unlisted subsidiaries.
In the LG Electronics case, the transfer pricing officer (TPO) observed that the assessee‘s expenses on advertisement, marketing and promotion including trade discount and volume rebate, described by him as the AMP expenses were 3.85% of its sales at Rs 6,553.36 crore.
The officer considered similar expenses incurred by Videocon Appliances Ltd. (0.12%) and Whirlpool of India Ltd (2.66%) and computed their arithmetic mean at 1.39%. It was opined that the assessee was promoting LG brand owned by its foreign AE and hence should have been adequately compensated by the foreign AE.
Applying the Bright Line Test, the TPO held that the expenses up to1.39%of the sales should be considered as having been incurred for the assessee's own business and the remaining part which is in excess of such percentage, at 2.46% (3.85% - 1.39%) on brand promotion ofthe foreign AE. Such excess at Rs 161.22 crore was proposed as atransfer pricing adjustment on account of AMP expenses for brand building. According to the tribunal, incurring proportionately higher AMP expenses coupled with the advertisement of brand or logo of the AE, gives inference of the existence of some informal or impliedagreement. Also, the fact that the taxpayer’s marketing strategy was under the directions, guidance and control of the parent implied that it had full control over the AMP expenses of the taxpayer. The Tribunal thus held that there is a transaction between the taxpayer and the AE under which the taxpayer incurred AMP expenses towards promotion of brand which is legally owned by the AE.
"This ruling of SB has far reaching consequences on MNCs operating in India and it is now imperative for such MNCs to review the current policies and arrangements and be geared up for more challenges from Indian transfer pricing authorities," lawyers in consulting firm SKP said.
Experts said it is not easy to pick the right comparables, which may skew the results of the bright line test. Samir Gandhi, Deloitte Haskins and Sells said, "Determination of whether there is a transaction of promotion of brand legally owned by a Foreign Enterprise is a factual excercise. One is required to consider what an independent enterprise behaving in a commercially rational manner would incur such extent of AMP expenses as the taxpayer."
The application of bright line test ( ratio of AMP expenses to Turnover of taxpayer versus that of comparables ) depends upon several factors – e.g. whether the brand is an established brand or not. For example, a newly introduced brand normally will require significantly higher AMP expenses than an established brand.
However, SKP said , not all is lost for the taxpayer. The SB did mention that what constitutes AMP has to be decided on facts of each case and cannot include expenses in connection with sales promotion. It also held that there is a need to look at the right comparable for the application of bright line test.
Central Board of Direct Taxes should issue guidelines with illustrations on this issue after consultation with all stakeholders - OECD discussion draft on intangibles is a good example to resolve the issue to a great extent, said Gandhi of Deloitte. 0000
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