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MNCs to document, rationalise royalty payments

Ranju Sarkar  |  New Delhi 

ruling to strengthen transfer pricing documentation, pacts with parents

Multinationals may have to rationalise the from India, especially if the Indian subsidiary or partner involved is also incurring huge advertising, and promotional (AMP) expenses in promoting the parent’s brands and products.

This could be the outcome of a recent Delhi High Court ruling, where it asked the tax authorities to determine an appropriate arms-length pricing mechanism for determining the royalty paid by Maruti Suzuki to its Japanese parent, Suzuki Motor Corporation.

Sunil Jain, partner, J Sagar & Associates, said the court ruling could have significant implications for multinationals where the Indian subsidiary incurs heavy expenses in promoting its brand here, and the MNC gains by increased awareness of its brand globally. Indian tax authorities have been saying that in such cases, the parent should compensate the Indian company for promoting its brand here.

"Royalty charged may need to be revisited. It may be not be possible (for MNCs) to charge substantial royalties while it is claimed as a tax deductible expense in the Indian company’s balance sheet. This is more important where the Indian company also incurs huge and expenses and claims such expenses as tax-deductible," said Jain, who often designs repatriation strategy for

Assume an Indian company pays Rs 100 crore as royalty to its parent. ‘‘It is able to claim it as an expense and use it as a tax shield. As attract 10 per cent tax deduction at source (TDS), by suffering 10 per cent TDS, the parent is able to take away the royalty. The Indian company also claims advertisement and expenses as tax deductible, leading to further reduction of the tax base in India," said another tax expert. The HC ruling could trigger a few other changes.

DATA DOCUMENTATION 
Sanjay Kapadia, tax and transfer pricing partner, Ernst & Young, said the ruling would require using foreign trade/brand names and incurring huge and marketing expenses to have a relook at their transfer pricing documentation to establish that the expenses so incurred are in relation to of products sold in/from India and that such expenditure is not towards promoting the global/overseas brand. The of the foreign brand, if any is purely incidental.

"will have to maintain data to establish the nexus between expenses incurred and benefits derived, say in the form of additional sales. The tax teams in will now have to work with marketing teams to develop robust transfer pricing documentation. The issue involved is complex and companies may find it difficult to demonstrate the above position objectively. Indian entities will now have to demonstrate that their marketing efforts are towards their own benefit and not towards enhancing the brand value of the overseas entity," said Kapadia.

"It’s a welcome ruling. It lays down the important principles of how the tax officer should go about making transfer pricing assessments. There’s a law, but each officer had their own interpretation" said another expert. Some experts feel the tax authorities could use this ruling to pursue cases where there are joint of brands.

Also read: 
Redo Maruti royalty demand: HC to I-T Dept

Sumes Dewan, partner, Fox Mandal Little, however, feels the merits of this case cannot be applied across board to all MNC companies doing business in India. However, companies may have to look carefully at licensing and royalty arrangements where the Indian markets are a significant market for such companies.

There could be challenges, as the intangibles are unique for every company. For instance, the royalties and know-how paid by Honda Siel to Honda Motor Corporation may not be comparable to the royalties paid by Maruti to Suzuki, say experts.

 

First Published: Fri, July 09 2010. 22:59 IST
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