“Marketing
intangibles”, in the form of advertisement, marketing and sales promotion (AMP)
expenses is one of the key areas of dispute between the Indian tax authorities
and taxpayers. Increasingly, complicated business structures and policies being
adopted by Multinational Entities (‘MNEs’) in order to efficiently manage their
global businesses has contributed in fair measure to this trend.
In emerging markets
such as India, the issue assumes particular relevance as many MNEs have set up
their sales and distribution entities to reap benefits of huge consumer base. A
number of difficulties arise while dealing with marketing intangibles i.e.
conflicting rulings from courts, evolving and disruptive business models and
retrospective amendment made in the Indian transfer pricing regulations to
incorporate exhaustive definition of intangibles.
The main dispute
has been in the area of excessive expenditure incurred on advertising,
marketing and sales promotion activities and whether such expenses are of
routine or non-routine nature. If the expenses are non-routine nature, the
Indian entity should be adequately compensated with arm’s length remuneration
so that there is no creation of marketing intangibles.
Over the past few
years, there have been two landmark Delhi High Court rulings on the AMP issue
namely Sony Ericsson Mobile Communications India Private Limited and
Maruti Suzuki India Limited. In the
case of Sony Ericsson, the Delhi High Court held that since taxpayer
distributors had argued that the rewards around their excessive AMP expenses
were subsumed within the profit margins of distribution, the taxpayers could
not at the same time contend that AMP expenses were not “international
transactions”. Having held the same the High Court further added if a taxpayer
distributor performs additional functions on account of AMP, as compared to
comparable companies then such additional rewards may be granted through
pricing of products or distribution margin; and if so received, the Revenue
Officer cannot demand a separate remuneration.
In the case of Maruti
Suzuki, the Delhi High Court, while dealing with a taxpayer, being optically of
the character of an entrepreneurial licensed manufacturer, dismissed the
attempt on the part of the Revenue Officer to impute TP adjustment for the
excess AMP spend of Maruti Suzuki India, as a percentage of its turnover, over
the average of those of its comparable companies selected under an overall
transactional net margin method (TNMM) approach.
The main reasoning of
the High Court, while it concurred with the arguments of the taxpayer in
deciding the case in its favour, was that the AMP spend on a stand-alone basis,
could not be treated to as an “international transaction” under the provisions
of the Indian TP regulations, in the context of licensed manufacturers of the
type of Maruti Suzuki India, and thus the TP adjustment with respect to any
part thereof, in the manner proposed by the Revenue Officer, namely
reimbursement of the “so called” excess amount of the AMP spend, by the foreign
licensor of brand, was clearly not sustainable.
The AMP issue is far
from being resolved and Special Leave Petitions (SLPs) have been lodged with
the Supreme Court of India on the issue of AMP – both, by the tax payers as
well as by the Revenue. The Supreme Court, apart from dealing with primary
question of AMP being an international transaction or not, would also be
required to delve into issues such as whether higher profits at entity level
can be said to subsume the return for marketing intangible creating functions,
whether setoff of a higher price/profit in one transaction with lower
price/profit in another is permissible, whether application of the bright line
test is justified etc.
More recently, the
Mumbai ITAT in the recent decision in case of Nivea India Pvt Ltd
has dealt with some of the key issues dealing with marketing intangibles
controversy.
Whether AMP expenditure qualifies as International Transaction
This has been a
primary bone of contention between tax payers and tax authorities.Tax payers
strongly contend that unless there is express provision in the law, the tax
authorities are not justified in inferring creation of marketing intangible for
the brand owner merely by virtue of excessive AMP expenditure incurred by the
tax payer.
Tax authorities’ stand
has been that mere fact the service or benefit has been provided by one party
to the other would by itself constitute a transaction irrespective of whether
the consideration for the same has been paid or remains payable or there is a
mutual agreement to not charge any compensation for the service or benefit
(i.e. gaining popularity or visibility of brand in the local market).
The Tribunal in line
with several past rulings negated tax authorities’ stand stating that
“Even if the word ‘transaction’ is given its widest connotation, and need
not involve any transfer of money or a written agreement or even if one resorts
to section 92F (v) of the Act, which defines ‘transaction’ to include
‘arrangement’, ‘understanding’ or ‘action in concert’, ‘whether formal or in
writing’, it is still incumbent on the tax authorities to show the existence of
an ‘understanding’ or an ‘arrangement’ or ‘action in concert’ between tax payer
and its Parent entity as regards AMP spend for brand promotion.” In other
words, unless it is demonstrated that the tax payer was obliged or mandated to
incur certain level of AMP expenditure for the purposes of promoting the brand,
the AMP expenditure incurred by the tax payer would not qualify as
international transaction.
Application of bright line test
Generally, the tax
authorities segregate the AMP expenditure incurred by the tax payer into
routine nature and non-routine nature by applying bright line test,
wherein they compare the AMP expenditure incurred by the tax payer vis-a-vis
comparables and deduce excessive / non routine of portion of AMP expenditure.
The Tribunal held that
bright line test cannot and should not be applied for making transfer pricing
adjustments, as same is not one of the recognised methods.
Incidental benefit
As the foreign brand
owner stands to benefit from AMP expenditure incurred in India, the tax
authorities insist on compensation for the Indian entity.
The Tribunal held that
with no specific guidelines on the AMP issue, merely because there is an
incidental benefit to the brand owner, it cannot be said that the AMP expenses
incurred by the tax payer was for promoting the brand. Any incidental benefit accrued to the brand
owner would not alter the character of the expenditure incurred wholly and
exclusively for the purpose of tax payer’s business. For e.g., the Indian
taxpayer incurs AMP expenses in the local market to create awareness about the
brand due to which his business is benefitted by virtue of increased sales and
at the same time overseas brand owner gets incidental benefit i.e. brand
becomes popular in the new geography, due to which intrinsic value of brand
gets enhanced.
Product promotion vs Brand Promotion
The Tribunal stated
there is a subtle but definite difference between the product promotion and
brand promotion. In the first case product is the focus of the advertisement
campaign and the brand takes secondary or backseat, whereas in second case,
brand is highlighted and not the product.
The distinction is
required to be drawn between expenditure incurred to perform distribution
function and a ‘transaction’ and that every expenditure forming part of the
function, cannot be construed as a ‘transaction’.The tax authorities’ attempt
to re-characterise the AMP expenditure as a transaction by itself when it has
neither been identified as such by the tax payer or legislatively recognised,
runs counter to legal position which requires tax authorities “to examine
the ‘international transaction’ as they actually exist.”
Letter of Understanding (LOU)
In certain instances,
it was observed that the Indian taxpayers entered into license agreement with
brand owner wherein certain conditions were stipulated by the brand owner to
maintain and enhance the brand in the local market.
Tax authorities
alleged that such conditions clearly showed the existence of agreement or
arrangement between AE and the taxpayer. The Tribunal held that financial responsibilities
on the tax payer did not prove understanding of sharing of AMP expenses.
Further, to compete with established brands in the local market the tax payer
may have to incur huge AMP expenses in local market. Thus, such arrangements
could not be viewed as being accretive to the brands owned by a foreign parent.
Conclusion
The ruling in case of
Nivea reiterates and lays down important guiding principles in connection with
marketing intangibles. It is only obvious that the facts of each case will differ
and the outcome therefor will differ. Even though all above rulings, provided
some guidance on the vexed issue of marketing intangible but they were not able
to fully address all concerns of both – the taxpayers and tax authorities and
they are now knocking at the doors of the Supreme Court to resolve the issue.
It is also pertinent
to note that in the recently released version of the United Nations Practical
Manual on Transfer Pricing for Developing Countries, the references to ‘bright
line test’ is removed from the India country practice chapter. This deletion
supports the principles emerging from various High Court & ITAT decisions
on marketing intangibles.
It seems that the AMP
matter itself being dependent on various business models adopted by the
taxpayers, the Supreme Court rulings on marketing intangible may be highly
fact-specific, which both taxpayers and tax authorities will not be able to
uniformly follow in other cases. Hence, prolonged litigation seems inevitable.
Each taxpayer would,
therefore, need to find its own resolution to the marketing intangible
controversy. Besides pursuing normal litigation route, alternate modes for
seeking resolutions could be explored such as Advanced Pricing Agreements (for
future years) and Mutual Agreement Process (for years with existing dispute).
