A recent decision of the Authority for Advance Rulings (AAR) comes as a shot in the arm for Indian Revenue who have been attempting to tax offshore transactions relying on strict ‘source’ based principles.
In its ruling in Foster’s case, the AAR has held that income from transfer of marketing intangibles (such as brand and trade marks) used and developed in India is liable to tax. The case is an example of strict application of the ‘source’ rule that determines fiscal jurisdiction based on territorial nexus and first of its kind dealing with an offshore transfer of intangible.
Transfer of marketing intangibles
Foster’s Australia Ltd (Foster’s Australia) is a leading multinational engaged in brewing and marketing of beer products. It held certificates of registration in India for use of Foster’s brand name and trademarks. A decade back, it entered into a Brand Licence Agreement (BLA) with Foster’s India Ltd (Foster’s India) to grant exclusive rights to brew, package, label and sell Foster’s beer in India.
The BLA also granted exclusive right to use Foster’s trademarks in India. Subsequently, Foster’s Australia and SABMiller executed (in Australia) a sale and purchase agreement whereby all proprietary rights and interests in Foster’s trade marks, brand and brewing intellectual property were transferred to SABMiller in India.
Foster’s Australia approached AAR seeking determination of its tax liability on transfer of such marketing and brewing intellectual property to SABMiller.
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Ruling focuses on deeming fiction
The decision turned upon a fundamental question – where was the intangible, a ‘capital asset’, situated .The deeming fiction under the domestic law taxes non-residents on transfer of ‘capital asset’ located in India. Since limited guidance is available on such deeming provision, several disputes have arisen and Vodafone is a case in point.
Foster’s primary contention was that the situs of intangible coincided with the domicile of transferor (Australia in this case). Moreover, since the agreement was executed in Australia there was no basis for taxing capital gain in India. Revenue’s representative on the other hand vehemently argued that situs was determined by place of use – similar to the contention in Vodafone’s case.
Unimpressed by the taxpayer’s arguments, AAR held that determination of situs was independent of legal ownership. Relying on American and English decisions, the Authority held that the place of use and development determined where the brand and trademarks were located.
Since in Foster’s case, the marketing intangibles were used in India, their situs was in India and, hence, Foster’s Australia was liable to pay tax. The Authority further held that the situs in Australia was at best ‘fictional’ or ‘notional’, for which no portion of capital gain was attributable.
Transfer pricing questions unanswered or not raised?
For those familiar with ‘transfer pricing’ (valuation of intra-group transactions), the similarity between ‘economic ownership’ and Foster’s principle is hard to miss. ‘Economic ownership’ is a transfer pricing concept recognised by OECD and common to several jurisdictions (notably USA, Australia and Japan).
Under the economic ownership concept, as opposed to vesting of legal title (‘legal ownership’), ownership of intangible is based on contribution towards IP development. It appears that unwittingly, AAR has applied ‘economic ownership’ concept for deciding the legal question in Foster’s case.
Even so, the Authority seems to have missed out contributions made by various parties (including Foster’s Australia) towards development of such marketing intangibles. Foster’s is and was a well-known global brand long before it arrived in India. Hence, attributing entire capital gain to India does not seem to be a fair proposition. Moreover, one wonders what the result would have been had Foster’s Australia funded marketing efforts in India. Surely an apportionment of capital gain based on transfer pricing principles would have been required in such a case.
I guess the question in relation to arm’s length determination of such transfer was not raised. My personal view is that if it was raised, either the Authority would not have answered the question or would have at least held that arm’s length principle would be paramount in taxing such transactions.
What about double taxation?
A ruling by AAR is binding on its facts, though it may have persuasive value in other cases. If the principle enunciated in Foster’s case is applied as a precedent, it shall have far reaching implications for tax planning and investment.
By linking situs of marketing intangibles with their place of use, the Foster ruling strengthens the concept of ‘exit tax’ in India, though we don’t have any comprehensive legislation unlike other jurisdictions.
Merely housing IP (brand intellectual property) in low tax jurisdiction may not exempt taxpayer from capital gains taxation unless treaty protection is available. Moreover, the possibility of double taxation can also not be ruled out where overseas jurisdiction applies ‘residence’ based principle of taxation.
Debate on ‘source’ based taxation
The Indian Income-tax law has inbuilt provisions for ‘source’ based taxation (‘business connection’ and taxation of royalty streams being some examples). Courts have interpreted these provisions with caution choosing not to impose ‘source’ based taxation in absence of legislative mandate (Supreme Court decision in Ishikawajima Harima being a case in point — held that ‘fee for technical services’ was not taxable in absence of territorial nexus).
Revenue on the other hand has been aggressive seeking to garner resources by holding it otherwise.
Foster’s ruling surely puts some wind in Revenue’s sails. However, from a policy standpoint one may question the wisdom in importing concepts like dual situs from advanced jurisdictions. If we need investment, we also need tax certainty as much as fiscal health and hence, the need for delicate balance.
‘Source-based’ taxation is a double edged sword — while Revenue may brandish it, judiciary may do better to serve as a shield. Surely, the Foster’s ruling will kick off another international tax debate with respect to India’s position on taxability of cross border transactions involving intangibles.
The author is Partner, BMR Advisors.Views expressed herein are personal and do not necessarily constitute those of the firm