HP Agrawal: Controversy on definition of international transaction

LG Electronics Inc, a Korean company, set up a wholly owned subsidiary in India (LG Electronics India Pvt Ltd). LG Korea provided its technical assistance to LG India for which it agreed to pay royalty at the rate of one per cent. LG Korea also permitted LG India to use its brand name and trade marks in relation to products manufactured in India. The use of brand name and trade marks were allowed on a royalty-free basis. LG India in the normal course of its business incurred certain advertising, marketing and promotion (AMP) expenditure for which payment was made to non-associated parties. The TPO held that the expenditure incurred by LG India resulted in promoting the LG brand owned by LG Korea and hence LG India should have been adequately compensated by LG Korea. In other words, the TPO made adjustments on account of expenditure incurred by LG India on AMP deeming that the expenditure has resulted in brand building of LG for which LG India should have been compensated by LG Korea.

The adjustment was made as under—

LG India incurred expenditure on AMP to the tune of 3.85 per cent of sales. The TPO observed that expenses up to 1.39 per cent of the sales should be considered as having been incurred for the LG India’s own business and the remaining part which is in excess of 3.8 per cent on brand promotion of the foreign Associated Enterprise (AE). The percentage of 1.39 per cent was computed on the basis of expenditure incurred on AMP by comparable companies. Accordingly, it was held that LG India should have received the expenditure over and above 1.39 per cent from LG Korea amounting to Rs 162 crore approx. On appeal by LG India to Dispute Resolution Panel (DRP), that upheld the view taken by the TPO and further held that there should be a mark-up also. Opportunity cost was finalised at 10.50 per cent, being the interest rate charged by the banks; and compensation for the assessee's entrepreneurial efforts was taken at 2.5 per cent, thereby, holding that a mark-up of 13 per cent should have been applied on the amount proposed for adjustment

LG India filed an appeal before ITAT against the order of the AO passed in pursuance to the direction of the DRP. Among the various grounds of appeal taken by LG India, it also took the following grounds —

A: Whether in the absence of any verbal or written agreement between the assessee and the AE for promoting the brand, there can be said to be any “transaction“?

B: Whether such a “transaction“, if any, can be treated as an “international transaction“?

The Hon’ble Tribunal held as under:

A: “It follows that a 'transaction' can be both express as well as oral. So long as there exists some sort of understanding between two AEs on a particular point, the same shall have to be considered as a transaction, whether or not it has been reduced to writing;”

B: “When we read sec. 92B(1) it comes to fore that in order to be characterised as an international transaction, the following salient features must be present : (1) There should be a 'transaction' (2) Such 'transaction' should be between two or more AEs and either or both of whom should be non-residents. (3) Such transaction should be of the nature as referred to in section 92B; All the three requisites must be cumulatively satisfied so as to make a 'transaction' an 'international transaction'.”

On the aforesaid basis, it was held that the understanding between LG India and LG Korea would be treated as an “international transaction” even though there is neither any agreement between the parties nor any consideration whether monetary or otherwise has flown from one party to the other.

In the above context, the observation of the Hon’ble Tribunal in treating the “brand building” as an international transaction is too far-fetched. Such a far-fetched view will open a Pandora box of litigation.

In addition to the above, LG India has received brand/ trade mark without any charge by LG Korea. If a far fetched view has to be taken, then why no adjustment has been made for the fact that LG India has not paid anything for obtaining use of “Brand/trade mark” to its AE in Korea.

With utmost respect to the Hon’ble Tribunal, the interpretation of the term “international transaction” taken by them is not practical. The Hon’ble Apex Court has repeatedly warned that “It is a well settled rule of construction that where the plain literal interpretation of a statutory provision produces a manifestly absurd and unjust result which could never have been intended by the legislature, the court may modify the language used by the legislature or even do some violence to it, so as to achieve the obvious intention of the legislature and produce a rational construction.” (See Varghese (KP) v ITO, 131 ITR 597).

This article has been co-authored by Alok Gupta Email: hp.agrawal@sskmin.com

a.gupta@sskmin.com