 "Consumer markets industry: Grappling with tax riddles")
With all eyes fixated on Budget 2014, the new Finance Ministry would be grappling with huge expectations from various industry sectors. Considering ‘taxpayer friendliness’ as one of the key focus areas, it would be just expectation from the industry to hope for clarity around some perennial tax issues. With Comptroller and Auditor General of India (CAG) report citing stakes of over Rs 4.4 lakh crores locked up in direct tax litigation till the end of 2011, it must surely be a top priority item for the new Finance Minister.
As per a KPMG report of 2011, India is likely to emerge as the world’s largest middle class consumer market with aggregated consumer spend of $ 13 trillion by 2030. Even with such a promising outlook, Indian markets are seen as having certain challenges, out of which protracted tax litigation have been at the forefront.
One of the most burning tax issues faced by consumer market sector is around adjustment of Advertisement, Marketing and Promotion (‘AMP’) expense incurred by the Indian subsidiaries of multinational companies (MNCs) to promote sale of their products in India. The issue, commonly referred to as bright line test, is based on the sole premise that AMP expenses incurred by Indian companies result into creation of marketing intangibles for the overseas parent, which legally owns the trademark. Tax authorities have raised huge tax demands on a number of MNCs on this ground by holding that this requires the Indian arm to be compensated on an arm’s length basis.
While this issue is fact specific, the new Government should use the opportunity to resolve the controversy by issuing appropriate guidelines with illustrations, preferably after consultation with all stakeholders. This is essentially because determination of whether a transaction involves promotion of brand legally owned by a foreign enterprise is a factual exercise. Even the application of bright line test also depends upon several factors, while the approach of tax authorities has been to apply similar methodology to all cases without considering their underlying facts. For instance, a newly introduced brand normally will require significantly higher AMP expenses than an established brand.
Another issue faced by consumer markets industry is relating to characterisation of rebates given to distributors, dealers and channel partners as discounts or commissions and the related deduction of tax at source (TDS) and levy of service-tax. These controversies hit at the very root of the business model of companies as huge demands have been raised by tax authorities in a number of cases by treating such rebates as commission. While the tax laws stipulate levy of service-tax and TDS on commission and not on discount, various rebates like cash discount as inducement for prompt payment, volume rebates as inducement for bulk purchases have been alleged by the tax authorities as commission. While the judiciary has applied the doctrine of ‘principal to principal’ relationship between the company and the dealer to quash such tax demands, the matter continues to be litigated by tax authorities and specific clarification from the Government will go a long way in achieving certainty over these issues.
Another tax issue faced by consumer markets industry is around disallowance of warranty expenses of companies towards future repair claims. While provision is generally created based on scientific estimation of past claims in accordance with the applicable accounting standards, tax authorities disallow the same on the ground of being contingent and ad-hoc. While this issue was clarified by the Supreme Court in 2009 in the case of Rotork Control, tax authorities have continued to litigate the same alleging certain factual distinctions. The industry hopes for an enabling provision in law or a circular from the Government to settle this long debated issue, even when this issue is merely a timing difference and helps Revenue’s cause only to a very limited extent.
To sum up, tax issues are increasingly becoming more and more important to determine the overall cost of operations in India. Accordingly, suitable clarifications and guidelines by the new Government would go a long way in sending out positive signals to the industry at large. After all, prevention is better than cure!
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The author is the Partner - Tax at KPMG in India
As per a KPMG report of 2011, India is likely to emerge as the world’s largest middle class consumer market with aggregated consumer spend of $ 13 trillion by 2030. Even with such a promising outlook, Indian markets are seen as having certain challenges, out of which protracted tax litigation have been at the forefront.
One of the most burning tax issues faced by consumer market sector is around adjustment of Advertisement, Marketing and Promotion (‘AMP’) expense incurred by the Indian subsidiaries of multinational companies (MNCs) to promote sale of their products in India. The issue, commonly referred to as bright line test, is based on the sole premise that AMP expenses incurred by Indian companies result into creation of marketing intangibles for the overseas parent, which legally owns the trademark. Tax authorities have raised huge tax demands on a number of MNCs on this ground by holding that this requires the Indian arm to be compensated on an arm’s length basis.
While this issue is fact specific, the new Government should use the opportunity to resolve the controversy by issuing appropriate guidelines with illustrations, preferably after consultation with all stakeholders. This is essentially because determination of whether a transaction involves promotion of brand legally owned by a foreign enterprise is a factual exercise. Even the application of bright line test also depends upon several factors, while the approach of tax authorities has been to apply similar methodology to all cases without considering their underlying facts. For instance, a newly introduced brand normally will require significantly higher AMP expenses than an established brand.
Another issue faced by consumer markets industry is relating to characterisation of rebates given to distributors, dealers and channel partners as discounts or commissions and the related deduction of tax at source (TDS) and levy of service-tax. These controversies hit at the very root of the business model of companies as huge demands have been raised by tax authorities in a number of cases by treating such rebates as commission. While the tax laws stipulate levy of service-tax and TDS on commission and not on discount, various rebates like cash discount as inducement for prompt payment, volume rebates as inducement for bulk purchases have been alleged by the tax authorities as commission. While the judiciary has applied the doctrine of ‘principal to principal’ relationship between the company and the dealer to quash such tax demands, the matter continues to be litigated by tax authorities and specific clarification from the Government will go a long way in achieving certainty over these issues.
Another tax issue faced by consumer markets industry is around disallowance of warranty expenses of companies towards future repair claims. While provision is generally created based on scientific estimation of past claims in accordance with the applicable accounting standards, tax authorities disallow the same on the ground of being contingent and ad-hoc. While this issue was clarified by the Supreme Court in 2009 in the case of Rotork Control, tax authorities have continued to litigate the same alleging certain factual distinctions. The industry hopes for an enabling provision in law or a circular from the Government to settle this long debated issue, even when this issue is merely a timing difference and helps Revenue’s cause only to a very limited extent.
Naveen Aggarwal, Partner - Tax, KPMG in India
To sum up, tax issues are increasingly becoming more and more important to determine the overall cost of operations in India. Accordingly, suitable clarifications and guidelines by the new Government would go a long way in sending out positive signals to the industry at large. After all, prevention is better than cure!
____________________________________________________________________________________________________
The author is the Partner - Tax at KPMG in India