In September 2007, when India was invited to present its views in Kyoto International Fiscal Association (IFA) Congress on ‘Transfer Pricing and intangibles’, I thought it was too early to warrant a debate where India should participate. I was perhaps wrong given the pace of developments.
The concept of marketing intangiables has become a debated issue within the International tax fraternity, particularly in the US. While its precise meaning is unclear and nebulous, and may vary in application by jurisdiction and industry, the breadth of its grasp continues to grow as tax administrators globally resort to invoke such provisions. Ordinarily, ‘marketing intangibles’ include a bundle of intellectual property rights such brands, trademarks, knowhow that surrounds knowledge of distribution channels and customer relationship. Tax administrators believe investment in such marketing intangibles is derived from, among other things, company’s advertising, marketing and promotion expenditure commonly called AMP by the Advertising & Media industry.
Under the principle, the tax administration disallows a portion of AMP incurred by an affiliate on the pretext a portion of such costs benefitted the parent and/ or other affiliates. The disallowance or, an adjustment in Transfer Pricing (TP) parlance, is done following the arm’s length Principle. Whereas, Australia, US and UK have formulated guidance in recent years empowering them to act against errant tax payers, OECD recently embarked on an project to supplement it with guidance on this part of international tax law. The guidance is expected in two years as it entails consultations with the business community and tax administrators of OECD members and key non-members including India. Historically, OECD’s TP guidelines have rendered guidance and clarity on complex Transfer Pricing issues and most nations (including India) have enshrined them in their domestic laws.
The Delhi HC judgment in the case of Maruti- Suzuki (MS) has examined the concept of marketing intangibles. MS entered into a foreign collaboration and licensing agreement with Suzuki Motor Corporation, Japan (‘SMC’) for the manufacture and sale of automobiles. The terms of such collaboration and license agreement provided that MS shall pay a lump sum and running royalty (to SMC) in consideration of technical assistance and usage of brands. MS used the logo of SMC (the famous “S” symbol) in front portion of the cars and, continued using the brand name ‘’Maruti-Suzuki’ on rear portion of its vehicles.
The Transfer Pricing officials alleged usage of SMC’s logo (in place of Maruti logo which was used in early years) symbolised a change, resulting in deemed sale of the brand ‘Maruti’ to SMC. This lead to a proposed adjustment of over Rs 4,000 crore representing cumulative AMP of Maruti Suzuki since the formation of the venture in early 80’s. The case ended in a different trajectory after Revenue failed to act on its proposal to tax AMP against which MS filed a writ petition questioning the jurisdiction and the basis. In the final order, the Revenue took a position SMC failed to compensate MS for using its trademark ‘Suzuki’, a weak brand in India (whereas ‘Maruti’ is considered strong). The Revenue contending that SMC did not compensate MS for co-developing marketing intangibles, which benefitted SMC and made an adjustment by disallowing 50 per cent of royalty and excess advertisement expenditure.
MS contended no additional benefit was passed to SMC by using Suzuki trademark; in fact use of the trademark enabled Maruti Suzuki to maintain its market share in face of competition from other MNCs. Against the Revenue order, MS pursued a writ petition route, rather than seeking ordinary administrative remedy. The Delhi HC felt an issue like ‘marketing intangibles’ is important enough to be examined and dealt with and quash the proceedings if the Revenue had exceeded its jurisdiction.
Bright line theory born
In concluding, the Delhi HC leaned towards the ‘bright line test’ and dismissed the Revenue order as baseless. The phrase ‘bright line’ first surfaced in 2002 in the DHL case, which addressed US IRS attempt to impute a trademark royalty for the use of DHL trademark by DHL’s foreign affiliates. At issue was DHL’s assertion no royalty can be imputed from such foreign affiliates, since they bore the economic risk and investment for the developing DHL trade mark. The trial court judge espoused ‘bright line’ test which notes, while every licensee or distributor is expected to incur a portion of cost to exploit intangibles, it is when the investment crosses the ‘bright line’ of routine expenditure (and enters realm of non-routine) that economic ownership such as marketing intangible is created.
While I am hesitant to sit on Judgment on the validity of these principles, in the Indian context, the ‘bright line’ theory serves as a precursor for the administration to continue challenging AMP expenditure. Though the MS decision was rendered in early July, I see how enthusiastic our Revenue officials are to invoke the ‘bright line’ test, disregarding business realities. Interestingly, last week the SC made an observation in coming to decision on withholding tax on network charges and remarked it is imperative for Revenue to understand and appreciate technical nuances associated with tax payers telecom business. The dispute had arisen as a result of opposing views on application of TDS provisions in payments by various telecom companies to BSNL towards interconnect charges. Several MNCs, with huge Advertising spends have faced ad hoc adjustments due to imposition of ‘bright line’ test.
Stretching the Principle
Firstly, unlike India, the US, UK, Australia have been exploring solutions on such complex issues after decades of experience and a degree of maturity in their administrative process . Importantly, Indian market is in a growth phase and hence, businesses would want to go aggressive on their AMP efforts. Should they now be guided by ‘bright line’ test? This takes us back to the age-old question: Can the fear of taxman impact boardroom decisions?
It appears to me, from a deductibility stand point, the Delhi HC has unintentionally drawn a “lakshman rekha” on AMP expenditure for promoting a brand/trademark, legally owned by the foreign parent. In defence of the Judgment, Principles of law have to have contextual application and cannot operate as an omnibus theory and hence, the risk of dealing with tax administration is evident. The focus of the tax administration evident from the adjustments that several Multinationals have faced seems now be on the principle of disproportionality of AMP . While some observations made by the HC on choice of comparable data (Maruti-Suzuki is comparable to Honda & Hyundai and not to Hindustan Motors, Tata Motors or Mahindra’s) are commendable, my concern is more on the practical application of such principles. The fact that companies even within the same industry have different marketing strategies and may account for their AMP expenditure under different accounting heads would make the exercise of determining the ‘bright line’ impractical and subjective. Businesses have varying approach to their marketing philosophies, product launches and/ or product dependence or interdependence. This could create very different ‘bright lines’ for peer companies.
To conclude, it would suffice to mention the principles articulated in Maruti’s case have far reaching impact on business models – FMCG, pharmaceutical, automobile and consumer electronics being the more prominent. ones. I look at raindrops outside my window. The way ahead looks slippery and bumpy. I wish the tax administration draws a sensible set of guidance to propound Indian ‘ bright line’ test.
(The author is a Partner with BMR Legal and speaker at the 2007 IFA Conference in Kyoto on Transfer Pricing and intangibles. Views are entirely personal. He was assisted by Sanjiv Malhotra. )
