In a severe blow to multinational corporations (MNCs) operating in India, a special bench of the Income Tax Appellate Tribunal (ITAT) has ruled that a significant portion of advertising, marketing and promotional (AMP) expenses incurred by their Indian arms to promote the brand and trademarks of the MNC will be taxable in India.
In a majority decision, the bench ruled in favour of the tax department that the taxpayer incurring AMP expenses in excess of amounts spent by comparable companies ought to have been compensated for creation or enhancement of such brand by its associated enterprise (AE), which owns the brand. The decision will be binding on other division benches of the tribunal unless overruled by a high court. The tribunal invoked the retrospective amendment to Section 92CA(2B) inserted by the Finance Act, 2012, effective from June 1, 2002, which grants powers to the transfer pricing officer to look into the transactions that are not reported by the taxpayer and which come to his notice during the course of assessment proceedings. It also upheld the usage of the Bright Line test, which uses the expenses incurred by comparable companies, to decide arms’ length pricing.
The ruling came on an appeal by LG Electronics, which faced transfer pricing adjustments of Rs 162 crore for assessment year 2007-08. However, 14 other Indian arms of MNCs also argued as “interveners” against the decision of the transfer pricing officer, which was earlier upheld by a dispute resolution panel. Pepsi Foods, Maruti Suzuki, Glaxosmithkline, Goodyear India, Bausch & Lomb, Amadeus, Canon, Fujifilm, Star India, Sony, Haier Telecom, Haier Appliances, LVMH Watch and Jewellery and Daikin Airconditioning also faced transfer pricing adjustments on excessive AMP.
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| Key elements in Bright Line test |
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| Source: Deloitte |
Of these 15 entities (including LG), only three were listed, all of which fell sharply following the decision on January 23. Maruti shares fell about four per cent from Rs 1,590-levels on January 22 to Rs 1,530 on January 24. However, it recovered on Friday. Goodyear shares fell nearly four per cent from Rs 328 to Rs 316 between January 22 and January 25. Glaxo fell from Rs 3,780 to Rs 3,766.
In the LG Electronics case, the transfer pricing officer observed that the assessee’s AMP expenses were 3.85 per cent of sales at Rs 6,553.36 crore.
The officer considered similar expenses incurred by Videocon Appliances (0.12 per cent) and Whirlpool of India (2.66 per cent) and computed their arithmetic mean at 1.39 per cent. It was opined that the assessee was promoting LG brand owned by its foreign AE and hence, should have been adequately compensated by the foreign AE.
Applying the Bright Line test, the transfer pricing officer held that expenses up to 1.39 per cent of sales should be considered as having been incurred for the assessee’s own business and the remaining, at 2.46 per cent (3.85 per cent-1.39 per cent) on brand promotion of the foreign AE. Such excess at Rs 161.22 crore was proposed as a transfer pricing adjustment on account of AMP expenses for brand building. According to the tribunal, incurring proportionately higher AMP expenses coupled with the advertisement of brand or logo of the AE, gives inference of the existence of some informal or implied agreement. Also, the fact that the taxpayer’s marketing strategy was under the directions, guidance and control of the parent implied that it had full control over the AMP expenses of the taxpayer. The tribunal thus, held that there is a transaction between the taxpayer and the AE under which the taxpayer incurred AMP expenses towards promotion of brand, which is legally owned by the AE.
“This ruling of special bench has far reaching consequences on MNCs operating in India. It is now imperative for such MNCs to review the current policies and arrangements and be geared up for more challenges from Indian transfer pricing authorities,” a lawyer in consulting firm SKP said.
Experts said it is not easy to pick the right comparables, which may skew the results of the Bright Line test. Samir Gandhi, Deloitte Haskins and Sells, said, “Determination of whether there is a transaction of promotion of brand legally owned by a foreign enterprise is a factual excercise. One is required to consider what an independent enterprise behaving in a commercially rational manner would incur such extent of AMP expenses as the taxpayer.”
The application of Bright Line test depends on several factors, e.g., whether or not the brand is an established one. For example, a newly introduced brand normally will require higher AMP expenses than an established brand.
However, SKP said not all is lost for the taxpayer. According to the SB, what constitutes AMP has to be decided on facts of each case and cannot include expenses in connection with sales promotion. It also held that there is a need to look at the right comparables for the application of the Bright Line test.
The Central Board of Direct Taxes should issue guidelines with illustrations on this issue after consultations with all stakeholders — OECD discussion draft on intangibles is a good example to resolve the issue to a great extent, said Gandhi of Deloitte.
