Substantial transfer pricing adjustments made by India’s Tax Department in the recent past have led to litigation concerning advertising, marketing and sales promotion (AMP) expenses and the creation of marketing intangibles for foreign associated enterprises (AEs). Appeals by assessees and the Tax Department on this contentious subject are presently pending before Delhi High Court.
The department contends that by promoting the brand in India, the Indian assessee is providing services to the AE and that the foreign AE must compensate for AMP expenditure exceeding the average AMP expenses incurred by comparable companies in India, disregarding spending by foreign brand companies in India.
The special bench of the Income Tax Appellate Tribunal, in the LG Electronics case, held that transfer pricing adjustment is permissible in relation to AMP expenses incurred by the assessee for creating/improving marketing intangibles for and on behalf of an AE. In a subsequent case involving BMW India, a division bench of the tribunal held that applying the LG ratio depended on the facts of a case. Since BMW India earned premium profits, the tribunal was convinced that compensation for its non-routine brand-building services was incorporated in the pricing of imported goods so no separate compensation was required from its AE. The tribunal also ruled that in the absence of specific provisions in the Income-tax Act, 1961 (ITA), tax authorities cannot adopt the mode of compensation for AMP expenses, whether by direct reimbursement or pricing adjustment.
Later, in the Casio India case, the tribunal observed that the judgment of the special bench binds a division bench. The tribunal followed the decision in the LG case and held that it applied to manufacturers and distributors.
Subsequently, in the Bose Corporation case, the tribunal observed that the BMW judgment had considered and followed, wherever applicable, the principles laid down in the LG case and was not contrary to that decision. The tribunal directed the transfer pricing officer (TPO) to re-examine and determine the AMP adjustment afresh in conformity with the LG ruling.
Similarly, in the Canon India case, the tribunal applied the LG principles to compute the arm’s length price for the excessive AMP. In the Perfetti Van Melle India case, the tribunal held that the LG decision applies to manufacturers and distributors irrespective of whether they bear full or limited risk.
The later case involving BMW India reconciled the observations in the LG and earlier BMW India cases. The tribunal held that the decision in the earlier BMW India case does not contradict the ratio in the LG case. The tribunal restored the matter to the TPO to undertake a fresh selection of comparables to identify excessive AMP spending following principles laid down in the LG case.
A division bench of Delhi High Court has admitted appeals by assessees and tax authorities against these orders of the tribunal. The court during hearings observed that the issues raised in the appeals require deep consideration and it is imperative to ensure the 3Cs – clarity, certainty and consistency – are applied in these matters.
The issue of AMP expenses and recompense for it rests on facts and depends on the functions, assets and risks profile of each case. Tax authorities have recharacterized AMP expenditure as an “international transaction” without considering that such expenditure is incurred to further sales, and thus forms part of the functional profile of an assessee in the normal course of its business operations. The Tax Department has not appreciated that any benefit to the AE arising from AMP expenditure is only incidental and does not merit compensation.
Other aspects of these transactions, such as customs valuation implications and deductibility of AMP expenses in terms of the ITA, have also been raised by concerned tax authorities.
In India, the law on the issue of marketing intangibles is evolving through judgments. Internationally, jurisdictions such as the US and Australia have formulated regulations to address this issue and adjustments. The OECD’s Guidance on Transfer Pricing Aspects of Intangibles dated 16 September 2014 recommends that distributors should be compensated for enhancing the value of trademarks and other marketing intangibles by virtue of costs incurred, functions performed and risks assumed exceeding those an independent distributor might incur for its own distribution activities. Per the guidance, the remuneration may be in the form of a decrease in purchase price, reduction in royalty rate or share in profits associated with enhanced value of trademark/brand name.
This issue involves great complexities, economic considerations and revenue implications. Given the scale of litigation on the issue, and without definitive provisions in the ITA to deal with AMP adjustments, the government would do well to consider international guidelines and India’s economic outlook to formulate rules in the ITA to deal with the AMP valuation transactions that increasingly arise in the Indian context.
Ranjeet Mahtani is an associate partner and Darshi Shah is an associate at Economic Laws Practice. This article is intended for informational purposes and does not constitute a legal opinion or advice.
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