Tangled In Marketing Intangibles!

The much awaited Special Bench ruling on Transfer Pricing principles for marketing intangibles is here but with no clear winner! Payaswini Upadhyay gets into the details.

LG India, Glaxo Smithkline, Maruti Suzuki, Sony, Pepsi Foods -- foreign brands that have one thing in common -- they are all subsidiaries whose foreign parents provide them with technical assistance and allow them to use trademarks and brand name. Now to augment their domestic sales, these Indian subsidiaries spend a considerable amount on advertising, marketing and promotion (AMP). And it's this expenditure the Indian IT department is interested in. It says that beyond a certain limit, these expenses by the Indian subsidiaries promote the foreign brand... so the Indian subsidiaries should be adequately compensated for this service by the parent. Rohan Phatarphekar
ED & National Head- Global Transfer Pricing, KPMG))
"The Revenue is saying is that if you are doing that expenses and if that expenses is beyond a particular limit and that limit is what they which is what is call as a bright line test which is say the comparable company's average spend of marketing to sales, if the tax paid is doing anything more than that, then they are saying that, that has to be something that has to be considered to be a service that is being rendered by the Indian company to the foreign company which is the owner of the brand and further that this service should be compensated on a cost plus mark up basis." The Bright Line Test that Rohan alluded to was laid down by a US Court in 2002 in DHL’s case. The court applied this test to differentiate routine and non-routine expenses. The tax department in India has been using this test to say that AMP spending on the product be treated as a routine expense but the amount spent on creating and maintaining the brand be treated as non-routine expenditure. Also, Revenue department wants this expense allocation to be compared with that of a similar third-party entity. Experts say this cannot be done, especially for licence manufacturers. Rahul Mitra
National Leader- Transfer Pricing, PwC
“A licence manufacturer can never ever have a comparable in India - the question of comparing either its margin from a profitability stand point or its marketing spend as a percentage of turnover without the comparables will also not arise. So this is, I would say the primary issue which permeates through all the facts of licence manufacturers that if it is an entrepreneur, then the question of comparing does not arise and as a corollary if you cannot compare yourself with another comparable or if you cannot have another comparable in India the question of comparing your ad marketing spend with another company and then to say that you should be getting a re-imbursement for the excess also does not arise.” However, this argument is not forthcoming in the order of the Special Bench of the Delhi ITAT. Remember, the Bench was constituted to ascertain a common question that was being contested by companies and Revenue across Tribunals - is the AMP expense by the Indian subsidiary an international transaction requiring a transfer pricing adjustment? The Bench delivered two judgments this week- the majority order by the Vice President and Accountant Member of the Special Bench ruled in favor of the Revenue on two aspects - one, that the tax department is right in applying a transfer pricing adjustment in the case of LG India as the company created a marketing intangible for its parent in Korea. Second, that the foreign parent needs to compensate the Indian subsidiary for the excess AMP spend. But there was also a dissenting order by the Judicial Member which agreed with LG India that no international transaction existed and there is no shifting of income to a different jurisdiction. Amit Rana
VP- Tax, GE India
“I don't know if this was argued in Court - we can't glean it from the ruling itself- there is no debate here. There could be fact patterns where the parent is taking out money from India in the form of various returns; thereby taking out the profits of the Indian company in which case the debate can arise that look while the profit accrues to the Indian company, through various channels, the parent is wiping out that cash back to Korea - in that case the debate can arise that look, the beneficiary of the additional profits of India is also Korea. So, if India is incurring additional spends, they should make a return. But in this case, there is nothing to suggest that. I don't think this debate should even be arising.” The Tribunal has now sent LG India back to the Transfer Pricing Officer or TPO ruling that the way the tax department calculated the cost of services provided by LG India to its parent is incorrect, it has directed the TPO to take into account 14 factors to arrive at the appropriate cost of the transaction. The Bench also ruled that the Revenue department's application of comparables in LG's case is not correct. To justify excess AMP, Revenue had compared LG India's marketing spend to that of Whirlpool and Videocon. LG India had argued that the right comparable for its case would be another foreign brand like Samsung. The Tribunal agreed, saying Revenue had faltered in limiting the comparables to only two... but it rejected LG India's argument that a foreign brand should be used as a comparable. Rohan Phatarphekar
ED & National Head- Global Transfer Pricing, KPMG
“The point of argument from Revenue perspective is that these companies who themselves are the licencees of foreign brands are not appropriate comparable, because they themselves will have the proof of burden about trying to prove whether the AMP expenses results into a service or not, and hence those companies are not considered to be comparables. But that again is debatable, because if you want to compare like with like, yes there could be a technical issue, whether they are comparable or not, but if one has to really understand, whether the AMP expenses are appropriate spend or not, one has to make a like comparison. But the Tribunal has again gone ahead, and said that you should look at domestic companies and the point here is that domestic companies who do the AMP expenses would probably be entrepreneurs and may themselves be owning the brand, so again you have a situation where you are comparing a licencee with the owner of a brand, so they are not the appropriate comparables.” Now besides the setback to LG India in particular, experts point out that several other legal principles laid down in this ruling may influence similar cases pending before various other Tribunals. One of them is the distinction between economic owner vs legal owner of a brand. Some of the 21 entities that intervened in the LG India case had argued that part of the AMP expense can be attributed to building the economic ownership of a foreign brand. They pointed out that since the Indian entity is the economic owner of the brand, the full AMP expense should be eligible for deduction. But the Tribunal struck down this argument saying such a distinction would lead to incongruous results and that the concept of economic ownership is not recognized in the Act.  Amit Rana
VP- Tax, GE India
“Assume the Revenue accepted this proposition that India is not even the economic owner, it would hurt them in various other cases; including the Advance Ruling in the case of Fosters where they themselves argued that Fosters Australia sold a brand to Sabmiller and the brand had been licenced to an Indian entity of Fosters. When the sale happened between an Australian company and a South African company, the debate was should that sale be taxable in India. There the Revenue argued that the economic owner of that IP or the brand is the Indian entity because they spent so much money on brand promotion and they are actually utilizing that. So they are the economic owners and any transfer of the IP should yield a result for India. Now it's flipping the other way. So suggesting that the concept of economic ownership does not exist, apart from being wrong, is also fraught with risk even for the Revenue.” 2006
Foster's Australia sold Indian beer arm to SABMiller for about $120 mn
Sale included brand & trademark rights
 
Tax Department
Alleged SABMiller should have withheld tax
Sent a tax notice to SABMiller for $42 mn
 
Foster's Australia approaced AAR on the question whether sale of brand & patent attracts tax in India 2008
AAR: Foster's sale taxable in India Another principle that is making tax consultants nervous is that the Special Bench ruled that even if the net profits are at arm's length price, there is scope for adjustment for marketing expenses. LG India's argument that its higher net margin vis-a-vis the comparables should compensate for the higher marketing spend did not find favor with the Tribunal. Experts point out that higher profitability is important to satisfy the required arm's length principle and this application by the Special Bench will impact the taxpayers adversely. But PwC's Rahul Mitra says all is not lost. Rahul Mitra
National Leader- Transfer Pricing, PwC
“I personally feel that the tax payers would still have a good chance to say that the special bench ruling was given or rendered in the context of a particular set of circumstances and in the context of a particular approach that was taken by the particular tax payer. By taking a more, I would say a robust or correct approach, tax payers might still say that look I am an entrepreneur then why are you comparing my ad marketing spend because I don't have a proper comparable, I cannot have a comparable here. And as I mentioned since tax payers were not distributors, you know their cases have not been adjudicated. It is my very stern feeling and I would say very strong feeling that the cases of the distributors need to be argued and need to be adjudicated in a manner which I discussed and the observations of the tribunal should not really I would say affect or have any implication whatsoever whether in favor or against the facts of any other distributor tax payer.” Notwithstanding Rahul Mitra’s optimism, the LG ruling is likely to have a significant impact on all the pending cases that were put on hold for the Special Bench to reach an outcome. And, so the debate around marketing intangibles is set to get a lot more interesting. In Mumbai, Payaswini Upadhyay