The tax authorities argue that these AMP expenses incurred by MNC subsidiaries enhance the value of trademarks or brands owned by the foreign parent entities
Expenses incurred by the Indian subsidiaries of multinational corporations on advertising, marketing and promotion (AMP) have become a controversial issue regarding their taxability.
The tax authorities argue that these AMP expenses incurred by these subsidiaries enhance the value of trademarks or brands owned by the foreign parent entities.
As such, the local subsidiaries should be compensated by the brand owners, they say.
Due to the lack of specific guidelines on these services within Indian transfer pricing (TP) regulations, this matter has become a highly contested issue between companies and the tax authorities.
So far, limited clarity is available on this issue by way of a few judgements by courts and tribunals in recent years.
However, clarity is yet to emerge with respect to the taxability of AMP expenses.
One of the methods adopted by the tax authorities to tax these expenses is the bright line test. The tax authorities use the bright line test (BLT) to tax these expenses. Under BLT, AMP expenses exceeding the industry average are considered as brand building for foreign parents and are taxed. However, rulings on this issue have been inconsistent.
The special bench of Delhi-based income tax appellate tribunal (ITAT) in an LG Electronics India case confirmed in a majority judgement that excess AMP expenses resulted in the promotion of the brand in India, legally owned by the taxpayer’s foreign parent company.
Hence, the excess AMP expenditure can be termed as the provision of service by Indian subsidiaries to foreign parents. These expenses were characterised as an international transaction.
The special bench accepted the BLT as a tool to determine the arm’s length nature of AMP expenditure by the taxpayer.
The bench laid down various criteria for determining the cost or value of the international transaction involved. The application of an arm’s length mark-up on the value of brand-building services provided by the Indian taxpayer was upheld.
The Delhi High Court in the Sony Ericsson Mobile Communications India case determined that the AMP expenses constituted an international transaction, ruling in favour of the tax authorities.
The court found the ITAT special bench ruling in the LG case was erroneous and unacceptable, thus remanding the matter back for reconsideration.
The HC ruled that the BLT lacks a statutory mandate.
It emphasized the importance of identifying potential comparables, stating that the selected method should accurately reflect the AMP transaction.
The HC held that branding and marketing are intertwined functions, allowing for the bunching of expenses under certain conditions.
It stated that equating brand building with advertisement is incorrect. Brand creation depends on specific facts and is influenced by the company’s reputation and quality control measures.
The court disagreed with the tax authorities’ broad-brush approach to distinguishing between routine and non-routine expenses.
It observed that its judgment should not be interpreted as providing a definitive solution to such a complex issue
The Delhi high court in another Maruti Suzuki India Ltd (MSIL) case held that AMP expenses by the company are not an international transaction.
The Court distinguished this case from the Sony Ericsson case, noting that Sony Ericsson dealt with distributors of foreign-manufactured products and not the manufacturer itself. Further, the judgement in the Sony case did not dispute the existence of an international transaction concerning AMP expenses.
The court observed that the decision in the Sony Ericsson case rejected the use of BLT to determine the existence of an international transaction or the arm's length price (ALP). Consequently, without BLT, there is no basis to assert that MSIL’s AMP expenses constituted an international transaction.
The Court conducted a detailed analysis of sections 92 B to 92 F of the Income Tax Act which deals with international transactions and concluded that without BLT, there is no provision to identify the existence of an international transaction due to AMP expenditure.
The court set aside ITAT orders which had made transfer pricing adjustments related to AMP expenses.
Recently, the Delhi High Court dismissed an appeal by the tax authorities against Pepsico India in a case related to taxation of AMP expenses. The tax authorities went to the High Court against the Delhi-based ITAT order of deleting a tax addition made by the assessing officer (AO) on AMP expenses of Pepsico.
The AO had taken part of AMP expenses as international transactions to contend that Pepsico India undertook brand-building activities for its foreign parent.
The AO came to this conclusion based on the BLT. The Delhi High Court had held that BLT is not a valid methodology under transfer pricing rules in India. The court relied on the judgement in the Sony Ericsson case to dismiss the appeal by the tax authorities against Pepsico Holdings.
In most of the judgements passed by high courts and tribunals so far, both companies and tax authorities have lodged SLPs against those judgements and now standing at the door of the Supreme Court waiting for the final verdict.
While the Supreme Court ruling can keep the AMP controversy at rest on limited facts applicable to SLPs filed, it is unlikely that the court can find a “one size fits all” solution given the unique peculiarities involved in every case.
Two pertinent questions are waiting to be addressed by the Supreme Court – whether the AMP expenses constitute international transaction and if yes, then what is the correct methodology to compute the arm’s length price for AMP transaction.
The best one can expect is that the Supreme Court may lay out certain parameters which might provide a broad framework on how to proceed in cases of marketing intangibles, says Manish Garg, lead transfer pricing and litigation at tax and consulting firm AKM Global.
There are two possible scenarios from the Supreme Court ruling, he says. “First if the Supreme Court holds that AMP expenses are not international transactions. In this case, the question of BLT or any other transfer pricing methodology will be put to rest forever,” he opines.
In the scenario of the Supreme Court holding that AMP expenses as international transactions, the biggest challenge for the court would be to determine the methodology to be applied in the computation of compensation for Indian distributors and manufacturers, Garg says.
“The BLT does not take into account the uniqueness of functions performed, assets employed and risks undertaken by the different companies and it attempts to measure all the companies using a single yardstick. Hence, BLT does not appear to be a fair tool,” he says.
He says a single broad-brush approach is unlikely to be helpful in determining compensation for advertising, marketing and promotion activities, as these expenses vary by industry and sometimes by product.
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