Section 92 of Income Tax Act, 1961 not applicable to advertisement expenditure incurred by assessee, a wholly owned subsidiary of an American restaurant company in India

Section 92 is not applicable with regard to advertisement expenditure which has been borne by the assessee as a result of the Franchise Agreement with Indian franchises and the same has resulted into lesser profit/loss of the assessee and more profit to the franchises and it has no impact on the income of the American principal because whether the advertisement expenditure is borne by the assessee or by the franchises, the benefit of American principal will remain the same.

CASE LAW DETAILS

Decided by: ITAT, DELHI BENCH `F’, NEW DELHI,  In The case of: McDonald’s (India) Pvt. Ltd. v. ACIT,  Appeal No.: ITA No. 3890/Del/2004,  Decided on: October____, 2009

RELEVANT PARAGRAPH

8 We have heard the rival submissions and have gone through the material available on record and the judgments cited by Ld AR of the assessee. We find that in view of Master License Agreement dated 1.4.1996 and Service Agreement dated 1.4.1999, the assessee is running two types of businesses although both are connected with Mc Donald’s Corporation USA As per this agreement dated 1.1.1996 I.e. Master License Agreement, the assessee can operate restaurant system under Mc Donald’s System and the assessee can run it of its own or through franchises. In both these situations, the assessee has to pay royalty to Mc Donald’s Corporation USA @ 5% of gross turnover. Regarding advertisement, clause (vi) of this Master License Agreement is relevasnt as per which, licensee has to spend during each calendar year for advertisement or promotion of restaurant business for the general public and amount which is not less than 5% of its gross sales. In view of this, we find that as per Master License Agreement dated 1 1 1996, the assessee has to pay 5% of gross turnover to Mc Donald’s Corporation USA as Royalty and at the same time, the assessee has to spend minimum 5% of gross turnover for advertisement. As per franchises agreement of the assessee with Connaught Plaza restaurant Pvt. Ltd. also, we find that the franchises has to incur minimum of 5% of gross sales towards advertisement and the franchises has to pay to the assessee royalty @ 5% of the gross sales This shows that as per the Master License agreement and franchises agreement, the assessee has to pass on the entire royalty which it has to receive from franchises and there is no income left to the assessee as per this Master License Agreement and franchises agreement. Thereafter, the assessee has entered into a Marketing Support Agreement with the franchises on 1 10.1997. As per this Marketing Support Agreement, the assessee has to contribute some part of the advertisement expenditure which is required to be borne by the franchises As per clause (d) of this Marketing Support agreement dated 1 10.1997. it is noted that if the business of the franchises is expanded and its sales are increased, it will result into an increase in profitability and consequently it will increase the return on the investments as well as result in an increase in the net wealth of the franchiee company This shows the purpose for which the assessee has agreed to bear a part of the advertisement expenditure which was otherwise to be borne by the franchises The purpose is to increase the return on investment i.e. dividend and increase in net worth of investment. We have also noted that as per the Master License Agreement along with franchises agreement, the assessee is not earning anything on account of royalty and entire royalty is to be passed on to Mc Donald’s Corporation USA and hence, the Assessing Officer could have examined the allowability of such advertisement expenditure borne by the assessee which was otherwise to be borne by the franchises Because the so-called increase in return on investment of the assessee will be in the form of dividend income which is an exempt income and hence any expenditure incurred for earning an exempt income is not allowable u/s 14A of the Income Tax Act, 1961 The Assessing Officer could have examined the allowability of such advertisement expenditure on this basis but this was dot done by him Be that as it may In the present appeal, we have to decide regarding applicability of section 92 with regard to advertisement expenditure partly borne by the assessee which was to be otherwise borne by the franchises In this regard, we are of the considered opinion that section 92 of the Income Tax Act, 1961 is not applicable with regard to advertisement expenditure which has been borne by the assessee as a result of this agreement with Indian franchises and the same has resulted into lesser profit/loss of the assessee and more profit to the franchises and it has no impact on the income of the Mc Donald’s Corporation USA because whether the advertisement expenditure is borne by the assessee or by the franchises, the benefit of Mc Donald’s Corporation USA will remain the same The benefit of Mc Donald’s USA remains unchanged. Mc Donald’s Corporation USA will get the same amount of royalty whether advertisement expenditure is borne by the assessee or by its franchises and hence, it cannot be said that by agreeing to bg Sra part of the advertisement expenditure which was to be borne by the franchises, there is any arrangement between the assessee and a non resident to the effect that there is no profit to the assessee or lesser profit to the assessee.

9. In fact, the Assessing Officer and Ld CIT(A) has applied terms and conditions of service agreement dated 14.1999 to this advertisement expenditure also. In this regard, we find that as per this service agreement dated 14 1999, the assessee was appointed as a service representative to perform on behalf of Mc Donald’s Corporation USA, the services described in this agreement and these types of services are specified in the agreement which does not include advertisement on behalf of Mc Donald’s Corporation USA. Similarly, as per this agreement Mc Donald’s Corporation USA had to pay @110% of authorized expenditure to the assessee and the list of authorized expenditure includes salary, fringe benefits, PF, travel, lodging and entertainment expenses of the employees. In addition to that, the expenses should be reimbursed at the rate of 110% includes lease and occupancy costs and utilities, turnover, transaction and similar taxes (other than income tax) and such direct and indirect cost which are provided as per this agreement. The advertisement expenditure were not incurred for providing those eight services which are part of the service agreement and hence the terms and conditions of this service agreement cannot be applied to advertisement expenditure which were incurred by the assessee as per Master License Agreement, Franchises agreement and Marketing Support Agreement between the assessee and the franchises As per none of these three agreements, advertisement expenditure was to be incurred by Mc Donald’s Corporation, USA and hence it cannot be said that the assessee has incurred more expenditure which were otherwise required to be incurred by Mc Donald’s Corporation USA. In fact, the assessee has borne part of the advertisement expenditure which was to be borne in full by the Indian franchises. Hence, we are of the considered opinion that section 92 is not applicable with regard to the advertisement expenditure. Since, allowability of advertisement expenditure is not an issue before us, we do not go into that aspect of the matter since we have found that section 92 is not applicable with regard to this advertisement expenditure because the same is an arrangement between the assessee and its two Indian franchises, we delete the addition made by the Assessing Officer by invoking provisions of section 92 of the Income Tax Act. 1961.

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