Advertising, Marketing & Promotion Expenses as International Transaction
There are a lot of international transactions which happen between foreign entity and its Indian subsidiary and due to the wave of Globalisation, these transactions are ever increasing and becoming more complex day by day. There are numerous activities which are carried out by the Indian subsidiaries of foreign entities including manufacturing of goods, advertising, marketing, promotion, etc. Deduction for all the expenses incurred for the business is allowed in accordance with Section 37 of the Income Tax Act, 1961 (hereinafter referred as “The IT Act”). While computing the Profits and gains of business or profession for taxation purposes, the expense of ‘advertising, marketing & promotion’ (hereinafter referred as “AMP”) is allowed as deduction in accordance with the above stated section. The dispute in taxation arises when an Indian subsidiary/associated enterprise of a foreign entity spends way too much on AMP i.e., the amount spent by them on AMP is much higher than what is spent by a legally distinct and separate enterprise performing the same or similar functions under the same or similar conditions.
An Intangible asset can be defined as ‘a claim to future benefits that does not have a physical or financial (a stock or a bond) embodiment[1]. It is being regularly argued by the revenue that the excessive amount spent on AMP by the subsidiary leads to an increase in the brand image of the foreign entity which further leads to an increase in the market intangibles such as Goodwill, etc. of the foreign entity. The Revenue argues that the excess AMP spent is an international transaction which must happen at Arm’s Length Price (hereinafter referred as “ALP”). The reason which Revenue states is that if the same expenditure was done by an independent entity for a foreign company, it would have been termed as a service provided to the foreign company and the independent entity would have received some consideration for it. Thus, the Indian subsidiary also needs to be given consideration for the excess AMP spent whose taxation must happen at ALP. There is no provision in the IT Act which provides whether AMP is an international transaction or not. Since there is no provision in the Act, the author is going to explain whether AMP is an international transaction or not with the judicial decisions.
This issue kicked off with the case of Maruti Suzuki India Ltd. vs. Addl. Commissioner of Income Tax TPO[2]. The facts of the case were such that Suzuki Motor Corporation, the foreign company had entered into an agreement with its Indian Associated Enterprise i.e., Maruti Suzuki India Limited wherein the products of Suzuki will be manufactured and sold in India by the Indian counterpart i.e., Maruti. Maruti had to pay a lumpsum consideration to Suzuki which also included royalty. Maruti spent heavily on the AMP expenses. The assessing transfer pricing officer held that Suzuki’s brand image benefitted from the AMP expenses incurred by Maruti thereby increasing the intangibles of Suzuki. That Suzuki should provide consideration to Maruti which is thus an international transaction. The High Court of Delhi reiterated the Bright Line Test which was laid down in the DHL Incorporated and Commissioner[3]. The High Court of Delhi while applying the principle of Bright Line on the facts at hand observed, “But, unless the transfer pricing officer was able to identify suitable comparables, it was not open to him to conclude that the expenses incurred by Maruti on promotion, marketing and advertising of its products were more than what an independent comparable entity would have incurred and, therefore, exceeded the bright line limit”[4] The court propounded the method on how the transfer pricing officer should tax AMP. That the TPO should compare the AMP expenses of independent businesses who are in the same line of business and then come to a conclusion whether the AMP expenses of Maruti are over and above the comparables.
The Bright Line test as laid down in DHL case stated that every license or distributor is expected to spend a certain amount of cost to exploit the items of intangible property to which it is provided. That it is when the investment crosses the bright line of routine expenditure into the realm of non-routine that, economic ownership likely in form of a marketing intangible is created[5].
The Supreme Court overruled the decision of the High Court and directed the TPO to follow the provisions of law and not the ruling of the High Court. The TPO thereafter applied the Bright Line Test for calculation of the ALP in order to determine taxable AMP expenditure.
In LG Electronics India Pvt Ltd. & Ors. vs. Asst. Commissioner of Income Tax, the parent company of LG situated in Korea and its Indian subsidiary entered into an agreement wherein LG Korea would provide technical know how in return for royalty. That the LG India would manufacture and sale the products under the brand name of LG. There were huge AMP expenses incurred by LG India. The deviation from market comparables was huge enough for the TPO to tax it as excessive AMP expenditure. The TPO applied the Bright Line Test and held the excessive AMP expenditure incurred by LG India was for the brand building of LG Korea and thus is a service. Thereafter the matter came up before the Tribunal, where it decided in favour of the TPO by upholding the use of Bright Line Test.
Nowhere in the Maruti case & the LG case, right from the bottom to the Supreme Court, the question whether AMP is even an international transaction arose.
The use of Bright Line Test was quashed in the Sony Ericsson Case[6] by the Delhi High Court. The Court observed that use of Bright Line Test is not prescribed under Indian Transfer Pricing Regulations and thus if used, it is bad in law. The Court further held that for an AMP expense to constitute an international transaction, the Indian Associated Enterprise should only be involved in distribution of goods manufactured outside India. The Court also laid down some guidelines for determining whether the AMP expenses lead to brand building or not.
The question whether AMP is an international transaction or not arose before the Delhi High Court in the case of Maruti Suzuki India Ltd. v. CIT[7]. The Court while relying on the Sony Ericsson judgment, held that the transfer pricing adjustment based on the comparables by applying Bright Line test is not to be undertaken by the Revenue. The Court opined, “An AMP TP adjustment to which none of the substantive or procedural provisions of Chapter X of the Act apply, cannot be held to be permitted by Chapter X. In other words, with neither the substantive nor the machinery provisions of Chapter X of the Act being applicable to an AMP TP adjustment, the inevitable conclusion is that Chapter X as a whole, does not permit such an adjustment.”[8] The court held that the IT Act does not provide for taxation of AMP and doing so means going against the statute. The court further held that the Revenue has to prove how the AMP expense constitute an international transaction and which has to be done without the application of Bright Line Test.
There have been numerous transfer pricing adjustments being made by the TPO using the Bright Line Test despite the Sony Ericsson and Maruti Suzuki (2014) judgments. The Revenue time and again argues that the income is escaping assessment due to non-taxability of AMP expense. However, the ITAT and the High Court have held that AMP expense cannot be assumed as an international transaction as per Section 92B of IT Act and thus has rejected the arguments of Revenue. The assessment for categorizing an AMP expense as international transaction should be made on case-to-case basis. The assessee could also take help of Advance Pricing Arrangements (APAs) to avoid any transfer pricing addition later on. The issue is pending before the Supreme Court. Either the Supreme Court ruling or CBDT Circular on this could lay down the path for future.
[1] Lev Baruch, Intangibles: Management, Measurement And Reporting (Brookings Institution Press 2002), 5.
[2] [2010] 328 ITR 210.
[3] Corporation and Subsidiaries v Comm’r US Court of Appeals [2002].
[4] Supra n2.
[5] Supra n3.
[6] Sony Ericsson Mobile Communications India Pvt Ltd. vs. Commissioner of Income Tax, CIT (2015 374 ITR 118).
[7] (ITA 110/2014).
[8] Ibid.
Author Bio
Hello,
I received the demand notice for AY2020-21 in Nov 2021,
I tried several times to file RECTIFICATION but I was getting
ERROR: ITD-EXEC2003.
Can I file the revised return or belated return now.
Appreciate your kind response.
Rgds,
Anushka