Marketing Intangibles
Marketing activities undertaken by one enterprise not owning the trademark or brand name lead to the creation of marketing intangibles for the legal owner of such trademark or brand name.
Indian enterprises having the right to use the brand name owned by their associated enterprises incurs the advertisement, marketing and promotional expenses (AMP Expenses) to get the benefit in the form of increased sales, higher profit etc. This in turns benefit the legal owner of the brand name i.e. associated enterprises.
Marketing intangibles are created by the efforts of the Indian associated enterprises and such intangibles are identified on the basis of these efforts towards[1]:
- Enhancing the value of the foreign trademark or brand that is unknown to Indian market by incurring very large AMP expenses;
- Creation of brand and product loyalty in the minds of the customers;
- Creation of an efficient supply chain;
- Establishing distributor networks in the country;
- Developing an after sale services and support network in the country;
- Conducting customer and market research; and
- Gathering customer data and establishing customer lists, etc.
In the different countries, marketing intangibles have become a hotly debated topic within the transfer pricing community. The tax payers have experienced aggressive approach by the Transfer Pricing Officer (TPO) where it is alleged that where an enterprise associated with the legal owner of trademark performs marketing or sales functions that benefit the legal owner of the trademark, then such marketer should be appropriately compensated for by the legal owner of such trademark.
The issue of marketing intangibles has been dealt by Organisation for Economic Co-operation and Development (OECD) in its Transfer Pricing Guidelines 2010 (OECD TP Guidelines). In the Para 6.36 of Chapter VI – Special Considerations for Intangible Property of OECD TP Guidelines, the aspect of market intangibles have been raised as follows:
“Difficult transfer pricing problems can arise when marketing activities are undertaken by enterprises that do not own the trademarks or trade names that they are promoting (such as a distributor of branded goods). In such a case, it is necessary to determine how the marketer should be compensated for those activities. The issue is whether the marketer should be compensated as a service provider, i.e. for providing promotional services, or whether there are any cases in which the marketer should share in any additional return attributable to the marketing intangibles.”
US regulations
Benchmarking of the income earned from the intangible property is one the most crucial and challenging issues in the Transfer Pricing (TP), and such aspect has been a focus area for the Indian transfer pricing administration. The issue is particularly relevant to India due to its unique market specific characteristics such as location advantages, market accessibility, large customer base, market premium, spending power of Indian customers etc.1
Direct Selling Expenses should not form part of AMP Expenses
The issue as to whether the direct selling and marketing expenses should form part of AMP expenses has been raised in the various cases and the decision of all the courts have been in consensus that such expenses should no form part of AMP expenses.
The issue of exclusion of direct marketing and selling expenses from the AMP expenses was raised in the case of LG Electronics India Ltd. v. Asstt. CIT [2013] 140 ITD 41/29 taxmann.com 300 (Delhi). The Special Bench held that bench-marking of AMP expenses, being international transaction was permissible under the TP Regulations, but expenses in connection with sales which did not lead to brand promotion could not be brought within the ambit of AMP expenses for determining cost/value of international transaction.
In the case of Stanley Black & Decker India Ltd. [TS-89-ITAT-2016(Bang)-TP], the assessee is engaged in the business of trading of power tool products like drills, grinders, saws, hammers etc. During the AY 2010-11, the assessee had entered into ITs with its AE towards purchase of traded goods and therefore the case was referred to the TPO for the determination of ALP. However, the TPO found that the assessee had incurred huge expenses in the nature of AMP expenses which are as under:
| Particulars | Amount (Rs.) |
| Trade and other discounts on sales | 4,98,72,466 |
| Sales Discount | 1,30,85,199 |
| Warranty expenses | 1,29,27,237 |
| Packing expenses | 30,26,454 |
| Advertisement and Sales Promotion | 58,22,797 |
| Total | 8,47,34,153 |
The TPO found that the average expenditure incurred by 3 comparables under AMP is only 2.44% of sales whereas the taxpayer had incurred 9.81% of sales, therefore the TPO suggested the TP adjustment amounting to Rs. 6,36,08,748/- on account of such excessive AMP expenses.
The assessee filed the objection before the Hon’ble DRP wherein it was contended inter alia that assessee had not incurred AMP expenses on behalf of its AE and also contended that selling expenses such as trade discount, sales discount, warranty expenses and packing expenses cannot be treated as Advertising and Marketing Promotion expenditure. The Hon’ble DRP rejected the contention made by the assessee for excluding the selling expenses owing to the reason that the assessee had failed to furnish specific information or details in respect of the claim.
The assessee moved a petition u/s 154 before the Hon’ble DRP for rectifying the directions issued u/s 144C praying that the assessee had placed on record the full details relating to nature of AMP expenditure before the TPO as well as before the DRP. The Hon’ble DRP held that the assessee had filed full details relating to AMP expenses and directed the AO to exclude such expenses from the AMP expenses in view of the law laid down by the Special Bench in the case of L.G. Electronics India Private Limited v. ACIT [140 ITR 41(SB)].
Aggrieved, the Revenue filed an appeal before the Bangalore ITAT. ITAT noted that the only issue for consideration was whether DRP was justified in assuming jurisdiction u/s 154 in the given facts and circumstances of the case. ITAT noted it was undisputed that assessee filed full details which were considered by AMP expenditure by TPO including sales discount, selling expenditure and warranty expenses. Further, ITAT observed that such details were not considered by DRP at the time of passing the original directions u/s 144C but when this fact was brought to DRP’s notice, DRP modified its directions to exclude those items from AMP expenditure following SB ruling in LG Electronics. Accordingly, ITAT held that “it is a case of non-consideration of material on record which would constitute a mistake apparent from record, as laid down by the Hon’ble Madhya Pradesh High Court in CIT vs. Mithalal Ashok Kumar (158 ITR 755)(MP). Therefore, the DRP was justified in assuming jurisdiction u/s 154 of the Act.”
Special Bench decision was though partially reversed by Delhi High Court vide Sony Ericsson Mobile Communications India (P.) Ltd. v. CIT [2015] 55 taxmann.com 240 (Delhi), however, on this point, it agreed with the decision of Special Bench in the case of LG Electronics India Ltd. v. Asstt. CIT [2013] 140 ITD 41/29 taxmann.com 300 (Delhi). The argument of the Revenue before the High Court on direct marketing expenses were as under:—
“1.Special Bench of the ITAT has decided in the case of LG Electronics India Pvt. Ltd. that selling expenses such as discounts and incentives/pricing adjustments should not be considered as part of AMP expenses. The argument against their inclusion in AMP expenses is that these expenses are nothing but a reduction in the price of product and do not create any marketing intangible.
- The objective of the AMP activities is not to merely advertise the brand to the ultimate customers. It is also to make the brand popular to the dealers who will eventually push the ‘XX’ brand over other brands in the market. Only when a reasonable amount of brand loyalty is built up among the dealers, the entire circle of AMP activities will be complete. The discounts and incentives that the assessing is passing on to the dealers is the tool that it employs to create this brand loyalty among them. Once they are convinced that this company is passing on a greater benefit to them only then will they push the products of this company towards the ultimate customer, over other brands.
- The dealer incentives and other selling expenses form part of the market penetration strategy of the assessee. Incentives given to dealers help the assessee in enhancing the market share of the assessee and create loyalty for the brand of the AE among the dealers. Since, these dealer incentives lead to creation of marketing intangible, the same need to be also considered as part of AMP expenses.
- In this connection, it may be mentioned that normal discounts are factored into the sales that are taken for calculation of the AMP expenses.
- As regards the other selling expenses, over and above the normal discounts, if they are being incurred at the behest of the AE, as part of the market penetration strategy, they will qualify as AMP expenses. These expenses form part of the brand building strategy that is being executed by the Indian subsidiary on behalf of the AE.”
However, the Court observed that the aforesaid argument, when AMP expenses are segregated from the composite transaction including distribution and marketing function, is flawed and has to be rejected. The assessees are engaged in distribution and marketing of consumer goods. Distribution and marketing exercise in case of tangibles requires transfer/sale of goods to third parties, be it sub-distributors or retailers. The said transaction is in the nature of sale of goods for consideration. The marketing or selling expenses like trade discounts, volume discounts, etc. offered to sub-distributors or retailers are not in the nature and character of “brand promotion”. They are not directly or immediately related to “brand building” exercise, but have a live link and direct connect with marketing and increased volume of sales or turnover. The brand building connect is too remote and faint. To include and treat the direct marketing expenses like trade or volume discount or incentive as “brand building” exercise would be contrary to common sense and would be highly exaggerated. These reduce the net profit margin. It would lead to abnormal financial results defying accountancy practices and commercial and business sense. The expenses being in the nature of selling expenses have an immediate connect with price/consideration payable for the goods sold. They are not incurred for publicity or advertisement. Direct marketing and sale related expenses or discounts/concessions would not form part of the AMP expenses.
In the case of Perfetti Van Melle India Private Limited [TS-119-ITAT-2014(DEL)-TP] transfer pricing adjustment in respect of advertising, marketing and promotion (AMP) expenses was made during transfer pricing proceedings for AY 2009-10. The assessee challenged the transfer pricing adjustment before Delhi ITAT. The Assessee also contended that the expenses relating to sales should not be considered within the purview of AMP expenses while computing the marketing intangible adjustment.
ITAT observed that the Special Bench in case of LG Electronics India Pvt. Ltd. Vs. ACIT, [TS-11-ITAT-2013(DEL)-TP] had held that incurring of AMP expenses towards promotion of brand, legally owned by the foreign AE, firstly constitutes a `transaction’ and then an `international transaction’. Further, the contention that no disallowance could be made out of AMP expenses by benchmarking them separately when the overall net profit rate declared by the assessee was higher than other comparable cases was also considered by the Special Bench. Further, Special Bench had in principle upheld the transfer pricing adjustment in relation to such AMP expenses. However, Special Bench upheld the assessee’s contention that the expenses directly connected with sales should be excluded from AMP expenditure. ITAT also noted that out of 22 interveners in LG’s case some were distributors, while others were licensed manufacturers. Special Bench had also laid down 14 parameters to be considered by TPO before reaching to the conclusion about requirement of TP adjustment for AMP expenditure. Therefore, ITAT held, “Thus there is not even a slightest doubt that the special bench order not only applies to a `Manufacturer’, but also extends to a distributor, whether he is a bearing full risk or least risk. Thus, such tests are applicable with full vigor to the extent applicable, to the distributors. There is nothing in the special bench order which restricts its operation only to the `Manufacturers’.” Following Special Bench ruling in LG Electronics, ITAT accepted assessee’s claim for exclusion of selling expenses such as dealers’ commission and sales commission, etc. Observing that there was no detail of expenditure placed on record by assessee, ITAT directed AO/TPO to examine the detail of total AMP expenses and exclude such sales specific expenses in line with the decision of LG Electronics for working out the remaining amount to be considered for proceeding with the AMP expenses under the TP provisions. Thus, ITAT set-aside CIT (A)’s and AO’s order and remitted the matter back to AO/TPO to determine afresh in light of LG Special Bench ruling.
The same issue has been dealt in the case of Ray Ban Sun Optics India Ltd. [TS-122-ITAT-2014(DEL)-TP]. In case of Assessee, transfer pricing adjustment in respect of advertising, marketing and promotion (AMP) expenses was made during transfer pricing proceedings for AY 2009-10. The assessee challenged the transfer pricing adjustment before Delhi ITAT. The Assessee also contended that the expenses relating to sales should not be considered within the purview of AMP expenses while computing the marketing intangible adjustment.
ITAT observed that the Special Bench in case of LG Electronics India Pvt. Ltd. Vs. ACIT, 2013 152 TTJ (Del) (SB) 273 had held that incurring of AMP expenses towards promotion of brand, legally owned by the foreign AE, firstly constitutes a `transaction’ and then an `international transaction’. Further, the contention that no disallowance could be made out of AMP expenses by benchmarking them separately when the overall net profit rate declared by the assessee was higher than other comparable cases was also considered by the Special Bench. Further, Special Bench had in principle upheld the transfer pricing adjustment in relation to such AMP expenses. However, Special Bench upheld the assessee’s contention that the expenses directly connected with sales should be excluded from AMP expenditure. ITAT also noted that out of 22 interveners in LG’s case some were distributors, while others were licensed manufacturers. Special Bench had also laid down 14 parameters to be considered by TPO before reaching to the conclusion about requirement of TP adjustment for AMP expenditure. Therefore, ITAT held, “Thus there is not even a slightest doubt that the special bench order not only applies to a `Manufacturer’, but also extends to a distributor, whether he is a bearing full risk or least risk. Thus, such tests are applicable with full vigor to the extent applicable, to the distributors. There is nothing in the special bench order which restricts its operation only to the `Manufacturers’.” Following Special Bench ruling in LG Electronics, ITAT accepted assessee’s claim for exclusion of selling expenses such as dealers’ commission and sales commission, etc. ITAT set-aside the impugned order and remit the matter to the file of the AO/TPO to decide this issue afresh in confirmity with the Special Bench decision in the case of LG Electronics (Supra).
In the case of Diageo India (P.) Ltd. [2013] 34 taxmann.com 284 (Mumbai – Trib.) also, the Mumbai ITAT held that sales related expenditure should be excluded while determining the cost/value of international transactions, as held by the Special Bench that the expenditure in connection with the sales, which do not lead to brand promotion cannot be brought within the ambit of advertisement, marketing and promotion expenses for determining the cost/value of such transactions with the AE.
In the case of Whirlpool of India Ltd. v. Dy. CIT [2014] 42 taxmann.com 553 (Delhi – Trib.), it is observed by the Delhi ITAT that —
“6. Adverting to the facts of the extant case, we find from pages 250 and 251 of the paper book, being the written submissions dated 14.9.2011 filed before the TPO, that the assessee categorically stated that the sum of Rs. 143.36 crore was in the nature of pricing adjustment passed on to its dealers and distributors as ‘extra trade discount’. It was further explained that: ‘pricing adjustment in a way is a reduction in the sales price as the same have been passed on to the dealers and distributors on effecting the sales’. The TPO did not dispute the nature of `pricing adjustment’ as being discount and incentive given to dealers. This fact is vivid from page 22 of his order wherein he recorded that: `The discount and incentives that the assessee is passing on to the dealers …………… ‘. It shows that the TPO duly accepted the nature of the amount as discount and incentives to the assessee’s dealers and distributors. He proceed to include this amount in the total AMP expenses by holding that it was a tool employed by the assessee to create this brand loyalty among the dealers. Thus it is patent that the nature of the amount of Rs. 143.36 crore is undisputed, as being discount given to dealers on the sales made. Once it is held that a particular amount is discount and is not in the nature of direct advertisement expenses, the same stands expelled from the qualifying amount which undergoes the process of determination of ALP of the AMP expenses. Respectfully following the mandate of the Special Bench verdict in the case of LG Electronics (supra), we order for the exclusion of the amount of ‘Pricing Adjustment’ from the total AMP expenses for the purposes of determination of ALP in respect of AMP expenses.”
Further in the case of Yamaha Motor India Sales (P.) Ltd. [2014] 46 taxmann.com 426 (Delhi-Trib.), the assessee is engaged in the business of trading of two-wheelers and is 100% subsidiary of M/s Yamaha Motor Company Ltd., Japan (YMC). It’s all purchases are from Yamaha Motor India Pvt. Ltd., which is an Indian company. The TP issue is regarding addition of Rs. 22,23,28,349/- made by the AO on account of adjustment of arm’s length price in respect of expenditure incurred by the assessee on advertisement and publicity. During the year under consideration the assessee has incurred a total expenditure of Rs. 49,68,34,848/- on account of sales promotion and a sum of Rs. 65,10,19,077/- on account of advertisement. The assessee contended that out of expenditure in question an amount to the extent of Rs. 44,68,34,848/- was incurred on account of sales promotion by way of discounts and incentives, servicing cost, repairs, etc., therefore, this amount cannot be considered as promotion of brand. The TPO out of the above list, deducted the expenditure only on account of servicing cost, incentive to dealers but did not deduct expenditure on account of discounts and incentives. It was further contented that sale to the extent of 21.68% was in respect of an Indian model of two wheeler i.e. Gladiator only, consequently the expenditure incurred on promotion of this Gladiator model, which was exclusive for India cannot be considered to be for promotion of brand of Yamaha, Japan. The TPO accordingly reduce Rs. 21,58,05,755/- being 21.68% of the total expenditure of Rs. 99,54,13,999/-. Aggrieved by the order of TPO, the assessee filed the objections before the DRP but the DRP, however, rejected all the contention of the appellant and confirmed the order of TPO.
Before the ITAT, Ld. Counsel for the assessee relied on the decision of Special Bench of the ITAT in the case of L.G. Electronics India (P.) Ltd. v. Asstt. CIT [2013] 29 taxmann.com 300/140 ITD 41 (Delhi – Trib.) and pleaded that dealers discount and incentive is not part of the AMP while applying the BLT. This has also been held by the ITAT in the case of Whirlpool of India Ltd. v. Dy. CIT [2014] 42 taxmann.com 553 (Delhi – Trib.) and the same judgment has been followed in the case of Amadeus India (P.) Ltd. v. Addl. CIT [2014] 44 taxmann.com 154 (Delhi – Trib.) by the Delhi Bench of the ITAT. It is pleaded that by excluding the amount paid on account of discount and incentive to dealers, the entire TP adjustment and consequent addition will go out, irrespective of the other issues raised in this appeal.
The ITAT held that “incentive expenditure of Rs. 34,43,94,922/- offered as discount need to be excluded from TP adjustment. By doing so the AMP attributable expenditure comes to Rs. 36,86,11,490/- as against Rs. 45,11,86,056/- which is the amount received from AE, YMC, Japan by way of reimbursement and allowed by the TPO. Expenditure incurred on dealers meet amounting to Rs. 2.07 cannot be held as advertisement expenses.”
Following are some of the other decisions in which it has been decided that the sales discount and sales promotion expenses should be excluded from the AMP expenses:
- Daikin Airconditioning India (P.) Ltd. v. Dy. CIT [2013] 37 taxmann.com 14 (Delhi – Trib.)
- Panasonic Sales & Services India (P.) Ltd. v. Asstt. CIT [2013] 143 ITD 733/34 taxmann.com 276 (Chennai)
- Maruti Suzuki India Ltd. v. Addl. CIT [2013] 38 taxmann.com 33 (Delhi – Trib.)
- Ford India (P.) Ltd. v. Dy. CIT [2013] 34 taxmann.com 50/59 SOT 221 (Chennai)
- Sony India (P.) Ltd. v. Addl. CIT [2013] 35 taxmann.com 586/[2014] 148 ITD 489 (Delhi)
- Reebok India Co. v. Addl. CIT [2013] 35 taxmann.com 578/[2014] 146 ITD 469 (Delhi)
- Haier Appliances India (P.) Ltd. v. Dy. CIT [2013] 35 taxmann.com 203/[2014] 146 ITD 730 (Delhi)
[1] United Nations Practical Manual on Transfer Pricing
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