Delhi High Court Ruling: Transfer Pricing – Sec 92 – An important ruling by the Hon’ble High Court wherein it has been held that the methodology to be adopted by the Revenue Authorities for making an adjustment should be equitable and fair, and has ruled on the payment for the use of intangible assets and attributing arm’s length consideration for activities carried out by the licensee, etc. [Maruti Suzuki India Limited – W.P. 6876/2008]
Maruti Suzuki India Limited (‘Petitioner / Maruti’) is engaged in manufacture and sale of automobiles. Maruti is also engaged in trading in spares and components of automotive vehicle. Trademark / Logo ‘M’ was registered in the name of Maruti. Maruti had entered into license agreement with Suzuki Motor Corporation (‘Suzuki’) with prior approval from Government of India for manufacture and sale of certain SH Series of Suzuki four wheel motor vehicles on December 4, 1992. Suzuki held more than 50% of the share capital of Maruti.
According to the license agreement, Suzuki was to provide all technical information whether patented or not, including know-how, trade secrets and other data (including all drawings, prints, machine and material specifications, engineering data and other information, knowledge and advice) to Maruti relating to engineering, design and development, manufacture, quality control, assembly, testing, sale and after-sales service of products and parts by Suzuki to Maruti. Based on the terms and conditions of the agreement, all the products and parts sold by Maruti in India had to bear the trademark of ‘Maruti-Suzuki’ and Maruti was to use the same trademark on containers, packages and wrappings used for and in connection with the sale of such products and parts. Both Maruti and Suzuki had agreed to apply for registration of the trademark ‘Maruti Suzuki’ jointly in India. Further, as per the terms of the agreement no other trademark other than ‘Maruti- Suzuki’ was to be affixed by Maruti on all the products or parts or containers, packages or wrappings for the products and parts manufactured and sold by Maruti. For the consideration and license with respect to SH Series Maruti was required to pay Five Hundred Million Japanese Yen in three installments. Further, Maruti was required to pay a running royalty of 2.5% of the aggregate FOB price of Deleted Portion of CKD Components and a running royalty of 2% of the aggregate sum on the ex-factory price of the Maruti parts shipped by Maruti (whether for sales in India or exports) for the Royalty Calculation Period. An additional running royalty of 0.5% of the aggregate of FOB price of Deleted Portion of CKD Components for exports of parts by Maruti.
Prior to 1993, Maruti was using the ‘Logo M’ on the front of the cars manufactured by it. From 1993 on wards, Maruti started using ‘Logo S’ which is the Logo of Suzuki in the front of the new models and continued to use the Mark ‘Maruti’ along with the word ‘Suzuki’ on the rear of the car manufactured and sold by it.
A reference was made by the Assessing Officer (‘AO’) under section 92CA(1) to the Transfer Pricing Officer (‘TPO’) for the determination of the Arm’s Length Price (‘ALP’) for the international transaction undertaken by Maruti with Suzuki in Financial Year (‘FY’) 2004-05. TPO issued the notice on Maruti in respect of the replacement of the front ‘Logo M’ by ‘Logo S’ in respect of its three models viz. Maruti 800, Maruti Omni and Maruti Esteem. According to the TPO the change of brand logo from ‘Maruti’ to ‘Suzuki’ amounted to sale of the brand ‘Maruti’ to ‘Suzuki’. TPO observed that substantial amount of royalty was by Maruti to Suzuki for no contribution of Suzuki towards brand development and penetration in the Indian market. TPO further noted that Maruti had incurred expenditure amounting to INR 4,092 crores on advertising, marketing and distribution activity, which helped in creation of ‘Maruti’ brand logo and due to which Maruti had become number one car in India. Accordingly computing the value of ‘Maruti’ brand at cost plus 8 % at INR 4,420 crores, TPO issued a show-cause notice as to why the value of ‘Maruti’ brand not be taken at INR 4,420 crores and why the international transaction not be adjusted on the basis of deemed sale to Suzuki.
Maruti in its reply stated that there was no transfer of ‘Maruti’ brand or logo by it. It was also submitted that ‘Maruti’ had a registered trademark which could be transferred only by a written instrument of assignment, to be registered with the Registrar of Trademarks and that no such instrument had been executed by Maruti at any point of time. It was further submitted that it continued to use the trademark / logo ‘Maruti’ in all its advertising, wrappers, letterheads, etc. It was because of the large holding by Suzuki in Maruti and stiff competition from the foreign multinationals that Suzuki had allowed to use the ‘Suzuki’ name as the logo. Further, Suzuki had not charged any additional consideration for the use of such logo on the vehicles manufactured by Maruti.
Jurisdiction of the TPO was challenged by Maruti however, Delhi High Court vide interim order dated 19.9.2008 directed that proceedings pursuant to the show- cause notice may go-on but no effect to order shall be given incase the order is passed by the TPO
Actions of the TPO:
· Issued a detailed questionnaire and clarified that this is a case of transfer of economic value of ‘Maruti’ brand to ‘Suzuki’ brand through replacement of logo fixed on the cars and co-branding of both the trademarks ‘Maruti’ and ‘Suzuki’;
· In the final order passed by the TPO on 30.10.2008, TPO concluded that ‘Suzuki’ trademark which was owned by the Suzuki had piggybacked on ‘Maruti’ trademark without payment of any compensation by Suzuki to Maruti. TPO further concluded that Maruti was a super brand in India whereas Suzuki was relatively weaker brand and that the promotion of the co-brand trademark ‘Maruti-Suzuki’ had resulted in
-Use of Suzuki trademark by Maruti;
-Use of Maruti trademark by Suzuki;
-Reinforcement of ‘Suzuki’ trademark which was a weak brand in the Indian market;
-Impairment of value of ‘Maruti’ trademark due to co-branding process;
· TPO further noted that Maruti had paid royalty of INR 198.6 crores to Suzuki but no compensation was paid by Suzuki on account of its trademark having piggybacked on the trademark of Maruti. TPO apportioned 50 % of the amount of royalty paid to use of the trademark on the basis of findings of piggybacking of ‘Maruti’ trademark, use of ‘Maruti’ trademark as a co-branded trademark ‘Maruti-Suzuki’, impairment of ‘Maruti’ trademark and reinforcement of ‘Suzuki’ trademark. The ALP of the royalty paid by Maruti to Suzuki was determined at ‘Nil’ using CUP Method;
· TPO also held based on the license agreement that Maruti had developed marketing intangibles for Suzuki in India, at its own cost, and Suzuki had not compensated Maruti India for development of such marketing intangibles. Based on the three comparable companies identified by him, he concluded that non-routine advertisement expenditure, amounting to INR 107.22 crores was to be adjusted, thereby making a total adjustment of INR 206.52 crores;
Contention of Petitioner before the Hon’ble High Court:
· The TPO had dropped the idea of making adjustment of Rs. 4,420 crores on account of deemed sale of ‘Maruti’ trademark to Suzuki as was proposed in the show cause notice. TPO never acted upon the show cause notice in making the adjustments to the international transaction;
· Further TPO raised fresh queries regarding the quantum of economic transfer of the economic value embedded in the ‘Maruti’ trademark, and justification for making royalty payment to ‘Suzuki’. TPO also raised the query on reimbursement of the expenditure incurred by Maruti on brand promotion of Suzuki;
Contention of Revenue before the Hon’ble High Court:
· It is evident from the agreement that the responsibility to develop and promote the trademark ‘Maruti’, ‘Maruti-Suzuki’ and ‘Suzuki’ was on Maruti. Maruti had incurred INR 204 crores on advertisement in order to develop a market for vehicles, which included promotion of trademarks ‘Suzuki’ and ‘Maruti Suzuki’ for which no part of the expenditure incurred by Maruti was reimbursed by Suzuki;
· The amount of INR 99.3 crores out of the royalty of INR 198.6 crores paid to Suzuki could be attributed to the use of the co-branded trademark ‘Maruti Suzuki’ and ‘Suzuki’ Since the trademark ‘Suzuki’ was used in the co-branded trademark ‘Maruti-Suzuki’, no royalty could be paid by Maruti to Suzuki for the use of co-branded trademark as ‘Maruti’ is a super brand and ‘Suzuki’ is the weaker brand and that co-branding of both the trademarks had resulted into migration of economic value embedded in ‘Maruti’ trademark to ‘Suzuki’ trademark for which no compensation was received by Maruti;
Observation and decision of the Hon’ble High Court:
· On perusal of the show cause notice, High Court observed that there was no allegation in the notice that the trademark ‘Suzuki’ had piggybacked on the trademark ‘Maruti’. There was no averment in the notice that Maruti had paid royalty amounting to INR 198.6 crores to Suzuki for the license to manufacture and use of the trademark ‘Suzuki’. Further, there is no averment in the notice that Maruti had paid some royalty for the use of co-branded trademark ‘Maruti-Suzuki’ and that there was impairment in the value of trademark or that the use of co-branded trademark resulted in reinforcement of the trademark ‘Suzuki’;
· Upon perusal of the agreement, it is clear that Maruti did not transfer its brand or logo to Suzuki. No right was given to Suzuki to use either the brand or logo of Maruti. It is only Maruti which was given the right to use the brand name or logo on its products. Suzuki even if it wants to, it cannot use the joint trademark ‘Maruti-Suzuki’ on its product, containers packaging, wrapping, etc. Further, the trademark ‘Maruti-Suzuki’ has not been registered with the Registrar of Trademark.
· When the show cause notice issued to Maruti is based solely on the premise that the trademark ‘Maruti’ had been transferred by Maruti to Suzuki and the TPO does not convey, to the noticee, that he had abandoned the show cause notice issued by him and was now proceeding on an altogether different ground for the purpose of making adjustments to its income, seeking additional information, without expressly conveying the grounds for the proposed adjustment, it cannot be said to be an appropriate substitute for the show cause notice, which was otherwise required to be issued to Maruti;
· The purpose of a show cause notice is to enable the assessee to meet the grounds, on which the ALP paid by him was sought to be rejected and adjustment was proposed to be made to its income by the TPO and thus the grounds needed to be conveyed to the assessee in clear, cogent, specific and in an unambiguous manner;
· If such procedure is not followed by the administrative authorities, the Constitution power of the High Court under Article 226 and 227 of the Constitution of India can be invoked to prevent gross injustice;
· The onus is on the assessee to satisfy the AO / TPO that its international transactions are at ALP as computed under section 92 of the Income Tax Act, 1961 (‘Act’);
· The use of intangible assets like trademarks / logo, etc. belonging to a foreign company, by the Indian company, does not envisage any payment for such use, whether such use is obligatory or discretionary, unless there is an agreement between the companies, envisaging such payment;
· In case of controlled transactions, discretionary use of intangible assets of the foreign associated enterprise by the Indian company does not result in any payment due to the foreign company. However, the income arising from such transaction needs to be determined on an arm’s length basis;
· Compulsory usage of the foreign trademark logo by the Indian company, results in the creation of marketing intangibles for the foreign company, and hence the Indian company needs to be compensated at an arm’s length for promoting the foreign brand in India;
· However, such payment for marketing intangibles is fact specific and hence needs to be evaluated considering all the economic parameters of the transaction;
· The expenditure incurred by the Indian company for an associated enterprise on advertising, promotion and marketing of its products using a foreign trademark or logo does not require any payment or compensation by the owner of such trademark or logo in promotion, advertising and marketing undertaken by it, so long as the expenses incurred by the Indian company does not exceed the expenses which a similarly situated comparable independent Indian company would have incurred;
· If the expenditure incurred by an Indian entity for an associated enterprise using a foreign brand trademark and/or logo while advertising, marketing and promoting its products, are more than what a similarly situated and comparable independent Indian company would have incurred, than such foreign entity is required to suitably compensated the Indian entity for the advantage obtained by it in form of brand building;
The ruling brings out the importance of the procedure to be followed by an administrative authority in administering the law equitably and judiciously.
The ruling has also touched upon the important aspects of the use of intangible assets namely trademark and logo. The ruling has tried to discern between normal and excessive advertising and promotional expenditure. It tends to point to the direction that such excessive expenditure results in the creation of marketing intangibles for the foreign company, by promoting the foreign brand in India. This, however, is a nebulous field, as what is brand maintenance expenditure, and expenditure which actually goes to create a brand as it is a highly subjective field. Thus, one hopes that this decision is interpreted in consonance to the facts of the case and is not read so broadly as to paint the complete canvas of all marketing spends, that it always results in creation of marketing intangibles, as marketing intangibles is uncertain of definition.
The Hon’ble High Court observation is not absolutely clear on the transactions between the associated enterprises, for the use of trademark/ logo owned by the foreign entity and is used by Indian entity, when such affixation of trademark/ logo is at the discretion of the Indian entity. Though the Hon’ble High Court observed that no payment is required to be made in respect of the same, however, in the same paragraph, the Hon’ble High Court also states that the income arising from such transaction needs to be determined on an arm’s length basis. We therefore believe that the use of such intangible assets needs to be compensated on the arm’s length basis, even if such use is at the discretion of the Indian entity.