Volume 6, Issue 2

19th April, 2013

Tax Alert
The Marketing Intangible saga continues to create dilemma for Multinationals in India


Indian subsidiaries incur advertisement, marketing and sales promotion expenses (AMP expenses) in India for marketing and promotion of the products manufactured or imported by them. The revenue authorities are of the view that by incurring disproportionately higher AMP expenses as compared to the other players in the similar industry, the Indian subsidiary is developing / enhancing the foreign intangible / brand. This concept of testing the AMP expenses incurred by the taxpayer with those incurred by the comparable companies is termed as Bright Line Test (‘BLT’). Recently, this matter gained magnitude with the ruling of the Delhi Special Bench (SB) in the case of LG Electronics India where it upheld the view that foreign intangibles are being developed / enhanced by the Indian entity by incurring disproportionately higher AMP which is considered to be a service rendered to the foreign Associated Enterprise (AE). This has turned to be a tool to make hefty transfer pricing adjustments across all the Indian subsidiaries of the foreign MNCs.

This tax alert summarizes a recent ruling by the Chandigarh Bench of the Income-tax Appellate Tribunal (ITAT) in the case of Glaxo Smithkline Consumer Healthcare Ltd. (the taxpayer / Glaxo India) which followed the SB’s ruling.

Facts of the case and the taxpayer’s approach:

  • The taxpayer is engaged in the business of manufacturing and selling of nutritional products under the brands of Horlicks, Boost, Maltova and Viva (Boost, Maltova and Viva being Indian brands owned by the taxpayer). The taxpayer made payment of royalty to its associated enterprise (AE) for the use of the ‘Horlicks’ trademark.
  • During the year under consideration, the taxpayer incurred AMP expenses @ 11.29% of sales amounting to INR 1427.5 Millions.
  • The Revenue selected a few domestic food and confectionery companies as comparables to be used for application of BLT and arrived at an average AMP expense of merely 0.95% to sales.
  • Based on this, the Revenue proposed a transfer pricing adjustment by applying BLT on account of incurring excessive AMP expenses in India (as compared to the proposed comparable companies) and also added a mark-up of 13.04% on these expenses as remuneration for the alleged services provided by the taxpayer for developing and enhancing brands owned by the AE. Aggrieved by the assessment order, the taxpayer took the matter in appeal.

Taxpayer’s contention:

  • The AMP expenses were incurred in India and payment was made to third party vendors in India and therefore this was not an international transaction.
  • The AMP expenses were in the nature of product advertisement and not for brand development/enhancement consequently no benefit was being derived by the AE.
  • The BLT applied by the revenue is not one of the prescribed methods laid down in the transfer pricing regulations in India.
  • For application of BLT, AMP expenses incurred on brands owned by the taxpayer in India should be excluded.
  • While arriving at the compensation for alleged development of brand by the taxpayer, expenses purely in the nature of advertisement only should be considered and other expenses be excluded.

Revenue’s contention:

  • Despite making payment of royalty to AE, the taxpayer incurs heavy AMP expenses (in comparison to comparable companies) in India which leads to development / enhancement of the brands owned by the AE for which AE should compensate the taxpayer.
  • Prior to Finance Act 2012, the definition of international transaction was limited and did not categorically cover development of intangibles. However, pursuant to retrospective amendment made to section 92B (definition of international transaction) and relying on the SB ruling that the taxpayer can, by incurring AMP expenses, be considered to have rendered the services of developing the foreign brands owned by the AE, it was argued that the said transaction falls within the definition of “international transaction”. Based on this, the Revenue contended  that the transfer pricing regulations would apply.

Tribunal’s Ruling:

  • Relying on the SB ruling, the tribunal has ruled in favour of the Revenue that the transaction of rendering services to AE by incurring AMP expenses in India falls within the definition of international transactions pursuant to retrospective amendments made by the Finance Act, 2012.
  • According to the tribunal, BLT is the tool to arrive at the value of the services rendered by the taxpayer to its AE by incurring AMP expenses in India.
  • However, the tribunal has observed that expenses purely in the nature of advertisement should only be considered for applying BLT and other expenses not purely in the nature of advertisement AMP expenses like sales promotion expenses, market research expenses, expenses towards development and scientific research, discounts etc should be excluded.
  • No adjustment is required in respect of the AMP expenses attributed to the promotion of the domestic brands owned by the taxpayer.
  • For the purpose of calculation, the assessee has the liberty to furnish a fresh set of comparable companies before the Transfer Pricing Officer (TPO) and accordingly, the matter was remanded back to the file of TPO for him to rework the amount of the adjustment.

SKP’s Comments:

Transfer Pricing issues relating to marketing intangibles have been one of the most complex issue raised by Indian authorities and have been an area of focus in the past few years. After the precedent set by the SB, other tribunals have started following in the footsteps of the SB. In light of this, the scope for taking legal arguments on this issue has narrowed and therefore factual aspects would be the deciding factor for individual cases. In the present ruling, the tribunal has given due consideration to factual aspects of the case such as exclusion of expenses not in the nature of advertisement, sales promotion expenses, market research expenses, expenses towards development and scientific research, discounts etc. and excluding expenses incurred on Indian brands for the application of BLT. Therefore, a thorough analysis of every item of expense forming part of AMP needs to be carried out to distinguish any case from these recent judicial precedents. When applying / defending the BLT it is important that taxpayers undertake an extensive exercise to better understand the products of the comparables, their life cycle, industry etc. to present a proper set of comparable companies. Additionally, such adjustments may entail compliance issues in the form of reporting and documentation requirements of such transactions for future years and also invite penalties upto 2% of the value of the transaction for non-reporting etc. Affected taxpayers are thus advised to proactively review their current business model and operational strategy to avoid such jolts.