ITAT ruling on the issue of marketing intangibles

 

In an important ruling in the case of Canon India Private Limited (“Canon India”), the Delhi Divisional Bench of the Income Tax Appellate Tribunal (“Tribunal”) has laid down important principles in relation to Transfer Pricing adjustments relating to the issue of creation of marketing intangibles. In this case, the Tribunal remanded back the matter to the Transfer Pricing Officer (“TPO”) with specific instructions that Advertisement, Marketing and Promotion (‘AMP') expenditure should be benchmarked in light of guidelines laid down by the Special Bench (“SB”) in the case of LG Electronics India Limited vs. ACIT^[1] (“LG India”) and Chandigarh Bench in the case of Glaxo Smithkline Consumer Healthcare Limited vs. ACIT^[2] (“GSK India”). While doing so, the Tribunal has directed the TPO to exclude subsidy [received from associated enterprise (“AE”)], trade discount & volume rebates, commission and cash discount from AMP. This serves as a significant relief to majority of taxpayers facing this issue.

Brief background

For the past few years, Indian Tax Authorities have been alleging that the non-routine marketing efforts of a subsidiary company should be categorized as ‘service’ rendered to their AE and accordingly, should be compensated for the same. Such adjustments have increased tremendously over the years and no jurisprudence existed to deal with this vexed issue. Thus, SB was constituted in the case of LG India that dealt with this issue. Canon India also participated as one of the interveners in addition to several other taxpayers facing similar issue. The SB in its ruling has ruled in favor of Tax Authorities in relation to the legal concept of marketing intangible by stating that excessive AMP expenditure constitutes an international transaction. Simultaneously, SB defined the scope of AMP expenditure by providing specific guidelines to benchmark AMP expenditure.

In view of the aforesaid, Delhi Divisional Bench construed the guidance provided by SB in case of LG India and ruled in favor of Canon India by adjudicating that the amount of subsidy (received from AEs), trade discount & volume rebates, commission and cash discount should be reduced from AMP expenditure while computing the bright line. Further, in context of legal issues the Tribunal has ruled in favor of Tax Authorities, thereby acknowledging the concept of marketing intangibles.

Brief facts of Canon India

· Canon India is primarily engaged in distribution of digital imaging products that include photocopiers, multifunctional peripherals, fax-machines, printers, scanners, digital cameras and multimedia projectors.

· Canon India also receives subsidy from its AE in relation to certain AMP related costs.

· Canon India had benchmarked its international transactions by using Resale Price Method as the most appropriate method with gross profit to sales as profit level indicator.

· During the Transfer Pricing assessment proceedings, the TPO made an adjustment questioning the adequacy of AMP expenditure incurred by Canon India and alleging that it resulted in creation of marketing intangibles. Accordingly, an adjustment was made by the TPO stating that Canon India should have been compensated for provision of services. TPO further added a mark-up.

· Transfer Pricing adjustment made by the TPO was upheld by the Dispute Resolution Panel.

· Aggrieved by the order of Assessing Officer, Canon India filed an appeal with the Tribunal.

Taxpayer’s contentions

Contentions of Canon India are summarized below:

· Canon India pressed upon the legal issues before the Divisional Bench of Tribunal. These issues primarily included arguments relating to the validity of TPO’s jurisdiction, qualification as transaction/ international transaction, use of bright line approach, etc.

· With respect to the composition of AMP expenditure, Canon India argued that expenses directly related to sales such as trade discount & volume rebates, commission/ cash discount and receipt of subsidy from the AE should be excluded while computing AMP expenditure to determine the bright line.

· Further, Canon India while seeking specific directions from the Tribunal argued that the thirteen criteria’s as laid down in the case of LG India by SB should be considered by the TPO while benchmarking the AMP expenditure in light of Canon India’s facts. These criterion include analysis of contractual arrangements, business model, product life cycles, choice of comparables, payment of royalty, etc.

Revenue’s contentions

· Revenue contended that the issue of Transfer Pricing adjustments made on account of AMP expenditure stands covered against Canon India by the decision of SB in the case of LG India and GSK India and the same should be followed.

· Nature of trade discount & volume rebates, commission and cash discount may be set aside and restored back to AO / TPO to verify the nature of such expenditure.

· If subsidy is reduced from the amount of AMP expenditure, Canon India may get double deduction as some part of the subsidy may have been received in respect of trade discounts and incentives provided to dealers, which has to be reduced from AMP expenditure.

Decision of the Tribunal

In view of SB decision in the case of LG India and Chandigarh Bench decision in the case of GSK India, the Delhi Divisional Bench of Tribunal adjudicated as follows:

· The Tribunal decision reaffirms the principles laid down by the majority view of the SB in the case of LG India. While reiterating the principles articulated by the SB, the Tribunal has unequivocally held that TP adjustments in relation to AMP expenditure incurred by the taxpayer for creating the marketing intangible for and on behalf of the foreign AE is permissible.

· Tribunal has allowed exclusion of trade discount & volume rebates, commission and cash discount form AMP expenditure and restricted the scope of AMP expenditure.

· Moreover, exclusion of subsidy (received from its AE) from AMP expenditure has resulted in a move that will benefit large number of subsidiaries functioning in India and receiving special subsidies from their AEs. This will significantly reduce the quantum of expenditure classified as non-routine AMP expenditure.

· Tribunal has restored the matter back to the TPO for computation/ benchmarking of AMP expenditure, after affording a reasonable opportunity.